U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the period ended September 30, 2004

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT

 

For the transition period from                    to                   

 

Commission file number 0-25366

 

WESTERN SIZZLIN CORPORATION

(formally Austins Steaks & Saloon, Inc.)
(Exact name of registrant as specified in its charter)

 

Delaware		86-0723400
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

1338 Plantation Road

Roanoke, Virginia 24012

(Address of principal executive offices)

 

(540) 345-3195

(Issuer’s telephone number)

 

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.  Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý

 

As of November 14, 2004, there were 11,908,571 shares of the issuer’s common stock outstanding.

 

 

WESTERN SIZZLIN CORPORATION

(formally Austins Steaks & Saloon, Inc.)

Form 10-Q Index

Nine Months Ended September 30, 2004

 

PART I.  FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets – September 30, 2004 and December 31, 2003	2
	Consolidated Statements of Income - Three Months and Nine Months Ended September 30, 2004 and 2003	3
	Consolidated Statement of Changes in Stockholders’ Equity - Nine Months Ended September 30, 2004	4
	Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2004 and 2003	5
	Notes to Consolidated Financial Statements	6-11
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11-16
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	16
Item 4.	Controls and Procedures	16
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	17
Item 2.	Change in Securities and Use of Proceeds	17
Item 3.	Defaults Upon Senior Securities	17
Item 4.	Submission of Matters to a Vote of Security Holders	17
Item 5.	Other Information	17
Item 6.	Exhibits and Reports on Form 8-K	17
Signatures

 

 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

WESTERN SIZZLIN CORPORATION
(formally Austsins Steaks & Saloon, Inc.)

Consolidated Balance Sheets
September 30, 2004 and December 31, 2003

 

		September 30, 2004			December 31, 2003
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	2,087,401		$	682,730
Short-term investments, restricted under long-term debt agreement		252,801			251,426
Trade accounts receivable, net of allowance for doubtful accounts of $404,231 in 2004 and $329,112 in 2003		831,403			838,931
Current installments of notes receivable		217,225			229,273
Other receivables		49,955			43,329
Inventories		91,676			66,390
Prepaid expenses		380,828			413,824
Deferred income taxes		382,428			382,428
Total current assets		4,293,717			2,908,331
Notes receivable, less allowance for doubtful accounts of $69,345 in 2004 and $69,345 in 2003, excluding current installments		1,093,620			1,170,804
Property and equipment, net of accumlated depreciation of $5,929,973 in 2004 and $4,667,923 in 2003		2,911,398			3,124,807
Franchise royalty contracts, net of accumulated amortization of $6,775,675 in 2004 and $6,302,954 in 2003		2,678,756			3,151,477
Goodwill		4,310,200			4,310,200
Financing costs, net of accumulated amortization of $113,895 in 2004 and $100,100 in 2003		86,315			100,110
Deferred income taxes		977,384			1,280,025
Asset held for sale		300,000			700,278
Other assets, net		401,848			148,044
		$	17,053,238		$	16,894,076
Liabilities and Stockholders’ Equity
Current liabilities:
Current installments of long-term debt		$	517,315		$	529,645
Accounts payable		1,031,497			991,328
Accrued expenses and other		1,232,404			1,246,785
Total current liabilities		2,781,216			2,767,758
Long-term debt, excluding current installments		3,169,501			3,548,971
Other long-term liabilities		34,467			50,000
Commitments and contingincies
Stockholders’ equity:
Common stock; $.01 par value. Authorized 20,000,000 shares; 11,908,571 issued and outstanding in 2004 and 2003		119,086			119,086
Additional paid-in capital		8,589,578			8,589,578
Retained earnings		2,359,390			1,818,683
Total stockholders’ equity		11,068,054			10,527,347
		$	17,053,238		$	16,894,076

 

See accompanying notes to consolidated financial statements.

 

2

 

WESTERN SIZZLIN CORPORATION
(formally Austins Steaks & Saloon, Inc.)

Consolidated Statements of Income

(Unaudited)

 

		Three Months Ended September 30						Nine Months Ended September 30
		2004			2003			2004			2003
Revenues:
Company-operated restaurants		$	4,475,230		$	4,242,932		$	12,888,541		$	12,276,250
Franchise operations		1,127,043			1,229,320			3,413,090			3,627,769
Other		99,527			102,670			294,194			320,791
Total revenues		5,701,800			5,574,922			16,595,825			16,224,810
Costs and expenses:
Cost of Company-operated restaurants		3,030,878			2,857,604			8,787,085			8,355,222
Cost of franchise operations		511,599			430,586			1,451,630			1,120,910
Other costs of operations		76,770			77,503			225,547			244,000
Restaurant operating expenses		932,312			886,490			2,754,730			2,626,847
General and administrative		469,403			508,860			1,432,638			1,608,506
Depreciation and amortization		291,373			317,920			898,959			945,484
Total costs and expenses		5,312,335			5,078,963			15,550,589			14,900,969
Income from operations		389,465			495,959			1,045,236			1,323,841
Other income (expense):
Interest expense		(95,239		)	(109,209		)	(294,603		)	(346,894		)
Interest income		20,026			23,927			62,415			70,727
Other		7,552			(8,322		)	59,027			6,857
		(67,661		)	(93,604		)	(173,161		)	(269,310		)
Income before income tax expense		321,804			402,355			872,075			1,054,531
Income tax expense		122,274			152,895			331,368			400,737
Net income		$	199,530		$	249,460		$	540,707		$	653,794
Earnings per share:
Basic		$	.02		$	.02		$	.05		$	.05
Diluted		$	.02		$	.02		$	.05		$	.05

 

See accompanying notes to consolidated financial statements

 

3

 

WESTERN SIZZLIN CORPORATION

(formally Austins Steaks & Saloon, Inc.)

Consolidated Statement of Changes in Stockholders’ Equity

Nine Months Ended September 30, 2004

(Unaudited)

 

							Additional Paid-in Capital
		Common Stock								Retained Earnings
		Shares		Dollars									Total
Balances, December 31, 2003		11,908,571		$	119,086		$	8,589,578		$	1,818,683		$	10,527,347
Net Income		—		—			—			540,707			540,707
Balances, September 30, 2004		11,908,571		$	119,086		$	8,589,578		$	2,359,390		$	11,068,054

 

See accompanying notes to consolidated financial statements

 

4

 

WESTERN SIZZLIN CORPORATION

(formally Austin Steak & Saloon, Inc.)

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2004 and 2003

(Unaudited)

 

		September
		2004				2003
Cash flows from operating activities:
Net income		$	540,707			$		653,794
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization of property and equipment		412,443				453,182
Amortization of franchise royalty contracts and financing costs		486,516				492,302
(Gain) Loss on disposal of fixed assets		(945			)	351
Gain on sale of asset held for sale						(790			)
Provision for deferred income taxes		302,641
Provision for bad debts		75,119				37,545
(Increase) decrease in:
Trade accounts receivable		(67,591			)	207,731
Notes receivable		89,232				111,474
Other receivables		(6,626			)	44,235
Inventories		(25,286			)	(2,212			)
Prepaid expenses		32,996				30,490
Other assets		110,284				(55,935			)
Income taxes refundable		—				47,198
Increase (decrease) in:
Accounts payable		40,169				(339,353			)
Accrued expenses and other		(14,381			)	(161,233			)
Income taxes payable		—				295,031
Other liabilities		(15,533			)	50,000
Net cash provided by operating activities		1,959,745				1,863,810
Cash flows from investing activities:
Short-term investments		(1,375			)	—
Additions to property and equipment		(169,020			)	(119,186			)
Proceeds from sale of assets held for sale/disposal		7,121				414,390
Net cash (used in) provided by investing activities		(163,274			)	295,204
Cash flows from financing activities:
Net decrease in bank overdraft		—				(346,351			)
Net increase (decrease) in credit line note payable		—				(363,180			)
Proceeds from note payable		—				450,000
Payments on note payable		—				(450,000			)
Payments on long-term debt		(391,800			)	(377,447			)
Repurchase of common stock		—				(68,183			)
Net cash used in financing activities		(391,800			)	(1,155,161			)
Net increase in cash and cash equivalents		1,404,671				1,003,853
Cash and cash equivalents at beginning of period		682,730				131,631
Cash and cash equivalents at end of period		$	2,087,401			$	1,135,484
Supplemental disclosure of cash flow information:
Cash payments for interest		$		294,605		$	346,888
Income taxes paid		$		30,358		$	60,474

 

See accompanying notes to consolidated financial statements.

 

5

 

WESTERN SIZZLIN CORPORATION

(formerly Austins Steaks & Saloon, Inc.)

 

Notes to Consolidated Financial Statements

 

Nine-Months Ended September 30, 2004 and 2003

 

(Unaudited)

 

(1)           General

 

The accompanying unaudited consolidated financial statements of Western Sizzlin Corporation, formerly Austins Steaks & Saloon, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting information and the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all material reclassifications and adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the results of operations, financial position and cash flows for each period shown have been included.  Operating results for interim periods are not necessarily indicative of the results for the full year because, among other things, the dining habits of the Company’s customers cannot be certain.  The unaudited consolidated financial statements and notes are presented as permitted by Form 10-Q and do not contain certain information included in the Company’s annual consolidated financial statements and accompanying notes.  For further information, refer to the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.

 

Recently Issued Accounting Standards

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (FIN) 46, “Consolidation of Variable Interest Entities – an interpretation of “Accounting Research Bulletin” (“ARB”) No. 51”. This Interpretation is intended to clarify the application of the majority voting interest requirement of ARB No. 51, “Consolidated Financial Statements”, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The controlling financial interest may be achieved through arrangements that do not involve voting interests.

 

Subsequent to issuing FIN 46, the FASB issued FIN 46 (revised) (“FIN 46R”), which replaces FIN 46. Among other things, FIN 46R clarifies and changes the definition and application of a number of provisions of FIN 46 including de facto agents, variable interests and variable interest entity (“VIE”). FIN 46R also expands instances when FIN 46 should not be applied. FIN 46R was issued December 23, 2003 and, for the Company, was effective as of the end of the first quarter of 2004.

 

The Company has a voting interest in WSI ADRF, Inc. (“ADRF”), an entity formed to develop national, regional and local advertising campaigns and materials for the benefit of the Company’s franchised and company-owned restaurants.  The company-owned restaurants and substantially all of its franchisees are members of ADRF and therefore are required to remit a monthly payment to ADRF.  These fees, along with contributions received from certain of the Company’s vendors, are used by ADRF to develop and produce advertising and related materials for the company-owned restaurants and the franchisees.  Total revenues of ADRF were approximately $582,000 for the year ended December 31, 2003.

 

The Company determined that ADRF is a variable interest entity but that neither the Company nor its company-owned stores are the primary beneficiary of ADRF and that the Company is not obligated to absorb the losses of ADRF, if any.  Accordingly, the results of ADRF are not

 

6

 

consolidated with the Company.   The Company’s maximum exposure to loss as a result of its involvement with ADRF is limited to reimbursement of the costs of providing certain personnel and space to ADRF.  The fee charged to ADRF for these services was $36,000 for each of the three-month periods ended September 30, 2004 and 2003 and $108,000 for each of the nine-month periods ended September 30, 2004 and 2003.

 

As of September 30, 2004, there are no other new accounting standards issued, but not yet adopted by the Company, which are expected to be applicable to the Company’s consolidated financial position, operating results or financial statement disclosures.

 

(2)           Stock Options

 

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price.  SFAS No. 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans.  As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123.  SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of SFAS No. 123, amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method on reported results.  The Company granted 10,000 stock options to each director, totaling 100,000, under a Non-Employee Stock Option Plan adopted by the Company on June 22, 2004.  These options immediately vested on the grant date.

 

The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding awards in each period.

 

		Three-months ended September 30,							Nine-months ended September 30,
		2004			2003				2004			2003
Net Income
As reported		$	199,530		$	249,460			$	540,707		$	653,794
Deduct total stock-based employee compensation expense determined under fair-value based method for all outstanding and unvested awards, net of tax		4,030			—				46,167			—
Pro forma		$	195,500		$		249,460		$	494,540		$		653,794
Basic and diluted net income per share
As reported		$	0.02		$		0.02		$	0.04		$		0.05
Pro forma		$	0.02		$		0.02		$	0.04		$		0.05

 

(3)           Goodwill and Other Intangible Assets

 

Goodwill and intangible assets deemed to have indefinite lives are reviewed for impairment and written down and charged to results of operations when their carrying amount exceeds their estimated fair value. The Company performs an annual impairment test in the fourth quarter, or between yearly tests in certain circumstances, for goodwill. There can be no assurance that future impairment tests will not result in a charge to earnings.

 

7

 

There were no changes in the net carrying amount of goodwill for the three and nine-months ended September 30, 2004 and 2003.

 

Amortizing Intangible Assets

 

Franchise royalty contracts are amortized on a straight-line basis over fifteen years, the estimated average life of the franchise agreements.  The Company assesses the recoverability of this intangible asset by determining whether the amortization of the franchise royalty contracts balance over their remaining life can be recovered through undiscounted future operating cash flows of the acquired operation.  The amount of impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company’s average cost of funds.

 

					As of September 30, 2004
		Gross carrying amount			Weighted average Amortization Period		Accumulated Amortization
Amortizing intangible assets:
Franchise Royalty Contracts		$	9,454,431		15.0 yrs.		$	6,775,675

 

Aggregate amortization expense for amortizing intangible assets for the three and nine-month period ended September 30, 2004 was $157,573 and $472,721, respectively.  Estimated amortization expense is $630,295 per year through December 31, 2009.

 

(4)           Earnings Per Share

 

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period.  Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.  Stock options for 175,000 shares of common stock were not included in computing diluted earnings per share for the three and nine-month periods ended September 30, 2004 and 2003 because the effect of these options is anti-dilutive.

 

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the periods indicated:

 

		Three-months ended September 30,								Nine- months ended September 30,
		2004				2003				2004			2003
Net Income:		$	199,530			$	249,460			$	540,707		$	653,794
Weighted average shares outstanding:
Weighted average shares outstanding (basic)		11,908,571				12,129,446				11,908,571			12,143,139
Dilutive effect of stock options		—				—				71			—
Weighted average shares outstanding (diluted)		11,908,571				12,129,446				11,908,642			12,143,139
Net income per share:
Basic		$		0.02		$		0.02		$	0.05		$	0.05
Diluted		$		0.02		$		0.02		$	0.05		$	0.05

 

8

 

(5)                                 Reportable Segments

 

The Company has defined two reportable segments: Company-operated restaurants and franchising and other.  The Company-operated restaurant segment consists of the operations of all Company-operated restaurants and derives its revenues from restaurant operations. The franchising and other segment consists of franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from franchisees.  Generally, the Company evaluates performance and allocates resources based on income from operations before income taxes and eliminations.  Administrative and capital costs are allocated to segments based upon predetermined rates or actual or estimated resource usage.

 

Reportable segments are business units that provide different products or services.  Separate management of each segment is required because each business unit is subject to different operational issues and strategies.  Through September 30, 2004, all revenues for each business segment were derived from business activities conducted with customers located in the United States.  No single external customer accounted for 10 percent or more of the Company’s consolidated revenues.

 

The following table summarizes reportable segment information:

 

		Three-Months Ended September 30,									Nine-months Ended September 30,
		2004				2003					2004						2003
Revenues from reportable segments:
Restaurants		$	4,475,230			$	4,242,932				$		12,888,541				$	12,276,250
Franchising and other		1,226,570				1,331,990					3,707,284						3,948,560
Total revenues		$	5,701,800			$	5,574,922				$				16,595,825		$		16,224,810
Depreciation and amortization:
Restaurants		$	114,954			$	133,982				$				371,062		$		394,457
Franchising and other		176,419				183,938					527,897						551,027
Total depreciation and amortization		$	291,373			$	317,920				$			898,959			$			945,484
Interest expense:
Restaurants		$	94,780			$	106,717				$	293,380					$				329,433
Franchising and other		459				2,492					1,223						17,461
Total interest expense		$	95,239			$	109,209				$	294,603					$				346,894
Interest income:
Restaurants		$	19,857			$	23,486				$	59,144					$				68,987
Franchising and other		169				441					3,271						1,740
Total interest income		$	20,026			$	23,927				$	62,415					$				70,727
Income before income tax expense:
Restaurants		$	226,066			$		117,605			$	464,460					$				163,494
Franchising and other		95,738				284,750					407,615						891,037
Total income before income tax expense		$		321,804		$			402,355		$	872,075					$				1,054,531

 

9

 

		September 30, 2004			September 30, 2003
Gross property and equipment:
Restaurants		$	7,072,713		$	6,241,972
Franchising and other		888,878			1,457,607
Total property and equipment		$	7,961,591		$	7,699,579
Expenditures for property and equipment:
Restaurants		$	136,305		$	110,005
Franchising and other		32,715			9,181
Total expenditures for property and equipment		$	169,020		$	119,186

 

(6)                                 Contingencies

 

In January 2001, the Company executed a series of Master Lease Agreements (“Agreements”) relating to certain franchised properties formerly operated by other parties as “Quincy’s” restaurants (“Former Quincy’s”).  Signed copies of these Agreements were required, pursuant to the terms of the document, to be executed by Franchise Financing Corporation of America, now known as General Electric Franchise Finance Corporation, (the “Lessor”), to be legally binding; however, no signed copies were ever returned to the Company.  At the end of January 2002, there remained only 25 Former Quincy’s operated by Company franchisees, the Lessor having taken back, in 2001 and 2002, other restaurants previously operated by Company franchisees.  The Agreements, incomplete for a lack of signature by the Lessor, provided for rental payments from the Company to the Lessor.  However, the cost of any rental payments was passed on to the franchisees operating the properties.  On May 15, 2003, the Company sent a letter to the Lessor, providing notice of the Company’s termination of any tenancies at-will on any remaining Former Quincy’s units effective May 31, 2003.  No response has ever been received from Lessor.

 

The Company intends to vigorously contest any potential claims asserted by General Electric Franchise Finance Corporation.  While the Company has previously engaged in discussions with the Lessor of the properties to resolve any rental payments claimed by the Lessor under the Agreements, it is not possible at this time to determine the outcome of these discussions.

 

The Company was a guarantor of a lease agreement in Lincoln, Nebraska, with monthly rentals of approximately $8,200.  The lease agreement, which originally ran through February 2014, was assigned by the Company to a third party in March 1998 and subsequently by the third party to another party.  The assignees apparently failed to make monthly rental, property tax, and association payments on the premises.  As a result the Landlord took possession of the premises and on or about May 12, 2004, sold the premises to a third party intending to use the premises for its own purposes.  The Landlord has alleged that he has suffered a loss of $149,226, exclusive of interest, through the date of the sale.

 

In November 2003, the Landlord filed a complaint in the District Court of Lancaster County, Nebraska alleging default under various terms and provisions of the lease agreement and seeking collection of approximately $43,000 in unpaid rent, real estate taxes and neighborhood association assessments through November 4, 2003.  The Company filed a cross-claim against its assignee and a Third-Party Complaint against a subsequent assignee for any accrued but unpaid obligations under the lease and guaranty for which the Company may be found liable.  The litigation is currently in the pretrial discovery phase.  The Company believes that its maximum exposure is limited to the alleged damage of $149,226, through May 12, 2004, plus pre, and post judgement interest, as the Company believes that the sale of the premises terminated the lease and any further obligation.

 

10

 

During late 2003, the Company was notified of a claim by Meadowbrook Meat Company, Inc. d/b/a MBM Corporation (MBM) alleging amounts owed by the Company to MBM.  In December 2003, MBM filed suit in Federal District Court in North Carolina, but only recently served the Company with that Complaint.  The complaint seeks damages in an amount in excess of $800,000, alleging the breach of an agreement to pay for food and other restaurant supplies, and unjust enrichment.  The Company has generally denied the allegations of MBM and believes it has factual and legal defenses to most, if not all, of the claim and is prepared to defend this action vigorously.  The litigation is currently in the pretrial discovery phase.

 

The Company entered into a Lease Agreement for restaurant premises located in Dickson, Tennessee in 1994.  The Lease Agreement had an original term of 15 years and requires monthly base rental payments of $6,500 for the final five years of the lease term.  The Company ceased operations of the premises as a restaurant in 1996 and subsequently sub-leased the property.  The location has been vacant since September 2001.  In June 2004, the Company advised the Landlord that it was surrending the property.  The Landlord is obligated to, and has advised the Company that he is attempting to find a replacement tenant.

 

The Landlord has filed complaints in the General Sessions Court of Dickson, Tennessee alleging default under the lease agreement and seeking collection of unpaid rent, real estate taxes and attorney’s fees for May through October 2004.  The Company has informally resolved this action through the payment of rent and real estates taxes, but has continued to assert that it has surrendered the property.

 

On July 11, 2004, the building, improvements, and contents located on real property owned by the Company in Lawrenceville, Georgia were completely destroyed by fire.  As a result of this casualty, the Company terminated the lease of the tenant operating the restaurant on these premises.  The Company is currently in the process of collecting insurance proceeds and resolving issues with its lender and the former tenant.  As of September 30, 2004, building, improvements, and contents were classified as other assets and land was classified as asset held for sale.  Management does not anticipate any impairment of these assets based on current estimates of the amount of insurable proceeds available to the Company and the anticipated selling price of the land.  The Company plans to sell the land after clean up of debris and the insurance matter is resolved.

 

The Company is involved in various other claims and legal actions arising in the ordinary course of business.  In the opinion of the management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

 

Item 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

From time to time, the Company may publish forward-looking statements relating to certain matters, including anticipated financial performance, business prospects, the future opening of Company-operated and franchised restaurants, anticipated capital expenditures, and other matters.  All statements other than statements of historical fact contained in the Form 10-Q or in any other report of the Company are forward-looking statements.  The Private Securities Litigation Reform Act of 1995 provided a safe harbor for forward-looking statements.  In order to comply with the terms of that safe harbor, the Company notes that a variety of factors, individually or in the aggregate, could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements including, without limitation, the following:  the ability of the Company or its franchises to obtain suitable locations for restaurant development; consumer spending trends and habits; competition in the restaurant segment with respect to price, service, location, food quality and personnel resources; weather conditions in the Company’s operating regions; laws and government regulations; general business and economic conditions; availability of capital; success of operating

 

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initiatives and marketing and promotional efforts; and changes in accounting policies.  In addition, the Company disclaims any intent or obligation to update those forward-looking statements.  The Company operated and franchised a total of 159 restaurants located in 21 states, including 7 Company-operated and 152 franchise restaurants as of September 30, 2004.  The restaurants include a family steakhouse concept and a steak and buffet concept.

 

Results of Operations

 

Net income for the three-month and nine-month periods ended September 30, 2004 was $199,530 and $540,707 as compared to net income of $249,460 and $653,794 for the three-month and nine-month periods ended September 30, 2003.   The decrease is attributable to decreased revenues in the franchising segment due to closing of franchised locations, along with increased spending in personnel costs, consumer research, and development of prototype plans.

 

The following table sets forth for the periods presented the percentage relationship to total revenues of certain items included in the consolidated statements of operations and certain restaurant data for the periods presented:

 

		Three-Months Ended September 30,				Nine-Months Ended September 30,
		2004		2003		2004		2003
Revenues:
Company-operated restaurants		78.5	%	76.1	%	77.7	%	75.7	%
Franchise operations		19.8		22.0		20.6		22.4
Other Sales		1.7		1.9		1.7		1.9
Total revenues		100.0		100.0		100.0		100.0
Costs and expenses:
Cost of company-operated restaurants		53.2		51.3		52.9		51.5
Cost of franchise operations		9.0		7.7		8.8		6.9
Other cost of operations		1.3		1.4		1.4		1.5
Restaurant operating expenses		16.4		15.9		16.6		16.2
General and administrative		8.2		9.1		8.6		9.9
Depreciation and amortization		5.1		5.7		5.4		5.8
Total costs and expenses		93.2		91.1		93.7		91.8
Income from operations		6.8		8.9		6.3		8.2
Other income (expense)		(1.2	)	(1.7	)	(1.0	)	(1.7	)
Income before income tax expense		5.6		7.2		5.3		6.5
Income tax expense		2.1		2.7		2.0		2.5
Net income		3.5	%	4.5	%	3.3	%	4.0	%

 

		Three-Months Ended September 30,				Nine-Months Ended September 30,
		2004		2003		2004		2003
Restaurant Data
Number of Company-Operated Restaurants:
Beginning of period		7		7		7		7
Opened		—		—		—		—
Closed		—		—		—		—
Franchised		—		—		—		—
End of period		7		7		7		7
Number of U.S. Franchised Restaurants:
Beginning of period		152		176		161		186
Opened		1		—		3		—
Closed		1		6		12		22
End of period		152		164		152		164

 

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Revenues

 

Company-operated restaurant revenues increased $23,000 (0.5%) to $4.48 million for the three-month period ended September 30, 2004 as compared to $4.24 million for the comparable three-month period ended September 30, 2003.  Revenues for company-operated restaurants increased $612,000 (4.8%) to $12.89 million for the nine-month period ended September 30, 2004 as compared to $12.28 million for the comparable nine-month period ended September 30, 2003. The three-month and nine-month increases over the respective comparable prior periods are attributable to improved performance and price increases.   Customer counts decreased by 3.84% and 1.10% for the three and nine-month periods.  A price increase went into effect on July 1, 2004 to combat the increased costs in commodities.

 

Franchise and other revenues decreased 8.67% to $1.23 million for the three-month period ended September 30, 2004 as compared to $1.33 million for the comparable three-month period ended September 30, 2003.  Franchise and other revenues decreased 6.5% to $3.71 million for the nine-month period ended September 30, 2004 as compared to $3.95 million for the comparable nine-month period ended September 30, 2003.  The decrease is attributable to less franchised stores in the system during the three and nine-month periods ended September 30, 2004 as compared to the three and nine-month periods ended September 30, 2003.  System-wide sales for the franchise system were $57.6 million and $171.5 million for the three and nine-month periods, respectively as compared to system-wide sales of $61.5 million and $185.9 million for the three and nine-month periods ending September 30, 2003.  Same store sales decreased .02% for the three-months ended September 30, 2004 over prior period and increased 1.42% for the nine-months ended September 30, 2004 over the prior period.

 

Costs and Expenses

 

Cost of company-operated restaurants, consisting of food, beverage, and employee costs increased $173,000 (5.7%) to $3.03 million for the three-month period ended September 30, 2004 from $2.9 million for the comparable three-month period ended September 30, 2003.  These costs increased as a percentage of total revenues from 51.3% in 2003 to 53.2% in 2004.  For the nine-month period ended September 30, 2004, cost of company-operated restaurants increased $432,000 (4.9%) from $8.4 million in 2003 to $8.8 million in 2004. These costs increased as a percent of total revenues from 51.5% in 2003 to 52.9% in 2004.  The increases are largely due to increased costs in commodities, such as meat.

 

Cost of franchise operations and other cost of operations was $588,000 (10.3%) for the three-month period ended September 30, 2004 compared to $508,000 (9.1%) in 2003.   For the nine-month period ended September 30, 2004, cost of franchise operations and other cost of operations was $1.7 million (10.2%) compared to $1.4 million (8.4%) for the nine-month period ended September 30, 2003.  The increase is attributable to increased personnel costs largely associated with the Company’s chief executive officer position being filled July 1, 2003.  Also, there has been increased spending over prior year in consumer research and development of prototype plans.

 

Restaurant operating expenses, which include utilities, insurance, maintenance, rent and other such costs of the company-operated restaurants, increased $46,000 (4.9%) for the three-month period ended September 30, 2004 over prior year’s comparable period.   For the nine-month period ended September 30, 2004 restaurant-operating expenses increased $128,000 (4.6%) over the comparable prior period. The majority of the slight increases are due to increased operating costs.

 

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For the three-month periods ended September 30, 2004 and 2003, general and administrative expenses were $469,000 and $509,000, respectively and as a percentage of total revenue were 8.2% and 9.1%, respectively.  For the nine-month periods ended September 30, 2004 and 2003, general and administrative expenses were $1.4 million and $1.6 million, respectively and as a percentage of total revenue were 8.6% and 9.9%, respectively.  The decrease for the nine-month period ended September 30, 2004 over the comparable prior period is primarily due to less legal fees and contingency accruals incurred in 2004, as well as fees associated with reimbursements to shareholders in 2003 that were involved in the proxy contest and settlement in 2002.

 

Depreciation and amortization expense was $27,000 less for the three-month period ended September 30, 2004 compared to the comparable period in 2003 and $47,000 less for the comparable nine-month period then ended.  The decreases are attributable to property and equipment becoming fully depreciated.

 

Other Income (Expense)

 

Interest expense decreased $14,000 and $52,000 for the three and nine-month periods ended September 30, 2004 versus the comparable periods in 2003, due to a lower average principal outstanding balance. Interest income fluctuates according to the levels of available cash balances.  The Company employs a cash management system whereby available balances are invested on an overnight basis.

 

Income Tax Expense

 

Income tax expense is directly affected by the levels of pretax income.  The Company’s effective tax rate of approximately 38.0% and 38.0% percent for the three and nine-month periods ended September 30, 2004 is comparable to the rate of 38.0% and 38.0% for the same periods in 2003.

 

Liquidity and Capital Resources

 

As is customary in the restaurant industry, the Company has historically operated with negative working capital.  Historically, the Company has leased the majority of its restaurants and through a strategy of controlled growth has financed operations from operating cash flows, the utilization of the Company’s line of credit and long-term debt provided by various lenders.  The Company had positive working capital of $1.6 million and $141,000 at September 30, 2004 and December 31, 2003, respectively.

 

Cash flows provided by operating activities were $2.0 million in 2004 compared to $1.9 million in 2003. During 2004, cash flows provided by operating activities were primarily due to net income of $541,000 and depreciation and amortization of $899,000, decrease in other assets of $110,000 due to sale of an asset, increase in accounts receivables of $71,000 offset by decreases in accrued expenses of $64,000. During 2003, cash flows provided by operations were primarily due to net income of $654,000 and depreciation and amortization of $945,000 offset by decrease in accounts payable and accrued expenses of $501,000. Net cash used in investing activities of $163,000 in 2004 and provided by investing activities of $295,000 in 2003, was for capital expenditures related to property and equipment and proceeds of $414,000 in 2003 from sale of property.  Net cash used in financing activities of $392,000 in 2004 was for payments on long-term debt.  Net cash used in financing activities of $1.2 million in 2003 was primarily for repayment of long-term debt, reduction of credit line and bank overdraft and repurchase of stock.

 

Management believes that the Company’s short-term cash requirements will include settlements related to certain legal proceedings, capital contribution related to a planned joint venture for development of a buffet concept restaurant, and capital improvements to Company-operated restaurants.

 

The Company utilizes its existing line of credit to provide short-term funding in addition to cash from operations.  Management reviews available financing alternatives to provide cash for future

 

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expansion, restructure existing debt, and provide additional working capital; however, management believes existing financing will provide adequate funding for cash requirements.

 

CRITICAL ACCOUNTING POLICIES

 

Franchise Revenue

 

Initial franchise fees are recognized when all material services have been substantially performed by the Company and the restaurant has opened for business.  Franchise royalties, which are based on a percentage of monthly sales, are recognized as income on the accrual basis.  Costs associated with franchise operations are recognized on the accrual basis.

 

Accounts and Notes Receivable and Allowance for Doubtful Accounts

 

In connection with franchise fees charged to our franchisees, we have accounts and notes receivable outstanding from our franchisees at any given time.  We review outstanding accounts and notes receivable monthly and record allowances for doubtful accounts as deemed appropriate for certain individual franchisees.  In determining the amount of allowance for doubtful accounts to be recorded, we consider the age of the receivable, the financial stability of the franchisee, discussions that may have been had with the franchisee and our judgement as to the overall collectibility of the receivable from that franchisee.

 

Franchise Royalty Contracts

 

Franchise royalty contracts are amortized on a straight-line basis over fifteen years, the estimated average life of the franchise agreements.  The Company assesses the recoverability of this intangible asset by determining whether the amortization of the franchise royalty contracts balance over their remaining life can be recovered though undiscounted future operating cash flows of the acquired operation.  The amount of impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company’s average cost of funds.

 

Goodwill

 

Goodwill represents the excess of purchase price over fair value of net assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually.

 

Impact of Inflation

 

The impact of inflation on the costs of food and beverage product, labor and real estate can affect the Company’s operations.  Over the past few years, inflation has had a lesser impact on the Company’s operations due to the lower rates of inflation in the nation’s economy and economic conditions in the Company’s market areas.

 

Management believes the Company has historically been able to pass on increased costs through certain selected menu price increases and has offset increased costs by increased productivity and purchasing efficiencies, but there can be no assurance that the Company will be able to do so in the future.  Management anticipates that the average cost of restaurant real estate leases and construction costs could increase in the future which could affect the Company’s ability to expand.  In addition, mandated health care or additional increases in the federal or state minimum wages could significantly increase the Company’s costs of doing business.

 

Impact of Recently Issued Accounting Standards

 

In January 2003, the FASB issued Interpretation No. 46 Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.  This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation.  The Interpretation

 

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applies immediately to variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003.  The application of this Interpretation did not have any impact on the Company’s consolidated financial position, results of operations or cash flows of the Company. See Note 1 to the Company’s consolidated financial statements, which are included in Item 1, Part I for a disassion of Interpretation No. 46.

 

As of September 30, 2004, there are no other new accounting standards issued, but not yet adopted by the Company, which are expected to be applicable to the Company’s consolidated financial position, operating results or financial statement disclosures.

 

Item 3.           Quantitative and Qualitative Disclosure about Market Risk

 

The Company does not engage in derivative financial instruments or derivative commodity instruments.  As of September 30, 2004, the Company’s financial instruments are not exposed to significant market risk due to foreign currency exchange risk.  The Company is exposed to market risk related to interest rates, as well as increased prices in restaurant industry commodities such as beef.

 

The table below provides information about the Company’s debt obligations that are sensitive to changes in interest rates.  The table presents principal cash flows and related weighted average interest rates by expected maturity dates.

 

Debt obligations held for other than trading purposes at September 30, 2004 (dollars in thousands):

 

EXPECTED MATURITY DATE

 

		2004			2005			2006			2007			2008			Thereafter			Total			Estimated Fair Value
Long-term debt
Fixed Rate		$	139		$	505		$	522		$	361		$	337		$	1,823		$	3,687		$	4,105
Average Interest Rate		9.93		%	9.94		%	9.94		%	10.02		%	10.06		%	10.07		%	10.00		%

 

Item 4.           Controls and Procedures

 

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures.  This evaluation was carried out under the supervision and with the participation of the Company’s management, including the President and Chief Executive Officer and the Company’s Chief Financial Officer.  Based upon their evaluation, the officers concluded that the Company’s disclosure controls and procedures are effective.  There have been no significant changes in the Company’s internal controls, or in other factors, which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

 

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in Company reports filed under the Exchange Act is accumulated and communicated to management, including the Company’s President and Chief Executive Officer and the Vice President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

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