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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED DECEMBER 31, 1997
GIANT GROUP, LTD.
9000 Sunset Boulevard, 16th Floor, Los Angeles, California 90069
Registrant's telephone number (310) 273-5678
Commission File Number 1-4323
I.R.S. Employer Identification Number 23-0622690
State of Incorporation Delaware
Securities registered pursuant to 12(b) of the Act:
Name of Each Exchange
Title of Class on Which Registered
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Common Stock, New York
$.01 Par Value Stock Exchange
(together with Preferred
Stock Purchase Rights)
Securities registered pursuant to 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
X
---
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 the 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.
---
As of March 20, 1998, 3,180,655 shares of the registrant's common stock,
par value $.01 per share, were outstanding, and the aggregate market value of
the registrant's common stock held by non-affiliates based on the closing price
on the New York Stock Exchange on March 20, 1998 was $10.2 million.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's definitive proxy statement for the annual
meeting of stockholders of the Company to be held June 8, 1998, are incorporated
by reference into Part III of this Report.
Exhibit Index located at page 36 herein.
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TABLE OF CONTENTS
PART I Page No.
Item 1. Business 3
Item 2. Properties 6
Item 3. Legal proceedings 6
Item 4. Submission of matters to a vote of security holders 9
PART II
Item 5. Market for the registrant's common equity and related stockholder matters 9
Item 6. Selected financial data 10
Item 7. Management's discussion and analysis of financial condition and results of operations 11
Item 8. Financial statements and supplementary data 15
Item 9. Changes in and disagreements with accountants on accounting and financial disclosure 36
PART III
Item 10. Directors and executive officers of the registrant 36
Item 11. Executive compensation 36
Item 12. Security ownership of certain beneficial owners and management 36
Item 13. Certain relationships and related transactions 36
PART IV
Item 14. Exhibits, financial statement schedules and reports on Form 8-K 36
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PART I
ITEM 1. BUSINESS.
LUXURY YACHTS
GIANT GROUP, LTD. (herein referred to as the "Company" or "GIANT") is
a corporation, which was organized under the laws of the State of Delaware in
1913. The Company's wholly-owned subsidiaries include GIANT MARINE GROUP, LTD.
d/b/a The Ocean Group ("GIANT MARINE"), organized under the laws of the state of
Delaware in 1996. GIANT MARINE is an operating company that was established to
start and operate a new business venture, co-ownership of luxury yachts. GIANT
MARINE's assets include two luxury yachts and related yacht improvements and
equipment.
On October 31, 1996, the Company started a new business and formed a
new wholly-owned subsidiary, GIANT MARINE, which offered the world's first
Luxury Yacht Co-Ownership Program of this type (the "Co-Ownership Program"). The
Co-Ownership Program provided individuals and companies the opportunity for a
Co-Ownership Program of a minimum of one-fourth interest in large ocean cruising
yachts. In addition, a 100% ownership in the luxury yacht was available. This
program also provided for the management of these yachts by The Ocean Group
resulting in a practical and economical way to own these yachts. In 1996, in
furtherance of this Co-Ownership Program, the Company purchased two yachts.
On November 17, 1997, the Company announced that GIANT MARINE would
end the Co-Ownership Program. The advertising in national newspapers and
yachting magazines and two actual presentations at major yacht shows attracted
many interested people, but only one, one-quarter interest was sold. The sale
was rescinded when management and the Board of Directors, after reviewing the
amount of time required to sell the quarter interests in the yachts, concluded
that the potential return on the capital invested did not justify continuing the
Co-Ownership Program. The yachts are now being marketed for sale, and are
included in assets held-for-sale on the Company's consolidated balance sheets.
Until they are sold, the yachts are being chartered.
RALLY'S HAMBURGERS, INC.
GIANT, through its ownership of common stock of Rally's Hamburgers,
Inc. ("Rally's"), also is involved in the operation and franchising of double
drive-through hamburger restaurants. Rally's is one of the largest chains of
double drive-through restaurants in the United States. On December 28, 1997, the
Rally's system included 477 restaurants in approximately 18 states, primarily in
the Midwest, comprised of 229 company-owned restaurants and 248 franchised
restaurants, including 27 restaurants in Western markets which are operated as
Rally's restaurants by CKE Restaurants, Inc. ("CKE"), an owner of Carl's Jr., a
competing fast-food restaurant chain (see Item 1. "Business", General
Development of Business, page 4). Two additional company-owned restaurants have
been converted to a Carl Jr.'s format and are not included in the restaurant
count. Rally's restaurants offer high quality fast food served quickly at
everyday prices generally below the regular prices of the four largest hamburger
chains. Rally's serves the drive-through and take-out segments of the
quick-service restaurant market. Rally's opened its first restaurant in January
1985 and began offering franchises in November 1986.
CHECKERS DRIVE-IN RESTAURANTS, INC.
Rally's owns approximately 27% of the outstanding common stock of
Checkers Drive-In Restaurants, Inc. ("Checkers"). Checkers develops, produces,
owns, operates and franchises quick-service "double drive-through"
restaurants. The restaurants are designed to provide fast and efficient
automobile-oriented service incorporating a 1950's diner and art deco theme with
a highly visible, distinctive and uniform look that is intended to appeal to
customers of all ages. The restaurants feature a limited menu of high quality
hamburgers, cheeseburgers and bacon cheeseburgers, specially seasoned french
fries, hot dogs, chicken sandwiches, as well as related items such as soft
drinks and old fashioned premium milk shakes, at everyday low prices. At
December 29, 1997, the Checkers system included 479 restaurants in 35 states and
the District of Columbia, Puerto Rico and West Bank, Israel, comprised of 230
company-owned and 249 franchised restaurants.
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ITEM 1. BUSINESS. (Cont.)
GENERAL DEVELOPMENT OF BUSINESS
From 1985 through October 1994, GIANT's major operating subsidiaries
were Giant Cement Company ("Giant Cement") and Keystone Cement Company, which
manufactured portland and masonry cements sold to ready-mix concrete plants,
concrete product manufacturers, building material dealers, construction
contractors and state and local government agencies. From 1987 through October
1994, GIANT also owned Giant Resource Recovery Company, Inc., which was a
marketing agent for resource recovery services for Giant Cement. On October 6,
1994, KCC Delaware Company ("KCC"), a wholly owned subsidiary of GIANT,
organized under the laws of the State of Delaware in 1985, sold 100% of the
stock of its wholly-owned subsidiary, Giant Cement Holding, Inc., through an
initial public offering. The Company received net proceeds of $125.8 million,
which resulted in a gain of $77 million before income taxes of $28.8 million. As
a result of the transaction, GIANT has fully divested its cement and resource
recovery operations.
Beginning in 1987, GIANT, through its equity investment in Rally's,
has been involved in the operation of double drive-through hamburger restaurants
and as of December 31, 1995 owned 48% of Rally's outstanding common stock. In
December 1995, GIANT filed an action against Fidelity National Financial, Inc.
("Fidelity"), CKE, an affiliate of Fidelity, and William P. Foley II
("Foley"), among others, arising from an attempted hostile takeover of Rally's
and GIANT, by Fidelity and Foley, which indirectly owns and/or controls Carl's
Jr., a competing fast-food restaurant chain. In January 1996, Fidelity and Foley
filed a counterclaim against GIANT and its Board of Directors alleging, among
other claims, that GIANT's Directors breached their fiduciary duties in
conjunction with certain enumerated transactions. On February 14, 1996, Fidelity
made an offer to acquire the Company in a merger by which the Company's
stockholders would acquire Fidelity common stock valued by Fidelity at $12.00
for each outstanding share of GIANT Common Stock. The Company's Board of
Directors determined that the Company was not for sale and unconditionally
rejected the merger offer. In April, the parties settled their disputes,
pursuant to a Purchase and Standstill Agreement (the "Agreement"). As a
result, Fidelity sold its investment of 705,000 shares in GIANT to the Company
for $6.1 million; Fidelity and CKE acquired an aggregate of approximately
3,118,000 shares of Rally's common stock from GIANT for $4.8 million and GIANT
recognized a pre-tax gain of $3.2 million; GIANT granted Fidelity and CKE
options to each purchase 1,175,000 shares of Rally's common stock at prices
ranging from $3.00 to $4.00 per share; two designees of CKE and Fidelity were
elected to Rally's Board and Fidelity agreed to a 10 year standstill with
respect to GIANT and its Common Stock. In March 1997, 1,175,000 options granted
to CKE and Fidelity by GIANT to purchase Rally's common stock at $4.00 per share
were canceled.
On January 22, 1996, the Company announced that it intended to offer
to exchange a new series of GIANT participating, non-voting preferred stock for
Rally's outstanding common stock ("Exchange Offer"). Upon successful completion
of the Exchange Offer, GIANT would have owned 79.9% of Rally's outstanding
common stock. On April 22, 1996, Rally's Board of Directors, after discussions
between a special committee of the Rally's Board and Donald E. Doyle, President
and Chief Executive Officer of Rally's, requested that GIANT terminate the
Exchange Offer. The termination was requested to retain sufficient market
capitalization to allow Rally's easier access to the capital markets to raise
capital in the future. GIANT agreed to the request and terminated the proposed
Exchange Offer.
During the period May 1996 through November 1996, GIANT's investment
in Rally's outstanding common stock decreased to approximately 15% from 48% at
December 31, 1995. The investment percentage decreased because of the following
three reasons: the sale by GIANT, on May 3, 1996, of approximately 768,000
shares of Rally's common stock to Fidelity and approximately 2,350,000 shares of
Rally's common stock to CKE; GIANT did not elect to participate in Rally's
Shareholder Rights Offering, completed in September 1996, and transferred its
4,312,000 available subscription rights to purchase Rally's common stock to an
unaffiliated third party, which subsequently exercised the subscription rights;
and during the fourth quarter of 1996, the election by CKE and Fidelity to
exercise its options previously granted by GIANT pursuant to the Agreement to
purchase 1,175,000 shares of Rally's common stock at the option price of $3.00
per share.
On November 14, 1996, KCC, along with CKE and others, purchased an
aggregate principal amount of $29,900,000 of Checkers $36,100,000 13.75% senior
subordinated debt, due July 31, 1998, from certain current debt holders. These
holders retained approximately $6,200,000 of the principal amount. The total
purchase price for the senior subordinated debt was $29,100,000. KCC purchased
$5,100,000 principal amount of this senior subordinated debt for $5,000,000. On
November 22, 1996, the senior subordinated debt was restructured. As part of the
restructuring, the aggregate principal amount was reduced to $35,800,000, the
interest rate was reduced to 13%, the term of the restructured
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ITEM 1. BUSINESS. (Cont.)
GENERAL DEVELOPMENT OF BUSINESS (Cont.)
credit agreement was extended one year and certain financial covenants were
modified. In addition, scheduled principal payments were deferred to May 1997.
However, during 1997, Checkers made approximately $9,691,000 in principal
payments to holders of the senior subordinated debt. Checkers was able to make
these payments due to proceeds received from the February 1997 private placement
of its common stock and asset sales made during the year. Per the restructured
credit agreement, 50% of the aggregate net proceeds from the sale of assets are
to be paid to the holders of the senior subordinated debt. Because Checkers made
these principal payments of approximately $9,691,000, the next scheduled
principal payment is due in July 1999, when the balance is due to
be paid in full. In return for the lenders to agree to this restructured credit
agreement, Checkers issued warrants ("Checkers Warrants") to all holders of
the senior subordinated debt, to purchase an aggregate of 20,000,000 shares of
Checkers common stock at an exercise price of $.75 per share. KCC received
2,849,000 Checkers Warrants, which are exercisable at any time until November
22, 2002. KCC assigned the Checkers Warrants a value of $1,168,000. The new
lenders also agreed to provide a short-term revolving line of credit up to
$2,500,000 to Checkers, which was canceled in the first quarter of 1997. As of
December 31, 1996 and 1997, KCC's investment in Checkers senior subordinated
debt was $3,832,000 and $2,715,000, net of related discount of $1,270,000 and
$1,007,000, respectively.
In June 1997, Rally's and Checkers ended talks for a proposed merger
between the two companies which was previously announced on March 25, 1997.
On November 13, 1997, Rally's and Checkers reached an agreement to
enter into a management services contract in which Checkers will provide
accounting, technology and other services to Rally's.
In December 1997, Rally's acquired 19,100,960 shares of Checkers,
from GIANT, CKE, Fidelity and other parties in exchange for securities of
Rally's, including convertible preferred stock. This transaction gave Rally's an
approximate 27% ownership in Checkers and made Rally's Checker's largest
stockholder. GIANT's ownership in Rally's after the transaction was concluded
amounted to 3,180,718 shares or approximately 13% as of December 31, 1997,
compared to 15% as of December 31, 1996. At the Rally's Annual Meeting in June
1998, it is expected that the stockholders will approve the automatic conversion
of its preferred stock to common stock thereby reducing GIANT's ownership in
Rally's to approximately 11%. GIANT accounted for the investment in Rally's
common stock under the equity method of accounting, as of December 31, 1996 and
through December 1997 when the Checkers exchange transaction occurred. As of
December 31, 1997, GIANT accounted for the investment as a marketable security
classified as an investment available-for-sale. In connection with the exchange
of Rally's stock for Checkers stock, William P. Foley II, Chairman of CKE
Restaurants, Inc. and Fidelity, Inc. was elected Chairman of both Rally's and
Checkers. In addition, James J. Gillespie, a 22 year veteran of the restaurant
business with Long John Silvers and Applebee's, was elected Chief Executive
Officer of both Rally's and Checkers.
In July 1996, KCC entered into an agreement ("NeoGen Agreement")
with Joseph Pike and his company, NeoGen Investors, L.P. ("NeoGen"), to
participate in the development, manufacturing and marketing of Mifepristone, an
abortion inducing drug with other significant potential uses, in the United
States and other parts of the world. The Federal Drug Administration had
recently approved Mifepristone as a safe and effective abortifacient. Under the
NeoGen Agreement, KCC for a cash payment of $6 million, would have obtained a
26% interest in NeoGen, the entity which held the sublicenses for all potential
uses of Mifepristone. Subsequent to the signing of this contract, in October
1996, KCC filed suit against Joseph Pike and NeoGen for fraud and breach of the
NeoGen Agreement and also filed suit against the licensors of Mifepristone, the
Population Council, Inc. and Advances in Health Technology, Inc. On November 4,
1996, the Population Council and Advances in Health Technology, filed suit
against Joseph Pike and NeoGen. The suit claimed Joseph Pike had concealed
information that he had been, among other things, convicted of forgery. Under a
settlement reached in 1996 with the Population Council, Joseph Pike agreed to
sell most of his financial stake in Mifepristone and relinquish his management
of the distribution company that was set up to sell and distribute this drug. In
February 1997, a new company called Advances for Choice was established to
oversee the manufacturing and distribution of Mifepristone. In October 1997, KCC
settled their litigation with the Population Council, Inc. and Advances in
Health Technology, Inc. and in November 1997,
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ITEM 1. BUSINESS. (Cont.)
GENERAL DEVELOPMENT OF BUSINESS (Cont.)
KCC, GIANT and Joseph Pike announced the settlement of their litigation. KCC's
action against NeoGen continues. (see Item 3, "Legal Proceedings").
GIANT's management is actively pursuing opportunities to purchase
operating companies, however, as of this date no definitive agreements have been
entered into.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Private Securities Litigation Reform Act of 1995 provides a
"safe harbor" for forward-looking statements: Certain information included in
this document (as well as information included in oral statements or other
written statements made or to be made by the Company) contains statements that
are forward-looking, such as statements relating to plans for future activities.
Such forward-looking information involves important risks and uncertainties that
could significantly affect anticipated results in the future and, accordingly,
such results may differ from those expressed in any forward-looking statements
made by or on behalf of the Company. These risks and uncertainties include, but
are not limited to, those relating to the development and implementation of the
Company's business plan, domestic and global economic conditions, activities of
competitors, changes in federal or state tax laws and of the administration of
such laws.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the executive officers of the Company, together
with their ages, their positions with the Company and the year in which they
first became an executive officer of the Company.
Burt Sugarman, 59, Chairman of the Board, President and Chief
Executive Officer. Mr. Sugarman has been Chairman of the Board of the Company
since 1983, and President and Chief Executive Officer since May 1985. Mr.
Sugarman was Chairman of Rally's Board of Directors from November 1994 through
October 1997, having also served as its Chairman of the Board and Chief
Executive Officer from 1990 through February 1994. He remains a Director of
Rally's. He is also a director of Checkers.
David Gotterer, 69, Vice Chairman and Director. Mr. Gotterer has been
Vice Chairman of the Company since May 1986 and Director of the Company since
1984. Mr. Gotterer is a senior partner in the accounting firm of Mason &
Company, LLP, New York, New York. Mr. Gotterer is also a Director of Rally's.
William H. Pennington, 50, Vice President, Chief Financial Officer,
Secretary and Treasurer. Mr. Pennington, a CPA with an MBA, joined the Company
in October 1997. Mr. Pennington served in senior financial positions as Vice
President, Finance for Earth Tech, Inc. in 1997, Vice President, Finance for BKK
Corporation from 1993 to 1996 and prior to that as Vice President, Controller
for Beneficial Standard Life Insurance Company since 1984.
ITEM 2. PROPERTIES.
GIANT presently leases approximately 9,800 square feet of office
space at a monthly payment of approximately $21,000. The lease term is 60 months
and the Company has two, three-year renewal options. In addition, the Company
leases approximately 5,500 square feet of hangar space at a local airport at a
monthly payment of approximately $5,000.
ITEM 3. LEGAL PROCEEDINGS.
Mittman, et al. v. Rally's Hamburgers, Inc., et al.
Jonathan Mittman, Steven Horowitz, Dina Horowitz and John Hannan v. Rally's
Hamburgers, Inc., Burt Sugarman, GIANT GROUP, Ltd., Wayne M. Albritton, Donald
C. Moore, Edward C. Binzel, Gena L. Morris, Patricia L. Glaser and Arthur
Andersen & Co., a purported class action alleging certain violations of the
Securities Exchange Act of 1934, as amended, was filed in the United States
Western District Court of Kentucky on January 24, 1994 (Civ. No. C94-0039-L(SC))
against Rally's, certain of Rally's officers, directors and shareholders, a
former officer of Rally's and Rally's auditors and GIANT
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ITEM 3. LEGAL PROCEEDINGS. (Cont.)
Mittman, et al. v. Rally's Hamburgers, Inc., et al. (Cont.)
and Burt Sugarman. In the action, plaintiffs seek an unspecified amount of
damages, including punitive damages. On February 14, 1994, a related lawsuit was
filed by two other shareholders making the same allegations before the same
court, known as Edward L. Davidson and Rick Sweeney v. Rally's Hamburgers, Inc.,
Burt Sugarman, GIANT GROUP, Ltd., Wayne M. Albritton, Donald C. Moore, Edward C.
Binzel, Gena L. Morris, Patricia L. Glaser and Arthur Andersen & Co., (Civ. No.
C-94-0087-L-S). On March 23, 1994, all plaintiffs filed a consolidated lawsuit
known as Mittman, et al. v. Rally's Hamburgers, Inc., et al., (Civ. No.
C-94-0039-L(SC) (the "Mittman Actions").
On April 15, 1994, Ms. Glaser and GIANT GROUP, LTD. ("GIANT") filed a
motion to dismiss the consolidated lawsuit for lack of personal jurisdiction.
The remaining defendants filed motions to dismiss for failure to state a claim
upon which relief can be granted. On April 5, 1995, the Court denied these
motions. (The Court struck plaintiffs' punitive damages allegations and required
plaintiffs to amend their claims under section 20 of the Securities Exchange Act
of 1934, but otherwise the Court let stand the most recent version of
plaintiffs' complaint at this juncture). The Court granted Mr. Sugarman's motion
to strike certain scurrilous and irrelevant allegations, and directed plaintiffs
to amend their complaint to conform to the Court's order. Finally, the Court
denied plaintiffs' motion for class certification, "until such time as the issue
of typicality of claims is further developed and clarified."
Plaintiffs filed their second amended complaints on June 29, 1995,
joining additional plaintiffs pursuant to stipulation of the parties.
Plaintiffs renewed their motion for class certification on July 31,
1995. Defendants filed their opposition on or about October 31, 1995. On April
16, 1996 the court granted the motion and certified a class period from July 20,
1992 to September 29, 1993.
On October 3, 1995, plaintiffs filed a motion to disqualify
Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP ("Christensen
Miller") as counsel for defendants based on a purported conflict of interest
allegedly arising from the representation of multiple defendants, as well as Ms.
Glaser's association with Christensen Miller. The Court denied the motion in the
fall of 1996 and refused to disqualify Christensen Miller.
Fact discovery will be concluded by the end of April 1998. No trial
date has been scheduled yet.
Rally's and GIANT deny all wrongdoing and intend to vigorously defend
this action. It is not possible to predict the outcome of this action at this
time.
Harbor Finance Partners v. Rally's and GIANT GROUP, LTD., et al.
On February 13, 1996, Harbor Finance Partners ("Harbor") commenced a
derivative action, purportedly on behalf of Rally's, against GIANT, Burt
Sugarman, Mary Hart, Michael M. Fleishman, David Gotterer, Patricia L. Glaser,
Willie D. Davis and John A. Roschman before the Delaware Chancery Courts. Harbor
named Rally's as a nominal defendant. Harbor claims that the directors and
officers of both Rally's and GIANT, along with GIANT, breached their fiduciary
duties to the public shareholders of Rally's by repurchasing certain Rally's
Senior Notes at an inflated price. Harbor seeks "millions of dollars in
damages", along with the rescission of the repurchase transaction. In the fall
of 1996, all defendants moved to dismiss this action. The Chancery Court denied
defendants' motions on April 3, 1997.
Discovery is in the initial stages. No trial date has been set.
Rally's and GIANT deny all wrongdoing and intend to vigorously defend
the action. It is not possible to predict the outcome of this action at this
time.
Michael Shores, et al. v. GIANT GROUP, LTD., et al.
By a stipulation of settlement dated as of October 14, 1997 (the
"Settlement"), defendants and plaintiffs agreed to a voluntary dismissal of the
action with Prejudice and appropriate releases of all claims arising out of or
related to the
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ITEM 3. LEGAL PROCEEDINGS. (Cont.)
Michael Shores, et al. v. GIANT GROUP, LTD., et al. (Cont.)
allegations in plaintiffs' complaint, in return for the payment of $125,000 to
defray plaintiffs' attorneys' fees and expenses, as well as the approval by the
Company's Board of Directors of two resolutions confirming certain previously
adopted corporate policies. By an order dated February 2, 1998 of the Los
Angeles Superior Court, the Honorable Ernest M. Hiroshige, judge presiding, the
fairness and effectiveness of the Settlement was confirmed.
On February 27, 1996, Michael Shores, on behalf of himself and all
other purported stockholders of the Company from and including November 29, 1995
to June 3, 1996, commenced a class action against the Company, and the Company's
directors, Burt Sugarman, David Gotterer, Terry Christensen and Robert Wynn (the
"Directors"). The complaint, filed in the Los Angeles County Superior Court,
alleges that the Directors breached their fiduciary duty by adopting a
stockholder rights plan, selling Rally's Senior Notes back to Rally's, agreeing
to the Exchange Offer, and engaging in an ongoing stock repurchase program. The
complaint claimed that these actions were undertaken to entrench management
rather than for the benefit of the Company and its stockholders. The complaint
sought unspecified damages, injunctive relief and a recovery of attorney's fees
and costs.
In February 1997, defendants filed a motion to dismiss for failure to
make a pre-litigation demand on the Board of Directors to investigate the
plaintiffs' claim. The motion asked the court, in the alternative, to stay the
litigation to permit the Company to address plaintiffs' claims internally. The
motion to dismiss was never heard.
Throughout the litigation, the Company has denied all wrongdoing. By
the Settlement and the payment thereunder, the Company has not admitted any
liability.
KCC Delaware v. Joseph D. Pike, et al.
KCC filed this action on October 31, 1996 against NeoGen Investors,
L.P., N.D. Management, Inc., NeoGen Holdings, L.P., Danco Laboratories, Inc. and
NeoGen Pharmaceutical, Inc. (collectively the "NeoGen Entities") and Joseph Pike
in Los Angeles Superior Court, Santa Monica branch. The complaint states causes
of action for fraud, breach of fiduciary duty, fraudulent concealment, breach of
contract, unfair business practices, permanent and preliminary injunctive
relief, and declaratory relief. The complaint seeks damages for the breach by
Joseph Pike and the NeoGen Entities of a July 24, 1996 Letter Agreement by which
KCC agreed to contribute $6,000,000 in return for a 26% equity interest in the
entity producing the abortion inducing drug Mifepristone in the United States
and other parts of the world. KCC also sued the licensors of Mifepristone, the
Population Council, Inc. and Advances in Health Technology, Inc., on a
declaratory relief claim. The Licensors claimed that their prior approval was
necessary for the July 24, 1996 Letter Agreement between KCC and the Pike
defendants.
On February 19, 1997, the Pike defendants filed an answer to the
complaint, denying its material allegations and raising affirmative defenses. On
that date the NeoGen Entities filed a cross-complaint against KCC, GIANT, Burt
Sugarman, David Malcolm and Terry Christensen alleging causes of action for
fraud, breach of contract, intentional and negligent interference with
prospective economic advantage, unfair business practices, and conspiracy to
defraud.
In October 1997, KCC settled their action with the licensors (The
Population Council, Inc. and Advances in Health Technologies, Inc.), and in
November 1997 KCC settled their action with Joseph Pike, leaving only the NeoGen
Entities as defendants.
Discovery is on going in KCC's action against the NeoGen Entities and
in the related cross-complaint. The trial is scheduled for June 2, 1998. The
Company denies all wrongdoing and intends to vigorously defend against the
cross-complaint. It is not possible to predict the outcome of this action at
this time.
Joseph D. Pike v. GIANT GROUP, LTD., et al.
On November 13, 1997, KCC, GIANT and Joseph Pike announced the
settlement of their litigation. This litigation had commenced in November 1996
when Joseph Pike filed a complaint for defamation against GIANT, KCC, Terry
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ITEM 3. LEGAL PROCEEDINGS. (Cont.)
Joseph D. Pike v. GIANT GROUP, LTD., et al. (Cont.)
Christensen, David Malcolm and Burt Sugarman (listed alphabetically) and Does 1
through 50, in the San Diego County Superior Court. The complaint had sought an
unspecified amount of general, special and exemplary damages. All defendants
answered the complaint, denying its material allegations and had raised several
affirmative defenses.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders, through
the solicitation of proxies or otherwise, during the fourth quarter of the
calendar year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange
(Symbol: GPO). On March 20, 1998, the approximate number of record holders of
the Company's Common Stock was 1,900. The high and low sale prices for such
stock during each quarter in 1997 and 1996 are set forth below. No dividends
were paid on the Common Stock in either year. The Company expects that earnings
will be retained in its business, and no cash dividends will be paid on its
Common Stock for the foreseeable future.
SALE PRICES OF COMMON STOCK
1997 1996
-------------------- --------------------
QUARTER High Low High Low
- ------- ------- ------- ------- -------
First .................................... $ 8 3/8 $ 7 1/8 $10 3/8 $ 8 1/8
Second ................................... 7 1/4 6 1/2 9 5/8 7 3/8
Third .................................... 6 13/16 6 1/2 8 1/4 7 1/4
Fourth ................................... 7 15/16 6 15/16 9 1/2 7 5/8
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ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the
Company for the five years ended December 31, 1993 through 1997 and is derived
from the audited financial statements of the Company. This information should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and related notes thereto included elsewhere herein.
Year Ended December 31, 1993 1994 1995 1996 1997
- ------------------------------------------------ ---------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
Income Statement Data:
Investment income $ 1,377 $ 1,507 $ 3,947 $ 2,736 $ 2,006
Gain (loss) on the sale of investments 542 (1,065) 41 5,234 (84)
Charter and other income (1) 41 209 108 48 662
Co-ownership program expenses -- -- -- (24) (5,615)
General and administrative expenses (3,574) (4,628) (4,123) (4,574) (4,458)
Proxy contest and related legal expenses -- -- -- (752) --
Exchange Offer and related legal expenses -- -- -- (518) --
Interest expense (4,854) (4,007) (149) (34) (153)
Depreciation (527) (390) (368) (397) (523)
Loss on extinguishment of debt -- (1,343) -- -- --
Gain on sale of investment in affiliate -- -- -- 6,177 --
Equity in earnings (loss) of affiliate (3,855) (8,898) (22,074) 367 (623)
Write-down in carrying value of
investment in affiliate -- (19,396) -- -- --
Benefit for income taxes 3,689 3,661 286 9,649 4,170
---------------------------------------------------------------------------
Income (loss) from continuing operations (7,161) (34,350) (22,332) 17,912 (4,618)
Income from discontinued operations, net 4,522 6,598 -- -- --
Gain on sale of discontinued operations, net -- 48,223 -- -- --
---------------------------------------------------------------------------
Net income (loss) $ (2,639) $ 20,471 $ (22,332) $ 17,912 $ (4,618)
===========================================================================
Basic earnings per common share (2), (4):
Income (loss) from continuing operations $ (1.38) $ (6.63) $ (4.37) $ 4.40 $ (1.42)
Net income (loss) (0.51) 3.95 (4.37) 4.40 (1.42)
Diluted earnings per common share (2), (3), (4):
Income (loss) from continuing operations $ (1.38) $ (6.63) $ (4.37) $ 4.07 $ (1.42)
Net income (loss) (0.51) 3.95 (4.37) 4.07 (1.42)
Weighted average shares outstanding (2):
Basic earnings per common share 5,180,000 5,180,000 5,110,000 4,074,000 3,260,000
Diluted earnings per common share 5,180,000 5,180,000 5,110,000 4,400,000 3,260,000
Balance sheet data as of December 31:
Assets held-for-sale $ -- $ -- $ -- $ 21,485 $ 24,362
Total assets 110,616 100,895 51,681 69,047 53,876
Long-term debt 44,489 1,816 -- -- --
Total stockholders' equity 47,467 69,942 45,145 52,815 48,498
(1) Charter income was earned only in 1997.
(2) All earnings per share amounts are computed in accordance with
SFAS No 128 "Earnings Per Share".
(3) The calculation for the year ended December 31, 1994 excludes
potentially dilutive 7% convertible subordinated debentures as
the effect of the inclusion of common stock upon the conversion
of these debentures would be anti-dilutive because the stock
conversion price exceeded the average price of the common stock
for the year. In addition, 45,000 options were not included in
the calculation as the effect would be anti-dilutive because the
exercise price of $11.00 exceeds the average market price of the
common stock for the year.
(4) Basic and diluted earnings per share for income from discontinued
operations, net for the years ended December 31, 1993 and 1994
were $0.87 and $0.87, and $1.27 and $1.27, respectively. Basic
and diluted earnings per share for gain on sale of discontinued
operations, net for the year ended December 31, 1994 were $9.31
and $9.31.
10
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. (Dollars in thousands, except share and per share amounts)
RESULTS OF OPERATIONS FOR 1997 VERSUS 1996
Total revenue for the twelve months ended December 31, 1997 decreased
by $5,434 to $2,584 from $8,018 in the prior period. In 1997, the Company had
investment income of $2,006 compared to $2,736 in 1996, primarily due to a lower
investment in U.S. government obligations in 1997. In 1996, the Company had
gains of $5,234 compared to losses of $84 in 1997 from sales of the Company's
investment in marketable securities.
During the twelve months ended December 31, 1997, The Ocean Group
incurred expenses of $5,615 including amortization of 1996 deferred start-up
costs of $598, in operating the Co-Ownership Program, compared to $24 in 1996.
In the fourth quarter of 1997, the Company provided a reserve of $1,500 for the
impairment of assets held-for-sale. In 1997 the Co-Ownership Program expenses,
including start-up costs, consisted primarily of crew and related expenses of
$1,292, repairs, maintenance and fuel of $717, advertising of $489, licenses and
permits of $364, and management and professional fees of $321. During the fourth
quarter, the sale of the only Co-Ownership quarter interest was rescinded and
the Co-Ownership Program was ended.
General and administrative expenses for the twelve months ended
December 31, 1997 decreased by $116 to $4,458 from $4,574 in 1996, resulting
primarily from lower professional fees and other various expenses which offset
each other.
1996 expenses included certain one time expenses for proxy contest and
related legal expenses of $752 and Exchange Offer and related legal expenses of
$518.
Interest expense for the twelve months ended December 31, 1997
increased by $119 to $153 from $34 in 1996 primarily due to interest of $150
associated with the financing of one of the luxury yachts for two months during
the current year. Interest expense for the prior year included $30 related to
the Company's 9.25% Term Note, which was repaid in February 1996.
Depreciation for the twelve months ended December 31, 1997 increased
by $126 to $523 compared to $397 in 1996 due to the addition of furniture,
equipment and leasehold improvements related primarily to the Company's new
office space.
As of December 31, 1997, GIANT accounted for its investment in Rally's
outstanding common stock as a marketable security, classified as an investment
available-for-sale. During 1997 and 1996, the Company accounted for its
investment under the equity accounting method. In 1997, Rally's reported a net
loss of $4,516, compared to net income of $1,988 for 1996. Effective December
18, 1997, the Company's ownership percentage decreased to approximately 13%. As
a result of the Company's reduction in ownership, the Company's investment in
Rally's is now accounted for as a marketable security. GIANT's non-cash charge
for its share of equity in Rally's loss for the twelve months ended December 28,
1997, was $623 compared to earnings of $367 for 1996. Rally's 1996 net income
included extraordinary income of $5,280, net of tax of $1,350, related to the
early extinguishment of debt.
The Company's net loss was $4,618 in 1997 compared to net income of
$17,912 in 1996. The Company's 1997 revenue decreased primarily due to lower
gains on the sale of marketable securities compared to 1996. The Company's 1997
expenses were higher than 1996 primarily due to the Co-Ownership Program. 1996
expenses included non-recurring expenses of $1,270 related to the Fidelity/Foley
litigation and the terminated Exchange Offer. 1996 included a gain on the sale
of common stock of an investment in an affiliate of $6,177. There were no sales
of investment in affiliate in 1997. In 1997, the Company recognized a tax
benefit of $4,170 related to the reversal of a liability the Company previously
recorded for an assessment the California Franchise Tax Board ("CFTB") made for
the tax years 1989 through 1991 of $3,100 and a federal net operating loss
carryback of $1,100. In 1996, an income tax benefit of $9,649 was recognized,
related to the carryback of the tax loss on the sale of Rally's common stock.
RESULTS OF OPERATIONS FOR 1996 VERSUS 1995
Total revenue for the twelve months ended December 31, 1996 increased
$3,922 to $8,018 in 1996 compared to
11
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. (Cont.) (Dollars in thousands, except share and per share
amounts)
RESULTS OF OPERATIONS FOR 1996 VERSUS 1995 (cont.)
$4,096 in 1995 primarily due to gains of $5,234 on the sale of equity and debt
investments, previously classified as investments available-for-sale. This
increase was offset by a decline in investment income, which decreased by $1,211
to $2,736 in 1996 compared to $3,947 in 1995. Approximately $859 of the
reduction in investment income was primarily due to reduced levels of
investments in short-term U.S. government obligations.
During the fourth quarter of 1996, the Company incurred expenses of
$24 related to the start-up of the Co-Ownership program.
General and administrative expenses increased $451 to $4,574 in 1996
compared to $4,123 in 1995 primarily due to higher legal fees of $193, other
professional fees of $132 and travel expenses of $170. The increase in these
expenses related primarily to the Company's activities reviewing possible
acquisitions.
Certain one-time expenses impacted the Company's results from
operations for 1996. The Company incurred legal and administrative expenses of
$752 consisting of proxy and related legal fees in connection with the
Fidelity/Foley litigation that has now been settled. In addition, the Company
incurred $518 in legal, accounting and administrative expenses due to the
Exchange Offer that was terminated on April 22, 1996.
Interest expense decreased $115 to $34 in 1996 compared to $149 in
1995 as a result of the prepayment in February 1996 of the Company's 9.25%
Term-Note, due December 18, 1996.
GIANT's investment in Rally's at December 31, 1996 and 1995 represents
approximately 15% and 48%, respectively, of Rally's outstanding common stock.
The investment percentage decreased because of the following three reasons: the
sale by GIANT, on May 3, 1996, of approximately 768,000 shares of Rally's common
stock to Fidelity and approximately 2,350,000 shares of Rally's common stock to
CKE; GIANT did not elect to participate in Rally's Shareholder Rights Offering,
completed in September 1996, and transferred its 4,312,000 available
subscription rights to purchase Rally's common stock to an unaffiliated third
party, which subsequently exercised the subscription rights and CKE and
Fidelity, in total, exercised its option to purchase 1,175,000 shares of Rally's
common stock at the option price of $3.00 previously granted to them by GIANT.
The Company's non-cash equity income was $367 in 1996 compared to a non-cash
equity loss of $22,074 in 1995. Rally's income from operations for 1996 was
$4,090 compared to a loss from operations of $36,470 in 1995. This increase in
operating income resulted primarily from significant reductions in expenses
across all major categories in 1996 and in 1995, non-cash charges of
approximately $31,000 related to asset write-downs and costs for closed stores
and the adoption of Statement of Financial Accounting Standards ("SFAS")
No.121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" ("SFAS 121"). Rally's reported net income of $1,988
in 1996 compared with a net loss of $46,919 in 1995. Rally's net income for 1996
included an extraordinary gain of $5,280, net of tax of $1,350, related
primarily to the early retirement of $22,000 principal amount of their Senior
Notes.
The Company's net income was $17,912 for 1996 compared to a loss of
$22,332 in 1995. This increase in net income resulted primarily from the
following: gains of $11,411 from the sale of marketable securities previously
classified as available-for-sale and from the sale of Rally's common stock;
non-cash equity income in Rally's of $367 in 1996 compared to a loss of $22,074
in 1995 and an income tax benefit of $9,649 primarily related to the realization
of capital losses on sale of Rally's common stock. These components of net
income were lowered by one-time expenses of the Fidelity/Foley litigation and
terminated Exchange Offer of $1,270, slightly higher general and administrative
expenses of $451 and lower income earned on the reduced levels of investments in
short-term U.S. government obligations of $859.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity, consisting of cash and cash equivalents,
marketable securities and income tax receivables of $21,111 at December 31,
1997, decreased $13,044 from $34,155 at December 31, 1996. At December 31, 1997
and 1996, the Company's current assets included income tax receivables of $1,100
and $10,928 related primarily to the net operating loss and realization of
capital losses on sale of Rally's common stock carryback claims, respectively.
The
12
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. (Cont.) (Dollars in thousands, except share and per share
amounts)
LIQUIDITY AND CAPITAL RESOURCES (Cont.)
Company received refunds of $10,855 related to these 1996 income tax
receivables, during the first quarter of 1997. At December 31, 1997 and 1996,
the Company had working capital of $42,021 and $45,420 with current ratios of
11.0 and 4.0 to 1, respectively.
During the quarter ended September 30, 1997, the CFTB announced their
acceptance of the combined report, as originally filed by the Company, for the
tax years 1989 through 1991 with only minor adjustments. At December 31, 1996
the Company's consolidated financial statements had reflected a liability
associated with the CFTB's original proposed assessment. As a result of winning
this dispute with the CFTB, the Company recognized a tax benefit of $3,100 in
the third quarter of 1997.
Net cash provided by operating activities for the year ended December
31, 1997 was $5,273 compared to cash used by operating activities of $3,387 for
1996 and to net cash used by operating activities of $1,699 in 1995. This
increase in cash provided by operating activities in 1997 was attributable to
income tax refunds of $10,855 received primarily related to the realization of
capital losses on the 1996 sales of Rally's common stock and net operating loss
carryback claims, lowered by cash used for the funding of the Company's
operations. In 1996 and 1995, cash was used to fund the operating activities of
the Company and in 1995, cash from operations was used to pay expenses which
were accrued from the 1994 sale of the cement operations.
Net cash used by investing activities for the year ended December 31,
1997 was $3,135 compared to cash provided by investing activities of $14,215 in
1996 and net cash used by investing activities of $1,583 for the comparable
period in 1995. During 1997, the Company received principal payments of $1,880
on its investment in Checkers Debt, including payment in full of the 1996
short-term advance. Finally, during the current year, the Company paid $1,869
for furniture, equipment and for leasehold improvements primarily for its new
office space. In 1996, Rally's purchased directly from GIANT $22,000 principal
amount of its Senior Notes. GIANT received cash of $11,053, including accrued
interest of $266, and a $4,145 short-term note bearing interest, which was paid
in full. During the second quarter of 1996, the Company sold an additional
$3,500 face value Senior Notes, through the open market, and received proceeds
of $2,760. In addition, during 1996, the Company sold marketable securities
receiving proceeds of $21,391 and also purchased marketable securities at a cost
of $15,373. In November 1996, the Company purchased Checkers Debt for $5,000 and
advanced $500 to Checkers. In 1996, the Company purchased assets, including
improvements, for $21,485. The Ocean Group incurred $598 related to the start-up
of the Program. The Company paid cash of $11,583 and financed the remaining
balance of $10,500. In May and November of 1996, the Company received proceeds
of $8,277 from the sale of Rally's stock to CKE and Fidelity. In 1995, the
Company received $20,720 from the sales and maturities, net of purchases, of
marketable securities and paid income taxes in the amount of $22,238 related to
the profit on the sale of the Company's cement business in 1994.
Net cash used by financing activities for the year ended December 31,
1997 was $14,138 compared to $14,682 for 1996 and $3,199 in 1995. During the
first quarter of 1997, the Company paid the remaining balance of $10,500 on the
short-term note, which financed assets purchased in 1996 for the Co-Ownership
Program. On May 16, 1997, the Company signed an agreement to borrow $10,000.
This loan was secured by one of its luxury yachts. The term of the mortgage was
twenty-six months from the date of advancement of funds, which occurred on May
30, and was subject to prepayment in the event of a transfer of an interest in
this yacht. In July, the loan was paid in full. The Company's Board of Directors
has reaffirmed its commitment to its ongoing stock repurchase program through
the open market and private purchases of its common stock. For the three years
ended December 31, 1997, the Company purchased 459,000 shares at a cost of
$3,638, 1,674,000 shares at a cost of $15,079 and 166,000 shares at a cost of
$1,137, respectively. In 1996, the Company pre-paid in full its 9.25% Term-Note
in the amount of $1,622. The Company incurred no additional expenses in
connection with this prepayment. On February 7, 1996, the Chairman of the Board
of GIANT exercised 300,000 options to purchase GIANT Common Stock at an exercise
price of $6.75 per share. As a result of this transaction, the Company received
cash of $2,025. In 1995, the Company paid $1,917 related to short-term margin
borrowings.
The Company's current liquidity is provided by cash and cash equivalents,
liquidation of marketable securities,
13
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. (Cont.) (Dollars in thousands, except share and per share
amounts)
LIQUIDITY AND CAPITAL RESOURCES (Cont.)
cash received from income tax and note receivables and investment income.
Management believes that this liquidity, plus the Company's capital resources
and its ability to obtain financing at favorable rates are sufficient for the
Company to properly capitalize its current and future business operations, as
well as fund its on-going operating expenses.
YEAR 2000
Based on the Company's existing operations, the Company believes that
it will be able to achieve the Year 2000 compliance through a modification of
some existing programs and systems at a minimal cost.
PERSONAL HOLDING COMPANY
Under the Internal Revenue Code, in addition to the regular corporate
income tax, an additional tax may be levied upon an entity that is classified as
a "personal holding company". In general, this tax is imposed on corporations
which are more than 50% owned, directly or indirectly, by 5 or fewer individuals
(the "Ownership Test") and which derive 60% or more of their income from
"personal holding company" sources, generally defined to be passive income
(the "Income Test"). If a corporation falls within the Ownership Test and the
Income Test, it is classified as a personal holding company, and will be taxed
on its "undistributed personal holding company income" at a rate of 39.6%. The
Company currently meets the stock ownership test. The Company has not met the
income requirement in recent years, therefore is not subject to this additional
tax; however no assurance can be given that the income test will not be
satisfied in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
14
15
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
GIANT GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(Dollars in thousands, except per share amounts)
1995 1996 1997
-------- -------- --------
Revenue:
Investment income $ 3,947 $ 2,736 $ 2,006
Gain (loss) on the sale of marketable securities 41 5,234 (84)
Charter and other income 108 48 662
-------- -------- --------
4,096 8,018 2,584
-------- -------- --------
Costs and expenses:
Co-ownership program -- 24 5,615
General and administrative 4,123 4,574 4,458
Proxy contest and related legal -- 752 --
Exchange Offer and related legal -- 518 --
Interest expense 149 34 153
Depreciation 368 397 523
-------- -------- --------
4,640 6,299 10,749
-------- -------- --------
Affiliate transactions:
Gain on sale of investment in affiliate -- 6,177 --
Equity in earnings (loss) of affiliate (22,074) 367 (623)
-------- -------- --------
(22,074) 6,544 (623)
-------- -------- --------
Income (loss) before benefit for income taxes (22,618) 8,263 (8,788)
Benefit for income taxes (286) (9,649) (4,170)
-------- -------- --------
Net income (loss) $(22,332) $ 17,912 $ (4,618)
======== ======== ========
Basic earnings (loss) per common share $ (4.37) $ 4.40 $ (1.42)
======== ======== ========
Diluted earnings (loss) per common share $ (4.37) $ 4.07 $ (1.42)
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
15
16
GIANT GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997
(Dollars in thousands, except per share amounts)
1996 1997
------- -------
ASSETS
Current assets:
Cash and cash equivalents $13,137 $ 1,137
Marketable securities 10,090 18,874
Income tax receivables 10,928 1,100
Note and other receivables 3,825 332
Assets held-for-sale 21,485 24,362
Prepaid expenses and other assets 1,013 420
------- -------
Total current assets 60,478 46,225
Property and equipment, net 3,559 4,905
Investment in affiliate 2,926 --
Note receivable and other assets 2,084 2,746
------- -------
Total assets $69,047 $53,876
======= =======
LIABILITIES
Current liabilities:
Note payable $10,500 $ --
Accounts payable and accrued expenses 1,032 1,209
Income taxes payable 3,362 219
Deferred income taxes 164 2,776
------- -------
Total current liabilities 15,058 4,204
Deferred income taxes 1,174 1,174
------- -------
Total liabilities 16,232 5,378
------- -------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; authorized 2,000,000 shares, none issued -- --
Class A common stock, $.01 par value; authorized 5,000,000 shares, none issued -- --
Common stock, $.01 par value; authorized 12,500,000 shares, 7,266,000 issued 73 73
Capital in excess of par value 36,767 36,767
Unrealized gains on marketable securities, net 246 4,185
Retained earnings 47,708 43,090
------- -------
84,794 84,115
Less common stock in treasury; 3,626,000 shares in 1996
and 4,085,000 in 1997, at cost 31,979 35,617
------- -------
Total stockholders' equity 52,815 48,498
------- -------
Total liabilities and stockholders' equity $69,047 $53,876
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
16
17
GIANT GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(Dollars in thousands)
1995 1996 1997
-------- -------- --------
Operating Activities:
Net income (loss) $(22,332) $ 17,912 $ (4,618)
Adjustments to reconcile net income (loss) to net cash (used) provided
by operating activities:
Depreciation 368 397 523
Provision for impairment of assets held-for-sale -- -- 1,500
Loss (gain) on the sale of marketable securities (41) (5,234) 84
Gain on the sale of investment in affiliate -- (6,177) --
Equity in loss (earnings) of affiliate 22,074 (367) 623
Benefit for deferred taxes 156 483 --
Accretion of discounts on investments (1,063) (318) (362)
Changes in assets and liabilities:
Decrease (increase) in income tax receivables -- (10,335) 9,828
Decrease (increase) in prepaid expenses and other assets (588) 75 662
Increase (decrease) in accounts payable and accrued expenses (545) 284 176
Increase (decrease) in income tax payable 272 (107) (3,143)
-------- -------- --------
Net cash (used) provided by operating activities (1,699) (3,387) 5,273
-------- -------- --------
Investing Activities:
Proceeds from sale of affiliate's debt securities -- 17,692 --
Proceeds from sale of investment in affiliate -- 8,277 --
Sales of marketable securities 48,022 21,391 14,730
Purchase of marketable securities (27,302) (15,373) (13,499)
Tax payments related to sale of discontinued operations (22,238) -- --
Debt (investment) payment and short-term (advance) repayment -- (5,500) 1,880
Purchase of assets held-for-sale and related costs (1) -- (11,583) (4,377)
Purchases of property and equipment (65) (689) (1,869)
-------- -------- --------
Net cash (used) provided by investing activities (1,583) 14,215 (3,135)
-------- -------- --------
Financing Activities:
Proceeds from the exercise of stock options -- 2,025 --
Proceeds from short-term borrowings -- -- 10,000
Repayment of short-term borrowings (1,917) (1,628) (20,500)
Repayment of long-term debt (145) -- --
Purchase of treasury stock (1,137) (15,079) (3,638)
-------- -------- --------
Net cash used by financing activities (3,199) (14,682) (14,138)
-------- -------- --------
Decrease in cash and cash equivalents (6,481) (3,854) (12,000)
Cash and cash equivalents:
Beginning of period 23,472 16,991 13,137
-------- -------- --------
End of period $ 16,991 $ 13,137 $ 1,137
======== ======== ========
Supplemental disclosure of cash received (paid) for:
Income taxes $ 22,364 $ (310) $ 10,855
Interest, net (149) (34) (153)
(1) In 1996, the Company purchased assets, including improvements, at a cost of
$21,485. The Ocean Group incurred $598 for pre-launching and organization costs.
The Company paid cash of $11,583 for these assets and financed the balance of
$10,500, which was paid in full in March 1997.
The accompanying notes are an integral part of these consolidated financial
statements.
17
18
GIANT GROUP, LTD.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(Dollars in thousands)
Unrealized
Capital in Gains (Losses) Common
Common Excess of on Marketable Retained Stock in
Stock Par Value Securities Earnings Treasury
------------------------------------------------------------------
Balance as of December 31, 1994 $ 69 $ 33,508 $ -- $ 52,128 $(15,763)
Net loss for 1995 (22,332)
Purchase of treasury stock (1,137)
Unrealized losses on marketable securities, net (1,328)
------------------------------------------------------------------
Balance as of December 31, 1995 69 33,508 (1,328) 29,796 (16,900)
Net income for 1996 17,912
Exercise of stock options 4 2,022
Company's share of increase in affiliate's
equity due to sale of rights, net 1,237
Purchase of treasury stock (15,079)
Unrealized gains on marketable securities, net 1,574
------------------------------------------------------------------
Balance as of December 31, 1996 73 36,767 246 47,708 (31,979)
Net loss for 1997 (4,618)
Purchase of treasury stock (3,638)
Unrealized gains on marketable securities, net 3,939
------------------------------------------------------------------
Balance as of December 31, 1997 $ 73 $ 36,767 $ 4,185 $ 43,090 $(35,617)
==================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
18
19
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of GIANT
GROUP, LTD. (the "Company" or "GIANT") and its wholly-owned subsidiaries,
KCC Delaware Company ("KCC") and GIANT MARINE GROUP, LTD., d/b/a as The Ocean
Group ("GIANT MARINE").
The investment in affiliate was accounted for by the equity method for
the years ended December 31, 1995 and 1996 and for the period ended December 18,
1997 (see Note 5 to these Consolidated Financial Statements). The effects of
changes in the Company's equity in the net assets of its affiliate resulting
from the issuance of capital stock were charged or credited to capital in excess
of par value.
All significant intercompany accounts and transactions have been
eliminated.
Revenue Recognition and Pre-Launch and Organization Costs
Revenue is recognized as earned and upon completion of the charter.
On October 31, 1996, the Company started a new business and formed a
new subsidiary, GIANT MARINE, which offered the world's first Luxury Yacht
Co-Ownership Program of this type (the "Co-Ownership Program"). Certain costs,
related to the preparation of the yachts for use and organization costs,
including legal and professional fees, were originally deferred and would have
been amortized to income over a period of not more than one year, beginning with
the start of operations in February 1997. However, because the Co-Ownership
Program ended in November, all costs were charged to expense in 1997. Costs
related to improvements that increase the lives of the yachts have been
capitalized.
Marketable Securities
Investments in marketable securities and corporate bonds are
considered available-for-sale and trading securities. Investments
available-for-sale are carried at market and adjustments for unrealized gains
and losses are reported as a separate component of stockholders' equity, net of
deferred income taxes. Trading securities are carried at market and net
unrealized gains and losses on trading securities are included in net income or
loss.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts through maturity. Such amortization and
accretion are included in investment income.
The cost of securities sold is based on the specific identification
method.
Property and Equipment
Depreciation for financial reporting purposes is provided by the
straight-line method over the estimated useful lives of the assets, ranging from
three to fifteen years. Amortization of leasehold improvements for financial
reporting purposes is provided by the straight-line method over the life of the
lease.
Supplemental Cash Flow Information
For purposes of the consolidated statements of cash flows, short-term
investments purchased with an original maturity date of three months or less are
considered to be cash equivalents. Cash equivalents are recorded at market value
and consist of short-term U.S. Government obligations.
19
20
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Use of Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent 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. In
management's opinion, these estimates and assumptions are reasonable and result
in the fair presentation of the consolidated financial statements.
Concentration of Risk
The Company places its temporary cash and cash investments with high
quality financial institutions. Management monitors the financial
creditworthiness of these financial institutions. At times, such investments may
be in excess of insured limits.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
1997 presentation.
2. THE OCEAN GROUP LUXURY YACHT CO-OWNERSHIP PROGRAM
On October 31, 1996, the Company started a new business and formed a
new subsidiary, GIANT MARINE, which offered the world's first Luxury Yacht
Co-Ownership Program of this type. The Co-Ownership Program had provided
individuals and companies the opportunity for a co-ownership of a minimum of a
one-fourth interest in transoceanic yachts. In addition, a 100% ownership in the
yacht was also available.
On November 17, 1997, the Company announced that GIANT MARINE would
end the Co-Ownership Program. The advertising and marketing activities attracted
many interested people, but only one-quarter interest was sold. The sale was
rescinded when management and the Board of Directors, after reviewing the amount
of time required to sell the quarter interests in the yachts, concluded that the
potential return on the capital invested did not justify continuing the program.
The yachts are now being marketed for sale, and are included in assets
held-for-sale on the Company's consolidated balance sheets. Until they are sold,
the yachts are being chartered.
As of December 31, 1997, the yachts are recorded at a carrying amount
of $24,362, net of a valuation allowance of $1,500. The Company estimated the
fair value of the yachts based on comparable market prices of similar yachts and
broker estimates. As a result, the Company recorded a valuation allowance of
$1,500 included in Co-Ownership Program in the consolidated statements of
operations for the year ended December 31, 1997.
3. EARNINGS (LOSS) PER SHARE
In 1997, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings per Share" ("SFAS 128"), effective for the
year ending December 31, 1997. Basic earnings (loss) per common share ("Basic
EPS") is computed by dividing reported net earnings or loss available to common
stockholders by the weighted average shares outstanding. The computation of
diluted earnings (loss) per common share ("Diluted EPS") includes the
application of the treasury stock method. The dilution for options is calculated
by using the options' price for the period. As a result of the Company's
adoption of SFAS 128, the Company's reported earnings per share ("EPS") for 1995
and 1996 were restated. The effect of this accounting change on previously
reported earnings per share data is as follows:
20
21
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
3. EARNINGS (LOSS) PER SHARE (Cont.)
1995 1996
-------- --------
Per share amounts :
Primary EPS as reported $ (4.37) $ 3.48
Effect of SFAS 128 -- .92
-------- --------
Basic EPS $ (4.37) $ 4.40
======== ========
Fully diluted EPS as reported $ (4.37) $ 3.48
Effect of SFAS 128 -- .59
-------- --------
Diluted EPS $ (4.37) $ 4.07
======== ========
The following shows the reconciliation of Basic EPS and Diluted EPS
for the years ended 1995, 1996 and 1997:
For the year ended 1995
Net Loss Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
BASIC LOSS PER SHARE
Loss available to common stockholders $ (22,332) 5,110,000 $ (4.37)
========= ========= =========
For the year ended 1996
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
BASIC EARNINGS PER SHARE
Income available to common stockholders $ 17,912 4,074,000 $ 4.40
========= =========
DILUTED EARNINGS PER SHARE
Options issued to employees and non-employee directors 326,000
-----------
Income available to common stockholders $ 17,912 4,400,000 $ 4.07
========= =========== =========
For the year ended 1997
Net Loss Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
BASIC LOSS PER SHARE
Loss available to common stockholders $ (4,618) 3,260,000 $ (1.42)
========= =========== =========
Diluted loss per share for 1995 and 1997 is the same as basic loss per share.
4. MARKETABLE SECURITIES
At December 31, 1996 and 1997, investments classified as available-for-sale
and trading securities are as follows:
21
22
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
4. MARKETABLE SECURITIES (Cont.)
AVAILABLE UNREALIZED DEFERRED TAX INCREASE
FOR SALE (1996) FAIR VALUE COST GAIN LIABILITY, NET IN EQUITY
- --------------- ---------- ---- ---- -------------- ---------
Equity securities $ 3,186 $ 3,043 $ 143 $ 57 $ 86
Corporate bonds 1,386 1,119 267 107 160
---------- ---------- ---------- ---------- ----------
Total $ 4,572 $ 4,162 $ 410 $ 164 $ 246
========== ========== ========== ========== ==========
TRADING
SECURITIES (1996) FAIR VALUE COST
- ----------------- ---------- ------
U.S. Government Bonds $1,011 $ 933
Corporate bonds 4,507 4,507
------ ------
Total $5,518 $5,440
====== ======
AVAILABLE UNREALIZED DEFERRED TAX INCREASE
FOR SALE (1997) FAIR VALUE COST GAIN LIABILITY, NET IN EQUITY
- --------------- ---------- ------- ---------- -------------- ---------
Equity securities $11,863 $ 5,200 $ 6,663 $ 2,665 $ 3,998
Corporate bonds 3,054 2,742 312 125 187
------- ------- ------- ------- -------
Total $14,917 $ 7,942 $ 6,975 $ 2,790 $ 4,185
======= ======= ======= ======= =======
TRADING
SECURITIES (1997) FAIR VALUE COST
- ----------------- ---------- ------
Corporate Bonds 3,957 3,991
------ ------
Total $3,957 $3,991
====== ======
The maturities for corporate and U.S. Government Bonds at December 31,
1996 and 1997 are as follows:
1996 1997
-------------------- -----------------
Fair Value Cost Fair Value Cost
---------- ---- ---------- ------
Due in one through five years $6,125 $5,809 $6,000 $5,716
Due after five through ten years 779 750 1,011 1,017
------ ------ ------ ------
$6,904 $6,559 $7,011 $6,733
====== ====== ====== ======
Proceeds from the sale of marketable securities totaled approximately
$48,022, $21,391 and $14,730 in 1995, 1996, and 1997, respectively.
5. INVESTMENT IN AFFILIATE
As of December 31, 1997, GIANT accounted for its investment in Rally's
outstanding common stock as a marketable security, classified as an investment
available-for-sale. During 1997 and 1996, the Company accounted for its
investment under the equity accounting method. Effective December 18, 1997, the
Company's ownership percentage decreased to approximately 13%. As a result of
the Company's reduction in ownership, the Company's investment in Rally's is now
accounted for as a marketable security. The decrease in the Company's ownership
percentage resulted from
22
23
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
5. INVESTMENT IN AFFILIATE (Cont.)
the exchange of Rally's securities for the common stock of Checkers Drive-In
Restaurants, Inc. ("Checkers") by the Company and certain of the Company's
related parties in December 1997 (the "Exchange"). CKE Restaurants, Inc. ("CKE")
and Fidelity National Financial, Inc. ("Fidelity") also participated in the
exchange of securities.
On December 8, 1997, an Exchange agreement was made between Rally's
and GIANT, CKE and Fidelity, among others. The Company exchanged approximately
200,000 shares of Checkers common stock, with a cost of $258 for approximately
43,000 shares of Rally's common stock and 449 shares of Rally's series A
participating preferred stock. The exchange of securities between Rally's and
all parties was completed on December 18, 1997. The annual dividend on preferred
stock received is $43.50 per share, subject to restrictions per the Exchange
agreement. One share of Rally's series A participating preferred stock is
convertible into 100 shares of Rally's common stock. The conversion cannot take
place until 90 days after the initial issuance of the series A preferred stock
and the conversion must have the approval of Rally's stockholders. The Company
assigned a total cost to both Rally's securities received equal to the cost of
Checkers stock exchanged and recognized no gain or loss for accounting purposes.
Effective in early November 1997, Rally's entered into an employment
agreement with James L. Gillespie to serve as Chief Executive Officer.
Additionally, William P. Foley, II has been appointed Chairman of the Board of
Rally's replacing GIANT's Chief Executive Officer who had been Chairman of
Rally's Board of Directors. Mr. Foley is also Chairman of Checkers, CKE and
Fidelity.
In June 1997, Rally's and Checkers ended talks for a proposed merger
between the two companies, which was previously announced on March 25, 1997.
However, as a result of the exchange of securities in December 1997, Rally's now
owns approximately 27% of Checkers. Rally's Chairman of the Board and Chief
Executive Officer have both been appointed to the same positions in Checkers and
further consolidations of management and operations are underway.
During the second quarter of 1997, the Company purchased $2,224 face
value of Rally's 9.875% senior notes ("Senior Notes") in the open market. The
Senior Notes are classified as an investment available-for-sale at December 31,
1997.
On January 29, 1996, Rally's purchased $22,000 principal amount of its
Senior Notes directly from GIANT for $14,932. The Company had purchased a total
of $26,424 in principal during 1995 for $14,051 and recorded these Senior Notes
as investments available-for-sale. The Company recognized a gain of $2,958 on
the sale of these Senior Notes. In addition, during the second quarter of 1996,
GIANT sold an additional principal amount of $3,500 of its investment in Rally's
Senior Notes through the open market, and recognized a pre-tax gain of $478.
On May 3, 1996, pursuant to a Purchase and Standstill Agreement
between GIANT and Fidelity, GIANT sold approximately 768,000 shares of Rally's
common stock to Fidelity and approximately 2,350,000 shares of Rally's common
stock to CKE. The Company received cash of $4,751 and recognized a pre-tax gain
of $3,197. As part of this transaction, GIANT granted irrevocable options to
Fidelity and CKE to each purchase an additional 1,175,000 shares of Rally's
common stock from GIANT, at exercise prices ranging from $3.00 to $4.00 per
share, through April 1998. In March 1997, 1,175,000 options granted to CKE and
Fidelity by GIANT to purchase Rally's common stock at $4.00 per share were
canceled.
On July 1, 1996, Rally's and CKE entered into a ten-year agreement
("Operating Agreement") pursuant to which 28 Rally's owned restaurants,
located in California and Arizona, are being operated by Carl's Jr. At the
discretion of CKE, certain restaurants will be converted to Carl's Jr. As of
December 31, 1997, 2 restaurants have been converted. Under the Operating
Agreement, Carl's Jr. is responsible for the conversion expenses, as well as the
operating expenses for all the restaurants. Rally's retains ownership of all the
restaurants and receives a percentage of gross revenues generated by each
restaurant. The Operating Agreement is cancelable, at the discretion of CKE,
after an initial five-year period.
On September 5, 1996, by prospectus, Rally's distributed transferable
subscription rights to holders of record of
23
24
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
5. INVESTMENT IN AFFILIATE (Cont.)
Rally's common stock on July 31, 1996. For each 3.25 rights held, a holder was
entitled to purchase one unit for $2.25. A unit consisted of one share of
Rally's common stock and one warrant to purchase an additional share of Rally's
common stock for $2.25. On September 16, 1996, GIANT elected to transfer its
4,312,000 subscription rights to an unaffiliated third party, who has
subsequently exercised the rights. GIANT's increase in Rally's shareholders'
equity due to Rally's Shareholder Rights Offering has been reflected as an
increase of $1,699 in GIANT's investment in affiliate and an increase in capital
in excess of par value of $1,699 before the sale of stock in the fourth quarter.
During the fourth quarter of 1996, CKE and Fidelity, in total,
exercised its option to purchase 1,175,000 shares of Rally's common stock at the
option price of $3.00 per share. The Company received cash of $3,526 and
recognized a pre-tax gain of $2,518. The Company, because of this sale,
recognized $462 in income that was previously shown as an increase in capital in
excess of par. This income is included in gain on the sale of investment in
affiliate.
The Company's sale of Rally's common stock to CKE and Fidelity, during
1996, generated a capital loss which was carried back to prior years and was
used to reduce capital gains taxes paid on the sale of the cement operations
which were sold on October 6, 1994. As of December 31, 1996, the Company
recorded a tax benefit of $10,285 for this carryback and refund of taxes paid in
prior years. In January 1997, the Company received this refund in full.
Summarized financial information for Rally's is as follows:
FINANCIAL POSITION AS OF DECEMBER 31, 1996 1997
--------- ---------
Current assets $ 10,416 $ 10,968
Less: current liabilities 19,968 21,777
--------- ---------
Working capital deficiency (9,552) (10,809)
Plus: noncurrent assets 101,842 123,329
Less: long-term debt and other noncurrent liabilities 72,925 71,007
--------- ---------
Stockholders' equity $ 19,365 $ 41,513
========= =========
OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1995 1996 1997
--------- --------- ---------
Revenues $ 188,859 $ 162,752 $ 144,930
Less: operating costs 225,329 158,662 141,610
--------- --------- ---------
Income (loss) from operations $ (36,470) $ 4,090 $ 3,320
========= ========= =========
Net income (loss) $ (46,919) $ 1,988 $ (4,516)
========= ========= =========
GIANT's share of non-cash equity earnings (loss) $ (22,074) $ 367 $ (623)
========= ========= =========
At December 31, 1996 GIANT's investment in Rally's was $2,926. At
December 31, 1997 the Company's investment in Rally's is accounted for as an
investment in marketable securities available-for-sale.
In 1995, Rally's adopted SFAS No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of ("SFAS 121")
and recorded a non-cash impairment loss of approximately $13,700.
24
25
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
6. CHECKERS DRIVE-IN RESTAURANTS, INC.
On November 14, 1996, KCC, along with CKE and others purchased an
aggregate principal amount of $29,900 of Checkers $36,100 13.75% senior
subordinated debt, due July 31, 1998, from certain current debt holders. These
holders retained approximately $6,200 of the principal amount. The total
purchase price for the senior subordinated debt was $29,100. KCC purchased
$5,100 principal amount of this senior subordinated debt for $5,000. On November
22, 1996, the senior subordinated debt was restructured. As part of the
restructuring, the aggregate principal amount was reduced to $35,800, the
interest rate was reduced to 13%, the term of the restructured credit agreement
was extended one year and certain financial covenants were modified. In
addition, scheduled principal payments were deferred to May 1997. In return for
the lenders acceptance of this restructured credit agreement, Checkers issued
warrants ("Checkers Warrants") to all holders of the senior subordinated debt,
to purchase an aggregate of 20,000,000 shares of Checkers common stock at an
exercise price of $.75 per share. KCC received 2,849,000 Checkers Warrants,
which are exercisable at any time until November 22, 2002. KCC recorded the
Checkers Warrants at $1,168 equal to the difference between the ending market
price of the common stock on November 22, 1996 and the exercise price of $.75
per share multiplied by the number of Checkers Warrants. KCC accounts for the
warrants as marketable securities classified as investments available-for-sale.
During 1997, Checkers made approximately $9,691 in principal payments
to holders of the senior subordinated debt. Checkers was able to make these
payments due to proceeds received from the February 1997 private placement of
its common stock and asset sales made during the year. Per the restructured
credit agreement, 50% of the aggregate net proceeds from the sale of assets are
to be paid to the holders of the senior subordinated debt. Because Checkers made
these principal payments of approximately $9,691 the next scheduled principal
payment is due in July 1999, when the remaining balance is due to be paid in
full.
As of December 31, 1996 and 1997, KCC's investment in Checkers senior
subordinated debt was $3,832 and $2,715, net of related discount of $1,270 and
$1,007, respectively. KCC's advance to Checkers of $500 as of December 31, 1996
was paid in full in February 1997. As of December 31, 1996 and 1997, KCC's
investment in Checkers warrants was recorded at $1,168 and $712, net of an
adjustment of $456 at December 31, 1997 to reduce the cost of the investment to
market. Additionally, KCC exchanged approximately 200,000 shares, with a cost of
$258 for Rally's securities in December 1997.
7. PROPERTY AND EQUIPMENT
AS OF DECEMBER 31, 1996 1997
------ ------
Land $ 120 $ 120
Leasehold improvements 175 1,098
Equipment and furnishings 5,462 5,898
------ ------
5,757 7,116
Less: accumulated depreciation 2,198 2,211
------ ------
$3,559 $4,905
====== ======
During 1997, the Company retired certain fully depreciated leasehold
improvements and equipment, due to the Company's move into its new office in
April 1997.
25
26
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
8. DEBT
On October 31, 1996, the Company financed $10,500 of the cost of one of
the yachts that was to be used in the Co-Ownership Program. This short-term loan
was paid in monthly installments, beginning January 1997 and was repaid in full
in March 1997. There was no interest charge.
On May 16, 1997, the Company signed an agreement to refinance one of
its luxury yachts available for sale under the Co-Ownership Program. The
mortgage, in the amount of $10,000, had a term of twenty-six months from the
date of advancement of funds, which occurred on May 30, 1997, and was subject to
prepayment upon the transfer of an interest in the yacht, which was collateral
for this loan. The interest rate was prime plus one half of one percent (0.50%).
This loan was paid in full in July 1997.
9. TREASURY STOCK
During 1995, the Company, with the approval of the Board of Directors,
acquired 166,000 shares of its Common Stock for an aggregate cost of $1,137.
During 1996, the Company, with the approval of the Board of Directors,
acquired 1,674,000 shares of its Common Stock at an aggregate cost of $15,079.
Included in these totals are 200,000 shares acquired from the Company's Chairman
of the Board at an aggregate cost of $1,652 and 705,000 shares purchased at an
aggregate cost of $6,085 directly from Fidelity.
During 1997, the Company, with the approval of the Board of Directors,
acquired 459,000 shares of its Common Stock for an aggregate cost of $3,638.
10. COMMON STOCK OPTIONS
Under the 1996 Employee Stock Option Plan (the "1996 Plan"), 500,000
shares of the Company's $.01 par value Common Stock were reserved for future
options, including 250,000 shares which were approved to be reserved for future
options at the May 1997 stockholders' meeting. The options, in general, can be
issued as either incentive or non-qualified options in accordance with the 1996
Plan. The options, in general, may be exercised in whole or in part any time
after the date of grant and terminate 10 years from the grant date. In most
cases, options shall have an exercise price equal to the fair market value of
the Common Stock on the date of grant. As of December 31, 1997, 200,000 options,
at an exercise price of $8.25, had been granted to the Company's Chief Executive
Officer in 1996 and were exercisable in 1997 and 15,000 options, at an exercise
price of $7.81, had been granted to the Company's Chief Financial Officer in
1997 and begin to become exercisable in 1998. The 200,000 and 15,000 options
terminate 5 and 10 years, respectively, from the grant date.
Under the 1996 Stock Option Plan for Non-Employee Directors (the
"Director Plan"), 400,000 shares of the Company's $.01 par value Common Stock
are reserved for future options, including 150,000 shares which were approved to
be reserved for future options at the May 1997 stockholders' meeting. Pursuant
to the Director Plan, each Non-Employee Director is entitled to receive an
option to purchase 10,000 shares on May 20, 1996 (the "Adoption Date") or 10,000
shares upon the subsequent initial appointment to the Board of Directors. On
each anniversary of the Adoption Date or the subsequent appointment date,
respectively, each Non-Employee Director will receive an additional option to
purchase 10,000 shares. Upon election to the Executive Committee on or after
July 12, 1996, and on each anniversary thereafter, the Non-Employee Director
will receive an additional option to purchase 10,000 shares. The options may be
exercised in whole or in part any time after the date of grant and terminate
five years from the grant date. All options shall have an exercise price equal
to the fair market value of the Common Stock on the date of grant.
As of December 31, 1997, 110,000 options had been granted to the four
Non-Employee members of the current Board of Directors. The exercise prices are
$6.875 for 50,000 options, $7.625 for 20,000 options and $7.75 for 40,000
options. No options have been exercised.
26
27
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
10. COMMON STOCK OPTIONS (Cont.)
Prior to August 1995, the Company had a 1985 Incentive Stock Option
Plan (the "Incentive Plan") and a 1985 Non-Qualified Stock Option Plan (the
"Non-Qualified Plan"). The Incentive Plan had provided for the grant of
options to purchase an aggregate of 750,000 shares of GIANT Common Stock, of
which no options are presently outstanding and options for 6,000 shares have
been exercised as of December 31, 1997. The Non-Qualified Plan provided for the
granting of options to purchase 3,000,000 shares of GIANT Common Stock and
options for 307,500 shares have been exercised as of December 31, 1997. In 1997,
no options were exercised under either plan. In 1996, the Chairman of the Board
of the Company exercised 300,000 options, issued under the Non-Qualified Plan to
purchase GIANT Common Stock at an exercise price of $6.75 per share. As a result
of this transaction, the Company received cash of $2,025. No options were
exercised during 1996 under the Incentive Plan.
In March 1995, 2,026,000 outstanding options held by certain officers
of the Company exercisable at $6.33 per share and expiring in 1996, were
canceled and an identical number of new options were issued to such persons.
Such new options have an exercise price of $6.75 per share, which was the fair
market value of the shares at the time of the grant, and will expire in 2005.
The new options (like the canceled options) are fully vested.
In 1995 and 1996, the Company purchased 164,000 and 7,000 options at
the difference between the fair market value and the exercise price, from former
Company officers and directors for an aggregate cost of $110 and $7 which is
included in general and administrative expenses.
The Company measures compensation expense for all stock option plans
under Accounting Principles Board Opinion No. 25 ("APB 25"). The Company has not
recognized compensation expense because the exercise price of the options issued
is equal to the fair market value of the options on the date of the grant. If
the Company recognized compensation expense under SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), net income (loss) would have been
impacted as shown in the following pro forma amounts:
Year ended Year ended Year ended
December 31, 1995 December 31, 1996 December 31, 1997
----------------- ----------------- -----------------
Net income (loss) As reported $ (22,332) $ 17,912 $ (4,618)
Proforma (27,007) 17,452 (4,789)
Basic earnings (loss) per share As reported $ (4.37) $ 4.40 $ (1.42)
Proforma (5.29) 4.28 (1.47)
Diluted earnings (loss) per share As reported $ (4.37) $ 4.07 $ (1.42)
Proforma (5.29) 3.97 (1.47)
The fair value of each option grant is estimated using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1995, 1996 and 1997 respectively: no dividend
yield for any years; expected volatility of 20 % for 1995 and 1996 and 37% for
1997; risk-free rate of return of 7.1% for 1995 and 1996 and 6.4% for 1997; and
expected lives of 5 years for 1995 and 1996 and expected lives of 5 and 10 years
for 1997. The SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, therefore, the resulting pro forma
compensation costs may not be representative of that to be expected in future
years.
27
28
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
10. COMMON STOCK OPTIONS (Cont.)
A summary of options is as follows:
Weighted Weighted Weighted
Average Average Average
1995 Exercise 1996 Exercise 1997 Exercise
Shares Price Shares Price Shares Price
----------- --------- ---------- -------- ---------- ---------
Beginning balance 2,319,000 $ 6.48 2,126,000 $ 6.76 2,056,000 $ 6.93
Granted 2,126,000 6.76 250,000 8.14 75,000 7.18
Exercised -- -- (300,000) 6.75 -- --
Canceled (2,319,000) 6.48 (20,000) 6.75 (55,000) 6.98
----------- ---------- ----------
Ending balance 2,126,000 6.76 2,056,000 6.93 2,076,000 6.93
=========== ========== ==========
Options exercisable
at end of year 2,054,000 2,024,000 2,059,000
=========== ========== ==========
Weighted average of
fair value of options
granted $ 2.28 $ 2.75 $ 3.03
The following table summarizes information about stock options outstanding and
exercisable at December 31, 1997:
Options Outstanding Options Exercisable
-------------------------------------------------------------- ---------------------------
Wtd. Avg.
Outstanding Remaining Wtd. Avg. Exercisable Wtd. Avg.
Range of as of Contractual Exercise as of Exercise
Exercise Prices Dec. 31, 1997 Life Price Dec. 31, 1997 Price
--------------- ------------- ----------- --------- ------------- --------
$6.75 to $6.88 1,796,000 7.1 years $6.75 1,796,000 $6.75
7.38 to 7.81 80,000 8.8 7.71 63,000 7.69
8.25 200,000 3.8 8.25 200,000 8.25
--------- ---------
6.75 to 8.25 2,076,000 6.8 years 6.93 2,059,000 6.93
========= =========
11. PREFERRED STOCK
Authorized preferred stock consists of 2,000,000 shares, $.01 par
value, issuable in one or more series with such dividend rates, liquidation
preferences and redemption, conversion and voting right restrictions as may be
determined by the Company's Board of Directors. No preferred stock has been
issued.
12. CLASS A COMMON STOCK, $.01 PAR VALUE
On July 12, 1996, GIANT's stockholders approved an amendment to the
Company's Certificate of Incorporation which authorized 5,000,000 shares of
Class A Common Stock, $.01 par value per share. This Class A Common Stock is
identical in all respects to the $.01 par value Common Stock except that the
Class A Common Stock, except in limited situations, have no voting rights.
Presently, there are no plans or commitments for this Class A Common Stock.
28
29
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
13. STOCKHOLDERS RIGHTS PLAN
On January 4, 1996, GIANT declared a dividend of one preferred share
purchase right ("Right") for each share of GIANT Common Stock outstanding on
January 16, 1996 and authorized the issuance of additional Rights for GIANT
Common Stock issued after that date.
Each Right entitles the holder to buy 1/1,000th of a share of Series
A Junior Participating Preferred Stock at an exercise price of $30 for each
1/1,000th share. The Rights will be exercisable and will trade separately from
the GIANT Common Stock (1) ten days after a public announcement that a person or
group of persons has become the beneficial owner of 15% or more of the GIANT
Common Stock (an "Acquiring Person"), or (2) ten business days (or such later
date as may be determined by the Board of Directors) after commencement or
announcement of an intention to make a tender or exchange offer, the
consummation of which would result in such person or group of persons becoming
the beneficial owner of 15% or more of GIANT Common Stock; provided however,
because Mr. Sugarman, Chairman and Chief Executive Officer of the Company,
beneficially owned in excess of 15% of GIANT Common Stock on the date the
Stockholders Rights Plan was adopted, Mr. Sugarman will become an Acquiring
Person only upon the acquisition by Mr. Sugarman of additional shares of GIANT
Common Stock, other than acquisitions through stock dividends, stock option
plans, GIANT compensation or employee benefit plans and other similar
arrangements.
If any person does become an Acquiring Person (subject to certain
exceptions), the other holders of GIANT Common Stock will be able to exercise
the Rights and buy GIANT Common Stock having twice the value of the exercise
price of the Rights. GIANT may, at its option, substitute fractional interests
of a share of Series A Junior Participating Preferred Stock for each share of
GIANT Common Stock to be issued upon exercise of the Rights. Additionally, if
GIANT is involved in certain mergers where its shares are exchanged or certain
major sales of its assets occur, holders of GIANT Common Stock will be able to
purchase for the exercise price, shares of stock of the Acquiring Person having
twice the value of the exercise price of the Rights.
The Rights may be redeemed by GIANT at any time prior to the time any
person becomes an Acquiring Person for a price of $.01 per Right. Unless
exercised, the Rights expire on January 4, 2006.
The Rights could have the effect of discouraging a third party from
making a tender offer or otherwise attempting to obtain control of GIANT. In
addition, because the Rights may discourage accumulations of large blocks of
GIANT Common Stock by purchasers whose objective is to take control of GIANT,
the Rights could tend to reduce the likelihood of fluctuations in the market
price of GIANT Common Stock that might result from accumulations of large blocks
of stocks.
14. INCOME TAXES
The benefit for income taxes is comprised of the following:
FOR THE YEAR ENDED DECEMBER 31, 1995 1996 1997
------- ------- -------
Current federal income tax benefit $ 413 $ 8,611 $ 1,066
Deferred federal income tax provision (156) (483) --
Current state income tax benefit 29 1,521 3,104
------- ------- -------
Benefit for income taxes $ 286 $ 9,649 $ 4,170
======= ======= =======
29
30
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
14. INCOME TAXES (Cont.)
The following is a reconciliation between the benefit for income
taxes and the amounts computed by applying the federal statutory rate of 34% to
pre-tax income or loss from continuing operations:
FOR THE YEAR ENDED DECEMBER 31, 1995 1996 1997
-------- -------- --------
Statutory federal tax (provision) benefit on pre-tax (income) loss $ 7,690 $ (2,809) $ 2,988
State tax benefit (provision), net of federal taxes 1,388 (507) 270
State tax reversal -- -- 3,100
(Increase) decrease in valuation allowance (8,898) 12,560 (2,401)
Other, net 106 405 213
-------- -------- --------
Benefit for income taxes $ 286 $ 9,649 $ 4,170
======== ======== ========
Deferred tax assets and (liabilities) of the Company consist of the
following:
AS OF DECEMBER 31, 1996 1997
------- -------
Investment in Rally's $ 2,341 $ 2,453
State capital loss carryforward 2,430 2,430
Operating losses -- 2,215
Depreciation (1,056) (1,152)
Other, net (93) 77
Valuation allowance (4,796) (7,197)
------- -------
Subtotal (1,174) (1,174)
Unrealized investment gains, net (164) (2,776)
------- -------
Net deferred tax liabilities $(1,338) $(3,950)
======= =======
The valuation allowance at December 31, 1996 and 1997 is provided
because it is not likely, as defined in SFAS No. 109, Accounting for Income
Taxes, that the deferred tax benefits will be realized through operations. The
valuation allowances recorded against deferred tax assets are based on
management's estimates related to the Company's ability to realize these
benefits. Appropriate adjustments will be made to the valuation allowance if
circumstances warrant in future periods. Such adjustments may have a significant
impact on the Company's consolidated financial statements.
At December 31, 1996, the Company's consolidated balance sheets
included a liability related to a proposed assessment by the State of
California, made as a result of their audit of the tax years 1989 through 1991.
GIANT had disputed this assessment and had provided documents to support the
Company's position during meetings with the New York office of the California
State Franchise Tax Board ("CFTB") during 1995 and 1996. As a result of a
preliminary proposed adjustment in December 1995, the Company made payments of
$259 during 1996. In the third quarter of 1997, the CFTB concluded the audit and
accepted the combined reports as originally filed by the Company, with only
minor adjustments. The Company's consolidated financial statements had reflected
a liability associated with the CFTB proposed assessment. As a result of winning
this dispute with the CFTB, the Company recognized a tax benefit of $3,100 in
the third quarter of 1997.
30
31
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
14. INCOME TAXES (Cont.)
Under the Internal Revenue Code, in addition to the regular corporate
income tax, an additional tax may be levied upon an entity that is classified as
a "personal holding company". In general, this tax is imposed on corporations
which are more than 50% owned, directly or indirectly, by 5 or fewer individuals
(the "Ownership Test") and which derive 60% or more of their income from
"personal holding company" sources, generally defined to be passive income
(the "Income Test"). If a corporation falls within the Ownership Test and the
Income Test, it is classified as a personal holding company, and will be taxed
on its "undistributed personal holding company income" at a rate of 39.6%. The
Company currently meets the stock ownership test. The Company has not met the
income requirement in recent years, therefore is not subject to this additional
tax; however no assurance can be given that the income test will not be
satisfied in the future.
15. LEASES
The Company leases office and hangar space under operating leases
with variable terms. The leases generally include renewal options. Total rental
expense for the years 1995, 1996 and 1997 amounted to $231, $186 and $316
respectively.
Future minimum rental commitments under noncancelable leases with a
remaining term in excess of one year as of December 31, 1997 are as follows:
1998 $ 258
1999 273
2000 297
2001 305
2002 96
16. COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal proceedings of a
nature considered normal to its business. In addition to these actions, The
Company is also involved in lawsuits as described in the following paragraphs.
Mittman/Rally's. In January and February 1994, two putative class
action lawsuits were filed, purportedly on behalf of the shareholders of Rally's
in the United States District Court for the Western District of Kentucky,
against Rally's, certain of Rally's present and former officers, directors and
shareholders and its auditors and GIANT and Burt Sugarman. The complaints allege
defendants violated the Securities Exchange Act of 1934, as amended, among other
claims, by issuing inaccurate public statements about Rally's in order to
arbitrarily inflate the price of Rally's common stock, and seek unspecified
damages, including punitive damages. On April 15, 1994, GIANT filed a motion to
dismiss and a motion to strike. On April 5, 1995, the Court struck certain
provisions of the complaint but otherwise denied GIANT's motion to dismiss. In
addition, the Court denied plaintiffs' motion for class certification. On July
31, 1995, the plaintiffs renewed this motion, and, on April 16, 1996, the Court
certified the class. Two settlement conferences have been conducted but have
been unsuccessful. Fact discovery is now set to be completed by the end of
April, 1998. No trial date has been scheduled yet. Management is unable to
predict the outcome of this matter at the present time and does not know if all
of the potentially available insurance coverages will apply. Rally's and GIANT
deny all wrongdoing and intend to defend themselves vigorously in this matter.
Harbor. In February 1996, Harbor Finance Partners ("Harbor")
commenced a derivative action, purportedly on behalf of Rally's, against certain
of Rally's officers and directors and GIANT, David Gotterer and Burt Sugarman
(listed alphabetically), before the Delaware Chancery Courts. Harbor named
Rally's as a nominal defendant. Harbor claims that the directors and officers of
both Rally's and GIANT, along with GIANT, breached their fiduciary duties to the
public shareholders of Rally's by causing Rally's to repurchase certain Rally's
Senior Notes at an inflated price. The NASDAQ closing price of the Senior Notes
as of March 6, 1998 was $981.25 per $1,000 principal amount, approximately 45%
higher than the repurchase price. Harbor seeks "millions of dollars in damages",
along with rescission of the repurchase
31
32
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
16. COMMITMENTS AND CONTINGENCIES (Cont.)
transaction. In the fall of 1996, all defendants moved to dismiss this action.
On April 3, 1997, the Chancery Court denied defendants' motion. Discovery is in
the initial stages. No trial date has been scheduled yet. Rally's and GIANT deny
all wrongdoing and intend to vigorously defend this action. It is not possible
to predict the outcome of this action at this time.
Shores. In October 1997, the putative class of plaintiffs and the
Company agreed through counsel, to settle the class action amicably, which
settlement provides for the payment of $125,000 to defray plaintiffs' attorneys'
fees and expenses as well as the approval by the Company's Board of Directors of
two resolutions confirming certain previously adopted corporate policies. In
February 1998, the Los Angeles Superior Court confirmed the Settlement. The
Company's applicable insurance should cover all or a substantial portion of the
payment. This class action had commenced in February 1996, when Michael Shores
on behalf of himself and purportedly all other stockholders of the Company
commenced a putative class action against the Company, and certain of the
Company's current and former directors, Terry Christensen, David Gotterer, Burt
Sugarman and Robert Wynn (listed alphabetically). The complaint, filed before
the Los Angeles County Superior Court, alleged that these directors breached
their fiduciary duties by adopting a stockholder rights plan, by causing GIANT
to sell certain Rally's Senior Notes back to Rally's, by causing GIANT to
repurchase certain amounts of its own Common Stock pursuant to its stock
repurchase program and by agreeing to the Exchange Offer. The complaint claimed
that these actions were undertaken to entrench management rather than for the
benefit of the Company and its stockholders. The complaint sought unspecified
damages, injunctive relief and a recovery of attorneys' fees and costs. In
February 1997, defendants filed a motion to dismiss for failure to make a
pre-litigation demand on the Board of Directors to investigate the plaintiffs'
claim. The motion asked the court, in the alternative, to stay the litigation to
permit the Company to address plaintiffs' claims internally. The motion to
dismiss was never heard. Throughout the litigation, the Company denied all
wrongdoing. By the settlement and the payment, the Company has not admitted any
liability.
KCC/Pike Santa Monica Action. In October 1996, KCC filed a complaint,
in the Los Angeles County Superior Court, against NeoGen Investors, L.P., N.D.
Management, Inc., NeoGen Holdings, L.P., Danco Laboratories, Inc. and NeoGen
Pharmaceutical, Inc. (collectively the "NeoGen Entities") and Joseph Pike,
stating causes of action for fraud, breach of fiduciary duty, fraudulent
concealment, breach of contract, unfair business practices and permanent and
preliminary injunctive relief and against the licensors of Mifepristone, the
Population Council, Inc. and Advances in Health Technology, Inc., on a
declaratory relief claim. The complaint seeks damages for the breach by Joseph
Pike and the NeoGen entities of a July 24, 1996 agreement by which KCC agreed to
contribute $6,000, in return for a 26% equity interest in the entity producing
the abortion inducing drug, Mifepristone, in the United States and other parts
of the world ("NeoGen Agreement"). On February 19, 1997, Joseph Pike and the
NeoGen Entities filed an answer to the complaint, denying its material
allegations and raising affirmative defenses. On that date, the NeoGen Entities
also filed a cross-complaint against KCC, the Company, and certain of the
Company's directors, Terry Christensen, David Malcolm and Burt Sugarman (listed
alphabetically), which alleged causes of action for fraud, breach of contract,
intentional interference with prospective economic advantage, negligent
interference with prospective economic advantage and unfair business practices.
In October 1997, KCC settled their action with the licensors, the Population
Council, Inc. and Advances in Health Technology, Inc., and in November 1997, KCC
settled their action with Joseph Pike. Discovery is on going in KCC's action
against the NeoGen Entities and in the related cross-complaint. Trial is
scheduled for June 2, 1998. The Company denies all wrongdoing and intends to
vigorously defend itself against the cross-complaint. It is not possible to
predict the outcome of this action at this time.
Pike Defamation Action (San Diego). On November 13, 1997, KCC, GIANT
and Joseph Pike announced the settlement of their litigation. This litigation
had commenced in November 1996 when Joseph Pike filed a complaint for defamation
against GIANT, KCC, Terry Christensen, David Malcolm and Burt Sugarman (listed
alphabetically) and Does 1 through 50, in the San Diego County Superior Court.
The complaint had sought an unspecified amount of general, special and exemplary
damages. All defendants answered the complaint, denying its material allegations
and had raised several affirmative defenses.
32
33
GIANT GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
16. COMMITMENTS AND CONTINGENCIES (Cont.)
Since management does not believe that the previously mentioned
lawsuits and other claims and legal proceedings, in which the Company is a
defendant, contain meritorious claims, management believes that the ultimate
resolution of the lawsuits will not materially and adversely affect the
Company's consolidated financial position or results of operations.
The Company has an employment contract with the Chairman of the Board,
President and Chief Executive Officer of the Company that expires on December
31, 2000. The contract calls for an annual base salary of $1,000 and an annual
bonus determined, year to year, by the Incentive Compensation Committee of the
Board of Directors within specified guidelines of the Incentive Compensation
Plan.
33
34
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of GIANT GROUP, LTD.:
We have audited the accompanying consolidated balance sheets of GIANT GROUP,
LTD. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statement of operations, stockholders' equity and
cash flows for the years ended December 31, 1997, 1996 and 1995. 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 generally accepted auditing
standards. 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 GIANT GROUP, LTD.
and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for the years ended December 31, 1997, 1996
and 1995, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Los Angeles, California
March 6, 1998
34
35
GIANT GROUP, LTD.
QUARTERLY FINANCIAL DATA
(Dollars in thousands, except per share amounts)
(Unaudited)
Quarter Ended
1997 March 31 June 30 September 30 December 31
- ---- ---------------------------------------------------------------
Revenue $ 745 $ 704 $ 709 $ 426
Co-ownership program expenses 463 551 1,684 2,917
Costs and expenses 1,231 1,422 1,392 1,089
Equity in earnings (loss) of affiliate (143) 14 (172) (322)
-------------------------------------------------------------
Loss before benefit for income taxes (1,092) (1,255) (2,539) (3,902)
Benefit for income taxes -- -- (3,100) (1,070)
-------------------------------------------------------------
Net income (loss) $(1,092) $(1,255) $ 561 $(2,832)
=============================================================
Basic earnings (loss) per common share (1) $ (0.31) $ (0.39) $ 0.18 $ (0.89)
Diluted earnings (loss) per common share (1) (0.31) (0.39) 0.18 (0.89)
Shares - Basic and diluted earnings (loss) per
common share 3,490 3,191 3,181 3,181
(1) The calculation for the quarter ended September 30, 1997 does not include
2,171,000 potentially dilutive stock options, as the effect of these options
would be anti-dilutive because the exercise price of these options, ranging from
a high of $8.25 to a low of $6.75, exceed the average market price for the
quarter.
Quarter Ended
1996 March 31 June 30 September 30 December 31
- ---- ----------------------------------------------------------------
Revenue $ 1,452 $ 2,612 $ 2,815 $ 1,139
Co-ownership program expenses -- -- -- 24
Costs and expenses 1,042 1,155 1,313 1,495
Proxy contest and related legal -- 736 -- 16
Exchange Offer and related legal 388 130 -- --
Gain on sale of investment in affiliate -- 3,197 -- 2,980
Equity in earnings (loss) of affiliate 397 (168) 88 50
---------------------------------------------------------------
Income before expense (benefit) 419 3,620 1,590 2,634
for income taxes
Expense (benefit) for income taxes -- (8,563) 51 (1,137)
---------------------------------------------------------------
Net income $ 419 $ 12,183 $ 1,539 $ 3,771
===============================================================
Basic earnings per common share $ 0.09 $ 2.90 $ 0.41 $ 1.04
Diluted earnings per common share 0.08 2.70 0.38 0.96
Shares - Basic earnings per common share (2) 4,678 4,200 3,779 3,639
Options issued to employees and non-
employee directors (2) 455 318 224 307
---------------------------------------------------------------
Shares - Diluted earnings per common share 5,133 4,518 4,003 3,946
===============================================================
(2) The calculation for the quarter ended September 30, 1996 does not include
200,000 potentially dilutive stock options, as the effect of these options would
be anti-dilutive because the exercise price of $8.25 for these options exceed
the average market price for the quarter.
QUARTERLY DATA
35
36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10, 11, 12 and 13.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; EXECUTIVE
COMPENSATION; SECURITY OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by these items, other than information
set forth in this Form 10-K under Item I, "Executive officers
of registrant", is omitted because the Company is filing a
definitive proxy statement pursuant to Regulation 14A not later
than 120 days after the end of the fiscal year covered by this
report which includes the required information. The required
information contained in the Company's proxy statement is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) DOCUMENTS FILED AS PART OF THIS REPORT:
1. The following financial statements and schedules of
Rally's are attached:
Management's Discussion and Analysis of Financial Condition
and Results of Operations
Consolidated Balance Sheets as of December 29, 1996 and
December 28, 1997
Consolidated Statements of Operations for each of the three
fiscal years in the period ended December 28, 1997
Consolidated Statements of Stockholders' Equity for each of
the three fiscal years in the period ended December 28,
1997
Consolidated Statements of Cash Flows for each of the three
fiscal years in the period ended December 28, 1997
Notes to Consolidated Financial Statements
Report of Independent Public Accountants
Schedule II - Valuation and Qualifying Accounts, for each
of the three fiscal years in the period ended December 28,
1997
Schedules not listed above have been omitted because they
are not applicable or are not required or the information
required to be set forth therein is included in the
Consolidated Financial Statements or Notes thereto.
36
37
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(Cont.)
2. Financial Statement Schedules.
The following financial statement schedules of the Company for the three
years ended December 31, 1997, 1996 and 1995 are filed as part of this
Report and should be read in conjunction with the Consolidated Financial
Statements of the Company.
Schedule Page
II Valuation and Qualifying Accounts at December 31, 1997.......S-1
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or Notes
thereto.
3. Exhibits
NO. DESCRIPTION OF EXHIBIT
- --- ----------------------
3.1.1 Restated Certificate of Incorporation of the Company, as amended
through May 21, 1987 (filed as Exhibit 3.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1987, and incorporated herein by reference).
3.1.2 Certificate of Amendment to Restated Certificate of
Incorporation of the Company, dated June 1, 1990 (filed as
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1990, and incorporated herein by
reference).
3.1.3 Certificate of Amendment to Restated Certificate of
Incorporation of the Company, dated November 9, 1992 (filed as
Exhibit 1 to the Company's Current Report on Form 8-K, dated
November 10, 1992, and incorporated herein by reference).
3.1.4 Certificate of Amendment to Restated Certificate of
Incorporation of the Company, dated May 9, 1994 (filed as
Exhibit 3.1.4 to the Company's Annual Report on Form 10-K, dated
March 28, 1995, and incorporated herein by reference).
3.1.5 Certificate of Designation of Series A Junior Participating
Preferred Stock, dated January 12, 1996 (filed as Exhibit 3.1.5
to the Company's Annual Report on Form 10-K, dated March 29,
1996, and incorporated herein by reference).
3.1.6 Certificate of Amendment to Restated Certificate of
Incorporation to Authorize Non-Voting Common Stock, dated July
20, 1996 (Proposal No. 4 in the Notice of Annual Meeting of
Stockholders held on July 12, 1996, filed with the SEC on June
7, 1996 and incorporated herein by reference).
3.2 By-laws of the Company, as amended (filed as Exhibit 1 to the
Company's Report on Form 8-K, dated January 7, 1996, and
incorporated herein by reference).
4.1 Rights Agreement of the Company, dated January 4, 1996 (filed as
Exhibit 1 to the Company's Form 8-K, dated January 4, 1996, and
incorporated herein by reference).
10.1 1985 Non-Qualified Stock Option Plan, as amended (filed as
Exhibit 10.1.2 to the Company's Annual Report on Form 10-K,
dated March 28, 1995, and incorporated herein by reference).
37
38
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(Cont.)
3. Exhibits (Cont.)
NO. DESCRIPTION OF EXHIBIT
- --- ----------------------
10.4 Tax Sharing and Indemnification Agreement, dated as of September
27, 1994 between the Company and Giant Cement Holding, Inc.
("GCHI") (filed as Exhibit 1 to the Company's Current Report on
Form 8-K, dated October 14, 1994, and incorporated herein by
reference).
10.5 Indemnification and Release Agreement, dated as of September 27,
1994, among the Company, KCC , GCHI (filed as Exhibit 2 to the
Company's Current Report on Form 8-K, dated October 6, 1994 and
incorporated herein by reference).
10.6 Note purchase agreement ($16 million face value bonds) between
GIANT (seller) and Rally's (buyer), dated January 29, 1996
(filed as Exhibit 10.7 to the Company's Annual Report on Form
10-K, dated March 28, 1996, and incorporated herein by
reference).
10.7 Note purchase agreement ($6 million face value bonds) between
GIANT (seller) and Rally's (buyer), dated January 29, 1996
(filed as Exhibit 10.8 to the Company's Annual Report on Form
10-K, dated March 28, 1996, and incorporated herein by
reference).
10.8 Short-term promissory note ($4.1 million) between GIANT (payee)
and Rally's (maker), dated January 29, 1996 (filed as Exhibit
10.9 to the Company's Annual Report on Form 10-K, dated March
28, 1996, and incorporated herein by reference).
10.9 Promissory note for advances of up to $2 million between GIANT
(payee) and Rally's (maker), dated February 1, 1996 (filed as
Exhibit 10.10 to the Company's Annual Report on Form 10-K, dated
March 28, 1996, and incorporated herein by reference).
10.10 Letter of Credit Reimbursement Agreement between GIANT and
Rally's, dated February 1, 1996. (filed as Exhibit 10.11 to the
Company's Annual Report on Form 10-K, dated March 28, 1996, and
incorporated herein by reference).
10.11 Letter of Credit Agreement between GIANT and Bank of America
National Trust and Savings Association, dated February 23, 1996
(filed as Exhibit 10.12 to the Company's Annual Report on Form
10-K, dated March 28, 1996, and incorporated herein by
reference).
10.12 Amendment Number 1, dated March 18, 1996, to Letter of Credit
Agreement between GIANT and Bank of America National Trust and
Savings Association, dated February 23, 1996 (filed as Exhibit
10.13 to the Company's Annual Report on Form 10-K, dated March
28, 1996, and incorporated herein by reference).
10.13 GIANT GROUP, LTD. 1996 Employee Stock Option Plan (Exhibit A in
the Notice of Annual Meeting of Stockholders held on July 12,
1996, filed with the SEC on June 7,1996, as amended by Exhibit B
in the Notice of Annual Meeting of Stockholders held on May 8,
1997, filed with the SEC on April 7, 1997, and incorporated
herein by reference).
10.14 GIANT GROUP, LTD. 1996 Stock Option Plan for Non-Employee
Directors (Exhibit B in the Notice of Annual Meeting of
Stockholders held on July 12, 1996, filed with the SEC on June
7, 1996, as amended by Exhibit C in the Notice of Annual Meeting
of Stockholders held on May 8, 1997, filed with the SEC on April
7, 1997, and incorporated herein by reference).
38
39
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(Cont.)
3. Exhibits (Cont.)
NO. DESCRIPTION OF EXHIBIT
- --- ----------------------
10.15 Promissory note ($5 million) between GIANT and CBI dated
September 27, 1996 (filed as Exhibit 10.1 to the Company's Form
10-Q for the third quarterly period ended September 30, 1996,
and incorporated herein by reference).
10.16 Guaranty between GIANT and CKE on $5 million promissory note,
dated September 27, 1996 (filed as Exhibit 10.2 to the Company's
Form 10-Q for the third quarterly period ended September 30,
1996, and incorporated herein by reference).
10.17 Employment Agreement dated February 24, 1997, between the
Company and Burt Sugarman (filed as Exhibit 10.17 to the
Company's Form 10K for the fiscal year ended December 31, 1996,
and incorporated herein by reference).
10.18 Amended and Restated Credit Agreement dated as of November 22,
1996 among Checkers, CKE as Agent, and the lenders listed
therein (filed as Exhibit 4.1 to Checkers Current Report on Form
8-K dated November 22, 1996, and incorporated herein by
reference).
10.19 Warrant to Purchase Common Stock of Checkers Drive-In
Restaurants, Inc. dated November 22, 1996 (filed as Exhibit 4.3
to Checkers Report on Form 8-K dated November 22, 1996, and
incorporated herein by reference).
10.20 SETTLEMENT AND LIMITED RELEASE AGREEMENT between GIANT and
Fidelity and CKE, dated March 21, 1997 (filed as Exhibit 10.1 to
the Company's Form 10-Q for the first quarterly period ended
March 31, 1997, and incorporated herein by reference).
10.21 Loan agreement ($10,000,000) between GIANT MARINE GROUP, LTD.
and Debis Financial Services, Inc., dated May 16, 1997 (filed as
Exhibit 10.1 to the Company's Form 10-Q for the second quarterly
period ended June 30, 1997, and incorporated herein by
reference).
10.22 Mortgage between GIANT MARINE GROUP, LTD. ("Owner") and Debis
Financial Services, Inc. ("Mortgage"), dated May 16, 1997 (filed
as Exhibit 10.1 to the Company's Form 10-Q for the second
quarterly period ended June 30, 1997, and incorporated herein by
reference).
10.23 GIANT GROUP, LTD. 1997 Incentive Compensation Plan (Exhibit D in
the Notice of Annual Meeting of Stockholders held on May 8,
1997, filed with the SEC on April 7, 1997, and incorporated
herein by reference).
16 Letter from Coopers & Lybrand L.L.P. to the SEC dated January
29, 1996 (filed as Exhibit 1 to the Company's Report on Form
8-K, dated January 25, 1996, and incorporated herein by
reference).
21* List of Subsidiaries.
23.1* Consent of Arthur Andersen LLP on Rally's financial statements.
23.2* Consent of Arthur Andersen LLP on GIANT's financial statements.
27* Financial Data Schedules.
* FILED HEREWITH
39
40
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(Cont.)
3. Exhibits (Cont.)
(b) REPORTS ON FORM 8-K:
During the quarter ended December 31, 1997, the Company did not
file any reports on Form 8-K.
(c) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K:
Described in Item 14 (a) 3 of this Annual Report on Form 10-K.
(d) SEPARATE FINANCIAL STATEMENTS AND SCHEDULES
See Item 14 (a) 1 and 2 for financial statements for 50% or less
owned persons and schedules included.
40
41
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of GIANT GROUP, LTD.:
We have audited in accordance with generally accepted auditing standards the
financial statements included in GIANT GROUP, LTD.'s annual report to
shareholders incorporated by reference in this Form 10-K, and have issued our
report thereon dated March 6, 1998. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The schedule listed in
the index under Item 14(a)2 is the responsibility of the company's management
and is presented for purposes of complying with the Securities and Exchange
Commissions rules and is not part of the basic financial statements. The
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly state in all material
respects the financial data required to be set forth therein in relation to the
basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Los Angeles, California
March 6, 1998
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42
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.
GIANT GROUP, LTD.
Registrant
Date: March 20, 1998 By: /s/ BURT SUGARMAN
-----------------------------
Burt Sugarman
Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 20, 1998 By: /s/ BURT SUGARMAN
-----------------------------
Burt Sugarman
Chairman of the Board and
Chief Executive Officer
Date: March 20, 1998 By: /s/ WILLIAM H. PENNINGTON
-----------------------------
William H. Pennington
Vice President, Chief Financial
Officer, Secretary and Treasurer
(Principal Financial and Accounting
Officer)
Date: March 20, 1998 By: /s/ DAVID GOTTERER
-----------------------------
David Gotterer
Director
Date: March 20, 1998 By: /s/ TERRY CHRISTENSEN
-----------------------------
Terry Christensen
Director
Date: March 20, 1998 By: /s/ DAVID MALCOLM
-----------------------------
David Malcolm
Director
Date: March 20, 1998 By: /s/ JEFF ROSENTHAL
-----------------------------
Jeff Rosenthal
Director
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43
FINANCIAL STATEMENTS AND SCHEDULES FOR RALLY'S HAMBURGERS, INC. LISTED IN
PART IV, ITEM 14(a)1. IN THE COMPANY'S FORM 10-K.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following table provides a comparative view of the Company's
operations:
(In thousands)
Fiscal Years Ended
--------------------------------------------------------
December 31, December 29, December 28,
1995 1996 1997
---------------- ----------------- -------------
Income (loss) from operations before restaurant
closures and other $ (5,425) $ 4,110 $ 3,478
Provision for restaurant closures and other (31,045) (20) (158)
------------- ------------- ------------
Income (loss) from operations (36,470) 4,090 3,320
Total other expense, net (9,910) (8,057) (7,381)
------------- ------------- ------------
Loss before income taxes and
extraordinary item (46,380) (3,967) (4,061)
(Provision) benefit for income taxes (539) 675 (455)
Extraordinary items, net of tax - 5,280 -
------------- ------------- ------------
Net income (loss) $ (46,919) $ 1,988 $ (4,516)
============= ============= ============
During 1997, the Company experienced an increase of 2.4% in the loss before
income taxes and extraordinary item. The 1996 extraordinary gain, net of tax, of
approximately $5.3 million, or $.31 per share from the Company's early
retirement of certain of its outstanding Senior Notes, at amounts below carrying
value, resulted in the Company reporting net income for fiscal 1996. The
transactions involving the Senior Notes were opportunities created by the
Company's conservation of cash during the second half of 1995 and the depressed
market price of the Senior Notes during the year. In addition, the transactions
resulted in a reduction of net interest expense in 1997 of approximately $2.1
million and $.8 million as compared to 1995 and 1996, respectively. These
transactions are more fully described in Note 10 to the accompanying
consolidated financial statements.
As more fully discussed in Note 13 to the accompanying financial
statements, the Company's effective tax rates on its reported pre-tax losses
differ significantly from statutory rates, due primarily to concerns as to the
ultimate realizability of net operating loss carryforwards. Until circumstances
otherwise indicate that realization becomes more likely than not, no additional
benefit will be recognized.
As evidenced in the table above, the provision for restaurant closures
and other was significantly reduced in 1996 and 1997 from the prior year levels.
These reductions are primarily attributable to the 1996 and early 1997
strengthening of the store level economics, which have improved the Company's
ability to recover, at a minimum, its store level investment and to prior
writedowns of underperforming assets, reducing the need at this time for
additional writedowns of Company assets. See the section below entitled
"Restaurant Closures and Other" for a more detailed discussion.
The Company's income from operations before restaurant closures and other
in fiscal 1997 declined $0.8 million from the prior year. Improved restaurant
costs of sales in fiscal 1997 were offset by continued declining same store
sales. The Company continues to refine its turnaround strategy as results show
the relative success or the need for reassessment for the various components.
The plan contains four key strategies that are designed to create a consistently
profitable environment: (i) strengthen the balance sheet and reduce fixed costs,
(ii) improve store level profitability, (iii) establish an effective brand
positioning and (iv) pursue various growth opportunities. The results of and
plans for each strategy are more fully discussed below:
Although the Company's debt level is still high, the Company has made
substantial progress in improving its balance sheet and reducing fixed costs.
Interest cost was reduced by another $1.2 million in 1997 after decreasing
1
44
$2.1 million in 1996, interest was significantly reduced through the retirement
of approximately $22 million face value of the Company's Senior Notes in January
1996 and an additional $4.7 million during the fourth quarter of 1996. In
addition, $10.8 million in gross proceeds were generated through the Company's
Rights Offering completed in September, 1996. The proceeds from the Offering
were used to pay off debt of approximately $4.5 million and the remainder is
being used for new store construction, refurbishment of some existing
restaurants and for other general corporate purposes. Outstanding warrants from
a Rights Offering and from a separate issuance of 1,500,000 additional warrants
in December, 1996, (see "Liquidity and Capital Resources") if exercised, would
raise an additional $17.4 million in cash proceeds. The Company also made
progress in disposing of surplus assets in 1996 and 1997, as assets held for
sale declined by approximately $5 million from the end of 1995. On December 18,
1997, the Company acquired approximately 19.1 million shares of Checkers
Drive-In Restaurants ("Checkers") pursuant to an exchange agreement in which the
Company's common and preferred shares were issued as consideration. This
agreement aligns the Company with its counterpart in the double drive-thru
segment, and enhances the ability to create synergies that will benefit both
Companies. This is evidenced by the Management Services Agreement dated November
30, 1997, pursuant to which Checkers is providing certain management services to
the Company. The agreement creates the opportunity for the Company to continue
to show key reductions in general and administrative expense. In fiscal 1997,
the Company reduced its general and administrative costs by $1.0 million after a
$2.2 million reduction in the prior year.
The Company has made progress in the second key strategy of its
turnaround plan, as store-level profitability has improved since 1995. Although
the Company has experienced a 10.9% decline in sales during 1997, the decline in
restaurant operating margins was only .5%. Much of the improvement since 1995
has resulted from the Company's cost reduction actions related to food, paper
and labor which were implemented in the beginning of the second quarter of 1996
and are further discussed in "Results of Operations." The primary impact of
these changes was realized during the third and fourth quarters of 1996 and was
reflected in the Company's store profit margins. Improvement in store level
profitability also resulted from the elimination of heavy discounting that drove
traffic increases but adversely affected the Company's profitability.
The Company's third key strategy in its turnaround plan will be the
primary focus going into 1998. Although the Company generated net income from
operations in 1996 and 1997, same store sales have declined during that period.
To combat this negative trend in sales, management believes an effective brand
positioning is essential in order to grow same store sales. During 1997, the
Company's brand positioning included a "Bigger, Better, Burger" campaign, which
included the introduction of two new premium burgers, new and more impactful
menu boards, and new advertising. The Company believes that although elements of
this program showed promise, the positioning did not differentiate the Company
enough to reverse the decline in sales. Therefore, the positioning for 1998 has
evolved into a campaign focusing on taste, supported by advertising designed to
create a point of difference that the leaders in the fast food hamburger segment
will find difficult to duplicate.
The final strategy in the Company's turnaround plan is to pursue growth
opportunities. In 1997, the Company opened nine stores and franchisees opened 19
stores. In addition to growth in the number of stores, the indoor dining test
being conducted in the Louisville market may provide customer count growth in
existing stores. The Company believes that a well-managed double drive-thru
concept can be profitable, but remaining exclusively in this arena excludes a
segment of the population that desires an indoor dining experience. Research has
indicated that a segment of the population does not even consider Rally's as a
place to eat because of the lack of indoor seating. As of March, 1998, the
Company had five dining rooms in test, where the passenger side drive-thru lane
had been removed and a 20 to 50 seat dining room was added to the side of the
existing unit. Early sales results at these units have been encouraging,
however, the Company continues to work to reduce the costs to construct these
dining rooms in order to improve the return on this investment. The Company also
plans to test other dining room designs that could retain the speed of service
expected with two drive-thru lanes.
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45
Further discussion of the factors affecting results of operations is
included below.
Restaurant Closures And Other
Certain charges in fiscals 1995, 1996 and 1997 have been aggregated and
segregated into the caption "Provision for Restaurant Closures and Other" in the
accompanying Statements of Operations. These items represent estimates of the
impact of management decisions which have been made at various points in time in
response to the Company's sales and profit performance and the then-current
revenue building and profit enhancing strategies and are discussed in further
detail below.
Prior to 1995, the Company's management had initiated efforts to franchise
or selectively divest itself of approximately 60 Company-Owned stores in
selected markets. This strategy was expected to allow the Company to concentrate
on regaining sales, profit and cash flow momentum in its other markets through
stronger focus on a smaller number of its most profitable markets. The Company
believed that franchisees would be better able to concentrate on the units that
had not been top performers and achieve near term improvements in the
performance of those units. Prior to 1995, the Company recorded a charge of $8.0
million which represented an estimate of the difference between the estimated
net realizable value, given the then most likely divestiture/disposal plan, and
the net book value of these restaurants and markets.
Early in 1995, six of the 60 units, five of which were in one market, were
closed and sublet. During the third quarter, 1995, management concluded that it
was unlikely that much of the 1994 plan of disposal described above could be
executed. For this reason, the Company decided to close up to 16 of the
remaining restaurants, resulting in additional charges in the third quarter of
1995 of approximately $400,000 to reflect additional writedown of the property
and equipment to currently estimated net realizable values and approximately
$2.3 million to record reserves for expected future occupancy related costs.
Eight of these restaurants were closed as of December 31, 1995. Six additional
restaurants were closed in 1996. The Company decided in 1996 to continue to
operate 2 of these 16 restaurants until such time that the leases have expired
or the properties have been sublet. The Company decided to continue to operate
the remaining 38 stores previously included in the original 60 restaurants. With
the restaurant closures discussed above and without the burden of impending
closure associated with the prior plan regarding these markets, management
believes that the markets represent acceptable growth opportunities for future
development.
Management also decided to close nine non-profitable restaurants in certain
of its core markets resulting in charges in the third quarter of 1995 of
approximately $1.9 million related to the writedown of assets to their net
realizable values and $1.9 million to record expected future occupancy related
costs. Seven of these restaurants were closed as of December 31, 1995. The
Company decided in 1996 to continue to operate two of these restaurants, one of
which is being operated by CKE, as part of a management agreement with the
Company.
During the third quarter of 1995, charges were recorded of approximately
$3.3 million to dispose of the assets located on eight sites in the Houston,
Texas market which had been operated as Company units and then leased to a
former franchisee. The Company decided not to refranchise these units due to
failure to identify a suitable franchise candidate which management believed had
adequate and evident financial resources to successfully open the Houston
market. This charge consisted of a writedown of approximately $2.7 million of
the assets to their estimated net realizable values and reserves of
approximately $600,000 for expected future occupancy related costs.
In 1995, 18 additional modular buildings became unutilized, as expected
Company development continued to be reduced and decisions were made regarding
other restaurant closures. At December 31, 1995, the Company had available for
sale 54 substantially completed modular restaurant buildings, which were not
expected to be assigned to future Company development. In order to recognize the
impact of the additional unutilized buildings and to more competitively price
all of the modular buildings available for sale, the Company recorded charges of
approximately $1.6 million in the third quarter of 1995 and $458,000 in the
fourth quarter of 1995. The charges of $2.3 million related to third quarter
1995 closure decisions, described above, also included approximately $1.5
million related to an additional writedown on modular buildings which were
previously utilized at those locations. During 1996 and 1997, the Company sold
20 buildings and 12 buildings, respectively. During 1996, the Company closed six
restaurants and during 1997 redeployed two buildings for corporate development.
At December 28, 1997, 26 buildings remain available for sale which are being
marketed to franchisees and others. Current expectations of net realizable value
are based on the Company's experience related to marketing the buildings.
15
46
The Company recorded approximately $1.5 million in charges in the third
quarter of 1995 related to further writedowns on excess land idled by slowdowns
in the Company's expansion plans. Such land had been scheduled to be auctioned
during the fourth quarter of 1995. These auctions occurred in the fourth quarter
and closed in the first quarter of 1996. The absolute auctions generated lower
than anticipated sales prices, and additional losses of $1.1 million were
recorded in the fourth quarter of 1995. As further discussed in "Liquidity and
Capital Resources," these sales provided cash flow of approximately $2.4
million, primarily in the first quarter of 1996.
During the fourth quarter, 1995 the sublessee of five of the six sites
closed under the November, 1994 plan, defaulted on the terms of the sublease
agreements, resulting in charges of $483,000 related to occupancy and $430,000
to reduce the carrying value of the tangible assets to management's estimate of
fair value less cost to sell.
Due to concerns about obsolescence and abnormal wear and tear associated
with transport and storage of surplus equipment, management recorded an $820,000
writedown in December, 1995 of the equipment's carrying value. Additionally,
fourth quarter, 1995 charges totaling approximately $1.1 million were recorded
to reflect changes in the estimated net realizable values of the Company's
remaining surplus assets and properties.
As described above, a substantial portion of the charges in fiscal year
1995 related to asset writedowns. The remainder of the charges related
substantially to the establishment of reserves for expected future
occupancy-related costs. During 1996, the Company revised its estimate of net
realizable value for five of its poor performing restaurants in Montgomery,
Alabama based upon an existing agreement to sell the restaurants to a
non-affiliated restaurant operator. Such change in estimate resulted in a
reduction of approximately $232,000 in related reserves. In addition, during the
fourth quarter of 1996, management decided to reopen three units previously
closed and to continue to operate a fourth unit that had been designated for
closure, resulting in a reduction in the reserves for future occupancy-related
costs of approximately $659,000. In addition, approximately $87,000 in other
charges for net changes in estimated asset recovery were recorded during 1996.
During 1997, the Company closed two restaurants and recorded provisions to
terminate leases on existing corporate office facilities and revised certain
reserves previously established, resulting in net provisions for restaurant
closures and other of $158,000. Such adjustments to the reserves are included in
the caption "Provision for restaurant closures and other" on the accompanying
Statement of Operations. As of December 28, 1997, approximately $4.6 million
remained in the reserve for expected future occupancy-related costs which is net
of estimated future sublease recoveries. Assets held for sale of $1.1 million at
December 28, 1997 resulting from the actions noted above consist mainly of
surplus land, buildings and equipment. The expected disposal dates for these
assets are over the next 12 months. The carrying amounts of such assets to be
disposed of are shown separately on the accompanying consolidated balance
sheets.
In addition to the charges described above, 1995 results include
approximately $13.7 million of certain charges recorded in the fourth quarter
related to the adoption of Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" (SFAS 121). This charge represents impairment of the carrying
value of the assets of 37 stores based on management's future cash flow
estimates given then current base lines and reasonable trend assumptions.
Additional impairment reserves of approximately $824,000 were recorded during
1996, primarily related to three underperforming restaurants. No additional
restaurants were determined to be impaired in 1997. See Notes 3 and 16 to the
accompanying consolidated financial statements.
General
Rally's revenues are derived primarily from Company-owned restaurant sales
and royalty fees from franchisees. The Company also receives revenues from the
award of exclusive rights to develop Rally's restaurants in certain geographic
areas (area development fees) and the award of licenses to use the Rally's brand
and confidential operating system (franchise fees). Systemwide sales consist of
aggregate revenues of Company-owned and franchised restaurants (including
CKE-operated restaurants). Company revenue also includes payments resulting from
an operating agreement with CKE, referred to as Owner fee income in the
accompanying consolidated financial statements. Restaurant cost of sales,
restaurant operating expenses, depreciation and amortization, and advertising
and promotion expenses relate directly to Company-owned restaurants. General and
administrative expenses relate to both Company-owned restaurants and franchise
operations. Owner expenses relate to CKE-operated restaurants and consist
primarily of depreciation and amortization.
The table below sets forth the percentage relationship to total revenues,
unless otherwise indicated, of certain items included in the Company's
consolidated statements of income and operating data for the periods indicated:
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47
Fiscal Years Ended
-----------------------------------------------------------------------
January 2, January 1, December 31, December 29, December 28,
1994 1995 1995 1996 1997
------------- ------------- ------------- ------------- -------------
Revenues:
Restaurant sales 95.1% 95.8% 96.2% 96.1% 96.2%
Franchise revenues and fees 4.9 4.2 3.8 3.6 3.3
Owner fee income - - - .3 .5
------------- ------------- ------------- ------------- -------------
100.0% 100.0% 100.0% 100.0% 100.0%
------------- ------------- ------------- ------------- -------------
Costs and expenses:
Restaurant cost of sales (1) 35.2% 35.0% 35.7% 34.3% 32.5%
Restaurant operating expenses (1) 42.5 43.3 46.0 44.2 42.8
General and administrative expenses 10.5 10.1 10.4 10.7 10.7
Advertising and promotion expenses (1) 7.0 6.1 7.3 5.0 7.1
Depreciation and amortization (1) 6.1 7.9 7.2 6.3 6.5
Owner expense (2) - - - 169.1 153.2
Warrant Expense - - - - .6
Other charges (credits) 7.2 9.3 16.4 - .1
Income (loss) from operations (4.0) (7.9) (19.3) 2.5 2.3
Total other (expense) (3.7) (5.1) (5.3) (5.0) (5.1)
------------- ------------- ------------- ------------- -------------
Net income (loss) before income taxes
and extraordinary items (7.7) (13.0) (24.6) (2.5) (2.8)
Net income (loss) (5.1)% (10.3)% (24.8)% 1.2% (3.1)%
============= ============= ============= ============= =============
Number of restaurants:
Restaurants open at the beginning of 450 520 542 481 467
period
------------- ------------- ------------- ------------- -------------
Company restaurants opened (closed or
transferred), net during period 55 (2) (11) (30) 20
Franchised restaurants opened (closed or
transferred), net during period 15 24 (50) 16 (10)
------------- ------------- ------------- ------------- -------------
Total restaurants opened (closed or
transferred), net during period 70 22 (61) (14) 10
------------- ------------- ------------- ------------- -------------
Total restaurants open at end of period 520 542 481 467 477
============= ============= ============= ============= =============
- --------------------------
(1) As a percentage of restaurant sales.
(2) As a percentage of owner fee income.
Results of Operations
Fiscal Year Ended December 28, 1997 Compared With Fiscal Year Ended
December 29, 1996
Systemwide sales declined 8.4% for 1997 to approximately $290.1 million
compared with approximately $316.7 million a year ago. This decrease is
attributable primarily to same store sales declines of 8.2% systemwide. The
decline in same store sales is primarily due to the highly competitive
environment during 1997 during which many competitors continued to discount
their menu items.
Total company revenues decreased 11% to approximately $144.9 million in
1997 compared with approximately $162.8 million in 1996. Company-owned
restaurant sales decreased 11% to approximately $139.4 million due to a 9.2%
decline in same stores sales and fewer Company units in operation. During the
year, the Company opened 9 new restaurants, re-opened three restaurants
previously closed, acquired 11 restaurants from franchisees, closed 2 units and
transferred 1 restaurant to a franchisee. Franchisees, exclusive of CKE, opened
19 new units, acquired 1 unit from the Company, closed 19 units and transferred
ownership of 11 restaurants to the Company.
Restaurant cost of sales, as a percentage of sales, decreased to 32.5% for
1997 compared with 34.3% for 1996. This decrease is attributable primarily to
various cost reduction actions taken during 1997 and the second half of 1996.
Management's efforts to improve food and paper costs by implementing tighter
operational controls was supplemented by cost of sales reductions realized by
cooperating with CKE Restaurants, Inc. and Checkers to leverage the purchasing
power of the three entities to negotiate improved terms for their respective
contracts with suppliers.
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Restaurant operating expenses, the major component of which is labor and
related expenses, were 42.8% of sales for 1997 compared with 44.2% for 1996. The
improvement is primarily attributable to reductions in management and crew labor
that resulted from implemented changes in staffing levels and labor deployment.
The reduction in operating expenses was achieved despite the inclusion of
several expense categories that are fixed in nature. The closing of poorer
performing units and the transfer of operational responsibility for certain
higher fixed cost restaurants in Western markets to CKE that occurred on July 1,
1996 enabled the company to show improvement in this category despite the
decline in same store sales.
General and administrative expenses decreased $1.9 million in 1997 due
primarily to reductions in the corporate and field operations staff and lower
levels of bad debt expense, partially offset by higher legal fees but remained
consistent as a percent of revenues due to the reductions in total revenues.
Advertising expenses increased approximately $2.2 million to 7.1% of sales
for 1997 compared to 5.0% for 1996. During the first quarter of 1997, the
company initiated a new campaign that made greater use of television advertising
than in previous years which also contributed to the increased cost. Media
expenditures were curtailed during the fourth quarter of 1996 as management
worked with the new advertising agency on new creative and brand positioning.
Depreciation and amortization decreased to approximately $9.1 million as
compared to approximately $9.8 million for the prior year. This decrease is
primarily due to a segregation into owner expense of depreciation and
amortization associated with the CKE-operated properties as of July 1, 1996 and
certain assets becoming fully depreciated during 1997.
Owner expense of approximately $1.1 million for 1997 represent the
Company's segregated ownership cost related to the 29 units operated by CKE.
These expenses consist primarily of depreciation and amortization associated
with the properties.
Warrant expense was approximately $940,000 in 1997 compared to
approximately $20,000 in 1996. The expense is related to warrants that were
issued to CKE and Fidelity National Financial, Inc. in a private placement on
December 20, 1996. See "Liquidity and Capital Resources" and Note 4 to the
accompanying consolidated financial statements, for further discussion.
Interest expense decreased 13.8% to approximately $7.4 million for 1997 as
compared to approximately $8.6 million for 1996 primarily due to the early
extinguishment of debt during the fourth quarter of 1996. See "Liquidity and
Capital Resources" and Note 10 to the accompanying consolidated financial
statements, for further discussion.
Interest income was higher for 1997 as compared to 1996 due to increases in
the average daily invested amounts.
During the fourth quarter of 1997, the Company recorded equity in the loss
of affiliate of $720,000 based upon it's share of the losses of Checkers for
December 1997 and the amortization of related goodwill. See "Item 1: Business,
Recent Acquisitions" and Note 2 to the accompanying Consolidated Financial
Statements.
The Company's 1997 tax provision is approximately $455,000 representing
estimated state taxes versus a prior year net tax provision of $675,000
(obtained by netting the tax benefit line with the tax expense of approximately
$1.4 million which has been netted against the extraordinary gain). Of the prior
year net amount, $575,000 related to state taxes expected to be payable and
$100,000 related to reduction of an IRS receivable for a NOL carryback to 1987,
1988, and 1989, further described in Note 13 to the accompanying consolidated
financial statements. See earlier discussion above concerning the extraordinary
gain.
Fiscal Year Ended December 29, 1996 Compared with Fiscal Year Ended
December 31, 1995
Systemwide sales declined 11% for 1996 to approximately $316.7 million
compared with approximately $355.7 million in 1995. This decrease is
attributable to the comparatively lower number of units in operation in 1996 and
to same store sales declines of 7% systemwide. The decline in same store sales
is primarily due to the
18
49
lower customer counts experienced upon the elimination of deep discounting
programs in the third and fourth quarters of 1996 and to the reduced media
spending in the fourth quarter of 1996.
Total Company revenues decreased 14% to approximately $162.8 million in
1996 compared with approximately $188.9 million in 1995. Company-owned
restaurant sales decreased 14% to approximately $156.5 million due to fewer
Company units in operation, a 6% decline in same store sales, and a decline of
approximately $9 million due to the Company's operating agreement with CKE, as
discussed in "Liquidity and Capital Resources." During 1996, the Company opened
6 units, closed 8 units, and transferred operational responsibility to CKE for
28 units. Franchisees, exclusive of CKE, opened 15 units and closed 26 units.
Five of the Company closures which were in the Montgomery DMA were sold in
September, 1996.
Restaurant cost of sales, as a percentage of sales, decreased to 34.3% for
1996 compared with 35.7% for 1995. This decrease is attributable primarily to
various cost reduction actions taken during the second half of 1996, partially
offset by higher food and paper costs as a percentage of sales in the first six
months of 1996. These cost reduction actions include selective changes in some
product and packaging specifications as well as renegotiation of purchase terms
and selection of alternative vendors. The increase in cost of sales in the first
half of 1996 resulted primarily from a carryover of deep discounting programs in
the first quarter of 1996 and to a shift in product mix sold, reflecting the
impact of a larger percent of Big Buford(TM) sandwich sales in the first two
quarters of 1996 compared to the same period of 1995. While this product carries
a significantly higher dollar profit per unit, it does carry a higher food cost
percentage than did the products formerly comprising its share of the total
product mix. The Company from time to time negotiates purchase contracts for
certain items used in its restaurants in the normal course of business. Although
some of these contracts contain minimum purchase quantities, such quantities do
not exceed expected usage over the term of such agreements.
Restaurant operating expenses were 45.5% of sales for 1996 compared with
46.4% for 1995. The reduction is primarily due to management's cost reduction
actions in the labor area and better fixed cost coverage in stores operating
during the second half of the year, partially offset by increased bonus costs
associated with store management compensation. This better fixed cost coverage
is the result of closing poorer performing units and of transferring operational
responsibility for certain higher fixed cost restaurants in Western markets to
CKE. The identified and implemented changes in staffing levels and labor
deployment in certain stores have yielded savings in management and crew labor.
Advertising expenses decreased approximately $5.4 million to 5.0% of sales
for 1996 compared to 7.3% for 1995 due primarily to decreases in levels of radio
advertising, outdoor advertising, and television advertising. During the fourth
quarter, management decided to limit media spending until work with the new
advertising agency on new creative and brand positioning was completed.
Company-wide spending on the new advertising campaign did not begin until late
February 1997.
General and administrative expenses decreased in 1996, on both a dollar and
a percentage of sales basis. This decrease is caused primarily by reductions in
the corporate and field operations staffs, and by lower levels of bad debt and
other dead project charges, partially offset by higher legal fees.
Depreciation and amortization decreased to approximately $9.8 million in
1996 as compared to approximately $13.0 million for the prior year. This
decrease is primarily due to asset writedowns associated with the adoption of
SFAS 121 at the beginning of the fourth quarter 1995, to a decrease in the
number of properties being operated by the Company, and to a segregation into
Owner expense of depreciation and amortization associated with the CKE-operated
properties.
Owner expense of approximately $744,000 for 1996 represent the Company's
segregated ownership cost related to the 28 units operated by CKE. These
expenses consist primarily of depreciation and amortization associated with the
properties.
Interest expense decreased 19.3% to approximately $8.6 million for 1996 as
compared to approximately $10.7 million for 1995 primarily due to the early
extinguishment of debt, as previously discussed. See "Liquidity and Capital
Resources" and Note 10 to the accompanying consolidated financial statements,
for further discussion.
Interest income was higher for 1996 as compared to 1995 due to increases in the
average daily invested amounts.
19
50
The Company's decrease in Other is due primarily to the current year
storage costs related to excess modular buildings.
The Company's net tax provision is approximately $675,000 (obtained by
netting the tax benefit line with the tax expense of approximately $1,350,000
which has been netted against the extraordinary gain). Of the net amount,
$575,000 is related to state taxes expected to be payable and $100,000 related
to reduction of an IRS receivable for a NOL carryback to 1987, 1988, and 1989,
further described in Note 13 to the accompanying consolidated financial
statements. See earlier discussion above concerning the extraordinary gain.
Liquidity and Capital Resources
The Company's cash flow from operating activity was approximately $8.3
million for 1997 compared with approximately $543,000 for 1996 and approximately
$8.5 million for 1995. The notable increase in 1997 from 1996 resulted primarily
from changes in working capital, specifically the increased balances in accounts
payable and accrued liabilities compared to a significant decreases in 1996. The
decreased balances in accounts payable in 1996 was due to decreased food and
paper costs as a percentage of sales and to decreased overall sales volumes. The
decreased overall sales volumes are attributable to the factors discussed above
in the year to year comparisons.
Capital expenditures of approximately $6.8 million for 1997 were funded
primarily through sales of surplus properties and existing cash balances.
Approximately $4.8 million of these expenditures were for the construction or
conversion of new stores in 1997. Additionally, in 1997, $510,000 was spent to
add dining rooms to three test units and $158,000 had been spent adding dining
rooms to two other units, completion of which occurred during 1998. Remaining
capital expenditures in 1997 of $1.4 million were primarily for the purchase and
installation of certain replacement equipment and menuboards as well as the
purchase of the land.
In July 1997, the Company acquired 10 units located in Arkansas from a
franchisee for approximately $2.8 million, including $2.2 million in cash. In
addition, the Company assumed five ground lease obligations, five ground and
building lease obligations and entered into three additional ground leases. The
cash disbursed in payment of the purchase price was reduced by certain amounts
owed by the seller to the Company.
The Company plans to use available cash flow to open additional indoor
dining facilities in 1998. The number of units to be opened will be dependent
on, among other factors, analysis of the five test units, permitting issues,
cost engineering issues and available cash flow.
In January 1996, the Company repurchased, in two transactions,
approximately $22 million face value of its 9 7/8% Senior Notes due in the year
2000. The Notes were purchased from GIANT GROUP, LTD. ("GIANT") at a price of
$678.75 per $1,000 principal amount, representing the market closing price on
the last business day prior to the repurchase date. The first transaction
involved the repurchase of approximately $16 million face value of the Notes for
approximately $11.1 million in cash. The second transaction involved the
purchase of approximately $6 million face value of the Notes in exchange for a
short-term note of approximately $4.1 million due in three installments of
principal and interest, bearing interest at prime. The Company paid the final
installment together with accrued interest on this note on September 27, 1996.
Prior to the Senior Notes repurchases, the Company's Board of Directors had
received an independent opinion from an investment banking firm as to the
fairness of the transactions. Additionally, in four separate transactions during
the fourth quarter 1996, the Company repurchased approximately $4.7 million face
value of the Senior Notes from various other bondholders for approximately $4.5
million in cash. As a result of these debt repurchases, the annualized ongoing
interest payments on the Senior Notes have been reduced by approximately $2.6
million per year to approximately $5.8 million.
Principal payments of debt and capital leases totaled approximately
$1.5 million during 1997. The Company is required to make a mandatory sinking
fund payment on June 15, 1999 calculated to retire 33 1/3% in aggregate
principal amount of the Senior Notes issued with the balance maturing on June
15, 2000. The repurchase discussed above reduces such sinking fund requirement
to approximately $1.6 million from approximately $28.3 million.
20
51
The Company is actively marketing the assets included in the caption
"Assets held for sale" in the accompanying consolidated balance sheet and
expects realization in cash over the next 12 months, although actual timing of
such cash flows cannot be predicted. The Company expects cash generated from
these assets to decline as the amount of assets held for sale decreased from
$2.0 million in 1996 to $1.1 million in 1997. The assets contained in this
caption are recorded at management's current estimate of fair market value less
costs to sell. There can be no assurances that these values will be realized.
On July 1, 1996, the Company entered into a ten-year operating
agreement with Carl Karcher Enterprises, Inc., a subsidiary of CKE Restaurants,
Inc. (collectively referred to as "CKE"). Pursuant to the agreement, 29 (2 of
which have been converted to a Carl's Jr. format) Rally's-owned restaurants
located in California and Arizona are being operated by CKE. The Company retains
ownership in the restaurants and receives from CKE a percentage of gross
revenues referred to in the financial statements as Owner fee income. This
income is offset by the Company's segregated ownership costs related to these
units, referred to as Owner expenses in the financial statements and consists
primarily of noncash expenses of depreciation and amortization. The agreement
has improved cash flow, generating cash flow of approximately $790,000 in 1997
and $340,000 in the last six months of 1996.
The Company completed its Shareholder Rights Offering on September 20,
1996. The Offering raised over $10.8 million in gross proceeds, offset by legal
and other issuance costs of approximately $437,000. In addition to the
approximate $10.8 million of gross proceeds provided by the Offering, the
Warrants, if exercised, would provide approximately $10.8 million for the
Company's future growth. The proceeds from the Offering have been used in 1997
to retire debt of approximately $4.5 million and the remainder has been used
primarily in 1997 for new store construction, refurbishment of some existing
restaurants and for other general corporate purposes.
On October 21, 1996, the Company was notified by the indenture trustee
that the noteholder consent it had been soliciting had been approved by the
required majority of the holders of record of its 9 7/8% Senior Notes due 2000.
The consent will allow two of the Company's current stockholders, CKE and
Fidelity National Financial, Inc. and/or their affiliates, to acquire 35% or
more of the outstanding shares of the Company's common stock without triggering
"Change in control" provisions requiring the Company to offer to purchase the
Senior Notes at 101% of their face value. This gives the Company greater
flexibility to raise capital in the future, and it gives two of its largest
stockholders the ability to increase their investment in the Company.
On December 20, 1996, the Company issued warrants (the "Warrants") to
purchase an aggregate of 1,500,000 restricted shares of its Common Stock to CKE
and Fidelity National Financial, Inc. The Warrants have a three-year term and
became exercisable on December 20, 1997. The exercise price is $4.375 per share,
the closing price of the Common Stock on December 20, 1996. The underlying
shares of Common Stock have not been registered with the Securities and Exchange
Commission and, therefore, are not freely tradable. If exercised, the Warrants
would provide approximately $6.6 million in additional capital to the Company.
See Note 4 to the accompanying consolidated financial statements for further
discussion.
Management has plans in place to improve profitability and cash flows
from operations. Additionally, management believes that, given the improvements
in operating results, the Company will realize the positive cash flows from the
exercise of Warrants discussed in Note 4. The Company believes existing cash
balances and cash flow from operations should be sufficient to fund its current
operations and obligations. The ability of the Company to satisfy its
obligations under the Senior Notes, however, continues to be dependent upon,
among other factors, the Company successfully increasing revenues and profits.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
21
52
Item 8. Financial Statements and Supplementary Data
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except shares and per share amounts)
December 29, December 28,
1996 1997
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,285 $ 4,008
Restricted cash 1,649 1,380
Investments 1,958 446
Royalties receivable, net of a reserve for doubtful accounts of $1,405 and $231, 437 394
respectively
Accounts and other receivables (including $565 and $1,078, respectively, from related
parties), net of a reserve for doubtful accounts of $301 and $200, respectively 1,698 1,555
Inventory, at lower of cost or market 794 1,052
Prepaid expenses and other current assets 999 1,057
Assets held for sale 596 1,076
------------- --------------
Total current assets 10,416 10,968
Assets held for sale 1,426 -
Property and equipment, net 69,806 68,067
Investment in affiliate - 24,988
Notes receivable, (including $127 and $86, respectively, from related parties), net of a
reserve for doubtful accounts of $853 and $231, respectively 773 872
Goodwill, less accumulated amortization of $2,243 and $2,811, respectively 10,482 9,913
Reacquired franchise and territory rights, less accumulated amortization of $1,984 and 11,439 12,758
$2,991, respectively
Other intangibles, less accumulated amortization of $2,459 and $2,894, respectively 4,769 4,334
Other assets, less accumulated amortization of $1,101 and $1,400, respectively 3,147 2,397
------------- --------------
Total assets $ 112,258 $ 134,297
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,884 $ 7,076
Accrued liabilities 13,600 13,507
Current maturities of long-term debt and obligations under capital leases 1,484 1,194
------------- --------------
Total current liabilities 19,968 21,777
Senior notes, net of discount of $429 and $321, respectively 57,897 58,005
Long-term debt, less current maturities 4,775 4,017
Obligations under capital leases, less current maturities 5,408 5,228
Other liabilities 4,845 3,757
------------- --------------
Total liabilities 92,893 92,784
------------- --------------
Commitments and contingencies (Note 12)
Shareholders' equity:
Preferred stock, $.10 par value, 5,000,000 shares authorized, -0- and 45,667 shares
issued, respectively - 5
Common stock, $.10 par value, 50,000,000 shares authorized, 20,788,000 and 24,836,900 shares
issued, respectively 2,079 2,484
Additional paid-in capital 71,023 97,277
Less: Treasury stock, 273,445 shares, at cost (2,108) (2,108)
Retained deficit (51,629) (56,145)
------------- --------------
Total shareholders' equity 19,365 41,513
------------- --------------
Total liabilities and shareholders' equity $ 112,258 $ 134,297
============= ==============
The accompanying notes to consolidated financial statements are an integral
part of these consolidated financial statements.
22
53
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Fiscal Years Ended
----------------------------------------------------
December 31, December 29, December 28,
1995 1996 1997
---------------- ---------------- ----------------
REVENUES:
Restaurant sales $ 181,778 $ 156,445 $ 139,350
Franchise revenues and fees 7,081 5,867 4,838
Owner fee income - 440 742
---------------- ---------------- ----------------
Total revenues 188,859 162,752 144,930
---------------- ---------------- ----------------
COSTS AND EXPENSES:
Restaurant costs of sales 64,813 53,712 45,241
Restaurant operating expenses, exclusive of depreciation and
amortization and advertising and promotion expenses 83,671 69,164 59,629
General and administrative expenses 19,606 17,397 15,451
Advertising and promotion expenses 13,188 7,767 9,948
Depreciation and amortization 13,006 9,838 9,106
Owner expense - 744 1,137
Warrant expense - 20 940
Provision for restaurant closures and other 31,045 20 158
---------------- ---------------- ----------------
Total costs and expenses 225,329 158,662 141,610
---------------- ---------------- ----------------
Income (loss) from operations (36,470) 4,090 3,320
---------------- ---------------- ----------------
OTHER INCOME (EXPENSE):
Interest expense (10,682) (8,622) (7,431)
Interest income 538 614 749
Equity in loss of affiliate - - (720)
Other 234 (49) 21
---------------- ---------------- ----------------
Total other (expense) (9,910) (8,057) (7,381)
---------------- ---------------- ----------------
Loss before income taxes and extraordinary items (46,380) (3,967) (4,061)
PROVISION (BENEFIT) FOR INCOME TAXES 539 (675) 455
---------------- ---------------- ----------------
Loss before extraordinary items (46,919) (3,292) (4,516)
EXTRAORDINARY ITEM (net of tax expense of $1,350) - 5,280 -
---------------- ---------------- ----------------
Net income (loss) $ (46,919) $ 1,988 $ (4,516)
================ ================ ================
Earnings (loss) per common share:
Loss before extraordinary item $ (3.00) $ (.19) $ (.22)
Extraordinary item - .31 -
---------------- ---------------- ----------------
Basic earnings (loss) per common share $ (3.00) $ .12 $ (.22)
================ ================ ================
Diluted earnings (loss) per common share $ (3.00) $ .12 $ (.22)
================ ================ ================
Weighted average shares outstanding 15,620 17,007 20,709
================ ================ ================
The accompanying notes to consolidated financial statements are an integral
part of these consolidated financial statements.
23
54
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Common Stock Preferred Stock
---------------------------- ----------------------------
Shares Shares Shares Shares
Authorized Issued Amount Authorized Issued Amount
---------- ------ ------ ---------- ------- ------
Balances at January 1, 1995 25,000 15,837 $ 1,584 - - $ -
Amendment to the Charter (A) 25,000 - - - - -
Issuance of common stock - 90 9 - - -
Treasury stock acquired - - - - - -
Net loss - - - - - -
------ ------ ------- ----- ------ ------
Balances at December 31, 1995 50,000 15,927 1,593 - - -
Issuance of common stock - 35 3 - - -
Authorization of preferred stock
(B) - - - 5,000 - -
Shareholders Rights Offering - 4,826 483 - - -
Compensatory stock options and
warrants - - - - - -
Net income - - - - - -
------ ------ ------- ----- ------ ------
Balances at December 29, 1996 50,000 20,788 2,079 5,000 - -
Issuance of common stock - 140 14 - - -
Compensatory stock options and
warrants - - - - - -
Issuance of common stock and
preferred to acquire
investment in affiliate - 3,909 391 - 46 5
Net loss - - - - - -
------ ------ ------- ----- ------ ------
Balances at December 28, 1997 50,000 24,837 $ 2,484 5,000 46 $ 5
====== ====== ======= ===== ====== ======
Treasury Stock
and Contingent
Shares
------------------
Additional Retained
Paid-In Earnings Total
Shares Amount Capital (Deficit) Equity
------ -------- --------- --------- ---------
Balances at January 1, 1995 (239) $ 2,009) $ 60,610 $ (6,698) $ 53,487
Amendment to the Charter (A) - - - - -
Issuance of common stock - - 194 - 203
Treasury stock acquired (34) (99) - - (99)
Net loss - - - (46,919) (46,919)
------ -------- --------- --------- --------
Balances at December 31, 1995 (273) (2,098) 60,804 (53,617) 6,672
Issuance of common stock - - 74 - 77
Authorization of preferred stock
(B) - - - - -
Shareholders Rights Offering - - 9,975 - 10,458
Compensatory stock options and
warrants - - 170 - 170
Net income - - - 1,988 1,988
------ -------- --------- --------- --------
Balances at December 29, 1996 (273) (2,108) 71,023 (51,629) 19,365
Issuance of common stock - - 264 - 278
Compensatory stock options and
warrants - - 957 - 957
Issuance of common stock and
preferred to acquire
investment in affiliate - - 25,033 - 25,429
Net loss - - - (4,516) (4,516)
------ -------- --------- --------- --------
Balances at December 28, 1997 (273) $(2,108) $ 97,277 $(56,145) $ 41,513
====== ======== ========= ========= ========
- ----------------------
(A) On May 13, 1995, stockholders of the Company approved a proposal to amend
the Certificate of Incorporation to increase the number of authorized
shares of Common Stock from 25,000,000 shares to 50,000,000.
(B) On July 10, 1996, stockholders of the Company ratified the authorization of
5,000,000 shares of Preferred Stock at a par value of $.10.
The accompanying notes to consolidated financial statements are an integral
part of these consolidated financial statements.
24
55
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands)
Fiscal Years Ended
-----------------------------------------------
December 31, December 29, December 28,
1995 1996 1997
--------------- -------------- --------------
CASH FLOWS PROVIDED FROM OPERATING ACTIVITIES:
Net income (loss) $ (46,919) $ 1,988 $ (4,516)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 13,006 10,482 10,106
Extraordinary items, before tax expense of $1,350 - (6,630) -
Provision for restaurant closures and other 31,045 20 158
Provision for losses on receivables 1,507 968 (392)
Other 2,276 1,245 101
Loss on sale of property and equipment - - 1,025
Warrant expense - 20 940
Equity in loss of affiliate - - 720
Changes in assets and liabilities net of effects from business
combinations:
(Increase) decrease in assets:
Receivables 775 (306) (331)
Inventory (63) 262 (196)
Prepaid expenses and other current assets 185 161 (376)
Other assets 292 (121) 221
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities 7,815 (6,011) 2,083
Deferred income taxes - - (107)
Other liabilities (1,424) (1,535) (1,178)
--------------- -------------- --------------
Net cash provided by operating activities 8,495 543 8,258
--------------- -------------- --------------
CASH FLOWS PROVIDED FROM (USED IN) INVESTING ACTIVITIES:
(Increase) decrease in investments (848) 2,975 1,512
Notes receivable 154 312 256
Pre-opening costs (45) (156) (237)
Capital expenditures (3,405) (2,306) (6,845)
Proceeds from the sale of property and equipment 4,266 4,392 1,872
(Increase) decrease in intangible assets (111) (39) -
Acquisition of businesses, net of cash acquired (1,931) - (2,172)
Proceeds from the sale of a business 2,730 - -
--------------- -------------- --------------
Net cash used in investing activities 810 5,178 (5,614)
--------------- -------------- --------------
CASH FLOWS PROVIDED FROM (USED IN) FINANCING ACTIVITIES:
(Increase) in restricted cash (683) (966) 269
Payment of organization and development costs (3) - -
Principal payments of debt (2,114) (1,696) (1,075)
Senior Notes retirement - (19,612) -
Issuance of common stock, net of costs of issuance 203 10,535 298
Principal payments on capital lease obligations (604) (508) (413)
--------------- -------------- --------------
Net cash provided from (used in) financing activities (3,201) (12,247) (921)
--------------- -------------- --------------
Net increase (decrease) in cash 6,104 (6,526) 1,723
CASH AND CASH EQUIVALENTS, beginning of period 2,707 8,811 2,285
---------------- -------------- --------------
CASH AND CASH EQUIVALENTS, end of period $ 8,811 $ 2,285 $ 4,008
=============== ============== ==============
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
25
56
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular dollars in thousands, except per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) FINANCIAL STATEMENT PRESENTATION AND ORGANIZATION
The accompanying consolidated financial statements include Rally's
Hamburgers, Inc. and its wholly-owned subsidiaries, each of which is
described below. Rally's Hamburgers, Inc. and its subsidiaries are
collectively referred to herein as the context requires as "Rally's" or
the "Company". The investment in affiliate, which is owned more than
20% and less than 50% represents an investment in Checkers Drive-In
Restaurants, Inc. and is recorded on the equity method (see Note 2).
All significant intercompany accounts and transactions have been
eliminated.
Rally's is one of the largest chains of double drive-thru
restaurants in the United States. At December 28, 1997, the Rally's
system included 477 restaurants in 18 states, primarily in the Midwest
and the Sunbelt, comprised of 229 Company-owned and operated, 221
franchised and 27 Company-owned restaurants in Western markets which
are operated as Rally's restaurants by CKE Restaurants, Inc. ("CKE"), a
significant shareholder of the Company, under an operating agreement
which began July, 1996. Two additional Company-owned stores covered by
the operating agreement have been converted to the Carl's Jr. format
and are not included in the above store count. The Company's
restaurants offer high quality fast food. The Company serves the
drive-thru and take-out segments of the quick-service restaurant
industry. The Company opened its first restaurant in January 1985 and
began offering franchises in November 1986.
Rally's Hamburgers, Inc., Rally's of Ohio, Inc., Self Service
Drive Thru, Inc. and Hampton Roads Foods, Inc. own and operate Rally's
restaurants in various states. Additionally, Rally's Hamburgers, Inc.
operates as franchisor of the Rally's brand. Rally's Management, Inc.
provides overall corporate management of the Company's businesses.
Rally's Finance, Inc. was organized for the purpose of making loans to
Rally's franchisees to finance the acquisition of restaurant equipment
and modular buildings. RAR, Inc. was organized for the purpose of
acquiring and operating a corporate airplane and is currently inactive.
The Company's wholly-owned subsidiary, ZDT Corporation, was formed to
own the Zipps brand and franchise system. MAC 1 was organized for the
purpose of acquiring a manufacturer of modular buildings. The
manufacturing business was sold in January 1995.
The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent 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, when actual transactions anticipated are
consummated. Certain of the most significant estimates include useful
lives assigned to depreciable/amortizable assets, fair value less costs
to sell of long-lived assets held for sale, fair value of long-lived
assets held for use, future net occupancy costs related to
closed/disposable properties, accruals for the Company's self-insured
and high deductible insurance programs, and disclosures regarding
commitments and contingencies.
b) REVENUE RECOGNITION
The Company recognizes franchise fees as income on the date a
restaurant is opened, at which time the Company has performed its
obligations relating to such fees. Area development fees are generated
from the awarding of exclusive rights to develop, own and operate
Rally's restaurants in certain geographic areas pursuant to an Area
Development Agreement. Such fees are recognized as income on a pro rata
basis as the restaurants are opened or upon the cancellation or
expiration of an Area Development Agreement. Both franchise fees and
area development fees are non-refundable. The Company also receives
royalty fees from franchisees in the amount of 4% of each franchised
restaurant's gross revenues, as defined in the Franchise Agreement.
Royalty fees are recognized as earned.
26
57
c) PROPERTY AND EQUIPMENT
Property and equipment are depreciated using the straight-line
method for financial reporting purposes and accelerated methods for
income tax purposes. The estimated useful lives for financial reporting
purposes are the shorter of 20 years or the lease life plus available
renewal options for buildings and property held under capital leases,
eight years for furniture and equipment, five years for software and
computer systems and the life of the lease for leasehold improvements.
Expenditures for major renewals and betterments are capitalized while
expenditures for maintenance and repairs are expensed as incurred.
d) INVENTORY
Inventory is valued at latest invoice cost which approximates the
lower of first-in, first-out cost or market.
e) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Fiscal Years Ended
-------------------------------------------------
December 31, December 29, December 28,
1995 1996 1997
--------------- ----------------- ---------------
Interest paid $ 10,679 $ 8,639 $ 7,013
Income taxes paid 212 983 545
Capital lease obligations incurred 1,616 111 386
On December 18, 1997 the Company acquired approximately 26.3% of
the outstanding common stock of Checkers Drive-In Restaurants, Inc. in
exchange for common and preferred stock of the Company (see Note 2).
On February 13, 1995, the Company acquired all of the shares of
common stock of Hampton Roads Foods, Inc. (a Louisiana corporation) and
certain of the assets of HRF, Inc. (a Virginia corporation),
collectively referred to as "HRF." On July 9, 1997, the Company
acquired from Arkansas Investment Group, Inc., substantially all the
operating assets employed in the franchisee Rally's restaurants.
The purchases were recorded as follows:
Fiscal Year Fiscal Year
Ended Ended
----------------- -----------------
December 31, December 28,
1995 1997
----------------- -----------------
Fair value of assets acquired $ 9,133 $ 2,800
Cash paid (2,125) (2,200)
================= =================
Liabilities assumed, receivables forgiven $ 7,008 $ 600
================= =================
On January 30, 1995, the Company sold all of the shares of common
stock of Beaman Corporation, its wholly-owned modular building
subsidiary, for approximately $3.1 million, of which approximately $2.7
million was received in cash. As a result of the sale of Beaman, the
Company recorded the net present value of a non-interest bearing note
of approximately $347,000.
The Company recorded in 1996 approximately $547,000 in notes
receivable primarily as the result of the sale of five of its
restaurants in Montgomery, Alabama. These non-cash transactions have
been excluded from the consolidated statements of cash flows.
During fiscal 1995, 1996, and 1997, the Company accepted notes due
within two to five years, bearing interest at rates previously
specified in the underlying franchise agreements, for certain
receivables from franchisees in the aggregate amount of approximately
$542,000 for 1995, approximately $340,000 for 1996 and approximately
$493,000 for 1997.
27
58
For purposes of the consolidated statement of cash flows, the
Company considers all highly liquid debt instruments with an original
maturity of three months or less at the date of purchase to be cash
equivalents. Cash equivalents at December 29, 1996 and December 28,
1997 were approximately $976,000 and $2.3 million, respectively.
f) EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share is calculated based upon
the Company's reported income and the weighted average common shares
outstanding of 15,620; 17,007 and 20,709 for fiscal years 1995, 1996
and 1997, respectively. The income and average shares outstanding for
purposes of the computation of diluted earnings per share are the same
as for the computation of basic earnings per share. Potentially
dilutive convertible preferred stock (see Note 2), common stock
warrants (see Notes 4 and 17) and common stock options (see Notes 4 and
14) have no effect as they are anti-dilutive for all periods presented.
g) STOCK OPTIONS
As discussed in Note 14, the Company adopted the disclosure-only
provisions of Statement of Financial Accounting Standards No. 123 (SFAS
123), "Accounting for Stock-Based Compensation".
h) IMPAIRMENT OF LONG-LIVED ASSETS
As discussed in Note 16, during the fourth quarter of 1995, the
Company early adopted Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to be Disposed Of" (SFAS 121).
i) INCOME TAXES
The Company accounts for income taxes under the asset or liability
method whereby deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that
includes the enactment date.
j) DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The balance sheets as of December 29, 1996 and December 28, 1997,
reflect the fair value amounts which have been determined, using
available market information and appropriate valuation methodologies.
However, considerable judgement is necessarily required in interpreting
market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the
amounts that the Company could realize in a current market exchange.
The use of different market assumptions and/or estimation methodologies
may have a material effect on the estimated fair value amounts.
Cash and cash equivalents, receivables - Due to the short maturity
of these items, the carrying amounts are a reasonable estimate of their
fair value.
28
59
Investments and Senior Notes - The fair values of investments and
Senior Notes are based upon quoted market prices.
Long-term debt - The fair value of long-term debt approximates the
carrying value due to all significant amounts bearing interest at rates
which are variable or approximate a rate estimated to be available
currently.
The following summarizes the carrying values and fair values of
financial instruments:
December 29, 1996 December 28, 1997
----------------- -----------------
Carrying Value Fair Value Carrying Value Fair Value
---------------------------------------------------------------------
Cash and Cash Equivalents $ 3,934 $ 3,934 $ 5,388 $ 5,388
Investments 1,958 1,958 446 446
Senior Notes 57,897 54,500 58,005 55,200
Long-term debt 5,874 5,874 4,798 4,798
k) GOODWILL, REACQUIRED FRANCHISE RIGHTS, OTHER INTANGIBLES AND OTHER
ASSETS
Goodwill, reacquired franchise and territory rights, other
intangibles and other assets are being amortized using the
straight-line method over the following periods:
Amortization
Period
------------------
Goodwill 5, 20-25 years
Reacquired franchise and territory 5-20 years
rights
Other intangibles 3-25 years
Other assets 3-25 years
Subsequent to the intangibles' acquisition, the Company evaluates
whether later events and circumstances have occurred that indicate the
remaining estimated useful life of goodwill and other intangibles may
warrant revision or that the remaining balance of goodwill and other
intangibles may not be recoverable. When factors indicate that goodwill
or other intangibles should be evaluated for possible impairment, the
Company utilizes the procedures as set forth in SFAS No. 121 and
discussed in Note 16, Impairment of Long-Lived Assets.
l) OWNER FEE INCOME AND EXPENSE
Revenue received as a result of the operating agreement with CKE
is referred to as Owner fee income in the accompanying consolidated
financial statements. Expenses related to the ongoing investment in the
CKE-operated restaurants consist primarily of depreciation and
amortization and are referred to as Owner expenses in the accompanying
consolidated financial statements.
m) ADVERTISING COSTS
It is the Company's policy to expense advertising costs as
incurred in accordance with Statement of Position 93-7. The amounts
expensed for fiscal years ended December 31, 1995, December 29, 1996
and December 28, 1997 were approximately $13,188,000, $7,767,000 and
$9,948,000, respectively, as reflected on the Consolidated Statements
of Operation.
n) RECLASSIFICATIONS
Certain items have been reclassified in the accompanying
consolidated financial statements for prior periods in order to be
comparable with the classification adopted for the fiscal year ended
December 28, 1997. Such reclassifications had no effect on previously
reported net income.
29
60
2. ACQUISITIONS
On July 9, 1997, the Company acquired from Arkansas Investment Group,
Inc. ("AIGI") (an Arkansas corporation) substantially all the operating
assets employed in the operation of AIGI's franchised Rally's restaurants
for approximately $2.8 million. The cash disbursed in payment of the
purchase price was reduced by certain amounts owed by AIGI to the Company.
Actual cash disbursed was approximately $2.2 million. In addition, the
Company assumed five of AIGI's ground lease obligations and five of its
ground and building lease obligations, and entered into three additional
ground leases. AIGI owned and operated a total of ten Rally's restaurants
in the Little Rock, Arkansas market. The acquisition of the AIGI operating
assets was accounted for as a purchase. The Company believes that the $2.8
million represents the fair value of the acquired assets. The impact on
operations of this acquisition was not significant for any of the periods
presented, and therefore, proforma amounts are not presented giving effect
to this acquisition.
On December 18, 1997, the Company acquired approximately 19.1 million
shares (the "Checkers Shares") of the common stock, $0.001 par value per
share (the "Checkers Common Stock"), of Checkers Drive-In Restaurants,
Inc., a Delaware corporation ("Checkers"), pursuant to that certain
Exchange Agreement, dated as of December 8, 1997 (the "Exchange
Agreement"), between Rally's, CKE Restaurants, Inc, ("CKE"), Fidelity
National Financial, Inc. ("Fidelity"), GIANT GROUP, LTD. ("GIANT") and the
other parties named in the Exchange Agreement. CKE, Fidelity and GIANT
beneficially owned 5,278,015 shares, 2,759,788 shares and 3,136,849 shares,
respectively, of Rally's Common Stock prior to the consummation of the
Exchange Agreement, approximately 23.9%, 12.7% and 15.2% of the then
outstanding shares of Rally's Common Stock. In addition, Terry Christensen,
William Foley, II, David Gotterer, Andrew Puzder, Burt Sugarman and C.
Thomas Thompson, who are Directors of Rally's, are parties to the Exchange
Agreement. Mary Hart Sugarman, AJ Sugarman and Al Sugarman, who also
participated in the exchange, are related to Burt Sugarman.
In consideration of the acquisition of the Checkers Shares, Rally's
issued 3,909,336 shares of its common stock, $.10 par value per share (the
"Rally's Common Stock"), and 45,667 shares of its Series A Participating
Preferred Stock, $.10 par value per share (the "Rally's Preferred Stock").
A dividend of $43.50 per share will accrue on the Rally's Preferred Stock
unless converted to Rally's Common Stock prior to July 31, 1998. The
parties to the Exchange Agreement, who own a majority of Rally's Common
Stock, have agreed to vote in favor of conversion. The Rally's Preferred
Stock will be converted into 4,566,700 shares of Rally's Common Stock upon
approval of such conversion by Rally's stockholders. The exchange ratio
used to determine the number of shares of Rally's Common Stock (including
the shares to be issued upon conversion of the Rally's Preferred Stock) to
be issued pursuant to the Exchange Agreement was based upon the average
closing price of the Checkers Common Stock and the Rally's Common Stock for
the five trading days preceding the public announcement of the proposed
exchange on September 19, 1997.
This stock acquisition was accounted for as a long term asset under
"Investment in Affiliate" using the equity method of accounting with an
initial investment value of $25.4 million, based upon the market value of
the Rally's Common Shares issued and issuable upon conversion of the
Rally's Preferred Stock issued. This investment represented 26.3% interest
in Checkers. The allocation of the purchase price of this investment has
not yet been finalized. For purposes of computing Rally's 1997 equity in
the loss of Checkers, the $12.5 million excess of the investment over the
pro-rata portion of Checkers' book value acquired has been treated as an
intangible asset with a 20 year life. The 1997 equity in the loss of
affiliate of $720,000 includes $52,000 of intangible amortization.
3. RESTAURANT CLOSURES AND OTHER
Certain charges in fiscal years 1995, 1996 and 1997 have been
aggregated and segregated into the caption "Provision for Restaurant
Closures and Other" in the accompanying Statements of Operations. These
items represent estimates of the impact of management decisions, which have
been made at various points in time in response to the Company's sales and
profit performance and the then-current revenue building and profit
enhancing strategies.
30
61
In summary and chronologically, the decisions that had been reached in
1994 were to abandon additional real estate development projects and
certain investment in infrastructure (approximately $5.3 million) and to
abandon additional projects and franchise or otherwise dispose of up to 60
Company restaurants (approximately $12.0 million). During 1995, the Company
concluded that much of its 1994 plan of disposal would not be executable.
As a result, the Company decided to (i) close up to 16 of the original 60
restaurants included in the 1994 disposal plan, (ii) close nine poor
performing restaurants in its core markets, (iii) write-off estimated
exposure resulting from the default of a subleasee/franchisee in a former
Company market, (iv) record additional writedowns of modular building
value, (v) record writedowns to sales price less cost to sell of all
properties auctioned in fourth quarter of 1995 (vi) record asset writedowns
and occupancy exposure related to the default of a tenant for five of the
units closed under the 1994 plan and (vii) record other changes in
estimates related to the Company's surplus properties. The charges for the
above 1995 items totaled approximately $17.3 million. Also reflected in
this caption for fiscal 1995 is an approximate $13.7 million charge related
to the Company's adoption of Statement of Financial Accounting Standards
No. 121 ("SFAS 121) further discussed in Note 16.
Included in this caption for fiscal 1996 are charges of approximately
$911,000 related to the write-down and sale of assets offset by
approximately $891,000 resulting from a reduction in surplus property
reserves related to Management's decision to re-open three units previously
closed and to continue to operate a fourth unit that had been designated
for closure. During 1997, the Company recorded provisions of $33,000 and
$199,000 to write-off leasehold improvements and future rental costs
associated with the Louisville corporate office and regional offices.
Additionally in 1997, the Company recorded gains on held for sale
properties of $74,000.
The following summarizes the components of the provision for restaurant
closures and other as well as the year end balances of certain related
reserves.
December December December
31, 1995 29, 1996 28, 1997
-------- -------- --------
Provisions -
- ----------
Abandoned projects & expected store closings
Fixed asset writedowns $ 5,484 $ 87 $ 33
Future occupancy costs 5,283 - 199
Modular building writedowns 2,058 - -
Excess land writedowns 2,600 - -
Surplus equipment writedowns 1,920 - -
Reduction in loss estimate on previously
reserved locations - (891) (74)
SFAS 121 impairment writedowns (see
Note 16) 13,700 824 -
------------ ------------ ------------
PROVISION FOR RESTAURANT
CLOSURES AND OTHER 31,045 20 158
============ ============ ============
Reserves -
- --------
Closed store reserve - current (see Note 8) 2,767 1,964 1,493
Closed store reserve - long term (see Note 9) 6,908 3,881 3,065
------------ ------------ ------------
TOTAL CLOSED STORE RESERVES 9,675 5,845 4,558
============ ============ ============
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4. RELATED PARTY TRANSACTIONS
a) ISSUANCE OF WARRANTS
On December 20, 1996, the Company issued warrants (the "Warrants")
to purchase an aggregate of 1,500,000 restricted shares of its Common
Stock to CKE and Fidelity National Financial, Inc. The Warrants were
granted as an incentive to CKE and Fidelity to continue to participate
in the identification and exploitation of synergistic opportunities
with the Company. The Warrants have a three-year term and became
exercisable on December 20, 1997. The exercise price is $4.375 per
share, the closing price of the Common Stock on December 20, 1996. The
underlying shares of Common Stock have not been registered with the
Securities and Exchange Commission and, therefore, are not freely
tradable. If exercised, the Warrants would provide approximately $6.6
million in additional capital to the Company. The Company obtained a
valuation analysis from an investment banking firm of national
standing. Such analysis estimated the value of the Warrants to be
approximately $960,000. Approximately $20,000 and $940,000 was expensed
in 1996 and 1997, respectively.
b) WEST COAST OPERATING AGREEMENT
On July 1, 1996, the Company entered into a ten-year Operating
Agreement with Carl Karcher Enterprises, Inc., a subsidiary of CKE
Restaurants, Inc. (collectively referred to as "CKE"). CKE is the
operator of the Carl's Jr. restaurant chain. Pursuant to the agreement,
29 Rally's owned restaurants located in California and Arizona are
being operated by CKE, two of which are converted to a Carl's Jrs.
format. Such agreement is cancelable after an initial five-year period,
at the discretion of CKE. A portion of these restaurants, at the
discretion of CKE, will be converted to the Carl's Jr. format. To date,
two restaurants have been converted. The agreement was approved by a
majority of the independent Directors of the Company. Prior to the
agreement, the Company's independent Directors had received an opinion
as to the fairness of the agreement, from a financial point of view,
from an investment banking firm of national standing.
Under the terms of the Operating Agreement, CKE is responsible for
any conversion costs associated with transforming restaurants to the
Carl's Jr. format, as well as the operating expenses of all the
restaurants. Rally's retains ownership of all 29 (two of which are
Carl's Jrs.) restaurants and is entitled to receive a percentage of
gross revenues generated by each restaurant. In the event of a sale by
Rally's of any of the 29 restaurants, Rally's and CKE would share in
the proceeds based upon the relative value of their respective capital
investments in such restaurant.
c) OPTION GRANTS TO NON-EMPLOYEES
During 1996, the Company granted 150,000 options to certain
individuals not employed by the Company for services provided.
Approximately $84,000 has been expensed for these grants in General and
Administrative Expenses in the accompanying 1996 Statement of
Operations. Such options were granted at the market values on the dates
of grant, were immediately exercisable and expire in five years.
d) OTHER TRANSACTIONS
The Company has had transactions with certain companies or
individuals which are related parties by virtue of having stockholders
in common, by being officers/directors or because they are controlled
by significant stockholders or officers/directors of the Company. Such
transactions which impacted the Company's consolidated financial
statements are summarized below. Information with respect to related
party rent is disclosed in Note 12. The Company and its franchisees
each pay 1/2% of sales to the Rally's National Advertising Fund (the
"Fund"), established for the purpose of creating and producing
advertising for the chain. The Fund is not included in the consolidated
financial statements, although the Company's contributions to the Fund
are included in the Advertising and Promotion Expenses in the Company's
consolidated Statements of Operations.
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63
Effective November 30, 1997, the Company entered into a Management
Services Agreement, pursuant to which certain of the management of
Checkers Drive-In Restaurants, Inc. ("Checkers") is providing key
services to Rally's, including executive management, financial planning
and accounting, franchise administration, purchasing and human
resources. In addition, Rally's and Checkers share certain of their
executive officers, including Chief Executive Officer and the Chief
Operating Officer. The total cost of these services was $95,000 in
1997.
See Note 2. Acquisitions for other related party transactions
"the Exchange Agreement".
SUMMARY OF RELATED PARTY TRANSACTIONS
-------------------------------------
December 29, December 28,
1996 1997
---------------------------------
BALANCE SHEET AMOUNTS
---------------------
Accounts receivable $ 565 $ 1,078
Notes receivable 127 86
Investment in affiliate - 24,988
Accounts payable 95 520
Accrued liabilities 60 65
Fiscal Years Ended
---------------------------------------------------
December 31, December 29, December 28,
1995 1996 1997
--------------- ---------------- -----------------
REVENUE AND TRANSACTION AMOUNTS
-------------------------------
Repurchase of Senior Notes (gross gain) $ - $ 6,339 $ -
Royalty fees 2,407 - -
Owner fee income - 440 742
Rental income 262 - -
Interest income 16 49 52
------------- -------------- --------------
$ 2,685 $ 6,828 $ 794
============= ============== ==============
EXPENSE AMOUNTS
---------------
Legal $ 777 $ 1,024 $ 1,017
Rent Expense 292 470 396
Owner expense - 744 1,137
Interest expense - 180 -
Compensatory stock options and
Warrants - 170 940
Management Services Agreement - - 95
--------------- -------------- ----------------
$ 1,069 $ 2,588 $ 3,585
=============== ============== ================
5. RESTRICTED CASH
Restricted cash consists of amounts held in various Certificates of
Deposit as collateral for Letters of Credit and daily Automated Clearing
House ("ACH") transactions.
6. INVESTMENTS
All of the Company's investment securities are deemed as
"available-for-sale" under SFAS 115, "Accounting for Certain Investments in
Debt and Equity Securities". Accordingly, investments are reported at fair
value with unrealized holding gains and losses, excluding those losses
considered to be other than temporary, reported as a net amount in a
separate component of shareholders' equity. Provisions for declines in
market value are made for losses considered to be other than temporary.
Realized gains or losses from the sale of investments are based on the
specific identification method.
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No unrealized gains or losses were recorded for any period presented,
due to the quoted market prices of the Company's investments approximating
the cost. Investments consist of:
December 29, December 28,
1996 1997
----------------- -----------------
US Government and Agencies $ 500 $ -
Mortgage - backed Securities 1,458 446
================= =================
$ 1,958 $ 446
================= =================
The contractual maturity of the mortgage-backed securities as of
December 28, 1997 was: $43 within five years, $403 over 10 years.
The proceeds from the sale of investments and related gross gains and
losses for the twelve months ended December 31, 1995, December 29, 1996 and
December 28, 1997 were as follows:
Fiscal Years Ended
---------------------------------------------------------
December 31, December 29, December 28,
1995 1996 1997
----------------- ---------------- ----------------
Proceeds from the sale of investments $ 15,653 $ 10,531 $ 3,674
Gross gains realized 56 - 6
Gross losses realized - (4) -
7. NET PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 29, December 28,
1996 1997
---------------- ----------------
Land $ 14,074 $ 14,145
Buildings and leasehold improvements 47,463 52,196
Equipment, furniture and fixtures 41,312 40,582
---------------- ----------------
102,849 106,923
Less accumulated depreciation (37,518) (42,872)
---------------- ----------------
65,331 64,051
---------------- ----------------
Property held under capital lease 6,145 6,145
Less accumulated amortization (1,670) (2,129)
---------------- ----------------
4,475 4,016
================ ================
Net property and equipment $ 69,806 $ 68,067
================ ================
8. ACCRUED LIABILITIES
Accrued liabilities (current) consist of the following:
December 29, December 28,
1996 1997
--------------- --------------
Payroll and payroll taxes $ 2,245 $ 1,944
Closed store reserve 1,964 1,493
Workers compensation 2,367 2,272
Bonuses and severance 979 712
Step leases 975 984
Accrued income taxes 935 828
Sales taxes 783 1,013
Legal fees and settlements 380 1,478
Other 2,972 2,783
=============== ==============
$ 13,600 $ 13,507
=============== ==============
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9. OTHER LIABILITIES
Other liabilities (non-current) consist of the following:
December 29, December 28,
1996 1997
--------------- ----------------
Closed store reserve $ 3,881 $ 3,065
Unfavorable lease loss 748 590
Other 216 102
--------------- ----------------
$ 4,845 $ 3,757
=============== ================
10. SENIOR NOTES
On March 9, 1993, the Company sold approximately $85 million of 9 7/8%
Senior, Notes due 2000 (the "Notes"). The Company is required to make a
mandatory sinking fund payment on June 15, 1999 to retire 33 1/3% in
aggregate principal amount of the Notes issued. The Notes are carried net
of the related discount, which is being amortized over the life of the
Notes. Interest is payable June 15 and December 15. The Notes include
certain restrictive covenants, which, among other restrictions, limit the
Company's ability to obtain additional borrowings and to pay dividends as
well as impose certain change of control provisions, as defined.
On January 29, 1996, the Company repurchased, in two transactions, at a
price of approximately $678.75 per $1,000 principal amount, approximately
$22 million face value of its 9 7/8% Senior Notes due in the year 2000 from
GIANT GROUP, LTD. ("GIANT"). The price paid in each transaction represented
the market closing price on January 26, 1996. The first transaction
involved the repurchase of approximately $16 million face value of the
Notes for approximately $11.1 million in cash. The second transaction
involved the purchase of approximately $6 million face value of Notes in
exchange for a short-term note of approximately $4.1 million, due in three
installments of principal and interest, issued by Rally's. The Company paid
the final installment on this note, together with accrued interest thereon,
on September 27, 1996. The purchases were approved by a majority of the
independent Directors of the Company. Prior to the purchases, the Company's
independent Directors had received an opinion as to the fairness of the
transactions, from a financial point of view, from an investment banking
firm of national standing.
Additionally, in four separate transactions during the fourth quarter
1996, the Company repurchased approximately $4.7 million face value of the
Notes from various other bondholders for approximately $4.5 million in
cash.
These purchases resulted in extraordinary gains in 1996 net of tax,
totaling approximately $5.3 million or $.31 per share. As a result of these
debt repurchases, the annualized ongoing interest payments on the Senior
Notes have been reduced by approximately $2.6 million per year to
approximately $5.8 million. In addition, these repurchases have reduced the
sinking fund requirement discussed above to approximately $1.6 million from
approximately $28 million.
The remaining outstanding Notes are publicly traded and at December 28,
1997 had a market value of approximately $55.2 million based on the quoted
market price for such notes.
On September 5, 1996 by Consent Solicitation Statement, the Company
solicited consent of its bondholders whereby the beneficial ownership of
35% or more of the voting stock of the Company by GIANT, Fidelity National
Financial, Inc., CKE and/or any of their affiliates would not constitute a
change of control for purposes of Section 4.14 of the Indenture. On October
21, 1996, the bondholder consent was approved by a majority of the holders
of record as of the date of the Consent Solicitation.
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11. LONG-TERM DEBT
Long-term debt consists of the following:
December December
29, 1996 28, 1997
------------ -----------
Notes payable to banks, maturing at various dates through November 10, 2001,
secured by property and/or equipment, bearing interest ranging from 1/2%
above prime to 9.25%. The notes are payable in monthly principal and
interest installments ranging from $1,531 to 13,333. Interest is payable $ 1,006 $ 530
monthly.
Note payable to finance company due September 1998, secured by certain
equipment, bearing interest at a rate of 7.3%. The note is payable in
monthly principal and interest installments of $6,762. 133 59
Note payable to Company for acquisition of certain markets, secured by
certain property and equipment, bearing interest of 8.3%. The note is
payable in monthly principal and interest installments of $11,494. 79 0
Secured notes payable to a bank used to finance equipment and/or modular
buildings for franchisees (the Franchisee Loans), maturing at various
dates through July 15, 2000, bearing interest at prime plus1/2%. The notes
are payable in monthly principal installments of $4,875. Interest is
payable monthly. 195 136
Notes payable to former owners for acquisition of market, secured by
common stock of Hampton Roads Foods, maturing March 13, 2001, with
outstanding balances due after last monthly payments, bearing interest of
9.0%. The notes are payable in monthly principal and interest installments
ranging from $4,742 to $50,211. 4,461 4,073
------------ ------------
5,874 4,798
Less - Current portion (1,099) (781)
-- --
------------ ------------
$ 4,775 $ 4,017
============ ============
At December 28, 1997, the prime rate was 8.50%.
The following are the remaining annual maturities of long-term debt:
Year
-------------------
1998 $ 781
1999 727
2000 578
2001 2,712
------------
$ 4,798
============
The Company is subject to certain restrictive covenants under its debt
agreements.
The market value of the Company's long-term debt approximated book
value at December 28, 1997. Debt related to the acquisition of Hampton
Roads Foods was entered into in 1995 and bears interest at rates which
approximate current rates for debt with similar terms. The majority of the
remaining long-term debt has contractual rates which vary based on
fluctuations in market rates.
12. COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The Company leases certain land and buildings generally under
agreements with terms of or renewable to 15 to 20 years. Some of the leases
contain contingent rental provisions based on percentages of gross sales.
The leases generally obligate the Company for the cost of property taxes,
insurance and maintenance.
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67
Following is a schedule by year of future minimum lease commitments
under all leases at December 28, 1997:
Capital Operating
Year Leases Leases
--------------------------------------------- ----------- -----------
1998 $ 1,035 $ 8,466
1999 997 7,733
2000 931 6,826
2001 897 6,489
2002 889 5,620
Thereafter 5,650 22,165
----------- ------------
Total minimum lease commitments 10,399 $ 57,299
============
Less amounts representing interest,
discounted at rates ranging from 10% to 12% (4,758)
-----------
Present value of minimum lease payments 5,641
Current portion of capital lease obligations (413)
-----------
Long-term lease obligations $ 5,228
===========
The discount rates applicable to the Company's capital leases
approximate currently available market rates. Minimum operating lease
payments have not been reduced by minimum sublease rentals of $5.6 million
due in the future under noncancellable subleases.
Rent expense consists of:
Fiscal Years Ended
--------------------------------------------
December 31, December 29, December
1995 1996 28, 1997
-------------- -------------- ----------
Minimum rentals - related parties $ 292 $ 470 $ 396
Minimum rentals - others 6,641 4,681 4,322
Contingent rentals - others 173 122 98
-------------- -------------- ----------
$ 7,106 $ 5,273 $ 4,816
============== ============== ==========
(b) LITIGATION
In January and February 1994, two putative class action lawsuits were
filed, purportedly on behalf of the stockholders of Rally's, in the United
States District Court for the Western District of Kentucky, against
Rally's, Burt Sugarman and GIANT and certain of Rally's present and former
officers and directors and its auditors. The complaints allege defendants
violated the Securities Exchange Act of 1934, among other claims, by
issuing inaccurate public statements about the Company in order to
arbitrarily inflate the price of its common stock. The plaintiffs seek
unspecified damages. On April 15, 1994, Rally's filed a motion to dismiss
and a motion to strike. On April 5, 1995, the Court struck certain
provisions of the complaint but otherwise denied Rally's motion to dismiss.
In addition, the Court denied plaintiffs' motion for class certification;
the plaintiffs renewed this motion, and despite opposition by the
defendants, the Court granted such motion for class certification on April
16, 1996, certifying a class from July 20, 1992 to September 29, 1993. In
October 1995, the plaintiffs filed a motion to disqualify Christensen,
Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP ("Christensen, Miller")
as counsel for defendants based on a purported conflict of interest
allegedly arising from the representation of multiple defendants as well as
Ms. Glaser's position as both a former director of Rally's and a partner in
Christensen, Miller. Defendants filed an opposition to the motion, and the
motion to disqualify Christensen, Miller was denied. Fact discovery is set
to close in April 1998. No trial date has been scheduled yet. Management is
unable to predict the outcome of this matter at the present time or whether
or not certain available insurance coverages will apply. The defendants
deny all wrongdoing and intend to defend themselves vigorously in this
matter. Discovery is proceeding. Because these matters are in a preliminary
stage, the Company is unable to determine whether a resolution adverse to
the Company will have a material effect on its results of operations or
financial condition. Accordingly, no provisions for any liabilities that
may result upon adjudication have been made in the accompanying financial
statements. An estimate of defense costs reimbursable under the Company's
directors' and officers' insurance is included in "Other Assets" in the
accompanying consolidated financial statements.
In February 1996, Harbor Finance Partners ("Harbor") commenced a
derivative action, purportedly on behalf of Rally's against GIANT and
certain of Rally's officers and directors before the Delaware Chancery
37
68
Court. Harbor named Rally's as a nominal defendant. Harbor claims that the
directors and officers of both Rally's and GIANT, along with GIANT,
breached their fiduciary duties to the public shareholders of Rally's by
causing Rally's to repurchase from GIANT certain Rally's Senior Notes at an
inflated price. Harbor seeks "millions of dollars in damages", along with
rescission of the repurchase transaction. In the fall of 1996, all
defendants moved to dismiss the action. The Chancery Court conducted a
hearing on November 26, 1996 and denied the motions to dismiss on April 3,
1997. The Company denies all wrongdoing and intends to vigorously defend
the action. It is not possible to predict the outcome of this action at
this time.
In December 1994, Rally's entered into two franchise agreements with
Kader Investments, Inc. ("Kader") for the development and operation of
Rally's Hamburgers restaurants in Anaheim, California and Tustin,
California. Rally's assisted the franchisee in developing and opening the
restaurants. On November 27, 1996, Kader filed a six-count Complaint
against Rally's in the California Superior Court for Orange County (Case
No. 772257) alleging material misrepresentation, respondent superior,
breach of contract, breach of the implied covenant of good faith and fair
dealing, fraud and unfair competition. These claims arise out of
allegations concerning Rally's offer and sale of two franchises (under a
two-store development agreement), and Rally's actions during the term of
the agreements. The Complaint seeks as relief rescission of the parties'
franchise and development agreements; general damages of at least
$1,494,277 and $1,400,000 for the material misrepresentation and fraud
counts, respectively; general damages in unspecified amounts as to the
other counts; punitive damages in unspecified amounts; and attorneys' fees.
Rally's filed an Answer, and intends to file a Cross-Complaint alleging
breach of contract. In settlement of the litigation, on December 18, 1997,
the parties entered into a memorandum of understanding pursuant to which
the Company would purchase Kader's restaurants for $1.65 million. The
purchase price will consist of $855,000 in cash, $375,000 in restricted
stock and $420,000 in notes, and the transaction is currently scheduled to
close on or about April 7, 1998, subject to completion of all necessary
documentation and final dismissal. Accordingly, a provision of $754,000 for
these liabilities, net of assets to be received upon adjudication, have
been made in the accompanying financial statements.
The Company is involved in other litigation matters incidental to its
business. With respect to such other suits, management does not believe the
litigation in which it is involved will have a material effect upon its
results of operation or financial condition.
(c) OTHER COMMITMENTS
The Company is contingently liable on certain franchisee lease
commitments totaling approximately $294,000. The Company from time to time
negotiates purchase contracts for certain items used in its restaurants in
the normal course of business. Although some of these contracts contain
minimum purchase quantities, such quantities do not exceed expected usage
over the term of such agreements.
13. INCOME TAXES
The asset and liability method contemplated by Statement of Financial
Accounting Standards No. 109 requires recognition of deferred tax assets
and liabilities for the expected future tax consequences of substantially
all temporary differences between the tax bases and financial reporting
bases of assets and liabilities (excluding goodwill).
38
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The major components of the Company's computation of deferred tax
assets and liabilities at December 29, 1996 and December 28, 1997 are as
follows:
December 29, December
1996 28, 1997
-------------- ------------
Excess of tax depreciation over book depreciation $ 8,430 $ 9,316
Acquired intangibles with no tax basis 2,070 2,070
Other 30 17
-------------- ------------
Gross deferred tax liabilities $ 10,530 $ 11,403
============== ============
Net operating loss carryforwards $ 12,824 $ 17,488
Amounts accrued for financial reporting purposes not yet deductible
for tax purposes 12,885 10,742
Alternative minimum tax and targeted jobs tax credit carryforwards 937 937
Other 1,514 1,230
-------------- ------------
Gross deferred tax assets 28,160 30,397
Less valuation allowance 17,630 18,994
-------------- ------------
Net deferred tax asset $ 10,530 $ 11,403
============== ============
The alternative minimum tax credit carryforward has no expiration. The
net operating loss carryforwards will expire approximately $641,000 in
2008, approximately $20.2 million in 2009, approximately $17.5 million in
2010, approximately $1.6 million in 2011 and approximately $10.5 million in
2012. The targeted jobs tax carryforward expires approximately $118,000 in
2006, approximately $184,000 in 2007 and approximately $200,000 in 2008. A
valuation allowance of approximately $19.0 million has been established due
to the uncertainty of realizing the benefit associated with the net
operating loss carryforwards generated in the current and previous years.
In addition, pursuant to Section 382 of the Internal Revenue Code of 1986,
as amended, the utilization of the Company's net operating loss
carryforwards to offset future taxable income may be limited if the Company
experiences a change in ownership of more than 50 percentage points within
a three-year period. The Company is in the process of determining whether
it has experienced one or more ownership changes pursuant to Section 382.
If the transactions in 1997 or earlier caused an ownership change(s), the
Company may be significantly limited in utilizing its tax net operating
loss carryforwards arising before such ownership change(s) to offset future
federal taxable income. Similarly, the Company may be limited in utilizing
its tax credit carryforwards arising before such ownership change(s) to
offset future federal taxable income.
Income tax expense, including the tax provision on the extraordinary
item in 1996, consists of the following:
Fiscal Years Ended
----------------------------------------
December December December
31, 1995 29, 1996 28, 1997
------------ ------------ ------------
Current $ 539 $ 675 $ 455
Deferred - -
------------ ------------ ------------
Total tax (benefit) expense $ 539 $ 675 $ 455
============ ============ ============
Income tax expense for the year ended December 28, 1997 consist of
$455,000 in state income tax expense.
A reconciliation of the provisions for income taxes with the federal
statutory rate is as follows:
Fiscal Years Ended
-----------------------------------------
December December 29, December
31, 1995 1996 28, 1997
------------- -------------- ------------
Provision (benefit) computed at $ (15,770) $ 905 $ (1,330)
statutory rate
Tax effect of equity in loss of - - 245
affiliate
State and local income taxes, net of
federal income tax benefit 736 575 455
Change in deferred tax asset valuation
allowance 15,352 (1,169) 1,364
Other 221 364 (279)
------------- -------------- ------------
$ 539 $ 675 $ 455
============= ============= =============
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14. STOCK-BASED COMPENSATION PLANS
The Company currently has three stock option plans in effect, the 1990
Stock Option Plan (the "Employees' Plan"), the 1990 Stock Option Plan for
Non-Employee Directors (the "1990 Directors' Plan"), and the 1995 Stock
Option Plan for Non-Employee Directors (the "1995 Directors' Plan").
Additionally, the Company has an employee stock purchase plan (the "1993
Purchase Plan"). Although there are existing options outstanding under the
1990 Directors' Plan, no additional grants will be made pursuant to this
plan. The Company accounts for these plans under APB Opinion No. 25, under
which approximately $66,000 of compensation cost has been recognized in
fiscal 1996 related to 157,000 options granted to directors under the 1995
Directors Plan. Such compensation represents the difference between the
market values on the dates of grant and the measurement date, July 10,
1996, the date when the grants were ultimately approved by the shareholders
at the annual meeting. No compensation cost was recognized in any other
period presented.
During 1996, a total of 350,000 additional options were granted to five
of the current directors. These options were not granted pursuant to an
option plan. The options were granted at a price equal to the stock's
market price on the date of grant. The options were immediately exercisable
and expire after five years.
Had compensation cost for all option grants to employees and directors
been determined consistent with FASB Statement No. 123, the Company's net
income and earnings per share would have been reduced to the following pro
forma amounts:
1995 1996 1997
---- ---- ----
Net Income (Loss): As Reported $ (46,919) $ 1,988 $ (4,516)
Pro Forma (47,154) (699) (5,577)
Earnings (Loss) Per
Common Share: As Reported $ (3.00) $ .12 $ (.22)
Pro Forma (3.02) (.04) (.27)
Because the Statement 123 method of accounting has not been applied to
options granted prior to January 2, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in
future years. Additionally, the pro forma amounts include approximately
$16,000, $12,000 and $17,000 in 1995, 1996 and 1997, respectively, related
to the purchase discount offered under the 1993 Purchase Plan.
The Company may sell up to 500,000 shares of stock to its employees
under the 1993 Purchase Plan. The Company has sold approximately 51,000
shares, 28,000 shares and 33,000 shares in 1995, 1996, and 1997,
respectively, and has sold approximately 161,000 shares through December
28, 1997 since the inception of this plan in 1993. The Company sells shares
at 85% of the stock's market price at date of purchase. The weighted
average fair value of shares sold in 1995, 1996 and 1997 was approximately
$2.06, $3.04 and $3.06, respectively.
Options to purchase an aggregate of 5.5 million shares of the Company's
Common Stock may be granted under the stock option plans, at a price not
less than the market value on the date of grant. The Company has granted
options on approximately 2.5 million shares under the stock option plans.
Outstanding options under the Employees' Plan generally expire ten years
after grant. Certain options granted to a former President and Chief
Executive Officer of the company expire five years from the date of grant.
Options outstanding under the two directors' plans expire five years after
grant. Options are exercisable over various periods ranging from immediate
to three years after grant depending upon their grant dates and the plan
under which the options were granted.
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71
A summary of the status of all options granted to employees and
directors, as well as those options granted to non-employees (see Note 4),
at December 31, 1995, December 29, 1996 and December 28, 1997, and changes
during the years then ended is presented in the table and narrative below:
December 31, 1995 December 29, 1996 December 28, 1997
------------------------- ------------------------ --------------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg
Shares Ex Price Shares Ex. Price Shares Ex. Price
--------- ------------ --------- ---------- ---------- ------------
Outstanding at beginning of year 2,225 $4.74 2,219 $4.24 3,664 $2.98
Granted at price equal to market 676 2.88 2,154 2.63 863 3.00
Granted at price greater than -- -- 176 1.75 -- --
market
Exercised -- -- (9) 3.05 (78) 2.48
Forfeited (412) 3.93 (207) 3.34 (429) 2.75
Expired (270) 5.38 (669) 5.62 (161) 3.63
--------- --------- ----------
Outstanding at end of year 2,219 4.24 3,664 2.92 3,859 2.99
========= ========= ==========
Exercisable at end of year 1,048 $5.09 2,359 $3.21 2,921 $3.07
Weighted average of fair value of
options granted $1.76 $1.31 $1.78
The Company had approximately 2,225,000 options outstanding as of January
1, 1995, with prices ranging form $2.67 to $9.333. At January 1, 1995,
approximately 756,000 options were exercisable at prices ranging from $2.67 to
$6.50.
The following table summarizes information about stock options outstanding
at December 28, 1997:
Options Outstanding Options Exercisable
------------------------------------------------------------------------ --------------------------------
Wtd. Avg.
Range of Outstanding Remaining Wtd. Avg. Exercisable Wtd. Avg.
Exercise Prices as of Contractual Exercise as of Exercise
Dec. 28, 1997 Life Price Dec. 28, 1997 Price
---------------- ---------------- --------------- ------------- --------------- -------------
$1.25 to 2.50 874,279 6.7 years $1.93 420,422 $1.94
2.50 to 3.75 1,997,330 4.3 2.90 1,813,137 2.91
3.75 to 5.00 987,350 5.7 4.12 687,350 4.17
------------ -----------
$1.25 to 5.00 3,858,959 5.2 2.99 2,920,909 3.07
============ ===========
For purposes of the pro forma disclosures assuming the use of the fair
value method of accounting, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model
with the following weighted-average assumptions used for grants in fiscal
1995, 1996 and 1997, respectively: expected volatility of 45.0 percent,
45.7 percent, and 47.0 percent; risk-free interest rates of 6.75 percent,
6.82 percent and 6.26 percent for options granted to employees and 6.54
percent, 6.59 percent and 6.47 percent for options granted to directors;
and expected lives for fiscal 1995, 1996 and 1997 of eight years for
options granted to employees and five years for options granted to
directors. An expected dividend yield of 0 percent was used for all periods
based on the Company's history of no dividend payments.
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15. UNAUDITED QUARTERLY FINANCIAL DATA
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
----------- ----------- ----------- ----------- -----------
Year Ended December 29, 1996
Revenues $ 41,912 $ 47,357 $ 38,781 $ 34,702 $ 162,752
Income (loss) from operations (3,369) 2,413 2,632 2,414 4,090
Net income 838 111 414 625 1,988
Earnings (loss) per common
share:
Earnings (loss) before (.24) .01 .01 .01 (.19)
extraordinary item
Extraordinary item .29 - .02 .02 .31
----------- ----------- ----------- ----------- -----------
Earnings per common share $ .05 $ .01 $ .03 $ .03 $ .12
=========== =========== =========== =========== ===========
Year Ended December 28, 1997
Revenues $ 32,595 $ 38,090 $ 38,522 $ 35,723 $ 144,930
Income from operations 1,015 1,806 543 (44) 3,320
Net income (loss) (952) 92 (1,148) (2,508) (4,516)
----------- ----------- ----------- ----------- -----------
Loss per common share $ (.05) $ - $ (.06) $ (.11) $ (.22)
=========== =========== =========== =========== ===========
16. IMPAIRMENT OF LONG-LIVED ASSETS
The Company adopted Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to Be Disposed of " (SFAS 121), at the beginning of the fourth
quarter, 1995. This Statement establishes accounting standards for the
impairment of long-lived assets, certain identifiable intangibles and
goodwill related to those assets to be held and used, and for long-lived
assets and certain identifiable intangibles to be disposed of. SFAS 121
requires that impairment for long-lived assets and identifiable intangibles
to be held and used, if any, be based on the fair value of the asset.
Long-lived assets and certain identifiable intangibles to be disposed of
are to be reported at the lower of carrying amount or fair value less cost
to sell. For purposes of applying this statement, the Company determines
fair value utilizing the present value of expected future cash flows using
a discount rate commensurate with the risks involved.
Long-lived assets considered for impairment under SFAS 121 are required
to be grouped at the "lowest level for which there are identifiable cash
flows that are largely independent of the cash flows of other groups." The
Company believes the most correct application of this standard is obtained
by examining individual restaurants where circumstances indicate that an
impairment issue may exist. This belief is primarily based on the fact that
it is at individual restaurant level that most investment and closure
decisions are made on an ongoing basis. In addition, if an asset being
tested for recoverability was acquired in a business combination accounted
for using the purchase method, the goodwill that arose in that transaction
is included as part of the asset being evaluated and in determining the
amount of any impairment.
Prior to the issuance of SFAS 121, the Company recorded impairment of
long-lived assets deemed to be permanently impaired. Generally, such
assessment of permanent impairment arose concurrent with a management
decision to dispose of such an asset at which time the asset was written
down to estimated net realizable value. In general, other long-lived assets
were reviewed for impairment only if there were dramatic changes in
operating results or cash flows of a segregable group of outlets,
indicating a likelihood that a permanent impairment has occurred.
The Company's past practices of estimating net realizable value for
assets to be disposed of are consistent with the Statement's requirements
to write down such assets to fair market value less costs to sell and no
adjustment regarding such assets was necessary upon adoption of the
Statement. The expected disposal dates for these assets are over the next
12 months and consist mainly of surplus land, buildings and equipment. The
carrying amounts of such assets to be disposed of are shown separately on
the accompanying balance sheets. The majority of assets held for sale
resulted from constriction of the Company's development plan and other
associated store closings further discussed in Note 3.
The Company's fourth quarter, 1995 review relating to assets to be held
and used indicated that 37 of its 238 operating restaurants met the
Company's criteria for impairment review. All of the indicated restaurants
were deemed to be impaired based on current estimates of their underlying
cash flows and a provision for
42
73
impairment was recorded in the fourth quarter, 1995 of approximately $13.7
million related to writedowns of the assets associated with these
restaurants. Approximately $825,000 of associated intangible assets was
included in this writedown. The writedown is included in the caption
"Provision for restaurant closures and other." The writedown of these
assets resulted in reduced depreciation and amortization expense in the
fourth quarter, 1995 of approximately $351,000.
The magnitude of the writedown noted above resulted primarily from two
factors: (1) the review of assets to be held and used at individual
restaurant level, a lower level than used in the past and (2) the recent
historical and continuing poor operating performance of the restaurants
themselves (including the restaurant's 1995 full year performance).
During 1996, three additional restaurants, due to their continued poor
operating performance, were determined to be impaired, resulting in charges
of approximately $824,000 included in the caption, "Provision for
restaurant closures and other". No additional restaurants were determined
to be impaired in 1997. As required by the SFAS 121, the Company will
continue to periodically review its assets for impairment where
circumstances indicate that such impairment may exist.
17. SHAREHOLDER RIGHTS OFFERING
A Shareholder Rights Offering (the "Offering") was completed on
September 20, 1996. The Company distributed to holders of record of its
Common Stock, as of the close of business on July 31, 1996 (the "Record
Date"), transferable subscription rights ("Right(s)") to purchase Units
consisting of one share of Common Stock and one Warrant to purchase an
additional share of Common Stock. Stockholders received one Right for each
share of Common Stock held on the Record Date. For each 3.25 Rights held, a
holder had the right to purchase one Unit for $2.25 each. The Offering
consisted of 4,825,805 Units. Each Warrant may be exercised to acquire an
additional share of Common Stock at an exercise price of $2.25 per share
and expires on September 26, 2000. The Company may redeem the Warrants, at
$.01 per Warrant, upon 30 days' prior written notice in the event the
closing price of the Common Stock equals or exceeds $6.00 per share for 20
out of 30 consecutive trading days ending not more than 30 days preceding
the date of the notice of redemption. The Offering was fully subscribed and
raised over approximately $10.8 million in gross proceeds, offset by legal
and other issuance costs of approximately $437,000. The net proceeds from
the Offering were attributable primarily to the sale of the Company's
common stock. The amount attributable to the warrants is included in
"Additional paid-in capital."
In addition to the approximately $10.8 million provided by the Rights
Offering, the Warrants issued, if exercised, could provide an additional
$10.8 million in proceeds. The Company had 15,683,869 shares of Common
Stock outstanding on the Record Date. Immediately after the Offering,
20,509,674 shares of Common Stock and 4,825,805 Warrants were outstanding.
As of December 28, 1997, 4,813,757 of these Warrants were outstanding. The
Warrants are publicly traded and at December 28, 1997 had a market value of
approximately $6.3 million based on the quoted market price for such
warrants.
18. SUBSEQUENT EVENTS
On January 8, 1998, the Company announced it intends to acquire in open
market purchases, from time to time, up to 1,000,000 shares of Common Stock
of Checkers Drive-In Restaurants, Inc. As of January 22, 1998, 30,000
shares had been purchased at a price of $1.07 per share.
43
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Rally's Hamburgers, Inc.:
We have audited the accompanying consolidated balance sheets of Rally's
Hamburgers, Inc. (a Delaware corporation) and subsidiaries as of December 29,
1996 and December 28, 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three fiscal
years in the period ended December 28, 1997. These consolidated financial
statements and the schedule referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audits. We did not
audit the financial statements of Checkers Drive-In Restaurants, Inc.
(Checkers), the investment in which is reflected in the accompanying financial
statements using the equity method of accounting. The investment in Checkers
represents 19 percent of the Company's total assets as of December 28, 1997, and
the equity in its net loss represents 16 percent of the Company's net loss. The
statements of Checkers were audited by other auditors whose report has been
furnished to us and our opinion, insofar as it relates to the amounts included
for Checkers, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. 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, based on our audit and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Rally's Hamburgers, Inc. and subsidiaries as of
December 29, 1996 and December 28, 1997, and the results of their operations and
their cash flows for each of the three fiscal years in the period ended December
28, 1997, in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule II is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
/s/ ARTHUR ANDERSEN LLP
Louisville, Kentucky
February 27, 1998
44
75
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Additions
--------------------------
Balance at Charged to Charged to
Beginning Costs and Other Balance at
Description of Year Expenses Accounts Deductions End of Year
- ------------------------------------ ------------ ------------ ------------ -------------- ------------
Year Ended December 31, 1995
Accounts receivable $ 176 $ 376 $ 18 $ 117 $ 453
Royalties receivable 402 838 (267) 51 922
Notes receivable - 293 249 - 542
------------ ------------ ------------ -------------- ------------
$ 578 $ 1,507 $ - $ 168 $ 1,917
============ ============ ============ ============== ============
Year Ended December 29, 1996
Accounts receivable 453 54 0 206 301
Royalties receivable 922 697 (81) 133 1,405
Notes receivable 542 200 81 (30) 853
------------ ------------ ------------ -------------- ------------
$ 1,917 $ 951 $ 0 $ 309 $ 2,559
============ ============ ============ ============== ============
Year Ended December 28, 1997
Accounts receivable $ 301 $ 136 $ (39) $ (198) $ 200
Royalties receivable 1,405 (316) (114) (744) 231
Notes receivable 853 (212) 148 (558) 231
------------ ------------ ------------ -------------- ------------
$ 2,559 $ (392) $ (5) $ (1,500) $ 662
============ ============ ============ ============== ============
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GIANT GROUP, LTD.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
Balance at Charged to Charged Balance at
Beginning costs and to other End
Description of Period expenses accounts Deductions of Period
- ---------------------------------------------------------------------------------------------------------------
Year ended December 31, 1997
Reserve for impairment
of assets held-for-sale $0 $1,500 $0 $0 $1,500
=========================================================================
S-1