-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Uzh2TMo3D5ReGcJlcZxWyFcbq9A5ah9WK6vAGVehS6JQgv8jzNoMgAIuS21iugNB 6WGZFHyAV6mgCW+JzewGUg== 0001042910-98-000224.txt : 19980331 0001042910-98-000224.hdr.sgml : 19980331 ACCESSION NUMBER: 0001042910-98-000224 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971228 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: RALLYS HAMBURGERS INC CENTRAL INDEX KEY: 0000854873 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 621210077 STATE OF INCORPORATION: DE FISCAL YEAR END: 1230 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-17980 FILM NUMBER: 98579457 BUSINESS ADDRESS: STREET 1: 10002 SHELBYVILLE RD STE 150 CITY: LOUISVILLE STATE: KY ZIP: 40223 BUSINESS PHONE: 5022458900 MAIL ADDRESS: STREET 1: 10002 SHELBYVILLE RD STREET 2: STE 150 CITY: LOUISVILLE STATE: KY ZIP: 40223 FORMER COMPANY: FORMER CONFORMED NAME: RALLYS INC DATE OF NAME CHANGE: 19920703 10-K 1 - ------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 --------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] for the fiscal year ended December 28, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from ____________ to ______________ Commission file number 0-17980 RALLY'S HAMBURGERS, INC. (Exact name of registrant as specified in its charter) Delaware 62-1210077 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 600 Cleveland Street, Eighth Floor, Clearwater, Florida 33755 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (813) 441-3500
Name of Each Exchange Title of Class on which Registered ---------------------- ---------------------------- Securities registered pursuant to 12(b) of the Act: 9 7/8% Senior Notes New York Stock Exchange due 2000 Securities registered pursuant to 12(g) of the Act: Common Stock, par NASDAQ -- NMS value $.10 per share Securities registered pursuant to 12(g) of the Act: Common Stock NASDAQ -- NMS Purchase Warrants
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. [ ] 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 [X] No The number of shares outstanding of the Registrant's Common Stock as of March 16, 1998, was 24,836,900 shares. The aggregate market value of the shares of Registrant held by non-affiliates of the Registrant, based on the closing price of such stock on the National Market System of the NASDAQ Stock Market, as of March 16, 1998, was approximately $30,306,518. For purposes of the foregoing calculation only, all directors and executive officers of the Registrant have been deemed affiliates. Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K. ------------------------------------------------------------------------- TABLE OF CONTENTS
Page No. -------- PART I - ------ Item 1. Business.....................................................................................3 Item 2. Properties...................................................................................9 Item 3. Legal Proceedings...........................................................................10 Item 4. Submission of Matters to a Vote of Security Holders.........................................11 PART II - ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................11 Item 6. Selected Consolidated Financial Data........................................................12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......13 Item 7A. Quantitative and Qualitative Disclosures about Market Risk..................................21 Item 8. Financial Statements and Supplementary Data.................................................22 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.......45 PART III - ------- Item 10. Directors, Executive Officers, Promoters and Control Persons of the Registrant..............45 Item 11. Executive Compensation......................................................................45 Item 12. Stock Ownership of Principal Holders and Management.........................................45 Item 13. Certain Relationships and Related Transactions..............................................45 PART IV - ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................45
2 PART I Item 1. Business General Rally's Hamburgers, Inc. and its subsidiaries are collectively referred to herein as the context requires as "Rally's" or the "Company". See Note 1 to Consolidated Financial Statements. Rally's is one of the largest chains of double drive-thru restaurants in the United States. At December 28, 1997, the Rally's system included 477 restaurants in 18 states, primarily in the Midwest and the Sunbelt, comprised of 229 Company-owned and operated and 248 franchised, including 27 Company-owned restaurants in Western markets which are operated as Rally's restaurants by CKE Restaurants, Inc. ("CKE"), a significant shareholder of the Company, under an operating agreement which began July 1996. Two additional Company-owned stores covered by the operating agreement have been converted to the Carl's Jr. format and are not included in the above store count. The Company's restaurants offer high quality fast food. The Company primarily serves the drive-thru and take-out segments of the quick-service restaurant industry. The Company opened its first restaurant in January 1985 and began offering franchises in November 1986. See "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations." Cautionary Statement Information provided herein by the Company contains, and from time to time the Company may disseminate material and make statements which may contain "forward-looking" information, as that term is defined by the Private Securities Litigation Reform Act of 1995 (the "Act"). These cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act. The Company cautions investors that any forward-looking statements made by the Company are not guarantees of future performance and that actual results may differ materially from those in the forward-looking statements as a result of various factors, including but not limited to, the following: (i) The Company competes with numerous well established competitors who have substantially greater financial resources and longer operating histories than the Company. Competitors have increasingly offered selected food items and combination meals, including hamburgers, at discounted prices, and continued discounting by competitors may adversely affect revenues and profitability of Company restaurants. (ii) The Company will be negatively impacted if the Company is unable to reverse declining same store sales. Sales increases will be dependent, among other things, on the success of Company advertising and promotion of new and existing menu items. No assurances can be given that such advertising and promotions will in fact be successful. The Company may also be negatively impacted by other factors common to the restaurant industry such as changes in consumer tastes, away from red meat and fried foods; increases in the costs of food, paper, labor, health care, worker's compensation or energy; an inadequate number of hourly paid employees; and/or decreases in the availability of affordable capital resources. Recent Acquisitions On December 18, 1997, the Company acquired approximately 19.1 million shares (the "Checkers Shares") of the common stock, $.001 par value per share (the "Checkers Common Stock"), of Checkers Drive-In Restaurants, Inc., a Delaware corporation ("Checkers"), pursuant to that certain Exchange Agreement, dated as of December 8, 1997 (the "Exchange Agreement"), between Rally's, CKE Restaurants, Inc, ("CKE"), Fidelity National Financial, Inc. ("Fidelity"), GIANT GROUP, LTD. ("GIANT") and the other parties named in the Exchange Agreement. Checkers owns, operates and franchises approximately 477 double drive-thru restaurants primarily in the Southeast and Mid-Atlantic regions. CKE, Fidelity and GIANT beneficially owned approximately 23.9%, 12.7% and 15.2%, respectively, of the Rally's Common Stock outstanding prior to the consummation of the Exchange Agreement and, as a result of the exchange, as of December 28, 1997, beneficially own approximately 32.5%, 3 12.6% and 12.8%, respectively. In addition, Terry Christensen, William Foley II, Burt Sugarman and C. Thomas Thompson, who are directors of Rally's and Checkers, and David Gotterer and Andrew Puzder, who are directors of Rally's, participated in the exchange. Mary Hart Sugarman, AJ Sugarman and Al Sugarman, who also participated in the exchange, are related to Burt Sugarman. In consideration of the acquisition of the Checkers Shares, Rally's issued 3,909,336 shares of its common stock, $.10 par value per share (the "Rally's Common Stock"), and 45,667 shares of its Series A Participating Preferred Stock, $.10 par value per share (the "Rally's Preferred Stock"), the terms of which are set forth in Exhibit B to the Exchange Agreement. The Rally's Preferred Stock will be converted into 4,566,700 shares of Rally's Common Stock upon approval of such conversion by Rally's stockholders. The exchange ratio used to determine the number of shares of Rally's Common Stock (including upon conversion of the Rally's Preferred Stock) received pursuant to the Exchange Agreement was based upon the average closing price of the Checkers Common Stock and the Rally's Common Stock for the five trading days preceding the public announcement of the proposed exchange on September 22, 1997. Effective November 30, 1997, Rally's and Checkers entered into a management services agreement pursuant to which Checkers is providing key services to Rally's, including executive management, financial planning and accounting, franchise, purchasing and human resources. In addition, Rally's and Checkers share certain of their executive officers, including the Chief Executive Officer and the Chief Operating Officer. Management believes that Rally's acquisition of the Checkers Common Stock, entering into the Management Services Agreement and sharing certain executive officers will enable Rally's and Checkers to take advantage of cost savings opportunities by facilitating the combination of administrative and operational functions. See "Employees" below, "Item 2. Properties," "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 4 to the Consolidated Financial Statements set forth under "Item 8. Consolidated Financial Statements and Supplementary Data." Concept and Strategy The Company's primary strategy is to serve the drive-thru and take-out segment of the quick-service restaurant industry. The Company's operating strategy is to take advantage of off-premise food consumption by serving a limited menu consisting of a variety of great tasting burgers with limited side items. The key elements of this strategy are Rally's operating system, restaurant design, brand positioning and marketing program. Rally's Operating System. The Rally's operating system is designed to provide fast and accurate service of high quality fast food. Within the restaurants, all products are prepared to order in a systematic fashion moving from the back of the restaurant to the front windows with each employee performing specific duties. Labor is staffed in an attempt to courteously serve guests within 45 seconds of their reaching the drive-thru window and to maintain a safe, clean food service environment. The Company's training and franchise support programs are designed to promote consistency of product and service throughout the Rally's system and are documented in a uniform confidential operations manual. The Company installed computer-based point of sale devices and related software in each of its Company-owned restaurants in 1993 and 1994. This software allows Rally's to centralize control over certain aspects of restaurant operations at the corporate office on a daily basis. As a result, menu prices and menus can be controlled and transactions reviewed and audited at corporate headquarters. The computer-based point of sale devices are coupled with a back office computer to monitor sales, assist inventory management, maintain cash control, provide variance reporting, and control labor and food costs. Each restaurant transmits its data via a daily polling procedure, and it is accumulated at the principal offices of the Company. This data is used to analyze and make decisions about the business. Many computer systems using two-digit fields to store years must be converted to read four-digit fields before the turn of the century in order to recognize the difference between the years 1900 and 2000. The Company's software system will be upgraded or replaced in time to meet the Year 2000 requirements at a cost estimated at approximately $300,000. Restaurant Design and Economics. Rally's restaurants present a distinctive design which conveys a message of "clean and fast" to the passing motorist. The restaurants' typical "double drive-thru" design features drive-thru windows on both sides of the restaurant for quicker service. While the restaurants generally do not have an interior dining area, most have a patio for outdoor eating. These areas contain canopy tables and seats and are landscaped to create an attractive eating environment. Rally's restaurant buildings average 600 to 720 square feet depending 4 upon geographic location and require less property than the traditional eat-in restaurants. As a result of the small size of the restaurant building, Rally's restaurants generally require a smaller capital investment and have lower occupancy and operating costs per restaurant than traditional dine-in fast feeders. The size of the facility also permits somewhat greater flexibility with respect to the selection of prospective sites for restaurants. During 1997, the Company opened nine new restaurants, re-opened three restaurants and acquired 11 restaurants from franchisees and sold one restaurant to a franchisee. The incremental cash outlay, exclusive of land, of opening these restaurants was reduced due to the substantial use of surplus assets as well as to the types of restaurants constructed (stick versus modular versus conversions of pre-existing restaurants). In total, the incremental cash outlay, exclusive of land, of these restaurants was approximately $4.8 million. In 1994, the full development cost associated with constructing and opening a Rally's restaurant (excluding land cost and interest on construction) was approximately $478,000. When purchased, the majority of real estate sites have cost between $100,000 and $300,000. As of December 28, 1997, approximately 69% of Company-owned and operated restaurants were located on leased real estate. Over the past two years, the Company has been building stores by either using surplus equipment and/or surplus modular buildings or purchasing conversion properties. When using surplus equipment and modular buildings, the Company's cash outlay has typically been approximately $250,000. Although the Company expects to continue to use excess modular buildings and seek additional conversion opportunities, the Company estimates that the cost associated with new store development will return to the higher pre-slowdown levels where these alternatives are not practical. During 1997, the Company initiated a test of an indoor seating environment where a 20 to 50 seat dining room replaced the passenger side drive-thru lane. As of March, 1998, five units were converted from a double-drive-thru format to a single drive-thru/indoor seating format. The Company plans to continue testing this design with a goal of engineering the costs down in order to achieve an attractive economic return. Brand Positioning: The Best Burger. Rally's is attempting to establish an overall brand positioning as the fast food hamburger chain which serves the best tasting hamburger in America. This positioning is supported by: 1. A limited menu of high quality hamburgers/cheeseburgers, chicken sandwiches, french fries and soft drinks, executed via a highly focused operating system. 2. Television, radio and outdoor advertising which differentiates Rally's from other fast food hamburger chains and targets heavy hamburger users. 3. New, visually attractive menu boards, merchandising and packaging that feature these high quality products/brands and ingredients. This new brand positioning continues to represent a strategic shift for Rally's away from its prior positioning which had been based primarily on low prices and quick service. Good value and quick service are still important to guests, but the competitive environment has become so price oriented that basing a brand positioning on low prices is not unique enough to differentiate Rally's from its competitors. Further, relying too heavily on low prices and price promotion had a negative financial impact on the Company, causing higher costs as a percentage of sales and lower profits. By focusing the brand positioning on what Rally's believes guests really want from a quick service hamburger restaurant and on what Rally's can effectively provide - great tasting burgers - Rally's believes that it will be able to effectively differentiate itself from its competitors and improve its sales and guest count trends over time. This shift in Rally's brand positioning began at the end of 1996 and resulted in an increase in the size of its hamburger patty from 2.8 ounces to 3.2 ounces, a reformulation of its spice profile and the addition of two new signature burgers to its product line - The Super Double and the Barbecue Bacon Cheeseburger (single and double). These new products, along with a bigger Rallyburger(R) and Big Buford(TM) double cheeseburger, currently represent the core burger line-up. Additionally, the Company offers its One of a Kind Fries(R), a chicken breast sandwich, onion rings, Coca-Cola(R) brand soft drinks and milk shakes. A limited number of additional products may be offered in some locations from time to time. Marketing Program. Rally's plans to introduce a new advertising campaign in all Company markets in April, 1998 to support the new brand positioning. The campaign will be based on strategic market research, which confirms the consumer appeal of "best tasting burger." This new advertising was created by the Company's 5 advertising agency, M&C Saatchi, New York, who were assigned the account in December, 1997. The new advertising campaign will rely heavily on television as the primary medium. In cases where effective levels of television are not affordable, the Company may use radio, outdoor or print advertising. Working Capital The Company's working capital requirements are generally typical of companies within the quick-service restaurant industry. The Company does not normally require large amounts of working capital to maintain operations since sales are for cash, purchases are on open accounts and meat and produce inventories are limited to a two to four day supply to assure freshness. During 1996 and 1997, the Company's working capital requirements were substantially reduced as a result of significant slowdowns in new store construction as compared with prior years. Additionally, sales of certain assets held for sale, net of underlying encumbrances, provided another source of working capital. Additional working capital could be required for the addition of indoor dining areas to existing units if the Company decides to expand this concept beyond the five units currently in test. See "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations." Franchising Program; Area Development Rights The Company offers area development agreements to franchisees for construction of one or more new restaurants over a defined period of time within a defined geographic area. The specific restaurant locations selected by franchisees are subsequently covered by separate franchise agreements. Under the standard area development agreement, a franchisee is generally required to pay, at the time the agreement is signed, a non-refundable fee of approximately $5,000 per potential restaurant in the defined geographic area. The number of potential restaurants is determined by negotiation between the Company and the franchisee. The Company's standard area development agreement also provides for a franchise fee of approximately $15,000 for each restaurant, which is due when the franchise agreement with respect to a restaurant is executed. The standard franchise agreement is for a term of 15 years and provides for payment to the Company of royalties equal to 4% of sales and minimum marketing expenditures of 4% of sales (1/2% of which is paid to the Rally's National Advertising Fund). The Company requires each franchisee to have an approved full-time Principal Operator who is responsible for the supervision and conduct of the franchise. As of December 28, 1997, the Company had 39 franchisees operating 221 restaurants (exclusive of the CKE-operated restaurants), representing approximately 46.3% of all systemwide restaurants. Approximately five of these franchisees operate 32 restaurants in Western markets that are in designated market areas ("DMA's") where Carl's Jr. has previously run commercials that were used by the Company in 1997. These Rally's stores were not be able to utilize the marketing material that the Company received from Carl's Jr. as part of the marketing-sharing agreement. The Company has reached an agreement in principle with these franchisee groups which would provide these franchisees additional funding and flexibility to allow them to continue to effectively compete without having access to the above referenced marketing materials. Expansion Strategy The Company currently intends to open approximately two new restaurants in an existing Company market in 1998. Currently, franchisees are expected to open approximately 10 locations during 1998. There can be no assurance that the Company or its franchisees will be able to open planned new restaurants or that, if opened, these restaurants can be operated profitably. The Company has pursued and intends to continue to pursue an expansion strategy, which may include addition of indoor seating to existing units. These strategies depend upon a number of factors, some of which are beyond the control of the Company. Such factors include the availability and cost of suitable locations, the hiring, training and retention of skilled management and other personnel, the availability of adequate financing and the selection of viable franchisees. The Company may also make selective acquisitions, depending on, among other factors, the availability of suitable acquisition prospects and appropriate financing. There can be no assurance that the Company will be able to build additional indoor dining facilities, acquire additional restaurants, or that this growth would add profits to the Rally's system. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." 6 Restaurant Locations The following table sets forth the number of restaurants in the Rally's system at December 28, 1997 by state:
Company-owned and operated Restaurants (229) Alabama (14) Kentucky (31) Ohio (23) Arkansas (10) Louisiana (22) Tennessee (9) Florida (17) Michigan (37) Virginia (13) Indiana (23) Missouri (30) Franchised Restaurants (including CKE - operated restaurants) (248) Alabama (1) Indiana (25) Ohio (85) Arizona (9) Kentucky (15) Pennsylvania (3) California (50) Louisiana (5) Tennessee (4) Florida (1) Michigan (20) Virginia (8) Georgia (7) Mississippi (4) West Virginia (4) Illinois (4) Missouri (3)
Site Selection and Construction The Company believes that the location of a Rally's restaurant is very important to its success. In evaluating particular sites, the Company uses demographic data related to quick-service restaurant sales. Sites proposed for both Company-owned restaurants and franchised restaurants must be accepted by a committee comprised of most members of the Company's senior management team. The committee considers, among other factors, the accessibility, visibility, cost, surrounding traffic patterns and population characteristics of each potential site. The Company has prototype plans and approved suppliers for the construction of its restaurants. Since 1990, the Company has increasingly used modular buildings. Prior to that time, "stick" (constructed on-site) buildings were used almost exclusively. Purchasing Franchisees are required to purchase their equipment, food, beverages and supplies from Company-approved suppliers. All products must meet specifications set by the Company, and management continually monitors the quality of the food, beverages and supplies provided to the restaurants. The Company negotiates directly with wholesale suppliers to ensure consistent quality and freshness of products throughout the Rally's system and believes that it has obtained competitive pricing from its suppliers. The Company currently has approximately 33 major food and paper suppliers and 15 distributors. During the year, the Company continued participating with related parties in attempting to leverage aggregate purchase volumes of common items to obtain more favorable pricing. The Company expects these efforts will continue in the future. Restaurant Staffing and Training; Franchise Support A typical Rally's restaurant, during peak hours, is staffed with 8 to 12 team members, with a manager generally on the premises at all times. The function of assuring that each Company-owned restaurant consistently delivers high-quality food and service is performed by Area Managers. Area Managers report to Regional Vice Presidents. Regional Vice Presidents, Area Managers and restaurant management are compensated with a fixed salary plus a bonus based on the performance of the restaurants under their supervision. On average, the Company has one Area Manager for every 5 to 10 Company restaurants and 8 to 11 Area Managers for each of the three Regional Vice Presidents. The Regional Vice Presidents report to the Chief Operating Officer. The Company believes that training is important to the success of its restaurant operations. The Company's training programs emphasize quality food preparation, quick service, cleanliness of restaurants, courteous employees and consistency of execution. 7 All General Managers of Company-owned restaurants are required to complete the Company's training program, which generally consists of five weeks of hands-on training. The designated operating partner of each franchisee is required to receive similar training, generally 12 weeks in duration. All Company and franchise General Managers must generally complete an intensive six-day "Train the Trainer" program before being certified to train management personnel in their respective markets. The certification process takes approximately 30 days to complete. In addition, the Company sends a training team consisting of both management and hourly workers to a new franchisee's first three restaurant openings for a duration of up to two weeks (one week before and one week after the opening). After a new franchisee opens three restaurants, the Company provides this training team as it deems necessary, or upon the franchisee's request at the franchisee's expense. The Company has six Franchise Business Managers, each of whom acts as a link between the Company and its franchisees. The Franchise Business Managers perform regularly scheduled restaurant operation evaluations to ensure that each franchised restaurant consistently delivers high quality food and fast, friendly service in a clean environment. They also review the financial results and effectiveness of franchise restaurant management to identify possible areas of improvement. Competition The quick-service restaurant industry is highly competitive and can be significantly affected by many factors, including changes in local, regional or national economic conditions, changes in consumer tastes, traffic patterns, consumer concerns about the nutritional quality of quick-service food and increases in the number and particular locations of competing quick-service restaurants. Factors such as inflation, increases in food, labor (including health care costs) and energy costs and the availability of an adequate number of hourly-paid employees also affect the quick-service restaurant industry. Major chains, which have substantially greater financial resources and longer operating histories than the Company, dominate the quick-service restaurant industry. The Company believes that its primary competitors are five national chains: McDonald's, Wendy's, Hardee's, Burger King and Taco Bell. In certain markets, the Company competes with other quick-service double drive-thru hamburger chains with operating concepts similar to the Company. Certain of the major chains have increasingly offered selected food items and combination meals, including hamburgers, at discounted prices. The Company believes that the pricing strategies of its competitors, in general, had an adverse impact on the Company's systemwide sales in the last three fiscal years. The pricing or other marketing strategies of one or more of these competitors could have a continuing adverse impact on the Company's performance. With respect to the sale of franchises, the Company competes with many franchisors of restaurants, including other double drive-thru franchisors, and franchisors of other business concepts. The Company believes it has attracted a number of franchisees with significant experience in the restaurant industry as a result of the strength of its concept and operating strategy and the favorable potential return available from a relatively low capital investment. In general, there is active competition for management personnel, capital and attractive commercial real estate sites suitable for restaurants. Employees As of March 24, 1998, the Company employed approximately 5,500 employees, including approximately 11 corporate personnel. On November 30, 1997, the Company entered into a Management Services Agreement, pursuant to which certain of the management of Checkers will manage certain operations of the Company. Most employees, other than restaurant management and certain corporate personnel, are paid on an hourly basis. The Company believes that it provides working conditions and wages that are comparable with those of other companies within the quick-service restaurant industry. The Company's employees are not covered by a collective bargaining agreement. Trademarks and Service Marks The Company regards its trademarks and service marks as having significant value and as being important to its marketing efforts. The Company has registered its principal logo Rally's Hamburgers(R) and its design with the U.S. Patent and Trademark Office (the "PTO") on the Principal Register as a service mark for its restaurant services. The Company registered One of a Kind Fries(R) with the PTO on the Principal Register as a trademark for 8 its french fries. The Company also registered the Rallyburger(R), Rally-Q(R) and Smokin' Sausage(R) with the PTO as a trademark for these Company sandwiches. The Company has also filed with the PTO several applications to register service marks and trademarks used in connection with its advertising of products and services including the Big Buford(TM) sandwich. The Company's policy is to pursue registration of its marks whenever possible and to oppose strenuously any infringement of its marks. Government Regulation The Company is subject to Federal Trade Commission ("FTC") regulation and state laws which regulate the offer and sale of franchises. The Company is also subject to a number of state laws which regulate substantive aspects of the franchisor-franchisee relationship. The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") requires the Company to furnish to prospective franchisees a franchise offering circular containing information prescribed by the FTC Rule. At least fifteen states presently regulate the offer and sale of franchises and, in almost all cases, require registration of the franchise offering with state authorities. State laws that regulate the offer and sale of franchises and/or the franchisor-franchisee relationship presently exist in a substantial number of states. Such laws generally require registration of the franchise offering with state authorities and/or regulate the franchise relationship by, for example, requiring the franchisor to deal with its franchisees in good faith, prohibiting interference with the right of free association among franchisees, limiting the imposition of standards of performance on a franchisee and regulating discrimination among franchisees in charges, royalties or fees. These laws have not precluded the Company from seeking franchisees in any given area. Although such laws may restrict a franchisor in the termination of a franchise agreement by, for example, requiring "good cause" to exist as a basis for the termination, advance notice to the franchisee of the termination, an opportunity to cure a default and repurchase of inventory or other compensation, these provisions have not had a significant effect on the Company's operations. The Company is not aware of any pending franchise legislation which, in its view, is likely to affect significantly the operations of the Company. The Company believes that its operations comply substantially with the FTC Rule and state franchise laws. Each Company-operated and franchised restaurant is subject to regulation by federal agencies and to licensing and regulation by state and local health, sanitation, safety, fire and other departments. Difficulties or failures in obtaining the required licenses or approvals could delay or prevent the opening of new restaurants. The Company is subject to federal and state environmental regulations, although such regulations have not had a material effect on the Company's operations. More stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay or prevent development of new restaurants in particular locations. The Company is also subject to the Fair Labor Standards Act and various state laws governing such matters as minimum wage requirements, overtime and other working conditions and citizenship requirements. A significant number of the Company's food service personnel are paid at rates related to the federal minimum wage and increases in the minimum wage could increase the Company's labor costs. The restaurant business is subject to extensive federal, state and local regulations relating to the development and operation of restaurants, including regulations relating to building and zoning requirements, access to persons with disabilities, preparation and sale of food and laws governing the Company's relationship with its employees, including minimum wage requirements, overtime and working conditions and citizenship requirements. The failure to obtain or retain food licenses, or a substantial increase in the minimum wage rate, could adversely affect the operations of the Company's restaurants. The Company believes that it is operating in substantial compliance with applicable laws and regulations governing its operations. Item 2. Properties As of January 23, 1998, the Company owned or leased parcels of land and buildings for restaurants, either operating, under construction or held for sale or disposal as follows: Company-owned land (82) and buildings (287); and Company-leased land (232) and buildings (36). Land leased by the Company for restaurants is generally under "triple net" leases that require the Company to pay real estate taxes, maintenance and insurance with respect to the premises and, in some cases, pay contingent rentals based on sales in excess of specified amounts. Generally, the leases have initial terms of five to fifteen years with options to renew for additional periods which 9 can range from five to twenty years. The Company also leases the Louisville office of approximately 18,800 square feet, approximately 6,300 of which has been subleased subsequent to the Company's transfer of substantially all of its corporate management functions to Clearwater, Florida in February 1998. See Note 4 to the Consolidated Financial Statements. The Company also leases certain temporary storage facilities for excess modular buildings and surplus equipment. Item 3. Legal Proceedings Jonathan Mittman, Steven Horowitz, Dina Horowitz and John Hannan v. Rally's Hamburgers, Inc., Burt Sugarman, GIANT GROUP, LTD., Wayne Albritton, Donald C. Moore, Edward C. Binzel, Gena L. Morris, Patricia L. Glaser and Arthur Andersen LLP (Case NO. C-94-0049-L-(CS). This putative class action purportedly on behalf of the stockholders' of Rally's, alleging certain violations of the Securities Exchange Act of 1934, among other claims, with respect to Rally's Common Stock, was filed in the United States District Court for the Western District of Kentucky on January 24, 1994 (Civ. No. C94-0039-L(CS)) against GIANT, Rally's, certain present and former officers and directors and Rally's auditors. The complaint alleges defendants violated the Securities Exchange Act of 1934, among other claims, by issuing inaccurate public statements about the Company in order to arbitrarily inflate the price of Rally's Common Stock. The plaintiffs seek unspecified damages. On February 14, 1994, a related lawsuit was filed by two other stockholders making the same allegations before the same court, known as Edward L. Davidson and Rick Sweeney v. Rally's Hamburgers, Inc., Burt Sugarman, GIANT GROUP, LTD., Wayne M. Albritton, Donald C. Moore, Edward C. Binzel, Gena L. Morris, Patricia L. Glaser and Arthur Andersen LLP, (Civ. No. C-94-0087-L-S). On March 23, 1994, all plaintiffs filed a consolidated lawsuit known as Mittman et al. v. Rally's Hamburgers, Inc. et al., (Civ. No. C-94-0039-L(CS)) (the "Mittman Actions"). The Court denied plaintiffs' motion for class certification, "until such time as the issue of typicality of claims is further developed and clarified." The Court granted Mr. Sugarman's motion to strike certain scurrilous and irrelevant allegations, and directed plaintiffs to amend their complaint to conform to the Court's order. On April 15, 1994, Ms. Glaser and GIANT filed a motion to dismiss the consolidated lawsuit for lack of personal jurisdiction. The remaining defendants filed motions to dismiss for failure to state a claim upon which relief can be granted. On April 5, 1995, the Court denied these motions. (The Court struck plaintiffs' punitive damages allegations and required plaintiffs to amend their claims under Section 20 of the Exchange Act but otherwise the Court let stand the most recent version of plaintiffs' complaint at this juncture). Plaintiffs filed their second amended complaint on June 29, 1995, joining additional plaintiffs pursuant to stipulation of the parties. Plaintiffs renewed their motion for class certification on or about July 31, 1995. Defendants filed an opposition to this motion on or about October 31, 1995. On April 16, 1996, the Court granted the motion and certified a class of shareholders who purchased Rally's Common Stock from July 20, 1992 to September 29, 1993. On October 3, 1995, plaintiffs filed a motion to disqualify Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP ("Christensen, Miller") as counsel for defendants based on a purported conflict of interest allegedly arising from the representation of multiple defendants as well as Ms. Glaser's position as both a director of Rally's and a partner in Christensen, Miller. The Court denied the motion in the fall of 1996 and refused to disqualify Christensen, Miller. Fact discovery is set to close in April 1998. No trial date has been scheduled yet. The Company denies all wrongdoing and intends to vigorously defend itself in this action. Because these matters are in a preliminary stage, the Company is unable to determine whether a resolution adverse to the Company will have a material effect on its results of operations or financial condition. Accordingly, no provisions for any liabilities that may result upon adjudication have been made in the accompanying financial statements. An estimate of defense costs reimbursable under the Company's directors' and officers' insurance is included in "Other Assets" in the accompanying consolidated financial statements. 10 Harbor Finance Partners v. GIANT GROUP, LTD., Burt Sugarman, Mary Hart, ----------------------------------------------------------------------- Michael M. Fleishman, David Gotterer, Patricia L. Glaser, Willie D. Davis and - ----------------------------------------------------------------------------- John A. Roschman (Civ. Act. No. 14834). - --------------------------------------- In February 1996, Harbor Finance Partners ("Harbor") commenced a derivative action, purportedly on behalf of Rally's, against GIANT and certain of Rally's officers and directors before the Delaware Chancery Court. Harbor named Rally's as a nominal defendant. Harbor claims that the directors and officers of both Rally's and GIANT, along with GIANT, breached their fiduciary duties to the public shareholders of Rally's by causing Rally's to repurchase from GIANT certain Rally's 97/8% Senior Notes due in the year 2000 at an inflated price. Harbor seeks "millions of dollars in damages," along with rescission of the repurchase transaction. In the fall of 1996, all defendants moved to dismiss the action. The Chancery Court conducted a hearing on November 26, 1996 and denied the motions to dismiss on April 3, 1997. The Company denies all wrongdoing and intends to vigorously defend the action. It is not possible to predict the outcome of this action at this time. Kader Investments, Inc. v. Rally's Hamburgers, Inc., CAL.SUPER.CT., Orange -------------------------------------------------------------------------- County (Case No. 772257) - ------------------------ In December 1994, Rally's entered into two franchise agreements with Kader Investments, Inc. ("Kader") for the development and operation of Rally's Hamburgers restaurants in Anaheim, California and Tustin, California. Rally's assisted the franchisee in developing and opening the restaurants. On November 27, 1996, Kader filed a six-count Complaint against Rally's in the California Superior Court for Orange County (Case No. 772257) alleging material misrepresentation, respondent superior, breach of contract, breach of the implied covenant of good faith and fair dealing, fraud and unfair competition. These claims arise out of allegations concerning Rally's offer and sale of two franchises (under a two-store development agreement), and Rally's actions during the term of the agreements. The Complaint seeks as relief rescission of the parties' franchise and development agreements; general damages of at least $1,494,277 and $1,400,000 for the material misrepresentation and fraud counts, respectively; general damages in unspecified amounts as to the other counts; punitive damages in unspecified amounts; and attorneys' fees. Rally's filed an Answer, and filed a Cross-Complaint alleging breach of contract. In settlement of the litigation, on December 18, 1997, the parties entered into a memorandum of understanding pursuant to which the Company would purchase Kader's restaurants for $1.65 million. The purchase price will consist of $855,000 in cash, $375,000 in restricted stock and $420,000 in notes, and the transaction is currently scheduled to close on or about April 7, 1998, subject to completion of all necessary documentation and final dismissal. Accordingly, a provision of $754,000 for these liabilities, net of assets to be received upon adjudication, has been made in the accompanying financial statements. See Note 12 to the Consolidated Financial Statements. The Company is involved in other litigation matters incidental to its business. With respect to such other suits, management does not believe the litigation in which it is involved will have a material effect upon its results of operation or financial condition. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. PART II ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's Common Stock is quoted on the National Market System of the NASDAQ Stock Market under the symbol "RLLY". As of March 16, 1998, there were approximately 1,074 record holders of the Company's Common Stock. The table below sets forth the high and low sales prices of the Company's Common Stock, as reported on the NASDAQ National Market System, for each quarter during the Company's last two years.
1997 ---- Quarter ended March 30 June 29 September 28 December 28 High $ 5 $ 3 13/16 $ 4 $ 4 5/8 Low 2 3/8 1 15/16 1 7/8 2 1996 ---- Quarter ended March 31 June 30 September 29 December 29 High $ 2 1/4 $ 4 5/16 $ 3 9/16 $ 4 7/8 Low 1 1/32 1 1/2 2 1/8 3
11 On December 18, 1997, the Company issued 3,909,336 shares of Rally's Common Stock and 45,667 shares of Rally's Preferred Stock pursuant to the Exchange Agreement, in a private placement pursuant to Section 4(2) of the Securities Act of 1933. The Company received approximately 19 million shares of Checkers Common Stock in exchange for the Rally's Common Stock and the Rally's Preferred Stock. The Rally's Preferred Stock is convertible into Rally's Common Stock (at a ratio of 100/1, subject to adjustment) upon approval of such conversion by Rally's stockholders. See Note 2 to the accompanying consolidated financial statements for further discussion. The terms of the Rally's Preferred Stock are set forth in Exhibit B to the Exchange Agreement. The parties to the Exchange Agreement include CKE, GIANT, and Fidelity. For a list of the other purchasers, see Exhibit A to the Exchange Agreement, which is filed as Exhibit 10.12 to this Form 10-K. The Company has not declared or paid any dividends on its Common Stock, and does not intend to declare or pay any dividends in the foreseeable future. The Company currently intends to retain any earnings for the future operation and development of its business. Any determination to pay dividends in the future will be at the discretion of the Company's Board of Directors and will be dependent upon the Company's results of operations, financial condition, capital expenditures, working capital requirements, any contractual restrictions and other factors deemed relevant by the Board of Directors. Furthermore, under the terms of the Indenture governing the 9 7/8% Senior Notes due 2000, the Company is not permitted to pay any dividends on the Common Stock unless certain income tests are met. Item 6. Selected Consolidated Financial Data The selected consolidated financial data was derived from the consolidated financial statements and includes Rally's Hamburgers, Inc. and its wholly-owned subsidiaries. This data should be read in conjunction with the consolidated financial statements of the Company and the notes thereto, and the information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere herein. (In thousands, except per share amounts and statistical data)
January 2, January 1, December 31 December 29, December 28, 1994 1995 1995 1996 1997 ------------- ------------- ------------ -------------- -------------- Systemwide sales $ 354,666 $ 370,087 $ 355,719 $ 316,670 $ 290,133 ============ ============= ============ ============== ============ Company restaurant sales $ 165,829 $ 178,476 $ 181,778 $ 156,445 $ 139,350 Other revenues 8,517 7,842 7,081 6,307 5,580 ------------ ----------- ------------ -------------- ------------ Total revenues 174,346 186,318 188,859 162,752 144,930 ------------ ----------- ------------ -------------- ------------ Income (loss) from operations (7,050) (14,636) (36,470) 4,090 3,320 (1)(2)(3) Other expenses (4,433) (9,619) (9,910) (8,057) (7,381) Litigation settlement (2,000) - - - - ------------ ----------- ------------ -------------- ------------ Income (loss) before taxes (13,483) (24,255) (46,380) (3,967) (4,061) Tax provision (benefit) (4,576) (4,982) 539 (675) 455 ------------ ----------- ------------ -------------- ------------ Loss before extraordinary items (8,907) (19,273) (46,919) (3,292) (4,516) Extraordinary items (4) - - - 5,280 - ------------ ----------- ------------ -------------- ------------ Net income (loss) $ (8,907) $ (19,273) $ (46,919) $ 1,988 $ (4,516) ============ ============= ============ ============== ============ Income (loss) per common share: Income (loss) before extraordinary $ (.67) $ (1.42) $ (3.00) $ (.19) $ (.22) item Extraordinary item - - - .31 - ------------ ----------- ------------ -------------- ------------ Net income (loss) per common share $ (.67) $ (1.42) $ (3.00) $ .12 $ (.22) ============ ============= ============ ============== ============ Weighted average shares outstanding 13,207 13,564 15,620 17,007 20,709 Total assets $ 185,397 $ 169,416 $ 137,392 $ 112,258 $ 134,297 Long-term debt and obligations under capital leases 97,784 94,141 97,958 69,564 68,444 Shareholders' equity 62,527 53,487 6,672 19,365 41,513 Restaurants open at end of period Company 252 250 239 209 229 Franchised 268 292 242 258 248 ============ ============= ============ ============== ============ Total 520 542 481 467 477 ============ ============= ============ ============== ============
12 (1) The fiscal year ended January 2, 1994 includes approximately $12.6 million charged against operations for a major business restructuring program and other restaurant closings. (2) The fiscal year ended January 1, 1995 includes approximately $17.3 million charged against operations for changes in business strategies. (3) The fiscal year ended December 31, 1995 includes approximately $17.3 million charged against operations for changes in business strategies and restaurant closings. The year also includes approximately $13.7 million related to the Company's implementation of Statement of Financial Accounting Standards No. 121. See Note 16 to the accompanying consolidated financial statements. (4) The extraordinary item for the fiscal year ended December 29, 1996 was a gain on the early retirement of debt, net of tax expense of $1,350,000. See Note 10 to the accompanying consolidated financial statements. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table provides a comparative view of the Company's operations:
(In thousands) Fiscal Years Ended -------------------------------------------------------- December 31, December 29, December 28, 1995 1996 1997 ---------------- ----------------- ------------- Income (loss) from operations before restaurant closures and other $ (5,425) $ 4,110 $ 3,478 Provision for restaurant closures and other (31,045) (20) (158) ------------- ------------- ------------ Income (loss) from operations (36,470) 4,090 3,320 Total other expense, net (9,910) (8,057) (7,381) ------------- ------------- ------------ Loss before income taxes and extraordinary item (46,380) (3,967) (4,061) (Provision) benefit for income taxes (539) 675 (455) Extraordinary items, net of tax - 5,280 - ------------- ------------- ------------ Net income (loss) $ (46,919) $ 1,988 $ (4,516) ============= ============= ============
During 1997, the Company experienced an increase of 2.4% in the loss before income taxes and extraordinary item. The 1996 extraordinary gain, net of tax, of approximately $5.3 million, or $.31 per share from the Company's early retirement of certain of its outstanding Senior Notes, at amounts below carrying value, resulted in the Company reporting net income for fiscal 1996. The transactions involving the Senior Notes were opportunities created by the Company's conservation of cash during the second half of 1995 and the depressed market price of the Senior Notes during the year. In addition, the transactions resulted in a reduction of net interest expense in 1997 of approximately $2.1 million and $.8 million as compared to 1995 and 1996, respectively. These transactions are more fully described in Note 10 to the accompanying consolidated financial statements. As more fully discussed in Note 13 to the accompanying financial statements, the Company's effective tax rates on its reported pre-tax losses differ significantly from statutory rates, due primarily to concerns as to the ultimate realizability of net operating loss carryforwards. Until circumstances otherwise indicate that realization becomes more likely than not, no additional benefit will be recognized. As evidenced in the table above, the provision for restaurant closures and other was significantly reduced in 1996 and 1997 from the prior year levels. These reductions are primarily attributable to the 1996 and early 1997 strengthening of the store level economics, which have improved the Company's ability to recover, at a minimum, its store level investment and to prior writedowns of underperforming assets, reducing the need at this time for additional writedowns of Company assets. See the section below entitled "Restaurant Closures and Other" for a more detailed discussion. 13 The Company's income from operations before restaurant closures and other in fiscal 1997 declined $0.8 million from the prior year. Improved restaurant costs of sales in fiscal 1997 were offset by continued declining same store sales. The Company continues to refine its turnaround strategy as results show the relative success or the need for reassessment for the various components. The plan contains four key strategies that are designed to create a consistently profitable environment: (i) strengthen the balance sheet and reduce fixed costs, (ii) improve store level profitability, (iii) establish an effective brand positioning and (iv) pursue various growth opportunities. The results of and plans for each strategy are more fully discussed below: Although the Company's debt level is still high, the Company has made substantial progress in improving its balance sheet and reducing fixed costs. Interest cost was reduced by another $1.2 million in 1997 after decreasing $2.1 million in 1996, interest was significantly reduced through the retirement of approximately $22 million face value of the Company's Senior Notes in January 1996 and an additional $4.7 million during the fourth quarter of 1996. In addition, $10.8 million in gross proceeds were generated through the Company's Rights Offering completed in September, 1996. The proceeds from the Offering were used to pay off debt of approximately $4.5 million and the remainder is being used for new store construction, refurbishment of some existing restaurants and for other general corporate purposes. Outstanding warrants from a Rights Offering and from a separate issuance of 1,500,000 additional warrants in December, 1996, (see "Liquidity and Capital Resources") if exercised, would raise an additional $17.4 million in cash proceeds. The Company also made progress in disposing of surplus assets in 1996 and 1997, as assets held for sale declined by approximately $5 million from the end of 1995. On December 18, 1997, the Company acquired approximately 19.1 million shares of Checkers Drive-In Restaurants ("Checkers") pursuant to an exchange agreement in which the Company's common and preferred shares were issued as consideration. This agreement aligns the Company with its counterpart in the double drive-thru segment, and enhances the ability to create synergies that will benefit both Companies. This is evidenced by the Management Services Agreement dated November 30, 1997, pursuant to which Checkers is providing certain management services to the Company. The agreement creates the opportunity for the Company to continue to show key reductions in general and administrative expense. In fiscal 1997, the Company reduced its general and administrative costs by $1.0 million after a $2.2 million reduction in the prior year. The Company has made progress in the second key strategy of its turnaround plan, as store-level profitability has improved since 1995. Although the Company has experienced a 10.9% decline in sales during 1997, the decline in restaurant operating margins was only .5%. Much of the improvement since 1995 has resulted from the Company's cost reduction actions related to food, paper and labor which were implemented in the beginning of the second quarter of 1996 and are further discussed in "Results of Operations." The primary impact of these changes was realized during the third and fourth quarters of 1996 and was reflected in the Company's store profit margins. Improvement in store level profitability also resulted from the elimination of heavy discounting that drove traffic increases but adversely affected the Company's profitability. The Company's third key strategy in its turnaround plan will be the primary focus going into 1998. Although the Company generated net income from operations in 1996 and 1997, same store sales have declined during that period. To combat this negative trend in sales, management believes an effective brand positioning is essential in order to grow same store sales. During 1997, the Company's brand positioning included a "Bigger, Better, Burger" campaign, which included the introduction of two new premium burgers, new and more impactful menu boards, and new advertising. The Company believes that although elements of this program showed promise, the positioning did not differentiate the Company enough to reverse the decline in sales. Therefore, the positioning for 1998 has evolved into a campaign focusing on taste, supported by advertising designed to create a point of difference that the leaders in the fast food hamburger segment will find difficult to duplicate. The final strategy in the Company's turnaround plan is to pursue growth opportunities. In 1997, the Company opened nine stores and franchisees opened 19 stores. In addition to growth in the number of stores, the indoor dining test being conducted in the Louisville market may provide customer count growth in existing stores. The Company believes that a well-managed double drive-thru concept can be profitable, but remaining exclusively in this arena excludes a segment of the population that desires an indoor dining experience. Research has indicated that a segment of the population does not even consider Rally's as a place to eat because of the lack of indoor seating. As of March, 1998, the Company had five dining rooms in test, where the passenger side drive-thru lane had been removed and a 20 to 50 seat dining room was added to the side of the existing unit. Early sales results at these units have been encouraging, however, the Company continues to work to reduce the costs to construct these dining rooms in order to improve the return on this investment. The Company also plans to test other dining room designs that could retain the speed of service expected with two drive-thru lanes. 14 Further discussion of the factors affecting results of operations is included below. Restaurant Closures And Other Certain charges in fiscals 1995, 1996 and 1997 have been aggregated and segregated into the caption "Provision for Restaurant Closures and Other" in the accompanying Statements of Operations. These items represent estimates of the impact of management decisions which have been made at various points in time in response to the Company's sales and profit performance and the then-current revenue building and profit enhancing strategies and are discussed in further detail below. Prior to 1995, the Company's management had initiated efforts to franchise or selectively divest itself of approximately 60 Company-Owned stores in selected markets. This strategy was expected to allow the Company to concentrate on regaining sales, profit and cash flow momentum in its other markets through stronger focus on a smaller number of its most profitable markets. The Company believed that franchisees would be better able to concentrate on the units that had not been top performers and achieve near term improvements in the performance of those units. Prior to 1995, the Company recorded a charge of $8.0 million which represented an estimate of the difference between the estimated net realizable value, given the then most likely divestiture/disposal plan, and the net book value of these restaurants and markets. Early in 1995, six of the 60 units, five of which were in one market, were closed and sublet. During the third quarter, 1995, management concluded that it was unlikely that much of the 1994 plan of disposal described above could be executed. For this reason, the Company decided to close up to 16 of the remaining restaurants, resulting in additional charges in the third quarter of 1995 of approximately $400,000 to reflect additional writedown of the property and equipment to currently estimated net realizable values and approximately $2.3 million to record reserves for expected future occupancy related costs. Eight of these restaurants were closed as of December 31, 1995. Six additional restaurants were closed in 1996. The Company decided in 1996 to continue to operate 2 of these 16 restaurants until such time that the leases have expired or the properties have been sublet. The Company decided to continue to operate the remaining 38 stores previously included in the original 60 restaurants. With the restaurant closures discussed above and without the burden of impending closure associated with the prior plan regarding these markets, management believes that the markets represent acceptable growth opportunities for future development. Management also decided to close nine non-profitable restaurants in certain of its core markets resulting in charges in the third quarter of 1995 of approximately $1.9 million related to the writedown of assets to their net realizable values and $1.9 million to record expected future occupancy related costs. Seven of these restaurants were closed as of December 31, 1995. The Company decided in 1996 to continue to operate two of these restaurants, one of which is being operated by CKE, as part of a management agreement with the Company. During the third quarter of 1995, charges were recorded of approximately $3.3 million to dispose of the assets located on eight sites in the Houston, Texas market which had been operated as Company units and then leased to a former franchisee. The Company decided not to refranchise these units due to failure to identify a suitable franchise candidate which management believed had adequate and evident financial resources to successfully open the Houston market. This charge consisted of a writedown of approximately $2.7 million of the assets to their estimated net realizable values and reserves of approximately $600,000 for expected future occupancy related costs. In 1995, 18 additional modular buildings became unutilized, as expected Company development continued to be reduced and decisions were made regarding other restaurant closures. At December 31, 1995, the Company had available for sale 54 substantially completed modular restaurant buildings, which were not expected to be assigned to future Company development. In order to recognize the impact of the additional unutilized buildings and to more competitively price all of the modular buildings available for sale, the Company recorded charges of approximately $1.6 million in the third quarter of 1995 and $458,000 in the fourth quarter of 1995. The charges of $2.3 million related to third quarter 1995 closure decisions, described above, also included approximately $1.5 million related to an additional writedown on modular buildings which were previously utilized at those locations. During 1996 and 1997, the Company sold 20 buildings and 12 buildings, respectively. During 1996, the Company closed six restaurants and during 1997 redeployed two buildings for corporate development. At December 28, 1997, 26 buildings remain available for sale which are being marketed to franchisees and others. Current expectations of net realizable value are based on the Company's experience related to marketing the buildings. 15 The Company recorded approximately $1.5 million in charges in the third quarter of 1995 related to further writedowns on excess land idled by slowdowns in the Company's expansion plans. Such land had been scheduled to be auctioned during the fourth quarter of 1995. These auctions occurred in the fourth quarter and closed in the first quarter of 1996. The absolute auctions generated lower than anticipated sales prices, and additional losses of $1.1 million were recorded in the fourth quarter of 1995. As further discussed in "Liquidity and Capital Resources," these sales provided cash flow of approximately $2.4 million, primarily in the first quarter of 1996. During the fourth quarter, 1995 the sublessee of five of the six sites closed under the November, 1994 plan, defaulted on the terms of the sublease agreements, resulting in charges of $483,000 related to occupancy and $430,000 to reduce the carrying value of the tangible assets to management's estimate of fair value less cost to sell. Due to concerns about obsolescence and abnormal wear and tear associated with transport and storage of surplus equipment, management recorded an $820,000 writedown in December, 1995 of the equipment's carrying value. Additionally, fourth quarter, 1995 charges totaling approximately $1.1 million were recorded to reflect changes in the estimated net realizable values of the Company's remaining surplus assets and properties. As described above, a substantial portion of the charges in fiscal year 1995 related to asset writedowns. The remainder of the charges related substantially to the establishment of reserves for expected future occupancy-related costs. During 1996, the Company revised its estimate of net realizable value for five of its poor performing restaurants in Montgomery, Alabama based upon an existing agreement to sell the restaurants to a non-affiliated restaurant operator. Such change in estimate resulted in a reduction of approximately $232,000 in related reserves. In addition, during the fourth quarter of 1996, management decided to reopen three units previously closed and to continue to operate a fourth unit that had been designated for closure, resulting in a reduction in the reserves for future occupancy-related costs of approximately $659,000. In addition, approximately $87,000 in other charges for net changes in estimated asset recovery were recorded during 1996. During 1997, the Company closed two restaurants and recorded provisions to terminate leases on existing corporate office facilities and revised certain reserves previously established, resulting in net provisions for restaurant closures and other of $158,000. Such adjustments to the reserves are included in the caption "Provision for restaurant closures and other" on the accompanying Statement of Operations. As of December 28, 1997, approximately $4.6 million remained in the reserve for expected future occupancy-related costs which is net of estimated future sublease recoveries. Assets held for sale of $1.1 million at December 28, 1997 resulting from the actions noted above consist mainly of surplus land, buildings and equipment. The expected disposal dates for these assets are over the next 12 months. The carrying amounts of such assets to be disposed of are shown separately on the accompanying consolidated balance sheets. In addition to the charges described above, 1995 results include approximately $13.7 million of certain charges recorded in the fourth quarter related to the adoption of Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121). This charge represents impairment of the carrying value of the assets of 37 stores based on management's future cash flow estimates given then current base lines and reasonable trend assumptions. Additional impairment reserves of approximately $824,000 were recorded during 1996, primarily related to three underperforming restaurants. No additional restaurants were determined to be impaired in 1997. See Notes 3 and 16 to the accompanying consolidated financial statements. General Rally's revenues are derived primarily from Company-owned restaurant sales and royalty fees from franchisees. The Company also receives revenues from the award of exclusive rights to develop Rally's restaurants in certain geographic areas (area development fees) and the award of licenses to use the Rally's brand and confidential operating system (franchise fees). Systemwide sales consist of aggregate revenues of Company-owned and franchised restaurants (including CKE-operated restaurants). Company revenue also includes payments resulting from an operating agreement with CKE, referred to as Owner fee income in the accompanying consolidated financial statements. Restaurant cost of sales, restaurant operating expenses, depreciation and amortization, and advertising and promotion expenses relate directly to Company-owned restaurants. General and administrative expenses relate to both Company-owned restaurants and franchise operations. Owner expenses relate to CKE-operated restaurants and consist primarily of depreciation and amortization. The table below sets forth the percentage relationship to total revenues, unless otherwise indicated, of certain items included in the Company's consolidated statements of income and operating data for the periods indicated: 16
Fiscal Years Ended ----------------------------------------------------------------------- January 2, January 1, December 31, December 29, December 28, 1994 1995 1995 1996 1997 ------------- ------------- ------------- ------------- ------------- Revenues: Restaurant sales 95.1% 95.8% 96.2% 96.1% 96.2% Franchise revenues and fees 4.9 4.2 3.8 3.6 3.3 Owner fee income - - - .3 .5 ------------- ------------- ------------- ------------- ------------- 100.0% 100.0% 100.0% 100.0% 100.0% ------------- ------------- ------------- ------------- ------------- Costs and expenses: Restaurant cost of sales (1) 35.2% 35.0% 35.7% 34.3% 32.5% Restaurant operating expenses (1) 42.5 43.3 46.0 44.2 42.8 General and administrative expenses 10.5 10.1 10.4 10.7 10.7 Advertising and promotion expenses (1) 7.0 6.1 7.3 5.0 7.1 Depreciation and amortization (1) 6.1 7.9 7.2 6.3 6.5 Owner expense (2) - - - 169.1 153.2 Warrant Expense - - - - .6 Other charges (credits) 7.2 9.3 16.4 - .1 Income (loss) from operations (4.0) (7.9) (19.3) 2.5 2.3 Total other (expense) (3.7) (5.1) (5.3) (5.0) (5.1) ------------- ------------- ------------- ------------- ------------- Net income (loss) before income taxes and extraordinary items (7.7) (13.0) (24.6) (2.5) (2.8) Net income (loss) (5.1)% (10.3)% (24.8)% 1.2% (3.1)% ============= ============= ============= ============= ============= Number of restaurants: Restaurants open at the beginning of 450 520 542 481 467 period ------------- ------------- ------------- ------------- ------------- Company restaurants opened (closed or transferred), net during period 55 (2) (11) (30) 20 Franchised restaurants opened (closed or transferred), net during period 15 24 (50) 16 (10) ------------- ------------- ------------- ------------- ------------- Total restaurants opened (closed or transferred), net during period 70 22 (61) (14) 10 ============= ============= ============= ============= ============= Total restaurants open at end of period 520 542 481 467 477 ============= ============= ============= ============= =============
- -------------------------- (1) As a percentage of restaurant sales. (2) As a percentage of owner fee income. Results of Operations Fiscal Year Ended December 28, 1997 Compared With Fiscal Year Ended December 29, 1996 Systemwide sales declined 8.4% for 1997 to approximately $290.1 million compared with approximately $316.7 million a year ago. This decrease is attributable primarily to same store sales declines of 8.2% systemwide. The decline in same store sales is primarily due to the highly competitive environment during 1997 during which many competitors continued to discount their menu items. Total company revenues decreased 11% to approximately $144.9 million in 1997 compared with approximately $162.8 million in 1996. Company-owned restaurant sales decreased 11% to approximately $139.4 million due to a 9.2% decline in same stores sales and fewer Company units in operation. During the year, the Company opened 9 new restaurants, re-opened three restaurants previously closed, acquired 11 restaurants from franchisees, closed 2 units and transferred 1 restaurant to a franchisee. Franchisees, exclusive of CKE, opened 19 new units, acquired 1 unit from the Company, closed 19 units and transferred ownership of 11 restaurants to the Company. Restaurant cost of sales, as a percentage of sales, decreased to 32.5% for 1997 compared with 34.3% for 1996. This decrease is attributable primarily to various cost reduction actions taken during 1997 and the second half of 1996. Management's efforts to improve food and paper costs by implementing tighter operational controls was supplemented by cost of sales reductions realized by cooperating with CKE Restaurants, Inc. and Checkers to leverage the purchasing power of the three entities to negotiate improved terms for their respective contracts with suppliers. 17 Restaurant operating expenses, the major component of which is labor and related expenses, were 42.8% of sales for 1997 compared with 44.2% for 1996. The improvement is primarily attributable to reductions in management and crew labor that resulted from implemented changes in staffing levels and labor deployment. The reduction in operating expenses was achieved despite the inclusion of several expense categories that are fixed in nature. The closing of poorer performing units and the transfer of operational responsibility for certain higher fixed cost restaurants in Western markets to CKE that occurred on July 1, 1996 enabled the company to show improvement in this category despite the decline in same store sales. General and administrative expenses decreased $1.9 million in 1997 due primarily to reductions in the corporate and field operations staff and lower levels of bad debt expense, partially offset by higher legal fees but remained consistent as a percent of revenues due to the reductions in total revenues. Advertising expenses increased approximately $2.2 million to 7.1% of sales for 1997 compared to 5.0% for 1996. During the first quarter of 1997, the company initiated a new campaign that made greater use of television advertising than in previous years which also contributed to the increased cost. Media expenditures were curtailed during the fourth quarter of 1996 as management worked with the new advertising agency on new creative and brand positioning. Depreciation and amortization decreased to approximately $9.1 million as compared to approximately $9.8 million for the prior year. This decrease is primarily due to a segregation into owner expense of depreciation and amortization associated with the CKE-operated properties as of July 1, 1996 and certain assets becoming fully depreciated during 1997. Owner expense of approximately $1.1 million for 1997 represent the Company's segregated ownership cost related to the 29 units operated by CKE. These expenses consist primarily of depreciation and amortization associated with the properties. Warrant expense was approximately $940,000 in 1997 compared to approximately $20,000 in 1996. The expense is related to warrants that were issued to CKE and Fidelity National Financial, Inc. in a private placement on December 20, 1996. See "Liquidity and Capital Resources" and Note 4 to the accompanying consolidated financial statements, for further discussion. Interest expense decreased 13.8% to approximately $7.4 million for 1997 as compared to approximately $8.6 million for 1996 primarily due to the early extinguishment of debt during the fourth quarter of 1996. See "Liquidity and Capital Resources" and Note 10 to the accompanying consolidated financial statements, for further discussion. Interest income was higher for 1997 as compared to 1996 due to increases in the average daily invested amounts. During the fourth quarter of 1997, the Company recorded equity in the loss of affiliate of $720,000 based upon it's share of the losses of Checkers for December 1997 and the amortization of related goodwill. See "Item 1: Business, Recent Acquisitions" and Note 2 to the accompanying Consolidated Financial Statements. The Company's 1997 tax provision is approximately $455,000 representing estimated state taxes versus a prior year net tax provision of $675,000 (obtained by netting the tax benefit line with the tax expense of approximately $1.4 million which has been netted against the extraordinary gain). Of the prior year net amount, $575,000 related to state taxes expected to be payable and $100,000 related to reduction of an IRS receivable for a NOL carryback to 1987, 1988, and 1989, further described in Note 13 to the accompanying consolidated financial statements. See earlier discussion above concerning the extraordinary gain. Fiscal Year Ended December 29, 1996 Compared with Fiscal Year Ended December 31, 1995 Systemwide sales declined 11% for 1996 to approximately $316.7 million compared with approximately $355.7 million in 1995. This decrease is attributable to the comparatively lower number of units in operation in 1996 and to same store sales declines of 7% systemwide. The decline in same store sales is primarily due to the 18 lower customer counts experienced upon the elimination of deep discounting programs in the third and fourth quarters of 1996 and to the reduced media spending in the fourth quarter of 1996. Total Company revenues decreased 14% to approximately $162.8 million in 1996 compared with approximately $188.9 million in 1995. Company-owned restaurant sales decreased 14% to approximately $156.5 million due to fewer Company units in operation, a 6% decline in same store sales, and a decline of approximately $9 million due to the Company's operating agreement with CKE, as discussed in "Liquidity and Capital Resources." During 1996, the Company opened 6 units, closed 8 units, and transferred operational responsibility to CKE for 28 units. Franchisees, exclusive of CKE, opened 15 units and closed 26 units. Five of the Company closures which were in the Montgomery DMA were sold in September, 1996. Restaurant cost of sales, as a percentage of sales, decreased to 34.3% for 1996 compared with 35.7% for 1995. This decrease is attributable primarily to various cost reduction actions taken during the second half of 1996, partially offset by higher food and paper costs as a percentage of sales in the first six months of 1996. These cost reduction actions include selective changes in some product and packaging specifications as well as renegotiation of purchase terms and selection of alternative vendors. The increase in cost of sales in the first half of 1996 resulted primarily from a carryover of deep discounting programs in the first quarter of 1996 and to a shift in product mix sold, reflecting the impact of a larger percent of Big Buford(TM) sandwich sales in the first two quarters of 1996 compared to the same period of 1995. While this product carries a significantly higher dollar profit per unit, it does carry a higher food cost percentage than did the products formerly comprising its share of the total product mix. The Company from time to time negotiates purchase contracts for certain items used in its restaurants in the normal course of business. Although some of these contracts contain minimum purchase quantities, such quantities do not exceed expected usage over the term of such agreements. Restaurant operating expenses were 45.5% of sales for 1996 compared with 46.4% for 1995. The reduction is primarily due to management's cost reduction actions in the labor area and better fixed cost coverage in stores operating during the second half of the year, partially offset by increased bonus costs associated with store management compensation. This better fixed cost coverage is the result of closing poorer performing units and of transferring operational responsibility for certain higher fixed cost restaurants in Western markets to CKE. The identified and implemented changes in staffing levels and labor deployment in certain stores have yielded savings in management and crew labor. Advertising expenses decreased approximately $5.4 million to 5.0% of sales for 1996 compared to 7.3% for 1995 due primarily to decreases in levels of radio advertising, outdoor advertising, and television advertising. During the fourth quarter, management decided to limit media spending until work with the new advertising agency on new creative and brand positioning was completed. Company-wide spending on the new advertising campaign did not begin until late February 1997. General and administrative expenses decreased in 1996, on both a dollar and a percentage of sales basis. This decrease is caused primarily by reductions in the corporate and field operations staffs, and by lower levels of bad debt and other dead project charges, partially offset by higher legal fees. Depreciation and amortization decreased to approximately $9.8 million in 1996 as compared to approximately $13.0 million for the prior year. This decrease is primarily due to asset writedowns associated with the adoption of SFAS 121 at the beginning of the fourth quarter 1995, to a decrease in the number of properties being operated by the Company, and to a segregation into Owner expense of depreciation and amortization associated with the CKE-operated properties. Owner expense of approximately $744,000 for 1996 represent the Company's segregated ownership cost related to the 28 units operated by CKE. These expenses consist primarily of depreciation and amortization associated with the properties. Interest expense decreased 19.3% to approximately $8.6 million for 1996 as compared to approximately $10.7 million for 1995 primarily due to the early extinguishment of debt, as previously discussed. See "Liquidity and Capital Resources" and Note 10 to the accompanying consolidated financial statements, for further discussion. Interest income was higher for 1996 as compared to 1995 due to increases in the average daily invested amounts. 19 The Company's decrease in Other is due primarily to the current year storage costs related to excess modular buildings. The Company's net tax provision is approximately $675,000 (obtained by netting the tax benefit line with the tax expense of approximately $1,350,000 which has been netted against the extraordinary gain). Of the net amount, $575,000 is related to state taxes expected to be payable and $100,000 related to reduction of an IRS receivable for a NOL carryback to 1987, 1988, and 1989, further described in Note 13 to the accompanying consolidated financial statements. See earlier discussion above concerning the extraordinary gain. Liquidity and Capital Resources The Company's cash flow from operating activity was approximately $8.3 million for 1997 compared with approximately $543,000 for 1996 and approximately $8.5 million for 1995. The notable increase in 1997 from 1996 resulted primarily from changes in working capital, specifically the increased balances in accounts payable and accrued liabilities compared to a significant decreases in 1996. The decreased balances in accounts payable in 1996 was due to decreased food and paper costs as a percentage of sales and to decreased overall sales volumes. The decreased overall sales volumes are attributable to the factors discussed above in the year to year comparisons. Capital expenditures of approximately $6.8 million for 1997 were funded primarily through sales of surplus properties and existing cash balances. Approximately $4.8 million of these expenditures were for the construction or conversion of new stores in 1997. Additionally, in 1997, $510,000 was spent to add dining rooms to three test units and $158,000 had been spent adding dining rooms to two other units, completion of which occurred during 1998. Remaining capital expenditures in 1997 of $1.4 million were primarily for the purchase and installation of certain replacement equipment and menuboards as well as the purchase of the land. In July 1997, the Company acquired 10 units located in Arkansas from a franchisee for approximately $2.8 million, including $2.2 million in cash. In addition, the Company assumed five ground lease obligations, five ground and building lease obligations and entered into three additional ground leases. The cash disbursed in payment of the purchase price was reduced by certain amounts owed by the seller to the Company. The Company plans to use available cash flow to open additional indoor dining facilities in 1998. The number of units to be opened will be dependent on, among other factors, analysis of the five test units, permitting issues, cost engineering issues and available cash flow. In January 1996, the Company repurchased, in two transactions, approximately $22 million face value of its 9 7/8% Senior Notes due in the year 2000. The Notes were purchased from GIANT GROUP, LTD. ("GIANT") at a price of $678.75 per $1,000 principal amount, representing the market closing price on the last business day prior to the repurchase date. The first transaction involved the repurchase of approximately $16 million face value of the Notes for approximately $11.1 million in cash. The second transaction involved the purchase of approximately $6 million face value of the Notes in exchange for a short-term note of approximately $4.1 million due in three installments of principal and interest, bearing interest at prime. The Company paid the final installment together with accrued interest on this note on September 27, 1996. Prior to the Senior Notes repurchases, the Company's Board of Directors had received an independent opinion from an investment banking firm as to the fairness of the transactions. Additionally, in four separate transactions during the fourth quarter 1996, the Company repurchased approximately $4.7 million face value of the Senior Notes from various other bondholders for approximately $4.5 million in cash. As a result of these debt repurchases, the annualized ongoing interest payments on the Senior Notes have been reduced by approximately $2.6 million per year to approximately $5.8 million. Principal payments of debt and capital leases totaled approximately $1.5 million during 1997. The Company is required to make a mandatory sinking fund payment on June 15, 1999 calculated to retire 33 1/3% in aggregate principal amount of the Senior Notes issued with the balance maturing on June 15, 2000. The repurchase discussed above reduces such sinking fund requirement to approximately $1.6 million from approximately $28.3 million. 20 The Company is actively marketing the assets included in the caption "Assets held for sale" in the accompanying consolidated balance sheet and expects realization in cash over the next 12 months, although actual timing of such cash flows cannot be predicted. The Company expects cash generated from these assets to decline as the amount of assets held for sale decreased from $2.0 million in 1996 to $1.1 million in 1997. The assets contained in this caption are recorded at management's current estimate of fair market value less costs to sell. There can be no assurances that these values will be realized. On July 1, 1996, the Company entered into a ten-year operating agreement with Carl Karcher Enterprises, Inc., a subsidiary of CKE Restaurants, Inc. (collectively referred to as "CKE"). Pursuant to the agreement, 29 (2 of which have been converted to a Carl's Jr. format) Rally's-owned restaurants located in California and Arizona are being operated by CKE. The Company retains ownership in the restaurants and receives from CKE a percentage of gross revenues referred to in the financial statements as Owner fee income. This income is offset by the Company's segregated ownership costs related to these units, referred to as Owner expenses in the financial statements and consists primarily of noncash expenses of depreciation and amortization. The agreement has improved cash flow, generating cash flow of approximately $790,000 in 1997 and $340,000 in the last six months of 1996. The Company completed its Shareholder Rights Offering on September 20, 1996. The Offering raised over $10.8 million in gross proceeds, offset by legal and other issuance costs of approximately $437,000. In addition to the approximate $10.8 million of gross proceeds provided by the Offering, the Warrants, if exercised, would provide approximately $10.8 million for the Company's future growth. The proceeds from the Offering have been used in 1997 to retire debt of approximately $4.5 million and the remainder has been used primarily in 1997 for new store construction, refurbishment of some existing restaurants and for other general corporate purposes. On October 21, 1996, the Company was notified by the indenture trustee that the noteholder consent it had been soliciting had been approved by the required majority of the holders of record of its 9 7/8% Senior Notes due 2000. The consent will allow two of the Company's current stockholders, CKE and Fidelity National Financial, Inc. and/or their affiliates, to acquire 35% or more of the outstanding shares of the Company's common stock without triggering "Change in control" provisions requiring the Company to offer to purchase the Senior Notes at 101% of their face value. This gives the Company greater flexibility to raise capital in the future, and it gives two of its largest stockholders the ability to increase their investment in the Company. On December 20, 1996, the Company issued warrants (the "Warrants") to purchase an aggregate of 1,500,000 restricted shares of its Common Stock to CKE and Fidelity National Financial, Inc. The Warrants have a three-year term and became exercisable on December 20, 1997. The exercise price is $4.375 per share, the closing price of the Common Stock on December 20, 1996. The underlying shares of Common Stock have not been registered with the Securities and Exchange Commission and, therefore, are not freely tradable. If exercised, the Warrants would provide approximately $6.6 million in additional capital to the Company. See Note 4 to the accompanying consolidated financial statements for further discussion. Management has plans in place to improve profitability and cash flows from operations. Additionally, management believes that, given the improvements in operating results, the Company will realize the positive cash flows from the exercise of Warrants discussed in Note 4. The Company believes existing cash balances and cash flow from operations should be sufficient to fund its current operations and obligations. The ability of the Company to satisfy its obligations under the Senior Notes, however, continues to be dependent upon, among other factors, the Company successfully increasing revenues and profits. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Not applicable. 21
Item 8. Financial Statements and Supplementary Data RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except shares and per share amounts) December 29, December 28, 1996 1997 ------------- -------------- ASSETS Current assets: Cash and cash equivalents $ 2,285 $ 4,008 Restricted cash 1,649 1,380 Investments 1,958 446 Royalties receivable, net of a reserve for doubtful accounts of $1,405 and $231, 437 394 respectively Accounts and other receivables (including $565 and $1,078, respectively, from related parties), net of a reserve for doubtful accounts of $301 and $200, respectively 1,698 1,555 Inventory, at lower of cost or market 794 1,052 Prepaid expenses and other current assets 999 1,057 Assets held for sale 596 1,076 ------------- -------------- Total current assets 10,416 10,968 Assets held for sale 1,426 - Property and equipment, net 69,806 68,067 Investment in affiliate - 24,988 Notes receivable, (including $127 and $86, respectively, from related parties), net of a reserve for doubtful accounts of $853 and $231, respectively 773 872 Goodwill, less accumulated amortization of $2,243 and $2,811, respectively 10,482 9,913 Reacquired franchise and territory rights, less accumulated amortization of $1,984 and 11,439 12,758 $2,991, respectively Other intangibles, less accumulated amortization of $2,459 and $2,894, respectively 4,769 4,334 Other assets, less accumulated amortization of $1,101 and $1,400, respectively 3,147 2,397 ------------- -------------- Total assets $ 112,258 $ 134,297 ============= ============== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,884 $ 7,076 Accrued liabilities 13,600 13,507 Current maturities of long-term debt and obligations under capital leases 1,484 1,194 ------------- -------------- Total current liabilities 19,968 21,777 Senior notes, net of discount of $429 and $321, respectively 57,897 58,005 Long-term debt, less current maturities 4,775 4,017 Obligations under capital leases, less current maturities 5,408 5,228 Other liabilities 4,845 3,757 ------------- -------------- Total liabilities 92,893 92,784 ------------- -------------- Commitments and contingencies (Note 12) Shareholders' equity: Preferred stock, $.10 par value, 5,000,000 shares authorized, -0- and 45,667 shares issued, respectively - 5 Common stock, $.10 par value, 50,000,000 shares authorized, 20,788,000 and 24,836,900 shares issued, respectively 2,079 2,484 Additional paid-in capital 71,023 97,277 Less: Treasury stock, 273,445 shares, at cost (2,108) (2,108) Retained deficit (51,629) (56,145) ------------- -------------- Total shareholders' equity 19,365 41,513 ============= ============== Total liabilities and shareholders' equity $ 112,258 $ 134,297 ============= ==============
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. 22
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Fiscal Years Ended ---------------------------------------------------- December 31, December 29, December 28, 1995 1996 1997 ---------------- ---------------- ---------------- REVENUES: Restaurant sales $ 181,778 $ 156,445 $ 139,350 Franchise revenues and fees 7,081 5,867 4,838 Owner fee income - 440 742 ---------------- ---------------- ---------------- Total revenues 188,859 162,752 144,930 ---------------- ---------------- ---------------- COSTS AND EXPENSES: Restaurant costs of sales 64,813 53,712 45,241 Restaurant operating expenses, exclusive of depreciation and amortization and advertising and promotion expenses 83,671 69,164 59,629 General and administrative expenses 19,606 17,397 15,451 Advertising and promotion expenses 13,188 7,767 9,948 Depreciation and amortization 13,006 9,838 9,106 Owner expense - 744 1,137 Warrant expense - 20 940 Provision for restaurant closures and other 31,045 20 158 ---------------- ---------------- ---------------- Total costs and expenses 225,329 158,662 141,610 ---------------- ---------------- ---------------- Income (loss) from operations (36,470) 4,090 3,320 ---------------- ---------------- ---------------- OTHER INCOME (EXPENSE): Interest expense (10,682) (8,622) (7,431) Interest income 538 614 749 Equity in loss of affiliate - - (720) Other 234 (49) 21 ---------------- ---------------- ---------------- Total other (expense) (9,910) (8,057) (7,381) ---------------- ---------------- ---------------- Loss before income taxes and extraordinary items (46,380) (3,967) (4,061) PROVISION (BENEFIT) FOR INCOME TAXES 539 (675) 455 ---------------- ---------------- ---------------- Loss before extraordinary items (46,919) (3,292) (4,516) EXTRAORDINARY ITEM (net of tax expense of $1,350) - 5,280 - ---------------- ---------------- ---------------- Net income (loss) $ (46,919) $ 1,988 $ (4,516) ================ ================ ================ Earnings (loss) per common share: Loss before extraordinary item $ (3.00) $ (.19) $ (.22) Extraordinary item - .31 - ---------------- ---------------- ---------------- Basic earnings (loss) per common share $ (3.00) $ .12 $ (.22) Diluted earnings (loss) per common share $ (3.00) $ .12 $ (.22) ================ ================ ================ Weighted average shares outstanding 15,620 17,007 20,709 ================ ================ ================
The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. 23 RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)
Common Stock Preferred Stock ---------------------------- ---------------------------- Shares Shares Shares Shares Authorized Issued Amount Authorized Issued Amount ---------- ------ ------ ---------- ------- ------ Balances at January 1, 1995 25,000 15,837 $ 1,584 - - $ - Amendment to the Charter (A) 25,000 - - - - - Issuance of common stock - 90 9 - - - Treasury stock acquired - - - - - - Net loss - - - - - - ------ ------ ------- ----- ------ ------ Balances at December 31, 1995 50,000 15,927 1,593 - - - Issuance of common stock - 35 3 - - - Authorization of preferred stock (B) - - - 5,000 - - Shareholders Rights Offering - 4,826 483 - - - Compensatory stock options and warrants - - - - - - Net income - - - - - - ------ ------ ------- ----- ------ ------ Balances at December 29, 1996 50,000 20,788 2,079 5,000 - - Issuance of common stock - 140 14 - - - Compensatory stock options and warrants - - - - - - Issuance of common stock and preferred to acquire investment in affiliate - 3,909 391 - 46 5 Net loss - - - - - - ------ ------ ------- ----- ------ ------ Balances at December 28, 1997 50,000 24,837 $ 2,484 5,000 46 $ 5 ====== ====== ======= ===== ====== ======
Treasury Stock and Contingent Shares ------------------ Additional Retained Paid-In Earnings Total Shares Amount Capital (Deficit) Equity ------ -------- --------- --------- --------- Balances at January 1, 1995 (239) $ 2,009) $ 60,610 $ (6,698) $ 53,487 Amendment to the Charter (A) - - - - - Issuance of common stock - - 194 - 203 Treasury stock acquired (34) (99) - - (99) Net loss - - - (46,919) (46,919) ------ -------- --------- --------- -------- Balances at December 31, 1995 (273) (2,098) 60,804 (53,617) 6,672 Issuance of common stock - - 74 - 77 Authorization of preferred stock (B) - - - - - Shareholders Rights Offering - - 9,975 - 10,458 Compensatory stock options and warrants - - 170 - 170 Net income - - - 1,988 1,988 ------ -------- --------- --------- -------- Balances at December 29, 1996 (273) (2,108) 71,023 (51,629) 19,365 Issuance of common stock - - 264 - 278 Compensatory stock options and warrants - - 957 - 957 Issuance of common stock and preferred to acquire investment in affiliate - - 25,033 - 25,429 Net loss - - - (4,516) (4,516) ------ -------- --------- --------- -------- Balances at December 28, 1997 (273) $(2,108) $ 97,277 $(56,145) $ 41,513 ====== ======== ========= ========= ========
- ---------------------- (A) On May 13, 1995, stockholders of the Company approved a proposal to amend the Certificate of Incorporation to increase the number of authorized shares of Common Stock from 25,000,000 shares to 50,000,000. (B) On July 10, 1996, stockholders of the Company ratified the authorization of 5,000,000 shares of Preferred Stock at a par value of $.10. The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements. 24
RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (In thousands) Fiscal Years Ended ----------------------------------------------- December 31, December 29, December 28, 1995 1996 1997 --------------- -------------- -------------- CASH FLOWS PROVIDED FROM OPERATING ACTIVITIES: Net income (loss) $ (46,919) $ 1,988 $ (4,516) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 13,006 10,482 10,106 Extraordinary items, before tax expense of $1,350 - (6,630) - Provision for restaurant closures and other 31,045 20 158 Provision for losses on receivables 1,507 968 (392) Other 2,276 1,245 101 Loss on sale of property and equipment - - 1,025 Warrant expense - 20 940 Equity in loss of affiliate - - 720 Changes in assets and liabilities net of effects from business combinations: (Increase) decrease in assets: Receivables 775 (306) (331) Inventory (63) 262 (196) Prepaid expenses and other current assets 185 161 (376) Other assets 292 (121) 221 Increase (decrease) in liabilities: Accounts payable and accrued liabilities 7,815 (6,011) 2,083 Deferred income taxes - - (107) Other liabilities (1,424) (1,535) (1,178) --------------- -------------- -------------- Net cash provided by operating activities 8,495 543 8,258 --------------- -------------- -------------- CASH FLOWS PROVIDED FROM (USED IN) INVESTING ACTIVITIES: (Increase) decrease in investments (848) 2,975 1,512 Notes receivable 154 312 256 Pre-opening costs (45) (156) (237) Capital expenditures (3,405) (2,306) (6,845) Proceeds from the sale of property and equipment 4,266 4,392 1,872 (Increase) decrease in intangible assets (111) (39) - Acquisition of businesses, net of cash acquired (1,931) - (2,172) Proceeds from the sale of a business 2,730 - - --------------- -------------- -------------- Net cash used in investing activities 810 5,178 (5,614) --------------- -------------- -------------- CASH FLOWS PROVIDED FROM (USED IN) FINANCING ACTIVITIES: (Increase) in restricted cash (683) (966) 269 Payment of organization and development costs (3) - - Principal payments of debt (2,114) (1,696) (1,075) Senior Notes retirement - (19,612) - Issuance of common stock, net of costs of issuance 203 10,535 298 Principal payments on capital lease obligations (604) (508) (413) --------------- -------------- -------------- Net cash provided from (used in) financing activities (3,201) (12,247) (921) --------------- -------------- -------------- Net increase (decrease) in cash 6,104 (6,526) 1,723 CASH AND CASH EQUIVALENTS, beginning of period 2,707 8,811 2,285 ---------------- -------------- -------------- CASH AND CASH EQUIVALENTS, end of period $ 8,811 $ 2,285 $ 4,008 =============== ============== ============== The accompanying notes to consolidated financial statements are an integral part of these consolidated financial statements.
25 RALLY'S HAMBURGERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (tabular dollars in thousands, except per share amounts) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a) Financial Statement Presentation and Organization The accompanying consolidated financial statements include Rally's Hamburgers, Inc. and its wholly-owned subsidiaries, each of which is described below. Rally's Hamburgers, Inc. and its subsidiaries are collectively referred to herein as the context requires as "Rally's" or the "Company". The investment in affiliate, which is owned more than 20% and less than 50% represents an investment in Checkers Drive-In Restaurants, Inc. and is recorded on the equity method (see Note 2). All significant intercompany accounts and transactions have been eliminated. Rally's is one of the largest chains of double drive-thru restaurants in the United States. At December 28, 1997, the Rally's system included 477 restaurants in 18 states, primarily in the Midwest and the Sunbelt, comprised of 229 Company-owned and operated, 221 franchised and 27 Company-owned restaurants in Western markets which are operated as Rally's restaurants by CKE Restaurants, Inc. ("CKE"), a significant shareholder of the Company, under an operating agreement which began July, 1996. Two additional Company-owned stores covered by the operating agreement have been converted to the Carl's Jr. format and are not included in the above store count. The Company's restaurants offer high quality fast food. The Company serves the drive-thru and take-out segments of the quick-service restaurant industry. The Company opened its first restaurant in January 1985 and began offering franchises in November 1986. Rally's Hamburgers, Inc., Rally's of Ohio, Inc., Self Service Drive Thru, Inc. and Hampton Roads Foods, Inc. own and operate Rally's restaurants in various states. Additionally, Rally's Hamburgers, Inc. operates as franchisor of the Rally's brand. Rally's Management, Inc. provides overall corporate management of the Company's businesses. Rally's Finance, Inc. was organized for the purpose of making loans to Rally's franchisees to finance the acquisition of restaurant equipment and modular buildings. RAR, Inc. was organized for the purpose of acquiring and operating a corporate airplane and is currently inactive. The Company's wholly-owned subsidiary, ZDT Corporation, was formed to own the Zipps brand and franchise system. MAC 1 was organized for the purpose of acquiring a manufacturer of modular buildings. The manufacturing business was sold in January 1995. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, when actual transactions anticipated are consummated. Certain of the most significant estimates include useful lives assigned to depreciable/amortizable assets, fair value less costs to sell of long-lived assets held for sale, fair value of long-lived assets held for use, future net occupancy costs related to closed/disposable properties, accruals for the Company's self-insured and high deductible insurance programs, and disclosures regarding commitments and contingencies. b) Revenue Recognition The Company recognizes franchise fees as income on the date a restaurant is opened, at which time the Company has performed its obligations relating to such fees. Area development fees are generated from the awarding of exclusive rights to develop, own and operate Rally's restaurants in certain geographic areas pursuant to an Area Development Agreement. Such fees are recognized as income on a pro rata basis as the restaurants are opened or upon the cancellation or expiration of an Area Development Agreement. Both franchise fees and area development fees are non-refundable. The Company also receives royalty fees from franchisees in the amount of 4% of each franchised restaurant's gross revenues, as defined in the Franchise Agreement. Royalty fees are recognized as earned. 26 c) Property and Equipment Property and equipment are depreciated using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. The estimated useful lives for financial reporting purposes are the shorter of 20 years or the lease life plus available renewal options for buildings and property held under capital leases, eight years for furniture and equipment, five years for software and computer systems and the life of the lease for leasehold improvements. Expenditures for major renewals and betterments are capitalized while expenditures for maintenance and repairs are expensed as incurred. d) Inventory Inventory is valued at latest invoice cost which approximates the lower of first-in, first-out cost or market. e) Supplemental Disclosures of Cash Flow Information
Fiscal Years Ended ------------------------------------------------- December 31, December 29, December 28, 1995 1996 1997 --------------- ----------------- --------------- Interest paid $ 10,679 $ 8,639 $ 7,013 Income taxes paid 212 983 545 Capital lease obligations incurred 1,616 111 386
On December 18, 1997 the Company acquired approximately 26.3% of the outstanding common stock of Checkers Drive-In Restaurants, Inc. in exchange for common and preferred stock of the Company (see Note 2). On February 13, 1995, the Company acquired all of the shares of common stock of Hampton Roads Foods, Inc. (a Louisiana corporation) and certain of the assets of HRF, Inc. (a Virginia corporation), collectively referred to as "HRF." On July 9, 1997, the Company acquired from Arkansas Investment Group, Inc., substantially all the operating assets employed in the franchisee Rally's restaurants. The purchases were recorded as follows:
Fiscal Year Fiscal Year Ended Ended ----------------- ----------------- December 31, December 28, 1995 1997 ----------------- ----------------- Fair value of assets acquired $ 9,133 $ 2,800 Cash paid (2,125) (2,200) ================= ================= Liabilities assumed, receivables forgiven $ 7,008 $ 600 ================= =================
On January 30, 1995, the Company sold all of the shares of common stock of Beaman Corporation, its wholly-owned modular building subsidiary, for approximately $3.1 million, of which approximately $2.7 million was received in cash. As a result of the sale of Beaman, the Company recorded the net present value of a non-interest bearing note of approximately $347,000. The Company recorded in 1996 approximately $547,000 in notes receivable primarily as the result of the sale of five of its restaurants in Montgomery, Alabama. These non-cash transactions have been excluded from the consolidated statements of cash flows. During fiscal 1995, 1996, and 1997, the Company accepted notes due within two to five years, bearing interest at rates previously specified in the underlying franchise agreements, for certain receivables from franchisees in the aggregate amount of approximately $542,000 for 1995, approximately $340,000 for 1996 and approximately $493,000 for 1997. 27 For purposes of the consolidated statement of cash flows, the Company considers all highly liquid debt instruments with an original maturity of three months or less at the date of purchase to be cash equivalents. Cash equivalents at December 29, 1996 and December 28, 1997 were approximately $976,000 and $2.3 million, respectively. f) Earnings (Loss) Per Common Share Basic earnings (loss) per common share is calculated based upon the Company's reported income and the weighted average common shares outstanding of 15,620; 17,007 and 20,709 for fiscal years 1995, 1996 and 1997, respectively. The income and average shares outstanding for purposes of the computation of diluted earnings per share are the same as for the computation of basic earnings per share. Potentially dilutive convertible preferred stock (see Note 2), common stock warrants (see Notes 4 and 17) and common stock options (see Notes 4 and 14) have no effect as they are anti-dilutive for all periods presented. g) Stock Options As discussed in Note 14, the Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation". h) Impairment of Long-Lived Assets As discussed in Note 16, during the fourth quarter of 1995, the Company early adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of" (SFAS 121). i) Income Taxes The Company accounts for income taxes under the asset or liability method whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. j) Disclosures about Fair Values of Financial Instruments The balance sheets as of December 29, 1996 and December 28, 1997, reflect the fair value amounts which have been determined, using available market information and appropriate valuation methodologies. However, considerable judgement is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Cash and cash equivalents, receivables - Due to the short maturity of these items, the carrying amounts are a reasonable estimate of their fair value. 28 Investments and Senior Notes - The fair values of investments and Senior Notes are based upon quoted market prices. Long-term debt - The fair value of long-term debt approximates the carrying value due to all significant amounts bearing interest at rates which are variable or approximate a rate estimated to be available currently. The following summarizes the carrying values and fair values of financial instruments:
December 29, 1996 December 28, 1997 ----------------- ----------------- Carrying Value Fair Value Carrying Value Fair Value --------------------------------------------------------------------- Cash and Cash Equivalents $ 3,934 $ 3,934 $ 5,388 $ 5,388 Investments 1,958 1,958 446 446 Senior Notes 57,897 54,500 58,005 55,200 Long-term debt 5,874 5,874 4,798 4,798
k) Goodwill, Reacquired Franchise Rights, Other Intangibles and Other Assets Goodwill, reacquired franchise and territory rights, other intangibles and other assets are being amortized using the straight-line method over the following periods: Amortization Period ------------------ Goodwill 5, 20-25 years Reacquired franchise and territory 5-20 years rights Other intangibles 3-25 years Other assets 3-25 years Subsequent to the intangibles' acquisition, the Company evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of goodwill and other intangibles may warrant revision or that the remaining balance of goodwill and other intangibles may not be recoverable. When factors indicate that goodwill or other intangibles should be evaluated for possible impairment, the Company utilizes the procedures as set forth in SFAS No. 121 and discussed in Note 16, Impairment of Long-Lived Assets. l) Owner Fee Income and Expense Revenue received as a result of the operating agreement with CKE is referred to as Owner fee income in the accompanying consolidated financial statements. Expenses related to the ongoing investment in the CKE-operated restaurants consist primarily of depreciation and amortization and are referred to as Owner expenses in the accompanying consolidated financial statements. m) Advertising Costs It is the Company's policy to expense advertising costs as incurred in accordance with Statement of Position 93-7. The amounts expensed for fiscal years ended December 31, 1995, December 29, 1996 and December 28, 1997 were approximately $13,188,000, $7,767,000 and $9,948,000, respectively, as reflected on the Consolidated Statements of Operation. n) Reclassifications Certain items have been reclassified in the accompanying consolidated financial statements for prior periods in order to be comparable with the classification adopted for the fiscal year ended December 28, 1997. Such reclassifications had no effect on previously reported net income. 29 2. ACQUISITIONS On July 9, 1997, the Company acquired from Arkansas Investment Group, Inc. ("AIGI") (an Arkansas corporation) substantially all the operating assets employed in the operation of AIGI's franchised Rally's restaurants for approximately $2.8 million. The cash disbursed in payment of the purchase price was reduced by certain amounts owed by AIGI to the Company. Actual cash disbursed was approximately $2.2 million. In addition, the Company assumed five of AIGI's ground lease obligations and five of its ground and building lease obligations, and entered into three additional ground leases. AIGI owned and operated a total of ten Rally's restaurants in the Little Rock, Arkansas market. The acquisition of the AIGI operating assets was accounted for as a purchase. The Company believes that the $2.8 million represents the fair value of the acquired assets. The impact on operations of this acquisition was not significant for any of the periods presented, and therefore, proforma amounts are not presented giving effect to this acquisition. On December 18, 1997, the Company acquired approximately 19.1 million shares (the "Checkers Shares") of the common stock, $0.001 par value per share (the "Checkers Common Stock"), of Checkers Drive-In Restaurants, Inc., a Delaware corporation ("Checkers"), pursuant to that certain Exchange Agreement, dated as of December 8, 1997 (the "Exchange Agreement"), between Rally's, CKE Restaurants, Inc, ("CKE"), Fidelity National Financial, Inc. ("Fidelity"), GIANT GROUP, LTD. ("GIANT") and the other parties named in the Exchange Agreement. CKE, Fidelity and GIANT beneficially owned 5,278,015 shares, 2,759,788 shares and 3,136,849 shares, respectively, of Rally's Common Stock prior to the consummation of the Exchange Agreement, approximately 23.9%, 12.7% and 15.2% of the then outstanding shares of Rally's Common Stock. In addition, Terry Christensen, William Foley, II, David Gotterer, Andrew Puzder, Burt Sugarman and C. Thomas Thompson, who are Directors of Rally's, are parties to the Exchange Agreement. Mary Hart Sugarman, AJ Sugarman and Al Sugarman, who also participated in the exchange, are related to Burt Sugarman. In consideration of the acquisition of the Checkers Shares, Rally's issued 3,909,336 shares of its common stock, $.10 par value per share (the "Rally's Common Stock"), and 45,667 shares of its Series A Participating Preferred Stock, $.10 par value per share (the "Rally's Preferred Stock"). A dividend of $43.50 per share will accrue on the Rally's Preferred Stock unless converted to Rally's Common Stock prior to July 31, 1998. The parties to the Exchange Agreement, who own a majority of Rally's Common Stock, have agreed to vote in favor of conversion. The Rally's Preferred Stock will be converted into 4,566,700 shares of Rally's Common Stock upon approval of such conversion by Rally's stockholders. The exchange ratio used to determine the number of shares of Rally's Common Stock (including the shares to be issued upon conversion of the Rally's Preferred Stock) to be issued pursuant to the Exchange Agreement was based upon the average closing price of the Checkers Common Stock and the Rally's Common Stock for the five trading days preceding the public announcement of the proposed exchange on September 19, 1997. This stock acquisition was accounted for as a long term asset under "Investment in Affiliate" using the equity method of accounting with an initial investment value of $25.4 million, based upon the market value of the Rally's Common Shares issued and issuable upon conversion of the Rally's Preferred Stock issued. This investment represented 26.3% interest in Checkers. The allocation of the purchase price of this investment has not yet been finalized. For purposes of computing Rally's 1997 equity in the loss of Checkers, the $12.5 million excess of the investment over the pro-rata portion of Checkers' book value acquired has been treated as an intangible asset with a 20 year life. The 1997 equity in the loss of affiliate of $720,000 includes $52,000 of intangible amortization. 3. RESTAURANT CLOSURES AND OTHER Certain charges in fiscal years 1995, 1996 and 1997 have been aggregated and segregated into the caption "Provision for Restaurant Closures and Other" in the accompanying Statements of Operations. These items represent estimates of the impact of management decisions, which have been made at various points in time in response to the Company's sales and profit performance and the then-current revenue building and profit enhancing strategies. 30 In summary and chronologically, the decisions that had been reached in 1994 were to abandon additional real estate development projects and certain investment in infrastructure (approximately $5.3 million) and to abandon additional projects and franchise or otherwise dispose of up to 60 Company restaurants (approximately $12.0 million). During 1995, the Company concluded that much of its 1994 plan of disposal would not be executable. As a result, the Company decided to (i) close up to 16 of the original 60 restaurants included in the 1994 disposal plan, (ii) close nine poor performing restaurants in its core markets, (iii) write-off estimated exposure resulting from the default of a subleasee/franchisee in a former Company market, (iv) record additional writedowns of modular building value, (v) record writedowns to sales price less cost to sell of all properties auctioned in fourth quarter of 1995 (vi) record asset writedowns and occupancy exposure related to the default of a tenant for five of the units closed under the 1994 plan and (vii) record other changes in estimates related to the Company's surplus properties. The charges for the above 1995 items totaled approximately $17.3 million. Also reflected in this caption for fiscal 1995 is an approximate $13.7 million charge related to the Company's adoption of Statement of Financial Accounting Standards No. 121 ("SFAS 121) further discussed in Note 16. Included in this caption for fiscal 1996 are charges of approximately $911,000 related to the write-down and sale of assets offset by approximately $891,000 resulting from a reduction in surplus property reserves related to Management's decision to re-open three units previously closed and to continue to operate a fourth unit that had been designated for closure. During 1997, the Company recorded provisions of $33,000 and $199,000 to write-off leasehold improvements and future rental costs associated with the Louisville corporate office and regional offices. Additionally in 1997, the Company recorded gains on held for sale properties of $74,000. The following summarizes the components of the provision for restaurant closures and other as well as the year end balances of certain related reserves.
December December December 31, 1995 29, 1996 28, 1997 -------- -------- -------- Provisions - - ---------- Abandoned projects & expected store closings Fixed asset writedowns $ 5,484 $ 87 $ 33 Future occupancy costs 5,283 - 199 Modular building writedowns 2,058 - - Excess land writedowns 2,600 - - Surplus equipment writedowns 1,920 - - Reduction in loss estimate on previously reserved locations - (891) (74) SFAS 121 impairment writedowns (see Note 16) 13,700 824 - ------------ ------------ ------------ PROVISION FOR RESTAURANT CLOSURES AND OTHER 31,045 20 158 ============ ============ ============ Reserves - - -------- Closed store reserve - current (see Note 8) 2,767 1,964 1,493 Closed store reserve - long term (see Note 9) 6,908 3,881 3,065 ============ ============ ============ TOTAL CLOSED STORE RESERVES 9,675 5,845 4,558 ============ ============ ============
31 4. RELATED PARTY TRANSACTIONS a) Issuance of Warrants On December 20, 1996, the Company issued warrants (the "Warrants") to purchase an aggregate of 1,500,000 restricted shares of its Common Stock to CKE and Fidelity National Financial, Inc. The Warrants were granted as an incentive to CKE and Fidelity to continue to participate in the identification and exploitation of synergistic opportunities with the Company. The Warrants have a three-year term and became exercisable on December 20, 1997. The exercise price is $4.375 per share, the closing price of the Common Stock on December 20, 1996. The underlying shares of Common Stock have not been registered with the Securities and Exchange Commission and, therefore, are not freely tradable. If exercised, the Warrants would provide approximately $6.6 million in additional capital to the Company. The Company obtained a valuation analysis from an investment banking firm of national standing. Such analysis estimated the value of the Warrants to be approximately $960,000. Approximately $20,000 and $940,000 was expensed in 1996 and 1997, respectively. b) West Coast Operating Agreement On July 1, 1996, the Company entered into a ten-year Operating Agreement with Carl Karcher Enterprises, Inc., a subsidiary of CKE Restaurants, Inc. (collectively referred to as "CKE"). CKE is the operator of the Carl's Jr. restaurant chain. Pursuant to the agreement, 29 Rally's owned restaurants located in California and Arizona are being operated by CKE, two of which are converted to a Carl's Jrs. format. Such agreement is cancelable after an initial five-year period, at the discretion of CKE. A portion of these restaurants, at the discretion of CKE, will be converted to the Carl's Jr. format. To date, two restaurants have been converted. The agreement was approved by a majority of the independent Directors of the Company. Prior to the agreement, the Company's independent Directors had received an opinion as to the fairness of the agreement, from a financial point of view, from an investment banking firm of national standing. Under the terms of the Operating Agreement, CKE is responsible for any conversion costs associated with transforming restaurants to the Carl's Jr. format, as well as the operating expenses of all the restaurants. Rally's retains ownership of all 29 (two of which are Carl's Jrs.) restaurants and is entitled to receive a percentage of gross revenues generated by each restaurant. In the event of a sale by Rally's of any of the 29 restaurants, Rally's and CKE would share in the proceeds based upon the relative value of their respective capital investments in such restaurant. c) Option Grants to Non-employees During 1996, the Company granted 150,000 options to certain individuals not employed by the Company for services provided. Approximately $84,000 has been expensed for these grants in General and Administrative Expenses in the accompanying 1996 Statement of Operations. Such options were granted at the market values on the dates of grant, were immediately exercisable and expire in five years. d) Other Transactions The Company has had transactions with certain companies or individuals which are related parties by virtue of having stockholders in common, by being officers/directors or because they are controlled by significant stockholders or officers/directors of the Company. Such transactions which impacted the Company's consolidated financial statements are summarized below. Information with respect to related party rent is disclosed in Note 12. The Company and its franchisees each pay 1/2% of sales to the Rally's National Advertising Fund (the "Fund"), established for the purpose of creating and producing advertising for the chain. The Fund is not included in the consolidated financial statements, although the Company's contributions to the Fund are included in the Advertising and Promotion Expenses in the Company's consolidated Statements of Operations. 32 Effective November 30, 1997, the Company entered into a Management Services Agreement, pursuant to which certain of the management of Checkers Drive-In Restaurants, Inc. ("Checkers") is providing key services to Rally's, including executive management, financial planning and accounting, franchise administration, purchasing and human resources. In addition, Rally's and Checkers share certain of their executive officers, including Chief Executive Officer and the Chief Operating Officer. The total cost of these services was $95,000 in 1997. See Note 2. Acquisitions for other related party transactions "the Exchange Agreement". Summary of Related Party Transactions -------------------------------------
December 29, December 28, 1996 1997 --------------------------------- Balance Sheet Amounts --------------------- Accounts receivable $ 565 $ 1,078 Notes receivable 127 86 Investment in affiliate - 24,988 Accounts payable 95 520 Accrued liabilities 60 65
Fiscal Years Ended --------------------------------------------------- December 31, December 29, December 28, 1995 1996 1997 --------------- ---------------- ----------------- Revenue and Transaction Amounts ------------------------------- Repurchase of Senior Notes (gross gain) $ - $ 6,339 $ - Royalty fees 2,407 - - Owner fee income - 440 742 Rental income 262 - - Interest income 16 49 52 ============= ============== ============== $ 2,685 $ 6,828 $ 794 ============= ============== ==============
Expense Amounts --------------- Legal $ 777 $ 1,024 $ 1,017 Rent Expense 292 470 396 Owner expense - 744 1,137 Interest expense - 180 - Compensatory stock options and Warrants - 170 940 Management Services Agreement - - 95 =============== ============== ================ $ 1,069 $ 2,588 $ 3,585 =============== ============== ================
5. RESTRICTED CASH Restricted cash consists of amounts held in various Certificates of Deposit as collateral for Letters of Credit and daily Automated Clearing House ("ACH") transactions. 6. INVESTMENTS All of the Company's investment securities are deemed as "available-for-sale" under SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, investments are reported at fair value with unrealized holding gains and losses, excluding those losses considered to be other than temporary, reported as a net amount in a separate component of shareholders' equity. Provisions for declines in market value are made for losses considered to be other than temporary. Realized gains or losses from the sale of investments are based on the specific identification method. 33 No unrealized gains or losses were recorded for any period presented, due to the quoted market prices of the Company's investments approximating the cost. Investments consist of:
December 29, December 28, 1996 1997 ----------------- ----------------- US Government and Agencies $ 500 $ - Mortgage - backed Securities 1,458 446 ================= ================= $ 1,958 $ 446 ================= =================
The contractual maturity of the mortgage-backed securities as of December 28, 1997 was: $43 within five years, $403 over 10 years. The proceeds from the sale of investments and related gross gains and losses for the twelve months ended December 31, 1995, December 29, 1996 and December 28, 1997 were as follows:
Fiscal Years Ended --------------------------------------------------------- December 31, December 29, December 28, 1995 1996 1997 ----------------- ---------------- ---------------- Proceeds from the sale of investments $ 15,653 $ 10,531 $ 3,674 Gross gains realized 56 - 6 Gross losses realized - (4) -
7. NET PROPERTY AND EQUIPMENT Property and equipment consists of the following:
December 29, December 28, 1996 1997 ---------------- ---------------- Land $ 14,074 $ 14,145 Buildings and leasehold improvements 47,463 52,196 Equipment, furniture and fixtures 41,312 40,582 ---------------- ---------------- 102,849 106,923 Less accumulated depreciation (37,518) (42,872) ---------------- ---------------- 65,331 64,051 ---------------- ---------------- Property held under capital lease 6,145 6,145 Less accumulated amortization (1,670) (2,129) ---------------- ---------------- 4,475 4,016 ================ ================ Net property and equipment $ 69,806 $ 68,067 ================ ================
8. ACCRUED LIABILITIES Accrued liabilities (current) consist of the following:
December 29, December 28, 1996 1997 --------------- -------------- Payroll and payroll taxes $ 2,245 $ 1,944 Closed store reserve 1,964 1,493 Workers compensation 2,367 2,272 Bonuses and severance 979 712 Step leases 975 984 Accrued income taxes 935 828 Sales taxes 783 1,013 Legal fees and settlements 380 1,478 Other 2,972 2,783 =============== ============== $ 13,600 $ 13,507 =============== ==============
34 9. OTHER LIABILITIES Other liabilities (non-current) consist of the following: December 29, December 28, 1996 1997 --------------- ---------------- Closed store reserve $ 3,881 $ 3,065 Unfavorable lease loss 748 590 Other 216 102 =============== ================ $ 4,845 $ 3,757 =============== ================ 10. SENIOR NOTES On March 9, 1993, the Company sold approximately $85 million of 9 7/8% Senior, Notes due 2000 (the "Notes"). The Company is required to make a mandatory sinking fund payment on June 15, 1999 to retire 33 1/3% in aggregate principal amount of the Notes issued. The Notes are carried net of the related discount, which is being amortized over the life of the Notes. Interest is payable June 15 and December 15. The Notes include certain restrictive covenants, which, among other restrictions, limit the Company's ability to obtain additional borrowings and to pay dividends as well as impose certain change of control provisions, as defined. On January 29, 1996, the Company repurchased, in two transactions, at a price of approximately $678.75 per $1,000 principal amount, approximately $22 million face value of its 9 7/8% Senior Notes due in the year 2000 from GIANT GROUP, LTD. ("GIANT"). The price paid in each transaction represented the market closing price on January 26, 1996. The first transaction involved the repurchase of approximately $16 million face value of the Notes for approximately $11.1 million in cash. The second transaction involved the purchase of approximately $6 million face value of Notes in exchange for a short-term note of approximately $4.1 million, due in three installments of principal and interest, issued by Rally's. The Company paid the final installment on this note, together with accrued interest thereon, on September 27, 1996. The purchases were approved by a majority of the independent Directors of the Company. Prior to the purchases, the Company's independent Directors had received an opinion as to the fairness of the transactions, from a financial point of view, from an investment banking firm of national standing. Additionally, in four separate transactions during the fourth quarter 1996, the Company repurchased approximately $4.7 million face value of the Notes from various other bondholders for approximately $4.5 million in cash. These purchases resulted in extraordinary gains in 1996 net of tax, totaling approximately $5.3 million or $.31 per share. As a result of these debt repurchases, the annualized ongoing interest payments on the Senior Notes have been reduced by approximately $2.6 million per year to approximately $5.8 million. In addition, these repurchases have reduced the sinking fund requirement discussed above to approximately $1.6 million from approximately $28 million. The remaining outstanding Notes are publicly traded and at December 28, 1997 had a market value of approximately $55.2 million based on the quoted market price for such notes. On September 5, 1996 by Consent Solicitation Statement, the Company solicited consent of its bondholders whereby the beneficial ownership of 35% or more of the voting stock of the Company by GIANT, Fidelity National Financial, Inc., CKE and/or any of their affiliates would not constitute a change of control for purposes of Section 4.14 of the Indenture. On October 21, 1996, the bondholder consent was approved by a majority of the holders of record as of the date of the Consent Solicitation. 35 11. LONG-TERM DEBT Long-term debt consists of the following:
December December 29, 1996 28, 1997 ------------ ----------- Notes payable to banks, maturing at various dates through November 10, 2001, secured by property and/or equipment, bearing interest ranging from 1/2% above prime to 9.25%. The notes are payable in monthly principal and interest installments ranging from $1,531 to 13,333. Interest is payable $ 1,006 $ 530 monthly. Note payable to finance company due September 1998, secured by certain equipment, bearing interest at a rate of 7.3%. The note is payable in monthly principal and interest installments of $6,762. 133 59 Note payable to Company for acquisition of certain markets, secured by certain property and equipment, bearing interest of 8.3%. The note is payable in monthly principal and interest installments of $11,494. 79 0 Secured notes payable to a bank used to finance equipment and/or modular buildings for franchisees (the Franchisee Loans), maturing at various dates through July 15, 2000, bearing interest at prime plus1/2%. The notes are payable in monthly principal installments of $4,875. Interest is payable monthly. 195 136 Notes payable to former owners for acquisition of market, secured by common stock of Hampton Roads Foods, maturing March 13, 2001, with outstanding balances due after last monthly payments, bearing interest of 9.0%. The notes are payable in monthly principal and interest installments ranging from $4,742 to $50,211. 4,461 4,073 ------------ ------------ 5,874 4,798 Less - Current portion (1,099) (781) -- -- ============ ============ $ 4,775 $ 4,017 ============ ============
At December 28, 1997, the prime rate was 8.50%. The following are the remaining annual maturities of long-term debt: Year ------------------- 1998 $ 781 1999 727 2000 578 2001 2,712 ============ $ 4,798 ============ The Company is subject to certain restrictive covenants under its debt agreements. The market value of the Company's long-term debt approximated book value at December 28, 1997. Debt related to the acquisition of Hampton Roads Foods was entered into in 1995 and bears interest at rates which approximate current rates for debt with similar terms. The majority of the remaining long-term debt has contractual rates which vary based on fluctuations in market rates. 12. COMMITMENTS AND CONTINGENCIES (a) Lease Commitments The Company leases certain land and buildings generally under agreements with terms of or renewable to 15 to 20 years. Some of the leases contain contingent rental provisions based on percentages of gross sales. The leases generally obligate the Company for the cost of property taxes, insurance and maintenance. 36 Following is a schedule by year of future minimum lease commitments under all leases at December 28, 1997:
Capital Operating Year Leases Leases --------------------------------------------- ----------- ----------- 1998 $ 1,035 $ 8,466 1999 997 7,733 2000 931 6,826 2001 897 6,489 2002 889 5,620 Thereafter 5,650 22,165 ----------- ------------ Total minimum lease commitments 10,399 $ 57,299 =========== ============ Less amounts representing interest, discounted at rates ranging from 10% to (4,758) 12% ----------- Present value of minimum lease payments 5,641 Current portion of capital lease obligations (413) ----------- Long-term lease obligations $ 5,228 ===========
The discount rates applicable to the Company's capital leases approximate currently available market rates. Minimum operating lease payments have not been reduced by minimum sublease rentals of $5.6 million due in the future under noncancellable subleases. Rent expense consists of:
Fiscal Years Ended -------------------------------------------- December 31, December 29, December 1995 1996 28, 1997 -------------- -------------- ---------- Minimum rentals - related parties $ 292 $ 470 $ 396 Minimum rentals - others 6,641 4,681 4,322 Contingent rentals - others 173 122 98 ============== ============== ========== $ 7,106 $ 5,273 $ 4,816 ============== ============== ==========
(b) Litigation In January and February 1994, two putative class action lawsuits were filed, purportedly on behalf of the stockholders of Rally's, in the United States District Court for the Western District of Kentucky, against Rally's, Burt Sugarman and GIANT and certain of Rally's present and former officers and directors and its auditors. The complaints allege defendants violated the Securities Exchange Act of 1934, among other claims, by issuing inaccurate public statements about the Company in order to arbitrarily inflate the price of its common stock. The plaintiffs seek unspecified damages. On April 15, 1994, Rally's filed a motion to dismiss and a motion to strike. On April 5, 1995, the Court struck certain provisions of the complaint but otherwise denied Rally's motion to dismiss. In addition, the Court denied plaintiffs' motion for class certification; the plaintiffs renewed this motion, and despite opposition by the defendants, the Court granted such motion for class certification on April 16, 1996, certifying a class from July 20, 1992 to September 29, 1993. In October 1995, the plaintiffs filed a motion to disqualify Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP ("Christensen, Miller") as counsel for defendants based on a purported conflict of interest allegedly arising from the representation of multiple defendants as well as Ms. Glaser's position as both a former director of Rally's and a partner in Christensen, Miller. Defendants filed an opposition to the motion, and the motion to disqualify Christensen, Miller was denied. Fact discovery is set to close in April 1998. No trial date has been scheduled yet. Management is unable to predict the outcome of this matter at the present time or whether or not certain available insurance coverages will apply. The defendants deny all wrongdoing and intend to defend themselves vigorously in this matter. Discovery is proceeding. Because these matters are in a preliminary stage, the Company is unable to determine whether a resolution adverse to the Company will have a material effect on its results of operations or financial condition. Accordingly, no provisions for any liabilities that may result upon adjudication have been made in the accompanying financial statements. An estimate of defense costs reimbursable under the Company's directors' and officers' insurance is included in "Other Assets" in the accompanying consolidated financial statements. In February 1996, Harbor Finance Partners ("Harbor") commenced a derivative action, purportedly on behalf of Rally's against GIANT and certain of Rally's officers and directors before the Delaware Chancery 37 Court. Harbor named Rally's as a nominal defendant. Harbor claims that the directors and officers of both Rally's and GIANT, along with GIANT, breached their fiduciary duties to the public shareholders of Rally's by causing Rally's to repurchase from GIANT certain Rally's Senior Notes at an inflated price. Harbor seeks "millions of dollars in damages", along with rescission of the repurchase transaction. In the fall of 1996, all defendants moved to dismiss the action. The Chancery Court conducted a hearing on November 26, 1996and denied the motions to dismiss on April 3, 1997. The Company denies all wrongdoing and intends to vigorously defend the action. It is not possible to predict the outcome of this action at this time. In December 1994, Rally's entered into two franchise agreements with Kader Investments, Inc. ("Kader") for the development and operation of Rally's Hamburgers restaurants in Anaheim, California and Tustin, California. Rally's assisted the franchisee in developing and opening the restaurants. On November 27, 1996, Kader filed a six-count Complaint against Rally's in the California Superior Court for Orange County (Case No. 772257) alleging material misrepresentation, respondent superior, breach of contract, breach of the implied covenant of good faith and fair dealing, fraud and unfair competition. These claims arise out of allegations concerning Rally's offer and sale of two franchises (under a two-store development agreement), and Rally's actions during the term of the agreements. The Complaint seeks as relief rescission of the parties' franchise and development agreements; general damages of at least $1,494,277 and $1,400,000 for the material misrepresentation and fraud counts, respectively; general damages in unspecified amounts as to the other counts; punitive damages in unspecified amounts; and attorneys' fees. Rally's filed an Answer, and intends to file a Cross-Complaint alleging breach of contract. In settlement of the litigation, on December 18, 1997, the parties entered into a memorandum of understanding pursuant to which the Company would purchase Kader's restaurants for $1.65 million. The purchase price will consist of $855,000 in cash, $375,000 in restricted stock and $420,000 in notes, and the transaction is currently scheduled to close on or about April 7, 1998, subject to completion of all necessary documentation and final dismissal. Accordingly, a provision of $754,000 for these liabilities, net of assets to be received upon adjudication, have been made in the accompanying financial statements. The Company is involved in other litigation matters incidental to its business. With respect to such other suits, management does not believe the litigation in which it is involved will have a material effect upon its results of operation or financial condition. (c) Other Commitments The Company is contingently liable on certain franchisee lease commitments totaling approximately $294,000. The Company from time to time negotiates purchase contracts for certain items used in its restaurants in the normal course of business. Although some of these contracts contain minimum purchase quantities, such quantities do not exceed expected usage over the term of such agreements. 13. INCOME TAXES The asset and liability method contemplated by Statement of Financial Accounting Standards No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of substantially all temporary differences between the tax bases and financial reporting bases of assets and liabilities (excluding goodwill). 38 The major components of the Company's computation of deferred tax assets and liabilities at December 29, 1996 and December 28, 1997 are as follows:
December 29, December 1996 28, 1997 -------------- ------------ Excess of tax depreciation over book depreciation $ 8,430 $ 9,316 Acquired intangibles with no tax basis 2,070 2,070 Other 30 17 -------------- ------------ Gross deferred tax liabilities $ 10,530 $ 11,403 ============== ============ Net operating loss carryforwards $ 12,824 $ 17,488 Amounts accrued for financial reporting purposes not yet deductible 12,885 10,742 for tax purposes Alternative minimum tax and targeted jobs tax credit carryforwards 937 937 Other 1,514 1,230 -------------- ------------ Gross deferred tax assets 28,160 30,397 Less valuation allowance 17,630 18,994 -------------- ------------ Net deferred tax asset $ 10,530 $ 11,403 ============== ============
The alternative minimum tax credit carryforward has no expiration. The net operating loss carryforwards will expire approximately $641,000 in 2008, approximately $20.2 million in 2009, approximately $17.5 million in 2010, approximately $1.6 million in 2011 and approximately $10.5 million in 2012. The targeted jobs tax carryforward expires approximately $118,000 in 2006, approximately $184,000 in 2007 and approximately $200,000 in 2008. A valuation allowance of approximately $19.0 million has been established due to the uncertainty of realizing the benefit associated with the net operating loss carryforwards generated in the current and previous years. In addition, pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, the utilization of the Company's net operating loss carryforwards to offset future taxable income may be limited if the Company experiences a change in ownership of more than 50 percentage points within a three-year period. The Company is in the process of determining whether it has experienced one or more ownership changes pursuant to Section 382. If the transactions in 1997 or earlier caused an ownership change(s), the Company may be significantly limited in utilizing its tax net operating loss carryforwards arising before such ownership change(s) to offset future federal taxable income. Similarly, the Company may be limited in utilizing its tax credit carryforwards arising before such ownership change(s) to offset future federal taxable income. Income tax expense, including the tax provision on the extraordinary item in 1996, consists of the following:
Fiscal Years Ended ---------------------------------------- December December December 31, 1995 29, 1996 28, 1997 ------------ ------------ ------------ Current $ 539 $ 675 $ 455 Deferred - - ============ ============ ============ Total tax (benefit) expense $ 539 $ 675 $ 455 ============ ============ ============
Income tax expense for the year ended December 28, 1997 consist of $455,000 in state income tax expense. A reconciliation of the provisions for income taxes with the federal statutory rate is as follows:
Fiscal Years Ended ----------------------------------------- December December 29, December 31, 1995 1996 28, 1997 ------------- -------------- ------------ Provision (benefit) computed at $ (15,770) $ 905 $ (1,330) statutory rate Tax effect of equity in loss of - - 245 affiliate State and local income taxes, net of federal income tax benefit 736 575 455 Change in deferred tax asset valuation allowance 15,352 (1,169) 1,364 Other 221 364 (279) ============= ============= ============= $ 539 $ 675 $ 455 ============= ============= =============
39 14. STOCK-BASED COMPENSATION PLANS The Company currently has three stock option plans in effect, the 1990 Stock Option Plan (the "Employees' Plan"), the 1990 Stock Option Plan for Non-Employee Directors (the "1990 Directors' Plan"), and the 1995 Stock Option Plan for Non-Employee Directors (the "1995 Directors' Plan"). Additionally, the Company has an employee stock purchase plan (the "1993 Purchase Plan"). Although there are existing options outstanding under the 1990 Directors' Plan, no additional grants will be made pursuant to this plan. The Company accounts for these plans under APB Opinion No. 25, under which approximately $66,000 of compensation cost has been recognized in fiscal 1996 related to 157,000 options granted to directors under the 1995 Directors Plan. Such compensation represents the difference between the market values on the dates of grant and the measurement date, July 10, 1996, the date when the grants were ultimately approved by the shareholders at the annual meeting. No compensation cost was recognized in any other period presented. During 1996, a total of 350,000 additional options were granted to five of the current directors. These options were not granted pursuant to an option plan. The options were granted at a price equal to the stock's market price on the date of grant. The options were immediately exercisable and expire after five years. Had compensation cost for all option grants to employees and directors been determined consistent with FASB Statement No. 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
1995 1996 1997 ---- ---- ---- Net Income (Loss): As Reported $ (46,919) $ 1,988 $ (4,516) Pro Forma (47,154) (699) (5,577) Earnings (Loss) Per Common Share: As Reported $ (3.00) $ .12 $ (.22) Pro Forma (3.02) (.04) (.27)
Because the Statement 123 method of accounting has not been applied to options granted prior to January 2, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Additionally, the pro forma amounts include approximately $16,000, $12,000 and $17,000 in 1995, 1996 and 1997, respectively, related to the purchase discount offered under the 1993 Purchase Plan. The Company may sell up to 500,000 shares of stock to its employees under the 1993 Purchase Plan. The Company has sold approximately 51,000 shares, 28,000 shares and 33,000 shares in 1995, 1996, and 1997, respectively, and has sold approximately 161,000 shares through December 28, 1997 since the inception of this plan in 1993. The Company sells shares at 85% of the stock's market price at date of purchase. The weighted average fair value of shares sold in 1995, 1996 and 1997 was approximately $2.06, $3.04 and $3.06, respectively. Options to purchase an aggregate of 5.5 million shares of the Company's Common Stock may be granted under the stock option plans, at a price not less than the market value on the date of grant. The Company has granted options on approximately 2.5 million shares under the stock option plans. Outstanding options under the Employees' Plan generally expire ten years after grant. Certain options granted to a former President and Chief Executive Officer of the company expire five years from the date of grant. Options outstanding under the two directors' plans expire five years after grant. Options are exercisable over various periods ranging from immediate to three years after grant depending upon their grant dates and the plan under which the options were granted. 40 A summary of the status of all options granted to employees and directors, as well as those options granted to non-employees (see Note 4), at December 31, 1995, December 29, 1996 and December 28, 1997, and changes during the years then ended is presented in the table and narrative below:
December 31, 1995 December 29, 1996 December 28, 1997 ------------------------- ------------------------ -------------------------- Wtd. Avg. Wtd. Avg. Wtd. Avg Shares Ex Price Shares Ex. Price Shares Ex. Price --------- ------------ --------- ---------- ---------- ------------ Outstanding at beginning of year 2,225 $4.74 2,219 $4.24 3,664 $2.98 Granted at price equal to market 676 2.88 2,154 2.63 863 3.00 Granted at price greater than -- -- 176 1.75 -- -- market Exercised -- -- (9) 3.05 (78) 2.48 Forfeited (412) 3.93 (207) 3.34 (429) 2.75 Expired (270) 5.38 (669) 5.62 (161) 3.63 --------- --------- ---------- Outstanding at end of year 2,219 4.24 3,664 2.92 3,859 2.99 ========= ========= ========== Exercisable at end of year 1,048 $5.09 2,359 $3.21 2,921 $3.07 Weighted average of fair value of options granted $1.76 $1.31 $1.78
The Company had approximately 2,225,000 options outstanding as of January 1, 1995, with prices ranging form $2.67 to $9.333. At January 1, 1995, approximately 756,000 options were exercisable at prices ranging from $2.67 to $6.50. The following table summarizes information about stock options outstanding at December 28, 1997:
Options Outstanding Options Exercisable ------------------------------------------------------------------------ -------------------------------- Wtd. Avg. Range of Outstanding Remaining Wtd. Avg. Exercisable Wtd. Avg. Exercise Prices as of Contractual Exercise as of Exercise Dec. 28, 1997 Life Price Dec. 28, 1997 Price ---------------- ---------------- --------------- ------------- --------------- ------------- $1.25 to 2.50 874,279 6.7 years $1.93 420,422 $1.94 2.50 to 3.75 1,997,330 4.3 2.90 1,813,137 2.91 3.75 to 5.00 987,350 5.7 4.12 687,350 4.17 ------------ ----------- $1.25 to 5.00 3,858,959 5.2 2.99 2,920,909 3.07 ============ ===========
For purposes of the pro forma disclosures assuming the use of the fair value method of accounting, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in fiscal 1995, 1996 and 1997, respectively: expected volatility of 45.0 percent, 45.7 percent, and 47.0 percent; risk-free interest rates of 6.75 percent, 6.82 percent and 6.26 percent for options granted to employees and 6.54 percent, 6.59 percent and 6.47 percent for options granted to directors; and expected lives for fiscal 1995, 1996 and 1997 of eight years for options granted to employees and five years for options granted to directors. An expected dividend yield of 0 percent was used for all periods based on the Company's history of no dividend payments. 41 15. UNAUDITED QUARTERLY FINANCIAL DATA
First Second Third Fourth Quarter Quarter Quarter Quarter Total ----------- ----------- ----------- ----------- ----------- Year Ended December 29, 1996 Revenues $ 41,912 $ 47,357 $ 38,781 $ 34,702 $ 162,752 Income (loss) from operations (3,369) 2,413 2,632 2,414 4,090 Net income 838 111 414 625 1,988 Earnings (loss) per common share: Earnings (loss) before (.24) .01 .01 .01 (.19) extraordinary item Extraordinary item .29 - .02 .02 .31 ----------- ----------- ----------- ----------- ----------- Earnings per common share $ .05 $ .01 $ .03 $ .03 $ .12 =========== =========== =========== =========== =========== Year Ended December 28, 1997 Revenues $ 32,595 $ 38,090 $ 38,522 $ 35,723 $ 144,930 Income from operations 1,015 1,806 543 (44) 3,320 Net income (loss) (952) 92 (1,148) (2,508) (4,516) ----------- ----------- ----------- ----------- ----------- Loss per common share $ (.05) $ - $ (.06) $ (.11) $ (.22) =========== =========== =========== =========== ===========
16. IMPAIRMENT OF LONG-LIVED ASSETS The Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed of " (SFAS 121), at the beginning of the fourth quarter, 1995. This Statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. SFAS 121 requires that impairment for long-lived assets and identifiable intangibles to be held and used, if any, be based on the fair value of the asset. Long-lived assets and certain identifiable intangibles to be disposed of are to be reported at the lower of carrying amount or fair value less cost to sell. For purposes of applying this statement, the Company determines fair value utilizing the present value of expected future cash flows using a discount rate commensurate with the risks involved. Long-lived assets considered for impairment under SFAS 121 are required to be grouped at the "lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups." The Company believes the most correct application of this standard is obtained by examining individual restaurants where circumstances indicate that an impairment issue may exist. This belief is primarily based on the fact that it is at individual restaurant level that most investment and closure decisions are made on an ongoing basis. In addition, if an asset being tested for recoverability was acquired in a business combination accounted for using the purchase method, the goodwill that arose in that transaction is included as part of the asset being evaluated and in determining the amount of any impairment. Prior to the issuance of SFAS 121, the Company recorded impairment of long-lived assets deemed to be permanently impaired. Generally, such assessment of permanent impairment arose concurrent with a management decision to dispose of such an asset at which time the asset was written down to estimated net realizable value. In general, other long-lived assets were reviewed for impairment only if there were dramatic changes in operating results or cash flows of a segregable group of outlets, indicating a likelihood that a permanent impairment has occurred. The Company's past practices of estimating net realizable value for assets to be disposed of are consistent with the Statement's requirements to write down such assets to fair market value less costs to sell and no adjustment regarding such assets was necessary upon adoption of the Statement. The expected disposal dates for these assets are over the next 12 months and consist mainly of surplus land, buildings and equipment. The carrying amounts of such assets to be disposed of are shown separately on the accompanying balance sheets. The majority of assets held for sale resulted from constriction of the Company's development plan and other associated store closings further discussed in Note 3. The Company's fourth quarter, 1995 review relating to assets to be held and used indicated that 37 of its 238 operating restaurants met the Company's criteria for impairment review. All of the indicated restaurants were deemed to be impaired based on current estimates of their underlying cash flows and a provision for 42 impairment was recorded in the fourth quarter, 1995 of approximately $13.7 million related to writedowns of the assets associated with these restaurants. Approximately $825,000 of associated intangible assets was included in this writedown. The writedown is included in the caption "Provision for restaurant closures and other." The writedown of these assets resulted in reduced depreciation and amortization expense in the fourth quarter, 1995 of approximately $351,000. The magnitude of the writedown noted above resulted primarily from two factors: (1) the review of assets to be held and used at individual restaurant level, a lower level than used in the past and (2) the recent historical and continuing poor operating performance of the restaurants themselves (including the restaurant's 1995 full year performance). During 1996, three additional restaurants, due to their continued poor operating performance, were determined to be impaired, resulting in charges of approximately $824,000 included in the caption, "Provision for restaurant closures and other". No additional restaurants were determined to be impaired in 1997. As required by the SFAS 121, the Company will continue to periodically review its assets for impairment where circumstances indicate that such impairment may exist. 17. SHAREHOLDER RIGHTS OFFERING A Shareholder Rights Offering (the "Offering") was completed on September 20, 1996. The Company distributed to holders of record of its Common Stock, as of the close of business on July 31, 1996 (the "Record Date"), transferable subscription rights ("Right(s)") to purchase Units consisting of one share of Common Stock and one Warrant to purchase an additional share of Common Stock. Stockholders received one Right for each share of Common Stock held on the Record Date. For each 3.25 Rights held, a holder had the right to purchase one Unit for $2.25 each. The Offering consisted of 4,825,805 Units. Each Warrant may be exercised to acquire an additional share of Common Stock at an exercise price of $2.25 per share and expires on September 26, 2000. The Company may redeem the Warrants, at $.01 per Warrant, upon 30 days' prior written notice in the event the closing price of the Common Stock equals or exceeds $6.00 per share for 20 out of 30 consecutive trading days ending not more than 30 days preceding the date of the notice of redemption. The Offering was fully subscribed and raised over approximately $10.8 million in gross proceeds, offset by legal and other issuance costs of approximately $437,000. The net proceeds from the Offering were attributable primarily to the sale of the Company's common stock. The amount attributable to the warrants is included in "Additional paid-in capital." In addition to the approximately $10.8 million provided by the Rights Offering, the Warrants issued, if exercised, could provide an additional $10.8 million in proceeds. The Company had 15,683,869 shares of Common Stock outstanding on the Record Date. Immediately after the Offering, 20,509,674 shares of Common Stock and 4,825,805 Warrants were outstanding. As of December 28, 1997, 4,813,757 of these Warrants were outstanding. The Warrants are publicly traded and at December 28, 1997 had a market value of approximately $6.3 million based on the quoted market price for such warrants. 18. SUBSEQUENT EVENTS On January 8, 1998, the Company announced it intends to acquire in open market purchases, from time to time, up to 1,000,000 shares of Common Stock of Checkers Drive-In Restaurants, Inc. As of January 22, 1998, 30,000 shares had been purchased at a price of $1.07 per share. 43 Report of Independent Public Accountants ---------------------------------------- To Rally's Hamburgers, Inc.: We have audited the accompanying consolidated balance sheets of Rally's Hamburgers, Inc. (a Delaware corporation) and subsidiaries as of December 29, 1996 and December 28, 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three fiscal years in the period ended December 28, 1997. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We did not audit the financial statements of Checkers Drive-In Restaurants, Inc. (Checkers), the investment in which is reflected in the accompanying financial statements using the equity method of accounting. The investment in Checkers represents 19 percent of the Company's total assets as of December 28, 1997, and the equity in its net loss represents 16 percent of the Company's net loss. The statements of Checkers were audited by other auditors whose report has been furnished to us and our opinion, insofar as it relates to the amounts included for Checkers, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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, based on our audit and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Rally's Hamburgers, Inc. and subsidiaries as of December 29, 1996 and December 28, 1997, and the results of their operations and their cash flows for each of the three fiscal years in the period ended December 28, 1997, in conformity with generally accepted accounting principles. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ ARTHUR ANDERSEN LLP Louisville, Kentucky February 27, 1998 44 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None. PART III -------- Items 10, 11, 12 and 13. Directors and Executive Officers of the Registrant; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management; and Certain Relationships and Related Transactions. The information required by these items is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Report which includes the required information. The required information contained in the Company's proxy statement is incorporated herein by reference. PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Page Number in This Form 10-K ------------------ (a)(1) Index to Consolidated Financial Statements: Report of Independent Public Accountants 44 Consolidated Balance Sheets as of December 29, 1996 and December 28, 1997 22 Consolidated Statements of Operations for each of the three years in the period ended December 28, 1997 23 Consolidated Statements of Shareholders' Equity for each of the three years in the period December 28, 1997 24 Consolidated Statements of Cash Flow for each of the three years in the period ended December 28, 1997 25 Notes to Consolidated Financial Statements 26 (a)(2) Index to Financial Statement Schedules: Report of Independent Public Accountants 44 Schedules as of and for each of the three years in the period ended December 28, 1997: Schedule II - Valuation and Qualifying Accounts 50
All other schedules have been omitted because the required information is not applicable, not required or is included elsewhere in the financial statements and notes thereto. 45 (a)(3) Exhibits: Exhibit Number Description of Document ------- ----------------------- 3.1 Restated Certificate of Incorporation. (Filed as Exhibit 3.1 to Rally's Quarterly Report on Form 10-Q for the quarter ended September 29, 1996, and incorporated herein by reference.) 3.2 Restated By-Laws. (Filed as Exhibit 3.3 to Form 8 Amendment No. 1 to Rally's Annual Report on Form 10-K dated September 28, 1990, and incorporated herein by reference.) 4.1 Indenture dated as of March 1, 1993, between the Company, certain of its subsidiaries and PNC Bank Kentucky, Inc., as Trustee, relating to the issuance of $85,000,000 principal amount of the Company's 9 7/8% Senior Notes due 2000. (Filed as Exhibit 4.1 to Rally's Annual Report on Form 10-K for the year ended January 3, 1993, and incorporated herein by reference.) 4.2 Specimen form of 9 7/8% Senior Note due 2000. (Filed as Exhibit 4.2 to Rally's Annual Report on Form 10-K for the year ended January 3, 1993, and incorporated herein by reference.) 4.3 Form of Common Stock Certificate. (Filed as Exhibit 4 to Rally's Registration Statement on Form S-1, dated October 11, 1989, and incorporated herein by reference.) 4.4 Form of Warrant Agreement between Rally's Hamburgers, Inc. and American Stock Transfer & Trust Company, as Warrant Agent, including form of Warrant Certificate (incorporated by reference to Exhibit 4.4 to Rally's Annual Report on Form 10-K for the fiscal year ended December 29, 1996 (the "1996 10-K")). 4.5 Form of Warrant Agreement between Rally's Hamburgers, Inc. and CKE Restaurants, Inc., including form of Warrant Certificate (incorporated by reference to Exhibit 4.5 to the 1996 10-K). 4.6 First Amendment to the Indenture (incorporated by reference to Exhibit 4.6 to the 1996 10-K). 4.7 Other Debt Instruments - Copies of debt instruments for which the related debt is less than 10% of the Company's total assets will be furnished to the Commission upon request. 4.8 Certificate of Designation for Rally's Series A Participating Preferred Stock. 10.1 Form of Indemnity Agreement between the Company and its directors and officers. (Filed as Exhibit 10.2 to Rally's Registration Statement on Form S-1, dated October 11, 1989, and incorporated herein by reference.) *10.2 Amended and Restated Non-qualified Stock Option Plan. (Filed as Exhibit 10.3 to Amendment No. 1 to Rally's Registration Statement on Form S-1, dated October 11, 1989, and incorporated herein by reference.) *10.3 First Amendment to the Amended and Restated Non-qualified Stock Option Plan, dated as of October 26, 1989. (Filed as Exhibit 10.4 to Rally's Registration Statement on form S-1, dated December 29, 1989, and incorporated herein by reference.) 10.4 Lease between Blue Ridge Associates and the Company dated November 17, 1987. (Filed as Exhibit 10.6 to Rally's Registration Statement on Form S-1, dated October 11, 1989, and incorporated herein by reference.) *10.5 Rally's, Inc. 1990 Stock Option Plan, as amended (incorporated by reference to Exhibit 10.5 to the 1996 10-K). * Compensatory plan required to be filed as an exhibit pursuant to Item 14c of Form 10K. 46 *10.6 Rally's Hamburgers, Inc. 1995 Stock Option Plan for Non-employee Directors. (Filed as Exhibit A to Rally's definitive Proxy Statement, dated June 19, 1996, for the Annual Meeting of Stockholders held on July 10, 1996, and incorporated herein by reference.) *10.7 Employment Agreement between the Company and Evan G. Hughes dated March 28, 1995. (Filed as Exhibit 10.13 to Rally's Quarterly Report on Form 10-Q for the quarter ended April 2, 1995, and incorporated herein by reference.) *10.8 Employment Agreement between the Company and Donald E. Doyle dated March 1, 1996. (Filed as Exhibit 10.12 to Rally's Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference.) *10.9 Supplemental Employment Agreement between the Company and Donald E. Doyle, dated February 11, 1997 (incorporated by reference to Exhibit 10.12 to the 1996 10-K). 10.10 Operating Agreement by and between Rally's Hamburgers, Inc. and Carl Karcher Enterprises. (Filed as Exhibit 10.43 to CKE Restaurants, Inc.'s Quarterly Report on Form 10-Q for the quarter ended May 20, 1996, and incorporated herein by reference.) 10.11 Consulting Agreement by and between Rally's Hamburgers, Inc. and CKE Restaurants, Inc (incorporated by reference to Exhibit 10.16 to the 1996 10-K). 10.12 Exchange Agreement, dated as of December 8, 1997, between Rally's Hamburgers, Inc., CKE, Fidelity, GIANT and the other parties named in Exhibit A thereto (incorporated by reference to Exhibit A to Rally's Statement on Schedule 13D, dated December 18, 1997. **10.13 Management Services Agreement, dated November 30, 1997, between Checkers Drive-In Restaurants, Inc. and Rally's Hamburgers, Inc.. **10.14 Employment Agreement dated November 10, 1997, between the Company, Checkers Drive-In Restaurants, Inc. and Jay Gillespie. **10.15 Certificate of Designation of Series A Participating Preferred Stock of Rally's Hamburgers, Inc., dated December 8, 1997. 10.16 Form 10-K of Checkers Drive-In Restaurants, Inc., filed with the commission on March 30, 1998 21 Subsidiaries of the Company: (a) Rally's of Ohio, Inc., an Ohio corporation. (b) Self-Service Drive-Thru, Inc., a Louisiana corporation. (c) Rally's Finance, Inc., a Delaware corporation. (d) Rally's Management, Inc., a Kentucky corporation. (e) ZDT Corporation, a Missouri corporation. (f) RAR, Inc., a Delaware corporation. (g) MAC1, Inc., a Delaware corporation. (h) Hampton Roads Foods, Inc., a Louisiana corporation. 23 Consent of Arthur Andersen LLP 23.1 Consent of KPMG Peat Marwick, LLP * Compensatory plan required to be filed as an exhibit pursuant to Item 14c of Form 10K. ** File herewith (b) Reports on Form 8-K: No reports on Form 8-K were filed during the last quarter of year 1997. 47 (c) Exhibits Required by Item 601 of Regulation S-K: Described in Item 14(a)(3) of this Annual Report on Form 10-K. (d) Financial Statement Schedules: Described in Item 14(a)(2) of this Annual Report on Form 10-K. 48 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. RALLY'S HAMBURGERS, INC. Date: By: /s/William P. Foley, II -------------------------------------- William P. Foley, II Chairman and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ William P. Foley, II Chairman and Director March 27, 1998 - ------------------------------------- William P. Foley, II /s/ Jay Gillespie President, Chief Executive Officers and March 27, 1998 - ------------------------------------- Director (Principal Executive Officer) Jay Gillespie /s/ Joseph N. Stein Executive Vice President, March 27, 1998 - ------------------------------------- Chief Financial Officer Joseph N. Stein (Principal Financial and Accounting Officer) /s/ Terry N. Christensen Director March 27, 1998 - ------------------------------------- Terry N. Christensen /s/ Willie D. Davis Director March 27, 1998 - ------------------------------------- Willie D. Davis /s/ David Gotterer Director March 27, 1998 - ------------------------------------- David Gotterer /s/ Ronald Maggard Director March 27, 1998 - ------------------------------------- Ronald Maggard /s/ Andrew Puzder Director March 27, 1998 - ------------------------------------- Andrew Puzder Director March 27, 1998 - ------------------------------------- Burt Sugarman
49 Rally's Hamburgers, Inc. and Subsidiaries Schedule II Valuation and Qualifying Accounts (In thousands)
Additions -------------------------- Balance at Charged to Charged to Beginning Costs and Other Balance at Description of Year Expenses Accounts Deductions End of Year - ------------------------------------ ------------ ------------ ------------ -------------- ------------ Year Ended December 31, 1995 Accounts receivable $ 176 $ 376 $ 18 $ 117 $ 453 Royalties receivable 402 838 (267) 51 922 Notes receivable - 293 249 - 542 ============ ============ ============ ============== ============ $ 578 $ 1,507 $ - $ 168 $ 1,917 ============ ============ ============ ============== ============ Year Ended December 29, 1996 Accounts receivable 453 54 0 206 301 Royalties receivable 922 697 (81) 133 1,405 Notes receivable 542 200 81 (30) 853 ============ ============ ============ ============== ============ $ 1,917 $ 951 $ 0 $ 309 $ 2,559 ============ ============ ============ ============== ============ Year Ended December 28, 1997 Accounts receivable $ 301 $ 136 $ (39) $ (198) $ 200 Royalties receivable 1,405 (316) (114) (744) 231 Notes receivable 853 (212) 148 (558) 231 ------------ ------------ ------------ -------------- ------------ $ 2,559 $ (392) $ (5) $ (1,500) $ 662 ============ ============ ============ ============== ============
50 EX-10.13 2 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT ("Agreement") is effective as of November 10, 1997 (the "Effective Date"), by and among RALLY'S HAMBURGERS, INC., a Kentucky corporation ("Rally's"), CHECKERS DRIVE-IN RESTAURANTS, INC., a Florida corporation ("Checkers"), and JAY GILLESPIE, an individual (the "Executive"). Rally's and Checkers are sometimes referred to herein singularly as a "Company" and collectively as the "Companies." In consideration of the mutual covenants and agreements set forth herein, the parties hereto agree as follows: l. Employment and Duties. Subject to the terms and conditions of this Agreement, the Companies each employ the Executive to serve in an executive and managerial capacity as their Chief Executive Officer, and the Executive accepts such employment and agrees to perform such reasonable responsibilities and duties commensurate with the aforesaid positions, as directed by the Boards of Directors of the Companies or as set forth in the Articles of Incorporation and/or the Bylaws of the Companies, for all locations in which the Companies have offices. In addition, the Boards of Directors of each Company, or any appropriate committee of such Board, shall recommend to the shareholders of such Company that Executive be elected to serve as a director on the Board of such Company for each year during the Term (as defined below). 2. Term. The term of employment under this Agreement shall be for a period of two (2) years (the "Term") commencing on the Effective Date, subject to termination pursuant to Section 4, below. This Agreement shall automatically be renewed each year for an additional one (1) year term unless the Companies notify the Executive that they are terminating this Agreement prior to November 10th of such year. 3. Compensation. 3.1 Annual Salary. During the Term of this Agreement, the Companies shall pay Executive an aggregate minimum base annual salary, before deducting all applicable withholdings, of Two Hundred Eighty-Two Thousand Five Hundred Dollars ($282,500) per year (the "Base Salary"), payable at the times and in the manner dictated by the Companies' standard payroll policies. The Boards of Directors of Checkers and Rally's shall determine how the Base Salary under this Section 3.1 and the Incentive Bonus earned by the Executive under 3.2(a), below shall be allocated between the Companies. 3.2. Other Compensation and Benefits. During the Term, as additional compensation, the Executive shall be entitled to participate in and receive the following: (a) Incentive Bonus. The Executive shall be entitled to participate in the Companies' Incentive Bonus Plan, pursuant to which the Executive shall be entitled to earn up to a maximum of fifty percent (50%) of his Base Salary (the "Incentive Bonus"). The Incentive Bonus will be based on certain performance criteria determined in good faith by the Companies' respective Boards of Directors. The Incentive Bonus shall be pro-rated for any partial employment period. Any Incentive Bonus due for a given year of the term shall be paid no later than April 15th of the following year. (b) Benefits. Executive shall be entitled to choose to participate in and receive all benefits under either (i) Rally's or (ii) Checker's employee benefit plans or programs (including, without limitation, medical, dental, disability, and group life), any retirement savings plans or programs (including, without limitation, employee stock purchase plans), and such other perquisites of office as Rally's or Checkers may, from time to time and in their sole discretion, make available generally to employees of similar rank as Executive, subject to such eligibility provisions as may be in effect from time to time. (c) Stock Options. Rally's hereby grants to Executive options to purchase 300,000 shares of Rally's Common Stock, in accordance with and pursuant to the terms of Rally's Stock Option Plan (the "Plan"). The exercise price for such options shall be the closing price on the Effective Date of Rally's Common Stock publicly traded on NASDAQ, as stated in the Wall Street Journal. The above described options shall vest and become exercisable in three (3) equal installments of 100,000 shares each on each of the first three (3) anniversaries of the Effective Date. Notwithstanding the above, if the Term is not extended for an addition one (1) year pursuant to Section 2, above, then 200,000 shares of options shall vest and become exercisable on the second anniversary of the Effective Date. (d) Moving Expenses/Monthly Stipend. Rally's and/or Checkers, as the Companies so determine, shall pay all of Executive's reasonable moving expenses from Dallas, Texas to the location at which Executive shall initially perform his primary duties hereunder or any subsequent relocation of Executive required by the Companies. In addition, in order to assist Executive with such transition expenses, Rally's and/or Checkers, as the Companies so determine, shall pay Executive the sum of One Thousand Dollars ($1,000) per month commencing on the Effective Date and continuing for the five (5) consecutive months thereafter. (e) Commencement Bonus. On the Effective Date, Rally's and/or Checkers, as the Companies so determine, shall pay Executive a one time commencement bonus of Fifty Thousand Dollars ($50,000). The Companies shall deduct from all compensation payable under this Agreement to Executive any taxes or withholdings the Companies are required to deduct pursuant to state and federal laws or by mutual agreement among the parties. 3.3. Vacation. Executive will be entitled to paid vacation time in accordance with the Companies' personnel policies and procedures made available to the Companies' executive employees of similar rank, as the same may change from time to time, or as otherwise determined 2 by the respective Boards of Directors of the Companies. In addition, Executive shall be entitled to such holidays consistent with the Companies' standard policies or as the Companies' respective Boards of Directors may approve. 3.4 Expense Reimbursement. In addition to the compensation and benefits provided herein, the Companies shall, upon receipt and approval of appropriate documentation, reimburse Executive each month for his reasonable travel, lodging, entertainment, promotion and other ordinary and necessary business expenses. The arrangement set forth in this Section 3.4 is intended to constitute an accountable plan within the meaning of Section 162 of the Internal Revenue Code, as amended (the "Code") and the accompanying regulations, and the Executive agrees to comply with all reasonable guidelines established by the Companies from time to time to meet the requirements of Section 162 of the Code and the accompanying regulations. 4. Termination. 4.1 For Cause. Notwithstanding any other provisions to the contrary contained herein, the Companies may terminate this Agreement immediately for cause upon written notice to the Executive, in which event the Companies shall be obligated to pay the Executive that portion of the Base Salary and the Incentive Bonus, if any, due him through the date of termination. For purposes of this Agreement, "cause" shall mean: (a) material default or other material breach by Executive of Executive's obligations hereunder; (b) the willful and habitual failure by Executive to perform the duties that Executive is required to perform under this Agreement or the Companies' corporate policies, provided such corporate policies have previously been delivered to Executive; or (c) misconduct, dishonesty, insubordination, or other act by Executive that in any way has a direct, substantial and adverse effect on either Company's reputation or their respective relationships with their customers or employees, including, without limitation, (i) use of alcohol or illegal drugs such as to interfere with the Executive's obligations hereunder, (ii) conviction of a felony or of any crime involving moral turpitude or theft, and (iii) material failure by Executive to comply with applicable laws or governmental regulations pertaining to Executive's employment hereunder. 4.2 Without Cause. Notwithstanding any other provisions to the contrary contained herein, the Companies, on the one hand, and the executive, on the other hand, may terminate this Agreement immediately without cause by giving written notice to the other. If the Companies terminate this Agreement under this Section 4.2, it shall continue to pay to the Executive (i) the Base Salary and (ii) the Incentive Bonus earned by the Executive in the prior year, for the unexpired Term of this Agreement. The amount payable to Executive hereunder shall be paid to the Executive in lump sum or as otherwise directed by the Executive. If the Executive terminates this Agreement under this Section 4.2, the Companies shall only be obligated to pay to the Executive the Base Salary due him through the date of termination. 3 4.3 Disability. Notwithstanding any other provisions to the contrary contained herein, if the Executive fails to perform his duties hereunder on account of illness or other incapacity for a period of six (6) consecutive months, the Companies shall have the right upon written notice to the Executive to terminate this Agreement, without further obligation, by paying Executive the Base Salary without offset for the remainder of the Term of this Agreement in a lump sum or as otherwise directed by Executive. 4.4 Death. Notwithstanding any other provisions to the contrary contained herein, if the Executive dies during the Term of this Agreement, this Agreement shall terminate immediately, and the Executive's legal representatives or designated beneficiary shall be entitled to receive the Base Salary to the date of Executive's death in a lump sum or as otherwise directed by Executive's legal representatives or designated beneficiary, whichever the case may be. 4.5 Termination by Companies Following Change of Control. In the event of a Change of Control (as defined below) of either Company, the Companies shall require any Successor (as defined below) to assume and agree to perform this Agreement in the same manner and to the same extent that such Company would be required to perform if the Change of Control had not occurred. Upon the assumption of this Agreement by the Successor, and its agreement to perform the duties and obligations of such Company hereunder, that Company shall be released from any further liability under this Agreement. As used herein, a "Change of Control" of either Company shall mean the acquisition by a "Successor," whether directly or indirectly, by purchase, merger, consolidation or otherwise, of all or substantially all of the common stock, business and/or assets of such Company; provided, however, that a Change of Control shall not be deemed to have occurred as a result of an increased ownership interest in either Company by Carl Karcher Enterprises, Inc. or Fidelity National Financial, Inc., or any of their respective affiliates, or a transfer of any such ownership interests by any such entity to any of its affiliates. 4.6 Effect of Termination. Termination for any cause shall not constitute a waiver of the Companies' rights under this Agreement as specified in Section 6 nor a release of Executive from any obligation hereunder except his obligation to perform his day-to-day duties as an Executive. 5. Non-Delegation of Executive's Rights. The obligations, rights and benefits of Executive hereunder are personal and may not be assigned or transferred in any manner whatsoever, nor are such obligations, rights or benefits subject to involuntary alienation, assignment or transfer. 6. Covenants of Executive. 6.1 Confidentiality. Executive acknowledges that in his capacity as an Executive of each Company he will occupy a position of trust and confidence, and he further acknowledges that 4 he will have access to and learn substantial information about each Company and its respective operations that is confidential or not generally known in the industry including, without limitation, information that relates to purchasing, sales, customers, marketing, such Company's financial position and financing arrangements. Executive agrees that all such information is proprietary or confidential or constitutes trade secrets and is the sole property of such Company. Accordingly, during the Executive's employment by each Company and for a period of two (2) years thereafter, Executive will keep confidential, and will not without such Company's permission reproduce, copy or disclose to any other person or firm, any such information or any documents or information relating to such Company's methods, processes, customers, accounts, analyses, systems, charts, programs, procedures, correspondence, or records, or any other documents used or owned by such Company, nor will Executive advise, discuss with or in any way assist any other person or firm in obtaining or learning about any of the items described in this section, either alone or with others, outside the scope of his duties and responsibilities with such Company unless otherwise required by law or court ordered subpoena. 6.2 Competitive Activities During Employment Executive agrees that during his employment by the Companies, he will devote substantially all his business time and effort to and give undivided loyalty to the Companies. Executive will not, during his employment by the Companies, engage in any way whatsoever, directly or indirectly, in any business that is competitive with either Company, nor solicit, or in any other manner work for or assist any business which is competitive with either Company. During his employment by the Companies, Executive will undertake no planning for or organization of any business activity competitive with the work he performs as an executive of either Company, and Executive will not, during his employment by the Companies, combine or conspire with any other employee of either Company or any other person for the purpose of organizing any such competitive business activity. 6.3 Remedy for Breach. Executive acknowledges that the Companies will be irrevocably damaged if all of the provisions of this Section 6 are not specifically enforced. Accordingly, the Executive agrees that, in addition to any other relief to which the Companies may be entitled, the Companies will be entitled to seek and obtain injunctive relief from a court of competent jurisdiction for the purpose of restraining the Executive from any actual or threatened breach of this Section 6. The Executive's obligations under this Section 6 shall survive the Executive's termination of employment with the Companies for the periods of time specified in this Section 6. 7. Return of Documents. Upon termination of this Agreement, Executive shall return immediately to the appropriate Company all records and documents of or pertaining to such Company and shall not make or retain any copy or extract of any such record or document. 5 8. Improvements and Inventions. Any and all improvements or inventions which Executive may conceive, make or participate in during the period of his employment shall be the sole and exclusive property of the Companies. Executive will, whenever requested by either Company during the period of his employment, execute and deliver any and all documents which such Company shall deem appropriate in order to apply for and obtain patents for improvements or inventions or in order to assign and convey to such Company the sole and exclusive right, title and interest in and to such improvements, inventions, patents or applications. 9. Miscellaneous. 9.1 Entire Agreement; Amendment. This Agreement constitutes the entire agreement between the parties with respect to Executive's employment with the Companies and supersedes any and all prior or contemporaneous agreements or understandings, whether oral or written, relating to the such employment. This Agreement may be amended, modified, supplemented, or changed only by a written document signed by all parties to this Agreement. 9.2 Governing Law and Venue. Any dispute arising exclusively from the relationship between Rally's and the Executive under this Agreement shall be governed by Kentucky law, and venue for any such dispute shall be in Clay County, Kentucky. Any dispute arising exclusively from the relationship between Checkers and the Executive under this Agreement shall be governed by Florida law, and venue for any such dispute shall be in Pinellas County, Florida. Any dispute under this Agreement involving both Companies and the Executive shall be governed either by Kentucky law or Florida law, and venue for any such dispute shall be either in Clay County, Kentucky or Pinellas County, Florida. 9.3 Attorneys' Fees. In any litigation, arbitration, or other proceeding by which one party either seeks to enforce its rights under this Agreement (whether in contract, tort, or both) or seeks a declaration of any rights or obligations under this Agreement, the prevailing party shall be entitled to recover from the non-prevailing party reasonable attorney fees, together with any costs and expenses, to resolve the dispute and to enforce the final judgment. 9.4 Severability. If any section, subsection or provision hereof is found for any reason whatsoever to be invalid or inoperative, that section, subsection or provision shall be deemed severable and shall not affect the force and validity of any other provision of this Agreement. If any covenant herein is determined by a court to be overly broad thereby making the covenant unenforceable, the parties agree and it is their desire that such court shall substitute a reasonable judicially enforceable limitation in place of the offensive part of the covenant and 6 that as so modified the covenant shall be as fully enforceable as if set forth herein by the parties themselves in the modified form. The covenants of each Company and the Executive in this Agreement shall each be construed as an agreement independent of any other provision in this Agreement, and the existence of any claim or cause of action of the Executive against either Company or of either Company against the Executive, whether predicated on this Agreement or otherwise, shall not constitute a defense to the enforcement by the Companies or the Executive of the covenants in this Agreement. 9.5 Notices. Any notice, request, or instruction to be given hereunder shall be in writing and shall be deemed given when personally delivered or three (3) days after being sent by United States certified mail, postage prepaid, with return receipt requested, to the parties at their respective addresses set forth below: To Rally's: Rally's Hamburgers, Inc. 10002 Shelbyville Road, Suite 150 Louisville, Kentucky 40223 Attn: William P. Foley, II To Checkers: Checkers Drive-In Restaurants, Inc. 600 Cleveland Street Clearwater, Florida 34615 Attn: William P. Foley, II To Executive: Jay Gillespie 115 Twin Lakes Drive Double Tree, Texas 75067 9.6 Waiver. The failure of a party to insist upon strict adherence to any term of this Agreement on any occasion shall not be considered a waiver thereof or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. 9.7 Assignment. This Agreement shall be binding upon and inure to the benefit of the parties and their permitted assigns. Neither this Agreement nor any of the rights of the parties hereunder may be transferred or assigned by either party, except that if there is a Change 7 of Control of a Company and the Successor assumes, either expressly or by operation of law, such Company's obligations under this Agreement, then such Company shall assign its rights and obligations hereunder to such Successor subject to the terms of Section 4.5 of this Agreement. Any assignment or transfer in violation of this Section 9.7 shall be void. 9.8 Captions and Headings. The captions and headings are for convenience of reference only and shall not be used to construe the terms or meaning of any provisions of this Agreement. 9.9 Potential Conflicts of Interests. In the event that the assumption by Executive of the duties of Chief Executive Officer of both Companies creates a conflict of interest, the Companies shall indemnify, defend and hold harmless Executive from and against any and all claims, losses, damages, causes of action or other proceedings, and any and all other liabilities of any nature whatsoever, which arise out of or relate to such alleged conflict. Nothing contained in this Section 9.9 shall be deemed to be an admission by the Companies that such a conflict exists, and notwithstanding the Companies agreement to abide by the terms of this Section 9.9, the Companies expressly disclaim that such a conflict exists. IN WITNESS WHEREOF the parties have executed this Employment Agreement as of the date set forth above. RALLY'S: RALLY'S HAMBURGERS, INC., a Kentucky corporation By: /s/ William P. Foley II ----------------------------- Its: Chairman of the Board CHECKERS: CHECKERS DRIVE-IN RESTAURANTS, INC., a Florida corporation By: /s/ William P. Foley II ----------------------------- Its: Chairman of the Board EXECUTIVE: /s/ Jay Gillespie ----------------------------- Jay Gillespie 8 EX-10.14 3 MANAGEMENT SERVICES AGREEMENT This Agreement, dated November 30, 1997, is by and between CHECKERS DRIVE-IN RESTAURANTS, INC., a Delaware corporation ("Checkers"), and RALLY'S HAMBURGERS, INC., a Delaware corporation ("Rally's"). Background of the Agreement Checkers is skilled and experienced in operating double-drive-through fast-food restaurants. Rally's is engaged in owning, operating and franchising double-drive-through restaurants (the "Rally's Restaurants") and believes that it would be beneficial to it and to its stockholders, by reducing overhead costs and gaining Checkers special skills, to engage Checkers to provide to the Rally's Restaurants the services described on Exhibit A attached hereto and incorporated herein by this reference (the "Services"). Checkers is willing to act as such manager in the terms and conditions herein contained and, as a consequence, the parties are entering into this Agreement in order to set forth the terms on which such Services are to be provided. Agreement NOW THEREFORE, in consideration of the mutual warrants and agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, it is agreed by the parties hereto as follows: 1. Services. During the term of this Agreement, Checkers shall provide to Rally's all of the Services for the Restaurants which are owned by Rally's (the "Owned Restaurants"), subject to the terms and conditions specified in this Agreement, and shall provide corporate purchasing services (the "Purchasing Services") to the Restaurants which are franchised by Rally's (the "Franchised Restaurants") which allow the Franchised Restaurants to purchase food and paper products, small wares and equipment on substantially the same terms that such products may be purchased by the Owned Restaurants. Checkers agrees and acknowledges that, subject to Section 6 below, certain information received by Rally's from Checkers in connection with Checkers performing the Services hereunder may be disclosed to franchises of Rally's provided, however, that Checkers shall have no obligation to provide any services to the Franchised Restaurants other than Purchasing Services. Checkers is expressly authorized to provide the Services (including the Purchasing Services with respect to Franchised Restaurants), in any reasonable manner it deems appropriate to meet the day-to-day requirements of the business and administrative aspects of Rally's' operation of the Owned Restaurants which shall be consistent with the services provided to the restaurants owned and operated by Rally's itself (the "Rally's Restaurants"). Notwithstanding anything herein to the contrary, (i) Checker's shall not be obligated to perform the Services for the Owned Restaurants or the Franchised Restaurants that is in a manner different from the manner which Rally's provides the Services for the Rally's Restaurants, (ii) Checker's shall not be obligated to perform Services for the Owned Restaurants that Rally's does not perform for Rally's Restaurants, (iii) Checkers shall not be liable for any direct, indirect or consequential damages suffered or incurred by Rally's or to any third party, including, without limitation, lost profits arising from or relating to any breach by Checkers of its obligations hereunder absent a finding in a final judgment of a court of competent jurisdiction that such damages proximately resulting from the bad faith, gross negligence or willful misconduct 1 of Checkers or its agents. Specifically excluded from the service to be provided hereunder are marketing and franchise operations services. 2. Term. The term of this Agreement will commence on the date hereof and will terminate or expire on the earlier of (a) seven (7) years from the date hereof; (b) a breach of a material provision of this Agreement by either party which is not cured by such party within 30 days of receipt of notice from the non-breaching party; (c) the entry of any judgment, order, injunction or decree of any court, arbitrator or governmental agency which would cause the provision of the Services to be in conflict with or in violation of any such judgment, order, injunction or decree; or (d) the mutual consent of the parties; provided, however, that unless the parties otherwise agreement, (i) Rally's shall continue to provide the Purchasing Services to the Owned Restaurants through the end of their respective lease terms on the same terms as set forth herein and (ii) Rally's shall continue to provide the Purchasing Services to the Franchised Restaurants until the expiration or termination of the existing franchise agreement for such Franchised Restaurant. 3. Transition of Services. Checkers and Rally's shall mutually and immediately undertake to develop and implement a plan (the "Plan") designed to ensure a smooth transition of the Services to be performed by Rally's. 4. Compensation. 4.1. In consideration for the Services provided hereunder Rally's agrees to pay to Checkers fees for the Services (the "Service Fee") for each regular four-week accounting period (each, an "Accounting Period") in accordance with the schedule of fees attached hereto as Exhibit B and incorporated herein by this reference. The ratio utilized in calculative the Service Fee shall be re-computed at the beginning of each fiscal quarter based upon the then current data. 4.2. In addition to the payment of the Service Fee as specified in paragraph 4.1 above. Rally's shall be responsible for the payment of any and all actual out-of-pocket costs and expenses incurred by or on behalf of Checkers and paid to any third party in connection with the Services to be provided hereunder and the operation of the Owned Restaurants and shall reimburse Checkers for such costs and expenses incurred by or on behalf of Checkers or its affiliates in connection with the services rendered hereunder, including, without limitation, costs of replacement equipment, travel expenses, year-end employee accounting reporting matters (for example, Form 1099's, W-2's, etc.) and legal and accounting and other professional fees and expenses. All such expenses which exceed $1,000.00 must be approved by Rally's prior to incurring such expense. 4.3. In addition to the Service Fee described in Paragraph 4.1 above and reimbursement of out of pocket expenses described in Paragraph 4.2 above, Rally's shall be responsible to pay an amount equal to a prorata portion (based on Corporate Store Ratio) of book depreciation of any new assets acquired by Checkers which benefit Checkers but are necessary to provide the services described herein. The cost of any assets acquired by either party hereto for its own exclusive use shall be borne by the party acquiring such asset. 2 4.4. Checkers shall calculate all Service Fees and expense reimbursements due to Checkers for each Accounting period hereunder, all of which shall be paid by Rally's within ten (10) days after receipt of Checkers invoice. 5. Indemnification. 5.1. Such party (the "Indemnifying Party") shall indemnify, hold harmless and defend the other and its affiliates, and the respective officers, directors, shareholders and employees of such other, and such affiliates (individually an "Indemnified Party" and collectively the "Indemnified Parties"), from and against any and all liabilities, losses, judgments, damages, demands, claims, causes of action or any other legal or government proceedings, or any settlement thereof, and any and all costs and expenses (including reasonable attorneys' fees), whether or not covered by insurance, caused or asserted to have been caused, directly or indirectly, by or as a result of any intentional or willful misconduct, or the gross negligence, of the Indemnifying Party or any of its officers or management employees in connection with its performance of its material covenants hereunder. 5.2. Promptly after being informed of, or learning of, any demand, claim, cause of action, proceeding or other matter (a "Claim") for which it may be entitled to indemnity hereunder, an Indemnified Party shall give written notice of the Claim to the Indemnifying Party, stating the nature and basis of the Claim and the amount thereof, to the extent known by the Indemnified Party; provided, however, that the failure to give such notice shall not relieve the Indemnifying Party of its obligations except if and to the extent it is materially prejudiced by such failure. The Indemnifying Party shall have the right, at its option, to defend, at its own expense and by counsel reasonably acceptable to the Indemnified Parties against any such Third Party Claim; provided that if the Indemnifying Party fails to do so within ten (10) days after being notified or otherwise learning of the Claim, the Indemnified Parties shall be entitled (i) to defend the Claim with counsel of its own choosing, at the expense of the Indemnifying Party (which shall pay such expenses, including the reasonable fees and expenses of such counsel, as and when they are incurred by the Indemnified Parties); and (ii) to settle or compromise the Claim without the consent of the Indemnifying Party. In no event shall any Indemnifying Party compromise or settle any Claim without the consent of the Indemnified Parties, unless the terms of the settlement or compromise provide for a general and unconditional release of the Indemnified Parties from the Claim and does not require the payments of any sums by, does not place any restrictions or imposes any covenants on, and does not require or provide for any admission of any liability on the part of, any Indemnified Party. 6. Confidential and Proprietary Information. 6.1. Checkers shall (a) maintain in strict confidence and not disclose any Confidential Information of Rally's without Rally's' express written authorization; (b) not use any Confidential Information in any way to the direct or indirect detriment of Rally's; and (c) ensure that its affiliates and advisors who have access to any of such Confidential Information shall comply with these nondisclosure obligations and use restrictions; provided, however, that Checkers may disclose Confidential Information to those of its representatives who need to know Confidential Information for the purposes of this Agreement, subject to the following conditions: (a) such representatives shall be informed of the confidential nature of the Confidential Information; (b) 3 such Representative shall agree to be bound by this Section and shall be directed by Checkers not to disclose to any other person any Confidential Information; and (c) Checkers shall be responsible for any breach of this Section by any of its representatives. 6.2. If Checkers is requested or required (by oral questions, interrogatories, requests for information or documents, subpoenas, civil investigative demands, or similar processes) to disclose or produce any Confidential Information furnished in the course of its dealings with Rally's or its advisors or representatives, Checkers shall (a) provide Rally's with prompt notice thereof and copies, if possible, and, if not, a description, of the Confidential Information requested or required to be produced so that Rally's may seek an appropriate protective order or waive compliance with the provisions of this Section and (b) consult with Rally's as to the advisability of Rally's taking legally available steps to quash or narrow such request. Checkers further agrees that, if in the absence of a protective order or the receipt of a waiver hereunder Checkers is nonetheless, in the written opinion of its legal counsel, compelled to disclose or produce Confidential Information of Rally's to any tribunal legally authorized to request and entitled to receive such Confidential Information or to stand liable for contempt or suffer other censure or penalty. Checkers may disclose or produce such Confidential Information to such tribunal without liability hereunder, provided, however, that Checkers shall give Rally's written notice of the Confidential Information to be so disclosed or produced as far in advance of its disclosure or production as is practicable and shall use its best efforts to obtain, to the greatest extent practicable, an order or other reliable assurance that confidential treatment will be accorded to such Confidential Information so required to be disclosed or produced. For purposes of this Section 6, the term "Confidential Information" shall mean any information of Rally's (whether written or oral), including all notes, studies, information, forms, business or management methods, formulae, recipes, marketing data, or trade secrets or know-how of Rally's, whether or not such Confidential Information is disclosed or otherwise made available to one party by the other party pursuant to this Agreement or otherwise. Confidential Information shall also include the terms and provisions of this Agreement. Confidential Information does not include, however, any information that (i) is or becomes generally available to and known by the public (other than as a result of the disclosure directly or indirectly by the receiving party or its affiliates, advisors or representatives that is not permitted by this Agreement or the consent of the furnishing party); (ii) has already been or is hereafter independently acquired or developed by the receiving party without violating any confidentiality agreement with or other obligation of secrecy to the furnishing party; or (iii) information which a party has determined, after consultation with its legal counsel, that it is required to disclose by laws or government regulations applicable to it. 7. General Provisions. 7.1. In providing the Services hereunder, Checkers shall not be required to make any financial commitments or expend any of its own funds, except under arrangements reasonably satisfactory to Checkers which will assure Checkers of prompt reimbursement by Rally's. 7.2. Checkers and its representatives shall have authority to act on behalf of Rally's to the extent reasonably required to perform the Services called for by this Agreement. In particular, representatives of Checkers shall be authorized to sign purchase orders in the name 4 of Rally's. Rally's shall at all times have designated personnel available for consultation by Checkers in respect of the Services to be provided hereunder, which personnel shall have full authority to make any determinations necessary in connection with such Services. Checkers shall be fully protected in relying upon any authorizations or instructions received by Checkers from any such personnel who shall have been so authorized in writing by Rally's to act hereunder. 7.3. Rally's acknowledges that Checkers is entering into this Agreement at the request of Rally's, and that Checkers has made no representation or warranty that the Services will enable Rally's to achieve any projected level of sales or profits or that any of the products or services ordered by Checkers from third parties on behalf of Rally's will be purchased at or below the prices projected by Rally's. Furthermore, Checkers has made no representation or warranty as to the quality or timeliness of delivery with respect to any products or services ordered by Checkers from third parties on behalf of Rally's pursuant hereto. The foregoing shall not, however, limit the obligation of Checkers to provide, or cause to be provided, the Services as called for hereunder in a good faith, diligent manner. 7.4. The parties hereto acknowledge that each owns and maintains its own assets such as office furniture and equipment. Except as specifically set forth herein, there will be no fees charged for the use of such assets by either party. 8. Relationship of Parties. Except as specifically provided herein, neither party shall act or represent or hold itself out as having the authority to act as an agent for or partner of the other party, or in any way bind or commit the other party to any obligations. Nothing contained in this Agreement shall be construed as creating a partnership, joint venture, agency, trust or other association of any kind, each party being individually responsible only for its obligations as set forth in this Agreement. 9. Force Majeure. If Checkers is prevented from complying, either totally or in part, with any of the terms or provisions of this Agreement by reason of fire, flood, storm, strike, lockout or other labor trouble, riot, war, rebellion or other causes beyond the reasonable control of Checkers or other acts of God, then upon written notice to Rally's, the affected provisions and/or other requirements of this Agreement shall be suspended during the period of such disability and Checkers shall have no liability to Rally's in connection therewith. Checkers shall make all reasonable efforts to remove such disability as soon as reasonably practicable but in no event later than thirty days after the occurrence of such disability. 10. Miscellaneous. 10.1. Entire Agreement. This Agreement contains the entire agreement between the parties with respect to the matters referred to herein, and supersedes all prior agreements and understandings of the parties relating to such matters. 10.2. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Florida. 10.3. Amendment. This Agreement may be amended only by a written document signed by the parties hereto. 5 10.4. Notices. Any notices hereunder shall be in writing and shall be effective upon receipt (by delivery, telex, telefax or similar electronic communication), or three business days after having been sent, by certified or registered mail, postage prepaid, addressed to the parties as follows: If to Checkers: Checkers Drive-In Restaurants, Inc. P.O. Box 1079 Clearwater, Florida 34617-1079 Attention: James Holder, Esq. If to Rally's: Rally's Hamburgers, Inc. 600 Cleveland Street 8th Floor Clearwater, Florida 34617 Attention: Joseph N. Stein Either party may change its address for notices by written notice as provided above. 10.5. Assignment. Neither party may assign this Agreement without the prior written consent of the other, except that Checkers may assign this Agreement to any wholly-owned subsidiary, but no such assignment shall release Checkers from its obligations set out in Section 6. Except as provided in the preceding sentence, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns, and any corporation into which or with which a party may be liquidated, merged or consolidated. 10.6. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute a single agreement. 6 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the day first above written. CHECKERS DRIVE-IN RESTAURANTS, INC. By: /s/ James T. Holder -------------------------------------- Senior Vice President Title RALLY'S HAMBURGERS, INC. By: /s/ Joseph N. Stein -------------------------------------- Chief Financial Officer Title 7 EXHIBIT A SERVICES TO BE PROVIDED o Executive Services: o Provide executive management and oversight to various departments performing services under this management agreement o Travel Service: o Provide travel, lodging and transportation arrangements including hotel, flight and car rental needs o Legal (in hours): o Provide traditional in-house legal services including engagement of outside counsel and general legal advice and support to all company departments o Litigation and case management services o Real estate and other transactional services o Contract negotiation and documentation o Documentation of Franchise work-outs o Real Estate & Construction Services: o Site selection for new sites o Administration of existing leases, including renewals o Disposition of excess properties o Construction manager, including new site relocations and other projects (including dining room additions) o Facilities maintenance supervision (R&M) o Franchise Administration: o Maintenance and enforcement of franchise agreements o Prepare UFOC updates including regulatory filings and compliance o Provide franchise workout assistance o Assist in franchise "town hall" and "business exchange" meetings o Franchise Sales and Development: o Develop sales kits o Pursue new franchisees through tradeshows, cold calls and solicitations, etc. o Provide turnkey management of new franchisee screenings, approvals and integration A-1 o Human Resources: o All Functions of HR except that Rally's would recruit and train its own Management Personnel o Assist in the initial response to employee grievances; provided, however, that in no event shall such services include legal representation, whether by in-house or outside counsel, for any legal or administrative claims brought by employees or third parties o Workers' Compensation Investigations o Public Accidents o Safety Program o Source Unit Liability Insurance o Source Workers' Compensation Insurance o Training: o Maintaining and updating all Materials, handbooks, Training Materials, etc. o Treasury; Tax; Internal Audit; Loss Prevention: o Process Personal Property Statements, as required o Reconcile Bank Statements o Reconcile Bank Card Deposits o Sales Tax o Licenses o Federal and State Tax Return Preparation o Company and Franchise Restaurant Audit Services o Loss Prevention Services, including Analysis and Management of Surveillance Equipment Installation and Maintenance o Collection and Tracking of Royalties o Restaurant Quality Assurance: o Develop and maintain restaurant quality assurance programs o Research and Development: o Product and Recipe Development o Accounting Functions: o Track & verify that Daily Sales Deposits are made in a timely manner o Issue Daily Sales Tracking Report o Bill and track Accounts Receivable o Process and Verify Daily Sales Activities A-2 o Issue Monthly Sales Reports to Landlords o Maintain Depreciation Schedules o Issue Weekly P&L's o Provide Detail Back-Up for period P&L's o Review Purveyor Statements and Request Past Due Invoices o Tickle Payments o Payroll: o All Payroll Functions o Bonus Calculations and Payments o Employee Benefits o Medical, Life & Disability Insurance o 1099 & W-9's o Forms and supply orders - All Restaurants/Corporate Office o Accounts Payable: o Process Accounts Payable, Including Prior Payment of Invoices o Issue Accounts Payable Checks o Issue Back-up for Accounts Payable Checks o Review Vendor Statements and Request Past Due Invoices o Issue Standard Payments; i.e., Building Rent, CAM, Miscellaneous o Track and Calculate and Issue Sales Tax Reports and Payments o Track and Issue Personal and Real Property Tax Payments o Calculate and Track Percentage Rent Liabilities and Payments o Information Technology: o Maintenance of POS system o Maintenance of Park City back office system (including any replacement) o Maintenance of all corporate systems (including general ledger and related programs and EIS programs) o Development of systems reasonably requested by Rally's management o Restaurant polling process administration o Administration of all telecommunication and network services o Financial and Planning: o Provide corporate and restaurant budgeting services o Provide ROI analysis o Provide operational and marketing analytical support A-3 o Purchasing: o Regular purveyor quality assurance visits and documentation o All Food and Paper Products, Smallwares and Equipment o Regional Operations Support: o Provide operational management guidance for corporate stores o Includes Chief Operating Officer and Regional Vice President support o Corporate Overhead Support: o Use of facilities at Clearwater, Florida office o Includes rent, utilities, supplies, phone service and other general corporate costs o Management of leases and equipment purchasing o Communication services A-4 EXHIBIT B SCHEDULE OF FEES
Service Area Fee Effective Date ------------ --- --------------- Executive Services Actual Cost x Corporate Store Ratio 12/31/97 Travel Services Same 12/31/97 Legal (in-house) Actual Cost x Corporate Same Ratio 12/31/97 Real Estate & Construction Services Same 1/27/98 Franchise Administration Actual Cost x Franchise Store Ratio 12/31/97 Franchise Sales and Development Same 1/27/98 Human Resources Actual Cost x Corporate Store Ratio 1/27/98 Training Same 1/27/98 Treasury; Tax; Internal Audit; Loss Prevention Same 1/27/98 Restaurant Quality Assurance Same 1/27/98 Research and Development Same 1/27/98 Accounting Functions Same 1/27/98 Payroll Same 1/27/98 Accounts Payable Same 1/27/98 Information Technology Same 1/27/98 Financial Planning Same 1/27/98 Purchasing Same 2/26/98 B-1 Regional Operations Support Same 2/26/98 Corporate Overhead Support Actual Cost x (Checkers corporate employees supporting Rally's/Checkers total corporate employees) 1/27/98
"Corporate Store Ratio" is the ratio of all Rally's stores (including JVs) to all stores (including JVs) of Checkers and Rally's combined. "Franchise Store Ratio" is the ratio of all Rally's franchised stores to all franchised stores of Checkers and Rally's combined. B-2 EX-23 4 Exhibit 23 ---------- Consent of Independent Public Accountants As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Form S-8 Registration Statements (Registration Statement Nos. 33-33367, 33-39419, 33-39420 and 33-62792). ARTHUR ANDERSEN LLP Louisville, Kentucky March 30, 1997 EX-23.1 5 Accountants' Consent The Board of Directors Checkers Drive-In Restaurants, Inc. We consent to incorporation by reference in the current report on Form 10-K of Rally's Hamburgers, Inc. of our report dated February 27, 1998, with respect to the consolidated balance sheets of Checkers Drive-In Restaurants, Inc. and subsidiaries as of December 29, 1997 and December 30, 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 29, 1997, which report appears in the current report on Form 10-K of Checkers Drive-In Restaurants, Inc. /s/ KPMG PEAT MARWICK LLP ------------------------- KPMG PEAT MARWICK LLP Tampa, Florida March 30, 1998 EX-27 6 FDS --
5 This schedule contains summary financial information extracted from the financial statements of Rally's Hamburgers, Inc., for the quarterly periods ended December 28, 1997 and December 29, 1996, and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS 12-MOS DEC-28-1997 DEC-29-1996 DEC-30-1996 JAN-01-1996 DEC-28-1997 DEC-29-1996 5,388 3,934 0 0 1,949 2,135 0 0 1,052 794 10,968 10,416 68,067 69,806 0 0 134,297 112,258 21,777 19,968 4,017 4,775 0 0 50 0 2,484 2,079 39,024 17,286 134,297 112,258 139,350 156,445 144,930 162,752 123,924 140,481 141,452 158,642 (50) (565) 158 20 7,431 8,622 (4,061) (3,967) 455 (675) (4,516) (3,292) 0 0 0 5,280 0 0 (4,516) 1,988 (.22) .12 (.22) .12 Footnotes: (1) Receivables consists of -- Accounts Receivable $1,555 $1,698 Royalties Receivable 394 437 ---------------------------------- Total $1,949 $2,125 ================================== (2) PP&E is net of accumulated depreciation and amortization of $45,001 and $39,188, respectively
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