ITEM 1. BUSINESS
GENERAL
The Company, Pancho's Mexican Buffet, Inc. and subsidiaries, is principally engaged in the operation and development of the Pancho's Mexican Buffet restaurant chain, serving Mexican food cafeteria style. However, Pancho's is more than a cafeteria because it features "all-you-can-eat" at a fixed price. Along the cafeteria line, servers fill a piping hot platter with a diner's choices from more than 20 items of freshly prepared Mexican food. Pancho's becomes a full-service restaurant when a diner is at the table. A waitress or waiter brings refills, or other food a diner may request from the buffet, at no extra charge. For service, a diner simply raises the small flag on the table. The Company currently operates 48 restaurants located in the states of Texas (39), Louisiana (4), Arizona (2), Oklahoma (2) and New Mexico (1).
In the quarter ended June 1998, the Company impaired assets at 22 locations based on its continuing evaluation of recoverability of long-lived store assets. In the same quarter, the Company adopted a restructuring plan to close 9 of those restaurants. Under the plan, in July and August 1998, the Company closed restaurants in Phoenix; Chalmette and Shreveport, Louisiana; Albuquerque; Oklahoma City; San Antonio, Galveston and Amarillo, Texas.
No new restaurants were opened in fiscal 1998, and none are currently planned, as management intends to focus on improving sales and profitability and reducing debt.
Jesse Arrambide, a Company founder, developed and opened the first Pancho's Mexican Buffet in El Paso, Texas in 1958. The Company was organized under the laws of the State of Delaware in December 1968 to succeed to the business operated by predecessor corporations which were merged into the Company on January 23, 1969. The Company's principal offices are located at 3500 Noble Avenue, Fort Worth, Texas 76111 (telephone number [817] 831-0081).
BUSINESS DEVELOPMENT
The Company has commissioned outside consultants to review the Pancho's concept and assist in developing a more modern prototype for future development and remodeling existing units. The goal is to refine food offerings, service systems and physical facilities to achieve increased customer count and require less labor than existing operations. The Company will conduct extensive testing and customer research while developing the new Pancho's.
The Company's long-term strategy is to expand Pancho's Mexican Buffet within the Company's existing five-state market, and possibly other contiguous states. The Company intends to concentrate on the development of existing markets to reduce its supervision expense as a percentage of sales and to improve the Company's competitive position, marketing potential and profitability. There can be no assurance that the Company will be able to achieve these objectives. The Company has no plans for franchising; however, one Pancho's is currently being operated under a license agreement.
The most important factors in selecting new locations are the demographics of the immediate market area within a radius of three to four miles and the occupancy cost of the proposed restaurant. The Company's experience indicates that it is relatively immaterial whether the location is free-standing or in a mall or shopping center. Senior management inspects each restaurant site prior to its acquisition. The Company has developed prototypes of both a free-standing building design and a shopping center space design to enhance site flexibility. The current restaurant prototypes are undergoing review and modification as the Company seeks to improve sales and profitability. In its restaurants, the Company maintains distinctive styling and colorful decor using authentic artifacts in a Mexican motif.
The current Pancho's concept is designed to combine the serving speed and economy of cafeteria-style service within an environment typical of table service restaurants. The customer selects and is served food and beverage items from the serving line. When the patron is seated a uniformed employee serves chips, hot sauce, sopaipillas (Mexican bread), beverage refills and more food on request for the "all-you-can-eat" patrons. This
is a unique variation of the traditional cafeteria concept, providing full table service after a customer has completed selection from the service line. During fiscal 1993, the Company added self-service soup/salad bars and dessert bars to provide greater food variety and value.
RESTAURANT OPERATIONS
The Company's restaurants serve continuously from 11:00 a.m. to 9:00 p.m. seven days a week. The restaurants are family-oriented and are designed to match serving-line service speed (three to three and one half patrons per minute) to seating capacity for optimum utilization of space and return on investment. Older Pancho's average approximately 7,300 square feet and seat 180 to 200. New restaurants, and higher volume restaurants in which seating capacity has been expanded, average approximately 9,000 square feet and seat 240 to 300.
A typical new restaurant in a strip shopping center costs about $900,000 to $1,000,000 to develop, including equipment and leasehold improvements. Free-standing units cost from $1.5 million to $1.9 million for land, building and equipment. These development costs are based on the current prototypes. The Company has not built any new restaurants since 1995. Inflation and changes to the Pancho's restaurant format may affect future development costs.
In addition to the "all-you-can-eat" buffet, the menu includes competitively-priced limited-selection plates: the Super Combo value meal, lunch specials, fajitas, a taco salad, soup/salad bar, and a child's plate. Children five years of age and under are served free. Senior citizens who belong to Pancho's Seniors Club are given a 20% discount on their personal purchases. Beverages are priced separately. All menu items include the soup/salad bar and dessert bar. The Company is considering a variety of alternatives to its current price structure.
More than 20 items of Mexican food are served, including tamales, refried beans, Mexican rice, flautas, five kinds of enchiladas, red chili stew, green chili stew, chili rellenos, chili con queso, three kinds of sauces, tacos, chalupas, pico de gallo, assorted relishes, chips, hot sauce and sopaipillas. Beverages are also available. Alcoholic beverages are served in 28 restaurants and accounted for 0.9% of the Company's sales for the year ended September 30, 1998. Pancho's restaurants offer food to go, which accounted for 10.8% of sales for the year ended September 30, 1998.
The Company has standard procedures for customer service, sanitation, food preparation and other operational matters. Depending on the size of the restaurant and the time of the year, each Pancho's will have from 30 to 90 employees. Each restaurant is under the direction of a general manager, associate manager and production manager (chef). Additionally, higher volume units have a first assistant manager who typically has completed the Company's formal Manager Training Program. The basic three-manager team participates in an incentive compensation program based upon sales and profitability of their specific restaurant. Company Area Supervisors and Production Supervisors inspect the restaurants regularly and assist the unit management to assure compliance with quality standards set by the Company. They also participate in incentive compensation based on the restaurant group for which they are responsible.
MARKETING AND ADVERTISING
The Company emphasizes a Neighborhood Marketing Strategy in which local store marketing efforts reach out to each restaurant's specific neighborhood customers. Restaurant managers are encouraged to participate in community affairs and, with the assistance of the general office, to cater school, church and other community events. Pancho's supports local schools with gift certificate awards for honor roll and perfect attendance students, and sponsors sports leagues for local children. There is a birthday club for children under twelve which serves the child free on his or her birthday and also provides a free pinata for the birthday celebration. A senior citizens program includes registered membership that entitles the member to a 20% discount. The neighborhood marketing is augmented by focused newspaper inserts, direct mail and billboards.
The Company uses extensive customer and employee surveys to help develop and evaluate marketing strategy and tactics. Local store marketing programs tailored to each restaurant are developed and implemented quarterly.
PURCHASING AND DISTRIBUTION
In July 1994, the Company entered into an agreement with The SYGMA Network, Inc. to purchase, warehouse and distribute substantially all the food products and supplies for the Company's restaurants. This agreement provided immediate benefits through increased delivery frequency at lower cost and decreased investment in inventory. SYGMA's nationwide distribution network will also allow the Company to develop new markets without capital investments to expand an internal distribution system. The SYGMA Network is a subsidiary of SYSCO Corporation, one of the nation's largest food service and distribution organizations. The SYGMA Network specializes in distribution for restaurant chains.
The Company believes that its system of central purchasing and distribution is critical to control of product cost and quality and permits restaurant managers to concentrate on quality of food preparation and customer service.
HUMAN RESOURCES
On September 30, 1998, the Company had about 2,147 employees, of whom 57 were corporate personnel, 2,078 were employed in restaurants and 12 were employed in maintenance and construction.
The Company considers its employee relations to be good. Most employees, other than restaurant management and corporate personnel, are paid on an hourly basis. The Company believes that it provides working conditions and wages that compare favorably with those of its competition. The Company's employees are not covered by a collective bargaining agreement.
COMPETITION
All aspects of the restaurant business are highly competitive. Price, restaurant location, food quality, service and attractiveness of facilities are important aspects of competition. The competitive environment is often affected by factors beyond a particular restaurant's control, including changes in population, traffic patterns, economic conditions and consumer preferences. The Company's restaurants compete with a wide variety of Mexican food, fast food, value-priced and "all-you-can-eat" restaurants, ranging from national and regional restaurant chains to locally-owned restaurants. The Company believes that its principal competitive strengths lie in the value, variety and quality of food products served, in the distinctive atmosphere and in the strength of the Pancho's Mexican Buffet name.
FORWARD-LOOKING STATEMENTS
Certain statements in this report are forward-looking statements which represent the Company's expectations or beliefs concerning future events, including, but not limited to the following: statements regarding restaurant concept changes, plans to sell assets, ability to service debt and satisfy loan covenants, unit growth, future capital expenditures, future borrowings, future cash flows and future results of operations. The Company warns that many factors could, individually or in aggregate, cause actual results to differ materially from those included in the forward-looking statements, including, without limitation, the following: consumer spending trends and habits; increased competition in the restaurant industry; weather conditions; and laws and regulations affecting labor and employee benefit costs. The Company does not expect to update such forward-looking statements continually as conditions change, and readers should consider that such statements pertain only to the date hereof.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns a combination general office/warehouse building located at 3500 Noble Avenue, Fort Worth, Texas. The headquarters facility consists of general offices, freezer space of about 194,000 cubic
feet and warehouse dry storage of approximately 31,400 square feet. The Company also owns land (85,500 sq. ft.) and a warehouse building (25,000 sq. ft.) adjoining its present general office/warehouse property.
The sites of seven operating restaurants are owned by the Company. The Company is seeking to sell three closed restaurant sites, including buildings and land which it owns in Amarillo and Galveston, Texas, and Albuquerque, New Mexico. In October 1998, the Company completed the sale of land and buildings it held for sale in Phoenix and Shreveport.
Forty-one operating restaurants are occupied pursuant to lease agreements with various expiration dates into the year 2009. Leases typically provide for a minimum rental based on the cost of improvements provided by the lessor and a maximum rental based upon the gross sales of the facility. The Company does not deem any individual restaurant lease to be significant in relation to its overall operations.
At September 30, 1998, the Company had remaining lease obligations on five closed restaurant locations. At November 30, 1998, one of these locations was subleased, and the Company was seeking to sublease three other sites, for which the lease terms expire in 1999, 2000 and 2007. The other lease expires in February 1999.
The Company has leased its Fort Worth cold storage facility to a food manufacturing concern whose chairman and chief executive officer is a non-employee director of the Company. The remainder of the space formerly occupied by the Company's internal distribution operation is currently used for equipment and document storage.
In connection with its revolving credit and term loan agreement with a bank, the bank has a security interest in substantially all of the real property owned by the Company. Substantially all of the equipment and furniture used in the operation of the restaurants and the headquarters facility are owned by the Company.
The cities and towns where the Company's restaurants are located are listed below:
ARIZONA: Mesa Phoenix
LOUISIANA: Baton Rouge Bossier City Lafayette Metairie
NEW MEXICO: Albuquerque
OKLAHOMA: Oklahoma City Tulsa
TEXAS: Abilene Arlington-3 Baytown Beaumont Burleson Carrollton Conroe Corpus Christi* Dallas-3 Denton El Paso-2** Euless Fort Worth-3 Garland Houston-6 Humble Irving Killeen League City Lewisville Longview Mesquite North Richland Hills Plano Richardson San Antonio Sherman Texarkana Tyler Waco
- ---------------
* Operated by licensee
** Operated by A&A Foods
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
Jesse Arrambide, III has been a Director since 1977. He has been Chairman of the Board of Directors since August 1993, and Chief Operations Officer since December 1994. He was Vice President, Operations from November 1984 to August 1993.
Hollis Taylor has been a Director since March 1974. He has been President and Chief Executive Officer since August 1979.
Samuel L. Carlson has been a Director since November 1993. He has been Senior Vice President, Administration and Secretary since December 1988.
Brad Fagan has been Vice President, Treasurer, Chief Financial Officer and Assistant Secretary since September 1995. Mr. Fagan, a certified public accountant, was Controller from December 1991 through September 1995.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
COMMON STOCK DATA
The Company's common stock is traded over-the-counter in the National Association of Securities Dealers, Inc. (Nasdaq) National Market System, under the symbol "PAMX." On November 30, 1998, the number of record holders was about 680 and the Company estimates that on that date there were an additional 1200 beneficial owners. The following table sets forth the quarterly high and low bid prices of the common stock, as reported by Nasdaq, for the calendar quarters indicated.
COMMON STOCK DIVIDENDS
The Company has paid cash dividends for the past 18 years. In 1998, cash dividends were $.015 per share. Future cash dividends will depend on loan restrictions, earnings, financial position, capital requirements and other relevant factors. The Company's Loan Agreement with a bank limits cash dividends to $150,000 per fiscal year, and dividends are prohibited until the Company achieves trailing EBITDA of at least $3,000,000.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company for each of the five fiscal years ended September 30, 1994 through 1998 has been derived from the more detailed consolidated financial statements and notes thereto of the Company contained elsewhere in this report or in previous reports.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA YEARS ENDED SEPTEMBER 30,
- ---------------
(a) Fiscal 1998 net income includes asset impairment and restructuring charges of $6,601,000. This includes impairment charges of $5,681,000 to impair assets at 22 locations and restructuring charges of $920,000 to exit nine locations closed in 1998.
(b) Fiscal 1998 net income includes income tax expense of $4,305,000 resulting from providing a valuation allowance for deferred tax assets.
(c) Fiscal 1997 includes asset impairment and restructuring charges of $5,066,000 to close seven restaurants, dispose of the Mexico joint venture, impair four other restaurants and increase restructuring reserves for two previously closed locations.
(d) Fiscal 1995 includes asset impairment and restructuring charges of $7,572,000 to close nine restaurants and impair asset values at eight other locations.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
The following table sets forth for the periods indicated: (i) items in the consolidated statements of operations as a percentage of sales; (ii) average restaurant sales; and (iii) the number of restaurants open at the end of each year.
Operating Results for Fiscal 1998 Compared to Fiscal 1997
Same-store sales increased 2.1% in fiscal 1998 versus 1997, reversing a three-year trend. Contributing to the increase was Pancho's most significant price increase since 1993, effective in July 1997. This price increase, plus two smaller subsequent increases, worked with the Company's neighborhood marketing strategy to provide four consecutive quarters of same-store sales increases through June 30, 1998. The Company experienced a 1.6% decline in same-store sales for the 1998 fiscal fourth quarter compared with the same 1997 quarter, reflecting lower customer traffic not compensated by price increases. The chart below shows quarterly and annual same-store sales comparisons over the past three fiscal years.
COMPARABLE-STORE SALES BY QUARTER
The Company increased average sales per store by 6.2%, to $1,192,000 in 1998. This increase was accomplished with the price increases and the benefits of closing lower volume restaurants. Total sales for 1998 were $64.1 million, down from $67 million in 1997 due to restaurant closings in 1998 and 1997.
Fourth quarter average store sales were up 2%, to $305,000 in 1998. Total sales were $15.6 million and $17.1 million for the fourth quarter of 1998 and 1997, respectively. Restaurant closings were the main factor in the higher average and lower total sales for the quarter.
Discounts increased to 4.2% of sales in 1998 from 2.2% of sales in 1997. Fourth quarter discounts were 4.5% and 2.9% of sales for 1998 and 1997, respectively. Discounting tactics are used to increase customer frequency and attract new customer trials. The increase in discounting has come mainly from coupons distributed by direct mail, newspaper inserts and a variety of neighborhood marketing promotions. The Company plans to reduce the level of discounting in fiscal 1999.
In 1997, the Company embraced a focused neighborhood marketing strategy using Company-wide and store-specific neighborhood marketing tactics based on detailed market research and analysis, supported by intensive planning and training. Neighborhood marketing strengthens Pancho's ties to each restaurant's community with a portfolio of specific tactics developed for each location. A series of Company-wide tactics complement existing Company programs such as the Birthday Club, School Rewards programs and Seniors Club.
Nine restaurants were closed in July and August 1998 as part of a restructuring plan adopted in the quarter ended June 30, 1998. Fourth quarter sales for the units closed under that plan were $932,000 and $2,175,000 for 1998 and 1997, respectively. Annual sales for the closed units were $6.8 million and $8 million in 1998 and 1997, respectively. No other closings are currently planned, but management will continue to evaluate operating results and consider closing other locations based on profitability and cash flow.
Under a 1997 restructuring plan, the Company closed seven low sales restaurants on April 15, 1997, and disposed of its interest in the Mexico operations effective May 31, 1997. Those eight locations contributed $2.9 million in sales in 1997.
To respond to declining margins caused primarily by labor cost inflation, the Company raised its menu pricing mix effective July 1, 1997 an estimated average of 5.1%. Another price increase, of about 1.5% was instituted in mid-September 1997 to offset the effect of the September federal minimum wage increase. A price increase of about 1% was implemented in April 1998.
No new restaurants were opened in 1998, and none are planned for fiscal 1999. Management plans to focus on improving same store sales and operating margins at its existing units before adding new locations.
Food cost was down 1% of sales in fiscal 1998. The benefit from the higher prices was partially offset by the increased discounting, cost inflation and use of higher quality items.
Labor and related expenses were up 1.9% and 2.2% of sales for the fourth quarter and year 1998, respectively, compared with the same periods in 1997. The Company benefited from $57,000 and $1,058,000 to recognize effective management of employee injury and health insurance costs in fourth quarter 1998 and fiscal 1997, respectively. After eliminating the benefits of these gains, labor and related costs were up 2.3% and 0.8% of sales for the 1998 quarter and year, respectively, versus the same periods in 1997, despite the price increases.
Hourly wage inflation increased labor cost about 2.1% and 2.3% of sales for the 1998 quarter and year, respectively. The federal minimum wage increased $0.40 September 1, 1997. Due to the increased federal minimum wage and a tight labor market, the Company's average hourly wage cost was 8.6% higher in 1998 than in 1997.
A tight labor market will continue to contribute to general wage inflation. Higher wages will make it difficult for the Company to achieve reductions in labor and related costs as percentages of sales unless the sales trend improvement continues.
Health insurance costs rose 0.4% and 0.2% of sales for the fourth quarter and year of 1998 over the same periods in 1997.
Fourth quarter 1998 restaurant bonuses were down 0.4% of sales from 1997, but higher sales per store increased restaurant bonuses 0.3% of sales for the year. The Company continued to augment its primary restaurant management bonus programs with additional bonus programs for restaurant service and management personnel to provide additional incentives for excellent service.
Pancho's prepares a large quantity and variety of fresh food in small batches throughout the day, and provides buffet-line and table service in each restaurant. Maintaining a high level of quality service, sanitation and food preparation makes it difficult to reduce labor costs proportionally when sales decline, as staffing cannot be reduced below certain levels to maintain Pancho's standards for quality service and sanitation. The Company has commissioned outside consultants to address these issues as it develops a more modern and labor-efficient Pancho's for the future.
Restaurant operating expenses, which include restaurant occupancy costs and advertising and promotion expenses, decreased 0.7% and 0.4% of sales for the 1998 quarter and year compared with the same 1997 periods. These percentages were down partially due to the price increases and restaurant closings in 1998 and 1997.
Credits from reducing general liability insurance reserves lowered restaurant operating expenses by $58,000 and $212,000 in the fourth and second quarters of 1998, respectively. Maintenance expense and the cost of supplies rose in 1998. Utility costs declined as a percentage of sales in 1998, while other occupancy costs and operating expenses stayed about the same. Restaurant advertising and promotion costs rose 0.5% of sales to 2.9% of sales for fiscal 1998, but were 2.1% of sales in the fourth quarter of both years.
Depreciation and amortization decreased $246,000, 1.2% of sales, and $618,000, 0.7% of sales, in the fourth quarter and year 1998, respectively, due to the asset write-downs taken in June 1998 and March 1997.
In the quarter ended June 30, 1998, the Company impaired assets at 22 locations based on its continuing evaluation of recoverability of long-lived store assets at 13 locations and its intent to close and dispose of nine locations. The Company initially estimated asset impairment charges of $6,049,000 for 22 restaurant locations, including one previously closed and held for sale. In the 1998 fourth quarter, the Company reversed $368,000 of the impairment charge for land and buildings held for sale, primarily based on the sale of one of the properties completed in October 1998 for significantly more than the previously estimated fair value less cost to sell. Impairment charges were determined in accordance with Statement of Financial Accounting Standard (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of."
The Company adopted a restructuring plan in the quarter ended June 30, 1998 which involved closing nine restaurants. The Company accrued exit costs of $920,000 for nine locations which were closed by August 10, 1998 under the plan. Four of those nine closures, plus one previously closed, included Company-owned land and buildings which the Company plans to sell. Those five owned sites are shown on the balance sheet as land and buildings held for sale.
Under a previous restructuring plan, adopted in March 1997, a charge of $5,066,000 was recorded in fiscal 1997 to close seven U.S. restaurants, dispose of the Mexico operation, and impair assets at four other locations.
The Company realized net gains on sales of assets of $153,000 and $256,000 in fiscal 1998 and 1997, respectively. Long-lived assets to be disposed of are carried at the lower of carrying amount or fair value less cost to sell.
In fiscal 1998, interest expense was $136,000 lower than in 1997. Outstanding debt decreased from $2,479,000 on September 30, 1997 to $2,250,000 on September 30, 1998. As outstanding debt decreased, interest expense declined, from $58,000 in the fourth quarter of 1997 to $42,000 in the fourth quarter of 1998. Interest expense is expected to continue falling in 1999 as debt is reduced.
Due to the factors discussed above, the Company reported net losses of $12.5 million, or $2.85 per share, and $4.7 million, or $1.07 per share, for 1998 and 1997, respectively. The Company achieved fourth quarter net earnings of $391,000 and $125,000 in 1998 and 1997, respectively. The Company's future earnings depend largely on improving sales and maintaining tight cost controls in the highly-competitive restaurant industry. To enhance potential profitability, the Company is seeking to develop a restaurant model that increases sales and lowers labor costs as a percentage of sales.
Provision for Income Taxes for 1998 Compared to 1997
Net deferred tax assets increased $3.0 million to $8.4 million in fiscal 1998, due mainly to increases in the federal net operating loss (NOL) carryforward and temporary book-tax differences resulting from asset impairments and restructuring charges taken in 1998. Due to the Company's net loss for the quarter ended June 30, 1998, combined with net losses for the three preceding years, it was considered necessary to provide a valuation allowance for all of its net deferred tax assets. The tax benefit of $3.0 million was offset by a $7.3 million increase in the valuation allowance, resulting in tax expense of $4.3 million for 1998.
The valuation allowance currently offsets the full amount of deferred tax assets. Despite the valuation allowance, the deferred tax assets are still available to the Company for future use. If the Company returns to profitability, the Company may recognize tax benefits for all or a portion of the deferred tax assets at a future date, when the valuation allowance is reduced or the tax assets realized. The deferred tax assets include federal employer tax credits and NOL carryforwards which expire in years 2009 through 2013, and state NOL carryforwards which expire in years 1999 through 2013.
The effective tax rate in fiscal 1997 was a benefit of 28.2% of the loss before income taxes. This benefit rate includes the effect of Mexico operations, which commenced in 1996, and for which no tax benefit was recognized. Adjusting pre-tax income to exclude Mexico operations reflects a U.S. tax benefit rate of 33.2% for 1997. The 1997 benefit rate was lower than prior years due to the increase in the valuation allowance in 1997. As detailed in Note 5 to the consolidated financial statements, the effective tax rates differed from the base federal rate of 34% each year due primarily to the effects of valuation allowance changes, state income taxes, federal employer tax credits and the results of foreign operations.
Liquidity and Capital Resources for 1998 Compared to 1997
The Company's current ratio was 0.3 to 1 at September 30, 1998 compared to 0.4 to 1 at fiscal year end 1997. Like many restaurant chains, the Company maintains a current ratio well below 1.0. Most of its current liabilities, primarily accounts payable and accrued wages and bonuses, flow through operations and roll over rather than being paid off. The Company keeps a low cash balance and draws on its line of credit only as needed.
Operating activities provided net cash of $794,000 in 1998 compared with $882,000 in 1997. The Company's operations generated positive cash flow even though significant non-cash operating expenses led to net losses both years.
Investing activities used $436,000 in 1998 and provided $622,000 in 1997. The Company invested $697,000 in asset additions in 1998, mainly to remodel three locations, upgrade point-of-sale (POS) systems and provide normal capital replacements.
No new restaurants were opened or under construction in 1998, and none are planned for fiscal 1999. In 1999, the primary capital investments will involve remodeling to develop and test one or more different restaurant formats, as the Company seeks to improve sales and operating margins. Capital expenditures to remodel existing restaurants, install restaurant computer POS systems and provide routine capital replacements will continue within the constraints of available cash flow and Loan Agreement restrictions (see Note 3 to the consolidated financial statements).
The Company closed nine restaurants in 1998, as part of its restructuring plan, and provided estimated reserves to exit those locations. The Company sold the land and building for two of the closed restaurants in October 1998, and is seeking to sell the land and building for the other closed locations which are included in
land and buildings held for sale on the balance sheet. Proceeds from real estate sales must be used mostly to pay down debt in accordance with the Loan Agreement.
In 1997, the Company realized $1,081,000 in proceeds from asset sales, including the Tucson land and building. The Company spent $459,000 cash to remodel three existing restaurants, install computer POS systems in two restaurants, and provide routine capital replacements. No new restaurants were opened in 1997.
Financing activities consumed $284,000 and $1,217,000 in 1998 and 1997, respectively, primarily to reduce debt and pay dividends. Net cash used for debt reduction was $228,000 and $1,162,000 in 1998 and 1997, respectively.
The Company plans to finance its 1999 operations and capital additions mainly with cash from operations and sales of land and buildings held for sale. The Company may also enter into lease agreements to acquire new POS systems or other equipment.
The Company's revolving credit and term loan agreement (Loan Agreement) with a bank has reduced the revolving credit line from $12 million at December 31, 1995 to $2 million at September 30, 1998. The Company had $268,000 of credit available under the line at September 30, 1998. The proceeds from asset sales will be used mainly to reduce bank debt.
In November 1998, the Company and the bank agreed to amend the Loan Agreement commitment reduction schedule and covenants, effective September 30, 1998. Under this amendment, the credit line limit is reduced the last day of each quarter until the agreement terminates September 30, 2000. The credit commitment reductions effective at each quarter end under the amended agreement, as of September 30, 1998, are shown below, subject to further reductions based on property sales:
The loan is secured by all of the Company's real property. Two closed locations were sold in October 1998, and the commitment limit was subsequently reduced by 60% of the net proceeds. The maximum loan commitment will be further reduced by all proceeds from subsequent real estate sales, equally reducing the final scheduled commitment reduction.
The Loan Agreement includes various financial covenants. One financial covenant requires the Company to achieve trailing three-months earnings before interest, taxes, depreciation and amortization (EBITDA) to equal or exceed established targets during each three-month period, beginning December 31, 1998. Cash capital expenditures are limited to $650,000 each fiscal year. Cash dividends are limited to $150,000 per fiscal year, and are prohibited until the Company achieves trailing 12-months EBITDA of at least $3 million.
Due to the operating losses (as defined by the Loan Agreement) incurred by the Company in the quarters ended March 31 and June 30, 1998, the Company violated various loan covenants. The Company also exceeded the Loan Agreement capital expenditure limit for the 1998 fiscal year. The bank has subsequently granted permanent waivers for these covenant violations. The Company was in compliance with all other loan covenants at September 30, 1998.
Management is taking steps to ensure that the Company will be able to comply with all of its covenants under the Loan Agreement in the future. However, if the bank declined to waive a future covenant violation, the bank would be required under the Loan Agreement to give the Company 15 days written notice of the
violation, after which time the Company would be in default. At the bank's option, it could then declare the loan principal and all accrued interest current and payable and/or refuse to make additional advances on the credit line. The Company could then be forced to seek alternative sources of financing.
The Company paid a dividend of $.015 per share on December 9, 1997. Future cash dividends are prohibited by the Loan Agreement until the Company achieves an earnings target, and will also depend on earnings, financial position, capital requirements and other relevant factors.
Operatory Results for Fiscal 1997 Compared to Fiscal 1996
The Company's same store sales trend turned positive in the fourth quarter of fiscal 1997, up 2.0% over the fourth quarter of 1996. This reversed quarterly same store sales decreases ranging from 1.2% to 12.7% over the past three fiscal years. Same store customer counts were down 1.4% for the fourth quarter of fiscal 1997, but price increases July 1 and mid-September 1997 helped raise average sales per customer significantly.
The Company adopted a restructuring plan in the quarter ended March 31, 1997. Under the plan, the Company closed seven low sales restaurants on April 15, 1997, and disposed of its interest in the Mexico operations effective May 31,1997. Those eight locations contributed $2,854,000 in sales in 1997, versus $5,512,000 in 1996, a difference of $2,658,000. Each closed unit had been producing far below company average sales per unit.
Sales decreased $4,530,000 in 1997 due to the store closings and same store sales declines in the first three fiscal quarters. Same-store sales were down 2.8% in fiscal 1997 compared with a decrease of 7.8% in fiscal 1996. The price increases and restructuring steps helped raise average sales for restaurants open throughout 1997 to $1,123,000, up 1.5% over 1996.
Total fourth quarter sales were down $1,054,000 in 1997 due to the restructuring. The eight eliminated locations accounted for $1,391,000 in fourth quarter 1996 sales. The restructuring and price increases brought a 7.4% increase in average sales for restaurants open throughout the fourth quarter of 1997 versus average sales for the fourth quarter of 1996.
To respond to declining margins caused primarily by wage inflation, the Company raised its menu pricing mix effective July 1, 1997 an estimated average of 5.1%. Another price increase, of about 1.5% was instituted in mid-September 1997 to partially offset the effect of the September federal minimum wage increase.
The Company included coupons, frequent diner cards and other discounts in its marketing tactics. Discounts rose to 2.9% and 2.2% of sales for the quarter and year ended September 30, 1997, compared with 1.4% and 1.2% of sales for the same periods in 1996.
No new restaurants were opened in fiscal 1997.
Food cost was down 0.7% of sales for the fourth quarter of fiscal 1997 versus the same period in 1996 due to the 1997 fourth quarter price increase. Food cost was up 0.6% of sales for the year. Meat cost was up 0.4% and 0.8% for the fourth quarter and year of 1997 compared with the same periods in 1996.
Labor and related expenses were up 1.5% and 0.5% of sales for the fourth quarter and year 1997, respectively, compared with the same periods in 1996. The benefits from 1997 adjustments to employment-related insurance reserves were more than offset by the effects of lower sales and wage rate inflation.
The Company benefited from reductions to the workers' compensation and Voluntary Employee Injury Benefit (VEIB) Plan insurance reserves of $500,000 in the third quarter and $558,000 in the second quarter of 1997. The reduction of VEIB Plan reserves recognized the benefits from effective risk and case management, based on closing out claim years 1990 through 1992. After removing the benefit from the VEIB Plan and workers' compensation credits, labor costs were 37.9% of sales for the fourth quarter and 39.3% for 1997.
Labor costs in 1996 benefited from a $128,000 refund of prior year health insurance payments and a $125,000 reduction in VEIB Plan reserves in the second and third quarters, plus fourth quarter reserve reductions of $82,000 for the VEIB Plan and $80,000 for workers' compensation. Without these benefit cost adjustments, labor costs were 37.3% and 37.8% of sales for the fourth quarter and year of 1996.
After removing the benefit of the above adjustments from all quarters and years, labor costs were up 0.6% and 1.5% of sales for the fourth quarter and year 1997 versus the same periods for 1996. Although the Company has had success with its loss control and risk management programs, the gains from adjustment of reserves should be considered one-time gains which may not be repeated in the future.
Labor and related expenses were up for 1997 due to higher restaurant salaries and wages caused by wage rate inflation and lower sales. Health insurance costs were up 0.2% over 1996 due to inflation and the refund benefit in 1996. Lower profitability in 1997 reduced store bonuses 0.2% of sales compared with 1996. The Company augmented its primary restaurant management bonus programs with additional bonus programs for restaurant service and management personnel to provide additional incentives for excellent service.
Fourth quarter restaurant salaries and wages were the same percentage of sales in 1997 and 1996, reflecting the benefit of the fourth quarter 1997 price increases. The fourth quarter operating results improvement increased store bonuses 0.2% of sales.
The federal minimum wage increased $0.50 per hour effective October 1, 1996, the first day of the Company's fiscal 1997, and $0.40 more September 1, 1997. Pancho's experienced increases of 7.8% and 5.9% in average hourly wage rates for the 1997 fourth quarter and year, respectively, versus the same periods in 1996. This wage rate inflation represented hourly labor cost increases of 1.6% and 2.2% of sales for the fourth quarter and year of 1997, respectively, compared with the same 1996 periods.
Restaurant operating expenses rose 0.5% of sales in 1997 compared with 1996. The percentage increase for the year resulted from lower total sales despite spending $711,000 less in 1997 than in 1996.
Restaurant operating expenses include occupancy costs, which rose 0.6% of sales in 1997 due equally to higher maintenance costs, property taxes and rent on lower sales. Restaurant supplies and other operating expenses each rose 0.2% of sales. These increases were partially offset by reductions of 0.3% of sales for marketing, and 0.2% of sales for restaurant general and administrative costs.
The Company spent $1,591,000, 2.4% of sales, and $1,908,000, 2.7% of sales, on marketing in fiscal 1997 and 1996, respectively. Due to its strategic shift from broadcast media to more local store marketing, the Company spent $953,000 less for advertising media, but $276,000 more for marketing research and consulting, plus $187,000 more for promotions.
The price increase and the restructuring helped reduce fourth quarter restaurant operating expenses 1.4% of sales in 1997. Utilities were down 0.3% of sales, marketing was down 0.6% of sales, supplies were down 0.4% and other operating costs were down 0.4% of sales. These were partially offset by the 0.4% increase in fourth quarter occupancy costs.
The Company spent 2.1% versus 2.7% of sales on marketing in the fourth quarter of fiscal 1997 and 1996, respectively. The Company spent $130,000 less in the 1997 fourth quarter due to the strategic shift from broadcast advertising to local store marketing. In the fourth quarter of 1996, the Company spent $243,000 for broadcast media for TV ads, compared with zero dollars for broadcast media in the fourth quarter of 1997. The savings were partially offset by $57,000 more spent on marketing consulting and research, and $15,000 more on promotions.
Depreciation and amortization decreased $199,000, 0.8% of sales, and $521,000, 0.4% of sales, in the fourth quarter and year 1997, respectively, due to the asset write-downs taken in the March 1997 restructuring.
The Company recorded asset impairment and restructuring charges of $5,066,000 in the quarter ended March 31, 1997. This charge included $3,033,000 for the impairment of land, buildings, leasehold improvements and equipment. Impairment charges were determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The charge also included $1,538,000 to reserve for exit costs of locations closed under the restructuring plan adopted in the quarter ended March 31, 1997. The rest of the restructuring charges consisted of a $455,000 loss from recognition of the Cumulative Foreign Currency
Translation Adjustment for disposal of the Mexico venture, plus $40,000 to record a valuation allowance for deferred tax assets unlikely to be realized due to the closing of two Arizona locations under the restructuring.
The Company realized net gains on sale of assets of $256,000 and $141,000 in fiscal 1997 and 1996, respectively. Long-lived assets held for sale are carried at the lower of depreciated cost or fair value less cost to sell.
In 1997, interest expense was $192,000 lower than in 1996. Outstanding debt decreased from $3,641,000 on September 30, 1996 to $2,479,000 on September 30, 1997. As outstanding debt decreased, interest expense declined, from $84,000 in the fourth quarter of 1996 to $58,000 in the fourth quarter of 1997.
The Company achieved net earnings of $125,000 in the fourth quarter of 1997, compared with a net loss of $143,000 for the 1996 fourth quarter. The price increases and restructuring helped improve operating margins in the final quarter of 1997.
Due to the factors discussed above, the Company reported net losses of $4,716,000 and $415,000 for fiscal years 1997 and 1996, respectively. The 1997 restructuring charge and net loss resulted from declining sales trends that could not be fully offset with cost controls.
SFAS No. 123, "Accounting for Stock-Based Compensation", became effective for the Company for the 1997 fiscal year. SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock-based compensation awards to employees and will disclose the required pro forma effect on net income and earning per share (see Note 6 to the consolidated financial statements).
Provision for Income Taxes for 1997 Compared to 1996
The effective tax rate in fiscal 1997 was a benefit of 28.2% of the total loss before income taxes, compared to a benefit of 24.6% for fiscal 1996. These effective rates include the results of Mexico operations, which commenced in fiscal 1996, and for which no tax benefit was recognized. As detailed in Note 5 to the consolidated financial statements, the effective tax rates differed from the base federal rate of 34% each year due primarily to the effects of state income taxes, federal employer tax credits and the results of foreign operations.
Significant current and deferred income tax benefits were recognized for 1997, resulting primarily from the asset impairments, restructuring charges and operating losses. Income taxes receivable and deferred tax assets were recorded for these benefits based on tax loss carry back opportunities and the Company's long history of and expected future taxable income. The income tax receivable of $538,000 was received in March 1998.
Net deferred tax assets increased $1,288,000 in 1997. The increase was due mainly to the federal net operating loss (NOL) carryforward, accrued reserves to exit closed stores and tax-book differences for fixed assets. These increases were partially offset by the reduction of insurance reserves, and the $783,000 increase in the valuation allowance to offset federal and state NOL carryforwards more likely than not to expire before realization. Note 5 to the consolidated financial statements identifies the components of the deferred tax assets and liabilities.
The deferred federal tax assets totaled $4,511,000 at September 30, 1997. Of that amount, $1,983,000 was a federal NOL carryforward which expires September 30, 2012, and $416,000 were employer tax credits which expire in fiscal years 2009 through 2012. The valuation allowance was increased $671,000 in 1997 to provide for the federal portion of the NOL carryforward which might not be realized. No other assets relating to federal income taxes had expiration dates.
State deferred tax assets were a net $464,000 after subtracting the related valuation allowance at September 30, 1997. The valuation allowance was increased $111,000 in 1997 to provide for state NOL
carryforwards likely to expire before being realized. State NOL carryforwards which expire on the fiscal yearend 1998 through 2002 represented $149,000 of those deferred tax assets, net of the related valuation allowances. Another $167,000 in deferred tax assets, net of related valuation allowances, were based on state NOL carryforwards which expire in fiscal years 2003 through 2012. The remaining $148,000 of state deferred tax assets do not have expiration dates.
Net deferred tax assets decreased $186,000, to $3,017,000 from September 30, 1995 to September 30, 1996. The decrease was due mainly to the reversal of tax-book differences for fixed assets and the realization of tax benefits as store exit costs were actually paid. These decreases were partially offset by the tax loss, which increased the federal alternative minimum tax carryforwards and the state NOL carryforwards. The valuation allowance was increased to $43,000 from $25,000 based on the expectation that not all the state NOL carryforwards will be realized before they expire.
Current and deferred income tax benefits were recognized in 1996, resulting primarily from operating losses. The federal income tax refund receivable September 30, 1996 of about $180,000 was received in February 1997.
Liquidity and Capital Resources for 1997 Compared to 1996
The Company's current ratio was 0.43 to 1 at September 30, 1997 compared with 0.39 to 1 at September 30, 1996. The increase was due to a $321,000 reduction in current accrued insurance costs plus the $284,000 increase in cash equivalents and $352,000 increase in income taxes receivable. The current ratio had decreased during fiscal 1996 mainly because about $1.2 million received for income taxes receivable plus about $1 million in cash at September 30, 1995 was applied primarily to reduce long-term debt.
Operating activities provided net cash of $882,000 in fiscal 1997 compared with $4,657,000 in 1996. Significant non-cash expenses led to net losses in both years, even though operations generated positive cash flow.
Investing activities provided $622,000 cash during 1997. The Company realized $1,081,000 in proceeds from asset sales, including the Tucson land and building. The Company spent $459,000 cash to remodel three existing restaurants, install computer point-of-sale systems in two restaurants, and provide routine capital replacements. No new restaurants were opened or under construction in fiscal 1997.
Under the restructuring plan formulated in the quarter ended March 31, 1997, the Company closed seven restaurants on April 15, 1997 and disposed of its interest in the Mexico venture. Units closed included five leased locations in Texas and two owned locations in Arizona. The Company provided estimated restructuring reserves to exit those locations. The Company sold the land and buildings for the closed Arizona restaurants in September 1997 and October 1998.
Investing activities used a net of $411,000 in fiscal 1996. Capital additions to remodel two existing restaurants, install computer point-of-sale systems in three restaurants and provide ordinary replacements were partially recouped by $278,000 in proceeds from the sale of fixed assets. The Company opened its Guadalajara restaurant in October 1995. No other new restaurants were opened in fiscal 1996.
Financing activities used $1,217,000 and $5,291,000 in 1997 and 1996, respectively, mainly to reduce debt and pay dividends. The Company applied $1,162,000 and $5,226,000 in cash to debt reduction in 1997 and 1996, respectively.
The Company's Loan Agreement with a bank reduced the revolving credit line limit from $6,483,000 at September 30, 1996 to $2,962,000 at September 30, 1997. The Company had $920,000 of credit available under the line at September 30, 1997.
The Company paid dividends of $.015 per share on December 10, 1996 and again on June 10, 1997.
Seasonality
The Company's business is seasonal. Traditionally, sales are higher in summer months, when students are not attending school.
Impact of Inflation
In the restaurant business, food, labor, and labor-related expenses are the major cost factors that effect profits. Many of the Company's employees are paid wages related to the statutory minimum wage and any increase in the minimum wage would increase the Company's cost. Also, most of the Company's leases require the payment of percentage rentals based on revenues, which along with taxes, repairs and maintenance, utilities and insurance are subject to inflation. The Company expects to be able to offset the effects of inflation through occasional price increases and savings due to volume purchasing.
The federal minimum wage increased $.50 per hour effective October 1, 1996, and further increased $.40 per hour effective September 1, 1997. The Company implemented price increases in July and September 1997 and April 1998 to offset the labor cost increases due to higher minimum wage levels and wage rate inflation.
Impact of Year 2000
Some computer hardware and software use only two digits to identify the year in date information. If not corrected, such systems could fail when processing dates for the year 2000 or later. The Company is in the process of evaluating its risk and the related costs of updating its computer hardware and software to properly process year 2000 and later dates.
The Company has identified all significant hardware and applications that it believes will require modification to provide Year 2000 processing compliance. Internal and external resources are being used to make the required modifications and test Year 2000 processing. The key Company systems for which Year 2000 problems might pose a significant risk are the Company's restaurant point-of-sale (POS) register systems and the Company's corporate accounting system. The Company plans to complete the testing process of all significant applications by September 30, 1999. If some of these systems are not Year 2000 capable by September 30, 1999, there are a number of alternate systems available in the marketplace which have been designed to be Year 2000 capable.
In addition, the Company has communicated with others with whom it does significant business to determine their Year 2000 readiness and the extent to which the Company may be vulnerable to third-party Year 2000 problems. However, there can be no guarantee that the systems of other companies will be converted timely, or that a failure to convert by another company will not have a material adverse effect on the Company.
The total cost to the Company of these Year 2000 compliance activities has not been and is not anticipated to be material to its financial position or results of operations in any given year. These costs and the date on which the Company plans to complete the Year 2000 modifications and testing are based on management's best estimates, which were derived using numerous assumptions about future events, including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ from those plans.
Other Uncertainties and Trends
The Company has been notified by Nasdaq that its common stock will be subject to de-listing from the Nasdaq National Market effective December 30, 1998 if it is unable to satisfy Nasdaq requirements for continued listing. The two key Nasdaq standards in question require common stock listed on the National Market to maintain a market value of public float of at least $5 million and a minimum share price of at least $1.
If necessary, the Company plans to appeal the de-listing to Nasdaq, but there is significant doubt about the Company's ability to satisfy the minimum public float standard for National Market listing within the
period provided by Nasdaq. The Company is therefore planning to request that its common stock be listed on the Nasdaq SmallCap Market. There can be no assurance that Nasdaq will approve the Company's listing on the SmallCap Market.
The SmallCap Market requires a minimum public float of $1 million and a minimum share price of $1. The Company's market value of public float is currently well over $1 million. The price per share of its common stock has fluctuated above and below $1 during the quarters ended September 30 and December 31, 1998.
To address the minimum share price standard, the Company's Board of Directors has authorized a one-for-three reverse stock split. The reverse split is subject to shareholders' approval at the Company's annual shareholders meeting on January 27, 1999. If approved, it is anticipated that the reverse split will help establish a price per common share over $1. The actual price will be determined by the market, and there can be no assurances that the Company's common stock will meet the standards for continued listing on either the Nasdaq National or SmallCap Markets.
In recent years, there has been accelerated development of value-priced menus and "all-you-can-eat" restaurant offerings. Pancho's Mexican Buffet has operated as a value-priced, "all-you-can-eat" concept for over 30 years and expects to compete effectively.
SFAS No. 121 requires the Company to review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company considers a history of operating losses or negative cash flows to be its main indicators of potential impairment. Assets are generally evaluated for impairment at the restaurant level. If a restaurant continues to incur negative cash flows or operating losses, an impairment or restaurant closing charge may be recognized in future periods.
Special Note Regarding Forward-Looking Information
Certain statements in this report are forward-looking statements which represent the Company's expectations or beliefs concerning future events, including, but not limited to the following: statements regarding restaurant concept changes, plans to sell assets, ability to service debt and satisfy loan covenants, unit growth, future capital expenditures, future borrowings, future cash flows and future results of operations. The Company warns that many factors could, individually or in aggregate, cause actual results to differ materially from those included in the forward-looking statements, including, without limitation, the following: consumer spending trends and habits; increased competition in the restaurant industry; weather conditions; and laws and regulations affecting labor and employee benefit costs. The Company does not expect to update such forward-looking statements continually as conditions change, and readers should consider that such statements pertain only to the date hereof.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and related notes thereto required by this item are listed and set forth herein beginning on page 24.
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Directors of Registrant
Information as to the names, ages, positions and offices with the Company, terms of office, periods of service, business experience during the past five years and other directorships held by each director or person nominated to become a director of the Company is set forth under the caption THE BOARD OF DIRECTORS appearing on page 2 of the Company's Proxy Statement dated December 22, 1998, and is incorporated herein by reference.
(b) Executive Officers of the Registrant
At the meeting of the Board of Directors of the Registrant, which immediately follows the annual meeting of stockholders, the Board of Directors elects officers for the Registrant. Such officers hold office until death, resignation, removal from office or until their successors are chosen and qualified. The names and ages of all executive officers of the Registrant, as well as all persons chosen to become executive officers, together with the nature of any family relationships between them, all positions and offices with the Registrant held by each person named and the period during which each person named has served as such officer is included in Part I under Executive Officers of the Registrant.
(c) Compliance with Section 16(a) of the Exchange Act
Information as to the compliance of the Company's directors and executive officers with Section 16(a) of the Exchange Act is set forth under the caption Section 16(a) Beneficial Ownership Reporting Compliance, appearing on page 4 of the Company's Proxy Statement dated December 22, 1998, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning remuneration received by the Company's directors and executive officers, stock options and transactions with management is set forth under the captions EXECUTIVE COMPENSATION, COMPENSATION OF DIRECTORS, AGGREGATED OPTION EXERCISES IN 1998 AND 1998 YEAR-END OPTION VALUES, REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS and TRANSACTIONS WITH MANAGEMENT AND OTHERS appearing on pages 5 through 10 of the Company's Proxy Statement dated December 22, 1998, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information as to the security ownership of certain beneficial owners of the Company and by each of its directors and nominees for directors and officers as of December 11, 1998, and the amount of such shares with respect to which certain of the directors or nominees and officers have the right to acquire beneficial ownership, is set forth under the caption SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AS OF DECEMBER 10, 1998, appearing on page 3 of the Company's Proxy Statement dated December 22, 1998, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning transactions with management and others and certain business relationships is set forth under the captions INDEBTEDNESS OF MANAGEMENT and TRANSACTIONS WITH MANAGEMENT AND OTHERS appearing on pages 7 and 10 of the Company's Proxy Statement dated December 22, 1998, and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. and 2. Financial Statements and Financial Statement Schedules -- see Index to Consolidated Financial Statements and Schedules on page 24.
3. Exhibits Required by Item 601 of Regulation S-K
- ---------------
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended September 30, 1998.
(c) Exhibits required by Item 601 of Regulation S-K.
See (a)(3) above.
(d) Financial Statement Schedules for Form 10-K.
All financial statement schedules are omitted, as the required information is not applicable or the information is presented in the consolidated financial statements or related notes.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED SEPTEMBER 30, 1998
All schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the consolidated financial statements or notes thereto.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
See notes to consolidated financial statements.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to consolidated financial statements.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of Pancho's Mexican Buffet, Inc. and its subsidiaries (the Company). Effective May 31, 1997, the Company abandoned its interest in a Mexican partnership. That partnership owned 73% of a Mexican subsidiary which operated a restaurant in Guadalajara, Mexico. The minority interest balance in that subsidiary was reduced to zero by the minority partner's interest in the operating losses of the joint venture. All material intercompany balances and transactions have been eliminated.
ACCOUNTING ESTIMATES
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those amounts.
ACCOUNT CLASSIFICATION
Certain prior year amounts have been reclassified to conform to the current year presentation.
CASH AND CASH EQUIVALENTS
For balance sheet classification and reporting cash flows, the Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.
INVENTORIES
Inventories consist primarily of food and supplies, and are stated at the lower of cost (first-in, first-out basis) or market.
DEFERRED INCOME TAXES
The Company accounts for and reports income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Applying SFAS No. 109, deferred tax assets and liabilities are recognized for temporary differences caused when the tax basis of an asset or liability differs from that reported in the consolidated financial statements, and for carryforwards for tax credits and operating losses. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax expense or benefit is recognized for the change in the asset or liability during the year.
PROPERTY, PLANT AND EQUIPMENT
Depreciation is provided for buildings and equipment on a straight-line basis over the following estimated service lives:
Leasehold improvements are amortized over the term of the lease or the life of the improvement, whichever is shorter.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company capitalizes interest incurred on debt for major construction projects and includes the capitalized interest in the asset basis. No interest was capitalized in 1998, 1997 or 1996.
LONG-LIVED ASSETS
In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company reviews long-lived assets to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or a group of assets may not be recoverable. The Company considers a history of operating losses or negative cash flows to be its main indicators of potential impairment. Assets are generally evaluated for impairment at the operating unit level.
An asset or group of assets is deemed to be impaired if a forecast of undiscounted future cash flows (excluding interest expense) directly related to the asset(s), including disposal value if any, is less than the carrying amount(s). If an asset is determined to be impaired, the loss is measured as the amount by which the carrying amount of the asset exceeds its fair value. Considerable management judgment is necessary to estimate cash flows and expected fair values. Accordingly, it is reasonably possible that actual results could vary significantly from such estimates.
Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. Assets held for sale are not depreciated.
PREOPENING COSTS
Preopening costs are expensed as incurred.
EARNINGS (LOSS) PER SHARE
The Company adopted SFAS No. 128, "Earnings per Share," in fiscal 1998. This standard replaced previous generally-accepted accounting principles for computing and disclosing earnings per share (EPS) information. Under SFAS No. 128, because it has potential common shares, the Company has a complex capital structure and must disclose both basic and diluted EPS. Basic EPS is computed by dividing income available to common shareholders by the weighted average number of shares outstanding. Diluted EPS adds the effect of all dilutive potential shares to the weighted average number of shares outstanding.
The weighted average outstanding shares were 4,395,000, 4,396,000 and 4,398,000 for the years ended September 30, 1998, 1997 and 1996, respectively. Due to the net loss, the Company's potential common shares are antidilutive and excluded from the loss per share calculation, so diluted and basic loss per share are the same. At September 30, 1998, there were 306,400 options outstanding which represented potential common shares which could be dilutive in the future. Earnings (loss) per share reported for the quarters and years ended September 30, 1997 and 1996 did not change due to the adoption of SFAS No. 128.
FOREIGN OPERATIONS AND CURRENCY TRANSLATION
The functional currency of the Company's Mexican operations was the new peso. Financial statements of the Company's Mexican subsidiaries were translated into U.S. dollars in accordance with SFAS No. 52, "Foreign Currency Translation." Results of operations were translated using an average exchange rate during the period, and assets and liabilities were translated using the year end exchange rate. The resulting cumulative foreign currency translation adjustment was shown as a separate line in stockholders' equity at September 30, 1996. When the plan to dispose of its Mexican operations was adopted in the quarter ended March 31, 1997, the balance of the cumulative foreign currency translation adjustment was expensed as part of the restructuring charge for that quarter.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENT OF CASH FLOWS
Cash flows from the Company's Mexican operations were calculated based on the new peso, in accordance with SFAS No. 95, "Statement of Cash Flows." As a result, for 1997 and 1996, amounts related to assets and liabilities reported on the consolidated statement of cash flows will not necessarily agree to changes in the corresponding balances on the consolidated balance sheets. The effect of exchange rate changes on cash balances held in foreign currencies is reported on a separate line in the consolidated statement of cash flows.
STOCK-BASED COMPENSATION
The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation," in fiscal 1997. Under the provisions of SFAS No. 123, companies can elect to account for stock-based compensation plans using a fair-value based method or continue measuring compensation expense for those plans using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations. The Company has elected to continue using the intrinsic value method to account for its stock-based compensation plans. SFAS No. 123 requires companies electing to continue using the intrinsic value method to make certain pro forma disclosures (see Note 6).
NEW ACCOUNTING STANDARDS
SFAS No. 130 -- In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting on Comprehensive Income," which is effective for periods beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and presenting comprehensive income in the financial statements. Management believes that the adoption of this statement will not impact the Company's financial statements.
SFAS No. 131 -- In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which will be effective for fiscal years beginning after December 15, 1997. SFAS No. 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a Company's operating segments. The Company operates as a single business segment, and accordingly, this standard will not affect the Company's future disclosures.
2. OTHER CURRENT LIABILITIES
Other current liabilities consist of:
3. LONG-TERM DEBT
The Company has a revolving credit and term loan agreement (Loan Agreement) with a bank. In November 1998, the Company and the bank agreed to amend the Loan Agreement commitment reduction schedule and covenants, effective September 30, 1998. Under this amendment, the credit line limit is reduced the last day of each quarter until the agreement terminates on September 30, 2000. The credit commitment
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reductions effective at each quarter end under the amended agreement, as of September 30, 1998, are shown below, subject to further reductions based on property sales:
The loan is secured by all of the Company's real property. Two closed locations were sold in October 1998, and the commitment level was subsequently reduced by 60% of the net proceeds. The maximum loan commitment will be further reduced by all proceeds from subsequent real estate sales, equally reducing the final scheduled commitment reduction.
The Loan Agreement includes various financial covenants. One financial covenant requires the Company to achieve trailing three-months earnings before interest, taxes, depreciation and amortization (EBITDA) to equal or exceed established targets during each three-month period, beginning December 31, 1998. Cash capital expenditures are limited to $650,000 each fiscal year. Cash dividends are limited to $150,000 per fiscal year, and are prohibited until the Company achieves trailing 12-months EBITDA of at least $3 million.
Due to the operating losses (as defined by the Loan Agreement) incurred by the Company in the quarters ended March 31 and June 30, 1998, the Company violated various loan covenants. The Company also exceeded the Loan Agreement capital expenditure limit for the 1998 fiscal year. The bank has subsequently granted a permanent waiver for these covenant violations. The Company was in compliance with all other loan covenants at September 30, 1998.
Management is taking steps to ensure that the Company will be able to comply with all of the covenants under the Loan Agreement in the future. However, if the bank declined to waive a future covenant violation, the bank would be required under the Loan Agreement to give the Company 15 days written notice of the violation, after which time the Company would be in default. At the bank's option, it could then declare the loan principal and all accrued interest current and payable and/or refuse to make additional advances on the credit line. The Company could then be forced to seek alternative sources of financing.
The current portion of bank debt of $332,000 and $42,000 is included in debt classified as current at September 30, 1998 and 1997, respectively. The non-current amount was $1,400,000 and $2,000,000 at September 30, 1998 and 1997, respectively.
Interest is payable monthly at a variable rate equal to the bank's prime rate plus a margin of 0 to 1% or, after the Company meets certain earnings goals, rates based upon the London Interbank Offering Rate. The interest rate effective at September 30, 1998 was 9.25%. The Company pays a commitment fee of 3/8 of 1 percent annually on the unused portion of the credit line.
Notes payable were issued in fiscal 1998, 1997 and 1996 to buy out the remaining lease terms of certain closed locations. The long-term portion of those notes was $361,000 and $287,000 at September 30, 1998 and 1997, respectively. The current portion of $158,000 and $150,000 is included in debt classified as current at September 30, 1998 and 1997, respectively. The effective interest rates range from 5.9% to 6.9%, with payments due monthly through November 2001.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The combined maturities of Company debt, as of September 30, 1998, subject to accelerated maturity based on property sales, are listed below:
4. OPERATING LEASES
The Company leases restaurant facilities under operating leases with terms expiring at various dates into 2007, some of which contain renewal options. Certain of the leases have provisions for contingent rentals based on a percentage of the excess of restaurant sales over stipulated minimum sales.
The minimum aggregate annual rentals required under operating leases in effect at September 30, 1998, exclusive of maintenance, taxes, etc., were as follows:
The composition of total yearly rental expense for operating leases is:
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES
Income tax expense (benefit) consists of:
The income tax benefit differs from the amounts computed by applying the U.S. federal statutory rate of 34 percent to the net loss before income taxes as follows:
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities are as follows:
Net deferred tax assets increased $3.0 million to $8.4 million in the year ended September 30, 1998, due mainly to increases in the federal net operating loss (NOL) carryforward and temporary book-tax differences resulting from the impairment and restructuring charges taken in 1998. Due to the Company's net loss for the quarter ended June 30, 1998, combined with net losses for the three preceding fiscal years, it was considered necessary to provide a valuation allowance for all of its net deferred tax assets. The tax benefit of $3.0 million was offset by the $7.3 million increase in the valuation allowance, resulting in tax expense of $4.3 million for fiscal 1998.
The valuation allowance currently offsets the full amount of the deferred tax assets net of deferred tax liabilities. Despite the valuation allowance, the deferred tax assets are still available to the Company for future use. If the Company returns to profitability, the Company may recognize tax benefits for all or a portion of the deferred tax assets at a future date, when the valuation allowance is reduced or the tax assets realized. The deferred tax assets include federal employer tax credits and NOL carryforwards which expire in years 2009 through 2013, and state NOL carryforwards which expire in years 1999 through 2013.
The federal NOL carryforward was $3,033,000 and $5,959,000 for 1998 and 1997, respectively. The 1997 federal NOL carryforward included a loss related to the foreign operations. Due to the Company's recognition of these foreign losses, previous losses which were treated as permanent differences were reclassified as temporary differences in 1997 and included in the 1997 federal NOL carryforward.
The valuation allowance is required to reduce deferred tax assets to the amount that will more likely than not be realized. In 1997, the valuation allowance was increased $671,000 to offset the increased federal NOL
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
carryforward and $111,000 for state NOL carryforwards. The valuation allowance was increased $18,000 in 1996 for state NOL carryforwards.
6. STOCKHOLDERS' EQUITY
STOCK NOTES RECEIVABLE
In April 1992, the Company sold 104,500 shares of common stock to certain officers in exchange for notes receivable in the amount of $758,000, the balance of which is shown in the balance sheet as a deduction from stockholders' equity. The notes bear interest at 7.83%, are payable in ten equal annual installments plus interest and are secured by the common stock. The shares were sold at the quoted market price on the day of sale.
In fiscal 1997, the Company recognized expense of $83,000 to write off the excess of stock notes receivable over the market value of stock collateral held for two former employees for which the receivable balances were considered uncollectable. One of those employees returned the stock collateral in fiscal 1997, the other in fiscal 1998, which provided 15,400 and 8,400 shares of treasury stock reflected on the balance sheet at September 30, 1998 and 1997, respectively.
STOCKHOLDERS' RIGHTS PLAN AND PREFERRED STOCK PURCHASE RIGHTS
In January 1996, the Company's Board of Directors adopted a Stockholders' Rights Plan to replace a similar plan which expired on March 31, 1996. Under the new plan, the Company declared a dividend distribution of one preferred share purchase right (Right) for each share of common stock outstanding at the close of business on March 29, 1996. Each Right entitles the holder to buy one one-thousandth of a share of the Company's newly-designated Series A Junior Participating Preferred Stock, for the exercise price of $10 per one one-thousandth of a Preferred Share, subject to adjustment.
If any person or group (other than certain current stockholders and their affiliates, associates and successors, which may acquire up to 28%) acquires 15% of the Common Stock, all stockholders except the acquiring person (Acquiror) will be entitled to purchase Common Stock having twice the market value of the Rights exercise price. If the Company is involved in a merger or other business combination, or sells 50% or more of its assets or earning power, all of the Stockholders, other than the Acquiror, will be entitled to purchase Common Shares of the other person having twice the market value of the exercise price. Under the Plan's exchange provision, any time after such an acquisition but before any person acquires a majority of the Common Stock, the Board of Directors may exchange all or part of the outstanding Rights (other than the Rights of the Acquiror) for Common Stock at a ratio of one Right per share.
The Rights trade with the common stock, and are not exercisable or transferable apart from the common stock until 10 days after a person or group acquires, or announces a tender offer for, 15% or more of the Company's outstanding common stock. Before acquisition by someone of beneficial ownership of 15% or more of the Company's common stock, the Rights are redeemable by the Board for $.01 per Right. The Rights expire on March 27, 2006.
Under the Plan, the Company's Board of Directors has designated 10,000 shares of preferred stock as Series A Junior Participating Preferred Stock. This designation is part of the 500,000 shares of preferred stock, par value $10, previously authorized. None is issued.
STOCK OPTIONS
The Company's stock option plans authorize the grant of options to purchase common stock to directors, officers, employees and consultants of the Company at prices not less than the fair market value of the stock at dates of grant. Outstanding options become exercisable cumulatively in four or five equal annual installments
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
commencing one year from date of grant and expire ten years from the date of grant. Options may be granted through November 5, 2002.
On January 28, 1998, at the Annual Meeting of Stockholders, the stockholders of the Company approved Amendment Number One to the 1992 Stock Option Plan. This amendment increased the number of shares which the Company may sell pursuant to options under the plan to 600,000 shares, from 400,000 shares. The amendment also increased the annual option grant to non-employee directors to 4,000 shares each from 2,000 shares each.
Summary information on stock option activity is shown below.
For shares outstanding at September 30, 1998:
The weighted-average fair value of options granted was $1.00 per share in 1998 and 1997. The pro forma effects of reporting stock options using the fair value approach under SFAS No. 123 are shown below.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1998, 1997 and 1996.
ANNUAL STOCK GRANT TO NON-EMPLOYEE DIRECTORS
Under the 1998 Restricted Stock Plan for Non-employee Directors, effective in January 1998, non-employee directors of the Company are granted $2,500 of common stock quarterly, based on the market price on the date of grant. The value of shares granted and recognized as directors' compensation was $29,000 in 1998.
PREFERRED STOCK
Shares of preferred stock, when issued, will have such rights, preferences and privileges as shall be adopted by the Board of Directors.
7. EMPLOYEE BENEFIT PLANS
VOLUNTARY EMPLOYEE INJURY BENEFIT PLAN
Concurrent with its decision to become a non-subscriber to the Workers' Compensation Act of Texas in December 1990, the Company adopted a Voluntary Employee Injury Benefit (VEIB) Plan to provide benefits for employees located in Texas who incur job related injuries in connection with their employment. The VEIB Plan, which is subject to Employee Retirement Income Security Act (ERISA) rules and regulations, provides for medical, short-term wage replacement, dismemberment and death benefits.
Coverage under the VEIB Plan is provided by the Company and through excess liability insurance, which provides coverage for claims in excess of certain stipulated amounts. The consolidated statements of operations for the years ended September 30, 1998, 1997, and 1996 include provisions for estimated expenses of the VEIB Plan of $440,000, $557,000, and $854,000, respectively.
BONUS PLANS
The Company has a bonus plan for restaurant managers and supervisors which provides bonuses based on restaurant performance. Such bonuses amounted to $480,000, $233,000, and $417,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
The Company has a bonus plan for corporate officers as a group based on stipulated operating results. Under this plan, no corporate officer bonuses were paid for the years ended September 30, 1998, 1997 and 1996.
An additional bonus plan compensates certain officers employed by the Company for the annual principal and interest payments on the stock notes receivable from officers (see Note 6). Under this plan, the Company recognized compensation expense of $124,000, $130,000 and $148,000 in fiscal years 1998, 1997 and 1996, respectively.
STOCK PURCHASE PLAN
The Company maintains a voluntary employee stock purchase plan for all eligible employees. The Company contributes 25% of the amount invested by the employee plus all commissions and brokerage fees.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company contributions vest immediately. Contributions are invested in common stock of the Company by a brokerage firm. The Company recognized expenses for contributions to the plan of $15,000, $23,000, and $36,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
8. RELATED PARTY TRANSACTIONS
The Company makes occasional sales of supplies and equipment to the family-owned restaurant operations of the Chairman of the Company. Sales amounts were $5,000, $7,000, and $7,000 for the years ended September 30, 1998, 1997, and 1996, respectively.
The Chairman of the Company and the family-owned restaurant operations, collectively, were indebted to the Company in the amount of $58,000 and $88,000 on September 30, 1998 and 1997, respectively. Payments on this receivable balance in 1998 include 50,000 shares of Company common stock taken into Treasury Stock in September 1998. This indebtedness includes the loan to purchase Company stock (see Note 6 regarding officer stock notes receivable, secured by Company stock), trade receivables for sales to the family-owned restaurant operations, and other advances. The balance at September 30, 1998 was secured by 40,000 shares of Company stock, in addition to the stock collateral under the officer stock note agreement.
The Company purchases food products manufactured by a Company whose chairman and chief executive officer is a non-employee director of the Company. Purchases were $1,839,000, $2,728,000, and $2,714,000 for the years ended September 30, 1998, 1997 and 1996, respectively. The same vendor purchased items from the Company in the amount of $53,000, $75,000, and $81,000 in 1998, 1997 and 1996, respectively. This vendor also leases the company's cold-storage facilities. The lease term including options runs through October 31, 2000, and represented $60,000 of annual rental revenue for the company in fiscal 1998, 1997 and 1996.
The Company and a former non-employee director were involved in a joint venture to operate a restaurant in Mexico. The Company invested $2,377,000 in its Mexican subsidiaries and operations related to the venture. The joint venture subsidiaries are included in the Company's consolidated financial statements. A company owned by this non-employee director received fees from the joint venture for management services of $36,000 and $48,000 in fiscal 1997 and 1996, respectively. Due to operating losses and negative cash flows for the Mexico operations, the Company transferred its interest in the Mexico operations to its joint venture partner effective May 31, 1997. The Company believes this was the most appropriate method of exiting the Mexico market under the available circumstances.
9. COMMITMENTS AND CONTINGENCIES
The Company has employment contracts with four executives which call for payment of salaries and benefits at or above current levels throughout the contract periods. Those agreements expire in December 2001.
The Company has been named in various lawsuits involving claims in the ordinary course of business, many of which are covered by insurance. Although the amounts of losses from such claims cannot be estimated, in the opinion of management, the ultimate disposition of these lawsuits and claims will not result in a material adverse effect on the Company's financial position, results of operations or cash flows.
10. ASSET IMPAIRMENT AND RESTRUCTURING COSTS
In the quarter ended June 30, 1998, the Company impaired assets at 22 locations based on its continuing evaluation of recoverability of long-lived store assets at 13 locations and its intent to close and dispose of nine locations. The Company initially estimated asset impairment charges of $6,049,000 for 22 restaurant locations, including one previously closed and held for sale. In the 1998 fourth quarter, the Company reversed $368,000 of the impairment charge for land and buildings held for sale, primarily based on the sale of one of the properties completed in October 1998 for significantly more than the previously estimated fair value less cost
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to sell. Impairment charges were determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed Of."
The Company adopted a restructuring plan in the quarter ended June 30, 1998 which involved closing nine restaurants. The Company accrued exit costs of $920,000 for nine locations which were closed by August 10, 1998 under the plan. Four of those nine closures, plus one previously closed, included company-owned land and buildings which the Company plans to sell. Those five owned sites are shown on the balance sheet as land and buildings held for sale.
The Company paid $658,000 and $959,000 in 1998 and 1997, respectively, against restructuring reserves, primarily lease and related expenses and exit costs. Sales for the nine restaurants closed under the 1998 restructuring plan were $932,000 and $6,832,000, respectively, for the quarter and year ended September 30, 1998. Sales for those units totaled $2,175,000 and $7,962,000, respectively, for the quarter and year ended September 30, 1997.
In the quarter ended March 31, 1997, the Company established a restructuring plan which included closing seven underperforming restaurants, disposing of the Mexico joint venture, impairing four other restaurants and increasing the reserves for lease buyout for two previously closed locations.
The Company recorded asset impairment and restructuring charges of $5,066,000 to execute the 1997 restructuring plan. Under the plan, the Company recognized $4,988,000 in asset impairment and restructuring charges in the quarter ended March 31, 1997, and $78,000 more in the quarter ended June 30, 1997. The charges included $3,033,000 for the impairment of land, buildings, leasehold improvements and equipment, determined in accordance with SFAS No. 121. The charge also included $1,538,000 to reserve for exit costs of closed locations. The rest of the charge consisted of a $455,000 loss from the recognition of the Cumulative Translation Adjustment for disposal of the Mexico venture, plus $40,000 to record a valuation allowance for deferred tax assets unlikely to be realized due to the closing of two Arizona locations under the restructuring.
Under the 1997 plan, the Company closed seven U.S. locations on April 15, 1997. The Company has written off its entire investment and transferred its interest in the Mexico venture effective May 31, 1997 to its joint venture partner, a former non-employee director of the Company.
Sales for the seven closed locations plus the Mexico operation were $2,854,000 and $5,512,000 for fiscal years 1997 and 1996, respectively.
11. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
In accordance with the provisions of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," the Company has estimated the fair value of financial instruments as of September 30, 1998. The estimated fair value amounts are determined by using available market information and appropriate valuation methodologies.
The Company's financial instruments under SFAS No. 107 include: accounts receivable, notes receivable, notes payable, accounts payable and long-term debt. The Company has estimated that the carrying amounts of accounts receivable, notes payable and accounts payable approximate fair value due to the short-term maturities of these instruments. Notes receivable bear interest at a rate that approximates the current market rate, therefore, the carrying value approximates the fair value. In addition, because the Company's long-term bank debt bears interest at rates which float with market rates, the Company has estimated that the carrying amount of its long-term debt also approximates its fair value.
PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. SUMMARY OF QUARTERLY RESULTS (UNAUDITED) (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
- ---------------
(1) Fourth quarter 1998 results include a pre-tax benefit of $368,000 to reverse third quarter impairment charges on land and buildings held for sale.
(2) Fourth quarter 1998 results include a pre-tax benefit of $113,000 to reduce insurance reserves for workers' compensation and general liability claims.
(3) Third quarter 1998 results include pre-tax asset impairment and restructuring charges of $6,969,000.
(4) Third quarter 1998 results include income tax expense of $4,305,000 to provide a valuation allowance for deferred tax assets net of deferred tax liabilities.
(5) Second quarter 1998 results include a pre-tax benefit of $212,000 to reduce general liability insurance reserves.
(6) Third quarter 1997 includes pre-tax asset impairment and restructuring charges of $78,000.
(7) Third quarter 1997 results include a pre-tax benefit of $500,000 to reduce insurance reserves for workers' compensation and the Voluntary Employee Injury Benefit (VEIB) Plan.
(8) Second quarter 1997 includes pre-tax asset impairment and restructuring charges of $4,988,000.
(9) Second quarter 1997 results include a pre-tax benefit of $558,000 to reduce insurance reserves for workers' compensation and the VEIB Plan.
(10) Fourth quarter 1996 results include a pre-tax benefit of $162,000 to reduce insurance reserves for workers' compensation and the VEIB Plan.
(11) Third quarter 1996 results include a pre-tax benefit of $179,000 to reduce insurance reserves for the VEIB Plan and to reduce expenses for the employee health insurance plan.
(12) Second quarter 1996 results include a pre-tax benefit of $74,000 to reduce expenses for the employee health insurance plan.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Pancho's Mexican Buffet, Inc.:
We have audited the consolidated balance sheets of Pancho's Mexican Buffet, Inc. and subsidiaries as of September 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Pancho's Mexican Buffet, Inc. and subsidiaries at September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles.
Fort Worth, Texas November 13, 1998
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.
PANCHO'S MEXICAN BUFFET, INC.
By /s/ HOLLIS TAYLOR ----------------------------------- Hollis Taylor, President and Chief Executive Officer (Principal Executive Officer)
December 11, 1998
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
- ---------------