O CHARLEYS INC 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the Quarterly Period Ended April 20, 2008
Commission file number 0-18629
(Exact name of registrant as specified in its charter)
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PART I FINANCIAL INFORMATION
See notes to accompanying unaudited consolidated financial statements
See accompanying notes to unaudited consolidated financial statements
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
16 Weeks Ended April 20, 2008 and April 22, 2007
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X. The Companys fiscal year ends on the last Sunday in December with its first quarter consisting of sixteen weeks and its second, third and fourth quarters consisting of twelve weeks each in most years.
In the opinion of management, the unaudited interim consolidated financial statements contained in this report reflect all adjustments, consisting primarily of normal recurring accruals, which are necessary for a fair presentation of the financial position and the results of operations for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year.
These unaudited consolidated financial statements, footnote disclosures and other information should be read in conjunction with the financial statements and the notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 30, 2007. Certain reclassifications have been made to the prior year information to conform to the current year presentation. Management of the Company has made certain estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period to prepare these consolidated financial statements in conformity with U.S. generally accepted accounting principles.
B. FAIR VALUE MEASUREMENTS
Effective December 31, 2007, the first day of fiscal 2008, the Company adopted Statement of Financial Accounting Standards No. 159 ("SFAS 159"), The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The Company did not elect the fair value reporting option for any assets and liabilities not previously recorded at fair value.
Effective December 31, 2007, the first day of fiscal 2008, the Company adopted the provisions of Statement of Financial Accounting Standards No. 157 ("SFAS 157"), Fair Value Measurements for financial assets and liabilities, as well as any other assets and liabilities that are carried at fair value on a recurring basis in financial statements. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the Financial Accounting Standards Board ("FASB") having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. As a result, the adoption of SFAS 157 did not have a material impact on the Company. The Company applied the provisions of FASB Staff Position (FSP) FAS 157-2, "Effective Date of FASB Statement 157," which defers the provisions of SFAS 157 for nonfinancial assets and liabilities to the first fiscal period beginning after November 15, 2008. The deferred nonfinancial assets and liabilities include items such as goodwill and other nonamortizable intangibles. The Company is required to adopt SFAS 157 for nonfinancial assets and liabilities in the first quarter of fiscal 2009 and is still evaluating the impact on its Consolidated Financial Statements.
Fair value is defined under SFAS 157 as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a three-level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date.
The deferred compensation asset is comprised of various investment funds, which are valued based upon their quoted market prices. The interest rate swap asset is valued based upon a mathematical approximation of market value, which can be observed moving directionally in relation to changes in the LIBOR.
Assets and liabilities measured at fair value on a recurring basis are summarized in the table below (in thousands):
C. SHARE-BASED COMPENSATION
Total share-based compensation expense for the first quarter of 2008 was approximately $1.5 million and for the first quarter of 2007 was approximately $1.3 million. The Companys net share-based compensation expense primarily consisted of expense associated with restricted stock awards and to a lesser extent expense associated with unvested stock options and the Companys employee share purchase plan.
During 2004, the Company changed its approach to equity-based compensation and discontinued issuing stock options, choosing to only issue restricted stock awards. As a result, during the first quarter of 2008, the Company granted approximately 0.4 million shares of time vested restricted stock awards to certain members of senior management, members of its board of directors and other employees. The Company also granted approximately 0.1 million of performance vested restricted stock to certain members of its senior management. The Company recognized share-based compensation expense of approximately $0.2 million related to these restricted stock awards granted during the 16-week period ended April 20, 2008. As of April 20, 2008, there were approximately 1.4 million options outstanding and 1.0 million restricted stock awards outstanding.
D. CASH DIVIDENDS AND STOCK REPURCHASE PROGRAM
On February 15, 2008, the Company announced that its Board of Directors approved a quarterly cash dividend on the Companys common stock of $0.06 per share. The dividend was payable on March 28, 2008 to shareholders of record on March 14, 2008. The total dividend of approximately $1.3 million was recorded in the first quarter of 2008 as a reduction to retained earnings.
On February 7, 2008, the Company announced that its Board of Directors approved a $20 million increase in the Company's share repurchase authorization. During 2007, the Board of Directors approved a $50 million repurchase authorization under which the Company had repurchased $30 million of its common stock by the end of fiscal 2007. With the increased authorization effective on February 7, 2008, the Company can repurchase an additional $40 million of its common stock. As a result, during the first quarter of 2008, the Company repurchased an additional 1.5 million shares for approximately $17.8 million. The share repurchase authorization does not have an expiration date and the pace of repurchase activity will depend on factors such as levels of cash generation from operations, cash requirements for strategic initiatives, repayment of debt, current stock price, and other factors. O'Charley's Inc. may repurchase shares from time to time on the open market or in private transactions, including structured transactions. The share repurchase program may be modified or discontinued at any time. The Company also announced that it has amended its revolving credit facility to permit this increased level of share repurchases.
Basic earnings per common share have been computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per common share have been computed on the basis of the weighted average number of common shares outstanding plus the dilutive effect of stock options and restricted (non-vested) stock awards outstanding.
Following is a reconciliation of the weighted average common shares used in the Companys basic and diluted earnings per share calculation (in thousands).
Options for approximately 1.3 million and 0.5 million shares were excluded from the 2008 and 2007 16-week diluted weighted average share calculations, respectively, due to the shares being anti-dilutive.
As of April 20, 2008, the Companys derivative financial instruments consisted of interest rate swaps with a combined notional amount of $78.0 million, which effectively convert an equal portion of the fixed-rate indebtedness related to the Companys $125.0 million senior subordinated notes due 2013 into variable-rate obligations (fair value hedges). The terms and conditions of the swaps mirror the terms and conditions of the respective debt. The Companys purpose for holding such instruments is to hedge its exposure to fair value fluctuations due to changes in market interest rates, as well as to maintain, in the Companys opinion, an appropriate mix of fixed and floating rate debt. The interest rate for these swap agreements is based on the six-month LIBOR rate in arrears plus a specified margin, the average of which is 3.9 percent.
On November 5, 2007, the Company filed suit in Davidson County, Tennessee against Richard Arras, Steven Pahl and WI-Tenn Investors, LLC, (Defendants) alleging breach of contract and breach of fiduciary duty by the Defendants related to WI-Tenn Restaurants, LLC, a joint venture owned 50% by the Company and 50% by the Defendants, which developed and operates an OCharleys restaurant in Grand Chute, Wisconsin (the Tennessee Action). Subsequently, on November 7, 2007, the Defendants filed suit in Outagamie County, Wisconsin against the Company and seven of its current and former employees alleging violations of the Wisconsin Franchise Investment Law, Wisconsin Uniform Securities Law, fraud, misrepresentation and unjust enrichment stemming from Defendants ownership in WI-Tenn Restaurants, LLC (the Wisconsin Action). Plaintiffs have alleged damages in excess of $75,000 in the Wisconsin Action, and on February 15, 2008, filed a counterclaim in the Tennessee Action against the Company and the aforementioned current and former employees, pertaining to the same subject matter referenced in the Wisconsin Action (the Tennessee Counterclaim). The Company has filed a motion to dismiss Defendants complaint in the Wisconsin Action, denies all liability and intends to vigorously contest the allegations contained in both the Wisconsin Action and Tennessee Counterclaim, and intends to vigorously prosecute the Tennessee Action against the Defendants.
The Company is also a defendant from time to time in various legal proceedings arising in the ordinary course of its business, including claims relating to injury or wrongful death under dram shop laws that allow a person to sue the Company based on any injury caused by an intoxicated person who was wrongfully served alcoholic beverages at one of its restaurants; claims relating to workplace, workers compensation and employment matters, discrimination and similar matters; claims resulting from slip and fall accidents; claims relating to lease and contractual obligations; claims relating to its joint venture and franchising initiatives; and claims from guests or employees alleging illness, injury or other food quality, health or operational concerns.
The Company does not believe that any of the legal proceedings pending against it as of the date of this report will have a material adverse effect on its liquidity or financial condition. The Company may incur liabilities, receive benefits, settle disputes, sustain judgments, or accrue expenses relating to legal proceedings in a particular fiscal quarter which may adversely affect its results of operations, or on occasion, receive settlements that favorably affect results of operations.
The amount shown in assets held for sale as of April 20, 2008 on the consolidated balance sheet consists of assets related to one Company-owned OCharleys restaurant that has been closed and two prospective restaurant sites, which were added to assets held for sale during the quarter, that the Company no longer plans to utilize. The closed restaurant and the real estate are currently being marketed for sale. The net book value related to closed restaurant and real estate is approximately $1.5 million and $1.4, respectively. The impairment charges related to the closed restaurant were recorded in prior quarters. The Company does not recognize depreciation expense for assets being held for sale. During the first quarter of 2008, the Company sold assets held for sale with an approximate net book value of $1.5 million and recognized a gain of approximately $0.3 million on the sale of those assets.
In connection with the Companys franchising initiative, the Company may from time to time enter into joint venture and franchise arrangements to develop and operate OCharleys restaurants. For any joint venture in which the Company has an ownership interest, the Company may make loans to the joint venture entity and/or guarantee certain of the joint ventures debt and obligations. As of April 20, 2008 the Company has a 50% interest in two joint ventures to operate OCharleys restaurants. Under Financial Accounting Standards Board Interpretation (FIN) No. 46R, the joint ventures (JFC Enterprises, LLC and Wi-Tenn Restaurants, LLC) are considered variable interest entities. Since the Company currently bears a disproportionate share of the financial risk associated with the joint ventures, it has been deemed to be the primary beneficiary of the joint ventures and, in accordance with FIN 46R, the Company consolidates the joint ventures in its consolidated financial statements. The JFC Enterprise, LLC, joint venture partner has neither the obligation nor the ability to contribute their proportionate share of expected future losses. Such losses may require additional financial support from the Company. As of April 20, 2008, JFC Enterprises, LLC, which owns and operates two OCharleys restaurants in Louisiana, had loans outstanding due to the Company of approximately $8.5 million. As of April 20, 2008, Wi-Tenn Restaurants, LLC, which owns and operates one OCharleys restaurant in Wisconsin, had loans outstanding due to the Company of approximately $4.0 million. The loans to Wi-Tenn Restaurants, LLC, were primarily used to purchase the property and fund construction of its first restaurant.
J. INCOME TAXES
Based upon the Companys current estimated full-year results, it expects its full year effective tax rate to be negative 127 percent. Under U.S. generally accepted accounting principles (GAAP), the Company is required to apply its estimated full year rate on a year to date basis in each interim period. The Company projects that its tax credits, which are primarily the FICA tip credits and the Work Opportunity Tax Credit (WOTC), will be approximately $7.6 million for the year. The FICA (Social Security and Medicare taxes) tip credit is a non refundable federal income tax credit available to offset a portion of employers FICA tax paid on employee cash tips. Given the Companys projected pretax profit on a GAAP basis, these credits are expected to exceed its tax liability at the applicable statutory rates.
In December 2007, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 141 (revised 2007), Business Combinations (SFAS No.141(R)), which replaces SFAS No. 141, Business Combinations. SFAS No. 141(R) retains the underlying concepts of SFAS No. 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but SFAS No. 141(R) changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. SFAS No. 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS No. 141(R) amends SFAS No. 109 such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS No. 141(R) would also apply the provisions of SFAS No. 141(R). Early adoption is not permitted. The Company has not yet determined the impact if any, that SFAS No. 141(R) may have on its results of operations and financial position.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51 (SFAS No. 160). This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with earlier adoption prohibited. This statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parents equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. It also amends certain of Accounting Research Bulletin (ARB) No. 51s consolidation procedures for consistency with the requirements of SFAS No. 141(R). This statement also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. The Company has not yet determined the impact if any, that SFAS No. 160 may have on its results of operations and financial position.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which amends and expands SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 161 requires tabular disclosure of the fair value of derivative instruments and their gains and losses. This statement also requires disclosure regarding the credit-risk related contingent features in derivative agreements, counterparty credit risk, and strategies and objectives for using derivative instruments. The Company is required to adopt SFAS No. 161 in the first quarter of 2009. The Company has not yet determined the impact if any, that SFAS No. 161 may have on its results of operations and financial position.
In the fourth quarter of 2003, the Company issued $125 million aggregate principal amount of 9 percent senior subordinated notes due 2013. The obligations of the Company under the senior subordinated notes are guaranteed by all of the Companys subsidiaries, with the exception of certain minor subsidiaries. The guarantees are made on a joint and several basis. The claims of creditors of the non-guarantor subsidiaries have priority over the rights of the Company to receive dividends or distributions from such subsidiaries. Presented below is supplementary consolidating financial information for the Company and the subsidiary guarantors as of April 20, 2008 and December 30, 2007 and for the 16 weeks ended April 20, 2008 and April 22, 2007.
Consolidating Balance Sheet
As of April 20, 2008
Consolidating Balance Sheet
As of December 30, 2007
Consolidating Statement of Operations
16 Weeks Ended April 20, 2008
Consolidating Statement of Operations
16 Weeks Ended April 22, 2007
Consolidating Statement of Cash Flows
16 Weeks Ended April 20, 2008