-----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, BtTGzBI3Xq9xGaKw9k1mv+6LYyt9aim/T894Qbs8zGgpwkeT0TxCgpfBVa/R0uLs TlE0ebHmUDb7OMm0aIqkQQ== 0000891082-98-000005.txt : 19980331 0000891082-98-000005.hdr.sgml : 19980331 ACCESSION NUMBER: 0000891082-98-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971228 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: TACO CABANA INC CENTRAL INDEX KEY: 0000891082 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 742201241 STATE OF INCORPORATION: DE FISCAL YEAR END: 1228 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20716 FILM NUMBER: 98577272 BUSINESS ADDRESS: STREET 1: 8918 TESORO DRIVE STREET 2: SUITE 200 CITY: SAN ANTONIO STATE: TX ZIP: 78217-6219 BUSINESS PHONE: 2108040990 MAIL ADDRESS: STREET 1: 3309 SAN PEDRO AVE CITY: SAN ANTONIO STATE: TX ZIP: 78212 10-K 1 UNITED STATES 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 for the fiscal year ended December 28, 1997 Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 0-20716 TACO CABANA, INC. (Exact name of registrant as specified in its charter) Delaware 74-2201241 (State or other jurisdiction (IRS employer identification no.) of incorporation or organization) 8918 Tesoro Drive, Suite 200 San Antonio, Texas 78217 (Address of principal executive offices, including ZIP Code) (210) 804-0990 (Registrant's telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: Title of Each Class Name of Exchange on Which Registered None None Securities Registered Pursuant to Section 12(g) of the Act: Title of Each Class Common Stock, $0.01 par value 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 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. X As of February 27, 1998, the aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the last sale price of the Common Stock of the Registrant as quoted on the NASDAQ National Market was $77,427,725 (for purposes of calculating this amount, only directors, officers, and beneficial owners of 5% or more of the capital stock of the Registrant have been deemed affiliates). The number of shares of the Common Stock of the Registrant outstanding as of February 27, 1998 was 14,824,600. FORM 10-K INDEX 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 10 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS 11 ITEM 6. SELECTED FINANCIAL DATA 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 25 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 25 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 26 ITEM 11. EXECUTIVE COMPENSATION 29 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 34 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 35 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 36 PART I ITEM 1. BUSINESS General Taco Cabana, Inc., a Delaware corporation (the "Company"), pioneered the Mexican patio cafe concept with its first restaurant in 1978 and, as of December 28, 1997, operates and franchises a total of 109 such restaurants system-wide. Of these, the Company owns and operates 96 Taco Cabana restaurants, and two mall-unit Two Pesos restaurants. Franchisees of the Company own and operate the remaining 11 Taco Cabana restaurants. The Company's restaurants (including franchises) are located primarily in Texas, and are also located in Georgia, Indiana, New Mexico, and Oklahoma. Taco Cabana restaurants feature generous portions of fresh, premium quality Tex-Mex and traditional Mexican style food at an exceptional value. The restaurants provide interior, semi-enclosed and patio dining areas with a festive Mexican theme. Menu items include flame-grilled beef and chicken fajitas served on sizzling iron skillets, "Chicken Flameante"TM (a marinated rotisserie chicken), quesadillas, traditional Mexican and American breakfasts, other Tex-Mex dishes, fresh, hot flour tortillas, and lighter items such as a variety of salad entrees. Unlike many of its competitors, the Company makes most menu items fresh daily in each of its restaurants. Taco Cabana Food and Pricing Philosophy The Company is committed to selling premium food which it believes to be among the highest quality of any chain in the restaurant industry. This process begins with the selection of the freshest available ingredients. The Company's menu items are prepared strictly in accordance with authentic and well-tested recipes. Taco Cabana restaurants also offer a variety of beverage choices, including margaritas and beer. Alcoholic beverages currently account for approximately 5% of gross sales. The Ingredients. The Company has implemented a purchasing program structured to ensure that all of the ingredients used in the preparation of the Taco Cabana menu items are of the highest quality. The Company regularly inspects its vendors to ensure both that the products purchased by the Company conform to its standards, and that the prices offered are competitive. The meat used in making fajitas as well as certain other principal ingredients are purchased through supply contracts to ensure availability and minimize the risks of price fluctuation. The Preparation. The menu items offered at any Taco Cabana restaurant are prepared at that restaurant from fresh meat and produce ingredients delivered by suppliers at least three times each week to each restaurant. The Company is committed to differentiating itself from other quick service competitors by utilizing fresh, high quality ingredients as well as the preparation of most items "from scratch". The Company is currently testing several pre-prepared items to simplify the kitchen operations. Pricing Philosophy. The Company offers value by pricing its menu items below the price of comparable menu items in sit-down Mexican restaurants. Although Taco Cabana's food costs (as a percentage of sales) are generally higher than quick service chains as a result of the premium quality of ingredients used, the Company believes that this point of differentiation contributes to the achievement of average unit volumes in excess of most quick service restaurants. Taco Cabana Restaurants Restaurant Layout. Taco Cabana restaurants average approximately 3,200 square feet (exclusive of the exterior dining area) and provide seating for approximately 80 customers, with additional patio seating for approximately 50 customers. Taco Cabana restaurants are typically a vivid pink color (with painted and neon accents), conveying a distinctive Mexican theme and permitting easy identification by passing motorists. Inside, exposed elements of the kitchen display the freshness of Taco Cabana's food and the authenticity of its preparation. Taco Cabana's restaurant design enables customers to observe fresh fajitas cooking on a charcoal grill, a machine making fresh, hot flour tortillas, Chicken FlameanteTM rotating on spits and the preparation of other food items. Upon entry, the customer places an order selected from an overhead menu board, proceeds down a service line to where the order is picked up, and then passes a Salsa Bar en route to the dining area. The distinctive Salsa Bar offers Taco Cabana customers freshly prepared, authentic Tex-Mex ingredients such as Salsa de Fuego (made with charred peppers and tomatoes), pico de gallo and salsa (all "made from scratch" throughout the day at each restaurant), and cilantro, pickled jalapeno slices, crisp chopped onions, and fresh sliced limes. According to the season, time of day and personal preference, the customer may choose to dine either in the restaurant's brightly colored and festive interior dining area or the semi-enclosed or outdoor patio areas. The addition of traditional and contemporary Latin music, tropical landscaping, and authentic decorative artifacts create an overall dining environment which the Company believes is both attractive and festive. Most Taco Cabana restaurants also offer drive-thru service. The Company began constructing its new prototype restaurant in 1996. The prototype incorporates several new and different features that set it apart from Taco Cabana restaurants previously constructed. The new prototype features a rounded front, as well as Southwest accents such as a clay tile roof, heavy wood beams and a trellis that shades the patio area, and adds the use of bright colors outside and inside, including colored tiles, doors, windows, and awnings. Corrugated metal wall panels, aged wood finishes, and distressed stainless steel counter tops are featured inside, all of which are intended to replicate an old Mexican cafe. Bright neon on the exterior of the building broadcasts the unique menu items served at Taco Cabana. Favorite features retained from the original Taco Cabana restaurants include working garage doors that open up the dining area to the outside when weather permits, display cooking where the guest can see the food being prepared, liberal use of the Taco Cabana's signature pink color, and the self- serve fresh Salsa Bar. The prototype was designed to reduce overall construction costs, improve functional efficiency, allow for better guest service, and to enhance Taco Cabana's unique patio cafe image. During 1997, the Company initiated a re-image program for existing restaurants which incorporates many of the features of the new prototype design. During 1997, eight restaurants were re-imaged to the new prototype design and the Company expects to re-image 20 to 25 restaurants during 1998. Restaurant Locations. The following table sets forth the number of restaurants as of December 28, 1997 by area of dominant influence ("ADI") for television and radio advertising: ADI* Company-OwnedFranchised(1) Total San Antonio 32 0 32 Houston 26(2) 0 26 Austin 14 0 14 Dallas/Fort Worth 14 0 14 El Paso 7 0 7 Rio Grande Valley 2 0 2 Lubbock 2 0 2 Atlanta, Georgia 0 1(3) 1 Bryan/College Station 0 2 2 Tulsa, Oklahoma 1 0 1 Waco 0 1 1 Albuquerque, New Mexico 0 2 2 Amarillo 0 2 2 Corpus Christi 0 1 1 Ft. Wayne, Indiana 0 1 1 Killeen 0 1 1 --- --- --- Total 98 11 109 === === === ___________________________________________________________________ * All of the ADIs are located in Texas except as otherwise indicated. (1) Represents franchised Taco Cabana restaurants, except as otherwise indicated. Does not include licensed Two Pesos franchises. (2) Includes two mall-unit Taco Cabana restaurants and two mall- unit Two Pesos restaurant. (3) Represents a joint-venture Customer Convenience The Company operates its restaurants to enable customers to dine-in or take-out, as they choose. In most cases, the restaurants also provide the convenience of drive-thru windows which, in the aggregate, account for approximately 40% of the Company's sales. A majority of the restaurants are open 24 hours a day. This strategy is continually evaluated for economic viability on a restaurant by restaurant basis. Customer Service The Company is committed to consistently providing personal, attentive and efficient service in order to attract repeat customers. Restaurant and shift managers are encouraged to follow a "front of the house" style of management, which requires that the managers spend most of their time attending to customers at the register, drive-thru windows or in the dining areas. Marketing The Company utilizes an integrated, multi-level marketing approach which includes periodic company-wide promotions, direct mail, in-store promotions, local store marketing, and other strategies, including the use of radio advertising in its major markets. The Company will execute this plan utilizing a marketing budget of approximately 3.75% of sales. Expansion The Company's near-term strategy is to achieve a dominant or leading position among Mexican food restaurants in each of its targeted principal markets in order to obtain marketing and operating efficiencies. The Company seeks to implement this strategy by selectively adding restaurants in existing markets in order to expand its existing market share. In accordance with this strategy, the Company may locate new restaurants in close proximity to existing Taco Cabana restaurants in order to provide the Company with increased market penetration and market profitability, even if this may result in a reduction in comparable store sales volumes of certain restaurants. The Company's 1998 objective is to open eight to ten freestanding restaurants, all of which will be in existing markets. The Company believes the site selection process is very important in determining the potential success of a particular restaurant and senior management devotes substantial time and resources to analyzing each prospective site. The Company focuses on selecting locations which clear stringent hurdles with regards to the return on initial investment. A variety of factors are considered in the site selection process, including local market demographics, site visibility and accessibility (including drive-by traffic and ease of drive-thru accessibility), proximity to competitive operations, and proximity to generators of potential customers, such as major retailers, retail centers, medical or hospital facilities, office complexes, hotel concentrations, and stadiums, arenas, theaters or other entertainment centers. The Company currently uses a software model to assist in the evaluation of potential locations. The software model was developed by the Company using the services of a consulting firm during 1996. Restaurant Operations and Management The Company seeks to maintain quality and consistency in its restaurant operations by carefully training and supervising personnel and establishing exacting standards relating to food quality, friendliness of service and cleanliness of the restaurant facility. It is the Company's policy to ensure that customers are served quickly and that customers receive orders correctly filled and delivered in a courteous manner. The Company maintains financial and accounting controls for each of its restaurants through use of centralized accounting and management information systems. The Company has installed throughout all of its company-owned restaurants an in-store computer-based management support system that allows for daily polling of sales and labor information. Additionally, a separate management information system has been developed and implemented in all company-owned restaurants which provides for daily polling of food costs. This system records the receipt of inventory through the scanning of bar-codes and integrates with the point of sale system thus providing immediate cost of sales data and inventory records. The system is designed to improve food cost management, provide corporate management quicker access to financial data and reduce the time devoted by its restaurant managers to administrative responsibilities. Operations are managed by restaurant general managers who complete an intensive training program during which they are instructed in all areas of Taco Cabana's restaurant operations. Such areas of training include food preparation, customer service, cost controls, facility maintenance, communications skills and employee relations. Restaurant general managers are overseen by division leaders (individuals with responsibility for the operation of multiple restaurants within a market) and by regional Vice Presidents of Operations. An incentive plan has been established in which all restaurant and division leaders participate. Awards under the incentive plan are tied to the achievement of specified sales, profitability and qualitative performance goals. Franchising Program At December 28, 1997, the Company had four franchisees and one joint venture partner operating a total of 11 Taco Cabana restaurants. The Company did not enter into any new franchise agreements during 1997 and does not currently anticipate new franchisee signings during 1998. Competition Taco Cabana's restaurants compete both with fast food operations and with traditional sit-down Mexican restaurants. Management believes that the Company's combination of freshly prepared food, distinctive ambiance, and superior service help to distinguish Taco Cabana restaurants from fast food operations, while Taco Cabana's price-value relationship differentiates its restaurants from more expensive sit-down or casual dining restaurants. The food service industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established national, regional and locally-owned competitors in the Company's market areas, some of which have greater financial and other resources than the Company. Some of such competitors have also been in existence longer than the Company and are better established in areas where Taco Cabana's restaurants are or will be located. The restaurant business is often affected by changes in consumer tastes, economic conditions, population, traffic patterns, availability of employees and cost increases. Employees At December 28, 1997, the Company employed approximately 3,000 persons, of whom approximately 2,900 were operations employees and the remainder were corporate personnel. Most employees, other than restaurant management and 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 in the restaurant industry operating in its market area. The Company's employees are not covered by a collective bargaining agreement. The Company does not subscribe to any workers' compensation insurance program in the State of Texas, where the great majority of its company-owned restaurants are currently located. As such, it is subject to negligence actions by its employees and is not able to assert contributory negligence and certain other defenses. In addition, employees might be able to recover certain types of damages that would not be available to them if the Company subscribed to a workers' compensation insurance program. The Company self-insures a portion of such risk, and carries excess liability coverage that it believes is adequate. This practice has not had any material adverse effect upon the Company's operations or financial position since it was adopted in November 1988. Trademarks, Service Marks and Trade Dress The Company regards its trademarks, service marks and trade dress as having significant value and as being important to its marketing efforts. The Company has registered its principal Taco Cabana logo and design with the United States Patent and Trademark Office on the Principal Register as a service mark for its restaurant services, has secured or has applied for state and federal registrations of several other advertising or promotional marks, including variations of its principal mark and the service mark "Get Real," and has applied for registrations in foreign countries of its principal mark and several other marks. The Company's policy is to pursue registration of its principal marks and to oppose strenuously any infringement of its marks or trade dress. Government Regulation Each company-owned 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 relating to the development and operation of restaurants, including regulations relating to alcoholic beverage sales, environmental, building and zoning requirements, preparation and sale of food, and laws governing the Company's relationship with its employees, including minimum wage requirements, overtime, working conditions and citizenship requirements. 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 Trade Commission ("FTC") regulation and state laws which regulate the offer and sales of franchises. The Company may also become subject to state laws which regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires the Company to furnish to prospective franchisees a franchise offering circular containing prescribed information. A number of states in which the Company might consider franchising also regulate the offer and sale of franchises and require registration of the franchise offering with state authorities. State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states and bills have been introduced in Congress and other states from time to time which would provide for regulation of the franchisor-franchisee relationship in certain respects. Certain of such laws may restrict a franchisor in the termination of a franchise agreement, although these provisions have not had a significant effect on the Company's operations. The Company is 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 will increase the Company's labor costs. The Company is subject to the Texas "dram-shop" laws and may be subject to the "dram-shop" laws of certain other states. Dram-shop laws provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. The Company is also subject to the Americans with Disabilities Act of 1990, which, among other things, may require certain minor further renovations to existing restaurants to meet federally mandated access and use requirements. The cost of these renovations is not expected to be material to the Company. The Company believes that it is operating in substantial compliance with applicable laws and regulations governing its operations. Geographic Concentration During fiscal 1997, approximately 93% of the Company's net sales were derived from restaurants located in the State of Texas. As a result, the Company's results of operations may be materially affected by weather, economic or business conditions within these markets. Also, given the Company's present geographic concentration, adverse publicity relating to Taco Cabana restaurants could have a more pronounced adverse effect on the Company's overall sales than might be the case if the Company's restaurants were more broadly dispersed. ITEM 2. PROPERTIES The Company currently owns 42 of its restaurant buildings, 31 of its sites, and leases the remaining restaurant locations. The Company may purchase a number of its current and future restaurant locations where it is cost effective to do so. Substantially all of Taco Cabana's restaurants are free-standing buildings. The Company has typically needed 120 days after the signing of a lease and obtaining required permits to complete construction and open a new restaurant. Additional time is sometimes needed to obtain certain government approvals and licenses, such as liquor licenses. Land leased by the Company is typically leased under "triple net" leases that require the Company to pay real estate taxes and utilities and maintain insurance with respect to the premises and, in many cases, to pay contingent rentals based on sales in excess of specified amounts. The leases have initial terms of 10 to 20 years with options to renew for additional periods which range from 5 to 15 years. Approximately 95% of the Company's current leases have remaining terms or renewal options extending more than five years from December 28, 1997. ITEM 3. LEGAL PROCEEDINGS The Company is a party to franchise, routine negligence or employment-related litigation in the ordinary course of its business. No such pending matters, individually or in the aggregate, are deemed to be material to the results of operations or financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matter during the fourth quarter of the Company's fiscal year ended December 28, 1997 to a vote of the Company's stockholders, through the solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Common Stock, $.01 par value, of the Company ("Common Stock") began trading on the NASDAQ National Market on October 16, 1992, the effective date of the Company's initial public offering. Prior to October 16, 1992, there was no public market for the Common Stock. The table below sets forth, for the periods indicated, the reported high and low last sale prices of the Company's Common Stock, as reported on the NASDAQ National Market: High Low Fiscal Year Ended December 28, 1997 Quarter Ended December 28, 1997 $5 11/16 $4 1/16 Quarter Ended September 28, 1997 5 3/4 4 Quarter Ended June 29, 1997 5 1/2 3 15/16 Quarter Ended March 30, 1997 7 3/8 4 3/4 Fiscal Year Ended December 29, 1996 Quarter Ended December 29, 1996 $7 3/4 $5 5/16 Quarter Ended September 29, 1996 8 3/16 5 9/16 Quarter Ended June 30, 1996 8 7/8 7 Quarter Ended March 31, 1996 6 11/16 5 As of February 27, 1998, the last reported sale price of the Common Stock on the NASDAQ National Market System was $6.25 per share. As of February 27, 1998, there were approximately 1,000 record holders of Common Stock. On June 9, 1995 the Board of Directors declared a dividend distribution of Preferred Share Purchase Rights. The Rights may be redeemed by the Board of Directors for one cent per Right prior to the close of the tenth day (subject to extension by the Board of Directors to the 30th day) after a person or group acquires (or has obtained the right to acquire or announces an intent to acquire) through open-market purchases, a tender offer or otherwise, 15% or more of the Company's shares. For a 120-day period after any date of a change (resulting from a proxy or consent solicitation) in a majority of the Board of Directors in office at the time the solicitation was commenced, the Rights may only be redeemed if there are directors then in office who are continuing directors and the Board of Directors of the Company, with the concurrence of a majority of such continuing directors, determine that the redemption is in the best interest of the Company and its stockholders. The Rights were issued on June 20, 1995 to stockholders of record on that date and will expire in ten years. The Rights are not currently exercisable and automatically trade with the common shares. However, upon the earlier of (i) ten days after a person or group acquires or has obtained the right to acquire 15% or more of the Company's shares, or (ii) ten business days after a person or group commences or discloses an intent to commence a tender or exchange offer the consummation of which would result in such person or group owning 15% or more of the shares, and subject to the Board's right to set a later date (which date will not be later than the 30th day after an event described in (i) or (ii)), the Rights will become exercisable and separate certificates representing the Rights will be distributed. When the Rights first become exercisable, a holder will be entitled to buy from the Company one one-thousandth of a share of a new series of participating cumulative preferred stock for $37.50. If the Company is involved in a merger or other business combination with, or 50% or more of its assets or earning power are sold to, a publicly-traded person or group that has acquired 15% or more of the Company's shares, the "flip-over" provision of the Rights will be triggered and the Rights will entitle a holder to buy a number of shares of common stock of the acquiring company having a market value of twice the exercise price of each Right. If the acquiring person or group is not publicly traded, the "flip- over" provision of the Rights will be triggered and the Rights will entitle the holder to buy at the exercise price, at the holder's option (i) the number of shares of the surviving company having a book value of twice the exercise price, (ii) the number of shares of the acquiring company having a book value of twice the exercise price, or (iii) the number of shares of any publicly traded affiliate of the acquiring company having a market value of twice the exercise price. If any person or group acquires or has obtained the right to acquire 15% or more of the Company's outstanding Common Stock, the "flip-in" provision of the Rights will be triggered and the Rights will entitle a holder (other than such person or any member of such group) to buy that number of one one-thousandths of a preferred share equivalent to the number of shares of Common Stock of the Company having a market value of twice the exercise price of each Right. Following the acquisition by any person or group of 15% or more of the Company's Common Stock, the Board of Directors will also have the ability to exchange the Rights, in whole or in part, for consideration per Right consisting of one-half of the securities that would be issuable at such time upon the exercise of one Right or cash equal to the exercise price of the Right. In addition to authorizing the Stockholder Rights Plan, the Board authorized a new series of participating cumulative preferred stock purchasable upon exercise of the Rights. The shares of the new series of participating cumulative preferred stock will be nonredeemable. Each preferred share will be entitled to a quarterly dividend equal to the greater of $.01 per share or 1,000 times any dividend declared on the common shares during such quarter. In the event of liquidation, the holders of the preferred shares will be entitled to receive an aggregate liquidation payment equal to the greater of $.01 per whole share or an amount per share equal to 1,000 times the payment made per share of Common Stock. Each preferred share will have 1,000 votes, voting together with the common shares. Finally, in the event of any merger, consolidation or other transaction in which common shares are exchanged, each preferred share will be entitled to receive 1,000 times the amount received per common share. These rights are protected by customary anti-dilution provisions. In the event of issuance of preferred shares upon exercise of the Rights, in order to facilitate trading a depository receipt may be issued for each one one-thousandth of a preferred share. The dividend, liquidation and voting rights, and the non-redemption feature, of the preferred shares are designed so that the value of the one-thousandth interest in a preferred share purchasable with each right will approximate the value of one share of Common Stock. The Company has never declared or paid cash dividends on the Common Stock or any of its other securities. The Company presently intends to retain all earnings for the operation and development of its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. Any future determination as to the payment of cash dividends will depend on a number of factors, including future earnings, capital requirements, the financial condition and prospects of the Company and present restrictions under credit facilities, as well as such other factors as the Board of Directors may deem relevant. There can be no assurance that the Company will pay any dividends in the future. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data, which set forth certain financial information with respect to the Company, have been derived from the financial statements of the Company. The financial statements of the Company for each of the fiscal years in the five-year period ended December 28, 1997 have been audited by Deloitte & Touche LLP, independent certified public accountants. The following selected financial data should be read in conjunction with the Consolidated Financial Statements and the notes thereto included elsewhere in this report. January 1, January 1, December 31, December 29,December 28, 1994 (1) 1995 (2) 1995 1996 1997 ---------- --------- ------------- ----------- ------------ (in thousands, except per share data) Income Statement Data: REVENUES: Restaurant sales $95,290 $124,826 $137,191 $131,680 $131,857 Franchise fees and royalty income 1,582 2,424 1,342 516 346 ------- -------- -------- -------- -------- Total revenues 96,872 127,250 138,533 132,196 132,203 COSTS AND EXPENSES: Restaurant cost of sales and operating costs 77,871 102,236 115,195 107,703 110,440 General and administrative 3,393 4,818 6,068 6,445 6,964 Depreciation and amortization 4,705 7,112 10,301 9,245 9,659 Special charges (4) - - 8,100 2,497 78,738 Litigation settlement (3) - - - 3,400 - Reserve for notes and other receivables (5) - - 3,500 - - Total costs and expenses 85,969 114,166 143,164 129,290 205,801 ------- ------- ------- ------- ------- INCOME (LOSS) FROM OPERATIONS 10,903 13,084 (4,631) 2,906 (73,598) ------- ------- ------- ------- ------- NON-OPERATING INCOME (EXPENSE): 3 220 (1,397) (1,348) (1,137) ------- ------- ------- ------- ------- INCOME (LOSS) BEFORE INCOME TAXES 10,906 13,3040 (6,028) 1,558 (74,735) BENEFIT (PROVISION FOR INCOME TAXES (3,850) (4,784) 2,230 (854) 1,537 ------ ------ ------ ------ ------- NET INCOME (LOSS) $7,056 $8,520 $(3,798) $ 704 $(73,198) ====== ======= ======= ===== ======== BASIC EARNINGS (LOSS) PER SHARE (6) $ 0.58 $ 0.56 $(0.24) $ 0.04 $(4.78) ====== ====== ====== ====== ======= DILUTED EARNINGS (LOSS) PER SHARE (6) $ 0.55 $ 0.55 $(0.24) $ 0.04 $(4.78) ====== ====== ====== ====== ====== Balance Sheet Data: Total assets $118,747 $152,222 $148,578 $142,706 $76,260 Line of credit, long-term debt and capital leases, including current maturities 4,730 12,945 19,290 13,668 19,323 Stockholders' equity 100,964 115,652 112,327 113,172 36,413 Dividends per common share - - - - - (1) Includes results of operations of the acquired Two Pesos restaurants and five acquired franchised restaurants since their respective dates of acquisition. (2) Includes results of eight acquired franchised restaurants since their respective dates of acquisition. (3) Includes the 1996 litigation settlement for $3.4 million pre- tax, as described in Note 15 to the Consolidated Financial Statements. (4) Includes the charge related to the 1995 operations review of $8.1 million, the 1996 write-down of the Company's investment in a joint venture and the accrual of related exit costs of $2.5 million and the 1997 charge for the write down of impaired assets and the closure of seventeen restaurants as described in Note 2 to the Consolidated Financial Statements. (5) Reserve resulted from the 1995 operations review as described in Note 3 to the Consolidated Financial Statements. (6) The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Standards No. 128, Earnings Per Share. For further discussion of earnings per share and the impact of Statement No. 128, see Note 12 to the consolidated financial statements. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The Company commenced operations in 1978 with the opening of its first Taco Cabana restaurant in San Antonio. As of December 28, 1997, the Company had 98 company-owned restaurants, and 11 franchised restaurants including one joint venture owned restaurant. The Company's revenues are derived primarily from sales by company-owned restaurants, with franchise fees and royalty income contributing less than 1% of total revenues for the 1997 fiscal year. Since April 1992, the Company has acquired a total of 58 restaurants. These acquisitions were accounted for under the purchase method of accounting. Goodwill aggregating approximately $47.7 million recognized in connection with these acquisitions is being amortized on a straight-line basis over periods ranging from 25 to 40 years. In conjunction with the special charge that was recorded in the fourth quarter of 1997, goodwill in the amount of $33.1 million was determined to be impaired in accordance with Statement of Financial Accounting Standards No. 121 (FAS 121). See discussion of the special charge hereunder in "Results of Operations - Fiscal 1997 Compared to Fiscal 1996" and Note 2 to the Consolidated Financial Statements. During the fiscal year ended December 28, 1997, the Company opened seven restaurants, acquired one restaurant from a franchisee and closed fourteen restaurants. Additionally, franchisees of the Company closed five restaurants. Results of Operations The following table sets forth the percentage relationship to total revenues, unless otherwise indicated, of certain income statement data. The table also sets forth certain restaurant data for the periods indicated. Fiscal Year Ended December 31, December 29, December 28, 1995 1996 1997 Income Statement Data: REVENUES: Restaurant sales 99.0% 99.6% 99.7% Franchise fees and royalty income 1.0 0.4 0.3 ----- ----- ----- Total revenues 100.0 100.0 100.0 ===== ===== ===== COSTS AND EXPENSES: Restaurant cost of sales (1) 32.1 31.4 30.8 Labor (1) 26.4 26.3 27.4 Occupancy (1) 6.0 6.2 6.2 Other restaurant operating costs (1) 19.4 17.9 19.3 General and administrative costs 4.4 4.9 5.3 Depreciation and amortization 7.4 7.0 7.3 Special charges 5.8 1.9 59.6 Litigation settlement - 2.6 - Reserve for notes and other receivables 2.5 - - ----- ----- ----- INCOME (LOSS) FROM OPERATIONS (3.3) 2.2 (55.7) INTEREST EXPENSE, NET (1.0) (1.0) (0.9) ----- ----- ----- INCOME (LOSS) BEFORE INCOME TAXES (4.3) 1.2 (56.5) INCOME TAXES 1.6 (0.6) 1.2 ----- ----- ----- NET INCOME (LOSS) (2.7)% 0.5% (55.4)% ===== ===== ===== Restaurant Data: COMPANY-OWNED RESTAURANTS: Beginning of period 104 106 104 Opened 12 1 8 Acquired 1 - - Sold (Refranchised) (3) - - Closed (8) (3) (14) --- --- --- End of period 106 104 98 FRANCHISED RESTAURANTS (2): 21 17 11 --- --- --- TOTAL RESTAURANTS: 127 121 109 ______________ === === === (1) As a percentage of restaurant sales. (2) Excludes Two Pesos licensed restaurants. Fiscal 1997 Compared to Fiscal 1996 Restaurant Sales. Restaurant sales increased $177,000, or 0.1%, to $131.9 million for fiscal 1997 from $131.7 million for fiscal 1996. The increase in sales is due to an increase in the number of store operating weeks during 1997 compared to 1996. The increase was offset by a decrease in comparable store sales in 1997 compared to 1996. In the aggregate, the number of operating weeks increased 1.6% in 1997 compared to 1996. Comparable store sales, defined as Taco Cabana restaurants that have been open 18 months or more at the beginning of each quarter, decreased 2.9% during 1997. Much of the decline in comparable store sales occurred during the first six months of the year. Comparable stores sales for the first six months of fiscal 1997 decreased 4.8%, while comparable store sales for the last six months of the year decreased only 0.8%. Management attributes much of the decline during the first six months to unfavorable weather conditions, significant declines in the Colorado market (which was closed in November 1997), and a promotional strategy which highlighted higher priced, premium products in an intensely price competitive landscape. This strategy was changed during the second half of the year to a promotional strategy which continually highlights various meals at a competitive price. Franchise Fees and Royalty Income. Franchise and royalty fees decreased $170,000 to $346,000 for 1997, from $516,000 for 1996, due primarily to a decrease in the number of franchises open during 1997 compared to 1996. Restaurant Cost of Sales. Restaurant cost of sales, calculated as a percentage of restaurant sales, decreased to 30.8% in 1997 from 31.4% in 1996. The decrease was due primarily to continued improvements in the management of food costs through utilizing increased controls and improved purchasing programs, including the continued negotiation of favorable commodity pricing. Labor. Labor costs, calculated as a percentage of sales, increased to 27.4% for the year ended December 28, 1997 compared to 26.3% in 1996. The increase is due to lower average unit volumes as well as management's commitment to increase staffing levels at the restaurant level in order to provide a consistent guest experience. In addition, approximately 15% of this increase in percentage of sales amount is due to increased labor costs associated with the Colorado market. During January 1997, the Company announced its plans to commit additional resources, primarily in marketing and restaurant level staffing, in an attempt to reverse the negative sales trends and operating losses of this market. The restaurants in the market were closed during November 1997. Occupancy. Occupancy costs increased slightly during 1997 compared to 1996. The increase is due to an increase in the number of restaurants open during fiscal 1997 compared to fiscal 1996. Other Restaurant Operating Costs. Other restaurant operating costs increased by $1.9 million for the year ended December 28, 1997 compared to the same period of 1996. As a percentage of restaurant sales, other restaurant operating costs increased to 19.3% for the year ended December 28, 1997 compared to 17.9% in the same period of 1996, primarily due to decreased sales at the restaurant level and additional marketing expenditures during the year ended December 28, 1997. Total marketing expenditures accounted for 4.7% of sales in 1997 versus 3.8% in 1996. Approximately $600,000, or 0.5% of sales, of this increase was due to increased marketing in the Colorado market. It is currently anticipated that marketing expenditures will amount to 3.75% of sales during 1998. General and Administrative. General and administrative expenses increased to $7.0 million from $6.4 million, and increased as a percentage of total revenues to 5.3% for the year ended December 28, 1997 from 4.9% for the comparable period in 1996. This increase was primarily attributable to the addition of corporate support staff, as well as an increased level of expenditures to support the Company's operations, offset by lower bonus accruals. Depreciation and Amortization. Depreciation and amortization expense consisted of the following: Year Ended ---------- December 29, December 28, 1996 1997 ------------ ----------- Depreciation of property and equipment $7,079,000 $7,942,000 Amortization of intangible assets 1,651,000 1,313,000 Amortization of pre-opening costs 515,000 404,000 Depreciation expense increased by approximately $863,000 for fiscal 1997 compared to fiscal 1996. The increase was due primarily to restaurant openings during 1997, as well as capital expenditures on existing restaurants during 1997 and 1996. The increase was partially offset by a reduction in depreciation due to the closure of 14 restaurants and the write-down of certain depreciable assets during the fourth quarter of 1997. Amortization of intangible costs decreased by $338,000 primarily due to the write-off of goodwill and other intangible costs during the fourth quarter of 1997. Amortization of pre-opening costs decreased by approximately $111,000 during fiscal 1997 compared to fiscal 1996, due to the decrease in the number of restaurants opened during the most recent twelve-month period compared to the twelve-month period ended December 29, 1996. Special Charge. During the fourth quarter of fiscal 1997, management made the decision to close the seven restaurants in its Colorado market. As previously announced, the Company committed substantial resources to this market during 1997 in an attempt to reverse trends of poor sales and losses. The desired results from the implementation of the plan were not achieved and the decision to close the market was made. These seven restaurants had total sales of approximately $3.0 million and operating losses of $2.1 million during the approximately eleven months of 1997 that they were in operation. Additionally, the Company continued to experience unfavorable sales trends during 1997, concluding the year with comparable restaurant sales declining 2.9%. However, during the first six months of 1997, comparable restaurant sales declined 4.8%. This trend compelled management to continue its evaluation of the operating model of the Company. During this evaluation, management concluded that certain volumes must be achieved in order to operate individual restaurants in accordance with Company standards. These standards include food quality, cleanliness, speed of service, and profitability. Management reviewed all existing restaurants to determine which restaurants could not reasonably be expected to achieve these volume levels, generally annual revenues of at least $1 million. This led to the decision to close an additional ten restaurants. Due to the significance of the closures described above, management performed an evaluation of the recoverability of all remaining assets as described in Statement of Financial Accounting Standards No. 121 (FAS 121). Management concluded from the results of this evaluation that a significant impairment of intangible as well as long-lived assets was required to be recognized. The impairment was reflective of a market value determined to be less than the carrying value of approximately 40 restaurants, 31 of which were acquired. The assets were tested for impairment by projecting cash flows for individual restaurants based on recent results and trends specific to that restaurant. The undiscounted projected cash flows for each restaurant were compared to the carrying value for that restaurant, including allocated goodwill, where applicable. If the undiscounted cash flows were less than the carrying value, an impairment was deemed to have occurred. The amount of the impairment was determined by calculating the difference between the present value of the projected cash flows and the carrying value attributable to the specific restaurant. The cash flows were discounted using the rate of return the Company utilizes for approving new restaurant construction. Such discounted cash flows are, in management's opinion, the best estimate of the assets current value. Considerable management judgment is necessary to estimate future discounted cash flows. Accordingly, actual results could vary significantly from management's estimates. The process described above resulted in the Company's recording a special charge during the fourth quarter of 1997 of $78.7 million pre-tax, $75.7 million after-tax, or $4.94 per share. This amount had the following components: Impairment of intangible assets of $33.1 million and impairment of long-lived assets of $22.1 million for restaurants that will continue in operation, based on the FAS 121 analysis described above; A provision of $23.3 million for the closure of seventeen restaurants, including all of the restaurants in the Colorado market. The amount was determined in accordance with FAS 121 and is comprised of: $13.3 million for the carrying value of the assets, net of estimated proceeds of $1.5 million for the sale of restaurant properties; $9.0 million to record the estimated lease related obligations for closed restaurants. This amount was determined as the lesser of the present value of the monthly lease commitments, net of expected sublease receipts, or lease termination provisions; $500,000 for severance and relocation benefits paid to employees displaced by the restaurant closures; $500,000 for the probable settlement of a franchisee lawsuit related to the Colorado market The write-off of other assets totaling $200,000. During 1997, the seventeen restaurants contributed a total of $9.6 million in sales, and had operating losses totaling $2.5 million. In addition, the total amount of depreciation an amortization recorded during 1997 relating to assets which were impaired was approximately $3.2 million. A total of approximately $473,000 of the amounts accrued had been paid prior to December 28, 1997. It is currently anticipated that payments of approximately $1.5 million will be made under the lease obligations during 1998. It is also anticipated that proceeds of approximately $1.5 million will be realized due to the sale of closed restaurants, although there can be no assurance of the particular price at which any of such properties will be sold. Interest Expense, net. Interest expense, net of interest income and interest capitalized on construction costs, decreased to $1.1 million in fiscal 1997 from $1.3 million in fiscal 1996. The difference is due to lower interest expense due to a decrease in the average debt outstanding during 1997 compared to 1996, a reduction in interest income and an increase in interest capitalized on construction cost. The Company earned $76,000 of interest income during 1997, compared to $201,000 of interest income earned during the 1996. The decrease was due to a reduction in short-term investments. In addition the Company capitalized $147,000 of interest during 1997. No interest was capitalized during 1996. Net Income (Loss) and Net Income (Loss) Per Share. The Company recorded a net loss of $73,198,000 for 1997 compared to net income of $704,000 for 1996. Net loss per share was $4.78 for 1997 compared to net income per share of $0.04 in 1996. The loss recorded in 1997 includes special charges totaling $78.7 million pretax ($75.7 million after-tax, or $4.94 per share). Excluding these charges, the Company would have reported net income of $2.5 million equal to $0.16 per share in fiscal 1997. Net income in 1996 included charges totaling $5.9 million pretax ($4.0 million after-tax, or 26 cents per share). Excluding these charges, the Company would have reported net income of $4.7 million equal to $0.30 per share for fiscal 1996. Disregarding these charges, management believes that the decrease in income is largely due to declining sales, and increased labor and marketing expenditures. Management has taken steps to address these issues as outlined in the description of the special charge. Fiscal 1996 Compared to Fiscal 1995 Restaurant Sales. Restaurant sales decreased by $5.5 million, or 4.0%, to $131.7 million for fiscal 1996 from $137.2 million for fiscal 1995. The decrease in sales was due to a decrease in the number of restaurants open during 1996 compared to 1995 and due to a decrease in comparable store sales in 1996 compared to 1995. In the aggregate, the number of operating weeks declined 2.9% in 1996 compared to 1995. Comparable store sales, defined as Taco Cabana restaurants that have been open 18 months or more at the beginning of each quarter, decreased 2.1% during 1996. Comparable store sales in the Company's core markets of San Antonio, Austin, Houston, and Dallas, which represent over 90% of the Company's sales volume, increased 0.1% during 1996. Management attributes much of the decline in sales to the adverse economic conditions in the Texas - Mexico border market. The Company also experienced a decrease in sales in its Colorado market during 1996. Franchise Fees and Royalty Income. Franchise and royalty fees decreased by approximately $826,000 to $516,000 for 1996, compared to approximately $1.3 million for 1995, due primarily to a decrease in fees from new franchise development agreements and related franchise royalties and due to a decrease in the number of franchises open during 1996 compared to 1995. Restaurant Cost of Sales. Restaurant cost of sales, calculated as a percentage of restaurant sales, decreased to 31.4% in 1996 from 32.1% in 1995. The decrease was due primarily to improvements in the management of food costs through utilizing increased controls and improved purchasing programs, including the negotiation of favorable commodity pricing at the beginning of 1996. Labor. Labor costs calculated as a percentage of restaurant sales improved slightly to 26.3% during 1996 from 26.4% in 1995. The labor costs were negatively impacted due to an increase in salaried restaurant management and a relatively high rate of restaurant management turnover. The turnover was part of the Company's continuing process of raising the standards and accountability within the management ranks of the Company. Occupancy. Occupancy costs decreased slightly during 1996 compared to 1995. The decrease is due to a decrease in the number of restaurants open during fiscal 1996 compared to fiscal 1995. As a percentage of restaurant sales, occupancy costs increased to 6.2% in 1996 compared to 6.0% in 1995. The increase was due to decreased sales at the restaurant level. Other Restaurant Operating Costs. Other restaurant operating costs as a percentage of restaurant sales decreased to 17.9% in 1996 from 19.4% for 1995. This decrease was due primarily to management's increased focus on unit level operations. General and Administrative. General and administrative expenses increased to $6.4 million from $6.1 million, and increased as a percentage of total revenues to 4.9% for fiscal 1996 from 4.4% for fiscal 1995. This increase was primarily attributable to the addition of management, as well as an increased level of expenditures to support the Company's operations. Depreciation and Amortization. Depreciation and amortization expense consisted of the following: Year Ended ---------- December 31, December 29, 1995 1996 ------------ ------------ Depreciation of property and equipment $6,209,000 $7,079,000 Amortization of intangible assets 1,663,000 1,651,000 Amortization of pre-opening costs 2,429,000 515,000 Depreciation expense increased by approximately $870,000 for the year ended December 29, 1996 compared to the year ended December 31, 1995. The increase was due primarily to restaurant openings during 1995, as well as capital expenditures on existing restaurants during 1996. Amortization of pre-opening costs decreased by approximately $1.9 million in the year ended December 29, 1996 compared to the year ended December 31, 1995, due to the decrease in the number of stores opened during fiscal 1996 compared to fiscal 1995. Litigation Settlement. On July 24, 1996, the Company approved the settlement of A.L. Park, et al v. Taco Cabana, Inc., et al., a suit originally filed in September 1995 seeking status as a class action. As a result thereof, the Company recorded a charge of $3.4 million pre-tax, $2.2 million after-tax, or $0.14 per share, during the second quarter of fiscal 1996. Under the terms of the settlement, the plaintiffs received a total of $6.0 million of which the Company's insurance carrier paid $3.05 million. Additionally, the Company has paid approximately $450,000 for legal and related expenses incurred in connection with the settlement Special Charge. The Company has a 50% interest in a joint venture which operated three restaurants in the Atlanta market. During the fourth quarter of 1996, the Company decided to write- down its investment in the joint venture and accrue for certain costs associated with the closing of two of the three restaurants operated by the joint venture. This decision resulted in a special charge of approximately $2.5 million pre-tax, $1.7 million after-tax or $0.11 per share. The special charge was comprised of the following: Write-down of investment in joint venture $ 1,191,000 Reserve for notes and accounts receivable 268,000 Estimated lease obligations 632,000 Legal and professional fees 245,000 Other costs 161,000 Two of the three restaurants in the Atlanta market were closed during the first quarter of 1997. It is currently anticipated that the third restaurant will remain in operation. Interest Income (Expense). Interest expense, net of interest capitalized on construction costs, decreased to $1.1 million in 1996 from $1.2 million in 1995 as a result of the repayment of a substantial portion of the Company's outstanding borrowings during 1996. The Company earned $201,000 of interest income during 1996 on cash balances compared to $310,000 of interest income earned during 1995. The decrease was due to a reduction in short-term investments during 1996. Net Income (Loss) and Net Income (Loss) Per Share. The Company recorded net income of $704,000 for 1996 compared to a net loss of $3.8 million for 1995. The recorded net income was 0.5% as a percentage of total revenues for 1996 compared to net loss of 2.7% as a percentage of total revenues for 1995. Income per share was $0.04 for 1996 compared to loss per share of $0.24 in 1995. Disregarding the litigation settlement, the reserve for notes and other receivables and the special charges, the Company would have reported net income of $4.7 million, equal to $0.30 per share or 3.6% as a percentage of revenues, for 1996 compared to $3.5 million, equal to $0.22 per share or 2.5% as a percentage of total revenues, for 1995. Disregarding the litigation settlement and the special charges, management believes that the remaining increase was largely due to better cost controls at the restaurant level as well as a substantial decrease in amortization of pre-opening costs. Liquidity and Capital Resources Historically, the Company has financed business and expansion activities by using funds generated from operating activities, build-to-suit leases, equity financing, short and long-term debt and capital leases. The Company maintains credit facilities totaling $30 million, including a $5 million unsecured revolving line of credit. As of February 27, 1998, approximately $16.4 million had been used under these commitments. Net cash provided by operating activities was $12.9 million for 1997, compared to $12.2 million for 1996. Net cash used in investing activities was $15.4 million for 1997, representing primarily capital expenditures for improvements to existing restaurants, the construction of five free-standing and two non- traditional restaurants, and the conversion of two Sombrero Rosa and two Two Pesos restaurants to the Taco Cabana concept. This compared to $8.7 million for 1996, representing primarily capital expenditures for improvements to existing restaurants, the construction of one restaurant, and the purchase of two pieces of land for future development. Net cash provided by financing activities was $2.1 million for 1997 representing primarily net borrowings under the Company's credit facilities, offset in part by the purchase of $3.6 million of the Company's stock in market transactions, which is held as treasury stock. This compared to net cash used by financing activities of $5.5 million in 1996 representing primarily repayment of the Company's line of credit and long term debt. On April 16, 1997, the Company's Board of Directors approved a plan to repurchase up to 1,500,000 shares of the Company's Common Stock. As of December 28, 1997 the Company had repurchased 871,937 shares at an average cost of $4.08 per share. The timing, price, quantity and manner of remaining purchases, if any, will be made at the discretion of management and will be dependent upon market conditions. The Company has funded the repurchases through available bank credit facilities, as well as the liquidation of the Company's short term investment portfolio. Remaining purchases, if any, will be funded through a combination of cash provided by operations and available bank credit facilities. The special charge recorded in the fourth quarter of 1997 included an accrual of approximately $9.0 million for closed restaurant liabilities. A total of approximately $473,000 of the amounts accrued had been paid prior to December 28, 1997. It is currently anticipated that payments of approximately $1.5 million will be made under lease and other obligations during 1998. It is also anticipated that proceeds of approximately $1.5 million will be realized due to the sale of closed restaurants, although there can be no assurance of the particular price at which any of such properties will be sold. The special charge recorded during the fourth quarter of 1996 included an accrual of approximately $1.0 million for the estimated lease obligations, legal and professional costs and other costs associated with the closing of two of the three restaurants operated by a joint venture in which the Company has a 50% interest. Cash requirements for this accrual were approximately $35,000 for the year ended December 28, 1997. The special charge recorded in the second quarter of 1995 included an accrual of approximately $1.2 million to record the estimated monthly lease payments, net of expected sublease receipts, associated with certain restaurants which have been closed. Cash requirements for this accrual were approximately $333,000 in 1997. During 1997, the Company sold properties relating to the 1995 special charge which resulted in proceeds of $603,000, which approximated the carrying value of the assets sold. Subsequent to December 28, 1997, the company sold properties relating to the special charge which resulted in proceeds of $1.3 million, which approximated the carrying value of the assets sold. The Company currently has one closed restaurant property for sale which was covered by the 1995 special charge. Although there can be no assurance of the particular price at which such property will be sold, the Company expects to receive funds equal to or in excess of the carrying value upon the actual disposition of this property. In addition, certain acquisition and accrued liabilities related to the Two Pesos acquisition were reduced by payments of approximately $900,000 during 1997. The Company believes that existing cash balances, funds generated from operations, its ability to borrow, and the possible use of lease financing will be sufficient to meet the Company's capital requirements through 1998, including the planned opening of eight to ten restaurants and the reimaging of 20 to 25 restaurants. Total capital expenditures related to new restaurants are estimated to be $12.0 to $15.0 million. The total for other capital expenditures, including the cost of the reimagings, is estimated to be $7.5 to $8.5 million. Total capital expenditures for 1998 are expected to approximate $19.5 to $23.5 million. Impact of Inflation Although increases in labor, food or other operating costs could adversely affect the Company's operations, management does not believe that inflation has had a material adverse effect on the Company's operations to date. Seasonality and Quarterly Results The Company's sales fluctuate seasonally. Historically, the Company's highest sales and earnings occur in the second and third quarters. In addition, quarterly results are affected by the timing of the opening of new stores, and the Company's growth may offset the impact of seasonal influences. Therefore, quarterly results are not indicative of results for the entire year. Year 2000 Issue The Company relies to a large extent on computer technology to carry out its day-to-day operations. Many software products in the marketplace are only able to recognize a two digit year date and therefore will recognize a date using "00" as the year 1900 instead of the year 2000 (the "Year 2000 Issue"). This problem could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in similar normal business activities. Based on a recent assessment, the Company has determined that it will be required to modify or replace significant portions of its software so that its systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications to existing software and conversions to new software, the effects of the Year 2000 Issue upon its operations can be mitigated. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company. The Company has initiated formal communications with all significant suppliers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate Year 2000 Issue effects upon their own operations, products or services. The Company's total Year 2000 Issue project cost and estimates to complete include estimated costs and time associated with the impact of a third party's Year 2000 Issue, and are based on presently available information. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company will use both internal and external resources to reprogram, or replace, and test software for Year 2000 Issue modifications. The Company plans to complete the Year 2000 Issue project by December 31, 1998. The total cost of the Year 2000 Issue project is estimated to be $600,000, of which the Company has incurred $400,000 relating to the purchase of new software. The costs relating to the Year 2000 Issue are being financed through operating cash flows and borrowings from the Company's available credit facilities. Of the total project cost, the majority is attributable to the purchase of new software which will be capitalized. The remaining amount, which will be expensed as incurred over the next two years, is not expected to have a material effect on the results of operations. To date, the costs the Company has incurred and expensed relating to the assessment of, and preliminary efforts in connection with, its Year 2000 Issue and the development of a remediation plan have not had a material effect on the results of operations. The costs of the project and the date on which the Company plans to complete the Year 2000 Issue project are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ from those plans. Specific factors that that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer code, and similar uncertainties. Forward-Looking Statements Statements in this Annual Report, including those contained in the foregoing discussion and other items herein, concerning the Company which are (a) projections of revenues, capital expenditures, costs and expenses or other financial items, (b) statements of plans and objectives for future operations, (c) statements of future economic performance, or (d) statements of assumptions or estimates underlying or supporting the foregoing are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. The ultimate accuracy of forward-looking statements is subject to a wide range of business risks and changes in circumstances, and actual results and outcomes often differ from expectations. Any number of important factors could cause actual results to differ materially from those in the forward-looking statements herein, including the following: the timing and extent of changes in prices; actions of our customers and competitors; state and federal environmental, economic, safety and other policies and regulations, any changes therein, and any legal or regulatory delays or other factors beyond the Company's control; execution of planned capital projects; weather conditions affecting the Company's operations or the areas in which the Company's products are marketed; natural disasters affecting operations; and adverse rulings, judgments, or settlements in litigations or other legal matters. The Company undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unantincipated events. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data are set forth in this annual report on Form 10-K commencing on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors and Executive Officers The directors and executive officers of the Company and their respective ages are as follows: Name Age Position Stephen V. Clark 44 Chief Executive Officer, President and Director James A. Eliasberg 40 Executive Vice President and General Counsel David G. Lloyd 34 Senior Vice President - Finance, Chief Financial Officer, Secretary and Treasurer Douglas Gammon 51 Senior Vice President - Human Resources and People Development William J. Nimmo 43 Director Richard Sherman 54 Director Cecil Schenker 55 Director Lionel Sosa 58 Director Mr. Clark has served as the Company's Chief Executive Officer since November 1996, and as the President, Chief Operating Officer, and as a Director since April 1995. Prior to that, Mr. Clark was with Church's Chicken, a division of America's Favorite Chicken, for eighteen years with his final title having been Senior Vice President and Concept General Manager. He also served on the executive committee of America's Favorite Chicken and was on the Board of Directors of Church's Operators Purchasing Association. In his final position with America's Favorite Chicken, Mr. Clark was primarily responsible for the day-to-day operations of over 1100 company-owned and franchised units with aggregate sales volume in excess of $600 million. Mr. Eliasberg has served as the Company's Executive Vice President and General Counsel since April 1995. From January 1991 to April 1995, Mr. Eliasberg served as the Company's Senior Vice President and General Counsel. Prior to that, Mr. Eliasberg was engaged in the private practice of law in Southern California at the law firms of Fierstein & Sturman (March 1989 to January 1991), Hill, Wynne, Troop & Meisinger (May 1986 to February 1989) and Jones, Day, Reavis & Pogue (October 1984 to March 1986). In addition to supervising all of the Company's legal affairs, Mr. Eliasberg's responsibilities include real estate, construction and franchise development. Mr. Eliasberg is a graduate of the University of Chicago law school. Mr. Lloyd joined the Company in October 1994 as Vice President - Finance, Chief Financial Officer, Secretary and Treasurer and was promoted to Senior Vice President in May 1996. From August 1985 to October 1994, Mr. Lloyd served in various capacities with Deloitte & Touche (the Company's independent auditors), with his last position being Senior Audit Manager. Mr. Lloyd is a certified public accountant. Mr. Gammon joined the Company in March 1997 as Senior Vice President, Human Resources and People Development. From December 1989 to March 1997, Mr. Gammon served as Vice President of Human Resources at Marriott International which has over 15,000 employees in 50 states. Mr. Gammon has over 18 years of experience in the human resources field as well as over six years experience in restaurant operations. He was the past President for the Council of Hotel and Restaurant Trainers. Mr. Nimmo has served as a director of the Company since November 1991. Since May 1997, Mr. Nimmo has been a Partner with Halpern, Denny & Co., a venture capital firm in Boston Massachusetts. Prior to that, Mr. Nimmo served as Managing Director of Cornerstone Equity Investors, Inc., and its predecessor firm, Prudential Equity Investors, Inc., since September 1989. Mr. Sherman has been a director of the Company since November 1991. Mr. Sherman is a private investor and retail consultant. Mr. Sherman served as President and Chief Executive Officer of Rally's, Inc. from September 1987 to January 1991. From August 1989 to January 1991, he also served as Chairman of the Board of Rally's, Inc. Mr. Sherman currently serves as a member of the Board of Trustees of Paul Quinn College in Dallas, Texas and as a director of Reed's Jewelers, Inc., Papa John's International, Inc., and PJ America, Inc. Mr. Schenker has been a director of the Company since January 1992. Mr. Schenker is a corporate securities attorney and is the managing partner of the San Antonio, Texas office of the law firm of Akin, Gump, Strauss, Hauer & Feld, L.L.P., of which Mr. Schenker has been a partner through his professional corporation since January of 1984. Akin, Gump, Strauss, Hauer & Feld, L.L.P. has regularly performed legal services for the Company. Mr. Schenker is also a director of LOT$OFF Corporation, formerly 50-Off Stores, Inc. Mr. Sosa has been a director of the Company since August, 1997. Mr. Sosa has served as the Chief Executive Officer of KJS Marketing Agency since January 1996. From 1994 to 1996 he served as Chairman of DMB&B/Americas, a network of advertising agencies in the U.S. and Latin America. In 1980 Mr. Sosa founded the agency of Sosa, Bromley, Aguilar, Noble & Associates, an advertising agency specializing in Hispanic marketing in the U.S. Mr. Sosa sold Sosa, Bromley, Aguilar, Noble & Associates in 1994. Mr. Sosa is currently a Director of the Children's Television Workshop Network. The Board of Directors has a compensation and stock option committee which currently consists of William J. Nimmo, Richard Sherman and Lionel Sosa. The Board of Directors also has an audit committee which currently consists of William J. Nimmo, Richard Sherman, Lionel Sosa and Cecil Schenker. The Board of Directors does not currently have a nominating committee. All directors serve for a term of one year and until their successors are duly elected. Each director who is not also an employee of the Company receives an annual retainer of $25,000, and an attendance fee of $2,500 per Board meeting for up to four meetings each year. All non-employee directors are reimbursed for their expenses. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") requires each director and executive officer of the Company, and each person who owns more than 10% of a registered class of the Company's equity securities to file by specific dates with the Securities and Exchange Commission (the "SEC") initial reports of ownership and reports of change in ownership of Common Stock and other equity securities of the Company. Officers, directors and 10% stockholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. The Company is required to report in this report any failure of its directors and executive officers to file by the relevant due date any of these reports during the Company's fiscal year. To the Company's knowledge, all Section 16(a) filing requirements applicable to the Company's officers, directors, and 10% stockholders were complied with, except for one late filing as to a Form 3 for Douglas Gammon. ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table. The following table sets forth certain information concerning the compensation earned during the Company's last three fiscal years by the Company's Chief Executive Officer and the Company's other executive officers (collectively the "named executive officers"): Summary Compensation Table Annual Compensation Long-Term Compensation -------------------- ------------------------ Pay- Awards outs ------------------- ------ Other Securites All Annual Restricted Underlying LTIP Other Name and Compen- Stock Options/ Pay- Compen- Principal Fiscal Salary Bonus sation Award(s) SARs outs sation Position Year ($) ($) ($)(1) ($) (#) ($) ($) Stephen V. 1997 255,420 - - - - - - Clark, Chief 1996 233,404 - - - - - - Executive Officer, 1995 152,455(2) 50,000 - - 200,000 - - President , Chief Operating Officer James A. 1997 191,877 - - - - - - Eliasberg, Executive 1996 189,235 - - - - - - Vice President 1995 175,025 - - - 200,000 - - and General Counsel David G. 1997 143,528 - - - - - - Lloyd, Senior Vice 1996 135,138 - - - - - - President, Chief 1995 117,605 - - - 75,000 - - Financial Officer, Secretary and Treasurer Douglas 1997 113,820(3) - 55,135(4) - 75,000 - - Gammon Senior Vice President - Human Resources and People Development __________________ (1) Certain of the Company's executive officers receive personal benefits in addition to salary; however, the Company has concluded that the aggregate amounts of such personal benefits do not exceed the lesser of $50,000 or 10% of annual salary and bonus reported for any named executive officer. (2) Mr. Clark joined the Company in April 1995. (3) Mr. Gammon joined the Company in March 1997. (4) Represents relocation expense reimbursements. Employment Agreements. The Company has written employment agreements with Stephen Clark and James Eliasberg. The Company's agreement with Mr. Clark expires in April 1998. Mr. Clark receives a base salary of not less than $200,000 per year during the term of his contract. Additionally, Mr. Clark can be paid a bonus based on the Company's achievement of certain performance goals. Pursuant to such agreement, Mr. Clark has agreed not to participate in any manner, during his term of employment and for two years thereafter, in any business which owns a Mexican fast food restaurant or Mexican "quick service" restaurant in the Continental United States. The Company's agreement with Mr. Eliasberg expires in April 1998. Mr. Eliasberg receives a base salary of $185,000 per year during the term of his contract. Additionally, Mr. Eliasberg will be paid a bonus based on the Company's achievement of certain performance goals. Pursuant to such agreement, Mr. Eliasberg has agreed not to participate in any manner, during his term of employment and for two years thereafter, in any business which owns a Mexican fast food restaurant or Mexican "quick service" restaurant in the Continental United States. Stock Option Plans and Directors' Options Under the Taco Cabana, Inc. 1990 Stock Option Plan (the "1990 Option Plan"), amended in August 1992, and the 1994 Stock Option Plan (the "1994 Option Plan"), amended in August 1997, options to purchase up to 1,500,000 and 1,250,000 shares, respectively, of Common Stock may be granted to employees, outside directors and consultants and advisers of the Company or any subsidiary corporation or entity. The stock is intended to permit the Company to retain and attract qualified individuals who will contribute to its overall success. Shares that by reason of the expiration of an option (other than by reason of exercise) or which are no longer subject to purchase pursuant to an option granted under an Option Plan may be reoptioned thereunder. The 1990 and 1994 Option Plans are administered by a committee of outside directors (the "Committee"). The Committee sets specific terms and conditions of options granted under the 1990 and 1994 Option Plans and administers the 1990 and 1994 Option Plans, as well as the Company's other employee benefit plans which may be in effect from time to time. The Committee currently consists of William J. Nimmo, Lionel Sosa, and Richard Sherman. The Company's employees are eligible to receive either incentive stock options or nonqualified stock options or a combination of both, as the Committee determines. Non-employee participants may be granted only nonqualified stock options. Stock options may be granted for a term not to exceed ten years (five years with respect to a holder of 10% or more of the Company's shares in the case of an incentive stock option) and are not transferable other than by will or the laws of descent and distribution. Each option may be exercised within the term of the option pursuant to which it is granted (so long as the optionee, if an employee, continues to be employed by the Company). In addition, an incentive option may be exercised within 90 days after the termination of employment of the optionee (subject to any limitations in the particular option), within one year after termination in case of termination because of disability, or throughout the term of the option in the event of the optionee's death, to the extent in each case the option was exercisable at the termination date. A nonqualified stock option may be exercised for such period, but not later than the expiration date, after termination of employment, disability or death, as may be specified in the particular option. The exercise price of all incentive stock options must be at least equal to the fair market value of the Common Stock on the date of grant, or 110% of fair market value with respect to any incentive stock option issued to a holder of 10% or more of the Company's shares. Stock options may be exercised by payment in cash of the exercise price with respect to each share to be purchased, by delivering Common Stock of the Company already owned by such optionee with a market value equal to the exercise price, or by a method in which a concurrent sale of the acquired stock is arranged, with the exercise price payable in cash from such sale proceeds. The 1994 Option Plan provides that each outside director will automatically receive a grant of 3,000 nonqualified stock options each year on the fifth business day following the first public release of the Company's audited earnings report on results of operations for the preceding fiscal year. Each such option will become exercisable in whole or in part on the first anniversary of the award through the balance of its ten-year term. Subject to availability of shares allocated to the 1994 Option Plan and not already reserved for other outstanding stock options, outside directors who join the Board in the future will in addition receive an initial grant of options for 20,000 shares, which will become exercisable in five equal increments beginning on the first anniversary of the award and on each of the next four succeeding anniversary dates. Such options will be exercisable for a term of ten years. Such options will be awarded upon their appointment or election to the Board. Options, once granted and to the extent exercisable, will remain exercisable throughout their term, regardless of whether the holder continues as a director. The exercise price of the options is equal to 100% of the fair market value of a share of Common Stock at the time of grant. The 1990 Option Plan will terminate on October 14, 2000. The 1994 Option Plan will terminate on October 17, 2004. The Board of Directors may, however, terminate the 1990 and 1994 Option Plans at any time prior to such respective dates. Termination of the 1990 and 1994 Option Plans will not alter or impair, without the consent of the optionee, any of the rights or obligations pursuant to any option granted under the Option Plans. As of December 28, 1997, options for 635,158 shares of common stock had been granted under the 1990 Option Plan and were outstanding, with a weighted average exercise price of $6.11 per share, and no additional shares were available for issuance upon exercise of options which may be granted in the future. As of December 28, 1997, options for 864,842 shares had been exercised. As of December 28, 1997, options for 715,717 shares of common stock had been granted under the 1994 Option Plan and were outstanding, with a weighted average exercise price of $5.23 per share, and 534,283 additional shares were available for issuance upon exercise of options which may be granted in the future. As of December 28, 1997, no options had been exercised. Stock Option Grant Table. The following table sets forth certain information concerning options granted to the named executive officers during the Company's fiscal year ended December 28, 1997: Option Grants in Last Fiscal Year Potential Realizable Percent of Value at Assumed Total Options Annual Rates of Granted to Stock Price Employees Excercise Appreciation Options in or Base Expir- for Option Term(2) Granted Fiscal Price ation ------------------- Name #(1) Year ($/Sh) Date 5%($) 10%($) - ----------------------------------------------------------------------- Stephen V. Clark - - - - - - James A. Eliasberg - - - - - - David G. Lloyd - - - - - - Douglas Gammon 50,000(3) 13% $5.25 3/10/07 $165,085 $418,357 25,000(3) 7% 4.5 11/17/07 74,681 189,257 - ----------------------------------------------------------------------- (1) All such stock options were granted for the number of shares indicated at an exercise price equal to the fair market value of the Common Stock on the date of grant as determined by the Company's Board of Directors. All such stock options noted above were granted 10 years prior to the noted expiration date. The options become exercisable beginning one year after the date of grant in five equal annual installments. The Company's current Option Plans do not make provision for the award of stock appreciation rights ("SARs") and the Company has no SARs currently outstanding. (2) As required by rules of the Securities and Exchange Commission ("SEC"), potential values stated are based on the assumption that the Company's Common Stock will appreciate in value from the date of grant to the end of the option term (ten years from the date of grant) at annualized rates of 5% and 10% (total appreciation of approximately 63% and 159%), respectively, and therefore are not intended to forecast possible future appreciation, if any, in the price of the Common Stock. (3) Upon occurrence of a change of control of Taco Cabana, as defined in the related Stock Option Agreements, all outstanding options, to the extent not exercisable, will immediately become exercisable. Stock Option Exercises and Holdings Table. The following table provides information concerning the exercise of options and value of unexercised options held by the named executive officers at December 28, 1997: Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values Shares Aquired Value on Real- Number of Unexercised Value of Unexercised Exercise ized Options In-the-Money Options (#) ($) at Fiscal Year End(#) at Fiscal Year End($)(1) - ----------------------------------------------------------------------------- Exercis- Unexercis- Exercis- Unexercis- able able able able - ----------------------------------------------------------------------------- Stephen V. Clark - - 80,000 120,000 - - James A. Elisaberg - - 104,000 120,000 $35,640 - David G. Lloyd - - 45,000 55,000 - - Douglas Gammon - - - 75,000 - - (1) Values stated are based on the last sale price of $4.63 per share of the Company's Common Stock on the NASDAQ National Market System on December 26, 1997, the last trading day of the fiscal year, and equal the aggregate amount by which the market value of the option shares exceeds the exercise price of such options at the end of the fiscal year. Compensation Committee Interlocks and Insider Participation None. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information concerning the beneficial ownership of the Company's Common Stock as of March 1, 1998, by: (i) each person known by the Company to be the beneficial owner of more than 5% of its Common Stock, (ii) each named executive officer of the Company, (iii) each director of the Company, and (iv) all directors and officers as a group. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned. Shares Beneficially Owned Name Number Percent Stephen V. Clark (1) 88,063 * James A. Eliasberg (2) 188,750 1.2% David G. Lloyd (3) 52,800 * Douglas Gammon (4) 10,000 * William J. Nimmo (5) 3,817 * Richard Sherman (6) 77,003 * Cecil Schenker (7) 97,503 * Lionel Sosa (8) 20,000 * Massachusetts Financial Services Co. (9) 1,310,970 8.6% Dimensional Fund Advisors, Inc. (10) 1,000,764 6.6% All directors and officers as a group (8 persons(11) 537,936 3.5% ___________________________ * Less than 1%. (1) Includes 80,000 shares subject to presently exercisable options (or those exercisable within 60 days). Excludes 120,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (2) Includes 104,000 shares subject to presently exercisable options (or those exercisable within 60 days). Excludes 120,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (3) Includes 45,000 shares issuable pursuant to presently exercisable options (or those exercisable within 60 days). Excludes 55,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (4) Represents shares issuable pursuant to presently exercisable options (or those exercisable within 60 days). Excludes 65,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (5) Excludes 23,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (6) Represents shares subject to presently exercisable options (or those exercisable within 60 days). Excludes 13,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (7) Represents shares subject to presently exercisable options (or those exercisable within 60 days). Excludes 13,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (8) Excludes 23,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). (9) Based upon Schedule 13G, filed jointly in February 1996, and amended in February 1998, indicating beneficial ownership as stated in the table, and shared dispositive power as to all shares beneficially owned. Included in the joint filing were Massachusetts Financial Services Company ("MFS"), indicating beneficial ownership of 1,310,970 shares and sole dispositive power as to 1,310,970 shares and MFS Series Trust II - MFS Emerging Growth Fund ("MEG"), indicating 962,395 shares beneficially owned by MFS as well as MEG. Address: 500 Boylston Street, Boston, Massachusetts 02116. (10) Based on Schedule 13G, filed in February 1997, and amended in February 1998, indicating beneficial ownership and sole dispositive power as stated in the table and sole voting power as to 665,464 shares. Address: 1299 Ocean Avenue, 11th Floor, Santa Monica, CA 90401. (11) Includes 413,506 shares subject to presently exercisable options (or those exercisable within 60 days). Excludes 432,000 shares issuable pursuant to options which are not currently exercisable (or exercisable within 60 days). ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS See "Compensation Committee Interlocks and Insider Participation" for certain relationships and related party transactions. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: Financial Statements Independent Auditors' Report Consolidated Balance Sheets at December 29, 1996 and December 28,1997 Consolidated Statements of Operations for the years ended December 31, 1995, December 29, 1996 and December 28, 1997 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, December 29, 1996 and December 28, 1997 Consolidated Statements of Cash Flows for the years ended December 31, 1995, December 29, 1996 and December 28, 1997 Notes to Consolidated Financial Statements Financial Statement Schedules No financial statement schedules are submitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements or notes thereto. Exhibits 3.1 Restated Certificate of Incorporation, filed on December 29, 1993. (b) 3.2 Bylaws of Registrant. (a) 4.1 Form of Common Stock Certificate. (a) 4.2 Rights Agreement dated as of June 9, 1995, between Taco Cabana, Inc. and Society National Bank, as Rights Agent. (d) 10.1* Employment Agreement dated April 24, 1995 between the Registrant and Stephen V. Clark. (c) 10.5 Sample Franchise Agreement. (a) 10.6 Sample Franchise Development Agreement. (a) 10.7 Sample Beverage Sublease Agreement. (a) 10.8 Sample Concessionaire Management Agreement. (a) 10.9* Amended and Restated Stock Option Plan. (a) 10.14* 1994 Stock Option Plan. (b) 10.15 Employment Agreement dated April 24, 1995 between the Registrant and James Eliasberg. (e) 10.16 Second Amended Loan Agreement with International Bank of Commerce. (e) 21. Subsidiaries of the Registrant. (f) 23. Consent of Deloitte & Touche LLP. (f) 24. Powers of attorney to sign amendments to this report. Reference is made to the signature page of this report. 27. Financial Data Schedule. (f) ________________________ * Executive compensation plan or arrangement. (a) Filed as an exhibit to Form S-1 Registration Statement No. 33-51430, effective October 16, 1992. (b) Filed as an exhibit to Form 10-K for the fiscal year ended January 1, 1995. (c) Filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1995. (d) Filed as an exhibit to Form 8-A Registration Statement No. 0-20716, effective June 9, 1995. (e) Filed as an exhibit to Form 10-K for the fiscal year ended December 29, 1996. (f) Filed herewith. (b) Reports on Form 8-K Press release relating to the closure of Colorado market and Special Charge filed December 24, 1997. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TACO CABANA, INC. By: STEPHEN V. CLARK ---------------- Stephen V. Clark Chief Executive Officer and President Date: March 27, 1998 Each person whose signature appears below authorizes Stephen V. Clark and David G. Lloyd or either of them, each of whom may act without joinder of the other, to execute in the name of each such person who is then an officer or director of the Registrant and to file any amendments to this annual report on Form 10-K necessary or advisable to enable the Registrant to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission in respect thereof, which amendments may make such changes in such report as such attorney-in-fact may deem appropriate. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date STEPHEN V. CLARK Chief Executive Officer, March 27, 1998 ---------------- President and Direcor Stephen V. Clark (Principal Executive Officer) DAVID G. LLOYD Senior Vice President - March 27, 1998 -------------- Finance, Chief Financial David G. Lloyd Officer, Secretary and Treasurer (Principal Financial and Accounting Officer) WILLIAM J. NIMMO Director March 27, 1998 ---------------- William J. Nimmo RICHARD SHERMAN Director March 27, 1998 --------------- Richard Sherman CECIL SCHENKER Director March 27, 1998 -------------- Cecil Schenker LIONEL SOSA Director March 27, 1998 ----------- Lionel Sosa TACO CABANA, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Consolidated Financial Statements: Independent Auditors' Report F-2 Consolidated Balance Sheets at December 29, 1996 and December 28, 1997 F-3 Consolidated Statements of Operations for the Years Ended December 31, 1995, December 29, 1996 and December 28, 1997 F-4 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1995, December 29, 1996 and December 28, 1997 F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, December 29, 1996 and December 28, 1997 F-6 Notes to Consolidated Financial Statements F-8 INDEPENDENT AUDITORS' REPORT To the Board of Directors Taco Cabana, Inc. We have audited the accompanying consolidated balance sheets of Taco Cabana, Inc. and subsidiaries as of December 28, 1997 and December 29, 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 28, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with 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, such consolidated financial statements present fairly, in all material respects, the financial position of Taco Cabana, Inc. and subsidiaries at December 28, 1997 and December 29, 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP San Antonio, Texas February 2, 1998 TACO CABANA, INC. CONSOLIDATED BALANCE SHEETS December 29, December 28, ASSETS 1996 1997 CURRENT ASSETS: Cash and cash equivalents $ 748,000 $ 339,000 Receivables, net 792,000 502,000 Inventory 1,858,000 2,105,000 Prepaid expenses 1,482,000 1,704,000 Federal income taxes receivable 363,000 200,000 Deferred income taxes 1,827,000 - ------------- ------------- Total current assets 7,070,000 4,850,000 PROPERTY AND EQUIPMENT, net 88,963,000 59,540,000 NOTES RECEIVABLE, net 738,000 344,000 INTANGIBLE ASSETS, net 45,394,000 11,293,000 OTHER ASSETS 541,000 233,000 ------------- ------------- TOTAL ASSETS $ 142,706,000 $ 76,260,000 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 4,181,000 $ 4,430,000 Accrued liabilities 3,171,000 6,266,000 Current maturities of long-term debt 2,409,000 1,573,000 and capital leases Line of credit 625,000 4,223,000 ------------- ------------- Total current liabilities 10,386,000 16,492,000 LONG-TERM OBLIGATIONS, net of current maturities: Capital leases 4,041,000 2,357,000 Long-term debt 6,593,000 11,170,000 ------------- ------------- Total long-term obligations 10,634,000 13,527,000 ACQUISITION AND CLOSED RESTAURANT 4,212,000 9,126,000 LIABILITIES DEFERRED LEASE PAYMENTS 657,000 702,000 DEFERRED INCOME TAXES 3,645,000 - STOCKHOLDERS' EQUITY: Preferred stock, series A; $.01 par - - value, 100,000 shares authorized Common stock; $.01 par value, 30,000,000 shares authorized15,706,537 and 14,834,600 shares issued and outstanding at December 29, 1996 and December 28, 1997, respectively - 157,000 157,000 Additional paid-in capital 97,095,000 97,095,000 Retained earnings (deficit) 15,920,000 (57,278,000) Treasury stock, at cost - 871,937 shares - (3,561,000) ------------- ------------- Total stockholders' equity 113,172,000 36,413,000 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 142,706,000 $ 76,260,000 ============= ============= See notes to consolidated financial statements. TACO CABANA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 REVENUES: Restaurant sales $137,191,000 $131,680,000 $131,857,000 Franchise fees and royalty income 1,342,000 516,000 346,000 ------------ ------------ ------------ Total revenues 138,533,000 132,196,000 132,203,000 ------------ ------------ ------------ COSTS AND EXPENSES: Restaurant cost of sales 44,083,000 41,336,000 40,668,000 Labor 36,262,000 34,653,000 36,169,000 Occupancy 8,192,000 8,161,000 8,185,000 Other restaurant operating costs 26,658,000 23,553,000 25,418,000 General and administrative 6,068,000 6,445,000 6,964,000 Depreciation and amortization 10,301,000 9,245,000 9,659,000 Special charges 8,100,000 2,497,000 78,738,000 Litigation settlement - 3,400,000 - Reserve for notes and other receivables 3,500,000 - - ------------ ----------- ------------ Total costs and expenses 143,164,000 129,290,000 205,801,000 ------------ ----------- ------------ INCOME (LOSS) FROM OPERATIONS (4,631,000) 2,906,000 (73,598,000) INTEREST EXPENSE, NET (1,397,000) (1,348,000) (1,137,000) ------------ ------------ ----------- INCOME (LOSS) BEFORE INCOME TAXES (6,028,000) 1,558,000 (74,735,000) BENEFIT (PROVISION) FOR INCOME TAXES 2,230,000 (854,000) 1,537,000 ------------ ------------ ------------ NET INCOME (LOSS) $(3,798,000) $ 704,000 $(73,198,000) ============ ============ ============ BASIC AND DILUTED EARNINGS PER SHARE $ (0.24) $ 0.04 $ (4.78) ============ ============ ============ See notes to consolidated financial statements. TACO CABANA, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Preferred Additional Stock Common Stock Additional Treasury Stock --------- --------------- Paid-in Retained ----------------- Amount Shares Amount Capital Earnings Shares Amount BALANCE, January 2, 1995 $- 15,561,162$156,000 $96,482,000 $19,014,000 - $ - Options exercised - 120,000 1,000 375,000 - - - Tax benefit from stock options - - - 97,000 - - - Net loss - - - - (3,798,000) - - --- ---------- -------- ---------- ----------- ------- ---------- BALANCE, December 31, 1995 - 15,681,162 157,000 96,954,000 15,216,000 - - Options exercised - 25,375 - 119,000 - - - Tax benefit from stock options - - - 22,000 - - - Net income - - - - 704,000 - - --- ---------- ------- --------- ----------- ------- --------- BALANCE, December 29, 1996 - 15,706,537 157,000 97,095,000 15,920,000 - - Purchase of stock - - - - - 871,937 (3,561,000) Net loss - - - - (73,198,000) - - --- ---------- ------- ---------- ---------- -------- ---------- BALANCE, December 28, 1997 $- 15,706,537$157,000 $97,095,000 $(57,278,000)871,937$(3,561,000) === ========== ======= ========== =========== ======= =========== See notes to consolidated financial statements. TACO CABANA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(3,798,000) $ 704,000 $(73,198,000) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 10,301,000 9,245,000 9,659,000 Deferred income taxes 386,000 450,000 (1,818,000) Special charges 8,100,000 2,497,000 78,738,000 Reserve for notes and other receivables 3,500,000 - - Capitalized interest (117,000) (12,000) (147,000) Deferred income and lease payments (687,000) (278,000) (157,000) (Increase) decrease in assets: Receivables (953,000) 291,000 634,000 Inventory 2,000 (12,000) (656,000) Prepaid expenses and other assets (780,000) 203,000 (1,018,000) Federal income taxes receivable (2,415,000) 2,414,000 163,000 Other assets 526,000 393,000 58,000 Increase (decrease) in liabilities: Accounts payable and accrued liabilities (5,237,000) (3,009,000) 2,328,000 Acquisition and closed restaurant liabilities (3,052,000) (676,000) (1,656,000) ------------ ----------- ----------- Net cash provided by operating activities 5,776,000 12,210,000 12,930,000 ------------ ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (18,738,000) (9,188,000) (16,812,000) Proceeds from sales of property and equipment 1,179,000 846,000 1,379,000 Investment in joint venture (186,000) (388,000) - ------------ ----------- ----------- Net cash used by investing activities (17,745,000) (8,730,000) (15,433,000) ------------ ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long- term debt and draws on line of credit 19,038,000 - 18,423,000 Principal payments under long- term debt and line of credit (11,823,000) (5,398,000) (11,074,000) Principal payments under capital leases (148,000) (224,000) (1,694,000) Purchase of treasury stock - - (3,561,000) Exercise of stock options 376,000 141,000 - ------------ ----------- ----------- Net cash provided (used) by financing activities 7,443,000 (5,481,000) 2,094,000 ------------ ----------- ----------- NET DECREASE IN CASH (4,526,000) (2,001,000) (409,000) CASH AND CASH EQUIVALENTS, beginning of period 7,275,000 2,749,000 748,000 ------------ ----------- ---------- CASH AND CASH EQUIVALENTS, end of period $2,749,000 $ 748,000 $ 339,000 ============ =========== ========== (Continued) TACO CABANA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS SUMMARY OF NON-CASH TRANSACTIONS During 1996, the Company closed one restaurant and charged its net book value of $139,000 to acquisition and closed restaurant liabilities. During 1995, the Company closed four restaurants and charged their net book value of $2.1 million to acquisition and closed restaurant liabilities. Also, the Company sold three restaurants to various franchisees in exchange for $1.2 million in notes receivable during 1995. Capital leases in the amount of $405,000 were terminated due to the sale of one of these restaurants. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 Cash paid for interest, net of interest capitalized $ 1,672,000 $ 1,144,000 $1,171,000 Cash received for income taxes 1,126,000 2,504,000 4,000 Cash paid for income taxes 580,000 477,000 74,000 (Concluded) TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS Nature of Operations - Taco Cabana, Inc. (the "Company") operates a chain of Mexican patio style fast food restaurants located primarily in the Southwestern United States. At December 28, 1997, the Company owned and operated a total of 98 units, 96 under the "Taco Cabana" name and two under the "Two Pesos" name. There were also 11 Taco Cabana franchise units. Principles of Consolidation - The consolidated financial statements include all accounts of the Company and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated. Fiscal Year - The Company's accounting period is based upon a 52 or 53 week fiscal year ending on the Sunday closest to December 31. The fiscal years 1995, 1996 and 1997 were comprised of the 52 weeks ending December 31, 1995, December 29, 1996, and December 28, 1997, respectively. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Liquor Sales - To conform to state liquor laws, liquor licenses are maintained and liquor sales are accounted for by a separate liquor corporation. The liquor corporation pays the Company a management fee based on liquor sales, reimburses the Company for its share of operating costs, and pays base and additional rent based on liquor sales. In order to more accurately reflect restaurant operations, all revenues and expenses relating to liquor sales have been included in the consolidated financial statements of the Company. Inventory - Inventory is stated at the lower of cost using the first-in, first-out method or market, and consists primarily of food products, beverages and paper supplies. Property and Equipment - Property and equipment is stated at cost. Equipment and buildings under capital leases are stated at the lower of the present value of minimum lease payments or fair market value of the asset at the inception of the lease. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets or the applicable lease term, if less. The estimated useful lives used in computing depreciation and amortization are as follows: Furniture, fixtures and equipment 2-10 years Buildings 20-30 years Leasehold improvements 5-30 years Maintenance and repairs are charged to expense as incurred; improvements which increase the value of the property and extend the useful life are capitalized. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (Continued) Intangible Assets - Goodwill, or the excess of acquisition costs over the fair market value of the assets acquired and liabilities assumed, is amortized using the straight-line method over 25 to 40 years. The trade name and the rights to the Taco Cabana name are amortized using the straight-line method over 40 years. Non-compete agreements are amortized using the straight-line method over their estimated useful lives, ranging from five to fifteen years. Management assesses the recoverability of goodwill on the basis of actual and undiscounted, projected cash flows from the restaurants acquired. Should projected cash flows not be sufficient to recover the Company's investment, including any recorded goodwill, management utilizes either a discounted cash flow basis or other determination of current fair value, in order to determine the amount of the impairment. Franchise Income - The Company has sold franchises that give the franchisees the right to operate Taco Cabana restaurants in specified areas. Generally, each franchisee acquires the right to open three or more restaurants. A development fee is recognized as income when the agreement is signed, while the franchise fee on each restaurant is deferred until the opening of the franchised restaurant. In addition, the franchise agreement requires a franchise royalty fee and an advertising fee on gross sales; such fees are recorded as income when earned. In some markets, franchisees pay an additional percentage of gross sales for expanded media coverage in their respective areas. Concentrations of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consisted principally of amounts due from franchisees and receivables from credit card sales. These risks are limited due to their geographic dispersion. The Company has no significant concentrations of credit risk. Income Taxes - Income taxes are recorded using a liability approach based upon currently enacted tax rates. The effect of future changes in tax laws will be recorded, when the laws are enacted. Earnings (Loss) Per Share - In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per Share", which requires presentation of basic and diluted earning per share. Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. As required, the Company adopted the provisions of SFAS No. 128 in the year ended December 28, 1997. All prior year weighted average and per share information has been restated in accordance with SFAS No. 128. Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. Statements of Cash Flows - For purposes of reporting cash flows, the Company considers all highly liquid debt instruments with a remaining maturity at the date of purchase of three months or less to be cash equivalents. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (Continued) Commitments and Contingencies - The Company does not subscribe to worker's compensation insurance in its Texas market. The Company accrues for claims based on historical actual payments made for such claims and expenses, as well as an evaluation of current and anticipated claims and expenses. The Company does maintain an excess liability coverage which management believes is adequate to cover any substantial claims. Stock-Based Compensation - The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, as included in Note 13. Reclassifications - Certain reclassifications have been made to the prior year's consolidated financial statements to conform to the presentation and classification used in fiscal 1997. 2. SPECIAL CHARGES During fiscal 1995, 1996 and 1997, the following special charges are included in the Company's consolidated financial statements: Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 Special charge $8,100,000 $2,497,000 $78,738,000 Income tax benefit (3,000,000) (747,000) (3,018,000) Impact on net income (loss) 5,100,000 1,750,000 75,720,000 Impact on net income (loss) per share $ 0.33 $ 0.11 $ 4.94 Fiscal 1997 - During the fourth quarter of fiscal 1997, management made the decision to close the seven restaurants in its Colorado market. As previously announced, the Company committed substantial resources to this market during 1997 in an attempt to reverse trends of poor sales and losses. The desired results from the implementation of the plan were not achieved and the decision to close the market was made. These seven restaurants had total sales of approximately $3.0 million and operating losses of $2.1 million during the approximately eleven months of 1997 that they were in operation. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SPECIAL CHARGES (Continued) Additionally, the Company continued to experience unfavorable sales trends during 1997, concluding the year with comparable restaurant sales declining 2.9%. However, during the first six months of 1997, comparable restaurant sales declined 4.8%. This trend compelled management to continue its evaluation of the operating model of the Company. During this evaluation, management concluded that certain volumes must be achieved in order to operate individual restaurants in accordance with Company standards. These standards include food quality, cleanliness, speed of service, and profitability. Management reviewed all existing restaurants to determine which restaurants could not reasonably be expected to achieve these volume levels, generally annual revenues of at least $1 million. This led to the decision to close an additional ten restaurants. Due to the significance of the closures described above, management performed an evaluation of the recoverability of all remaining assets as described in Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". Management concluded from the results of this evaluation that a significant impairment of intangible as well as long-lived assets was required to be recognized. The impairment was reflective of a market value determined to be less than the carrying value of approximately 40 restaurants, 31 of which were acquired. The assets were tested for impairment by projecting cash flows for individual restaurants based on recent results and trends specific to that restaurant. The undiscounted projected cash flows for each restaurant were compared to the carrying value for that restaurant, including allocated goodwill, where applicable. If the undiscounted cash flows were less than the carrying value, an impairment was deemed to have occurred. The amount of the impairment was determined by calculating the difference between the present value of the projected cash flows and the carrying value attributable to the specific restaurant. The cash flows were discounted using the rate of return the Company utilizes for approving new restaurant construction. Such discounted cash flows are, in management's opinion, the best estimate of the assets current value. Considerable management judgment is necessary to estimate future discounted cash flows. Accordingly, actual results could vary significantly from management's estimates. The process described above resulted in the Company's recording a special charge during the fourth quarter of 1997 of $78.7 million pre-tax, $75.7 million after-tax, or $4.94 per share. This amount had the following components: Impairment of intangible assets of $33.1 million and impairment of long-lived assets of $22.1 million for restaurants that will continue in operation, based on the SFAS 121 analysis described above; A provision of $23.3 million for the closure of seventeen restaurants, including all of the restaurants in the Colorado market. The amount was determined in accordance with SFAS 121 and is comprised of: $13.3 million for the carrying value of the assets, net of estimated proceeds of $1.5 million for the sale of restaurant properties; $9.0 million to record the estimated lease related obligations for closed restaurants. This amount was determined as the lesser of the present value of the monthly lease commitments, net of expected sublease receipts, or lease termination provisions; TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SPECIAL CHARGES (Continued) $500,000 for severance and relocation benefits paid to employees displaced by the restaurant closures; $500,000 for the probable settlement of a franchisee lawsuit related to the Colorado market. The write-off of other assets totaling $200,000. During 1997, the seventeen restaurants contributed a total of $9.6 million in sales, and had operating losses totaling $2.5 million. In addition, the total amount of depreciation recorded during 1997 relating to assets which were impaired was approximately $2.5 million. A total of approximately $473,000 of the amounts accrued had been paid prior to December 28, 1997. It is currently anticipated that payments of approximately $1.5 million will be made under the lease obligations during 1998. It is also anticipated that proceeds of approximately $1.5 million will be realized due to the sale of closed restaurants, although there can be no assurance of the particular price at which any of such properties will be sold. Fiscal 1996 - The Company has a 50% interest in a joint venture which operated three restaurants in the Atlanta market. During the fourth quarter of 1996, the Company decided to write-down its investment in the joint venture and accrue for certain costs associated with the closing of two of the three restaurants operated by the joint venture. This decision resulted in a special charge for $2.5 million pre-tax, $1.7 million after-tax or $0.11 per share. The special charge was comprised of the following: Write-down of investment in joint venture $ 1,191,000 Reserve for notes and accounts receivable 268,000 Estimated lease obligations 632,000 Estimated legal and professional fees 245,000 Other costs 161,000 ----------- Total $ 2,497,000 =========== Subsequent to December 29, 1996, two of the three restaurants in the Atlanta market were closed. Fiscal 1995 - During the second quarter of 1995, a review of all operations of the Company was performed. The review was precipitated by a change in the Company's core markets, including a decline in average unit volumes and profitability, as well as a change in the Company's senior management. Comparable restaurant sales trends softened in the third and fourth quarters of 1994, declining by about 2.9% in the third quarter and 5.9% in the fourth quarter. The decrease continued in the first quarter of 1995, when comparable restaurant sales declined by approximately 10.1%. The decline continued into the second quarter of 1995, which finished with a decline of approximately 7.7%. This decline in sales led to a decline in profitability. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SPECIAL CHARGES (Continued) In late April 1995, Stephen Clark was hired as President and Chief Operating Officer of the Company. After several weeks of analyzing the trends and personnel, Mr. Clark led a comprehensive review of the Company's operations. The review, which took place during May and June 1995, included a detailed review of the existing restaurants including their sales and profitability trends, recent and future marketing plans, development plans for new Company restaurants as well as for franchisees; relationships with current franchisees; and overhead components, including middle and senior level management, office space, non-restaurant assets and bonus pay- outs. To reverse the adverse trends in operating results, management began implementing a plan to improve the unit level economics of the Company's restaurants. In particular, the Company created several operations-related positions to design and implement comprehensive labor management and restaurant operating systems; increased the number of operations supervisory positions thus lowering the average number of restaurants each supervisor is responsible for, in order to increase the effectiveness of such positions; redirected its marketing program to increase focus on local store marketing efforts and promotional-based advertising; performed market research to enhance the effectiveness of the Company's marketing programs and to provide improved market data to aid in the design and location of future restaurants; and revised its development criteria, including the construction costs, design factors, menu strategy, and began reviewing the possibility of alternative development (e.g., in-line and other non-traditional construction versus stand- alone restaurants). The review described above resulted in the decision to close several restaurants, allow several franchise restaurants to close or revert back to the Company's control, restructure or forgive several franchise-related receivables, make several management personnel changes, sell certain non-restaurant assets, pay certain discretionary bonuses which related to the prior year but were not going to be paid by prior management, restructure the Company's marketing efforts, slow all current Company and franchise development, and write-off certain prepaid costs determined to no longer have future value due to the changes that management planned to make. These decisions resulted in the Company's recording a special charge during the second quarter of 1995 of $8.1 million pre- tax , $5.1 million after tax or $0.33 per share which was comprised of: Market valuation adjustments totaling $2.7 million resulting from the decision to close six Company-owned restaurants and dispose of those restaurant assets; A provision of $1.2 million to record the estimated monthly lease obligation, net of expected sublease receipts, for certain other restaurants which have been closed or were to be closed; Market valuation adjustments totaling $1.2 million to allow for the disposition of certain non-restaurant capital assets, including the Company's principal office and corporate airplanes (most of which assets are owned by the Company, so that the disposition of such assets will generate cash); The accrual of $980,000 related to the severance of certain contractual employment and consulting agreements and the payment of relocation expenses for Mr. Clark and other new members of management; TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SPECIAL CHARGES (Continued) The write-off of $810,000 related to certain capitalized media production assets which will no longer be utilized or were deemed to no longer have value due to the change in the Company's marketing philosophy described above; The write-off of $370,000 in development costs associated with the sites which were under development at the time of the decision to slow development; An accrual of $300,000 for the payment of certain operational bonuses which are described above; An accrual of $420,000 for certain employee litigation claims; An accrual of $120,000 for miscellaneous expenses. As of December 28, 1997, the Company had closed all of the six restaurants identified in the review above and paid costs of approximately $1.3 million and $283,000 during 1996 and 1997, respectively, that were applied against amounts accrued in the special charge. In addition, the Company sold a portion of the non-restaurant assets discussed above charging a loss of approximately $752,000 in 1996 to the related accrual and generating cash of $788,000 and $603,000 in 1996 and 1997, respectively. 3. RESERVE FOR NOTES AND OTHER RECEIVABLES During the second quarter of 1995, the decision was made to reserve for notes and other receivables of $3.5 million pre- tax. This reserve included $2.0 million for notes receivable which were outstanding in connection with the sales of restaurants to franchisees. The decision to reserve for these notes was based on discussions held with the franchisees during the second quarter of 1995 and a review of their financial position. Three notes totaling $1.3 million of this amount were reserved due to the fact that the franchisee approached the Company during the second quarter of 1995 and indicated that the devaluation of the Mexican Peso in December 1994 had permanently harmed its restaurants to an extent that they were going to close the restaurants. These restaurants were all closed during 1995. The remaining amount relates to a restaurant whose sales trends continue to erode and there is substantial doubt as to the recoverability of the balance. The reserve amounts were calculated by reducing the outstanding note balances to the estimated value of the underlying collateral and reserving the remaining balance. The restaurants were all in Texas. The remaining $1.5 million primarily relates to franchisee receivables. Approximately $250,000 of this amount relates to periodic franchise and royalty fees owed by the franchisees noted above, including interest. An additional $500,000 was reserved due to a franchisee's failure to meet a contractual obligation and make payment on a development agreement during the second quarter of 1995. Approximately $350,000 of the amount relates to periodic royalty fees and franchise fees from a franchisee with whom the Company had been in discussions to acquire its restaurants. Due to the Company's decision to slow all development, the Company broke off these negotiations. The remaining balances, totaling $400,000, include various types of receivables including other franchise amounts, employee receivables and other miscellaneous receivables. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. ACCOUNTS AND NOTES RECEIVABLE Accounts and notes receivable consisted of the following: December 29, December 28, 1996 1997 Trade receivables: Royalties $ 668,000 $ 84,000 Other 451,000 356,000 Notes receivable - current portion 250,000 109,000 Employees 18,000 2,000 ------------- ----------- Total 1,387,000 551,000 Less allowance for doubtful accounts (595,000) (49,000) ------------- ----------- Receivables, net $ 792,000 $ 502,000 ============= =========== Notes receivable - noncurrent: Franchisees $ 1,470,000 $ 344,000 Other 4,000 - ------------- ----------- Total 1,474,000 344,000 Less allowance for uncollectible notes (736,000) - ------------- ----------- Notes receivable, net $ 738,000 $ 344,000 ============= =========== Notes receivable from franchisees approximate fair value because the underlying instruments have an interest rate that approximates current market rates. The Company's allowance for doubtful accounts is reflected as a reduction of receivables in the consolidated balance sheets. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. PROPERTY AND EQUIPMENT, NET Property and equipment, net, consisted of the following: December 29, December 28, 1996 1997 Property and equipment: Land $20,507,000 $18,759,000 Furniture, fixtures and equipment 48,504,000 39,627,000 Leasehold improvements 19,048,000 8,335,000 Buildings 16,587,000 13,159,000 Construction in progress 178,000 1,195,000 ----------- ----------- 104,824,000 81,075,000 Less accumulated depreciation and amortization (20,348,000) (24,525,000) ----------- ---------- Total 84,476,000 56,550,000 ----------- ---------- Property and equipment held under capital leases: Buildings 5,780,000 4,254,000 Less accumulated amortization (1,293,000) (1,264,000) ----------- ----------- Total 4,487,000 2,990,000 ----------- ----------- Property and equipment, net $88,963,000 $59,540,000 =========== =========== At December 28, 1997, the Company had five restaurants and one office building held for sale. The total carrying amount of these assets are $2.2 million which management estimates to be the net proceeds from the disposition of these assets. See Note 2. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. INTANGIBLE AND OTHER ASSETS Intangible and other assets consisted of the following: December 29, December 28, 1996 1997 Intangible assets: Goodwill $48,048,000 $ 16,270,000 Noncompetition agreements 2,500,000 1,421,000 Trade name 1,571,000 1,580,000 ----------- ------------ 52,119,000 19,271,000 Less accumulated amortization (6,725,000) (7,978,000) ------------ ------------ Intangible assets, net $45,394,000 $ 11,293,000 =========== ============ Other assets: Deposits $ 290,000 $ 214,000 Prepaid leases 208,000 - Other 43,000 19,000 ----------- ------------ Other assets $ 541,000 $ 233,000 =========== ============ 7. ACCRUED LIABILITIES Accrued liabilities consisted of the following: December 29, December 28, 1996 1997 Closed restaurant obligations $ 845,000 $2,827,000 Payroll related 1,251,000 1,468,000 Property taxes 429,000 627,000 Employee injury 200,000 138,000 Restaurant expenses 91,000 297,000 Legal 188,000 332,000 Other 167,000 577,000 ---------- ---------- Total $3,171,000 $6,266,000 ========== ========== TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. LEASES Operating Leases - The Company leases restaurant facilities under non-cancelable operating leases with initial terms ranging from ten to twenty years with options to renew. The future minimum lease commitments under all non-cancelable lease obligations as of December 28, 1997 were as follows: Years ending: 1998 $ 7,973,000 1999 7,753,000 2000 7,787,000 2001 7,763,000 2002 7,286,000 Thereafter 44,289,000 -------------- Total $ 82,851,000 ============== The total rental expense for operating leases was approximately $6.9 million for 1995, 1996 and 1997, including additional rents of approximately $467,000, $376,000 and $354,000 for 1995, 1996 and 1997, respectively. The Company remains contingently liable on two operating leases which were assigned to the purchasers of units previously sold or closed. Future minimum lease commitments under these contingent obligations approximate $216,000 in 1998, and $936,000 in 1999 through 2002. Thereafter, the total minimum lease payments are approximately $2.2 million. The Company assesses the probability of its having to assume primary liability under these assignments as part of its ongoing assessment of franchisee relationships. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. LEASES (Continued) Capital Leases - The Company leases certain buildings under capital lease agreements with third parties. The leases have fifteen and twenty year terms. Future minimum lease payments under the capital leases and the net present value of the minimum lease payments at December 28, 1997 were: Years ending: 1998 $ 441,000 1999 445,000 2000 445,000 2001 446,000 2002 446,000 Thereafter 1,660,000 ------------- Total minimum lease payments 3,883,000 Less amount representing interest at 9% to 13% 1,337,000 ------------- Net present value of minimum lease payments 2,546,000 Less current portion 189,000 ------------- Long-term portion of capital leases $ 2,357,000 ============= In addition to the minimum lease payments, several of the leases have a contingent rental based on 5% to 6% of gross sales, if such amounts exceed minimum rent. No payments have been made under these agreements. Furthermore, certain leases have been guaranteed by a stockholder of the Company. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. LONG-TERM DEBT Long-term debt consisted of the following notes payable bearing interest at the prime rate of 8.50% at December 28, 1997: December 29, December 28, 1996 1997 Notes payable to a bank, collateralized by certain restaurant assets, due in monthly installments of principal and interest through August 2004 $ 6,101,000 $ 10,521,000 Note payable to a bank, unsecured, due in monthly installments of principal and interest through April 2000 2,189,000 1,777,000 Note payable to a corporation, collateralized by certain restaurants, due in monthly installments of principal and interest through September 1998 513,000 256,000 ----------- ------------ Total 8,803,000 12,554,000 Less current maturities 2,210,000 1,384,000 ----------- ------------ Long-term debt, net $ 6,593,000 $ 11,170,000 =========== ============ The future minimum payments of long-term debt outstanding at December 28, 1997 were as follows: Years ending: 1998 $1,384,000 1999 1,188,000 2000 1,798,000 2001 922,000 2002 1,004,000 Thereafter 6,258,000 ----------- Total $12,554,000 =========== The amounts stated in the Company's consolidated balance sheets for long-term debt approximate fair value because the underlying note payable balance fluctuates frequently or it is at a rate approximating current market rates. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. LINE OF CREDIT During 1995, the Company signed two secured credit facilities totaling $20.0 million including a $5.0 million revolving line of credit. The commitments were initially due to expire on January 31, 1999. Interest on funds borrowed under the facilities are charged at the New York prime rate which was 8.50% at December 28, 1997. The credit facilities are secured by the stock of a subsidiary company. The facilities contain certain covenants, including cash flow to fixed charges ratio, minimum net worth, debt to tangible net worth ratio, and intangible assets to net worth ratio requirements. During the year ended December 28, 1997, the Company was in compliance with all such covenants. At December 28, 1997, the Company had approximately $5.1 million available for cash borrowings under these credit facilities. On December 30, 1997, the credit facilities were amended and increased to a total of $30.0 million. As part of the amendment, the commitments were extended until December 31, 1999. 11. ACQUISITION AND CLOSED RESTAURANT LIABILITIES The Company establishes acquisition liabilities, as necessary, in connection with the purchase method of accounting for restaurants and other assets it acquires. Such liabilities are primarily related to leases that were at terms less favorable than market rates prevailing at the acquisition date and anticipated restaurant closure costs, if any. The liability established for leases in excess of the prevailing market were based on current market rental rates at the date of acquisition as compared to the terms of the leases acquired. This liability is being amortized as a reduction of occupancy expense over the remaining term of the applicable leases. The total amount of this reserve was $1.8 million and $1.4 million, at December 29, 1996 and December 28, 1997, respectively. During 1996 and 1997, approximately $157,000 and $203,000, respectively, of the balance was amortized in this manner. Acquisition liabilities includes reserves established for the closure of certain acquired restaurants. These restaurants were anticipated to be closed at the time of acquisition. The amounts reserved were equal to the value assigned to the building and equipment acquired, less any anticipated salvage value, plus an amount estimated to terminate the lease prior to its expiration date. The total amount of this reserve was $2.4 million and $1.5 million at December 29, 1996 and December 28, 1997, respectively. During 1996 and 1997, approximately $1.7 million and $900,000, respectively, of this reserve was utilized in the closure of restaurants. No gain or loss was recorded in any of these transactions. In 1997, as part of the special charge, the Company reserved approximately $9.0 million for closed restaurant liabilities. The amounts reserved were equal to the lesser of the present value of the monthly lease commitments, net of expected sublease receipts, or lease termination provisions. It is currently anticipated that payments of approximately $1.5 million will be made under lease and other obligations during 1998. During 1997, approximately $473,000 of this reserve was utilized in the closure of restaurants. No additional gain or loss was recorded in connection with these closures beyond amounts previously reserved. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share: Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 Numerator for basic and diluted earnings per share - net income (loss) $(3,798,000) $ 704,000 $(73,198,000) Denominator: Denominator for basic earnings per share - weighted-average shares 15,648,624 15,694,757 15,314,665 Effect of dilutive securities - Employee stock options - 251,923 - ---------- ---------- ---------- Denominator for diluted earnings per share - adjusted weighted-average and assumed conversions 15,648,624 15,946,680 15,314,665 ========== ========== ========== Basic and diluted earnings per share $ (0.24) $ 0.04 $ (4.78) ========== ========== ========== For additional disclosures regarding outstanding employee stock options, see Note 13. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. STOCKHOLDERS' EQUITY AND STOCK OPTIONS Stock Options - The Company has stock option plans (the "Plans") for employees, outside directors, and advisors of the Company covering 2,750,000 shares of the Company's common stock. Options under such plans principally are exercisable beginning one to ten years from the grant date. The Plans terminate in 2000 and in 2004. The Plans are administered by a committee of outside members of the Board of Directors. In addition, certain directors were awarded non-qualified stock options pursuant to the terms of separate compensation agreements. At December 28, 1997, there were 534,283 shares available for issuance upon exercise of options that may be granted in the future. Options outstanding are as follows: Weighted Total Average Options Exercise Outstanding Price Options outstanding, January 1, 1995 927,000 $ 11.80 Granted 938,125 5.41 Exercised (120,000) 3.14 Expired or canceled (692,000) 13.20 --------- Options outstanding, December 31, 1995 1,053,125 $ 6.40 Granted 231,250 6.30 Exercised (25,375) 4.85 Expired or canceled (147,500) 5.36 --------- Options outstanding, December 29, 1996 1,111,500 $ 6.18 Granted 379,750 4.63 Exercised - - Expired or canceled (140,375) 8.57 --------- Options outstanding, December 28,1997 1,350,875 $ 5.64 ========= Options exercisable, December 28, 1997 979,756 $ 5.69 ========= TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. STOCKHOLDERS' EQUITY AND STOCK OPTIONS (Continued) For the options outstanding at December 28, 1997, the weighted average remaining life and exercise price of these outstanding options were 14 months and $5.51, respectively. In addition, the weighted average exercise price of options granted during 1997 was $4.63. SFAS No. 123, Accounting for Stock-Based Compensation, allows entities to continue to use Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees. The Company has evaluated SFAS No. 123 and intends to continue following APB Opinion No. 25. The pro-forma compensation expense, net income (loss) and earnings (loss) per share which were calculated as if SFAS No. 123 had been applied are as follows: Year Ended ---------- December 31, December 29,December 28, Pro Forma 1995 1996 1997 Compensation expense $ 669,000 $ 741,000 $ 555,000 Net income (loss) (4,220,000) 237,000 (73,548,000) Income (loss) per share $ (0.27) $ 0.01 $ (4.80) The Black-Scholes option pricing model was used to determine the above pro-forma information. The calculations relied upon estimates of the volatility of the Company's stock and expected dividends, as well as determinations of a risk-free interest rate and expected life of the options. A volatility rate of 49.0% was used for options granted prior to 1994, 37.5% was used for options granted during 1994, 36.0% was used for options granted during 1995 through 1996 and 34.0% was used for options granted during 1997. Dividends were estimated at zero. The discount rate charged on loans to depository institutions by the Federal Reserve Bank was used as the risk-free interest rate. The discount rate was 5.0% for all of 1997. The life of the Company's options range from two to five years. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. STOCKHOLDERS' EQUITY AND STOCK OPTIONS (Continued) Preferred Stock Purchase Rights - In June 1995, the Company's Board of Directors declared a distribution of one preferred stock purchase right for each share of the Company's common stock. The rights were distributed on June 20, 1995 to stockholders of record as of the close of business on that day. Each right will entitle the holder to buy 1/100 of a share of a newly authorized Series A preferred stock at an exercise price of $37.50 per right. The rights become exercisable on the tenth day after public announcement that a person or group has acquired 15% or more of the Company's common stock. The rights may be redeemed by the Company prior to becoming exercisable by action of the Board of Directors at a redemption price of $0.01 per right. If the Company is acquired in a merger or other business combination transaction in which it is not the surviving corporation, each right will entitle its holder to purchase stock of the acquiring company having a market value of twice the exercise price. In the event that the Company is the surviving corporation, each right will entitle its holder to purchase the Company's common stock having a market value of twice the exercise price of each right. At December 28, 1997, there were 14,834,600 rights outstanding. Preferred Stock - In June 1995, the Company authorized 100,000 shares of Series A, preferred stock with a par value of $0.01 per share. As of December 28, 1997, there were no shares outstanding. Treasury Stock - In April 1997, the Board of Directors authorized the purchase in the open market of up to 1,500,000 shares of the Company's outstanding common stock. During 1997 the Company purchased 871,937 shares of its common stock at a cost of $3,561,000, which are being held as treasury stock. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. INCOME TAXES The provision (benefit) for income taxes differs from the amount computed using statutory rates as shown below: Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 Federal income tax at statutory rate $(2,049,000) $ 530,000 $(25,410,000) State income taxes (87,000) 39,000 48,000 Goodwill and other (94,000) 285,000 4,819,000 Valuation allowance on net deferred tax asset - - 19,006,000 ------------ ---------- ----------- Total $(2,230,000) $ 854,000 $(1,537,000) ============ ========== =========== The provision (benefit) for income taxes is comprised of the following: Year Ended ---------- December 31, December 29, December 28, 1995 1996 1997 Current $(1,844,000) $ 404,000 $ 281,000 Deferred (386,000) 450,000 (1,818,000) ----------- ---------- ----------- Total $(2,230,000) $ 854,000 $(1,537,000) =========== ========== =========== Deferred income taxes and benefits are provided for differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Significant deferred tax assets and liabilities are as follows: TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. INCOME TAXES (Continued) December 29, December 28, 1996 1997 Current: Deferred Federal Tax Assets: Workmen's compensation claims $ 194,000 $ 494,000 Investment in joint venture 879,000 718,000 Accounts receivable 211,000 17,000 Charitable contributions 32,000 34,000 Net operating loss carryforward 558,000 - Accrued vacation - 38,000 -------------- ----------- Total 1,874,000 1,301,000 -------------- ----------- Deferred Federal Tax Liabilities- Pre-opening costs (46,000) (119,000) State taxes (1,000) - -------------- ----------- Total (47,000) (119,000) -------------- ----------- Net Current Deferred Tax Asset $ 1,827,000 $1,182,000 ============== =========== Noncurrent: Deferred Federal Tax Assets: Net operating loss carryforward $ 1,598,000 $5,601,000 Tax credit carryforward 627,000 627,000 Notes receivable 261,000 - Media and production 202,000 194,000 Closed stores (83,000) 916,000 State taxes 160,000 - Alternative minimum tax 1,056,000 1,258,000 Production costs - 79,000 Deferred rent (1,505,000) 791,000 Other - Special charge - 12,713,000 ------------- ----------- Total 2,316,000 22,179,000 ------------- ----------- Deferred Federal Tax Liabilities: Fixed and intangible assets (5,961,000) (4,312,000) Other reserves - (43,000) ------------- ---------- Total (5,961,000) (4,355,000) ------------ ---------- Net Noncurrent Deferred Tax Asset (Liability) (3,645,000) 17,824,000 Valuation Allowance - (19,006,000) ------------- ---------- Net Deferred Tax Liability $(1,818,000) $ - ============= ========== TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. INCOME TAXES (Continued) At December 28, 1997, the Company had net operating loss, alternative minimum tax and general business tax credit carry- forwards of approximately $16 million, $1.3 million and $627,000, respectively. A portion of the above carry- forwards resulted from the acquisition of Two Pesos; the Company was allowed to utilize the net operating loss of $5.4 million and tax credit carry-forwards of $178,000 of Two Pesos that existed at the date of acquisition. However, these carry-forwards may only offset the post-acquisition taxable income and tax liability of the Company's subsidiary that acquired Two Pesos. In addition, because of the change in ownership, the net operating loss carry-forward utilization is further limited to approximately $953,000 per year, and the tax credit carry-forward acquired from Two Pesos is limited each year to the tax equivalent of any remaining portion of the net operating loss limitation. The net operating loss and tax credit carry-forwards begin to expire in 2003 and 2000, respectively. The alternative minimum tax credit carry-over and the remaining general business credit carry-over resulted from prior-year losses which were carried back three preceding tax years. These credits are available to offset future taxable income. The general business credit begins to expire in 2007. The alternative minimum tax credit has no expiration date. The above amounts are included as deferred tax assets within this footnote and have been fully reserved in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". 15. LITIGATION SETTLEMENT AND LEGAL PROCEEDINGS On July 24, 1996, the Company approved the settlement of A.L. Park, et al v. Taco Cabana, Inc., et al., a suit originally filed in September 1995 seeking status as a class action. As a result thereof, the Company recorded a charge of $3.4 million pre-tax, $2.2 million after-tax, or $0.14 per share, during the second quarter of fiscal 1996. Under the terms of the settlement, the plaintiffs received a total of $6.0 million of which the Company's insurance carrier paid $3.05 million. Additionally, the Company has paid approximately $450,000 for legal and related expenses incurred in connection with the settlement In addition, the Company is a party to routine negligence or employment-related litigation in the ordinary course of its business. No such pending matters, individually or in the aggregate, are deemed to be material to the results of operations or financial condition of the Company. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. QUARTERLY FINANCIAL DATA (Unaudited) Quarter Ended ------------- March 31, June 30, September 29, December 29, 1996 1996 (1) 1996 1996 (1) Total revenues $31,264,000 $35,308,000 $33,810,000 $31,814,000 Gross profit 21,562,000 24,234,000 23,040,000 22,024,000 Net income (loss) applicable to common stock 734,000 (553,000) 1,220,000 (698,000) Basic and diluted earnings per share (2) 0.05 (0.04) 0.08 (0.04) Quarter Ended ------------- March 30, June 29, September 28, December 28. 1997 1997 1997 1997 (1) Total revenues $30,186,000 $34,200,000 $35,051,000 $32,765,000 Gross profit 21,024,000 23,628,000 24,178,000 22,704,000 Net income (loss) applicable to common stock 556,000 876,000 562,000 (75,193,000) Basic and diluted earnings per share (2) $ 0.04 $ 0.06 $ 0.04 $ (5.07) (1) See Notes ,2, 3 and 15 for discussion of charges recorded in these quarters. (2) The earnings per share amounts have been restated as required to comply with Statment of Financial Standards No. 128 (SFAS 128), "Earnings Per Share". For further discussion of earnings per share and the impact of SFAS 128, see Note 12. EXHIBIT INDEX Exhibit No. 21. Subsidiaries of the Registrant 23. Consent of Deloitte & Touche LLP 27. Financial Data Schedule EX-21 2 Subsidiaries of Registrant Exhibit 21 TP Acquisition Corp., a Texas corporation Get Real, Inc., a Delaware corporation Texas Taco Cabana, L.P., a Texas limited partnership T. C. Management Inc., a Delaware corporation T.C Lease Holdings III, V and VI, Inc., a Texas corporation Taco Cabana Multistate, Inc., a Delaware corporation Colorado Cabana, Inc., a Colorado corporation Taco Cabana Atlanta, Inc., a Delaware corporation Taco Cabana Investments, Inc., a Delaware corporation Taco Cabana Management, Inc., a Texas corporation EX-23 3 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 33-56438 and No. 33-98124 of Taco Cabana, Inc. on Form S-8 of our report dated February 2, 1998 appearing in this Annual Report on Form 10-K of Taco Cabana, Inc. for the year ended December 28, 1997. DELOITTE & TOUCHE LLP San Antonio, Texas March 27, 1998 EX-27 4
5 YEAR DEC-28-1997 DEC-28-1997 339,000 0 895,000 595,000 2,105,000 4,850,000 85,329,000 25,789,000 76,260,000 16,492,000 0 0 0 157,000 36,256,000 76,260,000 131,857,000 132,203,000 40,668,000 76,837,000 122,000,000 0 1,137,000 (74,735,000) 1,537,000 (73,198,000) 0 0 0 (73,198,000) (4.78) (4.78)
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