Texas Roadhouse, Inc. - Quarter Report: 2004 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý                                  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 28, 2004

 

OR

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                  

 

Texas Roadhouse, Inc.

(Exact name of registrant specified in its charter)

 

 

Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  o  No  ý.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  ý.

 

The number of shares of Class A and Class B Common Stock outstanding were 30,867,906 and 2,632,688, respectively, on November 18, 2004.

 

 

Explanatory Note

 

Texas Roadhouse, Inc., the registrant whose name appears on the cover of this report, is the parent corporation of Texas Roadhouse Holdings LLC and affiliated entities as a result of a series of acquisition transactions that occurred on October 8, 2004, after the period covered by this report which is prior to our initial public offering.  The financial statements and pro forma share and earnings per share data for the period covered by this report included in Part I are those of Texas Roadhouse Holdings LLC and Entities Under Common Control and do not reflect the effect of the acquisitions and initial public offering.  The financial statements reflecting the effect of the acquisitions and initial public offering for the period covered by this report are included under Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

TABLE OF CONTENTS

 

				Page
PART I. FINANCIAL INFORMATION
	Item 1 – Financial Statements – Texas Roadhouse Holdings LLC and Entities Under Common Control
			Combined Balance Sheets – September 28, 2004 and December 30, 2003	3
			Combined Statements of Income – For the Thirteen and Thirty-nine Weeks Ended September 28, 2004 and September 30, 2003	4
			Combined Statements of Cash Flows – For the Thirty-nine Weeks Ended September 28, 2004 and September 30, 2003	5
			Notes to Combined Financial Statements	6
	Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
	Item 3 – Quantitative and Qualitative Disclosures About Market Risk			30
	Item 4 – Controls and Procedures			30
PART II. OTHER INFORMATION
	Item 1 – Legal Proceedings			31
	Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds			31
	Item 3 – Defaults Upon Senior Securities			31
	Item 4 – Submissions of Matters to a Vote of Security Holders			31
	Item 5 – Other Information			31
	Item 6 – Exhibits			32
	Signatures			33

 

2

 

PART I – FINANCIAL INFORMATION

 

ITEM 1 – FINANCIAL STATEMENTS

 

Texas Roadhouse Holdings LLC and Entities Under Common Control

Combined Balance Sheets

(in thousands, except share and per share data)

 

		Pro forma September 28, 2004			September 28, 2004			December 30, 2003
Assets
Current assets:
Cash and cash equivalents		$	9,395		$	9,395		$	5,728
Receivables, net of allowance for doubtful accounts of $23 and $18 in 2004 and 2003, respectively		5,526			5,526			10,473
Inventories		4,687			4,687			3,505
Prepaid expenses		916			916			1,232
Other current assets		36			36			36
Total current assets		20,560			20,560			20,974
Property and equipment, net		150,669			150,669			123,051
Goodwill		2,190			2,190			2,190
Other assets		2,049			2,049			1,978
Total assets		$	175,468		$	175,468		$	148,193
Liabilities and Stockholders’/Members’ Equity
Current liabilities:
Distributions payable		$	34,195		$	—		$	—
Current maturities of long-term debt		7,888			7,888			8,059
Current maturities of obligations under capital leases		179			179			221
Short term bank revolver		8,000			8,000			—
Accounts payable		12,292			12,292			11,570
Deferred revenue – gift certificates		6,291			6,291			10,885
Accrued wages		2,415			2,415			4,182
Accrued taxes and licenses		4,547			4,547			3,546
Other accrued liabilities		1,719			1,719			2,110
Total current liabilities		77,526			43,331			40,573
Long-term debt, excluding current maturities		68,868			68,868			56,254
Obligations under capital leases, excluding current maturities		837			837			914
Stock option deposits		2,568			2,568			2,455
Deferred rent		1,628			1,628			1,405
Other liabilities		2,681			2,681			3,005
Total liabilities		154,108			119,913			104,606
Minority interest in consolidated subsidiaries		6,663			6,663			5,685
Stockholders’/Members’ equity
Members’ equity		—			48,889			37,902
Preferred stock ($0.001 par value, 1,000,000 shares authorized; no shares outstanding or issued)		—			—			—
Common stock, Class A, ($0.001 par value, 100,000,000 shares authorized, 22,450,157 shares issued and outstanding)		22			—			—
Common stock, Class B, ($0.001 par value, 8,000,000 shares authorized, 2,632,688 shares issued and outstanding)		3			3			—
Additional paid in capital		14,792			—			—
Retained earnings		(77		)	—			—
Accumulated other comprehensive loss		(43		)	—			—
Total stockholders’/members’ equity		14,697			48,892			37,902
Total liabilities and stockholders’/members’ equity		$	175,468		$	175,468		$	148,193

 

See accompanying notes to combined financial statements.

 

3

 

Texas Roadhouse Holdings LLC and Entities Under Common Control

Combined Statements of Income

(in thousands, except per share data)

 

		13 Weeks Ended						39 Weeks Ended
		September 28, 2004			September 30, 2003			September 28, 2004			September 30, 2003
Revenue:
Restaurant sales		$	89,977		$	70,660		$	259,652		$	205,976
Franchise royalties and fees		2,270			1,768			6,412			5,086
Total revenue		92,247			72,428			266,064			211,062
Costs and expenses:
Restaurant operating costs:
Cost of sales		31,294			23,420			90,273			67,397
Labor		24,800			19,899			71,378			57,822
Rent		1,767			1,437			5,120			4,296
Other operating		14,725			12,224			42,180			34,787
Pre-opening		1,414			861			3,560			1,904
Depreciation and amortization		2,776			2,160			7,691			6,319
General and administrative		4,904			4,121			15,327			13,010
Total costs and expenses		81,680			64,122			235,529			185,535
Income from operations		10,567			8,306			30,535			25,527
Interest expense, net		1,121			1,397			3,160			3,436
Minority interest		1,725			1,640			5,582			5,083
Equity income (loss) from investments in unconsolidated affiliates		22			14			92			(22		)
Net income		$	7,743		$	5,283		$	21,885		$	16,986
Pro forma data:
Historical income before taxes		$	7,743		$	5,283		$	21,885		$	16,986
Pro forma provision for income taxes		2,733			1,912			7,722			$	6,149
Net income adjusted for pro forma provision for income taxes		$	5,010		$	3,371		$	14,163		$	10,837
Net income adjusted for pro forma provision for income taxes per common share:
Basic		$	0.20		$	0.14		$	0.57		$	0.46
Diluted		$	0.18		$	0.14		$	0.52		$	0.44
Pro forma weighted average shares outstanding:
Basic		25,079			23,538			25,033			23,442
Diluted		27,155			24,916			27,136			24,822

 

See accompanying notes to combined financial statements.

 

4

 

Texas Roadhouse Holdings LLC and Entities Under Common Control

Combined Statements of Cash Flows

(in thousands)

 

		39 Weeks Ended
		September 28, 2004			September 30, 2003
Cash flows from operating activities:
Net income		$	21,885		$	16,986
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		7,691			6,319
Loss on disposal of assets		89			70
Noncash compensation expense		931			803
Minority interest		5,582			5,083
Equity (income) loss from investments in unconsolidated affiliates		(92		)	22
Distributions received from investments in unconsolidated affiliates		98			29
Provision for doubtful accounts		5			(29		)
Changes in operating working capital:
Receivables		4,942			(1,116		)
Inventories		(1,182		)	(983		)
Prepaid expenses and other current assets		316			948
Other assets		191			425
Accounts payable		723			(733		)
Deferred revenue—gift certificates		(4,594		)	(3,437		)
Accrued wages		(1,767		)	(3,097		)
Accrued taxes and licenses		1,001			906
Accrued other liabilities		(391		)	234
Deferred rent		223			165
Other liabilities		503			(31		)
Net cash provided by operating activities		36,154			22,564
Cash flows from investing activities:
Capital expenditures—property and equipment		(35,404		)	(17,945		)
Proceeds from sale of property and equipment		6			343
Net cash used in investing activities		(35,398		)	(17,602		)
Cash flows from financing activities:
Proceeds from short term bank revolver		8,000			8,000
Proceeds from issuance of long-term debt		19,018			48,550
Proceeds from minority interest contributions and other		300			—
Repayment of stock option deposits		(215		)	(229		)
Proceeds from stock option deposits		433			803
Principal payments on long-term debt		(7,280		)	(46,430		)
Proceeds from repayment of notes receivable-stockholders		—			8
Principal payments on capital lease obligations		(119		)	(183		)
Payments for debt issuance costs		(199		)	(1,673		)
Proceeds from exercise of stock options		754			949
Distributions to minority interest holders		(4,928		)	(5,299		)
Distributions to members		(12,853		)	(11,110		)
Net cash provided by (used in) financing activities		2,911			(6,614		)
Net increase (decrease) in cash		3,667			(1,652		)
Cash and cash equivalents—beginning of period		5,728			7,816
Cash and cash equivalents—end of period		$	9,395		$	6,164
Cash paid during the period—interest, net of amounts capitalized		$	3,002		$	2,777

 

See accompanying notes to combined financial statements.

 

5

 

Texas Roadhouse Holdings LLC and Entities Under Common Control

Notes to Combined Financial Statements

(Tabular amounts in thousands, except per share data)

 

(1)         Basis of Presentation

 

The accompanying unaudited combined financial statements include the accounts of Texas Roadhouse Holdings LLC (“Holdings”), its wholly-owned and majority-owned subsidiaries,  Texas Roadhouse, Inc. (“TRI”), Texas Roadhouse Development Corporation (“TRDC”),  Texas Roadhouse Management Corp., and six license and three franchise restaurants, all of which are under common control by one controlling shareholder (collectively, “Texas Roadhouse Holdings LLC and Entities Under Common Control” or the “Company”) for the 13 and 39 weeks ended September 28, 2004 and September 30, 2003.  The controlling shareholder has the unilateral ability to implement major operating and financial policies for the combining entities. Texas Roadhouse Holdings LLC and its combined subsidiaries operate Texas Roadhouse restaurants. Holdings also provides supervisory and administrative services for certain other license and franchise restaurants. TRDC sells franchise rights and collects the franchise royalties and fees.  TRI is the managing member of Holdings. Texas Roadhouse Management Corp. provides management services to Holdings, TRDC and certain franchise and license restaurants.

 

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the combined financial statements and the reporting of revenue and expenses during the period to prepare these combined financial statements in conformity with U.S. generally accepted accounting principles. Significant items subject to such estimates and assumptions include the carrying amount of property and equipment, goodwill, and obligations related to workers’ compensation, general liability and property insurance. Actual results could differ from those estimates.

 

In the opinion of management, the accompanying unaudited financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position, the results of operations and cash flows of the Company for such periods.  The financial statements have been prepared in accordance with U.S. generally accepted accounting principles, except that certain information and footnotes have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”).  Operating results for the 13 and 39 week periods ended September 28, 2004 are not necessarily indicative of the results that may be expected for the year ending December 28, 2004.  The financial statements should be read in conjunction with the combined financial statements and notes thereto included in Amendment No. 8 to the registration statement on Form S-1 filed by the Company under the Securities Act of 1933 dated October 4, 2004.  See Notes 9 and 10 for further discussion.

 

(2)   Stock-Based Employee Compensation

 

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, (“SFAS No. 123”) and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by existing accounting standards, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123, as amended. The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period.

 

		13 Weeks Ended						39 Weeks Ended
		September 28, 2004			September 30, 2003			September 28, 2004			September 30, 2003
Net income, as reported		$	7,743		$	5,283		$	21,885		$	16,986
Deduct total stock-based-employee compensation expense determined under fair-value-based method for all awards		(117		)	(164		)	(425		)	(744		)
Pro forma net income		$	7,626		$	5,119		$	21,460		$	16,242

 

6

 

(3)   Long-term Debt

 

Long-term debt consisted of the following:

 

		September 28, 2004			December 30, 2003
Installment loans, due 2004-2026		$	14,656		$	14,126
Term loans, due in equal quarterly installments through June 2006		10,900			14,987
Revolver, due July 2006		51,200			35,200
		76,756			64,313
Less current maturities		7,888			8,059
		$	68,868		$	56,254

 

In July 2003, Holdings completed a $100.0 million, three-year syndicated banking arrangement (the “credit facility”), the proceeds of which were used to refinance approximately 80.0% of the existing debt. The credit facility includes approximately $50 million of available financing (the “revolver”) to fund development of new restaurants. The terms of this credit facility require Holdings to pay interest on outstanding term and revolver borrowings at LIBOR plus a margin of 1.50% to 2.75%, plus a commitment fee of 0.25% per year on any unused portion of the credit facility. The weighted average interest rate for term loans outstanding at September 28, 2004 was 4.14%. The weighted average interest rate for the revolver at September 28, 2004 was 4.03%. The debt is secured by certain land, buildings, and equipment.

 

See Note 10, Subsequent Events, for further discussion of the credit facilities of Holdings and TRI.

 

(4)         Recently Adopted Financial Accounting Standards

 

The Company has adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (“FIN 46R”), which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity.

 

FIN 46R excludes from its scope businesses (as defined by FIN 46R) unless certain conditions exist.  The Company believes the franchise entities which operate its restaurants meet the definition of a business.  The Company does not possess any ownership interests in its franchisees other than its investment in various unconsolidated affiliates accounted for under the equity method.  Additionally, the Company generally does not provide financial support to its franchisees in a typical franchise relationship.  As a result of the adoption of FIN 46R, the Company did not consolidate any franchise entities.

 

The Company’s majority-owned or controlled restaurant entities are considered variable interest entities under the provisions of FIN 46R and are currently combined.  The Company’s maximum exposure to loss as a result of its involvement with these entities is estimated to be the investment in the entities and the minority interests’ portion of debt to the Company and total approximately $7.9 million and $8.4 million at September 28, 2004 and December 30, 2003.

 

(5)   Commitments and Contingencies

 

The estimated cost of completing capital project commitments at September 28, 2004 and December 30, 2003 was approximately $26.4 million and $22.6 million, respectively.

 

The Company entered into real estate lease agreements for franchise restaurants located in Everett, MA and Longmont, CO before granting franchise rights for those restaurants. The Company has subsequently assigned the leases to the franchisees, but remains contingently liable if a franchisee defaults under the terms of a lease.  The Longmont lease was assigned in October 2003 and expires in May 2014, while the Everett lease was assigned in September 2002 and expires in February 2018. As the fair value of the guarantees is not considered significant, no liability has been recorded.

 

The Company is involved in various claims and legal actions arising in the normal course of business. In the opinion of management, the ultimate disposition of these matters will not have a material effect on the Company’s combined results of operations, financial position or liquidity.

 

7

 

(6)   Noncash Compensation Expense

 

Some of the Company’s executive officers earned compensation at rates significantly below market levels, and the Company paid no salary or bonus compensation to W. Kent Taylor, the Company’s founder and chairman. General and administrative expense includes an adjustment to record the difference between the actual salary and bonus compensation paid to these officers and the Company’s estimate of the fair market value, based on industry analysis and competitive benchmarking, of the services rendered by these officers.

 

General and administrative expense was increased by approximately $299,000 and $268,000 for the 13 weeks ended September 28, 2004 and September 30, 2003, respectively, and $931,000 and $803,000 for the 39 weeks ended September 28, 2004 and September 30, 2003, respectively.

 

(7)   Stock Split

 

On September 20, 2004, the Company declared a 1.1875-for-one stock split of the Company’s Class A and Class B common stock to stockholders of record immediately prior to the offering to be effective immediately before the consummation of the initial public offering. All share and per share information included in the accompanying combined financial statements for all periods presented have been adjusted to retroactively reflect the stock split.

 

(8)   Related Party Transactions

 

As of September 28, 2004, W. Kent Taylor owned a substantial interest in Buffalo Construction, Inc., a restaurant construction business which provides services to the Company and other restaurant companies. The Company paid Buffalo Construction, Inc. amounts totaling $6.2 million, $16.0 million, $4.3 million and $10.8 million for the 13 and 39 weeks ended September 28, 2004 and September 30, 2003, respectively.  In October 2004, W. Kent Taylor sold his interest in Buffalo Construction, Inc.  Mr. Taylor received a promissory note in the amount of $1.5 million from the purchaser of Buffalo Construction, Inc. in partial consideration of the purchase.

 

The Longview, Texas restaurant, which is being acquired by the Company in connection with the completion of the initial public offering, leases the land and restaurant building from an entity controlled by Steven L. Ortiz, the Company’s Chief Operating Officer. The lease is for 15 years and will terminate in November 2014. The lease can be renewed for two additional periods of five years each. Rent is approximately $16,000 per month and will increase by 5% on each of the 6^th and 11^th anniversary dates of the lease. The lease can be terminated if the tenant fails to pay the rent on a timely basis, fails to maintain the insurance specified in the lease, fails to maintain the building or property or becomes insolvent. Total rent payments were approximately $47,000 and $140,000 in each of the 13 and 39 weeks ended September 28, 2004 and September 30, 2003, respectively.

 

One restaurant is currently leased from an entity owned by W. Kent Taylor and three other stockholders. The lease is for 10 years and will terminate on March 31, 2007. The lease can be renewed for three additional periods of five years each. Rent throughout the term is approximately $12,000 per month. The lease can be terminated if the tenant fails to pay rent on a timely basis, fails to maintain insurance, abandons the property or becomes insolvent. Rent expense for this restaurant was approximately $36,000 and $108,000 in the 13 and 39 weeks ended September 28, 2004 and September 30, 2003, respectively.

 

The Company has eleven license and franchise restaurants owned in whole or part by certain officers, directors and stockholders of the Company. These eleven entities paid the Company fees of approximately $347,000, $1.0 million, $228,000 and $461,000 during the 13 and 39 weeks ended September 28, 2004 and September 30, 2003, respectively.  These entities are not consolidated in the Company’s results.

 

The Company employs Juli Miller Hart, the wife of G.J. Hart, the Company’s Chief Executive Officer, as Director of Public Relations. Ms. Hart reports to W. Kent Taylor who conducts her performance reviews and determines her compensation.

 

WKT Restaurant Corp. (“WKT”), which was owned by W. Kent Taylor, received royalties of approximately $819,000, $2.4 million, $655,000 and $1.9 million for the 13 and 39 weeks ended September 28, 2004 and September 30, 2003, respectively, that it was entitled to receive as consideration for its contribution of the Texas Roadhouse operating system and concept to Holdings.  In May 2004, WKT merged into and with TRI.  After the completion of the initial public offering, as more fully described in Note 10, TRI will no longer receive such royalties.

 

John D. Rhodes, a stockholder, is a director and substantial stockholder of Confluent Inc., which provided certain business intelligence services to the Company through February 2004 for which it was paid an aggregate of $91,000. Services included generating marketing analysis using their proprietary software program and data provided by the Company.  The contract ended in February 2004 and no further amounts will be paid to Confluent Inc.

 

8

 

(9)   Pro forma Adjustments

 

After the Company’s reorganization as a C corporation, the Company will make a distribution of approximately $34.2 million to Holdings’ members, representing undistributed net income for periods through September 28, 2004.  For a description of the Company’s reorganization see Note 10, Subsequent Events.  This distribution is shown on the accompanying pro forma combined balance sheet as distributions payable. In accordance with SEC guidance, 1,252,816 additional Class A shares have been included in the calculation of pro forma share and net income per share data for the 13 and 39 weeks ended September 28, 2004 . The addition of these shares, the value of which would be $21.9 million using an assumed initial offering price of $17.50 per share, gives effect to the sale of the number of additional shares that would have been necessary to pay the distributions in excess of the undistributed net income of Holdings for the twelve months ended September 28, 2004 (which does not include the results of TRDC, Texas Roadhouse Management Corp., WKT, and nine franchise restaurants). The distribution in excess of undistributed net income of Holdings for the twelve months ending September 28, 2004, was calculated as follows:

 

Distributions payable with respect to the net income of Holdings for all periods prior to September 28, 2004					$	34,195
Net income of Holdings for the twelve months ended September 28, 2004		$	22,084
Distributions paid on the net income of Holdings for the twelve months ended September 28, 2004		9,814
Undistributed net income of Holdings for the twelve months ended September 28, 2004					12,270
Distributions payable with respect to the net income of Holdings for all periods prior to September 28, 2004 in excess of its undistributed net income for the twelve months ended September 28, 2004					$	21,925

 

In connection with the reorganization as a C corporation, a pro forma income tax provision has been calculated as if the Company were taxable at an estimated combined effective income tax rate of 35.3% and 36.2% for the 13 and 39 weeks ended September 28, 2004 and September 30, 2003, respectively, and included in the accompanying pro forma combined statements of income. The pro forma income tax provision does not include an adjustment to establish a deferred tax liability related to the $4.9 million excess of the reported amounts of the Company’s assets and liabilities over the tax basis of those assets and liabilities at September 28, 2004.

 

Under the terms of an agreement associated with the formation of TRI, W. Kent Taylor contributed all of his interests in WKT, which owned 178,125 common shares of Holdings and the right to receive a one percent distribution on all sales of company and license Texas Roadhouse restaurants, in exchange for 178,125 shares of TRI Class A common stock and 2,632,688 shares of TRI Class B common stock. The shares and the related distribution have been reflected in the accompanying pro forma combined balance sheet and calculation of pro forma net income per share.

 

Mr. Taylor will also receive 1,754,531 shares of TRI Class A common stock in exchange for his 450 shares in TRDC, and 671,089 shares of TRI Class A common stock in exchange for his 36,651 shares in the six license restaurants and three franchise restaurants. The 2,425,620 Class A shares expected to be issued in exchange for Mr. Taylor’s 37,101 shares in these Texas Roadhouse entities, have been reflected in the accompanying calculation of pro forma net income per share.  The shares reflected in the accompanying calculation of pro forma net income per share vary during the periods presented due to the changes in measurement period and the relative proportion of the component entities’ net income used in the acquisition formulas provided under the corresponding operating or partnership agreements. These calculations are based on the net income of the six license restaurants and three franchise restaurants for the period presented.

 

The number of shares issued to Mr. Taylor for his majority interest in WKT and TRDC was calculated so as to be neither accretive nor dilutive since the 2003 earnings per share impact on our predecessor company, Holdings, was zero. The number of shares issued to Mr. Taylor for his controlling interest in nine restaurants was determined using the acquisition formulas stated in the corresponding operating, partnership or franchise agreements.

 

In addition to the shares expected to be issued to W. Kent Taylor in connection with the above transactions, the accompanying calculations of pro forma net income per share also include the weighted average outstanding shares of 18,767,431 and 18,420,140 for the 13 weeks ended September 28, 2004 and September 30, 2003, respectively, and shares of 18,721,971 and 18,324,465 for the 39 weeks ended September 28, 2004 and September 30, 2003, respectively, of Holdings.  The diluted earnings

 

9

 

per share calculations show the effect of the weighted average stock options outstanding from the Company’s stock option plan.  The following table sets forth the calculation of pro forma weighted average shares outstanding as presented in the accompanying combined statements of income:

 

 

		13 Weeks Ended						39 Weeks Ended
		September 28, 2004			September 30, 2003			September 28, 2004			September 30, 2003
Net income adjusted for pro forma income taxes		$	5,010		$	3,371		$	14,163		$	10,837
Basic EPS:
Weighted-average common shares outstanding:
Holdings		18,768			18,420			18,722			18,324
Shares issued for distribution payable		1,253			—			1,253			—
Class B shares to Mr. Taylor for his interests in WKT		2,633			2,633			2,633			2,633
Class A shares to Mr. Taylor for his interests in TRDC		1,755			1,755			1,755			1,755
Class A shares to Mr. Taylor for his interests in 9 restaurants		670			730			670			730
Shares - basic		25,079			23,538			25,033			23,442
Basic EPS		$	0.20		$	0.14		$	0.57		$	0.46
Diluted EPS:
Weighted-average common shares outstanding:
Shares - basic		25,079			23,538			25,033			23,442
Shares assumed issued on exercise of dilutive share equivalents		3,589			3,849			3,634			3,851
Shares assumed purchased with proceeds of dilutive share equivalents		(1,513		)	(2,471		)	(1,531		)	(2,471		)
Shares - diluted		27,155			24,916			27,136			24,822
Diluted EPS		$	0.18		$	0.14		$	0.52		$	0.44

 

(10)  Subsequent Events

 

On October 8, 2004, the Company completed a reorganization and initial public offering.  In connection with our reorganization and initial public offering the Company:

 

•                  Became a “C” corporation through the merger of Holdings into a wholly owned subsidiary of TRI;

•                  Issued an aggregate of 21,197,341 shares of Class A common stock and 2,632,688 shares of Class B common stock in the combination of our operations under our new holding company, TRI;

•                  Issued an aggregate of 3,089,084 shares of Class A common stock to acquire the remaining equity interests in TRDC and all 31 of our majority-owned or controlled company restaurants (including the remaining equity interests in the 9 controlled franchise restaurants), and all of the equity interests in one franchise restaurant;

•                  Issued and sold 6,250,000 new shares at $17.50 per share, raising approximately $100.2 million after underwriting discounts and transactions costs;

•                  Issued and sold 331,481 additional shares of Class A common stock in the over-allotment option, raising approximately $5.4 million after underwriting discounts and transactions costs;

•                  Repaid $68.9 million of indebtedness on our then existing credit facility with the proceeds raised in the public offering;

•                  Will pay distributions of $34.2 million to the equity holders of Holdings relating to its income for the periods through September 28, 2004;

•                  Will pay estimated distributions of $500,000 to the equity holders of Holdings relating to its income for the periods

 

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from September 29, 2004 through October 8, 2004; and,

•                  Recorded a cumulative net deferred tax liability of $4.9 million and a corresponding charge to its provision for income taxes upon becoming a “C” corporation.

 

The 3,089,084 shares of Class A common stock issued to the equity owners of the merged companies were calculated using predetermined acquisition formulas as required by each entity’s operating, partnership, or franchise agreement.  These transactions will be accounted for as step acquisitions using the purchase method as defined in SFAS No. 141, Business Combinations.  Assuming a purchase price of $54.0 million and our preliminary estimates of the fair value of net assets acquired, $47.4 million of goodwill was generated by the acquisitions.  The purchase price of $54.0 million was calculated using the initial public offering price of $17.50 per share.

 

On October 8, 2004, TRI entered into a new $150.0 million, five-year revolving credit facility with a syndicate of commercial lenders led by Bank of America, N. A., Banc of America Securities LLC and National City Bank of Kentucky. The new facility replaced Holdings’ previous credit facility. The terms of the new facility will require TRI to pay interest on outstanding borrowings at LIBOR plus a margin of 0.75% to 1.50% and to pay a commitment fee of 0.15% to 0.25% per year on any unused portion of the facility, in both cases depending on TRI’s leverage ratio. The facility prohibits TRI from incurring additional debt outside the facility with certain exceptions, including equipment financing up to $3.0 million, unsecured debt up to $500,000 and up to $20.0 million of debt incurred by majority-owned companies formed to open new restaurants.  The facility also prohibits the declaration or payment of cash dividends on TRI’s stock and requires W. Kent Taylor to maintain beneficial ownership of at least 20% of the voting power of TRI’s stock.  Additionally, the lenders’ obligations to extend credit under the facility depends upon maintaining certain financial covenants, including a minimum fixed charge coverage ratio of 1.50 to 1.00 and a maximum consolidated leverage ratio of 3.00 to 1.00. The lenders’ obligation to extend credit under the new facility will depend upon compliance with these covenants. The credit facility is secured by a pledge of TRI’s ownership interests in all subsidiaries.

 

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

Texas Roadhouse is a growing, moderately priced, full-service restaurant chain. Our founder and chairman, W. Kent Taylor, started the business in 1993. Our mission statement is “Legendary Food, Legendary Service.” Our operating strategy is designed to position each of our restaurants as the local hometown destination for a broad segment of consumers seeking high quality, affordable meals served with friendly, attentive service. As of September 28, 2004, 182 Texas Roadhouse restaurants were operating in 34 states, including:

 

•                                          99 “company restaurants,” of which 68 were wholly-owned and 31 were majority-owned or controlled by us and Mr. Taylor. Of these 31 restaurants, 22 were majority-owned by us and nine were license or franchise restaurants under the common control of us and Mr. Taylor. The results of operations of company restaurants are included in our combined operating results. The portion of income attributable to minority interests in company restaurants that are not wholly-owned is reflected in the line item entitled “Minority interest” in our combined statements of income.

 

•                                          83 “franchise restaurants,” of which 79 were franchise restaurants and four were license restaurants. We have a 10.0% ownership interest in two franchise restaurants, a 5.0% ownership interest in eight franchise restaurants, and a 1.0% ownership in one franchise restaurant. The income derived from our minority interests in these franchise restaurants is reported in the line item entitled “Equity income from investments in unconsolidated affiliates” in our combined statements of income. Additionally, we provide various management services to eleven franchise restaurants.

 

Contractual arrangements granted us the right, upon becoming a public company, to acquire at pre-determined valuation formulas (i) the remaining equity interests in all 31 of our majority-owned or controlled company restaurants and (ii) 57 of the franchise restaurants. In connection with our initial public offering on October 8, 2004, we exercised this buyout right with respect to all 31 of such company restaurants and one such franchise restaurant.  As a result, we currently maintain acquisition rights for 56 franchise restaurants.

 

Presentation of Financial and Operating Data

 

As of September 28, 2004 and through the closing of our reorganization and initial public offering on October 8, 2004, we conducted the Texas Roadhouse restaurant business through:

 

•                                          Texas Roadhouse Holdings LLC and its wholly-owned restaurants and 22 majority-owned restaurants;

 

•                                          Texas Roadhouse Development Corporation, holding the rights to franchise Texas Roadhouse restaurants;

 

•                                          Texas Roadhouse Management Corp., providing management services to Texas Roadhouse Holdings LLC,         Texas Roadhouse Development Corporation and certain license and franchise restaurants; and

 

•                                          nine controlled franchise restaurants;

 

all of which were entities under the common control of W. Kent Taylor, our founder and chairman. Our combined historical financial statements and financial and operating data reflect the combined operations and financial position of Texas Roadhouse Holdings LLC and the above affiliated entities.

 

Throughout this report, the 13 weeks ended September 28, 2004 and September 30, 2003 are referred to as Q3 2004 and Q3 2003, respectively, and the 39 weeks ended September 28, 2004 and September 30, 2003 are referred to as 2004 YTD and 2003 YTD, respectively.

 

Corporate Reorganization and Initial Public Offering

 

In connection with our reorganization and initial public offering on October 8, 2004 we:

 

•                  Became a “C” corporation through the merger of Texas Roadhouse Holdings LLC into a wholly owned subsidiary of Texas Roadhouse, Inc.;

•                  Issued an aggregate of 21,197,341 shares of Class A common stock and 2,632,688 shares of Class B common stock in the combination of our operations under our new holding company, Texas Roadhouse, Inc.;

•                  Issued an aggregate of 3,089,084 shares of Class A common stock to acquire the remaining equity interests in Texas

 

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Roadhouse Development Corporation and all 31 of our majority-owned or controlled company restaurants (including the remaining equity interests in the 9 controlled franchise restaurants), and all of the equity interests in one franchise restaurant;

•                  Issued and sold 6,250,000 new shares at $17.50 per share, raising approximately $100.2 million after underwriting discounts and transactions costs;

•                  Issued and sold 331,481 additional shares of Class A common stock in the over-allotment option, raising approximately $5.4 million after underwriting discounts and transactions costs;

•                  Repaid $68.9 million of indebtedness on our then existing credit facility with the proceeds raised in the public offering;

•                  Will pay distributions of $34.2 million to the equity holders of Texas Roadhouse Holdings LLC relating to its income for the periods through September 28, 2004.

 

As a result of all of these transactions, our company has a total of 100 wholly-owned company restaurants and there are 82 franchise restaurants (excluding any restaurants which opened after September 28, 2004), and we have acquisition rights for 56 of the franchise restaurants.

 

Going forward, these transactions will have the following effect on our financial position and results of operations:

 

•                                          first, unlike Texas Roadhouse Holdings LLC, Texas Roadhouse, Inc., as a C corporation, will be subject to state and federal income tax;

•                                          second, upon becoming a “C” corporation, we will record a cumulative net deferred tax liability and a corresponding charge to our provision for income taxes of approximately $4.9 million; and,

•                                          third, as a result of acquiring all of the remaining interests in our majority-owned or controlled restaurants and Texas Roadhouse Development Corporation, all of our 100 company restaurants will be wholly-owned by us and the provision for the related minority interest in our financial statements will be eliminated.

 

The Company’s condensed pro forma combined financial statements reflecting the effect of the acquisition and initial public offering as described above on the period covered by this report are included below under the caption “Condensed Pro Forma Combined Financial Statements.”

 

Long-Term Strategies to Grow Earnings Per Share

 

Our long-term strategies with respect to increasing net income and earnings per share include the following:

 

Expanding Our Restaurant Base.    We will continue to evaluate opportunities to develop Texas Roadhouse restaurants in existing and new markets. We will remain focused primarily on mid-sized markets where we believe there exists a significant demand for our restaurants because of population size, income levels and the presence of shopping and entertainment centers and a significant employment base.

 

Improving Restaurant Level Profitability.    We plan to increase restaurant level profitability through a combination of increased comparable restaurant sales and operating cost management.

 

Leveraging Our Scalable Infrastructure.    Over the past several years, we have made significant investments in our infrastructure, including information systems, real estate, human resources, legal, marketing and operations. As a result, we believe that our general and administrative costs will increase at a slower growth rate than our revenue.

 

Key Measures We Use To Evaluate Our Company

 

Key measures we use to evaluate and assess our business include the following:

 

Number of Restaurant Openings.    Number of restaurant openings reflects the number of restaurants opened during a particular period. For company restaurant openings we incur pre-opening costs, which are defined below, before the restaurant opening. Typically new restaurants open with an initial start-up period of higher than normalized sales volumes, which decrease to a steady level approximately three to six months after opening. However, although sales volumes are generally higher, so are initial costs, resulting in restaurant operating margins that are generally lower during the start-up period of operation and increase to a steady level approximately three to six months after opening.

 

Comparable Restaurant Sales Growth.   Comparable restaurant sales growth reflects the change in year-over-year sales for the comparable restaurant base. We define the comparable restaurant base to include those restaurants open for a full 18 months before the beginning of the later fiscal period. Comparable restaurant sales growth can be generated by an increase in guest traffic counts or by increases in the per person average check amount. Menu price changes and the mix of menu items sold can affect the per person

 

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average check amount.

 

Average Unit Volume.    Average unit volume represents the average annual restaurant sales for all company restaurants open for a full six months before the beginning of the period measured. Growth in average unit volumes in excess of comparable restaurant sales growth is generally an indication that newer restaurants are operating with sales levels in excess of the company average. Conversely, growth in average unit volumes less than growth in comparable restaurant sales growth is generally an indication that newer restaurants are operating with sales levels lower than the company average.

 

Net Income Margin.    Net income margin represents net income as a percentage of revenue.

 

Store Weeks.    Store weeks represent the number of weeks that our company restaurants were open during the reporting period.

 

Other Key Definitions

 

Restaurant Sales.    Restaurant sales include gross food and beverage sales, net of promotions and discounts.

 

Franchise Royalties and Fees.    Franchisees typically pay a $40,000 initial franchise fee for each new restaurant. Franchise royalties consist of royalties in the amount of 2.0% to 4.0% of gross sales paid to us by our franchisees.

 

Restaurant Cost of Sales.    Restaurant cost of sales consists of food and beverage costs.

 

Restaurant Labor Expenses.    Restaurant labor expenses include all direct and indirect labor costs incurred in operations except for profit sharing incentive compensation expenses earned by our managing and market partners. These profit sharing expenses are reflected in restaurant other operating expenses.

 

Restaurant Rent Expense.    Restaurant rent expense includes all rent payments associated with the leasing of real estate and includes base, percentage and straight-line rent.

 

Restaurant Other Operating Expenses.    Restaurant other operating expenses consist of all other restaurant-level operating costs, the major components of which are utilities, supplies, advertising, repair and maintenance, property taxes and other expenses. Profit sharing allocations to market partners and managing partners are also included in restaurant other operating expenses.

 

Restaurant Pre-opening Expenses.    Restaurant pre-opening expenses, which are charged to operations as incurred, consist of expenses incurred before the opening of a new restaurant and are comprised principally of training and opening team salaries, travel expenses, and food, beverage and other initial supplies and expenses.

 

General and Administrative Expenses.    General and administrative expenses (“G&A”) is comprised of expenses associated with corporate and administrative functions that support development and restaurant operations and provide an infrastructure to support future growth. Supervision and accounting fees received from certain franchise restaurants and license restaurants are offset against general and administrative expenses.

 

Depreciation and Amortization Expenses.    Depreciation and amortization expenses (“D&A”) includes the depreciation of fixed assets.

 

Interest Expense, Net.    Interest expense includes the cost of our debt obligations including the amortization of loan fees.

 

Minority Interest.    Our combined subsidiaries at September 28, 2004 included 31 majority-owned or controlled restaurants and Texas Roadhouse Development Corporation. Minority interest represents the portion of income attributable to the other owners of the majority-owned or controlled restaurants and Texas Roadhouse Development Corporation.

 

Equity Income from Unconsolidated Affiliates.    We own a 10.0% equity interest in two franchise restaurants, a 5.0% interest in eight franchise restaurants, and a 1.0% equity interest in one franchise restaurant, all of which were open and operating at September 28, 2004. Equity income from unconsolidated affiliates represents our percentage share of net income earned by these unconsolidated affiliates.

 

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Results of Operations

 

		13 Weeks Ended										39 Weeks Ended
		September 28, 2004					September 30, 2003					September 28, 2004					September 30, 2003
($ in thousands)		$			%		$			%		$			%		$			%
Revenue:
Restaurant sales		$	89,977		97.5	%	$	70,660		97.6	%	$	259,652		97.6	%	$	205,976		97.6	%
Franchise royalties and fees		2,270			2.5		1,768			2.4		6,412			2.4		5,086			2.4
Total revenue		$	92,247		100.0	%	$	72,428		100.0	%	$	266,064		100.0	%	$	211,062		100.0	%
Costs and expenses:
(As a percentage of restaurant sales)
Restaurant operating costs:
Cost of sales		31,294			34.8		23,420			33.1		90,273			34.8		67,397			32.7
Labor		24,800			27.6		19,899			28.2		71,378			27.5		57,822			28.1
Rent		1,767			2.0		1,437			2.0		5,120			2.0		4,296			2.1
Other operating		14,725			16.4		12,224			17.3		42,180			16.2		34,787			16.9
(As a percentage of total revenue)
Pre-opening		1,414			1.5		861			11.9		3,560			1.3		1,904			0.1
Depreciation and amortization		2,776			3.0		2,160			3.0		7,691			2.9		6,319			3.0
General and administrative		4,904			5.3		4,121			5.7		15,327			5.8		13,010			6.2
Total costs and expenses		$	81,680		88.5	%	$	64,122		88.5	%	$	235,529		88.5	%	$	185,535		87.9	%
Income from operations		10,567			11.5		8,306			11.5		30,535			11.5		25,527			12.1
Interest expense, net		1,121			1.2		1,397			1.9		3,160			1.2		3,436			1.6
Minority interest		1,725			1.9		1,640			2.3		5,582			2.1		5,083			2.4
Equity income (loss) from investments in unconsolidated affiliates		22			0.0		14			0.0		92			0.0		(22		)	0.0
Net income		$	7,743		8.4	%	$	5,283		7.3	%	$	21,885		8.2	%	$	16,986		8.1	%

 

Restaurant Unit Activity

 

		Company		Franchise		Total
Balance at December 30, 2003		87		75		162
Openings		2		1		3
Acquisitions (Dispositions)		—		—		—
Closures		—		—		—
Balance at March 30, 2004		89		76		165
Openings		5		3		8
Acquisitions (Dispositions)		—		—		—
Closures		—		—		—
Balance at June 29, 2004		94		79		173
Openings		5		4		9
Acquisitions (Dispositions)		—		—		—
Closures		—		—		—
Balance at September 28, 2004		99		83		182

 

Q3 2004  (13 weeks) Compared to Q3 2003 (13 weeks) and 2004 YTD (39 weeks) Compared to 2003 YTD (39 weeks)

 

Restaurant Sales.    Restaurant sales increased by 27.3% in Q3 2004 as compared to Q3 2003 and by 26.1% in 2004 YTD as compared to 2003 YTD. This increase was primarily attributable to the opening of new restaurants and comparable restaurant sales growth. The following table summarizes additional factors that influenced the changes in restaurant sales at company restaurants.

 

		Q3 2004			Q3 2003			2004 YTD			2003 YTD
Company Restaurants
Store Weeks		1,252			1,069			3,577			3,120
Comparable restaurant sales growth		6.8		%	4.3		%	8.1		%	2.2		%
Average unit volumes (in thousands)		$	919		$	850		$	2,775		$	2,555

 

Franchise Royalties and Fees.    Franchise royalties and fees increased by $502,000, or by 28.4%, from Q3 2003 to Q3 2004 and by $1.3 million, or by 26.1%, in 2004 YTD as compared to 2003 YTD. These increases were primarily attributable to the opening of new franchise restaurants and comparable restaurant sales growth.

 

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