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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED JANUARY 2, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ___________ to ______________
COMMISSION FILE NUMBER: 0-28234
MEXICAN RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 76-0493269
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
1135 EDGEBROOK, HOUSTON, TEXAS 77034-1899
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: 713/943-7574
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant, based on the sale trade price of the Common
Stock as reported by the Nasdaq Small Cap Market on the last business day of the
second quarter ended June 27, 2004 was $9,279,247. For purposes of this
computation, all officers, directors and 10% beneficial owners of the registrant
are deemed to be affiliates. Such determination should not be deemed an
admission that such officers, directors or 10% beneficial owners are, in fact,
affiliates of the Registrant.
Number of shares outstanding of the Registrant's Common Stock, as of March 23,
2005: 3,414,805 shares of common stock, par value $.01.
DOCUMENTS INCORPORATED BY REFERENCE
Specified portions of the Company's definitive proxy statement in connection
with the Annual Meeting of Shareholders to be held May 24, 2005, to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A, are
incorporated by reference into Part III of this report.
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for the Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of 11
Equity Securities
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 17
Item 8. Financial Statements and Supplementary Data 17
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 17
Item 9A. Controls and Procedures 17
PART III
Item 10. Directors and Executive Officers of the Registrant 17
Item 11. Executive Compensation 17
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters 18
Item 13. Certain Relationships and Related Transactions 18
Item 14. Principal Accountant Fees and Services 18
PART IV
Item 15. Exhibits and Financial Statement Schedules 18
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-K under "Business", "Legal
Proceedings". "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere in this report constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 (the "Reform Act"). Such forward-looking statements involve known and
unknown risks, uncertainties and other facts which may cause the actual results,
performance or achievements of Mexican Restaurants, Inc. and its subsidiaries
(the "Company"), its restaurants, area developers and franchisees to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following: general economic and business conditions;
competition; success of operating initiatives; development and operating costs;
advertising and promotional efforts; brand awareness; adverse publicity;
acceptance of new product offerings; availability, locations and terms of sites
for store development; changes in business strategy or development plans;
quality of management; availability, terms and development of capital; business
abilities and judgment of personnel; availability of qualified personnel; food,
labor and employee benefit costs; area developers' adherence to development
schedules; changes in, or the failure to comply with government regulations;
regional weather conditions; construction schedules; and other factors
referenced in the Form 10-K. The use in this Form 10-K of such words as
"believes", "anticipates", "expects", "intends" and similar expressions with
respect to future activities or other future events or conditions are intended
to identify forward-looking statements, but are not the exclusive means of
identifying such statements. The success of the Company is dependent on the
efforts of the Company, its employees, its area developers, and franchisees and
the manner in which they operate and develop stores in light of various factors,
including those set forth above.
Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no assurance that
the forward-looking statements included in this Form 10-K will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company that its objectives or
plans will be achieved.
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PART I
ITEM 1. BUSINESS
GENERAL
Mexican Restaurants, Inc. (the "Company") operates and franchises
Mexican-theme restaurants featuring various elements associated with the casual
dining experience under the names Casa Ole, Monterey's Tex-Mex Cafe, Monterey's
Little Mexico, Tortuga Coastal Cantina, La Senorita and Crazy Jose. The Casa
Ole, Monterey, Tortuga, La Senorita and Crazy Jose concepts have been in
business for 33, 50, 11, 26 and 18 years, respectively. Today the Company
operates 60 restaurants, franchises 19 restaurants and licenses one restaurant
in various communities across Texas, Louisiana, Oklahoma and Michigan. The Casa
Ole, Monterey, La Senorita and Crazy Jose restaurants are designed to appeal to
a broad range of customers, and are located primarily in small and in
medium-sized communities and middle-income areas of larger markets. The Tortuga
Coastal Cantina restaurants also are designed to appeal to a broad range of
customers and are located primarily in Houston suburban markets. The restaurants
offer fresh, quality food, affordable prices, friendly service and comfortable
surroundings. Menus feature a variety of traditional Mexican and Tex-Mex
selections, complemented by the Company's own original Mexican-based recipes,
designed to have broad appeal. The Company believes that the established success
of the Company in existing markets, its focus on middle-income customers, and
the skills of its management team provide significant opportunities to realize
the value inherent in the Mexican restaurant market and increase revenues in
existing markets.
On January 7, 2004, the Company completed its purchase of 13 restaurants
and related assets from its Beaumont-based franchisee for a total consideration
of approximately $13.75 million. The restaurants acquired include 8 Casa Ole
restaurants located in Southeast Texas, 2 Casa Ole restaurants located in
Southwest Louisiana, and 3 Crazy Jose's restaurants located in Southeast Texas.
In the past year these restaurants had combined sales of over $20 million. On
October 14, 2004, the Company completed its purchase of one Casa Ole franchise
restaurant in Brenham, Texas for approximately $215,000. The restaurant was
closed, remodeled and re-opened on November 22, 2004. The Company spent $329,489
remodeling the restaurant.
The Company was incorporated under the name "Casa Ole Restaurants, Inc."
under the laws of the State of Texas in February 1996, and had its initial
public offering in April 1996. On May 24, 1999, the Company changed its
corporate name to Mexican Restaurants, Inc. The Company operates as a holding
company and conducts substantially all of its operations through its
subsidiaries. All references to the Company include the Company and its
subsidiaries, unless otherwise stated.
STRATEGY AND CONCEPT
The Company's objective is to be perceived as a value leader in the
Mexican theme segment of the full-service casual dining marketplace. To
accomplish this objective, the Company has developed strategies designed to
achieve and maintain high levels of customer loyalty, frequent patronage and
profitability. The key strategic elements are:
- Offering consistent, high-quality, original recipe Mexican menu
items that reflect both national and local taste preferences;
- Pricing its menu offerings at levels below many family and
casual-dining restaurant concepts;
- Selecting, training and motivating its employees to enhance customer
dining experiences and the friendly casual atmosphere of its
restaurants;
- Providing customers with the friendly, attentive service typically
associated with more expensive casual-dining experiences; and
- Reinforcing the perceived value of the dining experience with a
comfortable and inviting Mexican decor.
MENU. The Company's restaurants offer high-quality products with a
distinctive, yet mild taste profile with mainstream appeal. Fresh ingredients
are a critical recipe component, and the majority of menu items are prepared
daily in the kitchen of each restaurant from original recipes.
The menus feature a wide variety of entrees including enchiladas,
combination platters, burritos, fajitas, coastal seafood and other house
specialties. The menu also includes soup, salads, appetizers and desserts. From
time to time the Company also introduces new dishes designed to keep the menus
fresh. Alcoholic beverages are served as a complement to meals and represent a
range of less than 5% of sales at its more family-oriented locations, and up to
20% in its more casual dining locations. At Company-owned restaurants the dinner
menu entrees presently range in price from $4.99 to $15.95, with
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most items priced between $5.95 and $9.95. Lunch prices at most Company-owned
restaurants presently range from $4.99 to $8.95.
ATMOSPHERE AND LAYOUT. The Company emphasizes an attractive interior and
exterior design for each of its restaurants. The typical restaurant has an
inviting and interesting Mexican exterior. The interior decor is comfortable
Mexican in appearance to reinforce the perceived value of the dining experience.
Stucco, tile floors, carpets, plants and a variety of paint colors are integral
features of each restaurant's decor. These decor features are incorporated in a
floor plan designed to provide a comfortable atmosphere. The Company's
restaurant designs are sufficiently flexible to accommodate a variety of
available sites and development opportunities, such as malls, end-caps of strip
shopping centers and free standing buildings, including conversions to the
Company's restaurant design. The restaurant facility is also designed to serve a
high volume of customers in a relatively limited period of time. The Company's
restaurants typically range in size from approximately 4,000 to 5,600 square
feet, with an average of approximately 4,500 square feet and a seating capacity
of approximately 180.
GROWTH STRATEGY
The Company believes that the unit economics of the various restaurant
concepts of the Company, as well as their value orientation and focus on middle
income customers, provide significant potential opportunities for growth. The
Company's long-standing strategy to capitalize on these growth opportunities has
been comprised of two key elements:
IMPROVE SAME RESTAURANT SALES AND PROFITS. The Company's first growth
opportunity is to improve the sales and controllable income of existing
restaurants (controllable income consists of restaurant sales less food and
beverage expenses, labor and controllable expenses, such as utilities and repair
and maintenance expenses, but excludes advertising and occupancy expenses). This
is accomplished through an emphasis on restaurant operations, coupled with
improving marketing, purchasing and other organizational efficiencies (see
"Restaurant Operations" below). During fiscal year 2005, the Company expects to
focus on improving sales and profitability so that it can maximize free cash
flow, which it will use to pay off debt, remodel existing restaurants, build new
restaurants, acquire existing franchise restaurants and to make repurchases of
its common stock when it determines such repurchases are a prudent use of its
capital.
INCREASED PENETRATION OF EXISTING MARKETS. The Company's second growth
opportunity is, when it believes market conditions warrant, to increase the
number of restaurants in existing Designated Market Areas ("DMAs") and to expand
into contiguous new markets. The DMA concept is a mapping tool developed by the
A.C. Nielsen Co. that measures the size of a particular market by reference to
communities included within a common television market. The Company's objective
in increasing the density of Company-owned restaurants within existing markets
is to improve operating efficiencies in such markets and to realize improved
overhead absorption. In addition, the Company believes that increasing the
density of restaurants in both Company-owned and franchised markets will assist
it in achieving effective media penetration while maintaining or reducing
advertising costs as a percentage of revenues in the relevant markets. The
Company believes that careful and prudent site selection within existing markets
will avoid cannibalization of the sales bases of existing restaurants.
In implementing its unit expansion strategy, the Company may use a
combination of franchised and Company-owned restaurants. The number of such
restaurants developed in any period will vary. The Company believes that a mix
of franchised and Company-owned restaurants would enable it to realize
accelerated expansion opportunities, while maintaining majority or sole
ownership of a significant number of restaurants. Generally the Company does not
anticipate opening franchised and Company-owned restaurants within the same
market. In seeking franchisees, the Company will continue to primarily target
experienced multi-unit restaurant operators with knowledge of a particular
geographic market and financial resources sufficient to execute the Company's
development strategy.
The restaurant industry is a competitive and fragmented business.
Moreover, the restaurant industry is characterized by a high initial capital
investment. Our focus is not on new restaurant expansion just to generate
additional sales, but a balanced approach that emphasizes same-restaurant sales
growth and selective new restaurant development and acquisitions of existing
franchise restaurants. Consequently, the Company did not build any new
restaurants in fiscal year 2004, but did acquire 13 restaurants and related
assets from its Beaumont-based franchisee on January 7, 2004 and one franchise
restaurant in Brenham, Texas on October 14, 2004. On December 15, 2004, one new
franchise restaurant was opened in Opelousas, Louisiana. The Company plans to
build two new restaurants in fiscal year 2005, as well as significantly remodel
one existing restaurant and moderately remodel five existing restaurants.
Further, the Company anticipates it will continue to selectively acquire
existing franchised restaurants from time to time when such opportunities arise.
In addition, the Company will actively promote the development of new franchise
restaurants (see "Franchising" below).
SITE SELECTION
When developing new restaurant sites, senior management of the Company
devotes significant time and resources to analyzing prospective sites for the
Company's restaurants. Senior management has also created and utilizes a site
selection committee, which reviews and approves each site to be developed. In
addition, the Company conducts customer surveys to define precisely the
demographic profile of the customer base of each of the Company's restaurant
concepts. The Company's site selection criteria focus on:
1) matching the customer profile of the respective restaurant
concept to the profile of the population of the target local
market;
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2) easy site accessibility, adequate parking, and prominent
visibility of each site under consideration;
3) the site's strategic location within the marketplace;
4) the site's proximity to the major concentration of shopping
centers within the market;
5) the site's proximity to a large employment base to support the
lunch segment; and
6) the impact of competition from other restaurants in the
market.
The Company believes that a sufficient number of suitable sites are
available for contemplated Company and franchise development in existing
markets. Based on its current planning and market information, the Company plans
to open two new restaurants in fiscal year 2005. The anticipated total
investment for a 4,200 to 5,600 square foot restaurant, including land,
building, equipment, signage, site work, furniture, fixtures and decor ranges
between $1.4 and $2.1 million (including capitalized lease value). Additionally,
training and other pre-opening costs are anticipated to approximate $50,000 to
$100,000 per location. The cost of developing and operating a Company restaurant
can vary based upon fluctuations in land acquisition and site improvement costs,
construction costs in various markets, the size of the particular restaurant and
other factors. Although the Company anticipates that development costs
associated with near-term restaurants will range between $1.4 and $2.1 million,
there can be no assurance of this. Where possible, the Company uses build to
suit, lease conversion or sale and leaseback transactions in an effort to limit
its cash investment to approximately $550,000 per location.
RESTAURANT OPERATIONS
MANAGEMENT AND EMPLOYEES. The management staff of each restaurant is
responsible for managing the restaurant's operations. Each Company-owned
restaurant operates with a general manager, one or more assistant managers and a
kitchen manager or a chef. Including managers, restaurants have an average of 50
full-time and part-time employees. The Company historically has spent
considerable effort developing its employees, allowing it to promote from
within. As an additional incentive to its restaurant management personnel, the
Company has a bonus plan in which restaurant managers can receive monthly
bonuses based on a percentage of their restaurants' controllable profits.
The Company's regional supervisors, who report directly to the Company's
Directors of Operation, offer support to the store managers. Each supervisor is
eligible for a monthly bonus based on a percentage of controllable profits of
the stores under their control.
As of January 2, 2005, the Company employed approximately 2,711 people, of
whom approximately 2,660 were restaurant personnel at the Company-owned
restaurants and 51 were corporate personnel. The Company considers its employee
relations to be good. Most employees, other than restaurant management and
corporate personnel, are paid on an hourly basis. The Company's employees are
not covered by a collective bargaining agreement.
TRAINING AND QUALITY CONTROL. The Company requires its hourly employees to
participate in a formal training program carried out at the individual
restaurants, with the on-the-job training program varying from three days to two
weeks based upon the applicable position. Managers of both Company-owned and
franchised restaurants are trained at one of the Company's specified training
stores by that store's general manager and are then certified upon completion of
a four to six week program that encompasses all aspects of restaurant operations
as well as personnel management and policy and procedures, with special emphasis
on quality control and customer relations. To evaluate ongoing employee service
and provide rewards to employees, the Company employs a "mystery shopper"
program that consists of two anonymous visits per month per restaurant. The
Company's franchise agreement requires each franchised restaurant to employ a
general manager who has completed the Company's training program at one of the
Company's specified training stores. Compliance with the Company's operational
standards is monitored for both Company-owned and franchised restaurants by
random, on-site visits by corporate management, regular inspections by regional
supervisors, the ongoing direction of a corporate quality control manager and
the mystery shopper program.
MARKETING AND ADVERTISING. The Company believes that when media
penetration is achieved in a particular market, investments in radio and
television advertising can generate significant increases in revenues in a
cost-effective manner. During fiscal 2004, the Company spent approximately 3.0%
of restaurant revenues on various forms of advertising and plans to spend a
comparable amount in fiscal 2005. Besides radio and television, the Company
makes use of in-store promotions, involvement in community activities, and
customer word-of-mouth to maintain their performance.
PURCHASING. The Company strives to obtain consistent quality products at
competitive prices from reliable sources. The Company works with its
distributors and other purveyors to ensure the integrity, quality, price and
availability of the various raw ingredients. The Company researches and tests
various products in an effort to maintain quality and to be responsive to
changing customer tastes. The Company operates a centralized purchasing system
that is utilized by all of the Company-owned restaurants and is available to the
Company's franchisees. Under the Company's franchise agreement, if a franchisee
wishes to purchase from a supplier other than a currently approved supplier, it
must first submit the products and supplier to the Company for approval.
Regardless of the purchase source, all purchases must comply with the Company's
product specifications. The Company's ability to maintain consistent product
quality throughout its operations depends upon acquiring specified food products
and supplies from reliable sources. Management believes that all essential food
and beverage products are available from other qualified sources at competitive
prices.
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FRANCHISING
The Company currently has 11 franchisees operating a total of 19
restaurants and one licensee operating one restaurant. Most franchisees operate
one or two restaurants. In fiscal year 2004, one new franchise restaurant was
opened, one was closed, and fourteen franchise restaurants were sold to the
Company. The Company's largest franchisee, a Beaumont-based franchisee, sold its
10 Casa Ole restaurants (it also sold its 3 Crazy Jose restaurants to the
Company) and related assets to the Company on January 7, 2004, and a Casa Ole
franchisee sold its Brenham, Texas restaurant to the Company on October 14,
2004.
Franchising allows the Company to expand the number of stores and
penetrate markets more quickly and with less capital than developing
Company-owned stores. The Company has the first right of refusal when a
franchisee decides to sell its restaurant(s). Historically, the Company has
selectively acquired franchisee restaurants when reasonably available. At the
same time, the Company plans to expand its base of franchise restaurants.
Consequently, in 2004 the Company updated its Casa Ole and La Senorita Uniform
Franchise Offering Circular ("UFOC") in order to pursue new franchisees.
Franchisees are selected on the basis of various factors, including
business background, experience and financial resources. In seeking new
franchisees, the Company targets experienced multi-unit restaurant operators
with knowledge of a particular geographic market and financial resources
sufficient to execute the Company's development schedule. Under the current
franchise agreement, franchisees are required to operate their stores in
compliance with the Company's policies, standards and specifications, including
matters such as menu items, ingredients, materials, supplies, services,
fixtures, furnishings, decor and signs. In addition, franchisees are required to
purchase, directly from the Company or its authorized agent, spice packages for
use in the preparation of certain menu items, and must purchase certain other
items from approved suppliers unless written consent is received from the
Company.
FRANCHISE AGREEMENTS. The Company enters into a franchise agreement with
each franchisee that grants the franchisee the right to develop a single store
within a specific territory at a site approved by the Company. The franchisee
then has limited exclusive rights within the territory. Under the Company's
current standard franchise agreement, the franchisee is required to pay a
franchise fee of $25,000 per restaurant. The current standard franchise
agreement provides for an initial term of 15 years (with a limited renewal
option) and payment of a royalty of 3% to 5% of gross sales. The termination
dates of the Company's franchise agreements with its existing franchisees
currently range from 2005 to 2015.
Franchise agreements are not assignable without the prior written consent
of the Company. Also, the Company retains rights of first refusal with respect
to any proposed sales by the franchisee. Franchisees are not permitted to
compete with the Company during the term of the franchise agreement and for a
limited time, and in a limited area, after the term of the franchise agreement.
The enforceability and permitted scope of such noncompetition provisions varies
from state to state. The Company has the right to terminate any franchise
agreement for certain specific reasons, including a franchisee's failure to make
payments when due or failure to adhere to the Company's policies and standards.
Many state franchise laws, however, limit the ability of a franchisor to
terminate or refuse to renew a franchise. See "Item 1. Business -- Government
Regulation."
Prior forms of the Company's franchise agreements may contain terms that
vary from those described above, including with respect to the payment or
nonpayment of advertising fees and royalties, the term of the agreement, and
assignability, noncompetition and termination provisions.
FRANCHISEE TRAINING AND SUPPORT. Under the current franchise agreement,
each franchisee (or if the franchisee is a business organization, a manager
designated by the franchisee) is required to personally participate in the
operation of the franchise. Before opening the franchisee's business to the
public, the Company provides training at its approved training facility for each
franchisee's general manager, assistant manager and kitchen manager or chef. The
Company recommends that the franchisee, if the franchisee is other than the
general manager, or if a business organization, its chief operating officer,
attend such training. The Company also provides a training team to assist the
franchisee in opening its restaurant. The team, supervised by the Director of
Training, will assist and advise the franchisee and/or its manager in all phases
of the opening operation for a seven to fourteen day period. The formal training
program required of hourly employees and management, along with continued
oversight by the Company's quality control manager, is designed to promote
consistency of operations.
AREA DEVELOPERS. The area development agreement is an extension of the
standard franchise agreement. The area development agreement provides area
developers with the right to execute more than one franchise agreement in
accordance with a fixed development schedule. Restaurants established under
these agreements must be located in a specific territory in which the area
developer will have limited exclusive rights. Area developers pay an initial
development fee generally equal to the total initial franchise fee for the first
franchise agreement to be executed pursuant to the development schedule plus 10%
of the initial franchise fee for each additional franchise agreement to be
executed pursuant to the development schedule. Generally the initial development
fee is not refundable, but will be applied in the proportions described above to
the initial franchise fee payable for each franchise agreement executed pursuant
to the development schedule. New area developers will pay monthly royalties for
all restaurants established under such franchise agreements on a declining scale
generally ranging from 5% of gross sales for the initial restaurant to 3% of
gross sales for the fourth restaurant and thereafter as additional restaurants
are developed. Area development agreements are not assignable without the prior
written consent of the Company. The Company will retain rights of first refusal
with respect to proposed sales of restaurants by the area developers. Area
developers are not permitted to compete with the Company. As described above,
the enforceability and permitted scope of such noncompetition provisions may
vary from state to state. If an area developer fails to meet its development
schedule obligations, the Company can, among other things, terminate the area
development agreement or
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modify the territory in the agreement. These termination rights may be limited
by applicable state franchise laws. The Company is currently seeking new area
developers. One area developer, a Beaumont-based franchisee, sold its 10 Casa
Ole franchise restaurants and related assets to the Company on January 7, 2004
(the Company also purchased three Crazy Jose restaurants in the same
transaction). The Company currently has two area developers operating a total of
four and three restaurants, respectively.
COMPETITION
The restaurant industry is intensely competitive. Competition is based
upon a number of factors, including concept, price, location, quality and
service. The Company competes against a broad range of other family dining
concepts, including those focusing on various other types of ethnic food, as
well as local restaurants in its various markets. The Company also competes
against other quick service and casual dining concepts within the Mexican and
Tex-Mex food segment. Many of the Company's competitors are well established and
have substantially greater financial and other resources than the Company. Some
of the Company's competitors may be better established in markets where the
Company's restaurants are or may be located. Also, the Company competes for
qualified franchisees with franchisors of other restaurants and various other
concepts.
The success of a particular restaurant concept is also affected by many
other factors, including national, regional or local economic and real estate
conditions, changes in consumer tastes and eating habits, demographic trends,
weather, traffic patterns, and the type, number and location of competing
restaurants. In addition, factors such as inflation, increased food, labor and
benefit costs, and the availability of experienced management and hourly
employees may adversely affect the restaurant industry in general and the
Company's restaurants in particular.
GOVERNMENT REGULATION
Each restaurant is subject to regulation by federal agencies and to
licensing and regulation by state and local health, sanitation, safety, fire and
other departments relating to the development and operation of restaurants.
These include regulations pertaining to the environmental, building and zoning
requirements in the preparation and sale of food. The Company is also subject to
laws governing the service of alcohol and its relationship with employees,
including minimum wage requirements, overtime, working conditions and
immigration requirements. Difficulties or failures in obtaining the required
construction and operating licenses, permits or approvals could delay or prevent
the opening of a specific new restaurant. The Company believes that it is
operating in substantial compliance with applicable laws and regulations that
govern its operations.
Alcoholic beverage control regulations require each of the Company's
restaurants to apply to a state authority and, in certain locations, county or
municipal authorities, for a license or permit to sell alcoholic beverages on
the premises and to provide service for extended hours. Typically, licenses must
be renewed annually and may be revoked or suspended for cause at any time.
Alcoholic beverage control regulations relate to numerous aspects of the
Company's restaurants, including minimum age of patrons drinking alcoholic
beverages and of employees serving alcoholic beverages, hours of operation,
advertising, wholesale purchasing, inventory control and handling, storage and
dispensing of alcoholic beverages. The Company is also subject to "dramshop"
statutes that generally provide a person injured by an intoxicated person may
seek to recover damages from an establishment determined to have wrongfully
served alcoholic beverages to the intoxicated person. The Company carries liquor
liability coverage as part of its existing comprehensive general liability
insurance. Additionally, within thirty days of employment by the Company, each
Texas employee of the Company who serves alcoholic beverages is required to
attend an alcoholic seller training program that has been approved by the Texas
Alcoholic Beverage Commission and endorsed by the Texas Restaurant Association
and that endeavors to educate the server to detect and prevent overservice, as
well as underage service, of the Company's customers.
In connection with the sale of franchises, the Company is subject to the
United States Federal Trade Commission rules and regulations and state laws that
regulate the offer and sale of franchises and business opportunities. The
Company is also subject to laws that regulate certain aspects of such
relationships. The Company has had no claims with respect to its programs and,
based on the nature of any potential compliance issues identified, does not
believe that compliance issues associated with its historic franchising programs
will have a material adverse effect on its results of operations or financial
condition. The Company believes that it is operating in substantial compliance
with applicable laws and regulations that govern franchising programs.
The federal Americans With Disabilities Act prohibits discrimination on
the basis of disability in public accommodations and employment. The Company is
required to comply with the Americans With Disabilities Act and regulations
relating to accommodating the needs of the disabled in connection with the
construction of new facilities and with significant renovations of existing
facilities.
The Company is subject to various local, state and federal laws regulating
the discharge of pollutants into the environment. The Company believes that it
conducts its operations in substantial compliance with applicable environmental
laws and regulations. The Company conducts environmental audits of each proposed
restaurant site in order to determine whether there is any evidence of
contamination prior to purchasing or entering into a lease with respect to such
site. To date the Company's operations have not been materially adversely
affected by the cost of compliance with applicable environmental laws.
TRADEMARKS, SERVICE MARKS AND TRADE DRESS
7
The Company believes its trademarks, service marks and trade dress have
significant value and are important to its marketing efforts. It has registered
the trademarks for "Casa Ole", "Casa Ole Mexican Restaurant", "Monterey's
Tex-Mex Cafe", "Monterey's Little Mexico", "Tortuga Cantina", "La Senorita" and,
as of January 7, 2004, "Crazy Jose" with the U.S. Patent Office.
RISK FACTORS
The Company cautions readers that its business is subject to a number of
risks, any of which could cause the actual results of the Company to differ
materially from those indicated by forward-looking statements made from time to
time in releases, including this Form 10-K, and oral statements. Certain risk
factors are presented throughout this document, including, among others,
business strategy; site selection; attracting and retaining franchisees,
managers and other employees; availability of food products; competition; and
government regulation. Certain other risks to which the Company is subject
include:
SEASONAL FLUCTUATIONS IN SALES AND EARNINGS AFFECT THE COMPANY'S QUARTERLY
RESULTS. The Company's sales and earnings fluctuate seasonally. Historically the
Company's highest sales and earnings have occurred in the second and third
calendar quarters, which the Company believes is typical of the restaurant
industry and consumer spending patterns in general. In addition, quarterly
results have been and, in the future are likely to be, substantially affected by
the timing of new restaurant openings. Because of the seasonality of the
Company's business and the impact of new restaurant openings, results for any
calendar quarter are not necessarily indicative of the results that may be
achieved for a full fiscal year and cannot be used to indicate financial
performance for the entire year.
INFLATION MAY ADVERSELY IMPACT NET INCOME. The Company believes that
inflation impacted net income during fiscal year 2004. Substantial increases in
utility expenses and certain food costs items had a marked impact on the
Company's operating results to the extent such increases could not be passed
along to customers. There can be no assurance that the Company will not
experience the same inflationary impact in the future. If operating expenses
increase, management intends to attempt to recover increased costs by increasing
prices to the extent deemed advisable in light of competitive conditions.
AN INCREASE IN INTEREST RATES MAY ADVERSELY IMPACT NET INCOME. Our
exposure to interest rate fluctuations is limited to our outstanding bank debt
with Bank of America. The interest rate is either the prime rate or LIBOR plus a
stipulated percentage. Accordingly, the Company is impacted by changes in the
prime rate and LIBOR. As of January 2, 2005, the Company had $4.0 million
outstanding on the credit facility with Bank of America. The Company is in full
compliance with all debt covenants as amended. The Company expects to be in
compliance with all debt covenants in fiscal year 2005. As of January 2, 2005,
the Company also had $3.0 million in notes which have a fixed interest rate of
7.0% (See Footnote 3 in the accompanying Consolidated Financial Statements).
THE COMPANY'S SMALL RESTAURANT BASE AND GEOGRAPHIC CONCENTRATION MAKES ITS
OPERATIONS MORE SUSCEPTIBLE TO LOCAL ECONOMIC CONDITIONS. The results achieved
to date by the Company's relatively small restaurant base may not be indicative
of the results of a larger number of restaurants in a more geographically
dispersed area. Because of the Company's relatively small restaurant base, an
unsuccessful new restaurant could have a more significant effect on the
Company's results of operations than would be the case in a company owning more
restaurants. Additionally, given the Company's present geographic concentration
(all Company-owned units are currently in Texas, Oklahoma, Louisiana and
Michigan), results of operations may be adversely affected by economic or other
conditions in the region and any adverse publicity in the region relating to the
Company's restaurants could have a more pronounced adverse effect on the
Company's overall sales than might be the case if the Company's restaurants were
more broadly dispersed.
THE COMPANY'S FINANCIAL COVENANTS COULD ADVERSELY AFFECT THE COMPANY'S
ABILITY TO BORROW. Under the Company's current credit agreement, it is subject
to certain reporting requirements and financial covenants, including
requirements that it maintain minimum levels of net worth and various financial
ratios. Although it is currently in compliance with such financial covenants, an
erosion of the Company's business could place the Company out of compliance in
future periods. Potential remedies for the lender if the Company is not in
compliance include declaring all outstanding amounts immediately payable,
terminating commitments and enforcing any liens; however, in the event of any
future noncompliance the Company may seek a waiver from such lender. See Note 3,
Long-term Debt, of Notes to Consolidated Financial Statements.
THE COMPANY'S MANAGEMENT AND DIRECTORS HOLD A MAJORITY OF THE COMMON
STOCK. Approximately 57.6% of the Common Stock and rights to acquire Common
Stock of the Company are beneficially owned or held by Larry N. Forehand, David
Nierenberg, Michael D. Domec and Louis P. Neeb, directors and/or executive
officers of the Company. As a result, these individuals have substantial control
over matters requiring shareholder approval, including the election of
directors.
COMPETITION MAY ADVERSELY AFFECT THE COMPANY'S OPERATIONS AND FINANCIAL
RESULTS. The restaurant industry is highly competitive with respect to price,
service, restaurant location and food quality, and is often affected by changes
in consumer tastes, economic conditions, population and traffic patterns. The
Company competes within each market against other family dining concepts, as
well as quick service and casual dining concepts, for customers, employees and
franchisees. Several of the Company's competitors operate more restaurants and
have significantly greater financial resources and longer operating histories
than the Company. The Company's inability to successfully compete with the other
restaurants in its
8
markets could prevent it from increasing or sustaining its revenues and
profitability and result in a material adverse effect on its business, financial
condition, results of operations or cash flows.
CHANGES IN GENERAL ECONOMIC AND POLITICAL CONDITIONS AFFECT CONSUMER
SPENDING AND MAY HARM THE COMPANY'S REVENUES AND OPERATING RESULTS. The United
States experienced an economic expansion throughout most of 2004, especially in
Texas where the majority of the Company's restaurants operate. Although the
forecast for 2005 is generally favorable, there remain a few significant
economic developments that could weaken economic conditions. Rising fuel and
energy costs could reduce consumers' level of discretionary spending. A decrease
in discretionary spending could impact the frequency with which the Company's
customers choose to dine out or the amount they spend on meals while dining out,
thereby decreasing the Company's revenues. Additionally, the continued responses
to the terrorist attacks on the United States, possible future terrorist attacks
and the conflict in Iraq and its aftermath may exacerbate current economic
conditions and lead to a weakening in the economy. Adverse economic conditions
and any related decrease in discretionary spending by the Company's customers
could have an adverse effect on the Company's revenues and operating results.
RISING INSURANCE COSTS COULD NEGATIVELY IMPACT PROFITABILITY. The Company
insures itself against a variety of uncertainties. While the cost of certain
insurance coverages increased in 2004, the Company was able to negotiate lower
premium costs for other insurance coverages, and in general, was able to
minimize the overall increase and impact of all total insurance costs to the
Company. Each year the Company renews its insurance coverages. While the Company
is proactive in its efforts to control insurance costs, market forces beyond the
Company's control may thwart the Company's ability to manage these costs. An
increase in premiums could have a negative impact on the Company's profitability
if it is not able to negate the effect of such increases by continuing to
improve its operating efficiencies.
IMPLEMENTING THE COMPANY'S GROWTH STRATEGY MAY STRAIN ITS RESOURCES. The
Company's ability to expand by adding Company-owned and franchised restaurants
will depend on a number of factors, including the availability of suitable
locations, the ability to hire, train and retain an adequate number of
experienced management and hourly employees, the availability of acceptable
lease terms and adequate financing, timely construction of restaurants, the
ability to obtain various government permits and licenses and other factors,
some of which are beyond the control of the Company and its franchisees. The
opening of additional franchised restaurants will depend, in part, upon the
ability of existing and future franchisees to obtain financing or investment
capital adequate to meet their market development obligations. Based on the
Company's experience in attempting to grow outside its existing markets, the
Company has found there can be limited consumer acceptance and that the cost of
such efforts can have a material adverse impact on the Company's financial
results.
SHARES ELIGIBLE FOR FUTURE SALE COULD ADVERSELY IMPACT THE STOCK PRICE.
Sales of substantial amounts of shares in the public market could adversely
affect the market price of the Common Stock. In connection with its 1996 initial
public offering, the Company granted limited registration rights to holders of
warrants granted by the Company and Larry N. Forehand to Louis P. Neeb, Tex-Mex
Partners, L.C. and a former officer of the Company to register the 757,465
underlying shares of Common Stock subject to such warrants in connection with
registrations otherwise undertaken by the Company. Such warrants have an
exercise price of $10.90 per share. If the Company registers these shares and
these shareholders sell a large portion of their holdings on the open market at
one time, the market price of the Common Stock will likely decline. In any
event, the market price of the Common Stock could be subject to significant
fluctuations in response to the Company's operating results and other factors.
LITIGATION COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S BUSINESS.
The Company is from time to time the subject of complaints or litigation from
guests alleging food-borne illness, injury or other food quality, health or
operational concerns. The Company may be adversely affected by publicity
resulting from such allegations, regardless of whether such allegations are
valid or whether it is liable. The Company is also subject to complaints or
allegations from former or prospective employees from time to time. A lawsuit or
claim could result in an adverse decision against the Company that could have a
materially adverse effect on its business.
The Company is subject to state "dramshop" laws and regulations, which
generally provide that a person injured by an intoxicated person may seek to
recover damages from an establishment that wrongfully served alcoholic beverages
to such person. Although the Company carries liquor liability coverage as part
of its existing comprehensive general liability insurance, it may still be
subject to a judgment in excess of its insurance coverage and it may not be able
to obtain or continue to maintain such insurance coverage at reasonable costs,
or at all.
COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC
DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES. Keeping up to date and in
compliance with changing laws, regulations and standards relating to corporate
governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new
SEC regulations and Nasdaq Stock Market rules, has required an increased amount
of management attention and external resources. The Company remains committed to
maintaining high standards of corporate governance and public disclosure. As a
result, the Company intends to invest all reasonably necessary resources to
comply with evolving standards, and this investment may result in increased
general and administrative expenses and a diversion of management time and
attention from revenue-generating activities to compliance activities.
OTHER RISKS, UNKNOWN OR IMMATERIAL TODAY, MAY BECOME KNOWN OR MATERIAL IN
THE FUTURE. The Company has attempted to identify certain material risks
currently affecting it. However, additional risks that the Company does not yet
know of, that are not described herein, or that it currently believes are
immaterial, may occur or become material. These risks could impair the Company's
business operations or adversely affect its results of operations.
9
ITEM 2. PROPERTIES
In fiscal year 2004, the Company's executive offices were located in
approximately 10,015 square feet of office space in Houston, Texas. The offices
are currently leased by the Company from Gillett Properties, Ltd., under a gross
lease (where the landlord pays utilities and property taxes) expiring in
December 2009, with rental payments of $10,500 per month. See "Notes to
Consolidated Financial Statements--Related Party Transactions." The Company
believes that its properties are generally well maintained, in good condition
and adequate for its operations. Further, the Company believes that suitable
additional or replacement space will be available if required.
The Company owns the land and buildings of one restaurant location, and
the building and improvements of two restaurant locations that are situated on
ground leases with the balance of locations being on leased sites. In fiscal
year 2004, the Company sold a previously closed restaurant in Plainview, Texas
for $422,000 in cash. On December 30, 2001 the Company closed three under -
performing leased restaurants and in fiscal year 2002 the Company subleased
those restaurants to other local operators. Real estate leased for Company-owned
restaurants is typically leased under triple net leases that require the Company
to pay real estate taxes and utilities, to maintain insurance with respect to
the premises and in certain cases to pay contingent rent based on sales in
excess of specified amounts. Generally the non-mall locations for the
Company-owned restaurants have initial terms of 10 to 20 years with renewal
options.
RESTAURANT LOCATIONS
At January 2, 2005, the Company had 60 Company-operated restaurants, 19
franchise restaurants and one licensed restaurant. As of such date, the Company
operated and franchised 41 Casa Ole restaurants in the State of Texas and 4 in
the State of Louisiana; operated 4 Monterey's Tex-Mex Cafe restaurants in the
State of Oklahoma; operated and licensed 16 Monterey's Little Mexico restaurants
in the State of Texas; operated 5 Tortuga Coastal Cantina restaurants in the
State of Texas; and also operated and franchised 7 La Senorita restaurants in
the State of Michigan. The Company's portfolio of restaurants is summarized
below:
CASA OLE
Company-operated 28 Leased
Franchisee-operated 17
--
CONCEPT TOTAL 45
==
MONTEREY'S TEX-MEX CAFE
Company-operated 4 Leased
-
CONCEPT TOTAL 4
=
MONTEREY'S LITTLE MEXICO
Company-operated 15 Leased
Licensee-operated 1
--
CONCEPT TOTAL 16
==
TORTUGA COASTAL CANTINA
Company-operated 5 Leased
-
CONCEPT TOTAL 5
=
LA SENORITA
Company-operated 5 Leased
Franchisee-operated 2
-
CONCEPT TOTAL 7
=
CRAZY JOSE'S
Company-operated 3
-
CONCEPT TOTAL 3
=
--
SYSTEM TOTAL 80
==
10
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in litigation relating to claims
arising from its operations in the normal course of business. Management
believes that the ultimate disposition of all uninsured matters resulting from
existing litigation will not have a material adverse effect on the Company's
business or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the shareholders of the Company
during the fourth quarter of the fiscal year ended January 2, 2005.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information. The Company's Common Stock trades on the Nasdaq Small
Cap Market tier of The Nasdaq Stock Market under the symbol "CASA." The
following table sets forth the range of quarterly high and low closing sale
prices of the Company's Common Stock on the Nasdaq Small Cap Market during each
of the Company's fiscal quarters since December 30, 2002.
HIGH LOW
----- ----
FISCAL YEAR 2003:
First Quarter (ended March 30, 2003) .................. 3.68 3.01
Second Quarter (ended June 29, 2003) .................. 3.53 3.01
Third Quarter (ended September 28, 2003) .............. 3.71 3.00
Fourth Quarter (ended December 28, 2003) .............. 4.08 3.32
FISCAL YEAR 2004:
First Quarter (ended March 28, 2004) .................. 4.88 3.65
Second Quarter (ended June 27, 2004) .................. 7.00 5.05
Third Quarter (ended September 26, 2004) .............. 9.25 6.49
Fourth Quarter (ended January 2, 2005) ................ 9.42 7.87
FISCAL YEAR 2005:
First Quarter (as of March 23, 2005) .................. 10.14 8.54
Holders. As of March 23, 2005, the Company estimates that there were
approximately 800 beneficial owners of the Company's Common Stock, represented
by approximately 55 holders of record, and 3,414,805 shares of Common Stock
outstanding.
Issuer Purchases. During its fiscal 2004 fourth quarter, the Company did
not purchase any shares of its Common Stock or other equity securities
registered under the Securities Exchange Act of 1934.
Dividends. Since its 1996 initial public offering, the Company has not
paid cash dividends on its Common Stock. The Company intends to retain earnings
of the Company to support operations, to finance expansion and pay down its debt
and does not intend to pay cash dividends on the Common Stock for the
foreseeable future. The payment of cash dividends in the future will be at the
discretion of the Board of Directors and will depend upon such factors as
earnings levels, capital requirements, the Company's financial condition and
other factors deemed relevant by the Board of Directors. In addition, the
Company's current credit agreement prohibits the payment of any cash dividends.
ITEM 6. SELECTED FINANCIAL DATA
Balance sheet data as of December 31, 2000, December 30, 2001,
December 29, 2002, December 28, 2003 and January 2, 2005 and income statement
data for the fiscal years then ended have been derived from consolidated
financial statements audited by KPMG LLP, Independent Registered Public
Accounting Firm. The selected financial data set forth below should be read in
conjunction with and are qualified by reference to the Consolidated Financial
Statements and the related Notes thereto included in Item 8. hereof and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in Item 7. hereof.
11
FISCAL YEARS
------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
(In thousands, except per share amounts)
INCOME STATEMENT DATA:
Revenues:
Restaurant sales ........................... $ 55,775 $ 56,466 $ 54,009 $ 53,813 $ 77,887
Franchise fees, royalties and other ........ 1,362 1,393 1,286 1,139 753
-------- -------- -------- -------- --------
Total revenues .............. 57,137 57,859 55,295 54,952 78,640
-------- -------- -------- -------- --------
Costs and expenses:
Cost of sales .............................. 15,627 15,549 14,636 14,878 21,904
Restaurant operating expenses .............. 32,001 32,330 30,620 31,011 43,403
General and administrative ................. 5,548 5,457 5,198 5,306 6,587
Depreciation and amortization .............. 1,863 2,121 1,927 2,080 2,239
Impairment and restaurant closure costs .... -- 972 -- 950 701
(Gain) loss on sale of assets .............. -- -- (28) (292) 182
-------- -------- -------- -------- --------
Total costs and expenses .... 55,039 56,429 52,353 53,933 75,016
-------- -------- -------- -------- --------
Operating income (loss) ...................... 2,098 1,430 2,942 1,019 3,624
Other income (expense) ....................... (885) (302) (85) (97) (459)
-------- -------- -------- -------- --------
Income from continuing operations before tax.. $ 1,213 $ 1,128 $ 2,857 $ 922 $ 3,165
Income tax expense (benefit) ................. 427 200 939 314 1,008
-------- -------- -------- -------- --------
Income (loss) from continuing operations ..... 786 928 1,918 608 2,157
Income (loss) from discontinued operations,
net of tax ................................... 81 (79) (214) (1,643) (396)
-------- -------- -------- -------- --------
Net income (loss) ............................ $ 867 $ 849 $ 1,704 $ (1,035) $ 1,761
-------- -------- -------- -------- --------
Basic income per share:
Income from continuing operations ....... $ 0.22 $ 0.26 $ 0.56 $ 0.18 $ 0.64
Loss from discontinued operations ....... 0.02 (0.02) (0.07) (0.49) (0.12)
======== ======== ======== ======== ========
Net income (loss) ....................... $ 0.24 $ 0.24 $ 0.49 $ (0.31) $ 0.52
======== ======== ======== ======== ========
Diluted income per share:
Income from continuing operations ....... $ 0.22 $ 0.26 $ 0.54 $ 0.18 $ 0.59
Loss from discontinued operations ....... 0.02 (0.02) (0.06) (0.49) (0.11)
======== ======== ======== ======== ========
Net income (loss) ....................... $ 0.24 $ 0.24 $ 0.48 $ (0.31) $ 0.48
======== ======== ======== ======== ========
In fiscal 2000 and 2001, the Company's consolidated statements of income
and cash flows included goodwill amortization. With the adoption of SFAS No.
142, no goodwill amortization was recorded for fiscal 2002, 2003 and 2004. The
following table provides a reconciliation of reported net income to adjusted
net income excluding goodwill amortization.
FISCAL YEARS
------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
(In thousands)
Reported net income (loss) ................... $ 867 $ 849 $ 1,704 $ (1,035) $ 1,761
Add back: Goodwill amortization,
(net of tax) ............................... 215 284 -- -- --
-------- -------- -------- -------- --------
Adjusted net income .......................... $ 1,082 $ 1,133 $ 1,704 $ (1,035) $ 1,761
-------- -------- -------- -------- --------
BASIC EARNINGS PER SHARE:
Reported net income (loss) ................... $ 0.24 $ 0.24 $ 0.49 $ (0.31) $ 0.52
Goodwill amortization ........................ .06 .08 -- -- --
-------- -------- -------- -------- --------
Adjusted net income .......................... $ 0.30 $ 0.32 $ 0.49 $ (0.31) $ 0.52
======== ======== ======== ======== ========
DILUTED EARNINGS PER SHARE:
Reported net income (loss) ................... $ 0.24 $ 0.24 $ 0.48 $ (0.31) $ 0.48
Goodwill amortization ........................ .06 .08 -- -- --
-------- -------- -------- -------- --------
Adjusted net income .......................... $ 0.30 $ 0.32 $ 0.48 $ (0.31) $ 0.48
======== ======== ======== ======== ========
AS OF THE END OF FISCAL YEARS
-----------------------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
(In thousands)
BALANCE SHEET DATA:
Working capital (deficit) .................... $ (1,920) $ (3,154) $ (2,736) $ (2,669) $ (1,184)
Total assets ................................. $ 31,509 $ 30,067 $ 28,983 $ 25,861 $ 32,326
Long-term debt, less
Current portion ........................... $ 8,300 $ 5,573 $ 3,400 $ 1,775 $ 6,000
Total stockholders' equity ................... $ 14,889 $ 15,717 $ 16,948 $ 15,954 $ 17,868
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements set forth below under this caption constitute
"forward-looking statements" within the meaning of the Reform Act. See "Special
Note Regarding Forward-Looking Statements" above for additional factors relating
to such
12
statements. The following discussion and analysis should be read in conjunction
with the Company's Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Report. Additional information concerning factors that could
cause results to differ materially from those in the forward-looking statements
is contained under "Item 1. Business-Rick Factors."
GENERAL OVERVIEW
The Company was organized under the laws of the State of Texas on February
16, 1996. Pursuant to the reorganization of the Company in preparation for the
initial public offering, the shareholders of the prior corporations contributed
to the Company all outstanding shares of capital stock of each corporation, and
the Company issued to such shareholders in exchange therefor an aggregate of
2,732,705 shares of its Common Stock. The exchange transaction was completed
April 24, 1996, and, as a result, the corporations became wholly-owned
subsidiaries of the Company, and each shareholder of the Company received a
number of shares of Common Stock in the Company.
The Company operates and franchises Mexican-theme restaurants featuring
various elements associated with the casual dining experience under the names
Casa Ole, Monterey's Tex-Mex Cafe, Monterey's Little Mexico, Tortuga Coastal
Cantina and La Senorita. At January 2, 2005 the Company operated 60 restaurants,
franchised 19 restaurants and licensed one restaurant in various communities in
Texas, Louisiana, Oklahoma and Michigan.
On January 7, 2004, the Company completed its purchase of 13 restaurants
and related assets from its Beaumont-based franchisee for a total consideration
of approximately $13.75 million. The restaurants acquired include 8 Casa Ole
restaurants located in Southeast Texas, 2 Casa Ole restaurants located in
Southwest Louisiana, and 3 Crazy Jose's restaurants located in Southeast Texas.
In the past year these restaurants had combined sales of over $20 million. On
October 14, 2004, the Company completed its purchase of one Casa Ole franchise
restaurant in Brenham, Texas for approximately $215,000. The restaurant was
closed, remodeled and re-opened on November 22, 2004. The Company spent $329,489
remodeling the restaurant.
The Company's primary source of revenues is the sale of food and beverages
at Company-owned restaurants. The Company also derives revenues from franchise
fees, royalties and other franchise-related activities. Franchise fee revenue
from an individual franchise sale is recognized when all services relating to
the sale have been performed and the restaurant has commenced operation. Initial
franchise fees relating to area franchise sales are recognized ratably in
proportion to services that are required to be performed pursuant to the area
franchise or development agreements and proportionately as the restaurants
within the area are opened.
The consolidated statements of income and cash flows for fiscal years
2004, 2003 and 2002 have been adjusted to remove the operations of closed
restaurants, which have been reclassified as discontinued operations.
Consequently, the consolidated statements of income and cash flows for fiscal
years 2003 and 2002 shown in the accompanying consolidated financial statements
have been reclassified to conform to the 2004 presentation. These
reclassifications had no effect on total assets, total liabilities,
stockholders' equity or net income.
FISCAL YEAR
The Company has a 52/53 week fiscal year ending on the Sunday nearest
December 31. References in this Report to fiscal 2002 2003 and 2004 relate to
the periods ended December 29, 2002, December 28, 2003 and January 2, 2005
respectively. Fiscal years 2002 and 2003 presented herein consisted of 52 weeks.
Fiscal year 2004 presented herein consisted of 53 weeks.
RESULTS OF OPERATIONS
FISCAL 2004 COMPARED TO FISCAL 2003 AS ADJUSTED FOR DISCONTINUED OPERATIONS
REVENUES. The Company's revenues for the fiscal year ended January 2, 2005
were up $23.7 million or 43.1% to $78.6 million compared with fiscal year 2003.
Restaurant sales for fiscal year 2004 increased $24.1 million or 44.7% to $77.9
million compared with fiscal year 2003. The increase reflects the January 2004
acquisition of 13 restaurants and related assets from the Company's
Beaumont-based franchisee. The increase also reflects positive same-restaurant
sales. Each quarter in fiscal 2004 had positive same-restaurant sales. For
fiscal 2004, total system same-restaurant sales increased 3.1%, Company-owned
same restaurant sales increased 3.3% and franchise-owned same-restaurant sales
increased 2.6% from fiscal year 2003.
Franchise fees, royalties and other decreased $385,975 or 33.9% to
$753,293, reflecting lost royalty income from the acquisition of the
Beaumont-based franchise restaurants, the acquisition of the Brenham, Texas
franchise restaurant, and the closure of a Houston based franchise restaurant.
COSTS AND EXPENSES. Costs of sales, consisting of food, beverage, liquor,
supplies and paper costs, increased as a percent of restaurant sales 50 basis
points to 28.1% compared with 27.6% in fiscal 2003. The increase reflects higher
cheese and protein commodity prices.
Labor and other related expenses decreased as a percentage of restaurant
sales 20 basis points to 32.8% compared with 33.0% in fiscal 2003. The decrease
in labor as a percentage of restaurant sales reflects labor efficiencies gained
from positive same-restaurant sales.
13
Restaurant operating expenses, which primarily includes rent, property
taxes, utilities, repair and maintenance, liquor taxes, property insurance,
general liability insurance and advertising, decreased as a percentage of
restaurant sales 170 basis points to 22.8% in fiscal year 2004 as compared with
24.5% in fiscal year 2003. Much of the improvement reflects the advertising
efficiency gained with the acquisition of the Beaumont-based restaurants.
Further, the Beaumont-based restaurants have lower occupancy costs and liquor
taxes relative to their sales volumes, which when consolidated brought the
overall percentage of these costs down. And finally, general liability and
property insurance premiums decreased as a percentage of restaurant sales in
fiscal 2004 compared with fiscal 2003.
General and administrative expenses consist of expenses associated with
corporate and administrative functions that support restaurant operations.
General and administrative expenses decreased as a percentage of total sales 130
basis points to 8.4% in fiscal year 2004 as compared with 9.7% in fiscal year
2003. The improvement reflects efficiencies gained with the acquisition of the
Beaumont-based restaurants, offset in part by executive and non-executive bonus
accruals and higher professional and legal expenses.
Depreciation and amortization expenses include the depreciation of fixed
assets and the amortization of intangible assets. Depreciation and amortization
expense decreased as a percentage of restaurant sales 100 basis points to 2.8%
in fiscal year 2004 as compared with 3.8% in fiscal year 2003. Actual
depreciation and amortization expense increased $158,161 in fiscal year 2004
compared with fiscal year 2003. The decrease as a percentage of total sales
reflects the acquisition of the Beaumont-based restaurants, which had a smaller
asset base relative to the restaurant sales added.
During fiscal year 2004, the Company incurred $74,099 in pre-opening
expenses related to the remodel of one existing restaurant and the remodel of
one acquired Casa Ole franchise restaurant. In fiscal year 2003, the Company
spent $95,891 in pre-opening expenses related to the purchase of one franchise
restaurant that the Company remodeled for a new grand opening.
(GAIN) LOSS ON SALE OF ASSETS. During fiscal year 2004, the Company
recorded a loss of $181,693 on the disposition of assets, primarily related to
the remodel of one existing restaurant and the sale of a leasehold interest of
another existing restaurant. During fiscal year 2003, the Company recorded a
gain of $291,777 for insurance proceeds received from fire damage at the Humble,
Texas restaurant location.
OTHER INCOME (EXPENSE). Net expense increased $362,148 to $458,779 in
fiscal year 2004 compared with a net expense of $96,631 in fiscal year 2003.
Interest expense increased $311,082 to $553,371 in fiscal year 2004 compared
with interest expense of $242,289 in fiscal year 2003, reflecting the increase
in outstanding debt incurred for the acquisition of the Beaumont-based
restaurants.
INCOME TAX EXPENSE. The Company's effective tax rate from continuing
operations for fiscal year 2004 was 31.8% as compared to fiscal year 2003 of
34.1%. In fiscal year 2004, the Company had a significantly higher pretax
income compared to fiscal 2003. In both years, the permanent differences were
approximately the same, resulting in a lower effective tax rate in fiscal 2004.
RESTAURANT CLOSURE COSTS AND DISCONTINUED OPERATIONS. In fiscal year 2004,
the Company recorded asset impairment and restaurant closure costs of $868,580.
Of this total, $167,565 of these costs are included in discontinued operations
related to the 2004 closure of three restaurants and the 2003 closure of one
restaurant, located in San Marcos, Texas. Impairment expense of $701,015 in
continuing operations relates primarily to four Tortuga restaurants that will be
re-concepted to one of the Company's other Mexican food concepts. In addition,
two Monterey's restaurants, which were impaired in 2003, incurred a small
impairment in 2004. These two restaurants will either be re-concepted or closed
at the expiration of their operating leases. The circumstances and testing
leading to the impairment in fiscal 2004 are determined in accordance with SFAS
No. 144 which requires that property, plant and equipment be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. During fiscal year 2003, the
Company recorded $2,908,406 related to restaurant closure and asset impairment
costs. Of this total, $1,958,279 of these costs are included in discontinued
operations and $950,127 of these costs are included in continuing operations.
FISCAL 2003 COMPARED TO FISCAL 2002
REVENUES. The Company's revenues for the fiscal year ended December 28,
2003 were down $342,122 or 0.6% to $54,952,456 compared with fiscal year 2002.
Restaurant sales for fiscal year 2003 decreased $195,759 or 0.4% to $53,813,188
compared with fiscal year 2002. The decrease in revenues reflects a decline in
same-restaurant sales, especially in the Houston market, where approximately 51%
of all restaurant sales are generated. For fiscal 2003, total system
same-restaurant sales decreased 2.4%, Company-owned same restaurant sales
decreased 3.6% and franchise-owned same-restaurant sales decreased 0.7%.
Franchise fees, royalties and other decreased 11.4% or $146,363 to
$1,139,268. The decrease reflects the decline in franchise-owned same-restaurant
sales and the sale of one franchise restaurant.
COSTS AND EXPENSES. Costs of sales, consisting of food, beverage, liquor,
supplies and paper costs, increased as a percent of restaurant sales 50 basis
points to 27.6% compared with 27.1% in fiscal 2002. The increase reflects higher
cheese, produce, liquor and paper and supply expenses.
14
Labor and other related expenses increased as a percentage of restaurant
sales 40 basis points to 33.0% compared with 32.6% in fiscal 2002. The increase
in labor as a percentage of restaurant sales reflects the semi-fixed nature of
management costs, worker's compensation and health insurance expenses relative
to declining same-restaurant sales.
Restaurant operating expenses, which primarily includes rent, property
taxes, utilities, repair and maintenance, liquor taxes, property insurance,
general liability insurance and advertising, increased as a percentage of
restaurant sales 40 basis points to 24.5% in fiscal year 2003 as compared with
24.1% in fiscal year 2002. The increase reflects higher utility expenses, higher
insurance premiums, and fixed restaurant expenses relative to declining
same-restaurant sales.
General and administrative expenses consist of expenses associated with
corporate and administrative functions that support restaurant operations.
General and administrative expenses increased as a percentage of total sales 30
basis points to 9.7% in fiscal year 2003 as compared with 9.4% in fiscal year
2002. Actual general and administrative expenses increased $108,335 in fiscal
year 2003 compared with fiscal year 2002. The increase in general and
administrative expenses reflects higher legal, officers and directors insurance
and research and development expenses.
Depreciation and amortization expenses include the depreciation of fixed
assets and the amortization of intangible assets. Depreciation and amortization
expense increased as a percentage of restaurant sales 30 basis points to 3.8% in
fiscal year 2003 as compared with 3.5% in fiscal year 2002. Actual depreciation
and amortization expense increased $153,807 in fiscal year 2003 compared with
fiscal year 2002. The increase, in part, reflects declining same-restaurant
sales. It also reflects the addition of new assets (routine replacements for
kitchen equipment, HVAC, etc. and restaurant remodels).
During fiscal year 2003, the Company incurred $95,891 in pre-opening
expenses related to the purchase of one franchise restaurant that the Company
remodeled for a new grand opening. In fiscal year 2002, the Company spent
$15,837 in pre-opening expenses to re-open a restaurant that had been closed for
six months due to fire damage.
(GAIN) LOSS ON SALE OF ASSETS. During fiscal year 2003, the Company
recorded a gain of $291,778 for insurance proceeds received from fire damage at
the Humble, Texas restaurant location.
OTHER INCOME (EXPENSE). Other income (expensee), net increased $11,524 to
$96,631 in fiscal year 2003 compared with a net expense of $85,107 in fiscal
year 2002. For fiscal 2003, interest expense decreased $128,410 to $242,289 as
debt decreased during fiscal year 2003 from a beginning balance of $4.4 million
to an ending balance of $2.8 million.
INCOME TAX EXPENSE. The Company's effective tax rate from continuing
operations for fiscal year 2003 was 34.1% as compared to fiscal year 2002 of
32.9%. In fiscal year 2003, the Company had a significantly lower pretax income
compared to fiscal 2002. In both years, the permanent differences were
approximately the same, resulting in a lower effective tax rate in fiscal 2002.
DISCONTINUED OPERATIONS AND RESTAURANT CLOSURE COSTS. During fiscal year
2003, the Company recorded $2,908,406 related to restaurant closure and asset
impairment costs. Of this total, $1,958,279 of these costs are included in
discontinued operations and $950,128 of these costs are included in continuing
operations. The discontinued operations loss relates to one restaurant that was
closed in fiscal 2003 and the reclassification of three restaurants that were
closed in fiscal 2004. These costs were determined in accordance with SFAS No.
144 which requires that property, plant and equipment be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. There were no impairments recorded in fiscal
year 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company met fiscal 2004 capital requirements with cash generated by
operations, its credit facility and a seller note. In fiscal 2004, the Company's
operations generated approximately $5.7 million in cash, as compared with $2.4
million in fiscal 2003 and $4.4 million in fiscal 2002. As of January 2, 2005,
the Company had a working capital deficit of approximately $1.2 million,
compared with a working capital deficit of approximately $2.7 million at
December 28, 2003. A working capital deficit is common in the restaurant
industry, since restaurant companies do not typically require a significant
investment in either accounts receivable or inventory.
The Company's principal capital requirements are the funding of routine
capital expenditures, new restaurant development or acquisitions and remodeling
of older units. During fiscal 2004, total cash used for capital requirements was
$9,757,350, of which $6,767,916 was used to acquire the Beaumont-based franchise
restaurants and the Brenham, Texas franchise restaurant. Cash used for capital
expenditures on property, plant and equipment and remodeling was approximately
$3.0 million as compared to approximately $1.8 million for fiscal 2003. The
capital expenditures were for necessary replacement of equipment and leasehold
improvements in various older units. The Company extensively remodeled two
restaurants in fiscal 2004. The Company also sold one previously closed
restaurant property located in Plainview, Texas for a total purchase price of
$442,000, and sold a leasehold interest located in Houston, Texas for a total
purchase price of $250,000, less transaction cost, respectively.
On January 7, 2004, the Company completed its purchase of 13 restaurants
and related assets from its Beaumont-based franchisee for a total consideration
of approximately $13.75 million. The financing for the acquisition was provided
by Bank of America (formerly Fleet National Bank), CNL Franchise Network, LP
("CNL") and the sellers of Beaumont-based franchise
15
restaurants. Bank of America provided $3.1 million of the acquisition by
amending its credit facility with Mexican Restaurants, Inc. Six of the acquired
restaurants were concurrently sold to CNL for $8.325 million in a sale-leaseback
transaction. The sellers accepted $3.0 million in notes from Mexican
Restaurants, Inc. for the balance of the purchase price. The seller notes pay
interest only for five years, with $1.5 million in principal due on January 7,
2009 and $1.5 million in principal amortizing over an additional five years.
On October 14, 2004, the Company completed its purchase of one franchise
restaurant in Brenham, Texas for approximately $215,000. The restaurant was
closed, remodeled and re-opened on November 22, 2004. The Company spent $329,489
remodeling the restaurant.
For fiscal year 2005, the Company plans to develop two new restaurants,
extensively remodel one restaurant and moderately remodel five other
restaurants. The estimated capital needed for fiscal year 2005 for general
corporate purposes, including remodeling and new restaurant expansion, is
approximately $4.1 million.
Over the last several years, the Company's debt was incurred to carry out
acquisitions, to develop new restaurants, and to remodel existing restaurants,
as well as to accommodate other working capital needs. The Company anticipates
that it will use excess cash flow during fiscal year 2005 to pay down debt
approximately $1.0 million.
On January 7, 2004, Bank of America amended its $10.0 million credit
facility to accommodate the acquisition of the Beaumont-based franchise
restaurants. The amended credit facility consists of a $5.0 million term note
that requires quarterly principal payments of $250,000 and matures on December
31, 2008. The credit facility also includes a $5.0 million revolving line of
credit that matures on January 7, 2007. The interest rate is either the prime
rate or LIBOR plus a stipulated percentage. Accordingly, the Company is impacted
by changes in the prime rate and LIBOR. The Company is subject to a non-use fee
of 0.75% on the unused portion of the revolver from the date of the credit
agreement. On January 7, 2004, the Company drew $3.1 million on its facility to
complete the Beaumont-based acquisition. Since January 7, 2004 the Company paid
down $1.85 million of its indebtedness to Bank of America during fiscal year
2004. As of January 2, 2005, the Company had $4.0 million outstanding on the
credit facility and $3.0 million in notes for a total indebtedness of $7.0
million. The Company is in full compliance with all debt covenants as amended.
The Company expects to be in compliance with all debt covenants in fiscal year
2005.
The Company's management believes that with its operating cash flow and
the Company's revolving line of credit with Bank of America, funds will be
sufficient to meet operating requirements and to finance routine capital
expenditures and new restaurant growth through the end of the 2005 fiscal year.
Unless the Company violates an important debt covenant, the Company's credit
facility with Bank of America is not subject to triggering events that would
cause the credit facility to become due sooner than the maturity dates described
in the previous paragraphs.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS.
The following table summarizes the Company's total contractual cash obligations
as of January 2, 2005 (in thousands);
LESS THAN 1 TO 3 4 TO 5 AFTER 5
CONTRACTUAL OBLIGATION TOTAL 1 YEAR YEARS YEARS YEARS
- ---------------------------------- ------------ ------------ ----------- ------------ ------------
Long-Term Debt $ 7,000,000 $ 1,000,000 $ 2,000,000 $ 2,775,000 $ 1,225,000
Long-Term Debt fixed interest 1,106,875 210,000 420,000 305,375 171,500
Operating Leases 54,636,453 5,227,699 10,246,559 9,377,726 29,784,469
------------ ------------ ----------- ------------ ------------
Total Contractual Cash Obligations $ 62,743,328 $ 6,437,699 $12,666,559 $ 12,458,101 $ 31,180,969
============ ============ =========== ============ ============
The contractual obligation table does not include interest payments on our
long-term debt with Bank of America (formerly Fleet National Bank) due to the
variable interest rates under our credit facility and the varying debt balance
during the year. The contractual interest rate for our credit facility is either
the prime rate or LIBOR base rate plus a stipulated margin. See Note 3 to our
consolidated financial statements for balances and terms of our credit facility
at January 2, 2005.
RELATED PARTIES. In May 1998 the Board of Directors of the Company adopted
a program to assist executives and five key employees of the Company in their
purchasing of shares of the Company. As adopted, the program provided
for the Company to assist the executives and key employees in obtaining third
party loans to finance such purchases. As of February 1, 2003, the maturity date
of the employee third party loans, the Company no longer guarantees employee
third party loans.
16
The Company provides accounting and administrative services for the Casa
Ole Media and Production Funds. The Casa Ole Media and Production Funds are
not-for-profit, unconsolidated entities used to collect money from company -
owned and franchise-owned restaurants to pay for the marketing of Casa Ole
restaurants. Each restaurant contributes an agreed upon percentage of its sales
to the funds.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have or participate in transactions involving
derivative, financial and commodity instruments. The Company's long-term debt
bears interest at floating market rates. Based on amounts outstanding at year-
end, a 1% change in interest rates would change interest expense by
approximately $40,000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data are set forth herein
commencing on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Company maintains disclosure controls and procedures, which it has
designed to ensure that material information related to the Company, including
its consolidated subsidiaries, is made known to a group comprised of designated
members of the Company's senior management and/or the certifying officer (i.e.,
Chief Executive Officer and Chief Financial Officer) (collectively, the
"Disclosure Committee"), on a timely basis. In response to recent legislation
and proposed regulations, the Company reviewed its internal control structure
and its disclosure controls and procedures. Although the Company believes its
pre-existing disclosure controls and procedures were adequate to enable the
Company to comply with its disclosure obligations, as a result of such review,
the Company implemented minor changes, primarily to formalize and document the
procedures already in place. As of the end of the period covered by this report,
the Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Securities Exchange Act of 1934, as amended, Rule 13a-15 and 15d-15.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company (including its consolidated subsidiaries) required to be included in the
Company's periodic filings with the Securities and Exchange Commission.
(b) Changes in internal controls
There were no significant changes in the Company's internal controls or in
other factors, including any corrective actions with regard to significant
deficiencies and material weaknesses, that could significantly affect these
controls subsequent to the date of their evaluation.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by this Item 10 is incorporated herein by
reference to the Company's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than 120
days after the end of the fiscal year covered by this report.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item 11 is incorporated herein by
reference to the Company's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than 120
days after the end of the fiscal year covered by this report.
17
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER MATTERS
The information called for by this Item 12 is incorporated herein by
reference to the Company's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than 120
days after the end of the fiscal year covered by this report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item 13 is incorporated herein by
reference to the Company's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than 120
days after the end of the fiscal year covered by this report.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by this Item 14 is incorporated herein by
reference to the Company's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than 120
days after the end of the fiscal year covered by this report.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Report:
1. Financial Statements:
The Financial Statements are listed in the index to
Consolidated Financial Statements on page F-1 of this Report.
2. The following exhibits are filed as part of this report. The
exhibits designated with a cross are management contracts and
compensatory plans and arrangements required to be filed as
exhibits to this report.
3. Exhibits:
3.1 Articles of Incorporation of the Company (as amended and
incorporated by reference to the corresponding Exhibit
number of the Company's Form 8-K filed on May 25, 1999
with the Securities and Exchange Commission).
++3.2 Bylaws of the Company.
++4.1 Specimen of Certificate of Common Stock of the Company.
++4.2 Articles of Incorporation of the Company (see 3.1
above).
++4.3 Bylaws of the Company (see 3.2 above).
++10.1 Employment Agreement by and between the Company and
Louis P. Neeb dated February 28, 1996.
10.2 Indemnity Agreement by and between the Company and Louis
P. Neeb dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.4 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.3 Indemnity Agreement by and between the Company and Larry
N. Forehand dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.5 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.4 Indemnity Agreement by and between the Company and John
C. Textor dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.6 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.5 Indemnity Agreement by and between the Company and
Michael D. Domec dated as of April 10, 1996
(incorporated by reference to Exhibit 10.8 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
18
10.6 Indemnity Agreement by and between the Company and J.J.
Fitzsimmons dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.10 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.7 Indemnity Agreement by and between the Company and
Richard E. Rivera dated as of April 10, 1996
(incorporated by reference to Exhibit 10.11 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.8 Corrected Warrant Agreement by and between the Company
and Louis P. Neeb dated as of February 26, 1996
(incorporated by reference to Exhibit 10.12 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.9 Corrected Warrant Agreement by and between the Company
and Tex-Mex Partners, L.C. dated as of February 26, 1996
(incorporated by reference to Exhibit 10.13 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.10 Form of the Company's Multi-Unit Development Agreement
(incorporated by reference to Exhibit 10.14 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.11 Form of the Company's Franchise Agreement (incorporated
by reference to Exhibit 10.15 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
+10.12 1996 Long Term Incentive Plan (incorporated by
reference to Exhibit 10.16 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
+10.13 Stock Option Plan for Non-Employee Directors
(incorporated by reference to Exhibit 10.17 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.14 Corrected Warrant Agreement by and between Larry N.
Forehand and Louis P. Neeb dated as of February 26, 1996
(incorporated by reference to Exhibit 10.31 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.15 Corrected Warrant Agreement by and between Larry N.
Forehand and Tex-Mex Partners, L.C. dated as of February
26, 1996 (incorporated by reference to Exhibit 10.32 of
the Company's Form S-1 Registration Statement filed
under the Securities Act of 1933, dated April 24, 1996,
with the Securities and Exchange Commission
(Registration Number 333-1678)).
10.16 Corrected Warrant Agreement by and between Larry N.
Forehand and Patrick A. Morris dated as of February 26,
1996 (incorporated by reference to Exhibit 10.33 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.17 Corrected Warrant Agreement by and between Larry N.
Forehand and Stacy M. Riffe dated as of February 26,
1996 (incorporated by reference to Exhibit 10.34 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.18 Indemnification letter agreement by Larry N. Forehand
dated April 10, 1996 (incorporated by reference to
Exhibit 10.35 of the Company's Form S-1 Registration
Statement filed under the Securities Act of 1933, dated
April 24, 1996, with the Securities and Exchange
Commission (Registration Number 333-1678)).
+10.19 1996 Manager's Stock Option Plan (incorporated by
reference to Exhibit 99.2 of the Company's Form S-8
Registration Statement Under the Securities Act of 1933,
dated February 24, 1997, filed with the Securities and
Exchange Commission).
+10.20 Employment Agreement by and between the Company and
Curt Glowacki dated May 15, 1997 (incorporated by
reference to Exhibit 10.44 of the Company's Form 10-K
Annual Report filed on March 30, 1998 with the
Securities and Exchange Commission).
19
+10.21 Employment Agreement by and between the Company and
Andrew J. Dennard dated May 20, 1997 (incorporated by
reference to Exhibit 10.45 of the Company's Form 10-K
Annual Report filed on March 30, 1998 with the
Securities and Exchange Commission).
*10.22 Fleet Revolving Credit and Term Loan Agreement between
Mexican Restaurants, Inc., as the Borrower, and Fleet
National Bank, as the Bank, for $10,000,000 dated June
29, 2001 and as amended on January 7, 2004.
21.1 List of subsidiaries of the Company (incorporated by
reference to Exhibit 22.1 of the Company's Form S-1
Registration Statement Under the Securities Act of 1933,
dated April 24,1996, filed by the Company with the
Securities and Exchange Commission).
*23.1 Consent of KPMG LLP, Independent Registered Public Accounting Firm.
*24.1 Power of Attorney (included on the signature page to
this Form 10-K).
*31.1 Certification filed pursuant to Rule 13a-14(a) or Rule 15d-14(a).
*31.2 Certification filed pursuant to Rule 13a-14(a) or Rule 15d-14(a).
#32.1 Certification of Chief Executive Officer furnished
pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
#32.2 Certification of Chief Financial Officer furnished
pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
- -----------
* Filed herewith.
++ Incorporated by reference to corresponding Exhibit number of the Company's
Form S-1 Registration Statement under the Securities Act of 1933, dated
April 24, 1996, with the Securities and Exchange Commission (Registration
number 333-1678).
+ Management contract or compensatory plan or arrangement.
# Furnished herewith.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on April 5, 2005.
MEXICAN RESTAURANTS, INC.
By:/s/ Louis P. Neeb
-------------------------------------
Louis P. Neeb,
Chairman of the Board of Directors
POWER OF ATTORNEY
KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Louis P. Neeb, Curt Glowacki and Andrew
Dennard, and each of them, such individual's true and lawful attorneys-in-fact
and agents, with full power of substitution and resubstitution, for such
individual and in his or her name, place and stead, in any and all capacities,
to sign any and all amendments to this Form 10-K under the Securities Exchange
Act of 1934, and to file the same, with all exhibits thereto, and all documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises as fully to all intents and purposes as he
or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents, or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Louis P. Neeb Chairman of the Board of
- --------------------------- Directors April 5, 2005
Louis P. Neeb
/s/ Larry N. Forehand Founder and Vice Chairman of the
- --------------------------- Board of Directors April 5, 2005
Larry N. Forehand
/s/ Curt Glowacki President and
- --------------------------- Chief Executive Officer April 5, 2005
Curt Glowacki (Principal Executive Officer)
/s/ Andrew J. Dennard Vice President and
- --------------------------- Chief Financial Officer
Andrew J. Dennard (Principal Financial and Accounting Officer) April 5, 2005
/s/ David Nierenberg Director April 5, 2005
- ---------------------------
David Nierenberg
/s/ Michael D. Domec Director April 5, 2005
- ---------------------------
Michael D. Domec
/s/ J. J. Fitzsimmons Director April 5, 2005
- ---------------------------
J. J. Fitzsimmons
/s/ Thomas E. Martin Director April 5, 2005
- ---------------------------
Thomas E. Martin
/s/ J. Stuart Sargent Director April 5, 2005
- ---------------------------
J. Stuart Sargent
21
MEXICAN RESTAURANTS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Registered Public Accounting Firm ........................................................ F-2
Consolidated Balance Sheets as of December 28, 2003 and January 2, 2005......................................... F-3
Consolidated Statements of Income for each of the years in the three fiscal-year
period ended January 2, 2005.................................................................................. F-4
Consolidated Statements of Stockholders' Equity for each of the years in
the three fiscal-year period ended January 2, 2005............................................................ F-5
Consolidated Statements of Cash Flows for each of the years in the three
fiscal-year period ended January 2, 2005...................................................................... F-6
Notes to Consolidated Financial Statements...................................................................... F-7
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Mexican Restaurants, Inc.:
We have audited the accompanying consolidated balance sheets of Mexican
Restaurants, Inc. and subsidiaries as of December 28, 2003 and January 2, 2005,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the years in the three-year period ended January 2, 2005.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mexican
Restaurants, Inc. and subsidiaries as of December 28, 2003, and January 2, 2005,
and the results of their operations and their cash flows for each of the years
in the three-year period ended January 2, 2005, in conformity with U.S.
generally accepted accounting principles.
KPMG LLP
Houston, Texas
March 28, 2005
F-2
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 28, 2003 AND JANUARY 2, 2005
FISCAL YEARS
2003 2004
---- ----
ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 366,042 $ 1,293,836
Royalties receivable ................................................ 179,517 85,377
Other receivables ................................................... 423,670 701,413
Inventory ........................................................... 555,064 658,687
Taxes receivable .................................................... 345,006 573,840
Prepaid expenses and other current assets ........................... 717,899 1,007,928
------------ ------------
Total current assets ......................................... 2,587,198 4,321,081
------------ ------------
Property, plant and equipment ......................................... 24,484,571 28,929,887
Less accumulated depreciation ....................................... (11,502,668) (13,464,153)
------------ ------------
Net property, plant and equipment ............................ 12,981,903 15,465,734
Goodwill, net ......................................................... 7,196,265 10,644,690
Deferred tax assets ................................................... 1,272,173 619,087
Property held for resale .............................................. 884,118 505,118
Other assets .......................................................... 939,579 770,476
------------ ------------
$ 25,861,236 $ 32,326,186
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt ................................ $ 1,000,000 $ 1,000,000
Accounts payable ...................................................... 1,516,217 1,623,859
Accrued sales and liquor taxes ........................................ 469,817 740,898
Accrued payroll and taxes ............................................. 976,146 1,043,182
Accrued expenses ...................................................... 1,294,486 1,097,640
------------ ------------
Total current liabilities .................................... 5,256,666 5,505,579
------------ ------------
Long-term debt ........................................................ 1,775,000 6,000,000
Other liabilities ..................................................... 898,115 1,183,426
Deferred gain ......................................................... 1,977,355 1,769,212
Stockholders' equity:
Preferred stock, $.01 par value,
1,000,000 shares authorized, none issued .......................... -- --
Capital stock, $0.01 par value, 20,000,000 shares
authorized, 4,732,705 shares issued ............................... 47,327 47,327
Additional paid-in capital .......................................... 20,121,076 20,121,076
Retained earnings ................................................... 7,542,817 9,303,791
Deferred Compensation ............................................... (47,607) (6,303)
Treasury stock, cost of 1,348,100 common shares in 2003 and 1,317,900
common shares in 2004 ............................................. (11,709,513) (11,597,922)
------------ ------------
Total stockholders' equity ................................... 15,954,100 17,867,969
------------ ------------
$ 25,861,236 $ 32,326,186
============ ============
See accompanying notes to consolidated financial statements.
F-3
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE FISCAL YEARS ENDED DECEMBER 29, 2002,
DECEMBER 28, 2003 AND JANUARY 2, 2005
FISCAL YEARS
2002 2003 2004
---- ---- ----
Revenues:
Restaurant sales $ 54,008,947 $ 53,813,188 $ 77,886,842
Franchise fees, royalties and other 1,285,631 1,139,268 753,293
------------ ------------ ------------
55,294,578 54,952,456 78,640,135
------------ ------------ ------------
Costs and expenses:
Cost of sales 14,635,503 14,877,654 21,904,257
Labor 17,595,664 17,752,949 25,575,058
Restaurant operating expenses 13,008,752 13,162,033 17,754,244
General and administrative 5,197,876 5,306,211 6,586,807
Depreciation and amortization 1,926,711 2,080,518 2,238,679
Pre-opening costs 15,837 95,891 74,099
Impairments and restaurant closure costs -- 950,128 701,015
(Gain) loss on sale of assets (27,727) (291,778) 181,693
------------ ------------ ------------
52,352,616 53,933,606 75,015,852
Operating income 2,941,962 1,018,850 3,624,283
------------ ------------ ------------
Other income (expense):
Interest income 113,128 28,736 9,711
Interest expense (370,699) (242,289) (553,371)
Other, net 172,464 116,922 84,881
------------ ------------ ------------
(85,107) (96,631) (458,779)
------------ ------------ ------------
Income from continuing operations before income taxes 2,856,855 922,219 3,165,504
Income tax expense 939,177 314,195 1,007,966
------------ ------------ ------------
Income from continuing operations 1,917,678 608,024 2,157,538
Discontinued Operations:
Loss from discontinued operations (356,730) (638,328) (255,246)
Impairments and restaurant closure costs -- (1,958,279) (167,565)
Loss on sale of assets -- (27,882) (210,816)
------------ ------------ ------------
Loss from discontinued operations before income taxes (356,730) (2,624,489) (633,627)
Income tax benefit 142,980 981,557 237,063
============ ============ ============
Net loss from discontinued operations (213,750) (1,642,932) (396,564)
============ ============ ============
Net Income (loss) $ 1,703,928 $ (1,034,908) $ 1,760,974
============ ============ ============
Basic income per share:
Income from continuing operations 0.56 0.18 0.64
Loss from discontinued operations (0.07) (0.49) (0.12)
------------ ------------ ------------
Net income (loss) $ 0.49 $ (0.31) $ 0.52
============ ============ ============
Diluted income per share:
Income from continuing operations 0.54 0.18 0.59
Loss from discontinued operations (0.06) (0.49) (0.11)
============ ============ ============
Net income (loss) $ 0.48 $ (0.31) $ 0.48
============ ============ ============
Weighted average number of shares (basic) 3,447,957 3,384,605 3,388,489
============ ============ ============
Weighted average number of shares (diluted) 3,520,769 3,430,380 3,634,849
============ ============ ============
See accompanying notes to consolidated financial statements.
F-4
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED
DECEMBER 29, 2002, DECEMBER 28, 2003
AND JANUARY, 2 2005
ADDITIONAL TOTAL
CAPITAL PAID-IN RETAINED TREASURY DEFERRED STOCKHOLDERS'
STOCK CAPITAL EARNINGS STOCK COMPENSATION EQUITY
-------- ----------- ---------- ------------ ------------ -------------
Balances at December 30, 2001 $47,327 $20,121,076 $6,873,797 $(11,194,772) $ (130,215) $ 15,717,213
Net income -- -- 1,703,928 -- -- 1,703,928
Repurchase of shares -- -- -- (514,741) -- (514,741)
Amortization of Deferred Compensation -- -- -- -- 41,304 41,304
------- ----------- ---------- ------------ ---------- -------------
Balances at December 29, 2002 $47,327 $20,121,076 $8,577,725 $(11,709,513) $ (88,911) $ 16,947,704
======= =========== ========== ============ ========== =============
Net income -- -- (1,034,908) -- -- (1,034,908)
Repurchase of shares -- -- -- -- -- --
Amortization of Deferred Compensation -- -- -- -- 41,304 41,304
------- ----------- ---------- ------------ ---------- -------------
Balances at December 28, 2003 $47,327 $20,121,076 $7,542,817 $(11,709,513) $ (47,607) $ 15,954,100
======= =========== ========== ============ ========== =============
Net income -- -- 1,760,974 -- -- 1,760,974
Issuance of Treasury Stock -- -- -- 111,591 -- 111,591
Amortization of Deferred Compensation -- -- -- -- 41,304 41,304
------- ----------- ---------- ------------ ---------- -------------
Balances at January 2, 2005 $47,327 $20,121,076 $9,303,791 $(11,597,922) $ (6,303) $ 17,867,969
======= =========== ========== ============ ========== =============
See accompanying notes to consolidated financial statements.
F-5
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED DECEMBER 29, 2002,
DECEMBER 28, 2003, AND JANUARY 2, 2005
FISCAL YEARS
2002 2003 2004
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income from continuing operations ............................... $ 1,917,678 $ 608,024 $ 2,157,538
Adjustments to reconcile net income to net cash provided by
operating activities ................................................
Depreciation and amortization ................................... 1,926,711 2,080,518 2,238,679
Deferred gain amortization ...................................... (208,141) (208,143) (208,143)
Asset impairments and restaurant closure costs .................. -- 950,128 701,015
Impairment of Notes Receivable .................................. -- 196,109 --
Gain on sale of fixed assets .................................... (27,727) (9,855) 181,693
Deferred compensation expense ................................... 41,304 41,304 41,304
Gain from insurance proceeds .................................... -- (478,032) --
Deferred income taxes ........................................... 785,209 (136,576) 499,025
Changes in assets and liabilities, net of effects of acquisitions....
Royalties receivable ............................................ (28,702) (37,486) 94,140
Other receivables ............................................... (114,200) 223,609 (306,528)
Taxes receivable/payable ........................................ (49,844) 37,876 (228,834)
Inventory ....................................................... 100,766 10,583 83,318
Prepaids and other current assets ............................... 21,203 (118,361) (337,080)
Other assets .................................................... 29,512 (373,926) 210,670
Accounts payable ................................................ (68,517) (416,648) 25,576
Accrued expenses and other liabilities .......................... (100,791) 12,351 120,089
Deferred rent and other long-term liabilities ................... 229,641 40,992 316,793
----------- ----------- -----------
Total Adjustments ......................................... 2,536,424 1,814,443 3,431,717
----------- ----------- -----------
Net cash provided by continuing operations ................ 4,454,102 2,422,467 5,589,255
----------- ----------- -----------
Net cash provided (used) in discontinued operations ....... (21,292) (17,554) 113,735
----------- ----------- -----------
Net cash provided by operating activities ................. 4,432,810 2,404,913 5,702,990
CASH FLOWS FROM INVESTING ACTIVITIES:
Insurance proceeds from fire loss on building ................... 255,844 488,629 --
Purchase of property, plant and equipment ....................... (2,137,518) (1,788,237) (2,989,434)
Proceeds from sale of property, plant and equipment ............. 478,000 476,500 655,752
Business Acquisitions, net of cash acquired ..................... -- -- (6,767,916)
----------- ----------- -----------
Net cash used in continuing operations ...................... (1,403,674) (823,108) (9,101,598)
----------- ----------- -----------
Net cash used in discontinued operations .................... (126,553) (117,299) (10,189)
----------- ----------- -----------
Net cash used in investing activities ....................... (1,530,227) (940,407) (9,111,787)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payment) under line of credit agreement ......... (2,172,729) (1,625,000) 1,225,000
Issuance (purchase) of treasury stock ........................... (514,741) -- 111,591
Additions to Long term Notes Payable ............................ -- -- 3,000,000
----------- ----------- -----------
Net cash provided (used) in financing activities .......... (2,687,470) (1,625,000) 4,336,591
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents ................ 215,113 (160,494) 927,794
Cash and cash equivalents at beginning of year .................. 311,423 526,536 366,042
----------- ----------- -----------
Cash and cash equivalents at end of year ........................ $ 526,536 $ 366,042 $ 1,293,836
=========== =========== -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year:
Interest .................................................... $ 341,330 $ 265,262 $ 494,844
Income taxes ................................................ 408,339 304,453 464,532
Non-cash financing activities:
CNL real estate transaction ................................. -- -- 8,325,000
See accompanying notes to consolidated financial statements.
F-6
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 29, 2002, DECEMBER 28, 2003 AND JANUARY 2, 2005
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
On February 16, 1996, Mexican Restaurants, Inc. (formerly Casa Ole
Restaurants, Inc.) was incorporated in the State of Texas, and on April 24,
1996, its initial public offering of 2,000,000 shares of Common Stock became
effective. Mexican Restaurants, Inc. is the holding company for Casa Ole
Franchise Services, Inc. and several subsidiary restaurant operating
corporations (collectively the "Company"). Casa Ole Franchise Services, Inc. was
incorporated in 1977, and derives its revenues from the collection of franchise
fees under a series of protected location franchise agreements and from the sale
of restaurant accessories to the franchisees of those protected location
franchise agreements. The restaurants feature moderately priced Mexican and
Tex-Mex food served in a casual atmosphere. The first Casa Ole restaurant was
opened in 1973.
On July 2, 1997, the Company purchased 100% of the outstanding stock of
Monterey's Acquisition Corp. ("MAC"). The Company purchased the shares of common
stock for $4.0 million, paid off outstanding debt and accrued interest totaling
$7.1 million and funded various other agreed upon items approximating $500,000.
Approximately $4.8 million of goodwill was recorded as a result of this
purchase. At the time of the acquisition, MAC owned and operated 26 restaurants
in Texas and Oklahoma under the names "Monterey's Tex-Mex Cafe," "Monterey's
Little Mexico" and "Tortuga Coastal Cantina."
On April 30, 1999, the Company purchased 100% of the outstanding stock of
La Senorita Restaurants, a Mexican restaurant chain operated in the State of
Michigan. The Company purchased the shares of common stock of La Senorita for
$4.0 million. The transaction was funded with the Company's revolving line of
credit with Bank of America. La Senorita operated five company-owned
restaurants, and has three franchise restaurants. One of the franchise
restaurants is owned by a partnership in which the parent company has a 16.5%
limited interest.
On January 7, 2004, the Company completed its purchase of 13 restaurants
and related assets from its Beaumont-based franchisee, Thomas Harken, and Mr.
Harken's operating partner, Victor Gonzalez, for a total consideration of
approximately $13.75 million. The financing for the acquisition was provided by
Fleet National Bank, CNL and the sellers. The restaurants acquired include 8
Casa Ole restaurants located in Southeast Texas, 2 Casa Ole restaurants located
in Southwest Louisiana, and 3 Crazy Jose's restaurants located in Southeast
Texas. In the past year these restaurants had combined sales of over $20
million.
On October 14, 2004, the Company completed its purchase of one franchise
restaurant in Brenham, Texas for approximately $215,000. The restaurant was
closed, remodeled and re-opened on November 22, 2004. The Company spent $329,489
remodeling the restaurant.
The consolidated statements of income and cash flows for fiscal years
2004, 2003, and 2002 have been adjusted to remove the operations of closed
restaurants, which have been reclassified as discontinued operations.
Consequently, the consolidated statements of income and cash flows for the
fiscal years 2003 and 2002 shown in the accompanying consolidated financial
statements have been reclassified to conform to the 2004 presentation. These
reclassifications have no effect on total assets, total liabilities,
stockholders equity or net income.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of Mexican
Restaurants, Inc. and its wholly owned subsidiaries, after elimination of all
significant inter-company transactions. The Company owns and operates various
Mexican restaurant concepts principally in Texas, Oklahoma, Louisiana and
Michigan. The Company's three Idaho restaurants were closed on December 30, 2001
and the restaurants are either subleased or leased to third parties. The Company
also franchises the Casa Ole concept principally in Texas and Louisiana and the
La Senorita concept principally in the State of Michigan.
(c) Fiscal Year
The Company maintains its accounting records on a 52/53 week fiscal year
ending on the Sunday nearest December 31. Fiscal years 2002 and 2003 consisted
of 52 weeks and fiscal year 2004 consisted of 53 weeks.
(d) Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid investments with original maturities of three months or less to be
cash equivalents.
F-7
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(e) Inventory
Inventory, which is comprised of food and beverages, is stated at the
lower of cost or market. Cost is determined using the first-in, first-out
method. Miscellaneous restaurant supplies are included in inventory and valued
on a specific identification basis.
(f) Pre-opening Costs
Pre-opening costs primarily consists of hiring and training employees
associated with the opening of a new restaurant and are expensed upon the
opening of the restaurant.
(g) Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation on
equipment and on buildings and improvements is calculated on the straight-line
method over the estimated useful lives of the assets. Leasehold improvements are
amortized straight-line over the shorter of the lease term plus options or
estimated useful life of the assets.
Buildings and improvements.......................................... 20-40 years
Vehicles............................................................ 5 years
Equipment........................................................... 3-15 years
Leasehold improvements.............................................. 3-20 years
Significant expenditures that add materially to the utility or useful
lives of property, plant and equipment are capitalized. All other maintenance
and repair costs are charged to current operations. The cost and related
accumulated depreciation of assets replaced, retired or otherwise disposed of
are eliminated from the property accounts and any gain or loss is reflected as
other income and expense. Recoverability of assets to be held and used is
measured by comparing the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount the carrying
value exceeds the fair value of the asset.
In fiscal year 2004, the Company recorded asset impairment and restaurant
closure costs of $868,580. Of this total, $167,565 of these costs are included
in discontinued operations related to the 2004 closure of three restaurants and
the 2003 closure of one restaurant, located in San Marcos, Texas, described
below. Impairment expense of $701,015 in continuing operations relates primarily
to four Tortuga restaurants that will be re-concepted to a different company
Mexican food concept. In addition, two Monterey's restaurants, which were
impaired in 2003, incurred a small impairment in 2004. These two restaurants
will either be re-concepted or closed at the expiration of their operating
leases. The circumstances and testing leading to the impairment in fiscal 2004
are the same as those described in the paragraph below.
In fiscal year 2003, the Company recorded asset impairment and restaurant
closure costs of $2,908,406. These costs related to the closure of three
restaurants, two located in the Houston, Texas and one located in San Marcos,
Texas. In addition to the three restaurant closures, five under-performing
restaurants incurred impairment costs based on current and projected operating
cash flows and Company-owned land and building, currently leased to a Monterey's
licensee, was written down to its appraised fair market value. Of the five
under-performing restaurants, two were subsequently re-concepted to a different
company Mexican food concept, one was closed at the expiration of its operating
lease and the other two are still operating, but will either be re-concepted or
closed at the expiration of their operating leases. The leased land and building
were subsequently sold to the Monterey's licensee. The circumstances leading to
the testing of these long-lived assets were declines in revenues, a current cash
flow loss combined with a forecast demonstrating continuing cash flow losses,
current market conditions and competitive intrusion. The fiscal 2003 impairments
were based on management's estimates of future cash flows to determine the
recoverability of each restaurant's long-lived assets. The service potential of
the assets includes assessment of future cash-flow-generating capacity, the
remaining lives of the assets, the remaining term of the operating lease and
evaluation of future cash flows associated with potential capital expenditures.
The method for determining the fair value of impaired assets to be sold is based
on its appraised fair market value or the value that a third party buyer would
be willing to pay. There were no such impairment costs in fiscal year 2002.
Management performed a detailed analysis of leasehold improvement
amortization. The purpose of the analysis was to verify that leasehold
improvements were amortized over the shorter of the lease term plus options or
estimated useful life of the assets. The analysis resulted in differences that
were immaterial to the financial statements for all periods presented, therefore
restatement of the financial statements was determined by management to be
unnecessary.
Property held for resale is separately aggregated in the consolidated
balance sheet and is recorded at the estimated fair market value of $505,118 and
$884,118 for fiscal years 2004 and 2003, respectively.
F-8
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(h) Goodwill and Other Intangible Assets
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The Company adopted the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets, as of January 1, 2002. Goodwill and
intangible assets acquired in a purchase business combination and determined to
have an indefinite useful life are not amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 also requires that intangible assets with estimable useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with SFAS No. 144,
Accounting for Impairment or Disposal of Long-Lived Assets.
At January 2, 2005, the balance sheet included $10.6 million of goodwill
primarily resulting from the MAC, La Senorita and Beaumont-based franchisee
acquisitions. In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement required the Company to perform an assessment of
whether there was an indication that goodwill is impaired as of the date of
adoption. To accomplish this, the Company was required to identify its reporting
units and determine the carrying value of each reporting unit by assigning the
assets and liabilities, including the existing goodwill and intangible assets,
to those reporting units as of January 1, 2002. The Company was required to
determine the fair value of each reporting unit and compare it to the carrying
amount of the reporting unit within six months of January 1, 2002. To the extent
the carrying amount of a reporting unit exceeded the fair value of the reporting
unit, the Company would be required to perform the second step of the
transitional impairment test, as this is an indication that the reporting unit
goodwill may be impaired. Management evaluated goodwill as required by SFAS 142
upon its adoption and annually as of December 29, 2002, December 28, 2003 and
January 2, 2005. Management performed its goodwill impairment testing of the 60
reporting units for fiscal year 2004 and has determined that the aggregate fair
value exceeded the aggregate carrying amount of the reporting units and that no
impairment of goodwill exists.
Prior to the adoption of SFAS No. 142, goodwill was amortized on a
straight-line basis over the expected periods to be benefited (40 years for MAC
and 15 years for La Senorita) and assessed for recoverability by determining
whether the amortization of the goodwill balance over its remaining life could
be recovered through undiscounted future operating cash flows of the acquired
operation. The amount of goodwill and other intangible asset impairment, if any,
was measured based on projected discounted future operating cash flows using a
discount rate reflecting the Company's average cost of funds.
(i) Impairment of Long-Lived Assets
SFAS No. 144 provides a single accounting model for long-lived assets to
be disposed of. SFAS No. 144 also changes the criteria for classifying an asset
as held for sale; and broadens the scope of businesses to be disposed of that
qualify for reporting as discontinued operations and changes the timing of
recognizing losses on such operations. The Company adopted SFAS No. 144 on
January 1, 2002. The adoption of SFAS No. 144 did not affect the Company's
financial statements.
In accordance with SFAS No. 144, long-lived assets, such as property,
plant, and equipment, and purchased intangibles subject to amortization, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized by the amount by which the carrying
amount of the asset exceeds the fair value of the asset. Assets to be disposed
of would be separately presented in the balance sheet and reported at the lower
of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held
for sale would be presented separately in the appropriate asset and liability
sections of the balance sheet.
Goodwill and intangible assets not subject to amortization are tested
annually for impairment, and are tested for impairment more frequently if events
and circumstances indicate that the asset might be impaired. An impairment loss
is recognized to the extent that the carrying amount exceeds the asset's fair
value.
Prior to the adoption of SFAS No. 144, the Company accounted for
long-lived assets in accordance with SFAS No. 121, Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of.
(j) Income Taxes
Income taxes are provided based on the asset and liability method of
accounting pursuant to Statement of Financial Accounting Standards (SFAS) No.
109, Accounting for Income Taxes.
F-9
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(k) Franchise Fees
Franchise fee revenue from an individual franchise sale is recognized when
all services relating to the sale have been performed and the restaurant has
commenced operation. Initial franchise fees relating to area franchise sales are
recognized ratably in proportion to services that are required to be performed
pursuant to the area franchise or development agreements and proportionately as
the restaurants within the area are opened.
(l) Stock Options
In December 2004, the FASB issued SFAS 123 (Revised), "Share-Based
Payment", a revision of SFAS 123, "Accounting for Stock-Based Compensation."
SFAS 123R required the fair value measurement of all stock-based payments to
employees, including grants of employee stock options, and recognition of those
expenses in the statement of operations. SFAS 123R is effective for reporting
periods beginning after June 15, 2005. We will continue to account for
stock-based compensation using the intrinsic value method until adoption of SFAS
123R on July 1, 2005. Historically, the compensation expense recognized related
to stock options under this method has been minimal. As a result, adoption of
the provisions of SFAS 123R are expected to have an impact to reported net
income and earnings per share. We have not yet determined the method of adoption
or the effect of adopting SFAS 123R and have not determined whether the adoption
will result in amounts that are similar to the current pro forma disclosures
under SFAS 123.
The Company has adopted the disclosure-only provisions of the FASB issued
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123, which amends SFAS No. 123,
"Accounting for Stock-Based Compensation," and has accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations. Accordingly, no compensation cost has been recognized
for stock options or warrants. Had compensation cost for the Company's
outstanding stock options and warrants been determined based on the fair value
at the grant date for awards consistent with the provisions of SFAS No. 123, the
Company's net income and net income per share would have been reduced to the pro
forma amounts indicated below for fiscal years 2002, 2003 and 2004:
2002 2003 2004
---- ---- ----
Net income - as reported ...................................... $ 1,703,928 $ (1,034,908) $1,760,974
Proforma net income - pro forma for SFAS No. 123 .............. 1,696,458 (1,079,476) 1,731,594
Net income per share - as reported............................. 0.49 (0.31) 0.52
Pro forma net income per share - pro forma for SFAS No. 123.... 0.49 (0.32) 0.51
(m) Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
(n) Insurance proceeds
During the first half of fiscal year 2003, the Company recorded a gain of
$478,032 for insurance proceeds received from fire damage at the Humble, Texas
restaurant location. During the second half of fiscal year 2002, the Company
received $105,000 of business interruption insurance proceeds and recorded a
partial gain of $46,268 for insurance proceeds received from the previously
mentioned fire damage at the Humble, Texas restaurant location. These amounts
were recorded in other income (expense) during fiscal years 2003 and 2002. There
were no insurance proceeds recorded in 2004.
(o) Recently Issued Accounting Standards
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, and interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after December
31, 2002 and did not have a material effect on the Company's financial
statements.
F-10
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002 and are included in the notes to
these consolidated financial statements.
(2) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at December 28, 2003 and January 2, 2005
were as follows:
2003 2004
---- ----
Land .............................................. $ 6,000 $ 360,750
Buildings and improvements ........................ 465,141 1,001,747
Vehicles .......................................... 50,953 20,874
Equipment and Smallwares........................... 14,499,748 17,809,973
Leasehold Improvements............................. 9,462,729 9,589,851
Construction in Progress .......................... -- 146,692
----------- -----------
Total $24,484,571 $28,929,887
=========== ===========
(3) LONG-TERM DEBT
Long-term debt consists of the following at December 28, 2003 and January
2, 2005:
FISCAL YEARS
2003 2004
---- ----
Revolving Line of Credit ........................... 750,000 --
Term Note .......................................... 2,025,000 4,000,000
Other long-term debt ............................... -- 3,000,000
----------- -----------
Total long-term debt ............................. 2,775,000 7,000,000
----------- -----------
Less current installments due in 2005 ............ (1,000,000) (1,000,000)
----------- -----------
Long-term debt, excluding current installments.... $ 1,775,000 $ 6,000,000
=========== ===========
On January 7, 2004, Bank of America (formerly Fleet National Bank) amended
its $10.0 million credit facility to accommodate the acquisition of the
Beaumont-based franchise restaurants. The amended credit facility consists of a
$5.0 million term note that requires quarterly principal payments of $250,000
and matures on December 31, 2008. The credit facility also includes a $5.0
million revolving line of credit that matures on January 7, 2007. The interest
rate is either the prime rate or LIBOR plus a stipulated percentage.
Accordingly, the Company is impacted by changes in the prime rate and LIBOR. The
Company is subject to a non-use fee of 0.75% on the unused portion of the
revolver from the date of the credit agreement. On January 7, 2004, the Company
drew up $3.1 million on its facility to complete the Beaumont-based acquisition.
Since January 7, 2004 the Company paid down $1.85 million of its indebtedness to
Bank of America during fiscal year 2004. As of January 2, 2005, the Company had
$4.0 million outstanding on the credit facility and $3.0 million in notes for a
total indebtedness of $7.0 million. The Company is in full compliance with all
debt covenants as amended. The Company expects to be in compliance with all debt
covenants in fiscal year 2005.
Maturities on long-term debt are as follows:
2005.................................................. 1,000,000
2006.................................................. 1,000,000
2007.................................................. 1,000,000
2008.................................................. 1,000,000
2009.................................................. 1,775,000
Thereafter............................................ 1,225,000
-----------
$ 7,000,000
===========
F-11
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(4) Income Taxes
The provision for income tax expense from continuing operations is
summarized as follows for fiscal years 2002, 2003 and 2004:
2002(1) 2003(1) 2004(1)
------- ------- -------
Current:
Federal ................... $ 90,168 $ 300,187 $ 421,838
State and local............ 63,800 150,584 87,103
Deferred ......................... 785,209 (136,576) 499,025
-------- ----------- ----------
$939,177 $ 314,195 $1,007,966
======== =========== ==========
(1) Excludes income tax benefits from discontinued operations of $142,980,
$981,557, and $237,063 for 2002, 2003 and 2004, respectively.
The actual income tax expense differs from expected income tax expense
calculated by applying the U.S. federal corporate tax rate to income before
income tax expense as follows:
2002 2003 2004
---- ---- ----
Expected tax expense ........... $ 971,329 $ 345,855 $ 1,076,271
State tax expense, net ......... 85,313 112,655 94,757
Non-deductible amortization .... 3,391 3,391 3,391
Tax credits .................... (122,788) (126,499) (171,547)
Other .......................... 1,932 (21,207) 5,094
--------- ----------- -----------
$ 939,177 $ 314,195 $ 1,007,966
========= =========== ===========
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities at December 28, 2003 and January 2, 2005
are as follows:
DECEMBER 28, JANUARY 2,
2003 2005
---- ----
Deferred tax assets:
Sale-leaseback ........................... $ 731,028 $ 654,212
Tax credit carryforwards.................. 433,791 591,592
Asset impairments ........................ 999,013 747,699
Accrued expenses ......................... 155,133 40,397
----------- -----------
$ 2,318,965 $ 2,033,900
----------- -----------
Deferred tax liabilities:
Other .................................... $ (5,556) $ (8,219)
Depreciation differences ................. (1,041,236) (1,406,594)
----------- -----------
$(1,046,792) $(1,414,813)
----------- -----------
Net deferred taxes .......................... $ 1,272,173 $ 619,087
=========== ===========
At January 2, 2005, the Company determined that it was more likely than
not that the deferred tax assets would be realized based on the level of
historical taxable income and projections of future taxable income over the
periods in which the deferred tax assets are deductible. At January 2, 2005, the
Company has tax credit carryforwards of $591,592 which are available to reduce
future Federal regular income taxes, if any, over an indefinite period.
(5) COMMON STOCK, OPTIONS AND WARRANTS
(a) 1996 Long Term Incentive Plan
The Board of Directors and shareholders of the Company have approved the
Mexican Restaurants, Inc. 1996 Long Term Incentive Plan (the "Incentive Plan").
The Incentive Plan, as amended, authorizes the granting of up to 500,000 shares
of Common Stock in the form of incentive stock options and non-qualified stock
options to key executives and other key employees of the Company, including
officers of the Company and its subsidiaries. The purpose of the Incentive Plan
is to attract and retain key employees, to motivate key employees to achieve
long-range goals and to further align the interests of
F-12
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
key employees with those of the other shareholders of the Company. Options
granted under the Incentive Plan will generally vest and become exercisable at
the rate of 10% on the first anniversary of the date of grant, 15% on the second
anniversary of the date of grant, and 25% on each of the third through fifth
anniversaries of the date of grant. All stock options granted pursuant to the
1996 Long Term Incentive Plan will be nonqualified stock options and will remain
exercisable until the earlier of ten years from the date of grant or no more
than 90 days after the optionee ceases to be an employee of the Company.
(b) Stock Option Plan for Non-Employee Directors
The Company has adopted the Mexican Restaurants, Inc. Stock Option Plan
for Non-Employee Directors (the "Directors Plan") for its outside directors and
has reserved 200,000 shares of Common Stock for issuance thereunder. The
Directors Plan provides that each outside director will automatically be granted
an option to purchase 10,000 shares of Common Stock at the time of becoming a
director. These options will be exercisable in 20% increments and will vest
equally over the five-year period from the date of grant. Such options are
priced at the fair market value at the time an individual is elected as a
director. Until the third quarter of fiscal year 2002, each outside director
received options to purchase 1,500 shares of Common Stock quarterly, plus
additional options for attendance at committee meetings, exercisable at the fair
market value of the Common Stock at the close of business on the date
immediately preceding the date of grant. Such annual options will vest at the
conclusion of one year, so long as the individual remains a director of the
Company. All stock options granted pursuant to the Directors Plan will be
nonqualified stock options and will remain exercisable until the earlier of ten
years from the date of grant or six months after the optionee ceases to be a
director of the Company.
As of the third quarter of fiscal year 2002, compensation for each outside
director was changed from quarterly options to cash payments of $2,000 per
quarter and $1,000 per board meeting attended. The chairman of the audit
committee receives compensation of $5,000 per quarter.
On November 15 and 18 of fiscal 2004, one director exercised 30,200 of his
options in the open market. The Company received $111,591 in exchange for 30,200
shares of common stock that was previously held as Treasury stock.
(c) 1996 Manager's Stock Option Plan
The Company has adopted the 1996 Manager's Stock Option Plan (the
"Manager's Plan") specifically for its store-level managers. The Manager's Plan
authorizes the granting of up to 200,000 shares of Common Stock in the form of
non-qualified stock options to store-level managers of the Company. The purpose
of the Manager's Plan is to attract, retain and motivate restaurant managers to
achieve long-range goals and to further align the interests of those employees
with those of the other shareholders of the Company. Options granted under the
Manager's Plan will generally vest and become exercisable at the rate of 10% on
the first anniversary of the date of grant, 15% on the second anniversary of the
date of grant, and 25% on each of the third through fifth anniversaries of the
date of grant. All stock options granted pursuant to the 1996 Manager's Stock
Option Plan will be nonqualified stock options and will remain exercisable until
the earlier of ten years from the date of grant or no more than 90 days after
the optionee ceases to be an employee of the Company.
(d) Warrants
In conjunction with the initial public offering, the Company entered into
warrant agreements with Louis P. Neeb and Tex-Mex, a limited liability company
in which a member of the Board of Directors prior to February 14, 2000 is a
principal, pursuant to which Mr. Neeb and Tex-Mex acquired warrants to purchase
shares of Common Stock at the initial public offering ($11.00 per share) price
less the amount paid for the warrant ($.10 per share) for an aggregate amount of
Common Stock equal to ten percent (10%) of the shares of Common Stock of the
Company outstanding upon consummation of the initial public offering, such
shares to be allocated 5%, or 179,885 shares, to Mr. Neeb and 5%, or 179,885
shares, to Tex-Mex. The Company's warrants to Mr. Neeb became exercisable on the
second anniversary of the initial public offering, and the Company's warrants to
Tex-Mex became exercisable on the first anniversary of the initial public
offering. The warrants expire on April 24, 2006.
In late fiscal 1998 the Company exchanged a note valued in the amount of
$148,534 (principal and accrued interest) for 98,301 warrants to purchase Common
Stock previously held by a former officer of the Company. The warrants, which
were granted by Larry N. Forehand with an exercise price of $10.90 per share,
became exercisable in April 1998. Upon an exercise by Mr. Neeb or Tex-Mex of the
warrants granted to them by the Company, the Company plans to exercise these
newly acquired warrants simultaneously and use the warrant shares acquired from
Mr. Forehand to satisfy a portion of its obligations under its warrant
agreements with Mr. Neeb and Tex-Mex.
(e) Stock Transactions
During 1999 and 2000 the Company authorized the granting of 64,000 shares
of restricted stock to key executives. The awards were valued at an average of
$3.50 per share and will vest in 20% increments over a five year period from the
date of the grant. Compensation expense of $41,304 was recognized in both fiscal
years 2003 and 2004, respectively.
F-13
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
During fiscal year 2004 and 2003, the Company did not repurchase any of its
common shares. During fiscal year 2002, the Company repurchased 119,500 shares
of common stock for $485,601, and also purchased 12,425 vested options for
$13,838 and 9,400 common shares for $29,140 from former employees and a former
director of the Company.
(f) Option and Warrant Summary Weighted Average
Weighted Average
Shares Exercise Price
------ ----------------
Balance at December 29, 2002 .................................
Granted .................................................. 76,800 $ 3.46
Exercised ................................................ -- --
Canceled ................................................. (77,300) $ 5.61
--------- --------
1,040,470 $ 6.90
Balance at December 28, 2003 .................................
Granted .................................................. 24,500 $ 3.31
Exercised ................................................ -- --
Canceled ................................................. (36,000) $ 4.67
--------- --------
1,028,970 $ 6.87
Balance at January 2, 2005 ...................................
Granted .................................................. -- $ --
Exercised ................................................ 30,200 3.70
Canceled ................................................. 22,500 $ 7.36
--------- --------
976,270 6.96
The options (616,500) and warrants (359,770) outstanding at January 2,
2005 had exercise prices ranging between $2.50 to $11.00, of which 135,000 of
the options had exercise prices ranging from $8.63 to $11.00, and 359,770 of the
warrants had a exercise price of $10.90. As of January 2, 2005, 808,470 options
and warrants were exercisable at an average price of $7.75.
The weighted average fair value of the options and warrants granted during
2002, 2003 and 2004 is estimated at $1.41, $1.40 and $0.00 per share (no options
or warrants were granted in 2004), respectively, on the date of grant using the
Black-Scholes option-pricing model with the following assumptions: volatility of
40% for 2002, 44% for 2003 and 35% for 2004, risk-free interest rate of 3.8% for
2002, 3.0% for 2003 and 3.0% for 2004, an expected life of 5 years for options
and 4 years for warrants and 0% dividend yield.
(g) Income Per Share
Basic income per share is based on the weighted average shares outstanding
without any dilutive effects considered. Diluted income per share reflects
dilution from all contingently issuable shares, including options and warrants.
For fiscal years 2002, 2003 and 2004, the effect of dilutive stock options
increase the weighted average shares outstanding by approximately 72,855, 45,775
and 246,360 shares respectively. For fiscal year 2003, the effect of dilutive
stock options did not affect the determination of diluted income per share. For
fiscal years 2002 and 2004, such stock options and warrants did affect the
determination of diluted income approximately $0.01 and $0.04 per share,
respectively. Approximately 659,470, 731,370 and 454,570 options and warrants
were considered antidilutive for fiscal years 2002, 2003 and 2004 respectively.
(6) LEASES
The Company leases restaurant operating space and equipment under
non-cancelable operating leases which expire at various dates through January
31, 2024.
The restaurant operating space base agreements typically provide for a
minimum lease rent plus common area maintenance, insurance, and real estate
taxes, plus additional percentage rent based upon revenues of the restaurant
(generally 2% to 7%) and may be renewed for periods ranging from five to
twenty-five years.
On June 25, 1998, the Company completed a sale-leaseback transaction
involving the sale and leaseback of land, building and improvements of 13
company-owned restaurants. The properties were sold for $11.5 million and
resulted in a gain of approximately $3.5 million that was deferred and is
amortized over the terms of the leases, which are 15 years each. The leases are
classified as operating leases in accordance with SFAS No. 13 "Accounting for
Leases". Subsequent to the original transaction one lease was sold. The
remaining 12 leases have a total future minimum lease obligation of
approximately $10,568,978 and are included in the future minimum lease payment
schedule below.
F-14
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future minimum lease payments (which includes the three closed restaurants
scheduled below) under non-cancelable operating leases with initial or remaining
lease terms in excess of one year as of January 2, 2005 are approximately:
2005........................................ 5,227,699
2006........................................ 5,205,510
2007........................................ 5,041,049
2008........................................ 4,808,761
2009........................................ 4,568,965
Thereafter.................................. 29,784,469
------------
$ 54,636,453
============
The three Idaho restaurants (which are included in the table above) have
been subleased to third party restaurant operators for five year terms. Two of
the subtenants have two five year options to extend their leases, and one of the
subtenants has one five year option to extend its lease. Future minimum lease
receipts under non-cancelable operating leases with initial or remaining lease
terms in excess of one year as of January 2, 2005 are approximately:
2005............................................... 285,500
2006............................................... 303,500
2007............................................... 233,500
2008............................................... 145,221
Thereafter......................................... --
--------
$967,721
========
Rent expense for restaurant operating space and equipment amounted to
approximately $4,424,641, $4,478,663 and $5,964,086 for the fiscal years 2002,
2003 and 2004, respectively.
(7) ACQUISITION
On January 7, 2004, the Company completed its purchase of 13 restaurants
and related assets from its Beaumont-based franchisee for a total consideration
of approximately $13.75 million. The financing for the acquisition was provided
by Bank of America (formerly Fleet National Bank), CNL Franchise Network, LP
("CNL") and the sellers of the Beaumont-based franchise restaurants. Bank of
America (formerly Fleet National Bank) provided $3.1 million of the acquisition
financing by amending its existing credit facility with Mexican Restaurants,
Inc. Six of the acquired restaurants were concurrently sold to CNL for $8.325
million in a sale-leaseback transaction. The sellers accepted $3.0 million in
notes from Mexican Restaurants, Inc. for the balance of the purchase price. The
seller notes require the payments of interest only for five years, with $1.5
million in principal due on January 7, 2009 and $1.5 million in principal
amortizing over an additional five years.
The table below presents pro forma income statement information as if the
Company had purchased the Beaumont-based restaurants at the beginning of fiscal
year 2003. Pro forma adjustments are to remove royalty income and expense,
reflect net interest expense on the debt resulting from the acquisition and
record additional income tax at an effective rate of 16.9% and 31.8% for the
fourth quarter and year to date, respectively, of fiscal 2004 and 29.8% and
34.1% for the fourth quarter and year to date, respectively, of fiscal 2003. The
pro forma information does not purport to be indicative of results of operations
which would have occurred had the acquisition been consummated on the date
indicated or future results of operations.
Fiscal Fourth
Quarter Ended
--------------------------
1/2/05 12/28/03
----------- -----------
Revenues from continuing operations.................... $20,226,240 $18,255,640
Net income............................................. 24,136 (1,872,971)
Diluted income per share............................... 0.01 (0.54)
Fiscal Year Ended
--------------------------
1/2/05 12/28/03
----------- -----------
Revenues from continuing operations.................... $78,640,135 $74,764,481
Net income............................................. 1,760,974 (869,971)
Diluted income per share............................... 0.48 (0.25)
The acquisition was accounted for under SFAS 141 and results of operations
are included in the accompanying financial statements from the date of
acquisition. The assets acquired and liabilities assumed of the acquisition were
recorded at estimated fair values using comparables, appraisals, and records.
Some of the acquisition amounts recorded are estimates and are subject to
change.
A summary of the assets acquired and liabilities assumed in the
acquisition follow:
Estimated fair value of assets acquired:
Current assets $ 184,601
Property and Equipment 2,946,365
Other assets 175,000
Goodwill 3,283,916
----------
Total assets $6,589,882
Less: Cash acquired (35,150)
----------
Net assets acquired $6,554,732
----------
On October 14, 2004, the Company completed its purchase of one franchise
restaurant in Brenham, Texas for approximately $215,000, which included $164,509
classified as goodwill. The restaurant was closed, remodeled and re-opened on
November 22, 2004.
(8) 401(k) PLAN
Beginning in fiscal year 1998, the Company established a defined
contribution 401(k) plan that covers substantially all full-time employees
meeting certain age and service requirements. Participating employees may elect
to defer a percentage of their qualifying compensation as voluntary employee
contributions. The Company may contribute additional amounts at the discretion
of management. The Company did not make any contributions to the plan in fiscal
years 2003 and 2004.
(9) RELATED PARTY TRANSACTIONS
The Company leased its executive offices from a company owned by two
shareholders of Mexican Restaurants, Inc. Net lease expense related to these
facilities in fiscal 2002, 2003 and 2004 was $122,584, $125,188 and $10,416
respectively. The building was sold to a non-related party on February 20, 2004.
In May 1998 the Board of Directors of the Company adopted a program to
assist executives and five key employees of the Company in their purchasing of
shares of the Company. As adopted, the program provided for the Company to
assist the executives and key employees in obtaining third party loans to
finance such purchases. As of February 1, 2003, the maturity date of the
employee third party loans, the Company no longer guarantees employee third
party loans.
The Company provides accounting and administrative services for the Casa
Ole Media and Production Funds. The Casa Ole Media and Production Funds are
not-for-profit, unconsolidated entities used to collect money from company -
owned and franchise-owned restaurants to pay for the marketing of Casa Ole
restaurants. Each restaurant contributes an agreed upon percentage of its sales
to the funds.
(10) CONTINGENCIES
The Company has litigation, claims and assessments that arise in the
normal course of business. Management believes that the Company's financial
position or results of operations will not be materially affected by such
matters.
F-15
MEXICAN RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(11) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The unaudited quarterly results for the fiscal year ended January 2, 2005
were as follows (in thousands, except per share data):
FISCAL YEAR 2003 QUARTER ENDED
DECEMBER 28 SEPTEMBER 28 JUNE 29 MARCH 30
----------- ------------ ------- --------
Revenues ..................................... 13,325 14,219 13,755 13,653
Income from continuing operations ............ (594) 344 312 546
Income from discontinued operations .......... (1,321) (147) (99) (76)
Net income (loss) ............................ (1,915) 197 214 469
Basic income per share
Income from continuing operations ......... ($ 0.18) $ 0.10 $ 0.09 $ 0.16
Loss from discontinued operations ......... ($ 0.39) ($ 0.04) ($ 0.03) ($ 0.02)
Net income (loss) ......................... ($ 0.57) $ 0.06 $ 0.06 $ 0.14
Diluted income per share
Income from continuing operations ......... ($ 0.18) $ 0.10 $ 0.09 $ 0.16
Loss from discontinued operations ......... ($ 0.39) ($ 0.04) ($ 0.03) ($ 0.02)
Net income (loss) ......................... ($ 0.57) $ 0.06 $ 0.06 $ 0.14
FISCAL YEAR 2004 QUARTER ENDED
JANUARY 02 SEPTEMBER 26 JUNE 27 MARCH 28
---------- ------------ ------- --------
Revenues....................................... 20,226 19,819 19,727 18,868
Income from continuing operations.............. 175 614 691 678
Income from discontinued operations............ (151) (31) (68) (147)
Net income (loss).............................. 24 583 623 531
Basic income per share
Income from continuing operations........... $ 0.05 $ 0.18 $ 0.20 $ 0.20
Loss from discontinued operations........... ($ 0.04) ($ 0.01) ($ 0.02) ($ 0.04)
Net income (loss)........................... $ 0.01 $ 0.17 $ 0.18 $ 0.16
Diluted income per share
Income from continuing operations........... $ 0.05 $ 0.17 $ 0.19 $ 0.19
Loss from discontinued operations........... ($ 0.04) ($ 0.01) ($ 0.02) ($ 0.04)
Net income (loss)........................... $ 0.01 $ 0.16 $ 0.17 $ 0.15
In the 4th quarter of fiscal 2003 and 2004, the Company recognized asset
impairment and restaurant closure costs of $950,128 and $701,015. Excluding
these infrequently occurring costs, income from continuing operations would be
$1,872,347 and $3,866,519, respectively.
F-16
INDEX TO EXHIBITS
Exhibits:
3.1 Articles of Incorporation of the Company (as amended and
incorporated by reference to the corresponding Exhibit
number of the Company's Form 8-K filed on May 25, 1999
with the Securities and Exchange Commission).
++3.2 Bylaws of the Company.
++4.1 Specimen of Certificate of Common Stock of the Company.
++4.2 Articles of Incorporation of the Company (see 3.1
above).
++4.3 Bylaws of the Company (see 3.2 above).
++10.1 Employment Agreement by and between the Company and
Louis P. Neeb dated February 28, 1996.
10.2 Indemnity Agreement by and between the Company and Louis
P. Neeb dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.4 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.3 Indemnity Agreement by and between the Company and Larry
N. Forehand dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.5 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.4 Indemnity Agreement by and between the Company and John
C. Textor dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.6 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.5 Indemnity Agreement by and between the Company and
Michael D. Domec dated as of April 10, 1996
(incorporated by reference to Exhibit 10.8 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.6 Indemnity Agreement by and between the Company and J.J.
Fitzsimmons dated as of April 10, 1996 (incorporated by
reference to Exhibit 10.10 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
10.7 Indemnity Agreement by and between the Company and
Richard E. Rivera dated as of April 10, 1996
(incorporated by reference to Exhibit 10.11 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.8 Corrected Warrant Agreement by and between the Company
and Louis P. Neeb dated as of February 26, 1996
(incorporated by reference to Exhibit 10.12 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.9 Corrected Warrant Agreement by and between the Company
and Tex-Mex Partners, L.C. dated as of February 26, 1996
(incorporated by reference to Exhibit 10.13 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.10 Form of the Company's Multi-Unit Development Agreement
(incorporated by reference to Exhibit 10.14 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.11 Form of the Company's Franchise Agreement (incorporated
by reference to Exhibit 10.15 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
+10.12 1996 Long Term Incentive Plan (incorporated by
reference to Exhibit 10.16 of the Company's Form S-1
Registration Statement filed under the Securities Act of
1933, dated April 24, 1996, with the Securities and
Exchange Commission (Registration Number 333-1678)).
+10.13 Stock Option Plan for Non-Employee Directors
(incorporated by reference to Exhibit 10.17 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.14 Corrected Warrant Agreement by and between Larry N.
Forehand and Louis P. Neeb dated as of February 26, 1996
(incorporated by reference to Exhibit 10.31 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.15 Corrected Warrant Agreement by and between Larry N.
Forehand and Tex-Mex Partners, L.C. dated as of February
26, 1996 (incorporated by reference to Exhibit 10.32 of
the Company's Form S-1 Registration Statement filed
under the Securities Act of 1933, dated April 24, 1996,
with the Securities and Exchange Commission
(Registration Number 333-1678)).
10.16 Corrected Warrant Agreement by and between Larry N.
Forehand and Patrick A. Morris dated as of February 26,
1996 (incorporated by reference to Exhibit 10.33 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.17 Corrected Warrant Agreement by and between Larry N.
Forehand and Stacy M. Riffe dated as of February 26,
1996 (incorporated by reference to Exhibit 10.34 of the
Company's Form S-1 Registration Statement filed under
the Securities Act of 1933, dated April 24, 1996, with
the Securities and Exchange Commission (Registration
Number 333-1678)).
10.18 Indemnification letter agreement by Larry N. Forehand
dated April 10, 1996 (incorporated by reference to
Exhibit 10.35 of the Company's Form S-1 Registration
Statement filed under the Securities Act of 1933, dated
April 24, 1996, with the Securities and Exchange
Commission (Registration Number 333-1678)).
+10.19 1996 Manager's Stock Option Plan (incorporated by
reference to Exhibit 99.2 of the Company's Form S-8
Registration Statement Under the Securities Act of 1933,
dated February 24, 1997, filed with the Securities and
Exchange Commission).
+10.20 Employment Agreement by and between the Company and
Curt Glowacki dated May 15, 1997 (incorporated by
reference to Exhibit 10.44 of the Company's Form 10-K
Annual Report filed on March 30, 1998 with the
Securities and Exchange Commission).
+10.21 Employment Agreement by and between the Company and Andrew J. Dennard
dated May 20, 1997 (incorporated by reference to Exhibit 10.45 of the
Company's Form 10-K Annual Report filed on March 30, 1998 with the
Securities and Exchange Commission).
*10.22 Fleet Revolving Credit and Term Loan Agreement between Mexican
Restaurants, Inc., as the Borrower, and Fleet National Bank, as the
Bank, for $10,000,000 dated June 29, 2001 and as amended on January 7,
2004.
21.1 List of subsidiaries of the Company (incorporated by reference to
Exhibit 22.1 of the Company's Form S-1 Registration Statement Under the
Securities Act of 1933, dated April 24,1996, filed by the Company with
the Securities and Exchange Commission).
*23.1 Consent of KPMG LLP, Independent Registered Public Accounting Firm.
*24.1 Power of Attorney (included on the signature page to this Form 10-K).
*31.1 Certification filed pursuant to Rule 13a-14(a) or Rule 15d-14(a).
*31.2 Certification filed pursuant to Rule 13a-14(a) or Rule 15d-14(a).
#32.1 Certification of Chief Executive Officer furnished pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
#32.2 Certification of Chief Financial Officer furnished pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- -----------------
* Filed herewith.
++ Incorporated by reference to corresponding Exhibit number of the
Company's Form S-1 Registration Statement under the Securities Act of
1933, dated April 24, 1996, with the Securities and Exchange Commission
(Registration number 333-1678).
+ Management contract or compensatory plan or arrangement.
# Furnished herewith.