10-Q 1 jun0210-q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 or the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For transition period from to --------- -------- Commission file number 0-20040 --------------------------------- THE KRYSTAL COMPANY ----------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) TENNESSEE 62-0264140 --------- ---------- (State or other jurisdiction of (IRS Employer identification incorporation or organization) Number) One Union Square, Chattanooga, TN 37402 ----------------------------------------------------------------------------- (Address of principal executive offices, including zip code) (423) 757-1550 ----------------------------------------------------------------------------- (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 Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---- ---- This report is filed by the Company pursuant to Section 15(d) of the Securities Exchange Act of 1934. The Company has 100 shares of common stock outstanding held of record by Port Royal Holdings, Inc. as of August 7, 2002. THE KRYSTAL COMPANY ------------------- JUNE 30, 2002 ------------- PART I. FINANCIAL INFORMATION ------------------------------ The condensed financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the Company's latest annual report on Form 10-K. In the opinion of management of the Company, all adjustments necessary to present fairly (1) the financial position of The Krystal Company and Subsidiary as of June 30, 2002 and December 30, 2001, and (2) their change in shareholder's equity for the six months ending June 30, 2002 and (3) the results of their operations for the three and six months ended June 30, 2002 and July 1, 2001 and (4) their cash flows for the six months ended June 30, 2002 and July 1, 2001 have been included. The results of operations for the interim period ended June 30, 2002 are not necessarily indicative of the results for the full year. Certain written and oral statements made by or on behalf of the Company may constitute "forward-looking" statements as defined under the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). The PSLRA contains a safe harbor in making such disclosures. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the Company's historical experience and its present expectations or projections. These risks and uncertainties include, but are not limited to, unanticipated economic changes, interest rate movements, changes in governmental policies, the impact of competition, changes in consumer tastes, increases in costs for food and/or labor, the availability and adequate supply of hourly-paid employees, the ability of the Company to attract and retain suitable franchisees, the Company's ability to obtain funding sufficient to meet operational requirements and capital expenditures and the impact of governmental regulations. The Company cautions that such factors are not exclusive. Caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date of the making of such statements and are based on certain expectations and estimates of the Company which are subject to risks and changes in circumstances that are not within the Company's control. The Company does not undertake to update forward-looking statements other than as required by law. The information provided herein should be read in conjunction with information provided in the Company's Form 10-K for the fiscal year ended December 30, 2001. PART I. FINANCIAL INFORMATION ----------------------------- Item I. Financial Statements THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED BALANCE SHEETS --------------------------- (In thousands) June 30, December 30, 2002 2001 --------- ---------- ASSETS (Unaudited) ------ CURRENT ASSETS: Cash and temporary investments $ 13,022 $ 13,042 Receivables, net 1,593 1,418 Inventories 1,729 2,033 Deferred income taxes 2,877 2,877 Prepayments and other 965 823 -------- -------- Total current assets 20,186 20,193 -------- -------- PROPERTY, BUILDINGS, AND EQUIPMENT, net 97,360 114,800 -------- -------- LEASED PROPERTIES, net 6,038 9,144 -------- -------- OTHER ASSETS: Goodwill, net 40,759 40,759 Prepaid pension asset 8,374 8,754 Deferred financing costs, net 2,435 2,735 Other 1,041 1,605 -------- -------- Total other assets 52,609 53,853 -------- -------- TOTAL ASSETS $176,193 $197,990 ======== ======== See accompanying notes to consolidated condensed financial statements. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED BALANCE SHEETS (CONTINUED) --------------------------------------- (In thousands) June 30, December 30, 2002 2001 LIABILITIES AND SHAREHOLDER'S EQUITY ----------- ---------- ------------------------------------ (Unaudited) CURRENT LIABILITIES: Accounts payable $ 5,523 $ 5,175 Accrued liabilities 26,595 22,719 Current portion of long-term debt 1,479 1,361 Current portion of capital lease obligations 1,214 2,133 -------- -------- Total current liabilities 34,811 31,388 -------- -------- LONG-TERM DEBT, excluding current portion 87,820 118,581 -------- -------- CAPITAL LEASE OBLIGATIONS, excluding current portion 5,813 8,170 -------- -------- DEFERRED INCOME TAXES 7,471 8,912 -------- -------- OTHER LONG-TERM LIABILITIES 5,475 1,501 -------- -------- SHAREHOLDER'S EQUITY: Common stock, without par value; 100 shares authorized, issued and outstanding, at June 30, 2002, and at December 30, 2001 35,000 35,000 Accumulated deficit ( 197) ( 5,562) -------- -------- Total shareholder's equity 34,803 29,438 -------- -------- TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $176,193 $197,990 ======== ======== See accompanying notes to consolidated condensed financial statements.

THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY ----------------------------------------------- FOR THE SIX MONTHS ENDED ------------------------- June 30, 2002 ------------- (In thousands) (Unaudited) Common Accumulated Stock Deficit -------- -------- BALANCE, December 30, 2001 $35,000 $( 5,562) Net income -- 5,365 ------- ------- BALANCE, June 30, 2002 $35,000 $( 197) ======= ======= See accompanying notes to consolidated condensed financial statements. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (In thousands) (Unaudited) For The Six Months Ended -------------------------- June 30, July 1, 2002 2001 --------- --------- OPERATING ACTIVITIES: Net income (loss) $ 5,365 $ (2,100) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities- Depreciation and amortization 5,539 7,265 Change in deferred taxes ( 1,441) ( 80) Gain on early retirement of debt ( 4,375) -- Gain on sale of assets ( 11) ( 596) Changes in operating assets and liabilities: Receivables, net ( 175) 128 Inventories 304 ( 49) Prepayments and other ( 142) ( 498) Accounts payable 348 ( 3,870) Accrued liabilities 3,876 ( 1,335) Other, net 1,167 619 -------- -------- Net cash provided by (used in) operating activities 10,455 ( 516) -------- -------- INVESTING ACTIVITIES: Additions to property, buildings, and equipment ( 4,265) ( 3,579) Proceeds from sale of property, buildings, and equipment 23,334 1,984 -------- ------- Net cash provided by (used in) investing activities 19,069 ( 1,595) -------- ------- FINANCING ACTIVITIES: Net borrowings under revolving credit facility ( 3,417) 2,075 Repayments of long-term debt (22,851) ( 76) Outstanding checks in excess of bank balance -- 800 Principal payments of capital lease obligations ( 3,276) ( 981) -------- ------- Net cash provided by (used in) financing activities (29,544) 1,818 -------- -------- NET DECREASE IN CASH AND TEMPORARY INVESTMENTS ( 20) ( 293) CASH AND TEMPORARY INVESTMENTS, beginning of period 13,042 4,979 --------- ------- CASH AND TEMPORARY INVESTMENTS, end of period $13,022 4,686 ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 5,475 $ 6,395 ======= ======= Income taxes $ 1,225 $ 69 ======= ======= See accompanying notes to consolidated condensed financial statements. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) ---------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Business Activities -- The Krystal Company (a Tennessee corporation) ("Krystal") is engaged primarily in the development, operation and franchising of quick-service restaurants in the southeastern United States. Krystal's wholly-owned subsidiary, Krystal Aviation Co. ("Aviation") operates a fixed base airport hangar operation in Chattanooga, Tennessee. Aviation's revenues provide less than 3% of the Company's total revenues. Principles of Consolidation -- The accompanying consolidated financial statements include the accounts of Krystal and Aviation (hereinafter referred to collectively as "the Company"). All significant intercompany balances and transactions have been eliminated. Cash and temporary investments -- The Company considers repurchase agreements and other temporary cash investments with a maturity of three months or less to be temporary investments. Inventories -- Inventories are stated at cost and consist primarily of food, paper products and other supplies. Property, Buildings, and Equipment -- Property, buildings and equipment are stated at cost. Expenditures which materially increase useful lives are capitalized, whereas ordinary maintenance and repairs are expensed as incurred. Depreciation of fixed assets is computed using the straight-line method for financial reporting purposes and accelerated methods for tax purposes over the estimated useful lives of the related assets as follows: Buildings and improvements 10-39 years Equipment 3-10 years Leaseholds Life of lease up to 20 years Long-lived assets -- The Company periodically evaluates the carrying value of long-lived assets when events or changes in circumstances warrant such a review. When an asset is determined to be impaired, its carrying value is reduced and a charge is recognized in the Consolidated Statement of Operations. Leased property -- The lower of fair market value or the discounted value of that portion of a capital lease attributable to building costs is capitalized and amortized by the straight-line method over the term of such leases and included with depreciation expense. The portions of such leases relating to land are accounted for as operating leases. Intangibles -- In June 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" (collectively the "Standards"). The Standards are effective for fiscal years beginning after December 15, 2001. SFAS No. 141 requires companies to recognize acquired identifiable intangible assets separately from goodwill if certain conditions are met. The Standards require the value of separately identifiable intangible assets to be measured at fair value. SFAS No. 142 requires that goodwill not be amortized, but that amounts recorded as goodwill be periodically tested for value impairment. Upon adoption of SFAS No. 142, if the value of goodwill is determined to be impaired, the Company is required to reduce goodwill through a charge to earnings. The Company adopted the Standards effective December 31, 2001. The adoption of the Standards has the effect of eliminating the amortization of goodwill. Had the non-amortization provisions of SFAS 142 not been adopted, net income would have been reduced by $491,900 and $983,900, respectively, in the three months and six months ended June 30, 2002. Based on an independent valuation of the Company as of December 31, 2001, the Company has determined there is no impairment of its goodwill asset as of that date. Prior to the adoption of SFAS 142, the Company amortized goodwill over 25 years. Had the Company accounted for goodwill consistent with the provisions of SFAS 142 in prior periods, the Company's net income would have been affected as follows (in thousands): For the Three For the Six Months Ended Months Ended ------------------ ------------------ June 30, July 1, June 30, July 1, 2002 2001 2002 2001 -------- ------- -------- ------- Net income (loss) $1,839 $( 175) $5,365 $(2,100) Add back: Goodwill amortization -0- 492 -0- 984 ------ ------- ------ ------- Adjusted net income (loss) $1,839 $ 317 $5,365 $(1,116) ====== ======= ====== ======= The consolidated balance sheet includes the allocation of purchase accounting goodwill of $49,190,000 (net of amounts written off in connection with the subsequent sale of certain assets) and deferred financing costs of $5,778,700 at June 30, 2002. Deferred financing costs are amortized over the life of the debt agreement. The financing costs related to the Senior Notes are amortized over 10 years. The financing costs associated with the Company's Credit Facility are being amortized in part through May 2004 and in part through January 2007. Amortization expense for deferred financing costs for the three months ended June 30, 2002 was $150,600 and for the three months ended July 1, 2001 was $135,900. Amortization expense for deferred financing costs for the six months ended June 30, 2002 was $352,900 and for the six months ended July 2001 was $271,700. Amortization expense for goodwill for the three months ended July 1, 2001 was $491,900 and was $983,800 for the six months ended July 1, 2001. Accumulated amortization of goodwill at June 30, 2002 and July 1, 2001 was $8,430,900 and $7,447,100, respectively. Accumulated amortization of deferred financing costs at June 30, 2002 and July 1, 2001 was $3,343,400 and $2,778,300, respectively. Franchise and License Agreements -- Franchise or license agreements are available for single and multi-unit restaurants. The multi-unit agreement establishes the number of restaurants the franchisee or licensee is to construct and open in the franchised area during the term of the agreement. At June 30, 2002, there were 173 franchised or licensed restaurants and at July 1, 2001, there were 148 franchised or licensed restaurants. Franchisees and licensees are required to pay the Company an initial franchise or license fee plus a weekly royalty and service fee of either 4.5% or 6.0% of the restaurants' gross receipts, depending on the duration of the franchise agreement. The initial franchise and license fees are recorded as income as related restaurants begin operations. Royalty and service fees, which are based on restaurant sales of franchisees and licensees, are recognized as earned. Franchise fees received prior to the opening of the restaurant are deferred and included in accrued liabilities on the consolidated balance sheets. At June 30, 2002 and July 1, 2001, total deferred franchise and license fees were approximately $958,500 and $995,000, respectively. Fair Market Value of Financial Instruments -- Unless otherwise indicated elsewhere in the notes to the consolidated financial statements, the carrying values of the Company's financial instruments approximate their fair values. Benefit Plans -- The determination of obligations and expenses under the Company's retirement and post retirement benefit plans is dependent on the selection of certain assumptions used by actuaries in calculating such amounts. In accordance with generally accepted accounting principles, actual results that differ from assumptions are accumulated and amortized over future periods and therefore, generally affect our recognized expense and the recorded obligation in such periods. Significant differences in actual experience or significant changes in the assumptions used may materially affect the pension and post retirement obligations and future expenses. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications-- Certain reclassifications have been made to prior year financial statements to conform with the 2002 presentation. Income Taxes -- During the second quarter of 2002, the Company revised its estimate of certain tax liability contingencies resulting in a reduction of income tax expense of $200,000. 2. SUMMARIZED FINANCIAL INFORMATION - SUBSIDIARY GUARANTORS The Company's subsidiaries have fully and unconditionally guaranteed the notes (See Note 4) of the Company. The guarantees do not restrict the ability of the subsidiary guarantors to declare dividends, or make loans or advances to the Company. Set forth below are condensed consolidating financial statements for the Company and the Subsidiary Guarantors as of June 30, 2002 and December 30, 2001 and the six months ended June 30, 2002 and July 1, 2001. The equity method has been used by the Company with respect to investments in subsidiaries.

3. Segment Reporting The Company has three defined reportable segments: restaurants, franchising, and fixed base airport hanger operations ("FBO"). The restaurant segment consists of the operations of all Company-owned restaurants and derives its revenues from retail sales of food products to the general public. The franchising segment consists of franchise sales and support activities and derives its revenues from fees related to the sales of franchise and development rights and collection of royalties from franchisees of the Krystal brand. The FBO operation consists primarily of aircraft fuel sales and the leasing of aircraft hanger space. All of the Company's revenues are derived within the United States. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies. Segment information is as follows: ---------------------------------------------------------------------------- June 30, July 1, (in thousands) 2002 2001 ---------------------------------------------------------------------------- Revenues: Restaurants $123,937 $122,635 Franchising 3,937 3,339 FBO 3,349 3,508 ---------------------------------------------------------------------------- Total segment revenues $131,223 $129,482 ============================================================================ Depreciation and Amortization Restaurants $ 5,293 $ 6,959 Franchising 2 2 FBO 94 155 ---------------------------------------------------------------------------- Total segment depreciation and amortization $ 5,389 $ 7,116 ============================================================================ Earnings before Interest, Taxes, Depreciation, and Amortization ("EBITDA") Restaurant $ 10,231 $ 7,289 Franchising 2,791 2,412 FBO 841 889 ---------------------------------------------------------------------------- Total segment EBITDA $ 13,863 $ 10,590 ============================================================================ June 30, December 30, 2002 2001 ----------------------------------------------------------------------------- Capital Expenditures: Restaurants $ 6,338 $ 5,665 Franchising 0 0 FBO 15 166 ------------------------------------------------------------------------------- Total segment capital expenditures $ 6,353 $ 5,831 =============================================================================== Total Assets: Restaurants $168,066 $189,695 Franchising 1,664 1,718 FBO 2,774 2,722 ------------------------------------------------------------------------------- Total segment assets $172,504 $194,135 =============================================================================== A reconciliation of segment depreciation and amortization to consolidated depreciation and amortization is as follows: ------------------------------------------------------------------------------- June 30, July 1, 2002 2001 ------------------------------------------------------------------------------- Segment depreciation and amortization $ 5,389 $ 7,116 Unreported segments (1) 150 149 ------------------------------------------------------------------------------- Total consolidated depreciation and amortization $ 5,539 $ 7,265 =============================================================================== A reconciliation of segment EBITDA to consolidated EBITDA is as follows: Segment EBITDA $ 13,863 $ 10,590 Unreported segments (1) 297 301 ------------------------------------------------------------------------------- Total consolidated EBITDA $ 14,160 $ 10,891 =============================================================================== A reconciliation of segment total assets to consolidated total assets is as follows: ------------------------------------------------------------------------------- June 30, December 30, 2002 2001 ------------------------------------------------------------------------------- Total segment assets $172,504 $194,135 Unreported segments (1) 3,689 3,855 ------------------------------------------------------------------------------- Total consolidated assets $176,193 $197,990 =============================================================================== (1) Unreported segments do not meet the quantitative thresholds for segment reporting. 4. INDEBTEDNESS Senior Secured Credit Agreement-- 0n January 28, 2002, the Company entered into a $25.0 million credit agreement (the "Credit Facility"). The Credit Facility provides for $10.0 million in revolving loan commitments and a $15.0 million term loan commitment, with maturity dates of June 1, 2004 and January 28, 2007, respectively. Borrowings under the revolving loan commitment bear interest rates, at the option of the Company, and depending on the certain financial covenants, equal to either (a) the greater of the prime rate, or the federal funds rate plus 0.5%, plus a margin (which ranges from 0.25% to 2.0%) or (b) the rate offered in the Eurodollar market for amounts and periods comparable to the relevant loan, plus a margin (which ranges from 1.75% to 3.5% and is determined by certain financial covenants). Borrowings under the term loan commitment bear interest rates equal to the rate offered in the Eurodollar market for 30 day borrowings, plus an applicable margin (which ranges from 3.5% to 4.0% and is determined by certain financial covenants). The Credit Facility contains restrictive covenants including, but not limited to (a) the Company's required maintenance of a minimum amount of tangible net worth; (b) the Company's required maintenance of certain levels of funded debt coverage; (c) limitations regarding additional indebtedness; (d) the Company's required maintenance of a minimum amount of fixed charges coverage; (e) limitations regarding consolidated capital expenditures and (f) limitations regarding liens on assets. Essentially all assets of the Company are pledged as collateral on the Credit Facility. Additionally, the Credit Facility is guaranteed by Port Royal through a secured pledge of all of the Company's common stock held by Port Royal and the common stock of each existing and future subsidiary of the Company. Senior Notes-- In September 1997, the Company issued $100.0 million in unsecured 10.25% senior notes ("the Notes") which mature on October 1, 2007. The Notes pay interest semi-annually on April 1 and October 1 of each year. The Notes are redeemable at the option of the Company at prices decreasing from 105 1/8% of the principal amount on April 1, 2002 to 100% of the principal amount on April 1, 2005. Additionally, upon a change of control of the Company, the holders of the Notes will have the right to require the Company to purchase all or a portion of the Notes at a price equal to 101% of the original principal amount. The proceeds of the Notes were used to fund the acquisition of the Company by Port Royal. On December 31, 2001 and May 30, 2002, the Company purchased $27.0 million and $20,000, respectively, aggregate principal amount of its Notes. These Notes were retired resulting in an extraordinary gain of $2.7 million. The extraordinary gain resulted from retirement discounts of $5.4 million, offset by fees, taxes and other costs of approximately $2.7 million. 5. SALE AND LEASEBACK TRANSACTION On December 31, 2001, the Company entered into a real estate sale and leaseback transaction in which it sold commercial real property and improvements of 32 restaurant locations to an unaffiliated third party and leased the properties back for a period of twenty years. Proceeds from this transaction were approximately $23,317,000, net of expenses of $950,000. The Company has the option to extend the leases past the original twenty years for four additional periods of five years each. The leases are accounted for as operating leases. The net proceeds of this transaction were used to repurchase the Notes in the tender offer on December 31, 2001. The gain that the Company realized on the above real estate transactions was approximately $4,101,000 and has been deferred and classified in the balance sheets in Other Long-Term Liabilities, and will be amortized as a reduction of rental expense over the life of the leases. 6. COMMITMENTS AND CONTINGENCIES The Company is a party to various legal proceedings incidental to its business. The ultimate disposition of these matters is not presently determinable but will not, in the opinion of management and the Company's legal counsel, have a material adverse effect on the Company's financial condition or results of operations. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements of the Company (including the notes thereto) contained elsewhere in this report. Cash operating profit -- Cash operating profit (net income or loss before interest, taxes, depreciation, amortization and other non-operating gains, losses or expenses) is one of the key standards used by the Company to measure operating performance. Cash operating profit is used to supplement operating income as an indicator of operating performance and cash flows from operating activities as a measure of liquidity, and not as an alternative to measures defined and required by generally accepted accounting principles. Cash operating profit may not be comparable to similarly titled measures reported by other companies. Cash operating profit for the three months ended June 30, 2002 was $7.6 million compared to $6.2 million for the three months ended July 1, 2001, an increase of 22.6%. This increase in cash operating profit was primarily attributable to a decrease in cost of labor and food as a percent of restaurant sales. The following table reflects certain key operating statistics which impact the Company's financial results:

Comparison of the Three Months Ended June 30, 2002 --------------------------------------------------- to the Three Months Ended July 1, 2001 --------------------------------------- RESULTS OF OPERATIONS --------------------- Total Krystal systemwide restaurant sales, which included restaurant sales of $62.9 million for Company-owned and $36.7 million for franchised units, for the three months ended June 30, 2002 increased 5.3% to $99.6 million compared to $94.6 million for the same period in 2001. Total Company revenues decreased $37,000 to $66.7 million in the three months ended June 30, 2002 compared to the same period in 2001. The decrease was comprised of a $396,000 decrease in restaurant sales, a $428,000 increase in royalty and franchise revenue, and a $69,000 decrease in other revenue from the Company's aviation subsidiary. The decrease in restaurant sales was primarily due to a decrease in the number of Company owned restaurants in operation during the period, offset by an increase in check average, resulting in an increase in same restaurant sales for the period. The Company operated 246 restaurants at June 30, 2002 compared to 247 restaurants at July 1, 2001. Company-owned same restaurant sales increased 0.2%, compared to the same period in 2001. The increase was primarily attributable to an increase in average check amount for the three months ended June 30, 2002 compared to the same period in 2001. The average customer check for Company owned restaurants increased 1.3% to $4.75 for the three months ended June 30, 2002, compared to $4.69 for the same period in 2001. This increase resulted primarily from price increases implemented by the Company in the third quarter of 2001. Franchise fee income was $302,000 in the three months ended June 30, 2002 compared to $145,000 in the same period in 2001. The increase in franchise fees, which are collected upon the opening, transfer or renewal of new franchise restaurants, related primarily to the higher number of franchise restaurants opened in the second quarter of 2002 compared to 2001. The Company's franchisees opened seven franchised restaurants in the three months ended June 30, 2002 compared to four in the same period in 2001. Royalty revenue increased 18.3% to $1.8 million in the three months ended June 30, 2002 from $1.5 million in the same period in 2001. The increase in royalty revenue, which is earned based on a percentage of sales by franchise restaurants, was due to a 17.3% increase in franchise restaurant sales resulting from an increase in the number of franchise restaurants in operation. The franchise system operated 173 restaurants at June 30, 2002 compared to 148 at July 1, 2001. Other revenue, which is generated primarily from the Company's aviation subsidiary, was $1.7 million for the three months ended June 30, 2002 compared to $1.8 million for the same period in 2001, a 3.8% decrease. This decrease in revenue resulted from a 6.6% decrease in retail jet fuel prices and a 2.4% increase in jet fuel volume sold during the three months ended June 30, 2002 compared to the same period in 2001. Cost of restaurant sales was $50.7 million for the three months ended June 30, 2002 compared to $53.6 million for the same period in 2001. Food and paper costs as a percent of restaurant sales decreased to 30.3% in the three months ended June 30, 2002 from 33.1% in the same period in 2001. The decrease in food and paper costs as a percent of restaurant sales resulted primarily from improved restaurant level controls over food and paper usage, a change in menu mix and the effect of the Company's 1.4% price increase effected in the third quarter of 2001. During the second quarter of fiscal 2001, the Company's menu included a Steak and Cheese sandwich as a limited time offering. The Steak and Cheese offering had a higher food cost as a percentage of restaurant sales than other Company menu offerings. The Steak and Cheese sandwich is no longer included on the Company's menu. The change in menu mix had the effect of decreasing food cost as a percentage of restaurant sales for the three months ended June 30, 2002 by 1.2% as compared to the same period of 2001. Direct labor as a percent of restaurant sales decreased to 21.8% for the three months ended June 30, 2002 from 22.6% for the same period in 2001. Average hourly wage increased 0.5% to $6.37 for the three months ended June 30, 2002 from $6.34 for the same period in 2001. This increase was more than offset by operating efficiencies gained with improvements in the utilization of store level labor tracking systems. Advertising expense decreased 0.6% to $2.6 million in the three months ended June 30, 2002 from $2.7 million in the same period in 2001. Advertising expense is accrued based on 4.2% of restaurant sales and will vary with the volume of such sales. Depreciation and amortization expenses decreased $858,000, or 23.7%, to $2.8 million in the three months ended June 30, 2002 compared to the same period in 2001. The decrease resulted primarily from a reduction in depreciation as a result of the sale and leaseback of 32 restaurants on December 31, 2001, and the elimination of goodwill amortization expense resulting from the adoption by the Company of SFAS 142 as of December 31, 2001. Goodwill amortization expense for the three months ended July 1, 2001 was approximately $491,900. General and administrative expenses for the three months ended June 30, 2002 was $4.7 million compared to $3.2 million for the same period in fiscal 2001. The increase resulted primarily from an increase of approximately $799,000 in accruals for the management incentive plan, and an increase of approximately $316,000 in expense associated with the Company's defined benefit plan. In the first six months of 2001, the Company's performance failed to meet the criteria for payment of management incentive bonuses and, accordingly, no provision was made for such bonuses. In the first six months of 2002, the Company's year-to- date performance warranted the accrual of funds for the anticipated payment of such bonuses. The increase in expense associated with the defined benefit plan results from the actuarial impact of lower investment returns and lower interest rates assumed in the actuarial valuation performed for fiscal 2002 compared to the 2001 valuation. Because the Company's defined benefit plan is currently over funded under the requirements of the Employee Retirement Income Act of 1974, the increase in expense does not impact the Company's funding policy for the defined benefit plan. Other expenses decreased $30,000, or 2.8%, to $1.1 million in the three months ended June 30, 2002 compared to the same period in 2001. This decrease resulted primarily from a decrease in the wholesale cost of jet fuel purchased by the Company's aviation subsidiary in the three months ended June 30, 2002 compared to the same period in 2001. The Company recognized an $11,000 gain on sale of assets for the three months ended June 30, 2002 compared to gains of $566,000 for the same period in 2001. The gains in the second quarter of 2001 resulted from the sale of a restaurant to a franchisee and the sale of non-operating properties. Interest expense, net of interest income, decreased $844,000 to $2.4 million in the three months ended June 30, 2002 from $3.3 million in the same period in 2001. This decrease resulted primarily from the Company's retirement of a portion of the Notes and lower borrowings under its Credit Facility during the quarter ended June 30, 2002. The Company's provision for income taxes for the three months ended June 30, 2002 increased $527,000, to $566,000 from $39,000, in the same period in 2001. During the second quarter of 2002, the Company revised its estimate of certain tax liability contingencies resulting in a reduction of income tax expense of $200,000. In the quarter ended June 30, 2002, the Company recognized an extraordinary gain of $2,000, net of income taxes of $2,000, resulting from the repurchase and retirement $20,000 aggregate principle amount of the Company's Notes. Comparison of the Six Months Ended June 30, 2002 ------------------------------------------------ to the Six Months Ended July 1, 2001 ------------------------------------ RESULTS OF OPERATIONS --------------------- Total Krystal systemwide restaurant sales, which included restaurant sales of $123.9 million for Company-owned and $70.5 million for franchised units, for the six months ended June 30, 2002 increased 6.8% to $194.4 million compared to $182.1 million for the same period in 2001. Total Company revenues increased 1.3% to $131.2 million in the six months ended June 30, 2002 compared to $129.5 million in the same period in 2001. The $1.7 million increase was comprised of a $1.3 million increase in restaurant sales, a $598,000 increase in royalty and franchise revenue, offset by a $159,000 decrease in other revenue from the Company's aviation subsidiary. The increase in restaurant sales was primarily due to an increase in sales volumes and check average, resulting in an increase in same restaurant sales. The Company operated 246 restaurants at June 30, 2002 compared to 247 restaurants at July 1, 2001. Company-owned same restaurant sales increased 2.1%, compared to the same period in 2001. The increase was primarily attributable to an increase in sales volumes and an increase in average check amount for the six months ended June 30, 2002 compared to the same period in 2001. The average customer check for Company owned restaurants increased 1.9% to $4.72 for the six months ended June 30, 2002, compared to $4.63 for the same period in 2001. This increase resulted primarily from price increases of approximately 1.4% implemented by the Company in the third quarter of 2001. Franchise fee income was $597,000 in the six months ended June 30, 2002 compared to $503,000 in the same period in 2001. The increase in franchise fees, which are collected upon the opening, transfer or renewal of franchise restaurants, related primarily to the collection of franchise renewals, transfer, and extension fees, offset by a reduction in the number of franchise restaurants opened in the first six months of 2002 compared to 2001. Franchise renewal, transfer and extension fees were approximately $207,000 for the first six months of 2002 compared to $15,600 in the same period in 2001. The Company's franchisees opened 12 franchised restaurants in the six months ended June 30, 2002 compared to 15 in the same period in 2001. Royalty revenue increased 17.8% to $3.3 million in the six months ended June 30, 2002 from $2.8 million in the same period in 2001. The increase in royalty revenue, which is earned based on a percentage of sales by franchise restaurants, was due to a 18.6% increase in franchise restaurant sales resulting primarily from an increase in the number of franchise restaurants in operation. The franchise system operated 173 restaurants at June 30, 2002 compared to 148 at July 1, 2001. Other revenue, which is generated primarily from the Company's aviation subsidiary, decreased 4.5% to $3.3 million for the six months ended June 30, 2002 compared to $3.5 million for the same period in 2001. This decrease in revenue resulted from a 2.5% decrease in retail jet fuel prices offset by a 4.8% increase in jet fuel volume sold during the six months ended June 30, 2002 compared to the same period in 2001. Cost of restaurant sales was $100.7 million for the six months ended June 30, 2002 compared to $104.3 million for the same period in 2001. Food and paper costs as a percent of restaurant sales decreased to 30.5% in the six months ended June 30, 2002 from 32.5% in the same period in 2001. The decrease in food and paper costs as a percent of restaurant sales resulted primarily from improved restaurant level controls over food and paper usage, a change in menu mix and the effect of the Company's 1.4% price increase effected in the third quarter of 2001. During the first six months of fiscal 2001, the Company's menu included Chicken Strippers and a Steak and Cheese Sandwich as limited time offerings. These menu offerings had a higher food cost as a percentage of restaurant sales than other Company menu offerings. Chicken Strippers and the Steak and Cheese Sandwich are no longer included on the Company's menu. The change in menu mix had the effect of decreasing food cost by 0.7% in the first six months of 2002 as compared to the same period of 2001. Direct labor as a percent of restaurant sales decreased to 21.8% in the first six months of 2002 from 23.1% in the same period in 2001. Average hourly wage increased 0.5% to $6.36 for the first six months of 2002 from $6.33 for the first six months of 2001. This increase was more than offset by operating efficiencies gained with increased sales volumes and improvements in the utilization of store level labor tracking systems. Advertising expense increased 1.1% to $5.2 million in the six months ended June 30, 2002 from $5.1 million in the same period in 2001. Advertising expense is accrued based on 4.2% of restaurant sales and will vary with the volume of such sales. Depreciation and amortization expenses decreased $1.7 million, or 23.8%, to $5.5 million in the six months ended June 30, 2002 compared to the same period in 2001. The decrease resulted primarily from a reduction in depreciation as a result of the sale and leaseback of 32 restaurants on December 31, 2001, and a reduction in goodwill amortization expense resulting from the adoption by the Company of SFAS 142 as of December 31, 2001. Goodwill amortization expense for the six months ended July 1, 2001 was approximately $983,800. General and administrative expenses for the six months ended June 30, 2002 was $9.1 million compared to $7.6 million for the same period in fiscal 2001. The increase resulted primarily from an increase of approximately $960,000 in accruals for the management incentive plan, and an increase of approximately $578,000 in expense associated with the Company's defined benefit plan. In the first six months of 2001, the Company's performance failed to meet the criteria for payment of management incentive bonuses and, accordingly, no provision was made for such bonuses. In the first six months of 2002, the Company's year-to-date performance warranted the accrual of funds for the anticipated payment of such bonuses. The increase in expense associated with the defined benefit plan results from the actuarial impact of lower investment returns and lower interest rates assumed in the actuarial valuation performed for fiscal 2002 compared to the 2001 valuation. Because the Company's defined benefit plan is currently over funded under the requirements of the Employee Retirement Income Security Act of 1974, the increase in expense does not impact the Company's funding policy for the defined benefit plan. Other expenses decreased $119,000, or 5.4%, to $2.1 million in the six months ended June 30, 2002 compared to the same period in 2001. This decrease resulted primarily from a decrease in the wholesale cost of jet fuel purchased by the Company's aviation subsidiary in the six months ended June 30, 2002 compared to the same period in 2001. The Company recognized an $11,000 gain on sale of assets for the six months ended June 30, 2002 compared to gains of $596,000 for the same period in 2001. The gains in the first six months of 2001 resulted from the sale of a restaurant to a franchisee and the sale of other non-operating properties. Interest expense, net of interest income, decreased $1.7 million to $4.9 million in the six months ended June 30, 2002 from $6.6 million in the same period in 2001. This decrease resulted primarily from the Company's retirement of a portion of the Notes and lower borrowings under its Credit Facility during the six months ended June 30, 2002. The Company's provision for income taxes for the six months ended June 30, 2002 increased $1.9 million, to a $1.1 million tax expense from a $833,000 tax benefit in the same period in 2001. During the second quarter of 2002, the Company revised its estimate of certain tax liability contingencies resulting in a reduction of income tax expense of $200,000. During the six months ended June 30, 2002, the Company recorded an extraordinary gain of $2.7 million, net of income taxes of $1.7 million, resulting from the repurchase and retirement of the Company's Notes. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company does not maintain significant inventory or accounts receivables since substantially all of its restaurants' sales are for cash. Royalties from franchisees, which are payable weekly, and other receivables from franchisees are closely monitored by the Company. The Company typically receives several weeks of trade credit in purchasing food and supplies which is standard in the restaurant business. The Company normally operates with working capital deficits (current liabilities exceeding current assets) and had a working capital deficit of $14.6 million at June 30, 2002, compared to a working capital deficit of $11.2 million at December 30, 2001. Capital expenditures totaled approximately $4.3 million in the six months ended June 30, 2002 as compared to $3.6 million in the same period in 2001. The Company opened no new restaurants during the six months ended June 30, 2002 or July 1, 2001. In addition, the Company purchased approximately $2.7 million of leased assets previously recognized as capital leases. Management estimates that capital expenditures will be approximately $3.5 million during the remainder of 2002. Capital expenditures for the remainder of the current year are expected to include the refurbishment and remodeling of certain restaurants, ongoing capital improvements, and the conversion of restaurant cash register systems. On December 31, 2001 and May 28, 2002, the Company purchased $27.0 million and $20,000, respectively, aggregate principal amount of its Notes. These Notes were retired resulting in an extraordinary gain of $2.7 million. The extraordinary gain resulted from retirement discounts of $5.4 million, offset by fees, taxes and other costs of approximately $2.7 million. During the second quarter of 2002, the Company exercised its option to purchase certain leased assets that were previously classified as capital leases on the balance sheet. The assets were purchased for $2.7 million. 0n January 28, 2002, the Company entered into a $25.0 million credit agreement (the "Credit Facility"). The Credit Facility provides for $10,000,000 in revolving loan commitments and a $15,000,000 term loan commitment, with maturity dates of June 1, 2004 and January 28, 2007, respectively. At June 30, 2002, the Company had available cash of approximately $13.0 million, receivables of $1.6 million, and $6.9 million available under the Company's line of credit. In the opinion of management, these funds and funds from operations will be sufficient to meet operating requirements, anticipated capital expenditures and other obligations for the foreseeable future. PART II OTHER INFORMATION Item 1. Legal Proceedings The Company is party to various legal proceedings incidental to its business. The ultimate disposition of these matters is not presently determinable but will not, in the opinion of management, have a material adverse effect on the Company's financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders By unanimous written consent dated April 18, 2002, Port Royal Holdings, Inc., the Company's sole shareholder, elected the following directors for the Company: Philip H. Sanford, James F. Exum, Jr., Andrew G. Cope, S. K. Johnston III, W. A. Bryan Patten, Richard C. Patton, Benjamin R. Probasco and A. Alexander Taylor II. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits- No exhibit is filed with this 10-Q. (b) Reports on Form 8-K- Form 8-K was filed by the Registrant during the second quarter of 2002 stating a change in the Registrant's certifying accountant. CERTIFICATION ------------- The undersigned principal executive officer and principal financial officer of the Company certify that (1) the undersigned has reviewed this report on form 10-Q, (2) based on the undersigned's knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which the statements were made, not misleading and (3) based on the undersigned's knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition and results of operations of the Company as of, and for, the periods presented in this report. Dated: 8/7/02 /s/Philip H. Sanford -------------- -------------------- Philip H. Sanford, Chairman and Chief Executive Officer /s/Larry D. Bentley -------------------- Larry D. Bentley, Vice President and Chief Financial Officer THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- 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. THE KRYSTAL COMPANY (Registrant) Dated: 8/7/02 /s/Larry D. Bentley --------------- ------------------------ Larry D. Bentley (Vice President, Chief Financial Officer and Principal Accounting Officer)

KRYSTAL COMPANY 10-Q