10-K/A 1 c83535e10vkza.htm FORM 10-K/A Form 10-K/A
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K/A
(Amendment No. 1)
 
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 28, 2008
     
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 333-116310
 
Real Mex Restaurants, Inc.
(Exact name of Registrant as specified in its charter)
     
DELAWARE   13-4012902
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
5660 Katella Avenue, Suite 100, Cypress, CA   90630
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: (562) 346-1200
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one)
             
Large Accelerated Filer o        Accelerated Filer o        Non-Accelerated Filer þ        Smaller Reporting Company o
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
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant is not applicable as no public market for the voting stock of the registrant exists.
As of March 29, 2009, Real Mex Restaurants, Inc. had outstanding 1,000 shares of Common Stock, par value $0.001 per share.
DOCUMENTS INCORPORATED BY REFERENCE:
None
 
 

 

 

 

EXPLANATORY NOTE

This Amendment No. 1 to our Annual Report on Form 10-K for the fiscal year ended December 28, 2008, filed with the Securities and Exchange Commission on March 30, 2009 (the “Original Filing”) is being filed to correct a typographical error appearing in the content of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Notes to Consolidated Financial Statements.” The error appears in the fourth paragraph on page 23 and the fifth paragraph on page 42 of the Original Filing. The final sentences in these paragraphs indicate that $5.1 million was outstanding under the New Senior Secured Letter of Credit Facility at December 28, 2008, but have been corrected to indicate that $5.1 million remained available under the New Senior Secured Letter of Credit Facility at December 28, 2008. Additionally, corrections have been made for immaterial typographical errors within Item 6, “Selected Financial Data” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

Except as described above, no other changes have been made to the Original Filing. We have not updated the information contained herein for events occurring subsequent to the filing date of the Original Filing. New certifications of our principal executive and financial officer are included as exhibits to this amendment.

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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical consolidated financial and other data of our Company. The selected historical consolidated financial data has been derived from our Company’s audited consolidated financial statements for the Successor Period from November 14, 2008 to December 28, 2008 (“Successor 2008”), the Predecessor Period from December 31, 2007 to November 13, 2008 (“Predecessor 2008”), the Predecessor Fiscal Year 2007 (“Predecessor 2007”), the Predecessor Period from August 21, 2006 to December 31, 2006 (“Predecessor 2006-2”), the Predecessor Period from December 26, 2005 to August 20, 2006 (“Predecessor 2006-1”) and the Predecessor Fiscal Years ended December 2005 and 2004. When combined, Fiscal Year 2006 consists of 53 weeks and all other fiscal years presented consist of 52 weeks. This data presented below should be read in conjunction with, and is qualified in its entirety by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and our consolidated financial statements and the notes thereto appearing elsewhere in this report.
                                                         
    Successor     Predecessor        
    November     December     Fiscal     August     December        
    14, 2008 to     31, 2007 to     Year     21, 2006 to     26, 2005 to     Predecessor  
    December     November     Ended     December     August     Fiscal Year Ended  
    28, 2008     13, 2008     2007     31, 2006     20, 2006     2005(4)     2004  
    (in thousands)  
Statement of Operations Data:
                                                        
Restaurant revenues
   $ 52,448     $ 456,587     $ 523,352     $ 179,630     $ 351,591     $ 510,013     $ 314,157  
Other revenue
     4,571       37,110       38,164       11,094       18,358       20,532       10,787  
Total revenues
     57,316       496,429       565,191       192,098       372,552       534,296       326,810  
Cost of sales
     14,255       123,878       140,824       46,883       87,388       127,126       80,839  
Labor
     21,210       178,962       199,843       67,729       125,748       186,390       118,888  
Direct operating and occupancy expense
     14,886       133,337       148,088       51,127       94,422       140,648       76,760  
Total operating costs
     50,351       436,177       488,755       165,739       307,558       454,164       276,487  
General and administrative expenses
     3,219       25,726       31,718       11,414       18,893       28,346       17,725  
Depreciation and amortization
     3,750       21,724       23,961       10,323       12,230       18,498       11,837  
Goodwill impairment
     —       163,196       10,000       —       —       —       —  
Operating (loss) income
     (19 )     (158,668 )     6,854       3,379       18,150       31,433       20,299  
Interest expense
     4,108       16,407       19,326       10,481       16,005       22,973       12,528  
Debt termination costs
     —       —       —       —       —       —       4,677  
(Loss) income before income tax provision
     (4,103 )     (173,061 )     (10,802 )     (8,238 )     2,787       8,677       4,546  
Net (loss) income
     (4,103 )     (173,113 )     (23,546 )     (5,047 )     1,480       13,386       13,616  
Redeemable preferred stock accretion
     —       —       —       —       (10,126 )     (14,583 )     (11,862 )
Net (loss) income attributable to common stockholders(1)
   $ (4,103 )   $ (173,113 )   $ (23,546 )   $ (5,047 )   $ (8,646 )   $ (1,197 )   $ 1,754  
Balance Sheet Data:
                                                        
Cash and cash equivalents
     2,099               2,323       2,710               14,871       10,690  
Property and equipment, net
     110,505               96,179       90,802               82,592       36,589  
Total assets
     298,328               434,455       447,135               310,889       186,951  
Total debt(2)
     161,813               186,187       183,905               182,031       106,503  
Total stockholders’ equity
     23,044               163,113       184,077               50,584       29,849  
Other Financial Data:
                                                        
Capital expenditures
   $ 736             $ 34,404     $ 23,545             $ 23,408     $ 9,982  
Ratio of earnings to fixed charges(3)
     —               —       —               1.2 x     1.2 x
 
     
(1)    Net (loss) income attributable to common stockholders includes the effect of the accretion of the liquidation preference on the redeemable preferred stock which reduces net income or increases net loss attributable to common stockholders for the relevant periods through August 20, 2006.
 
(2)    Total debt includes long-term debt, obligations under capital leases and unamortized debt premium/discount.
 
(3)    For purposes of calculating the ratio of earnings to fixed charges, earnings consist of net income before income taxes plus fixed charges. Fixed charges consist of interest expense on all indebtedness, plus one-third of rental expense (the portion deemed representative of the interest factor). For periods with a net loss before income taxes, this calculation is not performed since the ratio is not meaningful.
 
(4)    Includes the results of Chevys since January 12, 2005, the date of acquisition.

 

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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements as a result of certain factors, including those set forth under the heading “Forward-Looking Statements” above and elsewhere in this report. Unless otherwise provided below, references to “we”, “us” and “our Company” refer to Real Mex Restaurants, Inc. and our consolidated subsidiaries. The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this report.
Overview
We are one of the largest full service, casual dining Mexican restaurant chain operators in the United States in terms of number of restaurants. As of December 28, 2008, we operated 190 restaurants, 157 of which are located in California, with additional restaurants in Arizona, Florida, Indiana, Illinois, Maryland, Missouri, Nevada, New Jersey, New York, Oregon, Virginia and Washington. Our three major subsidiaries are El Torito Restaurants, Inc., Acapulco Restaurants, Inc., Chevys Restaurants LLC, and a purchasing, distribution, and manufacturing subsidiary, Real Mex Foods, Inc.
El Torito, El Torito Grill (including Sinigual), Acapulco and Chevys, our primary restaurant concepts, each offer high quality Mexican food, a wide selection of alcoholic beverages and excellent guest service. In addition to the El Torito, El Torito Grill, Acapulco and Chevys concepts, we operate 8 additional restaurant locations, most of which are also full service Mexican formats, under the following brands: Las Brisas; Casa Gallardo; El Paso Cantina; and Who·Song & Larry’s.
During Fiscal Year 2008, we opened five restaurants, including our first Sinigual restaurants in Brandon, Florida and New York, New York. Sinigual is the name for El Torito Grill style restaurants outside southern California. The other three restaurants opened in 2008 include one El Torito and two Chevys restaurants in California. During Fiscal Year 2007, we opened four restaurants, including two El Torito, one El Torito Grill and one Chevys restaurants, all in California. During Fiscal Year 2006, we opened six restaurants, including three El Torito, one El Torito Grill and one Chevys restaurants, all in California, and one Chevys restaurant in New York.
Our Fiscal Year consists of 52 or 53 weeks and ends on the last Sunday in December of each year. Fiscal Year 2006 is comprised of 53 weeks and all other fiscal years presented are comprised of 52 weeks. See additional breakdown of these years into reported periods in Results of Operations below. When calculating same store sales, we include a restaurant that has been open for more than 18 months and for the entirety of each comparable period. As of December 28, 2008, we had 180 restaurants that met this criterion.
In Fiscal Year 2008, we generated revenues of $553.7 million. Our revenues are comprised of restaurant sales, other revenues and royalty and franchise fees. Restaurant revenues include sales of food and alcoholic and other beverages. Other revenues consist primarily of sales by Real Mex Foods to outside customers of processed and packaged prepared foods and other merchandise items.
Cost of sales is comprised primarily of food and alcoholic beverage expenses. The components of cost of sales are variable and increase with sales volume. In addition, the components of cost of sales are subject to increase or decrease based on fluctuations in commodity costs and depend in part on the success of controls we have in place to manage cost of sales in our restaurants. The cost, availability and quality of the ingredients we use to prepare our food and beverages are subject to a range of factors including, but not limited to, seasonality, political conditions, weather conditions, and ingredient shortages.
Labor cost includes direct hourly and management wages, operations management bonus, vacation pay, payroll taxes, workers’ compensation insurance and health insurance.
Direct operating and occupancy expense includes operating supplies, repairs and maintenance, advertising expenses, utilities, and other restaurant related operating expenses. This expense also includes all occupancy costs such as fixed rent, percentage rent, common area maintenance charges, real estate taxes and other related occupancy costs.
General and administrative expense includes all corporate and administrative functions that support our operations. Expenses within this category include executive management, supervisory and staff salaries, bonus and related employee benefits, travel and relocation costs, information systems, training, corporate rent, professional fees and other consulting fees.
Depreciation principally includes depreciation of capital expenditures for restaurants.
Pre-opening costs are expensed as incurred and include costs associated with the opening of a new restaurant or the conversion of an existing restaurant to a different concept.

 

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Goodwill is deemed to have an indefinite life and is subject to an annual impairment test. Other intangible assets are amortized over their useful lives in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”. Impairment of goodwill and intangible assets reflects the impairment losses related to the difference between the fair value and recorded value as identified in our annual impairment test. The fair value was determined using discounted cash flow projections based upon management forecasts. We recorded impairment charges of $163.2 million and $10.0 million in 2008 and 2007, respectively as a result of the impact of the downturn in the economy on current operations and growth projections.
Amortization of favorable lease asset and unfavorable lease liability, net, represents the amortization of the asset in excess of the approximate fair market value and the liability in excess of the approximate fair market value of the leases assumed, which is revalued in purchase price accounting. The amounts are being amortized over the remaining primary term of the underlying leases.
Our annual operating results are impacted by restaurant closures to the extent we close locations. Due to our long operating history, restaurant closures are generally the result of lease expirations. Many of our leases are non-cancelable and have initial terms of 10 to 20 years with one or more renewal terms of three or more years that we may exercise at our option. As of December 28, 2008, we owned one restaurant location and leased the remaining 189.
We perform ongoing analyses of restaurant cash flow and in the case of negative cash flow or underperforming restaurants, we may negotiate early termination of leases, allow leases to expire without renewal or sell restaurants. In addition, from time to time we may be forced to close a successful restaurant if we are unable to renew the lease on satisfactory terms, or at all. From the end of Fiscal 2006 to the end of Fiscal Year 2008, we closed 24 restaurants, 16 of which were early lease terminations and 8 of which we were unable to renew the leases thereon.
Results of Operations
Our operating results for the Successor Period from November 14, 2008 to December 28, 2008 (“Successor 2008”), the Predecessor Period from December 31, 2007 to November 13, 2008 (“Predecessor 2008”), the Predecessor Fiscal Year 2007 (“Predecessor 2007”), the Predecessor Period from August 21, 2006 to December 31, 2006 (“Predecessor 2006-2”) and the Predecessor Period from December 26, 2005 to August 20, 2006 (“Predecessor 2006-1”) are expressed as a percentage of total revenues below. Because of purchase accounting adjustments to the fair market value of long-term assets and long-term liabilities, and because the number of days in each period presented vary, certain amounts may not be comparable between each period presented.
                                         
    Successor (1)     Predecessor (1)  
    November     December     Fiscal     August     December  
    14, 2008 to     31, 2007 to     Year     21, 2006 to     26, 2005 to  
    December     November     Ended     December     August  
    28, 2008     13, 2008     2007 (5)     31, 2006     20, 2006  
Total revenues
     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales
     24.9       25.0       24.9       24.4       23.5  
Labor
     37.0         36.0         35.4         35.3         33.8  
Direct operating and occupancy expense
     26.0       26.9       26.2       26.6       25.3  
Total operating costs
     87.8         87.9         86.5         86.3         82.6  
General and administrative expense
     5.6       5.2       5.6       5.9       5.1  
Depreciation and amortization
     6.5       4.4       4.2       5.4         3.3  
Goodwill impairment
     —       32.9       1.8       —       —  
Operating (loss) income
     —         (32.0 )       1.2         1.8         4.9  
Interest expense
     7.2       3.3       3.4       5.5       4.3  
(Loss) income before income tax provision
     (7.2 )     (34.9 )     (1.9 )     (4.3 )     0.7  
Net (loss) income
     (7.2 )       (34.9 )       (4.2 )     (2.6 )       0.4  
 
     
(1)   When combined, Fiscal Years 2008 and 2007 are comprised of 52 weeks and Fiscal Year 2006 is comprised of 53 weeks.

 

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Fiscal Year 2008 Compared to Fiscal Year 2007
Total Revenues. Total revenues were $57.3 million in Successor 2008 and $496.4 million in Predecessor 2008, compared to $565.2 million in Predecessor 2007. The overall decrease of $11.4 million or 2.0% was due to a $3.5 million increase in other revenues, offset by a $14.3 million decrease in restaurant revenues and a $0.6 million decrease in royalty and franchise fees. The $3.5 million increase in other revenues was primarily due to an increase in sales to existing outside customers and the addition of new outside customers by Real Mex Foods, Inc., our distribution and manufacturing subsidiary. The $14.3 million decrease in restaurant revenues was primarily due to comparable store sales declines of 2.3% versus Fiscal Year 2007. The comparable store sales decline was approximately 1.2% during Predecessor 2008 and approximately 13.2% during Successor 2008. This decline is primarily attributable to a reduction in guest count at our existing restaurants resulting from the slowing U.S. economy, which has negatively impacted overall consumer traffic in the restaurant industry. This decline particularly impacted our December sales, combined with the shortened peak shopping period between Thanksgiving and Christmas holidays from almost 5 weeks in 2007 to 4 weeks in 2008.
Cost of Sales. Total cost of sales was $14.3 million in Successor 2008 and $123.9 million in Predecessor 2008, compared to $140.8 million in Predecessor 2007. The overall decrease of $2.7 million or 1.9% was primarily due to the comparable store sales decline noted above. As a percentage of total revenues, cost of sales remained consistent, at 24.9% in Successor 2008 and 25.0% in Predecessor 2008 compared to 24.9% in Predecessor 2007. The slight increase in Predecessor 2008 of 0.1% was primarily due to higher commodity costs, specifically poultry, dairy and oils during 2008.
Labor. Labor costs were $21.2 million in Successor 2008 and $179.0 million in Predecessor 2008, compared to $199.8 million in Predecessor 2007. The overall increase of $0.3 million or 0.2% was primarily due to higher benefits expense combined with annual restaurant management salary increases partially offset by lower hourly labor expense related to the comparable store sales decline. As a percentage of total revenues, labor costs increased to 37.0% in Successor 2008 and 36.0% in Predecessor 2008 compared to 35.4% in Predecessor 2007. Payroll and benefits remain subject to inflation and government regulation; especially wage rates that are currently at or near the minimum wage and expenses for health insurance.
Direct Operating and Occupancy Expense. Direct operating and occupancy expense was $14.9 million in Successor 2008 and $133.3 million in Predecessor 2008, compared to $148.1 million in Predecessor 2007. The overall decrease was less than $0.1 million or 0.1%. As a percentage of total revenues, direct operating and occupancy expense was 26.0% in Successor 2008 and 26.9% in Predecessor 2008 compared to 26.2% in Predecessor 2007. The increase as a percent of total revenues in Predecessor 2008 was primarily due to the comparable store sales decline, since a significant portion of these costs are fixed or take time to adjust for the reduction in sales.
General and Administrative Expense. General and administrative expense was $3.2 million in Successor 2008 and $25.7 million in Predecessor 2008 as compared to $31.7 million in Predecessor 2007. The overall decrease of $2.8 million or 8.7% was primarily due to lower salary expense associated with position eliminations during Predecessor 2008. As a percentage of total revenues, general and administrative expense was flat at 5.6% in Successor 2008 and decreased to 5.2% in Predecessor 2008 compared to 5.6% in Predecessor 2007. The increase from Predecessor 2008 to Successor 2008 resulted from the decrease in comparable sales for Successor 2008, as noted above, plus accrued severance of $0.5 million related to the resignation of our CEO in December 2008.
Depreciation and Amortization. Depreciation and amortization expense was $3.8 million in Successor 2008 and $21.7 million in Predecessor 2008 as compared to $24.0 million in Predecessor 2007. The overall increase of $1.5 million or 6.3% was primarily due to depreciation on the assets of new restaurants. In addition, in conjunction with the Exchange, we revalued our assets, which resulted in an increase in property and equipment of $18.7 million at November 13, 2008, resulting in additional depreciation in Successor 2008 of $0.8 million. As a percentage of total revenues, depreciation and amortization increased to 6.5% in Successor 2008 and 4.4% in Predecessor 2008 from 4.2% in Predecessor 2007.
Goodwill Impairment. Non-cash goodwill and intangible asset impairment charges of $163.2 million and $10.0 million were recorded in Predecessor 2008 and Predecessor 2007, respectively, to reflect the impairment losses related to the difference between the fair value and recorded value for goodwill and other indefinite lived intangible assets. The fair value was determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. No goodwill or trademark impairment was recognized by the Company during Successor 2008.
Interest Expense. Interest expense was $4.1 million in Successor 2008 and $16.4 million in Predecessor 2008 as compared with $19.3 million in Predecessor 2007. As a percentage of total revenues, interest expense increased to 7.2% in Successor 2008 and decreased to 3.3% in Predecessor 2008 as compared to 3.4% in Predecessor 2007. The decrease in interest as a percentage of total revenues during Predecessor 2008 resulted primarily from a reduction in the weighted average interest rate on our senior unsecured credit facility from 10.36% in Predecessor 2007 to 8.45% in Predecessor 2008. The increase in interest expense as a percentage of total sales during Successor 2008 was primarily due to the amortization of the discount recorded as a reduction of debt related to our senior secured notes, with total amortization of $1.5 million recorded as interest expense in Successor 2008.

 

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Income tax provision. No income tax expense was recorded during Successor 2008. We have recorded income tax expense of $0.1 million in Predecessor 2008 and $12.7 million in Predecessor 2007. During Predecessor 2007 we recorded a deferred tax valuation allowance of $13.3 million. In 2008 we continue to record a valuation allowance against our deferred tax assets, which was $23.1 million at December 28, 2008. The amount of deferred tax assets considered realizable is based upon our ability to generate future taxable income, exclusive of reversing temporary differences and carry forwards. In evaluating future taxable income for valuation allowance purposes as of December 28, 2008, we considered only income expected to be generated in Fiscal Years 2009, 2010 and 2011.
Fiscal Year 2007 Compared to Fiscal Year 2006
Total Revenues. Total revenues were $565.2 million in Predecessor 2007 as compared to $192.1 million in Predecessor 2006-2 and $372.6 million in Predecessor 2006-1. The overall increase of $0.5 million or 0.1% was due to an $8.7 million increase in other revenues, partially offset by a $7.9 million decrease in restaurant revenues. The $8.7 million increase in other revenues to $38.2 million in Predecessor 2007 was primarily due to an increase in sales to existing outside customers and the addition of new outside customers by Real Mex Foods, Inc., our distribution and manufacturing subsidiary. The $7.9 million decrease in restaurant revenues to $523.4 million in Predecessor 2007 was primarily due to one less week of operations in Predecessor 2007. Comparable store sales increased 1.3% in Predecessor 2007 when comparing 52 comparable weeks’ sales results with the combined Predecessor 2006 periods.
Cost of Sales. Total cost of sales was $140.8 million in Predecessor 2007 as compared to $46.9 million in Predecessor 2006-2 and $87.4 million in Predecessor 2006-1. The overall increase was $6.6 million or 4.9%. As a percentage of total revenues, cost of sales increased to 24.9% in Predecessor 2007 from 24.4% in Predecessor 2006-2 and from 23.5% in Predecessor 2006-1 primarily due to higher commodity costs, specifically beef, cheese, dairy and oils, in Predecessor 2007.
Labor. Total Labor costs were $199.8 million in Predecessor 2007 as compared to $67.7 million in Predecessor 2006-2 and $125.7 million in Predecessor 2006-1. The overall increase was $6.4 million or 3.3%. As a percentage of total revenues, labor costs increased to 35.4% in Predecessor 2007 from 35.3% in Predecessor 2006-2 and 33.8% in Predecessor 2006-1. These increases were primarily due to minimum wage increases which took place in January in the majority of the states in which we operate combined with annual management salary increases. Payroll and benefits remain subject to inflation and government regulation; especially wage rates that are currently at or near the minimum wage, and expenses for health insurance.
Direct Operating and Occupancy Expense. Direct operating and occupancy expense was $148.1 million in Predecessor 2007 as compared to $51.1 million in Predecessor 2006-2 and $94.4 million in Predecessor 2006-1. The overall increase was $2.5 million or 1.7%. Direct operating and occupancy expense as a percentage of sales of 26.2% was a decrease versus direct operating and occupancy expense of 26.6% in Predecessor 2006-2 and an increase versus direct occupancy and operating expense of 25.3% in Predecessor 2006-1 primarily due to an increase in expenditures for advertising and promotion and increases in property taxes, common area maintenance expense and rent expense in Predecessor 2007.
General and Administrative Expense. General and administrative expense was $31.7 million in Predecessor 2007 as compared to $11.4 million in Predecessor 2006-2 and $18.9 million in Predecessor 2006-1. The overall increase of $1.4 million or 4.7% was primarily due to higher salaried labor expense combined with higher insurance expense and stock-based compensation expense related to options issued during Predecessor 2007. General and Administrative expense as a percentage of sales decreased to 5.6% in Predecessor 2007 from 5.9% in Predecessor Fiscal Year 2006-2 and increased from 5.1% in Predecessor 2006-1.
Depreciation and Amortization. Depreciation and amortization expense was $24.0 million in Predecessor 2007 as compared to $10.3 million in Predecessor 2006-2 and $12.2 million in Predecessor 2006-1. The overall increase was $1.4 million or 6.2%. As a percentage of total revenues, depreciation and amortization was 4.2% in Predecessor 2007 as compared to 5.4% in Predecessor 2006-2 and 3.3% in Predecessor 2006-1. The increase to 4.2% in Predecessor 2007 from 4.0% in the combined Predecessor Year 2006 was due to the increase in the depreciable basis of furniture, fixtures and equipment to fair market value and net favorable lease asset and unfavorable lease liability amortization required under purchase accounting rules due to the Merger on August 21, 2006 and depreciation on the assets of new restaurants.
Goodwill Impairment. A non-cash goodwill impairment charge of $10.0 million was recorded in Predecessor 2007 to reflect the impairment losses related to the difference between the fair value and recorded value for goodwill. The fair value was determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. No goodwill or trademark impairment was recognized by the Company during Predecessor 2006-1 or Predecessor 2006-2.

 

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Interest Expense. Interest expense was $19.3 million in Predecessor 2007 as compared to $10.5 million in Predecessor 2006-2 and $16.0 million in Predecessor 2006-1. The overall decrease of $7.2 million or 27.0% was primarily due to a $10.0 million reduction in our senior unsecured credit facility and a reduction in the weighted average interest rate on our senior unsecured credit facility from 13.61% in the combined Predecessor 2006 to 10.36% in Predecessor 2007. As a percentage of total revenues, interest expense was 3.4% in Predecessor 2007 as compared to 4.7% in the combined Predecessor 2006.
Income tax provision. The income tax provision for Predecessor 2007 and for the combined Predecessor 2006 was based on estimated annual effective tax rates. A rate of 118.0% was applied to Predecessor 2007 versus a rate of 34.6% in the combined Predecessor 2006. The rates are comprised of the combined federal and state statutory rates. The difference in rates primarily results from the valuation allowance of $13.3 million recorded in Predecessor 2007.
Liquidity and Capital Resources
Our principal liquidity requirements are to service our debt and meet our capital expenditure and working capital needs. Our indebtedness at December 28, 2008, including obligations under capital leases and unamortized debt discount, was $161.8 million, and we had $7.4 million of revolving credit availability under our $15.0 million New Senior Secured Revolving Credit Facility. Our ability to make principal and interest payments and to fund planned capital expenditures will depend on our ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Based on our current level of operations, we believe our cash flow from operations, available cash and available borrowings under our New Senior Secured Revolving Credit Facility will be adequate to meet our liquidity needs for the near future. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our New Senior Secured Revolving Credit Facility in an amount sufficient to enable us to service our indebtedness or to fund our other liquidity needs. If we consummate an acquisition, our debt service requirements could increase. As discussed below, our senior secured notes and senior unsecured credit facility each mature in 2010 and we will need additional financing to meet this obligation. Also, we may need to refinance all or a portion of our indebtedness on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all.
Working Capital and Cash Flows
We presently have, in the past have had, and in the future are likely to have, negative working capital balances. The working capital deficit principally is the result of accounts payable and accrued liabilities being more than current asset levels. The largest components of our accrued liabilities include reserves for our self-insured workers’ compensation and general liability insurance, accrued payroll and related employee benefits costs and gift card liabilities. We do not have significant receivables and we receive trade credit based upon negotiated terms in purchasing food and supplies. Funds available from cash sales not needed immediately to pay for food and supplies or to finance receivables or inventories typically have been used for capital expenditures and/or debt service payments under our existing indebtedness.
Operating Activities. We had net cash provided by operating activities of $7.2 million for Successor 2008 and $17.7 million for Predecessor 2008, compared to $25.4 million for Predecessor 2007, resulting in a net decrease overall of $0.5 million from Predecessor 2007 to the combined results from Predecessor and Successor 2008. Overall, we remained consistent year over year, with a slight decrease of $0.5 million. However, as shown on our consolidated statement of cash flows, the sources fluctuated when comparing Predecessor 2007 to Predecessor and Successor 2008, due to changes in the timing of accounts payable and accrued liabilities, mostly offset by decreases in trade and other receivables.
Investing Activities. We had net cash used in investing activities of $0.8 million for Successor 2008 and $23.6 million for Predecessor 2008, compared to $28.4 million for Predecessor 2007. The overall decrease in cash used in investing activities of $4.0 million was primarily the result of a decrease in additions to property and equipment of $11.1 million from Predecessor 2007 to Predecessor 2008, partially offset by the sale of all remaining Fuzio units, including the rights to the Fuzio trademark, of $6.0 million during Predecessor 2007.
We expect to make capital expenditures totaling approximately $11.9 million in Fiscal Year 2009 comprised of approximately $0.5 million for information technology, approximately $1.3 million for Real Mex Foods and approximately $10.1 million for restaurant maintenance and other capital expenditures related to our restaurants. These and other similar costs may be higher in the future due to inflation and other factors. We expect to fund the capital expenditures described above from cash flow from operations, available cash, available borrowings under our senior credit facility and trade financing received from trade suppliers. We do not plan to remodel or open any new restaurants during 2009 as a result of the continued impact of the downturn in the economy which we do not expect to improve during 2009.

 

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Financing Activities. We had net cash used in financing activities of $5.7 million for Successor 2008 and net cash provided by financing activities of $4.9 million for Predecessor 2008 and $2.6 million for Predecessor 2007. The changes are primarily a result of the timing of our borrowings under our revolving credit facilities, for which we had net repayments of $5.9 million during Successor 2008 compared to net borrowings of $2.5 million and $3.1 million in Predecessor 2008 and Predecessor 2007, respectively. In addition, during Predecessor 2008, we had a capital contribution from our parent company of $3.0 million, primarily to partially fund new store openings.
Debt and Other Obligations
Senior Secured Notes due 2010. Our $105.0 million senior secured registered notes (“Senior Secured Notes”) mature on April 1, 2010. We will need additional financing in order to meet our obligation to pay the Senior Secured Notes at maturity. Interest on our Senior Secured Notes accrues at a rate of 10.25% per annum. The interest rate increased from the stated rate of 10.00% to 10.25% on April 1, 2008. The increase to 10.25% resulted from us exceeding the capital expenditure limit in Fiscal Year 2007 under the indenture governing the Senior Secured Notes and as a result were required to pay a 0.25% increase from the stated rate. Exceeding the capital expenditure limit did not constitute a default with respect to the Senior Secured Notes or indenture. Interest is payable in arrears semiannually on April 1 and October 1 of each year. Our Senior Secured Notes are guaranteed on a senior secured basis by all of our present and future domestic subsidiaries which are restricted subsidiaries under the indenture governing our Senior Secured Notes. All of the subsidiary guarantors are 100% owned by the Company and such guarantees are full and unconditional and joint and several, and the Company has no independent assets or operations outside of the subsidiary guarantors. Our Senior Secured Notes and related guarantees are secured by substantially all of our domestic restricted subsidiaries’ tangible and intangible assets, subject to the prior ranking claims on such assets by the lenders under our New Senior Secured Revolving Credit Facilities. The indenture governing our Senior Secured Notes contains various affirmative and negative covenants, subject to a number of important limitations and exceptions, including but not limited to our ability to incur additional indebtedness, make capital expenditures, pay dividends, redeem stock or make other distributions, issue stock of our subsidiaries, make certain investments or acquisitions, grant liens on assets, enter into transactions with affiliates, merge, consolidate or transfer substantially all of our assets, and transfer and sell assets. The covenant that limits our incurrence of indebtedness requires that, after giving effect to any such incurrence of indebtedness and the application of the proceeds thereof, our fixed charge coverage ratio as of the date of such incurrence will be at least 2.50 to 1.00. The indenture defines consolidated fixed charge coverage ratio as the ratio of Consolidated Cash Flow (as defined therein) to Fixed Charges (as defined therein). The Company was in compliance with all specified financial and other covenants under the Senior Secured Notes indenture at December 28, 2008.
We can redeem our Senior Secured Notes at any time, with a prepayment penalty of 2.50% until March 31, 2009. We are required to offer to redeem our Senior Secured Notes under certain circumstances involving a change of control. Additionally, if we or any of our domestic restricted subsidiaries engage in asset sales, we generally must either invest the net cash proceeds from such sales in our business within 360 days, prepay the indebtedness obligations under our New Senior Secured Revolving Credit Facility or certain other secured indebtedness or make an offer to purchase a portion of our Senior Secured Notes.
As a result of the Exchange and under purchase accounting rules we recorded $ 20.0 million of unamortized debt discount as a reduction of debt related to our Senior Secured Notes as the fair market value of the debt on the Exchange date was less than its carrying value. The discount is amortized to interest expense over the remaining life of the debt. In addition, the remaining unamortized debt premium of $1.6 million recorded in conjunction with the Merger dated August 20, 2006 was written off in the purchase price allocation of the Exchange at November 13, 2008.
Senior Secured Revolving Credit Facilities. In 2004, the Company entered into an amended and restated revolving credit agreement providing for $30.0 million of senior secured credit facilities. The revolving credit agreement included a $15.0 million letter of credit facility and a $15.0 million revolving credit facility that could be used for letters of credit.
On October 5, 2006, the Company entered into a new amended and restated revolving credit facility, pursuant to which the existing $15.0 million revolving credit facility and $15.0 million letter of credit facility, was increased to a $15.0 million revolving credit facility (the “Old Senior Secured Revolving Credit Facility”) and a $25.0 million letter of credit facility (the “Old Senior Secured Letter of Credit Facility”, together with the Old Senior Secured Revolving Credit Facility, the “Old Senior Secured Revolving Credit Facilities”) maturing on October 5, 2008, pursuant to which the Lenders agreed to make loans to the Company and its subsidiaries (all of the proceeds of which were to be used for working capital purposes) and issue letters of credit on behalf of the Company and its subsidiaries.
On January 29, 2007, the Company entered into a Second Amended and Restated Credit Agreement pursuant to which the Old Senior Secured Revolving Credit Facilities were refinanced with a new agent and administrative agent, General Electric Capital Corporation, and a new $15.0 million revolving credit facility (the “New Senior Secured Revolving Credit Facility”) and $25.0 million letter of credit facility (the “New Senior Secured Letter of Credit Facility”, together with the New Senior Secured Revolving Credit Facility, the “New Senior Secured Revolving Credit Facilities”), maturing on January 29, 2009, were put into place, pursuant to which the lenders agree to make loans and issue letters of credit to and on behalf of the Company and its subsidiaries.

 

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The Company and its lender determined that the definition of the cash flow ratio covenant had been drafted improperly and therefore the lender and the Company executed an amendment (“Amendment No. 1”) to the New Senior Secured Revolving Credit Agreement in August 2007 which waived compliance of this ratio until the first quarter of 2008.
On April 17, 2008, the Company executed a second amendment (“Amendment No. 2”) to the New Senior Secured Revolving Credit Facilities. Amendment No. 2 modified certain definitions and measures related to covenants for the reporting periods ending March 30, 2008 and June 29, 2008, including the Applicable Margin, Leverage Ratio, Adjusted Leverage Ratio and Cash Flow Ratio, as defined in the agreement.
On November 13, 2008, concurrent with the Exchange, the Company executed a Limited Waiver, Consent and Amendment No. 3 to its New Senior Secured Revolving Credit Facility ( “Amendment No. 3”) which extended the term for one year to January 29, 2010, modified the definition of Applicable Margin and Base Rate, amended Leverage and Adjusted Leverage Ratio covenants for the period ending September 28, 2008 and thereafter, replaced the Cash Flow Ratio covenant with a Minimum Interest Coverage Ratio covenant, and added a Monthly Debt to EBITDA Ratio covenant. In addition, Amendment No. 3 terminated the cross-default provision described below as it relates to Holdco debt.
Obligations under the New Senior Secured Revolving Credit Facilities are guaranteed by all of the Company’s subsidiaries as well as by Holdco, which wholly owns the Company and has made a first priority pledge of all of its equity interests in the Company as security for the obligations. Interest on the New Senior Secured Revolving Credit Facility accrues pursuant to an Applicable Margin as set forth in Amendment No. 3 to the Amended and Restated Credit Agreement. The New Senior Secured Revolving Credit Facilities are secured by, among other things, first priority pledges of all of the equity interests of the Company’s direct and indirect subsidiaries, and first priority security interests (subject to customary exceptions) in substantially all of the current and future property and assets of the Company and its direct and indirect subsidiaries, with certain limited exceptions. In connection with the Company’s entrance into the New Senior Secured Revolving Credit Facilities on January 29, 2007, the Company borrowed $7.4 million under the New Senior Secured Revolving Credit Facility, the proceeds of which were used to pay the outstanding revolving borrowings under the Old Senior Secured Revolving Credit Facility. As of December 28, 2008, there was $7.6 million outstanding under the New Senior Secured Revolving Credit Facility. As of December 28, 2008, there was $5.1 million available under the New Senior Secured Letter of Credit Facility.
The Second Amended and Restated Credit Agreement, as amended, contains various affirmative and negative covenants and restrictions, which among other things, require us to meet certain financial tests (including certain leverage and coverage ratios), and limits our and our subsidiaries’ ability to incur or guarantee additional indebtedness, make certain capital expenditures, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, enter into arrangements that restrict dividends from subsidiaries, sell assets, engage in transactions with affiliates and effect a consolidation or merger. This agreement contains a cross-default provision wherein if we are in default on any other credit facilities, default on this facility is automatic. The Company was in compliance with all specified financial and other covenants under the New Senior Secured Revolving Credit Facilities at December 28, 2008, as amended.
Senior Unsecured Credit Facility. In 2005 we entered into a $75.0 million senior unsecured credit facility (the “Old Senior Unsecured Credit Facility”) consisting of a single term loan maturing on December 31, 2008, all of the proceeds of which were used to finance a portion of the cash consideration of an acquisition and pay related fees and expenses. On October 5, 2006, the Company entered into an Amended and Restated Senior Unsecured Credit Facility, pursuant to which the Old Senior Unsecured Credit Facility was decreased to a $65.0 million senior unsecured credit facility (the “ New Senior Unsecured Credit Facility”), consisting of a single term loan maturing on October 5, 2010. All of the proceeds of the New Senior Unsecured Credit Facility were used to repay in full any term loans outstanding under the Old Senior Unsecured Credit Facility and not continued on the restatement date. The total amount of term loans repaid was $10.0 million. Obligations under the New Senior Unsecured Credit Facility are guaranteed by all of the Company’s subsidiaries.
On November 13, 2008, concurrent with the Exchange, the Company executed a Limited Waiver, Consent and Amendment to its New Senior Unsecured Credit Facility which provided a change in the interest rate from variable to a fixed rate of 12.50% and amended the Maximum Leverage Ratio and Minimum Interest Coverage Ratio covenants for the period ending September 28, 2008 and thereafter and the Capital Expenditure covenant going forward. As a result of the Exchange, the existing lenders to the New Senior Unsecured Credit Facility became owners of Holdco, the Company’s parent. As a result, the New Senior Unsecured Credit Facility is now held by related parties to the Company.

 

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Our New Senior Unsecured Credit Facility, as amended, contains various affirmative and negative covenants which, among other things, require us to meet certain financial tests (including certain leverage and interest coverage ratios) and limits our and our subsidiaries’ ability to incur or guarantee additional indebtedness, grant certain liens, make certain restricted payments, make capital expenditures, engage in transactions with affiliates, make certain investments, sell our assets, make acquisitions, effect a consolidation or merger and amend or modify instruments governing certain indebtedness (including relating to our Senior Secured Notes and the New Senior Secured Revolving Credit Facilities). The Company was in compliance with all specified financial and other covenants under the New Senior Unsecured Credit Facility at December 28, 2008.
Mortgage. In 2005, concurrent with an acquisition, we assumed a $0.8 million mortgage secured by the building and improvements of one of the restaurants acquired in the transaction. The mortgage carries a fixed annual interest rate of 9.28% and requires equal monthly payments of principal and interest through April 2015. As of December 28, 2008, the principal amount outstanding on the mortgage was $0.6 million.
Capital Leases. In conjunction with our acquisition of El Torito, we assumed capital lease obligations, collateralized with leasehold improvements, in an aggregate amount of $9.2 million. In addition, we have entered into additional capital leases for equipment of $0.3 million during Fiscal Year 2008. The remaining capital lease obligations have a weighted-average interest rate of 8.7%. As of December 28, 2008, the principal amount due relating to capital lease obligations was $1.4 million. Principal and interest payments on the capital lease obligations are due monthly and range from $2,600 to $11,400 per month. The capital lease obligations mature between 2009 and 2025.
The following table represents our contractual commitments as of December 28, 2008 associated with obligations under debt agreements, other obligations discussed above and from our operating leases:
                                         
            Less than                     More than 5  
    Total     1 Year     1-3 Years     3-5 Years     Years  
    ($ in thousands)  
Contractual Obligations
                                        
Long Term Debt Obligations(1)
   $ 178,833     $ 8,313     $ 170,166     $ 199     $ 155  
Capital Lease Obligations
     1,794       565       702       223       304  
Operating Lease Obligations(2)
     251,670       41,389       68,976       52,301       89,004  
Purchase Obligations
     43,810       27,244       5,522       5,522       5,522  
 
                              
 
Total
   $ 476,107     $ 77,511     $ 245,366     $ 58,245     $ 94,985  
 
                              
 
     
(1)   Includes our Senior Secured Notes, unsecured term loan, New Senior Secured Revolving Credit Facility, mortgage and an obligation to a vendor. We have not included any scheduled interest payments in this table. Please see discussion of terms for each significant component of long term debt above.
 
(2)   In addition to the base rent, many of our leases contain percentage rent clauses, which obligate us to pay additional rents based on a percentage of sales, when sales levels exceed a contractually defined base. We recorded such additional rent expenses of $198 in Successor 2008, $1,926 in Predecessor 2008, $2,164 in Predecessor 2007, $907 in Predecessor 2006-2 and $1,755 in Predecessor 2006-1. Operating Lease Obligations do not reflect potential renewals or replacements of expiring leases.
Off-Balance Sheet Arrangements
None.
Inflation
The impact of inflation on labor, food and occupancy costs could, in the future, significantly affect our operations. We pay many of our employees hourly rates related to the federal or applicable state minimum wage. Our workers’ compensation and health insurance costs have been and are subject to continued inflationary pressures. Costs for construction, taxes, repairs, maintenance and insurance all impact our occupancy costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance and utilities, all of which may be subject to inflationary increases.
Management continually seeks ways to mitigate the impact of inflation on our business. We believe that our current practice of maintaining operating margins through a combination of periodic menu price increases, cost controls, careful evaluation of property and equipment needs, and efficient purchasing practices is our most effective tool for dealing with inflation.

 

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Critical Accounting Policies
Our Company’s accounting policies are fully described in Note 3 of the Consolidated Financial Statements. As disclosed in Note 3, the discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to property and equipment, impairment of long-lived assets, valuation of goodwill, self-insurance reserves, income taxes and revenue recognition. We base our estimates on historical experience and on various other assumptions and factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Based on our ongoing review, we plan to adjust our judgments and estimates where facts and circumstances dictate. Actual results could differ from our estimates.
We believe the following critical accounting policies are important to the portrayal of our financial condition and results and require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Property and Equipment
Property and equipment is recorded at cost and depreciated over its estimated useful life using the straight-line method for financial reporting purposes. The lives for furniture, fixtures and equipment range from three to 10 years. The life for buildings is the shorter of 20 years or the term of the related operating lease. Costs of leasehold rights and improvements and assets held under capital leases are amortized on the straight-line basis over the shorter of the estimated useful lives of the assets or the non-cancelable term of their underlying leases. The costs of repairs and maintenance are expensed when incurred, while expenditures for refurbishments and improvements that extend the useful life of an asset are capitalized.
Long-Lived Asset Impairment
We assess the impairment of long-lived assets, including restaurant sites and other assets, when events or changes in circumstances indicate that the carrying value of the assets or the asset group may not be recoverable. The asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from the disposition of the asset (if any) are less than the related asset’s carrying amount. Impairment losses are measured as the amount by which the carrying amounts of the assets exceed their fair values. The net proceeds expected from the disposition of the asset are determined by independent quotes or expected sales prices developed by internal specialists. Estimates of future cash flows and expected sales prices are judgments based on our experience and knowledge of local operations. These estimates can be significantly affected by future changes in real estate market conditions, the economic environment, and capital spending decisions and inflation.
For properties to be closed that are under long-term lease agreements, the present value of any remaining liability under the lease, discounted using risk-free rates and net of expected sublease rentals that could be reasonably obtained for the property, is recognized as a liability and expensed. The value of any equipment and leasehold improvements related to a closed store is reduced to reflect net recoverable values. Internal specialists estimate the subtenant income, future cash flows and asset recovery values based on their historical experience and knowledge of (1) the market in which the store to be closed is located, (2) the results of its previous efforts to dispose of similar assets and (3) the current economic conditions. Specific real estate markets, the economic environment and inflation affect the actual cost of disposition for these leases and related assets.
Management recorded no impairment for Successor 2008 or Predecessor 2006-2. During Predecessor 2008, Predecessor 2007, and Predecessor 2006-1, management determined that certain identified property and equipment was impaired and recorded an impairment charge of $5.2 million, $1.4 million and $1.2 million, respectively, reducing the carrying value of such assets to the estimated fair value.
Goodwill and Intangible Assets
Goodwill and indefinite-lived intangible assets are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired, in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”. Management performs its annual impairment test during the last quarter of the Company’s fiscal year. An impairment loss is recognized to the extent that the carrying amount exceeds an asset’s fair value. Management considers the reporting unit level to be the Company level, as the components (e.g., brands) within the Company have similar economic characteristics, including production processes, types or classes of customers and distribution methods. This determination is made at the reporting unit level and consists of two steps. First, management determines the fair value of a reporting unit and compares it to its carrying amount. The fair value is determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations”. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

 

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Factors that could change the result of our goodwill impairment test include, but are not limited to, different assumptions used to forecast future revenues, expenses, capital expenditures and working capital requirements used in our cash flow models. In addition, selection of a risk-adjusted discount rate on the estimated undiscounted cash flows is susceptible to future changes in market conditions, and when unfavorable, can adversely affect our original estimates of fair values. A variance in the discount rate could have a significant impact on the valuation of the goodwill for purposes of the impairment test. We cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions made in response to the economic environment on our customer base or a material negative change in relationships with our customers.
During the second quarter of 2008, management forecasts were revised due to the continued impact of the downturn in the economy on current operations and growth projections. As a result, the Company identified impairment of approximately $34.0 million, including $30.0 million related to goodwill and $4.0 million related to trademarks. As of November 13, 2008, in conjunction with the Exchange, the Company completed a valuation and identified additional impairment of approximately $129.2 million, including $87.6 million related to goodwill and $41.6 million related to trademarks. The Company recorded total non-cash charges of $163.2 million for the write-down of the goodwill and trademarks during the Predecessor Period December 31, 2007 to November 13, 2008.
Self-Insurance
Our business is primarily self-insured for workers’ compensation and general liability costs. Our recorded self-insurance liability is determined actuarially based on claims filed and an estimate of claims incurred but not yet reported. Any actuarial projection of ultimate losses is subject to a high degree of variability. Sources of this variability are numerous and include, but are not limited to, future economic conditions, court decisions and legislative actions. Our workers’ compensation future funding estimates anticipate no change in the benefit structure. Statutory changes could have a significant impact on future claim costs.
Our workers’ compensation liabilities are from claims occurring in various states. Individual state workers’ compensation regulations have received a tremendous amount of attention from state politicians, insurers, employers and providers, as well as the public in general. Recent years have seen an escalation in the number of legislative reforms, judicial rulings and social phenomena affecting our business. The changes in a state’s political and economic environment increase the variability in the unpaid claim liabilities.
Income Taxes
Our Company utilizes the liability method of accounting for income taxes as set forth in SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). Under the liability method, deferred taxes are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Recognition of deferred tax assets is limited to amounts considered by management to be more likely than not to be realizable in future periods. We have significant deferred tax assets, which are subject to periodic recoverability assessments. In accordance with SFAS 109, net deferred tax assets are reduced by a valuation allowance if, based on all the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. We recorded a valuation allowance of $23.1 million and $13.3 million at December 28, 2008 and December 30, 2007, respectively. The amount of deferred tax assets considered realizable was based upon our ability to generate future taxable income, exclusive of reversing temporary differences and carry-forwards. In evaluating future taxable income for valuation allowance purposes as of December 28, 2008, we concluded that it was appropriate to consider only income expected to be generated in fiscal years 2009, 2010 and 2011.
Under Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” the Company is required to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. Management has concluded that there are no significant uncertain tax positions requiring recognition in the financial statements.
Revenue Recognition
Revenues from the operation of Company-owned restaurants are recognized when sales occur. Fees from franchised and licensed restaurants are included in revenue as earned. Royalty fees are based on franchised restaurants’ revenues and we record these fees in the period the related franchised restaurants’ revenues are earned. Real Mex Foods’ revenues from sales to outside customers are recognized upon delivery, when title transfers to the customer, and are included in other revenues. Sales tax collected from customers and remitted to governmental authorities is presented on a net basis (excluded from revenue) in our financial statements.

 

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Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and was adopted by us in the first quarter of 2008. As a result, the adoption of SFAS 159 had no impact on our consolidated results of operations and financial condition as of December 28, 2008.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”). SFAS 141R provides companies with principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree as well as the recognition and measurement of goodwill acquired in a business combination. SFAS 141R also requires certain disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS 141R is effective for business combinations occurring in fiscal years beginning after December 15, 2008, which will require us to adopt these provisions for business combinations occurring in fiscal year 2009 and thereafter. Early adoption of SFAS 141R is not permitted. The Company does not believe that the adoption of SFAS 141R will have an effect on its financial statements; however, the effect is dependent upon whether the company makes any future acquisitions and the specifics of those acquisitions.
In April 2008, the FASB issued Staff Position No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”).  FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, “Goodwill and Other Intangible Assets” and requires enhanced related disclosures.  FSP 142-3 must be applied prospectively to all intangible assets acquired subsequent to fiscal years beginning after December 15, 2008.  Implementation of this staff position in the first quarter of fiscal 2009 will not have a material impact on our consolidated financial statements.

 

14

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The audited consolidated financial statements are set forth below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Real Mex Restaurants, Inc.
We have audited the accompanying consolidated balance sheet of Real Mex Restaurants, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 28, 2008 (the “Successor”) and the related consolidated statements of operations, stockholders’ equity, and cash flows for the period November 14, 2008 to December 28, 2008 (the “Successor Period”) subsequent to the exchange of debt for equity transaction that was reflected on the financial statements of the Company, between RM Restaurant Holding Corp., the Company’s parent, and the parent’s creditors. We have also audited the consolidated balance sheet of Real Mex Restaurants, Inc. as of December 30, 2007 (the “Predecessor”) and the consolidated statements of operations, stockholders’ equity, and cash flows for the period December 31, 2007 to November 13, 2008, and the year ended December 30, 2007 (the “Predecessor Periods”), prior to the exchange of debt for equity transaction. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Real Mex Restaurants, Inc. and subsidiaries as of December 28, 2008 and December 30, 2007, and the results of its operations and its cash flows for the Successor and Predecessor Periods in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
Irvine, California
March 27, 2009

 

15

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Real Mex Restaurants, Inc.
We have audited the accompanying consolidated statements of operations, stockholders’ equity, and cash flows of Real Mex Restaurants, Inc. and its subsidiaries (collectively, the Company), for the period from August 21, 2006 to December 31, 2006, subsequent to the acquisition of the Company by RM Restaurant Holding Corp., a majority owned subsidiary of Sun Cantinas LLC. We have also audited the consolidated statements of operations, stockholders’ equity, and cash flows for the period ended December 26, 2005 through August 20, 2006, prior to the acquisition of the Company by RM Restaurant Holding Corp. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material aspects, the consolidated results of the operations and cash flows of the Company for the period from August 21, 2006 to December 31, 2006, subsequent to the acquisition of the Company by RM Restaurant Holding Corp., a majority owned subsidiary of Sun Cantinas LLC., and for the period from December 26, 2005 through August 20, 2006, prior to the acquisition of the Company by RM Restaurant Holding Corp., in conformity with accounting principles generally accepted in the United States.
As discussed in Note 8 to the consolidated financial statements, the Company changed its method of accounting for Share Based Payments in accordance with Statements of Accounting Financial Standards No. 123 (revised 2004) on December 26, 2005.
/s/ Ernst & Young LLP
Los Angeles, California
March 16, 2007

 

16

 

Real Mex Restaurants, Inc.
Consolidated Balance Sheets
(In Thousands, Except For Share Data)
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Assets
                
Current assets:
                
Cash and cash equivalents
   $ 2,099     $ 2,323  
Trade receivables, net
     9,102       10,160  
Other receivables
     873       2,594  
Inventories, net
     13,563       12,049  
Deferred compensation plan assets
     1,848       3,115  
Prepaid expenses and other current assets
     7,253       7,186  
Current portion of favorable lease asset, net
     5,902       3,454  
 
            
Total current assets
     40,640       40,881  
 
                
Property and equipment, net
     110,505       96,179  
Goodwill, net
     43,200       160,621  
Trademarks and other intangibles
     68,900       113,000  
Deferred charges
     1,404       3,115  
Favorable lease asset, less current portion, net
     25,382       11,313  
Other assets
     8,297       9,346  
 
            
Total assets
   $ 298,328     $ 434,455  
 
            
 
                
Liabilities and stockholders’ equity
                
Current liabilities:
                
Accounts payable
   $ 23,198     $ 22,692  
Accrued self-insurance reserves
     15,619       15,479  
Accrued compensation and benefits
     16,216       17,402  
Other accrued liabilities
     15,426       14,014  
Related party payables
     —       2,505  
Current portion of long-term debt
     8,313       12,579  
Current portion of capital lease obligations
     453       433  
 
            
Total current liabilities
     79,225       85,104  
 
                
Long-term debt, less current portion
     152,105       172,057  
Capital lease obligations, less current portion
     942       1,118  
Deferred tax liabilities
     31,549       —  
Unfavorable lease liability, less current portion, net
     8,445       4,394  
Other liabilities
     3,018       8,669  
 
            
Total liabilities
     275,284       271,342  
 
                
Commitments and contingencies
     —       —  
 
                
Stockholders’ equity:
                
Common stock, $.001 par value, 1,000 shares authorized, issued and outstanding at December 28, 2008 and December 30, 2007
     —       —  
Additional paid-in capital
     27,147       201,706  
Accumulated deficit
     (4,103 )     (38,593 )
 
            
Total stockholders’ equity
     23,044       163,113  
 
            
Total liabilities and stockholders’ equity
   $ 298,328     $ 434,455  
 
            
See notes to consolidated financial statements.

 

17

 

Real Mex Restaurants, Inc.
Consolidated Statements of Operations
(In Thousands)
                                         
    Successor     Predecessor  
    November 14,     December 31,     Fiscal     August 21,     December 26,  
    2008 to     2007 to     Year Ended     2006 to     2005 to  
    December 28,     November 13,     December 30,     December 31,     August 20,  
    2008     2008     2007     2006     2006  
Revenues:
                                        
Restaurant revenues
   $ 52,448     $ 456,587     $ 523,352     $ 179,630     $ 351,591  
Other revenues
     4,571       37,110       38,164       11,094       18,358  
Franchise revenues
     297       2,732       3,675       1,374       2,603  
 
                              
Total revenues
     57,316       496,429       565,191       192,098       372,552  
 
                                        
Costs and expenses:
                                        
Cost of sales
     14,255       123,878       140,824       46,883       87,388  
Labor
     21,210       178,962       199,843       67,729       125,748  
Direct operating and occupancy expense
     14,886       133,337       148,088       51,127       94,422  
General and administrative expense
     3,219       25,726       31,718       11,414       18,893  
Depreciation and amortization
     3,750       21,724       23,961       10,323       12,230  
Legal settlement costs
     15       781       402       19       4,180  
Merger costs
     —       —       —       307       9,434  
Pre-opening costs
     —       2,342       2,139       917       910  
Impairment of goodwill and intangible assets
     —       163,196       10,000       —       —  
Impairment of property and equipment
     —       5,151       1,362       —       1,197  
 
                              
 
                                        
Operating (loss) income
     (19 )     (158,668 )     6,854       3,379       18,150  
 
                                        
Other income (expense):
                                        
Interest expense
     (4,108 )     (16,407 )     (19,326 )     (10,481 )     (16,005 )
Other income (expense), net
     24       2,014       1,670       (1,136 )     642  
 
                              
 
                                        
Total other expense, net
     (4,084 )     (14,393 )     (17,656 )     (11,617 )     (15,363 )
 
                                        
(Loss) income before income tax provision
     (4,103 )     (173,061 )     (10,802 )     (8,238 )     2,787  
 
                                        
Income tax provision (benefit)
     —       52       12,744       (3,191 )     1,307  
 
                              
 
                                        
Net (loss) income before redeemable preferred stock accretion
     (4,103 )     (173,113 )     (23,546 )     (5,047 )     1,480  
 
                                        
Redeemable preferred stock accretion
     —       —       —       —       (10,126 )
 
                              
 
                                        
Net loss attributable to common stockholders
   $ (4,103 )   $ (173,113 )   $ (23,546 )   $ (5,047 )   $ (8,646 )
 
                              
See notes to consolidated financial statements.

 

18

 

Real Mex Restaurants, Inc.
Consolidated Statements of Stockholders’ Equity
(In Thousands, Except For Share Data)
 
                                                                         
    Predecessor  
    Series A     Series B     Series C                                            
    Redeemable     Redeemable     Redeemable                             Additional              
    Preferred     Preferred     Preferred     Common Stock             Paid-in     Accumulated        
    Stock     Stock     Stock     Shares     Amount     Warrants     Capital     Deficit     Total  
Balance at December 25, 2005
   $ 35,646     $ 25,365     $ 58,080       316,290     $ —     $ 4,027     $ 16,203     $ (88,737 )   $ 50,584  
Issuance of Series A Redeemable Preferred Stock
     1,897       —       —       —       —       —       —       —       1,897  
Issuance of Series B Redeemable Preferred Stock
     —       1,433       —       —       —       —       —       —       1,433  
Issuance of Series D Redeemable Preferred Stock
     —       —       2,352       —       —       —       —       —       2,352  
Tax benefit from employee stock option exercise
     —       —       —       —       —       —       1,800       —       1,800  
Accretion on redeemable preferred stock
     2,861       2,177       5,089       —       —       —       —       (10,127 )     —  
Net income
     —       —       —       —       —       —       —       1,480       1,480  
 
                                                      
Balance at August 20, 2006
     40,404       28,975       65,521       316,290       —       4,027       18,003       (97,384 )     59,546  
Initial capitalization of the Company, August 21, 2006
     —       —       —       1,000       —       —       199,124       —       199,124  
Dividend distribution to parent
     —       —       —       —       —       —       —       (10,000 )     (10,000 )
Net loss
     —       —       —       —       —       —       —       (5,047 )     (5,047 )
 
                                                      
Balance at December 31, 2006
     —       —       —       1,000       —       —       199,124       (15,047 )     184,077  
Contribution from parent
     —       —       —       —       —       —       1,743       —       1,743  
Stock-based compensation
     —       —       —       —       —       —       839       —       839  
Net loss
     —       —       —       —       —       —       —       (23,546 )     (23,546 )
 
                                                      
Balance at December 30, 2007
     —       —       —       1,000       —       —       201,706       (38,593 )     163,113  
Contribution from parent
     —       —       —       —       —       —       5,554       —       5,554  
Stock-based compensation
     —       —       —       —       —       —       406       —       406  
Net loss
     —       —       —       —       —       —       —       (173,113 )     (173,113 )
 
                                                      
Balance at November 13, 2008
   $ —     $ —     $ —       1,000     $ —     $ —     $ 207,666     $ (211,706 )   $ (4,040 )
 
                                                      
 
    Successor  
    Series A     Series B     Series C                                            
    Redeemable     Redeemable     Redeemable                             Additional              
    Preferred     Preferred     Preferred     Common Stock             Paid-in     Accumulated        
    Stock     Stock     Stock     Shares     Amount     Warrants     Capital     Deficit     Total  
Recapitalization of the Company, November 14, 2008
   $ —     $ —     $ —       1,000     $ —     $ —     $ 27,175     $ —     $ 27,175  
Stock-based compensation
     —       —       —       —       —       —       (28 )             (28 )
Net loss
     —       —       —       —       —       —       —       (4,103 )     (4,103 )
 
                                                      
Balance at December 28, 2008
   $ —     $ —     $ —       1,000     $ —     $ —     $ 27,147     $ (4,103 )   $ 23,044  
 
                                                      
See notes to consolidated financial statements.

 

19

 

Real Mex Restaurants, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
 
                                         
    Successor     Predecessor  
    November 14,     December 31,             August 21,     December 26,  
    2008     2007     Fiscal Year     2006     2005  
    to     to     Ended     to     to  
    December 28,      November 13,     December 30,      December 31,     August 20,   
    2008     2008     2007     2006     2006  
Operating activities
                                        
Net (loss) income
   $ (4,103 )   $ (173,113 )   $ (23,546 )   $ (5,047 )   $ 1,480  
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
                                        
Depreciation
     3,334       19,780       22,254       8,505       12,230  
Amortization of:
                                        
Favorable lease asset and unfavorable lease liability, net
     416       1,944       1,707       1,818       —  
Deferred financing costs
     169       1,571       1,828       2,286       1,179  
Debt discount/(premium)
     1,535       (1,050 )     (1,563 )     —       —  
Impairment of goodwill and intangible assets
     —       163,196       10,000       —       —  
(Gain) loss on disposal of property and equipment
     —       (402 )     (877 )     706       (19 )
Gain on lease termination
     —       (600 )     —       —       —  
Impairment of property and equipment
     —       5,151       1,362       —       1,197  
Stock-based compensation expense
     (28 )     406       839       —       1,800  
Deferred income taxes
     —       —       12,731       (3,218 )     (1,108 )
Other
     —       —       231       —       —  
Changes in operating assets and liabilities:
                                        
Trade and other receivables
     2,125       654       (2,578 )     1,449       (1,071 )
Inventories
     (625 )     (889 )     (1,484 )     (553 )     (35 )
Deferred compensation plan assets
     (51 )     1,347       (745 )     (755 )     (573 )
Prepaid expenses and other current assets
     (3,358 )     3,291       544       (3,310 )     (952 )
Related party receivable/payable
     —       (66 )     6,096       (3,591 )     —  
Deferred charges, net
     —       35       (148 )     (80 )     (301 )
Other assets
     6       66       73       (107 )     912  
Accounts payable and accrued liabilities
     7,342       (7,551 )     (6,519 )     (2,151 )     14,235  
Other liabilities
     424       3,959       5,225       629       1,484  
 
                              
Net cash provided by (used in) operating activities
     7,186       17,729       25,430       (3,419 )     30,458  
 
                                        
Investing activities
                                        
Purchases of property and equipment
     (736 )     (23,332 )     (34,404 )     (10,495 )     (15,885 )
Exchange transaction costs
     (20 )     (1,153 )     —       —       —  
Sale of Fuzio trademark
     —       —       1,200       —       —  
Proceeds from lease termination
     —       600       —       —       —  
Net proceeds from disposal of property and equipment
     —       302       4,789       —       —  
 
                              
 
                                        
Net cash used in investing activities
     (756 )     (23,583 )     (28,415 )     (10,495 )     (15,885 )
 
                                        
Financing activities
                                        
Net (payment) borrowing under revolving credit facility
     (5,900 )     2,500       3,050       7,950       —  
Borrowings under long-term debt agreements
     466       1,375       981       437       —  
Payments on long-term debt agreements and capital lease obligations
     (314 )     (1,449 )     (577 )     (10,148 )     (174 )
Payment of financing costs
     —       (500 )     (856 )     (885 )     —  
Dividend paid
     —       —       —       (10,000 )     —  
Capital contributions
     —       3,022       —       —       —  
 
                              
Net cash (used in) provided by financing activities
     (5,748 )     4,948       2,598       (12,646 )     (174 )
 
                              
Net increase (decrease) in cash and cash equivalents
     682       (906 )     (387 )     (26,560 )     14,399  
 
                                        
Cash and cash equivalents at beginning of period
     1,417       2,323       2,710       29,270       14,871  
 
                              
Cash and cash equivalents at end of period
   $ 2,099     $ 1,417     $ 2,323     $ 2,710     $ 29,270  
 
                              
 
                                        
Supplemental disclosure of cash flow information
                                        
Interest paid
   $ 873     $ 16,910     $ 19,722     $ 11,225     $ 11,405  
 
                              
Income taxes paid
   $ —     $ 52     $ 38     $ 17     $ 44  
 
                              
 
                                        
Supplemental disclosure of noncash investing and financing activities
                                        
Preferred and common stock issued as consideration for the Chevys Acquisition
   $ —     $ —     $ —     $ —     $ 5,682  
 
                              
See notes to consolidated financial statements.

 

20

 

Real Mex Restaurants, Inc.
Notes to Consolidated Financial Statements
December 28, 2008
(In Thousands, Except For Share Data)
1. Description of Business
Real Mex Restaurants, Inc., (together with its subsidiaries, the “Company”) is a Delaware corporation which is engaged in the business of owning and operating restaurants, primarily under the names El Torito®, Acapulco Mexican Restaurant Y Cantina® and Chevys Fresh Mex®. At December 28, 2008, the Company, primarily through its major subsidiaries (El Torito Restaurants, Inc., Chevys Restaurants LLC and Acapulco Restaurants, Inc.), owned and operated 190 restaurants, of which 157 were in California and the remainder in 12 other states. The Company’s other major subsidiary, Real Mex Foods, Inc. (“RMF”), provides internal production, purchasing and distribution services for the restaurant operations and manufactures specialty products for sales to outside customers.
Basis of Presentation
The Company prior to November 14, 2008 is referred to as the “Predecessor” and after November 13, 2008 is referred to as the “Successor”.
The Company’s fiscal year consists of 52 or 53 weeks ending on the last Sunday in December which in 2008 was December 28, 2008, in 2007 was December 30, 2007 and in 2006 was December 31, 2006. The accompanying consolidated balance sheets present the Company’s financial position as of December 28, 2008 (Successor) and December 30, 2007 (Predecessor). The accompanying consolidated statements of operations, stockholders’ equity and cash flows present the 6 week Successor Period from November 14, 2008 to December 28, 2008, the 46 week Predecessor Period from December 31, 2007 to November 13, 2008, the 52 week Predecessor Period ended December 30, 2007, the 19 week Predecessor Period from August 21, 2006 to December 31, 2006, the 34 week Predecessor Period from December 25, 2005 to August 20, 2006. See further description of the successor and predecessor periods in Note 2.
Liquidity
The Company’s financial statements as of December 28, 2008 have been presented on the basis that it is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company’s principal liquidity requirements are to service debt and meet capital expenditure and working capital needs. The Company’s ability to make principal and interest payments and to fund planned capital expenditures will depend on the ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond the control of the Company. Based upon anticipated cash flow generated from operations and availability of other borrowings, the Company does not plan to open any new restaurants during fiscal year 2009. Although the Company had negative working capital as of December 28, 2008 (as has been the case at year end for all prior years being reported on), based on the current level of operations and the Company’s revised business plan, management believes the cash flow generated from operations, available cash and available borrowings under the New Senior Secured Revolving Credit Facility will be adequate to meet liquidity needs for the near future.
The Senior Secured Notes and senior unsecured credit facility each mature in 2010 and the Company will require additional financing to meet this obligation. The Company is currently evaluating its options to raise the necessary funds. No assurance can be given that the Company will be able to refinance any of its indebtedness on commercially reasonable terms or at all. If revenues decline further than management’s expectations, the Company will take steps to further reduce costs to ensure sufficient cash is available to allow the Company to meet its obligations for the next 12 months. No assurance can be given that the Company will generate sufficient cash flow from operations or that future borrowings will be available under the New Senior Secured Revolving Credit Facility in an amount sufficient to enable the Company to service existing indebtedness or to fund other liquidity needs.
2. Acquisitions
Exchange Agreement
Effective November 13, 2008, RM Restaurant Holding Corp. (“Holdco”), the Company’s parent, owned substantially by an affiliate of Sun Capital Partners (“Sun Capital”), and each of Holdco’s existing lenders executed an agreement to exchange Holdco’s then outstanding borrowings under its unsecured term loan facility for 94.5% of the common stock of Holdco (the “Exchange”). Immediately prior to the Exchange, Holdco effected a 100:1 reverse stock split of its common stock and after the exchange the immediately post-split existing holders retained 5.5% of the shares of Holdco common stock. Immediately after the Exchange, no stockholder, together with its affiliates, owned more than 50% of the capital stock of Holdco. Affiliates of Sun Capital remain stockholders of Holdco.

 

21

 

In connection with the Exchange, the cross-default provision described in Note 6 was terminated as it related to the Holdco debt. Concurrent with the Exchange, the Company executed a Limited Waiver, Consent and Amendment No. 3 to its Senior Secured Revolving Credit Facility (the “Amendment”) which extended the term for one year to January 29, 2010, modified the definition of Applicable Margin and Base Rate, amended Leverage and Adjusted Leverage Ratio covenants for the period ending September 28, 2008 and thereafter and the Capital Expenditure covenant going forward, replaced the Cash Flow Ratio covenant with a Minimum Interest Coverage Ratio covenant, and added a Monthly Debt to EBITDA Ratio covenant. Also concurrent with the Exchange, the Company executed a Limited Waiver, Consent and Amendment to its Senior Unsecured Credit Facility which provided a change in the interest rate from variable to a fixed rate of 12.5% and amended the Maximum Leverage Ratio and Minimum Interest Coverage Ratio covenants for the period ending September 28, 2008 and thereafter and the Capital Expenditure covenant going forward.
The Exchange was accounted for by Holdco under the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” (“SFAS 141”). Holdco then applied push-down accounting to the Company as of November 13, 2008. As no cash consideration was exchanged, the Company completed a valuation to determine the value of the equity exchanged, the assets acquired and the liabilities assumed based on their estimated fair market values at the date of the Exchange. The allocation of the purchase price is a preliminary estimate as the determination of the fair market values of the assets acquired and the liabilities assumed has not been finalized, primarily with respect to income taxes. The Company attributes the goodwill associated with the Exchange to the historical financial performance and the anticipated future performance of the Company’s operations. As this was a non-cash transaction, it has been excluded from the statement of consolidated cash flows.
The following table presents the allocation to the assets acquired and liabilities assumed based on their estimated fair values as determined by the valuation of the Company (in thousands):
         
Cash and cash equivalents
   $ 1,417  
Trade and other accounts receivable
     12,100  
Inventories
     12,938  
Other current assets
     5,692  
Property and equipment
     113,154  
Other assets
     41,841  
Trademark and other intangibles
     68,900  
Goodwill
     43,178  
 
      
Total assets acquired
     299,220  
 
      
 
        
Accounts payable and accrued liabilities
     60,616  
Long-term debt
     166,026  
Deferred tax liability
     31,549  
Other liabilities
     13,854  
 
      
Total liabilities assumed
     272,045  
 
      
Net assets acquired
   $ 27,175  
 
      
As a result of the Exchange, fiscal year 2008 is presented as the Successor Period from November 14, 2008 to December 28, 2008 and the Predecessor Period from December 31, 2007 to November 13, 2008.
Merger Agreement
On August 17, 2006, the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) with Holdco and its subsidiary, RM Integrated, Inc. On August 21, 2006, the closing of the transactions contemplated by the Merger Agreement occurred, and RM Integrated merged with and into the Company, with the Company continuing as the surviving corporation and the 100% owned subsidiary of Holdco. The net purchase price of the Company was $200,900, consisting of $359,000 in cash, plus net cash acquired of $35,200, plus $4,600 in working capital and other adjustments plus direct acquisition costs of $3,900, less indebtedness assumed of $188,200 and seller costs of $9,300. Pursuant to the Merger Agreement, $6,000 of the Merger Consideration was held in escrow. As a result of the Merger Agreement, fiscal year 2006 is presented as the 19 week Predecessor Period from August 21, 2006 to December 31, 2006 and the 34 week Predecessor Period from December 25, 2005 to August 20, 2006.

 

22

 

3. Summary of Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts and results of operations of the Company. All significant inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates, and they may be adjusted as more information becomes available.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash balances in bank accounts and investments with a maturity of three months or less at the time of purchase.
Receivables
Receivables consist primarily of amounts due from credit card companies, outside customers of RMF and franchisees. Receivables from credit card companies are generally settled in the week following the transaction date. Receivables from RMF’s outside customers are generally collected within 30 days of the date of the sale and receivables from franchisees are generally collected within 21 days following the close of the royalty period. Receivables are stated net of an allowance for doubtful accounts of $333 and $320 at December 28, 2008 and December 30, 2007, respectively.
Inventories
Inventories, consisting primarily of food and beverages, are carried at the lower of cost (first-in, first-out method) or market. Inventories are reviewed for spoilage and excess or obsolete products and reserved accordingly.
Supplies and Expendable Equipment
The initial purchase of supplies and expendable equipment, when a restaurant is first opened, such as china, glass and silverware, is capitalized and depreciated over a period of 5 years. Replacements of supplies and expendable equipment are expensed.
Pre-Opening Costs
Pre-opening costs incurred with the start-up of a new restaurant, or the conversion of an existing restaurant to a different concept, are expensed as incurred.
Property and Equipment
Property and equipment is recorded at cost and depreciated over its estimated useful life using the straight-line method for financial reporting purposes. The lives for furniture, fixtures and equipment range from three to 10 years. The life for buildings is the shorter of 20 years or the term of the related operating lease. Costs of leasehold rights and improvements and assets held under capital leases are amortized on the straight-line basis over the shorter of the estimated useful lives of the assets or the non-cancelable term of their underlying leases. The costs of repairs and maintenance are expensed when incurred, while expenditures for refurbishments and improvements that extend the useful life of an asset are capitalized. Depreciation expense includes the amortization of assets held under capital leases.
Impairment of Long-Lived Assets
Long-lived assets are tested for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. Management recorded no impairment for the Successor Period from November 14, 2008 through December 28, 2008. During the Predecessor Period from December 31, 2007 through November 13, 2008, the Predecessor year ended December 30, 2007, and the Predecessor Period from December 26, 2006 to August 20, 2006, management of the Company determined that certain identified property and equipment was impaired and recorded an impairment charge of $5,151, $1,362 and $1,197, respectively, reducing the carrying value of such assets to the estimated fair value. Fair value was based on management’s estimate of future cash flows to be generated by the property and equipment determined to be impaired. During the Predecessor Period ended December 30, 2006, management recorded no impairment.

 

23

 

Impairment of Goodwill and Intangible Assets
Goodwill and indefinite-lived intangible assets are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Management performs its annual impairment test during the last quarter of the Company’s fiscal year. An impairment loss is recognized to the extent that the carrying amount exceeds an asset’s fair value. Management considers the reporting unit level to be the Company level, as the components (e.g., brands) within the Company have similar economic characteristics, including production processes, types or classes of customers and distribution methods. This determination is made at the reporting unit level and consists of two steps. First, management determines the fair value of a reporting unit and compares it to its carrying amount. The fair value is determined based upon a combination of two valuation techniques, including an income approach, which utilizes discounted future cash flow projections based upon management forecasts, and a market approach, which is based upon pricing multiples at which similar companies have been sold. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation in accordance with SFAS 141. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.
Factors that could change the result of our goodwill impairment test include, but are not limited to, different assumptions used to forecast future revenues, expenses, capital expenditures and working capital requirements used in our cash flow models. In addition, selection of a risk-adjusted discount rate on the estimated undiscounted cash flows is susceptible to future changes in market conditions, and when unfavorable, can adversely affect our original estimates of fair values. A variance in the discount rate could have a significant impact on the valuation of the goodwill for purposes of the impairment test. We cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions made in response to the economic environment on our customer base or a material negative change in relationships with our customers.
During the second quarter of 2008, management forecasts were revised due to the continued impact of the downturn in the economy on current operations and growth projections. As a result, the Company recorded impairment of approximately $34,000 during the second quarter of 2008, including $30,000 related to goodwill and $4,000 related to trademarks. As of November 13, 2008, in conjunction with the Exchange, the Company completed a valuation and identified additional impairment of approximately $129,196, including $87,596 related to goodwill and $41,600 related to trademarks. The Company recorded total non-cash charges of $163,196 for the write-down of the goodwill and trademarks during the Predecessor Period December 31, 2007 to November 13, 2008.
Intangible Assets
Intangible assets consist of the following indefinite-lived assets resulting from the Exchange in the successor period and the Merger in the predecessor period:
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Trademarks
   $ 55,900     $ 101,500  
Franchise agreements
     13,000       11,500  
 
            
 
   $ 68,900     $ 113,000  
 
            

 

24

 

Deferred Charges
Deferred charges at December 28, 2008 consists of deferred financing costs of $1,114 related to the sale of $105,000 aggregate principal amount of the Senior Secured Notes due 2010 (as defined in Note 6), $249 related to the $65,000 Senior Unsecured Credit Facility maturing on October 5, 2010 and $41 related to the Senior Secured Revolving Credit Facilities. Capitalized deferred charges are amortized over the lives of the respective long-term borrowings on a straight-line basis and are included in interest expense in the accompanying consolidated statements of operations. Amounts capitalized related to leases are amortized over the primary term of their respective leases and are included in occupancy expense in the accompanying statements of operations. The following table shows the estimated amortization expense for the years after December 28, 2008:
                 
    2009     2010  
 
                
Financing and lease acquisition costs
   $ 1,074     $ 330  
Favorable Lease Asset and Unfavorable Lease Liability
Favorable lease asset represents the approximate fair market value arising from lease rates that are below market rates as of November 13, 2008, the date of the Exchange. The amount is being amortized over the remaining primary term of the underlying leases.
Unfavorable lease liability represents the approximate fair market value arising from lease rates that are above market rates as of November 13, 2008, the date of the Exchange. The amount is being amortized over the remaining primary term of the underlying leases. The current portion of unfavorable lease liabilities is recorded in other accrued liabilities.
The following table shows the estimated amortization expense for the years after December 28, 2008:
                                                 
    2009     2010     2011     2012     2013     Thereafter  
 
                                                
Favorable lease asset
   $ 5,902     $ 5,511     $ 4,855     $ 4,404     $ 3,710     $ 6,902  
Unfavorable lease liability
     (2,286 )     (2,017 )     (1,532 )     (1,380 )     (833 )     (2,683 )
 
                                    
 
                                                
Net amortization expense
   $ 3,616     $ 3,494     $ 3,323     $ 3,024     $ 2,877     $ 4,219  
 
                                    
Liquor Licenses
Transferable liquor licenses, which have a market value, are carried at the lower of aggregate acquisition cost or market and are not amortized. Liquor licenses are included in other assets.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). In accordance with SFAS 109, income taxes are accounted for using the liability method.
Under Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), the Company is required to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The Company has concluded that there are no significant uncertain tax positions requiring recognition in the financial statements.
The Company’s policy is to recognize interest and penalties expense, if any, related to unrecognized tax benefits as a component of income tax expense. As of December 28, 2008, the Company has not recorded any interest and penalty expense. The Company’s determination on its analysis of uncertain tax positions are related to tax years that remain subject to examination by the relevant tax authorities. These include the 2005 through 2007 tax years for federal purposes and the 2004 through 2007 tax years for California purposes.
Revenue Recognition
Revenues from the operation of Company-owned restaurants are recognized when sales occur. Fees from franchised operations are included in revenue as earned. Royalty fees are based on franchised restaurants’ revenues and we record these fees in the period the related franchised restaurants’ revenues are earned. Real Mex Foods’ revenues from sales to outside customers are recognized upon delivery, when title transfers to the customer, and are included in other revenues. Sales tax collected from customers and remitted to governmental authorities is presented on a net basis (excluded from revenue) in our financial statements.
Self Insurance
The Company is self-insured for most workers’ compensation and general liability losses (collectively “casualty losses”). The Company maintains stop-loss coverage with third party insurers to limit its total exposure. The recorded liability associated with these programs is based on an estimate of the ultimate costs to be incurred to settle known claims and claims incurred but not reported as of the balance sheet date. The estimated liability is not discounted and is based on a number of assumptions and factors, including historical trends, actuarial assumptions and economic conditions. If actual claims trends, including the severity or frequency of claims, differ from estimates, the financial results could be significantly impacted.

 

25

 

Gift Certificates and Gift Cards
The Company records deferred revenue, included in accounts payable, for gift certificates and gift cards outstanding until they are redeemed. Revenues from unredeemed gift cards are recognized based on historical and expected redemption trends and are classified as revenues in our consolidated statement of operations.
Segment Information
The Company operates 190 restaurants through its three restaurant operating subsidiaries, providing similar products to similar customers. These restaurants possess similar economic characteristics resulting in similar long-term expected financial characteristics. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. Based upon its methods of internal reporting and management structure, management believes that the Company meets the criteria for aggregating its 190 operating restaurants into a single reporting segment called restaurant operations. The Company’s RMF manufacturing operations are dissimilar from our restaurant operations, but do not meet the required quantitative thresholds and therefore qualify for aggregation.
Promotion and Advertising Expense
The cost of promotion and advertising is expensed as incurred. The Company incurred $1,260, $15,077, $15,478, $5,652 and $8,716 in promotion and advertising expense during the 6 week Successor Period from November 14, 2008 to December 28, 2008, the 46 week Predecessor Period December 31, 2007 to November 13, 2008, the Predecessor Year ended December 30, 2007, the 19 week Predecessor Period from August 21, 2006 to December 31, 2006, and the 34 week Predecessor Period December 26, 2005 to August 20, 2006, respectively.
Operating Leases
Most of our restaurant and office facilities are under operating leases with expirations in 2009 through 2028. The minimum lease payments, including any predetermined fixed escalations of the minimum rent, are recognized as rent expense on a straight-line basis over the lease term as defined in SFAS No. 13, “Accounting for Leases.” Most of the restaurant facilities have renewal clauses exercisable at the option of the Company and include rent escalation clauses stipulating specific rent increases upon exercise, some of which are based upon the Consumer Price Index. Certain of these leases require the payment of contingent rentals based on a percentage of gross revenues. At December 28, 2008 and December 30, 2007, deferred rent equaled $174 and $2,958, respectively, which is included in other long-term liabilities.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company places its cash and cash equivalents with high quality financial institutions. At times, balances in the Company’s cash accounts may exceed the Federal Deposit Insurance Corporation (FDIC) limit. Most of the Company’s restaurants are located in California. Consequently, the Company may be susceptible to adverse trends and economic conditions in California.
Fair Value of Financial Instruments
The Company’s financial instruments are primarily comprised of cash and cash equivalents, receivables, accounts payable, accrued liabilities and long-term debt. For cash and cash equivalents, receivables, accounts payable and accrued liabilities, the carrying amount approximates fair value because of the short maturity of these instruments. The estimated fair value of the Senior Secured Notes due 2010 at December 28, 2008, based on quoted market prices, was $79,800. Management estimates that the carrying values of its other financial instruments approximate their fair values since their realization or satisfaction is expected to occur in the short term or have been renegotiated at a date close to year end.
Recent Accounting Pronouncements
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and was adopted by us in the first quarter of 2008. As a result, the adoption of SFAS 159 had no impact on our consolidated results of operations and financial condition as of December 28, 2008.

 

26

 

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”). SFAS 141R provides companies with principles and requirements on how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree as well as the recognition and measurement of goodwill acquired in a business combination. SFAS 141R also requires certain disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Acquisition costs associated with the business combination will generally be expensed as incurred. SFAS 141R is effective for business combinations occurring in fiscal years beginning after December 15, 2008, which will require us to adopt these provisions for business combinations occurring in fiscal year 2009 and thereafter. Early adoption of SFAS 141R is not permitted. The Company does not believe that the adoption of SFAS 141R will have an effect on its financial statements; however, the effect is dependent upon whether the company makes any future acquisitions and the specifics of those acquisitions.
In April 2008, the FASB issued Staff Position No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, “Goodwill and Other Intangible Assets” and requires enhanced related disclosures. FSP 142-3 must be applied prospectively to all intangible assets acquired subsequent to fiscal years beginning after December 15, 2008. Implementation of this staff position in the first quarter of fiscal 2009 will not have a material impact on our consolidated financial statements.
4. Property and Equipment
Property and equipment consists of the following:
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Land and land improvements
   $ 1,530     $ 2,079  
Buildings and improvements
     939       1,201  
Furniture, fixtures and equipment
     43,789       51,240  
Leasehold improvements and leasehold rights
     79,193       73,207  
 
            
Property and equipment, total
     125,451       127,727  
Less accumulated depreciation and amortization
     (14,946 )     (31,548 )
 
            
Property and equipment, net
   $ 110,505     $ 96,179  
 
            
5. Accounts Payable and Other Accrued Liabilities
Accounts payable consist of the following:
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Trade accounts payable
   $ 20,329     $ 19,445  
Gift cards and gift certificates
     2,869       3,247  
 
            
 
   $ 23,198     $ 22,692  
 
            
Other accrued liabilities consist of the following:
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Rent and occupancy expenses
   $ 1,500     $ 1,345  
Sales taxes
     3,960       4,378  
Accrued interest
     3,444       2,937  
Other
     6,522       5,354  
 
            
 
   $ 15,426     $ 14,014  
 
            

 

27

 

6. Long-Term Debt
Long-term debt consists of the following:
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Senior Secured Notes due 2010
   $ 105,000     $ 105,000  
Senior Secured Notes unamortized debt (discount)/premium
     (18,415 )     2,637  
Senior Secured Revolving Credit Facility
     7,600       11,000  
Senior Unsecured Credit Facility — Related Party
     65,000       65,000  
Mortgage
     591       656  
Other
     642       343  
 
            
 
     160,418       184,636  
Less current portion
     (8,313 )     (12,579 )
 
            
 
   $ 152,105     $ 172,057  
 
            
Senior Secured Notes due 2010. Interest on our senior secured registered notes (“Senior Secured Notes”) accrues at a rate of 10.25% per annum. The interest rate increased from the stated rate of 10.00% to 10.25% on April 1, 2008. The increase to 10.25% resulted from us exceeding the capital expenditure limit in fiscal year 2007 under the indenture governing the Senior Secured Notes and as a result we were required to pay a 0.25% increase from the stated rate. Exceeding the capital expenditure limit did not constitute a default with respect to the Senior Secured Notes or indenture. Interest is payable semiannually on April 1 and October 1 of each year. Our Senior Secured Notes are guaranteed on a senior secured basis by all of our present and future domestic subsidiaries which are restricted subsidiaries under the indenture governing our Senior Secured Notes. All of the subsidiary guarantors are 100% owned by the Company and such guarantees are full and unconditional and joint and several, and the Company has no independent assets or operations outside of the subsidiary guarantors. Our Senior Secured Notes and related guarantees are secured by substantially all of our domestic restricted subsidiaries’ tangible and intangible assets, subject to the prior ranking claims on such assets by the lenders under our New Senior Secured Revolving Credit Facilities. The indenture governing our Senior Secured Notes contains various affirmative and negative covenants, subject to a number of important limitations and exceptions, including but not limited to our ability to incur additional indebtedness, make capital expenditures, pay dividends, redeem stock or make other distributions, issue stock of our subsidiaries, make certain investments or acquisitions, grant liens on assets, enter into transactions with affiliates, merge, consolidate or transfer substantially all of our assets, and transfer and sell assets. The covenant that limits our incurrence of indebtedness requires that, after giving effect to any such incurrence of indebtedness and the application of the proceeds thereof, our fixed charge coverage ratio as of the date of such incurrence will be at least 2.50 to 1.00. The indenture defines consolidated fixed charge coverage ratio as the ratio of Consolidated Cash Flow (as defined therein) to Fixed Charges (as defined therein). The Company was in compliance with all specified financial and other covenants under the Senior Secured Notes indenture at December 28, 2008.
We can redeem our Senior Secured Notes at any time, with a prepayment penalty of 2.5% until March 31, 2009. We are required to offer to redeem our Senior Secured Notes under certain circumstances involving a change of control. Additionally, if we or any of our domestic restricted subsidiaries engage in asset sales, we generally must either invest the net cash proceeds from such sales in our business within 360 days, prepay the indebtedness obligations under our New Senior Secured Revolving Credit Facility or certain other secured indebtedness or make an offer to purchase a portion of our Senior Secured Notes.
As a result of the Exchange and under purchase accounting rules requiring fair value measurement, we recorded $19,950 of unamortized debt discount as a reduction of debt related to our Senior Secured Notes as the fair market value of the debt on the Exchange date was less than its carrying value. The discount is amortized to interest expense over the remaining life of the debt. In addition, the remaining unamortized debt premium of $1,587 recorded in conjunction with the Merger dated August 20, 2006 was written off in the purchase price allocation of the Exchange at November 13, 2008.
Senior Secured Revolving Credit Facilities. In 2004, the Company entered into an amended and restated revolving credit agreement providing for $30,000 of senior secured credit facilities. The revolving credit agreement included a $15,000 letter of credit facility and a $15,000 revolving credit facility that could be used for letters of credit.
On October 5, 2006, the Company entered into a new amended and restated revolving credit facility, pursuant to which the existing $15,000 revolving credit facility and $15,000 letter of credit facility, was increased to a $15,000 revolving credit facility (the “Old Senior Secured Revolving Credit Facility”) and a $25,000 letter of credit facility (the “Old Senior Secured Letter of Credit Facility”, together with the Old Senior Secured Revolving Credit Facility, the “Old Senior Secured Revolving Credit Facilities”) maturing on October 5, 2008, pursuant to which the Lenders agreed to make loans to the Company and its subsidiaries (all of the proceeds of which were to be used for working capital purposes) and issue letters of credit on behalf of the Company and its subsidiaries.

 

28

 

On January 29, 2007, the Company entered into a Second Amended and Restated Credit Agreement pursuant to which the Old Senior Secured Revolving Credit Facilities were refinanced with a new agent and administrative agent, General Electric Capital Corporation, and a new $15,000 revolving credit facility (the “New Senior Secured Revolving Credit Facility”) and $25,000 letter of credit facility (the “New Senior Secured Letter of Credit Facility”, together with the New Senior Secured Revolving Credit Facility, the “New Senior Secured Revolving Credit Facilities”), maturing on January 29, 2009, were put into place, pursuant to which the lenders agree to make loans and issue letters of credit to and on behalf of the Company and its subsidiaries.
The Company and its lender determined that the definition of the cash flow ratio covenant had been drafted improperly and therefore the lender and the Company executed an amendment (“Amendment No. 1”) to the New Senior Secured Revolving Credit Agreement in August 2007 which waived compliance of this ratio until the first quarter of 2008.
On April 17, 2008, the Company executed a second amendment (“Amendment No. 2”) to the New Senior Secured Revolving Credit Facilities. Amendment No. 2 modified certain definitions and measures related to covenants for the reporting periods ending March 30, 2008 and June 29, 2008, including the Applicable Margin, Leverage Ratio, Adjusted Leverage Ratio and Cash Flow Ratio, as defined in the agreement.
On November 13, 2008, concurrent with the Exchange, the Company executed a Limited Waiver, Consent and Amendment No. 3 to its New Senior Secured Revolving Credit Facility ( “Amendment No. 3”) which extended the term for one year to January 29, 2010, modified the definition of Applicable Margin and Base Rate, amended Leverage and Adjusted Leverage Ratio covenants for the period ending September 28, 2008 and thereafter, replaced the Cash Flow Ratio covenant with a Minimum Interest Coverage Ratio covenant, and added a Monthly Debt to EBITDA Ratio covenant. In addition, Amendment No. 3 terminated the cross-default provision described below as it relates to Holdco debt.
Obligations under the New Senior Secured Revolving Credit Facilities are guaranteed by all of the Company’s subsidiaries as well as by Holdco, which wholly owns the Company and has made a first priority pledge of all of its equity interests in the Company as security for the obligations. Interest on the New Senior Secured Revolving Credit Facility accrues pursuant to an Applicable Margin as set forth in Amendment No. 3 to the Amended and Restated Credit Agreement. The New Senior Secured Revolving Credit Facilities are secured by, among other things, first priority pledges of all of the equity interests of the Company’s direct and indirect subsidiaries, and first priority security interests (subject to customary exceptions) in substantially all of the current and future property and assets of the Company and its direct and indirect subsidiaries, with certain limited exceptions. In connection with the Company’s entrance into the New Senior Secured Revolving Credit Facilities on January 29, 2007, the Company borrowed $7,400 under the New Senior Secured Revolving Credit Facility, the proceeds of which were used to pay the outstanding revolving borrowings under the Old Senior Secured Revolving Credit Facility. As of December 28, 2008, there was $7,600 outstanding under the New Senior Secured Revolving Credit Facility. As of December 28, 2008, there was $5,060 available under the New Senior Secured Letter of Credit Facility.
The Second Amended and Restated Credit Agreement, as amended, contains various affirmative and negative covenants and restrictions, which among other things, require us to meet certain financial tests (including certain leverage and coverage ratios), and limits our and our subsidiaries’ ability to incur or guarantee additional indebtedness, make certain capital expenditures, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, enter into arrangements that restrict dividends from subsidiaries, sell assets, engage in transactions with affiliates and effect a consolidation or merger. This agreement contains a cross-default provision wherein if we are in default on any other credit facilities, default on this facility is automatic. The Company was in compliance with all specified financial and other covenants under the New Senior Secured Revolving Credit Facilities at December 28, 2008, as amended.
Senior Unsecured Credit Facility. In 2005 we entered into a $75,000 senior unsecured credit facility (the “Old Senior Unsecured Credit Facility”) consisting of a single term loan maturing on December 31, 2008, all of the proceeds of which were used to finance a portion of the cash consideration of an acquisition and pay related fees and expenses. On October 5, 2006, the Company entered into an Amended and Restated Senior Unsecured Credit Facility, pursuant to which the Old Senior Unsecured Credit Facility was decreased to a $65,000 senior unsecured credit facility (the “ New Senior Unsecured Credit Facility”), consisting of a single term loan maturing on October 5, 2010. All of the proceeds of the New Senior Unsecured Credit Facility were used to repay in full any term loans outstanding under the Old Senior Unsecured Credit Facility. The total amount of term loans repaid was $10,000. Obligations under the New Senior Unsecured Credit Facility are guaranteed by all of the Company’s subsidiaries.
On November 13, 2008, concurrent with the Exchange, the Company executed a Limited Waiver, Consent and Amendment to its New Senior Unsecured Credit Facility which provided a change in the interest rate from variable to a fixed rate of 12.5% and amended the Maximum Leverage Ratio and Minimum Interest Coverage Ratio covenants for the period ending September 28, 2008 and thereafter and the Capital Expenditure covenant going forward.

 

29

 

As a result of the Exchange, the existing lenders to the New Senior Unsecured Credit Facility became owners of Holdco, the Company’s parent. As a result, the New Senior Unsecured Credit Facility is now held by related parties to the Company.
Our New Senior Unsecured Credit Facility, as amended, contains various affirmative and negative covenants which, among other things, require us to meet certain financial tests (including certain leverage and interest coverage ratios) and limits our and our subsidiaries’ ability to incur or guarantee additional indebtedness, grant certain liens, make certain restricted payments, make capital expenditures, engage in transactions with affiliates, make certain investments, sell our assets, make acquisitions, effect a consolidation or merger and amend or modify instruments governing certain indebtedness (including relating to our Senior Secured Notes and the New Senior Secured Revolving Credit Facilities). The Company was in compliance with all specified financial and other covenants under the New Senior Unsecured Credit Facility at December 28, 2008.
Mortgage. In 2005, concurrent with an acquisition, we assumed a $816 mortgage secured by the building and improvements of one of the restaurants acquired in the transaction. The mortgage carries a fixed annual interest rate of 9.28% and requires equal monthly payments of principal and interest through April 2015. As of December 28, 2008, the principal amount outstanding on the mortgage was $591.
Interest rates for the Company’s long-term debt are shown in the following table:
         
    Successor   Predecessor
    December 28,   December 30,
    2008   2007
Senior Secured Notes due 2010
   10.25%   10.00%
Senior Secured Revolving Credit Facilities
   7.11 to 7.94%   7.02 to 8.00%
Senior Unsecured Credit Facility
   12.50%   9.83%
Mortgage
   9.28%   9.28%
Other
   3.98 to 4.70%   6.45 to 7.75%
The maturity of long-term debt for the fiscal years succeeding December 28, 2008, is as follows:
                         
            Unamortized        
            Debt        
    Principal     Discount     Total  
2009
   $ 8,313     $ (14,732 )   $ (6,419 )
2010
     170,079       (3,683 )     166,396  
2011
     87       —       87  
2012
     95       —       95  
2013
     104       —       104  
Thereafter
     155       —       155  
 
                  
 
   $ 178,833     $ (18,415 )   $ 160,418  
 
                  
7. Capitalization
Common Stock-Successor
The Company is authorized to issue 1,000 shares of common stock. At December 28, 2008 and December 30, 2007 there were 1,000 shares of common stock issued and outstanding.
Redeemable Preferred Stock-Predecessor
Prior to the Merger on August 20, 2006, the Company was authorized to issue 100,000 shares of Preferred Stock. Shares were issued upon approval of the board of directors and all outstanding shares of Preferred Stock were redeemable at any time at the option of the Company, subject to restrictions under certain debt covenants.
Series A 12.5% Cumulative Compounding Redeemable Preferred Stock (Series A) and Series B 13.5% Cumulative Compounding Redeemable Preferred Stock (Series B) had a liquidation preference equal to $1 per share plus accreted dividends. With respect to dividend rights and rights of liquidation, Series A ranked senior to all classes of Common Stock and Series B. Series B ranked senior to all classes of Common Stock.

 

30

 

Series C 15% Cumulative Compounding Participating Preferred stock (Series C) ranked senior with respect to payment of dividends, liquidation, and redemption to all other series of preferred stock and common stock of the Company. The Series C had a liquidation preference equal to two times the original issue price of $1 per share, plus accreted dividends. As a result of the liquidation preference, Series C was recorded at liquidation value at the date of issuance. Holders of Series C were entitled to receive, in addition to the liquidation preference, an amount equal to 40% of any amounts that would otherwise be available to the holders of Common Stock in the event of a liquidation or sale of the Company.
The liquidation preference on the Series A, Series B and Series C accreted at the stated rates on the liquidation preference value thereof; dividends (representing accreted liquidation preference) were to be paid from legally available funds, when and if declared by the board of directors. Dividends were payable only when and if declared, or upon a sale or liquidation of the Company or upon redemption of the applicable series of preferred stock. Accretion of the liquidation preference on the redeemable preferred stock was reflected as an increase in the preferred stock values and an increase in the accumulated deficit. Accretion of the liquidation preference on the Redeemable Preferred Stock during the two month and eight month Predecessor periods ended August 20, 2006 was $2,300 and $10,100, respectively. In the Predecessor periods, net loss attributable to common stockholders includes the effect of the accretion of the liquidation preference on the redeemable preferred stock which reduced net income attributable to common stockholders for the period.
On August 21, 2006, as a result of the Merger and in accordance with the terms of the Merger Agreement, all issued and outstanding preferred stock was converted into the right to receive a portion of the Merger consideration.
Stock Option Plans
As a result of the Merger and in accordance with the terms of the Merger Agreement all of the Company’s then outstanding vested and unvested stock options were cancelled and converted into the right to receive a portion of the purchase price, less the exercise prices thereon, as applicable. Concurrent with the Merger, the Company’s 1998 and 2000 Stock Option Plans were terminated.
In December 2006, the Board of Directors of Holdco (the “Board”), adopted a Non-Qualified Stock Option Plan (the “2006 Plan”). The 2006 Plan reserved 100,000 shares of Holdco’s non-voting common stock for issuance upon exercise of stock options granted under the 2006 Plan. In January 2007, the Board issued stock options to certain members of management. These options vest 20% per year beginning August 16, 2007, with full vesting on August 16, 2011. Accelerated vesting of all outstanding options is triggered upon a change of control of the Company. The options have a life of 10 years, and can only be exercised upon the earliest of the following dates: (i) the 10 year anniversary of the effective date; (ii) the date of a change in control, as defined in the 2006 Plan; or (iii) date of employment termination, subject to certain exclusions.
In conjunction with the Exchange, a 100:1 reverse stock split was effected immediately prior to the exchange related to Holdco common stock and all outstanding options to acquire Holdco stock. The reverse stock split reduced the number of outstanding options at November 13, 2008 from 62,750 to 630. The exercise price was adjusted accordingly from $81.50 per share to $8,150 per share. All disclosures related to the stock options have been presented as if the 100:1 reverse stock split had occurred as of the beginning of the periods for which the specific information is presented.
The Company accounts for stock-based compensation in accordance with SFAS No. 123 (Revised), “Share-Based Payment” (“SFAS 123R”), which requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the consolidated statement of operations over the period during which an employee is required to provide service in exchange for the award — the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee stock options is estimated using the Black-Scholes option pricing model.
The Company utilizes comparator companies to estimate its price volatility and the simplified method to calculate option expected time to exercise, under Staff Accounting Bulletin No. 107, “Share-Based Payment”. The fair value of stock-based payment awards was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values for the years ended December 28, 2008 and December 30, 2007:
                 
    Successor     Predecessor  
    2008     2007  
Weighted average fair value of grants
   $ 3,942.64     $ 3,942.64  
Risk-free interest rate
     4.52 %     4.52 %
Expected volatility
     42.28 %     42.28 %
Expected life in years
     7.67       6.15  

 

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The following table summarizes stock option activity:
                 
            Weighted  
            Average  
    Shares     Exercise Price  
Outstanding at December 31, 2006 — Predecessor
     —       —  
Granted
     808     $ 8,150  
Exercised
     —       —  
Forfeited/expired
     (9 )     8,150  
 
            
Outstanding at December 30, 2007 — Predecessor
     799     $ 8,150  
Granted
     —       —  
Exercised
     —       —  
Forfeited/expired
     (169 )     8,150  
 
            
Outstanding at November 13, 2008 — Predecessor
     630     $ 8,150  
Granted
     —       —  
Exercised
     —       —  
Forfeited/expired
     (300 )     8,150  
 
            
Outstanding at December 28, 2008 — Successor
     330     $ 8,150  
 
            
Vested and expected to vest at December 28, 2008
     314     $ 8,150  
Exercisable at December 28, 2008
     129     $ 8,150  
The Company recorded a net stock-based compensation credit of $28 during the Successor Period November 14, 2008 through December 28, 2008. The credit resulted from the reversal of compensation cost for unvested shares related to a termination of one of our executives during that period. The Company recorded $406 and $839 of stock-based compensation expense for the Predecessor Period from December 31, 2007 through November 13, 2008 and the Predecessor year ended December 30, 2007, respectively. Stock-based compensation expense is included in general and administrative expense on the consolidated statements of operations.
As of December 28, 2008, $1,638 of total unrecognized compensation costs related to non-vested stock-based awards is expected to be recognized through fiscal year 2012, and the weighted average remaining vesting period of those awards is approximately 1.7 years. At December 28, 2008, the aggregate intrinsic value of exercisable options was $0.
8. Income Taxes
Significant components of the income tax provision (benefit) consist of the following:
                                         
    Successor     Predecessor  
    December 28,     November 13,     December 30,     December 31,     August 20,  
    2008     2008     2007     2006     2006  
Current:
                                        
Federal
   $ —     $ 28     $ —     $ —     $ 1,570  
State
     —       24       58       61       344  
 
                              
 
     —       52       58       61       1,914  
 
                              
Deferred:
                                        
Federal
     —       —       (467 )     (2,729 )     (367 )
State
     —       —       (129 )     (523 )     (240 )
 
                              
 
     —       —       (596 )     (3,252 )     (607 )
 
                              
 
     —       —       (538 )     (3,191 )     1,307 )
Change in valuation allowance
     —       —       13,282       —       —  
 
                              
 
   $ —     $ 52     $ 12,744     $ (3,191 )   $ 1,307  
 
                              

 

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Deferred income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows:
                 
    Successor     Predecessor  
    December 28,     December 30,  
    2008     2007  
Deferred tax assets:
                
Federal net operating loss carry-forwards
   $ —     $ 9,481  
State net operating loss carry-forwards
     —       1,805  
Goodwill and other intangibles
     24,808       4,398  
Accrued expenses not currently deductible
     6,470       3,394  
Tax credit carry-forwards
     —       592  
Property and equipment basis difference
     7,144       17,455  
Deferred rent
     72       1,006  
Gift certificates and other deferred income
     537       692  
Unamortized debt premium
     —       1,729  
Deferred compensation
     1,262       1,640  
State taxes
     1,872       —  
Other
     5,204       784  
 
            
Total deferred tax assets
     47,369       42,976  
 
            
 
                
Deferred tax liabilities:
                
Prepaid expenses
     (397 )     (504 )
Trademarks and other indefinite lived intangibles
     (31,549 )     (17,170 )
Lease amortization
     (12,732 )     (10,279 )
State taxes
     —       (631 )
Unamortized landlord allowance
     (3,097 )     (1,110 )
Unamortized debt discount
     (8,019 )     —  
 
            
Total deferred tax liabilities
     (55,794 )     (29,694 )
 
            
 
                
Valuation allowance
     (23,124 )     (13,282 )
 
            
 
                
Net deferred tax liability
   $ (31,549 )   $ —  
 
            
Immediately prior to the Exchange, deferred tax assets and liabilities were $56,811 and $32,322, respectively, offset by a valuation allowance of $24,489. Approximately $3,000 of the change in deferred tax assets during 2007 was recorded as a reduction to goodwill, as it was related to the Merger.
The reconciliation of income tax at the U.S. federal statutory tax rates to income tax expense is as follows:
                                 
    Successor     Predecessor  
    December 28,     December 30,     December 31,     August 20,  
    2008     2007     2006     2006  
 
                                
Income tax at U.S. federal statutory tax rate
     34.0 %     34.0 %     34.0 %     34.0 %
State income tax, net of federal benefit
     0.0       4.7       5.8       5.7  
Valuation allowance
     (13.0 )     (123.0 )     —       —  
Non-deductible transaction costs
     —       —       —       11.2  
Impairment of goodwill and intangibles
     (92.1 )     —       —       —  
Purchase accounting adjustment
     71.2       —       —       —  
Permanent true-ups
     —       (33.3 )     —       —  
Other
     (0.1 )     (0.4 )     (1.1 )     (4.0 )
 
                        
Effective tax rate
     (0.0 )%     (118.0 )%     38.7 %     46.9 %
 
                        
In accordance with SFAS 109, net deferred tax assets are reduced by a valuation allowance if, based on all the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The amount of deferred tax assets considered realizable was determined based on future reversals of existing taxable temporary differences and future taxable income, exclusive of reversing temporary differences and carry-forwards.
In evaluating future taxable income for valuation allowance purposes at December 28, 2008 and December 30, 2007 , the Company concluded that it was appropriate to consider income expected to be generated in 2009, 2010 and 2011. For the years ended December 28, 2008 and December 30, 2007, the Company recorded a valuation allowance of $23,124 and $13,282, respectively in accordance with SFAS 109.
In accordance with FAS 141, any changes regarding the realization of the acquired deferred tax assets which occur within the measurement period resulting from new information regarding facts and circumstances that existed at the date of the Exchange, then, to the extent there is a reduction in the valuation allowance, the benefit will reduce goodwill. All other reductions to the valuation allowance will benefit tax expense.

 

33

 

The Company files U.S. and State consolidated tax returns with Holdco. The Company uses the separate return method for allocating taxes to its separate financial statements. One exception to the separate return method used in the current year was the reduction of tax attributes as a result of the Exchange transaction that took place on November 13, 2008 at Holdco. Consolidated tax attributes belonging to the Company have been reduced to reflect their utilization under IRC Section 108. No tax expense was recorded as these tax attributes were previously offset by a full valuation allowance, which was, accordingly, reduced. The Company has not completed the full analysis of the impact of the Exchange, but has preliminarily concluded that, while there may be additional reductions of deferred tax assets as a result of the transaction, there should be no additional income tax expense due to the corresponding release of the valuation allowance. The Company expects to complete the analysis during 2009.
At December 28, 2008, the Company no longer had federal and state net operating loss carry-forwards for utilization against future taxable income. At December 30, 2007, the Company had a federal net operating loss carry-forward of $19,170 and state net operating loss carry-forward of $37,613, respectively, which would have started to expire beginning in 2021.
9. Fair Value Measurement
On December 31, 2007, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements. The statement applies whenever other statements require or permit assets or liabilities to be measured at fair value. SFAS 157 is effective for fiscal years beginning after November 15, 2007, except for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis, for which application was deferred for one year.
SFAS 157 established the following fair value hierarchy that prioritizes the inputs used to measure fair value:
         
 
  Level 1:   Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, listed equities and U.S. government treasury securities.
 
        
 
  Level 2:   Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category include non-exchange-traded derivatives such as over the counter forwards, options and repurchase agreements.
 
        
 
  Level 3:   Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. At each balance sheet date, we perform an analysis of all instruments subject to SFAS 157 and include in Level 3 all of those whose fair value is based on significant unobservable inputs.
We do not have any of financial assets and liabilities that we account for at fair value on a recurring basis. However, as a result of the Exchange, we completed a valuation of the Company as of November 13, 2008. The financial assets and liabilities that we accounted for at fair value by level within the fair value hierarchy:
Level 1: Quoted Prices in Active Markets
As of November 13, 2008, we revalued our senior secured notes by recording a discount of $19,950 against the carrying value of $105,000. This value was based upon quote market prices for recent trades of our senior secured notes. The discount is amortized to interest expense over the remaining life of the debt.

 

34

 

Level 2: Significant Other Observable Inputs
As of November 13, 2008, we revalued certain assets and liabilities through valuation models, including goodwill and property and equipment. The values recorded as of November 13, 2008 are included in Note 2.
In accordance with the provisions of FAS 142, goodwill and other intangibles assets were written down to fair value as a result of impairment charges of $163,196, which was included in earnings for the predecessor period of 2008.
In accordance with the provisions of FAS 144, certain long-lived assets were written down to fair value as a result of impairment charges of $5,151 recorded in earnings during the predecessor period of 2008.
Level 3: Significant Unobservable Inputs
As of November 13, 2008, trademarks and other intangible assets were revalued using a discounted cash flow analysis. The values recorded as of November 13, 2008 are included in Note 2.
10. Commitments and Contingencies
Leases
The Company leases restaurant and office facilities that have terms with expirations in 2009 through 2028. Most of the restaurant facilities have renewal clauses exercisable at the option of the Company with rent escalation clauses stipulating specific rent increases, some of which are based upon the Consumer Price Index. Certain of these leases require the payment of contingent rentals based on a percentage of gross revenues, as defined. Additionally, the Company leases several properties that are not being operated by the Company. Several of those properties are subleased.
The Company leases certain leasehold improvements and equipment under agreements that are classified as capital leases. The cost of assets under capital leases is included in the balance sheets as property and equipment and was $1,228 and $1,644 at December 28, 2008 and December 30, 2007, respectively. Accumulated amortization of these assets was $39 and $199 at December 28, 2008 and December 30, 2007, respectively. Amortization of assets under capital leases is included in depreciation expense. The amount of capital assets placed in service was $326 and $947 at December 28, 2008 and December 30, 2007.
The minimum annual lease commitment and subtenant income of the Company for the years succeeding December 28, 2008 is approximately as follows:
                                 
    Capital     Minimum             Net  
    Lease     Lease     Sublease     Lease  
    Obligations     Commitments     Income     Commitments  
2009
   $ 565     $ 41,389     $ (678 )   $ 41,276  
2010
     433       36,742       (505 )     36,670  
2011
     269       32,234       (420 )     32,083  
2012
     194       28,561       (345 )     28,410  
2013
     29       23,740       (240 )     23,529  
Thereafter
     304       89,004       (559 )     88,749  
 
                        
 
                                
Total minimum lease payments
     1,794     $ 251,670     $ (2,747 )   $ 250,717  
 
                        
Less: Amount representing interest
     (399 )                        
 
                              
Present value of net minimum capital lease payments
     1,395                          
Less: Current maturities of capital lease obligations
     (453 )                        
 
                              
Long-term capital lease obligations
   $ 942                          
 
                              
The Company is contingently liable for leases on sold or assigned premises for $1,925 as of December 28, 2008.
Some of the above leases provide for additional rentals based on a percentage of revenues. The following table summarizes the rental expense, percentage rent expense above minimum rent and net sublease income:
                                         
    Successor     Predecessor  
    December 28,     November 13,     December 30,     December 31,     August 20,  
    2008     2008     2007     2006     2006  
Rental expense
   $ 4,997     $ 41,935     $ 45,369     $ 14,893     $ 30,003  
Percentage rent expense above minimum rent (included in rental expense)
     198       1,926       2,164       907       1,755  
Net sublease income
     45       344       227       122       289  

 

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Purchase Obligations
In December 2007, the Company entered into an agreement with a certain vendor to purchase a minimum volume of product from December 1, 2007 through December 31, 2015, to be extended for any shortfall in purchases until such volume is met. The contract is based upon expiration date or volume, which ever occurs last. As of December 28, 2008, $1,177 had been purchased, representing 9.3% of the total contractual volume to be purchased throughout the life of the contract.
Litigation
The Company is periodically a defendant in cases involving personal injury, employment-related claims and other matters that arise in the normal course of business. While any pending or threatened litigation has an element of uncertainty, the Company believes that the outcome of these lawsuits or claims, individually or combined, will not materially adversely affect the consolidated financial position, results of operations or cash flows of the Company.
Self-Insurance
The Company is self-insured for most casualty losses up to certain stop-loss limits. The Company has accounted for its liabilities for these casualty losses and claims, including both reported and incurred but not reported claims, based on information provided by independent actuaries. Management believes that it has recorded reserves for casualty losses at a level that has substantially mitigated the potential negative impact of adverse developments and/or volatility. Management believes that its calculation of casualty loss liabilities would not change materially under different conditions and/or different methods. However, due to the inherent volatility of actuarially determined casualty claims, it is reasonably possible that the Company could experience changes in estimated casualty losses, which could be material to both quarterly and annual net income. Amounts estimated to be ultimately payable with respect to existing claims and an estimate for claims incurred but not reported under these programs have been accrued and are included in the accompanying consolidated balance sheets. Estimated liabilities related to the self-insured casualty losses were $15,619 and $15,479 as of December 28, 2008 and December 30, 2007, respectively.
The Company is also required to maintain collateral securing future payment under the self-insured retention insurance programs. As of December 28, 2008 and December 30, 2007, this collateral consisted of stand-by letters of credit of $16,892 and $18,674, respectively.
11. Related Party Transactions
Successor Transactions
As discussed in Note 6, as a result of the Exchange, the existing lenders to the New Senior Unsecured Credit Facility became owners of Holdco, the Company’s parent. As a result, the New Senior Unsecured Credit Facility is now held by related parties to the Company.
Several of our directors are employed by Farallon Capital Management, LLC (“Farallon”). Funds managed by Farallon are indirect stockholders of Holdco. Funds managed by Farallon hold an indirect interest in a shopping center from which we lease property for the operation of an Acapulco restaurant. Total payments in connection with our lease in 2008 were $414, of which approximately $103 is attributable to the Farallon funds’ indirect interest in the shopping center.
On February 27, 2009, the Company entered into a contract for consulting services with an entity which has a material relationship with one of Holdco’s stockholders. This consulting contract has an initial term from March 1, 2009 to March 31, 2009 with three optional one month renewal terms through June 30, 2009. Prior to the end of the initial term, the Company may cancel the agreement with no fees due. The monthly fee of $190 will be recorded in general and administrative expense and will be paid in shares of Holdco common stock.

 

36

 

Predecessor Transactions
The Company has a Management Services Agreement (the “Management Agreement”) dated August 21, 2006, by and between the Company and Sun Capital Partners Management IV, LLC (the “Manager”), an affiliate of Sun Cantinas LLC, the indirect holder of the majority of the capital stock of the Company prior to the Exchange. The Manager was paid annual fees equal to the greater of (i) $500 or (ii) 1% of the Company’s EBITDA for such period. EBITDA is defined as (A) net income (or loss) after taxes of the Company and its direct and indirect subsidiaries on a consolidated basis (“Net Income”), plus (B) interest expense which has been deducted in the determination of Net Income, plus (C) federal, state and local taxes which have been deducted in determining Net Income, plus (D) depreciation and amortization expenses which have been deducted in determining Net Income, including without limitation amortization of capitalized transaction expenses incurred in connection with the transactions contemplated by the Merger plus (E) extraordinary losses which have been deducted in the determination of Net Income, plus (F) un-capitalized transaction expenses incurred in connection with the Merger, plus (G) all other non-cash charges, minus (H) extraordinary gains which have been included in the determination of Net Income. EBITDA is computed without taking into consideration the fees payable under the Management Agreement. The Company paid the fees in quarterly installments in advance equal to the greater of (i) $125 or (ii) 1% of EBITDA for the immediately preceding fiscal quarter. In connection with the Exchange, the Management Agreement was terminated effective November 13, 2008, with the exception of certain provisions having to do with limitation of liability and indemnification, which will survive and continue in full force and effect. Expenses relating to the Management Agreement of $448, $500 and $174 were recorded as general and administrative expense in the Predecessor Period from December 31, 2007 to November 13, 2008, the Predecessor Year Ended December 30, 2007 and Predecessor Period from August 21, 2006 to December 31, 2006, respectively.
The Company periodically makes payments to (subject to restricted payment covenants under the indenture governing the senior secured notes), from and on behalf of RM Restaurant Holding Corp., its parent. In September 2006, the Company made a dividend distribution of $10,000 to RM Restaurant Holding, its parent, which was recorded as a reduction to retained earnings. A contribution of $1,743 was received from RM Restaurant Holding during 2007 related to a distribution to former stockholders of proceeds from the sale of land subsequent to the acquisition date, as specified in the Merger Agreement, and was recorded as additional paid in capital. The Company has also made subsequent additional distributions to and on behalf of RM Restaurant Holding Corp. in the amount of $5,399 and has recorded the distributions as a related party receivable. During 2007 and the predecessor period 2008, the Company received advances from RM Restaurant Holding totaling $8,036 and $2,000, respectively, which were recorded as a related party payable. During 2008, management determined that certain payments received from its parent during 2007 and the predecessor period of 2008 which had been recorded as intercompany payables should be recorded as capital contributions. As a result, a reclassification of $5,554 was recorded to reduce related party payables and increase additional paid in capital. The Company received an additional $335 from RM Restaurant Holding Corp. which was recorded as a capital contribution during the predecessor period of 2008. The Company had a net related party payable of $2,505 at December 30, 2007 and a net related party receivable of $3,591 at December 31, 2006. There was no outstanding balance at December 28, 2008.
The Company had an Amended and Restated Management Agreement dated June 28, 2000 with two of its former stockholders Bruckman, Rosser, Sherrill & Co., L.P. and FS Private Investments, LLC. The stockholders were paid annual fees equating to .667% and .333%, respectively, of consolidated earnings before interest, income taxes, depreciation and amortization of the Company. As described in the Merger Agreement, the Amended and Restated Management Agreement dated June 28, 2000 was terminated in connection with the Merger. Expenses relating to the agreement of $436 and $510 were recorded as general and administrative expense in the periods from December 26, 2005 to August 20, 2006 and the fiscal year ended December 25, 2005, respectively. Additionally, the Company recorded a termination fee of $1,819 in the period from December 26, 2005 to August 20, 2006, related to the termination of the Amended and Restated Management Agreement.
12. Employee Benefit Plan
The Company is the sponsor for a defined contribution plan (401(k) plan) for qualified Company employees, as defined. Participants may contribute from 1% to 50% of pre-tax compensation, subject to certain limitations. The plan contains a provision that provides that the Company may make discretionary contributions. The Company has recorded contribution expense of $26, $207, $255, $93 and $159 during the 6 week Successor Period November 14, 2008 through December 28, 2008, the 46 week Predecessor Period from December 31, 2007 through November 13, 2008, the Predecessor Year ended December 30, 2007, the 19 week Predecessor Period from August 21, 2006 to December 31, 2006 and the 34 week Predecessor Period from December 26, 2005 to August 20, 2006, respectively.
13. Other Events
In May 2007, the Company sold four Company-owned Fuzio restaurants to a franchisee, entered into a management agreement with the franchisee on a fifth Company-owned Fuzio restaurant and sold the Fuzio trademark, trade name and Fuzio franchise rights to the franchisee (the “Fuzio Transaction”). The selling price of $4,850 in cash included $714 in prepaid management fees associated with the management agreement. The management fees will be amortized over seven years beginning in May 2007. Concurrent with the sale, the Company purchased three franchised Chevys restaurants from the franchisee for $3,124 in cash.
The Company recorded a gain of $1,467 on the disposal of the assets of the Fuzio Transaction. The gain is included in other income on the consolidated statements of operations and has been recorded net of associated expenses and remaining net book value of the assets transferred.

 

37

 

14. Condensed Consolidating Financial Statements
Pursuant to the notes accompanying Rule 3-10(f) of Regulation S-X, we have not provided the condensed consolidated financial statements of our subsidiaries guaranteeing our outstanding senior notes as (i) we have no independent assets or operations, (ii) the guarantees are full and unconditional, joint and several and (iii) we have no subsidiaries who are not subsidiary guarantors of our senior notes.
15. Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the years ended December 28, 2008 and December 30, 2007:
                                         
                            Predecessor     Successor  
    Predecessor     Predecessor     Predecessor     Period from     Period from  
    13 weeks ended     13 weeks ended     13 weeks ended     September 29, 2008     November 14, 2008  
    March 30,     June 29,     September 28,     to     to  
    2008     2008     2008     November 13, 2008     December 28, 2008  
Total revenues
   $ 137,577     $ 152,528     $ 137,461     $ 68,863     $ 57,316  
Operating income (loss)
   $ 2,242     $ (27,728 )   $ 1,931     $ (135,113 )   $ (20 )
Net loss
   $ (2,204 )   $ (31,839 )(1)   $ (1,080 )   $ (137,990 )(2)   $ (4,103 )
                                 
    Predecessor  
    13 weeks ended     13 weeks ended     13 weeks ended     13 weeks ended  
    April 1,
2007		     July 1,
2007		     September 30,
2007		     December 30,
2007		  
Total revenues
   $ 138,511     $ 149,575     $ 142,510     $ 134,595  
Operating income (loss)
   $ 5,593     $ 7,813     $ 4,070     $ (10,622 )
Net income (loss)
   $ 380     $ 2,973     $ (591 )   $ (26,679 )(3)
 
     
(1)   Includes goodwill impairment of $34,000.
 
(2)   Includes goodwill impairment of $129,196.
 
(3)   Includes goodwill impairment charge of $10,000 and a deferred tax valuation allowance of $13,300.

 

38

 

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
             
    REAL MEX RESTAURANTS, INC.
 
            
 
  By:   /s/ Steven Tanner    
 
           
 
      Steven Tanner    
Date: April 2, 2009
      Interim Chief Executive Officer    

 

39

 

EXHIBIT INDEX
Documents filed as a part of this Amendment:
         
EXHIBIT    
NO.   DESCRIPTION
  31.1    
Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive and Chief Financial Officer. (Filed herewith)
       
 
  32.1    
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive and Chief Financial Officer. (Filed herewith)