e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
| |
|
|
| þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended May 23, 2010
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 1-08395
Morgan’s Foods, Inc.
(Exact name of registrant as specified in its charter)
| |
|
|
|
| Ohio
|
|
34-0562210 |
|
|
|
|
(State or other jurisdiction of
incorporation or organization)
|
|
(I.R.S. Employer Identification No.) |
| |
|
|
| 4829 Galaxy Parkway, Suite S, Cleveland, Ohio
|
|
44128 |
|
|
|
|
| (Address of principal executive offices)
|
|
(Zip Code) |
(216) 359-9000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the 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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
Yeso No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated
filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
| |
|
|
|
|
|
|
|
| Large accelerated filer o
|
|
Accelerated filer o
|
|
Non-accelerated filer o
(do not check if a smaller reporting company)
|
|
Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
As of July 2, 2010, the issuer had 2,934,995 common shares outstanding.
TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
MORGAN’S FOODS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
| |
|
|
|
|
|
|
|
|
| |
|
Quarter Ended |
|
| |
|
May 23, 2010 |
|
|
May 24, 2009 |
|
Revenues |
|
$ |
22,170,000 |
|
|
$ |
22,931,000 |
|
|
|
|
|
|
|
|
|
|
Cost of sales: |
|
|
|
|
|
|
|
|
Food, paper and beverage |
|
|
6,757,000 |
|
|
|
7,410,000 |
|
Labor and benefits |
|
|
6,231,000 |
|
|
|
6,428,000 |
|
Restaurant operating expenses |
|
|
5,634,000 |
|
|
|
5,876,000 |
|
Depreciation and amortization |
|
|
647,000 |
|
|
|
717,000 |
|
General and administrative expenses |
|
|
1,320,000 |
|
|
|
1,409,000 |
|
Loss on restaurant assets |
|
|
50,000 |
|
|
|
6,000 |
|
| |
|
|
Operating income |
|
|
1,531,000 |
|
|
|
1,085,000 |
|
Interest expense: |
|
|
|
|
|
|
|
|
Prepayment fees and deferred financing costs |
|
|
98,000 |
|
|
|
— |
|
Bank debt and notes payable |
|
|
561,000 |
|
|
|
625,000 |
|
Capital leases |
|
|
24,000 |
|
|
|
25,000 |
|
Other (income) expense, net |
|
|
89,000 |
|
|
|
(44,000 |
) |
| |
|
|
Income before income taxes |
|
|
759,000 |
|
|
|
479,000 |
|
Provision for income taxes |
|
|
184,000 |
|
|
|
125,000 |
|
| |
|
|
Net income |
|
$ |
575,000 |
|
|
$ |
354,000 |
|
| |
|
|
Basic net income per common share: |
|
$ |
0.20 |
|
|
$ |
0.12 |
|
| |
|
|
Diluted net income per common share: |
|
$ |
0.19 |
|
|
$ |
0.12 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average number of shares outstanding |
|
|
2,934,995 |
|
|
|
2,934,995 |
|
Diluted weighted average number of shares outstanding |
|
|
3,033,634 |
|
|
|
2,963,105 |
|
See notes to these consolidated financial statements.
2
MORGAN’S FOODS, INC.
CONSOLIDATED BALANCE SHEETS
| |
|
|
|
|
|
|
|
|
| |
|
May 23, 2010 |
|
|
February 28, 2010 |
|
| |
|
UNAUDITED |
|
|
|
|
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and equivalents |
|
$ |
5,317,000 |
|
|
$ |
4,205,000 |
|
Receivables |
|
|
440,000 |
|
|
|
470,000 |
|
Inventories |
|
|
762,000 |
|
|
|
682,000 |
|
Prepaid expenses |
|
|
595,000 |
|
|
|
742,000 |
|
Deferred tax asset |
|
|
15,000 |
|
|
|
15,000 |
|
Assets held for sale |
|
|
678,000 |
|
|
|
678,000 |
|
| |
|
|
|
|
|
7,807,000 |
|
|
|
6,792,000 |
|
|
|
|
|
|
|
|
|
|
Property and equipment: |
|
|
|
|
|
|
|
|
Land |
|
|
9,308,000 |
|
|
|
9,558,000 |
|
Buildings and improvements |
|
|
20,609,000 |
|
|
|
20,960,000 |
|
Property under capital leases |
|
|
1,314,000 |
|
|
|
1,314,000 |
|
Leasehold improvements |
|
|
10,306,000 |
|
|
|
10,373,000 |
|
Equipment, furniture and fixtures |
|
|
20,226,000 |
|
|
|
20,337,000 |
|
Construction in progress |
|
|
268,000 |
|
|
|
626,000 |
|
| |
|
|
|
|
|
62,031,000 |
|
|
|
63,168,000 |
|
Less accumulated depreciation and amortization |
|
|
31,318,000 |
|
|
|
31,941,000 |
|
| |
|
|
|
|
|
30,713,000 |
|
|
|
31,227,000 |
|
|
|
|
|
|
|
|
|
|
Other assets |
|
|
533,000 |
|
|
|
546,000 |
|
Franchise agreements, net |
|
|
1,099,000 |
|
|
|
1,133,000 |
|
Goodwill |
|
|
9,227,000 |
|
|
|
9,227,000 |
|
| |
|
|
|
|
$ |
49,379,000 |
|
|
$ |
48,925,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Long-term debt, current |
|
$ |
3,163,000 |
|
|
$ |
3,165,000 |
|
Current maturities of capital lease obligations |
|
|
45,000 |
|
|
|
44,000 |
|
Accounts payable |
|
|
4,070,000 |
|
|
|
3,683,000 |
|
Accrued liabilities |
|
|
4,426,000 |
|
|
|
3,884,000 |
|
| |
|
|
|
|
|
11,704,000 |
|
|
|
10,776,000 |
|
|
|
|
|
|
|
|
|
|
Long-term debt |
|
|
28,533,000 |
|
|
|
29,725,000 |
|
Long-term capital lease obligations |
|
|
1,050,000 |
|
|
|
1,061,000 |
|
Other long-term liabilities |
|
|
3,827,000 |
|
|
|
3,853,000 |
|
Deferred tax liabilities |
|
|
2,067,000 |
|
|
|
1,887,000 |
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS’ EQUITY |
|
|
|
|
|
|
|
|
Preferred shares, 1,000,000 shares authorized,
no shares outstanding |
|
|
— |
|
|
|
— |
|
Common stock, no par value |
|
|
|
|
|
|
|
|
Authorized shares - 25,000,000 |
|
|
|
|
|
|
|
|
Issued shares - 2,969,405 |
|
|
30,000 |
|
|
|
30,000 |
|
Treasury shares - 34,410 |
|
|
(81,000 |
) |
|
|
(81,000 |
) |
Capital in excess of stated value |
|
|
29,488,000 |
|
|
|
29,488,000 |
|
Accumulated deficit |
|
|
(27,239,000 |
) |
|
|
(27,814,000 |
) |
| |
|
|
Total shareholders’ equity |
|
|
2,198,000 |
|
|
|
1,623,000 |
|
| |
|
|
|
|
$ |
49,379,000 |
|
|
$ |
48,925,000 |
|
| |
|
|
See notes to these consolidated financial statements.
3
MORGAN’S FOODS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(UNAUDITED)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Common |
|
|
Treasury |
|
|
Capital in |
|
|
|
|
|
|
Total |
|
| |
|
Shares |
|
|
Shares |
|
|
excess of |
|
|
Accumulated |
|
|
Shareholders’ |
|
| |
|
Shares |
|
|
Amount |
|
|
Shares |
|
|
Amount |
|
|
stated value |
|
|
Deficit |
|
|
Equity |
|
| |
|
|
Balance February 28, 2010 |
|
|
2,969,405 |
|
|
$ |
30,000 |
|
|
|
(34,410 |
) |
|
$ |
(81,000 |
) |
|
$ |
29,488,000 |
|
|
$ |
(27,814,000 |
) |
|
$ |
1,623,000 |
|
Net income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
575,000 |
|
|
|
575,000 |
|
| |
|
|
Balance May 23, 2010 |
|
|
2,969,405 |
|
|
$ |
30,000 |
|
|
|
(34,410 |
) |
|
$ |
(81,000 |
) |
|
$ |
29,488,000 |
|
|
$ |
(27,239,000 |
) |
|
$ |
2,198,000 |
|
| |
|
|
See notes to these consolidated financial statements.
4
MORGAN’S FOODS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| |
|
|
|
|
|
|
|
|
| |
|
Twelve Weeks Ended |
|
| |
|
May 23, 2010 |
|
|
May 24, 2009 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
575,000 |
|
|
$ |
354,000 |
|
Adjustments to reconcile net income to net cash
from operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
$ |
647,000 |
|
|
|
717,000 |
|
Amortization of deferred financing costs |
|
|
26,000 |
|
|
|
27,000 |
|
Amortization of supply agreement advances |
|
|
(282,000 |
) |
|
|
(257,000 |
) |
Funding from supply agreements |
|
|
764,000 |
|
|
|
— |
|
Deferred taxes |
|
|
180,000 |
|
|
|
116,000 |
|
Stock compensation expense |
|
|
— |
|
|
|
56,000 |
|
Loss on restaurant assets |
|
|
50,000 |
|
|
|
6,000 |
|
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
Receivables |
|
|
(25,000 |
) |
|
|
359,000 |
|
Inventories |
|
|
(80,000 |
) |
|
|
(47,000 |
) |
Prepaid expenses |
|
|
147,000 |
|
|
|
113,000 |
|
Other assets |
|
|
(13,000 |
) |
|
|
2,000 |
|
Accounts payable |
|
|
387,000 |
|
|
|
931,000 |
|
Accrued liabilities and other |
|
|
89,000 |
|
|
|
1,136,000 |
|
| |
|
|
Net cash from operating activities |
|
|
2,465,000 |
|
|
|
3,513,000 |
|
| |
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
(381,000 |
) |
|
|
(401,000 |
) |
Proceeds from sale of fixed assets |
|
|
232,000 |
|
|
|
— |
|
| |
|
|
Net cash from investing activities |
|
|
(149,000 |
) |
|
|
(401,000 |
) |
| |
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Principal payments on long-term debt |
|
|
(743,000 |
) |
|
|
(726,000 |
) |
Principal payments on capital
lease obligations |
|
|
(10,000 |
) |
|
|
(9,000 |
) |
Bank debt repayment in advance |
|
|
(451,000 |
) |
|
|
— |
|
| |
|
|
Net cash from financing activities |
|
|
(1,204,000 |
) |
|
|
(735,000 |
) |
| |
|
|
Net change in cash and equivalents |
|
|
1,112,000 |
|
|
|
2,377,000 |
|
Cash and equivalents, beginning balance |
|
|
4,205,000 |
|
|
|
5,257,000 |
|
| |
|
|
Cash and equivalents, ending balance |
|
$ |
5,317,000 |
|
|
$ |
7,634,000 |
|
| |
|
|
Supplemental Cash Flow Information:
Interest paid on debt and capitalized leases was $624,000 and $680,000 in fiscal 2011 and
2010, respectively.
Cash payments/(refunds) for income taxes were ($15,000) and $2,000 in the first 12 weeks of fiscal
2011 and 2010, respectively.
See accompanying Notes to Consolidated Financial Statements.
5
MORGAN’S FOODS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The interim consolidated financial statements of Morgan’s Foods, Inc. (the “Company”) have been
prepared without audit. In the opinion of Company management, all adjustments have been included.
Unless otherwise disclosed, all adjustments consist only of normal recurring adjustments necessary
for a fair statement of results of operations for the interim periods. These unaudited financial
statements have been prepared using the same accounting principles that were used in preparation of
the Company’s annual report on Form 10-K for the year ended February 28, 2010. Certain prior
period amounts have been reclassified to conform to current period presentations. The results of
operations for the twelve weeks ended May 23, 2010 are not necessarily indicative of the results to
be expected for the full year. Although the Company believes that the disclosures are adequate to
make the information presented not misleading, it is suggested that these condensed consolidated
financial statements be read in conjunction with the audited consolidated financial statements and
the notes thereto included in the Company’s Form 10-K for the fiscal year ended February 28, 2010.
The Company’s debt is reported at historical cost, based upon stated interest rates which
represented market rates at the time of borrowing. Due to subsequent declines in credit quality
throughout the restaurant industry resulting from weak and volatile operating performance and
related declines in restaurant values, the market for fixed rate mortgage debt for restaurant
financing is currently extremely limited. The Company’s debt is not publicly traded and there are
few lenders or financing transactions for similar debt in the marketplace at this time.
Consequently, management has not been able to identify a market for fixed rate restaurant mortgage
debt with a similar risk profile, and has concluded that it is not practicable to estimate the fair
value of the Company’s debt as of May 23, 2010.
NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS
Effective July 1, 2009, the FASB (Financial Accounting Standards Board) Accounting Standards
Codification (ASC) (Topic 105, “Generally Accepted Accounting Principles”), became the single
source for authoritative nongovernmental U.S. generally accepted accounting principles. During
fiscal 2010, several Accounting Standards Updates (“ASU”) were issued.
ASU 2010-05 January, 2010. Topic 718 “Compensation-Stock Compensation”
This update is a clarification of the treatment of escrowed share arrangements and provides
guidance on the presumption of compensation under such arrangements. The Company has determined
that the changes to the accounting standards required by this update do not have a material effect
on the Company’s financial position or results of operations.
ASU 2010-06 January, 2010. Topic 820 “Fair Value Measurements and Disclosures”
This update improves the disclosures regarding fair value measurements including information
regarding the level of disaggregation of assets and liabilities and the valuation methods being
employed. The provisions of this update are effective for the Company’s fiscal year ending
February 27, 2011. Management is evaluating what effect, if any, the adoption of these provisions
will have on the Company’s financial position or results of operations.
NOTE 3 – NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted net income per common share is
based on the combined weighted average number of shares outstanding, which includes the assumed
exercise, or conversion of options. In computing diluted net income per common share, the Company
has utilized the treasury stock method. The following table reconciles the difference between basic
and diluted earnings per common share:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the Quarter ended May 23, 2010 |
|
|
For the Quarter ended May 24, 2009 |
|
| |
|
Net income |
|
|
Shares |
|
|
Per Share |
|
|
Net income |
|
|
Shares |
|
|
Per Share |
|
| |
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
|
(Numerator) |
|
|
(Denominator) |
|
|
Amount |
|
| |
|
|
Basic EPS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common shareholders |
|
$ |
575,000 |
|
|
|
2,934,995 |
|
|
$ |
0.20 |
|
|
$ |
354,000 |
|
|
|
2,934,995 |
|
|
$ |
0.12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of Dilutive Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Stock Options |
|
|
— |
|
|
|
98,639 |
|
|
|
|
|
|
|
— |
|
|
|
28,110 |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income available to common shareholders |
|
$ |
575,000 |
|
|
|
3,033,634 |
|
|
$ |
0.19 |
|
|
$ |
354,000 |
|
|
|
2,963,105 |
|
|
$ |
0.12 |
|
| |
|
|
Options to purchase 149,000 common shares were outstanding during the 2011 fiscal year and were included in the computation only for the time during which their exercise price was less than the average market price of the common shares.
6
NOTE 4 – DEBT
The Company’s debt arrangements require the maintenance of a consolidated fixed charge coverage
ratio of 1.20 to 1 regarding all of the Company’s loans and the maintenance of individual
restaurant fixed charge coverage ratios of between 1.20 and 1.50 to 1 on certain of the Company’s
individual restaurant loans. A portion of the Company’s debt also contains a funded debt to
EBITDAR (earnings before interest, taxes, depreciation, amortization and rent) requirement of 5.5.
Fixed charge coverage ratios are calculated by dividing the cash flow before rent and debt service
for the previous 12 months by the debt service and rent due in the coming 12 months. In the
calculation of funded debt to EBITDAR, funded debt is the next twelve month operating lease
obligation times eight plus the debt balance at the measurement date. The funded debt is then
divided by the prior twelve month EBITDAR to obtain the calculated ratio. The consolidated and
individual ratios are all computed quarterly. The Company entered into a loan modification
agreement covering a portion of its debt which increased the funded debt to EBITDAR ratio to 5.75
from 5.5 for the first quarter of fiscal 2011 and is in compliance with that requirement. As of
the measurement date of May 23, 2010, the Company’s consolidated fixed charge coverage ratio was
1.20 to 1, funded debt to EBITDAR was 5.6 and management projects that the Company will be in
compliance with its consolidated debt covenants at the relevant future measurement dates. As of
May 23, 2010, the Company was not in compliance with the individual fixed charge coverage ratio on
18 of its restaurant properties and has obtained waivers of these requirements covering a period of
longer than one year. The debt obligations of the Company which contain fixed charge coverage
ratio and funded debt to EBITDAR requirements are classified as long-term, except for the amounts
due within one year. If the Company does not comply with the covenants of its various debt
agreements in the future, and if future waivers are not obtained, the respective lenders will have
certain remedies available to them which include calling the debt, increasing the interest rates
and the acceleration of payments. Noncompliance with the requirements of the Company’s debt
agreements, if not waived, could also trigger cross-default provisions contained in the respective
agreements.
NOTE 5 — STOCK OPTIONS
On April 2, 1999, the Board of Directors of the Company approved a Stock Option Plan for Executives
and Managers. Under the plan 145,500 shares were reserved for the grant of options. The Stock
Option Plan for Executives and Managers provides for grants to eligible participants of
nonqualified stock options only. The exercise price for any option awarded under the Plan is
required to be not less than 100% of the fair market value of the shares on the date that the
option is granted. Options are granted by the Stock Option Committee of the Company. Options for
the 145,150 shares were granted to executives and managers of the Company on April 2, 1999 at an
exercise price of $4.125. The plan provides that the options are exercisable after a waiting period
of 6 months and that each option expires 10 years after its date of issue.
At the Company’s annual meeting on June 25, 1999 the shareholders approved the Key Employees Stock
Option Plan. This plan allows the granting of options covering 291,000 shares of stock and has
essentially the same provisions as the Stock Option Plan for Executives and Managers which was
discussed above. Options for 129,850 shares were granted to executives and managers of the Company
on January 7, 2000 at an exercise price of $3.00. Options for 11,500 shares were granted to
executives on April 27, 2001 at an exercise price of $.85. Options for 150,000 common shares were
granted on November 6, 2008 at the closing price on that day of $1.50 per share. The options vest
six months after issue and expire ten years after issue.
As of May 23, 2010, 149,000 options were outstanding, fully vested and exercisable at a weighted
average exercise price of $1.50 per share. No options are available for grant.
The following table summarizes information about stock options outstanding at May 23, 2010:
| |
|
|
|
|
|
|
| Exercise |
|
Outstanding |
|
Average |
|
Number |
| Prices |
|
5-23-10 |
|
Life |
|
Exercisable |
| |
| 1.50
|
|
149,000
|
|
8.7
|
|
149,000 |
| |
|
|
NOTE 6 – CAPITAL EXPENDITURES
The Company is required by its franchise agreements to periodically bring its restaurants up
to the required image of the franchisor. This typically involves a new dining room décor and
seating package and exterior changes and related items but can, in some cases, require the
relocation of the restaurant. If the Company deems a particular image enhancement expenditure to
be inadvisable, it has the option to cease operations at that restaurant. Over time, the estimated
cost and time deadline for each restaurant may change due to a variety of circumstances and the
Company revises its requirements accordingly. Also, significant numbers of restaurants may have
image enhancement deadlines that coincide, in which case, the Company will adjust the actual timing
of the image enhancements in order to facilitate an orderly construction schedule. During the
image enhancement process, each restaurant is normally closed for up to two weeks, which has a
negative impact on the Company’s revenues and operating efficiencies. At the time a restaurant is
closed for a required image enhancement,
7
the Company may deem it advisable to make other capital expenditures in addition to those required
for the image enhancement.
The franchise agreements with KFC and Taco Bell Corporation require the Company to upgrade and
remodel its restaurants to comply with the franchisors’ current standards within agreed upon
timeframes. As discussed below, the Company did not meet its obligations with respect to four
restaurants due in fiscal 2010 but the image enhancement of one of the restaurants was completed in
April, 2010 and another is scheduled to begin on July 12, 2010. As a result, the franchisor may
terminate the franchise agreement for those restaurants for which the required image enhancement is
not in progress. In the case of a restaurant containing two concepts, even though only one is
required to be remodeled, additional costs will be incurred because the dual concept restaurant is
generally larger and contains more equipment and signage than the single concept restaurant. If a
property is of usable size and configuration, the Company can perform an image enhancement to bring
the building to the current image of the franchisor. If the property is not large enough to fit a
drive-thru or has some other deficiency, the Company would need to relocate the restaurant to
another location within the trade area to meet the franchisor’s requirements. In order to meet the
terms and conditions of the franchise agreements, the Company has the following image enhancement
obligations as of May 23, 2010:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Number of Units |
|
|
Period |
|
Type |
|
|
Total (1) |
|
|
Required (2) |
|
|
Additional (3) |
|
| |
| |
2 |
|
|
Fiscal 2010 |
|
IE (4) |
|
$ |
660,000 |
|
|
|
580,000 |
|
|
$ |
80,000 |
|
| |
1 |
|
|
Fiscal 2010 |
|
Relo (4) (5) |
|
|
750,000 |
|
|
|
750,000 |
|
|
$ |
— |
|
| |
1 |
|
|
Fiscal 2011 |
|
Relo (5) |
|
|
1,400,000 |
|
|
|
1,400,000 |
|
|
|
— |
|
| |
5 |
|
|
Fiscal 2011 |
|
IE |
|
|
1,600,000 |
|
|
|
1,400,000 |
|
|
|
200,000 |
|
| |
8 |
|
|
Fiscal 2012 |
|
IE |
|
|
2,560,000 |
|
|
|
2,240,000 |
|
|
|
320,000 |
|
| |
5 |
|
|
Fiscal 2013 |
|
IE |
|
|
1,600,000 |
|
|
|
1,400,000 |
|
|
|
200,000 |
|
| |
1 |
|
|
Fiscal 2015 |
|
Rebuild |
|
|
1,000,000 |
|
|
|
1,000,000 |
|
|
|
— |
|
| |
4 |
|
|
Fiscal 2015 |
|
Relo (5) |
|
|
5,600,000 |
|
|
|
5,600,000 |
|
|
|
— |
|
| |
1 |
|
|
Fiscal 2016 |
|
Relo (5) |
|
|
1,400,000 |
|
|
|
1,400,000 |
|
|
|
— |
|
| |
4 |
|
|
Fiscal 2020 |
|
Relo (5) |
|
|
5,600,000 |
|
|
|
5,600,000 |
|
|
|
— |
|
| |
1 |
|
|
Fiscal 2020 |
|
Rebuild |
|
|
1,000,000 |
|
|
|
1,000,000 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
33 |
|
|
Total |
|
|
|
|
|
$ |
23,170,000 |
|
|
$ |
22,370,000 |
|
|
$ |
800,000 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
These amounts are based on estimates of current construction costs and actual costs may vary. |
| |
| (2) |
|
These amounts include only the items required to meet the franchisor’s current image requirements. |
| |
| (3) |
|
These amounts are for capital upgrades performed on or which may be performed on the image enhanced restaurants which were or may
be deemed by the Company to be advantageous to the operation of the
units and which may be done at the time of the image enhancement. |
| |
| (4) |
|
Not completed in fiscal 2010, as required. |
| |
| (5) |
|
Relocations of fee owned properties are shown net of expected recovery of capital from the sale of the former location.
Relocation of leased properties assumes the capital cost of only
equipment because it is not known until each lease is finalized
whether the lease will be a capital or operating lease. |
As referenced above, the Company did not complete the image enhancement or relocation action
relating to four locations which were required to be completed in fiscal 2010, one of which was
completed in April, 2010 and another of which is scheduled to begin on July 12, 2010. The Company
recently received letters from the franchisor regarding two of these restaurants warning of the
necessity to perform the image enhancements. The Company relies mainly on cashflow and borrowings
to complete its image enhancements and experienced a decline in cashflow during the later part of
fiscal 2009 and early fiscal 2010 which caused the Company to temporarily suspend its image
enhancement activities resulting in the failure to complete the referenced projects. Negotiations
are continuing between the Company and the franchisor to obtain revisions to its image enhancement
schedule. Any revisions to the image enhancement schedule arrived at through these negotiations
may, and likely will, involve material differences when compared to the schedule presented above.
The Company can provide no assurance
that the Company’s negotiations to modify the required image enhancement schedule will be
successful or, if successful, that the modified schedule will not require materially increased
capital expenditures in any fiscal year over the next ten years. In addition, no assurance can be
given that if the negotiations are not successful that the franchisor will not terminate the
franchise agreement on the three restaurants not completed in 2010. The termination of those
franchise agreements would likely have a material adverse effect on the Company’s financial
condition and results of operations.
8
Capital expenditures to meet the image requirements of the franchisors and additional
capital expenditures on those same restaurants being image enhanced are a large portion of the
Company’s annual capital expenditures. However, the Company also has made and may make capital
expenditures on restaurant properties not included on the foregoing schedule for upgrades or
replacement of capital items appropriate for the continued successful operation of its restaurants.
The Company may not be able to finance capital expenditures in the volume and time horizon
required by the image enhancement deadlines solely from existing cash balances and existing
cashflow and the Company expects that it will have to utilize financing for a portion of the
capital expenditures. The Company may use both debt and sale/leaseback financing but has no
commitments for either. As of May 23, 2010 management believes that it will not meet the
stated deadlines for seven of its image enhancement projects and is in discussions with its
franchisors to obtain revised schedules.
There can be no assurance that the Company will be able to accomplish the image enhancements and
relocations required in the franchise agreements on terms acceptable to the Company. If the
Company is unable to meet the requirements of a franchise agreement, the franchisor may choose to
extend the time allowed for compliance or may terminate the franchise agreement.
NOTE 7 — ASSETS HELD FOR SALE
The Company owns the land and building of two closed KFC restaurants and the land and building
adjacent to another of its restaurants, all of which are listed for sale and are shown on the
Company’s consolidated balance sheet as Assets Held for Sale as of May 23, 2010.
NOTE 8 — SUBSEQUENT EVENTS
Subsequent to May 23, 2010 the Company removed the Taco Bell brand from one of its KFC/Taco Bell
restaurants in West Virginia. Management determined that the Taco Bell revenues at the location
were too low to profitably maintain the brand.
|
|
|
| Item 2. |
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Description of Business. Morgan’s Foods, Inc. (the “Company”), which was formed in 1925,
operates through wholly-owned subsidiaries KFC restaurants under franchises from KFC Corporation,
Taco Bell restaurants under franchises from Taco Bell Corporation, Pizza Hut Express restaurants
under licenses from Pizza Hut Corporation and an A&W restaurant under a license from A&W
Restaurants, Inc. As of July 2, 2010, the Company operates 69 KFC restaurants, 6 Taco Bell
restaurants, 11 KFC/Taco Bell “2n1’s” under franchises from KFC Corporation and franchises or
licenses from Taco Bell Corporation, 3 Taco Bell/Pizza Hut Express “2n1’s” under franchises from
Taco Bell Corporation and licenses from Pizza Hut Corporation, 1 KFC/Pizza Hut Express “2n1” under
a franchise from KFC Corporation and a license from Pizza Hut Corporation and 1 KFC/A&W “2n1”
operated under a franchise from KFC Corporation and a license from A&W Restaurants, Inc. The
Company’s fiscal year is a 52 — 53 week year ending on the Sunday nearest the last day of February.
Summary of Expenses and Operating Income as a Percentage of Revenues
| |
|
|
|
|
|
|
|
|
| |
|
Quarter Ended |
|
| |
|
May 23, 2010 |
|
|
May 24, 2009 |
|
| |
|
|
Cost of sales: |
|
|
|
|
|
|
|
|
Food, paper and beverage |
|
|
30.5 |
% |
|
|
32.3 |
% |
Labor and benefits |
|
|
28.1 |
% |
|
|
28.0 |
% |
Restaurant operating expenses |
|
|
25.4 |
% |
|
|
25.6 |
% |
Depreciation and amortization |
|
|
2.9 |
% |
|
|
3.1 |
% |
General and administrative expenses |
|
|
6.0 |
% |
|
|
6.1 |
% |
Operating income |
|
|
6.9 |
% |
|
|
4.7 |
% |
Revenues. The revenue decrease of $761,000 in the quarter ended May 23, 2010 as
compared to the prior year quarter was primarily the result of a decrease in comparable restaurant
revenues of 2.6% or $582,000 as well as the permanent closing of two restaurants and the temporary
closing during the current year quarter of one restaurant for image enhancement. The decline in
comparable restaurant revenues was mainly the result of higher revenues in the prior year period
related to the introduction of Kentucky Grilled Chicken (“KGC”).
Cost of Sales — Food, Paper and Beverage. Food, paper and beverage costs decreased as a
percentage of revenue to 30.5% for the quarter ended May 23, 2010 compared to 32.3% for the quarter
ended May 24, 2009. The improvement in the current year quarter
9
was primarily the result of higher food costs related to the national roll out of KGC which
included the free KGC day and the free two piece dinner promotion in the first quarter of the prior
fiscal year.
Cost of Sales — Labor and Benefits. Labor and benefits were relatively unchanged as a
percentage of revenue at 28.1% in the first of fiscal 2011 compared to 28.0% in the first quarter
of fiscal 2010.
Restaurant Operating Expenses. Restaurant operating expenses were relatively unchanged as
a percentage of revenue at 25.4% in the first quarter of fiscal 2011 compared to 25.6% in the first
quarter of fiscal 2010.
Depreciation and Amortization. Depreciation and amortization decreased to $647,000 for the
quarter ended May 23, 2010 compared to $717,000 in the prior year quarter primarily due to assets
becoming fully depreciated.
General and Administrative Expenses. General and administrative expenses decreased to
$1,320,000 in the first quarter of fiscal 2011 compared to $1,409,000 in the first quarter of
fiscal 2010. This improvement was due to the recording of compensation expense related to the
granting of stock options in the prior year quarter and a reduction in the costs related to
professional services offset by slight increases in employee health and welfare, vehicle and
recruitment expenses.
Loss on Restaurant Assets. The Company experienced a loss on restaurant assets of $50,000
for the first quarter of fiscal 2011 compared to a loss of $6,000 in the comparable prior year
quarter. The current year loss includes the permanent closing of one restaurant and the sale of
one previously closed restaurant location. Prior year amounts contain reductions in the reserve
for closed restaurants offset by a loss on the permanent closing of one restaurant.
Operating Income. Operating income increased to $1,531,000 or 6.9% of revenue for the
quarter ended May 23, 2010 from $1,085,000 or 4.7% of revenue in the prior year quarter. The
improvement of $446,000 consists of a decrease in revenues offset by decreases in costs and
operating expenses as noted above.
Interest Expense. The first quarter of fiscal 2011 contained $98,000 of prepayment
penalties and the write off of deferred financing costs related to the early payment of the debt on
a closed restaurant location which was sold while the comparable prior year period did not contain
any expense related to the early payment of debt. Interest expense on bank debt and notes payable
including capitalized leases decreased to $585,000 in the first quarter of fiscal 2011 from
$650,000 in the first quarter of fiscal 2010 due to lower debt balances and variable rates.
Other Income and Expense. Other income and expense was an expense of $89,000 for the
quarter ended May 23, 2010 compared to income of $44,000 for the prior year quarter. Other expenses
for the current year quarter included $111,000 in charitable contributions to the Susan G. Komen
Foundation generated by KFC’s Buckets for the Cure promotion.
Provision for Income Taxes. The provision for income taxes for the quarter ended May 23,
2010 was $184,000 on pre-tax income of $759,000 compared to $125,000 on pre-tax income of $479,000
for the comparable prior year period. The provision for income taxes is recorded at the Company’s
projected annual effective tax rate and consists of a current tax provision of $5,000 and a
deferred tax provision of $179,000 compared to a current tax provision of $9,000 and a deferred tax
provision of $116,000 for the comparable prior year period.
The effective tax rate for the current year quarter is lower than the comparable prior year period
by two percentage points due to a decrease in the deferred tax asset valuation allowance. The
decrease is based on the Company’s estimate regarding the realization of its net deferred tax
assets not changing since its last fiscal year end. The projections indicate that a lower
valuation allowance is needed to result in the projected net deferred tax balance. Since the
decrease is due to the projected realization of ordinary income it has been included in the
computation of the effective tax rate. The changes in deferred taxes and valuation allowances are
non-cash items and do not affect the Company’s cash flow or cash balances.
Liquidity and Capital Resources. Cash flow activity for the twelve weeks ended May 23,
2010 is presented in the Consolidated Statements of Cash Flows. Cash provided by operating
activities was $2,465,000 for the twelve weeks ended May 23, 2010 compared to $3,513,000 for the
twelve weeks ended May 24, 2009. The decrease in operating cash flow was the result of the
increase of $221,000 in net income and $764,000 of funding from supply agreements in the current
year period compared to none in the prior year period, offset by an increase in accounts receivable
in the current year period compared to a decrease in the prior year period and lower increases in
accounts payable and accrued liabilities in the current year period. There was a $25,000 increase
in accounts receivable in the current year period compared to a reduction of $359,000 in the prior
year period. In the twelve weeks ended May 23, 2010, accounts payable increased by $387,000 and
accrued liabilities by $89,000 compared to increases of $931,000 and $1,136,000, respectively, in
the comparable prior year period. The difference in cash provided by the current year changes in
receivables, payables and accrued liabilities compared to the prior year were caused primarily by
the receipt of vendor rebates and incentives during fiscal 2009 while the most recent rebates were
received subsequent to the end of fiscal 2010. The Company paid scheduled long-term bank and
capitalized lease debt of $753,000 and $451,000 of debt before its scheduled maturity in the first
twelve weeks of fiscal 2011 compared to payments of $735,000 for the same period in fiscal 2010.
Capital expenditures
10
for the first twelve weeks of fiscal 2011 were $381,000 less $232,000 of proceeds from the sale of
assets, compared to $401,000 for the same period in fiscal 2010 as the Company completed the image
enhancement of one location in the current year period and purchased the ovens for Kentucky Grilled
Chicken in the prior year period. As of May 23, 2010 management believes that it will not meet the
stated deadlines for seven of its image enhancement projects and is in discussions with its
franchisors to obtain revised schedules. Capital expenditure activity is discussed in more detail
in Note 6 to the consolidated financial statements.
The Company’s debt arrangements require the maintenance of a consolidated fixed charge coverage
ratio of 1.20 to 1 regarding all of the Company’s loans and the maintenance of individual
restaurant fixed charge coverage ratios of between 1.20 and 1.50 to 1 on certain of the Company’s
individual restaurant loans. A portion of the Company’s debt also contains a funded debt to
EBITDAR (earnings before interest, taxes, depreciation, amortization and rent) requirement of 5.5.
Fixed charge coverage ratios are calculated by dividing the cash flow before rent and debt service
for the previous 12 months by the debt service and rent due in the coming 12 months. In the
calculation of funded debt to EBITDAR, funded debt is the next twelve month operating lease
obligation times eight plus the debt balance at the measurement date. The funded debt is then
divided by the prior twelve month EBITDAR to obtain the calculated ratio. The consolidated and
individual ratios are all computed quarterly. The Company entered into a loan modification
agreement covering a portion of its debt which increased the funded debt to EBITDAR ratio to 5.75
from 5.5 for the first quarter of fiscal 2011 and is in compliance with that requirement. As of
the measurement date of May 23, 2010, the Company’s consolidated fixed charge coverage ratio was
1.20 to 1, funded debt to EBITDAR was 5.6 and management projects that the Company will be in
compliance with its consolidated debt covenants at the relevant future measurement dates. As of
May 23, 2010, the Company was not in compliance with the individual fixed charge coverage ratio on
18 of its restaurant properties and has obtained waivers of these requirements covering a period of
longer than one year. The debt obligations of the Company which contain fixed charge coverage
ratio and funded debt to EBITDAR requirements are classified as long-term, except for the amounts
due within one year. If the Company does not comply with the covenants of its various debt
agreements in the future, and if future waivers are not obtained, the respective lenders will have
certain remedies available to them which include calling the debt, increasing the interest rates
and the acceleration of payments. Noncompliance with the requirements of the Company’s debt
agreements, if not waived, could also trigger cross-default provisions contained in the respective
agreements.
Recent Accounting Pronouncements. Effective July 1, 2009, the FASB (Financial Accounting
Standards Board) Accounting Standards Codification (ASC) (Topic 105, “Generally Accepted Accounting
Principles”), became the single source for authoritative nongovernmental U.S. generally accepted
accounting principles. During fiscal 2010, several Accounting Standards Updates (“ASU”) were
issued.
ASU 2010-05 January, 2010. Topic 718 “Compensation-Stock Compensation”
This update is a clarification of the treatment of escrowed share
arrangements and provides
guidance on the presumption of compensation under such arrangements.
The Company has determined that the changes to the accounting standards required by this update do
not have a material effect on the Company’s financial position or results of operations.
ASU
2010-06 January, 2010. Topic 820 “Fair Value Measurements and Disclosures”
This update improves the disclosures regarding fair value
measurements including information regarding the level of
disaggregation of assets and liabilities and the valuation methods
being employed. The provisions of this update are effective for the Company’s fiscal year ending
February 27, 2011. Management is evaluating what effect, if any, the adoption of these provisions will have on the Company’s financial position or results of operations.
Seasonality. The operations of the Company are affected by seasonal fluctuations.
Historically, the Company’s revenues and income have been highest during the summer months with the
fourth fiscal quarter representing the slowest period. This seasonality is primarily attributable
to weather conditions in the Company’s marketplace, which consists of portions of Ohio,
Pennsylvania, Missouri, Illinois, West Virginia and New York.
Safe Harbor Statements. This report contains “forward-looking statements” within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The statements include those identified by such words as “may,”
“will,” “expect” “anticipate,” “believe,” “plan” and other similar terminology. Forward looking
statements involve risks and uncertainties that could cause actual events or results to differ
materially from those expressed or implied in this report. The “forward-looking statements”
reflect the Company’s current expectations and are based upon data available at the time of the
statements. Actual results involve risks and uncertainties, including both those specific to the
Company and general economic and industry factors. Factors specific to the Company include, but
are not limited to, its debt covenant compliance, actions that lenders may take with respect to any
debt covenant violations, its ability to obtain waivers of any debt covenant violations and its
ability to pay all of its current and long-term obligations, the Company’s ability to negotiate
extensions to franchisors’ image enhancement requirements and those factors described in Part I
Item 1A (“Risk Factors”) of the Company’s annual report on Form 10-K filed with the SEC on June 1,
2010. Economic and industry risks and uncertainties include, but are not limited, to, franchisor
promotions, business and economic conditions, legislation and governmental regulation, competition,
success of operating initiatives and advertising and promotional efforts, volatility of commodity
costs and increases in minimum wage and other operating costs, availability and cost of land and
construction, consumer preferences, spending patterns and demographic trends.
11
|
|
|
| Item 3. |
|
Quantitative and Qualitative Disclosures About Market Risk |
Certain of the Company’s debt comprising approximately $13.2 million of principal balance has a
variable rate which is adjusted monthly. A one percent increase in variable rate base (90 day
LIBOR) of the loans at the beginning of the year would cost the Company approximately $132,000 in
additional annual interest costs. The Company may choose to offset all, or a portion of the risk
through the use of interest rate swaps or caps. The Company’s remaining borrowings are at fixed
interest rates, and accordingly the Company does not have market risk exposure for fluctuations in
interest rates relative to those loans. The Company does not enter into derivative financial
investments for trading or speculation purposes. Also, the Company is subject to volatility in
food costs as a result of market risk and we manage that risk through the use of a franchisee
purchasing cooperative which uses longer term purchasing contracts. Our ability to recover
increased costs through higher pricing is, at times, limited by the competitive environment in
which we operate. The Company believes that its market risk exposure is not material to the
Company’s financial position, liquidity or results of operations.
|
|
|
| Item 4T. |
|
Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
The Principal Executive Officer (“PEO”) and Principal Financial Officer (“PFO”) carried out an
evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (“the Exchange Act”)) as of the end
of the period covered by this report. Disclosure controls and procedures are designed only to
provide reasonable assurance that controls and procedures will meet their objectives. Based on
that evaluation, the Company’s PEO and PFO, concluded that our disclosure controls and procedures
were effective as of May 23, 2010.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting (as defined in
Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended May 23, 2010 that
materially affected, or are reasonably likely to materially affect, the Company’s internal control
over financial reporting.
PART II — OTHER INFORMATION
|
|
|
| Item 1. |
|
Legal Proceedings |
The Company is a party to various legal proceedings and claims arising in the ordinary course of
its business. The Company believes that the outcome of these matters will not have a material
adverse affect on its consolidated financial position, results of operations or liquidity.
The Company’s annual report on Form 10-K for the fiscal year ended February 28, 2010 discusses the
risk factors facing the Company. There has been no material change in the risk factors facing our
business since February 28, 2010.
|
|
|
| Item 2. |
|
Unregistered Sale of Equity Securities and Use of Proceeds |
None
|
|
|
| Item 3. |
|
Defaults Upon Senior Securities |
None
|
|
|
| Item 4. |
|
Submission of Matters to a Vote of Security Holders (removed and reserved) |
|
|
|
| Item 5. |
|
Other Information |
None
Reference is made to “Index to Exhibits”, filed herewith.
12
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
| |
|
|
|
|
| |
MORGAN’S FOODS, INC.
|
|
| |
/s/ Kenneth L. Hignett
|
|
| |
Senior Vice President, |
|
| |
Chief Financial Officer and Secretary |
|
| |
July 7, 2010 |
|
13
MORGAN’S FOODS, INC.
INDEX TO EXHIBITS
| |
|
|
| Exhibit |
|
|
| Number |
|
Exhibit Description |
31.1
|
|
Certification of the Chairman of the Board and Chief Executive
Officer pursuant to Rule 13a-14(a) of Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
|
31.2
|
|
Certification of the Senior Vice President, Chief Financial
Officer and Secretary pursuant to Rule 13a-14(a) of Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. |
|
|
|
32.1
|
|
Certification of the Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2
|
|
Certification of the Senior Vice President, Chief Financial
Officer and Secretary pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. |