SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K/A NO. 2
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED] for the fiscal year ended December 29, 1996 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [ FEE REQUIRED]
For the transition period from ____________ to _________________
Commission file number 0-17980
RALLY'S HAMBURGERS, INC.
(Exact name of registrant as specified in its charter)
Delaware 62-1210077
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10002 Shelbyville Road, Suite 150, Louisville, Kentucky 40223
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 245-8900
Purpose: This revision to Form 10-K, "Item 8. Financial Statements and
Supplementary Data" for the year ended December 29, 1996 contains the
auditor's name on the Report of Independent Public Accountants. No other
changes have been made from the previously dated filed 1996 Form 10-K.
<PAGE>
Item 8. Financial Statements and Supplementary Data
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<CAPTION>
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1995 AND DECEMBER 29, 1996
(In thousands, except shares and per share amounts)
December 31, December 29,
1995 1996
------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,811 $ 2,285
Restricted cash 683 1,649
Investments 4,933 1,958
Royalties receivable, including $483 and $0 from related parties at December 31, 1995 and
December 29, 1996, respectively, net of a reserve for doubtful accounts of $922 and
$1,405 at December 31, 1995 and December 29, 1996, respectively 818 437
Accounts and other receivables including $23 and $565 from related parties at December 31,
1995 and December 29, 1996, respectively, net of a reserve for doubtful accounts of $453
and $301 at December 31, 1995 and December 29, 1996, respectively 2,131 1,698
Inventory, at lower of cost or market 1,056 794
Prepaid expenses and other current assets 1,131 999
Assets held for sale 2,506 596
------------- --------------
Total current assets 22,069 10,416
Assets held for sale 3,517 1,426
Net property and equipment, at historical cost 78,683 69,806
Notes receivable, including $175 and $127 from related parties at December 31, 1995 and
December 29, 1996, respectively, net of a reserve for doubtful accounts of $542 and $853 at
December 31, 1995 and December 29, 1996, respectively 789 773
Goodwill, less accumulated amortization of $1,704 and $2,243 at December 31, 1995 and
December 29, 1996, respectively 10,921 10,482
Reacquired franchise and territory rights, less accumulated amortization of $1,202 and $1,984
at December 31, 1995 and December 29, 1996, respectively 12,261 11,439
Other intangibles, less accumulated amortization of $2,344 and $2,459 at December 31, 1995 and
December 29, 1996, respectively 5,262 4,769
Other assets, less accumulated amortization of $1,638 and $1,101 at December 31, 1995 and
December 29, 1996, respectively 3,890 3,147
------------- --------------
Total assets $ 137,392 $ 112,258
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Accounts payable $ 8,773 4,884
Accrued liabilities 15,959 13,600
Current maturities of long-term debt and obligations under capital leases 17,544 1,484
------------- --------------
Total current liabilities 42,276 19,968
Senior notes, less current maturities, net of discount of $768 and $429 at December 31, 1995
and December 29, 1996, respectively 69,034 57,897
Long-term debt, less current maturities 5,749 4,775
Obligations under capital leases, less current maturities 5,631 5,408
Other liabilities 8,030 4,845
------------- --------------
Total liabilities 130,720 92,893
------------- --------------
Commitments and contingencies (Note 12)
Shareholders' equity:
Preferred stock, $.10 par value, 5,000,000 shares authorized, no shares issued - -
Common stock, $.10 par value, 50,000,000 shares authorized, 15,927,000 and 20,788,000 shares
issued at December 31, 1995 and December 29, 1996, respectively 1,593 2,079
Additional paid-in capital 60,804 71,023
Less: Treasury shares, 273,000 at December 31, 1995 and December 29, 1996 (2,108) (2,108)
Retained deficit (53,617) (51,629)
------------- --------------
Total shareholders' equity 6,672 19,365
============= ==============
Total liabilities and shareholders' equity $ 137,392 $ 112,258
============= ==============
The accompanying notes to consolidated financial
statements are an integral part of these
consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JANUARY 1, 1995, DECEMBER 31, 1995, AND DECEMBER 29, 1996
(In thousands, except per share amounts)
Fiscal Years Ended
----------------------------------------------
<S> <C> <C> <C>
January 1, December 31, December 29,
1995 1995 1996
------------ --------------- ---------------
REVENUES:
Restaurant sales $ 178,476 $ 181,778 $ 156,445
Franchise revenues and fees 7,842 7,081 5,867
Owner fee income - - 440
------------ --------------- ---------------
Total revenues 186,318 188,859 162,752
------------ --------------- ---------------
COSTS AND EXPENSES:
Restaurant costs of sales 62,518 64,813 53,712
Restaurant operating expenses exclusive of depreciation and
amortization and advertising and promotion expenses 78,072 84,305 71,155
General and administrative expenses 18,068 18,972 15,426
Advertising and promotion expenses 10,898 13,188 7,767
Depreciation and amortization 14,139 13,006 9,838
Owner expense - - 744
Provision for restaurant closures and other 17,259 31,045 20
------------ --------------- ---------------
Total costs and expenses 200,954 225,329 158,662
------------ --------------- ---------------
Income (loss) from operations (14,636) (36,470) 4,090
------------ --------------- ---------------
OTHER INCOME (EXPENSE):
Interest expense (9,742) (10,682) (8,622)
Interest income 477 538 614
Other (354) 234 (49)
------------ --------------- ---------------
Total other (expense) (9,619) (9,910) (8,057)
------------ --------------- ---------------
Loss before income taxes and extraordinary items (24,255) (46,380) (3,967)
PROVISION (BENEFIT) FOR INCOME TAXES (4,982) 539 (675)
------------ --------------- ---------------
Loss before extraordinary items (19,273) (46,919) (3,292)
EXTRAORDINARY ITEMS (net of tax expense of $1,350) - - 5,280
------------ --------------- ---------------
Net income (loss) $ (19,273) $ (46,919) $ 1,988
============ =============== ===============
Earnings (loss) per common share:
Earnings (loss) before extraordinary item $ $ $
(1.42) (3.00) (.19)
Extraordinary item - - .31
============ =============== ===============
Earnings (loss) per common share $ $ $
(1.42) (3.00) .12
============ =============== ===============
Weighted average shares outstanding 13,564 15,620 17,007
============ =============== ===============
The accompanying notes to consolidated
financial statements are an integral part
of these consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Treasury Stock and
Common Stock Preferred Stock Contingent Shares
--------------------------- ------------------------- -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Additional Retained
Shares Shares Shares Shares Paid-In Earnings Total
Authorized Issued Amount Authorized Issued Amount Shares Amount Capital (Deficit) Equity
---------- -------- ------- ---------- ------- ------- ------ ---------- --------- ---------- ----------
Balances at January 2,1994 25,000 13,268 $1,327 - - $ - (239) $(2,009) 50,634 $ 12,575 $ 62,527
Issuance of common stock - 2,569 257 - - - - - 9,976 - 10,233
Net loss - - - - - - - - - (19,273) (19,273)
---------- -------- ------- ---------- ------- ------- ------ ---------- ---------- ---------- --------
Balances at January 1, 25,000 15,837 1,584 - - - (239) (2,009) 60,610 (6,698) 53,487
1995
Amendment to the 25,000 - - - - - - - - -
Charter (A)
Issuance of common stock - 90 9 - - - - - 194 - 203
Treasury stock acquired - - - - - - (34) (99) - - (99)
Net loss - - - - - - - - - (46,919) (46,919)
---------- -------- ------- ---------- ------- ------- ------ ---------- ---------- ---------- --------
Balances at
December 31, 1995 50,000 15,927 1,593 - - - (273) (2,108) 60,804 (53,617) 6,672
Issuance of common stock - 35 3 - - - - - 74 - 77
Authorization of
preferred stock (B) - - - 5,000,000 - - - - - -
Shareholders Rights Offering - 4,826 483 - - - - - 9,975 - 10,458
Issuance of
compensatory stock
options and warrants - - - - - - - - 170 - 170
Net income - - - - - - - - - 1,988 1,988
========== ======== ======= ========== ======= ======= ====== ========== ========== ========== ========
Balances at December
29, 1996 50,000 20,788 $2,079 5,000,000 - $ - (273) $(2,108) $71,023 $(51,629) $ 19,365
========== ======== ======= ========== ======= ======= ====== ========== ========== ========== ========
(A) On May 13, 1995, stockholders of the Company approved a proposal to amend
the Certificate of Incorporation to increase the number of authorized
shares of Common Stock from 25,000,000 shares to 50,000,000.
(B) On July 10, 1996, stockholders of the Company ratified the authorization of
5,000,000 shares of Preferred Stock at a par value of $.10.
The accompanying notes to consolidated financial statements
are an integral part of these
consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands)
Fiscal Years Ended
--------------------------------------------
<S> <C> <C> <C>
January 1, December 31, December 29,
1995 1995 1996
------------ -------------- ---------------
CASH FLOWS PROVIDED FROM OPERATING ACTIVITIES:
Net income (loss) $ (19,273) $ (46,919) $ 1,988
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 14,139 13,006 10,482
Extraordinary items, before tax expense of $1,350 - - (6,630)
Provision for restaurant closures and other 17,259 31,045 20
Provision for losses on receivables 377 1,507 968
Other 568 2,276 1,265
Changes in assets and liabilities net of effects from business
combinations:
(Increase) decrease in assets:
Receivables (1,810) 775 (306)
Inventory (14) (63) 262
Prepaid expenses and other current assets 752 185 161
Other assets (2,563) 292 (121)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities 187 7,815 (6,011)
Deferred income taxes (1,524) - -
Other liabilities (1,824) (1,424) (1,535)
------------ -------------- ---------------
Net cash provided by operating activities 6,274 8,495 543
------------ -------------- ---------------
CASH FLOWS PROVIDED FROM (USED IN) INVESTING ACTIVITIES:
(Increase) decrease in investments 9,022 (848) 2,975
Notes receivable 429 154 312
Pre-opening costs (832) (45) (156)
Capital expenditures (19,808) (3,405) (2,306)
Proceeds from the sale of property and equipment 2,525 4,266 4,392
(Increase) decrease in intangible assets (1,436) (111) (39)
Acquisition of businesses, net of cash acquired (1,836) (1,931) -
Proceeds from the sale of a business - 2,730 -
------------ -------------- ---------------
Net cash provided by (used in) investing activities (11,936) 810 5,178
------------ -------------- ---------------
CASH FLOWS PROVIDED FROM (USED IN) FINANCING ACTIVITIES:
(Increase) in restricted cash - (683) (966)
Payment of organization and development costs (4) (3) -
Principal payments of debt (5,538) (2,114) (1,696)
Senior Notes retirement - - (19,612)
Issuance of common stock, net of costs of issuance 10,233 203 10,535
Principal payments on capital lease obligations (393) (604) (508)
------------ -------------- ---------------
Net cash provided from (used in) financing activities 4,298 (3,201) (12,247)
------------ -------------- ---------------
Net increase (decrease) in cash (1,364) 6,104 (6,526)
CASH AND CASH EQUIVALENTS, beginning of period 4,071 2,707 8,811
============ ============== ===============
CASH AND CASH EQUIVALENTS, end of period $ 2,707 $ 8,811 $ 2,285
============ ============== ===============
The accompanying notes to consolidated financial
statements are an integral part of these
consolidated financial statements.
</TABLE>
5
<PAGE>
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(tabular dollars in thousands, except per share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Financial Statement Presentation and Organization
The consolidated financial statements include Rally's Hamburgers, Inc.
and its wholly-owned subsidiaries, each of which is described below.
Rally's Hamburgers, Inc. and its subsidiaries are collectively
referred to herein as the context requires as "Rally's" or the
"Company". All significant intercompany accounts and transactions have
been eliminated.
Rally's is one of the largest chains of double drive-thru restaurants
in the United States. At December 29, 1996, the Rally's system
included 467 restaurants in 19 states, primarily in the Midwest and
the Sunbelt, comprised of 209 Company-owned and operated, 231
franchised and 27 Company-owned restaurants in Western markets which
are operated as Rally's restaurants by CKE Restaurants, Inc. ("CKE"),
a significant shareholder of the Company, under an operating agreement
which began July, 1996. One additional Company-owned store covered by
the operating agreement has been converted to the Carl's Jr. format
and is not included in the above store count. The Company's
restaurants offer high quality fast food. The Company serves the
drive-thru and take-out segments of the quick-service restaurant
industry. The Company opened its first restaurant in January 1985 and
began offering franchises in November 1986.
Rally's Hamburgers, Inc., Rally's of Ohio, Inc., Self Service Drive
Thru, Inc. and Hampton Roads Foods, Inc. own and operate Rally's
restaurants in various states. Additionally, Rally's Hamburgers, Inc.
operates as franchisor of the Rally's brand. Rally's Management, Inc.
provides overall corporate management of the Company's businesses.
Rally's Finance, Inc. was organized for the purpose of making loans to
Rally's franchisees to finance the acquisition of restaurant equipment
and modular buildings. RAR, Inc. was organized for the purpose of
acquiring and operating a corporate airplane and is currently
inactive. The Company's wholly-owned subsidiary, ZDT Corporation, was
formed to own the Zipps brand and franchise system. MAC 1 was
organized for the purpose of acquiring a manufacturer of modular
buildings. The manufacturing business was sold in January 1995 (see
Note 2).
The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates, when actual transactions
anticipated are consummated. In addition, despite management
diligence, changes in estimates do and will continue to occur due to
changes in available relevant data and consummation of the events and
transactions. The statements are prepared on a going concern basis.
Certain of the most significant estimates include useful lives
assigned to depreciable/amortizable assets, fair value less costs to
sell of long-lived assets held for sale, fair value of long-lived
assets held for use, future net occupancy costs related to
closed/disposable properties, accruals for the Company's self-insured
and high deductible insurance programs, and disclosures regarding
commitments and contingencies.
b) Revenue Recognition
The Company recognizes franchise fees as income on the date a
restaurant is opened, at which time the Company has performed its
obligations relating to such fees. Area development fees are generated
from the awarding of exclusive rights to develop, own and operate
Rally's restaurants in certain
6
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geographic areas pursuant to an Area Development Agreement. Such fees
are recognized as income on a pro rata basis as the restaurants are
opened or upon the cancellation or expiration of an Area Development
Agreement. Both franchise fees and area development fees are
non-refundable. The Company also receives royalty fees from
franchisees in the amount of 4% of each franchised restaurant's gross
revenues, as defined in the Franchise Agreement. Royalty fees are
recognized as earned.
c) Property and Equipment
Property and equipment are depreciated using the straight-line method
for financial reporting purposes and accelerated methods for income
tax purposes. The estimated useful lives for financial reporting
purposes are the shorter of 20 years or the lease life plus available
renewal options for buildings and property held under capital leases,
eight years for furniture and equipment, five years for software and
computer systems and the life of the lease for leasehold improvements.
Expenditures for major renewals and betterments are capitalized while
expenditures for maintenance and repairs are expensed as incurred.
d) Interest Costs
Interest costs incurred during the construction of restaurants are
capitalized as a component of the cost of the restaurants and are
amortized on a straight-line basis over the estimated useful lives of
the restaurants. The amounts capitalized for the fiscal years ended
January 1, 1995, December 31, 1995 and December 29, 1996 were
approximately $490,000, $30,000 and $7,000, respectively.
e) Inventory
Inventory is valued at latest invoice cost which approximates the
lower of first-in, first-out cost or market.
f) Supplemental Disclosures of Cash Flow Information
Fiscal Years Ended
--------------------------------------
January 1, December 31, December 29,
1995 1995 1996
------------ ------------ ------------
Interest paid (net of amount capitalized) $ 9,760 $ 10,679 $ 8,639
Income taxes paid 163 212 983
Capital lease obligations incurred - 1,616 111
The purchase of HRF described in Note 2 was recorded as follows:
Fiscal
Year Ended
---------------
December 31,
1995
---------------
Fair value of assets acquired $ 9,133
Cash paid (2,125)
===============
Liabilities assumed $ 7,008
===============
As a result of the sale of Beaman discussed in Note 2, the Company
recorded the net present value of a non-interest bearing note of
approximately $347,000. The Company recorded in 1996 approximately
$547,000 in notes receivable primarily as the result of the sale of
five of its restaurants in Montgomery, Alabama. These non-cash
transactions have been excluded from the consolidated statement of
cash flows.
7
<PAGE>
During fiscal 1995 and 1996, the Company accepted notes due within two
to five years, bearing interest at rates previously specified in the
underlying franchise agreements, for certain receivables from
franchises in the aggregate amount of approximately $542,000 for 1995
and approximately $340,000 for 1996. There were no such notes in 1994.
For purposes of the consolidated statement of cash flows, the Company
considers all highly liquid debt instruments with an original maturity
of three months or less at the date of purchase to be cash
equivalents. Cash equivalents at December 31, 1995 and December 29,
1996 were approximately $6.8 million and $976,000, respectively.
g) Earnings (Loss) Per Common Share
Earnings (loss) per common share is calculated based upon the weighted
average shares and common equivalent shares outstanding during the
periods.
h) Goodwill, Reacquired Franchise Rights, Other Intangibles and Other
Assets
Goodwill, reacquired franchise and territory rights, other intangibles
and other assets are being amortized using the straight-line method
over the following periods:
Amortization
Period
--------------
Goodwill 5, 20-25 years
Reacquired franchise and territory rights 15-20 years
Other intangibles 3-25 years
Other assets 5-25 years
Subsequent to the intangibles' acquisition, the Company evaluates
whether later events and circumstances have occurred that indicate the
remaining estimated useful life of goodwill and other intangibles may
warrant revision or that the remaining balance of goodwill and other
intangibles may not be recoverable. When factors indicate that
goodwill or other intangibles should be evaluated for possible
impairment, the Company uses an estimate of the related undiscounted
cash flows over the remaining life of the goodwill and other
intangibles in measuring whether the goodwill and other intangibles
are recoverable. The amount of any such impairment is determined as
the difference between carrying value and fair value based upon
discounted cash flows. No such impairment was recorded in any period
presented except as disclosed in Note 16.
i) Owner Fee Income and Expense
Revenue received as a result of the operating agreement with CKE is
referred to as Owner fee income in the accompanying consolidated
financial statements. Expenses related to the ongoing investment in
the CKE-operated restaurants consist primarily of depreciation and
amortization and are referred to as Owner expenses in the accompanying
consolidated financial statements.
j) Advertising Costs
It is the Company's policy to expense advertising costs as incurred.
k) Reclassification
Certain items have been reclassified in the accompanying consolidated
financial statements for prior periods in order to be comparable with
the classification adopted for the fiscal year ended December 29,
1996. Such reclassifications had no effect on previously reported net
income.
8
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2. ACQUISITION AND DISPOSITION
On February 13, 1995, the Company acquired all of the shares of common
stock of Hampton Roads Foods, Inc. (a Louisiana corporation) and certain of
the assets of HRF, Inc. (a Virginia corporation), collectively referred to
as "HRF", for approximately $7.2 million, of which approximately $2.1
million was paid in cash and the remainder to be paid over the ensuing six
years pursuant to a secured promissory note, bearing interest at 9%. In
addition, the Company assumed approximately $654,000 of notes payable and
other liabilities and HRF's lease obligations, including capital lease
obligations of approximately $1.3 million. HRF owned and operated a total
of ten Rally's restaurants and owned the exclusive right to develop
additional Rally's restaurants in the Hampton Roads and Norfolk, Virginia
areas. The acquisition of HRF was accounted for as a purchase.
The total purchase price of approximately $9.1 million has been allocated
in the accompanying balance sheet as net property and equipment
(approximately $2.1 million) and as intangible and other assets
(approximately $6.7 million). The remainder of the purchase price,
approximately $319,000, was allocated to various current assets. The
intangible and other asset amounts include a non-compete (approximately
$150,000) which is being amortized over five years and reacquired franchise
and territory rights (approximately $6.6 million) which are being amortized
over 15 years.
The impact on operations of this acquisition was not significant for any of
the periods presented, and, therefore, proforma amounts are not presented
giving effect to this acquisition.
On January 30, 1995, the Company sold all of the shares of common stock of
Beaman Corporation, its wholly-owned modular building subsidiary, for
approximately $3.1 million, of which approximately $2.7 million was paid in
cash, and the remainder to be paid pursuant to a non-interest bearing,
unsecured promissory note.
3. RESTAURANT CLOSURES AND OTHER
Certain charges in fiscals1994, 1995 and 1996 have been aggregated and
segregated into the caption "Provision for Restaurant Closures and Other"
in the accompanying Statements of Operations. These items represent
estimates of the impact of management decisions which have been made at
various points in time in response to the Company's sales and profit
performance and the then-current revenue building and profit enhancing
strategies.
In summary and chronologically, the decisions that had been reached in 1994
were to abandon additional real estate development projects and certain
investment in infrastructure (approximately $5.3 million) and to abandon
additional projects and franchise or otherwise dispose of up to 60 Company
restaurants (approximately $12.0 million). During 1995, the Company
concluded that much of its 1994 plan of disposal would not be executable.
As a result, the Company decided to (i) close up to 16 of the original 60
restaurants included in the 1994 disposal plan, (ii) close nine poor
performing restaurants in its core markets, (iii) writeoff estimated
exposure resulting from the default of a subleasee/franchisee in a former
Company market, (iv) record additional writedowns of modular building
value, (v) record writedowns to sales price less cost to sell of all
properties auctioned in fourth quarter, 1995 (vi) record asset writedowns
and occupancy exposure related to the default of a tenant for five of the
units closed under the 1994 plan and (vii) record other changes in
estimates related to the Company's surplus properties. The charges for the
above 1995 items totaled approximately $17.3 million. Also reflected in
this caption for fiscal 1995 is an approximate $13.7 million charge related
to the Company's adoption of Statement of Financial Accounting Standards
No. 121 ("SFAS 121) further discussed in Note 16.
Included in this caption for fiscal 1996 are charges of approximately
$679,000 related to the writedown and sale of assets offset by
approximately $659,000 resulting from a reduction in surplus property
reserves related to Management's decision to re-open three units previously
closed and to continue to operate a fourth unit that had been designated
for closure. See also "Management's Discussion and Analysis of Financial
Condition and Results of Operations--"Restaurants Closures and Other."
9
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4. RELATED PARTY TRANSACTIONS
a) Issuance of Warrants
On December 20, 1996, the Company issued warrants (the "Warrants") to
purchase an aggregate of 1,500,000 restricted shares of its Common
Stock to CKE and Fidelity National Financial, Inc. The Warrants were
granted as an incentive to CKE and Fidelity to continue to participate
in the identification and exploitation of synergistic opportunities
with the Company. The Warrants have a three-year term and are not
exercisable until December 20, 1997. The exercise price is $4.375 per
share, the closing price of the Common Stock on December 20, 1996. The
underlying shares of Common Stock have not been registered with the
Securities and Exchange Commission and, therefore, are not freely
tradable. Upon exercise, the Warrants would provide approximately $6.6
million in additional capital to the Company. The Company obtained a
valuation analysis from an investment banking firm of national
standing. Such analysis estimated the value of the Warrants to be
approximately $960,000. Approximately $24,000 has been expensed during
1996 within General and Administrative expenses. The remaining value
will be expensed in fiscal 1997 over the remainder of the vesting
period of the underlying Warrants.
b) West Coast Operating Agreement
On July 1, 1996, the Company entered into a ten-year Operating
Agreement with Carl Karcher Enterprises, Inc., a subsidiary of CKE
Restaurants, Inc. (collectively referred to as "CKE"). CKE is the
operator of the Carl's Jr. restaurant chain. Pursuant to the
agreement, 28 Rally's owned restaurants located in California and
Arizona are being operated by CKE. Such agreement is cancelable after
an initial five-year period, at the discretion of CKE. A portion of
these restaurants, at the discretion of CKE, will be converted to the
Carl's Jr. format. To date, one restaurant has been converted. The
agreement was approved by a majority of the independent Directors of
the Company. Prior to the agreement, the Company's independent
Directors had received an opinion as to the fairness of the agreement,
from a financial point of view, from an investment banking firm of
national standing.
Under the terms of the Operating Agreement, CKE is responsible for
conversion costs associated with transforming the restaurants to the
Carl's Jr. format, as well as the operating expenses of all the
restaurants. Rally's retains ownership of all 28 restaurants and is
entitled to receive a percentage of gross revenues generated by each
restaurant. Subsequent to the agreement, the Company's revenues have
been, and will continue to be, reduced by the absence of the
restaurants' sales, somewhat offset by the fee paid to the Company by
CKE. For the first six months of the current year, the restaurants
covered by this Operating Agreement had sales of approximately $10.5
million. The Company anticipates that the agreement will continue to
positively impact both net income and cash flow. While the overall
impact of the agreement is not expected to be material to the
financial statements, it will allow management to concentrate its
efforts in more fully developed Rally's markets. The agreement will
also allow the Company to take advantage of any improvements in
restaurant operations attained by CKE by implementing these
improvements in Company stores. In the event of a sale by Rally's of
any of the 28 restaurants, Rally's and CKE would share in the proceeds
based upon the relative value of their respective capital investments
in such restaurant.
c) Option Grants to Non-employees
During 1996, the Company granted 150,000 options to certain
individuals not employed by the Company for services provided.
Approximately $84,000 has been expensed for these grants in General
and Administrative Expenses in the accompanying Statement of
Operations. Such options were granted at the market values on the
dates of grant, were immediately exercisable and expire in five years.
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d) Other Transactions
The Company has had transactions with certain companies or individuals
which are related parties by virtue of having stockholders in common,
by being officers/directors or because they are controlled by
significant stockholders or officers/directors of the Company. Such
transactions which impacted the Company's consolidated financial
statements are summarized below. Information with respect to related
party rent is disclosed in Note 12. The Company and its franchisees
each pay 1/2% of sales to the Rally's National Advertising Fund (the
"Fund"), established for the purpose of creating and producing
advertising for the chain. The Fund is not included in the
consolidated financial statements, although the Company's
contributions to the Fund are included in the Advertising and
Promotion Expenses in the Company's consolidated Statements of
Operations.
December 31, December 29,
1995 1996
------------------ ----------------
Balance Sheet Amounts
Royalties receivable $ 483 $ -
Accounts receivable 23 565
Notes receivable 175 127
Accounts payable 307 95
Accrued liabilities - 60
Fiscal Years Ended
----------------------------------------------
January 1, December 31, December 29,
1995 1995 1996
------------- ------------- ---------------
Revenue and Transaction Amounts
Repurchase of Senior Notes (gross) $ - $ - $ 6,339
Royalty fees 2,129 2,407 -
Owner fee income - - 440
Rental income 195 262 -
Interest income 93 16 49
========== ========== =============
$ 2,417 $ 2,685 $ 6,828
========== ========== =============
Expense Amounts
Legal $ 923 $ 777 $ 1,024
Owner expense - - 744
Interest expense - - 180
Compensatory stock options and
warrants - - 170
Other 14 - -
========== ========== =============
$ 937 $ 777 $ 2,118
========== ========== =============
5. RESTRICTED CASH
Restricted cash consists of amounts held in various Certificates of Deposit
as collateral for Letters of Credit and daily Automated Clearing House
("ACH") transactions.
6. INVESTMENTS
Excess funds are being invested in U.S. Treasury and investment grade
corporate debt securities. These securities are deemed as
"available-for-sale" under SFAS 115, "Accounting for Certain Investments in
Debt and Equity Securities" and are reported at fair value. Unrealized
holding gains and losses, excluding those
11
<PAGE>
losses considered to be other than temporary, are reported as a net amount
in a separate component of shareholders' equity. No net unrealized losses
were reported for any period presented. Provisions for declines in market
value are made for losses considered to be other than temporary. No such
provision was necessary for the years ended December 31, 1995 and December
29, 1996. The provision for the year ended January 1, 1995 was
approximately $95,000. The market value of the portfolio was determined
based on quoted market prices for these investments. Realized gains or
losses from the sale of investments are based on the specific
identification method.
The carrying value is equal to the market value of investments at December
31, 1995 and December 29, 1996 and consist of the following:
December 31, 1995
United States government and its agencies $ 4,933
Corporate debt instruments -
==========
Total $ 4,933
==========
December 29, 1996
United States government and its agencies $ 500
Corporate debt instruments 1,458
==========
Total $ 1,958
==========
The contractual maturities of these investments at December 29, 1996 were
as follows:
1997 $ 500
2002 248
2012 299
2013 597
2017 314
=========
1,958
=========
The proceeds from the sale of investments and related gross gains and
losses for the twelve months ended January 1, 1995, December 31, 1995 and
December 29, 1996 were as follows:
Fiscal Years Ended
----------------------------------------
January 1, December 31, December 29,
1995 1995 1996
---------- -------------- ------------
Proceeds from the sale of $ 17,798 $ 15,653 $ 10,531
investments
Gross gains realized 137 56 -
Gross losses realized (364) - (4)
12
<PAGE>
7. NET PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
December 31, December 29,
1995 1996
---------------- ---------------
Land $ 14,310 $ 14,074
Buildings and leasehold improvements 46,520 47,463
Equipment, furniture and fixtures 45,036 41,312
---------------- ---------------
105,866 102,849
Less accumulated depreciation (32,049) (37,518)
---------------- ---------------
73,817 65,331
---------------- ---------------
Property held under capital lease 6,208 6,145
Less accumulated amortization (1,342) (1,670)
---------------- ---------------
4,866 4,475
================ ===============
Net property and equipment $ 78,683 $ 69,806
================ ===============
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
December 31, December 29,
1995 1996
--------------- ---------------
Payroll and payroll taxes $ 3,013 $ 2,245
Closed store reserve 2,767 1,964
Workers compensation 2,102 2,367
Advertising 1,819 316
Other 6,258 6,708
=============== ===============
$ 15,959 $ 13,600
=============== ===============
9. OTHER LIABILITIES
Other liabilities consist of the following:
December 31, December 29,
1995 1996
--------------- ---------------
Closed store reserve $ 6,908 $ 3,881
Unfavorable lease loss 890 748
Other 232 216
=============== ===============
$ 8,030 $ 4,845
=============== ===============
10. SENIOR NOTES
On March 9, 1993, the Company sold approximately $85 million of 9 7/8%
Senior, Notes due 2000 (the "Notes"). The Company is required to make a
mandatory sinking fund payment on June 15, 1999 to retire 33 1/3% in
aggregate principal amount of the Notes issued. The Notes are carried net
of the related discount, which is being amortized over the life of the
Notes. Interest is payable June 15 and December 15. The Notes include
certain restrictive covenants which, among other restrictions, limit the
Company's ability to obtain additional borrowings and to pay dividends as
well as impose certain change of control provisions, as defined.
13
<PAGE>
On January 29, 1996, the Company repurchased, in two transactions, at a
price of approximately $678.75 per $1,000 principal amount, approximately
$22 million face value of its 9 7/8% Senior Notes due in the year 2000 from
GIANT GROUP, LTD. ("GIANT"). The price paid in each transaction represented
the market closing price on January 26, 1996. The first transaction
involved the repurchase of approximately $16 million face value of the
Notes for approximately $11.1 million in cash. The second transaction
involved the purchase of approximately $6 million face value of Notes in
exchange for a short-term note of approximately $4.1 million, due in three
installments of principal and interest, issued by Rally's. The Company paid
the final installment on this note, together with accrued interest thereon,
on September 27, 1996. The purchases were approved by a majority of the
independent Directors of the Company. Prior to the purchases, the Company's
independent Directors had received an opinion as to the fairness of the
transactions, from a financial point of view, from an investment banking
firm of national standing. Due to the repurchases in January 1996, the
redemption price of approximately $15.2 million has been classified in the
caption "Current Maturities of Long-Term Debt and Obligations Under Capital
Leases" in the accompanying consolidated balance sheet for fiscal 1995.
Additionally, in four separate transactions during the fourth quarter 1996,
the Company repurchased approximately $4.7 million face value of the Notes
from various other bondholders for approximately $4.5 million in cash.
These purchases resulted in extraordinary gains in 1996 net of tax,
totaling approximately $5.3 million or $.31 per share. As a result of these
debt repurchases, the annualized ongoing interest payments on the Senior
Notes have been reduced by approximately $2.6 million per year to
approximately $5.8 million. In addition, these repurchases have reduced the
sinking fund requirement discussed above to approximately $1.6 million from
approximately $28 million.
The remaining outstanding Notes are publicly traded and at December 29,
1996 had a market value of approximately $54.5 million based on the quoted
market price for such notes.
On September 5, 1996 by Consent Solicitation Statement, the Company
solicited consent of its bondholders whereby the beneficial ownership of
35% or more of the voting stock of the Company by GIANT, Fidelity National
Financial, Inc., CKE and/or any of their affiliates would not constitute a
change of control for purposes of Section 4.14 of the Indenture. On October
21, 1996, the bondholder consent was approved by a majority of the holders
of record as of the date of the Consent Solicitation.
14
<PAGE>
11. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31, December 29,
1995 1996
-------------- --------------
<S> <C> <C>
Notes payable to banks, maturing at various dates through February 10, 2000,
secured by property and/or equipment, bearing interest ranging from
1/2% above prime to 9.25%. The notes are payable in monthly principal
and interest installments ranging from $848 to $41,033. $ 1,883 $ 1,006
Note payable to finance company due October 1998, secured by certain
equipment, bearing interest at a rate of 7.3%. The note is payable in
monthly principal and interest installments of $6,762. 384 133
Note payable to Company for acquisition of certain markets, secured by
certain property and equipment, maturing November 30, 1998, bearing
interest of 8.3%. The note is payable in monthly principal and
interest installments of $11,494. 205 79
Secured notes payable to a bank used to finance equipment and/or modular
buildings for franchisees (the Franchisee Loans), maturing at various
dates through July 15, 2000, bearing interest at prime plus 1/2%. The
notes are payable in monthly principal installments of $4,875.
Interest is payable monthly. 261 195
Notespayable to former owners for acquisition of market, secured by common
stock of Hampton Roads Foods, maturing March 13, 2001, with
outstanding balances due after last monthly payments, bearing interest
of 9.0%. The notes are payable in monthly principal and interest
installments ranging from $4,742 to $50,211. 4,814 4,461
-------------- --------------
7,547 5,874
Less - Current portion (1,798) (1,099)
- -
============== ==============
$ 5,749 $ 4,775
============== ==============
</TABLE>
At December 29, 1996, the prime rate was 8.25%. There were no short-term
borrowings in the year ended December 31, 1995.
The following are the maturities of long-term debt for each of the next
five years and thereafter:
Year
-------------------
1997 $ 1,099
1998 722
1999 727
2000 590
Thereafter 2,736
============
$ 5,874
============
The Company is subject to certain restrictive covenants under its debt
agreements.
The market value of the Company's long-term debt approximated book value at
December 29, 1996. Debt related to the acquisition of Hampton Roads Foods
was entered into in 1995 and bears interest at rates which approximate
current rates for debt with similar terms. The majority of the remaining
long-term debt has contractual rates which vary based on fluctuations in
market rates.
15
<PAGE>
12. COMMITMENTS AND CONTINGENCIES
(a) Lease Commitments
The Company leases certain land and buildings generally under
agreements with terms of or renewable to 15 to 20 years. Some of the
leases contain contingent rental provisions based on percentages of
gross sales. The leases generally obligate the Company for the cost of
property taxes, insurance and maintenance. Following is a schedule by
year of future minimum lease commitments under all leases at December
29, 1996:
Capital Operating
Year Leases Leases
- --------------------------------------------- ----------- ----------
1997 $ 1,087 8,475
1998 1,010 7,870
1999 973 7,216
2000 906 6,413
Thereafter 6,772 33,052
---------- ==========
Total minimum lease commitments 10,748 $ 63,026
==========
Less amounts representing interest,
discounted at rates ranging from 10% to 12% (4,955)
-----------
Present value of minimum lease payments 5,793
Current portion of capital lease obligations (385)
===========
Long-Term lease obligations $ 5,408
===========
The discount rates applicable to the Company's capital leases
approximate currently available market rates. Minimum operating lease
payments have not been reduced by minimum sublease rentals of $2.7
million due in the future under noncancellable subleases.
Rent expense consists of:
Fiscal Years Ended
----------------------------------------
January 1, December December
1995 31, 1995 29, 1996
----------- ------------- -------------
Minimum rentals - related parties $ 261 $ 292 $ 470
Minimum rentals - others 6,514 6,641 4,681
Contingent rentals - others 136 173 122
=========== ============= ============
$ 6,911 $ 7,106 $ 5,273
=========== ============= ============
(b) Litigation
In January and February 1994, two putative class action lawsuits were
filed, purportedly on behalf of the stockholders of Rally's in the
United States District Court for the Western District of Kentucky,
against Rally's, Burt Sugarman and GIANT and certain of Rally's
present and former officers and directors and its auditors. The
complaints allege defendants violated the Securities Exchange Act of
1934, among other claims, by issuing inaccurate public statements
about the Company in order to arbitrarily inflate the price of its
common stock. The plaintiffs seek unspecified damages. On April 15,
1994, Rally's filed a motion to dismiss and a motion to strike. On
April 5, 1995, the Court struck certain provisions of the complaint
but otherwise denied Rally's motion to dismiss. In addition, the Court
denied plaintiffs' motion for class certification; the plaintiffs
renewed this motion, and despite opposition by the defendants, the
Court granted such motion for class certification on April 16, 1996,
certifying a class from July 20, 1992 to September 29, 1993. In
October 1995, the plaintiffs filed a motion to disqualify Christensen,
Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP ("Christensen,
Miller") as counsel for defendants based on a purported conflict of
interest allegedly arising from the representation of multiple
defendants as well as Ms. Glaser's position as both a former director
of Rally's and a partner in Christensen, Miller. Defendants filed an
opposition to the motion, and the motion to disqualify Christensen,
Miller was denied. The action was stayed between May 30 and July 31,
1996 to facilitate settlement discussions. One settlement conference
has been conducted; no others are currently scheduled. The Court
denied the motion in the fall of 1996 and refused to disqualify
Christensen, Miller. Fact
16
<PAGE>
discovery is set to close in April 1997. No trial date has been
scheduled yet. Management is unable to predict the outcome of this
matter at the present time or whether or not certain available
insurance coverages will apply. The defendants deny all wrongdoing and
intend to defend themselves vigorously in this matter. Discovery is
proceeding. Because these matters are in a preliminary stage, the
Company is unable to determine whether a resolution adverse to the
Company will have a material effect on its results of operations or
financial condition. Accordingly, no provisions for any liabilities
that may result upon adjudication have been made in the accompanying
financial statements. An estimate of defense costs reimbursable under
the Company's directors' and officers' insurance is included in "Other
Assets" in the accompanying consolidated financial statements.
In July 1994, the Company entered into an agreement with Red Line
Burgers, Inc. ("Red Line") whereby Red Line leased from the Company
all of its assets being operated as Rally's restaurants in Houston,
Texas. Additionally, the agreement called for Red Line to convert Red
Line's eight competing units in the Houston market to the Rally's
brand. Red Line failed to make certain lease payments and on June 20,
1995, the Company filed an action in the United States District Court
for the Southern District of Texas, Galveston Division, seeking
recovery of damages from Red Line for its breach of the leases and
subleases entered into with the Company. The action alleges that Red
Line also committed events of default under the terms of all of its
Franchise Agreements with the Company. As a result of such defaults,
the Company terminated such Franchise Agreements, and on August 3,
1995, the Company filed suit in the United States District Court,
Western District of Kentucky, alleging breach of contract due to Red
Line's failure to pay royalties and other payments required by the
Franchise Agreements and its failure to pay approximately $400,000
plus interest owed on certain promissory notes issued to the Company
in lieu of such payments. The Company also seeks accountability for
approximately $660,000 in conversion costs paid by the Company for
conversion of Red Line's Houston restaurants. Subsequent to the
commencement of the foregoing actions, Red Line filed for
reorganization under Chapter 11 of the United States Bankruptcy Code.
In connection with such proceedings, the Company's actions against Red
Line have been stayed. In November, 1996, Red Line filed a First
Amended Disclosure Statement and First Amended Liquidating Plan of
Reorganization (the "Plan") which disputed Red Line's obligation to
pay the Company any of the foregoing monies. By Bankruptcy Court Order
entered February 28, 1997 (the "Confirmation Order"), the Company's
general unsecured claims were allowed in the amount of approximately
$615,000. The Confirmation Order also approved the Plan. The Plan
provides for, among other things, mutual releases among the Company
and Red Line (such releases do not affect the allowed general
unsecured claims described above) and the sale of Red Line's assets.
Cash from those sales will be insufficient to pay all secured claims,
taxes and administrative claims. Some of the Red Line assets are to be
acquired by New Red Line, Inc., an entity involving certain insiders
and/or affiliates of Red Line. Unsecured creditors of Red Line
(including the Company) will receive under the Plan a minority stock
interest in New Red Line, Inc. At this time, the likelihood of
realizing any value on account of such minority stock interest is
considered extremely speculative. The receivable balances have been
fully reserved.
In February 1996, Harbor Finance Partners ("Harbor") commenced a
derivative action, purportedly on behalf of Rally's against GIANT and
certain of Rally's officers and directors before the Delaware Chancery
Court. Harbor named Rally's as a nominal defendant. Harbor claims that
the directors and officers of both Rally's and GIANT, along with
GIANT, breached their fiduciary duties to the public shareholders of
Rally's by causing Rally's to repurchase from GIANT certain Rally's
Senior Notes at an inflated price. Harbor seeks "millions of dollars
in damages", along with rescission of the repurchase transaction. In
the fall of 1996, all defendants moved to dismiss the action. The
Chancery Court conducted a hearing on November 26, 1996, but has not
yet ruled on the pending motions. The Company denies all wrongdoing
and intends to vigorously defend the action. It is not possible to
predict the outcome of this action at this time.
Rally's filed a lawsuit on August 12, 1996 against Arkansas Investment
Group, Inc. ("AIGI"), a franchisee that currently operates ten Rally's
restaurants located in Arkansas. The lawsuit seeks to recover
royalties and contributions to the Rally's National Advertising Fund
owed by AIGI pursuant to the applicable franchise agreements, which
total approximately $500,000 with accrued interest as of December 29,
1996. After falling in arrears on its royalties and advertising fund
contributions, Rally's and AIGI negotiated a written agreement to
allow AIGI to make payments under a revised payment schedule. AIGI
also defaulted on that written
17
<PAGE>
obligation. AIGI has filed an Answer and Counterclaim in which it
alleges it does not owe the royalties and advertising contributions
due to its alleged disagreement with operational and marketing
decisions of Rally's and Rally's alleged failure to rebate sums
obtained from suppliers. AIGI has asserted causes of action for breach
of contract, violation of the Arkansas Franchise Practices Act, unjust
enrichment and fraud. The Counterclaim alleges that AIGI has been
damaged in excess of approximately $75,000 (the minimum jurisdictional
amount for federal court), but no specific amount of damages is
identified in the Counterclaim. Rally's denies AIGI's allegations and
intends to vigorously defend the Counterclaim. Because the litigation
is in a preliminary stage, the Company is unable to determine whether
a resolution adverse to the Company will have a material effect on its
results of operations or financial condition. Accordingly, no
provisions for any liabilities that may result upon adjudication have
been made in the accompanying financial statements.
In December 1994, Rally's entered into two franchise agreements with
Kader Investments, Inc. ("Kader") for the development and operation of
Rally's Hamburgers restaurants in Anaheim, California and Tustin,
California. Rally's assisted the franchisee in developing and opening
the restaurants. On November 27, 1996, Kader filed a six-count
Complaint against Rally's in the California Superior Court for Orange
County (Case No. 772257) alleging material misrepresentation,
respondent superior, breach of contract, breach of the implied
covenant of good faith and fair dealing, fraud and unfair competition.
These claims arise out of allegations concerning Rally's offer and
sale of two franchises (under a two-store development agreement), and
Rally's actions during the term of the agreements. The Complaint seeks
as relief rescission of the parties' franchise and development
agreements; general damages of at least $1,494,277 and $1,400,000 for
the material misrepresentation and fraud counts, respectively; general
damages in unspecified amounts as to the other counts; punitive
damages in unspecified amounts; and attorneys' fees. Rally's filed an
Answer, and intends to file a Cross-Complaint alleging breach of
contract. The court has permitted the parties to hold discovery in
abeyance for a short period pending settlement discussions. Rally's is
currently attempting to settle the claim. However, the outcome of such
settlement discussion is uncertain at this time. Should discussions
not result in a settlement, Rally's intends to vigorously defend
against the claims. Because the litigation is in a preliminary stage,
the Company is unable to determine whether a resolution adverse to the
Company will have a material effect on its results of operations or
financial condition. Accordingly, no provisions for any liabilities
that may result upon adjudication have been made in the accompanying
financial statements.
The Company is involved in other litigation matters incidental to its
business. With respect to such other suits, management does not
believe the litigation in which it is involved will have a material
effect upon its results of operation or financial condition.
(c) Other Commitments
The Company is contingently liable on certain franchisee lease
commitments totaling approximately $366,000. The Company from time to
time negotiates purchase contracts for certain items used in its
restaurants in the normal course of business. Although some of these
contracts contain minimum purchase quantities, such quantities do not
exceed expected usage over the term of such agreements.
13. INCOME TAXES
The asset and liability method contemplated by Statement of Financial
Accounting Standards No. 109 requires recognition of deferred tax assets
and liabilities for the expected future tax consequences of substantially
all temporary differences between the tax bases and financial reporting
bases of assets and liabilities (excluding goodwill).
18
<PAGE>
The major components of the Company's computation of deferred tax assets
and liabilities at December 31, 1995 and December 29, 1996 are as follows:
<TABLE>
<CAPTION>
December 31, December 29,
1995 1996
-------------- ------------
<S> <C> <C>
Excess of tax depreciation over book depreciation $ 11,390 $ 8,430
Acquired intangibles with no tax basis 2,199 2,070
Other 8 30
============== ============
Gross deferred tax liabilities $ 13,597 $ 10,530
============== ============
Net operating loss carryforwards $ 13,070 $ 12,824
Amounts accrued for financial reporting purposes not yet 17,122 12,885
deductible for tax purposes
Alternative minimum tax and targeted jobs tax credit carryforwards 937 937
Other 1,267 1,514
------------ ------------
Gross deferred tax assets 32,396 28,160
Less valuation allowance 18,799 17,630
============== ============
Net deferred tax asset $ 13,597 $ 10,530
============== ============
</TABLE>
The primary changes from December 31, 1995 in the components of the above
assets and liabilities relate to the Company's changes and business
strategies, restructuring, other restaurant closings (See Note 3) and
impact of SFAS 121 (See Note 16) offset by current year tax depreciation in
excess of book depreciation. The alternative minimum tax credit
carryforward has no expiration. The net operating loss carryforwards will
expire approximately $641,000 in 2008, approximately $20.2 million in 2009
and approximately $17.5 million in 2010 and approximately $1.6 million in
2011. The targeted jobs tax carryforward expires approximately $118,000 in
2006, approximately $184,000 in 2007 and approximately $200,000 in 2008. A
valuation allowance of approximately $17.6 million has been established due
to the uncertainty of realizing the benefit associated with the net
operating loss carryforwards generated in the current and previous years.
Income tax expense consists of the following:
Fiscal Years Ended
----------------------------------------
January 1, December December
1995 31, 1995 29, 1996
------------ ------------ ------------
Current $ (3,458) $ 539 $ (675)
Deferred (1,524) - -
============ ============ ============
Total tax (benefit) expense $ (4,982) $ 539 $ (675)
============ ============ ============
Income tax expense for year ended December 29, 1996 consists of a benefit
of $1,350,000 related to the extraordinary gain recognized from the
purchase of bonds, $575,000 in state income tax expense and $100,000 in
expense related to a reduction in a receivable from the IRS resulting from
a NOL carryback to the years 1987, 1988 and 1989.
A reconciliation of the provisions for income taxes with the federal
statutory rate is as follows:
Fiscal Years Ended
----------------------------------------
January 1, December 31, December
1995 1995 29, 1996
----------- -------------- ------------
Provision (benefit) computed at $ (8,247) $ (15,770) $ (1,349)
statutory rate
State and local income taxes, net of
federal income tax benefit 162 736 380
Valuation allowance 3,446 15,352 182
Other (343) 221 112
=========== ============== ============
$ (4,982) $ 539 $ (675)
=========== ============== ============
19
<PAGE>
14. STOCK-BASED COMPENSATION PLANS
The Company currently has three stock option plans in effect, the 1990
Stock Option Plan (the "Employees' Plan"), the 1990 Stock Option Plan for
Non-Employee Directors (the "1990 Directors' Plan"), and the 1995 Stock
Option Plan for Non-Employee Directors (the "1995 Directors' Plan").
Additionally, the Company has an employee stock purchase plan (the "1993
Purchase Plan"). Although there are existing options outstanding under the
1990 Directors' Plan, no additional grants will be made pursuant to this
plan. The Company accounts for these plans under APB Opinion No. 25, under
which approximately $66,000 of compensation cost has been recognized in
fiscal 1996 related to 157,000 options granted to directors under the 1995
Directors Plan. Such compensation represents the difference between the
market values on the dates of grant and the measurement date, July 10,
1996, the date when the grants were ultimately approved by the shareholders
at the annual meeting. No compensation cost was recognized in any other
period presented.
During 1996, a total of 350,000 additional options were granted to five of
the current directors. These options were not granted pursuant to an option
plan. The options were granted at a price equal to the stock's market price
on the date of grant. The options were immediately exercisable and expire
after five years.
Had compensation cost for all option grants to employees and directors been
determined consistent with FASB Statement No. 123, the Company's net income
and earnings per share would have been reduced to the following pro forma
amounts:
1995 1996
---- ----
Net Income (Loss): As Reported $ (46,919) $ 1,988
Pro Forma (47,154) (699)
Earnings (Loss) Per
Common Share: As Reported $ (3.00) $ .12
Pro Forma (3.02) (.04)
Because the Statement 123 method of accounting has not been applied to
options granted prior to January 2, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in
future years. Additionally, the pro forma amounts include approximately
$16,000 and $12,000 in 1995 and 1996, respectively, related to the purchase
discount offered under the 1993 Purchase Plan.
The Company may sell up to 500,000 shares of stock to its employees under
the 1993 Purchase Plan. The Company has sold approximately 36,000 shares,
51,000 shares, and 25,000 shares in 1994, 1995, and 1996, respectively, and
has sold approximately 126,000 shares through December 29, 1996 since the
inception of this plan in 1993. The Company sells shares at 85% of the
stock's market price at date of purchase. The weighted average fair value
of shares sold in 1995 and 1996 was approximately $2.06 and $3.03,
respectively.
Options to purchase an aggregate of 5.5 million shares of the Company's
Common Stock may be granted under the stock option plans, at a price not
less than the market value on the date of grant. The Company has granted
options on approximately 2.4 million shares under the stock option plans.
Outstanding options expire ten years after grant under the Employees' Plan,
except with regard to shares granted to the Company's President and Chief
Executive Officer pursuant to his employment agreement which expires in
five years. Options outstanding under the two directors' plans expire five
years after grant. Options are exercisable over various periods ranging
from immediate to three years after grant depending upon their grant dates
and the plan under which the options were granted.
On August 26, 1994, the Board of Directors authorized an option exchange
program, subject to shareholder approval, pursuant to which options to
purchase 1,042,000 common shares at prices ranging from $8.00 to $21.50 per
share were terminated. These options were reissued, subject to shareholder
approval, at $4.125 per share, which was the closing price of the Company's
Common Stock on August 26, 1994. The option exchange program was approved
by the shareholders at the annual meeting held on May 13, 1995.
20
<PAGE>
A summary of the status of all options granted to employees and directors,
as well as those options granted to non-employees (see Note 4), at January
1, 1995, December 31, 1995, and December 29, 1996, and changes during the
years then ended is presented in the table and narrative below:
<TABLE>
<CAPTION>
December 31, 1995 December 29, 1996
---------------------- ----------------------
Wtd. Avg. Wtd. Avg.
Shares Ex. Price Shares Ex. Price
--------- ---------- -------- ------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 2,225 $ 4.74 2,219 $ 4.24
Granted at price equal to market 676 2.88 2,154 2.63
Granted at price greater than market --- --- 350 1.75
Exercised --- --- (9) 3.05
Forfeited (412) 3.93 (201) 3.34
Expired (270) 5.38 (667) 5.62
========= ========
Outstanding at end of year 2,219 4.24 3,846 2.92
========= ========
Exercisable at end of year 1,048 5.09 2,359 3.21
Weighted average of fair value of
options granted $1.76 $1.31
</TABLE>
The Company had approximately 1,910,000 options outstanding as of January
2, 1994 at prices ranging form $2.67 to $21.50. During fiscal 1994,
approximately 1,925,000 options were granted at prices ranging from $2.875
to $11.25; approximately 34,000 options were exercised at prices ranging
form $2.66 to $6.92; and approximately 1,576,000 options were terminated
with prices ranging from $4.125 to $21.50. These transactions resulted in
approximately 2,225,000 options outstanding as of January 1, 1995, with
prices ranging form $2.67 to $9.333. At January 1, 1995, approximately
756,000 options were exercisable at prices ranging from $2.67 to $6.50.
The following table summarizes information about stock options outstanding
at December 29, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------------------ --------------------------------
Wtd. Avg.
Range of Outstanding Remaining Wtd. Avg. Exercisable Wtd. Avg.
Exercise Prices as of Contractual Exercise as of Exercise
Dec. 29, 1996 Life Price Dec. 29, 1996 Price
---------------- ---------------- --------------- ------------- --------------- -------------
<S> <C> <C> <C> <C> <C>
$1.25 to 2.50 982 6.9 years $1.88 80 $2.36
2.50 to 3.75 2,047 5.1 2.93 1,679 2.92
3.75 to 5.00 817 5.1 4.16 599 4.16
================ ===============
$1.25 to 5.00 3,846 5.6 2.92 2,358 3.21
================ ===============
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in fiscal 1995 and 1996, respectively: expected
volatility of 45.0 percent and 45.7 percent; risk-free interest rates of
6.75 percent and 6.82 percent for options granted to employees and 6.54
percent and 6.59 percent for options granted to directors; and expected
lives for fiscal 1995 and 1996 of eight years for options granted to
employees and five years for options granted to directors. An expected
dividend yield of 0 percent per share was used for all periods based on the
Company's history of no dividend payments.
21
<PAGE>
15. UNAUDITED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1995
Revenues $ 42,470 $ 49,843 $ 49,851 $ 46,695 $ 188,859
Income (loss) from operations (993) 1,205 (14,803) (21,879) (36,470)
Net loss (3,509) (1,244) (17,316) (24,850) (46,919)
Loss per common share (.22) (.08) (1.11) (1.59) (3.00)
Year Ended December 29, 1996
Revenues $ 41,912 $ 47,357 $ 38,781 $ 34,702 $ 162,752
Income (loss) from operations (3,369) 2,413 2,632 2,414 4,090
Net income 838 111 414 625 1,988
Earnings (loss) per common
share:
Earnings (loss) before (.24) .01 .01 .01 (.19)
extraordinary item
Extraordinary item .29 - .02 .02 .31
=========== =========== =========== =========== ===========
Earnings (loss) per common share .05 .01 .03 .03 .12
=========== =========== =========== =========== ===========
</TABLE>
16. IMPAIRMENT OF LONG-LIVED ASSETS
The Company adopted Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to Be Disposed of " (SFAS 121), at the beginning of the fourth quarter,
1995. This Statement establishes accounting standards for the impairment of
long-lived assets, certain identifiable intangibles and goodwill related to
those assets to be held and used, and for long-lived assets and certain
identifiable intangibles to be disposed of. SFAS 121 requires that
impairment for long-lived assets and identifiable intangibles to be held
and used, if any, be based on the fair value of the asset. Long-lived
assets and certain identifiable intangibles to be disposed of are to be
reported at the lower of carrying amount or fair value less cost to sell.
For purposes of applying this statement, the Company determines fair value
utilizing the present value of expected future cash flows using a discount
rate commensurate with the risks involved.
Long-lived assets considered for impairment under SFAS 121 are required to
be grouped at the "lowest level for which there are identifiable cash flows
that are largely independent of the cash flows of other groups." The
Company believes the most correct application of this standard is obtained
by examining individual restaurants where circumstances indicate that an
impairment issue may exist. This belief is primarily based on the fact that
it is at individual restaurant level that most investment and closure
decisions are made on an ongoing basis. In addition, if an asset being
tested for recoverability was acquired in a business combination accounted
for using the purchase method, the goodwill that arose in that transaction
is included as part of the asset being evaluated and in determining the
amount of any impairment.
Prior to the issuance of SFAS 121, the Company recorded impairment of
long-lived assets deemed to be permanently impaired. Generally, such
assessment of permanent impairment arose concurrent with a management
decision to dispose of such an asset at which time the asset was written
down to estimated net realizable value. In general, other long-lived assets
were reviewed for impairment only if there were dramatic changes in
operating results or cash flows of a segregable group of outlets,
indicating a likelihood that a permanent impairment has occurred.
The Company's past practices of estimating net realizable value for assets
to be disposed of are consistent with the Statement's requirements to write
down such assets to fair market value less costs to sell and no adjustment
regarding such assets was necessary upon adoption of the Statement. The
expected disposal dates for these assets are over the next 3 to 24 months
and consist mainly of surplus land, buildings and equipment. The carrying
amounts of such assets to be disposed of are shown separately on the
accompanying balance sheets. The majority of assets held for sale resulted
from constriction of the Company's development plan and other associated
store closings further discussed in Note 3.
22
<PAGE>
The Company's fourth quarter, 1995 review relating to assets to be held and
used indicated that 37 of its 238 operating restaurants met the Company's
criteria for impairment review. All of the indicated restaurants were
deemed to be impaired based on current estimates of their underlying cash
flows and a provision for impairment was recorded in the fourth quarter,
1995 of approximately $13.7 million related to writedowns of the assets
associated with these restaurants. Approximately $824,000 of associated
intangible assets was included in this writedown. The writedown is included
in the caption " Restaurant Closures and Other." The writedown of these
assets resulted in reduced depreciation and amortization expense in the
fourth quarter, 1995 of approximately $351,000.
The magnitude of the writedown noted above resulted primarily from two
factors: (1) the review of assets to be held and used at individual
restaurant level, a lower level than used in the past and (2) the recent
historical and continuing poor operating performance of the restaurants
themselves (including the restaurant's 1995 full year performance).
During the first quarter of 1996, two additional restaurants, due to their
continued poor operating performance, were determined to be impaired,
resulting in charges of approximately $754,000 included in the caption,
"Restaurant Closures and Other". No additional restaurants were determined
to be impaired in 1996. As required by the SFAS 121, the Company will
continue to periodically review its assets for impairment where
circumstances indicate that such impairment may exist.
17. SHAREHOLDER RIGHTS OFFERING
A Shareholder Rights Offering (the "Offering") was completed on September
20, 1996. The Company distributed to holders of record of its Common Stock,
as of the close of business on July 31, 1996 (the "Record Date"),
transferable subscription rights ("Right(s)") to purchase Units consisting
of one share of Common Stock and one Warrant to purchase an additional
share of Common Stock. Stockholders received one Right for each share of
Common Stock held on the Record Date. For each 3.25 Rights held, a holder
had the right to purchase one Unit for $2.25 each. The Offering consisted
of 4,825,805 Units. Each Warrant may be exercised to acquire an additional
share of Common Stock at an exercise price of $2.25 per share and expires
on September 26, 2000. The Company may redeem the Warrants, at $.01 per
Warrant, upon 30 days' prior written notice in the event the closing price
of the Common Stock equals or exceeds $6.00 per share for 20 out of 30
consecutive trading days ending not more than 30 days preceding the date of
the notice of redemption. The Offering was fully subscribed and raised over
approximately $10.8 million in gross proceeds offset by legal and other
issuance costs of approximately $437,000. The proceeds from the Offering
have been used to pay off debt of approximately $4.5 million and the
remainder will be used for new store construction, refurbishment of some
existing restaurants and for other general corporate purposes, including
possible further debt reduction. The net proceeds from the Offering were
attributable primarily to the sale of the Company's common stock. The
amount attributable to the warrants is included in "Additional paid-in
capital."
In addition to the approximately $10.8 million provided by the Rights
Offering, the Warrants issued, if exercised, could provide an additional
$10.8 million in proceeds.. The Company had 15,683,869 shares of Common
Stock outstanding on the Record Date. Immediately after the Offering,
20,509,674 shares of Common Stock and 4,825,805 Warrants were outstanding.
As of December 29, 1996, 4,818,597 of these Warrants were outstanding. The
Warrants are publicly traded and at December 29, 1996 had a market value of
approximately $11.7 million based on the quoted market price for such
warrants.
18. SUBSEQUENT EVENTS
On March 25, 1997, the Company agreed in principle to a merger transaction
pursuant to which the Company would become a wholly-owned subsidiary of
Checkers Drive-In Restaurants, Inc., a Delaware corporation ("Checkers").
Checkers, together with its franchisees, operates approximately 478 double
drive-thru hamburger restaurants primarily located in the Southeastern
United States. Under the terms of the letter of intent executed by the
Company and Checkers, each share of the Company's Common Stock will be
converted into three shares of Checker's common stock upon consummation of
the merger. The transaction is subject to negotiation of definitive
agreements, receipt of fairness opinions by each party, receipt of
stockholder and other required approvals and other customary conditions.
23
<PAGE>
Report of Independent Public Accountants
To Rally's Hamburgers, Inc.:
We have audited the accompanying consolidated balance sheets of Rally's
Hamburgers, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1995 and December 29, 1996, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three fiscal
years in the period ended December 29, 1996. These consolidated financial
statements and the schedule referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Rally's Hamburgers, Inc. and
subsidiaries as of December 31, 1995 and December 29, 1996, and the results of
their operations and their cash flows for each of the three fiscal years in the
period ended December 29, 1996, in conformity with generally accepted accounting
principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule II is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Louisville, Kentucky
February 12, 1997 (except with respect to the matter discussed in Note 18, as to
which the dates are March 25, 1997, and September 22, 1997, respectively).
24
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
RALLY'S HAMBURGERS, INC.
Date: January 22, 1998
By: /s/ Joseph Stein
--------------------------------------
Joseph Stein
Chief Financial Officer
25
