Texas Roadhouse, Inc. - Quarter Report: 2005 June (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 June 28, 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)

 

Delaware		20-1083890
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)
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.

 

The number of shares of Class A and Class B common stock outstanding were 32,070,402 and 2,632,688, respectively, on August 5, 2005.

 

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
Item 1 – Financial Statements – Texas Roadhouse, Inc. and Subsidiaries
	Condensed Consolidated Balance Sheets – June 28, 2005 and December 28, 2004
	Condensed Consolidated Statements of Income – For the Thirteen and Twenty-six Weeks Ended June 28, 2005 and June 29, 2004
	Condensed Consolidated Statements of Cash Flows – For the Twenty-six Weeks Ended June 28, 2005 and June 29, 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)

 

		June 28, 2005			December 28, 2004
Assets
Current assets:
Cash and cash equivalents		$	9,481		$	46,235
Receivables, net of allowance for doubtful accounts of $24		6,835			6,139
Inventories		5,687			5,169
Prepaid expenses		1,413			2,652
Deferred tax asset		600			499
Other current assets		1,268			144
Total current assets		25,284			60,838
Property and equipment, net		181,238			162,991
Goodwill		50,753			50,753
Other assets		1,292			1,272
Total assets		$	258,567		$	275,854
Liabilities and Stockholders’ Equity
Current liabilities:
Distributions payable		$	—		$	31,176
Current maturities of long-term debt		476			525
Current maturities of obligations under capital leases		198			198
Accounts payable		11,519			12,093
Deferred revenue – gift certificates		7,049			14,676
Accrued wages		7,938			7,285
Income taxes payable		5,287			544
Accrued taxes and licenses		1,564			4,275
Other accrued liabilities		4,487			3,647
Total current liabilities		38,518			74,419
Long-term debt, excluding current maturities		10,511			12,760
Obligations under capital leases, excluding current maturities		699			771
Stock option deposits		2,885			2,617
Deferred rent		4,115			3,781
Deferred tax liability		5,150			5,100
Other liabilities		2,812			2,496
Total liabilities		64,690			101,944
Minority interest in consolidated subsidiaries		678			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, 31,679,481 and 30,928,340 shares issued and outstanding at June 28, 2005 and December 28, 2004, respectively)		32			31
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		176,800			173,654
Retained earnings (loss)		16,364			(584		)
Accumulated other comprehensive gain		—			107
Total stockholders’ equity		193,199			173,211
Total liabilities and stockholders’ equity		$	258,567		$	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						26 Weeks Ended
		June 28, 2005			June 29, 2004			June 28, 2005			June 29, 2004
Revenue:
Restaurant sales		$	113,108		$	87,782		$	221,715		$	169,675
Franchise royalties and fees		2,649			2,137			5,109			4,142
Total revenue		115,757			89,919			226,824			173,817
Costs and expenses:
Restaurant operating costs:
Cost of sales		39,906			30,806			77,940			58,979
Labor		30,473			24,303			59,716			46,578
Rent		2,089			1,730			4,126			3,353
Other operating		18,109			14,121			35,492			27,455
Pre-opening		1,135			1,250			2,170			2,146
Depreciation and amortization		3,475			2,567			6,723			4,916
General and administrative		7,886			5,853			14,196			10,422
Total costs and expenses		103,073			80,630			200,363			153,849
Income from operations		12,684			9,289			26,461			19,968
Interest expense, net		112			1,012			69			2,039
Minority interest		194			1,898			221			3,857
Equity (loss) income from investments in unconsolidated affiliates		(30		)	26			22			70
Income before taxes		12,348			6,405			26,193			14,142
Provision for income taxes		4,358			—			9,245			—
Net income		$	7,990		$	6,405		$	16,948		$	14,142
					Pro forma						Pro forma
Historical net income					$	6,405					$	14,142
Pro forma provision for income taxes					2,258						4,989
Net income adjusted for pro forma provision for income taxes					$	4,147					$	9,153
Net income per common share:
Basic		$	0.24		$	0.17		$	0.50		$	0.39
Diluted		$	0.22		$	0.16		$	0.47		$	0.36
Weighted average shares outstanding:
Basic		33,855			23,788			33,760			23,757
Diluted		36,314			25,796			36,198			25,765

 

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)

 

		26 Weeks Ended
		June 28, 2005			June 29, 2004
Cash flows from operating activities:
Net income		$	16,948		$	14,142
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		6,723			4,916
Loss on disposal of assets		107			72
Noncash compensation expense		—			632
Minority interest		221			3,857
Equity income from investments in unconsolidated affiliates		(22		)	(70		)
Distributions received from investments in unconsolidated affiliates		139			71
Provision for doubtful accounts		—			5
Changes in operating working capital:
Receivables		(696		)	5,423
Inventories		(518		)	(669		)
Prepaid expenses and other current assets		1,239			147
Other assets		(137		)	(18		)
Accounts payable		(574		)	1,885
Deferred revenue—gift certificates		(7,627		)	(4,219		)
Accrued wages		653			(1,682		)
Income taxes payable		4,692			—
Accrued taxes and licenses		(2,711		)	501
Accrued other liabilities		840			(172		)
Deferred rent		334			143
Other liabilities		316			550
Net cash provided by operating activities		19,927			25,514
Cash flows from investing activities:
Capital expenditures—property and equipment		(25,077		)	(21,792		)
Proceeds from sale of property and equipment		—			2
Net cash used in investing activities		(25,077		)	(21,790		)
Cash flows from financing activities:
Proceeds from short term bank revolver		—			8,000
Proceeds from issuance of long-term debt		—			7,075
Proceeds from minority interest contributions and other		70			—
Repayment of stock option deposits		(35		)	(185		)
Proceeds from stock option deposits		552			375
Principal payments on long-term debt		(2,298		)	(5,374		)
Principal payments on capital lease obligations		(72		)	(83		)
Proceeds from exercise of stock options		1,671			694
Payment of initial public offering expenses		(41		)	—
Distributions to minority interest holders		(275		)	(3,447		)
Distributions to members		(31,176		)	(8,682		)
Net cash used in financing activities		(31,604		)	(1,627		)
Net (decrease) increase in cash		(36,754		)	2,097
Cash and cash equivalents—beginning of period		46,235			5,728
Cash and cash equivalents—end of period		$	9,481		$	7,825
Supplemental disclosures of cash flow information:
Interest, net of amounts capitalized		$	421		$	2,042
Income taxes		$	4,568		$	—

 

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., for the 13 and 26 weeks ended June 28, 2005 and June 29, 2004.  The Company and its wholly-owned 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.  Texas Roadhouse 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 Texas Roadhouse Management Corp. and six license and three franchise 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 26 week periods ended June 28, 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.

 

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						26 Weeks Ended
		June 28, 2005			June 29, 2004			June 28, 2005			June 29, 2004
Net income, 2004 as adjusted for pro forma provision for income taxes		$	7,990		$	4,147		$	16,948		$	9,153
Deduct total stock-based-employee compensation expense determined under fair-value-based method for all awards, net of taxes		(1,029		)	(80		)	(1,687		)	(202		)
Pro forma net income		$	6,961		$	4,067		$	15,261		$	8,951
Earnings per share:
Basic – as reported		$	0.24		$	0.17		$	0.50		$	0.39
Basic – pro forma		$	0.21		$	0.17		$	0.45		$	0.38
Diluted – as reported		$	0.22		$	0.16		$	0.47		$	0.36
Diluted – pro forma		$	0.19		$	0.16		$	0.42		$	0.35

 

(3)   Long-term Debt

 

Long-term debt consisted of the following:

 

 

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 June 28, 2005 was 3.06%.  At June 28, 2005, the Company had $4.0 million of borrowings outstanding under its credit facility and $144.2 million of availability net of $1.8 million of outstanding letters of credit.  In addition, the Company had various other notes payable totaling $7.0 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 June 28, 2005 was 6.93%.

 

(4)   Recently Issued Financial Accounting Standards

 

In October 2004, the 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 a) the amount by which the contract is favorable or unfavorable under market terms from the perspective of the acquirer or b) the stated settlement provisions of the contract available to the counterparty to which the contract is unfavorable.

 

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

 

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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. Accordingly, any impact cannot be currently determined.

 

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.

 

The Company will be required to choose between the modified-prospective and modified-retrospective transition alternatives in adopting SFAS No. 123R. Under the modified-prospective transition method, compensation cost will be recognized in financial statements issued subsequent to the date of adoption for all share-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to the date of adoption. The Company will recognize compensation cost relating to the unvested portion of awards granted prior to the date of adoption using the same estimate of the grant-date fair value and the same attribution method used to determine the pro forma disclosures under SFAS No. 123. Under the modified-retrospective transition method, compensation cost will be recognized in a manner consistent with the modified-prospective method, however, prior period financial statements will also be restated by recognizing compensation cost as previously reported in the proforma disclosures under SFAS No. 123. The restatement provisions can be applied to either a) all periods presented or b) beginning of the fiscal year in which SFAS No. 123R is adopted.

 

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).  The Company is in the process of evaluating the use of certain option-pricing models as well as the assumptions to be used in such models. When such evaluation is complete, we will determine the transition method to use, the timing of adoption and the impact any change in valuation models might have.

 

(5)   Commitments and Contingencies

 

The estimated cost of completing capital project commitments at June 28, 2005 and June 29, 2004 was approximately $31.5 million and $36.6 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 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.

 

(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 26 weeks ended June 29, 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 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 Company’s initial public offering. 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

 

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totaling $4.5 million and $9.8 million for the 13 and 26 weeks ended June 29, 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 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 $49,000 and $47,000 for the 13 weeks ended June 28, 2005 and June 29, 2004, respectively.  For the 26 weeks ended June 28, 2005 and June 29, 2004, rent payments were approximately $0.1 million.

 

The Elizabethtown, Kentucky 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 $37,000 for the 13 weeks ended June 28, 2005 and June 29, 2004.  For the 26 weeks ended June 28, 2005 and June 29, 2004, rent expense was approximately $73,000 and $72,000, respectively.

 

The Company had 13 and 11 license and franchise restaurants owned in whole or part by certain officers, directors and 5% stockholders of the Company at June 28, 2005 and June 29, 2004, respectively. These entities paid the Company fees of approximately $0.5 million and $0.4 million during the 13 weeks ended June 28, 2005 and June 29, 2004, respectively.  For the 26 weeks ended June 28, 2005 and June 29, 2004, these entities paid the Company fees of approximately $0.8 million and $0.7 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 $0.5 million and $1.3 million for the 13 and 26 weeks ended June 29, 2004, 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 the Company.  After the completion of the initial public offering, the Company no longer receives 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.  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 26 weeks ended June 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.

 

 

For the 13 and 26 weeks ended June 28, 2005 and June 29, 2004, all unexercised stock options were included in the computation of diluted EPS because their exercise prices were less than the average market price of our common stock during the quarter.  The Company issued 184,431 stock options at $29.07 per share and 378,300 stock options at a weighted average grant price of $28.78 during the thirteen and twenty-six weeks ended June 28, 2005, respectively.  Additionally, 556,987 and 751,461 shares were exercised in the thirteen and twenty-six weeks ended June 28, 2005, respectively.  The proceeds for the exercise price related to stock option exercises of 386,920 shares of Class A common stock that were sold in the follow-on offering discussed below were not received until July 2005 and as such are reflected in other current assets in the accompanying condensed consolidated balance sheet.

 

(11)   Subsequent Events

 

On July 5, 2005, the Company sold 350,000 shares as part of a follow-on Class A common stock offering and received net offering proceeds of $11.6 million, net of $0.6 million of offering expenses.  In conjunction with the offering, the Company paid off $4.0 million of borrowings under its credit facility, with the remaining proceeds intended to be used to fund development of new restaurants and for general corporate purposes.

 

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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 June 28, 2005, 204 Texas Roadhouse restaurants were operating in 37 states, including:

 

•  113 “company restaurants,” of which 110 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.

 

•  91 “franchise restaurants,” of which 87 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 (loss) 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) 65 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 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 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 June 28, 2005 and June 29, 2004 are referred to as Q2 2005 and Q2 2004, respectively, and the 26 weeks ended June 28, 2005 and June 29, 2004 are referred as 2005 YTD and 2004 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 combination of our operations into a new holding company, Texas Roadhouse, Inc.;

•                  Issued an aggregate of 21,257,779 shares of Class A common stock and 2,632,688 shares of Class B common stock in the combination of our operations under Texas Roadhouse, Inc.;

•                  Issued an aggregate of 3,089,080 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;

•                  Issued and sold 6,581,481 new shares at $17.50 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.

 

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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.

 

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.

 

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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. Interest income includes earnings on cash and cash equivalents.

 

Minority Interest.   Our consolidated subsidiaries at June 28, 2005 included three majority-owned or controlled restaurants.  Our consolidated subsidiaries at June 29, 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 (Loss) 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 June 28, 2005. Equity (loss) income from investments in unconsolidated affiliates represents our percentage share of net income (loss) earned by these unconsolidated affiliates.

 

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Results of Operations

 

		13 Weeks Ended								26 Weeks Ended
		June 28, 2005				June 29, 2004				June 28, 2005				June 29, 2004
($ in thousands)		$		%		$		%		$		%		$		%
Revenue:
Restaurant sales		113,108		97.7		87,782		97.6		221,715		97.7		169,675		97.6
Franchise royalties and fees		2,649		2.3		2,137		2.4		5,109		2.3		4,142		2.4
Total revenue		115,757		100.0		89,919		100.0		226,824		100.0		173,817		100.0
Costs and expenses:
(As a percentage of restaurant sales)
Restaurant operating costs:
Cost of sales		39,906		35.3		30,806		35.1		77,940		35.2		58,979		34.8
Labor		30,473		26.9		24,303		27.7		59,716		26.9		46,578		27.5
Rent		2,089		1.8		1,730		2.0		4,126		1.9		3,353		2.0
Other operating		18,109		16.0		14,121		16.1		35,492		16.0		27,455		16.2
(As a percentage of total revenue)
Pre-opening		1,135		1.0		1,250		1.4		2,170		1.0		2,146		1.2
Depreciation and amortization		3,475		3.0		2,567		2.9		6,723		3.0		4,916		2.8
General and administrative		7,886		6.8		5,853		6.5		14,196		6.3		10,422		6.0
Total costs and expenses		103,073		89.0		80,630		89.7		200,363		88.3		153,849		88.5
Income from operations		12,684		11.0		9,289		10.3		26,461		11.7		19,968		11.5
Interest expense, net		112		0.1		1,012		1.1		69		NM		2,039		1.2
Minority interest		194		0.2		1,898		2.1		221		0.1		3,857		2.2
Equity (loss) income from investments in unconsolidated affiliates		(30	)	NM		26		NM		22		NM		70		NM
Income before taxes		12,348		10.7		6,405		7.1		26,193		11.5		14,142		8.1
Provision for income taxes		4,358		3.8		—		—		9,245		4.1		—		—
Net income		7,990		6.9		6,405		7.1		16,948		7.5		14,142		8.1

 

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

 

Q2 2005 (13 weeks) Compared to Q2 2004 (13 weeks) and 2005 YTD (26 weeks) Compared to 2004 YTD (26 weeks)

 

Restaurant Sales.   Restaurant sales increased by 28.9% in Q2 2005 as compared to Q2 2004 and by 30.7% in 2005 YTD as compared to 2004 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.

 

		Q2 2005			Q2 2004			2005 YTD			2004 YTD
Company Restaurants
Store weeks		1,460			1,198			2,868			2,330
Comparable restaurant sales growth		6.8		%	7.8		%	6.8		%	8.8		%
Average unit volume (in thousands)		$	1,008		$	938		$	2,000		$	1,864

 

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Franchise Royalties and Fees.   Franchise royalties and fees increased by $0.5 million, or by 24.0%, from Q2 2004 to Q2 2005 and by $1.0 million, or by 23.3%, in 2005 YTD as compared to 2004 YTD. These increases were primarily attributable to the opening of new franchise restaurants and comparable restaurant sales growth.

 

Restaurant Cost of Sales.   Restaurant cost of sales as a percentage of restaurant sales increased to 35.3% in Q2 2005 from 35.1% in Q2 2004 and to 35.2% in 2005 YTD from 34.8% in 2004 YTD.  This increase was primarily due to the higher cost of pork ribs and was partially offset by menu price increases of approximately 2% and the lower cost of dairy products.  We expect restaurant cost of sales, as a percentage of restaurant sales, to be approximately 25 to 50 basis points higher in 2005 versus 2004.  This increase is expected to be principally driven by the higher cost of pork ribs.

 

Restaurant Labor Expenses.   Restaurant labor expenses, as a percentage of restaurant sales, decreased to 26.9% in Q2 2005 from 27.7% in Q2 2004 and to 26.9% in 2005 YTD from 27.5% in 2004 YTD. The percentage of sales benefit generated from comparable restaurant sales growth more than offset modest wage rate inflation.

 

Restaurant Rent Expense.   Restaurant rent expense, as a percentage of restaurant sales, decreased to 1.8% in Q2 2005 and 2005 YTD from 2.0% in Q2 2004 and 2004 YTD.  The increase in deferred rent due to the impact of our fourth quarter correction of our lease accounting practices was offset by the percentage of sales benefit generated from comparable restaurant sales growth.

 

Restaurant Other Operating Expenses.   Restaurant operating expenses, as a percentage of restaurant sales, decreased to 16.0% in Q2 2005 from 16.1% in Q2 2004 and to 16.0% in 2005 YTD from 16.2% in 2004 YTD. In Q2 2005, we recorded a $0.3 million decrease in general liability insurance expense due to changes in our claim development history based on our second quarter actuarial analysis. In addition, the Q2 2005 and 2005 YTD percentage of restaurant sales changes were primarily due to the percentage of sales benefit generated from comparable restaurant sales growth, along with decreases in gift card fees, equipment rent and other expenses and was partially offset by higher restaurant-level management bonuses, outside services, credit card charges and utility costs.

 

Restaurant Pre-opening Expenses.   Pre-opening expenses decreased slightly in Q2 2005 to $1.1 million from $1.3 million in Q2 2004 and increased slightly to $2.2 million in 2005 YTD from $2.1 million in 2004 YTD.

 

Depreciation and Amortization Expense.   D&A, as a percentage of revenue, increased slightly to 3.0% in Q2 2005 from 2.9% in Q2 2004 and increased slightly to 3.0% for 2005 YTD as compared to 2.8% for 2004 YTD. Increases related to capital spending on new restaurants were partially offset by the percentage of sales benefit generated from comparable restaurant sales growth.

 

General and Administrative Expenses.   G&A increased in Q2 2005 to $7.9 million (6.8% of revenue) from $5.9 million (6.5% of revenue) in Q2 2004 and in 2005 YTD to $14.2 million (6.3% of revenue) from $10.4 million (6.0% of revenue) in 2004 YTD.  These increases were primarily due to general business growth, public company costs which did not exist in Q2 2004 or 2004 YTD and increases in annual conference expenses.

 

Interest Expense, Net.   Interest expense decreased to $0.1 million in Q2 2005 from $1.0 million in Q2 2004 and to $0.1 million in 2005 YTD from $2.0 million in 2004 YTD.   Interest expense in Q2 2005 and 2005 YTD included interest income of $0.1 million and $0.4 million, respectively.  Excluding this income, interest expense decreased by approximately $0.8 million from Q2 2004 to Q2 2005 and $1.6 million from 2004 YTD to 2005 YTD due to a significant reduction in long term debt.

 

Minority Interest.   The minority interest deducted from income in Q2 2005 decreased to $0.2 million from $1.9 million in Q2 2004 and to $0.2 million in 2005 YTD from $3.9 million in 2004 YTD.  These decreases were due to the acquisition of the remaining minority interest in 31 majority-owned restaurants in connection with the closing of our corporate reorganization and initial public offering on October 8, 2004.  Subsequent to October 8, 2004, minority interest includes three majority-owned restaurants.

 

Equity (Loss) Income from Investments in Unconsolidated Affiliates.   Equity (loss) income from investments in unconsolidated affiliates decreased to $(30,000) in Q2 2005 from $26,000 in Q2 2004 and to $22,000 in 2005 YTD from $70,000 in 2004 YTD due to our share of losses generated by four franchise restaurants which were opened in 2005.  Primarily due to pre-opening expenses, new restaurants take three to six months to become profitable.

 

Income Tax Expense.    Until October 8, 2004, we operated as a limited liability company and, as such, were taxed as a partnership.  Accordingly, we paid no significant income taxes on our own behalf and there is no provision for taxes prior to October 8, 2004 in our condensed consolidated financial statements,

 

In connection with the closing of our corporate reorganization and initial public offering, we became a “C” corporation subject to federal and state income taxes.  Our effective tax rate for 2005 YTD is 35.3%.

 

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Liquidity and Capital Resources

 

The following table presents a summary of our net cash provided by (used in) operating, investing and financing activities:

 

		26 Weeks Ended
		2005 YTD			2004 YTD
Net cash provided by operating activities		$	19,927		$	25,514
Net cash used in investing activities		(25,077		)	(21,790		)
Net cash used in financing activities		(31,604		)	(1,627		)
Net (decrease) increase in cash		$	(36,754	)	$	2,097

 

Net cash provided by operating activities was $19.9 million in 2005 YTD compared to $25.5 million in 2004 YTD.  The decrease was driven primarily by higher gift card sales in Q4 2004 followed by higher redemptions in 2005 YTD and changes in working capital offset by an increase in net income.

 

Net cash used in investing activities was $25.1 million in 2005 YTD compared to $21.8 million in 2004 YTD.  The increase was primarily due to an increase in capital spending associated with new restaurant construction.

 

Net cash used in financing activities was $31.6 million in 2005 YTD as compared to $1.6 million in 2004 YTD.  The increase was due primarily to the payment of distributions of $31.2 million to members of our predecessor company, Texas Roadhouse Holdings LLC, in redemption of its preferred shares related to its income for periods prior to and through October 8, 2004.  Additionally, 2004 YTD included net proceeds from short-term and long-term debt of $15.1 million.

 

Our operations have not required significant working capital and, like many restaurant companies, we have been able to operate with negative working capital. Sales are primarily for cash, and restaurant operations do not require significant inventories or receivables. In addition, we receive trade credit for the purchase of food, beverages and supplies, thereby reducing the need for incremental working capital to support growth.

 

We require capital principally for the development of new company restaurants and the refurbishment of existing restaurants.   Capital expenditures totaled approximately $25.1 million and $21.8 million in 2005 YTD and 2004 YTD, respectively.  We either lease our restaurant site locations under operating leases for periods of five to 30 years (including renewal periods) or purchase the land where it is cost effective. As of June 28, 2005, there were 57 restaurants developed on land which we owned.

 

We have also required cash to pay distributions to our equity holders relating to periods before our initial public offering. Our predecessor companies paid aggregate distributions to their equity holders for the 26 weeks ended June 29, 2004 of $12.1 million.

 

We intend to retain our future earnings, if any, to finance the future development and operation of our business. Accordingly, we do not anticipate paying any dividends on our common stock in the foreseeable future.

 

On July 5, 2005, the Company sold 350,000 shares as part of a follow-on Class A common stock offering and received net offering proceeds of $11.6 million, net of $0.6 million of offering expenses.  In conjunction with the offering, the Company paid off $4.0 million of borrowings under its credit facility, with the remaining proceeds intended to be used to fund development of new restaurants and for general corporate purposes.

 

In 2005 YTD and 2004 YTD, we used cash on hand, borrowings under our credit facility and net cash provided by operating activities to fund capital expenditures and distributions.

 

On October 8, 2004, we 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 Texas Roadhouse Holdings LLC's previous credit facility. The terms of the new facility require us 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 our leverage ratio. The facility prohibits us 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 our stock and requires W. Kent Taylor to maintain beneficial ownership of at least 20% of the voting power of our 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.  At June 28, 2005, we had $4.0 million of borrowings outstanding under our credit facility and $144.2 million of availability net of $1.8 million of outstanding letters of credit.  In addition, we had various other notes payable totaling $7.0 million with interest rates ranging from 5.50% to 10.80%.  Each of these notes related to the financing of specific restaurants.  Our total weighted average effective interest rate at June 28, 2005 was 6.93%.  We repaid the $4.0 million borrowed under our credit facility in July 2005.

 

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