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 October 1, 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
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(Registrant's telephone number, including area code)
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(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 November 3, 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>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Flagstar Corporation
(Debtor-in-Possession)
Statements of Consolidated Operations
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Three Quarters Ended
October 1, September 30, October 1, September 30,
1997 1996 1997 1996
----------- --------- --------- ---------
<S> <C> <C> <C> <C>
(In thousands)
Operating revenue $ 654,153 $ 703,838 $ 1,989,355 $ 1,880,834
----------- ----------- ----------- -----------
Operating expenses:
Product cost 191,026 213,295 580,979 572,732
Payroll and benefits 235,826 258,613 736,059 708,749
Depreciation and amortization expense 38,672 33,555 106,902 92,606
Utilities expense 28,968 30,698 82,956 77,781
Other 115,394 119,350 369,005 309,792
----------- ----------- ----------- -----------
609,886 655,511 1,875,901 1,761,660
----------- ----------- ----------- -----------
Operating income 44,267 48,327 113,454 119,174
Other charges:
Interest and debt expense - net (contractual
interest for the quarter and three quarters ended
October 1, 1997 is $74,503 and $218,099 50,588 72,430 194,184 199,762
Other - net 2,897 72 6,654 229
----------- ----------- ----------- -----------
Loss before reorganization expenses and taxes (9,218) (24,175) (87,384) (80,817)
Reorganization expenses 11,613 -- 23,549 --
----------- ----------- ----------- -----------
Loss before taxes (20,831) (24,175) (110,933) (80,817)
Provision for (benefit from) income taxes 482 (8,118) 1,484 (12,923)
----------- ----------- ----------- -----------
Net loss $ (21,313) $ (16,057) $ (112,417) $ (67,894)
=========== =========== =========== ===========
</TABLE>
See accompanying notes
2
<PAGE>
Flagstar Corporation
(Debtor-in-Possession)
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
October 1, December 31,
1997 1996
------- ---------
<S> <C> <C>
(In thousands)
Assets
Current assets:
Cash and cash equivalents $ 29,666 $ 92,358
Receivables, less allowance for doubtful accounts of:
1997 - $3,190; 1996 - $2,405 14,360 17,823
Loan receivable from former officer -- 13,922
Merchandise and supply inventories 27,809 31,543
Net assets held for sale -- 5,114
Other 44,496 29,895
---------- ----------
116,331 190,655
---------- ----------
Property:
Property owned (at cost):
Land 250,264 252,741
Buildings and improvements 889,374 891,512
Other property and equipment 552,389 536,886
---------- ----------
Total property owned 1,692,027 1,681,139
Less accumulated depreciation 696,752 629,676
---------- ----------
Property owned - net 995,275 1,051,463
---------- ----------
Buildings and improvements, vehicles, and other
equipment held under capital leases 225,323 210,533
Less accumulated amortization 109,530 93,740
---------- ----------
Property held under capital leases - net 115,793 116,793
---------- ----------
1,111,068 1,168,256
---------- ----------
Other assets:
Goodwill, net of accumulated amortization of: 1997 - $6,789;
1996 - $3,077 209,190 205,389
Other intangible assets - net 26,408 27,595
Deferred financing costs - net 55,607 64,153
Other 39,509 37,385
---------- ----------
330,714 334,522
---------- ----------
Total assets $1,558,113 $1,693,433
========== ==========
</TABLE>
See accompanying notes
3
<PAGE>
Flagstar Corporation
(Debtor-in-Possession)
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
October 1, December 31,
1997 1996
------- --------------
(In thousands)
<S> <C> <C>
Liabilities
Liabilities not subject to compromise:
Current liabilities:
Current maturities of long-term debt $ 85,006 $ 62,885
Accounts payable 99,610 160,444
Accrued payroll and related 58,916 58,838
Accrued insurance 46,562 52,244
Accrued taxes 16,109 25,060
Accrued interest 15,639 51,220
Other 81,007 76,114
----------- -----------
402,849 486,805
----------- -----------
Long-term liabilities:
Debt, less current maturities 655,703 2,179,393
Deferred income taxes 15,392 16,361
Liability for self-insured claims 53,565 57,665
Other non-current liabilities and deferred credits 156,309 178,203
----------- -----------
880,969 2,431,622
----------- -----------
Notes payable to FCI -- 150,000
----------- -----------
Total liabilities not subject to compromise 1,283,818 3,068,427
Liabilities subject to compromise 1,761,706 --
----------- -----------
Total liabilities 3,045,524 3,068,427
----------- -----------
Shareholder's deficit (1,487,411) (1,374,994)
----------- -----------
Total liabilities and shareholder's deficit $ 1,558,113 $ 1,693,433
=========== ===========
</TABLE>
See accompanying notes
4
<PAGE>
Flagstar Corporation
(Debtor-in-Possession)
Statements of Consolidated Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Quarters Ended
October 1, 1997 September 30, 1996
--------------- -------------------
(In thousands)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (112,417) $ (67,894)
Adjustments to reconcile net loss to cash flows from
operating activities:
Depreciation and amortization of property 100,696 85,320
Amortization of other intangible assets 6,205 7,286
Amortization of deferred financing costs 7,639 6,183
Amortization of deferred gains (12,275) (6,983)
Deferred income tax benefit (745) (269)
Gains on sales of company-owned restaurants (956) (7,532)
Write-off deferred financing costs 2,533 ---
Other 2,463 2,937
Decrease (increase) in assets:
Receivables 1,332 8,910
Inventories 3,734 (865)
Other current assets (1,699) (10,482)
Other assets (8,562) (15,925)
Increase (decrease) in liabilities:
Accounts payable (59,770) (21,661)
Accrued payroll and related 1,612 1,261
Accrued taxes 4,138 (6,018)
Other accrued liabilities 62,000 (6,541)
Other non-current liabilities and deferred credits (9,868) 1,443
---------- ----------
Net cash flows used in operating activities
before reorganization activities (13,940) (30,830)
Increase (decrease) in liabilities from reorganization activities:
Accrued payroll and related 795 ---
Other accrued liabilities 2,417 ---
---------- -------------
Net cash flows used in operating activities (10,728) (30,830)
--------- ---------
Cash flows from investing activities:
Purchase of property (42,171) (24,699)
Proceeds from disposition of property 14,342 10,499
Acquisition of business, net of cash acquired --- (127,068)
Other - net (283) 61,013
------------ ----------
Net cash flows used in investing activities (28,112) (80,255)
---------- ----------
</TABLE>
See accompanying notes
5
<PAGE>
Flagstar Corporation
(Debtor-in-Possession)
Statements of Consolidated Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Quarters Ended
October 1, 1997 September 30, 1996
--------------- ------------------
<S> <C> <C>
(In thousands)
Cash flows from financing activities:
Net borrowings under credit agreement $ 23,000 $ 56,000
Long-term debt payments (45,319) (28,353)
Deferred financing costs (1,533) (7,995)
--------- ---------
Net cash flows (used in) provided by financing activities (23,852) 19,652
--------- ---------
Decrease in cash and cash equivalents (62,692) (91,433)
Cash and cash equivalents at:
Beginning of period 92,358 196,966
--------- ---------
End of period $ 29,666 $ 105,533
========= =========
</TABLE>
See accompanying notes
6
<PAGE>
FLAGSTAR CORPORATION
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 1, 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. ("FCI").
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 three quarters ended October 1, 1997 and September 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 three quarters ended October 1, 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 (the "Bankruptcy Court"), Case Nos. 97-05431-B,
97-05795-B, and 97-05796-B, respectively. These are being jointly administered
for procedural purposes only by the Bankruptcy Court under Case No. 97-05431-B.
FCI, Flagstar and Holdings (collectively referred to as the "Debtors") sought
bankruptcy protection in order to implement their joint prepackaged plan of
reorganization (the "Prepackaged Plan"). On November 12, 1997, the Bankruptcy
Court entered an order confirming an Amended Joint Plan of Reorganization (the
"Amended Plan") (as further described in Note 2), subject to notice to
creditors. The Company's operating subsidiaries, Denny's Holdings, Inc., Spartan
Holdings, Inc. and FRD Acquisition Co. (and their respective subsidiaries), are
not parties 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 October 1, 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 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 Bankruptcy Court
rather than estimates of the amounts for which those allowed claims may be
settled as a result of the plan of reorganization approved by the Bankruptcy
Court. In addition, SOP 90-7 requires the Company to report interest expense
during the bankruptcy proceeding only to the extent that it will be paid during
the proceedings or that it is probable to be an allowed priority, secured, or
unsecured claim. Accordingly, and in view of the terms of the Plan, as of July
11, 1997, the Company ceased recording interest on its 11.25% Debentures,
11 3/8% Debentures and 10% Convertible Debentures (each as defined in Note 2
below). The contractual interest expense for the quarter and three quarters
ended October 1, 1997 is disclosed in the accompanying Statements of
Consolidated Operations.
As of the effective date of the Plan (the "Effective Date") , 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
7
<PAGE>
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, the Company's financial
statements will not be comparable with those prepared before the Effective Date,
including the historical financial statements included in this quarterly report.
Prior year 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 and prior years' 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 subject to
compromise at October 1, 1997.
The consolidated financial statements include the accounts of the operating
subsidiaries of the Company which are not parties to the previously described
Chapter 11 proceedings. The following condensed financial statements of the
Debtors have been prepared using the equity method of accounting for reporting
the results of all wholly-owned subsidiaries of Flagstar that are not parties to
such Chapter 11 proceedings.
Flagstar Corporation and Flagstar Holdings, Inc.
(Debtors-in-Possession)
Condensed Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended Three Quarters Ended
October 1, 1997 October 1, 1997
--------------- -----------------
(In thousands)
<S> <C> <C>
Operating revenue $ --- $ ---
Operating expenses 3,924 16,974
--------- ---------
Operating loss (3,924) (16,974)
Equity in earnings of subsidiaries 20,336 47,203
Other charges:
Interest 26,128 119,061
Other (16) 36
----------- --------------
Loss before reorganization expenses (9,700) (88,868)
Reorganization expenses 11,613 23,549
--------- -----------
Net loss $(21,313) $(112,417)
========= ==========
</TABLE>
8
<PAGE>
Flagstar Corporation and Flagstar Holdings, Inc.
(Debtors-in-Possession)
Condensed Balance Sheet
(Unaudited)
October 1, 1997
------------------
(In thousands)
Assets
Current assets $ 3,262
Investment in operating subsidiaries, net (9,303)
Property owned, net 2,465
Property held under capital leases, net 2,220
Other assets:
Deferred financing costs 15,886
Receivable from operating subsidiaries 347,463
Other 19,693
-----------
Total assets $ 381,686
===========
Liabilities
Liabilities not subject to compromise
Current liabilities $ 49,442
Long-term liabilities 57,949
-----------
Total liabilities not subject to compromise 107,391
Liabilities subject to compromise 1,761,706
-----------
Total liabilities 1,869,097
-----------
Shareholder's deficit (1,487,411)
-----------
Total liabilities and shareholder's deficit $ 381,686
===========
9
<PAGE>
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 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 parties
to and are unaffected by the above mentioned Chapter 11 proceedings. On November
12, 1997, the Bankruptcy Court entered an order confirming the Amended Plan. The
Bankruptcy Court will retain jurisdiction over certain matters pending the
Effective Date and, pursuant to the terms of the Amended Plan, will retain
jurisdiction over certain limited matters after the Effective Date.
FCI and Flagstar filed their Chapter 11 cases to implement their Prepackaged
Plan. The Bankruptcy Court originally scheduled a confirmation hearing with
respect to the Prepackaged Plan on October 7, 1997 which was subsequently
adjourned by the Bankruptcy Court until November 6, 1997, and then again until
November 7, 1997. The Prepackaged Plan was developed in the course of
negotiations with an ad hoc committee (the "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 Prepackaged
Plan from holders of claims against or interests in FCI's and Flagstar's estates
whose legal rights would be impaired by the Prepackaged 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 Prepackaged Plan. On July
7, 1997, FCI and Flagstar completed their solicitation of votes on the
Prepackaged 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 Debentures due 2014, formerly referred to as Flagstar 10%
Convertible Junior Subordinated Debentures (the "10% Convertible Debentures").
The Prepackaged Plan as filed proposed to modify the rights of certain creditors
of FCI and Flagstar in the following manner: (a) FCI and Flagstar would merge
into one holding company ("Reorganized Flagstar"), (b) general unsecured claims
would be unimpaired, (c) each holder of Old Senior Notes would 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
would 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 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 10% Convertible
Debentures, the Old FCI Preferred Stock, and the Old FCI Common Stock had the
class of 10% Convertible Debentures accepted the Prepackaged Plan. Because the
class of 10% Convertible Debentures voted to reject the Prepackaged Plan, that
class, and all junior classes, were not entitled to a recovery under the
Prepackaged Plan. See Note 3 for information regarding such claims.
Notwithstanding the terms of the Prepackaged Plan and its rejection by holders
of the 10% Convertible Debentures, holders of the Senior Subordinated Debentures
agreed, at the time of their approval of the Prepackaged Plan by supplemental
indenture, 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 Prepackaged Plan. Specifically, the
holders of the Senior Subordinated Debentures 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 Prepackaged Plan's classification of the 10% Convertible Debentures as
subordinate to the Senior Subordinated Debentures was challenged by certain
holders of the 10% Convertible Debentures and was 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 Prepackaged Plan and enforcing the
subordination provisions of the 10% Convertible Debentures as provided
10
<PAGE>
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 opposed the Classification Motion. A hearing on the
Classification Motion commenced on September 30, 1997 and was continued on
October 1, November 5 and 6, 1997. On November 6, 1997, the Bankruptcy Court
determined that the Supplemental Indenture executed by the Indenture Trustee and
the Company in August 1992 violated the Indenture governing the 10% Convertible
Debentures. Following this ruling, the Ad Hoc Committee, the Official Junior
Committee and the Debtors entered into negotiations concerning the recovery that
the 10% Convertible Debentureholders would receive. As a result of these
negotiations, on November 7, 1997, the Debtors filed an Amended Joint Plan of
Reorganization (the "Amended Plan"; together with the Prepackaged Plan, "the
Plan"), which was confirmed by the Bankruptcy Court and the material terms of
which remain identical to the terms of the Prepackaged Plan described above with
the following changes: (i) each holder of 10% Convertible Debentures will be
entitled to receive on account of the unpaid principal amount of its 10%
Convertible Debentures plus all unpaid interest which accrued thereon prior to
the Petition Date, such holder's pro rata share of shares of New Common Stock
equivalent to 4.5% of the New Common Stock and certain warrants to be
outstanding on the Effective Date, and (ii) the remaining junior impaired
classes (the classes of FCI Old Common Stock and FCI Old Preferred Stock) will
receive or retain no property under the Amended Plan.
At the hearing on November 7, 1997 to consider the adequacy of FCI and
Flagstar's Joint Disclosure Statement (the "Disclosure Statement") and to
consider confirmation of the Amended Plan, the Bankruptcy Court ruled that (i)
the Disclosure Statement contained adequate information to enable creditors to
make an informed judgment about the Prepackaged Plan pursuant to section 1125 of
the Bankruptcy Code (ii) the modifications of the Prepackaged Plan by the
Amended Plan complied with the Bankruptcy Code, did not materially adversely
effect any class, and did not require further disclosure or solicitation, and
(iii) the Amended Plan would be confirmed as meeting the requirements of section
1129(a) of the Bankruptcy Code. The Bankruptcy Court's order confirming the
Amended Plan was entered pursuant to such ruling on November 12, 1997, subject
to notice to creditors. The Effective Date of the Amended Plan is contemplated
to occur on or before March 15, 1998. All pending objections to the approval of
the Disclosure Statement and confirmation of the Amended Plan were either
resolved, withdrawn or overruled.
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, certain 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 and a letter of credit facility. The Interim
DIP Order authorized the Debtors to use funds from the DIP Facility for working
capital and general corporate purposes 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. The DIP Facility will remain in effect until the earlier to occur
of (x) July 10, 1998 and (y) the substantial consummation of the Plan. For the
period following the Debtors' emergence from Chapter 11, Chase has agreed to
provide the Company with 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 Debtors
from Chapter 11 and will be used thereafter for working capital and general
corporate purposes and for letters of credit. The terms of the agreement with
Chase for the Exit Facility have been approved by the Bankruptcy Court pursuant
to the terms of the order confirming the Amended Plan.
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 Amended 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. The Company has decided not to
reject any executory contracts or unexpired leases.
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
11
<PAGE>
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.
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. (The Prepackaged Plan had also contemplated the Debtors'
payment of expenses, including counsel and professional fees, of the Ad Hoc
Committee and of an informal committee representing holders of the Old Senior
Notes.) 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 120 days after the Petition Date, the Debtors have the exclusive right to
propose and file an alternative or modified plan of reorganization and for 180
days after the Petition Date the exclusive right to solicit acceptances thereon
(the "Exclusivity Periods"). FCI and Flagstar's exclusive right to file a plan
of reorganization was set to expire on November 10, 1997, and their exclusive
right to solicit acceptances thereof was set to expire on January 9, 1998. On
November 7, 1997, the Bankruptcy Court granted FCI and Flagstar's request to
extend the Exclusivity Periods for 90 days.
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 Plan.
October 1, 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 115,011
-----------
Total liabilities subject to compromise $ 1,761,706
===========
Note 4. Reorganization Expenses
Reorganization expenses included in the accompanying Statements of Consolidated
Operations consist of the following items:
(In thousands)
Professional fees $ 15,186
Debtor-in-possession financing expenses 2,963
Other reorganization items 5,400
--------------
$ 23,549
==============
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.
12
<PAGE>
Due to the timing of this change, the three quarters ended October 1, 1997
include more than thirty-nine 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 each 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 10%
Convertible 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. During the pendency of Flagstar's bankruptcy proceeding,
Flagstar also missed the $14.5 million interest payment due September 15, 1997
on its 10 3/4% Senior Notes and the $7.1 million interest payment due September
15, 1997 on its 11 3/8% 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 Senior Subordinated
Debentures, 10% Convertible Debentures, the Old Senior Notes and the respective
indenture trustees with respect to Flagstar's 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 October 1, 1997 and the results of operations for the
quarter and three quarters ended October 1, 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
Corporation, its subsidiaries, and underlying restaurant 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.
13
<PAGE>
Chapter 11 Proceedings
As discussed in Note 2 to the consolidated 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 sought bankruptcy protection in order to implement the Prepackaged
Plan of FCI and Flagstar. The Prepackaged Plan was developed with the full
support of FCI's largest shareholder and through negotiations with the 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 10% Convertible Debentures.
The Bankruptcy Court originally scheduled a confirmation hearing with respect to
the Plan on October 7, 1997 which was subsequently adjourned by the Bankruptcy
Court until November 6, 1997, and then again until November 7, 1997. On November
12, 1997, the Bankruptcy Court entered an order confirming the Amended Plan
reflecting certain amendments from the Prepackaged Plan, agreed to by the
Official Junior Committee representing the 10% Convertible Debentures, and
settling the litigation with that class. The Amended Plan, as confirmed, effects
a major financial restructuring that enables FCI and Flagstar to service their
remaining debt obligations. For a detailed discussion concerning the Prepackaged
Plan, the litigation with the 10% Convertible Debentureholders and the resulting
Amended Plan, see Note 2 to the consolidated financial statements.
Results of Operations
Quarter Ended October 1, 1997 Compared to Quarter Ended September 30, 1996
The Company's consolidated revenue for the third quarter of 1997 decreased by
$49.7 million (7.1%) as compared with the 1996 comparable quarter. This decrease
reflects decreases in comparable store sales at all of the Company's concepts
except for El Pollo Loco and Coco's, as well as a 46-unit decrease in
Company-owned units. Such decreases are slightly offset by a $1.3 million
increase in franchise revenue due to a 123-unit increase in franchise units.
Consolidated operating expenses for the third quarter of 1997 decreased by $45.6
million (7.0%) as compared with the 1996 comparable quarter. This decrease
primarily reflects a decline in costs associated with the decline in revenue,
the positive impact of cost cutting measures, and a 46-unit decrease in
Company-owned units.
Consolidated operating income for the third quarter of 1997 decreased by $4.1
million (8.4%) as compared with the 1996 comparable quarter as a result of the
factors noted above.
Consolidated interest and debt expense, net totaled $50.6 million during the
1997 quarter as compared with $72.4 million during the comparable 1996 period.
The decrease is principally due to the fact that the Company ceased recording
interest on the Senior Subordinated Debentures and 10% Convertible Debentures on
July 11, 1997 in accordance with SOP 90-7. This decrease is partially offset by
a $3.6 million charge representing interest and penalties associated with the
early termination of the Company's interest rate exchange agreements. Such
termination occurred in conjunction with the refinancing of the Company's bank
credit facility necessitated by the bankruptcy filing on July 11, 1997.
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 4 to the consolidated
financial statements included herein.
The provision for (benefit from) 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 2.3% for the
1997 quarter compared to a benefit for the comparable 1996 quarter reflecting an
approximate rate of (33.6%). 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.
14
<PAGE>
The net loss was $21.3 million in the 1997 quarter as compared to $16.1 million
for the prior year quarter. The increase in the net loss is due to the factors
noted above.
Restaurant Operations:
The table below summarizes restaurant unit activity for the quarter ended
October 1, 1997.
<TABLE>
<CAPTION>
Units Converted
Units from Company
Ending Units Units Closed/ to Franchise Ending Units Ending Units
7/2/97 Opened Sold (Turnkeys) 10/1/97 9/30/96
------------- ------ ------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Denny's
Company owned 891 --- (2) (2) 887 902
Franchised 716 15 --- 2 733 653
International licensees 26 --- --- --- 26 25
-------- ------- ------- ------- ---------- --------
1,633 15 (2) --- 1,646 1,580
Hardee's 579(a) --- (21) --- 558(a) 579
Quincy's 198 1 (2) --- 197(b) 199
El Pollo Loco
Company owned 94 3 --- --- 97 98
Franchised 143(a) --- --- --- 143(a) 128
International licensees 10 --- (6) --- 4 8
-------- -------- --------- -------- ------ --------
247 3 (6) --- 244 234
Coco's
Company owned 185 1 --- --- 186 184
Franchised 7 1 --- --- 8 6
International licensees 286 6 --- --- 292 266
------- -------- --------- --------- -------- -------
478 8 --- --- 486 456
Carrows
Company owned 156 --- (2) (1) 153 162
Franchised 1 1 --- 1 3(b) ---
--------- ---------- ------- --------- ---------- ---------
157 1 (2) --- 156 162
------- ---------- ------- --------- -------- -------
3,292 28 (33) --- 3,287 3,210
====== ======= ====== ========= ======= ======
</TABLE>
(a) Unit count includes one Hardee's and El Pollo Loco dual unit. The unit's
operating results are included in Hardee's operating results.
(b) Unit count includes one Quincy's unit converted to a Carrows that is
operated by Quincy's as a Carrows franchise. The unit's operating results
are included in Quincy's operating results. Intercompany franchise fees
are eliminated in consolidation.
15
<PAGE>
Denny's:
- --------
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
------------ ------------ ------
<S> <C> <C> <C>
Net company sales $ 292.0 $ 317.0 (7.9)
Franchise revenue 16.1 15.3 5.2
----------- -------------
Total revenue 308.1 332.3 (7.3)
Operating expenses 275.7 298.8 (7.7)
----------- ------------
Operating income $ 32.4 $ 33.5 (3.3)
=========== =============
Average unit sales
Company-operated $ 326,200 $ 348,000 (6.3)
Franchise $ 284,500 $ 299,700 (5.1)
Comparable Store Data (Company-Operated):
Comparable store sales (decrease) increase (5.8%) 0.9%
Average guest check $ 5.60 $ 5.04 11.1
</TABLE>
Denny's net company sales decreased by $25.0 million (7.9%) during the 1997
quarter as compared with the 1996 quarter. This decrease reflects 15 fewer
Company-owned units and a decline in comparable store sales. The decrease in
Company-owned units, primarily from units 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, offset
somewhat by an increase in average guest check. Both of these changes reflect
the impact of the September 1996 price increase that eliminated certain value
pricing. Franchise revenue for the quarter increased by $0.8 million (5.2%),
primarily due to an 81-unit increase in the number of franchise units at the
1997 quarter end as compared with the 1996 quarter end.
Denny's operating expenses for the 1997 quarter as compared with the 1996
quarter decreased by $23.1 million (7.7%), reflecting the impact of 15 fewer
Company-owned units and a decrease in labor costs associated with improved labor
efficiencies and lower guest counts. These decreases are offset somewhat by
increased costs for produce, coffee, sausage and bacon and increases in the
Federal and state minimum wage rates. In addition, operating expenses in the
current year quarter include $0.1 million of gains on sales of restaurants to
franchisees as compared with $0.8 million in the prior year quarter. Food cost
as a percent of revenue improved during the quarter due to the September 1996
price increase and a shift in promotional emphasis to higher margin products in
the current year quarter.
Denny's operating income for the 1997 quarter decreased by $1.1 million (3.3%)
as compared to the comparable 1996 quarter as a result of the factors noted
above.
16
<PAGE>
Hardee's:
- --------
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
--------- ------------ -----------
<S> <C> <C> <C>
Revenue $134.0 $154.2 (13.1)
Operating expenses 125.1 142.1 (12.0)
------- ------
Operating income $ 8.9 $ 12.1 (26.4)
======== =======
Average unit sales $239,400 $266,400 (10.1)
Comparable Store Data:
Comparable store sales decrease (9.1%) (6.1%)
Average guest check $ 3.17 $ 3.16 0.3
</TABLE>
Hardee's revenue decreased by $20.2 million (13.1%) during the 1997 quarter as
compared with the 1996 quarter, reflecting a 9.1% decline in comparable store
sales as well as a 21-unit decrease in comparison to the prior year quarter. The
decrease in comparable store sales reflects a decline in traffic reflecting 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 $17.0 million
(12.0%), in spite of 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. The net decrease primarily reflects the
lower number of units, the impact on expenses from the lower comparable store
sales noted above and management's continued focus on tight cost controls.
Hardee's operating income for the 1997 quarter decreased by $3.2 million (26.4%)
as compared to the prior year quarter as a result of the factors noted above.
Quincy's:
- -----------
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
---------- -------------- -----------
<S> <C> <C> <C>
Revenue $ 57.2 $ 62.2 (8.0)
Operating expense 56.1 61.4 (8.6)
------- -------
Operating income $ 1.1 $ 0.8 37.5
======= ========
Average unit sales $288,600 $313,000 (7.8)
Comparable Store Data:
Comparable store sales decrease (7.1%) (17.5%)
Average guest check $ 6.20 $ 6.07 2.1
</TABLE>
17
<PAGE>
Quincy's revenue decreased by $5.0 million (8.0%) during the 1997 quarter as
compared with the 1996 quarter, reflecting a 7.1% 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" customers who have been lost over the past several years.
Quincy's operating expenses in the 1997 quarter decreased by $5.3 million (8.6%)
in spite of 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. The net decrease primarily reflects the impact on
the expenses from the lower comparable store sales noted above and a decrease in
product costs due to various cost reduction initiatives including purchasing
contract renegotiations and reviews of product usage and packaging.
Quincy's operating income for the 1997 quarter increased by $0.3 million as
compared to the prior year quarter as a result of the factors noted above.
El Pollo Loco:
- ---------------
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
---------- ----------- ----------
<S> <C> <C> <C>
Net company sales $ 29.2 $ 29.2 ---
Franchise revenue 3.9 3.5 11.4
-------- --------
Total revenue 33.1 32.7 1.2
Operating expense 29.6 29.2 1.4
------- -------
Operating income $ 3.5 $ 3.5 ---
======== =========
Average unit sales
Company-operated $309,200 $298,600 3.5
Franchise $224,500 $216,600 3.6
Comparable Store Data (Company-Operated):
Comparable store sales increase 1.9% 6.5%
Average guest check $ 6.69 $ 6.65 0.6
</TABLE>
El Pollo Loco's net company sales were unchanged for the 1997 quarter as
compared with the 1996 quarter, despite a 1.9% comparable store sales increase,
primarily due to a one-unit decrease in Company-owned units. The increase in the
comparable stores sales was partially driven by a higher guest check average due
to a shift in promotional emphasis, as well as an increase in weekly guest
counts in comparison to the prior year quarter. Franchise revenue for the
quarter increased by $0.4 million (11.4%), primarily due to a net increase of 11
franchise units at the 1997 quarter end as compared with the 1996 quarter end,
reflecting the Company's strategy of focusing on growth through franchising, as
well as 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 $0.4 million (1.4%), primarily due to increased labor
expenses due to Federal and state minimum wage rate increases, increased
advertising expenses, and the timing of reengineering project expenditures. In
addition, there were no gains on sales of restaurants to franchisees in the
current quarter as compared to a $0.1 million gain in the 1996 quarter. The
operating expense increase is offset somewhat by the impact on expenses of a
one-unit decrease in Company-owned units and a decrease in food costs primarily
due to lower chicken prices as compared with the prior year quarter.
18
<PAGE>
El Pollo Loco's operating income for the 1997 quarter was unchanged as compared
to the prior year quarter as a result of the factors noted above.
Coco's
- ------
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
---------- --------- -----------
<S> <C> <C> <C>
Net company sales $ 68.2 $ 66.2 3.0
Franchise revenue 1.1 1.1 ---
-------- -------
Total revenue 69.3 67.3 3.0
Operating expenses 65.6 63.6 3.1
------- ------
Operating income $ 3.7 $ 3.7 ---
======== ========
Average unit sales
Company-operated $366,500 $356,900 2.7
Franchise $441,700 $448,100 (1.4)
Comparable Store Data (Company-Operated):
Comparable store sales increase (decrease) 2.7% (3.1%)
Average guest check (a) $ 6.79 $ 6.75 0.6
</TABLE>
(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 October 1, 1997 increased $2.0
million (3.0%) as compared to the prior year comparable quarter. This increase
is due primarily to an increase in comparable store sales which reflects an
increase in average check as well as an increase in guest counts. In addition,
the Company experienced an increase of two Company-owned units from the
comparable quarter in 1996.
Franchise and foreign licensing revenue was essentially flat for the third
quarter of 1997 as compared to the prior year quarter, in spite of two
additional domestic franchise units in 1997 as well as an increase in the number
of foreign licenses from 266 at September 26, 1996 to 292 at October 1, 1997.
The increase in revenue from the additional domestic franchise units and foreign
licenses was offset by lower royalties as a result of lower sales experienced by
the Japan and Korea units due to economic conditions in those countries.
Coco's operating expenses for the third quarter of 1997 increased by $2.0
million (3.1%) as compared to the prior year quarter, reflecting the impact on
expenses of the increase in net company revenue and the impact of Federal and
state minimum wage rate increases. Such increases were somewhat offset by
reduced product costs due to increased focus on portion size and minimizing
waste.
Operating income for Coco's for the quarter ended October 1, 1997 as compared to
the prior year quarter was essentially flat due to the factors noted above.
19
<PAGE>
Carrows
- --------
<TABLE>
<CAPTION>
Quarter Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
---------- ----------- ------------
<S> <C> <C> <C>
Net company sales $ 52.4 $ 54.8 (4.4)
Franchise revenue 0.1 --- ---
--------- ---------
Total revenue 52.5 54.8 (4.2)
Operating expenses 49.5 51.6 (4.1)
-------- -------
Operating income $ 3.0 $ 3.2 (6.2)
======== ========
Average unit sales
Company-operated $339,500 $341,000 (0.4)
Comparable Store Data (Company-Operated):
Comparable store sales decrease (0.3%) (3.3%)
Average guest check (a) $ 6.52 $ 6.22 4.8
</TABLE>
(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 $2.4 million (4.4%) as compared to the
prior year comparable quarter, reflecting the impact of a nine-unit decrease in
the number of Company-owned restaurants as well as a slight decrease in
comparable store sales. The decline in comparable store sales reflects a
decrease in guest counts partially offset by an increase in average guest check.
Carrows opened its second and third domestic franchise locations in the third
quarter of 1997.
Carrows' operating expenses for the quarter ended October 1, 1997 decreased by
$2.1 million (4.1%) as compared to the prior year quarter, reflecting the impact
of nine fewer Company-owned units and a reduction in product costs during the
quarter as a result of increased focus on waste reduction. Such decreases were
somewhat offset by the impact of the Federal and state minimum wage rate
increases.
Operating income for Carrows for the quarter ended October 1, 1997 as compared
to the prior year quarter decreased $0.2 million due to the factors noted above.
20
<PAGE>
Results of Operations
Three Quarters Ended October 1, 1997 Compared to Three Quarters Ended September
30, 1996
Company Consolidated
The Company's consolidated revenue for the three quarters ended October 1, 1997
increased by $108.5 million (5.8%) 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 three quarters ended October 1,
1997 in comparison to the prior year period and an approximate $202.3 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 $117.8 million in
comparison to the prior year period. This decrease reflects decreases in
comparable store sales at all of the Company's concepts except for El Pollo Loco
and Coco's, as well as a 46-unit decrease in Company-owned units. Such decreases
are slightly offset by a $6.6 million increase in franchise revenue due to a
123-unit increase in franchise units.
Consolidated operating expenses for the three quarters ended October 1, 1997
increased by $114.2 million (6.5%) as compared with the 1996 comparable period.
The expense increase is primarily attributable to two factors: the estimated
$20.3 million impact of the additional days in the 1997 period in comparison to
the prior year comparable period and a $190.6 million impact of 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 $96.7 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 the impact
on expenses of a 46-unit decrease in Company-owned units.
Consolidated operating income for the three quarters ended October 1, 1997
decreased by $5.7 million (4.8%) as compared with the 1996 comparable period as
a result of the factors noted above.
Consolidated interest and debt expense, net totaled $194.2 million during the
1997 period as compared with $199.8 million during the comparable 1996 period.
The decrease is due principally to the fact that the Company ceased recording
interest on the Senior Subordinated Debentures and 10% Convertible Debentures on
July 11, 1997 in accordance with SOP 90-7. This decrease is partially offset by
the addition of $12.1 million of interest and debt expense associated with the
Coco's and Carrows acquisition in May 1996 and a $3.6 million charge
representing interest and penalties associated with the early termination of the
Company's interest rate exchange agreements in 1997. Such termination occurred
in conjunction with the refinancing of the Company's bank facility necessitated
by the bankruptcy filing on July 11, 1997. In addition, interest income for the
1997 period decreased $3.2 million in comparison to the prior year period due to
decreased cash and cash equivalents available for investment during the 1997
period.
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 4 to the consolidated
financial statements included herein.
The provision for (benefit from) 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 1.3% for the
1997 period compared to a benefit for the comparable 1996 period reflecting an
approximate rate of (16.0%). 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 $112.4 million in the 1997 period as compared to $67.9 million
for the prior year comparable period. The increase in the net loss is due to the
factors noted above.
21
<PAGE>
Restaurant Operations:
- ----------------------
Denny's:
- ---------
<TABLE>
<CAPTION>
Three Quarters Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
----------- -------- ----------
<S> <C> <C> <C>
Net company sales $ 873.4 $ 912.9 (4.3)
Franchise revenue 46.2 41.3 11.9
---------- --------
Total revenue 919.6 954.2 (3.6)
Operating expenses 833.1 868.1 (4.0)
--------- ------
Operating income $ 86.5 $ 86.1 0.5
========= ========
Average unit sales
Company-operated $978,100 $994,600 (1.7)
Franchise $827,000 $833,400 (0.8)
Comparable Store Data (Company-Operated):
Comparable store sales (decrease) increase (4.6%) 1.9%
Average guest check $ 5.51 $ 4.93 11.8
</TABLE>
Denny's net company sales decreased by $39.5 million (4.3%) during the 1997
period as compared with the 1996 comparable period. This decrease reflects 15
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 fluctuations reflect the
impact of the September 1996 price increase that eliminated certain value
pricing. Franchise revenue for the period increased by $4.9 million (11.9%),
reflecting 81 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
comparable period decreased by $35.0 million (4.0%), reflecting the impact of 15
fewer Company-owned units and a decrease in labor costs associated with improved
labor efficiencies and lower guest counts. 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 produce, coffee,
bacon, and sausage and increases in the Federal and state minimum wage rates.
In addition, operating expenses in the prior year period included $6.9 million
of gains on sales of restaurants in comparison to $0.6 million of gains in the
current period. Food cost as a percent of revenue improved during the period
because of the September 1996 price increase and a shift to higher margin
products in the 1997 period.
Denny's operating income for the 1997 period increased by $0.4 million (0.5%) as
compared to the prior year comparable period as a result of the factors noted
above.
22
<PAGE>
Hardee's:
- ---------
<TABLE>
<CAPTION>
Three Quarters Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
-------- ----------- -----------
<S> <C> <C> <C>
Revenue $ 416.9 $ 459.2 (9.2)
Operating expenses 395.9 434.3 (8.8)
------- -------
Operating income $ 21.0 $ 24.9 (15.7)
======== ========
Average unit sales $727,400 $792,600 (8.2)
Comparable Store Data:
Comparable store sales decrease (8.2%) (6.9%)
Average guest check $ 3.23 $ 3.13 3.2
</TABLE>
Hardee's revenue decreased by $42.3 million (9.2%) during the 1997 period as
compared with the 1996 comparable period, reflecting an 8.2% decline in
comparable store sales, as well as a 21-unit decrease in comparison to the prior
year period end. 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 $38.4 million
(8.8%), in spite of 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. The net decrease primarily reflects the
impact of the cost reduction program implemented in the second half of 1996, the
impact on expenses from the lower comparable store sales noted above and a
21-unit decrease in comparison to the prior year period end.
Hardee's operating income for the 1997 period decreased by $3.9 million (15.7%)
as compared to the prior year period as a result of the factors noted above.
Quincy's:
- ----------
<TABLE>
<CAPTION>
Three Quarters Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
--------- ------------- -----------
<S> <C> <C> <C>
Revenue $ 183.2 $ 197.4 (7.2)
Operating expense 179.4 189.5 (5.3)
-------- -------
Operating income $ 3.8 $ 7.9 (51.9)
========= =========
Average unit sales $922,900 $991,000 (6.9)
Comparable Store Data:
Comparable store sales decrease (7.0%) (10.9%)
Average guest check $ 6.27 $ 5.98 4.8
</TABLE>
Quincy's revenue decreased by $14.2 million (7.2%) 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
23
<PAGE>
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" customers who have been lost over the past several years.
Quincy's operating expenses in the 1997 period decreased by $10.1 million
(5.3%), primarily reflecting the impact on expenses of the lower comparable
store sales noted above and a decrease in product costs due to various cost
reduction initiatives including contract renegotiations and reviews of product
usage and packaging. These decreases are somewhat offset by increased labor
costs due to 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.
Quincy's operating income for the 1997 period decreased by $4.1 million as
compared to the prior year period as a result of the factors noted above.
El Pollo Loco:
- --------------
<TABLE>
<CAPTION>
Three Quarters Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
------- ------ ---------
<S> <C> <C> <C>
Net company sales $ 87.3 $ 87.2 0.1
Franchise revenues 11.2 9.9 13.1
------- --------
Total revenue 98.5 97.1 1.4
Operating expense 87.9 86.4 1.7
------- -------
Operating income $ 10.6 $ 10.7 (0.9)
======= =======
Average unit sales
Company-operated $921,000 $873,200 5.5
Franchise $667,700 $644,300 3.6
Comparable Store Data (Company-Operated):
Comparable store sales increase 0.0% 7.7%
Average guest check $ 6.69 $ 6.56 2.0
</TABLE>
El Pollo Loco's net company sales increased $0.1 million (0.1%) during the 1997
period as compared with the 1996 comparable period. This increase reflects an
estimated $2.3 million impact from the additional week in the 1997 period
compared with the prior year comparable period. Excluding the impact of the
additional week, revenue decreased $2.2 million in comparison to the prior year
period, primarily reflecting a five-unit decrease in the number of units
operating for the entire current year period as compared to the entire prior
year period. Comparable store sales were unchanged as a result of lower customer
counts offset by higher guest check averages, both of which are largely
explained by a shift in promotional emphasis during the first two quarters of
1997. 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
compared with the 1996 comparable period increased by $1.3 million (13.1%),
primarily due to 11 more franchise units open at the end of the 1997 period as
compared with the 1996 period, as well as an increase in franchise average unit
sales. This increase in revenue over the prior year comparable period reflects
the Company's strategy of focusing on growth through franchising.
El Pollo Loco's operating expenses for the 1997 period as compared with the 1996
comparable period increased by $1.5 million (1.7%), primarily reflecting an
estimated $1.8 million impact from the additional week in the 1997 period in
comparison to the prior year comparable period. Other factors which affected the
current year period include an increase in advertising expenses, expenses
related to El Pollo Loco's current reengineering project, and a slight increase
in food costs over the comparable 1996
24
<PAGE>
period. In addition, operating expenses in the current period include $0.4
million of gains on sales of restaurants in comparison to $0.6 million of gains
in the prior comparable period. These increases were somewhat offset by lower
promotional discounting and the impact of a shift in promotional emphasis.
El Pollo Loco's operating income for the 1997 period decreased by $0.1 million
(0.9%) as compared to the prior year comparable period as a result of the
factors noted above.
Coco's and Carrows:
The following information is provided for analysis purposes only as it includes
information for periods prior to the acquisition of Coco's and Carrows by the
Company on May 23, 1996:
Coco's:
- --------
<TABLE>
<CAPTION>
Three Quarters Ended %
($ in millions, except average unit and October 1, September 30, Increase/
comp. store data) 1997 1996 (Decrease)
------------ --------------- --------------
<S> <C> <C> <C>
Net company sales $ 206.7 $ 201.5 2.6
Franchise revenue 3.1 2.8 10.7
--------- ---------
Total revenue 209.8 204.3 2.7
Operating expenses 196.4 197.0 (0.3)
------- -------
Operating income $ 13.4 $ 7.3 83.6
======== =========
Average unit sales
Company-operated $1,119,400 $1,117,500 0.2
Franchise $1,323,900 $1,285,000 3.0
Comparable Store Data (Company-Operated):
Comparable store sales decrease 0.1% (2.3%)
Average guest check (a) $ 6.70 $ 6.79 (1.3)
</TABLE>
(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 $5.2 million (2.6%) for the three quarters
ended October 1, 1997 as compared to the prior year comparable period. This
increase reflects an estimated $4.8 million impact from the additional six days
in the 1997 period in comparison to the prior year comparable period as well as
a slight increase in comparable store sales. The increase in comparable store
sales was driven by an increase in guest count somewhat offset by a decrease in
average guest check.
Franchise and foreign licensing revenue increased by $0.3 million (10.7%) for
the three quarters ended October 1, 1997 as compared to the prior year
comparable period. This increase is a result of two additional domestic
franchise units as well as an increase in the number of foreign licenses from
266 at September 26, 1996 to 292 at October 1, 1997.
Coco's operating expenses for the three quarters ended October 1, 1997 decreased
by $0.6 million (0.3%) as compared to the prior year comparable period,
primarily as a result of savings in product and labor costs due to an increased
operations
25
<PAGE>
focus on cost controls, waste reduction and labor initiatives. In addition, the
prior year included non-recurring adjustments of approximately $1.6 million,
which increased legal and workers' compensation expenses. No comparable charges
are included in the current year period. These decreases were partially offset
by the impact of an additional six days in the 1997 period as compared to the
prior year comparable period and the increase in Federal and state minimum wage
rates.
Operating income for Coco's for the three quarters ended October 1, 1997 as
compared to the prior year comparable period in 1996 increased $6.1 million due
to the factors noted above.
Carrows:
- ---------
<TABLE>
<CAPTION>
Three Quarters Ended %
($ in millions, except average unit and October 1 September 30, Increase/
comp. store data) 1997 1996 (Decrease)
------------ -------------------- ----------
<S> <C> <C> <C>
Net company sales $ 161.2 $ 163.0 (1.1)
Franchise revenue 0.2 --- ---
---------- ----------
Total revenue 161.4 163.0 (1.0)
Operating expenses 152.5 157.1 (2.9)
-------- -------
Operating income $ 8.9 $ 5.9 50.8
========== =========
Average unit sales
Company-operated $1,028,400 $1,044,600 (1.6)
Comparable Store Data (Company-Operated):
Comparable store sales decrease (1.5%) (0.4%)
Average guest check (a) $ 6.46 $ 6.20 4.2
</TABLE>
(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 $1.8 million (1.1%) for the three quarters
ended October 1, 1997 as compared to the prior year comparable period in spite
of an estimated $3.8 million impact from the additional six days in the 1997
period in comparison to the prior year comparable period. The sales decrease is
primarily the result of a nine-unit decrease in Company-owned restaurants and
also reflects a decrease in comparable store sales. The decrease in comparable
store sales was driven by a decrease in customer counts, partially offset by an
increase in average guest check. Carrows opened its first domestic franchise
location in the first quarter of 1997 and its second and third in the third
quarter of 1997.
Carrows' operating expenses decreased $4.6 million (2.9%) for the three quarters
ended October 1, 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 comparable period and increases in the Federal and state minimum wage
rates. This expense decrease reflects the impact of approximately $1.5 million
of non-recurring adjustments which increased legal and workers' compensation
expenses in the prior year comparable period and also reflects savings in
product and labor costs due to increased focus by operations on cost control,
waste reduction and labor initiatives.
Operating income for Carrows increased $3.0 million for the three quarters ended
October 1, 1997 as compared to the prior year comparable period due to the
factors noted above.
26
<PAGE>
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 Prepackaged 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 10% Convertible
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 have presented 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 Company's pre-bankruptcy 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 Senior Subordinated Debentures
and the 10% Convertible Debentures without triggering a default under the Credit
Agreement, unless any such debt was 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 10% Convertible 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. During
the pendency of Flagstar's bankruptcy proceeding, Flagstar also missed the
$14.5 million interest payment due September 15, 1997 on its 10 3/4% Senior
Notes and the $7.1 million interest payment due September 15, 1997 on its
11 3/8% Debentures. As described in more detail in Note 2 to the consolidated
financial statements, the bankruptcy filings operate as an automatic stay of all
collection and enforcement actions by the holders of the Senior Subordinated
Debentures, the 10% Convertible Debentures, the Old Senior Notes, and by 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 is required to allow the Company to meet
its long-term debt obligations and is a prerequisite to future growth through
additional investment in its restaurants. In this regard, FCI and Flagstar
developed the Prepackaged Plan.
As discussed in Note 2 to the consolidated financial statements, on July 11,
1997, the Debtors 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 for working capital and
general corporate purposes and for letters of credit during the pendency of the
Chapter 11 case until the earlier to occur of (x) July 10, 1998 and (y) the
substantial consummation of the Plan. 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. As of
October 1, 1997, the Company had working capital advances outstanding of $23.0
million and letters of credit outstanding of $79.9 million.
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 a
commitment from Chase for a $200 million senior secured revolving credit
facility (the "Exit Facility") for the benefit of certain of the Company's
operating subsidiaries, which facility will refinance the DIP Facility upon the
emergence of the Debtors from Chapter 11 and will be used thereafter for working
capital and general corporate purposes and for 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 certain of the Company's operating
subsidiaries and generally is secured by liens on the same
27
<PAGE>
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
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
(as defined). 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 negotiation 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 FCI and Flagstar commenced their
Chapter 11 cases. The agreement with Chase for the Exit Facility has been
approved by the Bankruptcy Court pursuant to the order confirming the Amended
Plan.
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 Amended 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 meet its debt service obligations will
depend on a number of factors, including management's ability to maintain
operating cash flow.
At October 1, 1997 and December 31, 1996, the Company had working capital
deficits, exclusive of net assets held for sale, of $286.5 million and $301.3
million, respectively. The decrease in the deficit is attributable primarily to
a reclassification at October 1, 1997 of accrued interest of $115.0 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.
Due to the Bankruptcy Court's approval of the Amended Plan for FCI and Flagstar
on November 7, 1997, management has decided that it would be appropriate for the
Company's franchising subsidiaries to update their offering circulars and to
cease sales of new franchises until an updated UFOC has been prepared and
approved by those states that regulate the sale of franchises.
28
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Chapter 11 Reorganization Under the Bankruptcy Code
As discussed in Note 2 to the consolidated 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,
Case Nos. 97-05431-B, 97-05795-B, and 97-05796-B (jointly administered under
Case No. 97-05431-B). Flagstar's operating subsidiaries did not file for
bankruptcy protection. On July 24, 1997, the United States Trustee appointed the
Official Junior Committee. No other official committees have been appointed. On
November 12, 1997, the Bankruptcy Court entered an order confirming the Amended
Plan. The Bankruptcy Court will retain jurisdiction over certain matters pending
the Effective Date and, pursuant to the terms of the Amended Plan, will retain
jurisdiction over certain limited matters after the Effective Date.
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 Amended 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. The Company has decided not to
reject any executory contracts or unexpired leases.
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.
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. (The Prepackaged Plan had also provided for the Debtors'
payment of expenses, including counsel and professional fees, of the Ad Hoc
Committee and of an informal committee representing holders of the Old Senior
Notes.) 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 10% Convertible
Debentures to the Prepackaged Plan's classification of the 10% Convertible
Debentures as subordinate to the Senior Subordinated Debentures and for a
discussion of the outcome of such litigation, see Note 2 to the consolidated
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 the Ad Hoc Committee of holders of
Senior Subordinated Debentures.
The United States Trustee and the Bankruptcy Court 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
29
<PAGE>
purposes; (ii) the firm of Parker, Poe, Adams & Bernstein LLP as special
corporate and securities counsel and (iii) the firm of Deloitte & Touche LLP as
accountants and auditors. 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.
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. FCI and
Flagstar's exclusive right to file a plan of reorganization was set to expire on
November 10, 1997, and the exclusive right to solicit acceptances thereof was
set to expire on January 9, 1998. On November 7, 1997, the Bankruptcy Court
granted FCI and Flagstar's request to extend the Exclusivity Periods for 90
days.
Each of the Debtors filed with its Chapter 11 petition a list containing the
names and addresses of its twenty largest known creditors. On August 11, 1997,
Holdings filed its schedules of assets and liabilities and statements of
financial affairs with the Bankruptcy Court, and on August 25, 1997, FCI and
Flagstar filed their schedules of assets and liabilities and statements of
financial affairs with 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
Code 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. Pursuant to the order confirming
the Amended Plan, no deadline for filing proofs of claims will be enforced with
respect to trade claims or other unimpaired claims.
As described in Note 2 to the consolidated financial statements, the Debtors
solicited prepetition acceptances of their Prepackaged 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. The Prepackaged 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 10% Convertible 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
Prepackaged Plan.
On November 6, 1997, the Bankruptcy Court determined that the Supplemental
Indenture executed by the Indenture Trustee and the Company in August 1992
violated the Indenture governing the 10% Convertible Debentures. Following this
ruling, the Ad Hoc Debentureholders' Committee, the Official Junior Committee
and the Debtors entered into negotiations concerning the recovery that the 10%
Convertible Debentureholders would receive. As a result of these negotiations,
on November 7, 1997, the Debtors filed the Amended Plan, which was confirmed by
the Bankruptcy Court and the material terms of which remain identical to the
terms of the Prepackaged Plan described above with the following changes: (i)
each holder of 10% Convertible Debentures will be entitled to receive on account
of the unpaid principal amount of its 10% Convertible Debentures plus all unpaid
interest which accrued thereon prior to the Petition Date, such holder's pro
rata share of shares of New Common Stock equivalent to 4.5% of the New Common
Stock and certain warrants to be outstanding on the Effective Date, and (ii) the
remaining junior impaired classes (the classes of FCI Old Common Stock and FCI
Old Preferred Stock) will receive or retain no property under the Amended Plan.
At the hearing on November 7, 1997, to consider the adequacy of the Disclosure
Statement and to consider confirmation of the Amended Plan, the Bankruptcy Court
ruled that (i) the Disclosure Statement contained adequate information to enable
creditors to make an informed judgment about the Prepackaged Plan pursuant to
section 1125 of the Bankruptcy Code (ii) the modifications of the Prepackaged
Plan by the Amended Plan complied with the Bankruptcy Code, did not materially
adversely effect any class, and did not require further disclosure or
solicitation, and (iii) the Amended Plan would be confirmed as meeting the
requirements of section 1129(a) of the Bankruptcy Code. The Bankruptcy Court's
order confirming the Amended Plan was entered pursuant to such ruling on
November 12, 1997, subject to notice to creditors. The Effective Date of the
Amended Plan is contemplated to occur on or before March 15, 1998. All pending
objections to the approval of the Disclosure Statement and
30
<PAGE>
confirmation of the Amended Plan were either resolved, withdrawn or overruled.
Item 2. Changes in Securities and Use of Proceeds
As of July 10, 1997, Flagstar and the indenture trustee for the 11 3/8%
Debentures and 11.25% Debentures executed supplemental indentures amending the
indentures governing such securities, upon the receipt of consents of
securityholders pursuant to such indentures, in order to implement certain
agreements relating to the Prepackaged Plan as described in Note 2 to the
consolidated financial statements included elsewhere herein. As a result of
amendments to the Prepackaged Plan, however, as reflected in the Amended Plan
confirmed by the Bankruptcy Court, the provisions of such supplemental
indentures are of no force or effect.
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%
Convertible 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. During the pendency of Flagstar's bankruptcy proceeding, Flagstar
also missed the $14.5 million interest payment due September 15, 1997 on its
10 3/4% Senior Notes and the $7.1 million interest payment due September
15, 1997 on its 11 3/8% Debentures. As described in more detail in Note 2 to the
consolidated financial statements, the bankruptcy filings on July 11, 1997
operate as an automatic stay of all collection and enforcement actions by the
holders of the Senior Subordinated Debentures, 10% Convertible Debentures, the
Old Senior Notes and the respective indenture trustees with respect to
Flagstar's failure to make the interest payments when due.
31
<PAGE>
Item 5. Exhibits and Reports on Form 8-K
a. The following are included as exhibits to this report:
Exhibit
No. Description
*4.1 Fourth Amendment and Limited Waiver, dated July 9, 1997, to the
Credit Agreement, dated as of May 23, 1996, by and among FRD
Acquisition Co., FRI-M Corporation, certain lenders and co-agents named
therein, and Credit Lyonnais New York Branch as administrative agent
(incorporated by reference to Exhibit 4.1 to FCI's quarterly report on
Form 10-Q for the period ending October 1, 1997, File No. 0-18051 (the
"1997 third quarter FCI 10-Q")).
*4.2 Supplemental Indenture dated as of July 10, 1997 to Indenture dated
September 23, 1993 relating to the 11 3/8% Debentures (incorporated by
reference to Exhibit 4.2 to the third quarter FCI 10-Q).
*4.3 Supplemental Indenture dated as of July 10, 1997 to Indenture dated
November 16, 1992 relating to the 11.25% Debentures (incorporated by
reference to Exhibit 4.3 to the third quarter FCI 10-Q).
*10.1 Revolving Credit and Guaranty Agreement, dated as of July 11, 1997,
among Flagstar Corporation, as Borrower, Flagstar Companies, Inc.,
Flagstar Holdings, Inc. and Borrower's Subsidiaries, as guarantors, the
banks named therein and Chase Manhattan Bank, as agent (referred to
herein as the "DIP Facility") (incorporated by reference to Exhibit
10.1 to the 1997 third quarter FCI 10-Q).
*10.2 Final Amendment to Revolving Credit and Guaranty Agreement, dated as of
August 15, 1997 (incorporated by reference to Exhibit 10.2 to the third
quarter FCI 10-Q).
27 Financial Data Schedule
- ------------------
* Certain of the exhibits to this Quarterly Report on Form 10-Q, indicated by
an asterisk, are hereby incorporated by reference to other documents
physically on file with the Commission, to be part hereof as of their
respective dates.
b. The Company filed a report on Form 8-K on July 24, 1997, providing
certain information in Item 3. Bankruptcy or Receivership, of such
report. That filing reported that on July 11, 1997, the Company and its
parent company, Flagstar Companies, Inc., filed their joint prepackaged
plan of reorganization pursuant to Chapter 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the District
of South Carolina. No financial statements were included in the filing.
32
<PAGE>
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: November 17, 1997 By: /s/ Rhonda J. Parish
-------------------------
Rhonda J. Parish
Senior Vice President and
General Counsel
Date: November 17, 1997 By: /s/ C. Robert Campbell
-------------------------
C. Robert Campbell
Executive Vice President and
Chief Financial Officer
33
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
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 October 1, 1997 and is qualified in its entirety to
such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> OCT-01-1997
<CASH> 29,666
<SECURITIES> 0
<RECEIVABLES> 17,550
<ALLOWANCES> 3,190
<INVENTORY> 27,809
<CURRENT-ASSETS> 116,331
<PP&E> 1,917,350
<DEPRECIATION> 806,282
<TOTAL-ASSETS> 1,558,113
<CURRENT-LIABILITIES> 402,849
<BONDS> 655,703
0
0
<COMMON> 0
<OTHER-SE> (1,487,411)
<TOTAL-LIABILITY-AND-EQUITY> 1,558,113
<SALES> 0
<TOTAL-REVENUES> 1,989,355
<CGS> 0
<TOTAL-COSTS> 1,875,901
<OTHER-EXPENSES> 6,654
<LOSS-PROVISION> 194,184
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (110,933)
<INCOME-TAX> 1,484
<INCOME-CONTINUING> (112,417)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (112,417)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
