August 25, 1999
TANNERS RESTAURANT GROUP INC (ROTI)
Quarterly Report (SEC form 10QSB)
Management's Discussion and Analysis or Plan of Operation -
Please read the following discussion in connection with the consolidated financial statements and related notes to them included elsewhere in this report.
Overview
Tanner's Restaurant Group, Inc. ("we" or "Tanner's"), formerly known as Harvest Restaurant Group, Inc., was incorporated in June 1993 under the name "Clucker's Tex-Mex Venture, Inc."
On January 14, 1999, Harvest Restaurant Group, Inc. and TRC Acquisition Corporation completed a forward triangular merger. For financial and accounting purposes, the effective date of the merger was December 27, 1998, and we have prepared the consolidated financial statements assuming the merger closed as of the end of the day on December 27, 1998. In the merger, TRC's shareholders received a majority of the shares of our outstanding common stock. For this reason, we have treated the merger as a reverse acquisition by TRC for accounting purposes. Therefore, the consolidated financial statements presented are those of TRC rather than Harvest.
As a result of the merger, we now own and franchise ten "Rick Tanner's Original Grill" restaurants formerly owned and franchised by TRC. All ten Tanner's restaurants are located in Georgia - eight are company-owned and two are franchised. In May 1999, we opened a seafood restaurant, also in Georgia, operating under the name "Crabby Bob's Seafood Grill." Additionally, in May 1999 we entered into an agreement with Crabby Bob's Seafood, Inc. and its parent entities to acquire the assets of two more Crabby Bob's restaurants. Assuming we receive the $1,500,000 balance under the financing commitment described below, we expect to complete this acquisition in the third quarter of 1999. In June 1999, upon the expiration of one of our restaurant leases, we sold the assets of that restaurant to a franchisee with whom we established a franchise arrangement.
Our restaurants are designed to appeal to traditional casual dining customers by offering large portions of high quality foods at low prices. Our restaurants are competitively positioned between home meal replacement restaurants and full bar casual restaurants that have less portable foods. The menu at our Rick Tanner's Original Grill restaurants features over 40 different entrees and 11 different appetizers. All entrees are prepared using aged beef and fresh chicken and seafood, cooked to order, and served with a choice of two out of 13 different freshly prepared vegetables. Since inception, over 20% of our sales at Rick Tanner's Original Grill restaurants have come from takeout/take-home service. Our Crabby Bob's restaurant offers fresh seafood, crabs, oysters and a full service bar.
Our growth strategy is to open new company-owned restaurants, to increase sales at existing restaurants, to develop and expand our franchising program, and to evaluate and possibly acquire complementary restaurant concepts. We intend to develop restaurants both in Atlanta, to complete our penetration of the Atlanta market, and in southern California, where, if our acquisition of Crabby Bob's is successful, we will operate two Crabby Bob's restaurants. We believe we will be able to use existing supervisory, marketing and distribution systems in both Atlanta and southern California to facilitate our development in these areas. Additionally, we may seek to acquire other restaurant concepts that would complement our existing business, allowing growth and improving profitability. We continue to evaluate our existing restaurant locations and may close certain unprofitable restaurants as we expand our business concept and focus on achieving profitability. We anticipate leasing most of our future locations.
A significant factor in both the structure and completion of the merger with TRC was a commitment by third party investors to invest $6,000,000 in the new combined company. As of July 11, 1999, we had received $4,500,000 of this $6,000,000 commitment. Of the net proceeds of the remaining $1,500,000 to be invested, we intend to use up to $600,000 as consideration for the acquisition of Crabby Bob's and approximately $550,000 to pay certain liabilities of Crabby Bob's that we are assuming as part of the acquisition, including a $350,000 bridge loan made in March 1999 to the parent entity of Crabby Bob's by Clyde E. Culp, III, our Chairman and Chief Executive Officer. We intend to use the balance of the net proceeds primarily for working capital, the payment of indebtedness, and general corporate purposes, including the development of new company-owned restaurants, the opening of a franchised restaurant, and the evaluation of opportunities to acquire new restaurant concepts. We cannot assure you that any of our development or acquisition plans will be successful.
Results of Operations for the 28 Week Period Ended July 11, 1999 Compared to the 28 Week Period Ended July 12, 1998
Revenues. Total net revenues decreased $965,949, or 15.1%, during the first two quarters (28 weeks) ended July 11, 1999, compared to the corresponding period of 1998. This decrease in sales is primarily due to a decline in same store sales of 17.7%. Same store sales decreased by $961,953, partially due to the leveling of sales at two restaurants that opened in the fourth quarter of 1997. Sales also decreased as a result of the closings of two stores, offset by the opening of our Crabby Bob's restaurant on May 24, 1999. Crabby Bob's net sales through July 11 were $283,801.
Costs and Expenses. In general, costs of goods sold decreased as a percentage of sales during the first two quarters of 1999. This is due to operational improvements and purchasing efficiencies, and a reduction in coupons and promotions, which decreased from $217,078 to $84,815, or 60.9%. Although these types of promotions tend to increase the number of customers that visit the restaurant and thereby increase sales, the operating expenses on these sales are higher than on ordinary sales because the sales have been discounted below the menu price. This decrease in costs as a percentage of sales is most evident in food, beverage and paper costs.
Food, beverage and paper costs were $1,777,700, or 32.8% of sales, for the first two quarters of 1999 versus $2,255,479, or 35.3% of sales, for the same period in 1998. Operational improvements and reduced coupon and discount promotions caused a 3.0% decrease in food costs as a percentage of sales at comparable stores. This was offset somewhat by opening promotions at our new Crabby Bob's restaruant.
Payroll and benefit expense was $1,978,982, or 36.5% of sales, for the first two quarters of 1999 compared to $2,273,890, or 35.6% of sales, for the same period in 1998. Labor costs rose 0.9% due to increased competition for labor and higher costs associated with the opening of our new Crabby Bob's restaurant.
Other operating expenses increased as a percentage of sales to 26.2% ($1,421,342) for the first two quarters of 1999 from 22.3% ($1,424,063) for the same period in 1998. Advertising expenditures decreased by 1.4% of sales. Repairs and maintenance expenses increased, while service contracts decreased due to negotiation of a more favorable pest control contract, for a net increase of .3% of sales. Utilities increased by 0.4% of sales, primarily because of the decrease in sales. Restaurant administration expense increased by 0.7% of sales, partially due to
an increase in credit card processing fees. Rent expense increased by 2.7 % of sales, primarily due to the sale and leaseback of one restaurant in late June of 1998. Pre-opening expenses increased 1.2% of sales in the first half of 1999, due to the development of our Crabby Bob's restaurant. Development of this restaurant involved the conversion of a nearly-completed Tanner's restaurant into a Crabby Bob's restaurant, resulting in a longer construction period than usual. We also had higher costs at this store due to the travel expenses and payroll costs of training personnel from Crabby Bob's.
Total occupancy costs, consisting of depreciation, rent and restaurant interest expense, increased to 11.0% of sales in the first two quarters of 1999 from 8.2% of sales in the first two quarters of 1998. Again, this is primarily due to the sale and leaseback of one restaurant. We expect occupancy costs to decrease as a percentage of sales as we open more "end-cap" restaurants located at the end of strip shopping centers, as opposed to freestanding buildings.
Depreciation and amortization expense in the first two quarters of 1999 increased by 1.2% of sales over the first two quarters of 1998, due to fixed asset additions at two new stores opened since May of 1998.
Loss on restaurant closings of $300,000 for the first half of 1999 relates to charges recognized in connection with the closure of two of our under-performing units. Included in this item are charges for the write-down of property and equipment to their net realizable values and real estate disposition costs.
General and administrative expenses increased to $745,735 in the first two quarters of 1999 from $691,474 in the first two quarters of 1998. This is due to the write-off of costs associated with abandonment of a potential site, the disposal of old warehoused equipment, and the increased cost of corporate office personnel to support additional growth.
Other Income (Expense). Interest expense decreased to $206,209 in the first two quarters of 1999 from $398,889 in the first two quarters of 1998. This is primarily attributable to the cancellation of the debenture to the former president of Tanner's. Our effective interest rate increased to 12.3% for the first half of 1999.
Net Loss. We incurred a net loss of $1,374,264 for the first two quarters of 1999 compared to $1,037,182 for the same period in 1998. This increase was primarily attributable to the $300,000 charge for store closings, and the additional expenses associated with the opening of Crabby Bob's restaurant. We expect to incur losses in future periods until we expand our base of restaurants to offset current general and administrative expenses and costs of expansion.
As we pursue our plans for growth, we expect to see the following trends in operating costs. We expect that food, beverage and paper costs and payroll expenses will increase during the first two months of a restaurant's operations. Pre-opening expenses are expected to total approximately $100,000 for each new restaurant and are expensed as incurred in accordance with Statement of Position 98-5, Reporting on the Costs of Start-up Activities. The majority of pre-opening costs are incurred in the accounting period prior to opening and in the period that a restaurant opens. If we are able to increase our base of restaurants, the effects of the above-mentioned operating trends will decrease, and the new restaurants will have less of an impact on our consolidated results.
Liquidity and Capital Resources -
Our cash and cash equivalents decreased $168,507 during the first two quarters of 1999. The principal source of funds consisted of $2,500,000 received from outside investors. The primary uses of funds consisted of
(a) cash used in operations of $2,003,272, including the payment and resolution of current accounts payable and accrued liabilities of $1,299,055,
(b) the purchase of additional fixed assets for one new restaurant and the remodeling of another for $487,796, and
(c) payment of debt of $177,439.
We have incurred operating losses since inception, and as of July 11, 1999, we had an accumulated deficit of $7,764,269 and a working capital deficit of $3,054,726. We are not currently generating sufficient revenues from operations to meet our cash requirements. Because substantially all sales in our restaurants are for cash, and operating costs are generally due in 15 to 45 days, we are able to operate with negative working capital. We have obtained extended payment schedules with several of our larger vendors allowing for longer payment terms. Additionally, some of our vendors have agreed to extend payment terms for obligations we previously incurred.
In addition to our other liabilities, we currently owe a total of approximately $650,000 to two lenders, one of which is SECA VII, LLC, a significant shareholder, for interim financing loaned in early 1998. One of our directors, James R. Walker, is an equity owner of SECA. The $350,000 SECA loan matured on July 31, 1999, thereby placing us in technical default of the SECA loan. The other unsecured loan, with an outstanding balance of approximately $300,000, matures on our receipt of the final $1,500,000 of the financing commitment. FINOVA Mezzanine Capital, Inc., our senior secured lender, has advised us that any payment of the principal amount on these two loans will be a default under our outstanding $2,000,000 loan from FINOVA, unless we repay the FINOVA loan in full at the same time. The final $1,500,000 that we are scheduled to receive under the financing commitment will be insufficient to repay the FINOVA loan, repay the short-term loans, and provide necessary working capital. We presently have no arrangement to repay these loans. Therefore, we may default on the other loan as well, unless we can make other arrangements. We are working to resolve this situation. If we cannot work out an acceptable arrangement to extend the terms of these loans, we may be forced to sell some or all of our assets, to relinquish control of the company, or to renegotiate terms of our outstanding obligations on terms less favorable to us. Any event of that nature is likely to have a material adverse effect on us.
We have not paid dividends on our Series A preferred stock since June 1998, and we are currently analyzing our alternatives for addressing these arrearages. The total amount of dividends in arrears on our Series A preferred stock as of June 30, 1999 was $716,813. Additionally, the total amount of dividends accumulated but not paid on our Series D preferred stock and Series E preferred stock as of July 11, 1999 was $532,387. Dividends on our Series D and Series E preferred stock are payable only on conversion of these shares into common stock.
We opened one new company-owned restaurant in May 1999. One of our franchised restaurants closed in February 1999 due to franchisee financing arrangements and location issues. We closed two under-performing company-owned restaurants in March 1999, resulting in a charge to earnings of $300,000. We also sold one store to a franchisee. In the remainder of 1999, we plan to open new company-owned restaurants and a franchised restaurant. Our capital requirements to meet this development plan could be as much as $1.2 million.
On May 11, 1999, we entered into an agreement to acquire certain assets of Crabby Bob's. Crabby Bob's is a restaurant chain consisting of two restaurants located in Southern California that offer fresh seafood, crabs, oysters and a full service bar. We will pay $600,000 in cash and assume certain liabilities related to the Crabby Bob's business as consideration for the acquisition of these restaurants and other assets related to their operation.
Although we do not currently have the capital resources to meet our development plan, outside investors invested $2,500,000 of their $6,000,000 financing commitment in the first half of 1999, after having invested $2,000,000 of the $6,000,000 commitment during 1998. These investors have committed to invest the remaining $1,500,000 of the commitment on or before the date on which the shares of common stock into which the Series D preferred shares are convertible are registered with the SEC, which we expect to occur shortly. We plan to meet our capital requirements for new restaurant development, the acquisition of Crabby Bob's, and working capital through the remainder of this funding. We may also raise additional funds by borrowing.
Additionally, we sold our property on Tezel Road in San Antonio, Texas on July 30, 1999. The sale generated approximately $382,000 in net proceeds. Under the terms of a severance agreement that we entered into with William J. Gallagher, our former chief executive officer and a former director, we were obligated to apply the proceeds of the sale of the Tezel property to satisfy any remaining obligations to Mr. Gallagher. We paid Mr. Gallagher $65,000 out of these net proceeds, in full satisfaction of our outstanding obligations to him.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements appear in a number of places in this report and include all statements that are not historical facts. Some of the forward-looking statements relate to our intent, belief or expectations regarding our strategies and plans for operations and growth, including development and construction of new restaurants. Other forward-looking statements relate to trends affecting our financial condition and results of operations, and our anticipated capital needs and expenditures.
Our forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those anticipated in the forward-looking statements, as a result of:
- an inability to meet our obligations as they become due; - increased competition in the casual dining market; - difficulty attracting and keeping good managers and franchisees; - increased labor, food and other costs; - changes in economic conditions; - the possibility that we do not close the Crabby Bob's acquisition as we anticipate; and - the possibility that we will not receive the final $1,500,000 of our $6,000,000 financing commitment.
In addition, the market price of the common stock may from time to time fluctuate widely because of, among other things:
- our operating results; - the operating results of other similarly-situated companies; - and changes in the performance of the stock market in general.
Investors should review the more detailed description of these and other possible risks contained in the "Risk Factors" sections of the registration statements we file with the SEC under the Securities Act.
Year 2000 Computer Issues -
The "Year 2000 problem" is a general term used to identify those computer problems or applications that are programmed to use a two-digit field, instead of a four-digit field, for the year component of a date. Those programs or applications that are programmed in this manner, may, for example, recognize the year 2000 as the year 1900; thus causing potential system failures or miscalculations that could result in disruptions of normal business operations. We have evaluated our state of readiness, the costs involved to become compliant, the risks involved, and our contingency plans. Our primary uses of software systems are our corporate accounting and restaurant management software.
We have completed an initial assessment of our core computer information systems and are now undertaking the necessary steps to make our systems Year 2000 compliant. We believe that the cost to upgrade our software will not be material. We are currently evaluating and assessing those computer systems that do not relate to information systems, such as telecommunications, HVAC, and fire and safety systems. These typically include embedded technology such as microcontrollers that may be harder to test, and may require repairs or complete replacement. We expect to complete this assessment during the third quarter of 1999.
We are in the process of contacting all significant vendors and our independent payroll vendor to verify that those vendors are also addressing the problem. We have developed contingency plans where necessary. Some Year 2000 issues that may adversely affect our operations are beyond our control. We cannot now estimate the potential adverse effect that may result from the failure of any of our vendors to become Year 2000 compliant. We continue to believe that there will be no direct material effect on our operating performance or results of operations. |
