Texas Roadhouse, Inc. - Quarter Report: 2005 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 27, 2005

 

OR

 

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

 

For the transition period from                            to

 

 

Commission File Number 000-50972

 

Texas Roadhouse, Inc.

(Exact name of registrant specified in its charter)

 

 

 

6040 Dutchmans Lane, Suite 400

Louisville, Kentucky 40205

(Address of principal executive offices) (Zip Code)

 

(502) 426-9984

(Registrant’s telephone number, including area code)

 

 

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   ý  No  o.

 

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.

 

Indicate by check mark whether the registrant is a shell company (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 64,802,010 and 5,265,376, respectively, on November 4, 2005.

 

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TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
Item 1 — Financial Statements — Texas Roadhouse, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets — September 27, 2005 and December 28, 2004
Condensed Consolidated Statements of Income — For the Thirteen and Thirty-nine Weeks Ended September 27, 2005 and September 28, 2004
Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income — For the Thirty-nine Weeks Ended September 27, 2005
Condensed Consolidated Statements of Cash Flows — For the Thirty-nine Weeks Ended September 27, 2005 and September 28, 2004
Notes to Condensed Consolidated Financial Statements
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 — Quantitative and Qualitative Disclosures About Market Risk
Item 4 — Controls and Procedures
PART II. OTHER INFORMATION
Item 1 — Legal Proceedings
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 — Defaults Upon Senior Securities
Item 4 — Submissions of Matters to a Vote of Security Holders
Item 5 — Other Information
Item 6 — Exhibits
Signatures

 

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PART I — FINANCIAL INFORMATION

 

ITEM 1 — FINANCIAL STATEMENTS

 

Texas Roadhouse, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

 

		September 27, 2005			December 28, 2004
Assets
Current assets:
Cash and cash equivalents		$	15,136		$	46,235
Receivables, net of allowance for doubtful accounts of $24		7,485			6,139
Inventories		5,647			5,169
Prepaid income taxes		724			—
Prepaid expenses		904			2,652
Deferred tax assets		591			499
Other current assets		36			144
Total current assets		30,523			60,838
Property and equipment, net		192,556			162,991
Goodwill		50,753			50,753
Other assets		1,411			1,272
Total assets		$	275,243		$	275,854
Liabilities and Stockholders’ Equity
Current liabilities:
Distributions payable		$	—		$	31,176
Current maturities of long-term debt		487			525
Current maturities of obligations under capital leases		179			198
Accounts payable		10,982			12,093
Deferred revenue — gift certificates		6,139			14,676
Accrued wages		6,581			7,285
Income taxes payable		—			544
Accrued taxes and licenses		4,524			4,275
Other accrued liabilities		4,911			3,647
Total current liabilities		33,803			74,419
Long-term debt, excluding current maturities		6,384			12,760
Obligations under capital leases, excluding current maturities		639			771
Stock option deposits		3,085			2,617
Deferred rent		4,250			3,781
Deferred tax liabilities		3,844			5,100
Other liabilities		2,560			2,496
Total liabilities		54,565			101,944
Minority interest in consolidated subsidiaries		649			699
Stockholders’ equity
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, 64,414,450 and 61,856,680 shares issued and outstanding at September 27, 2005 and December 28, 2004, respectively)		64			62
Common stock, Class B, ($0.001 par value, 8,000,000 shares authorized, 5,265,376 shares issued and outstanding)		5			5
Additional paid in capital		196,535			173,621
Retained earnings (loss)		23,425			(584		)
Accumulated other comprehensive gain		—			107
Total stockholders’ equity		220,029			173,211
Total liabilities and stockholders’ equity		$	275,243		$	275,854

 

See accompanying notes to condensed consolidated financial statements.

 

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Texas Roadhouse, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(in thousands, except per share data)

 

		13 Weeks Ended						39 Weeks Ended
		September 27, 2005			September 28, 2004			September 27, 2005			September 28, 2004
Revenue:
Restaurant sales		$	111,642		$	89,977		$	333,357		$	259,652
Franchise royalties and fees		2,685			2,270			7,794			6,412
Total revenue		114,327			92,247			341,151			266,064
Costs and expenses:
Restaurant operating costs:
Cost of sales		39,335			31,294			117,275			90,273
Labor		30,715			24,800			90,431			71,378
Rent		2,099			1,767			6,225			5,120
Other operating		19,205			14,725			54,697			42,180
Pre-opening		1,874			1,414			4,044			3,560
Depreciation and amortization		3,818			2,776			10,541			7,691
General and administrative		6,157			4,904			20,353			15,327
Total costs and expenses		103,203			81,680			303,566			235,529
Income from operations		11,124			10,567			37,585			30,535
Interest expense, net		93			1,121			162			3,160
Minority interest		181			1,725			402			5,582
Equity income from investments in unconsolidated affiliates		(65		)	(22		)	(87		)	(92		)
Income before taxes		$	10,915		$	7,743		$	37,108		$	21,885
Provision for income taxes		3,854			—			13,099			—
Net income		$	7,061		$	7,743		$	24,009		$	21,885
					Pro forma						Pro forma
Historical net income					$	7,743					$	21,885
Pro forma provision for income taxes					2,733						7,722
Net income adjusted for pro forma provision for income taxes					$	5,010					$	14,163
Net income per common share:
Basic		$	0.10		$	0.11		$	0.35		$	0.30
Diluted		$	0.10		$	0.10		$	0.33		$	0.27
Weighted average shares outstanding:
Basic		69,471			47,652			68,166			47,560
Diluted		73,833			51,804			72,538			51,766

 

See accompanying notes to condensed consolidated financial statements.

 

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Texas Roadhouse, Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income

(in thousands, except share data)

 

 

		Class A					Class B											Accumulated
		Shares		Par Value			Shares		Par Value			Paid in Capital			Retained Earnings (Deficit)			Other Comprehensive Income (Loss)			Total
Balance, December 28, 2004		61,856,680		$	62		5,265,376		$	5		$	173,621		$	(584	)	$	107		$	173,211
Comprehensive income:
Realized gain on derivatives, net of tax		—		—			—		—			—			—			(107		)	(107		)
Net income		—		—			—		—			—			24,009			—			24,009
Total comprehensive income																					23,902
Shares issued under stock option plan, including related tax effects		1,857,770		2			—		—			11,912			—			—			11,914
Minority interest liquidation adjustments		—		—			—		—			36			—			—			36
Issuance of Class A Common Stock in follow-on offering		700,000		—			—		—			12,163			—			—			12,163
Follow-on offering expenses		—		—			—		—			(1,197		)	—			—			(1,197		)
Balance, September 27, 2005		64,414,450		$	64		5,265,376		$	5		$	196,535		$	23,425		$	—		$	220,029

 

See accompanying notes to condensed consolidated financial statements.

 

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Texas Roadhouse, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in thousands)

 

		39 Weeks Ended
		September 27, 2005			September 28, 2004
Cash flows from operating activities:
Net income		$	24,009		$	21,885
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		10,541			7,691
Deferred income taxes		(1,348		)	—
Loss on disposal of assets		164			89
Noncash compensation expense		—			931
Minority interest		402			5,582
Equity income from investments in unconsolidated affiliates		(87		)	(92		)
Distributions received from investments in unconsolidated affiliates		204			98
Provision for doubtful accounts		—			5
Income tax benefit from exercise of stock options		7,645			—
Changes in operating working capital:
Receivables		(1,346		)	4,942
Inventories		(478		)	(1,182		)
Prepaid income taxes		(724		)	—
Prepaid expenses and other current assets		1,748			316
Other assets		(255		)	191
Accounts payable		(1,111		)	723
Deferred revenue—gift certificates		(8,537		)	(4,594		)
Accrued wages		(704		)	(1,767		)
Income taxes payable		(544		)	—
Accrued taxes and licenses		249			1,001
Other accrued liabilities		1,264			(391		)
Deferred rent		469			223
Other liabilities		64			503
Net cash provided by operating activities		31,625			36,154
Cash flows from investing activities:
Capital expenditures—property and equipment		(40,270		)	(35,404		)
Proceeds from sale of property and equipment		—			6
Net cash used in investing activities		(40,270		)	(35,398		)
Cash flows from financing activities:
Proceeds from short term bank revolver		—			8,000
Proceeds from issuance of long-term debt		—			19,018
Proceeds from minority interest contributions and other		70			300
Repayment of stock option deposits		(170		)	(215		)
Proceeds from stock option deposits		888			433
Principal payments on long-term debt		(6,414		)	(7,280		)
Principal payments on capital lease obligations		(151		)	(119		)
Payments for debt issuance costs		—			(199		)
Proceeds from exercise of stock options		4,018			754
Proceeds from follow-on offering		12,163			—
Payment of follow-on offering expenses		(1,197		)	—
Distributions to minority interest holders		(485		)	(4,928		)
Distributions to members		(31,176		)	(12,853		)
Net cash (used in) provided by financing activities		(22,454		)	2,911
Net (decrease) increase in cash		(31,099		)	3,667
Cash and cash equivalents—beginning of period		46,235			5,728
Cash and cash equivalents—end of period		$	15,136		$	9,395
Supplemental disclosures of cash flow information:
Interest, net of amounts capitalized		$	612		$	3,002
Income taxes		$	8,069		$	—

 

See accompanying notes to condensed consolidated financial statements.

 

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Texas Roadhouse, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Tabular amounts in thousands, except per share data)

 

(1)   Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of Texas Roadhouse, Inc. (the “Company”), its wholly-owned subsidiaries, Texas Roadhouse Holdings LLC (“Holdings”), Texas Roadhouse Development Corporation (“TRDC”), and Texas Roadhouse Management Corp. (“Management Corp.”), for the 13 and 39 weeks ended September 27, 2005 and September 28, 2004.  The Company and its wholly-owned subsidiaries operate Texas Roadhouse restaurants. Holdings also provides supervisory and administrative services for certain other franchise and license restaurants. TRDC sells franchise rights and collects the franchise royalties and fees.  Management Corp. provides management services to Holdings, TRDC and certain franchise and license restaurants.

 

Prior to October 8, 2004, the condensed consolidated financial statements included the accounts of Holdings and its wholly-owned and majority-owned subsidiaries, TRDC, WKT Restaurant Corp. (“WKT”), and Management Corp. and three franchise and six license restaurants, all of which were under common control by one controlling shareholder.  The controlling shareholder had the unilateral ability to implement major operating and financial policies for the entities.  On October 8, 2004, Holdings and its wholly-owned and majority-owned subsidiaries completed a reorganization and initial public offering.  In connection with the reorganization and public offering, Holdings became a subsidiary of the Company.

 

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 condensed consolidated financial statements and the reporting of revenue and expenses during the period to prepare these condensed consolidated 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 27, 2005 are not necessarily indicative of the results that may be expected for the year ending December 27, 2005.  The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s report on Form 10-K for the year ended December 28, 2004.

 

In the third quarter of 2005, the Company began recording credit card fees in the month in which the fees are incurred, rather than the month in which the fees are paid. This change resulted in a one-time, non-cash charge of $0.5 million ($0.3 million, net of tax) to restaurant other operating costs.

 

Certain prior year amounts have been reclassified to conform with the current year presentation.  These reclassifications had no effect on previously reported net income.

 

(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 (“APB No. 25”), 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.

 

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		13 Weeks Ended						39 Weeks Ended
		September 27, 2005			September 28, 2004			September 27, 2005			September 28, 2004
Net income, 2004 as adjusted for pro forma provision for income taxes		$	7,061		$	5,010		$	24,009		$	14,163
Deduct total stock-based-employee compensation expense determined under fair-value-based method for all awards, net of taxes		(1,340		)	(76		)	(3,027		)	(278		)
Pro forma net income		$	5,721		$	4,934		$	20,982		$	13,885
Earnings per share:
Basic — as reported		$	0.10		$	0.11		$	0.35		$	0.30
Basic — pro forma		$	0.08		$	0.10		$	0.31		$	0.29
Diluted — as reported		$	0.10		$	0.10		$	0.33		$	0.27
Diluted — pro forma		$	0.08		$	0.10		$	0.29		$	0.27

 

 

(3)   Long-term Debt

 

Long-term debt consisted of the following:

 

		September 27, 2005			December 28, 2004
Installment loans, due 2005-2026		$	6,871		$	7,285
Revolver, due October 2009		—			6,000
		6,871			13,285
Less current maturities		487			525
		$	6,384		$	12,760

 

In October 2004, the Company completed a $150.0 million, five-year revolving credit facility which replaced a credit facility dated July 2003.  The terms of this credit facility require the Company to pay interest on outstanding borrowings at LIBOR plus a margin of 0.75% to 1.50%, plus a commitment fee of 0.15% to 0.25% per year on any unused portion of the facility, in both cases, depending on the Company’s leverage ratio.  The facility prohibits the Company 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 the Company’s stock and requires W. Kent Taylor to maintain beneficial ownership of at least 20% of the voting power of the Company’s stock. Additionally, the lenders’ obligation 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 credit facility is secured by a pledge of our ownership interests in all subsidiaries. The weighted average interest rate for the revolver at September 27, 2005 was 3.06%.  At September 27, 2005, the Company had no borrowings outstanding under its credit facility and $148.2 million of availability net of $1.8 million of outstanding letters of credit.  In addition, the Company had various other notes payable totaling $6.9 million with interest rates ranging from 5.65% to 10.80%.  The majority of these notes related to the financing of specific restaurants.  The Company’s total weighted average effective interest rate at September 27, 2005 was 9.14%.

 

(4)   Recently Adopted or Issued Financial Accounting Standards

 

In October 2004, the Financial Accounting Standards Board (“FASB”) ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue 04-1, Accounting for Preexisting Relationships between the Parties to a Business Combination, (“EITF No. 04-1”). EITF No. 04-1 requires that a business combination between two parties that have a preexisting relationship be evaluated to determine if a settlement of a preexisting relationship exists. EITF No. 04-1 also requires that certain reacquired rights (including the rights to the acquirer’s trade name under a franchise agreement) be recognized as intangible assets apart from goodwill. However, if a contract giving rise to the reacquired rights includes terms that are favorable or unfavorable when compared to pricing for current market transactions for the same or similar items, EITF No. 04-1 requires that a settlement gain or loss should be measured as the lesser of i) the amount by which the contract is favorable or unfavorable under market terms from the perspective of the acquirer or ii) the stated settlement provisions of the contract available to the counterparty to which the contract is unfavorable.

 

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EITF No. 04-1 was effective prospectively for business combinations consummated in reporting periods beginning after October 13, 2004 (fiscal year beginning December 29, 2004 for the Company). EITF No. 04-1 will apply to acquisitions of restaurants the Company may make from our franchisees or licensees. The Company currently attempts to have its franchisees or licensees enter into standard franchise or license agreements when renewing or entering into a new agreement. However, in certain instances franchisees or licensees have existing agreements that possess terms that differ from the Company’s current standard agreements. If in the future the Company were to acquire a franchisee or licensee with such an existing agreement, the Company would be required to record a

settlement gain or loss at the date of acquisition. The amount and timing of any such gains or losses the Company might record is dependent upon which franchisees or licensees the Company might acquire and when they are acquired. The Company has announced its intention to acquire 11 franchise restaurants later in the fourth quarter of 2005.  In addition, the Company has begun negotiations to acquire another six to ten restaurants during the first half of 2006.  Should the acquisitions be completed within the estimated time frame the Company will record a one-time, non-cash charge of approximately $0.8 million ($0.5 million, net of tax) relating to the 2005 acquisitions and $1.3 million ($0.8 million, net of tax) relating to the 2006 acquisitions.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), which revised SFAS No. 123, supercedes APB No. 25 and related interpretations and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123R addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services with a primary focus on transactions in which an entity obtains employee services in share-based payment transactions. The provisions of SFAS No. 123R are similar to those of SFAS No. 123, however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements as compensation cost based on their fair value on the date of grant. Fair value of share-based awards will be determined using option-pricing models (e.g. Black Scholes or binomial models) and assumptions that appropriately reflect the specific circumstances of the awards. Compensation cost will be recognized over the vesting period based on the fair value of the awards that actually vest. SFAS No. 123R also requires the benefit of tax deductions in excess of recognized compensation costs to be reported as financing cash flow, rather than an operating cash flow as required under current accounting rules. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

 

On April 15, 2005, the SEC announced the deferral of the effective date of SFAS No. 123R for calendar year companies until the beginning of the first fiscal year beginning after June 15, 2005 (the year beginning December 28, 2005 for the Company).  As of the effective date, the Company will apply the statement using a modified version of prospective application.  Under that transition method, compensation cost is recognized for (i) all awards granted after the required effective date and for awards modified, cancelled or repurchased after that date, and (ii) the portion of prior awards granted on or after October 4, 2004 for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated for either recognition or pro forma disclosures under SFAS 123.

 

The impact of this statement on the Company in fiscal 2006 and beyond will depend upon various factors, including, but not limited to, the Company’s future compensation strategy.  The pro forma compensation costs presented in Note 2 and in the Company’s prior filings have been calculated using a Black-Scholes option pricing model and may not be indicative of amounts which should be expected in future years.  The Company currently estimates the adoption of SFAS No. 123R will decrease net income and diluted earnings per common share for the year ending December 28, 2006 by approximately $3.9 million to $4.5 million and $0.05 to $0.06 per share, respectively. The Company used the following weighted average assumptions in estimating the impact of the adoption of SFAS No. 123R: (i) no dividend yield on the Company’s Class A stock, (ii) expected volatility of the Company’s Class A stock of 44% to 46%, (iii) risk-free rates ranging from 4% to 5%, and (iv) expected option life of four years.

 

In October 2005, the FASB issued Staff Position FAS 13-1, Accounting for Rental Costs Incurred during a Construction Period, which requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense.  This Staff Position is effective for reporting periods beginning after December 15, 2005, and retrospective application is permitted but not required.  The Company currently capitalizes rent incurred during the tenant improvement construction phase.  The Company expects to incur additional pre-opening expense in fiscal 2006 of approximately $0.5 million to $0.6 million related to expensing rental costs associated with the construction of new restaurants. The Company has not yet determined if it will apply retrospective application.

 

(5)   Commitments and Contingencies

 

The estimated cost of completing capital project commitments at September 27, 2005 and September 28, 2004 was approximately $52.3 million and $26.4 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 was not considered significant, no liability was 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 consolidated results of operations, financial position or liquidity.

 

9

 

(6)   Noncash Compensation Expense

 

Prior to October 8, 2004, 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 for the 13 weeks and 39 weeks ended September 28, 2004 includes an adjustment of $0.3 million and $0.6 million 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.

 

(7)   Stock Split

 

On August 18, 2005, the Company declared a two-for-one stock split of the Company’s Class A and Class B common stock to stockholders of record as of the close of business on September 6, 2005.  The stock split was effected in the form of a 100% stock dividend on September 23, 2005.  All share and per share information included in the accompanying condensed consolidated financial statements for all periods presented have been adjusted to retroactively reflect the stock split.

 

(8)   Related Party Transactions

 

Prior to October 8, 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 and $16.0 million for the 13 and 39 weeks ended September 28, 2004, 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 was 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 6th and 11th 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 $49,000 and $47,000 for the 13 weeks ended September 27, 2005 and September 28, 2004, respectively.  For the 39 weeks ended September 27, 2005 and September 28, 2004, rent payments were approximately $148,000 and $140,000, respectively.

 

Prior to September 22, 2005, the Elizabethtown, Kentucky restaurant was leased from an entity owned by W. Kent Taylor and three other stockholders.   On September 22, 2005, the Company purchased the land and building associated with the Elizabethtown, Kentucky restaurant for $1.5 million.  Rent expense for this restaurant was approximately $29,000 and $45,000 for the 13 weeks ended September 27, 2005 and September 28, 2004, respectively.  For the 39 weeks ended September 27, 2005 and September 28, 2004, rent expense was approximately $102,000 and $117,000, respectively.  The lease was terminated upon purchase of the land and building.

 

The Company had 13 and 12 franchise and license restaurants owned in whole or part by certain officers, directors and 5% stockholders of the Company at September 27, 2005 and September 28, 2004, respectively. These entities paid the Company fees of approximately $0.4 million during the 13 weeks ended September 27, 2005 and September 28, 2004.  For the 39 weeks ended September 27, 2005 and September 28, 2004, these entities paid the Company fees of approximately $1.3 million and $1.1 million, 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, which was owned by W. Kent Taylor, received royalties of approximately $1.3 million for the 39 weeks ended September 28, 2004 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 the Company.  After the completion of the initial public offering, the Company no longer receives such royalties. These royalties were classified as distributions in the Company’s consolidated statement of stockholders’ equity and comprehensive income.

 

John D. Rhodes, a stockholder, was 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.  After completion of the corporate reorganization and initial public offering on October 8, 2004, Dr. Rhodes is no longer a 5% stockholder of the Company.

 

(9)   Pro forma Adjustments

 

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% for the 13 and 39 weeks ended September 28, 2004 and included in the accompanying pro forma provision for income tax.

 

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(10)   Earnings Per Share

 

The share and net income per share data for all periods presented are based on the historical weighted average shares outstanding.  The diluted earnings per share calculations show the effect of the weighted average stock options outstanding from the Company’s stock option plan. The 2004 net income per share data reflects a pro forma income tax provision.

 

		13 Weeks Ended						39 Weeks Ended
		September 27, 2005			September 28, 2004			September 27, 2005			September 28, 2004
Net income, 2004 as adjusted for pro forma income taxes		$	7,061		$	5,010		$	24,009		$	14,163
Basic EPS:
Weighted-average common shares outstanding		69,471			47,652			68,166			47,560
Basic EPS		$	0.10		$	0.11		$	0.35		$	0.30
Diluted EPS:
Weighted-average common shares outstanding		69,471			47,652			68,166			47,560
Dilutive effect of stock options		4,362			4,152			4,372			4,206
Shares — diluted		73,833			51,804			72,538			51,766
Diluted EPS		$	0.10		$	0.10		$	0.33		$	0.27

 

 

For the 13 and 39 weeks ended September 27, 2005, options to purchase 390,676 shares of common stock were outstanding but not included in the computation of diluted earnings  per share because their inclusion would have had an anti-dilutive effect.  For the 13 and 39 weeks ended September 28, 2004, all unexercised stock options were included in the computation of diluted earnings per share because their exercise prices were less than the average market price of our common stock during the respective periods.  The Company issued 390,676 stock options at $18.66 per share and 1,147,276 stock options at a weighted average grant price of $15.84 per share during the thirteen and thirty-nine weeks ended September 27, 2005, respectively.  Additionally, 354,838 and 1,857,760 shares were exercised in the thirteen and thirty-nine weeks ended September 27, 2005, respectively.

 

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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 27, 2005, 214 Texas Roadhouse restaurants were operating in 39 states, including:

 

•  120 “company restaurants,” of which 117 were wholly-owned and three were majority-owned.  The results of operations of company restaurants are included in our consolidated 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 condensed consolidated statements of income.

 

•  94 “franchise restaurants,” of which 90 were franchise restaurants and four were license restaurants. We have a 10.0% ownership interest in three franchise restaurants, a 5.0% ownership interest in 13 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 condensed consolidated statements of income. Additionally, we provide various management services to 17 franchise restaurants.

 

We have contractual arrangements which grant us the right to acquire at pre-determined valuation formulas (i) the remaining equity interests in the three majority-owned company restaurants and (ii) 68 of the franchise restaurants.

 

Presentation of Financial and Operating Data

 

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 franchise and license restaurants; and

•           nine controlled franchise restaurants;

 

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

 

Since the closing of our reorganization and initial public offering on October 8, 2004, we conduct the Texas Roadhouse restaurant business through Texas Roadhouse, Inc.

 

Throughout this report, the 13 weeks ended September 27, 2005 and September 28, 2004 are referred to as Q3 2005 and Q3 2004, respectively, and the 39 weeks ended September 27, 2005 and September 28, 2004 are referred as 2005 YTD and 2004 YTD, respectively.

 

On August 18, 2005, the Company declared a two-for-one stock split of the Company’s Class A and Class B common stock to stockholders of record as of the close of business on September 6, 2005.  The stock split was effected in the form of a 100% stock dividend on September 23, 2005.  All share and per share information included throughout this report for all periods presented have been adjusted to retroactively reflect the stock split.

 

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 combination of our operations into a new holding company, Texas Roadhouse, Inc.;

•                                          Issued an aggregate of 42,515,558 shares of Class A common stock and 5,265,376 shares of Class B common stock in the combination of our operations under Texas Roadhouse, Inc.;

•                                          Issued an aggregate of 6,178,160 shares of Class A common stock to acquire the remaining equity interests in Texas 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;

 

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•                                          Issued and sold 13,162,962 new shares at $8.75 per share, raising approximately $105.1 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;

•                                          Recorded distributions payable of $31.2 million to the equity holders of Texas Roadhouse Holdings LLC in redemption of its preferred shares relating to its income for the periods prior to October 8, 2004.

 

The reorganization has impacted our financial position and results of operations as follows:

 

•                                          First, unlike Texas Roadhouse Holdings LLC, Texas Roadhouse, Inc., as a “C” corporation, is subject to state and federal income tax;

•                                          Second, upon becoming a “C” corporation, we recorded a cumulative net deferred tax liability and a corresponding charge to our provision for income taxes of approximately $5.0 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 but three of our company restaurants are wholly-owned by us. The provision for the minority interest related to the acquired entities has been eliminated from our 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.

 

We may, at our discretion, add franchise restaurants primarily with franchisees who have demonstrated prior success with the Texas Roadhouse or other restaurant concepts and in markets in which the franchisee demonstrates superior knowledge of the demographics and restaurant operating conditions.

 

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 fiscal period. For company restaurant openings we incur pre-opening costs, which are defined below, before the restaurant opens. 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 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.

 

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.

 

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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 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.

 

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

 

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.

 

Interest Expense, Net.   Interest expense includes the cost of our debt obligations including the amortization of loan fees and any interest income earned, net of any interest capitalized. Interest income includes earnings on cash and cash equivalents.

 

Minority Interest.   Our consolidated subsidiaries at September 27, 2005 included three majority-owned restaurants.  Our consolidated 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 Investments in Unconsolidated Affiliates.   We own a 10.0% equity interest in three franchise restaurants, a 5.0% interest in 13 franchise restaurants, and a 1.0% equity interest in one franchise restaurant, all of which were open and operating at September 27, 2005. Equity income from investments in 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 27, 2005				September 28, 2004				September 27, 2005				September 28, 2004
		$		%		$		%		$		%		$		%
		($ in thousands)
Revenue:
Restaurant sales		111,642		97.7		89,977		97.5		333,357		97.7		259,652		97.6
Franchise royalties and fees		2,685		2.3		2,270		2.5		7,794		2.3		6,412		2.4
Total revenue		114,327		100.0		92,247		100.0		341,151		100.0		266,064		100.0
Costs and expenses: (As a percentage of restaurant sales)
Restaurant operating costs:
Cost of sales		39,335		35.2		31,294		34.8		117,275		35.2		90,273		34.8
Labor		30,715		27.5		24,800		27.6		90,431		27.1		71,378		27.5
Rent		2,099		1.9		1,767		2.0		6,225		1.9		5,120		2.0
Other operating (As a percentage of total revenue)		19,205		17.2		14,725		16.4		54,697		16.4		42,180		16.2
Pre-opening		1,874		1.6		1,414		1.5		4,044		1.2		3,560		1.3
Depreciation and amortization		3,818		3.3		2,776		3.0		10,541		3.1		7,691		2.9
General and administrative		6,157		5.4		4,904		5.3		20,353		6.0		15,327		5.8
Total costs and expenses		103,203		90.3		81,680		88.5		303,566		89.0		235,529		88.5
Income from operations		11,124		9.7		10,567		11.5		37,585		11.0		30,535		11.5
Interest expense, net		93		0.1		1,121		1.2		162		NM		3,160		1.2
Minority interest		181		0.2		1,725		1.9		402		0.1		5,582		2.1
Equity income from investments in unconsolidated affiliates		(65	)	(0.1	)	(22	)	NM		(87	)	NM		(92	)	NM
Income before taxes		10,915		9.5		7,743		8.4		37,108		10.9		21,885		8.2
Provision for income taxes		3,854		3.3		—		—		13,099		3.9		—		—
Net income		7,061		6.2		7,743		8.4		24,009		7.0		21,885		8.2

NM - Not meaningful

 

Restaurant Unit Activity

 

		Company		Franchise		Total
Balance at December 28, 2004		107		86		193
Openings		4		1		5
Acquisitions (Dispositions)		—		—		—
Closures		—		—		—
Balance at March 29, 2005		111		87		198
Openings		2		4		6
Acquisitions (Dispositions)		—		—		—
Closures		—		—		—
Balance at June 28, 2005		113		91		204
Openings		7		3		10
Acquisitions (Dispositions)		—		—		—
Closures		—		—		—
Balance at September 27, 2005		120		94		214

 

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