ELEPHANT & CASTLE GROUP INC - 10-Q Quarterly Report

Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

For the quarterly period ended March 30, 2003

/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ___________________ to _______________________

Commission file number 33-60612

ELEPHANT & CASTLE GROUP INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)

BRITISH COLUMBIA NOT APPLICABLE
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

Suite 1200, 1190 Hornby Street, Vancouver, BC, Canada V6Z 2K5
----------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)

(Issuer's telephone number) (604) 684-6451

----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)

Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
/X/ Yes / / No

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. / / Yes / / No

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:

Common Shares at March 30, 2003: 5,144,604

ELEPHANT & CASTLE GROUP INC.
CONSOLIDATED BALANCE SHEETS
CANADIAN DOLLARS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)

See notes to financial statements

ELEPHANT & CASTLE GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
CANADIAN DOLLARS
(IN THOUSANDS OF DOLLARS, EXCEPT NET INCOME/(LOSS) PER SHARE)
(UNAUDITED)

See notes to financial statements

ELEPHANT & CASTLE GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
CANADIAN DOLLARS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)

See notes to financial statements

ELEPHANT & CASTLE GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
CANADIAN DOLLARS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)

See notes to financial statements

ELEPHANT & CASTLE GROUP INC.
NOTES TO FINANCIAL STATEMENTS
THIRTEEN WEEKS ENDED MARCH 30, 2003 AND MARCH 31, 2002
CANADIAN DOLLARS
(IN THOUSANDS OF DOLLARS, EXCEPT NET INCOME/(LOSS) PER SHARE)
(UNAUDITED)

1. BASIS OF PRESENTATION

These consolidated financial statements have been prepared in accordance
with generally accepted accounting principles in Canada for interim
financial information. These financial statements are condensed and do not
include all disclosures required for annual financial statements. The
organization and business of the Company, accounting policies followed by
the Company and other information are contained in the notes to the
Company's audited consolidated financial statements filed as part of the
Company's December 29, 2002 Form 10-K.

In the opinion of the Company's management, these interim financial
statements reflect all adjustments necessary to present fairly the
Company's consolidated financial position at March 30, 2003 and the
consolidated results of operations, the consolidated statement of
shareholders' equity and cash flow for the thirteen weeks then ended. The
results of operations for the interim period are not necessarily indicative
of the results of any other interim periods or for the entire fiscal year.

2. CLOSED LOCATIONS

The comparative financial statements for 2002 include the results of
operations for two locations, which are excluded from the 2003 results. The
Elephant & Castle Bellingham, WA location closed on October 14, 2002, and
the Company's only owned Alamo Steakhouse & Grill restaurant at the Mall of
America, Minneapolis, closed January 5, 2003. No revenue or expenses were
recognized during this period for either location.

3. COMPARATIVE FIGURES

Certain comparative figures have been reclassified to conform to the
current period's presentation.

4. FRANCHISES

Royalties receivable from franchised locations are included in sales.

5. DIFFERENCES BETWEEN CANADIAN AND UNITED STATES GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES

Financial statement presentation differs in certain respects between Canada
and the United States. Reconciliation of Canadian earnings and US earnings
is as follows (the reader is referred to the Company's Form 10K for the
Year Ended December 29, 2002, as filed with the Securities and Exchange
Commission):

6. LONG-TERM DEBT RENEGOTIATION

In December 2000 the Company reached an agreement with the holders of its
8% notes whereby $1,583 US ($2,374 CDN.) was converted into 791,250 shares.
During 2001, $1,000 US was renegotiated and included in the $10,000 US of
convertible subordinated notes (see below). The conversion rate on the
remaining $683 remains unchanged at $4 US per share.

In June 2001, the Company and General Electric Investment Private Placement
Partners II ("GEIPPPII") agreed to renegotiate the terms on $10,000 US of
convertible subordinated notes and debentures held by GEIPPPII. As part of
the renegotiation, the Company issued 2,600,000 shares in payment of
accrued interest, reduction of future interest rate and issued the
following notes.

o $5,000 US of the restated and amended senior secured convertible
6% notes (the "senior notes"); and

o $5,000 US of the restated and amended junior secured convertible
6% notes (the "junior notes"), in exchange for the securities to
be surrendered by GEIPPII.

Both the senior notes and the junior notes shall be convertible into shares
of the Company's common shares at the holder's option. However the junior
notes are mandatorily convertible into common shares, subject to certain
targeted performance requirements to be measured by the Company's earnings
before interest, taxes, depreciation and amortization ("EBITDA") as
follows:

(i) On or after September 1, 2002, $1,250 US of the junior notes
would convert into common shares at a conversion price at one
dollar ($1.00 US) per share (1,250,000 shares);

(ii) On or after September 1, 2003, $1,250 US of the junior notes
would convert into common shares at a conversion price of one
dollar and twenty-five cents ($1.25 US) per share (1,000,000
shares);

(iii)On or after September 1, 2004, $1,250 US of the junior notes
would convert into common shares at a conversion price of one
dollar and fifty cents ($1.50 US) per share (833,333 shares); and

(iv) On or after September 1, 2005, $1,250 US of the junior notes
would convert into common shares at a conversion price of one
dollar and seventy-five cents ($1.75 US) per share (714,286
shares);

6. LONG-TERM DEBT RENEGOTIATION (CONTINUED)

Conversion is subject only to the Company's meeting certain minimum tests
of EBITDA during each twelve month period ended each June 30, preceding
each such conversion date. The EBITDA targets for mandatory conversion are
fixed as follows:

For the twelve month period ended June 30, 2002, the Company did not
achieve the above EBITDA target. It did, however, achieve 67% of the
target, and therefore would still be able to convert both the first and
second tranche of junior notes into equity, if the Company were to meet
100% of its EBITDA target for the twelve months ending June 30, 2003.
Achievement of 80% of EBITDA target for the twelve months ending June 30,
2003 would allow the Company to convert two thirds of the second tranche of
junior notes into equity, but the Company would lose the ability to convert
any of the first tranche.

7. STOCK BASED COMPENSATION

The Company applies the Intrinsic Method in accounting for its stock
options granted to employees. Accordingly, compensation expense of $Nil was
recognized as wage expense for the 400,000 stock options granted to
employees during the period ended March 30, 2003 (March 31, 2002 - $Nil).
Had compensation expense been determined as provided using the Fair Value
Method, the pro-forma effect on the Company's net income and per share
amounts would have been as follows:

--------------------------------------------------------------------------

Net Income, as reported $382,000
Net Income, pro-forma $340,677
Net Income per share, as reported $ 0.07
Net Income per share, pro-forma $ 0.06
--------------------------------------------------------------------------

The Fair Value Method applies the Black-Scholes option-pricing model, using
the following weighted average assumptions:

--------------------------------------------------------------------------

Expected life (years) 5
Interest rate 2.50%
Volatility 83.81%
Dividend yield 0.00%
--------------------------------------------------------------------------

8. GOODWILL AND INTANGIBLE ASSETS

Effective January 2002, the Company adopted the new recommendations of the
CICA in accounting for goodwill and other intangible assets. This
recommendation includes requirements to test goodwill and indefinite lived
intangible assets annually for impairment rather than amortization. The
impact of this recommendation on the Company's operations is nil for the
thirteen weeks ended March 30, 2003.

9. FOREIGN EXCHANGE

Effective January 2002, the Company adopted the new CICA Handbook
recommendation in accounting for foreign currency translation whereby
unrealized gains and losses are recorded as income or expensed in the
period incurred.

10. JOINT VENTURE

In 2002 the Company signed a joint venture agreement to open an Elephant &
Castle restaurant in a new Club Quarters hotel in San Francisco. This
restaurant opened for business on 28 March, 2003.

Neither the Company, nor its joint venture partner, has unilateral control
over major strategic, investing and financing decisions. Accordingly, the
Company will account for this operation as a joint venture and use the
proportionate method of consolidation.

ELEPHANT & CASTLE GROUP INC.

PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

From time to time lawsuits are filed against the Company in the ordinary
course of business. The Company is not currently a party to any litigation which
would, if adversely determined, have a material adverse effect on the Company or
its business and is not aware of any such threatened litigation.

In 1989 and 1990, the Canadian subsidiary received notices of assessment
from Canadian Customs and Revenue Agency and the Ontario Ministry of Revenue
regarding a construction allowance received in 1984 from the landlord for its
former Sarnia, Ontario location. The reassessment has been under appeal since
1989. Including interest and penalties, the assessment demand totals $1,118,000.
The Company continues to contest the total amount owed, and holds a provision of
$585,000 against the dispute. The difference between the Company's reserve and
the tax assessment relates specifically to a partial settlement in the Company's
favour from 2001 which the Company believes is not reflected in the assessment
demand. Canadian Customs and Revenue Agency have been unable to produce adequate
paperwork in support of their claim.

On October 14, 2002 the Company closed its unsuccessful Elephant & Castle
restaurant located in Bellingham, WA. The lease of this location was due to
expire in 2005. The company is in the process of negotiating an agreement with
the landlord to terminate the lease early in exchange for the surrender of
substantially all of the assets at that location, and the payment of a to be
agreed level of compensation for loss of rent. Provision for the disposal of
assets, payment for loss of rent and other closing costs was made, resulting in
a charge to earnings of CDN$425,000 in 2002. The Company has recently received a
summons from the Landlord claiming CDN$457,000 damages upon breach of lease. The
Company believes this amount to be excessive.

ITEM 2 - CHANGES IN SECURITIES

None

ELEPHANT & CASTLE GROUP INC.

PART II - OTHER INFORMATION (CONTINUED)

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5 - OTHER INFORMATION

None

ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

EXHIBITS

None

REPORTS ON FORM 8-K

None

ELEPHANT & CASTLE GROUP INC.
QUARTERLY REPORT
THIRTEEN WEEKS ENDED MARCH 30, 2003
(IN THOUSANDS OF DOLLARS, EXCEPT NET INCOME/(LOSS) PER SHARE)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THIRTEEN WEEKS ENDED MARCH 30, 2003 (UNAUDITED) VS. THIRTEEN WEEKS ENDED MARCH
31, 2002 (UNAUDITED)

NET INCOME

For the thirteen weeks ended March 30, 2003, the Company's net profit before
income taxes was CDN $441 compared to a net loss of CDN ($140) for the
corresponding period in 2002. Earnings per share for the current period were CDN
$0.07 compared to a loss per share of CDN ($0.03) in 2002. The average number of
shares outstanding decreased from 5,169,604 in 2002 to 5,144,604 for the current
period.

SALES

Overall, sales decreased 9.8% during the thirteen weeks ended March 30, 2003 to
CDN $9,363 from CDN $10,376 for the comparable period in 2002. The 2002 figure
included sales for one Elephant & Castle location that was closed in October
2002 and sales for the Alamo Steakhouse and Grill location that was closed on
January 5, 2003.

For the twelve Canadian locations fully open throughout both periods, sales for
the thirteen weeks ended March 30, 2003 totaled CDN $4,762 compared with CDN
$4,626 compared to the thirteen weeks ended March 31, 2002, an increase of 2.9%
on a same store basis.

For the five US locations open throughout both periods, sales for the 2003
period were US $2,845 compared with US $2,823 for the 2002 period, an increase
of 0.4% on a same store basis.

FOOD AND BEVERAGE COSTS

Overall, food and beverage costs, as a percentage of sales, decreased to 26.9%
compared to 28.0% for the thirteen weeks ended March 31, 2002. This reflects
improvements in procurement management for both Canada and the US, and the
benefit of closing two underperforming stores.

LABOUR AND BENEFITS COSTS

Labour and benefits decreased to 31.7% of sales, compared to 33.2% for the
thirteen weeks ended March 31, 2002. This reduction reflects the closure of two
under performing stores, and efficiency improvements in Canadian stores, offset
by rising payroll benefit costs in the US.

OCCUPANCY AND OTHER OPERATING COSTS

Occupancy and other operating expenses decreased as a percentage of sales to
25.4%, compared to 25.7% for the thirteen weeks ended March 31, 2002. Upwards
pressure on insurance costs was offset by the benefit of closing two
underperforming stores.

DEPRECIATION AND AMORTIZATION EXPENSE

Depreciation and amortization costs decreased to 5.3% of sales for the current
period from 5.5% last year.

INCOME FROM RESTAURANT OPERATIONS

Income from restaurant operations was CDN $1,003 for the current period, an
increase of CDN $217 versus the prior year. As a percentage of sales, income
from restaurant operations grew to 10.7% versus 7.6% in the prior year. This
improvement reflects the closure of two loss making stores.

GENERAL AND ADMINISTRATIVE COSTS

General and administrative costs increased by CDN $133 from 7.1% of sales in
2002 to 9.2% in the current period. The Company has strengthened its operations,
food development, human resources and finance/systems functions to provide
better support for its existing restaurant operations and to support planned
growth.

INTEREST ON LONG-TERM DEBT

Interest on long-term debt rose to CDN $254 in 2003 compared to CDN $246 in
2002. The 2002 interest figure has been restated to split out a CDN $51 gain on
foreign exchange which was previously shown as a reduction in interest on
long-term debt (see below).

GAIN (LOSS) ON FOREIGN EXCHANGE

There was a gain of CDN $556 on foreign exchange resulting from a strengthening
of the Canadian dollar relative to the US dollar during this quarter which
impacts primarily the US dollar denominated debt. The equivalent figure for the
thirteen weeks ended March 31, 2002, was a gain of CDN $51.

INCOME (LOSS) BEFORE TAXES

The Company recorded a profit before income taxes of CDN $441 for the 2003
period compared to a loss of CDN ($140) for the corresponding 2002 period. The
improvement of CDN $581 includes CDN $505 attributed to a gain on foreign
exchange.

INCOME TAXES

The current quarter tax charge of CDN $59 represents estimated State taxes paid
by US operations. The Company has sufficient capital and non-capital loss carry
forwards in both the US and Canada, and has therefore made no provision for
Federal income taxes in either country.

LIQUIDITY AND CAPITAL RESOURCES

Operating cash flow for the thirteen week period ended March 30, 2003 was CDN
$409 compared to CDN $445 for the thirteen week period ended March 31, 2002.
Changes in non-cash working capital items, provided a cash inflow of CDN $96
compared to an outflow of CDN $359 in the same period last year. Capital
expenditures and pre-opening costs, mainly associated with the opening of the
new store in San Francisco, required CDN $497 compared to CDN $457 in the
comparable period of 2002. Repayment of capital leases was CDN $28 in 2003
compared to CDN $18 in 2001. Debt repayments on the Senior Notes were CDN $226
compared to $198 in the prior period. Resulting net use of funds of CDN ($246)
in the current period, compared to a net use of funds of CDN ($587) a year ago.

The Company's cash balance as of March 30, 2003 was CDN $424 compared to CDN
$464 on March 31, 2002. The Company's current growth strategy is to focus on
strengthening the profitability of existing operations and leveraging the
brand's strength through franchising and through managed joint venture store
growth to the extent deliverable through internally generated cash flow. It is
likely that internally generated cash flows will be fully utilized to meet
scheduled debt repayments over the next 12 months, so growth plans are
accordingly restricted.

On initial recognition, the Company presented the Junior Notes issued to
GEIPPPII in June 2001 (see Financial Statements note 6), as an equity instrument
as management believed the Company would meet the EBITDA requirements for
mandatory conversion to common shares. In accordance with Canadian generally
accepted accounting principles, once initial recognition is made, such
determination should not be changed until the triggering event has or has not
occurred. Therefore, if the Company does not reach the required EBITDA, and if
the instruments are not otherwise amended, the notes will be reclassified as a
debt instrument at such time when the conversion feature is no longer available
to the Company.

The Company did not meet the EBITDA target for the 12 months ended June 30,
2002 required for mandatory conversion of the first tranche of Junior Notes
at the first opportunity at September 29, 2002. It did, however, achieve 67%
of the target, and therefore would still be

able to convert both the first and second tranche of junior notes into
equity, if the Company were to meet 100% of its EBITDA target for the twelve
months ending June 30, 2003. Achievement of 80% of EBITDA target for the
twelve months ending June 30, 2003 would allow the Company to convert two
thirds of the second tranche of junior notes into equity, but the Company
would lose the ability to convert any of the first tranche.

Reflecting the effects of September 11, 2001, and the continuing uncertain
political and economic environment, the company's forecast for the 12 months
ending June 30, 2003 is slightly below 67% of the EBITDA requirements for
conversion at that date. Should the Company not reach the 67% mark of the June
30, 2003 EBITDA requirements, the Company will reclassify the first two tranches
totalling US$2,500 as debt. For accounting purposes, this will represent a
change in estimate and as such, interest from the reclassified notes will be
recorded as interest on a prospective basis.

Interest payments on the junior notes in the amount of 6% per annum shall be
payable in arrears on the earlier of conversion or maturity. The Company shall
have the option to pay up to one-half of the interest, in common shares upon
each conversion date. The interest payment shares will be valued at US $0.40.

The junior notes are considered a compound instrument and have been included in
the financial statements as part of other paid-in capital. Interest payable with
cash has been discounted and included in the consolidated financial statements
as other liabilities of $169 as of March 30, 2003.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.

ELEPHANT & CASTLE GROUP INC.
----------------------------
(Registrant)

CERTIFICATION

In accordance with Section 906 of the Sarbanes-Oxley Act, the undersigned
Chief Executive Officer and Chief Financial Officer, or persons fulfilling
similar functions, each certify:

(i) That the financial information included in this Quarterly Report
fairly presents in all material respects the financial condition and
results of operations of the Company as of, and for the periods
presented in the report; and

(ii) That the Quarterly Report fully complies with the requirements of
Sections 13(a) or 15(d) of the Securities Exchange Act of 1934.

Date April 30, 2003 /s/ Richard Bryant
-------------- -------------------------------------
Richard Bryant, President & C.E.O.

Date April 30, 2003 /s/ Roger Sexton
-------------- --------------------------------------
Roger Sexton, Chief Accounting Officer