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EX-32.2 - CHIEF FINANCIAL OFFICER'S CERTIFICATE PURSUANT TO 18 U.S.C. SECTION 1350 - Fiesta Restaurant Group, Inc.frgi-ex322_2016703xq2.htm
EX-32.1 - CHIEF EXECUTIVE OFFICER'S CERTIFICATE PURSUANT TO 18 U.S.C. SECTION 1350 - Fiesta Restaurant Group, Inc.frgi-ex321_2016703xq2.htm
EX-31.2 - CHIEF FINANCIAL OFFICER'S CERTIFICATE PURSUANT TO SECTION 302 - Fiesta Restaurant Group, Inc.frgi-ex312_2016703xq2.htm
EX-31.1 - CHIEF EXECUTIVE OFFICER'S CERTIFICATE PURSUANT TO SECTION 302 - Fiesta Restaurant Group, Inc.frgi-ex311_2016703xq2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549 
__________________________________________________________
FORM 10-Q
__________________________________________________________
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 3, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-35373 
__________________________________________________________
FIESTA RESTAURANT GROUP, INC.
(Exact name of Registrant as specified in its charter)
__________________________________________________________
Delaware
90-0712224
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
14800 Landmark Boulevard, Suite 500
Dallas, Texas
75254
(Address of principal executive office)
(Zip Code)
Registrant’s telephone number, including area code: (972) 702-9300
__________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý  No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on their Corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer
ý
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
¨
Smaller reporting company
¨
(Do not check if smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of August 1, 2016, Fiesta Restaurant Group, Inc. had 26,921,404 shares of its common stock, $.01 par value, outstanding.



FIESTA RESTAURANT GROUP, INC.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
QUARTER ENDED JULY 3, 2016
 
 
 
Page
PART I   FINANCIAL INFORMATION
 
 
 
 
Item 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2
 
 
 
Item 3
 
 
 
Item 4
 
 
 
 
 
 
Item 1
 
 
 
Item 1A
 
 
 
Item 2
 
 
 
Item 3
 
 
 
Item 4
 
 
 
Item 5
 
 
 
Item 6

2


PART I—FINANCIAL INFORMATION
ITEM 1—INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FIESTA RESTAURANT GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except share and per share amounts)
(Unaudited)
 
July 3,
2016
 
January 3,
2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash
$
4,809

 
$
5,281

Trade receivables
10,167

 
9,217

Inventories
2,648

 
2,910

Prepaid rent
3,388

 
3,163

Income tax receivable
1,829

 
7,448

Prepaid expenses and other current assets
3,783

 
3,219

Total current assets
26,624

 
31,238

Property and equipment, net
274,960

 
248,992

Goodwill
123,484

 
123,484

Deferred income taxes
8,497

 
8,497

Deferred financing costs, net
764

 
918

Other assets
2,546

 
2,516

Total assets
$
436,875

 
$
415,645

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
55

 
$
69

Accounts payable
19,022

 
12,405

Accrued payroll, related taxes and benefits
12,493

 
15,614

Accrued real estate taxes
5,191

 
6,121

Other liabilities
10,404

 
12,096

Total current liabilities
47,165

 
46,305

Long-term debt, net of current portion
69,498

 
72,612

Lease financing obligations
1,663

 
1,663

Deferred income—sale-leaseback of real estate
29,036

 
30,086

Other liabilities
24,532

 
20,997

Total liabilities
171,894

 
171,663

Commitments and contingencies

 

Stockholders' equity:
 
 
 
Common stock, par value $.01; authorized 100,000,000 shares, issued 26,921,449 and 26,829,220 shares, respectively, and outstanding 26,687,168 and 26,571,602 shares, respectively.
267

 
266

Additional paid-in capital
161,911

 
159,724

Retained earnings
102,803

 
83,992

Total stockholders' equity
264,981

 
243,982

Total liabilities and stockholders' equity
$
436,875

 
$
415,645



The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
3


FIESTA RESTAURANT GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JULY 3, 2016 AND JUNE 28, 2015
(In thousands of dollars, except share and per share amounts)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
Revenues:
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
Restaurant sales
$
180,835

 
$
171,268

 
$
356,774

 
$
334,326

Franchise royalty revenues and fees
697

 
632

 
1,435

 
1,449

Total revenues
181,532

 
171,900

 
358,209

 
335,775

Costs and expenses:
 
 
 
 
 
 
 
Cost of sales
54,607

 
54,223

 
108,657

 
105,346

Restaurant wages and related expenses (including stock-based compensation expense of $40, $40, $76, and $107, respectively)
46,981

 
42,383

 
92,033

 
82,973

Restaurant rent expense
9,113

 
8,048

 
18,034

 
16,055

Other restaurant operating expenses
24,263

 
21,362

 
46,651

 
41,221

Advertising expense
7,006

 
5,144

 
14,001

 
10,698

General and administrative (including stock-based compensation expense of $1,218, $1,055, $2,193, and $1,929, respectively)
14,253

 
13,624

 
28,101

 
27,388

Depreciation and amortization
8,625

 
7,401

 
16,961

 
14,248

Pre-opening costs
2,016

 
1,211

 
3,198

 
2,162

Impairment and other lease charges
82

 

 
94

 
94

Other expense (income)
10

 
(142
)
 
(238
)
 
(514
)
Total operating expenses
166,956

 
153,254

 
327,492

 
299,671

Income from operations
14,576

 
18,646

 
30,717

 
36,104

Interest expense
535

 
414

 
1,093

 
852

Income before income taxes
14,041

 
18,232

 
29,624

 
35,252

Provision for income taxes
5,125

 
6,983

 
10,813

 
13,502

Net income
$
8,916

 
$
11,249

 
$
18,811

 
$
21,750

 
 
 
 
 
 
 
 
Basic net income per share
$
0.33

 
$
0.42

 
$
0.70

 
$
0.81

Diluted net income per share
$
0.33

 
$
0.42

 
$
0.70

 
$
0.81

Basic weighted average common shares outstanding
26,654,280

 
26,490,673

 
26,629,999

 
26,462,919

Diluted weighted average common shares outstanding
26,660,269

 
26,497,658

 
26,636,145

 
26,470,130



The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
4


FIESTA RESTAURANT GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JULY 3, 2016 AND JUNE 28, 2015
(In thousands of dollars, except share amounts) 
(Unaudited)

 
 
Number of
 
 
 
Additional
 
 
 
Total
 
 
Common
 
Common
 
Paid-In
 
Retained
 
Stockholders'
 
 
Stock Shares
 
Stock
 
Capital
 
Earnings
 
Equity
Balance at December 28, 2014
 
26,358,448

 
$
264

 
$
153,867

 
$
45,456

 
$
199,587

Stock-based compensation
 

 

 
2,036

 

 
2,036

Vesting of restricted shares and related tax benefit
 
173,031

 
1

 
1,015

 

 
1,016

Net income
 

 

 

 
21,750

 
21,750

Balance at June 28, 2015
 
26,531,479

 
$
265

 
$
156,918

 
$
67,206

 
$
224,389

 
 
 
 
 
 
 
 
 
 
 
Balance at January 3, 2016
 
26,571,602

 
$
266

 
$
159,724

 
$
83,992

 
$
243,982

Stock-based compensation
 

 

 
2,269

 

 
2,269

Vesting of restricted shares and related tax deficiency
 
115,566

 
1

 
(82
)
 

 
(81
)
Net income
 

 

 

 
18,811

 
18,811

Balance at July 3, 2016
 
26,687,168

 
$
267

 
$
161,911

 
$
102,803

 
$
264,981



The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
5


FIESTA RESTAURANT GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JULY 3, 2016 AND JUNE 28, 2015
(In thousands of dollars)
(Unaudited)
 
Six Months Ended
 
July 3, 2016
 
June 28, 2015
Cash flows from operating activities:
 
 
 
Net income
$
18,811

 
$
21,750

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
Loss (gain) on disposals of property and equipment
25

 
(271
)
Stock-based compensation
2,269

 
2,036

Impairment and other lease charges
94

 
94

Depreciation and amortization
16,961

 
14,248

Amortization of deferred financing costs
154

 
154

Amortization of deferred gains from sale-leaseback transactions
(1,791
)
 
(1,812
)
Changes in other operating assets and liabilities
7,046

 
(1,997
)
Net cash provided from operating activities
43,569

 
34,202

Cash flows from investing activities:
 
 
 
Capital expenditures:
 
 
 
New restaurant development
(35,760
)
 
(33,462
)
Restaurant remodeling
(486
)
 
(1,526
)
Other restaurant capital expenditures
(1,995
)
 
(2,679
)
Corporate and restaurant information systems
(3,997
)
 
(2,233
)
Total capital expenditures
(42,238
)
 
(39,900
)
Properties purchased for sale-leaseback
(2,663
)
 

Proceeds from sale-leaseback transactions
3,642

 

Proceeds from disposals of other properties
226

 
139

Net cash used in investing activities
(41,033
)
 
(39,761
)
Cash flows from financing activities:
 
 
 
Excess tax benefit from vesting of restricted shares
120

 
1,016

Borrowings on revolving credit facility
9,400

 
16,000

Repayments on revolving credit facility
(12,500
)
 
(11,000
)
Principal payments on capital leases
(28
)
 
(25
)
Net cash (used in) provided by financing activities
(3,008
)
 
5,991

Net (decrease) increase in cash
(472
)
 
432

Cash, beginning of period
5,281

 
5,087

Cash, end of period
$
4,809

 
$
5,519

Supplemental disclosures:
 
 
 
Interest paid on long-term debt
$
921

 
$
819

Interest paid on lease financing obligations
$
71

 
$
70

Accruals for capital expenditures
$
6,093

 
$
4,813

Income tax payments, net
$
5,275

 
$
9,270


The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
6

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands of dollars, except share and per share amounts)



1. Basis of Presentation
Business Description. Fiesta Restaurant Group, Inc. ("Fiesta Restaurant Group" or "Fiesta") owns, operates and franchises two fast-casual restaurant brands through its wholly-owned subsidiaries Pollo Operations, Inc., and its subsidiaries, and Pollo Franchise, Inc., (collectively “Pollo Tropical”) and Taco Cabana, Inc. and its subsidiaries (collectively “Taco Cabana”). Unless the context otherwise requires, Fiesta and its subsidiaries, Pollo Tropical and Taco Cabana, are collectively referred to as the “Company”. At July 3, 2016, the Company owned and operated 172 Pollo Tropical® restaurants and 164 Taco Cabana® restaurants. The Pollo Tropical restaurants include 122 located in Florida, 33 located in Texas, thirteen located in Georgia and four located in Tennessee. The Taco Cabana restaurants include 163 located in Texas and one located in Oklahoma. At July 3, 2016, the Company franchised a total of 37 Pollo Tropical restaurants and seven Taco Cabana restaurants. The franchised Pollo Tropical restaurants include 17 in Puerto Rico, one in Honduras, one in the Bahamas, three in Trinidad & Tobago, one in Venezuela, five in Panama, three in Guatemala, and six on college campuses and a hospital in Florida. The franchised Taco Cabana restaurants include five in New Mexico and two on college campuses in Texas.
Basis of Consolidation. The unaudited condensed consolidated financial statements presented herein reflect the consolidated financial position, results of operations and cash flows of Fiesta and its wholly-owned subsidiaries. All intercompany transactions have been eliminated in consolidation.
Fiscal Year. The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. The fiscal year ended January 3, 2016 contained 53 weeks. The three and six months ended July 3, 2016 and June 28, 2015 each contained thirteen and twenty-six weeks, respectively. The fiscal year ending January 1, 2017 will contain 52 weeks.
Basis of Presentation. The accompanying unaudited condensed consolidated financial statements for the three and six months ended July 3, 2016 and June 28, 2015 have been prepared without an audit pursuant to the rules and regulations of the Securities and Exchange Commission and do not include certain information and footnotes required by U.S. Generally Accepted Accounting Principles ("GAAP") for complete financial statements. In the opinion of management, all normal and recurring adjustments considered necessary for a fair presentation of such financial statements have been included. The results of operations for the three and six months ended July 3, 2016 and June 28, 2015 are not necessarily indicative of the results to be expected for the full year.
These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended January 3, 2016 included in the Company's Annual Report on Form 10-K for the fiscal year ended January 3, 2016. The January 3, 2016 balance sheet data is derived from those audited financial statements.
Fair Value of Financial Instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. In determining fair value, the accounting standards establish a three level hierarchy for inputs used in measuring fair value as follows: Level 1 inputs are quoted prices in active markets for identical assets or liabilities; Level 2 inputs are observable for the asset or liability, either directly or indirectly, including quoted prices in active markets for similar assets or liabilities; and Level 3 inputs are unobservable and reflect our own assumptions. The following methods were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate the fair value:
Current Assets and Liabilities. The carrying values reported on the balance sheet of cash, accounts receivable and accounts payable approximate fair value because of the short maturity of those financial instruments.
Revolving Credit Borrowings. The fair value of outstanding revolving credit borrowings under the Company's senior credit facility, which is considered Level 2, is based on current LIBOR rates. At July 3, 2016, the fair value and carrying value of the Company's senior credit facility was approximately $67.9 million.
Long-Lived Assets. The Company reviews its long-lived assets, principally property and equipment, for impairment at the restaurant level. In addition to considering management’s plans, known regulatory or governmental actions and damage due to acts of God (hurricanes, tornadoes, etc.), the Company considers a triggering event to have occurred related to a specific restaurant if the restaurant’s cash flows for the last twelve months are less than a minimum threshold or if consistent levels of cash flows for the remaining lease period are less than the carrying value of the restaurant’s assets. If an indicator of impairment exists for any of its assets, an estimate of undiscounted future cash flows over the life of the primary asset for each restaurant is compared to that long-lived asset’s carrying value. If the carrying value is greater than the undiscounted cash flow, the Company then determines the fair value of the asset and if an asset is determined to be impaired, the loss is measured by the excess of the carrying amount of the asset over its fair value. For closed restaurant locations, the Company reviews the future minimum lease payments and

7

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In thousands of dollars, except share and per share amounts)


related ancillary costs from the date of the restaurant closure to the end of the remaining lease term and records a lease charge for the lease liabilities to be incurred, net of any estimated sublease recoveries.
Use of Estimates. The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements. Estimates also affect the reported amounts of expenses during the reporting periods. Significant items subject to such estimates and assumptions include: accrued occupancy costs, insurance liabilities, evaluation for impairment of goodwill and long-lived assets and lease accounting matters. Actual results could differ from those estimates.
2. Other Liabilities
Other liabilities, current, consisted of the following:
 
July 3, 2016
 
January 3, 2016
Accrued workers' compensation and general liability claims
$
6,113

 
$
5,540

Sales and property taxes
1,905

 
3,031

Accrued occupancy costs
884

 
980

Other
1,502

 
2,545

 
$
10,404

 
$
12,096

Other liabilities, long-term, consisted of the following:
 
July 3, 2016
 
January 3, 2016
Accrued occupancy costs
$
16,915

 
$
15,349

Deferred compensation
1,687

 
1,665

Accrued workers' compensation and general liability claims
1,792

 
697

Other
4,138

 
3,286

 
$
24,532

 
$
20,997

Accrued occupancy costs include obligations pertaining to closed restaurant locations and accruals to expense operating lease rental payments on a straight-line basis over the lease term.
The following table presents the activity in the closed-store reserve, of which $1.0 million and $1.2 million are included in long-term accrued occupancy costs at July 3, 2016 and January 3, 2016, respectively, with the remainder in other current liabilities:
 
Six Months Ended July 3, 2016
 
Year Ended January 3, 2016
Balance, beginning of period
$
1,832

 
$
1,251

Provisions for restaurant closures

 
554

       Additional lease charges, net of (recoveries)
13

 
258

       Payments, net
(338
)
 
(358
)
Other adjustments
141

 
127

Balance, end of period
$
1,648

 
$
1,832

3. Stock-Based Compensation
During the six months ended July 3, 2016 and June 28, 2015, the Company granted 50,087 and 22,597 non-vested restricted shares, respectively, under the Fiesta Restaurant Group, Inc. 2012 Stock Incentive Plan (the "Fiesta Plan") to certain employees. These shares generally vest and become non-forfeitable over a four year vesting period. The weighted average fair value at grant date for these non-vested shares issued to employees during the six months ended July 3, 2016 and June 28, 2015 was $35.25 and $62.05, respectively.
During the six months ended July 3, 2016 and June 28, 2015, the Company granted 5,762 and 10,007 restricted stock units, respectively, under the Fiesta Plan to certain employees. The restricted stock units granted during the six months ended July 3,

8

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In thousands of dollars, except share and per share amounts)


2016 vest and become non-forfeitable at the end of a four year vesting period. The restricted stock units granted during the six months ended June 28, 2015 vest and become non-forfeitable over a four year vesting period or, for certain units, at the end of a four year vesting period. The weighted average fair value at grant date for these restricted stock units issued to employees during six months ended July 3, 2016 and June 28, 2015 was $35.25 and $62.05, respectively.
Also during the six months ended July 3, 2016 and June 28, 2015, the Company granted 33,691 and 17,501 non-vested restricted shares, respectively, and 33,691 and 17,501 restricted stock units, respectively, under the Fiesta Plan to certain employees subject to performance conditions. The non-vested restricted shares vest and become non-forfeitable over a four year vesting period subject to the attainment of performance conditions. The restricted stock units vest and become non-forfeitable at the end of a three year vesting period. The number of shares into which the restricted stock units convert is determined based on the attainment of certain performance conditions, and for the restricted stock units granted during the six months ended July 3, 2016 and June 28, 2015, ranges from no shares, if the minimum performance condition is not met, to 67,382 and 35,002 shares, respectively, if the maximum performance condition is met. The weighted average fair value at grant date for restricted non-vested shares and restricted stock units subject to performance conditions granted during the six months ended July 3, 2016 and June 28, 2015 was $35.25 and $65.01, respectively.
During the three months ended July 3, 2016 and June 28, 2015, the Company granted 14,081 and 8,698 non-vested restricted shares, respectively, to non-employee directors. The weighted average fair value at the grant date for restricted non-vested shares issued to directors during the three months ended July 3, 2016 and June 28, 2015, was $33.39 and $54.06, respectively. These shares vest and become non-forfeitable over a one year vesting period.
Stock-based compensation expense for the three and six months ended July 3, 2016 was $1.3 million and $2.3 million, respectively, and for the three and six months ended June 28, 2015 was $1.1 million and $2.0 million, respectively. As of July 3, 2016, the total unrecognized stock-based compensation expense relating to non-vested restricted shares and restricted stock units was approximately $8.4 million. At July 3, 2016, the remaining weighted average vesting period for non-vested restricted shares was 1.8 years and restricted stock units was 2.3 years.
A summary of all non-vested restricted shares and restricted stock units activity for the six months ended July 3, 2016 was as follows:
 
Non-Vested Shares
 
Restricted Stock Units
 
 
 
Weighted
 
 
 
Weighted
 
 
 
Average
 
 
 
Average
 
 
 
Grant Date
 
 
 
Grant Date
 
Shares
 
Price
 
Units
 
Price
Outstanding at January 3, 2016
257,618

 
$
30.69

 
42,840

 
$
56.46

Granted
97,859

 
34.98

 
39,453

 
35.25

Vested/Released
(115,327
)
 
26.19

 
(239
)
 
50.80

Forfeited
(5,869
)
 
36.79

 
(2,148
)
 
46.82

Outstanding at July 3, 2016
234,281

 
$
34.54

 
79,906

 
$
46.26

The fair value of the non-vested restricted shares and restricted stock units is based on the closing price on the date of grant.
4. Business Segment Information
The Company is engaged in the fast-casual restaurant industry, with two restaurant concepts (each of which is an operating segment): Pollo Tropical and Taco Cabana. Pollo Tropical restaurants offer a wide variety of freshly prepared Caribbean inspired food, while our Taco Cabana restaurants offer a broad selection of hand-made, freshly prepared and authentic Mexican food.

9

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In thousands of dollars, except share and per share amounts)


The accounting policies of each segment are the same as those described in the summary of significant accounting policies discussed in Note 1 to the Company's audited financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended January 3, 2016. The Company reports more than one measure of segment profit or loss to the chief operating decision maker for the purposes of allocating resources to the segments and assessing their performance. The primary measures of segment profit or loss used to assess performance and allocate resources are income before taxes and Adjusted EBITDA, which is defined as earnings attributable to the applicable operating segment before interest, income taxes, depreciation and amortization, impairment and other lease charges, stock-based compensation expense and other income and expense. Although the chief operating decision maker uses Adjusted EBITDA as a measure of segment profitability, in accordance with Accounting Standards Codification 280, Segment Reporting, the following table includes segment income before taxes, which is the measure of segment profit or loss determined in accordance with the measurement principles that are most consistent with the principles used in measuring the corresponding amounts in the consolidated financial statements.
The “Other” column includes corporate related items not allocated to reportable segments and consists primarily of corporate owned property and equipment, miscellaneous prepaid costs, capitalized costs associated with the issuance of indebtedness, corporate cash accounts, a current income tax receivable and advisory fees related to a proposed separation transaction.
Three Months Ended
 
Pollo Tropical
 
Taco Cabana
 
Other
 
Consolidated
July 3, 2016:
 
 
 
 
 
 
 
 
Restaurant sales
 
$
101,879

 
$
78,956

 
$

 
$
180,835

Franchise revenue
 
508

 
189

 

 
697

Cost of sales
 
32,266

 
22,341

 

 
54,607

Restaurant wages and related expenses (1)
 
23,980

 
23,001

 

 
46,981

Restaurant rent expense
 
4,825

 
4,288

 

 
9,113

Other restaurant operating expenses
 
13,701

 
10,562

 

 
24,263

Advertising expense
 
3,685

 
3,321

 

 
7,006

General and administrative expense (2)
 
8,843

 
5,363

 
47

 
14,253

Depreciation and amortization
 
5,428

 
3,197

 

 
8,625

Pre-opening costs
 
1,795

 
221

 

 
2,016

Impairment and other lease charges
 

 
82

 

 
82

Interest expense
 
228

 
307

 

 
535

Income before taxes
 
7,636

 
6,452

 
(47
)
 
14,041

Capital expenditures
 
20,468

 
3,633

 
1,346

 
25,447

June 28, 2015:
 
 
 
 
 
 
 
 
Restaurant sales
 
$
89,569

 
$
81,699

 
$

 
$
171,268

Franchise revenue
 
477

 
155

 

 
632

Cost of sales
 
30,094

 
24,129

 

 
54,223

Restaurant wages and related expenses (1)
 
19,251

 
23,132

 

 
42,383

Restaurant rent expense
 
3,820

 
4,228

 

 
8,048

Other restaurant operating expenses
 
10,893

 
10,469

 

 
21,362

Advertising expense
 
1,904

 
3,240

 

 
5,144

General and administrative expense (2)
 
7,651

 
5,973

 

 
13,624

Depreciation and amortization
 
4,340

 
3,061

 

 
7,401

Pre-opening costs
 
1,144

 
67

 

 
1,211

Impairment and other lease charges
 

 

 

 

Interest expense
 
176

 
238

 

 
414

Income before taxes
 
10,908

 
7,324

 

 
18,232

Capital expenditures
 
17,102

 
2,607

 
934

 
20,643


10

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In thousands of dollars, except share and per share amounts)



 
Six Months Ended
 
Pollo Tropical
 
Taco Cabana
 
Other
 
Consolidated
July 3, 2016:
 
 
 
 
 
 
 
 
Restaurant sales
 
$
200,785

 
$
155,989

 
$

 
$
356,774

Franchise revenue
 
1,085

 
350

 

 
1,435

Cost of sales
 
63,870

 
44,787

 

 
108,657

Restaurant wages and related expenses (1)
 
46,876

 
45,157

 

 
92,033

Restaurant rent expense
 
9,469

 
8,565

 

 
18,034

Other restaurant operating expenses
 
26,293

 
20,358

 

 
46,651

Advertising expense
 
7,447

 
6,554

 

 
14,001

General and administrative expense (2)
 
16,528

 
10,825

 
748

 
28,101

Depreciation and amortization
 
10,706

 
6,255

 

 
16,961

Pre-opening costs
 
2,909

 
289

 

 
3,198

Impairment and other lease charges
 

 
94

 

 
94

Interest expense
 
479

 
614

 

 
1,093

Income before taxes
 
17,305

 
13,067

 
(748
)
 
29,624

Capital expenditures
 
34,567

 
5,267

 
2,404

 
42,238

June 28, 2015:
 
 
 
 
 
 
 
 
Restaurant sales
 
$
176,458

 
$
157,868

 
$

 
$
334,326

Franchise revenue
 
1,158

 
291

 

 
1,449

Cost of sales
 
58,633

 
46,713

 

 
105,346

Restaurant wages and related expenses (1)
 
38,005

 
44,968

 

 
82,973

Restaurant rent expense
 
7,469

 
8,586

 

 
16,055

Other restaurant operating expenses
 
20,982

 
20,239

 

 
41,221

Advertising expense
 
4,262

 
6,436

 

 
10,698

General and administrative expense (2)
 
15,448

 
11,940

 

 
27,388

Depreciation and amortization
 
8,079

 
6,169

 

 
14,248

Pre-opening costs
 
2,014

 
148

 

 
2,162

Impairment and other lease charges
 

 
94

 

 
94

Interest expense
 
361

 
491

 

 
852

Income before taxes
 
22,498

 
12,754

 

 
35,252

Capital expenditures
 
32,144

 
5,658

 
2,098

 
39,900

Identifiable Assets:
 
 
 
 
 
 
 
 
July 3, 2016:
 
263,100

 
162,505

 
11,270

 
436,875

January 3, 2016
 
237,065

 
165,549

 
13,031

 
415,645

(1) Includes stock-based compensation expense of $40 and $76 for the three and six months ended July 3, 2016, respectively, and $40 and $107 for the three and six months ended June 28, 2015, respectively.
(2) Includes stock-based compensation expense of $1,218 and $2,193 for the three and six months ended July 3, 2016, respectively, and $1,055 and $1,929
for the three and six months ended June 28, 2015, respectively.


11

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In thousands of dollars, except share and per share amounts)


5. Net Income per Share
The Company computes basic net income per share by dividing net income applicable to common shares by the weighted average number of common shares outstanding during each period. Our non-vested restricted shares contain a non-forfeitable right to receive dividends on a one-to-one per share ratio to common shares and are thus considered participating securities. The impact of the participating securities is included in the computation of basic net income per share pursuant to the two-class method. The two-class method of computing earnings per share is an earnings allocation formula that determines earnings attributable to common shares and participating securities according to dividends declared (whether paid or unpaid) and participation rights in undistributed earnings. Net income per common share was computed by dividing undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and non-vested restricted shares based on the weighted average shares outstanding during the period.
Diluted earnings per share reflects the potential dilution that could occur if our restricted stock units were converted into common shares. Restricted stock units with performance conditions are only included in the diluted earnings per share calculation to the extent that performance conditions have been met at the measurement date. We compute diluted earnings per share by adjusting the basic weighted average number of common shares by the dilutive effect of the restricted stock units, determined using the treasury stock method.
Weighted average outstanding restricted stock units totaling 13,990 and 10,698 shares for the three and six months ended July 3, 2016, respectively, and 9,391 and 4,696 shares for the three and six months ended June 28, 2015, respectively, were not included in the computation of diluted earnings per share because to do so would have been antidilutive.
The computation of basic and diluted net income per share is as follows:
 
 
Three Months Ended
 
Six Months Ended
 
  
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
Basic and diluted net income per share:
  
 
 
 
 
 
 
 
Net income
  
$
8,916

 
$
11,249

 
$
18,811

 
$
21,750

Less: income allocated to participating securities
  
(89
)
 
(142
)
 
(183
)
 
(285
)
Net income available to common stockholders
  
$
8,827

 
$
11,107

 
$
18,628

 
$
21,465

Weighted average common shares, basic
 
26,654,280

 
26,490,673

 
26,629,999

 
26,462,919

Restricted stock units
 
5,989

 
6,985

 
6,146

 
7,211

Weighted average common shares, diluted
  
26,660,269

 
26,497,658

 
26,636,145

 
26,470,130

 
 
 
 
 
 
 
 
 
Basic net income per common share
  
$
0.33

 
$
0.42

 
$
0.70

 
$
0.81

Diluted net income per common share
 
$
0.33

 
$
0.42

 
$
0.70

 
$
0.81

6. Commitments and Contingencies
Lease Assignments. Taco Cabana has assigned three leases on properties where it no longer operates restaurants with lease terms expiring on various dates through 2029 to various parties. The assignees are responsible for making the payments under these leases. The Company is a guarantor under one of these leases and it remains secondarily liable as a surety with respect to two of these leases. The maximum potential liability for future rental payments the Company could be required to make under these leases at July 3, 2016 was $1.8 million. The Company could also be obligated to pay property taxes and other lease related costs. The obligations under these leases will generally continue to decrease over time as the operating leases expire. The Company does not believe it is probable that it would be ultimately responsible for the obligations under these leases.
Legal Matters. The Company is a party to legal proceedings incidental to the conduct of business, including the matter
described below. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be
incurred and the amount can be reasonably estimated. The Company evaluates, on a quarterly basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, the Company does not establish an accrued liability.

12

FIESTA RESTAURANT GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(In thousands of dollars, except share and per share amounts)



On September 29, 2014, Daisy, Inc., an automotive repair shop in Cape Coral, Florida, filed a putative class action suit against Fiesta's subsidiary, Pollo Operations, Inc. ("Pollo Operations") in the United States District Court for the Middle District of Florida. The suit alleged that Pollo Operations engaged in unlawful activity in violation of the Telephone Consumer Protection Act, § 227 et seq. occurring in December 2010 and January 2011. During the first quarter of 2016, Pollo Operations reached a settlement with the plaintiff which resulted in dismissal of the case and paid all settlement claims.
The Company is also a party to various other litigation matters incidental to the conduct of business. The Company does not believe that the outcome of any of these matters will have a material effect on its consolidated financial statements.
7. Recent Accounting Pronouncements
In May 2014, and in subsequent updates, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606), which amends the guidance in former Topic 605, Revenue Recognition, and provides for either a full retrospective adoption in which the standard is applied to all of the periods presented or a modified retrospective adoption in which the cumulative effect of initially applying the standard is recognized at the date of initial application. The new standard provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers unless the contracts are in the scope of other US GAAP requirements. The guidance also provides a model for the measurement and recognition of gains and losses on the sale of certain non-financial assets, such as property and equipment, including real estate. The Company is currently evaluating the impact of the provisions of Topic 606; however, the Company expects the provisions to primarily impact certain franchise revenues and does not expect the standard to have a material effect on its financial statements. For the Company, the new standard is effective for interim and annual periods beginning after December 15, 2017.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessee recognition of lease assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements. For the Company, the new standard is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. A modified retrospective approach is required with an option to use certain practical expedients. The new guidance is required to be applied at the beginning of the earliest comparative period presented. The Company is currently evaluating the impact on its financial statements. Although the impact is not currently estimable, the Company expects to recognize lease assets and lease liabilities for most of the leases it currently accounts for as operating leases.
In March 2016, the FASB issued ASU No. 2016-04, Recognition of Breakage for Certain Prepaid Stored-Value Products (Topic 405-20), which creates an exception under Topic 405-20 to derecognize financial liabilities related to certain prepaid stored-value products using a breakage model consistent with the revenue breakage model in Topic 606. The new guidance will be effective concurrent with Topic 606, which is effective for the Company for interim and annual periods beginning after December 15, 2017. The Company does not expect this standard to have a material effect on its financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718), to simplify various aspects of the accounting and presentation of share-based payments, including the income tax effects of awards and forfeiture assumptions. Currently, tax deductions in excess of compensation costs (excess tax benefits) are recorded in equity and tax deduction shortfalls (tax deficiencies), to the extent of previous excess tax benefits, are recorded in equity and then to income tax expense. Under the new guidance, all excess tax benefits and tax deficiencies will be recorded to income tax expense in the income statement, which could create volatility in the Company's income statement. The new guidance will also change the classification of excess tax benefits in the cash flow statement and impact the diluted earnings per share calculation. The guidance will be effective for interim and annual periods beginning after December 15, 2016, and early adoption is permitted. Different components of the guidance require prospective, retrospective and/or modified retrospective adoption. The Company is currently evaluating the impact on its financial statements and it is not currently estimable.


13


ITEM 2-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of financial condition and results of operations ("MD&A") is written to help the reader understand our company. The MD&A is provided as a supplement to, and should be read in conjunction with, our unaudited condensed consolidated financial statements and the accompanying financial statement notes. Any reference to restaurants refers to company-owned restaurants unless otherwise indicated. Throughout this MD&A, we refer to Fiesta Restaurant Group, Inc., together with its consolidated subsidiaries, as "we," "our" and "us."
We use a 52-53 week fiscal year ending on the Sunday closest to December 31. The fiscal year ended January 3, 2016 contained 53 weeks. The three and six months ended July 3, 2016 and June 28, 2015 each contained thirteen and twenty-six weeks, respectively. The fiscal year ending January 1, 2017 will contain 52 weeks.
Company Overview
We own, operate and franchise two fast-casual restaurant brands, Pollo Tropical® and Taco Cabana®, which have almost 30 years and 40 years, respectively, of operating history and loyal customer bases in their core markets. Our Pollo Tropical restaurants offer a wide variety of freshly prepared Caribbean inspired food, while our Taco Cabana restaurants offer a broad selection of hand-made, freshly prepared and authentic Mexican food. We believe that both brands are differentiated from other restaurant concepts and offer a unique dining experience. We are positioned within the value-oriented fast-casual restaurant segment, which combines the convenience and value of quick-service restaurants with the variety, food quality, décor and atmosphere more typical of casual dining restaurants. Our open display kitchen format allows guests to view and experience our food being freshly-prepared and cooked to order. Additionally, nearly all of our restaurants offer the convenience of drive-thru windows. As of July 3, 2016, our company-owned restaurants included 172 Pollo Tropical restaurants and 164 Taco Cabana restaurants.
We franchise our Pollo Tropical restaurants primarily internationally and as of July 3, 2016, we had 31 franchised Pollo Tropical restaurants located in Puerto Rico, Honduras, Trinidad & Tobago, the Bahamas, Venezuela, Panama and Guatemala, and six licensed locations on college campuses and a hospital in Florida. We have agreements for the continued development of franchised Pollo Tropical restaurants in certain of our existing franchised markets, and we have commitments for additional non-traditional locations in U.S. markets in which we currently operate.
As of July 3, 2016, we had five Taco Cabana franchised restaurants located in New Mexico and two non-traditional Taco Cabana licensed locations on college campuses in Texas.
Executive Summary-Consolidated Operating Performance for the Three Months Ended July 3, 2016
Our second quarter 2016 results and highlights include the following:
Net income decreased $2.3 million to $8.9 million in the second quarter of 2016, or $0.33 per diluted share, compared to net income of $11.2 million, or $0.42 per diluted share in the second quarter of 2015, primarily due to new restaurant performance, lower comparable restaurant sales and higher operating expenses.
Total revenues increased 5.6% in the second quarter of 2016 to $181.5 million compared to $171.9 million in the second quarter of 2015, driven primarily by an increase in the number of our company-owned restaurants, partially offset by a decrease in comparable restaurant sales. Comparable restaurant sales decreased 3.8% for our Taco Cabana restaurants resulting primarily from a decrease in comparable guest traffic of 5.5% partially offset by an increase in average check of 1.7%. Comparable restaurant sales decreased 1.4% for our Pollo Tropical restaurants resulting primarily from a decrease in comparable guest traffic of 2.6% partially offset by an increase in average check of 1.2%.
During the second quarter of 2016, we opened eleven new company-owned Pollo Tropical restaurants and two Taco Cabana restaurants. During the second quarter of 2015, we opened six new company-owned Pollo Tropical restaurants and one Taco Cabana restaurant and permanently closed two company-owned Taco Cabana restaurants.
Adjusted EBITDA decreased $2.4 million in the second quarter of 2016 to $24.6 million compared to $27.0 million in the second quarter of 2015. Revenue growth in the second quarter of 2016 was offset by lower profitability as a result of new restaurant performance, lower comparable restaurant sales, higher operating expenses and severance and relocation costs associated with transitioning our Pollo Tropical headquarters from Miami, Florida to Dallas, Texas. Adjusted EBITDA is a non-GAAP financial measure of performance. For a discussion of our use of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see "Management's Use of Non-GAAP Financial Measures".


14


Results of Operations
The following table summarizes the changes in the number and mix of Pollo Tropical and Taco Cabana company-owned and franchised restaurants:

 
Pollo Tropical
 
Taco Cabana
 
Owned
 
Franchised
 
Total
 
Owned
 
Franchised
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
January 3, 2016
155

 
35

 
190

 
162

 
6

 
168

   New
6

 
1

 
7

 

 

 

   Closed

 
 
 

 

 

 

April 3, 2016
161

 
36

 
197

 
162

 
6

 
168

   New
11

 
2

 
13

 
2

 
1

 
3

   Closed

 
(1
)
 
(1
)
 

 

 

July 3, 2016
172

 
37

 
209

 
164

 
7

 
171

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 28, 2014
124

 
37

 
161

 
167

 
7

 
174

   New
6

 

 
6

 

 

 

   Closed

 

 

 
(3
)
 

 
(3
)
March 29, 2015
130

 
37

 
167

 
164

 
7

 
171

   New
6

 

 
6

 
1

 

 
1

   Closed

 
(2
)
 
(2
)
 
(2
)
 
(1
)
 
(3
)
June 28, 2015
136

 
35

 
171

 
163

 
6

 
169


Three Months Ended July 3, 2016 Compared to Three Months Ended June 28, 2015
The following table sets forth, for the three months ended July 3, 2016 and June 28, 2015, selected consolidated operating results as a percentage of consolidated restaurant sales and selected segment operating results as a percentage of applicable segment restaurant sales:
 
Three Months Ended
 
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
 
Pollo Tropical
 
Taco Cabana
 
Consolidated
Restaurant sales:
 
 
 
 
 
 
 
 
 
 
 
Pollo Tropical
 
 
 
 
 
 
 
 
56.3
%
 
52.3
%
Taco Cabana
 
 
 
 
 
 
 
 
43.7
%
 
47.7
%
Consolidated restaurant sales
 
 
 
 
 
 
 
 
100.0
%
 
100.0
%
Costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
31.7
%
 
33.6
%
 
28.3
%
 
29.5
%
 
30.2
%
 
31.7
%
Restaurant wages and related expenses
23.5
%
 
21.5
%
 
29.1
%
 
28.3
%
 
26.0
%
 
24.7
%
Restaurant rent expense
4.7
%
 
4.3
%
 
5.4
%
 
5.2
%
 
5.0
%
 
4.7
%
Other restaurant operating expenses
13.4
%
 
12.2
%
 
13.4
%
 
12.8
%
 
13.4
%
 
12.5
%
Advertising expense
3.6
%
 
2.1
%
 
4.2
%
 
4.0
%
 
3.9
%
 
3.0
%
Pre-opening costs
1.8
%
 
1.3
%
 
0.3
%
 
0.1
%
 
1.1
%
 
0.7
%





15


Consolidated Revenues. Revenues include restaurant sales, which consist of food and beverage sales, net of discounts, at our company-owned restaurants, and franchise royalty revenues and fees, which represent ongoing royalty payments that are determined based on a percentage of franchisee sales, franchise fees associated with new restaurant openings, and development fees associated with the opening of new franchised restaurants in a given market. Restaurant sales are influenced by new restaurant openings, closures of restaurants and changes in comparable restaurant sales.
Total revenues increased 5.6% to $181.5 million in the second quarter of 2016 from $171.9 million in the second quarter of 2015. Restaurant sales increased 5.6% to $180.8 million in the second quarter of 2016 from $171.3 million in the second quarter of 2015.
The following table presents the primary drivers of the increase or decrease in restaurant sales for both Pollo Tropical and Taco Cabana for the second quarter of 2016 compared to the second quarter of 2015 (in millions):
Pollo Tropical:
 
Decrease in comparable restaurant sales
$
(1.1
)
Incremental sales related to new restaurants, net of closed restaurants
13.4

   Total increase
$
12.3

 
 
Taco Cabana:
 
Decrease in comparable restaurant sales
$
(3.0
)
Incremental sales related to new restaurants, net of closed restaurants
0.3

   Total decrease
$
(2.7
)
Comparable restaurant sales for Pollo Tropical restaurants decreased 1.4% in the second quarter of 2016. Comparable restaurant sales for Taco Cabana restaurants decreased 3.8% in the second quarter of 2016. Restaurants are included in comparable restaurant sales after they have been open for 18 months. Increases or decreases in comparable restaurant sales result primarily from an increase or decrease in guest traffic and an increase in average check. The increase in average check is primarily driven by menu price increases. For Pollo Tropical, a decrease in guest traffic of 2.6% was partially offset by menu price increases which drove an increase in restaurant sales of 1.0% in the second quarter of 2016 as compared to the second quarter of 2015. For Taco Cabana, a decrease in guest traffic of 5.5% was partially offset by menu price increases which drove an increase in restaurant sales of 2.4% in the second quarter of 2016 as compared to the second quarter of 2015. As a result of new restaurant openings, expected sales cannibalization of existing restaurants negatively impacted comparable restaurant sales for Pollo Tropical by 2.0% in the second quarter of 2016. Comparable restaurant sales for both brands continue to be negatively impacted by the general slowdown in restaurant sales industrywide.
Restaurants in newer markets that have not reached media efficiency generally have lower sales than restaurants in mature, media-efficient markets. As a result, Pollo Tropical revenues are growing at a slower rate than the average number of restaurants.
Franchise revenues remained relatively stable and increased by less than $0.1 million to $0.7 million in the second quarter of 2016 from $0.6 million in the second quarter of 2015.
Operating costs and expenses. Operating costs and expenses include cost of sales, restaurant wages and related expenses, other restaurant expenses and advertising expenses. Cost of sales consists of food, paper and beverage costs including packaging costs, less rebates and purchase discounts. Cost of sales is generally influenced by changes in commodity costs, the sales mix of items sold and the effectiveness of our restaurant-level controls to manage food and paper costs. Key commodities, including chicken and beef, are generally purchased under contracts for future periods of up to one year.
Restaurant wages and related expenses include all restaurant management and hourly productive labor costs, employer payroll taxes, restaurant-level bonuses and related benefits. Payroll and related taxes and benefits are subject to inflation, including minimum wage increases and increased costs for health insurance, workers' compensation insurance and state unemployment insurance.
Other restaurant operating expenses include all other restaurant-level operating costs, the major components of which are utilities, repairs and maintenance, general liability insurance, real estate taxes, sanitation, supplies and credit card fees.
Advertising expense includes all promotional expenses including television, radio, billboards and other sponsorships and promotional activities.

16


Pre-opening costs include costs incurred prior to opening a restaurant, including restaurant employee wages and related expenses, travel expenditures, recruiting, training, promotional costs associated with the restaurant opening and rent, including any non-cash rent expense recognized during the construction period. Pre-opening costs are generally incurred beginning four to six months prior to a restaurant opening.
The following tables present the primary drivers of the changes in the components of restaurant operating margins for Pollo Tropical and Taco Cabana for the second quarter of 2016 compared to the second quarter of 2015. All percentages are stated as a percentage of applicable segment restaurant sales.
Pollo Tropical:
 
Cost of sales:
 
   Lower commodity costs
(2.2
)%
   Menu price increases
(0.3
)%
   Operating inefficiencies
0.5
 %
   Other
0.1
 %
      Net decrease in cost of sales as a percentage of restaurant sales
(1.9
)%
 
 
Restaurant wages and related expenses:
 
   Higher labor costs and impact of lower sales volumes for comparable restaurants
0.7
 %
   Higher labor costs and impact of lower sales volumes for new restaurants (1)
0.8
 %
   Higher medical benefit costs
0.3
 %
   Higher workers compensation costs
0.3
 %
   Other
(0.1
)%
      Net increase in restaurant wages and related costs as a percentage of restaurant sales
2.0
 %
 
 
Other operating expenses:
 
   Higher repairs and maintenance costs
0.6
 %
   Higher insurance costs
0.5
 %
   Higher real estate taxes related to new restaurants
0.3
 %
   Lower utilities costs
(0.3
)%
   Other
0.1
 %
      Net increase in other restaurant operating expenses as a percentage of restaurant sales
1.2
 %
 
 
Advertising expense:
 
   Increase in advertising
1.5
 %
      Net increase in advertising expense as a percentage of restaurant sales
1.5
 %
 
 
Pre-opening costs:
 
   Timing of restaurant openings
0.5
 %
      Net increase in pre-opening costs as a percentage of restaurant sales
0.5
 %
(1) Includes additional restaurant managers in training that will be deployed to new restaurants as they open.


17


Taco Cabana:
 
Cost of sales:
 
   Lower commodity costs
(1.0
)%
   Menu price increases
(0.7
)%
   Operating inefficiencies
0.5
 %
      Net decrease in cost of sales as a percentage of restaurant sales
(1.2
)%
 
 
Restaurant wages and related expenses:
 
   Impact of lower sales volumes and higher labor costs for comparable restaurants
1.1
 %
   Impact of closing lower sales volume restaurants, net of new restaurants
(0.2
)%
   Lower medical benefit costs
(0.3
)%
   Other
0.2
 %
      Net increase in restaurant wages and related costs as a percentage of restaurant sales
0.8
 %
 
 
Other operating expenses:
 
   Higher repairs and maintenance costs
0.3
 %
   Higher real estate taxes
0.2
 %
   Other
0.1
 %
      Net increase in other restaurant operating expenses as a percentage of restaurant sales
0.6
 %
 
 
Advertising expense:
 
   Increase in advertising
0.2
 %
      Net increase in advertising expense as a percentage of restaurant sales
0.2
 %
 
 
Pre-opening costs:
 
   Timing of restaurant openings
0.2
 %
      Net increase in pre-opening costs as a percentage of restaurant sales
0.2
 %
Consolidated Restaurant Rent Expense. Restaurant rent expense includes base rent and contingent rent on our leases characterized as operating leases, reduced by amortization of gains on sale-leaseback transactions. Restaurant rent expense, as a percentage of total restaurant sales, increased to 5.0% in the second quarter of 2016 from 4.7% in the second quarter of 2015 primarily as a result of new restaurants, which generally have higher rent, and the impact of lower comparable restaurant sales.
Consolidated General and Administrative Expenses. General and administrative expenses are comprised primarily of (1) salaries and expenses associated with the development and support of our company and brands and the management oversight of the operation of our restaurants; and (2) legal, auditing and other professional fees and stock-based compensation expense.
General and administrative expenses were $14.3 million in the second quarter of 2016 and $13.6 million in the second quarter of 2015, and as a percentage of total revenues, general and administrative expenses were 7.9% in the second quarter of 2016 and the second quarter of 2015 due primarily to higher current year sales and lower incentive based compensation costs. In addition, general and administrative expenses in the second quarter of 2016 include $0.4 million in severance and relocation costs associated with transitioning our Pollo Tropical headquarters from Miami, Florida to Dallas, Texas.
Adjusted EBITDA. Adjusted EBITDA, which is one of the measures of segment profit or loss used by our chief operating decision maker for purposes of allocating resources to our segments and assessing their performance, is defined as earnings attributable to the applicable segment before interest, income taxes, depreciation and amortization, impairment and other lease charges, stock-based compensation expense and other income and expense. Adjusted EBITDA may not be necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculation. Adjusted EBITDA for each of our segments includes an allocation of general and administrative expenses associated with administrative support for executive management, information systems and certain accounting, legal, supply chain, development, and other administrative functions. Adjusted EBITDA is a non-GAAP financial measure of performance. For a discussion of our use of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see the heading entitled "Management's Use of Non-GAAP Financial Measures".

18


Adjusted EBITDA for Pollo Tropical decreased to $14.0 million in the second quarter of 2016 from $15.9 million in the second quarter of 2015 primarily as a result of lower profitability at new restaurants, the impact of lower comparable restaurant sales and higher operating expenses. Adjusted EBITDA for Taco Cabana decreased to $10.6 million in the second quarter of 2016 from $11.1 million in the second quarter of 2015 primarily due to the impact of the decrease in revenues. Consolidated Adjusted EBITDA decreased to $24.6 million in the second quarter of 2016 from $27.0 million in the second quarter of 2015.
Depreciation and Amortization. Depreciation and amortization expense increased to $8.6 million in the second quarter of 2016 from $7.4 million in the second quarter of 2015 due primarily to increased depreciation relating to new restaurant openings.
Impairment and Other Lease Charges. Each quarter we assess the potential impairment of any long-lived assets that have experienced a triggering event, including restaurants for which the related cash flows are below a certain threshold. After reviewing the specific cash flows and management’s plans related to the restaurants for which an impairment review was performed, we determined that no impairment was currently necessary. However, for seven Pollo Tropical restaurants and one Taco Cabana restaurant, the projected cash flows were not substantially in excess of their combined carrying values of $11.8 million and $1.3 million, respectively. If the performance of these restaurants does not improve as projected, an impairment charge could be recognized in future periods, and such charge could be material.
Other Expense (Income). Other income in the second quarter of 2015 primarily consisted of expected business interruption insurance proceeds for a Pollo Tropical location that was temporarily closed due to a fire.
Interest Expense. Interest expense increased to $0.5 million in the second quarter of 2016 from $0.4 million in the second quarter of 2015.
Provision for Income Taxes. The provision for income taxes was derived using an estimated effective annual income tax rate of 36.5% for the second quarter of 2016 and 38.3% for the second quarter of 2015. There were no discrete tax adjustments in the second quarter of 2016 or 2015. The effective annual income tax rate decreased in the second quarter of 2016 compared to the second quarter of 2015 due primarily to the reinstatement of Work Opportunity Tax Credits.
Net Income. As a result of the foregoing, we had net income of $8.9 million in the second quarter of 2016 compared to net income of $11.2 million in the second quarter of 2015.
Six Months Ended July 3, 2016 Compared to Six Months Ended June 28, 2015
The following table sets forth, for the six months ended July 3, 2016 and June 28, 2015, selected consolidated operating results as a percentage of consolidated restaurant sales and selected segment operating results as a percentage of applicable segment restaurant sales:
 
Six Months Ended
 
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
 
Pollo Tropical
 
Taco Cabana
 
Consolidated
Restaurant sales:
 
 
 
 
 
 
 
 
 
 
 
Pollo Tropical
 
 
 
 
 
 
 
 
56.3
%
 
52.8
%
Taco Cabana
 
 
 
 
 
 
 
 
43.7
%
 
47.2
%
Consolidated restaurant sales
 
 
 
 
 
 
 
 
100.0
%
 
100.0
%
Costs and expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
31.8
%
 
33.2
%
 
28.7
%
 
29.6
%
 
30.5
%
 
31.5
%
Restaurant wages and related expenses
23.3
%
 
21.5
%
 
28.9
%
 
28.5
%
 
25.8
%
 
24.8
%
Restaurant rent expense
4.7
%
 
4.2
%
 
5.5
%
 
5.4
%
 
5.1
%
 
4.8
%
Other restaurant operating expenses
13.1
%
 
11.9
%
 
13.1
%
 
12.8
%
 
13.1
%
 
12.3
%
Advertising expense
3.7
%
 
2.4
%
 
4.2
%
 
4.1
%
 
3.9
%
 
3.2
%
Pre-opening costs
1.4
%
 
1.1
%
 
0.2
%
 
0.1
%
 
0.9
%
 
0.6
%
Total revenues increased 6.7% to $358.2 million in the six months ended July 3, 2016 from $335.8 million in the six months ended June 28, 2015. Restaurant sales increased 6.7% to $356.8 million in the six months ended July 3, 2016 from $334.3 million in the six months ended June 28, 2015.

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The following table presents the primary drivers of the increase or decrease in restaurant sales for both Pollo Tropical and Taco Cabana for the six months ended July 3, 2016 compared to the six months ended June 28, 2015 (in millions):
Pollo Tropical:
 
Decrease in comparable restaurant sales
$
(1.1
)
Incremental sales related to new restaurants, net of closed restaurants
25.4

   Total increase
$
24.3

 
 
Taco Cabana:
 
Decrease in comparable restaurant sales
$
(1.8
)
Decrease in sales related to closed restaurants, net of new restaurants
(0.1
)
   Total decrease
$
(1.9
)
Comparable restaurant sales for Pollo Tropical restaurants decreased 0.7% in the six months ended July 3, 2016. Comparable restaurant sales for Taco Cabana restaurants decreased 1.2% in the six months ended July 3, 2016. For Pollo Tropical, a decrease in guest traffic of 1.3% was partially offset by menu price increases which drove an increase in restaurant sales of 0.8% in the six months ended July 3, 2016 as compared to the six months ended June 28, 2015. For Taco Cabana, a decrease in guest traffic of 3.2% was partially offset by menu price increases which drove an increase in restaurant sales of 2.6% in the six months ended July 3, 2016 as compared to the six months ended June 28, 2015. As a result of new restaurant openings, expected sales cannibalization of existing restaurants negatively impacted comparable restaurant sales for Pollo Tropical by 2.0% in the six months ended July 3, 2016. Comparable restaurant sales for both brands continue to be negatively impacted by the general slowdown in restaurant sales industrywide.
Restaurants in newer markets that have not reached media efficiency generally have lower sales than restaurants in mature, media-efficient markets. As a result, Pollo Tropical revenues are growing at a slower rate than the average number of restaurants.
Franchise revenues were $1.4 million in the six months ended July 3, 2016 and June 28, 2015.
The following tables present the primary drivers of the changes in the components of restaurant operating margins for Pollo Tropical and Taco Cabana for the six months ended July 3, 2016 compared to the six months ended June 28, 2015. All percentages are stated as a percentage of applicable segment restaurant sales.

20


Pollo Tropical:
 
Cost of sales:
 
   Lower commodity costs
(2.2
)%
   Menu price increases
(0.3
)%
   Operating inefficiencies
0.6
 %
   Higher promotions and discounts
0.2
 %
   Other
0.3
 %
      Net decrease in cost of sales as a percentage of restaurant sales
(1.4
)%
 
 
Restaurant wages and related expenses:
 
   Higher labor costs and impact of lower sales volumes for comparable restaurants
0.5
 %
   Higher labor costs and impact of lower sales volumes for new restaurants (1)
1.0
 %
   Higher medical benefit costs
0.3
 %
   Higher workers compensation costs
0.2
 %
   Other
(0.2
)%
      Net increase in restaurant wages and related costs as a percentage of restaurant sales
1.8
 %
 
 
Other operating expenses:
 
   Higher repairs and maintenance costs
0.6
 %
   Higher real estate taxes related to new restaurants
0.4
 %
   Other
0.2
 %
      Net increase in other restaurant operating expenses as a percentage of restaurant sales
1.2
 %
 
 
Advertising expense:
 
   Increase in advertising
1.3
 %
      Net increase in advertising expense as a percentage of restaurant sales
1.3
 %
 
 
Pre-opening costs:
 
   Timing of restaurant openings
0.3
 %
      Net increase in pre-opening costs as a percentage of restaurant sales
0.3
 %
(1) Includes additional restaurant managers in training that will be deployed to new restaurants as they open.


21


Taco Cabana:
 
Cost of sales:
 
   Menu price increases
(0.8
)%
   Lower commodity costs
(0.5
)%
   Operating inefficiencies
0.4
 %
      Net decrease in cost of sales as a percentage of restaurant sales
(0.9
)%
 
 
Restaurant wages and related expenses:
 
   Higher labor costs and impact of lower sales volumes for comparable restaurants
0.9
 %
   Impact of closing lower sales volume restaurants, net of new restaurants
(0.2
)%
   Higher workers' compensation claim costs
0.2
 %
   Lower medical benefit costs
(0.4
)%
   Other
(0.1
)%
      Net increase in restaurant wages and related costs as a percentage of restaurant sales
0.4
 %
 
 
Other operating expenses:
 
   Higher repairs and maintenance costs
0.3
 %
   Lower utilities
(0.3
)%
   Other
0.3
 %
      Net increase in other restaurant operating expenses as a percentage of restaurant sales
0.3
 %
 
 
Advertising expense:
 
   Increase in advertising
0.1
 %
      Net increase in advertising expense as a percentage of restaurant sales
0.1
 %
 
 
Pre-opening costs:
 
   Timing of restaurant openings
0.1
 %
      Net increase in pre-opening costs as a percentage of restaurant sales
0.1
 %
Consolidated Restaurant Rent Expense. Restaurant rent expense includes base rent and contingent rent on our leases characterized as operating leases, reduced by amortization of gains on sale-leaseback transactions. Restaurant rent expense, as a percentage of total restaurant sales, increased to 5.1% in the six months ended July 3, 2016 from 4.8% in the six months ended June 28, 2015 primarily as a result of new restaurants, which generally have higher rent, and the impact of lower comparable sales.
Consolidated General and Administrative Expenses. General and administrative expenses were $28.1 million in the six months ended July 3, 2016 and $27.4 million the six months ended June 28, 2015, and as a percentage of total revenues, general and administrative expenses decreased to 7.8% in the six months ended July 3, 2016 compared to 8.2% in the six months ended June 28, 2015 due primarily to higher current year sales and lower incentive based compensation costs. In addition, general and administrative expenses in the six months ended July 3, 2016 include $1.1 million in advisory fees related to the proposed separation transaction discussed in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016 and severance and relocation costs associated with transitioning our Pollo Tropical headquarters from Miami, Florida to Dallas, Texas, partially offset by a $0.4 million reduction in legal settlement costs.
Adjusted EBITDA. Adjusted EBITDA, which is one of the measures of segment profit or loss used by our chief operating decision maker for purposes of allocating resources to our segments and assessing their performance, is defined as earnings attributable to the applicable segment before interest, income taxes, depreciation and amortization, impairment and other lease charges, stock-based compensation expense and other income and expense. Adjusted EBITDA may not be necessarily comparable to other similarly titled captions of other companies due to differences in methods of calculation. Adjusted EBITDA for each of our segments includes an allocation of general and administrative expenses associated with administrative support for executive management, information systems and certain accounting, legal, supply chain, development, and other administrative functions. Adjusted EBITDA is a non-GAAP financial measure of performance. For a discussion of our use of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see the heading entitled "Management's Use of Non-GAAP Financial Measures".

22


Adjusted EBITDA for Pollo Tropical decreased to $29.7 million in the six months ended July 3, 2016 from $31.9 million in the six months ended June 28, 2015 primarily as a result of lower profitability at new restaurants, the impact of lower comparable restaurant sales and higher operating expenses. Adjusted EBITDA for Taco Cabana increased to $20.8 million in the six months ended July 3, 2016 from $20.1 million in the six months ended June 28, 2015 primarily due to a decrease in cost of sales as a percentage of sales driven by menu price increases and lower commodity costs partially offset by the impact of the decrease in revenues. Consolidated Adjusted EBITDA decreased to $49.8 million in the six months ended July 3, 2016 from $52.0 million in the six months ended June 28, 2015 primarily a result of the decrease in Pollo Tropical and Taco Cabana Adjusted EBITDA and $0.7 million in advisory fees related to the proposed separation transaction discussed in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016.
Depreciation and Amortization. Depreciation and amortization expense increased to $17.0 million in the six months ended July 3, 2016 from $14.2 million in the six months ended June 28, 2015 due primarily to increased depreciation relating to new restaurant openings.
Impairment and Other Lease Charges. Each quarter we assess the potential impairment of any long-lived assets that have experienced a triggering event, including restaurants for which the related cash flows are below a certain threshold. After reviewing the specific cash flows and management’s plans related to the restaurants for which an impairment review was performed, we determined that no impairment was currently necessary. However, for seven Pollo Tropical restaurants and one Taco Cabana restaurant, the projected cash flows were not substantially in excess of their combined carrying values of $11.8 million and $1.3 million, respectively. If the performance of these restaurants does not improve as projected, an impairment charge could be recognized in future periods, and such charge could be material.
Other (Income) Expense. Other income in the six months ended July 3, 2016 primarily consisted of additional proceeds related to a location that closed in 2015 as a result of an eminent domain proceeding. Other income in the six months ended June 28, 2015 primarily consisted of a previously deferred gain from a sale-leaseback transaction that was recognized upon termination of the lease as a result of an eminent domain proceeding and expected business interruption insurance proceeds for a Pollo Tropical location that was temporarily closed due to a fire.
Interest Expense. Interest expense increased to $1.1 million in the six months ended July 3, 2016 from $0.9 million in the six months ended June 28, 2015.
Provision for Income Taxes. The provision for income taxes was derived using an estimated effective annual income tax rate of 36.5% for the six months ended July 3, 2016 and 38.3% for the six months ended June 28, 2015. There were no discrete tax adjustments in the six months ended 2016 or 2015. The effective annual income tax rate decreased in the six months ended July 3, 2016 compared to the six months ended June 28, 2015 due primarily to the reinstatement of Work Opportunity Tax Credits.
Net Income. As a result of the foregoing, we had net income of $18.8 million in the six months ended July 3, 2016 compared to net income of $21.8 million in the six months ended June 28, 2015.

Liquidity and Capital Resources
We do not have significant receivables or inventory and receive trade credit based upon negotiated terms in purchasing food products and other supplies. We are able to operate with a substantial working capital deficit because:
restaurant operations are primarily conducted on a cash basis;
rapid turnover results in a limited investment in inventories; and
cash from sales is usually received before related liabilities for food, supplies and payroll become due.
Capital expenditures and payments related to our lease obligations represent significant liquidity requirements for us. We believe cash generated from our operations, availability of borrowings under our senior credit facility and proceeds from any sale-leaseback transactions which we may choose to do will provide sufficient cash availability to cover our anticipated working capital needs, capital expenditures and debt service requirements for the next twelve months.
Operating Activities. Net cash provided by operating activities in the first six months of 2016 and 2015 was $43.6 million and $34.2 million, respectively. The increase in net cash provided by operating activities in the first six months of 2016 was primarily driven by the timing of payments.
Investing Activities. Net cash used in investing activities in the first six months of 2016 and 2015 was $41.0 million and $39.8 million, respectively. Capital expenditures are the largest component of our investing activities and include: (1) new restaurant development, which may include the purchase of real estate; (2) restaurant remodeling/reimaging, which includes the renovation

23


or rebuilding of the interior and exterior of our existing restaurants; (3) other restaurant capital expenditures, which include capital maintenance expenditures for the ongoing reinvestment and enhancement of our restaurants; and (4) corporate and restaurant information systems.
The following table sets forth our capital expenditures for the periods presented (in thousands):
 
Pollo
Tropical
 
Taco
Cabana
 
Other
 
Consolidated
Six Months Ended July 3, 2016:
 
 
 
 
 
 
 
New restaurant development
$
32,572

 
$
3,188

 
$

 
$
35,760

Restaurant remodeling
486

 

 

 
486

Other restaurant capital expenditures (1)
659

 
1,336

 

 
1,995

Corporate and restaurant information systems
850

 
743

 
2,404

 
3,997

Total capital expenditures
$
34,567

 
$
5,267

 
$
2,404

 
$
42,238

Number of new restaurant openings
17

 
2

 
 
 
19

Six Months Ended June 28, 2015:
 
 
 
 
 
 
 
New restaurant development
$
30,559

 
$
2,903

 
$

 
$
33,462

Restaurant remodeling

 
1,526

 

 
1,526

Other restaurant capital expenditures (1)
1,559

 
1,120

 

 
2,679

Corporate and restaurant information systems
26

 
109

 
2,098

 
2,233

Total capital expenditures
$
32,144

 
$
5,658

 
$
2,098

 
$
39,900

Number of new restaurant openings
12

 
1

 
 
 
13

(1) Excludes restaurant repair and maintenance expenses included in other restaurant operating expenses in our consolidated financial statements. For the six months ended July 3, 2016 and June 28, 2015, total restaurant repair and maintenance expenses were approximately $9.2 million and $7.2 million, respectively.
In the first six months of 2016, investing activities also included $2.7 million for the purchase of a property for a sale-leaseback and a sale-leaseback transaction related to our restaurant properties, the net proceeds from which were $3.6 million.
Financing Activities. Net cash used in financing activities in the first six months of 2016 was $3.0 million and included net revolving credit borrowing repayments under our senior credit facility of $3.1 million and excess tax benefits of $0.1 million. Net cash provided by financing activities in the first six months of 2015 was $6.0 million and included net revolving credit borrowings under our senior credit facility of $5.0 million and the excess tax benefit from vesting of restricted shares of $1.0 million.
Senior Credit Facility. Our senior credit facility provides for aggregate revolving credit borrowings of up to $150 million (including $15 million available for letters of credit) and matures on December 11, 2018. The senior credit facility also provides for potential incremental increases of up to $50 million to the revolving credit borrowings available under the senior credit facility. On July 3, 2016, there were $67.9 million in outstanding revolving credit borrowings under our senior credit facility.
Borrowings under the senior credit facility bear interest at a per annum rate, at our option, equal to either (all terms as defined in the senior credit facility):
1) the Alternate Base Rate plus the applicable margin of 0.50% to 1.50% based on our Adjusted Leverage Ratio
(with a margin of 0.50% as of July 3, 2016), or
2) the LIBOR Rate plus the applicable margin of 1.50% to 2.50% based on our Adjusted Leverage Ratio (with a
margin of 1.50% at July 3, 2016).
In addition, the senior credit facility requires us to pay (i) a commitment fee based on the applicable Commitment Fee margin of 0.25% to 0.45%, based on our Adjusted Leverage Ratio, (with a margin of 0.25% at July 3, 2016) and the unused portion of the facility and (ii) a letter of credit fee based on the applicable LIBOR margin and the dollar amount of outstanding letters of credit.
All obligations under the senior credit facility are guaranteed by all of our material domestic subsidiaries. In general, our obligations under our senior credit facility and our subsidiaries’ obligations under the guarantees are secured by a first priority lien and security interest on substantially all of our assets and the assets of our material subsidiaries (including a pledge of all of the capital stock and equity interests of our material subsidiaries), other than certain specified assets, including real property owned by us or our subsidiaries.

24


The outstanding borrowings under the senior credit facility are prepayable without penalty (other than customary breakage costs). The senior credit facility requires us to comply with customary affirmative, negative and financial covenants, including, without limitation, those limiting our and our subsidiaries’ ability to (i) incur indebtedness, (ii) incur liens, (iii) loan, advance, or make acquisitions and other investments or other commitments to construct, acquire or develop new restaurants (subject to certain exceptions), (iv) pay dividends, (v) redeem and repurchase equity interests, (vi) conduct asset and restaurant sales and other dispositions (subject to certain exceptions), (vii) conduct transactions with affiliates and (viii) change our business. In addition, the senior credit facility will require us to maintain certain financial ratios, including minimum Fixed Charge Coverage and maximum Adjusted Leverage Ratios (all as defined under the senior credit facility).
Our senior credit facility contains customary default provisions, including without limitation, a cross default provision pursuant to which it is an event of default under this facility if there is a default under any of our indebtedness having an outstanding principal amount of $5.0 million or more which results in the acceleration of such indebtedness prior to its stated maturity or is caused by a failure to pay principal when due.
As of July 3, 2016, we were in compliance with the covenants under our senior credit facility. After reserving $5.2 million for letters of credit issued under the senior credit facility, $76.9 million was available for borrowing under the senior credit facility at July 3, 2016.
Off-Balance Sheet Arrangements and Contractual Obligations
We have no off-balance sheet arrangements other than our operating leases, which are primarily for our restaurant properties and not recorded on our consolidated balance sheet.
There have been no significant changes outside the ordinary course of business to our contractual obligations since January 3, 2016. Information regarding our contractual obligations is included under "Contractual Obligations" in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016.
Inflation
The inflationary factors that have historically affected our results of operations include increases in food and paper costs, labor and other operating expenses and energy costs. Labor costs in our restaurants are impacted by changes in the Federal and state hourly minimum wage rates as well as changes in payroll related taxes, including Federal and state unemployment taxes. We typically attempt to offset the effect of inflation, at least in part, through periodic menu price increases and various cost reduction programs. However, no assurance can be given that we will be able to fully offset such inflationary cost increases in the future.
Application of Critical Accounting Policies
Our unaudited interim condensed consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America. Preparing consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by the application of our accounting policies. Our significant accounting policies are described in the “Significant Accounting Policies” footnote in the notes to our consolidated financial statements for the year ended January 3, 2016 included in our Annual Report on Form 10-K for the fiscal year ended January 3, 2016. Critical accounting estimates are those that require application of management's most difficult, subjective or complex judgments, often as a result of matters that are inherently uncertain and may change in subsequent periods. There have been no material changes affecting our critical accounting policies for the six months ended July 3, 2016.
Management's Use of Non-GAAP Financial Measures
Adjusted EBITDA is a non-GAAP financial measure. We use Adjusted EBITDA in addition to net income, income from operations, and income before income taxes to assess our performance, and we believe it is important for investors to be able to evaluate us using the same measures used by management. We believe this measure is an important indicator of our operational strength and the performance of our business. Adjusted EBITDA as calculated by us is not necessarily comparable to similarly titled measures reported by other companies, and should not be considered as an alternative to net income, earnings per share, cash flows from operating activities or other financial information determined under GAAP.
Adjusted EBITDA is defined as earnings before interest, income taxes, depreciation and amortization, impairment and other lease charges, stock-based compensation expense and other income and expense. Adjusted EBITDA for each of our segments includes an allocation of general and administrative expenses associated with administrative support for executive management, information systems and certain accounting, legal, supply chain, human resources, development and other administrative functions.

25


Management believes that Adjusted EBITDA, when viewed with our results of operations calculated in accordance with GAAP and our reconciliation of Adjusted EBITDA to net income (i) provide useful information about our operating performance and period-over-period growth, (ii) provide additional information that is useful for evaluating the operating performance of our business and (iii) permit investors to gain an understanding of the factors and trends affecting our ongoing earnings, from which capital investments are made and debt is serviced. However, such measures are not measures of financial performance or liquidity under GAAP and, accordingly, should not be considered as alternatives to net income or cash flow from operating activities as indicators of operating performance or liquidity. Also these measures may not be comparable to similarly titled captions of other companies.
All of such non-GAAP financial measures have important limitations as analytical tools. These limitations include the following:
such financial information does not reflect our capital expenditures, future requirements for capital expenditures or contractual commitments to purchase capital equipment;
such financial information does not reflect interest expense or the cash requirements necessary to service payments on our debt;
although depreciation and amortization are non-cash charges, the assets that we currently depreciate and amortize will likely have to be replaced in the future, and such financial information does not reflect the cash required to fund such replacements; and
such financial information does not reflect the effect of earnings or charges resulting from matters that our management does not consider to be indicative of our ongoing operations. However, some of these charges (such as impairment and other lease charges, other income and expense and stock-based compensation expense) have recurred and may recur.
A reconciliation of Adjusted EBITDA to consolidated net income follows:
 
Three Months Ended
 
Six Months Ended
(Dollars in thousands)
July 3, 2016
 
June 28, 2015
 
July 3, 2016
 
June 28, 2015
Adjusted EBITDA: