ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not Applicable.
Our corporate headquarters are located in Cypress, California. We occupy this facility under a lease that expires in 2012. As of December 26, 2010, we leased 180 restaurant facilities and owned one. The majority of our leases are for 10, 15 or 20-year terms, include options to extend the terms, include rent holidays, rent escalation clauses and/or contingent rent provisions and some of our leases have tenant improvement allowances. Our restaurant leases have terms that expire between fiscal years 2011 and 2028 (excluding renewal options not yet exercised) and have an average remaining term of approximately 12 years, including options.
Restaurant Locations
As of December 26, 2010, we owned, licensed or franchised 212 restaurants in 15 states and two foreign countries, of which 181 are Company operated and 31 operate under franchise or license arrangements.
Our restaurant locations by concept and state as of December 26, 2010 were as follows:
(1)
Includes El Torito Grill and Sinigual restaurants.
(2)
Includes Las Brisas, Who Song&Larry’s, El Paso Cantina and Casa Gallardo restaurants.
We also lease an approximately 101,000 square foot dedicated manufacturing facility located in Vernon, California, an approximately 67,000 square foot warehouse and distribution facility located in Buena Park, California and an approximately 54,000 square foot warehouse and distribution facility located in Union City, California, utilized by our subsidiary, Real Mex Foods.
Our owned and certain of our leased real property is pledged to secure indebtedness outstanding under our senior credit facility and our senior secured notes.
We are periodically a defendant in cases involving personal injury, employment-related claims, third-party Americans with Disabilities Act accessibility claims and other matters that arise in the normal course of business. While any pending or threatened litigation has an element of uncertainty, we believe that the outcome of these lawsuits or claims, individually or combined, will not materially adversely affect the consolidated financial position, results of operations or cash flows of our Company.
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
There is currently no established public trading market for our outstanding common stock.
Holders
The number of record holders of each of our classes of common stock as of February 20, 2011 was as follows:
Common Stock: 1
Dividends
No dividends were paid during fiscal years 2010, 2009 or 2008. We presently intend to retain all earnings, if any, for use in our business operations and, accordingly, we currently do not anticipate declaring any dividends in the foreseeable future. Our ability to pay dividends is restricted by certain covenants contained in our secured and unsecured senior credit facilities, as well as certain restrictions contained in our indenture relating to our senior secured notes.
Securities Authorized For Issuance under Equity Compensation Plans
For information on securities authorized for issuance under equity compensation plans, see “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters-Equity Compensation Plan Information.”
Recent Sales of Unregistered Securities and Repurchases of Equity Securities
We did not sell any unregistered equity securities in fiscal year 2010 nor did we repurchase any equity securities in the fourth quarter of 2010.
The following table sets forth selected historical consolidated financial and other data of our Company, with respect to the periods prior to (“Predecessor”) and following (“Successor”) the Share Purchase. The selected historical consolidated financial data has been derived from our Company’s audited consolidated financial statements for the Successor six months ended December 26, 2010 (“Successor 2010”), the Predecessor six months ended June 27, 2010 (“Predecessor 2010”), the Predecessor fiscal year 2009 (“Predecessor 2009”), the Predecessor period from November 14, 2008 to December 28, 2008 (“Predecessor 2008-2”), the Predecessor period from December 31, 2007 to November 13, 2008 (“Predecessor 2008-1”), the Predecessor fiscal year 2007 (“Predecessor 2007”), the Predecessor period from August 21, 2006 to December 31, 2006 (“Predecessor 2006-2”) and the Predecessor period from December 26, 2005 to August 20, 2006 (“Predecessor 2006-1”) When combined, fiscal year 2006 consists of 53 weeks and all other fiscal years presented consist of 52 weeks. This data presented below should be read in conjunction with, and is qualified in its entirety by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and our consolidated financial statements and the notes thereto appearing elsewhere in this report.
(1)
Net loss attributable to common stockholders includes the effect of the accretion of the liquidation preference on the redeemable preferred stock which reduces net income or increases net loss attributable to common stockholders for the relevant periods through August 20, 2006.
(2)
Total debt includes long-term debt, obligations under capital leases and unamortized debt premium/discount.
(3)
For purposes of calculating the ratio of earnings to fixed charges, earnings consist of net income before income taxes plus fixed charges. Fixed charges consist of interest expense on all indebtedness, plus one-third of rental expense (the portion deemed representative of the interest factor). For periods with a net loss before income taxes, this calculation is not performed since the ratio is not meaningful.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements as a result of certain factors, including those set forth under the heading “Forward-Looking Statements” above and elsewhere in this report. Unless otherwise provided below or the context otherwise requires, references to “we”, “us”, “our” and “Company” refer to Real Mex Restaurants, Inc. and our consolidated subsidiaries. The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this report.
Overview
We are one of the largest full service, casual dining Mexican restaurant chain operators in the United States in terms of number of restaurants. As of December 26, 2010, we operated 181 restaurants, 151 of which are located in California, with additional restaurants in Arizona, Florida, Illinois, Maryland, Missouri, Nevada, New Jersey, New York, Oregon, Virginia and Washington. Our four major subsidiaries are El Torito Restaurants, Inc., Acapulco Restaurants, Inc., Chevys Restaurants LLC, and a purchasing, distribution, and manufacturing subsidiary, Real Mex Foods.
El Torito, El Torito Grill (including Sinigual), Acapulco and Chevys, our primary restaurant concepts, each offer high quality Mexican food, a wide selection of alcoholic beverages and excellent guest service. In addition to the El Torito, El Torito Grill, Acapulco and Chevys concepts, we operate 8 additional restaurant locations, most of which are also full service Mexican formats, under the following brands: Las Brisas; Casa Gallardo; El Paso Cantina; and Who·Song & Larry’s.
As a result of restrictions in our notes and the downturn in the economy, no new restaurants were opened during fiscal years 2010 and 2009. During fiscal year 2008, we opened five restaurants, including our first Sinigual restaurants in Brandon, Florida and New York, New York. Sinigual is the name for El Torito Grill style restaurants outside southern California. The other three restaurants opened in 2008 include one El Torito and two Chevys restaurants in California.
Our fiscal year consists of 52 or 53 weeks and ends on the last Sunday in December of each year. Fiscal years 2008, 2009 and 2010 are comprised of 52 weeks. See additional breakdown of these years into reported periods in Results of Operations below. When calculating same store sales, we include a restaurant that has been open for more than 18 months and for the entirety of each comparable period. As of December 26, 2010, we had 179 restaurants that met this criterion.
Our revenues are comprised of restaurant sales, manufacturing and distribution revenues and franchise and other revenues. Restaurant revenues include sales of food and alcoholic and other beverages. Manufacturing and distribution revenues consist of sales by Real Mex Foods to outside customers of processed and packaged prepared foods and other merchandise items. Franchise and other revenues primarily includes franchise and royalty fees from our franchisees of our Chevys concept.
Cost of sales is comprised primarily of food and alcoholic beverage expenses. The components of cost of sales are variable and change with sales volume. In addition, the components of cost of sales are subject to increase or decrease based on fluctuations in commodity costs and depend in part on the success of controls we have in place to manage cost of sales in our restaurants. The cost, availability and quality of the ingredients we use to prepare our food and beverages are subject to a range of factors, including, but not limited to, seasonality, political conditions, weather conditions, and ingredient shortages.
Labor cost includes direct hourly and management wages, operations management bonus, vacation pay, payroll taxes, workers’ compensation insurance and health insurance.
Direct operating and occupancy expense includes operating supplies, repairs and maintenance, advertising expenses, utilities, and other restaurant related operating expenses. This expense also includes all occupancy costs such as fixed rent, percentage rent, common area maintenance charges, real estate taxes and other related occupancy costs.
General and administrative expense includes all corporate and administrative functions that support our operations. Expenses within this category include executive management, supervisory and staff salaries, bonus and related employee benefits, travel and relocation costs, information systems, training, corporate rent, professional fees and other consulting fees.
Depreciation and amortization principally includes depreciation of capital expenditures for restaurants and also includes amortization of favorable lease asset and unfavorable lease liability. Amortization of favorable lease asset and unfavorable lease liability represents the amortization of the asset in excess of the approximate fair market value and the liability in excess of the approximate fair market value of the leases assumed, which is revalued in purchase price accounting. The amounts are being amortized over the remaining primary terms of the underlying leases.
Goodwill and other indefinite lived intangible assets are deemed to have an indefinite life and are subject to an annual impairment test. Other intangible assets are amortized over their useful lives. Impairment of goodwill and intangible assets reflects the impairment losses related to the difference between the fair value and recorded value as identified in our annual impairment tests. The fair value of goodwill was determined using discounted cash flow projections based upon management forecasts. For the valuation of other indefinite lived intangible assets, including trademarks and franchise agreements, discounted future royalty methods are used. We recorded impairment charges related to goodwill and other indefinite lived intangible assets of $1.1 million, $16.3 million and $163.2 million in fiscal years 2010, 2009 and 2008, respectively, as a result of the impact of the downturn in the economy on current operations and growth projections.
Our annual operating results are impacted by restaurant closures to the extent we close locations. Due to our long operating history, restaurant closures are generally the result of lease expirations. Many of our leases are non-cancelable and have initial terms of 10 to 20 years with one or more renewal terms of three or more years that we may exercise at our option. As of December 26, 2010, we owned one restaurant location and leased the remaining 180.
We perform ongoing analyses of restaurant cash flow and in the case of negative cash flow or underperforming restaurants, we may negotiate early termination of leases, allow leases to expire without renewal or sell restaurants. In addition, from time to time we may be forced to close a successful restaurant if we are unable to renew the lease on satisfactory terms, or at all. From the end of fiscal year 2008 to the end of fiscal year 2010, we closed 9 restaurants, 1 of which was an early lease termination and 8 of which were natural lease ends for which we chose not to renew or no renewal was available.
Results of Operations
Our operating results for the Successor six months ended December 26, 2010 (“Successor 2010”), the Predecessor six months ended June 27, 2010 (“Predecessor 2010”), the Predecessor fiscal year 2009 (“Predecessor 2009”), the Predecessor period from November 14, 2008 to December 28, 2008 (“Predecessor 2008-2”) and the Predecessor period from December 31, 2007 to November 13, 2008 (“Predecessor 2008-1”) are expressed as a percentage of total revenues below. Because of purchase accounting adjustments to the fair market value of long-term assets and long-term liabilities, and because the number of days in each period presented vary, certain amounts may not be comparable between each period presented.
Fiscal Year 2010 Compared to Fiscal Year 2009
Total Revenues. Total revenues were $227.9 million in the Successor 2010 and $250.1 million in the Predecessor 2010 compared to $500.6 million in Predecessor 2009. The overall decrease of $22.6 million, or 4.5%, was due to a $19.2 million decrease in restaurant revenues and a $3.1 million decrease in manufacturing and distribution revenues combined with a $0.3 million decrease in franchise and other revenues. The $19.2 million decrease in restaurant revenues was primarily due to comparable store sales declines of 2.3% versus fiscal year 2009. This decline is primarily attributable to a 1.7% reduction in average check and a 0.5% reduction in check count. The 1.7% decrease in average check was attributable to a $4.5 million increase in customer discounts as well as a shift in product mix. The decrease in manufacturing and distribution revenues was due to a decrease in sales to outside customers by Real Mex Foods, primarily related to distribution customers.
Cost of Sales. Total cost of sales was $55.5 million in the Successor 2010 and $60.6 million in the Predecessor 2010 compared to $121.5 million in Predecessor 2009. The overall decrease of $5.4 million, or 4.5%, was primarily due to lower commodity costs, primarily oil, flour, tortillas and sauces, combined with the comparable store sales decline noted above. As a percentage of total revenues, cost of sales was 24.3% in Successor 2010 and 24.2% in Predecessor 2010 as compared to 24.3% in Predecessor 2009.
Labor. Labor costs were $83.4 million in the Successor 2010 and $88.6 million in the Predecessor 2010 compared to $185.5 million in Predecessor 2009. The overall decrease of $13.4 million, or 7.2%, was primarily due to adjustments in staffing and wages as a result of the decrease in restaurant revenue combined with lower health insurance expense. As a percentage of total revenues, labor costs were 36.6% in Successor 2010 and 35.4% in Predecessor 2010 compared to 37.0% in Predecessor 2009. Payroll and benefits remain subject to inflation and government regulation; especially wage rates that are currently at or near the minimum wage and expenses for health insurance.
Direct Operating and Occupancy Expense. Direct operating and occupancy expense was $67.7 million in Successor 2010 and $68.2 million in Predecessor 2010 compared to $136.4 million in Predecessor 2009. The overall decrease of $0.5 million, or 0.3%, was primarily due to lower occupancy expense. As a percentage of total revenues, direct operating and occupancy expense was 29.7% in Successor 2010 and 27.3% in Predecessor 2010 compared to 27.2% in Predecessor 2009. The increase as a percent of total revenues in Successor 2010 was primarily due to the comparable store sales decline, since a significant portion of these costs are fixed in nature and do not vary substantially with changes in sales volume.
General and Administrative Expense. General and administrative expense was $11.7 million in Successor 2010 and $11.1 million in Predecessor 2010 compared to $25.3 million in Predecessor 2009. The overall decrease of $2.5 million, or 9.9%, was primarily due to lower labor expense as a result of reductions in headcount and wage rate reductions to minimize the impact of lower restaurant revenues. As a percentage of total revenues, general and administrative expense was 5.2% in Successor 2010 and 4.4% in Predecessor 2010 compared to 5.1% in Predecessor 2009.
Depreciation and Amortization. Depreciation and amortization expense was $11.9 million in Successor 2010 and $12.7 million in Predecessor 2010 compared to $31.2 million in Predecessor 2009. The overall decrease of $6.6 million, or 21.1%, was primarily due to assets which became fully depreciated in fiscal 2010. As a percentage of total revenues, depreciation and amortization decreased to 5.2% in Successor 2010 and 5.1% in Predecessor 2010 compared to 6.2% in Predecessor 2009.
Impairment of Goodwill and Other Intangible Assets. In Successor 2010 and Predecessor 2009, $1.1 million and $16.3 million, respectively, was recorded to reflect the impairment losses related to the difference between the fair value and recorded value for goodwill and other indefinite lived intangible assets. The fair value of goodwill was determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. For the valuation of other indefinite lived intangible assets, including trademarks and franchise agreements, discounted future royalty methods are used. No impairment was recorded in Predecessor 2010.
Interest Expense. Interest expense was $13.5 million in Successor 2010 and $15.3 million in Predecessor 2010 compared to $45.9 million in Successor 2009. The overall decrease of $17.0 million, or 37.1%, was primarily due to a decrease in the amortization of debt discount of $18.4 million combined with a decrease in interest expense in the senior secured notes of $1.6 million and a decrease in the amortization of deferred debt fees of $0.1 million, partially offset by an increase in interest expense on the senior secured notes of $3.1 million. The decrease in the amortization of the debt discount was due to both the refinancing of our debt during the third quarter of 2009 and the revaluation of the notes in conjunction with the Share Purchase. As a percentage of total revenues, interest expense decreased to 5.9% in Successor 2010 and 6.1% in Predecessor 2010 compared to 9.2% in Predecessor 2009.
Gain on Extinguishment of Debt. As a result of the exchange by a lender under the senior unsecured credit facility, as amended, of $15.0 million of unsecured debt for $4.6 million aggregate principal amount of our notes issued in July 2009 (which were issued for $4.1 million), we recorded $10.9 million as a gain on extinguishment of debt in Predecessor 2009. Please see “Debt and Other Obligations” for details on the refinancing of our debt. No such extinguishment was recorded in Successor or Predecessor 2010.
Income tax provision. We have recorded a full valuation allowance against our deferred tax assets. During Successor 2010, we recorded an income tax benefit of $0.4 million as a result of the impairment to our intangible assets, resulting in a reduction of our related deferred tax liability. During Predecessor 2010, we recorded an income tax benefit of less than $0.1 million as a result of refunds on income tax. During Predecessor 2009, we recorded an income tax benefit of $5.4 million as a result of the impairment to our intangible assets, resulting in a reduction of our related deferred tax liability.
Fiscal Year 2009 Compared to Fiscal Year 2008
Total Revenues. Total revenues were $500.6 million in Predecessor 2009 compared to $57.3 million in Predecessor 2008-2 and $496.4 million in Predecessor 2008-1. The overall decrease of $53.1 million, or 9.6%, was due to a $52.3 million decrease in restaurant revenues, a $0.5 million decrease in manufacturing and distribution revenues and a $0.4 million decrease in franchise and other revenues. The $52.3 million decrease in restaurant revenues was primarily due to comparable store sales declines of 10.4% versus fiscal year 2008. This decline is primarily attributable to a reduction in guest count at our existing restaurants resulting from the slowing U.S. economy, which has negatively impacted overall consumer traffic in the restaurant industry. The decrease in manufacturing and distribution revenues was due to a decrease in sales to outside customers by Real Mex Foods, including a decrease in distribution sales of $8.6 million, partially offset by an increase in manufacturing sales of $8.1 million.
Cost of Sales. Total cost of sales was $121.5 million in Predecessor 2009 compared to $14.3 million in Predecessor 2008-2 and $123.9 million in Predecessor 2008-1. The overall decrease of $16.7 million, or 12.1%, was primarily due to lower commodity costs, primarily cheese, dairy, beef and poultry, combined with the comparable store sales decline noted above. As a percentage of total revenues, cost of sales decreased to 24.3% from 24.9% in Predecessor 2008-2 and 25.0% in Predecessor 2008-1.
Labor. Labor costs were $185.5 million in Predecessor 2009 compared to $21.2 million in Predecessor 2008-2 and $179.0 million in Predecessor 2008-1. The overall decrease of $14.7 million, or 7.4%, was primarily due to adjustments in staffing and wages as a result of the decrease in restaurant revenue combined with lower casualty insurance expense and health insurance expense. As a percentage of total revenues, labor costs were 37.0% in Predecessor 2009 as compared to 37.0% in Predecessor 2008-2 and 36.0% in Predecessor 2008-1. Payroll and benefits remain subject to inflation and government regulation; especially wage rates that are currently at or near the minimum wage and expenses for health insurance.
Direct Operating and Occupancy Expense. Direct operating and occupancy expense was $136.4 million in Predecessor 2009 compared to $14.9 million in Predecessor 2008-2 and $133.4 million in Predecessor 2008-1. The overall decrease of $11.8 million, or 8.0%, was primarily due to lower utilities, maintenance and cleaning and advertising expense in Predecessor 2009 as a result of management’s focus on decreasing costs to minimize the impact of lower restaurant revenues. As a percentage of total revenues, direct operating and occupancy expense was 27.2% in Predecessor 2009 as compared to 26.0% in Predecessor 2008-2 and 26.9% in Predecessor 2008-1. The increase as a percent of total revenues in Predecessor 2009 was primarily due to the comparable store sales decline, since a significant portion of these costs are fixed or take time to adjust for the reduction in sales.
General and Administrative Expense. General and administrative expense was $25.3 million in Predecessor 2009 compared to $3.2 million in Predecessor 2008-2 and $26.5 million in Predecessor 2008-1. The overall decrease of $4.4 million, or 14.8%, was primarily due to lower labor expense as a result of reductions in headcount and wage rate reductions to minimize the impact of lower restaurant revenues. As a percentage of total revenues, general and administrative expense was 5.1% in Predecessor 2009 as compared to 5.6% in Predecessor 2008-2 and 5.3% in Predecessor 2008-1.
Depreciation and Amortization. Depreciation and amortization expense was $31.2 million in Predecessor 2009 compared to $3.8 million in Predecessor 2008-2 and $21.7 million in Predecessor 2008-1. The overall increase of $5.7 million, or 22.6%, was primarily due to depreciation of the assets of new restaurants combined with the revaluation of tangible and intangible assets in conjunction with the Exchange. As a percentage of total revenues, depreciation and amortization was 6.2% in Predecessor 2009 as compared to 6.5% in Predecessor 2008-2 and 4.4% in Predecessor 2008-1.
Impairment of Goodwill and Other Intangible Assets. Goodwill and other intangible asset impairment charges of $16.3 million were recorded in Predecessor 2009, compared to $163.2 million recorded in Predecessor 2008-1, to reflect the impairment losses related to the difference between the fair value and recorded value for goodwill and other indefinite lived intangible assets. The fair value of goodwill was determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. For the valuation of other indefinite lived intangible assets, including trademarks and franchise agreements, discounted future royalty methods are used. No goodwill or trademark impairment was recognized by the Company during Predecessor 2008-2.
Interest Expense. Interest expense was $45.9 million in Predecessor 2009 compared to $4.1 million in Predecessor 2008-2 and $16.4 million in Predecessor 2008-1. The overall increase of $25.4 million, or 123.6%, was primarily due to the refinancing of our debt during the third quarter of 2009, resulting in the write off of the remaining deferred debt fees and unamortized debt discount on our senior secured notes due 2010, with total amortization of $22.9 million recorded as interest expense in Predecessor 2009. The remaining increase of $2.5 million was primarily related to the increase in principal and interest rate on the new issuance of our notes in July 2009. See “Debt and Other Obligations” for details on the refinancing of our debt. As a percentage of total revenues, interest expense was 9.2% in Predecessor 2009 as compared to 7.2% in Predecessor 2008-2 and 3.3% in Predecessor 2008-1.
Gain on Extinguishment of Debt. As a result of the exchange by a lender under our senior unsecured credit facility, of $15.0 million of unsecured debt for $4.6 million aggregate principal amount of our notes issued in July 2009 (which were issued for $4.1 million), we recorded $10.9 million as a gain on extinguishment of debt in Predecessor 2009. (See “Debt and Other Obligations” for details on the refinancing of our debt).
Income tax provision. We have recorded a full valuation allowance against our deferred tax assets. During Predecessor 2009, we recorded an income tax benefit of $5.4 million as a result of the impairment to our intangible assets, resulting in a reduction of our related deferred tax liability. As a result of our valuation allowance, no income tax benefit was recorded in Predecessor 2008-2. The provision recorded of less than $0.1 million in Predecessor 2008-1 represents various state taxes incurred.
Liquidity and Capital Resources
Our principal liquidity requirements are to service our debt and meet our capital expenditure and working capital needs. Our indebtedness at December 26, 2010, including obligations under capital leases and unamortized debt discount, was $162.0 million, and we had $15.0 million of revolving credit availability under our $15.0 million senior secured revolving credit facility. As discussed below, in July 2009, we refinanced our notes, amended the credit agreement relating to our senior secured revolving credit facilities and amended and restated the credit agreement relating to our senior unsecured credit facility. Our ability to make principal and interest payments and to fund planned capital expenditures will depend on our ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our senior secured revolving credit facility will be adequate to meet our liquidity needs for the near future. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our senior secured revolving credit facility in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. If we consummate an acquisition, our debt service requirements could increase. We may need to refinance all or a portion of our indebtedness on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all.
Working Capital and Cash Flows
We presently have, in the past have had, and in the future are likely to have, negative working capital balances. The working capital deficit principally is the result of accounts payable and accrued liabilities being more than current asset levels. The largest components of our accrued liabilities include reserves for our self-insured workers’ compensation and general liability insurance, accrued payroll and related employee benefits costs and gift card liabilities. We do not have significant receivables and we receive trade credit based upon negotiated terms in purchasing food and supplies. Funds available from cash sales not needed immediately to pay for food and supplies or to finance receivables or inventories typically have been used for capital expenditures and/or debt service payments under our existing indebtedness.
Operating Activities. We had net cash provided by operating activities of $1.4 million in Successor 2010 and $10.1 million in Predecessor 2010 compared to $16.9 million for Predecessor 2009, resulting in a net decrease overall of $5.4 million from Predecessor 2009 to the combined results from Successor 2010 and Predecessor 2010. The decrease in cash provided by operating activities was primarily attributable to the decrease in revenues combined with changes in working capital.
Investing Activities. We had net cash used in investing activities of $5.6 million in Successor 2010 and $5.1 million in Predecessor 2010 compared to $7.2 million for Predecessor 2009. The overall increase in cash used in investing activities of $3.5 million was primarily the result of an increase in additions to property and equipment of $3.9 million. The increase in additions primarily resulted from an increase in maintenance capital expenditures from 2009 to a more normal level in 2010, as a result of management’s focus in 2009 on reducing capital expenditures in order to minimize the impact of lower restaurant revenues and restrictions in our notes issued during July 2009. While still within the restrictions in our notes, management determined the increase was necessary in order to maintain restaurant facilities.
We expect to make capital expenditures totaling approximately $10.0 million in fiscal year 2011 comprised of approximately $0.8 million for information technology, approximately $0.5 million for Real Mex Foods and approximately $8.7 million for restaurant maintenance and other capital expenditures related to our restaurants, including refurbishments and relocations of approximately $2.0 million. These and other similar costs may be higher in the future due to inflation and other factors. We expect to fund the capital expenditures described above from cash flow from operations, available cash, available borrowings under our senior credit facility and trade financing received from trade suppliers. We do not plan to open any new restaurants during 2011 as a result of the continued impact of the downturn in the economy which we do not expect to improve during 2011 and restrictions in our notes issued during July 2009.
Financing Activities. We had net cash used in financing activities of $0.8 million for Successor 2010 and net cash provided by financing activities of less than $0.1 million in Predecessor 2010, compared to net cash used in financing activities of $8.5 million for Predecessor 2009. The overall decrease in cash used in financing activities of $7.7 million was primarily the result of the net repayment of our senior secured revolving credit facility during the 2009 of approximately $7.6 million, resulting in no outstanding borrowings on the facility at the end of 2009. There was also no outstanding balance at the end of 2010. Additionally, as a result of the refinancing of our debt, we had a net cash outflow of approximately $0.7 million during Predecessor 2009. See “Debt and Other Obligations” below for further discussion of the refinancing transactions.
Debt and Other Obligations
On July 7, 2009, we completed an offering of $130.0 million aggregate principal amount of 14.0% senior secured notes due January 1, 2013, which are guaranteed by RM Restaurant Holding Corp. (“Holdco”), our parent company, and all of our existing and future domestic restricted subsidiaries, or the guarantors. The notes were offered and sold in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act, a limited number of institutional accredited investors in the United States, and outside the United States in reliance on Regulation S under the Securities Act. The notes were issued pursuant to an indenture, dated July 7, 2009, by and among the Company, the guarantors and Wells Fargo Bank, National Association, as trustee. The net proceeds from the issuance of the notes was used to refinance a portion of the existing indebtedness, including repayment of our existing $105.0 million senior secured notes due 2010 and to pay fees and expenses in connection therewith. Deferred debt fees of $6.5 million were recorded related to the issuance of the notes. The remaining deferred debt fees and unamortized debt discount related to the $105.0 million senior secured notes due 2010 of $11.7 million were recorded as interest expense on July 7, 2009.
Effective June 28, 2010, we entered into a supplemental indenture, which amended the indenture to permit affiliates of Sun Capital to acquire a majority of the stock of Holdco without requiring us to make a change of control offer to repurchase the notes that would otherwise have been required under the original indenture, as described below.
Prior to July 1, 2011, we may redeem up to 35% of the original aggregate principal amount of the notes at a redemption price equal to 114% of the principal amount thereof, plus accrued and unpaid interest thereon, with the net proceeds of certain equity financings; provided that (i) at least 65% of the aggregate principal amount of notes remains outstanding immediately after such redemption and (ii) the redemption occurs within 90 days of the date of the closing of such sale of our equity interests. Prior to July 1, 2011, we may also redeem some or all of the notes at a “make-whole” premium. On or after July 1, 2011, we may redeem some or all of the notes at 100% of the notes’ principal amount, plus accrued and unpaid interest up to the date of redemption.
Within 90 days of the end of each four fiscal quarter period ending on or near December 31, beginning in 2009, we must, subject to certain exceptions, offer to repay the notes with 75% of the Excess Cash Flow (as defined in the indenture) from the period, at 100% of the principal amount plus any accrued and unpaid interest and liquidated damages. If the excess cash flow offer is prohibited by the terms of the Second Amended and Restated Credit Agreement entered into in connection with the senior secured revolving credit facilities, as described below, we will deposit the amount that would have been used to fund the excess cash flow offer into an escrow account. Funds from the escrow account will only be released to us to repay borrowings under the senior secured revolving credit facilities or to make an excess cash flow offer. No Excess Cash Flow Offer was required for 2010 or 2009.
If we undergo a change of control, we will be required to make an offer to each holder to repurchase all or a portion of their notes at 101% of their principal amount, plus accrued and unpaid interest up to the date of purchase. If we sell assets outside the ordinary course of business and we do not use the net proceeds for specified purposes, we may be required to use such net proceeds to repurchase the notes at 100% of their principal amount, together with accrued and unpaid interest up to the date of repurchase.
The terms of the indenture generally limit our ability and the ability of our restricted subsidiaries to, among other things: (i) make certain investments or other restricted payments; (ii) incur additional debt and issue preferred stock; (iii) create or incur liens on assets to secure debt; (iv) incur dividends and other payment restrictions with regard to restricted subsidiaries; (v) transfer, sell or consummate a merger or consolidation of all, or substantially all, of our assets; (vi) enter into transactions with affiliates; (vii) change our line of business; (viii) repay certain indebtedness prior to stated maturities; (ix) pay dividends or make other distributions on, redeem or repurchase, capital stock or subordinated indebtedness; (x) engage in sale and leaseback transactions; or (xi) issue stock of subsidiaries.
The notes and the guarantees are secured by a second-priority security interest in substantially all of our assets and the assets of the guarantors, including the pledge of 100% of all outstanding equity interests of each of our domestic subsidiaries. On the closing date of the issuance of the notes, the Company and the guarantors entered into a registration rights agreement, pursuant to which we agreed to file with the SEC, and cause to become effective, a registration statement with respect to a registered offer to exchange the notes for an issue of our senior secured notes with terms identical to the notes in all material respects. The registration statement was declared effective on October 8, 2009. A shelf registration statement covering resales of the notes was declared effective by the SEC on December 1, 2009.
Senior Secured Revolving Credit Facilities. Our Second Amended and Restated Revolving Credit Agreement with General Electric Capital Corporation, as amended, provides for a $15.0 million revolving credit facility and $25.0 million letter of credit facility, maturing on July 1, 2012, collectively, the senior secured revolving credit facilities. Under the senior secured revolving credit facilities, the lenders agreed to make loans and issue letters of credit to and on behalf of the Company and our subsidiaries. Interest on the outstanding borrowings under the senior secured revolving credit facilities is based on either prime rate plus Applicable Margin or ninety-day LIBOR plus Applicable Margin, as defined in and subject to certain restrictions in the 2009 amendment, which extended the due date and modified certain covenants, and fees on the letters of credit issued thereunder accrue at a rate of 4.5% per annum. Deferred debt fees of $1.6 million were recorded in 2009 related to the amendment.
On April 2, 2010, we amended the Second Amended and Restated Revolving Credit Agreement which modified certain definitions in order to allow the transfer of shares in Holdco within current stockholders of Holdco. No such amendment was required related to our senior secured notes due 2013 as a result of such transfer.
Obligations under the senior secured revolving credit facilities are guaranteed by all of our subsidiaries, as well as by Holdco, which has made a first priority pledge of all of its equity interests in the Company as security for the obligations. The senior secured revolving credit facilities are secured by, among other things, first priority pledges of all of the equity interests of our direct and indirect subsidiaries, and first priority security interests (subject to customary exceptions) in substantially all of our current and future property and assets and our direct and indirect subsidiaries, with certain limited exceptions. As of December 26, 2010, we had $8.4 million available under the $25.0 million letter of credit facility and $15.0 million available under the $15.0 million revolving credit facility that may also be utilized for the letters of credit.
The Second Amended and Restated Revolving Credit Agreement, as amended, contains various affirmative and negative covenants and restrictions, which among other things, require us to meet certain financial tests (including certain leverage and cash flow ratios), and limits the Company and our subsidiaries’ ability to incur or guarantee additional indebtedness, make certain capital expenditures, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, sell assets, engage in transactions with affiliates and effect a consolidation or merger. The agreement contains a cross-default provision wherein if we are in default on any other credit facilities, default on this facility is automatic. At December 26, 2010, we were in compliance with all specified financial and other covenants under the Second Amended and Restated Credit Agreement, as amended.
Senior Unsecured Credit Facility. In connection with the offering of the notes, we entered into a Second Amended and Restated Credit Agreement, by and among the Company, Holdco, the lenders party thereto and Credit Suisse, Cayman Islands Branch, pursuant to which the principal balance of the existing unsecured loan owing by the Company under the existing senior unsecured credit facility, as amended, was reduced from $65.0 million to $25.0 million through (i) the assumption by Holdco of $25.0 million of such unsecured debt and (ii) the exchange by a lender under the senior unsecured credit facility, as amended, of $15.0 million of such unsecured debt for $4.6 million aggregate principal amount of notes, subject to an original issue discount of 10%. As a result, we recorded a gain on extinguishment of debt of $10.9 million. Deferred debt fees of $0.2 million were recorded related to the Second Amended and Restated Credit Agreement. Interest accrues at an annual rate of 16.5% and is payable quarterly; provided that (i) such interest is payable in kind for the first four quarters following the closing date of the issuance of the notes and (ii) thereafter will be payable in a combination of cash and in kind. The term of the senior unsecured credit facility was extended to July 1, 2013 and certain covenants were modified. Certain lenders to the senior unsecured credit facility are owners of Holdco, and as a result, the senior unsecured credit facility is held by related parties to the Company.
The senior unsecured credit facility, as amended, contains various affirmative and negative covenants which, among other things, require us to meet certain financial tests (including certain leverage and interest coverage ratios) and limits the Company and our subsidiaries’ ability to incur or guarantee additional indebtedness, grant certain liens, make certain restricted payments, make capital expenditures, engage in transactions with affiliates, make certain investments, sell our assets, make acquisitions, effect a consolidation or merger and amend or modify instruments governing certain indebtedness (including relating to the notes and the senior secured revolving credit facilities). At December 26, 2010, we were in compliance with all specified financial and other covenants under the senior unsecured credit facility, as amended.
Mortgage. In 2005, concurrent with an acquisition, we assumed a $0.8 million mortgage secured by the building and improvements of one of the restaurants acquired in the transaction. The mortgage carries a fixed annual interest rate of 9.28% and requires equal monthly payments of principal and interest through April 2015. As of December 26, 2010, the principal amount outstanding on the mortgage was $0.4 million.
Capital Leases. In conjunction with our acquisition of El Torito, we assumed capital lease obligations, collateralized with leasehold improvements, in an aggregate amount of $9.2 million. In addition, we have entered into additional capital leases for equipment of $0.3 million during fiscal year 2009. The remaining capital lease obligations have a weighted-average interest rate of 8.5%. As of December 26, 2010, the principal amount due relating to capital lease obligations was $0.8 million. Principal and interest payments on the capital lease obligations are due monthly and range from $2,500 to $4,400 per month. The capital lease obligations mature between 2011 and 2025.
The following table represents our contractual commitments as of December 26, 2010 associated with obligations under debt agreements, other obligations discussed above and from our operating leases:
Off-Balance Sheet Arrangements
None.
Inflation
The impact of inflation on labor, food and occupancy costs could, in the future, significantly affect our operations. We pay many of our employees hourly rates related to the federal or applicable state minimum wage. Our workers’ compensation and health insurance costs have been and are subject to continued inflationary pressures. Costs for construction, taxes, repairs, maintenance and insurance all impact our occupancy costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance and utilities, all of which may be subject to inflationary increases.
Management continually seeks ways to mitigate the impact of inflation on our business. We believe that our current practice of maintaining operating margins through a combination of periodic menu price increases, cost controls, careful evaluation of property and equipment needs, and efficient purchasing practices is our most effective tool for dealing with inflation.
Critical Accounting Policies
Our Company’s accounting policies are fully described in Note 3 of the Consolidated Financial Statements. As disclosed in Note 3, the discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to property and equipment, impairment of long-lived assets, valuation of goodwill, self-insurance reserves, income taxes and revenue recognition. We base our estimates on historical experience and on various other assumptions and factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Based on our ongoing review, we plan to adjust our judgments and estimates where facts and circumstances dictate. Actual results could differ from our estimates.
We believe the following critical accounting policies are important to the portrayal of our financial condition and results and require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Property and Equipment
Property and equipment is recorded at cost and depreciated over its estimated useful life using the straight-line method for financial reporting purposes. The lives for furniture, fixtures and equipment range from three to 10 years. The life for buildings is the shorter of 20 years or the term of the related operating lease. Costs of leasehold rights and improvements and assets held under capital leases are amortized on the straight-line basis over the shorter of the estimated useful lives of the assets or the non-cancelable term of their underlying leases. The costs of repairs and maintenance are expensed when incurred, while expenditures for refurbishments and improvements that extend the useful life of an asset are capitalized.
Long-Lived Asset Impairment
We assess the impairment of long-lived assets, including restaurant sites and other assets, when events or changes in circumstances indicate that the carrying value of the assets or the asset group may not be recoverable. The asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from the disposition of the asset (if any) are less than the related asset’s carrying amount. Impairment losses are measured as the amount by which the carrying amounts of the assets exceed their fair values. The net proceeds expected from the disposition of the asset are determined by independent quotes or expected sales prices developed by internal specialists. Estimates of future cash flows and expected sales prices are judgments based on our experience and knowledge of local operations. These estimates can be significantly affected by future changes in real estate market conditions, the economic environment, and capital spending decisions and inflation.
For properties to be closed that are under long-term lease agreements, the present value of any remaining liability under the lease, discounted using risk-free rates and net of expected sublease rentals that could be reasonably obtained for the property, is recognized as a liability and expensed. The value of any equipment and leasehold improvements related to a closed store is reduced to reflect net recoverable values. Internal specialists estimate the subtenant income, future cash flows and asset recovery values based on their historical experience and knowledge of (1) the market in which the store to be closed is located, (2) the results of its previous efforts to dispose of similar assets and (3) the current economic conditions. Specific real estate markets, the economic environment and inflation affect the actual cost of disposition for these leases and related assets.
During Successor 2010, Predecessor 2009 and Predecessor 2008-1, management determined that certain identified property and equipment was impaired and recorded an impairment charge of $1.0 million, $4.7 million and $5.2 million, respectively, reducing the carrying value of such assets to the estimated fair value. Management recorded no impairment for Predecessor 2010 or Predecessor 2008-2.
Goodwill and Intangible Assets
Goodwill and indefinite-lived intangible assets are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. Management performs its annual impairment tests during the last quarter of the Company’s fiscal year. An impairment loss is recognized to the extent that the carrying amount exceeds an asset’s fair value. Management considers the reporting unit level to be the Company level, as the components (e.g., brands) within the Company have similar economic characteristics, including production processes, types or classes of customers and distribution methods. This determination is made at the reporting unit level and consists of two steps. First, management determines the fair value of a reporting unit and compares it to its carrying amount. The fair value is determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. For the valuation of other indefinite lived intangible assets, including trademarks and franchise agreements, discounted future royalty methods are used.
Factors that could change the result of our goodwill impairment test include, but are not limited to, different assumptions used to forecast future revenues, expenses, capital expenditures and working capital requirements used in our cash flow models. In addition, selection of a risk-adjusted discount rate on the estimated undiscounted cash flows is susceptible to future changes in market conditions, and when unfavorable, can adversely affect our original estimates of fair values. A variance in the discount rate could have a significant impact on the valuation of the goodwill for purposes of the impairment test. We cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions made in response to the economic environment on our customer base or a material negative change in relationships with our customers.
During the fourth quarter of 2010, management completed the annual impairment test and as a result recorded $1.1 million in impairment of intangible assets, related to Chevys trademarks and franchise assets. No goodwill impairment was identified.
During the third quarter of 2009, management recorded $2.7 million in goodwill impairment that was related to the Agreement and Plan of Merger at the time of the Exchange. During the fourth quarter of 2009, management forecasts were revised due to the continued impact of the downturn in the economy on current operations and growth projections. As a result, we recorded impairment of approximately $13.2 million related to trademarks and franchise agreements. We recorded total non-cash charges of $16.3 million for the write-down of the goodwill and other intangible assets during the fiscal year ended December 27, 2009, which also includes $0.4 million related to favorable lease assets.
During the second quarter of 2008, management identified impairment of approximately $34.0 million, including $30.0 million related to goodwill and $4.0 million related to trademarks. As of November 13, 2008, in conjunction with the Exchange, we completed a valuation and identified additional impairment of approximately $129.2 million, including $87.6 million related to goodwill and $41.6 million related to trademarks. We recorded total non-cash charges of $163.2 million for the write-down of the goodwill and trademarks during the Predecessor Period December 31, 2007 to November 13, 2008.
Self-Insurance
Our business is primarily self-insured for workers’ compensation and general liability costs. Our recorded self-insurance liability is determined actuarially based on claims filed and an estimate of claims incurred but not yet reported. Any actuarial projection of ultimate losses is subject to a high degree of variability. Sources of this variability are numerous and include, but are not limited to, future economic conditions, court decisions and legislative actions. Our workers’ compensation future funding estimates anticipate no change in the benefit structure. Statutory changes could have a significant impact on future claim costs.
Our workers’ compensation liabilities are from claims occurring in various states. Individual state workers’ compensation regulations have received a tremendous amount of attention from state politicians, insurers, employers and providers, as well as the public in general. Recent years have seen an escalation in the number of legislative reforms, judicial rulings and social phenomena affecting our business. The changes in a state’s political and economic environment increase the variability in the unpaid claim liabilities.
Income Taxes
Our Company utilizes the liability method of accounting for income taxes, under which deferred taxes are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Recognition of deferred tax assets is limited to amounts considered by management to be more likely than not to be realizable in future periods. We have significant deferred tax assets, which are subject to periodic recoverability assessments. Net deferred tax assets are reduced by a valuation allowance if, based on all the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. We recorded a valuation allowance of $66.8 million and $50.9 million at December 26, 2010 and December 27, 2009, respectively. The amount of deferred tax assets considered realizable was based upon our ability to generate future taxable income, exclusive of reversing temporary differences and carry-forwards.
The Company is required to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. Management has concluded that there are no significant uncertain tax positions requiring recognition in the financial statements.
Revenue Recognition
Revenues from the operation of Company-owned restaurants are recognized when sales occur. Fees from franchised and licensed restaurants are included in revenue as earned. Royalty fees are based on franchised restaurants’ revenues and we record these fees in the period the related franchised restaurants’ revenues are earned. Real Mex Foods’ revenues from sales to outside customers are recognized upon delivery, when title transfers to the customer, and are included in other revenues. Sales tax collected from customers and remitted to governmental authorities is presented on a net basis (excluded from revenue) in our financial statements.
Recently Adopted Accounting Standards
In January 2010, the Financial Accounting Standards Board (the “FASB”) issued guidance requiring increased fair value disclosures. There are two components to the increased disclosure requirements set forth in the update: (1) a description of, as well as the disclosure of, the dollar amount of transfers in or out of level one or level two in the reconciliation for fair value measurements using significant unobservable inputs (level three), a reporting entity should present separately information about purchases, sales, issuances and settlements (that is, gross amounts shall be disclosed as opposed to a single net figure). Increased disclosures regarding the transfers in/out of level one and two are required for interim and annual periods beginning after December 15, 2009. Increased disclosures regarding the level three fair value reconciliation are required for fiscal years beginning after December 15, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued guidance requiring a company to disclose information that provides financial statement users more information about the credit quality of a creditor’s financing receivables and the adequacy of its allowance for credit losses. Short-term accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt. For public companies, the amendments that require disclosures as of the end of a reporting period and the amendments that requires disclosures for activity that occurs during a reporting period are effective for periods ending on or after December 15, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The inherent risk in market risk sensitive instruments and positions primarily relates to potential losses arising from adverse changes in foreign exchange rates and interest rates.
We consider the U.S. dollar to be the functional currency for all of our entities. All of our net sales are denominated in U.S. dollars. Therefore, foreign currency fluctuations did not materially affect our financial results in any period presented.
We are also subject to market risk from exposure to changes in interest rates based on our financing activities. This exposure relates to borrowings under our senior secured credit facilities that are payable at floating rates of interest. As of February 20, 2011, we had borrowings of $11.9 million outstanding under our senior secured revolving credit facilities. A hypothetical 10% fluctuation in interest rates as of February 20, 2011 would have a net after tax impact of less than $0.1 million on our earnings in 2010, in addition to its effect on cash flows.
Many of the food products purchased by us are affected by changes in weather, production, availability, seasonality and other factors outside our control. In an effort to control some of this risk, we have entered into certain fixed price purchase agreements with varying terms of generally no more than a year in duration. In addition, we believe that almost all of our food and supplies are available from several sources, which helps to control food commodity risks.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The audited consolidated financial statements are set forth below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Real Mex Restaurants, Inc.
We have audited the accompanying consolidated balance sheets of Real Mex Restaurants, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 26, 2010 (the “Successor”) and December 27, 2009 (the “Predecessor”) and the related consolidated statements of operations, stockholder’s equity, and cash flows for the six months ended December 26, 2010 (the “Successor” period), subsequent to the equity transaction of RM Restaurant Holding Corp., the Company’s parent, that was reflected on the financial statements of the Company. We have also audited the consolidated statements of operations, stockholder’s equity and cash flows for the six months ended June 27, 2010, the year ended December 27, 2009, the period from November 14, 2008 to December 28, 2008 and the period from December 31, 2007 to November 13, 2008 (the “Predecessor Periods”). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Real Mex Restaurants, Inc. and subsidiaries as of December 26, 2010 and December 27, 2009, and the results of its operations and its cash flows for the Successor and Predecessor Periods in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Irvine, California
March 24, 2011
Real Mex Restaurants, Inc.
Consolidated Balance Sheets
(In Thousands, Except For Share Data)
See notes to consolidated financial statements.
Real Mex Restaurants, Inc.
Consolidated Statements of Operations
(In Thousands)
See notes to consolidated financial statements.
Real Mex Restaurants, Inc.
Consolidated Statements of Stockholder’s Equity
(In Thousands, Except For Share Data)
See notes to consolidated financial statements.
Real Mex Restaurants, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
See notes to consolidated financial statements.
Real Mex Restaurants, Inc.
Notes to Consolidated Financial Statements
December 26, 2010
(In Thousands, Except For Share Data)
1. Description of Business
Real Mex Restaurants, Inc. (together with its subsidiaries, the “Company”), is a Delaware corporation which is engaged in the business of owning and operating restaurants, primarily under the names El Torito®, Acapulco Mexican Restaurant Y Cantina® and Chevys Fresh Mex®. At December 26, 2009, the Company, primarily through its major subsidiaries (El Torito Restaurants, Inc., Chevys Restaurants LLC and Acapulco Restaurants, Inc.), owned and operated 181 restaurants, of which 152 were in California and the remainder in 12 other states. The Company’s other major subsidiary, Real Mex Foods, Inc. (“RMF”), provides internal production, purchasing and distribution services for the restaurant operations and manufactures specialty products for sales to outside customers.
Basis of Presentation
Prior to June 28, 2010, the Company is referred to as the “Predecessor” and after June 27, 2010 is referred to as the “Successor”.
The Company’s fiscal year consists of 52 or 53 weeks ending on the last Sunday in December which in 2010 was December 26, 2010, in 2009 was December 27, 2009 and in 2008 was December 28, 2008. The accompanying consolidated balance sheets present the Company’s financial position as of December 26, 2010 and December 27, 2009. The accompanying consolidated statements of operations, stockholder’s equity and cash flows present the 26 week Successor Period ended December 26, 2010, the 26 week Predecessor Period ended June 27, 2010, the 52 week Predecessor Year ended December 27, 2009, the 6 week Predecessor Period from November 14, 2008 to December 28, 2008 and the 46 week Predecessor Period from December 31, 2007 to November 13, 2008. See further description of the successor and predecessor periods in Note 2.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Liquidity
The Company’s financial statements as of December 26, 2010 have been presented on the basis that it is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company’s principal liquidity requirements are to service debt and meet capital expenditure and working capital needs.
In addition, the Company’s debt agreements require compliance with specified financial covenants. These covenants could adversely affect the Company’s ability to finance future operations or capital needs and pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default occurs, the relevant lenders could elect to declare the indebtedness, together with accrued interest and other fees, to be immediately due and payable and proceed against any collateral securing that indebtedness. Acceleration of other indebtedness could result in a default under the terms of the indenture governing the notes. In such an event, the Company may be required to refinance all or part of the then-existing debt (including the notes), sell assets or borrow more money. The Company may not be able to accomplish any of the alternatives on acceptable terms, or at all. The failure to generate sufficient cash flow or to achieve any of these alternatives could significantly adversely affect the Company.
The Company’s ability to make principal and interest payments, fund planned capital expenditures and meet financial covenants will depend on the ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond the control of the Company. Although the Company had negative working capital as of December 26, 2010 (as has been the case for all years being reported on), based on the current level of operations and the Company’s revised business plan, management believes the cash flow generated from operations, available cash and available borrowings under the Senior Secured Revolving Credit Facilities will be adequate to meet liquidity needs for the near future.
2. Acquisitions
Share Purchase - Successor
Effective June 28, 2010, immediately after the Company entered into a supplemental indenture (see Note 6), Sun Cantinas, LLC (“Sun Cantinas”), an affiliate of Sun Capital Partners (“Sun Capital”), an equityholder of Holdco, acquired 43,338 shares of common stock (the “Share Purchase”) of RM Restaurant Holding Corp. (“Holdco”) from Cocina Funding Corp., L.L.C. (“Cocina”), an existing equityholder of Holdco managed by Farallon Capital Management, LLC (“Farallon”). As a result, Sun Cantinas and SCSF Cantinas, LLC, another affiliate of Sun Capital, together own approximately 70% of the outstanding common stock of Holdco, and together are entitled, under the cumulative voting provisions of Holdco’s Certificate of Incorporation, to elect at least five members of the seven-member board of directors of Holdco and the Company, giving them the ability indirectly to control the Company. Following the Share Purchase, Cocina holds approximately 13% of the outstanding common stock of Holdco, and no longer has a representative on the board of directors of Holdco or the Company.
The Share Purchase was accounted for by Holdco under the purchase method of accounting and push-down accounting was applied to the Company. The Company completed a valuation to determine the value of the assets acquired and the liabilities assumed based on their estimated fair market values at the date of the Share Purchase. The Company attributes the goodwill associated with the Share Purchase to the historical financial performance and the anticipated future performance of the Company’s operations. Since this was a non-cash transaction for the Company, it has been excluded from the consolidated statement of cash flows.
The following table presents the allocation to the assets acquired and liabilities assumed based on their estimated fair values as determined by the valuation of the Company (in thousands):
As a result of the Share Purchase, fiscal year 2010 is presented as the Predecessor Period from December 28, 2009 to June 27, 2010 and the Successor Period subsequent to June 27, 2010.
Exchange Agreement - Predecessor
Effective November 13, 2008, Holdco, owned substantially by an affiliate of Sun Capital, and each of Holdco’s existing lenders executed an agreement to exchange Holdco’s then outstanding borrowings under its unsecured term loan facility for 94.5% of the common stock of Holdco (the “Exchange”). Immediately prior to the Exchange, Holdco effected a 100:1 reverse stock split of its common stock and after the Exchange the immediately post-split existing holders retained 5.5% of the shares of Holdco common stock. Immediately after the Exchange, no stockholder, together with its affiliates, owned more than 50% of the capital stock of Holdco. Affiliates of Sun Capital remained stockholders of Holdco.
3. Summary of Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts and results of operations of the Company. All significant inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates, and they may be adjusted as more information becomes available.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash balances in bank accounts and investments with a maturity of three months or less at the time of purchase.
Receivables
Receivables consist primarily of amounts due from credit card companies, outside customers of RMF and franchisees. Receivables from credit card companies are generally settled in the week following the transaction date. Receivables from RMF’s outside customers are generally collected within 30 days of the date of the sale and receivables from franchisees are generally collected within 21 days following the close of the royalty period. Receivables are stated net of an allowance for doubtful accounts of $517 and $694 at December 26, 2010 and December 27, 2009, respectively. Activity during fiscal year 2010 included a net decrease in the allowance of $177, including an increase of $499 primarily related to a sub tenant, offset by the reversal of $154 related to franchisee receivables and write-offs of $522 primarily related to franchisee receivables.
Inventories
Inventories, consisting primarily of food and beverages, are carried at the lower of cost (first-in, first-out method) or market. Inventories are reviewed for spoilage and excess or obsolete products and reserved accordingly.
Supplies and Expendable Equipment
The initial purchase of supplies and expendable equipment, when a restaurant is first opened, such as china, glass and silverware, is capitalized and depreciated over a period of 5 years. Replacements of supplies and expendable equipment are expensed.
Pre-Opening Costs
Pre-opening costs incurred with the start-up of a new restaurant, or the conversion of an existing restaurant to a different concept, are expensed as incurred.
Property and Equipment
Property and equipment is recorded at cost and depreciated over its estimated useful life using the straight-line method for financial reporting purposes. The lives for furniture, fixtures and equipment range from three to 10 years. The life for buildings is the shorter of 20 years or the term of the related operating lease. Costs of leasehold rights and improvements and assets held under capital leases are amortized on the straight-line basis over the shorter of the estimated useful lives of the assets or the non-cancelable term of their underlying leases. The costs of repairs and maintenance are expensed when incurred, while expenditures for refurbishments and improvements that extend the useful life of an asset are capitalized. Depreciation expense includes the amortization of assets held under capital leases.
Impairment of Long-Lived Assets
Long-lived assets are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the assets might be impaired. During the Successor Six Months ended December 26, 2010, the Predecessor Year ended December 27, 2009 and the Predecessor Period from December 31, 2007 through November 13, 2008, management of the Company determined that certain identified property and equipment was impaired and recorded an impairment charge of $1,007, $4,708 and $5,151, respectively, reducing the carrying value of such assets to the estimated fair value. Fair value was based on management’s estimate of future cash flows to be generated by the property and equipment determined to be impaired. During the Predecessor Six Months ended June 27, 2010 and the Predecessor Period from November 14, 2008 through December 28, 2008, management recorded no impairment.
Impairment of Goodwill and Intangible Assets
Goodwill and indefinite-lived intangible assets are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. Management performs its annual impairment test during the last quarter of the Company’s fiscal year. An impairment loss is recognized to the extent that the carrying amount exceeds an asset’s fair value. Management considers the reporting unit level to be the Company level, as the components (e.g., brands) within the Company have similar economic characteristics, including production processes, types or classes of customers and distribution methods. This determination is made at the reporting unit level and consists of two steps. First, management determines the fair value of a reporting unit and compares it to its carrying amount. The fair value is determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. For the valuation of other indefinite lived intangible assets, including trademarks and franchise agreements, discounted future royalty methods are used.
Factors that could change the result of our goodwill impairment test include, but are not limited to, different assumptions used to forecast future revenues, expenses, capital expenditures and working capital requirements used in our cash flow models. In addition, selection of a risk-adjusted discount rate on the estimated undiscounted cash flows is susceptible to future changes in market conditions, and when unfavorable, can adversely affect our original estimates of fair values. A variance in the discount rate could have a significant impact on the valuation of the goodwill for purposes of the impairment test. We cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions made in response to the economic environment on our customer base or a material negative change in relationships with our customers.
During the fourth quarter of 2010, the Company completed the annual impairment test and as a result recorded $1,100 in impairment of intangible assets, related to Chevys trademarks and franchise assets. No goodwill impairment was identified.
During the third quarter of 2009, the Company recorded $2,728 in goodwill impairment that was related to a previous merger at the time of the Exchange. During the fourth quarter of 2009, management forecasts were revised due to the continued impact of the downturn in the economy on current operations and growth projections. As a result, the Company recorded impairment of approximately $13,200 related to trademarks and franchise agreements. The Company recorded total non-cash charges of $16,294 for the write-down of the goodwill and other intangible assets during the fiscal year ended December 27, 2009, which also includes $366 related to favorable lease assets.
During the second quarter of 2008, the Company recorded impairment of $34,000, including $30,000 related to goodwill and $4,000 related to trademarks. As of November 13, 2008, in conjunction with the Exchange, the Company completed a valuation and identified additional impairment of approximately $129,196, including $87,596 related to goodwill and $41,600 related to trademarks. The Company recorded total non-cash charges of $163,196 for the write-down of the goodwill and trademarks during the Predecessor Period December 31, 2007 to November 13, 2008.
Intangible Assets
Intangible assets consist of the following indefinite-lived assets as follows:
Deferred Charges
Deferred charges at December 26, 2010 consists of deferred financing costs of $3,827 related to the sale of $130,000 aggregate principal amount of the senior secured notes due January 1, 2013, $100 related to the $25,000 senior unsecured credit facility maturing on July 1, 2013 and $783 related to the senior secured revolving credit facilities. Capitalized deferred charges are amortized over the lives of the respective long-term borrowings on a straight-line basis and are included in interest expense in the accompanying consolidated statements of operations. Amounts capitalized related to leases are amortized over the primary term of their respective leases and are included in occupancy expense in the accompanying statements of operations. The following table shows the estimated amortization expense for the years after December 26, 2010:
Favorable Lease Asset and Unfavorable Lease Liability
Favorable lease asset represents the approximate fair market value arising from lease rates that are below market rates as of June 27, 2010, the date of the Share Purchase. The amount is being amortized over the remaining primary term of the underlying leases.
Unfavorable lease liability represents the approximate fair market value arising from lease rates that are above market rates as of June 27, 2010, the date of the Share Purchase. The amount is being amortized over the remaining primary term of the underlying leases. The current portion of unfavorable lease liabilities is recorded in other accrued liabilities.
The following table shows the estimated amortization expense for the years after December 26, 2010:
Liquor Licenses
Transferable liquor licenses, which have a market value, are carried at the lower of aggregate acquisition cost or market and are not amortized. Liquor licenses are included in other assets.
Income Taxes
The Company utilizes the liability method of accounting for income taxes in which deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Recognition of deferred tax assets is limited to amounts considered by management to be more likely than not of realization in future periods.
The Company is required to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The Company has concluded that there are no significant uncertain tax positions requiring recognition in the financial statements.
The Company’s policy is to recognize interest and penalties expense, if any, related to unrecognized tax benefits as a component of income tax expense. As of December 26, 2010, the Company has not recorded any significant interest and penalty expense. The Company’s determination on its analysis of uncertain tax positions are related to tax years that remain subject to examination by the relevant tax authorities. These include the 2007 through 2009 tax years for federal purposes and the 2006 through 2009 tax years for California purposes.
Revenue Recognition
Revenues from the operation of Company-owned restaurants are recognized when sales occur. Fees from franchised operations are included in revenue as earned. Royalty fees are based on franchised restaurants’ revenues and we record these fees in the period the related franchised restaurants’ revenues are earned. RMF’s revenues from sales to outside customers are recognized upon delivery, when title transfers to the customer, and are included in other revenues. Sales tax collected from customers and remitted to governmental authorities is presented on a net basis (excluded from revenue) in our financial statements.
Self Insurance
The Company is self-insured for most workers’ compensation and general liability losses (collectively “casualty losses”). The Company maintains stop-loss coverage with third party insurers to limit its total exposure. The recorded liability associated with these programs is based on an estimate of the ultimate costs to be incurred to settle known claims and claims incurred but not reported as of the balance sheet date. The estimated liability is not discounted and is based on a number of assumptions and factors, including historical trends, actuarial assumptions and economic conditions. If actual claims trends, including the severity or frequency of claims, differ from estimates, the financial results could be significantly impacted.
Gift Certificates and Gift Cards
The Company records deferred revenue, included in accounts payable, for gift certificates and gift cards outstanding until they are redeemed. Revenues from unredeemed gift cards are recognized based on historical and expected redemption trends and are classified as revenues in our consolidated statement of operations.
Segment Information
The Company operates 181 restaurants through its three restaurant operating subsidiaries, providing similar products to similar customers. These restaurants possess similar economic characteristics resulting in similar long-term expected financial characteristics. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. Based upon its methods of internal reporting and management structure, management believes that the Company meets the criteria for aggregating its 181 operating restaurants into a single reporting segment called restaurant operations. The Company’s RMF manufacturing operations are dissimilar from our restaurant operations, but do not meet the required quantitative thresholds and therefore qualify for aggregation.
Promotion and Advertising Expense
The cost of promotion and advertising is expensed as incurred. The Company incurred $7,054, $9,133, $14,325, $1,260 and $15,077 in promotion and advertising expense during the Successor Six Months ended December 26, 2010, the Predecessor Six Months ended June 27, 2010, the Predecessor Year ended December 27, 2009, the 6 week Predecessor Period from November 14, 2008 to December 28, 2008 and the 46 week Predecessor Period December 31, 2007 to November 13, 2008, respectively.
Operating Leases
Most of our restaurant and office facilities are under operating leases with expirations in fiscal years 2011 through 2028. The minimum lease payments, including any predetermined fixed escalations of the minimum rent, are recognized as rent expense on a straight-line basis over the lease term. Most of the restaurant facilities have renewal clauses exercisable at the option of the Company and include rent escalation clauses stipulating specific rent increases upon exercise, some of which are based upon the Consumer Price Index. Certain of these leases require the payment of contingent rentals based on a percentage of gross revenues. At December 26, 2010 and December 27, 2009, deferred rent equaled $775 and $2,092, respectively, which is included in other long-term liabilities.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company places its cash and cash equivalents with high quality financial institutions. At times, balances in the Company’s cash accounts may exceed the Federal Deposit Insurance Corporation (FDIC) limit. Most of the Company’s restaurants are located in California. Consequently, the Company may be susceptible to adverse trends and economic conditions in California.
Fair Value of Financial Instruments
The Company’s financial instruments are primarily comprised of cash and cash equivalents, receivables, accounts payable, accrued liabilities and long-term debt. For cash and cash equivalents, receivables, accounts payable and accrued liabilities, the carrying amount approximates fair value because of the short maturity of these instruments. The estimated fair value of the Senior Secured Notes due 2013 at December 26, 2010, based on quoted market prices was $135,850. Management estimates that the carrying values of its other financial instruments approximate their fair values since their realization or satisfaction is expected to occur in the short term or have been renegotiated at a date close to year end.
Recently Adopted Accounting Standards
In January 2010, the Financial Accounting Standards Board (the “FASB”) issued guidance requiring increased fair value disclosures. There are two components to the increased disclosure requirements set forth in the update: (1) a description of, as well as the disclosure of, the dollar amount of transfers in or out of level one or level two in the reconciliation for fair value measurements using significant unobservable inputs (level three), a reporting entity should present separately information about purchases, sales, issuances and settlements (that is, gross amounts shall be disclosed as opposed to a single net figure). Increased disclosures regarding the transfers in/out of level one and two are required for interim and annual periods beginning after December 15, 2009. Increased disclosures regarding the level three fair value reconciliation are required for fiscal years beginning after December 15, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued guidance requiring a company to disclose information that provides financial statement users more information about the credit quality of a creditor’s financing receivables and the adequacy of its allowance for credit losses. Short-term accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt. For public companies, the amendments that require disclosures as of the end of a reporting period and the amendments that requires disclosures for activity that occurs during a reporting period are effective for periods ending on or after December 15, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
4. Property and Equipment
Property and equipment consists of the following:
5. Accounts Payable and Other Accrued Liabilities
Accounts payable consist of the following:
Other accrued liabilities consist of the following:
6. Long-Term Debt
Long-term debt consists of the following:
Senior Secured Notes due 2013. On July 7, 2009 (the “Closing Date”), the Company completed an offering of $130,000 aggregate principal amount of 14.0% Senior Secured Notes due January 1, 2013 (the “Notes”), which are guaranteed (the “Guarantees”) by Holdco and all of the Company’s existing and future domestic restricted subsidiaries (together with Holdco, the “Guarantors”). The Notes were offered and sold in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), a limited number of institutional accredited investors in the United States, and outside the United States in reliance on Regulation S under the Securities Act. The Notes were issued pursuant to an indenture, dated July 7, 2009 (the “Indenture”), by and among the Company, the Guarantors and Wells Fargo Bank, National Association, as trustee. The net proceeds from the issuance of the Notes were used to refinance a portion of the existing indebtedness, including repayment of the Company’s $105,000 senior secured notes due 2010 and to pay fees and expenses in connection therewith. Deferred debt fees of $6,596 were recorded related to the issuance of the Notes. The remaining deferred debt fees and unamortized debt discount related to the $105,000 senior secured notes due 2010 of $11,717 were recorded as interest expense on July 7, 2009.
Effective June 28, 2010, the Company entered into a Supplemental Indenture, which amended the Indenture to permit affiliates of Sun Capital to acquire a majority of the stock of Holdco without requiring the Company to make a change of control offer to repurchase the Notes that would otherwise have been required under the Indenture.
Prior to July 1, 2011, the Company may redeem up to 35% of the original aggregate principal amount of the Notes at a redemption price equal to 114% of the principal amount thereof, plus accrued and unpaid interest thereon, with the net proceeds of certain equity financings; provided that (i) at least 65% of the aggregate principal amount of Notes remains outstanding immediately after such redemption and (ii) the redemption occurs within 90 days of the date of the closing of such sale of our equity interests. Prior to July 1, 2011, the Company may also redeem some or all of the Notes at a “make-whole” premium. On or after July 1, 2011, the Company may redeem some or all of the Notes at 100% of the Notes’ principal amount, plus accrued and unpaid interest up to the date of redemption.
Within 90 days of the end of each four fiscal quarter period ending on or near December 31, beginning in 2009, the Company must, subject to certain exceptions, offer to repay the Notes with 75% of the Excess Cash Flow (as defined in the Indenture) from the period, at 100% of the principal amount plus any accrued and unpaid interest and liquidated damages. If the excess cash flow offer is prohibited by the terms of the Company’s Second Amended and Restated Credit Facility, as amended, governing the Company’s New Senior Secured Revolving Credit Facilities, the Company will deposit the amount that would have been used to fund the excess cash flow offer into an escrow account. Funds from the escrow account will be released to the Company only to repay borrowings under the New Senior Secured Revolving Credit Facilities or to make an excess cash flow offer. No Excess Cash Flow Offer was required for 2010 or 2009.
If the Company undergoes a change of control, the Company will be required to make an offer to each holder to repurchase all or a portion of their Notes at 101% of their principal amount, plus accrued and unpaid interest up to the date of purchase. If the Company sells assets outside the ordinary course of business and the Company does not use the net proceeds for specified purposes, the Company may be required to use such net proceeds to repurchase the Notes at 100% of their principal amount, together with accrued and unpaid interest up to the date of repurchase.
The terms of the Indenture generally limit the Company’s ability and the ability of the Company’s restricted subsidiaries to, among other things: (i) make certain investments or other restricted payments; (ii) incur additional debt and issue preferred stock; (iii) create or incur liens on assets to secure debt; (iv) incur dividends and other payment restrictions with regard to restricted subsidiaries; (v) transfer, sell or consummate a merger or consolidation of all, or substantially all, of the Company’s assets; (vi) enter into transactions with affiliates; (vii) change the Company’s line of business; (viii) repay certain indebtedness prior to stated maturities; (ix) pay dividends or make other distributions on, redeem or repurchase, capital stock or subordinated indebtedness; (x) engage in sale and leaseback transactions; or (xi) issue stock of subsidiaries.
The Notes and the Guarantees are secured by a second-priority security interest in substantially all of the assets of the Company and the Guarantors, including the pledge of 100% of all outstanding equity interests of each of the Company’s domestic subsidiaries. On the Closing Date, the Company and the Guarantors entered into a registration rights agreement, pursuant to which the Company and the Guarantors have agreed for the benefit of the holders of the Notes to file with the SEC and cause to become effective a registration statement with respect to a registered offer to exchange the Notes for an issue of the Company’s senior secured notes with terms identical to the Notes in all material respects. The registration statement was declared effective on October 8, 2009. A shelf registration statement covering resales of the Notes was declared effective by the SEC on December 1, 2009.
Senior Secured Revolving Credit Facilities. The Second Amended and Restated Revolving Credit Agreement with General Electric Capital Corporation, as amended, provides for a $15.0 million revolving credit facility and $25.0 million letter of credit facility, maturing on July 1, 2012 (collectively, the “Senior Secured Revolving Credit Facilities”). Under the Senior Secured Revolving Credit Facilities, the lenders agreed to make loans and issue letters of credit to and on behalf of the Company and its subsidiaries. Interest on the outstanding borrowings under the senior secured revolving credit facilities is based on either prime rate plus Applicable Margin or ninety-day LIBOR plus Applicable Margin, as defined in and subject to certain restrictions in the 2009 amendment, which extended the due date and modified certain covenants and fees on the letters of credit issued thereunder accrue at a rate of 4.5% per annum. Deferred debt fees of $1,562 were recorded in 2009 related to the amendment.
Obligations under the Senior Secured Revolving Credit Facilities are guaranteed by all of the Company’s subsidiaries as well as by Holdco, which wholly owns the Company and has made a first priority pledge of all of its equity interests in the Company as security for the obligations. The Senior Secured Revolving Credit Facilities are secured by, among other things, first priority pledges of all of the equity interests of the Company’s direct and indirect subsidiaries, and first priority security interests (subject to customary exceptions) in substantially all of the current and future property and assets of the Company and its direct and indirect subsidiaries, with certain limited exceptions. As of December 26, 2010, the Company had $8,393 available under the Senior Secured Letter of Credit Facility and $15,000 available under the Senior Secured Revolving Credit Facility that may also be utilized for the letters of credit.
On April 2, 2010, the Company entered into an amendment to the Second Amended and Restated Revolving Credit Agreement which modified certain definitions in order to allow the transfer of shares in Holdco within current stockholders of Holdco. No such amendment was required related to the Notes as a result of such transfer.
The Second Amended and Restated Revolving Credit Agreement, as amended, contains various affirmative and negative covenants and restrictions, which among other things, require the Company to meet certain financial tests (including certain leverage and cash flow ratios), and limits the Company and its subsidiaries’ ability to incur or guarantee additional indebtedness, make certain capital expenditures, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, sell assets, engage in transactions with affiliates and effect a consolidation or merger. The agreement contains a cross-default provision wherein if the Company is in default on any other credit facilities, default on this facility is automatic. At December 26, 2010, the Company was in compliance with all specified financial and other covenants under the Second Amended and Restated Revolving Credit Agreement, as amended.
Senior Unsecured Credit Facility. In connection with the offering of the Notes, the Company entered into a Second Amended and Restated Credit Agreement, by and among the Company, Holdco, the lenders party thereto and Credit Suisse, Cayman Islands Branch (the “Senior Unsecured Credit Facility”), pursuant to which the principal balance of the existing unsecured loan owing by the Company under the existing senior unsecured credit facility, as amended, was reduced from $65,000 to $25,000 through (i) the assumption by Holdco of $25,000 of such unsecured debt and (ii) the exchange by a lender under the Senior Unsecured Credit Facility, as amended, of $15,000 of such unsecured debt for $4,583 aggregate principal amount of Notes (which were issued for $4,125), resulting in a gain on extinguishment of debt of $10,875. Deferred debt fees of $161 were recorded related to the Second Amended and Restated Credit Agreement. Interest accrues at an annual rate of 16.5% and is payable quarterly, provided that (i) such interest is payable in kind for the first four quarters following the Closing Date and (ii) thereafter will be payable in a combination of cash and in kind. The term of the Company’s credit facility was extended to July 1, 2013 and certain covenants were modified. Certain lenders to the Senior Unsecured Credit Facility are owners of Holdco, and as a result, the Senior Unsecured Credit Facility is held by related parties to the Company.
The Senior Unsecured Credit Facility, as amended, contains various affirmative and negative covenants which, among other things, require the Company to meet certain financial tests (including certain leverage and interest coverage ratios) and limits the Company’s and its subsidiaries’ ability to incur or guarantee additional indebtedness, grant certain liens, make certain restricted payments, make capital expenditures, engage in transactions with affiliates, make certain investments, sell its assets, make acquisitions, effect a consolidation or merger and amend or modify instruments governing certain indebtedness (including relating to the Company’s Notes and the Senior Secured Revolving Credit Facilities). At December 26, 2010, the Company was in compliance with all specified financial and other covenants under the Senior Unsecured Credit Facility, as amended.
Mortgage. In 2005, concurrent with an acquisition, we assumed a $816 mortgage secured by the building and improvements of one of the restaurants acquired in the transaction. The mortgage carries a fixed annual interest rate of 9.28% and requires equal monthly payments of principal and interest through April 2015. As of December 26, 2010, the principal amount outstanding on the mortgage was $440.
Interest rates for the Company’s long-term debt are shown in the following table:
The maturity of long-term debt for the fiscal years succeeding December 26, 2010, is as follows:
7. Capitalization
Common Stock
The Company is authorized to issue 1,000 shares of common stock. At December 26, 2010 and December 27, 2009 there were 1,000 shares of common stock issued and outstanding.
Stock Option Plans
In December 2006, the Board of Directors of Holdco adopted a Non-Qualified Stock Option Plan (the “2006 Plan”). The 2006 Plan reserved 100,000 shares of Holdco’s non-voting common stock for issuance upon exercise of stock options granted under the 2006 Plan. Options vest 20% per year according to the schedule specified in each option agreement. Accelerated vesting of all outstanding options is triggered upon a change of control of Holdco, as defined in the 2006 Plan. This was not triggered as a result of the Share Purchase. The options have a life of 10 years, and can only be exercised upon the earliest of the following dates: (i) the 10 year anniversary of the effective date; (ii) the date of a change in control, as defined in the 2006 Plan; or (iii) date of employment termination, subject to certain exclusions.
When stock-based compensation is awarded, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the consolidated statement of operations over the period during which an employee is required to provide service in exchange for the award - the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee stock options is estimated using the Black-Scholes option pricing model. The Company utilizes comparable companies to estimate its price volatility and the simplified method to calculate option expected time to exercise. No options were granted during 2009 or 2010.
The following table summarizes the stock option activity:
The Company recorded $65, $49 and $260 of stock-based compensation for the Successor Six Months ended December 26, 2010, the Predecessor Six Months ended June 27, 2010 and the Predecessor Year ended December 27, 2009. The Company recorded a net stock-based compensation credit of $28 during the Successor Period November 14, 2008 through December 28, 2008. The credit resulted from the reversal of compensation cost for unvested shares related to a termination of one of our executives during that period. The Company recorded $406 of stock-based compensation expense for the Predecessor Period from December 31, 2007 through November 13, 2008. Stock-based compensation expense is included in general and administrative expense on the consolidated statements of operations.
As of December 26, 2010, $105 of total unrecognized compensation costs related to non-vested stock-based awards is expected to be recognized through fiscal year 2012, and the weighted average remaining vesting period of those awards is approximately one year. At December 26, 2010, the aggregate intrinsic value of exercisable options was $0.
8. Income Taxes
Significant components of the income tax provision (benefit) consist of the following:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows:
Immediately prior to the Share Purchase, deferred tax assets and liabilities were $68,675 and $38,582, respectively, offset by a valuation allowance of $56,152.
The reconciliation of income tax at the U.S. federal statutory tax rates to income tax expense is as follows:
Net deferred tax assets are reduced by a valuation allowance if, based on all the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. In assessing the adequacy of the valuation allowance, the Company considers various factors including reversal of deferred tax liabilities, future taxable income, and potential tax planning strategies. Accordingly, the Company has recorded a valuation allowance since the Company currently believes the deferred tax assets will not be realized. For the years ended December 26, 2010 and December 27, 2009, the Company recorded a valuation allowance of $66,779 and $50,933, respectively.
Any changes regarding the realization of the acquired deferred tax assets which occur within the measurement period resulting from new information regarding facts and circumstances that existed at the date of the Exchange, then, to the extent there is a reduction in the valuation allowance, the benefit will reduce goodwill. All other reductions to the valuation allowance will benefit tax expense.
The Company files U.S. and State consolidated tax returns with Holdco. The Company uses the separate return method for allocating taxes to its separate financial statements. One exception to the separate return method used in the current year was the reduction of tax attributes as a result of the Exchange transaction that took place on November 13, 2008 at Holdco. Consolidated tax attributes belonging to the Company have been reduced to reflect their utilization under Internal Revenue Code (“IRC”) Section 108. Based upon the Company’s preliminary analysis of IRC Section 108, the net operating losses were reduced to zero at December 28, 2008. Upon completion of the final analysis during 2009, the Company concluded that at December 28, 2008, there were $23,578 of federal net operating loss carry-forward and $68,862 of state net operating loss carry-forward, respectively. As the Company had recorded a full valuation allowance on these items, this resulted in no impact on the consolidated statement of operations in either period.
At December 26, 2010 and December 27, 2009, the Company had a federal net operating loss carry-forward of $49,014 and $27,211 which will begin to expire in 2028 and a federal business tax credit carry-forward of $7,448 and $4,133, respectively, which will begin to expire in 2013. In addition, at December 26, 2010 and December 27, 2009, the Company had a state net operating loss carry-forward of $100,130 and $79,019 which will begin to expire in 2012 and a state tax credit carry-forward of $71 for both years, which will begin to expire in 2013. The utilization of the net operating loss carry-forward is subject to limitations under the Internal Revenue Code Section 382 and similar state provisions.
9. Fair Value Measurement
Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:
Level 1: Quoted prices are available in active markets for identical assets or liabilities.
Level 2: Inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable.
Level 3: Unobservable inputs that are supported by little or no market activity, therefore requiring an entity to develop its own assumptions that market participants would use in pricing.
As of December 26, 2010, the Company had no assets or liabilities that were measured using Level 1 or Level 2 inputs on a recurring or non-recurring basis. Using Level 3 inputs, as described in Note 3, intangible assets and certain long-lived assets were written down to fair value as a result of impairment charges of $1,100 and $1,007, respectively during the fourth quarter of Successor 2010.
In conjunction with the Share Purchase, the Company completed a valuation and recorded adjustments to fair value for the following assets and liabilities by level at June 28, 2010:
10. Commitments and Contingencies
Leases
The Company leases restaurant and office facilities that have terms with expirations in 2011 through 2028. Most of the restaurant facilities have renewal clauses exercisable at the option of the Company with rent escalation clauses stipulating specific rent increases, some of which are based upon the Consumer Price Index. Certain of these leases require the payment of contingent rentals based on a percentage of gross revenues, as defined. Additionally, the Company leases several properties that are not being operated by the Company. Several of those properties are subleased.
The Company leases certain leasehold improvements and equipment under agreements that are classified as capital leases. The cost of assets under capital leases is included in the balance sheets as property and equipment and was $927 and $1,464 at December 26, 2010 and December 27, 2009, respectively. Accumulated amortization of these assets was $162 and $354 at December 26, 2010 and December 27, 2009, respectively. Amortization of assets under capital leases is included in depreciation expense. The Company recorded no new capital assets at December 26, 2010 and the amount of capital assets placed in service was $261 at December 27, 2009, respectively.
The minimum annual lease commitment and subtenant income of the Company for the years succeeding December 26, 2010 is approximately as follows:
The Company is contingently liable for leases on sold or assigned premises for $1,527 as of December 26, 2010.
Some of the leases provide for additional rentals based on a percentage of revenues. The following table summarizes the rental expense, percentage rent expense above minimum rent and net sublease income:
Purchase Obligations
In December 2007, the Company entered into an agreement with a certain vendor to purchase a minimum volume of product from December 1, 2007 through December 31, 2015, to be extended for any shortfall in purchases until such volume is met. The contract is based upon expiration date or volume, which ever occurs last. As of December 26, 2010, $3,141 had been purchased, representing 24% of the total contractual volume to be purchased throughout the life of the contract.
Litigation
The Company is periodically a defendant in cases involving personal injury, employment-related claims, third-party Americans with Disabilities Act accessibility claims and other matters that arise in the normal course of business. While any pending or threatened litigation has an element of uncertainty, the Company believes that the outcome of these lawsuits or claims, individually or combined, will not materially adversely affect the consolidated financial position, results of operations or cash flows of the Company.
Self-Insurance
The Company is self-insured for most casualty losses up to certain stop-loss limits. The Company has accounted for its liabilities for these casualty losses and claims, including both reported and incurred but not reported claims, based on information provided by independent actuaries. Management believes that it has recorded reserves for casualty losses at a level that has substantially mitigated the potential negative impact of adverse developments and/or volatility. Management believes that its calculation of casualty loss liabilities would not change materially under different conditions and/or different methods. However, due to the inherent volatility of actuarially determined casualty claims, it is reasonably possible that the Company could experience changes in estimated casualty losses, which could be material to both quarterly and annual net income. Amounts estimated to be ultimately payable with respect to existing claims and an estimate for claims incurred but not reported under these programs have been accrued and are included in the accompanying consolidated balance sheets. Estimated liabilities related to the self-insured casualty losses were $13,212 and $14,790 as of December 26, 2010 and December 27, 2009, respectively.
The Company is also required to maintain collateral securing future payment under the self-insured retention insurance programs. As of December 26, 2010 and December 27, 2009, this collateral consisted of stand-by letters of credit of $13,047 and $13,902, respectively.
11. Related Party Transactions
As discussed in Note 6, as a result of the Exchange, the existing lenders to the Senior Unsecured Credit Facility became owners of Holdco. As a result, the Senior Unsecured Credit Facility is held by related parties to the Company. Subsequent to the Share Purchase, this continues to be the case.
Certain funds managed by Farallon are indirect stockholders of Holdco. Certain funds managed by Farallon hold an indirect interest in a shopping center from which the Company leases property for the operation of an Acapulco restaurant. Total payments in connection with the lease in 2010 and 2009 were $329 and $190, of which approximately $82 and $44 is attributable to the indirect interest of funds managed by Farallon in the shopping center. Additionally, on July 7, 2009, certain funds managed by Farallon purchased $13,000 aggregate principal amounts of the Notes.
On February 27, 2009, the Company entered into a contract for consulting services with an entity which has a material relationship with one of Holdco’s stockholders. This consulting contract had a monthly fee of $190 with an initial term from March 1, 2009 to March 31, 2009 and three optional one month renewal terms through June 30, 2009, each of which was exercised. The Company extended the contract for one additional month through July 31, 2009 at the same terms. Fees of $950 were recorded in general and administrative expense during 2009 and reflected as non-cash consulting expense on the consolidated statement of cash flows. The fees were paid in shares of Holdco common stock, resulting in an increase in additional paid in capital for the Company. The shares were issued on September 28, 2009.
The Company periodically makes payments to (subject to restricted payment covenants under the indenture governing the Notes), from and on behalf of Holdco. No related party payables or receivables were outstanding at December 26, 2010 or December 27, 2009.
12. Employee Benefit Plan
The Company is the sponsor of a defined contribution plan (401(k) plan) for qualified Company employees, as defined. Participants may contribute from 1% to 50% of pre-tax compensation, subject to certain limitations. The plan contains a provision that provides that the Company may make discretionary contributions. The Company made no contributions for the Success Six Months ended December 26, 2010 and the Predecessor Six Months ended June 27, 2010. The Company has recorded contribution expense of $144, $26 and $207 during the Predecessor Year ended December 27, 2009, the 6 week Predecessor Period November 14, 2008 through December 28, 2008 and the 46 week Predecessor Period from December 31, 2007 through November 13, 2008, respectively.
13. Condensed Consolidating Financial Statements
Pursuant to the notes accompanying Rule 3-10(f) of Regulation S-X, we have not provided the condensed consolidated financial statements of our subsidiaries guaranteeing the Notes as (i) we have no independent assets or operations, (ii) the guarantees are full and unconditional, joint and several and (iii) we have no subsidiaries who are not subsidiary guarantors of our senior notes.
14. Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the years ended December 26, 2010 and December 27, 2009:
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act.) Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the record period covered by this report, our disclosure controls and procedures are effective.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). Under the supervision and with the participation of our management, including our principal executive and financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management determined that our internal control over financial reporting is effective as of the end of our 2010 fiscal year.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors, Executive Officers and Key Employees
The following table sets forth certain information regarding the current Board of Directors, executive officers and other key employees of our Company:
*
Member of our audit committee.
+
Member of our compensation committee.
Richard E. Rivera has been our President, Chief Executive Officer and Chairman of the Board since April 2009. Mr. Rivera will be retiring effective April 1, 2011. Mr. Rivera is an owner of Rubicon Enterprises LLC, a Sarasota, FL-based restaurant management and investment company with ownership in four T.G.I Friday’s and six Marlow’s Taverns, for which he has served as President and CEO since 2004. From 2002 to 2004, Mr. Rivera was Vice Chairman, President and Chief Operating Officer responsible for the day-to-day operations at Darden Restaurants, Inc., the parent company which operates casual dining concepts including Red Lobster, Olive Garden, Bahama Breeze and Seasons 52. From 1997 to 2002, Mr. Rivera was President of the Red Lobster division at Darden Restaurants, Inc. Prior to his employment with Darden Restaurants, Inc., Mr. Rivera served at various times as an executive officer of the following restaurant concepts: Chart House Enterprises, RARE Hospitality International (which operates Long Horn Steakhouse and The Capital Grille among other restaurant concepts), Applebee’s, TGI Friday’s, Del Taco, El Chico, and Steak & Ale Restaurants of America. Mr. Rivera is also active on behalf of the restaurant industry having served as Chairman of the National Restaurant Association in 2007-2008 and as a board member since 1993. Mr. Rivera has served as a director of Winn-Dixie Stores, Inc. since 2006. Mr. Rivera was selected to serve as a member of our Board of Directors as a result of his role as our President and Chief Executive Officer, for his ability to provide key information about the Company during Board meetings.
Richard P. Dutkiewicz has been our Executive Vice President and Chief Financial Officer since April 2010. From 2003 to 2010, Mr. Dutkiewicz, served as Chief Financial Officer of Einstein Noah Restaurant Group (“ENRG”), the largest operator of bagel bakeries in the U.S. Prior to ENRG, Mr. Dutkiewicz had been recruited to take over the CFO role with a troubled publicly traded electronics manufacture, Vari-L Company, where he overhauled the finance department, including personnel and systems, leading the way to a successful sale and transition to Sirenza Microdevices in 2003. In the six years preceding Vari-L, Mr. Dutkiewicz was CFO for Coleman Natural Products, a leading supplier of natural beef in the U.S.. Mr. Dutkiewicz is a graduate of Loyola University where he earned a B.B.A. in Accounting and worked in public accounting as an audit manager with KPMG until 1984. He has more than 30 years of experience spanning both public and privately held organizations for a variety of restaurant, technology, and manufacturing organizations.
Carlos Angulo has been the President of Real Mex Foods, Inc. since January 2005. Mr. Angulo joined us in 2000 as Vice President of Real Mex Foods, Inc. Previously, Mr. Angulo worked for Smart & Final for 18 years in a variety of positions from Store Manager to Vice President of Northern California Distribution. Mr. Angulo received a Bachelor of Science degree from the University of Southern California.
Roberto (Pepe) Lopez has been our Executive Chef since 1992. In addition, in 1994, Mr. Lopez was promoted to Vice President, Research and Development and in 2004, he was promoted to Senior Vice President, Research and Development. Previously, Mr. Lopez served as Director of Product Development. His prior experience includes serving as Executive Chef at Cano’s and Las Brisas, and as Manager at El Torito. Between 1988 and 1992, he was Director of Product Development for Visions Restaurants, Inc.
Raymond Garcia has been our Senior Vice President of Operations since July 2010. Prior to that time, Mr. Garcia served as the Senior Vice President of Operations for El Torito and Acapulco since June 2005. Previously, Mr. Garcia served from 1991 in a variety of positions at Acapulco rising from Assistant Manager to Vice President of Operations. Before joining Acapulco, Mr. Garcia held positions of General Manager and Regional Manager at El Torito.
Jeff Campbell became a Director of the Company in July 2009. Mr. Campbell is currently the Brinker Executive in Residence at San Diego State’s School of Hospitality and Tourism. He is also Chairman of “The Chairmen’s Roundtable”, a San Diego based organization composed of former CEO’s and entrepreneurs. Mr. Campbell is the former CEO of Burger King and ex-Chairman of the Pillsbury Restaurant Group. He also served as Senior Vice President for Brand Development for Pepsi-Cola as well as CEO of the Johnny Rockets and Catalina Restaurant Groups. Mr. Campbell was selected to serve as a member of our Board of Directors because of his extensive background in restaurant and related industries, as noted above.
Anthony DiLucente was appointed as a Director of the Company in October 2010. Mr. DiLucente has served as Group CFO of Sun Capital Partners, a private investment firm, since April 2010. Mr. DiLucente was selected to serve as a member of our Board of Directors by Sun Capital Partners, in accordance with Sun Capital Partners’ rights as a shareholder.
Craig S. Miller became a Director of the Company in July 2009. Mr. Miller is a principal in Miller Partners Restaurant Solutions (MPRS). MPRS, thru an affiliate, owns and operates Miller’s Field, a sports restaurant located in San Diego, California. Mr. Miller served as President, CEO and Chairman of Ruth’s Hospitality Group from 2004 to 2008. He also served as President and CEO of Furr’s Hospitality from 2001 to 2002 and as President, Director and CEO of Uno Restaurants from 1983 to 2001. Mr. Miller serves as a director of the National Restaurant Association and served as its Chairman from 2005 to 2006. Mr. Miller served as a director of Tim Hortons Inc. from 2007 to 2010. Mr. Miller was selected to serve as a member of our Board of Directors because of his extensive background in the restaurant industry.
Anthony Polazzi was reappointed as a Director of the Company in October 2009. Mr. Polazzi previously served as a Director of the Company from November 2008 until July 2009. Mr. Polazzi has served as a principal of Sun Capital Partners, a private investment firm, since October 2003. Mr. Polazzi was selected to serve as a member of our Board of Directors by Sun Capital Partners, in accordance with Sun Capital Partners’ rights as a shareholder.
R. Lynn Skillen was appointed as a Director of the Company in June 2010. Mr. Skillen serves as Managing Director of Sun Capital Partners, a private investment firm, and has 30 years experience in finance and operations. Mr. Skillen was selected to serve as a member of our Board of Directors by Sun Capital Partners, in accordance with Sun Capital Partners’ rights as a shareholder.
Clarence E. Terry was reappointed as a Director of the Company in April 2010. Mr. Terry previously served as a Director of the Company from August 2006 until November 2008. Mr. Terry serves as Senior Managing Director of Sun Capital Partners, a private investment firm, and he has more than 30 years of operating experience. Mr. Terry was selected to serve as a member of our Board of Directors by Sun Capital Partners, in accordance with Sun Capital Partners’ rights as a shareholder.
Audit Committee Financial Expert
The non-employee directors currently act as the Company’s Audit Committee. The Board of Directors has determined Craig S. Miller qualifies as an “Audit Committee Financial Expert” as this term has been defined under the rules and restrictions of the SEC and has designated him as such.
Code of Ethics
On February 7, 2007, the Company adopted a Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, and all persons performing similar functions.
COMPENSATION DISCUSSION AND ANALYSIS
Compensation Philosophy and Overall Objectives
We believe that the compensation paid to our Chief Executive Officer, our Chief Financial Officer and our three other most highly compensated executive officers, whom we collectively refer to as our named executive officers (“Named Executive Officers”), should be closely aligned with our performance as well as that of each Named Executive Officer’s individual performance on both a short- and long-term basis, and that such compensation should be sufficient to attract and retain highly qualified leaders who can create significant value for our organization. Our compensation programs are designed to provide Named Executive Officers meaningful incentives for superior performance. Performance is evaluated using both financial and non-financial objectives that we believe contribute to our long-term success. Among these objectives are financial strength, customer service, operational excellence, employee commitment and regulatory integrity.
How is Compensation Determined
Due to the unique nature of each Named Executive Officer’s duties, our criteria for assessing executive performance and determining compensation in any year is inherently subjective and is not based upon specific formulas or weighting of factors. We use companies in similar industries as benchmarks when initially establishing Named Executive Officers’ compensation. We also review peer company data when making annual base salary and incentive recommendations.
Discussion of Specific Compensation Elements
The following describes the components of our executive compensation program and the basis upon which recommendations and determinations were made. Each compensation element is designed to fit one or more components of the Company’s compensation objectives, that when taken as a whole, is competitive with the external market.
Base Salary
We determine base salaries for all of our Named Executive Officers by reviewing company and individual performance, the value each Named Executive Officer brings to us and general labor market conditions. While base salary provides a base level of compensation intended to be competitive with the external market, the base salary for each Named Executive Officer is determined on a subjective basis after consideration of these factors and is not based on target percentiles or other formal criteria. The base salaries of Named Executive Officers are reviewed on an annual basis, and any annual increase is the result of an evaluation of the Company and of the individual Named Executive Officer’s performance for the period. An increase or decrease in base pay may also result from a promotion or other significant change in a Named Executive Officer’s responsibilities during the year.
Annual Bonus Plan
We maintain an annual bonus plan that provides for annual incentive awards to be made to our senior management (including the Named Executive Officers) upon our Company’s attainment of certain financial targets. During fiscal 2009, awards were be based upon the attainment of pre-set annual EBITDA and cash-flow targets (as defined in the annual bonus plan). During fiscal 2010, the plan was amended to provide that awards would be based upon the attainment of pre-set annual Consolidated Cash Flow and pre-set Free Cash Flow targets (as defined in the annual bonus plan), at which point the EBITDA target was removed. The annual bonus plan is designed to reward our executives for achievement of annual financial performance of the Company. The amount of the annual award to each executive is based upon a percentage of the executive’s base salary. Awards are normally paid in cash in a lump sum following the completion of our Company’s audit for each plan year. To be eligible for a full share of the bonus, executives must be employed on the first day of the fiscal year, provided that under the plan we may adjust awards based on individual performance factors or special circumstances affecting our Company.
Stock Option Plan
We have a Non-Qualified Stock Option Plan (the “2006 Plan”) which was adopted by our Board of Directors in December 2006. The Stock Option Plan is intended to offer long-term incentives and to reward our executives for superior performance. We also regard the 2006 Plan as an important retention tool. 1,000 shares of our parent’s non-voting common stock are reserved for issuance upon exercise of stock options granted under the 2006 Plan. In January 2007, the Board of Directors issued stock options to certain members of management. These options vest 20% per year beginning August 16, 2007, with full vesting on August 16, 2011. Accelerated vesting of all outstanding options is triggered upon a change of control of the Company. The options have a life of 10 years, and can only be exercised upon the earliest of the following dates: (i) the 10 year anniversary of the effective date; (ii) the date of a change in control, as defined in the 2006 Plan; or (iii) date of employment termination, subject to certain exclusions. Shares above have been adjusted for the 100:1 reverse stock split effected in conjunction with the Exchange.
Employment Agreements
Richard E. Rivera
We entered into an executive employment agreement with Richard E. Rivera, our Chief Executive Officer, President and Chairman, effective April 6, 2009. Under the terms of the employment agreement, Mr. Rivera is entitled to a base salary of $500,000 per annum, or such greater amount as the Board of Directors shall determine, and customary executive benefits. Contingent upon our meeting certain financial goals set annually in accordance with our bonus plan, Mr. Rivera is eligible to receive a bonus of up to 150% of his base salary.
Unless sooner terminated in accordance with its terms, the employment agreement with Mr. Rivera expires on April 6, 2011, subject to automatic 1 year renewals unless either party provides notice of its intent not to renew 90 days prior to the renewal date. Mr. Rivera provided such notice during 2010 upon announcement of his retirement at the end of his current contract.
Richard P. Dutkiewicz
In connection with Mr. Dutkiewicz’s employment as Executive Vice President and CFO, Mr. Dutkiewicz signed an offer letter with the Company dated March 17, 2010. The offer letter provides for an initial annual base salary of $325,000. Mr. Dutkiewicz participates in the Company’s bonus program that entitles him to an annual performance bonus up to 50% of his base salary. Mr. Dutkiewicz received a signing bonus of $50,000 and received reimbursements for his relocation of $75,000. In addition, Mr. Dutkiewicz will receive an option grant with a targeted payout of $1,500,000. In the event Mr. Dutkiewicz is terminated without cause, he will be entitled to receive twelve months of his base salary and payment of premiums for COBRA coverage for a twelve-month period.
Steven Tanner
Mr. Steven Tanner served as our Chief Financial Officer until his departure from the Company in February 2010. We entered into an executive employment agreement with Mr. Tanner effective February 28, 2008. Under the employment agreement, Mr. Tanner was entitled to a base salary of $296,587 per annum, or such greater amount as determined by the Board of Directors, and customary executive benefits. Contingent upon our meeting certain financial goals set annually in accordance with our bonus plan, Mr. Tanner was eligible to receive a bonus of up to 50% of his base salary. In addition, the employment agreement imposed non-competition, non-solicitation and confidentiality obligations on Mr. Tanner.
In connection with Mr. Tanner’s departure from the Company and in addition to the payments provided by the employment agreement, the Company entered into a Separation Agreement and General Release with Mr. Tanner dated December 17, 2009 with an employment termination date of February 12, 2010, pursuant to which the Company agreed (i) to pay Mr. Tanner his annual salary of $296,587 for one year following his termination date in installments to be paid on the dates that he normally received his salary and (ii) to pay the cost of Mr. Tanner’s health insurance premiums for one year if he elects to continue his health insurance through COBRA.
Compensation Policies and Practices As They Relate to the Company’s Risk Management
The Company believes that its compensation policies and practices for all employees, including executive officers, do not create risks that are reasonably likely to have a material adverse effect on the Company.
Compensation Committee Interlocks and Insider Participation
All compensation decisions are approved by the Compensation Committee, which is made up of the non-employee directors on an ad hoc basis. None of the Company’s executive officers currently serve, or in the past have served, as a director or member of any compensation committee of another entity that has one or more executive officers serving on the Company’s Board of Directors.
Compensation Committee Report
The non-employee directors of the Board discussed the Compensation Discussion and Analysis with management, and recommended its inclusion in the Company’s Form 10-K. The non-employee directors at the time the Company’s 10-K for the fiscal year ended December 26, 2010 was filed were:
Jeff Campbell
Anthony DiLucente
Craig S. Miller
Anthony Polazzi
R. Lynn Skillen
Clarence E. Terry
Summary Compensation Table
The following table sets forth certain information with respect to annual and long-term compensation for services in all capacities for fiscal years 2010, 2009 and 2008 paid to our Named Executive Officers:
(1)
The Company does not have a Non-Equity Incentive Plan.
(2)
The Company does not have a pension plan and does not pay above market or preferential earnings on deferred compensation plans.
(3)
All Other Compensation includes medical and dental reimbursements, automobile expenses, employer matching contribution of a nonqualified deferred compensation plan, and relocation reimbursements.
(4)
Amounts for Mr. Rivera and Mr. Dutkiewicz include reimbursements related to their relocation in accordance with their employment agreements.
(5)
Mr. Rivera joined the Company as an executive officer in April 2009.
(6)
Mr. Dutkiewicz joined the Company as an executive officer in April 2010.
(7)
Mr. Tanner departed from his position as an executive officer of the Company on February 12, 2010.
Option Grants in Fiscal Year Ended December 26, 2010
None.
Outstanding Equity Awards at Year End
The following table provides information regarding outstanding stock options held by our Named Executive Officers at December 26, 2010.
Options Exercised and Stock Vested
None of the Named Executive Officers exercised any stock options during the fiscal year ended December 26, 2010.
Pension Benefits
None.
Nonqualified Deferred Compensation
The following table sets forth certain information with respect to our nonqualified deferred compensation plan for fiscal year 2010 for our Named Executive Officers:
Potential Payments Upon Termination or Change in Control
We have arrangements with certain of our Named Executive Officers that may provide them with compensation following termination of employment. These arrangements are discussed above under “Employment Agreements”.
Compensation of Directors
Two of our directors, Jeff Campbell and Craig S. Miller, are entitled to $16,000 per year, payable in installments of $4,000 per quarter in arrears, plus an annual option grant valued at $35,000 per year. None of our other directors are compensated for serving as a director of the Company. All directors are entitled to reimbursement of their reasonable out-of-pocket expenses in connection with their travel to and attendance at meetings of the Board of Directors or committees thereof.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Equity Compensation Plan Information
As of December 26, 2010, our parent’s common stock authorized for issuance under its Non-Qualified Stock Option Plan included 1,000 shares of non-voting common stock, of which 194 options to purchase such shares are outstanding, with a weighted average exercise price of $8,150 per share.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information with respect to the beneficial ownership of outstanding common stock and preferred stock of Real Mex Restaurants, Inc. as of February 20, 2011:
•
Each person (or group of affiliated persons) who is known by us to beneficially own 5% or more of Real Mex Restaurants, Inc.’s common and preferred stock;
•
Each of our Named Executive Officers;
•
Each of our Directors; and
•
All of our Directors and executive officers as a group.
To our knowledge, each of the holders of shares listed below has sole voting and investment power as to the shares owned unless otherwise noted. Beneficial ownership of the securities listed in the table has been determined in accordance with the applicable rules and regulations promulgated under the Exchange Act.
Number and Percent of Shares of
Stock of
Real Mex Restaurants, Inc.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Certain funds managed by Farallon are indirect stockholders of Holdco. Certain funds managed by Farallon hold an indirect interest in a shopping center from which the Company leases property for the operation of an Acapulco restaurant. Total payments in connection with the lease in 2010 were $0.3 million, of which less than $0.1 million is attributable to the indirect interest of funds managed by Farallon in the shopping center.
Director Independence
We are not listed on any national securities exchange and therefore are not subject to any listing standards for director independence. The Company has determined that 2 of our 7 directors, Jeff Campbell and Craig S. Miller, are independent under the existing standards of the New York Stock Exchange and the SEC. Because our other non-employee directors are affiliated with stockholders of our parent company, they are not considered independent.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Principal Accounting Fees and Services
The Board of Directors approved the engagement of Grant Thornton LLP (“Grant”) to continue as our independent auditors to conduct the audit of our books and records for the fiscal year ending December 26, 2010, including required quarterly reviews. The following table shows the aggregate fees for professional services rendered during the last two fiscal years:
Audit Fees represent the aggregate fees billed or estimated to be billed to us for professional services rendered for the audit of our annual financial statements, review of financial statements included in our Form 10-Qs and services normally provided by our accountants in connection with statutory and regulatory filings or engagements.
Audit-Related Fees represent the aggregate fees billed to us or estimated to be billed to us for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees” above.
Tax Fees represent the aggregate fees billed to us or estimated to be billed to us for professional services rendered for tax compliance, tax advice and tax planning.
All Other Fees represent the aggregate fees billed to us or estimated to be billed to us for products or services provided to us, other than the services reported in the above categories.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of the Independent Auditor
The Audit Committee is responsible for appointing, setting compensation for and overseeing the work of the independent auditor. The Audit Committee has established a policy requiring pre-approval of all audit and permissible non-audit services provided by the independent auditor. The Audit Committee considers whether such services are consistent with the rules of the SEC on auditor independence as well as whether the independent auditor is best positioned to provide the most effective and efficient service, for reasons such as familiarity with our Company’s business, people, culture, accounting systems, risk profile and other factors and input from our management. The Audit Committee may delegate to one or more of its members the pre-approval of audit and permissible non-audit services provided that those members report any pre-approvals to the full committee. Pursuant to this authority, the Audit Committee has previously delegated to its Chair the authority to address any requests for pre-approval of services between Audit Committee meetings provided that the amount of fees for any particular services requested does not exceed $10,000, and required the Chair to report any pre-approval decisions to the Audit Committee at its next scheduled meeting. The policy prohibits the Audit Committee from delegating to management the Audit Committee’s responsibility to pre-approve permitted services of the independent auditor. During fiscal year 2010 all of the services related to the audit or other fees described above were pre- approved by the Audit Committee and none were provided pursuant to any waiver of the pre-approval requirement.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) FINANCIAL STATEMENTS
The Consolidated Financial Statements are filed as part of this report under Item 8 Financial Statements and Supplementary Data.
(2) FINANCIAL STATEMENT SCHEDULE
The financial statement schedules are not required under the related instructions, are inapplicable or are included in our Notes to Consolidated Financial Statements, and therefore have been omitted.
(3) EXHIBITS
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX