Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] Quarterly report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended
July 2, 1997 or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period
from ___________ to __________
Commission file number 1-9364
FLAGSTAR CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3027522
- ------------------------- -------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
203 East Main Street
Spartanburg, South Carolina 29319-9966
- --------------------------------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(864) 597-8000
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of August 1, 1997, 440 shares of the registrant's Common Stock, par value
$0.01 per share, were outstanding, all of which are owned by the registrant's
parent, Flagstar Companies, Inc.
1
<PAGE>
Form 10-Q
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Flagstar Corporation
(Debtor-in-Possession)
Statements of Consolidated Operations
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Two Quarters Ended
July 2, June 30, July 2, June 30,
1997 1996 1997 1996
-------------- -------------- -------------- ---------
<S> <C> <C> <C> <C>
(In thousands)
Operating revenue $ 659,428 $ 626,570 $ 1,335,203 $ 1,176,995
------------ ------------ ----------- -----------
Operating expenses:
Product cost 192,261 192,520 389,953 359,438
Payroll and benefits 243,446 235,605 500,233 450,136
Depreciation and amortization expense 33,546 30,006 68,231 59,052
Utilities expense 26,508 24,329 53,988 47,083
Other 117,505 100,750 253,610 190,440
------------- ------------- ------------- -------------
613,266 583,210 1,266,015 1,106,149
------------- ------------- ------------ ------------
Operating income 46,162 43,360 69,188 70,846
Other charges:
Interest and debt expense - net 71,469 66,083 143,596 127,332
Other - net 2,205 172 3,756 156
-------------- ---------------- --------------- ----------------
Loss before reorganization expenses and taxes (27,512) (22,895) (78,164) (56,642)
Reorganization expenses 7,929 --- 11,936 ---
-------------------------------- --------------------------------
Loss before taxes (35,441) (22,895) (90,100) (56,642)
Provision for (benefit from) income taxes 378 (1,914) 1,002 (4,804)
-------------- --------------- --------------- ---------------
Net loss (35,819) (20,981) (91,102) (51,838)
============== =============== =============== ===============
</TABLE>
See accompanying notes
2
<PAGE>
Form 10-Q
Flagstar Corporation
(Debtor-in-Possession)
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
July 2, December 31,
1997 1996
(In thousands) ------------- ---------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 57,332 $ 92,358
Receivables, less allowance for doubtful accounts of:
1997 - $3,356; 1996 - $2,405 10,961 17,823
Loan receivable from former officer --- 13,922
Merchandise and supply inventories 31,127 31,543
Net assets held for sale --- 5,114
Other 32,839 29,895
------------ -------------
132,259 190,655
------------ ------------
Property:
Property owned (at cost):
Land 251,786 252,741
Buildings and improvements 893,063 891,512
Other property and equipment 541,695 536,886
------------ ------------
Total property owned 1,686,544 1,681,139
Less accumulated depreciation 673,384 629,676
------------ ------------
Property owned - net 1,013,160 1,051,463
------------ -----------
Buildings and improvements, vehicles, and other
equipment held under capital leases 223,382 210,533
Less accumulated amortization 104,719 93,740
------------ -------------
Property held under capital leases - net 118,663 116,793
------------ ------------
1,132,823 1,168,256
------------ -----------
Other assets:
Goodwill, net of accumulated amortization of: 1997 - $5,510
1996 - $3,077 210,469 205,389
Other intangible assets - net 28,105 27,595
Deferred financing costs - net 60,467 64,153
Other 40,780 37,385
------------- -------------
339,821 334,522
------------ -------------
Total assets $1,603,903 $1,693,433
========== ===========
</TABLE>
See accompanying notes
3
<PAGE>
Form 10-Q
Flagstar Corporation
(Debtor-in-Possession)
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
July 2, December 31,
1997 1996
(In thousands) ------------- ---------------
Liabilities
Liabilities not subject to compromise:
Current liabilities:
<S> <C> <C>
Current maturities of long-term debt $ 76,647 $ 62,885
Accounts payable 113,843 160,444
Accrued payroll and related 63,120 58,838
Accrued insurance 50,608 52,244
Accrued taxes 26,042 25,060
Accrued interest 16,495 51,220
Other 80,566 76,114
------------- ----------
427,321 486,805
------------- -----------
Long-term liabilities:
Debt, less current maturities 664,696 2,179,393
Deferred income taxes 15,796 16,361
Liability for self-insured claims 60,365 57,665
Other non-current liabilities and deferred credits 161,298 178,203
------------ ----------
902,155 2,431,622
------------ -----------
Notes payable to FCI --- 150,000
------------ -----------
Total liabilities not subject to compromise 1,329,476 3,068,427
Liabilities subject to compromise 1,740,523 ---
----------- -----------
Total liabilities 3,069,999 3,068,427
----------- -----------
Shareholders' deficit (1,466,096) (1,374,994)
----------- -----------
Total liabilities and shareholders' deficit $1,603,903 $1,693,433
========== ==========
</TABLE>
See accompanying notes
4
<PAGE>
Form 10-Q
Flagstar Corporation
(Debtor-in-Possession)
Statements of Consolidated Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Two Quarters Ended
July 2, 1997 June 30, 1996
------------ -------------
<S> <C> <C>
(In thousands)
Cash flows from operating activities:
Net loss $ (91,102) $ (51,838)
Adjustments to reconcile net loss to cash flows from
operating activities:
Depreciation and amortization of property 62,733 55,790
Amortization of other intangible assets 5,498 3,262
Amortization of deferred financing costs 5,301 3,804
Amortization of deferred gains (8,192) (4,454)
Deferred income tax benefit (500) (193)
Gains on sales of company-owned restaurants (641) (6,629)
Other 3,119 2,669
Decrease (increase) in assets:
Receivables 4,447 9,911
Inventories 1,606 600
Other current assets 10,126 20
Other assets (6,964) (7,504)
Increase (decrease) in liabilities:
Accounts payable (46,597) (29,569)
Accrued payroll and related 6,811 8,863
Accrued taxes 963 (7,758)
Other accrued liabilities 56,459 (6,899)
Other non-current liabilities and deferred credits (1,260) (1,236)
-------------- ------------
Net cash flows provided by (used in) operating activities 1,807 (31,161)
------------- ------------
Cash flows from investing activities:
Purchase of property (24,796) (9,658)
Proceeds from disposition of property 7,975 7,367
Acquisition of business, net of cash acquired --- (127,961)
Other - net (141) (50)
------------- ------------
Net cash flows used in investing activities (16,962) (130,302)
------------ ------------
</TABLE>
See accompanying notes
5
<PAGE>
Form 10-Q
Flagstar Corporation
(Debtor-in-Possession)
Statements of Consolidated Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Two Quarters Ended
July 2, 1997 June 30, 1996
------------ -------------
<S> <C> <C>
(In thousands)
Cash flows from financing activities:
Net borrowings under credit agreement $ 17,000 $ 57,400
Long-term debt payments (35,338) (20,469)
Deferred financing costs (1,533) (4,252)
------------- --------------
Net cash flows (used in) provided by financing activities (19,871) 32,679
------------- -------------
Decrease in cash and cash equivalents (35,026) (128,784)
Cash and cash equivalents at:
Beginning of period 92,358 196,966
------------- -------------
End of period $ 57,332 $ 68,182
============= =============
</TABLE>
See accompanying notes
6
<PAGE>
Form 10-Q
FLAGSTAR CORPORATION
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 2, 1997
(UNAUDITED)
Note 1. Basis of Presentation
Flagstar Corporation ("Flagstar" or, together with its subsidiaries, the
"Company") is a wholly-owned subsidiary of Flagstar Companies, Inc. Flagstar,
through its wholly-owned subsidiaries, Denny's Holdings, Inc., Spartan Holdings,
Inc. and FRD Acquisition Co. (and their respective subsidiaries), owns and
operates the Carrows, Coco's, Denny's, El Pollo Loco and Quincy's Family
Steakhouse restaurant brands, and is the largest franchisee of Hardee's.
The consolidated financial statements of Flagstar and its subsidiaries for the
quarter and two quarters ended July 2, 1997 and June 30, 1996 are unaudited and
include all adjustments management believes are necessary for a fair
presentation of the results of operations for such interim periods. All such
adjustments are of a normal and recurring nature. The interim consolidated
financial statements should be read in conjunction with the Consolidated
Financial Statements and notes thereto for the year ended December 31, 1996 and
the related Management's Discussion and Analysis of Financial Condition and
Results of Operations, both of which are contained in the Flagstar Corporation,
1996 Annual Report on Form 10-K (the "Flagstar 10-K"). The results of operations
for the quarter and two quarters ended July 2, 1997 are not necessarily
indicative of the results for the entire fiscal year ending December 31, 1997.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
Flagstar Holdings, Inc. ("Holdings"), a wholly-owned subsidiary of Flagstar,
filed on June 27, 1997, and FCI and Flagstar each filed on July 11, 1997, their
respective petitions for relief under Chapter 11 of Title 11 of the United
States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for
the District of South Carolina, Case Nos. 97-05431-B, 97-05795-B, and 97-
05796-B, respectively, with such cases to be jointly administered by the
Bankruptcy Court under Case No. 97-5431-B. The Company's operating subsidiaries,
Denny's Holdings, Inc., Spartan Holdings, Inc. and FRD Acquisition Co. (and
their respective subsidiaries), are not a party to and are unaffected by these
Chapter 11 proceedings (See Note 2). The financial statements of the Company
have been prepared on a going concern basis, which contemplates continuity of
operations, the realization of assets and the satisfaction of liabilities and
commitments in the ordinary course of business.
The Company's financial statements as of July 2, 1997 have been presented in
conformity with the AICPA's Statement of Position 90-7, "Financial Reporting By
Entities In Reorganization Under the Bankruptcy Code" ("SOP 90-7"). Accordingly,
all prepetition liabilities of Flagstar and Holdings (together with FCI,
collectively referred to as the "Debtors") that are subject to compromise under
the Plan (as defined in Note 2) are segregated in the Company's consolidated
balance sheets as liabilities subject to compromise. These liabilities are
recorded at the amounts expected to be allowed as claims by the Court rather
than estimates of the amounts for which those allowed claims may be settled as a
result of any plan of reorganization approved by the Court. As of the effective
date of the Plan, the Company will adopt "fresh start" reporting pursuant to the
guidance provided by SOP 90-7. Under "fresh start" reporting, the reorganization
value of the entity is allocated to the entity's assets. If any portion of the
reorganization value cannot be attributed to specific tangible or identified
intangible assets of the emerging entity, such amount is to be reported as
"reorganization value in excess of amounts allocable to identifiable assets".
The Company intends to amortize such amount over a five year amortization
period. As a result of adopting "fresh start" reporting upon emerging from
Chapter 11 status, the Company's financial statements will not be comparable
with those prepared before the Plan is confirmed, including the historical
financial statements included in this quarterly report.
Prior year's comparative balances have not been reclassified to conform with the
current year's balances stated under SOP 90-7. The most significant difference
between the current year and the prior year's presentations is the
reclassification of substantially all of the outstanding debt of the Debtors to
"liabilities subject to compromise". See Note 3 for a detailed description of
liabilities
7
<PAGE>
Form 10-Q
subject to compromise at July 2, 1997.
The consolidated financial statements include the accounts of the operating
subsidiaries of the Company which are not a party to the previously described
Chapter 11 proceedings. The following condensed financial statements of Flagstar
and Holdings have been prepared using the equity method of accounting for
reporting the results of all wholly-owned subsidiaries of Flagstar that are not
a party to such Chapter 11 proceedings.
Flagstar Corporation and Flagstar Holdings, Inc.
(Debtors-in-Possession)
Condensed Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Two Quarters Ended
July 2, 1997 July 2, 1997
----------------- ----------------
<S> <C> <C>
(In thousands)
Operating revenue $ --- $ ---
Operating expenses 3,552 13,050
----------------- ----------------
Operating loss (3,552) (13,050)
Equity in earnings of subsidiaries 21,991 26,868
Other charges:
Interest 46,286 92,933
Other 42 51
----------------- ----------------
Loss before reorganization expenses and taxes (27,889) (79,166)
Reorganization expenses 7,930 11,936
----------------- ----------------
Net loss $ (35,819) $ (91,102)
================= ================
</TABLE>
8
<PAGE>
Form 10-Q
Flagstar Corporation and Flagstar Holdings, Inc.
(Debtors-in-Possession)
Condensed Balance Sheet
(Unaudited)
<TABLE>
<CAPTION>
July 2, 1997
<S> <C>
(In thousands)
Assets
Current assets $ 2,665
Investment in operating subsidiaries, net (27,748)
Property owned, net 2,640
Property held under capital leases, net 2,522
Other assets:
Deferred financing costs 18,853
Receivable from operating subsidiaries 340,427
Other 22,294
--------------
Total assets $ 361,653
==============
Liabilities
Liabilities not subject to compromise
Current liabilities $ 27,723
--------------
Long-term liabilities:
Debt, less current maturities 1,169
Other non-current liabilities 58,334
--------------
59,503
--------------
Total liabilities not subject to compromise 87,226
Liabilities subject to compromise 1,740,523
--------------
Total liabilities 1,827,749
--------------
Shareholders' deficit (1,466,096)
--------------
Total liabilities and shareholders' deficit $ 361,653
==============
</TABLE>
9
<PAGE>
Form 10-Q
Note 2. Bankruptcy Filings and Proceedings
FCI, Flagstar, and Holdings have all filed voluntary petitions for relief under
Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the
District of South Carolina (the "Bankruptcy Court"). Holdings filed its petition
on June 27, 1997, and Flagstar and FCI both filed their petitions on July 11,
1997 (the "Petition Date"). The subsidiaries that operate the businesses of
Flagstar have not filed bankruptcy petitions and are not a party to and are
unaffected by the above mentioned Chapter 11 proceedings. The Debtors are
currently operating their businesses as debtors-in-possession pursuant to
Sections 1107(a) and 1108 of the Bankruptcy Code and subject to the jurisdiction
of the Bankruptcy Court.
FCI and Flagstar filed their Chapter 11 cases to implement their joint
prepackaged plan of reorganization (the "Plan" or the "Prepackaged Plan"). The
Bankruptcy Court has scheduled a confirmation hearing with respect to the Plan
on October 7, 1997. The Plan was developed in the course of negotiations with an
Ad Hoc Committee of holders of Flagstar's 11.25% Senior Subordinated Debentures
due 2004 (the "11.25% Debentures") and 11 3/8% Senior Subordinated Debentures
due 2003 (the "11 3/8% Debentures", and together with the 11.25% Debentures,
the "Senior Subordinated Debentures") and with the support of FCI's majority
shareholder. On March 24, 1997, FCI filed a Registration Statement on Form S-4
(No. 333-23875) (the "Registration Statement") with the Securities and Exchange
Commission (the "SEC") for the purpose of soliciting prepetition acceptances of
the Plan from holders of claims against or interests in FCI and Flagstar's
estates whose legal rights will be impaired by the Plan. On June 5, 1997, the
Registration Statement was declared effective by the SEC and FCI and Flagstar
commenced their solicitation of votes on the Plan. On July 7, 1997, FCI and
Flagstar completed their solicitation of votes on the Plan. The classes of
holders of Flagstar's 10 7/8% Senior Notes due 2002 and 10 3/4% Senior Notes due
2001 (together, the "Old Senior Notes") and the classes of holders of the Senior
Subordinated Debentures (which together represent approximately $1.5 billion in
claims), as well as the classes of FCI's currently outstanding preferred stock
(the "Old FCI Preferred Stock") and common stock (the "Old FCI Common Stock"),
voted to accept the Prepackaged Plan by the requisite majorities required by the
Bankruptcy Code. The only impaired class that voted to reject the Prepackaged
Plan was the class of holders of Flagstar's 10% Convertible Junior Subordinated
Debentures due 2014 (the "Junior Subordinated Debentures").
The Plan proposes to modify the rights of certain creditors of FCI and Flagstar
in the following manner: (a) FCI and Flagstar will merge into one holding
company ("Reorganized Flagstar"), (b) general unsecured claims will be
unimpaired, (c) each holder of Old Senior Notes will receive such holder's pro
rata portion of 100% of 11 1/4% Senior Notes due 2007 of Reorganized Flagstar in
exchange for 100% of the principal amount of Old Senior Notes and accrued
interest (subject to the right of Reorganized Flagstar to pay accrued interest
in cash), (d) each holder of Senior Subordinated Debentures will receive such
holder's pro rata portion of $0.01 par value common stock of Reorganized
Flagstar (the "New Common Stock") equivalent to 95.5% of the new Common Stock to
be outstanding upon the effective date of the Plan (the "Effective Date"), plus
the remaining 4.5% of the New Common Stock and certain warrants to be
outstanding on the Effective Date that otherwise would have gone to holders of
the Junior Subordinated Debentures, the Old FCI Preferred Stock, and the Old FCI
Common Stock, had the class of Junior Subordinated Debentures accepted the Plan.
Because the class of Junior Subordinated Debentures voted to reject the Plan,
that class is not entitled to a recovery under the Plan. See Note 3 for
information regarding such claims. Notwithstanding the terms of the Plan,
holders of the Senior Subordinated Debentures have agreed to make distributions
to holders of the Old FCI Preferred Stock and Old FCI Common Stock because the
classes of Old FCI Preferred Stock and Old FCI Common Stock each voted to accept
the Plan. Specifically, the holders of the Senior Subordinated Debentures have
agreed to transfer (x) 1.25% of the New Common Stock to be outstanding on the
Effective Date to the holders of Old FCI Preferred Stock and (y) warrants to
purchase New Common Stock representing 7% of the New Common Stock on a
fully-diluted basis to the holders of Old FCI Common Stock.
The Plan's classification of the Junior Subordinated Debentures as subordinate
to the Senior Subordinated Debentures has been challenged by holders of the
Junior Subordinated Debentures and is now the subject of litigation before the
Bankruptcy Court. On July 15, 1997, the Debtors and the Ad Hoc Committee of
holders of Senior Subordinated Debentures filed a motion with the Bankruptcy
Court (the "Classification Motion") seeking the entry of an order confirming the
classifications in the Plan and enforcing the subordination provisions of the
Junior Subordinated Debentures as provided in the Indenture dated November 1,
1989 and Supplemental Indenture dated as of August 7, 1992 between Flagstar and
the United States Trust Company of New York. On July 24, 1997, the United States
Trustee appointed an Official Committee of Convertible Junior Debentureholders
(the "Official Junior Committee"). The Official Junior Committee has indicated
that it will oppose the Classification Motion. A hearing on the Classification
Motion is scheduled to commence on September 30, 1997. Inasmuch as the
supplemental indenture was duly executed and delivered by Flagstar and the
trustee for the Junior Subordinated Debentures pursuant to the requirements
under the indenture therefor, the Company believes such assertion is completely
without merit and that such supplemental indenture was validly effected. If,
however, the Bankruptcy Court were to determine, as asserted by holders of the
Junior Subordinated Debentures, that the Junior Subordinated Debentures are pari
passu with the Old Senior Notes and Senior Subordinated Debentures, it may be
unable or unwilling to confirm
10
<PAGE>
Form 10-Q
the Plan. If the Plan were not to be confirmed, it is unclear whether a
reorganization could be implemented and what holders of Claims and Interests
would ultimately receive with respect to their Claims and Interests. If an
alternative reorganization could not be agreed to, it is possible that FCI and
Flagstar would have to liquidate their assets, in which case it is likely that
Holders of Claims and Interests would receive less than they would have received
pursuant to the Plan.
On June 17, 1997, prior to the filing of Holdings, FCI and Flagstar's voluntary
petitions for relief under Chapter 11 of the Bankruptcy Code, GEM Convertible
Securities Partners, L.P., Georgica Partners, Oak Tree Partners, L.P., and
Maurice A. Halperin, alleged holders of the Junior Subordinated Debentures,
filed an involuntary petition under Chapter 11 of the Bankruptcy Code against
Flagstar. On June 18, 1997, Flagstar filed an emergency motion seeking to
suspend the involuntary petition for 30 days to permit Flagstar to conclude its
prepetition solicitation of votes on the Plan and to extend the deadline to
answer the involuntary petition (the "Emergency Motion"). A hearing was held
to consider the Emergency Motion on June 23, 1997. At the hearing,
representatives of Flagstar, representatives of certain holders of the Old
Senior Notes, representatives of certain holders of the Senior Subordinated
Debentures, and representatives of certain holders of the Junior Subordinated
Debentures engaged in negotiations and reached a settlement the terms of which
included the dismissal of the involuntary petition. On June 30, 1997, the
parties filed a joint motion to withdraw the involuntary petition and to dismiss
the Chapter 11 case against Flagstar. On July 9, 1997, the Bankruptcy Court
entered an order approving the withdrawal of the involuntary petition and
dismissing the Chapter 11 case against Flagstar.
On the Petition Date, the Debtors filed a motion seeking approval of a $200
million Debtor-in-Possession financing facility (the "DIP Facility") between
FCI, Flagstar, Holdings, subsidiaries of Flagstar, and The Chase Manhattan Bank
("Chase"). At a hearing on July 15, 1997, the Bankruptcy Court entered an
interim order (the "Interim DIP Order") authorizing the Debtors to obtain up to
$135 million in emergency post-petition credit through a combination of a
revolving credit facility and a letter of credit facility. The Interim DIP Order
authorized the Debtors to use funds from the facility for working capital and to
refinance and replace existing credit under its prepetition credit agreement
with a syndicate of banks (the "Credit Agreement"). On July 16, 1997, the
initial extensions of credit were made pursuant to the Interim DIP Order. On
August 12, 1997, the Bankruptcy Court entered a final order authorizing the
Debtors to access the entire $200 million DIP Facility.
Under Section 365 of the Bankruptcy Code, the Debtors have the right, subject to
Bankruptcy Court approval, to assume or reject any executory contracts and
unexpired leases. As described more fully in the Plan, if an executory contract
or unexpired lease entered into before the Petition Date is rejected by FCI or
Flagstar, it will be treated as if FCI or Flagstar breached such contract or
lease on the date immediately preceding the Petition Date, and the other party
to the agreement may assert an unsecured claim for damages incurred as a result
of the rejection. In the case of the rejection of employment agreements and real
property leases, damages are subject to certain limitations imposed by Sections
365 and 502 of the Bankruptcy Code.
Pursuant to Section 362 of the Bankruptcy Code, the commencement of each of the
Debtors' Chapter 11 cases operates as an automatic stay, applicable to all
entities, of the following: (i) commencement or continuation of a judicial,
administrative, or other proceeding against any of the Debtors that was or could
have been commenced prior to commencement of that Debtor's Chapter 11 case, or
to recover for a claim that arose before the commencement of each Debtor's
Chapter 11 case; (ii) enforcement of any judgments against any of the Debtors
that arose before the commencement of that Debtor's Chapter 11 case; (iii) the
taking of any action to obtain possession of or to exercise control over the
property of Debtors; (iv) the creation, perfection or enforcement of any lien
against the property of the Debtors; (v) the taking of any action to collect,
assess, or recover a claim against any of the Debtors that arose before the
commencement of that Debtor's Chapter 11 case; or (vi) the setoff of any debt
owing to any of the Debtors that arose prior to commencement of that Debtor's
Chapter 11 case against a claim held by such creditor of or party-in-interest
against the Debtor that arose before the commencement of that Debtor's Chapter
11 case. Any entity may apply to the Bankruptcy Court for relief from the
automatic stay to allow enforcement of any of the aforesaid remedies that are
automatically stayed by operation of law at the commencement of the Debtors'
Chapter 11 cases.
Although the Debtors are authorized to operate their businesses as
debtors-in-possession, they may not engage in transactions outside the ordinary
course of business without first complying with the notice and hearing
provisions of the Bankruptcy Code and obtaining Bankruptcy Court approval. The
Debtors are required to pay certain expenses of the Official Junior Committee,
including counsel and professional fees, to the extent allowed by the Bankruptcy
Court. Other parties in interest in the Chapter
11
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Form 10-Q
11 cases are also entitled to be heard on motions made in the Chapter 11 cases,
including motions for approval of transactions outside the ordinary course of
business.
For 180 days after the Petition Date, the Debtors have the exclusive right to
propose and file an alternative or modified plan of reorganization and the
exclusive right to solicit acceptances thereon. A hearing on the Debtors'
disclosure statement, solicitation of votes, and confirmation of the Plan is
currently scheduled for October 7, 1997.
Note 3. Liabilities Subject to Compromise
Liabilities subject to compromise are obligations which were outstanding on the
Petition Date and are subject to compromise under the terms of the Plans.
July 2, 1997
(In thousands)
10 3/4% Senior Notes Due 2001 $ 270,000
10 7/8% Senior Notes Due 2002 280,025
11.25% Senior Subordinated Debentures Due 2004 722,411
11 3/8% Senior Subordinated Debentures Due 2003 125,000
10% Convertible Junior Subordinated Debentures Due 2014 99,259
Notes payable to FCI 150,000
Accrued interest 93,828
------------
Total liabilities subject to compromise $ 1,740,523
===========
Note 4. Reorganization Items
Reorganization items included in the accompanying statements of operations
consist of the following items:
(In thousands)
Professional fees $ 9,371
Debtor-in-possession financing expenses 586
Other reorganization items 1,979
---------------
$ 11,936
===============
Note 5. Change in Fiscal Year
Effective January 1, 1997, the Company changed its fiscal year end from December
31 to the last Wednesday of the calendar year. Concurrent with this change, the
Company changed to a four-four-five week quarterly closing calendar which is the
restaurant industry standard, and generally results in four thirteen-week
quarters during the year with each quarter ending on a Wednesday. Due to the
timing of this change, the two quarters ended July 2, 1997 include more than
twenty-six weeks of operations. Carrows and Coco's include an additional six
days, Denny's includes an additional five days, El Pollo Loco includes an
additional week and Hardee's and Quincy's include an additional day.
Note 6. Debt in Default
On March 17, 1997, in connection with the Prepackaged Plan described in Note 2,
Flagstar elected not to make the $7.1 million interest payment due and payable
as of that date to holders of the 11 3/8% Debentures. In addition, on May 1,
1997, also in connection with the Prepackaged Plan described in Note 2, Flagstar
elected not to make the $40.6 million and $5.0 million interest payments due and
payable as of that date to holders of the 11.25% Debentures and the Junior
Subordinated Debentures, respectively. As a result of these nonpayments, and as
a result of a continuation of such nonpayments for 30 days past their respective
due dates, Flagstar is in default under the terms of the indentures governing
such debentures. As described in more
12
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Form 10-Q
detail in Note 2 to the financial statements, the bankruptcy filings operate as
an automatic stay of all collection and enforcement actions by the holders of
the 11 3/8% Debentures, 11.25% Debentures, Junior Subordinated Debentures and
the respective indenture trustees with respect to the Debtors' failure to make
the interest payments when due.
Note 7. Commitments and Contingencies
The Company's Hardee's restaurants are operated under licenses from Hardee's
Food Systems, Inc. ("HFS"). The Company does not believe HFS has satisfied its
contractual obligations to support the Hardee's franchise and on March 19, 1997,
the Company notified HFS, pursuant to its various license agreements, that its
subsidiary was seeking to arbitrate certain claims of the subsidiary against
HFS. In its demand for arbitration, the Company's subsidiary alleges (i) breach
by HFS of its license agreements with the Company's subsidiary, (ii) breach of
fiduciary duty and negligence by HFS in mishandling and misapplying funds of the
Company's subsidiary held for advertising, and (iii) unfair trade practices. No
assurances can be given as to the outcome of such arbitration proceeding or its
impact on the Company's Hardee's operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to highlight significant changes in
financial position as of July 2, 1997 and the results of operations for the
quarter and two quarters ended July 2, 1997 as compared to the corresponding
1996 periods.
The forward-looking statements included in Management's Discussion and Analysis
of Financial Condition and Results of Operations, which reflect management's
best judgment based on factors currently known, involve risks, uncertainties,
and other factors which may cause the actual performance of Flagstar,
its subsidiaries, and underlying concepts to be materially different from the
performance indicated or implied by such statements. Such factors include, among
others: uncertainties related to the bankruptcy filings referred to in Note 2
and the arbitration proceeding referred to in Note 7 in the consolidated
financial statements included herein; competitive pressures from within the
restaurant industry; the level of success of the Company's operating initiatives
and advertising and promotional efforts, including the initiatives and efforts
specifically mentioned herein; adverse publicity; changes in business strategy
or development plans; terms and availability of capital; regional weather
conditions; overall changes in the general economy, particularly at the retail
level; and other factors included in the discussion below, or in the
Management's Discussion and Analysis and in Exhibit 99 to the Company's Annual
Report on Form 10-K for the period ended December 31, 1996.
Chapter 11 Proceedings
As discussed in Note 2 to the financial statements, FCI and two of its
subsidiaries, Flagstar and Holdings, filed voluntary petitions for
reorganization under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court.
The Debtors have sought bankruptcy protection in order to implement the
Prepackaged Plan of FCI and Flagstar which, if confirmed, would effect a major
financial restructuring that would enable FCI and Flagstar to service their
remaining debt obligations. The Prepackaged Plan was developed with the full
support of FCI's largest shareholder and through negotiations with an Ad Hoc
Committee of holders of the Senior Subordinated Debentures, the Debtors' largest
class of debtholders. The only impaired class that voted to reject the
Prepackaged Plan was the class of holders of the Junior Subordinated Debentures.
13
<PAGE>
Form 10-Q
The Bankruptcy Court has scheduled a confirmation hearing with respect to the
Plan on October 7, 1997. The Plan proposes to modify the rights of certain
creditors of FCI and Flagstar in the following manner: (a) FCI and Flagstar will
merge into one holding company, Reorganized Flagstar, (b) general unsecured
claims will be unimpaired, (c) each holder of Old Senior Notes will receive such
holder's pro rata portion of 100% of 11 1/4% Senior Notes due 2007 of
Reorganized Flagstar in exchange for 100% of the principal amount of Old Senior
Notes and accrued interest (subject to the right of Reorganized Flagstar to pay
accrued interest in cash), (d) each holder of Senior Subordinated Debentures
will receive such holder's pro rata portion of the New Common Stock equivalent
to 95.5% of the New Common Stock to be outstanding upon the Effective Date, plus
the remaining 4.5% of the New Common Stock and certain warrants to be
outstanding on the Effective Date that otherwise would have gone to holders of
the Junior Subordinated Debentures, the Old FCI Preferred Stock, and the Old FCI
Common Stock, had the class of Junior Subordinated Debentures accepted the Plan.
Because the class of Junior Subordinated Debentures voted to reject the Plan,
that class is not entitled to a recovery under the Plan. See Note 3 for
information regarding such claims. Notwithstanding the terms of the Plan,
holders of the Senior Subordinated Debentures have agreed to make distributions
to holders of the Old FCI Preferred Stock and Old FCI Common Stock because the
classes of Old FCI Preferred Stock and Old FCI Common Stock each voted to accept
the Plan. Specifically, the holders of the Senior Subordinated Debentures have
agreed to transfer (x) 1.25% of the New Common Stock to be outstanding on the
Effective Date to the holders of Old FCI Preferred Stock and (y) warrants to
purchase New Common Stock representing 7% of the New Common Stock on a
fully-diluted basis to the holders of Old FCI Common Stock.
The Plan's classification of the Junior Subordinated Debentures as subordinate
to the Senior Subordinated Debentures has been challenged by holders of the
Junior Subordinated Debentures and is now the subject of litigation before the
Bankruptcy Court. On July 15, 1997, the Debtors and the Ad Hoc Committee of
holders of Senior Subordinated Debentures filed the Classification Motion with
the Bankruptcy Court seeking the entry of an order confirming the
classifications in the Plan and enforcing the subordination provisions of the
Junior Subordinated Debentures as provided in the Indenture dated November 1,
1989 and Supplemental Indenture dated as August 7, 1992 between Flagstar and the
Indenture Trustee. On July 24, 1997, the United States Trustee appointed the
Official Junior Committee. The Official Junior Committee has indicated that it
will oppose the Classification Motion. A hearing on the Classification Motion is
scheduled to commence on September 30, 1997. Inasmuch as the supplemental
indenture was duly executed and delivered by Flagstar and the trustee for the
Junior Subordinated Debentures pursuant to the requirements under the indenture
therefor, the Company believes such assertion is completely without merit and
that such supplemental indenture was validly effected. If, however, the
Bankruptcy Court were to determine, as asserted by holders of the Junior
Subordinated Debentures, that the Junior Subordinated Debentures are pari passu
with the Old Senior Notes and Senior Subordinated Debentures, it may be unable
or unwilling to confirm the Plan; if the Plan were not to be confirmed, it is
unclear whether a reorganization could be implemented and what holders of Claims
and Interests would ultimately receive with respect to their Claims and
Interests. If an alternative reorganization could not be agreed to, it is
possible that the Company and Flagstar would have to liquidate their assets, in
which case it is likely that Holders of Claims and Interests would receive less
than they would have received pursuant to the Plan.
The Debtors believe that the Plan provides a fair allocation of value that (a)
reflects the priority rights of the respective classes of claims and interests,
(b) is consistent with the requirements of the Bankruptcy Code, (c) is capable
of being confirmed on a prompt basis, and (d) will allow the Debtors to emerge
from the bankruptcy process with significantly improved financial stability.
Results of Operations
Quarter Ended July 2, 1997 Compared to Quarter Ended June 30, 1996
Flagstar Consolidated
The Company's CONSOLIDATED REVENUE for the second quarter of 1997 increased by
$32.9 million (5.2%) as compared with the 1996 comparable quarter. This increase
reflects the $73.1 million positive impact of a full quarter of operations of
Coco's and Carrows in the 1997 quarter in comparison to one month in the prior
year quarter. Excluding the impact of the Coco's and Carrows acquisition,
revenue for the 1997 quarter decreased $40.2 million in comparison to the prior
year quarter. This decrease reflects decreases in comparable store sales at all
of the Company's concepts except for El Pollo Loco, as well as a 26-unit
decrease in Company-owned units (excluding Coco's and Carrows). Such decreases
are slightly offset by a $2.3 million increase in franchise revenue due to a
108-unit increase in franchise units at Denny's and El Pollo Loco.
CONSOLIDATED OPERATING EXPENSES for the second quarter of 1997 increased by
$30.1 million (5.2%) as compared with the 1996 comparable quarter. The expense
increase is primarily attributable to a $68.5 million impact due to the
additional two months of operations of Coco's and Carrows in the current year
quarter in comparison to the prior year quarter. Excluding the impact
14
<PAGE>
Form 10-Q
of the Coco's and Carrows acquisition, operating expenses for the 1997 quarter
decreased $38.5 million in comparison to the prior year quarter. This decrease
primarily reflects a decline in costs associated with the decline in revenue,
the positive impact of cost cutting measures, and a 26-unit decrease in
Company-owned units (excluding Coco's and Carrows). Such decreases are somewhat
offset by an increase in general and administrative expenses related to
retention and other bonuses totaling $1.9 million and company contributions to
the profit sharing plan of $0.7 million (no contributions were made in the prior
year).
CONSOLIDATED OPERATING INCOME for the first quarter of 1997 increased by $2.8
million (6.5%) as compared with the 1996 comparable quarter as a result of the
factors noted above.
CONSOLIDATED INTEREST AND DEBT EXPENSE, NET totaled $71.5 million during the
1997 quarter as compared with $66.1 million during the comparable 1996 period.
The increase is due principally to the addition of $5.0 million of interest and
debt expense associated with the Coco's and Carrows acquisition in May 1996 and
a $1.1 million decrease in interest income during 1997 due to decreased cash and
cash equivalents subsequent to the purchase of Coco's and Carrows, partially
offset by a decline of $0.7 million in interest expense during the 1997 quarter
associated with lower interest rates related to interest rate exchange
agreements.
REORGANIZATION EXPENSES include professional fees and other expenditures
incurred by the Company in conjunction with the reorganization under Chapter 11
of the Bankruptcy Code as further discussed in Note 2 to the consolidated
financial statements included herein.
THE PROVISION (BENEFIT) FOR INCOME TAXES from continuing operations for the
quarter has been computed based on management's estimate of the annual effective
income tax rate applied to loss before taxes. The Company recorded an income tax
provision reflecting an effective income tax rate of approximately 1.1% for the
1997 quarter compared to a benefit for the comparable 1996 quarter reflecting an
approximate rate of (8.4%). The change in the effective income tax rate from the
prior year can be attributed to the recognition in the prior year of anticipated
refunds due to the carryback of prior year tax losses.
THE NET LOSS was $35.8 million in the 1997 quarter as compared to $21.0 million
for the prior year quarter. The increase in the net loss is due to the factors
noted above.
15
<PAGE>
Form 10-Q
Restaurant Operations:
The table below summarizes restaurant unit activity for the quarter ended July
2, 1997.
<TABLE>
<CAPTION>
Units Converted
from Company
Ending Units Units Units to Franchise Ending Units Ending Units
4/2/97 Opened Closed (Turnkeys) 7/2/97 6/30/96
Denny's
<S> <C> <C> <C> <C> <C> <C>
Company owned 891 1 --- (1) 891 911
Franchised 694 25 (4) 1 716 628
International licensees 25 1 --- --- 26 26
-------- --------- --------- --------- -------- --------
1,610 27 (4) --- 1,633 1,565
Hardee's 580(a) --- (1) --- 579(a) 580
Quincy's 199 --- (1) --- 198(b) 199
El Pollo Loco
Company owned 95 --- --- (1) 94 98
Franchised 139(a) 4 (1) 1 143(a) 126
International licensees 10 --- --- --- 10 7
-------- --------- --------- --------- -------- --------
244 4 (1) --- 247 231
Coco's
Company owned 184 2 (1) --- 185 184
Franchised 5 2 --- --- 7 6
International licensees 281 5 --- --- 286 261
------- --------- --------- --------- ------- -------
470 9 (1) --- 478 451
Carrows
Company owned 158 --- (2) --- 156 162
Franchised 1 --- --- --- 1 ---
--------- --------- --------- --------- --------- ---------
159 --- (2) --- 157 162
------- --------- --------- --------- ------- -------
3,262 40 (10) --- 3,292 3,188
====== ======== ======== ========= ====== ======
</TABLE>
(a) Unit count includes one Hardee's and El Pollo Loco dual unit.
(b) Unit decrease reflects unit temporarily closed for conversion.
16
<PAGE>
Form 10-Q
<TABLE>
<CAPTION>
Denny's:
Quarter Ended %
<C> <C> <C>
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
Net company sales $ 281.2 $ 303.3 (7.3)
Franchise revenue 15.2 13.4 13.4
-------------- ---------------
Total revenue 296.4 316.7 (6.4)
Operating expenses 266.3 285.0 (6.6)
------------- --------------
Operating income $ 30.1 $ 31.7 (5.0)
============= ==============
Average unit sales
Company-operated $ 315,700 $ 330,700 (4.5)
Franchise $ 266,200 $ 273,600 (2.7)
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales increase (decrease) (5.5%) 1.7%
Average guest check $ 5.55 $ 4.92 12.8
</TABLE>
Denny's NET COMPANY SALES decreased by $22.1 million (7.3%) during the 1997
quarter as compared with the prior year comparable quarter. This decrease
reflects 20 fewer Company-owned units and a decline in comparable store sales.
The decrease in Company-owned units, the majority of which were converted to
franchise units, is consistent with the Company's strategy of focusing on growth
through franchising and the sale of Company-owned restaurants to franchisees,
along with selected restaurant closures where continued operation is considered
uneconomical. The decline in comparable store sales was driven by lower guest
counts, partially offset by an increase in average guest check, with both
changes reflecting the impact of the September 1996 price increase that
eliminated certain value pricing. FRANCHISE REVENUE for the quarter increased by
$1.8 million (13.4%), reflecting 88 more franchised units at the 1997
quarter-end than at the 1996 quarter-end.
Denny's OPERATING EXPENSES for the 1997 quarter as compared with the 1996
quarter decreased by $18.7 million (6.6%), reflecting the impact of 20 fewer
Company-owned units; an improvement in food cost as a percent of revenue because
of a shift to higher margin items in the 1997 quarter; and a $1.5 million
increase in the current quarter amortization of the deferred gains attributable
to the sales of Proficient Food Company, Portion-Trol Foods, Inc. and Mother
Butler Pies over the prior quarter amounts. This decrease is somewhat offset by
increased costs for coffee, bacon and sausage; the impact of increases in the
Federal and state minimum wage rates; and labor productivity declines associated
with lower guest counts. In addition, operating expenses in the prior year
quarter included $6.1 million of gains on sales of restaurants to franchisees in
comparison to $0.2 million in the current year quarter.
Denny's OPERATING INCOME for the 1997 quarter decreased by $1.6 million (5.0%)
as compared to the prior year quarter as a result of the factors noted above.
17
<PAGE>
Form 10-Q
<TABLE>
<CAPTION>
Hardee's:
Quarter Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Revenue $ 145.4 $ 160.0 (9.1)
Operating expenses 136.2 151.8 (10.3)
-------------- --------------
Operating income $ 9.2 $ 8.2 12.2
=============== ===============
Average unit sales $ 250,800 $ 275,900 (9.1)
COMPARABLE STORE DATA:
Comparable store sales decrease (9.4%) (7.0%)
Average guest check $ 3.33 $ 3.11 7.1
</TABLE>
Hardee's REVENUE decreased by $14.6 million (9.1%) during the 1997 quarter as
compared with the 1996 quarter, reflecting a 9.4% decline in comparable store
sales. The decrease in comparable store sales reflects a decline in traffic
which was partially offset by an increase in average guest check. The decrease
in traffic count reflects the impact of continuing aggressive promotions by
competitors within the quick-service category compounded by the persistent
weakness of Hardee's brand positioning and advertising programs.
Hardee's OPERATING EXPENSES in the 1997 quarter decreased by $15.6 million
(10.3%), reflecting a decrease in advertising expense in comparison to the prior
year, the impact of the cost reduction program implemented in the second half of
1996, and the impact on expenses of the lower comparable store sales noted
above. These decreases are somewhat offset by the Federal minimum wage rate
increase and the fact that certain labor and other fixed costs cannot be reduced
in proportion to the significant decline in sales.
Hardee's OPERATING INCOME for the 1997 quarter increased by $1.0 million (12.2%)
as compared to the prior year quarter as a result of the factors noted above.
18
<PAGE>
Form 10-Q
Quincy's:
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Revenue $ 61.8 $ 66.7 (7.3)
Operating expense 59.4 64.9 (8.5)
-------------- ----------------
Operating income $ 2.4 $ 1.8 33.3
============== =================
Average unit sales $ 311,800 $ 335,000 (6.9)
COMPARABLE STORE DATA:
Comparable store sales decrease (7.3%) (10.9%)
Average guest check $ 6.31 $ 5.80 8.8
</TABLE>
Quincy's REVENUE decreased by $4.9 million (7.3%) during the 1997 quarter as
compared with the 1996 quarter, reflecting a 7.3% decline in comparable store
sales. The decrease in comparable store sales resulted from a decrease in
traffic which was partially offset by an increase in average guest check. The
decline in customer traffic reflects, among other things, continuing traffic
declines in the family-steak category in general and the difficulty, in spite of
product quality improvements and increased emphasis on consistency of service,
of "winning back" Quincy's customers that have been lost over the past several
years.
Quincy's OPERATING EXPENSES in the 1997 quarter decreased by $5.5 million
(8.5%), reflecting a decrease in product costs due to various cost reduction
initiatives, as well as a decrease in advertising expense in the current quarter
in comparison to the prior year quarter. This decrease is somewhat offset by
increased product costs as a percent of revenue due to the higher quality food
items offered as part of management's efforts to "win back" customers; increased
labor costs due to the Federal minimum wage increase; and the fact that there is
a base level of labor and other fixed costs necessary regardless of sales
levels.
Quincy's OPERATING INCOME for the 1997 quarter increased by $0.6 million as
compared to the prior year quarter as a result of the factors noted above.
19
<PAGE>
Form 10-Q
El Pollo Loco:
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 29.5 $ 29.9 (1.3)
Franchise revenues 3.9 3.4 14.7
---------------- ----------------
Total revenue 33.4 33.3 ---
Operating expense 29.3 29.0 1.0
--------------- ---------------
Operating income $ 4.1 $ 4.3 (4.7)
=============== ===============
Average unit sales
Company-operated $ 311,200 $ 298,600 4.2
Franchise $ 222,300 $ 219,000 1.5
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales increase 1.9% 8.5%
Average guest check $ 6.80 $ 6.37 6.8
</TABLE>
El Pollo Loco's NET COMPANY SALES decreased $0.4 million (1.3%) during the 1997
quarter as compared with the 1996 quarter. This decrease reflects the impact of
a four-unit decrease in Company-owned units somewhat offset by an increase in
comparable store sales. The decrease in Company-owned units, all of which were
converted to franchise units, is consistent with the Company's strategy of
focusing on growth through franchising and the sale of Company-owned restaurants
to franchisees. The increase in comparable store sales was driven by a higher
guest check average, reflecting a shift in promotional emphasis during the
second quarter of 1997 in comparison to the prior year quarter. In 1997, El
Pollo Loco ran two "large meal" promotions and one "small meal" promotion in
comparison to one "large meal" and two "small meal" promotions during the year
ago period. This shift also resulted in a decrease in guest counts in comparison
to the prior year. FRANCHISE REVENUE for the quarter increased by $0.5 million
(14.7%), primarily due to 20 more franchise units at the 1997 quarter-end as
compared with the 1996 quarter-end and an increase in franchise average unit
sales.
El Pollo Loco's OPERATING EXPENSES for the 1997 quarter as compared with the
1996 quarter increased by $0.3 million (1.0%) primarily due to the expenses
related to El Pollo Loco's current reengineering project and increased
advertising expenses. This increase is somewhat offset by the impact of the
four-unit decrease in Company-owned units; lower chicken costs in comparison to
the prior year; a decrease in direct labor costs due to improved labor
scheduling and staffing initiatives; and food cost control measures.
El Pollo Loco's OPERATING INCOME for the 1997 quarter decreased by $0.2 million
(4.7%) as compared to the prior year quarter as a result of the factors noted
above.
20
<PAGE>
Form 10-Q
Coco's and Carrows:
The following information is provided for analysis purposes only as it includes
information for periods prior to the acquisition of Coco's and Carrows by the
Company on May 23, 1996:
Coco's
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 67.6 $ 68.5 (1.3)
Franchise revenue 1.4 1.0 40.0
--------------- ----------------
Total revenue 69.0 69.5 (0.7)
Operating expenses 63.6 68.9 (7.7)
-------------- ----------------
Operating income $ 5.4 $ 0.6 NM
============== ================
Average unit sales
Company-operated $ 367,400 $ 370,900 (0.9)
Franchise $ 434,000 $ 427,300 1.6
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales decrease (1.5%) (2.8%)
Average guest check (a) $ 6.73 $ 6.90 (2.5)
</TABLE>
NM = Not meaningful
(a) The method for determining weekly customer traffic and average guest check
was changed in September 1996 in order to better conform to Flagstar's
methodology. Amounts for periods prior to September 1996 have not been restated.
Relative to Coco's, the new method will generally result in higher weekly
traffic counts and lower average guest checks than calculated under the previous
method.
Coco's NET COMPANY SALES for the quarter ending July 2, 1997 decreased $0.9
million (1.3%) as compared to the prior year comparable quarter. This decrease
reflects a decrease in comparable store sales driven by a decrease in average
check, slightly offset by an increase in customer counts. In addition, the
company experienced a net increase of one company-owned unit from the comparable
quarter in 1996.
FRANCHISE AND FOREIGN LICENSING REVENUE increased by $0.4 million (40.0%) for
the second quarter of 1997 as compared to the prior year quarter. This increase
is a result of one additional domestic franchise unit as well as an increase in
the number of foreign licenses from 261 at June 27, 1996 to 286 at July 2, 1997.
Coco's OPERATING EXPENSES for the second quarter of 1997 decreased by $5.3
million (7.7%) as compared to the prior year quarter. This decrease reflects the
impact of approximately $1.6 million in non-recurring adjustments which
increased legal and worker's compensation expenses in the prior year quarter and
also reflects current year savings in product and labor costs due to increased
focus by operations on minimizing product waste and reducing kitchen prep labor.
Such cost savings were achieved despite the impact of Federal and state minimum
wage rate increases and increased commodity prices for coffee and bacon.
OPERATING INCOME for Coco's for the quarter ended July 2, 1997 as compared to
the prior year quarter increased $4.8 million due to the factors noted above.
21
<PAGE>
Form 10-Q
Carrows
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 53.3 $ 55.9 (4.6)
Franchise revenue 0.1 --- ---
--------------- ------------------
Total revenue 53.4 55.9 (4.5)
Operating expenses 50.3 55.3 (9.0)
-------------- ----------------
Operating income $ 3.1 $ 0.6 NM
============== ================
Average unit sales
Company-operated $ 339,600 $ 343,600 (1.2)
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales increase (decrease) (3.2%) 1.2%
Average guest check (a) $ 6.50 $ 6.30 3.2
</TABLE>
NM = Not meaningful
(a) The method for determining weekly customer traffic and average guest check
was changed in September 1996 in order to better conform to Flagstar's
methodology. Amounts for periods prior to September 1996 have not been restated.
Relative to Carrows, the new method will generally result in lower weekly
traffic counts and higher average guest checks than calculated under the
previous method.
Carrows' NET COMPANY SALES decreased $2.6 million (4.6%) for the quarter ended
July 2, 1997 as compared to the prior year comparable quarter, reflecting the
impact of a six-unit decrease in the number of company-operated restaurants and
a decrease in comparable store sales. The decline in comparable store sales
reflects a decrease in guest counts, partially offset by an increase in average
check. Carrows opened its first domestic franchise location in the first quarter
of 1997.
Carrows' OPERATING EXPENSES for the quarter ended July 2, 1997 decreased by $5.0
million (9.0%) as compared to the prior year quarter. This decrease reflects the
impact of approximately $1.5 million of non-recurring adjustments which
increased legal and worker's compensation expenses in the prior year quarter and
also reflects current year savings in product and labor costs due to increased
focus by operations on minimizing product waste and reducing kitchen prep labor.
Such cost savings were achieved despite the impact of the Federal and state
minimum wage rate increases and increased commodity prices for coffee and bacon.
OPERATING INCOME for Carrows for the quarter ended July 2, 1997 as compared to
the prior year quarter increased $2.5 million due to the factors noted above.
22
<PAGE>
Results of Operations
Two Quarters Ended July 2, 1997 Compared to Two Quarters Ended June 30, 1996
Flagstar Consolidated
The Company's CONSOLIDATED REVENUE for the two quarters ended July 2, 1997
increased by $158.2 million (13.4%) as compared with the 1996 comparable period.
This increase is primarily attributable to two factors: the estimated $24.0
million impact due to the additional days in the two quarters ended July 2, 1997
in comparison to the prior year period and the $200.2 million impact of an
additional five months of operations of Coco's and Carrows in 1997 in comparison
to 1996. Excluding the impact of the extra days and the Coco's and Carrows
acquisition, revenue for the 1997 period decreased $66.0 million in comparison
to the prior year period. This decrease reflects decreases in comparable store
sales at all of the Company's concepts, as well as a 26-unit decrease in
Company-owned units (excluding Coco's and Carrows). Such decreases are slightly
offset by a $5.0 million increase in franchise revenue due to a 108-unit
increase in franchise units at Denny's and El Pollo Loco.
CONSOLIDATED OPERATING EXPENSES for the two quarters ended July 2, 1997
increased by $159.9 million (14.4%) as compared with the 1996 comparable period.
The expense increase is primarily attributable to two factors: the estimated
$20.3 million impact due to the additional days in the 1997 period in comparison
to the prior year comparable period and a $188.5 million impact due to the
additional five months of operations of Coco's and Carrows in the current year
period in comparison to the prior year comparable period. Excluding the extra
days and the impact of the Coco's and Carrows acquisition, operating expenses
for the 1997 period decreased $48.9 million in comparison to the prior year
comparable period. This decrease primarily reflects a decline in costs
associated with the decline in revenue, the positive impact of cost cutting
measures, and a 26-unit decrease in Company-owned units (excluding Coco's and
Carrows). Such decreases are somewhat offset by an increase in general and
administrative expenses related to retention and other bonuses totaling $4.9
million and company contributions to the profit sharing plan of $1.4 million (no
contributions were made in the prior year).
CONSOLIDATED OPERATING INCOME for the two quarters ended July 2, 1997 decreased
by $1.7 million (2.3%) as compared with the 1996 comparable period as a result
of the factors noted above.
CONSOLIDATED INTEREST AND DEBT EXPENSE, NET totaled $143.6 million during the
1997 period as compared with $127.3 million during the comparable 1996 period.
The increase is due principally to the addition of $12.5 million of interest and
debt expense associated with the Coco's and Carrows acquisition in May 1996 and
a $3.2 million decrease in interest income during 1997 due to decreased cash and
cash equivalents subsequent to the purchase of Coco's and Carrows, partially
offset by a decline of $0.7 million in interest expense during the 1997 period
associated with lower interest rates related to interest rate exchange
agreements.
REORGANIZATION EXPENSES include professional fees and other expenditures
incurred by the Company in conjunction with the reorganization under Chapter 11
of the Bankruptcy Code as further discussed in Note 2 to the consolidated
financial statements included herein.
THE PROVISION (BENEFIT) FOR INCOME TAXES from continuing operations for the
period has been computed based on management's estimate of the annual effective
income tax rate applied to loss before taxes. The Company recorded an income tax
provision reflecting an effective income tax rate of approximately 1.1% for the
two quarters ended July 2, 1997 compared to a benefit for the comparable 1996
period reflecting an approximate rate of (8.5%). The change in the effective
income tax rate from the prior year can be attributed to the recognition in the
prior year of anticipated refunds due to the carryback of prior year tax losses.
THE NET LOSS was $91.1 million in the 1997 period as compared to $51.8 million
for the prior year comparable period. The increase in the net loss is due to the
factors noted above.
23
<PAGE>
Form 10-Q
Restaurant Operations:
Denny's:
<TABLE>
<CAPTION>
Two Quarters Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 581.4 $ 595.9 (2.4)
Franchise revenue 30.1 26.0 15.8
-------------- --------------
Total revenue 611.5 621.9 (1.7)
Operating expenses 557.4 569.4 (2.1)
------------- -------------
Operating income $ 54.1 $ 52.5 3.0
============= =============
Average unit sales
Company-operated $ 652,000 $ 646,600 0.8
Franchise $ 542,500 $ 533,700 1.6
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales increase (decrease) (3.9%) 2.6%
Average guest check $ 5.48 $ 4.88 12.3
</TABLE>
Denny's NET COMPANY SALES decreased by $14.5 million (2.4%) during the 1997
period as compared with the prior year comparable period. This decrease reflects
20 fewer Company-owned units and a decrease in comparable store sales, somewhat
offset by an estimated $21.7 million increase because of an additional five days
in the 1997 period compared to the prior year period. The decrease in
Company-owned units, the majority of which were converted to franchise units, is
consistent with the Company's strategy of focusing on growth through franchising
and the sale of Company-owned restaurants to franchisees, along with selected
restaurant closures where continued operation is considered uneconomical. The
decline in comparable store sales was driven by lower guest counts, partially
offset by an increase in average guest check, both changes reflecting the impact
of the September 1996 price increase that eliminated certain value pricing.
FRANCHISE REVENUE for the period increased by $4.1 million (15.8%), reflecting
88 more franchised units at the 1997 period end than at the 1996 period end.
Denny's OPERATING EXPENSES for the 1997 period as compared with the 1996 period
decreased by $12.0 million (2.1%), reflecting the impact of 20 fewer
Company-owned units; an improvement in food cost as a percent of revenue because
of a shift to higher margin items in the 1997 period; and a $3.0 million
increase in the current period amortization of the deferred gains attributable
to the sales of Proficient Food Company, Portion-Trol Foods, Inc. and Mother
Butler Pies over the prior year comparable period amounts. These decreases are
somewhat offset by an estimated $18.5 million impact from five additional days
in the 1997 period compared to the 1996 period; increased costs for coffee,
bacon and sausage; increases in the Federal and state minimum wage rates; and
labor productivity declines associated with lower guest counts. In addition,
operating expenses in the prior year period included $6.1 million of gains on
sales of restaurants to franchisees in comparison to $0.4 million of gains in
the current period.
Denny's OPERATING INCOME for the 1997 period increased by $1.6 million (3.0%) as
compared to the prior year period as a result of the factors noted above.
24
<PAGE>
Hardee's:
<TABLE>
<CAPTION>
Two Quarters Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Revenue $ 282.9 $ 305.1 (7.3)
Operating expenses 270.8 292.3 (7.4)
------------- --------------
Operating income $ 12.1 $ 12.8 (5.5)
============= ==============
Average unit sales $ 488,000 $ 526,200 (7.3)
COMPARABLE STORE DATA:
Comparable store sales decrease (8.0%) (7.2%)
Average guest check $ 3.28 $ 3.12 5.1
</TABLE>
Hardee's REVENUE decreased by $22.2 million (7.3%) during the 1997 period as
compared with the 1996 comparable period, reflecting an 8.0% decline in
comparable store sales. The decrease in comparable store sales reflects a
decline in traffic which was partially offset by an increase in average guest
check. The decrease in traffic count reflects the impact of continuing
aggressive promotions by competitors within the quick-service category
compounded by the persistent weakness of Hardee's brand positioning and
advertising programs.
Hardee's OPERATING EXPENSES in the 1997 period decreased by $21.5 million
(7.4%), primarily reflecting the impact of the cost reduction program
implemented in the second half of 1996 and the impact on expenses of the lower
comparable store sales noted above. These decreases are somewhat offset by the
Federal minimum wage rate increase and the fact that certain labor and other
fixed costs cannot be reduced in proportion to the significant decline in sales.
Hardee's OPERATING INCOME for the 1997 period decreased by $0.7 million (5.5%)
as compared to the prior year period as a result of the factors noted above.
25
<PAGE>
Form 10-Q
Quincy's:
<TABLE>
<CAPTION>
Two Quarters Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Revenue $ 126.0 $ 135.2 (6.8)
Operating expense 123.4 128.1 (3.7)
------------- ----------------
Operating income $ 2.6 $ 7.1 (63.4)
============== =================
Average unit sales $ 634,300 $ 677,900 (6.4)
COMPARABLE STORE DATA:
Comparable store sales decrease (7.0%) (7.6%)
Average guest check $ 6.31 $ 5.94 6.2
</TABLE>
Quincy's REVENUE decreased by $9.2 million (6.8%) during the 1997 period as
compared with the 1996 comparable period, reflecting a 7.0% decline in
comparable store sales. The decrease in comparable store sales resulted from a
decrease in traffic which was partially offset by an increase in average guest
check. The decline in customer traffic reflects, among other things, continuing
traffic declines in the family-steak category in general and the difficulty, in
spite of product quality improvements and increased emphasis on consistency of
service, of "winning back" Quincy's customers that have been lost over the past
several years.
Quincy's OPERATING EXPENSES in the 1997 period decreased by $4.7 million (3.7%),
primarily reflecting a decrease in product costs due to various cost reduction
initiatives, as well as a decrease in advertising expense in the current period
in comparison to the prior year comparable period. This decrease is somewhat
offset by increased product costs as a percent of revenue due to the higher
quality food items offered as part of management's efforts to "win back"
customers; increased labor costs due to the Federal minimum wage rate increase;
and the fact that there is a base level of labor and other fixed costs necessary
regardless of sales levels.
Quincy's OPERATING INCOME for the 1997 period decreased by $4.5 million as
compared to the prior year period as a result of the factors noted above.
26
<PAGE>
Form 10-Q
El Pollo Loco:
<TABLE>
<CAPTION>
Two Quarters Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 58.1 $ 58.0 0.2
Franchise revenues 7.3 6.4 14.1
--------------- ----------------
Total revenue 65.4 64.4 1.6
Operating expense 58.4 57.2 2.1
-------------- ---------------
Operating income $ 7.0 $ 7.2 (2.8)
============== ===============
Average unit sales
Company-operated $ 611,800 $ 574,700 6.5
Franchise $ 443,200 $ 427,700 3.6
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales increase (decrease) (0.9%) 8.2%
Average guest check $ 6.69 $ 6.51 2.8
</TABLE>
El Pollo Loco's NET COMPANY SALES increased $0.1 million (0.2%) during the 1997
period as compared with the 1996 comparable period. This increase reflects an
estimated $2.3 million impact due to the additional week in the 1997 period in
comparison to the prior year comparable period, somewhat offset by the impact of
a four-unit decrease in Company-owned units and a slight decrease in comparable
store sales. The decrease in Company-owned units, all of which were converted to
franchise units, is consistent with the Company's strategy of focusing on growth
through franchising and the sale of Company-owned restaurants to franchisees.
The decrease in comparable store sales reflects a decrease in customer counts,
nearly offset by a higher guest check average. Both fluctuations are primarily
explained by a shift in promotional emphasis during the first two quarters of
1997 in comparison to the prior year period. In 1997, the Company ran three
"large meal" and only two "small meal" promotions in comparison to two "large
meal" and three "small meal" promotions a year ago. A menu price increase taken
in March 1997 also contributed to the increase in average check in comparison to
1996. FRANCHISE REVENUE for the 1997 period increased by $0.9 million (14.1%),
primarily due to 20 more franchise units at the 1997 period-end as compared with
the 1996 period-end and an increase in franchise average unit sales.
El Pollo Loco's OPERATING EXPENSES for the 1997 period as compared with the 1996
comparable period increased by $1.2 million (2.1%) reflecting an estimated $1.8
million impact due to the additional week in the 1997 period in comparison to
the prior year comparable period as well as increased advertising expenses and
expenses related to El Pollo Loco's current reengineering project. These
increases are somewhat offset by the impact of the four-unit decrease in
Company-owned units; lower promotional discounting; lower chicken costs in
comparison to the prior year; a decrease in direct labor costs due to improved
labor scheduling and staffing initiatives; and food cost control measures.
El Pollo Loco's OPERATING INCOME for the 1997 period decreased by $0.2 million
(2.8%) as compared to the prior year comparable period as a result of the
factors noted above.
27
<PAGE>
Form 10-Q
Coco's and Carrows:
The following information is provided for analysis purposes only as it includes
information for periods prior to the acquisition of Coco's and Carrows by the
Company on May 23, 1996:
Coco's
<TABLE>
<CAPTION>
Two Quarters Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 138.5 $ 135.2 2.4
Franchise revenue 2.0 1.8 11.1
---------------- -----------------
Total revenue 140.5 137.0 2.5
Operating expenses 130.8 133.3 (1.9)
-------------- ---------------
Operating income $ 9.7 $ 3.7 NM
=============== ================
Average unit sales
Company-operated $ 753,000 $ 728,100 3.4
Franchise $ 874,900 $ 836,800 4.6
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales decrease (1.1%) (1.7%)
Average guest check (a) $ 6.66 $ 6.81 (2.2)
</TABLE>
NM = Not Meaningful
(a) The method for determining weekly customer traffic and average guest check
was changed in September 1996 in order to better conform to Flagstar's
methodology. Amounts for periods prior to September 1996 have not been restated.
Relative to Coco's, the new method will generally result in higher weekly
traffic counts and lower average guest checks than calculated under the previous
method.
Coco's NET COMPANY SALES increased $3.3 million (2.4%) for the two quarters
ended July 2, 1997 as compared to the prior year comparable period. This
increase reflects an estimated $4.8 million impact due to the additional six
days in the 1997 period in comparison to the prior year comparable period,
somewhat offset by a decrease in comparable store sales. The decrease in
comparable store sales was driven by a decrease in average check slightly offset
by an increase in customer counts.
FRANCHISE AND FOREIGN LICENSING REVENUE increased by $0.2 million (11.1%) for
the two quarters ended July 2, 1997 as compared to the prior year comparable
period. This increase is a result of one additional domestic franchise unit as
well as an increase in the number of foreign licenses from 261 at June 27, 1996
to 286 at July 2, 1997.
Coco's OPERATING EXPENSES for the two quarters ended July 2, 1997 decreased by
$2.5 million (1.9%) as compared to the prior year comparable period, despite the
impact of an additional six days in the 1997 period as compared to the prior
year comparable period. The expense decrease reflects the impact of
approximately $1.6 million of non-recurring adjustments which increased legal
and worker's compensation expenses in the prior year comparable period and also
reflects significant savings in product and labor costs due to an increased
operations focus on cost controls, waste reduction and labor initiatives in the
current period. Such cost savings were achieved despite increases in the Federal
and state minimum wage rates.
OPERATING INCOME for Coco's for the two quarters ended July 2, 1997 as compared
to the prior year comparable period in 1996 increased $6.0 million due to the
factors noted above.
28
<PAGE>
Form 10-Q
Carrows:
<TABLE>
<CAPTION>
Two Quarters Ended %
($ in millions, except average unit and July 2, June 30, Increase/
comp. store data) 1997 1996 (Decrease)
<S> <C> <C> <C>
Net company sales $ 108.8 $ 108.2 0.5
Franchise revenue 0.1 --- ---
--------------- -----------------
Total revenue 108.9 108.2 0.6
Operating expenses 103.0 105.6 (2.5)
------------- --------------
Operating income $ 5.9 $ 2.6 NM
============== ===============
Average unit sales
Company-operated $ 688,900 $ 667,200 3.3
COMPARABLE STORE DATA (COMPANY-OPERATED):
Comparable store sales increase (decrease) (2.0%) 1.5%
Average guest check (a) $ 6.44 $ 6.19 4.0
</TABLE>
NM = Not Meaningful
(a) The method for determining weekly customer traffic and average guest check
was changed in September 1996 in order to better conform to Flagstar's
methodology. Amounts for periods prior to September 1996 have not been restated.
Relative to Carrows, the new method will generally result in lower weekly
traffic counts and higher average guest checks than calculated under the
previous method.
Carrows' NET COMPANY SALES increased $0.6 million (0.5%) for the two quarters
ended July 2, 1997 as compared to the prior year comparable period. This
increase reflects an estimated $3.8 million impact due to the additional six
days in the 1997 period in comparison to the prior year comparable period,
somewhat offset by a decrease in comparable store sales. The decrease in
comparable store sales was driven by a decrease in customer counts, slightly
offset by an increase in average guest check. In addition, the Company
experienced a six-unit decrease in the number of Company-operated restaurants.
Carrows opened its first domestic franchise location in the first quarter of
1997.
Carrows' OPERATING EXPENSES decreased $2.6 million (2.5%) for the two quarters
ended July 2, 1997 as compared to the prior year comparable period, despite the
impact of an additional six days in the 1997 period as compared to the prior
year period. This expense decrease reflects the impact of approximately $1.5
million of non-recurring adjustments which increased legal and worker's
compensation expenses in the prior year comparable period and also reflects
current period savings in product and labor costs due to increased focus by
operations on cost control, waste reduction and labor initiatives. Such cost
savings were achieved despite increases in Federal and state minimum wage rates.
OPERATING INCOME for Carrows increased $3.3 million for the two quarters ended
July 2, 1997 as compared to the prior year comparable period due to the factors
noted above.
29
<PAGE>
Form 10-Q
Liquidity and Capital Resources
Since the leveraged buyout of Flagstar in 1989, the Company has not achieved the
revenue and earnings projections prepared at the time of the transaction, due in
large part to increased competition, intensive pressure on pricing due to
discounting, adverse economic conditions and relatively limited capital
resources to respond to these changes. Such trends have generally continued into
1997. The Company's cash flows have been sufficient to fund its operations and
make interest payments when due (although in anticipation of the Prepackaged
Plan and related bankruptcy filings to implement the Plan, Flagstar did not make
the March 15, 1997 interest payment on the 11 3/8% Debentures or the May 1, 1997
interest payments on the 11.25% Debentures or Junior Subordinated Debentures).
However, the Company's core businesses have not experienced cash flow growth
sufficient to provide adequate funds to invest for future growth.
These conditions present both short-term and long-term financial challenges to
the Company. To address these matters, management has developed and is
continuing to develop plans to maintain its liquidity and improve its capital
structure. On March 6, 1997, the Credit Agreement was amended to
provide for less restrictive financial covenants for measurement periods ending
on April 2, 1997 and July 2, 1997, as well as to provide Flagstar flexibility to
forego scheduled interest payments due in March, May and June 1997 under the Old
Senior Notes, the 11 3/8% Debentures, the 11.25% Debentures and the Junior
Subordinated Debentures without triggering a default under the Credit Agreement,
unless any such debt is declared to be due and payable as a result of the
failure to pay any such interest. On March 17, 1997, Flagstar elected not to
make an interest payment due and payable as of that date with respect to the 11
3/8% Debentures. As a result, and as a result of a continuation of such
non-payment for 30 days following the due date, Flagstar is in default under the
indenture governing the 11 3/8% Debentures. In addition, on May 1, 1997,
Flagstar elected not to make interest payments due and payable as of that date
with respect to the 11.25% Debentures and the Junior Subordinated Debentures. As
a result, and as a result of such non-payment for 30 days following the due
date, Flagstar is in default under the indentures governing such debentures. As
described in more detail in Note 2 to the financial statements, the bankruptcy
filings operate as an automatic stay of all collection and enforcement actions
by the holders of the 11 3/8% Debentures, 11.25% Debentures, Junior Subordinated
Debentures and the respective indenture trustees with respect to Flagstar's
failure to make the interest payments when due.
Management has concluded that, over the long-term, a substantial restructuring
or refinancing of the Company's debt will be required to allow the Company to
meet its long-term debt obligations and will be a prerequisite to future growth
through additional investment in its restaurants. In this regard, FCI and
Flagstar have developed the Prepackaged Plan.
As discussed in Note 2 to the financial statements, on July 11, 1997, the
Company filed a motion with the Bankruptcy Court seeking authorization to enter
into the DIP Facility between FCI, Flagstar, Holdings, certain subsidiaries of
Flagstar and Chase. The DIP Facility refinanced the Credit Agreement and is
otherwise available to the Company during the pendency of the Chapter 11 case
until the earlier to occur of (x) the date that is one year after the
commencement of the Chapter 11 case and (y) the substantial consummation of the
Plan for working capital advances and letters of credit. At a hearing on
July 15, 1997, the Bankruptcy Court entered the Interim DIP Order and on
July 16, 1997, the initial extensions of credit under the DIP Facility were made
pursuant to the Interim DIP Order. On August 12, 1997, the Bankruptcy Court
entered a final order authorizing the Debtors to access the entire $200 million
DIP Facility.
For the period following the Debtor's emergence from Chapter 11, the Company has
entered into a written commitment letter pursuant to which it has received (i) a
commitment from Chase for advances and letters of credit, and (ii) a $200
million senior secured revolving credit facility (the "Exit Facility") for the
benefit of the Company's operating subsidiaries, which facility will refinance
the DIP Facility upon the emergence of the Company from Chapter 11 and will be
used thereafter for working capital advances and letters of credit. The Company
believes the DIP Facility and the Exit Facility, together with cash generated
from operations, various cash management measures and other sources, will
provide the Company with adequate liquidity to meet its working capital, debt
service and capital expenditure requirements for at least the next twelve
months.
The DIP Facility is guaranteed by the Company's operating subsidiaries and
generally is secured by liens on the same collateral that secured the Company's
obligations under the Credit Agreement. The Exit Facility will have the benefit
of similar guarantees and collateral security (and the Company's guarantee and
additional liens on the Company's corporate headquarters in Spartanburg, South
Carolina and accounts receivable). The Exit Facility will have a maturity five
(5) years from the date of the
30
<PAGE>
Form 10-Q
Company's emergence from Chapter 11 (subject to earlier termination of
commitments in certain events). The DIP Facility contains negative covenants
that restrict, among other things, the Company's ability to pay dividends, incur
additional indebtedness, further encumber its assets and purchase or sell
assets. The Exit Facility will contain certain financial and negative covenants,
conditions precedent, events of default and other terms, conditions and
provisions customarily found in credit agreements for companies emerging from
Chapter 11. The closing of the Exit Facility is subject, among other conditions,
to negotiations of definitive agreements with Chase and the initial borrowings
thereunder having been made on or before July 11, 1998, the date that is twelve
months after the date on which the Company commenced its Chapter 11 case.
With respect to the long-term liquidity of the Company, the Company's management
believes that, based on its forecasts, after giving effect to the Plan, the
Company will have sufficient operating cash flow from operations (together with
funds available under the Exit Facility) to pay interest and scheduled
amortization on all of its outstanding indebtedness and to fund anticipated
capital expenditures through 1999. However, even if the reorganization is
completed, the Company's ability to meets its debt service obligations will
depend on a number of factors, including management's ability to maintain
operating cash flow.
At July 2, 1997 and December 31, 1996, the Company had working capital deficits,
exclusive of net assets held for sale, of $295.1 million and $301.3 million,
respectively. The decrease in the deficit is attributable primarily to a
reclassification at July 2, 1997 of accrued interest of $93.8 million from
current liabilities to liabilities subject to compromise, largely offset by a
reduction in cash and cash equivalents which has been used for Company
operations. The Company is able to operate with a substantial working capital
deficiency because: (i) restaurant operations are conducted primarily on a cash
(and cash equivalent) basis with a low level of accounts receivable, (ii) rapid
turnover allows a limited investment in inventories and (iii) accounts payable
for food, beverages, and supplies usually become due after the receipt of cash
from related sales.
Impact of Bankruptcy Petitions on Franchising
The operation of the Company's franchise system is subject to regulations
enacted by a number of states, and rules promulgated by the Federal Trade
Commission. Among other things, such regulations require that each franchising
entity annually renew its Uniform Franchise Offering Circular (the "UFOC") which
provides current information about the business. In addition, in the event that
any information in the UFOC becomes misleading, inaccurate or incomplete during
the year, the UFOC must be amended at that time to make appropriate disclosures.
When this occurs, the franchising entity must cease its sale of new franchises
until the UFOC has been updated to make the required disclosures. In some
states, the updated UFOC must be reviewed and approved by a regulatory agency
before the entity can resume franchise sales. Due to the involuntary Chapter 11
proceeding that was filed against Flagstar on June 17, 1997 (which was
subsequently dismissed) and the subsequent filing of voluntary petitions with
the Bankruptcy Court by FCI and Flagstar on July 11, 1997, management decided
that it would be appropriate for the Company's franchising subsidiaries
(Carrows, Coco's, Denny's and El Pollo Loco) to update their offering circulars
and to cease sales of new franchises until an updated UFOC had been prepared and
approved by those states that regulate the sale of franchises. Denny's obtained
approval and began selling franchises again in all states in which it has
significant operations in mid-July; Carrows and Coco's obtained approval and
began selling franchises again in all states in which they have significant
operations in late-July; and El Pollo Loco resumed franchising in early August.
31
<PAGE>
Form 10-Q
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Chapter 11 Reorganization Under the Bankruptcy Code
As discussed in Note 2 to the financial statements, FCI and two of its
subsidiaries, Flagstar and Holdings, filed voluntary petitions for
reorganization under Chapter 11 of the Bankruptcy Code in the United States
Bankruptcy Court for the District of South Carolina, Case Nos. 97-05431-B,
97-05795-B, and 97-05796-B (jointly administered under Case No. 97-5431-B).
Flagstar's operating subsidiaries did not file for bankruptcy. On July 24, 1997,
the United States Trustee appointed the Official Junior Committee. No other
committees have been appointed. FCI, Flagstar, and Holdings are continuing to
manage their affairs and operate their businesses under Chapter 11 as
debtors-in-possession subject to the jurisdiction of the Bankruptcy Court and
pending the Bankruptcy Court's confirmation of a plan of reorganization.
Under Section 365 of the Bankruptcy Code, the Debtors have the right, subject to
Bankruptcy Court approval, to assume or reject any executory contracts and
unexpired leases. As described more fully in the Plan, if an executory contract
or unexpired lease entered into before the Petition Date is rejected by FCI or
Flagstar, it will be treated as if FCI and Flagstar breached such contract or
lease on the date immediately preceding the Petition Date, and the other party
to the agreement may assert an unsecured claim for damages incurred as a result
of the rejection. In the case of rejection of employment agreements and real
property leases, damages are subject to certain limitations imposed by Sections
365 and 502 of the Bankruptcy Code.
Pursuant to Section 362 of the Bankruptcy Code, the commencement of each of the
Debtors' Chapter 11 cases operates as an automatic stay, applicable to all
entities, of the following: (i) commencement or continuation of a judicial,
administrative, or other proceeding against any of the Debtors that was or could
have been commenced prior to commencement of the Debtor's Chapter 11 case, or to
recover for a claim that arose before the commencement of each Debtor's Chapter
11 case; (ii) enforcement of any judgments against any of the Debtors that arose
before the commencement of that Debtor's Chapter 11 case; (iii) the taking of
any action to obtain possession of or to exercise control over the property of
the Debtors; (iv) the creation, perfection or enforcement of any lien against
the property of the Debtors; (v) the taking of any action to collect, assess, or
recover a claim against any of the Debtors that arose before the commencement of
that Debtor's Chapter 11 case; or (vi) the setoff of any debt owing to any of
the Debtors that arose prior to the commencement of that Debtor's Chapter 11
case against a claim held by such creditor of or party-in-interest against the
Debtor that arose before the commencement of that Debtor's Chapter 11 case. Any
entity may apply to the Bankruptcy Court for relief from the automatic stay to
allow enforcement of any of the aforesaid remedies that are automatically stayed
by operation of law at the commencement of the Debtors' Chapter 11 cases.
Although the Debtors are authorized to operate their businesses as
debtors-in-possession, they may not engage in transactions outside the ordinary
course of business without first complying with the notice and hearing
provisions of the Bankruptcy Code and obtaining Bankruptcy Court approval. The
Debtors are required to pay certain expenses of the Official Junior Committee,
including counsel and professional fees, to the extent allowed by the Bankruptcy
Court. Other parties in interest in the Chapter 11 cases are also entitled to be
heard on motions made in the Chapter 11 cases, including motions for approval of
transactions outside the ordinary course of business.
For information regarding the challenge by holders of the Junior Subordinated
Debentures to the Plan's classification of the Junior Subordinated Debentures
as subordinate to the Senior Subordinated Debentures, see Note 2 to the
financial statements.
Other Parties in Interest
The interests of the holders of the Old Senior Notes are represented by an
informal noteholders committee and the interests of the holders of the Senior
Subordinated Debentures are represented by an Ad Hoc Committee of holders of
Senior Subordinated Debentures.
The United States Trustee and the Bankruptcy Court have approved and authorized
the Company's retention of (i) the firms of Latham & Watkins; Weil, Gotshal &
Manges, LLP; and the McNair Law Firm, P.A. as co-bankruptcy counsel and for
certain other purposes; and (ii) the firm of Parker, Poe, Adams & Bernstein LLP
as special corporate and securities counsel. The Bankruptcy Court granted a
motion on July 11, 1997 authorizing the Company to retain outside professionals
in the ordinary course of business subject to certain limitations.
32
<PAGE>
Plan of Reorganization - Procedures
Under Section 1121 of the Bankruptcy Code, there is an exclusivity period (the
"Exclusivity Period") during which only the Debtors may propose a plan of
reorganization. Because the Debtors have already filed the Prepackaged Plan with
the Bankruptcy Court, the Exclusivity Period runs for 180 days--i.e., no other
party may file a plan unless no plan has been confirmed by the Bankruptcy Court
within 180 days after the Petition Date. Under the Bankruptcy Code, upon notice
and a hearing, a debtor, for cause shown, may seek extensions of the Exclusivity
Period from the bankruptcy court. However, if the Bankruptcy Court were to
appoint a Chapter 11 trustee, any party-in-interest may file a plan, regardless
of whether any additional time remains in the Exclusivity Period.
Each of the Debtors filed with its Chapter 11 petition a list containing the
names and addresses of its twenty largest known creditors. FCI, Flagstar, and
Holdings, within the time periods set by the Bankruptcy Court, will file with
the Bankruptcy Court schedules of assets and liabilities and other schedules and
statements of affairs as required by the Bankruptcy Rules and by the Local Rules
of the Bankruptcy Court. Section 501 of the Bankruptcy Code allows any creditor
or indenture trustee to file a proof of claim with the Bankruptcy Court. A claim
or interest, proof of which is filed under Bankruptcy Section 501, is deemed
allowed, unless a party-in-interest (including any of the Debtors) objects
thereto. If an objection is made to the allowance of a claim, the Bankruptcy
Court, after notice and hearing, will determine the amount, validity, and
priority of such claim. The Debtors anticipate that with respect to trade claims
and other unimpaired claims no deadline will be set by the Bankruptcy Court for
filing a proof of claim or interest.
As described in Note 2 to the financial statements, the Debtors solicited
pre-petition acceptances of their Plan prior to filing it with the Bankruptcy
Court on the Petition Date. This solicitation was accomplished by means of a
Registration Statement the Debtors filed with the SEC that became effective on
June 5, 1997. The Registration Statement contained the Prepackaged Plan now
awaiting confirmation of the Bankruptcy Court. The Plan, which was developed in
the course of negotiations with a committee representing the Senior Subordinated
Debentures (the Debtors' largest class of debtholders) and with the support of
FCI's largest shareholder, was accepted by every class impaired thereunder
except for one--the class of Junior Subordinated Debentures. The classes of
holders of the Old Senior Notes and the Senior Subordinated Debentures (which
together represent approximately $1.5 billion of claims), as well as the classes
of holders of the Old FCI Preferred Stock and the Old FCI Common Stock, all
voted to accept the Plan.
If at least one class of claims that is impaired under a plan has accepted the
plan, and certain other requirements of the Bankruptcy Code relating to the plan
confirmation are satisfied, the proponent of the plan may invoke the so-called
"cramdown" provisions of Section 1129(b) of the Bankruptcy Code. Under these
provisions, the Bankruptcy Court on request of the proponent of the plan shall
confirm the plan if the plan does not discriminate unfairly, and is fair and
equitable, with respect to each class of claims or interests that is impaired
under, and has not accepted, the plan. As used in the Bankruptcy Code, the
phrases "discriminate unfairly" and "fair and equitable" have narrow and
specific meanings.
FCI and Flagstar believe that, if necessary, the Plan may be crammed down over
the dissent of classes of certain claims and interests, in view of the treatment
proposed for such classes. If necessary and appropriate, FCI and Flagstar intend
to amend the Plan to permit cramdown of dissenting classes of claims or
interests. There can be no assurance, however, that the requirements of Section
1129(b) of the Bankruptcy Code would be satisfied even if the Plan treatment
provisions were amended or withdrawn as to one or more classes.
ITEM 2. CHANGES IN SECURITIES
See Item 4 below for information regarding the amendments to the indentures
governing the Senior Subordinated Debentures.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
On March 17, 1997, Flagstar elected not to make the $7.1 million interest
payment due and payable as of that date to holders of its 11 3/8% Senior
Subordinated Debentures. In addition, on May 1, 1997, Flagstar elected not to
make the $40.6 million and $5.0 million interest payments due and payable as of
that date to holders of its 11.25% Senior Subordinated Debentures and its 10%
33
<PAGE>
Form 10-Q
Convertible Junior Subordinated Debentures, respectively. As a result of these
nonpayments, and as a result of a continuation of such nonpayments for 30 days
following their respective due dates, Flagstar is in default under the
indentures governing such debentures. As described in more detail in Note 2 to
the financial statements, the bankruptcy filings operate as an automatic stay of
all collection and enforcement actions by the holders of the 11 3/8% Debentures,
11.25% Debentures, Junior Subordinated Debentures and the respective indenture
trustees with respect to the Debtors' failure to make the interest payments when
due.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 5, 1997, FCI and Flagstar began a solicitation of votes with respect to
the Plan. On July 7, 1997, FCI and Flagstar completed the solicitation. See Note
2 to the Notes to Consolidated Financial Statements for a description of the
terms of the Plan. The classes of holders of Flagstar's Old Senior Notes,
Flagstar's Senior Subordinated Debentures, the Old FCI Preferred Stock and the
Old FCI Common Stock voted to accept the Plan by the requisite majorities
required by the Bankruptcy Code and the class of holders of Flagstar's Junior
Subordinated Debentures voted to reject the Plan. Following is a summary of the
voting:
<TABLE>
<CAPTION>
$ Value of $ Value of
# of Holders Securities Securities # of Shares # of Shares
# of Holders Voting Voting in Voting Voting in Voting
Voting for Against Favor of Against Favor of Against
the Plan the Plan the Plan the Plan the Plan the Plan
<S> <C> <C> <C> <C>
Old Senior Notes 529 37 $333,503,696 $84,360,000 --- ---
Senior Subordinated Debentures 835 73 $615,999,800 $31,546,000 --- ---
Junior Subordinated Debentures 150 132 $ 4,563,054 $39,571,000 --- ---
Old FCI Preferred Stock --- --- --- --- 3,019,832 911,941
Old FCI Common Stock --- --- --- --- 23,864,284.4 288,583.4
</TABLE>
As part of the solicitation of votes with respect to the Plan, Flagstar asked
holders of its Senior Subordinated Debentures to consent to an amendment to the
indentures governing the Senior Subordinated Debentures which would effect the
redistribution of the Plan consideration to which such holders are entitled if
either or both of the classes of Flagstar's Junior Subordinated Debentures and
holders of the Old FCI Preferred Stock do not accept the Plan and either or both
of the classes of holders of the Old FCI Preferred Stock and holders of the Old
FCI Common Stock do not accept the Plan. The results of the voting are as
follows:
$ value of securities voting $ value of securities voting
for the Amendment against the Amendment
11.25% Debentures $407,447,300 $4,466,000
11 3/8% Debentures $ 88,263,000 $ 350,000
See Note 2 to the financial statements for information regarding the
amount of Plan consideration to be transferred to holders of the Old FCI
Stock and Old FCI Common Stock pursuant to agreement by the holders of the
Senior Subordinated Debentures.
34
<PAGE>
Form 10-Q
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. The following are included as exhibits to this report:
Exhibit
No. Description
27 Financial Data Schedule
b. No reports on Form 8-K were filed during the quarter ended
July 2, 1997.
35
<PAGE>
Form 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FLAGSTAR CORPORATION
Date: August 18, 1997 By: /s/ Rhonda J. Parish
----------------------------------
Rhonda J. Parish
Senior Vice President and
General Counsel
Date: August 18, 1997 By: /s/ C. Robert Campbell
----------------------------------
C. Robert Campbell
Executive Vice President and
Chief Financial Officer
36
<PAGE>
Form 10-Q
FLAGSTAR CORPORATION
FINANCIAL DATA SCHEDULE
Exhibit 27
(In Thousands Except Per Share Amount)
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF FLAGSTAR CORPORATION AS CONTAINED IN ITS FORM 10-Q FOR
THE QUARTERLY PERIOD ENDED JULY 2, 1997 AND IS QUALIFIED IN ITS ENTIRETY TO SUCH
FINANCIAL STATEMENTS.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> APR-03-1997 JAN-01-1997
<PERIOD-END> JUL-02-1997 JUL-02-1997
<CASH> 57,332 0
<SECURITIES> 0 0
<RECEIVABLES> 14,317 0
<ALLOWANCES> 3,356 0
<INVENTORY> 31,127 0
<CURRENT-ASSETS> 132,259 0
<PP&E> 1,909,926 0
<DEPRECIATION> 778,103 0
<TOTAL-ASSETS> 1,603,903 0
<CURRENT-LIABILITIES> 427,321 0
<BONDS> 664,696 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> (1,466,096) 0
<TOTAL-LIABILITY-AND-EQUITY> 1,603,903 0
<SALES> 0 0
<TOTAL-REVENUES> 659,428 1,335,203
<CGS> 0 0
<TOTAL-COSTS> 613,266 1,266,015
<OTHER-EXPENSES> 2,205 3,756
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 71,469 143,596
<INCOME-PRETAX> (35,441) (90,100)
<INCOME-TAX> 378 1,002
<INCOME-CONTINUING> (35,819) (91,102)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (35,819) (91,102)
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
