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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended February 15, 2004
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the transition period from to
-------------- --------------------
Commission file number 0-23420
QUALITY DINING, INC.
(Exact name of registrant as specified in its charter)
Indiana 35-1804902
----------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4220 Edison Lakes Parkway, Mishawaka, Indiana 46545
---------------------------------------------------
(Address of principal executive offices and zip code)
(574) 271-4600
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The number of shares of the registrant's common stock outstanding as of March
19, 2004 was 11,596,781.
Page 1
QUALITY DINING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED FEBRUARY 15, 2004
INDEX
Page
----
PART I - Financial Information
Item 1. Consolidated Financial Statements (Unaudited):
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 28
Item 4. Controls and Procedures 28
Part II - Other Information
Item 1. Legal Proceedings 29
Item 2. Changes in Securities 29
Item 3. Defaults upon Senior Securities 29
Item 4. Submission of Matters to Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
Page 2
PART I. FINANCIAL INFORMATION
ITEM 1. - CONSOLIDATED FINANCIAL STATEMENTS
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Sixteen Weeks Ended
February 15, February 16,
2004 2003
---- ----
Revenues:
Burger King $ 32,307 $ 33,941
Chili's Grill & Bar 24,807 23,517
Italian Dining Division 5,027 5,644
Grady's American Grill 1,922 2,042
-------- --------
Total revenues 64,063 65,144
-------- --------
Operating expenses:
Restaurant operating expenses:
Food and beverage 17,586 17,399
Payroll and benefits 18,780 19,336
Depreciation and amortization 2,866 3,075
Other operating expenses 16,818 17,395
-------- --------
Total restaurant operating expenses 56,050 57,205
-------- --------
Income from restaurant operations 8,013 7,939
-------- --------
General and administrative expense 5,014 4,936
Facility closing costs 54 5
Amortization of trademarks 82 116
-------- --------
Operating income 2,863 2,882
-------- --------
Other income (expense):
Interest expense (2,059) (2,305)
Loss on sale of property and equipment (47) (11)
Minority interest in earnings (480) (781)
Other income (expense), net 86 493
-------- --------
Total other expense, net (2,500) (2,604)
-------- --------
Income from continuing operations
before income tax 363 278
Income tax provision 272 341
-------- --------
Income (loss) from continuing operations 91 (63)
Income from discontinued operations,
net of tax 188 242
-------- --------
Net income $ 279 $ 179
======== ========
Basic net income per share:
Continuing operations - -
Discontinued operations 0.02 0.02
-------- --------
Basic net income per share $ 0.02 $ 0.02
======== ========
Diluted net income per share:
Continuing operations - -
Discontinued operations 0.02 0.02
-------- --------
Diluted net income per share $ 0.02 $ 0.02
======== ========
Weighted average shares outstanding:
Basic 11,311 11,311
======== ========
Diluted 11,343 11,311
======== ========
See Notes to Consolidated Financial Statements.
Page 3
QUALITY DINING, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
February 15, October 26,
2004 2003
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 1,244 $ 1,724
Accounts receivable 2,137 1,723
Inventories 1,622 1,670
Deferred income taxes 2,370 2,251
Assets held for sale 6,841 5,821
Other current assets 1,969 2,192
--------- ---------
Total current assets 16,183 15,381
--------- ---------
Property and equipment, net 109,310 112,826
--------- ---------
Other assets:
Deferred income taxes 6,630 6,749
Trademarks, net 1,202 1,285
Franchise fees and development fees, net 8,570 8,801
Goodwill 7,960 7,960
Liquor licenses, net 2,763 2,820
Other 3,554 3,454
--------- ---------
Total other assets 30,679 31,069
--------- ---------
Total assets $ 156,172 $ 159,276
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 14,110 $ 10,055
Accounts payable 7,047 6,182
Accrued liabilities 21,004 19,520
--------- ---------
Total current liabilities 42,161 35,757
Long-term debt 75,919 85,335
--------- ---------
Total liabilities 118,080 121,092
--------- ---------
Minority interest 13,868 14,272
Stockholders' equity:
Preferred stock, without par value:
5,000,000 shares authorized; none issued - -
Common stock, without par value: 50,000,000
shares authorized; 12,955,781 and 12,955,781
shares issued, respectively 28 28
Additional paid-in capital 237,402 237,402
Accumulated deficit (206,235) (206,514)
Unearned compensation (542) (575)
--------- ---------
30,653 30,341
Treasury stock, at cost, 2,508,587
and 2,508,587 shares, respectively (6,429) (6,429)
--------- ---------
Total stockholders' equity 24,224 23,912
--------- ---------
Total liabilities and stockholders' equity $ 156,172 $ 159,276
========= =========
See Notes to Consolidated Financial Statements.
Page 4
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Sixteen Weeks Ended
February 15, February 16,
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 279 $ 179
Income from discontinued operations (188) (242)
Minority interest in earnings 480 781
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization of
property and equipment 2,776 3,076
Amortization of other assets 468 497
Loss on sale of property and equipment 47 11
Amortization of unearned compensation 33 34
Changes in current assets and current liabilities:
Net increase in current assets (143) (440)
Net increase (decrease) in current liabilities 2,349 (54)
-------- --------
Net cash provided by operating activities 6,101 3,842
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (1,633) (1,972)
Proceeds from the sales of property and equipment 1,303 -
Purchase of other assets (197) (201)
-------- --------
Net cash used for investing activities (527) (2,173)
-------- --------
Cash flows from financing activities:
Borrowings of long-term debt 14,875 16,221
Repayment of long-term debt (20,236) (15,220)
Cash distributions to minority interest
in consolidated partnerships (884) (2,946)
-------- --------
Net cash used by financing activities (6,245) (1,945)
-------- --------
Cash provided by discontinued operations 191 387
-------- --------
Net increase in cash and cash equivalents (480) 111
Cash and cash equivalents, beginning of period 1,724 1,174
-------- --------
Cash and cash equivalents, end of period $ 1,244 $ 1,285
======== ========
See Notes to Consolidated Financial Statements.
Page 5
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Note 1: Description of Business.
Quality Dining, Inc. (the "Company") operates four distinct restaurant concepts.
It owns the Grady's American Grill(R) and two Italian Dining concepts and
operates Burger King(R) restaurants and Chili's Grill & Bar(R) ("Chili's") as a
franchisee of Burger King Corporation and Brinker International, Inc.
("Brinker"), respectively. The Company operates its Italian Dining restaurants
under the tradenames of Spageddies Italian Kitchen(R) ("Spageddies"(R)) and Papa
Vino's(TM) Italian Kitchen ("Papa Vino's"). The Company operates one of its
Grady's American Grill(R) restaurants under the tradename Porterhouse Steaks and
Seafood(TM) and one under the tradename Regas Grill(R). As of February 15, 2004,
the Company operated 176 restaurants, including 118 Burger Kings, 37 Chili's
Grill & Bar restaurants, 10 Grady's American Grill restaurants, six Papa Vino's,
three Spageddies, one Regas Grill(R) and one Porterhouse Steak and Seafood
restaurant(TM).
Note 2: Summary of Significant Accounting Policies.
Basis of Presentation
During the first quarter of 2004, the Company adopted FASB Interpretation No.
46, "Consolidation of Variable Interest Entities", as revised by the FASB in
December 2003 (FIN 46R). As a result of the adoption of this Interpretation, the
Company changed its consolidation policy whereby the accompanying consolidated
financial statements now include the accounts of Quality Dining, Inc., its
wholly owned subsidiaries, and certain related party affiliates that are
variable interest entities. Previously, the consolidated financial statements
included only the accounts of Quality Dining, Inc., and its wholly owned
subsidiaries. Prior periods have been restated to reflect this change.
The Company determined that certain affiliated real estate partnerships from
which the Company leases 42 of its Burger King restaurants and that are
substantially owned by certain directors, officers, and stockholders of the
Company meet the definition of variable interest entities as defined in FIN 46R
("VIE's"). Furthermore, the Company has determined that it is the primary
beneficiary of these VIE's, based on the criteria in FIN 46R. The Company holds
no direct ownership or voting interest in the VIE's. Additionally, the creditors
and beneficial interest holders of the VIE's have no recourse to the general
credit of the Company.
The assets of the VIE's, which consist primarily of property and equipment,
totaled $18,061,000 and $18,599,000 at February 15, 2004 and October 26, 2003,
respectively. The liabilities of the VIE's, which consist primarily of debt,
totaled $7,294,000 and $7,493,000 at February 15, 2004 and October 26, 2003,
respectively. Certain of the assets of the VIE's serve as collateral for the
debt obligations. Because certain of these assets were previously recorded as
capital leases by the Company, with a resulting lease obligation, the
consolidation of the VIE's served to increase total assets as reported by the
Company by $13,281,000 and $13,869,000 and total liabilities by $3,513,000 and
$3,697,000 at February 15, 2004 and October 26, 2003, respectively.
Additionally, the consolidation of the VIE's increased treasury stock by
$2,806,000 at February 15, 2004 and October 26, 2003, as one of the VIE's owns
common stock of the Company. The change had no impact on reported net income or
earnings per share for the sixteen weeks ended February 15, 2004 and February
16, 2003.
Page 6
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
The following table presents the effect of the consolidation of the VIE's on
depreciation and amortization expense, other operating expenses, general and
administrative expense, interest expense and other income (expense) for the
sixteen weeks ended February 15, 2004 and February 16, 2003:
16-Weeks ended 16-Weeks ended
(In thousands) February 15, 2004 February 16, 2003
----------------- -----------------
Depreciation and amortization expense $ 2,833 $ 3,030
Change in consolidation policy 33 45
-------- --------
Consolidated depreciation and amortization $ 2,866 $ 3,075
======== ========
Other operating expenses $ 17,533 $ 18,092
Change in consolidation policy (715) (697)
-------- --------
Consolidated other operating expenses $ 16,818 $ 17,395
======== ========
General and administrative expenses $ 5,013 $ 4,905
Change in consolidation policy 1 31
-------- --------
Consolidated general and administrative
expense $ 5,014 $ 4,936
======== ========
Interest expense $ 2,129 $ 2,425
Change in consolidation policy (70) (120)
-------- --------
Consolidated interest expense $ 2,059 $ 2,305
======== ========
Other income (expense) $ 357 $ 453
Change in consolidation policy (271) 40
-------- --------
Consolidated other income (expense) $ 86 $ 493
======== ========
All significant intercompany balances and transactions have been eliminated.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for annual financial statement reporting purposes. In the opinion of management,
all adjustments, consisting only of normal recurring accruals, considered
necessary for a fair presentation have been included. Operating results for the
16-week period ended February 15, 2004 are not necessarily indicative of the
results that may be expected for the 53-week year ending October 31, 2004.
Page 7
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
These financial statements should be read in conjunction with the Company's
audited financial statements for the fiscal year ended October 26, 2003 included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
As a result of the adoption of Statement of Financial Accounting Standard
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", the Company has classified the revenues, expenses and related assets
and liabilities of four Grady's American Grill restaurants that were sold in
2003, one Grady's American Grill that the Company sold and leased back in the
first quarter of fiscal 2004 and nine Grady's American Grill restaurants that
were held for sale at the end of the first quarter of fiscal 2004, as
discontinued operations in the accompanying consolidated financial statements.
Intangible Assets
Franchise Fees and Development Fees - The Company's Burger King and Chili's
franchise agreements require the payment of a franchise fee for each restaurant
opened. Franchise fees are deferred and amortized on the straight-line method
over the lives of the respective franchise agreements. Development fees paid to
Brinker were deferred and expensed in the period the related restaurants were
opened. Franchise fees are being amortized on a straight-line basis, generally
over 20 years.
Page 8
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Trademarks - The Company owns the trademarks for its Grady's American Grill,
Spageddies Italian Kitchen, Papa Vino's Italian Kitchen, Regas Grill and
Porterhouse Steaks and Seafood. During the second quarter of fiscal 2003 the
Company recorded an impairment charge of $4,411,000, consisting of a reduction
in the net book value of the Grady's American Grill trademark of $2,882,000 and
in the net book value of certain fixed assets of $1,529,000. The net book value
of the Grady's American Grill trademark was $1,123,000 as of February 15, 2004.
During the second quarter of fiscal 2003 the Company reviewed the useful life of
the Grady's American Grill trademark and determined that the remaining useful
life should be reduced from 15 years to five years. In determining the fair
value of the impaired assets, the Company relied primarily on the discounted
cash flow analyses that incorporated an investment horizon of five years and
utilized a risk adjusted discount factor.
Below are the gross carrying amount and accumulated amortization of the
trademarks, franchise fees and development fees as of February 15, 2004.
As of February 15, 2004
-----------------------
Net
Amortized Intangible Assets Gross Carrying Accumulated Book
- --------------------------- Amount Amortization Value
(Dollars in thousands) ------ ------------ -----
Amortized intangible assets:
Trademarks $ 2,809 $(1,607) $ 1,202
Franchise fees and development fees 14,782 (6,212) 8,570
------- ------- -------
Total $17,591 $(7,819) 9,772
======= ======= =======
As of October 26, 2003
----------------------
Net
Gross Carrying Accumulated Book
Amount Amortization Value
------ ------------ -----
Amortized intangible assets:
Trademarks $ 2,961 $(1,676) $ 1,285
Franchise fees and development fees 14,782 (5,981) 8,801
------- ------- -------
Total $17,743 $(7,657) $10,086
======= ======= =======
The Company's intangible asset amortization expense for the sixteen week period
ending February 15, 2004 was $314,000 compared to $343,000 for the comparable
periods in fiscal 2003. The estimated intangible amortization expense for each
of the next five years is as follows:
Year one $1,018,000
Year two $1,018,000
Year three $1,018,000
Year four $1,018,000
Year five $ 872,437
Page 9
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Goodwill - The Company operates four distinct restaurant concepts in the
food-service industry. It owns the Grady's American Grill and two Italian Dining
concepts and operates Burger King restaurants and Chili's Grill & Bar
restaurants as a franchisee of Burger King Corporation and Brinker
International, Inc., respectively. The Company has identified each restaurant
concept as an operating segment based on management structure and internal
reporting. The Company has two operating segments with goodwill - Chili's Grill
& Bar and Burger King. The Company had a total of $7,960,000 in goodwill as of
February 15, 2004. The Chili's Grill and Bar operating segment had $6,902,000 of
goodwill and the Burger King operating segment had $1,058,000 of goodwill.
Stock Options
The Company accounts for all of its stock-based compensation awards in
accordance with APB Opinion No. 25 which requires compensation cost to be
recognized based on the excess, if any, between the quoted market price of the
stock at the date of grant and the amount an employee must pay to acquire the
stock. Under this method, no compensation cost has been recognized for stock
option awards.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value method as prescribed by SFAS 123, the
Company's net earnings (loss) and net earnings (loss) per share would have been
the pro forma amounts indicated below:
Sixteen Weeks Ended
February 15, February 16,
(In thousands, except per share amounts) 2004 2003
---------------------------------------- ---- ----
Net income, as reported $ 279 $ 179
Deduct: Total stock option based employee
compensation expense determined by using
the Black-Scholes option pricing model,
net of related tax effects (9) (11)
----- -----
Net income, pro forma $ 270 $ 168
===== =====
Basic net income per common share, as reported $0.02 $0.02
===== =====
Basic net income per common share, pro forma $0.02 $0.02
===== =====
Diluted net income per common share, as reported $0.02 $0.02
===== =====
Diluted net income per common share, pro forma $0.02 $0.01
===== =====
Page 10
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Note 3: Acquisitions and Dispositions.
During the first sixteen weeks of fiscal 2004, the Company received net proceeds
of $1,297,000 from a sale-leaseback of one Grady's American Grill restaurant.
Subsequent to the end of the first quarter of fiscal 2004, the Company received
net proceeds of approximately $6,274,000 from the sale of another Grady's
American Grill restaurant and the sale-leaseback of five additional Grady's
American Grill restaurants. In each of the six sale-leaseback transactions, the
Company's lease obligations extend for less than one year.
During fiscal 2003, the Company sold four Grady's American Grill restaurants for
net proceeds of $4,779,000. The Company recorded a $1,160,000 gain related to
these sales in fiscal 2003.
As discussed in Note 2, discontinued operations includes the revenues and
expenses of the four Grady's American Grill restaurants that were sold in fiscal
2003, the one restaurant sold and leased back in the first quarter of fiscal
2004 and the eight restaurants that were being held for sale as of February 15,
2004. The decision to dispose of the locations reflects the Company's ongoing
process of evaluating the performance of the Grady's American Grill restaurants
and using the proceeds from dispositions to reduce debt. Assets held for sale
includes property, plant and equipment totaling $6,841,000 as of February 15,
2004.
Page 11
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Net income from discontinued operations for the periods ended February 15, 2004,
and February 16, 2003 were made up of the following components:
Sixteen Weeks Ended
February 15, February 16,
(In thousands, except per share amounts) 2004 2003
- ---------------------------------------- ---- ----
Revenue discontinued operations $ 3,639 $ 6,272
Income discontinued
restaurant operations 136 255
Gain on sale of assets 63 -
---------- -----------
Income before taxes 199 255
Income tax provision (11) (13)
Income from ---------- -----------
discontinued operations $ 188 $ 242
========== ===========
Basic and diluted net income per
share from discontinued operations $ 0.02 $ 0.02
========== ===========
Note 4: Commitments.
The Company is self-insured for a portion of its employee health care costs. The
Company is liable for medical claims up to $125,000 per eligible employee
annually, and aggregate annual claims up to approximately $3,160,000. The
aggregate annual deductible is determined by the number of eligible covered
employees during the year and the coverage they elect.
The Company is self-insured with respect to any worker's compensation claims not
covered by insurance. The Company maintains a $250,000 per occurrence deductible
and is liable for aggregate claims up to $2,400,000 for the twelve-month period
beginning September 1, 2003 and ending August 31, 2004.
The Company is self-insured with respect to any general liability claims below
the Company's self-insured retention of $150,000 per occurrence for the
twelve-month period beginning September 1, 2003 and ending August 31, 2004.
As of February 15, 2004, the Company has accrued $3,951,000 for the estimated
expense for its self-insured insurance plans. These accruals require management
to make significant estimates and assumptions. Actual results could differ from
management's estimates.
At February 15, 2004, the Company had commitments aggregating $1,570,000 for the
construction of restaurants.
The Company is involved in various legal proceedings incidental to the conduct
of its business, including employment discrimination claims. Based upon
currently available information, the Company does not expect that any such
proceedings will have a material adverse effect on the Company's financial
position or results of operations but there can be no assurance thereof.
Page 12
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Note 5: Debt Instruments.
As of February 15, 2004, the Company had a financing package totaling
$109,066,000, consisting of a $60,000,000 revolving credit agreement (the "Bank
Facility") and a $49,066,000 mortgage facility (the "Mortgage Facility"), as
described below.
The Mortgage Facility currently includes 34 separate mortgage notes, with
initial terms of either 15 or 20 years. The notes have fixed rates of interest
of either 9.79% or 9.94%. The notes require equal monthly interest and principal
payments. The mortgage notes are collateralized by a first mortgage/deed of
trust and security agreement on the real estate, improvements and equipment on
19 of the Company's Chili's restaurants (nine of which the Company mortgaged its
leasehold interest) and 15 of the Company's Burger King restaurants (three of
which the Company mortgaged its leasehold interest). The mortgage notes contain,
among other provisions, financial covenants which require the Company to
maintain a consolidated fixed charge coverage ratio of at least 1.30 for each of
six subsets of the financed properties.
The Company was not in compliance with the required consolidated fixed charge
coverage ratio for two of the subsets of the financed properties as of October
26, 2003. Both of these subsets are comprised solely of Burger King restaurants
and had fixed charge coverage ratios of 1.11 and 1.26 as of October 26, 2003.
The Company sought and obtained waivers of these covenant defaults from the
mortgage lenders through November 28, 2004. If the Company is not in compliance
with these covenants as of November 28, 2004, the Company will most likely seek
additional waivers. The Company believes it would be able to obtain such waivers
but there can be no assurance thereof. If the Company is unable to obtain such
waivers it is contractually entitled to pre-pay the outstanding balances under
one or more of the separate mortgage notes such that the remaining properties in
the subsets would meet the required ratio. However, any such prepayments would
be subject to prepayment premiums and to the Company's ability to maintain its
compliance with the financial covenants in its Bank Facility. Alternatively, the
Company is contractually entitled to substitute one or more better performing
restaurants for under-performing restaurants such that the reconstituted subsets
of properties would meet the required ratio. However, any such substitutions
would require the consent of the lenders in the Bank Facility. For these
reasons, the Company believes that its rights to prepay mortgage notes or
substitute properties may be impractical depending on the circumstances existing
at the time.
On June 10, 2002, the Company refinanced its Bank Facility with a $60,000,000
revolving credit agreement with JP Morgan Chase Bank, as agent, and four other
banks. The Bank Facility is collateralized by the stock of certain subsidiaries
of the Company, certain interests in the Company's franchise agreements with
Brinker and Burger King Corporation and substantially all of the Company's
personal property not pledged in the Mortgage Facility.
The Bank Facility contains restrictive covenants including maintenance of
certain prescribed debt and fixed charge coverage ratios, limitations on the
incurrence of additional indebtedness, limitations on consolidated capital
expenditures, cross-default provisions with other material agreements,
restrictions on the payment of dividends (other than stock dividends) and
limitations on the purchase or redemption of shares of the Company's capital
stock.
Page 13
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
The Bank Facility provides for borrowings at the adjusted LIBOR rate plus a
contractual spread which is as follows:
RATIO OF FUNDED DEBT
TO CASH FLOW LIBOR MARGIN
- ------------------------------------------------ ------------
Greater than or equal to 3.50 3.00%
Less than 3.5x but greater than or equal to 3.00 2.75%
Less than 3.0x but greater than or equal to 2.5x 2.25%
Less than 2.5x 1.75%
The Bank Facility also contains covenants requiring maintenance of funded debt
to cash flow and fixed charge coverage ratios as follows:
MAXIMUM FUNDED DEBT
TO CASH FLOW RATIO COVENANT
- -------------------- ----------
Fiscal 2003
Q1 through Q3 4.00
Q4 3.75
Fiscal 2004
Q1 through Q3 3.75
Q4 3.50
Fiscal 2005
Q1 through Q2 3.50
Thereafter 3.00
FIXED CHARGE COVERAGE RATIO 1.50
The Company's funded debt to consolidated cash flow ratio may not exceed 3.75
through the third quarter of fiscal 2004 and 3.50 by the end of fiscal 2004. The
Company's funded debt to consolidated cash flow ratio on February 15, 2004 was
3.66. To maintain the required ratios throughout fiscal 2004, the Company plans
to continue to dispose of under-performing restaurants, using the proceeds to
reduce debt and to continue its efforts to optimize cash flow from its
restaurant operations. Subsequent to the end of the first quarter of fiscal
2004, the Company sold six Grady's American Grill restaurants (five of which it
leased back) and received net proceeds of approximately $6,274,000.
If the Company does not maintain the required funded debt to consolidated cash
flow ratio, that would constitute an event of default under the Bank Facility.
The Company would then need to seek waivers from its lenders or amendments to
the covenants. If the Company was unable to obtain waivers from its lenders or
amendments to the covenants the Company would be in default under the Bank
Facility. During continuance of an event of default, the Company would be
subject to a post-default interest rate under the Bank Facility which increases
the otherwise effective interest rate by 1.50%. In addition to the right to
declare all obligations immediately due and payable, the Bank Facility also has
additional rights including, among other things, the right to sell any of the
collateral securing the Company's obligations under the Bank Facility. In the
event the Company's obligations under the Bank Facility become immediately due
and payable the Company does not have sufficient liquidity to satisfy these
obligations and it is likely that the Company would be forced to seek protection
from its creditors. Such events would also constitute a default under the
Company's franchise agreements with Brinker and Burger King Corporation.
Page 14
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Note 6: Net Income Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding. Diluted earnings per
share is based on the weighted average number of common shares outstanding plus
all potential dilutive common shares outstanding. For all years presented, the
difference between basic and dilutive shares represents options on common stock.
For the period ended February 15, 2004, 579,473 options were excluded from the
diluted earnings per share calculations because to do so would have been
anti-dilutive. For the period ended February 16, 2003, 638,189 options were
excluded from the diluted earnings per share calculations because to do so would
have been anti-dilutive.
Page 15
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 15, 2004
(UNAUDITED)
Note 7: Segment Reporting.
The Company operates four distinct restaurant concepts in the food-service
industry. It owns the Grady's American Grill and two Italian Dining concepts and
operates Burger King restaurants and Chili's Grill & Bar as a franchisee of
Burger King Corporation and Brinker International, Inc., respectively. The
Company has identified each restaurant concept as an operating segment based on
management structure and internal reporting. For purposes of applying SFAS 131,
the Company considers the Grady's American Grill, the two Italian concepts and
Chili's Grill & Bar to be similar and has aggregated them into a single
reportable operating segment (Full Service). The Company considers the Burger
King restaurants as a separate reportable segment (Quick Service). Summarized
financial information concerning the Company's reportable segments is shown in
the following table. The "all other" column is the VIE activity, see Note 2. The
"other reconciling items" column includes corporate related items, intercompany
eliminations and income and expense not allocated to reportable segments.
Other
Full Quick All Reconciling
(Dollars in thousands) Service Service Other Items Total
- ---------------------- ------- ------- ----- ----- -----
First quarter fiscal 2004
Revenues $31,756 $32,307 $ 1,100 $(1,100) $ 64,063
Income from restaurant
operations 4,121 3,175 214 503 8,013
Operating income (loss) 2,381 120 885 (523) $ 2,863
Interest expense (2,059)
Other income (441)
Income from continuing
operations before income ---------
taxes $ 363
=========
Total Assets 77,505 47,363 18,061 13,243 $ 156,172
Depreciation and
amortization 1,460 1,360 145 343 $ 3,308
First quarter fiscal 2003
Revenues $31,203 $33,941 $ 1,053 (1,053) $ 65,144
Income from restaurant
operations 4,292 2,968 197 482 7,939
Operating income (loss) 2,516 70 825 (529) $ 2,882
Interest expense (2,305)
Other income (299)
Income from continuing ---------
operations before income
taxes $ 278
=========
Total Assets 91,200 51,574 16,134 10,760 $ 169,668
Depreciation and
amortization 1,498 1,551 157 367 $ 3,573
Page 16
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company has a 52/53-week fiscal year ending on the last Sunday in October of
each year. The current fiscal year consists of 53 weeks and ends October 31,
2004. The first quarter of the Company's fiscal year consists of 16 weeks. The
second and third quarter of fiscal 2004 each consist of 12 weeks. The fiscal
2004 fourth quarter consists of 13 weeks.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentages which
certain items of revenue and expense bear to total revenues.
Sixteen weeks Ended
February 15, February 16,
2004 2003
---- ----
Total revenues 100.0% 100.0%
Operating expenses:
Restaurant operating expenses
Food and beverage 27.5 26.7
Payroll and benefits 29.3 29.7
Depreciation and amortization 4.5 4.7
Other operating expenses 26.3 26.7
------ ------
Total restaurant operating expenses 87.6 87.8
------ ------
Income from restaurant operations 12.4 12.2
General and administrative expenses 7.8 7.6
Amortization of intangibles 0.1 0.2
Facility closing costs - -
------ ------
Operating income 4.5 4.4
------ ------
Other income (expense):
Interest expense (3.2) (3.5)
Loss on sale of property and equipment (0.1) -
Minority partners interest (0.8) (1.2)
Other income, net 0.1 0.7
------ ------
Total other expense, net (4.0) (4.0)
------ ------
Income from continuing operation before income taxes 0.5 0.4
Income tax provision 0.4 0.5
------ ------
Income from continuing operations 0.1 (0.1)
Income from discontinued operations, net of tax 0.3 0.4
------ ------
Net income 0.4% 0.3
====== ======
Page 17
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Restaurant sales in the first quarter of fiscal 2004 were $64,063,000, a
decrease of $1,081,000, compared to restaurant sales of $65,144,000 in the first
quarter of fiscal 2003. The following factors influenced first quarter revenues:
The Company's Burger King restaurant sales decreased $1,634,000 to $32,307,000
in the first quarter of fiscal 2004 when compared to restaurant sales of
$33,941,000 in the same period of fiscal 2003. The Company had increased revenue
of $678,000 due to additional sales weeks from three restaurants opened in
fiscal 2003. The Company's Burger King restaurants had average weekly sales of
$17,112 in the first quarter of fiscal 2004 versus $18,412 in the same period in
fiscal 2003. Sales at restaurants owned for more than one year decreased 7.3% in
the first quarter of fiscal 2004 when compared to the same period in fiscal
2003. The Company believes that the sales decline it experienced in the first
quarter of fiscal 2004 resulted primarily from ineffective marketing and
unsuccessful new product introductions by Burger King Corporation.
The Company's Chili's Grill & Bar restaurant sales increased $1,290,000 to
$24,807,000 in the first quarter of fiscal 2004 compared to restaurant sales of
$23,517,000 in the same period in fiscal 2003. The Company had increased revenue
of $1,861,000 due to additional sales weeks from three restaurants opened during
fiscal 2003. Average weekly sales were $41,903 in the first quarter of fiscal
2004 versus $43,729 in the same period in fiscal 2003. Sales at restaurants open
for more than one year decreased 2.5% in the first quarter of fiscal 2004 when
compared to the same period in fiscal 2003. Restaurant sales were hindered by
harsh winter weather in the Company's Philadelphia market.
Sales in the Company's Grady's American Grill restaurant division decreased
$120,000 to $1,922,000 in the first quarter of fiscal 2004 compared to sales of
$2,042,000 in the same period in fiscal 2003. The Company sold four units in
fiscal 2003, one unit in the first quarter of fiscal 2004 and had committed to
dispose of nine more units as of February 15, 2004. As required by SFAS 144, the
results of operations for these restaurants have been classified as discontinued
operations for all periods reported. The remaining three Grady's American Grill
restaurants had average weekly sales of $40,050 in the first quarter of fiscal
2004 versus $42,537 in the first quarter of fiscal 2003, a decrease of 5.8%. The
Company believes sales declines in its Grady's American Grill division resulted
from competitive intrusion and the Company's inability to efficiently market
this concept.
The Company's Italian Dining Division restaurant sales decreased $617,000 to
$5,027,000 in the first quarter of fiscal 2004 when compared to restaurant sales
of $5,644,000 in the same period in fiscal 2003. Average weekly sales were
$34,913 in the first quarter of fiscal 2004 versus $39,198 in fiscal 2003. Sales
at restaurants open for more than one year decreased 11.0% in the first quarter
of fiscal 2004 when compared to the same period in fiscal 2003. The Company
believes that the sales declines it experienced in its Italian division resulted
primarily from competitive intrusion and the Company's inability to efficiently
market this concept.
Total restaurant operating expenses were 87.6% of revenues in the first quarter
of fiscal 2004 versus 87.8% in the first quarter of fiscal 2003. The following
factors influenced the operating margins:
Food and beverage costs were $17,586,000, or 27.5% of total revenues, in the
first quarter of fiscal 2004, compared to $17,399,000, or 26.7% of total
revenues, in the same period in fiscal 2003. Food and beverage costs as a
percentage of sales increased in all the Company's restaurant concepts, mainly
due to higher beef prices.
Page 18
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Payroll and benefits were $18,780,000 in the first quarter of fiscal 2004,
compared to $19,336,000 in the same period in fiscal 2003. As a percentage of
total revenues, payroll and benefits decreased to 29.3% in the first quarter of
fiscal 2004 from 29.7% in the same period of fiscal 2003. Payroll and benefits,
as a percentage of sales, improved in both the quick service and the full
service segments. The improvement was mainly due to the Company's increased
focus on payroll costs in light of declining sales. The Company does not believe
that it can continue to decrease payroll expense without diminishing customer
satisfaction; therefore, if the negative sales trends do not abate, payroll
costs as a percentage of sales are likely to increase in the remaining quarters
of fiscal 2004.
Depreciation and amortization expense was $2,928,000 in the first quarter of
fiscal 2004 compared to $3,075,000 in the first quarter of fiscal 2003. As a
percentage of total restaurant sales, depreciation and amortization decreased to
4.5% for the first quarter of fiscal 2004 compared to 4.7% in the same period in
fiscal 2003. The decrease, as a percentage of revenues, was mainly due to a
$191,000 decrease in depreciation expense in the quick service segment. The
decrease was mainly due to certain assets becoming full depreciated.
Other restaurant operating expenses include rent and utilities, royalties,
promotional expense, repairs and maintenance, property taxes and insurance.
Other restaurant operating expenses were $16,756,000 in the first quarter of
fiscal 2004 compared to $17,395,000 in the same period of fiscal 2003. As a
percentage of total revenues, other restaurant operating expenses were 26.3% in
the first quarter of fiscal 2004 compared to 26.7% in the same period of fiscal
2003. The Company's other operating expenses, as a percentage of sales,
decreased in the Company's quick service segment, mainly due to a $711,000
decrease in promotional expenses. The Company's other operating expenses, as a
percentage of sales, increased in the Company's full service segment, primarily
due to lower average weekly sales at each of the Company's full service
restaurants.
Income from restaurant operations increased $74,000 to $8,013,000, or 12.4% of
revenues, in the first quarter of fiscal 2004 compared to $7,939,0000, or 12.2%
of revenues, in the comparable period of fiscal 2003. Income from restaurant
operations in the Company's quick service segment increased by $207,000,
primarily due to a decrease in promotional expenditures and a reduction in
payroll expense. Income from restaurant operations in the full service segment
decreased by $171,000, mainly due to decreased average weekly sales at the full
service concepts.
General and administrative expenses increased $78,000 to $5,014,000, or 7.8% of
revenues, in the first quarter of fiscal 2004 compared to $4,936,0000, or 7.6%
of revenues, in the comparable period of fiscal 2003. The Company had a $534,000
increase in bonus expense in fiscal 2004 versus fiscal 2003 because the Company
was significantly below its profitability targets at the end of the first
quarter. The increase in bonus expense was partially offset by a $142,000
decrease in payroll expense due to headcount reductions at the Corporate office
and a $116,000 decrease in legal fees.
Trademark amortization was $82,000 in the first quarter of fiscal 2004 compared
to $116,000 in the first quarter of fiscal 2003. In the second quarter of fiscal
2003 the Company reduced the Grady's trademark by $2,882,000 through an
impairment charge. The Company also determined that the useful life of the
trademark should be reduced from 15 to five years. The net effect of these
changes reduced trademark amortization by $34,000 in the first quarter of fiscal
2004.
Total other expenses were $2,500,000 for the first quarter of fiscal 2004 versus
$2,604,000 during the comparable period in fiscal 2003. The decrease was mainly
due to a $246,000 decrease in interest expense. The decrease in
Page 19
2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
interest expense was due to lower debt levels and a decrease in interest rates.
Income tax expense of $272,000 was recorded in the first quarter of fiscal 2004
compared to $341,000 in the same period of fiscal 2003. The provision for income
taxes in the first quarter of fiscal 2004 and the first quarter of fiscal 2003
consisted of the Company's estimated state tax expense.
At the end of the first quarter of fiscal 2004 the Company had a valuation
reserve against its deferred tax asset resulting in a net deferred tax asset of
$9.0 million. The Company's assessment of its ability to realize the net
deferred tax asset was based on the weight of both positive and negative
evidence, including the taxable income of its current operations. Based on this
assessment, the Company believes it is more likely than not that the net
deferred tax asset of $9.0 million will be realized. Such evidence is reviewed
periodically and could result in the recognition of additional tax benefit or
expense related to its net deferred tax asset position in the future.
Discontinued operations includes all disposed of restaurants and the nine
current Grady's American Grill restaurants which at the end of the first quarter
the Company expected to sell before the end of fiscal 2004. The decision to
dispose of these locations reflects the Company's ongoing process of evaluating
the performance and cash flows of its various restaurant locations and using the
proceeds from the sale of closed restaurants to reduce outstanding debt. The net
income from discontinued operations for the first quarter of fiscal 2004 was
$188,000 versus income of $242,000 in fiscal 2003. The total restaurant sales
from discontinued operations for fiscal 2004 were $3,639,000 versus $6,272,000
in fiscal 2003.
For the first quarter of fiscal 2004, the Company reported net income of
$279,000 compared to net income of $179,000 for the first quarter of fiscal
2003.
Management Outlook
The following section contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, including statements about
trends in and the impact of certain initiatives upon the Company's operations
and financial results. Forward-looking statements can be identified by the use
of words such as "anticipates," "believes," "plans," "estimates," "expects,"
"intends," "may," and other similar expressions. Forward-looking statements are
made based upon management's current expectations and beliefs concerning future
developments and their potential effects on the Company. There can be no
assurance that the Company will actually achieve the plans, intentions and
expectations discussed in these forward-looking statements. Actual results may
differ materially.
Quick Service
The quick service segment of the restaurant industry is a very mature and
competitive segment, which is dominated by several national chains. Market share
is gained through national media campaigns promoting specific sandwiches,
usually at a discounted price. The national chains extend marketing efforts to
include nationwide premiums and movie tie-ins. To date in fiscal 2004, other
chains in the quick-service restaurant industry, including McDonald's and
Wendy's, promotional campaigns and new products have been successful in taking
away market share from Burger King. The Company believes that the introduction
of appealing new products and improved promotional campaigns is a prerequisite
for successfully gaining market share in the quick service segment.
Page 20
2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
Full Service
The full service segment of the restaurant industry is also mature and
competitive. This segment has a few national companies that utilize national
media efficiently. This segment also has numerous regional and local chains that
provide service and products comparable to the national chains but which cannot
support significant marketing campaigns. The Company operates three restaurant
concepts that compete in the full service segment.
During fiscal 2004, the Company has continued to emphasize the operational and
marketing initiatives that contributed to the success of its Chili's division in
fiscal 2003. While the average weekly sales trends were not as good as the
Company had expected, the Company expects steady financial results for the
remainder of fiscal 2004.
During the first quarter of fiscal 2004, the Company continued to experience a
deterioration in its Italian Dining division's profitability. The Company has
experienced significant competitive intrusion in the markets where it has
Italian Dining restaurants. The Company expects the competitive pressures to
continue for the remainder of fiscal 2004.
During the first quarter of fiscal 2004, the Grady's American Grill concept was
negatively affected by competitive intrusion in the Company's markets and
limitations in the Company's ability to efficiently market its restaurants. The
Company will continue to consider opportunities to divest under-performing or
non-strategic restaurants during fiscal 2004. The Company expects the Grady's
American Grill division's operating performance to continue to decline during
fiscal 2004.
Income taxes
The Company has recorded a valuation allowance to reduce its deferred tax assets
since it is more likely than not that some portion of the deferred assets will
not be realized. Management has considered all available evidence both positive
and negative, including the Company's historical operating results, estimates of
future taxable income and ongoing feasible tax strategies in assessing the need
for the valuation allowance. The Company believes the positive evidence includes
the historically consistent profitability of its Chili's, Italian Dining and
Burger King divisions, and the resolution of substantially all of its
bagel-related contingent liabilities. The Company believes the negative evidence
includes the persistent negative trends in its Grady's American Grill division
and the recent sales declines in its Burger King division. During the first
quarter of fiscal 2004, the Company continued to experience unusual uncertainty
concerning whether, when and to what extent the recent sales declines in its
Burger King division will be reversed. In estimating its deferred tax asset,
management used its 2004 operating plan as the basis for a forecast of future
taxable earnings. Management did not incorporate growth assumptions and limited
the forecast to five years, the period that management believes it can project
results that are more likely than not achievable. Absent a significant and
unforeseen change in facts or circumstances, management re-evaluates the
realizability of its tax assets in connection with its annual budgeting cycle.
Page 21
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital principally for building or acquiring new
restaurants, replacing equipment and remodeling existing restaurants. The
Company's restaurants generate cash immediately through sales. As is customary
in the restaurant industry, the Company does not have significant assets in the
form of trade receivables or inventory, and customary payment terms generally
result in several weeks of trade credit from its vendors. Therefore, the
Company's current liabilities have historically exceeded its current assets.
During the first sixteen weeks of 2004, net cash provided by operating
activities was $6,101,000 compared to $3,842,000 in fiscal 2003. The increase
was mainly due to changes in working capital that provided cash.
During the first sixteen weeks of fiscal 2004, the Company had $1,633,000 in
capital expenditures in connection with the building of one new full service
restaurant that will open in the second quarter of fiscal 2004 and the
refurbishing of existing restaurants.
The Company had a net repayment of $4,600,000 under its revolving credit
agreement during the first sixteen weeks of fiscal 2004. As of February 15,
2004, the Company's revolving credit agreement had an additional $18,654,000
available for future borrowings. The Company's average borrowing rate on
February 15, 2004, was 4.24%.
The Company's primary cash requirements in fiscal 2004 will be capital
expenditures in connection with the building or acquiring of new restaurants,
remodeling of existing restaurants, maintenance expenditures, and the reduction
of debt under the Company's debt agreements. During the remainder of fiscal
2004, the Company anticipates opening two or three full service restaurants. The
Company does not plan to open any new quick service restaurants. The actual
amount of the Company's cash requirements for capital expenditures depends in
part on the number of new restaurants opened, whether the Company owns or leases
new units, and the actual expense related to remodeling and maintenance of
existing units. While the Company's capital expenditures for fiscal 2004 are
expected to range from $10,000,000 to $12,000,000, if the Company has
alternative uses or needs for its cash, the Company believes it could reduce
such planned expenditures without affecting its current operations. The Company
has debt service requirements of approximately $1,474,000 in fiscal 2004,
consisting primarily of the principal payments required under its mortgage
facility. The Company expects to reduce its borrowings under its revolving
credit agreement by $7,000,000 before year end and therefore has classified
$7,000,000 of revolving credit debt as current. The Company had $5,431,000 of
current debt related to the consolidation of its variable interest entities, see
Note 2.
The Company anticipates that its cash flow from operations, together with the
$18,654,000 available under its revolving credit agreement as of February 15,
2004, will provide sufficient funds for its operating, capital expenditure, debt
service and other requirements through the end of fiscal 2004.
As of February 15, 2004, the Company had a financing package totaling
$109,066,000, consisting of a $60,000,000 revolving credit agreement (the "Bank
Facility") and a $49,066,000 mortgage facility (the "Mortgage Facility"), as
described below.
The Mortgage Facility currently includes 34 separate mortgage notes, with
initial terms of either 15 or 20 years. The notes have fixed rates of interest
of either 9.79% or 9.94%. The notes require equal monthly interest and principal
payments. The mortgage notes are collateralized by a first mortgage/deed of
trust and security agreement on the real estate, improvements
Page 22
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
and equipment on 19 of the Company's Chili's restaurants (nine of which the
Company mortgaged its leasehold interest) and 15 of the Company's Burger King
restaurants (three of which the Company mortgaged its leasehold interest). The
mortgage notes contain, among other provisions, financial covenants which
require the Company to maintain a consolidated fixed charge coverage ratio of at
least 1.30 for each of six subsets of the financed properties.
The Company was not in compliance with the required consolidated fixed charge
coverage ratio for two of the subsets of the financed properties as of October
26, 2003. Both of these subsets are comprised solely of Burger King restaurants
and had fixed charge coverage ratios of 1.11 and 1.26 as of October 26, 2003.
The Company sought and obtained waivers of these covenant defaults from the
mortgage lenders through November 28, 2004. If the Company is not in compliance
with these covenants as of November 28, 2004, the Company will most likely seek
additional waivers. The Company believes it would be able to obtain such waivers
but there can be no assurance thereof. If the Company is unable to obtain such
waivers it is contractually entitled to pre-pay the outstanding balances under
one or more of the separate mortgage notes such that the remaining properties in
the subsets would meet the required ratio. However, any such prepayments would
be subject to prepayment premiums and to the Company's ability to maintain its
compliance with the financial covenants in its Bank Facility. Alternatively, the
Company is contractually entitled to substitute one or more better performing
restaurants for under-performing restaurants such that the reconstituted subsets
of properties would meet the required ratio. However, any such substitutions
would require the consent of the lenders in the Bank Facility. For these
reasons, the Company believes that its rights to prepay mortgage notes or
substitute properties may be impractical depending on the circumstances existing
at the time.
On June 10, 2002, the Company refinanced its Bank Facility with a $60,000,000
revolving credit agreement with JP Morgan Chase Bank, as agent, and four other
banks. The Bank Facility is collateralized by the stock of certain subsidiaries
of the Company, certain interests in the Company's franchise agreements with
Brinker and Burger King Corporation and substantially all of the Company's
personal property not pledged in the Mortgage Facility.
The Bank Facility contains restrictive covenants including maintenance of
certain prescribed debt and fixed charge coverage ratios, limitations on the
incurrence of additional indebtedness, limitations on consolidated capital
expenditures, cross-default provisions with other material agreements,
restrictions on the payment of dividends (other than stock dividends) and
limitations on the purchase or redemption of shares of the Company's capital
stock.
The Bank Facility provides for borrowings at the adjusted LIBOR rate plus a
contractual spread which is as follows:
RATIO OF FUNDED DEBT
TO CASH FLOW LIBOR MARGIN
- ------------------------------------------------ -------------
Greater than or equal to 3.50 3.00%
Less than 3.5x but greater than or equal to 3.00 2.75%
Less than 3.0x but greater than or equal to 2.5x 2.25%
Less than 2.5x 1.75%
Page 23
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Bank Facility also contains covenants requiring maintenance of funded debt
to cash flow and fixed charge coverage ratios for fiscal 2004 and 2005 as
follows:
MAXIMUM FUNDED DEBT
TO CASH FLOW RATIO COVENANT
- -------------------- -------
Fiscal 2003
Q1 through Q3 4.00
Q4 3.75
Fiscal 2004
Q1 through Q3 3.75
Q4 3.50
Fiscal 2005
Q1 through Q2 3.50
Thereafter 3.00
FIXED CHARGE COVERAGE RATIO 1.50
The Company's funded debt to consolidated cash flow ratio may not exceed 3.75
through the third quarter of fiscal 2004 and 3.50 by the end of fiscal 2004. The
Company's funded debt to consolidated cash flow ratio on February 15, 2004 was
3.66. To maintain the required ratios throughout fiscal 2004, the Company plans
to continue to dispose of under-performing restaurants, using the proceeds to
reduce debt. Subsequent to the end of the first quarter of fiscal 2004, the
Company sold six Grady's American Grill restaurants (five of which it leased
back) and received net proceeds of approximately $6,274,000).
If the Company does not maintain the required funded debt to consolidated cash
flow ratio, that would constitute an event of default under the Bank Facility.
The Company would then need to seek waivers from its lenders or amendments to
the covenants. If the Company was unable to obtain waivers from its lenders or
amendments to the covenants the Company would be in default under the Bank
Facility. During continuance of an event of default, the Company would be
subject to a post-default interest rate under the Bank Facility which increases
the otherwise effective interest rate by 1.50%. In addition to the right to
declare all obligations immediately due and payable, the Bank Facility also has
additional rights including, among other things, the right to sell any of the
collateral securing the Company's obligations under the Bank Facility. In the
event the Company's obligations under the Bank Facility become immediately due
and payable the Company does not have sufficient liquidity to satisfy these
obligations and it is likely that the Company would be forced to seek protection
from its creditors. Such events would also constitute a default under the
Company's franchise agreements with Brinker and Burger King Corporation.
Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of
Operations are based upon the Company's consolidated financial statements, which
were prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and notes thereto. Actual results may differ from these estimates,
and such differences may be material to the consolidated financial statements.
Management believes that the following significant accounting policies involve a
higher degree of judgment or complexity.
Page 24
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Property and Equipment
Property and equipment are depreciated on a straight-line basis over the
estimated useful lives of the assets. The useful lives of the assets are based
upon management's expectations for the period of time that the asset will be
used for the generation of revenue. Management periodically reviews the assets
for changes in circumstances that may impact their useful lives.
Impairment of Long-Lived Assets
Management periodically reviews property and equipment for impairment using
historical cash flows as well as current estimates of future cash flows. This
assessment process requires the use of estimates and assumptions that are
subject to a high degree of judgment. In addition, at least annually, or as
circumstances dictate, management assesses the recoverability of goodwill and
other intangible assets which requires assumptions regarding the future cash
flows and other factors to determine the fair value of the assets. In
determining fair value, the Company relies primarily on discounted cash flow
analyses that incorporates an investment horizon of five years and utilizes a
risk adjusted discount factor. If these assumptions change in the future,
management may be required to record impairment charges for these assets. As a
result of the adoption of Statement of Financial Accounting Standard ("SFAS")
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the
Company has classified the revenues, expenses and related assets and liabilities
of four Grady's American Grill restaurants that were sold in fiscal 2003, one
Grady's American Grill that the Company sold and leased back in the first
quarter of fiscal 2004 and nine Grady's American Grill restaurants that are held
for sale, as discontinued operations in the accompanying consolidated financial
statements.
Page 25
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Income taxes
The Company has recorded a valuation allowance to reduce its deferred tax assets
since it is more likely than not that some portion of the deferred assets will
not be realized. Management has considered all available evidence both positive
and negative, including the Company's historical operating results, estimates of
future taxable income and ongoing feasible tax strategies in assessing the need
for the valuation allowance. In estimating its deferred tax asset, management
used its 2004 operating plan as the basis for a forecast of future taxable
earnings. Management did not incorporate growth assumptions and limited the
forecast to five years, the period that management believes it can project
results that are more likely than not achievable. Absent a significant and
unforeseen change in facts or circumstances, management re-evaluates the
realizability of its tax assets in connection with its annual budgeting cycle.
The Company operates in a very competitive industry that can be significantly
affected by changes in local, regional or national economic conditions, changes
in consumer tastes, weather conditions and various other consumer concerns.
Accordingly, the amount of the deferred tax asset considered by management to be
realizable, more likely than not, could change in the near term if estimates of
future taxable income change. This could result in a charge to, or increase in,
income in the period such determination is made.
Other estimates
Management is required to make judgments and or estimates in the determination
of several of the accruals that are reflected in the consolidated financial
statements. Management believes that the following accruals are subject to a
higher degree of judgment.
Management uses estimates in the determination of the required accruals for
general liability, workers' compensation and health insurance. These estimates
are based upon a detailed examination of historical and industry claims
experience. The claims experience may change in the future and may require
management to revise these accruals.
The Company is periodically involved in various legal actions arising in the
normal course of business. Management is required to assess the probability of
any adverse judgments as well as the potential ranges of any losses. Management
determines the required accruals after a careful review of the facts of each
legal action and assistance from outside legal counsel. The accruals may change
in the future due to new developments in these matters.
Management continually reassesses its assumptions and judgments and makes
adjustments when significant facts and circumstances dictate. Historically,
actual results have not been materially different than the estimates that are
described above.
Page 26
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
This report contains and incorporates forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements about the Company's development plans and trends in the Company's
operations and financial results. Forward-looking statements can be identified
by the use of words such as "anticipates," "believes," "plans," "estimates,"
"expects," "intends," "may," and other similar expressions. Forward-looking
statements are made based upon management's current expectations and beliefs
concerning future developments and their potential effects on the Company. There
can be no assurance that the Company will actually achieve the plans, intentions
and expectations discussed in these forward-looking statements. Actual results
may differ materially. Among the risks and uncertainties that could cause actual
results to differ materially are the following: the availability and cost of
suitable locations for new restaurants; the availability and cost of capital to
the Company; the ability of the Company to develop and operate its restaurants;
the hiring, training and retention of skilled corporate and restaurant
management and other restaurant personnel; the integration and assimilation of
acquired concepts; the overall success of the Company's franchisors; the ability
to obtain the necessary government approvals and third-party consents; changes
in governmental regulations, including increases in the minimum wage; the
results of pending litigation; and weather and other acts of God. The Company
undertakes no obligation to update or revise any forward-looking information,
whether as a result of new information, future developments or otherwise.
Page 27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate risk in connection with its $60.0
million revolving credit facility which provides for interest payable at the
LIBOR rate plus a contractual spread. The Company's variable rate borrowings
under this revolving credit facility totaled $39.0 million at February 15, 2004.
The impact on the Company's annual results of operations of a one-point interest
rate change would be approximately $390,000.
ITEM 4. CONTROLS AND PROCEDURES.
As of the end of the period covered by this report, the Company conducted an
evaluation, under the supervision and with the participation of the principal
executive officer and principal financial officer, of its disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 (the "Exchange Act")). Based on this evaluation, the
principal executive officer and principal financial officer concluded that the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. There was no change in the Company's internal control over financial
reporting during the Company's most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
Page 28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Note 4 to the unaudited consolidated financial statements of the Company
included in Part I of this report is incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
On March 9, 2004, the Company held its annual meeting of shareholders. At the
meeting, the shareholders elected the following directors by the vote indicated
to serve until the year 2007 annual meeting of shareholders.
For Withheld
---------- --------
James K. Fitzpatrick 10,601,265 219,527
Ezra H. Friedlander 10,592,765 228,027
Steven M. Lewis 10,615,165 206,627
In addition, the following directors continue in office until the annual meeting
of shareholders in the year indicated:
Term Expires
------------
Bruce M. Jacobson 2005
Christopher J. Murphy III 2005
Daniel B. Fitzpatrick 2006
Philip J. Faccenda 2006
The appointment of PricewaterhouseCoopers LLP as auditors for the Company for
2004 was ratified:
For 10,639,190; Against 124,992; Abstentions 56,610
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
A list of exhibits required to be filed as part of this report is set
forth in the Index to Exhibits, which immediately precedes such
exhibits, and is incorporated herein by reference.
(b) Reports on Form 8-K
On March 31, 2004, the Company filed a current report on Form 8-K
furnishing under Item 12 a copy of the Company's press release dated
March 31, 2004.
Page 29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Quality Dining, Inc.
(Registrant)
Date: March 31, 2004 By: /s/John C. Firth
------------------------------
Executive Vice President
General Counsel and Secretary
(Principal Financial Officer)
Page 30
INDEX TO EXHIBITS
Exhibit Number Description
- -------------- -------------------------------------------------------
31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Principal
Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Executive Vice President
and General Counsel (Principal Financial Officer)
Page 31