Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 26, 2004

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number 0-49916

 


 

RED ROBIN GOURMET BURGERS, INC.

(Exact Name of Registrant as Specified in its Charter)

 


 

Delaware   84-1573084

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

6312 S Fiddler’s Green Circle, Suite 200N Greenwood Village, CO   80111
(Address of Principal Executive Offices)   (Zip Code)

 

(303) 846-6000

(Registrant’s Telephone Number, Including Area Code)

 


 

Securities Registered Pursuant to Section 12(b) of the Act:    None

Securities Registered Pursuant to Section 12(g) of the Act:    Common Stock, $0.001 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.    ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes  x    No  ¨

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates (based on the closing price on the last business day of the registrant’s most recently completed second fiscal quarter on The NASDAQ National Market) was $336.9 million. All executive officers and directors of the registrant and all persons filing a Schedule 13D with the Securities and Exchange Commission with respect to the registrant’s common stock have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant.

 

There were 16,178,727 shares of common stock outstanding as of April 1, 2005.

 

Certain information required for Items 10, 11, 12, 13 and 14 of Part III of this annual report on Form 10-K is incorporated by reference to the registrant’s definitive proxy statement for the 2005 annual meeting of stockholders.

 



Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

TABLE OF CONTENTS

 

          Page

PART I     

ITEM 1.

   Business    1

ITEM 2.

   Properties    23

ITEM 3.

   Legal Proceedings    24

ITEM 4.

   Submission of Matters to a Vote of Security Holders    24
PART II     

ITEM 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    24

ITEM 6.

   Selected Financial Data    26

ITEM 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    28

ITEM 7A.

   Quantitative and Qualitative Disclosures About Market Risk    42

ITEM 8.

   Financial Statements and Supplementary Data    43

ITEM 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    71

ITEM 9A.

   Controls and Procedures    71

ITEM 9B.

   Other Information    74
PART III     

ITEM 10.

   Directors and Executive Officers of the Registrant    75

ITEM 11.

   Executive Compensation    75

ITEM 12.

   Security Ownership of Certain Beneficial Owners and Management    75

ITEM 13.

   Certain Relationships and Related Transactions    75

ITEM 14.

   Principal Accounting Fees and Services    75
PART IV     

ITEM 15.

   Exhibits, Financial Statement Schedules    76

Signatures

   79


Table of Contents

PART I

 

ITEM 1.    Business

 

Overview

 

Red Robin Gourmet Burgers, Inc., together with its subsidiaries, is a casual dining restaurant chain focused on serving an imaginative selection of high quality gourmet burgers in a family-friendly atmosphere. Unless otherwise provided in this annual report on Form 10-K, references to “Red Robin,” “we”, “us” and “our” refer to Red Robin Gourmet Burgers, Inc. and our consolidated subsidiaries. As of April 1, 2005, Red Robin owns and operates 141 restaurants in 17 states, with an additional 122 restaurants operating under franchise or license agreements in 24 states and two Canadian provinces.

 

Our menu features our signature product, the gourmet burger, which we make from premium quality beef, chicken, veggie patties, pot roast, pork, fish or turkey and serve in a variety of recipes. We offer a wide selection of toppings for our gourmet burgers, including fresh guacamole, roasted green chilies, honey mustard sauce, grilled pineapple, crispy onion straws, sautéed mushrooms and a choice of six different cheeses. In addition to gourmet burgers, which accounted for approximately 47.2% of our total food sales in 2004, we serve an array of other food items that are designed to appeal to a broad group of guests, including a variety of appetizers, salads, soups, pastas, seafoods, other entrees, desserts and our signature Mad Mixology® alcoholic and non-alcoholic specialty beverages.

 

Our restaurants are designed to create a fun and memorable dining experience in a family-friendly atmosphere and provide our guests with an exceptional dining value. Our concept attracts a broad guest base by appealing to the entire family, particularly women, teens, kids ages 8 to 12 whom we refer to as tweens, and younger children. Our mascot “Red” appeals to toddlers, and our carousel horses, televisions in the floors, three dimensional art and humorous posters appeal to children of all ages. We believe that our quick meal preparation, upbeat, popular music and enthusiastic team members enable us to achieve high sales productivity and create a sense of activity and excitement. All of our menu items are designed to be delivered to guests in a time-efficient manner, and we have a per person average check of approximately $10.36, including beverages.

 

To increase guest traffic, we locate our restaurants near high activity areas, such as regional malls, lifestyle centers, big box shopping centers and entertainment centers. We believe that women, teens and tweens are extremely attractive consumers to real estate developers in these types of locations as they often strive to attract a consumer base similar to ours. We further believe that these individuals are the primary visitors to the high activity areas where our restaurants are located and are predominantly responsible for family dining decisions. Data from an independent source indicates that in 2003 approximately 30.0% of our guests are in the highly desirable under 18 consumer segment, which compared to 20.0% in the major casual dining bar and grill chains. In addition, approximately 54.0% of our guests are females and approximately 58.0% of our guest visits include families accompanied by teens and tweens. We believe our unique guest demographic mix provides us with a competitive advantage over other casual dining chains, enhancing our ability to enter into real estate locations favorable to us.

 

We believe that the appeal of our imaginative, high quality product offerings, our fun, family-friendly atmosphere, and our ability to operate in a wide variety of real estate formats and geographic locations have created an attractive restaurant model, providing us with significant opportunities for continued growth through both new company-owned and franchised restaurants.

 

History

 

The first Red Robin® restaurant was opened in Seattle, Washington in September 1969. In 1979, the first franchised Red Robin® restaurant was opened in Yakima, Washington by Mike Snyder and his brother. Mike Snyder subsequently became our president and chief operating officer in 1996, and was elected chief executive

 

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officer in 1997. In 2000, we completed a series of financing transactions that helped position our company for future growth. At that time, we acquired The Snyder Group, a 14-restaurant franchise company owned by Mike Snyder, in exchange for equity, cash and notes. In addition, a private equity firm, whose principals had substantial experience in the restaurant industry, made an equity investment of $25.0 million in our company through its affiliates. As a result of these two transactions, Mike Snyder acquired a significant equity interest in our company and the private equity firm became, at the time, our largest stockholder. In January 2001, our management formed Red Robin Gourmet Burgers, Inc., a Delaware corporation, to facilitate a reorganization of the company. The reorganization was consummated in August 2001, and since that time, Red Robin Gourmet Burgers, Inc. has owned all of the outstanding capital stock of Red Robin International, Inc., and our other operating subsidiaries through which our company-owned restaurants are operated. We completed an initial public offering of our common stock in July 2002.

 

Concept and business strategy

 

Our objective is to be the leading gourmet burger and casual dining restaurant destination. To achieve our objective, we have developed the following strategies.

 

    Focus on key guiding principles, or “cornerstones,” that drive our success.    In managing our operations, we focus on four cornerstones that we believe are essential to our business. Our four cornerstones are:

 

    Values.    To enhance the dining experience of our guests, we strive to maintain our core values: honor, integrity, seeking knowledge and having fun.

 

    People.    We recognize that our team members are our strongest asset. We seek to hire high quality team members and provide them with comprehensive training programs to ensure that we deliver superior service to our guests.

 

    Burgers.    We strive to be the number one casual dining destination for gourmet burgers in the markets in which we operate.

 

    Time.    We believe in giving our guests the “gift of time.” Our service sequence is designed to consistently prepare every menu item in less than eight minutes, which allows guests to enjoy time-efficient lunches and dinners. We strive to provide guests with a 37-minute dining experience at lunch and a 42-minute experience at dinner.

 

    Offer high quality, imaginative menu items.    Our restaurants feature menu items that use imaginative toppings and showcase recipes that capture tastes and flavors that our guests do not typically associate with burgers, salads and sandwiches. We believe the success of our concept is due to our ability to interpret the latest food trends and incorporate them into our gourmet burgers, pastas, carnitas fajitas, appetizers, salads, sandwiches and beverages. Our menu items are cooked to order, using high-quality, fresh ingredients and premium meats and are based on unique recipes. One of our signature menu items is our Royal Red Robin Burger, which features a gourmet burger topped with a fried egg, along with bacon, cheese, lettuce, tomato and mayonnaise. We offer a wide selection of toppings for our gourmet burgers, including fresh guacamole, roasted green chilies, honey mustard sauce, grilled pineapple, crispy onion straws, sautéed mushrooms and a choice of six different cheeses. We serve all of our gourmet burgers and sandwiches with “bottomless” french fries.

 

    Create a fun, festive and memorable dining experience.    We promote an exciting, high-energy and family-friendly atmosphere by decorating our restaurant interiors with an eclectic selection of celebrity posters, three-dimensional artwork, carousel horses and statues of our mascot “Red.” We enhance the excitement and energy levels in our restaurants by placing televisions in our main dining areas, in our floors and in our bathrooms and by playing upbeat, popular music throughout the day.

 

   

Provide an exceptional dining value with broad consumer appeal.    We offer generous portions of high quality, imaginative food and beverages for a per person average check of approximately $10.36, including beverages. We believe this price-to-value relationship differentiates us from our competitors,

 

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many of whom have significantly higher average guest checks, and allows us to appeal to a broad base of consumers with a wide range of income levels. In addition to attracting families and groups, our restaurant features seating in the bar area, which is often used by our single diners. Our restaurants are popular during both the day and evening hours as evidenced by our almost equal split between lunch and dinner sales. We believe that our diverse menu further enhances our broad appeal by accommodating groups with different tastes.

 

    Build awareness of the Red Robin® America’s Gourmet Burgers & Spirits® brand.    We believe that the Red Robin name has achieved substantial brand equity among our guests and has become well known within our markets for our signature menu items. We intend to strengthen this brand loyalty by continuing to offer new menu items and by delivering a consistently memorable guest experience. Additionally, we believe that Red Robin is recognized for the family-friendly, high-energy and exciting atmosphere our restaurants offer. Key brand attributes that we continue to build upon are our high-quality imaginative food items, commitment to guest service and a strong price-to-value relationship.

 

    Continue to capitalize on favorable lifestyle and demographic trends.    We believe that we have benefited from several key lifestyle and demographic trends that have helped drive our business. These trends include:

 

    Increase in consumption of food away from home.    According to an April 2002 report, the National Restaurant Association estimated that the restaurant industry captured 45.3% of all consumer dollars spent on food in 2000 and projected the restaurant industry’s share to increase to 53.0% by 2010. Given our attractive average guest check, family-friendly atmosphere and fun, festive and memorable dining experience, we believe we are well-positioned to continue to benefit from this expected increase in food consumed away from home.

 

    The large and growing teen population.    According to a January 2000 study conducted by the United States Census Bureau, the teen segment of the population, persons 12 to 19 years old, is expected to grow 36.6% faster than the overall population from 31.6 million in 2000 to 33.6 million by 2005. Given that our concept attracts a significant number of teens and tweens, we believe we will continue to benefit from the strong growth in this segment of the population.

 

We believe these and other lifestyle and demographic trends will continue to be favorable to us and offer us strong opportunities for future restaurant expansion.

 

Unit level economics

 

In 2004, our comparable company-owned restaurants generated average sales of $3.2 million. The average cash investment cost for our free-standing restaurants opened in 2004 was $2.2 million, excluding land and pre-opening costs. Pre-opening costs averaged $227,100 per restaurant during 2004.

 

Our existing restaurants range in size from 3,800 square feet to 10,700 square feet. Our prototype restaurant is a free-standing building with approximately 6,350 square feet, approximately 200 seats and a patio. Based on this prototype, we expect that our average cash investment cost for our free-standing restaurants in 2005 will be $2.3 million, excluding land and pre-opening costs. We expect pre-opening costs will average $245,000 per restaurant in 2005.

 

Expansion strategy and site selection

 

We are pursuing a disciplined growth strategy that includes the addition of company-owned and franchised restaurants. Our restaurant expansion strategy focuses primarily on further penetrating existing markets with a cluster strategy and selectively entering into new markets. We believe this clustering strategy enables us to gain operating efficiencies, increase brand awareness and enhance convenience and ease of access for our guests, all of which we believe leads to significant repeat business. For example, clustering enables us to reduce costs

 

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associated with regional supervision of restaurant operations. We also believe this approach reduces the risks involved with opening new restaurants given that we better understand the competitive conditions, consumer tastes, demographics and discretionary spending patterns in our existing markets. In addition, our ability to hire qualified team members is enhanced in markets in which our brand is well known.

 

We believe that our site selection strategy is critical to our success and we devote substantial time and effort to evaluating each site. Our site selection criteria focuses on identifying markets, trade areas and other specific sites that are likely to yield the greatest density of desirable demographic characteristics, heavy retail traffic and a highly visible site.

 

In order to maximize our market penetration potential, we have developed a flexible physical site format that allows us to operate in a range of real estate venues located near high activity areas such as regional malls, lifestyle centers, big box shopping centers and entertainment centers. Approved sites generally have a population of at least 70,000 people within a three-mile radius and at least 100,000 people within a five-mile radius. Sites generally require a strong daytime and evening population, adequate parking and a visible and easy entrance and exit.

 

Our real estate team focuses on site selection and future development, and thoroughly analyzes each prospective site before we sign a lease or purchase agreement. Prior to committing to a restaurant site, members of our senior management team visit and thoroughly evaluate the proposed site. Our chief executive officer and/or our chief financial officer personally visit and approve all new sites.

 

With the exception of the 21 sites for which we own the real estate, we operate our restaurants under leases. Our primary site objective is to secure a suitable site, with the decision to buy or lease as a secondary objective. We believe that our unique guest demographic mix provides us with a major competitive advantage in securing sites. Our long-standing relationships with several major retail developers and owners and our favorable demographics afford us the opportunity to negotiate additional sites in their new developments.

 

Restaurant locations

 

We believe that there are significant opportunities to grow our concept and brand on a nationwide basis, and we continue to believe that our concept and brand can support as many as 755 additional company-owned or franchised restaurants throughout the United States.

 

In 2004, we opened 22 new company-owned restaurants. In 2005, we expect to open 26 to 28 new company-owned restaurants. In 2004, our franchisees opened 17 new restaurants, and we believe our franchisees will open an additional 15 to 17 new franchise restaurants in 2005.

 

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As of April 1, 2005, we have 141 company-owned restaurants and 122 franchised restaurants in 31 states and two Canadian provinces as shown in the table below:

 

     Number of Restaurants As of April 1, 2005

     Company-Owned

   Franchised

   Total

Alaska

   —      2    2

Arizona

   9    3    12

Arkansas

   1    —      1

California

   37    17    54

Colorado

   19    —      19

Connecticut

   —      2    2

Delaware

   —      1    1

Idaho

   —      3    3

Illinois

   1    5    6

Indiana

   1    1    2

Kansas

   —      2    2

Maryland

   7    —      7

Michigan

   —      12    12

Minnesota

   —      4    4

Missouri

   4    1    5

Montana

   —      1    1

Nebraska

   3    —      3

Nevada

   3    1    4

New Jersey

   —      1    1

New Mexico

   —      2    2

New York

   —      2    2

North Carolina

   2    —      2

Ohio

   11    1    12

Oklahoma

   2    —      2

Oregon

   11    3    14

Pennsylvania

   3    9    12

Texas

   —      9    9

Utah

   —      4    4

Virginia

   10    —      10

Washington

   17    13    30

Wisconsin

   —      5    5
    
  
  

Total United States

   141    104    245
    
  
  

Canada

   —      18    18
    
  
  

Total

   141    122    263
    
  
  

 

Menu

 

Our menu features our signature product, the gourmet burger, which we define as “anything that can go in, on or between two buns”. We make our gourmet burgers from premium quality beef, chicken, veggie patties, pot roast, pork, fish or turkey, and serve them in a variety of recipes. We offer a wide selection of toppings for our gourmet burgers, including fresh guacamole, roasted green chilies, honey mustard sauce, grilled pineapple, crispy onion straws, sautéed mushrooms and a choice of six different cheeses. For example, one of our signature creations, the Banzai Burger, is marinated in teriyaki and topped with grilled pineapple, cheddar cheese, lettuce, tomato and mayonnaise.

 

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In addition to gourmet burgers, which accounted for approximately 47.2% of our total food sales in 2004, we serve an array of other food items that are designed to appeal to a broad group of guests, including a variety of appetizers, salads, soups, pastas, seafoods, other entrees and desserts. One of our top selling non-burger menu items is the Crispy Chicken Tender Salad, which features crisp greens topped with lightly fried chicken breast, hard-boiled egg, diced tomato, cheddar cheese, bacon bits and green onion served with house bread and a choice of dressing. We serve all of our burgers and sandwiches with “bottomless” french fries. Our guests can also choose from a wide variety of beverages, including fountain beverage products, smoothies, monster milkshakes, our Strawberry Ecstasy and our signature Mad Mixology® alcoholic and non-alcoholic specialty beverages, including our Freckled Lemonade.

 

All of our menu items are prepared to order in our restaurants. The food items currently on our menu range in price from $2.99 to $11.49, with a per person average check of approximately $10.36, including beverages. Sales of alcoholic beverages represented approximately 7.7% and sales of non-alcoholic beverages represented 13.8% of total restaurant sales in 2004.

 

We continuously experiment with food and beverage items and flavor combinations to create selections that are imaginative and exciting to our guests. Ideas for new menu items are generated at the restaurant level as well as through consumer research and franchisees. Menu items are rotated on and off the menu based on the changing tastes of our guests. Every new recipe idea goes through our test menu development process. The proposed menu item must appeal to a sufficient number of guests and require a preparation time of less than eight minutes to be added to our menu. In addition, the corresponding ingredients must retain or improve the overall menu quality while meeting our gross profit margin targets. All new menu items are then test marketed for 8 to 12 weeks in selected restaurants. Our franchisees are given the opportunity to review proposed menu items and offer feedback before the recipes are finalized and added to the menu.

 

Guest loyalty and experience

 

Through our unique guest service philosophy, which we describe as “unbridled”, we feel we have created a culture that has enabled us to build a strong and loyal guest base. Unbridled acts are common in our company, as our team members have a history of going far beyond the customary level of guest service. In 2002, we were proud to be recognized as a gold winner of Restaurants & Institutions 2002 Choice in Chains Award for excellence in customer service, food quality and overall dining experience, as voted on by a nationally representative sample of consumers. In 2004, we were proud to be a large business category finalist of the Colorado Restaurant Association’s, Restaurant Neighbor Award, which celebrates restaurateurs’ commitment to community involvement.

 

We use many industry standard techniques to measure our guests’ experiences at our restaurants. These include comment cards, mystery shoppers, internet feedback, market area and in-restaurant consumer research. We also employ several additional techniques at the restaurant level, including a “systems check” performed each week by our general managers to track and measure our guests’ experiences. This “systems check” evaluates our speed of service, our food preparation times, seating utilization measures and guest feedback for each week. The key measurement criteria evaluated in our “systems check” contribute to our ability to give our guests the “gift of time.” We strive to provide guests with a 37-minute dining experience at lunch and a 42-minute experience at dinner. Our regional operations directors utilize these and other reports to determine which restaurants in their region may need additional support to address any problems.

 

Marketing and advertising

 

During 2004, we spent an aggregate of 2.7% of restaurant sales on marketing efforts. Of this amount, we spent less than 1.0% of restaurant sales on major media initiatives such as television commercials, radio advertisements and free-standing inserts in newspapers and other print media. We expect to continue investing a similar percentage of restaurant sales in marketing efforts in the future, primarily in connection with driving

 

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comparable restaurant sales and new restaurant openings. Our marketing strategy focuses on building positive, long term relationships by making emotional connections with our team members and guests. We do this by:

 

    driving comparable restaurant sales through attracting new guests and increasing the frequency of visits by current guests;

 

    supporting new restaurant openings to achieve their sales and profit goals; and

 

    communicating a unique, powerful and consistent brand.

 

We accomplish these objectives through four major marketing initiatives.

 

In-restaurant marketing

 

We spend a significant portion of our marketing funds communicating with our guests while they are in our restaurants. The core of our strategy revolves around keeping our menu items fresh, with innovative gourmet burgers and other offerings. Throughout the year, we promote new burgers and new non-burger items. These items are featured along with our existing gourmet burgers and entrees on table merchandising and other printed materials throughout our restaurants. This strategy focuses on highlighting both our core menu burgers along with new burgers and other food items and beverages. The goal is to enhance our brand by creating variety and excitement for our guests and team members, which we believe drives frequency of visits.

 

New restaurant openings

 

We use new restaurant openings as opportunities to reach out to the local community and media. Our openings are often covered by local media. We employ a variety of marketing techniques in connection with our new restaurant openings, including community “Sneak Preview” parties, with invitations to media personalities, community leaders and local businesses. We also typically tie our openings to a charitable organization.

 

Local restaurant marketing

 

We believe we are a wholesome, values-focused leader in family casual dining. With our focus on women, teens and tweens, we have a unique opportunity to market our restaurants locally. We reach out to schools, churches, charities, and community organizations to build brand awareness within the communities that we serve.

 

Advertising

 

Although our restaurant concept is not media driven, we do spend a limited amount of our marketing dollars on media vehicles in select markets to build brand awareness. This includes radio, free-standing newspaper inserts, outdoor billboards, and on-screen cinema advertising.

 

Operations

 

Restaurant management

 

Our restaurant operations are divided into four distinct geographic regions which are overseen by a senior regional operations director who reports to our vice president of restaurant operations. In general, each geographic region contains four to six regional operations directors, one to three regional recruiters, a regional training manager and one to two regional kitchen managers. Our regional directors oversee five to eight company-owned restaurants each, which we believe enables them to better support the general managers and achieve sales and cash flow targets for each restaurant within their region. In certain instances, regional operations directors invest a limited portion of their time on franchised operations in their respective regions.

 

Our typical restaurant management team consists of a general manager, an assistant general manager, a kitchen manager and one or two assistant managers. Most of our restaurants employ approximately 85 hourly

 

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team members, many of whom work part-time. The general manager of each restaurant is responsible for the day-to-day operation of that restaurant, including hiring, training and development of team members, as well as operating results. The kitchen manager is responsible for product quality, daily production, shift execution, food costs and kitchen labor costs. Our restaurants are generally open Sunday through Thursday from 11:00 AM until 10:00 PM and on Friday and Saturday from 11:00 AM to 11:00 PM.

 

Operational tools and programs

 

We utilize a customized food and beverage analysis program that determines the optimal food and beverage costs for each restaurant and provides additional tools and reports to help us identify opportunities, such as waste management, which we believe affords us lower than industry average food and beverage costs. We also utilize a labor program to determine the optimal staffing needs of each restaurant based on its actual guest flow and demand.

 

We employ several additional operational tools. For example, each week every general manager performs a “systems check” that tracks and measures our guests’ experiences based upon key criteria. This “systems check” evaluates our speed of service, food preparation times, seating utilization measures and guest feedback for each week. Our regional operations directors utilize these and other reports to determine which restaurants in their region may need additional support to address any problems.

 

Training

 

We strive to maintain quality and consistency in each of our restaurants through the careful training and supervision of team members and the establishment of, and adherence to, high standards relating to personnel performance, food and beverage preparation and maintenance of our restaurants. Each location has eight to ten certified trainers who provide classroom and on-the-job instruction for new team members. All of our trainers participate in an eight-hour training seminar on good training skills, which provides them with knowledge and tactics to enable them to be better trainers and coaches. We provide all new team members with complete orientation and one-on-one training for their positions to ensure they are able to meet our high standards. All of our new team members are trained by partnering with a certified designated trainer to assure that the training and information they receive is complete and accurate. Team members are certified for their positions by passing a series of tests.

 

New restaurant managers are required to complete an eight-week training program that includes service, kitchen and management responsibilities. Newly trained managers are then assigned to their home restaurant where they spend one additional training week with their general manager. We place a high priority on our continuing management development programs in order to ensure that qualified managers are available for our future openings. We conduct semi-annual performance reviews with each manager to discuss prior performance and future performance goals. Once a year, we hold a general manager conference in which our general managers receive additional training on financial management, food preparation, hospitality and other relevant topics.

 

When we open a new restaurant, we provide training to team members in each position to ensure the smooth and efficient operation of the restaurant from the first day it opens to the public. Prior to opening a new restaurant, our dedicated training and opening team travels to the location to prepare for an intensive seven-day training program for all team members hired for the new restaurant opening. Part of the training team stays on-site during the first week of operation and an additional team of training support arrives for on-site support during the second and third weeks. We believe this additional investment in our new restaurants is important because it helps us provide our guests with a quality dining experience from day one. We also make on-site training teams available when our franchisees open new restaurants. After a restaurant has been opened and is operating smoothly, the general manager supervises the training of new team members.

 

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Recruiting and retention

 

In 2004, we were proud to be a recipient of Nation’s Restaurant News’ 2004 People and Performance Awards, sponsored by Coca-Cola®. This award honors multi-unit food service operators for excellence in recruiting, retention and recognition of hourly and management team members. We seek to hire experienced general managers and team members. We support our team members by offering competitive wages and benefits, including a 401(k) plan, an employee stock purchase plan, medical insurance and stock options for general managers. We motivate and prepare our team members by providing them with opportunities for increased responsibilities and advancement, as well as significant performance-based incentives tied to sales, profitability, certain qualitative measures and length of service at one of our restaurant locations. For example, we provide our general managers with the use of a Jeep Wrangler for two years if they increase restaurant sales in a single restaurant by 15.0% for four consecutive quarters. If this increase is maintained for eight consecutive quarters, we give the manager outright title to the Jeep Wrangler. We also provide various other incentives including vacations, car allowances and quarterly sales and profit bonuses. Our most successful general managers are eligible for promotion to training general manager status and are entitled to receive more lucrative compensation packages based on various performance criteria. We also provide monetary rewards for general managers who develop future managers for our restaurants.

 

Restaurant franchise and licensing arrangements

 

As of April 1, 2005, we have 27 franchisees that operate 122 restaurants in 24 states and two Canadian provinces, and we have 21 exclusive franchise development arrangements with these franchisees. Our two largest franchisees are Red Robin Restaurants of Canada, Ltd., with 18 restaurants throughout Alberta and British Columbia, Canada, and Top Robin Ventures, Inc., with 16 restaurants in Southern California. In 2004, our franchisees opened 17 new restaurants and we expect our franchisees to open 15 to 17 additional new restaurants in 2005. The success of our current franchisees and the popularity of our concept have created significant interest by potential franchisees.

 

Each franchise arrangement typically consists of an area development agreement and a separate franchise agreement for each restaurant. Our current form of area development agreement grants exclusive rights to a franchisee to develop a minimum number of restaurants in a defined area, typically over a five-year period. Individual franchise agreements relate to the operation of each restaurant opened and typically have a term of 20 years with a renewal option for an additional ten years if certain conditions are satisfied.

 

Under our current form of area development agreement, we collect a $10,000 area development fee for each restaurant the franchisee agrees to develop at the time we enter into the area development agreement. When a franchisee opens a new restaurant, we collect an additional franchise fee of $25,000. We may charge lower area development fees and franchise fees for existing franchisees. Area development fees and franchise fees are recognized as income when all material obligations and initial services to be provided by us have been performed, generally upon the opening of the restaurant. Until earned, these fees are accounted for as deferred income, a liability. Our current form of franchise agreement requires the franchisee to pay a royalty fee equal to 4.0% of adjusted restaurant sales.

 

Franchisees are required to spend a minimum of 1.5% of adjusted restaurant sales on local advertising or promotional activities and to pay an advertising fee of 0.5% of adjusted restaurant sales to a cooperative advertising fund for marketing studies and the development of commercials or other print and electronic media promotional material. We also have the ability under most of our franchise agreements to require the franchisee to contribute up to 4.0% of adjusted sales to a separate national advertising and marketing fund. The royalty fee and advertising and marketing contributions of our franchisees vary depending on when the agreements were executed and the number of restaurants that the franchisee committed to open during the term of the area development agreement.

 

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Franchise compliance assurance

 

We have instituted a comprehensive system to ensure the selection of quality franchisees and compliance with our systems and standards, both during the development and operating of franchise restaurants.

 

    Selection process.    We generally select franchisees that are experienced, well capitalized, multi-unit restaurant operators or that have demonstrated the ability to raise capital and rapidly grow a multi-unit retail or service organization. During the selection process, we conduct comprehensive background, financial and reference checks on all candidates. Key department heads will typically meet with each franchisee candidate and often visit their current business operations to assess his or her level of relevant expertise. References are obtained from the candidates as well as through industry sources, such as former suppliers, executives, managers or other business associates. We will generally not grant development rights for the development of a single restaurant.

 

    Development and operations.    After a franchise agreement is signed, we actively work with and monitor our franchisees to ensure successful franchise operations as well as compliance with Red Robin systems and procedures. During the development phase, we assist in the selection of restaurant sites and the development of prototype and building plans, including all required changes by local municipalities and developers. After construction is completed, we review the building for compliance with our standards and provide eight trainers to assist in the opening of the restaurant. We advise the franchisee on menu, management training, and equipment and food purchases. At least once a year, we review all menu items and descriptions to ensure compliance with our requirements and standards. We require all suppliers of ground beef, if different than ours, to pay for and pass an annual inspection performed by third party auditors. Finally, on an ongoing basis, we conduct brand equity reviews on all franchise restaurants to determine their level of effectiveness in executing our concept at a variety of operational levels. Reviews are conducted by seasoned operations teams, last approximately two to three days, and focus on seven key areas including health, safety, brand foundation, and execution proficiency.

 

To continuously improve our operations, we maintain a franchise marketing advisory council, a franchise business advisory council and a food and beverage committee. The councils provide advice to us regarding operations and consist of three franchisee representatives and three members of our senior management. The food and beverage committee, which is also comprised of three franchisee representatives and three members of our senior management team, helps determine which items are selected for menu testing and which items will be featured in future promotions. In addition, several times each year we solicit feedback and insights on specific topics from the broad group of franchisees and then get together with them to discuss and share their insights. These gatherings are an effort to attain a high level of franchisee buy-in and to assure the system is evolving in a positive direction through the exchange of best practices.

 

Management information systems

 

All of our restaurants use computerized management information systems, which are designed to improve operating efficiencies, provide corporate management with timely access to financial and marketing data, and reduce restaurant and corporate administrative time and expense. We believe our management information systems are sophisticated and are sufficient to support our restaurant expansion plans.

 

With the data provided by our information systems, we can report daily, weekly and period-to-date numbers on an automated daily report that is delivered electronically to our restaurants and our field personnel. On a weekly and a periodic basis, we issue other electronic reports that provide comparative data regarding food, labor and other cost information. Our information systems also enable us to automatically post restaurant-level data, such as restaurant sales, cash and credit card receipts and promotion usage into our corporate accounting software. We also use our information systems to capture information regarding our payroll and the status of new and existing team members. Specifically, we use Menulink, a Windows-based product, to perform our restaurant-level bookkeeping, electronic ordering and food cost and management functions. Our Radiant Systems, formally Aloha Technologies, point-of-sale system facilitates the supply of data to Menulink and also assists with labor

 

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scheduling and credit card authorizations. Our new Scheduling Team Members and Reporting System (NuSTaRs) helps our managers schedule the optimal amount of team members at any time. We believe these systems enable both restaurant-level and corporate-level management to adequately supervise the operational and financial performance of our restaurants as necessary to support our planned expansion.

 

Food preparation, quality control and purchasing

 

We believe that we have some of the highest food quality standards in the industry. Our systems are designed to protect our food supply throughout the preparation process. We provide detailed specifications to suppliers for our food ingredients, products and supplies. We inspect specific qualified manufacturers and growers. Our purchasing team and restaurant managers are certified in a comprehensive safety and sanitations course by the National Restaurant Association. Minimum cook temperature requirements and twice-a-day line checks ensure the safety and quality of both burgers and other items we use in our restaurants.

 

We rely on SYSCO Corporation, a national food distributor, as the primary distributor of our food ingredients, supplies and other products. Our current contract with SYSCO ends on June 30, 2007. To maximize our purchasing efficiencies and obtain the lowest possible prices for our ingredients, products and supplies, while maintaining the highest quality, our centralized purchasing team generally negotiates fixed price contracts with terms of between one month and one year or monthly commodity pricing formulas. In order to provide the freshest ingredients and products, and to maximize operating efficiencies between purchase and usage, each restaurant’s kitchen manager determines the restaurant’s daily usage requirements for food ingredients, products and supplies. Accordingly, the kitchen manager orders from approved local suppliers and our national master distributor and all deliveries are inspected to ensure that the items received meet our quality specifications and negotiated prices. We believe that competitively priced, high quality alternative manufacturers, suppliers, growers and distributors are available should the need arise.

 

Team members

 

As of March 6, 2005, we had just over 13,000 employees, whom we refer to as team members, consisting of approximately 12,900 team members at company-owned restaurants and 176 team members at our corporate headquarters and in our regional offices. During our higher volume summer months, we experience an increase in the number of hourly team members in our restaurants of approximately 10.0%. None of our team members are covered by any collective bargaining agreement. We consider our team member relations to be good.

 

Competition

 

The restaurant industry is highly competitive. We compete on the basis of the taste, quality, price of food offered, guest service, ambiance, location and overall dining experience. We believe that our guest demographics, our gourmet burger concept, attractive price-value relationship, and the quality of our food and service enable us to differentiate ourselves from our competitors. Although we believe we compete favorably with respect to each of these factors, many of our direct and indirect competitors are well-established national, regional or local chains, and some have substantially greater financial, marketing, and other resources than we do. We also compete with many other restaurant and retail establishments for site locations and team members.

 

Seasonality

 

Our business is subject to seasonal fluctuations. Historically, sales in most of our restaurants have been higher during the summer months and winter holiday season. As a result, our quarterly and annual operating results and comparable restaurant sales may fluctuate significantly as a result of seasonality and other factors. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable restaurant sales for any particular future period may decrease.

 

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Trademarks

 

Our registered trademarks and service marks include, among others, the marks “Red Robin®”, “America’s Gourmet Burgers & Spirits®”, “Mad Mixology®” and our logo. We have registered these marks with the United States Patent and Trademark Office. We have registered or have registrations pending in Canada for our most significant trademarks and service marks. In order to better protect our brand, we have also registered the Internet domain name www.redrobin.com. We believe that our trademarks, service marks, and other proprietary rights have significant value and are important to our brand-building efforts and the marketing of our restaurant concepts. We have in the past, and expect to continue to vigorously protect our proprietary rights. We cannot predict, however, whether steps taken by us to protect our proprietary rights will be adequate to prevent misappropriation of these rights or the use by others of restaurant features based upon, or otherwise similar to, our concept. It may be difficult for us to prevent others from copying elements of our concept and any litigation to enforce our rights will likely be costly and may not be successful. Although we believe that we have sufficient rights to all of our trademarks and service marks, we may face claims of infringement that could interfere with our ability to market our restaurants and promote our brand. Any such litigation may be costly and divert resources from our business. Moreover, if we are unable to successfully defend against such claim(s), we may be prevented from using our trademarks and/or service marks in the future and may be liable for damages.

 

Government regulation

 

Our restaurants are subject to licensing and regulation by state and local health, safety, fire and other authorities, including licensing and regulation requirements for the sale of alcoholic beverages and food. To date, we have not experienced an inability to obtain or maintain any necessary licenses, permits or approvals, including restaurant, alcoholic beverage and retail licensing. The development and construction of additional restaurants will also be subject to compliance with applicable zoning, land use, and environmental regulations. We are also subject to federal regulation and state laws that regulate the offer and sale of franchises and substantive aspects of a franchisor-franchisee relationship. Various federal and state labor laws govern our relationship with our team members and affect operating costs. These laws include minimum wage requirements, overtime, unemployment tax rates, workers’ compensation rates, citizenship requirements and sales taxes. In addition, the Federal Americans with Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment.

 

Available Information

 

We maintain a link to investor relations information on our website, www.redrobin.com, where we make available, free of charge, our Securities and Exchange Commission filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We are providing the address to our website solely for the information of investors. Information contained on our website is not incorporated by reference herein and our web address is included as an inactive textual reference only.

 

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Executive officers

 

The following table sets forth information about our executive officers and other key officers as of April 1, 2005:

 

Name


   Age

  

Position


Executive Officers:

         

Michael J. Snyder

   55    Chairman of the Board, Chief Executive Officer, President

James P. McCloskey

   54    Chief Financial Officer

Michael E. Woods

   55    Senior Vice President of Franchise Development

Robert J. Merullo

   50    Senior Vice President of Restaurant Operations

Todd A. Brighton

   47    Vice President of Development

Eric C. Houseman

   37    Vice President of Restaurant Operations

Other Key Officers:

         

G. Dwayne Chambers

   39    Vice President of Marketing

John W. Grant

   58    Vice President and General Counsel

Jeffrey T. Neely

   44    Vice President of Franchise Operations

Robert F. Fix

   52    Vice President of Franchise Sales

Douglas D. Gammon

   58    Vice President of Human Resources

Lisa A. Dahl

   46    Vice President and Controller

Robert K. Jakoby

   39    Vice President of Management Information Systems

Ray S. Masters

   45    Vice President of Purchasing

Scott A. Schooler

   37    Vice President of Food and Beverage

 

Michael J. Snyder.    Mr. Snyder was elected as our president, chief operating officer and as a director in April 1996, and currently serves in these positions under the terms of his employment agreement with the Company. In March 1997, Mr. Snyder was elected as our chief executive officer. In May 1997, Mr. Snyder was elected as our chairman of the board. From 1979 to May 2000, Mr. Snyder also served as president of The Snyder Group Company.

 

James P. McCloskey.    Mr. McCloskey was elected as our chief financial officer and secretary in June 1996. From March 1994 to January 1996, Mr. McCloskey served as chief financial officer for Avalon Software in Tucson, Arizona. From July 1988 to March 1994, Mr. McCloskey served as chief financial officer for Famous Amos Cookies in San Francisco, California.

 

Michael E. Woods.    Mr. Woods joined us in January 1997 as our vice president of franchise development and was appointed senior vice president in January 1999. From 1992 to June 1999, Mr. Woods also served as director of corporate development for The Snyder Group Company.

 

Robert J. Merullo.    Mr. Merullo joined us in April 2000 as our senior vice president of restaurant operations. Mr. Merullo was the director of operations for The Snyder Group Company from November 1991 to April 2000.

 

Todd A. Brighton.    Mr. Brighton joined us in April 2001 as our vice president of development with management responsibility over real estate and design and construction. From August 1999 to April 2001, Mr. Brighton was director of real estate with RTM Restaurant Group and was responsible for strategic analysis and market planning for three restaurant chains. From November 1996 to July 1999, Mr. Brighton was the western development manager for Blockbuster Entertainment, Inc. and was responsible for all real estate development in 17 states and select international markets.

 

Eric C. Houseman.    Mr. Houseman joined us in 1993 and has served as our vice president of restaurant operations since March 2000. From 1993 to March 2000, Mr. Houseman served in various regional operations management positions with our company.

 

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G. Dwayne Chambers.    Mr. Chambers joined us in August 2003 as our vice president of marketing with responsibility for marketing, advertising, media buying and public relations. From July 1999 to May 2003, Mr. Chambers served as vice president of marketing for Sonic Drive Ins. From May 1987 to June 1999, Mr. Chambers served in various positions including vice president at Moroch and Associates in Dallas, where he directed the agency’s McDonald’s account.

 

John W. Grant.    Mr. Grant joined us in January 1995 as our director of real estate and legal and was promoted to vice president and general counsel in August 1996. From December 1993 to December 1994, Mr. Grant was self-employed as an attorney in Santa Barbara, California.

 

Jeffrey T. Neely.    Mr. Neely joined us in November 2003 as our vice president of franchise operations. From February 2000 to October 2003, Mr. Neely served as senior director of franchise and license operations at Einstein & Noah Bagel Corporation. From September 1989 to January 2000, Mr. Neely served as president and chief executive officer of Domino’s Pizza Neely Enterprises of Wichita.

 

Robert F. Fix.    Mr. Fix joined us in March 2001 as our vice president of franchise sales. From 1996 until March 2001, Mr. Fix was director of U.S. franchise development for Boston Pizza International of Richmond in British Columbia, Canada.

 

Douglas D. Gammon.    Mr. Gammon joined us in November 2003 as our vice president of human resources. From March 1997 to October 2003, Mr. Gammon served as senior vice president of human resources and people development at Taco Cabana, Inc. From December 1989 to March 1997, Mr. Gammon served as vice president of human resources at Marriott International.

 

Lisa A. Dahl.    Ms. Dahl joined us in March 1997 as our corporate controller and was promoted to vice president in January 2003. Prior to joining us, Ms. Dahl was an accounting director for Vicorp Restaurants. Ms. Dahl is a certified public accountant and has served as chairperson for the National Restaurant Association Finance Executive Group.

 

Robert K. Jakoby.    Mr. Jakoby joined us in March 1997 as manager of restaurant systems, was later promoted to director of management information systems and in January 2004 was promoted to vice president of management information systems and chief information officer. From May 1993 to March 1997, Mr. Jakoby was store systems project manager for Boston Chicken, Inc. Mr. Jakoby currently serves as chairman of the National Restaurant Association MIS executive study group and also serves on the Nation’s Restaurant News Foodservice Technology Advisory Board.

 

Ray S. Masters.    Mr. Masters joined us in May 1996 as director of purchasing and was promoted to vice president of purchasing in October 1998. Prior to joining us, Mr. Masters held multi-unit national account executive sales positions with SYSCO Foods and Johnsonville Foods.

 

Scott A. Schooler.    Mr. Schooler joined us in April 2000 as vice president of food and beverage. He was the director of food and beverage for The Snyder Group Company from March 1987 to April 2000.

 

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RISK FACTORS

 

An investment in our common stock involves a high degree of risk. You should carefully read and consider the risks described below before deciding to invest in our common stock. If any of the following risks actually occurs, our business, financial condition, results of operations or cash flows could be materially harmed. In any such case, the trading price of our common stock could decline, and you could lose all or part of your investment. When determining whether to invest in our common stock, you should also refer to the other information contained or incorporated by reference in this annual report on Form 10-K, including our consolidated financial statements and the related notes.

 

Risks related to our business

 

Our growth strategy depends on opening new restaurants. Our ability to expand our restaurant base is influenced by factors beyond our control, which may slow restaurant development and expansion and impair our growth strategy.

 

We are pursuing an aggressive but disciplined growth strategy, which, to be successful, will depend in large part on our ability and the ability of our franchisees to open new restaurants and to operate these restaurants on a profitable basis. We anticipate that our new restaurants will generally take several months to reach planned operating levels due to inefficiencies typically associated with new restaurants, including lack of market awareness, the need to hire and train sufficient team members and other factors. We cannot guarantee that we, or our franchisees, will be able to achieve our expansion goals or that new restaurants will be operated profitably. Further, we cannot assure you that any restaurant we open will obtain operating results similar to those of our existing restaurants. One of our biggest challenges in meeting our growth objectives will be to locate and secure an adequate supply of suitable new restaurant sites. We have experienced delays in opening some of our restaurants and may experience delays in the future. Delays or failures in opening new restaurants could materially and adversely affect our planned growth. The success of our planned expansion will depend upon numerous factors, many of which are beyond our control, including the following:

 

    the hiring, training and retention of qualified operating personnel, especially managers;

 

    reliance on the knowledge of our executives and franchisees to identify available and suitable restaurant sites;

 

    competition for restaurant sites;

 

    negotiation of favorable lease terms;

 

    timely development of new restaurants, including the availability of construction materials and labor;

 

    management of construction and development costs of new restaurants;

 

    securing required governmental approvals and permits in a timely manner, or at all;

 

    cost and availability of capital;

 

    competition in our markets; and

 

    general economic conditions.

 

Our restaurant expansion strategy focuses primarily on further penetrating existing markets. This strategy could cause sales in some of our existing restaurants to decline.

 

Our areas of highest concentration are California, Colorado, Washington and Oregon. In accordance with our expansion strategy, we intend to open new restaurants primarily in our existing markets. Because we typically draw guests from a relatively small radius around each of our restaurants, the sales performance and guest counts for restaurants near the area in which a new restaurant opens may decline due to the opening of new restaurants.

 

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Our expansion into new markets may present increased risks due to our unfamiliarity with the area.

 

Some of our new restaurants will be located in areas where we have little or no meaningful experience. Those markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets, which may cause our new restaurants to be less successful than restaurants in our existing markets. An additional risk in expansion into new markets is the lack of market awareness of the Red Robin® brand. Restaurants opened in new markets may open at lower average weekly sales volumes than restaurants opened in existing markets, and may have higher restaurant-level operating expense ratios than in existing markets. Sales at restaurants opened in new markets may take longer to reach average annual company-owned restaurant sales, if at all, thereby affecting the profitability of these restaurants.

 

Our expansion may strain our infrastructure and other resources, which could slow our restaurant development or cause other problems.

 

We face the risk that our existing systems and procedures, restaurant management systems, financial controls, information and accounting systems, management resources and human resources will be inadequate to support our planned expansion of company-owned and franchised restaurants. We may not be able to respond on a timely basis to all of the changing demands that our planned expansion will impose on our infrastructure and other resources. If we fail to continue to improve our infrastructure or to manage other factors necessary for us to achieve our expansion objectives, this could have a material adverse effect on our operating results.

 

Our ability to utilize our revolving credit agreement and our ability to raise capital in the future may be limited, which could adversely impact our business.

 

Our revolving credit agreement contains a number of restrictive covenants that limit our ability to, among other things, engage in mergers, acquisitions, joint ventures and sale-leaseback transactions, and to sell assets, incur indebtedness, make investments, create liens and pay dividends. Our revolving credit agreement also requires us to maintain compliance with specified financial ratios and tests. These restrictions could affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. In addition, because our revolving credit agreement expires in May 2006, we cannot give any assurance that we will be able to renew this agreement at or prior to that time.

 

Changes in our operating plans, acceleration of our expansion plans, lower than anticipated sales, increased expenses or other events, including those described in this section, may cause us to seek additional debt or equity financing on an accelerated basis. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth and other plans as well as our financial condition and results of operations. Additional equity financing may be dilutive to the holders of our common stock and debt financing, if available, may involve significant cash payment obligations and covenants and/or financial ratios that restrict our ability to operate our business.

 

If our franchisees cannot develop or finance new restaurants or build them on suitable sites or open them on schedule, our growth and success may be impeded.

 

Under our current form of area development agreement, franchisees must develop a predetermined number of restaurants in their area according to a schedule that lasts for the term of their development agreement. Franchisees may not have access to the financial or management resources that they need to open the restaurants required by their development schedules, or be able to find suitable sites on which to develop them. Franchisees may not be able to negotiate acceptable lease or purchase terms for the sites, obtain the necessary permits and government approvals or meet construction schedules. In the past, we have agreed to extend or modify development schedules for certain area developers, and we may do so in the future. Any of these problems could slow our growth and reduce our franchise revenues.

 

Additionally, our franchisees depend upon financing from banks and other financial institutions in order to construct and open new restaurants. Over the past several years, financing has been difficult to obtain for some

 

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small operators. Should these conditions continue, the lack of adequate availability of debt financing could adversely affect the number and rate of new restaurant openings by our franchisees and adversely affect our future franchise revenues.

 

Our franchisees could take actions that could harm our business.

 

Franchisees are independent contractors and are not our employees. We provide training and support to franchisees, but the quality of franchised restaurant operations may be diminished by any number of factors beyond our control. Consequently, franchisees may not successfully operate restaurants in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other restaurant personnel. Our image and reputation, and the image and reputation of other franchisees, may suffer materially and system-wide sales could significantly decline if our franchisees do not operate successfully.

 

The acquisition of existing restaurants from our franchisees may have unanticipated consequences that could harm our business and financial condition.

 

We may seek to selectively acquire existing restaurants from our franchisees. To do so, we would need to identify suitable acquisition candidates, negotiate acceptable acquisition terms and obtain appropriate financing. Any acquisition that we pursue, whether or not successfully completed, may involve risks, including:

 

    material adverse effects on our operating results, particularly in the fiscal quarters immediately following the acquisition as it is integrated into our operations;

 

    risks associated with entering into markets or conducting operations where we have no or limited prior experience; and

 

    the diversion of management’s attention from other business concerns.

 

Future acquisitions of existing restaurants from our franchisees, which may be accomplished through a cash purchase transaction or the issuance of our equity securities, or a combination of both, could result in potentially dilutive issuances of our equity securities, the incurrence of debt and contingent liabilities and impairment charges related to goodwill and other intangible assets, any of which could harm our business and financial condition.

 

Our operations are susceptible to changes in food availability and cost which could adversely affect our operating results.

 

Our profitability depends in part on our ability to anticipate and react to changes in food costs. We rely on SYSCO Corporation, a national food distributor, as the primary distributor of our food ingredients, supplies and other products. Any increase in distribution prices or failure to perform by SYSCO could cause our food costs to increase. There also could be a significant short-term disruption in our supply chain if SYSCO failed to meet our distribution requirements or our relationship was terminated at the end of the contract term on June 30, 2007 or earlier by SYSCO upon breach or material deterioration of our financial position.

 

Various factors beyond our control, including adverse weather conditions, governmental regulation, production, availability, recalls of food products and seasonality may affect our food costs or cause a disruption in our supply chain. Chicken represented approximately 18.0% and beef represented approximately 10.6% of our food purchases in 2004. We enter into annual contracts with our beef and chicken suppliers. Our contracts for chicken are fixed price contracts. Our contracts for beef are generally based on current market prices plus a processing fee. Changes in the price or availability of chicken or beef could materially adversely affect our profitability. We cannot predict whether we will be able to anticipate and react to changing food costs by adjusting our purchasing practices and menu prices, and a failure to do so could adversely affect our operating results. In addition, because we provide a “value-priced” product, we may not be able to pass along price increases to our guests.

 

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Our quarterly operating results may fluctuate significantly and could fall below the expectations of securities analysts and investors due to seasonality and other factors, resulting in a decline in our stock price.

 

Our quarterly operating results may fluctuate significantly because of several factors, including:

 

    the timing of new restaurant openings and related expenses;

 

    restaurant operating costs for our newly-opened restaurants, which are often materially greater during the first several months of operation than thereafter, and pre-opening costs;

 

    labor availability and costs for hourly and management personnel;

 

    profitability of our restaurants, especially in new markets;

 

    franchise development costs;

 

    increases and decreases in comparable restaurant sales;

 

    impairment of long-lived assets, including goodwill, and any loss on restaurant closures;

 

    changes in borrowings and interest rates;

 

    general economic conditions;

 

    changes in consumer preferences and competitive conditions;

 

    fluctuations in food and commodity prices; and

 

    fluctuations in costs attributable to public company compliance costs, including Sarbanes-Oxley Act related costs.

 

Our business is also subject to seasonal fluctuations. Historically, sales in most of our restaurants have been higher during the summer months and winter holiday season of each fiscal year. As a result, our quarterly and annual operating results and comparable restaurant sales may fluctuate significantly as a result of seasonality and the factors discussed above. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable restaurant sales for any particular future period may decrease. In the future, operating results may fall below the expectations of securities analysts and investors. In that event, the price of our common stock would likely decrease.

 

A decline in visitors to any of the regional malls, lifestyle centers, big box shopping centers and entertainment centers near the locations of our restaurants could negatively affect our restaurant sales.

 

Our restaurants are primarily located near high activity areas such as regional malls, lifestyle centers, big box shopping centers and entertainment centers. We depend on high visitor rates at these centers to attract guests to our restaurants. If visitors to these centers decline due to economic conditions, changes in consumer preferences or shopping patterns, changes in discretionary consumer spending or otherwise, our restaurant sales could decline significantly and adversely affect our results of operations.

 

If we lose the services of any of our key management personnel, our business could suffer.

 

Our future success significantly depends on the continued services and performance of our key management personnel, particularly Mike Snyder, our chief executive officer and president; Jim McCloskey, our chief financial officer; Mike Woods, our senior vice president of franchise development; Bob Merullo, our senior vice president of restaurant operations; Todd Brighton, our vice president of development; and Eric Houseman, our vice president of restaurant operations. Our future performance will depend on our ability to motivate and retain these and other key officers and key team members, particularly regional operations directors, restaurant general managers and kitchen managers. Competition for these employees is intense. The loss of the services of members of our senior management or key team members or the inability to attract additional qualified personnel as needed could materially harm our business.

 

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Approximately 68% of our company-owned restaurants are located in the Western United States and, as a result, we are sensitive to economic and other trends and developments in this region.

 

As of April 1, 2005, we operate a total of 96 company-owned restaurants in the Western United States. As a result, we are particularly susceptible to adverse trends and economic conditions in this region, including its labor market. In addition, given our geographic concentration, negative publicity regarding any of our restaurants in the Western United States could have a material adverse effect on our business and operations, as could other regional occurrences such as local strikes, energy shortages or increases in energy prices, droughts, earthquakes, fires or other natural disasters.

 

Our future success depends on our ability to protect our proprietary information.

 

Our business prospects will depend in part on our ability to develop favorable consumer recognition of the Red Robin® name and logo. Although Red Robin®, America’s Gourmet Burgers & Spirits® and Mad Mixology® are federally registered trademarks with the United States Patent and Trademark Office and in Canada, our trademarks could be infringed in ways that leave us without redress, such as by imitation. In addition, we rely on trade secrets and proprietary know-how, and we employ various methods, to protect our concepts and recipes. However, such methods may not afford adequate protection and others could independently develop similar know-how or obtain access to our know-how, concepts and recipes. Moreover, we may face claims of infringement that could interfere with our use of our proprietary know-how, concepts, recipes or trade secrets. Defending against such claims may be costly and, if we are unsuccessful, we may be prevented from continuing to use such proprietary information in the future and/or be forced to pay damages. We do not maintain confidentiality and non-competition agreements with all of our executives, key personnel or suppliers. In the event competitors independently develop or otherwise obtain access to our know-how, concepts, recipes or trade secrets, the appeal of our restaurants could be reduced and our business could be harmed. We franchise our system to various franchisees. While we try to ensure that the quality of our brand and compliance with our operating standards, and the confidentiality thereof are maintained by all of our franchisees, we cannot assure that our franchisees will avoid actions that adversely affect the reputation of Red Robin or the value of our proprietary information.

 

Future changes in financial accounting standards may cause adverse unexpected operating results and affect our reported results of operations.

 

Changes in accounting standards can have a significant effect on our reported results and may affect our reporting of transactions completed before the change is effective. As an example, the recent change requiring that we record compensation expense in the statement of operations for employee stock options using the fair value method may likely have a significant negative effect on our reported results. New pronouncements and varying interpretations of pronouncements have occurred and may occur in the future. Changes to existing rules or differing interpretations with respect to our current practices may adversely affect our reported financial results.

 

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.

 

Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and The NASDAQ National Market rules, has required an increased amount of management attention and external resources. We remain committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment has resulted in and will continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. During 2004, we incurred $822,500 of costs to comply with the Section 404 internal control requirements of the

 

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Sarbanes-Oxley Act of 2002. These costs were primarily related to professional services and additional independent auditor fees. We anticipate that we will continue to incur significant costs related to ongoing compliance with Section 404 in the future.

 

Risks related to the restaurant industry

 

Changes in consumer preferences or discretionary consumer spending could negatively impact our results of operations.

 

Our restaurants feature burgers, salads, soups, appetizers, other entrees such as carnitas fajitas and pasta, desserts and our signature Mad Mixology® alcoholic and non-alcoholic beverages in a family-friendly atmosphere. Our continued success depends, in part, upon the popularity of these foods and this style of casual dining. Shifts in consumer preferences away from this cuisine or dining style could have a material adverse affect on our future profitability. The restaurant industry is characterized by the continual introduction of new concepts and is subject to rapidly changing consumer preferences, tastes and eating and purchasing habits. While burger consumption in the United States has grown over the past 20 years, the demand may not continue to grow or taste trends may change. Our success will depend in part on our ability to anticipate and respond to changing consumer preferences, tastes and eating and purchasing habits, as well as other factors affecting the food service industry, including new market entrants and demographic changes. Also, our success depends to a significant extent on numerous factors affecting discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce guest traffic or impose practical limits on pricing, either of which could harm our results of operations.

 

Health concerns relating to the consumption of beef or other food products could affect consumer preferences and could negatively impact our results of operations.

 

Like other restaurant chains, consumer preferences could be affected by health concerns about the consumption of beef, the key ingredient in many of our menu items, or negative publicity concerning food quality, illness and injury generally, such as negative publicity concerning E. coli, “mad cow” or “foot-and-mouth” disease, publication of government or industry findings concerning food products served by us, or other health concerns or operating issues stemming from one restaurant or a limited number of restaurants. This negative publicity may adversely affect demand for our food and could result in a decrease in guest traffic to our restaurants. If we react to the negative publicity by changing our concept or our menu, we may lose guests who do not prefer the new concept or menu, and may not be able to attract a sufficient new guest base to produce the revenue needed to make our restaurants profitable. In addition, we may have different or additional competitors for our intended guests as a result of a concept change and may not be able to compete successfully against those competitors. A decrease in guest traffic to our restaurants as a result of these health concerns or negative publicity or as a result of a change in our menu or concept could materially harm our business.

 

Labor shortages could slow our growth or harm our business.

 

Our success depends in part upon our ability to attract, motivate and retain a sufficient number of qualified, high-energy team members. Qualified individuals of the requisite caliber and number needed to fill these positions are in short supply in some areas. The inability to recruit and retain these individuals may delay the planned openings of new restaurants or result in high employee turnover in existing restaurants, which could harm our business. Additionally, competition for qualified team members could require us to pay higher wages to attract sufficient team members, which could result in higher labor costs. Most of our employees are paid on an hourly basis. These employees are paid in accordance with applicable minimum wage regulations. Accordingly, any increase in the minimum wage, whether state or federal, could have a material adverse impact on our business.

 

We are subject to extensive government laws and regulations that govern various aspects of our business. Our operations and our ability to expand and develop our restaurants may be adversely affected by these laws and regulations, which could cause our revenues to decline and adversely affect our growth strategy.

 

The restaurant industry is subject to various federal, state and local government regulations, including those relating to the sale of food and alcoholic beverages. While in the past we have been able to obtain and maintain

 

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the necessary governmental licenses, permits and approvals, our failure to maintain these licenses, permits and approvals, including food and liquor licenses, could adversely affect our operating results. Difficulties or failures in obtaining the required licenses and approvals could delay or result in our decision to cancel the opening of new restaurants. Local authorities may suspend or deny renewal of our food and liquor licenses if they determine that our conduct does not meet applicable standards or if there are changes in regulations.

 

We are subject to “dram shop” statutes in some states. These statutes generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. A judgment substantially in excess of our insurance coverage could harm our financial condition.

 

Various federal and state labor laws govern our relationship with our employees and affect operating costs. These laws include minimum wage requirements, overtime pay, unemployment tax rates, workers’ compensation rates, citizenship or residency requirements and sales taxes. Additional government-imposed increases in minimum wages, overtime pay, paid leaves of absence and mandated health benefits such as those to be imposed by recently enacted legislation in California, increased tax reporting and tax payment requirements for employees who receive gratuities, or a reduction in the number of states that allow tips to be credited toward minimum wage requirements could harm our operating results.

 

The federal Americans with Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment. Although our restaurants are designed to be accessible to the disabled, we could be required to make modifications to our restaurants to provide service to, or make reasonable accommodations for, disabled persons.

 

We are also subject to federal regulation and state laws that regulate the offer and sale of franchises and aspects of the licensor-licensee relationship. Many state franchise laws impose restrictions on the franchise agreement, including limitations on non-competition provisions and the termination or non-renewal of a franchise. Some states require that franchise materials be registered before franchises can be offered or sold in the state.

 

A significant increase in litigation could have a material adverse effect on our results of operations, financial condition and business prospects.

 

As a participant in the restaurant industry, we are sometimes the subject of complaints or litigation from guests alleging illness, injury or other food quality, health or operational concerns. Recently, the restaurant industry also has been subject to an increase in claims that the menus and practices of restaurant chains have led to the obesity of some guests. Adverse publicity resulting from these allegations could harm our restaurants, regardless of whether the allegations are valid or whether we are liable. In fact, we are subject to the same risks of adverse publicity resulting from these sorts of allegations even if the claim actually involves one of our franchisees. Further, employee claims against us based on, among other things, discrimination, harassment or wrongful termination may divert our financial and management resources that would otherwise be used to benefit the future performance of our operations.

 

Our success depends on our ability to compete effectively in the restaurant industry.

 

Competition in the restaurant industry is increasingly intense. We compete on the basis of the taste, quality, and price of food offered, guest service, ambiance and overall dining experience. We believe that our operating concept, attractive dining value, quality of food and guest service, enable us to differentiate ourselves from our competitors. Our competitors include a large and diverse group of restaurant chains and individual restaurants that range from independent local operators that have opened restaurants in various markets, to well-capitalized national restaurant companies. In addition, we compete with other restaurants and with retail establishments for real estate. Many of our competitors are well established in the casual dining market segment and some of our competitors have substantially greater financial, marketing and other resources than do we.

 

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Risks related to our company

 

Our stock price may be volatile.

 

The market for equity securities has been extremely volatile. The following factors could cause the price of our common stock in the public market to fluctuate significantly:

 

    actual or anticipated variations in our quarterly results of operations;

 

    changes in market valuations of companies in our industry;

 

    changes in expectations of future financial performance or changes in estimates of securities analysts;

 

    fluctuations in stock market prices and volumes;

 

    issuances of common stock or other securities in the future; and

 

    the addition or departure of key personnel.

 

Our common stock began trading on July 19, 2002, and prior to this date there was no public market for shares of our common stock. The stock market is subject to significant price and volume fluctuations. Fluctuations or decreases in the trading price of our common stock may adversely affect stockholders’ ability to trade their shares. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in substantial costs and divert management’s attention and resources that would otherwise be used to benefit the future performance of our operations.

 

Some of our stockholders could exert influence over us, and may not make decisions that are in the best interests of all stockholders.

 

As of March 15, 2005, Mike Snyder owns 9.5% of our outstanding common stock. Our officers, directors and principal stockholders, i.e., stockholders holding more than 5.0% of our common stock, including Mike Snyder, together hold approximately 12.8% of our outstanding common stock. These stockholders, acting individually or together, could exert influence over various matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership could delay or prevent a change in control of our company, and make some transactions more difficult without the support of these stockholders. The interests of these stockholders may not always coincide with our interests as a company or the interest of other stockholders. Accordingly, Mike Snyder and these other stockholders could cause us to enter into transactions or agreements that our other stockholders might not approve. Our certificate of incorporation and bylaws require a 66 2/3% supermajority vote of our stockholders to remove a director or to amend specified provisions of our certificate of incorporation or bylaws.

 

Provisions in Delaware law and our charter may prevent or delay a change of control, even if that change of control may be beneficial to our stockholders.

 

We are subject to the Delaware anti-takeover laws regulating corporate takeovers. These anti-takeover laws prevent Delaware corporations from engaging in business combinations with any stockholder, including all affiliates and associates of the stockholder, who owns 15.0% or more of the corporation’s outstanding voting stock, for three years following the date that the stockholder acquired 15.0% or more of the corporation’s voting stock unless specified conditions are met.

 

Our amended and restated certificate of incorporation and our amended and restated bylaws include a number of provisions that may deter or impede hostile takeovers or changes of control. These provisions:

 

    authorize our board of directors to establish one or more series of preferred stock, the terms of which can be determined by the board of directors at the time of issuance;

 

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    create a three class structure for our board of directors, with each class serving a staggered three-year term. As the classification of the board of directors generally increases the difficulty of replacing a majority of the directors, it may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of us and may maintain the composition of the board of directors;

 

    do not provide for cumulative voting in the election of directors unless required by applicable law. Under cumulative voting, a minority stockholder holding a sufficient percentage of a class of shares may be able to ensure the election of one or more directors;

 

    provide that a director may be removed from our board of directors only for cause, and then only by a supermajority vote of the outstanding shares;

 

    require that any action required or permitted to be taken by our stockholders must be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing;

 

    state that special meetings of our stockholders may be called only by the chairman of the board of directors, our chief executive officer, by the board of directors after a resolution is adopted by a majority of the total number of authorized directors, or by the holders of not less than 10.0% of our outstanding voting stock;

 

    provide that the chairman or other person presiding over any stockholder meeting may adjourn the meeting whether or not a quorum is present at the meeting;

 

    establish advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by stockholders at a meeting;

 

    provide that certain provisions of our certificate of incorporation can be amended only by supermajority vote of the outstanding shares, and that our bylaws can be amended only by supermajority vote of the outstanding shares or our board of directors;

 

    allow our directors, not our stockholders, to fill vacancies on our board of directors; and

 

    provide that the authorized number of directors may be changed only by resolution of the board of directors.

 

ITEM 2.    Properties

 

We currently lease the majority of our company-owned restaurant facilities under operating leases with remaining terms ranging from less than one year to just over 20 years. These leases generally contain renewal options which permit the Company to renew the leases at defined contractual rates or prevailing market rates. Certain leases provide for contingent rents, which are determined as a percentage of adjusted restaurant sales in excess of specified levels. The Company records a contingent rent liability and the corresponding rent expense when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable. Certain lease agreements also require the Company to pay maintenance, insurance and property tax costs.

 

We own real estate for 21 company-owned restaurants located in Mesa, Peoria, and Prescott, Arizona; Fayetteville, Arkansas; Moreno Valley and Yuba City, California; Castle Rock, Greeley and Highlands Ranch, Colorado; Columbia, Maryland; St. Peters, Missouri; Chagrin Highlands, North Olmstead and Westchester, Ohio; Homestead and Oxford Valley, Pennsylvania; Chesapeake, Fairfax, Glen Allen and Potomac Mills, Virginia; and Issaquah, Washington. See “Restaurant Locations” under Item I for additional information regarding our restaurants.

 

We own real estate in Oswego, Illinois; Grove City, Ohio; Toringdon, North Carolina and Monroe, Washington where we plan to develop new company-owned restaurants. In addition, we own one property in Lake Howell, Florida and a second property in Grapevine, Texas, both of which we lease to others.

 

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Our corporate headquarters are located in Greenwood Village, Colorado. We occupy this facility under a lease that expires on May 30, 2011. We lease approximately 1,500 square feet of regional office space in Seattle, Washington, under an agreement expiring in October 2005. In addition, we lease approximately 2,900 square feet of regional office space in Tustin, California, under an agreement expiring in December 2007.

 

ITEM 3.    Legal Proceedings

 

Occasionally, we are a defendant in litigation arising in the ordinary course of our business, including claims resulting from “slip and fall” accidents, employment related claims and claims from guests or team members alleging illness, injury or other food quality, health or operational concerns. To date, none of these types of litigation, all of which are generally covered by insurance policies, has had a material effect on us, and as of the date of this filing, we are not a party to any litigation that we believe would have a material adverse effect on our business or financial condition.

 

ITEM 4.    Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year covered by this report.

 

PART II

 

ITEM 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock is listed on The NASDAQ National Market under the symbol RRGB. The table below sets forth the high and low per share sales prices for our common stock as reported by The NASDAQ National Market.

 

     Sales Price

     High

   Low

2004

             

4th Quarter

   $ 54.30    $ 41.69

3rd Quarter

     44.94      29.00

2nd Quarter

     29.38      26.21

1st Quarter

     32.37      26.06

2003

             

4th Quarter

   $ 31.71    $ 25.07

3rd Quarter

     27.05      20.95

2nd Quarter

     22.66      14.50

1st Quarter

     15.69      11.50

 

As of April 1, 2005, there were approximately 3,750 registered owners of our common stock.

 

Dividends

 

We did not declare or pay any cash dividends on our common stock during 2004 or 2003. We currently anticipate that we will retain any future earnings for the operation and expansion of our business. In addition, our revolving credit agreement prohibits us from declaring or paying any dividends or making any other distributions on any of our shares, subject to specified exceptions. Accordingly, we do not anticipate declaring or paying any cash dividends on our common stock in the foreseeable future.

 

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Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on then existing conditions including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors our board of directors may deem relevant.

 

Issuer Purchases of Equity Securities

 

We did not repurchase any of our registered securities during the fourth quarter of 2004. As of April 1, 2005, the Company has no programs which have been approved by stockholders pursuant to which we would repurchase any of our equity securities. As of April 1, 2005, we have a right to repurchase 11,495 shares of common stock at the lower of fair value or issuance price related to unvested early exercise options that were exercised in April 2002. This right expires when the shares vest on January 29, 2006.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

We maintain five equity-based compensation plans—the 1996 Stock Plan, the 2000 Stock Plan, the 2002 Stock Plan, the 2004 Stock Plan and the employee stock purchase plan. Our stockholders have approved each of these plans.

 

The following table sets forth for each of our equity compensation plans, the number of shares of our common stock subject to outstanding options and rights under these plans, the weighted-average exercise price of outstanding options, and the number of shares remaining available for future award grants under these plans as of December 26, 2004 (in thousands, except per share data):

 

Plan Category


   Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
(a)


   

Weighted-average
exercise price of
outstanding
options, warrants
and rights

(b)


  

Number of securities
remaining available
for issuance under
equity compensation
plans (excluding
securities reflected
in column (a))

(c)


 

Equity compensation plans approved by security holders

   1,136 (1)(2)   $ 20.88    1,718 (3)

Equity compensation plans not approved by security holders

   N/A       N/A    N/A  
    

 

  

     1,136     $ 20.88    1,718  
    

 

  


(1)   54,185 of these shares were subject to options then outstanding under the 1996 Stock Plan; 152,560 of these shares were subject to options then outstanding under the 2000 Stock Plan; 725,686 of these shares were subject to options then outstanding under the 2002 Stock Plan; and 203,268 of these shares were subject to options then outstanding under the 2004 Stock Plan.
(2)   Excludes 275,649 shares that were available for issuance under the employee stock purchase plan.
(3)   Of the aggregate number of shares that remained available for future issuance, 275,649 shares were available for issuance under the employee stock purchase plan and 1,442,191 shares were available for issuance under the 2004 Stock Plan. A total of 9,175 shares were issued in 2005 prior to the filing of this report on Form 10-K for the employee stock purchase plan period that ended on December 31, 2004. Any shares subject to options granted under the employee stock purchase plan or the 1996 Stock Plan, the 2000 Stock Plan or the 2002 Stock Plan that are not exercised before they expire or are terminated will become available for additional award grants under the 2004 Stock Plan. No new awards may be granted under the 1996 Stock Plan, the 2000 Stock Plan or the 2002 Stock Plan.

 

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ITEM 6.    Selected Financial Data

 

The table below, which contains selected consolidated financial and operating data, gives effect to corrections for lease accounting and certain other immaterial adjustments for all years presented. The statement of income, cash flow and balance sheet data for each year has been derived from our consolidated financial statements. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this annual report on Form 10-K.

 

     Fiscal Year Ended

 
     2004

    2003(1)

    2002(1)

    2001(1)

    2000(1)

 
    

(in thousands, except per share data,

restaurant-related data and footnotes)

 

Statement of Income Data:

                                        

Revenue:

                                        

Restaurant

   $ 396,995     $ 318,878     $ 265,518     $ 214,963     $ 180,414  

Franchise royalties and fees

     11,769       9,320       8,565       9,002       8,247  

Rent revenue

     300       409       327       520       509  
    


 


 


 


 


Total revenues

     409,064       328,607       274,410       224,485       189,170  

Costs and expenses:

                                        

Restaurant operating costs:

                                        

Cost of sales

     93,280       75,067       61,009       50,850       43,896  

Labor

     136,817       112,872       94,030       74,854       64,566  

Operating

     57,158       48,085       40,428       33,195       27,959  

Occupancy

     25,242       21,248       17,830       14,034       10,670  

Restaurant closures and impairment

     —         —         1,393       36       1,302  

Depreciation and amortization(2)

     21,070       16,395       13,198       10,786       8,461  

General and administrative

     28,675       21,990       20,239       16,784       16,987  

Franchise development

     4,063       2,848       3,256       3,704       3,386  

Pre-opening costs

     5,143       3,891       2,265       1,354       3,228  

Gain on lease buy-out

     —         —         (945 )     —         —    

Impairment of property held for sale

     —         —         150       —         —    
    


 


 


 


 


Total costs and expenses

     371,448       302,396       252,853       205,597       180,455  
    


 


 


 


 


Income from operations

     37,616       26,211       21,557       18,888       8,715  

Other (income) expense:

                                        

Interest expense(3)

     2,706       2,974       5,769       7,850       6,482  

Interest income

     (322 )     (341 )     (398 )     (746 )     (742 )

Loss on extinguishment of debt

     —         258       4,336       —         —    

Gain on sale of property

     (257 )     —         —         —         —    

Other

     89       (14 )     106       190       19  
    


 


 


 


 


Total other expenses

     2,216       2,877       9,813       7,294       5,759  
    


 


 


 


 


Income before income taxes

     35,400       23,334       11,744       11,594       2,956  

Provision (benefit) for income taxes(4)

     12,019       7,888       3,857       3,779       (12,524 )
    


 


 


 


 


Net income(4)

   $ 23,381     $ 15,446     $ 7,887     $ 7,815     $ 15,480  
    


 


 


 


 


Earnings per share(4)

                                        

Basic

   $ 1.46     $ 1.02     $ 0.64     $ 0.77     $ 2.08  
    


 


 


 


 


Diluted

   $ 1.43     $ 1.00     $ 0.62     $ 0.76     $ 2.08  
    


 


 


 


 


Shares used in computing earnings per share

                                        

Basic

     16,022       15,182       12,278       10,085       7,444  
    


 


 


 


 


Diluted

     16,406       15,465       12,660       10,236       7,444  
    


 


 


 


 


 

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     Fiscal Year Ended

 
     2004

    2003(1)

    2002(1)

    2001(1)

    2000(1)

 
    

(in thousands, except per share data,

restaurant-related data and footnotes)

 

Balance Sheet Data:

                                        

Cash and cash equivalents

   $ 4,980     $ 4,871     $ 4,797     $ 18,992     $ 8,317  

Total assets(2)(3)

     264,501       214,382       173,774       157,786       142,837  

Long-term debt, including current portion(3)

     47,743       37,628       39,980       80,088       78,413  

Total stockholders’ equity(3)

   $ 161,733     $ 132,386     $ 98,022     $ 46,388     $ 38,792  

Cash Flow Data:

                                        

Net cash provided by operating activities

   $ 55,521     $ 44,044     $ 30,268     $ 27,507     $ 9,480  

Net cash used in investing activities

     (69,551 )     (53,894 )     (46,178 )     (18,128 )     (22,156 )

Net cash provided by financing activities

     14,139       13,924       1,715       1,296       15,817  

Selected Operating Data:

                                        

Average annual comparable restaurant sales

   $ 3,236     $ 3,045     $ 2,982     $ 3,066     $ 2,896  

Comparable restaurant sales increase

     7.5 %     4.1 %     1.8 %     1.8 %     7.1 %

Company-owned restaurants open at end of period

     137       115       96       77       73  

Franchised restaurants open at end of period

     118       103       98       105       91  

(1)   The consolidated financial statements included elsewhere in this annual report on Form 10-K contain restated results for 2003 and 2002. A description of the adjustments related to the restatement of the consolidated balance sheet as of December 28, 2003 as well as the effects of the restatement of our consolidated statements of income and cash flows for 2003 and 2002 can be found in Note 3 to our consolidated financial statements.
       Our consolidated balance sheet as of December 29, 2002, December 30, 2001 and December 31, 2000 and our consolidated statements of income and cash flows for the years ended December 30, 2001 and December 31, 2000 have been restated from the amounts previously reported to reflect the effect of the adjustments discussed in Note 3 to our consolidated financial statements.
(2)   We ceased amortizing goodwill as of the beginning of 2002 in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.
(3)   In November 2003, we received proceeds of $18.0 million from a secondary offering of common stock. These proceeds were used to repay $18.0 million of borrowings outstanding under our revolving credit agreement. In July 2002, we received proceeds of $42.8 million from our initial public offering of common stock. These proceeds, along with borrowings from our revolving credit agreement, were used to repay $55.0 million of borrowings then outstanding.
(4)   Net income in 2000 included a tax benefit of $12.5 million as a result of the reversal of previously recorded deferred tax asset valuation allowance.

 

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ITEM 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Organization of Information

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations provides a narrative on our financial performance and condition that should be read in conjunction with the accompanying consolidated financial statements and the related notes included elsewhere in this annual report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Future results could differ materially from those anticipated in these forward-looking statements as a result of certain risk factors including, but not limited to, those discussed in “Risk Factors” under Item 1 and elsewhere in this annual report on Form 10-K. This section includes the following discussions:

 

Overview

Restatement

Unit Data and Comparable Restaurant Sales

Results of Operations

Liquidity and Capital Resources

Contractual Obligations

Inflation

Critical Accounting Policies and Estimates

Recent Accounting Pronouncements

Forward-Looking Statements

 

Overview

 

Red Robin, which was founded in 1969, is a casual dining restaurant chain focused on serving an imaginative selection of high quality gourmet burgers in a family-friendly atmosphere. As of April 1, 2005, we operate 141 company-owned restaurants in 17 states. We began franchising the Red Robin® brand in 1979 and as of April 1, 2005, we have 27 franchisees that operate 122 restaurants in 24 states and two Canadian provinces. Our objective is to be the leading gourmet burger and casual dining restaurant destination. In managing our operations, we focus on four cornerstones that we believe are essential to the success of our business: Values, People, Burgers and Time.

 

Our restaurants are designed to create a fun and memorable dining experience in a family-friendly atmosphere and provide our guests with an exceptional dining value. Our concept attracts a broad guest base by appealing to the entire family, particularly women, teens, kids ages 8 to 12 whom we refer to as tweens, and younger children. All of our menu items are prepared to order in our restaurants. The food items currently on our menu range in price from $2.99 to $11.49, with a per person average check in 2004 of approximately $10.36, including beverages. During 2004, our company-owned comparable restaurants had average unit volumes that exceeded $3.2 million.

 

We are pursuing a disciplined growth strategy that includes the addition of company-owned and franchised restaurants. Our restaurant expansion strategy focuses primarily on further penetrating existing markets with a cluster strategy and selectively entering into new markets. We believe that our site selection strategy is critical to our success and we devote substantial time and effort to evaluating each site. Our site selection criteria focus on identifying markets, trade areas and other specific sites that are likely to yield the greatest density of desirable demographic characteristics, heavy retail traffic and a highly visible site. Our prototype restaurant is a free-standing building with approximately 6,350 square feet, approximately 200 seats and a patio. Based on this prototype, we expect that our average cash investment cost for our free-standing restaurants in 2005 will be $2.3 million, excluding land and pre-opening costs.

 

Our fiscal years ended December 26, 2004, December 28, 2003 and December 29, 2002 are referred to as 2004, 2003 and 2002, respectively. Each year presented included 52 weeks. We also refer to our fiscal year ending December 25, 2005 as 2005.

 

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Restatement

 

On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (SEC) issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease-related accounting issues and their application under accounting principles generally accepted in the United States of America (GAAP). In light of this letter, management initiated a review of our lease accounting and determined that our previous methods of accounting for rent holidays and for leasehold improvements funded by landlord incentives or allowances under operating leases (tenant improvement allowances) were not in accordance with GAAP. As a result, we have restated our audited consolidated financial statements for the fiscal years ended December 28, 2003 and December 29, 2002. Our restated financial statements also reflect certain immaterial adjustments as further described in Note 3 to the consolidated financial statements, included elsewhere herein.

 

See Note 3 to the consolidated financial statements of this Annual Report on Form 10-K for a summary of the effects of the restatement of the Company’s consolidated balance sheet as of December 28, 2003, as well as on the Company’s consolidated statements of income and cash flows for 2003 and 2002. The accompanying Management’s Discussion and Analysis gives effect to these corrections. In 2005, we will amend our 2004 quarterly filings to reflect this restatement. See Note 18 to the consolidated financial statements.

 

The cumulative effect of this restatement resulted in an increase in the accumulated deficit of $590,000 as of December 30, 2001, and decreases in net income of $288,000 and $377,000 for the fiscal years ended December 28, 2003 and December 29, 2002, respectively.

 

Unit Data and Comparable Restaurant Sales

 

The following table details restaurant unit data for our company-owned and franchise locations for the years indicated.

 

     2004

    2003

    2002

 

Company-owned:

                  

Beginning of period

   115     96     77  

Opened during period

   22     18     10  

Acquired or assumed from franchisees

   —       1     10  

Closed during period

   —       —       (1 )
    

 

 

End of period

   137     115     96  

Franchised:

                  

Beginning of period

   103     98     105  

Opened during period

   17     10     5  

Sold or transferred to company-owned

   —       (1 )   (10 )

Closed during period

   (2 )   (4 )   (2 )
    

 

 

End of period

   118     103     98  

Total Number of Red Robin® restaurants

   255     218     194  
    

 

 

 

Since December 26, 2004 and through April 1, 2005, we have opened 4 additional company-owned restaurants and our franchisees have opened 4 additional franchise restaurants. These openings bring our total restaurant count as of April 1, 2005, to 141 company-owned restaurants, 122 franchised restaurants and 263 total restaurants. We expect to open an additional 22 to 24 company-owned restaurants and anticipate that our franchisees will open 11 to 13 additional restaurants during the remainder of 2005.

 

We reflect restaurants as comparable in the first period following five full quarters of operations. Our company-owned comparable restaurant sales increased 7.5% in 2004, 4.1% in 2003 and 1.8% in 2002.

 

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Results of Operations

 

Operating results for each period presented below are expressed as a percentage of total revenues, except for the components of restaurant operating costs, which are expressed as a percentage of restaurant revenues:

 

     2004

    2003

    2002

 

Revenues:

                  

Restaurant

   97.0 %   97.1 %   96.8 %

Franchise royalties and fees

   2.9     2.8     3.1  

Rent revenue

   0.1     0.1     0.1  
    

 

 

Total revenues

   100.0     100.0     100.0  
    

 

 

Costs and expenses:

                  

Restaurant operating costs:

                  

Cost of sales

   23.5     23.5     23.0  

Labor

   34.5     35.4     35.4  

Operating

   14.4     15.1     15.2  

Occupancy

   6.4     6.7     6.7  

Restaurant closures and impairment

   —       —       0.5  
    

 

 

Total restaurant operating costs

   78.8     80.7     80.8  

Depreciation and amortization

   5.2     5.0     4.8  

General and administrative

   7.0     6.7     7.4  

Franchise development

   1.0     0.9     1.2  

Pre-opening costs

   1.3     1.2     0.8  

Gain on lease buy-out

   —       —       (0.3 )

Impairment of property held for sale

   —       —       0.1  

Income from operations

   9.2     8.0     7.9  
    

 

 

Other (income) expense:

                  

Interest expense

   0.7     0.9     2.1  

Interest income

   (0.1 )   (0.1 )   (0.1 )

Loss on extinguishment of debt

   —       0.1     1.6  

Gain on sale of property

   (0.1 )   —       —    

Other

   —       —       —    
    

 

 

Total other expenses

   0.5     0.9     3.6  

Income before income taxes

   8.7     7.1     4.3  

Provision for income taxes

   (3.0 )   (2.4 )   (1.4 )
    

 

 

Net income

   5.7 %   4.7 %   2.9 %
    

 

 

 

2004 compared to 2003

 

Total revenues.    Total revenues increased by $80.5 million, or 24.5%, to $409.1 million, from $328.6 million, due primarily to a $78.1 million increase in restaurant revenues. The increase in restaurant revenues was due to $32.3 million of revenues from 22 new restaurants opened during 2004, $23.4 million in additional revenues from the non-comparable restaurants we opened in 2003 and 2002, and $22.4 million from a comparable restaurant sales increase of 7.5%. The increase in comparable restaurant sales was driven by an increase in guest counts of 3.9% and an increase in the average guest check of 3.6%.

 

Franchise royalties and fees increased $2.5 million, or 26.3%, to $11.8 million from $9.3 million. Franchise royalties increased $2.2 million, or 24.6%, to $11.2 million, from $9.0 million, due primarily to royalties generated from the 27 franchise restaurants opened in 2003 and 2004. Our franchisees reported that annual comparable sales for U.S. and Canadian franchise restaurants increased 5.8% and 4.8%, respectively. Franchise

 

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fees increased $236,400, or 74.7%, to $553,100, from $316,700, due to the fact that there were seven additional franchise restaurants opened in 2004 compared to 2003.

 

Cost of sales.    Cost of sales increased by $18.2 million, or 24.3%, to $93.3 million, from $75.1 million, due primarily to more restaurants being operated during 2004. Cost of sales as a percentage of restaurant revenues remained constant at 23.5%, primarily due to the menu price increases we implemented during January and mid-June of 2004, offset by higher commodity costs.

 

Labor.    Labor expenses increased by $23.9 million, or 21.2%, to $136.8 million, from $112.9 million, due primarily to more restaurants being operated in 2004. Labor expense as a percentage of restaurant revenues improved 0.9%, to 34.5% compared to 35.4% in 2003. Overall, labor as a percentage of restaurant revenues averaged 34.0% at our comparable restaurants and 36.4% at our non-comparable restaurants. Total wages as a percentage of restaurant revenues improved 0.9% during 2004 due to a 1.2% improvement in controllable labor and a 0.1% improvement in workers’ compensation costs offset by a 0.4% increase in bonus expenses. The improvement in workers’ compensation expense as a percentage of restaurant revenues was attributable to recent lower claims experience and per claim costs. We cannot predict with certainty whether or not our workers’ compensation expense and controllable labor costs will increase or decrease during 2005. The increase in bonus expenses as a percentage of restaurant revenues was due primarily to improved comparable restaurant sales.

 

Operating.    Operating expenses increased by $9.1 million, or 18.9%, to $57.2 million, from $48.1 million, due primarily to more restaurants being operated in 2004. Operating expenses as a percentage of restaurant revenues improved 0.7%, to 14.4% compared to 15.1% in 2003. The improvement as a percentage of restaurant revenues was due primarily to leverage from our comparable restaurant sales increase offset by cost pressures in certain supplies and energy-related items, such as plastic wrap, fuels and utilities, particularly during the fourth quarter of 2004.

 

Occupancy.    Occupancy expenses increased by $4.0 million, or 18.8%, to $25.2 million, from $21.2 million, due primarily to more restaurants being operated in 2004. Occupancy expense as a percentage of restaurant revenues improved 0.3%, to 6.4% compared to 6.7% in 2003. Our occupancy expense as a percentage of restaurant revenues improved as a result of our comparable restaurant sales increase. In addition, the percentage of free-standing restaurants that we own or have ground leases on has increased in 2004 compared to 2003, and free-standing units generally have lower occupancy costs than in-line units.

 

Depreciation and amortization.    Depreciation and amortization increased $4.7 million, or 28.5%, to $21.1 million, from $16.4 million. The increase was primarily due to the addition of 22 new restaurants in 2004 and a full year of depreciation related to the 18 restaurants opened in 2003. Depreciation and amortization expense as a percentage of total revenues increased 0.2%, to 5.2% compared to 5.0% in 2003. The increase as a percentage of total revenues is primarily a result of newer restaurants having a higher depreciable costs basis than older restaurants.

 

General and administrative.    General and administrative expenses increased by $6.7 million, or 30.4%, to $28.7 million, from $22.0 million, generally due to additional headcount, higher salaries and related costs attributable to operating more company-owned restaurants and to costs associated with our public company reporting requirements. General and administrative expenses as a percentage of total revenues increased 0.3%, to 7.0% compared to 6.7% in 2003. During 2004 we incurred $822,500 of costs to comply with the Section 404 internal control requirements of the Sarbanes-Oxley Act. There were no comparable Section 404 costs incurred during 2003. These costs were primarily related to professional services and additional independent auditor fees. We anticipate that we will continue to incur additional costs related to ongoing compliance with Section 404 in the future. In addition, we incurred approximately $200,000 of additional audit and legal expenses related to the restatement of our financial statements as previously discussed.

 

Franchise development.    Franchise development expenses increased $1.2 million, or 42.7%, to $4.1 million, from $2.8 million. Approximately one quarter of this increase was attributable to our annual leadership

 

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conference which takes place in January each year. Costs for the 2004 leadership conference were higher than in 2003 due in part to the increased number of attendees. Franchise development expenses as a percentage of total revenues increased 0.1%, to 1.0% compared to 0.9% in 2003. We substantially increased the size of our franchise development and support teams during the second half of 2003 in order to support 2004 franchisee restaurant openings and the growing franchisee restaurant base. Our franchisees opened 17 restaurants during 2004 compared to ten in 2003.

 

Pre-opening costs.    Pre-opening costs increased $1.2 million, or 32.2%, to $5.1 million, from $3.9 million, due primarily to the fact that there were 22 company-owned restaurants opened during 2004, compared to 18 during 2003. Pre-opening costs as a percentage of total revenues were 1.3% and 1.2% for 2004 and 2003, respectively. Overall, pre-opening costs for the restaurants we opened in 2004 averaged $227,100 per restaurant compared to an average of $209,900 per restaurant in 2003. On a per unit basis, pre-opening expenses for restaurants that we opened in 2004 were higher as a result of increased costs related to opening restaurants in newer markets. Labor, training, travel and marketing costs are typically higher for newer markets compared to opening restaurants in more mature markets.

 

Interest expense.    Interest expense declined by $268,200, or 9.0%, to $2.7 million, from $3.0 million. Our interest expense was lower in 2004 due to the early payoff of various real estate and equipment loans during 2003 that bore significantly higher interest rates than borrowings under our revolving credit agreement. These reductions were partially offset by increased loan amortization and unused loan fees related to our revolving credit agreement as well as increased interest expense on borrowings from our revolving credit agreement.

 

Interest income.    Interest income was $321,600 in 2004 compared to $340,700 in 2003. Interest income in 2004 and 2003 included $303,000 and $298,800, respectively, from related party notes receivable. During December 2004 and February 2005, certain officers repaid their notes in full, and as a result, we expect interest income to decrease by at least $125,000 during 2005.

 

Loss on extinguishment of debt.    During 2003, we incurred $257,500 of charges related to debt extinguishment, which included a $186,400 non-cash write-off of capitalized debt issuance costs. There were no similar charges in 2004.

 

Gain on sale of property.    During 2004, we sold a parcel of land for $1.1 million, resulting in a pre-tax gain of $256,900. There were no similar gains in 2003.

 

Other.    Other expense was $88,400 in 2004, compared to other income of $14,200 in 2003.

 

Income before income taxes.    As a result of the above, income before income taxes increased $12.1 million, or 51.7%, to $35.4 million, from $23.3 million.

 

Provision for income taxes.    The provision for income taxes increased $4.1 million, or 52.4%, to $12.0 million, from $7.9 million. The increase was due primarily to increased pre-tax earnings. Our effective income tax rate for 2004 was 34.0% compared to 33.8% for 2003.

 

Net income.    As a result of the above, net income increased by $7.9 million, or 51.4%, to $23.4 million, from $15.4 million.

 

2003 compared to 2002

 

Total revenues.    Total revenues increased by $54.2 million, or 19.8%, to $328.6 million, from $274.4 million, due primarily to a $53.4 million increase in restaurant revenues. The increase in restaurant revenues was due to $28.1 million of revenues from 18 new restaurants opened and the one franchise restaurant we assumed operation of during 2003, $13.6 million in additional revenues from the non-comparable restaurants that we

 

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opened in 2002, $1.7 million related to a full year of revenues for the ten restaurants we acquired from two franchisees during first quarter 2002 and $10.0 million from comparable restaurant sales increases of 4.1%. The increase in comparable restaurant sales was driven by an increase in guest counts of 4.0% and an increase in the average guest check of 0.1%.

 

Franchise royalties and fees increased $754,600, or 8.8%, to $9.3 million from $8.6 million. Franchise royalties increased $603,700, or 7.2%, to $9.0 million, from $8.4 million, due to an increase in royalties attributable to new franchise restaurants, comparable U.S. franchise restaurant revenues increases of 3.7%, and an increase in royalties from our Canadian franchisee primarily due to more favorable currency exchange rates. Royalties from the ten new franchise restaurants opened during 2003 were partially offset because four franchise restaurants closed and we assumed the operations of one additional franchise restaurant in April 2003. Franchise fees increased $150,900, or 91.0%, to $316,700, from $165,800, because ten franchise restaurants were opened in 2003 compared to five in 2002.

 

Cost of sales.    Cost of sales increased by $14.1 million, or 23.0%, to $75.1 million, from $61.0 million, due primarily to more restaurants being operated during 2003. Cost of sales as a percentage of restaurant revenues increased 0.5%, to 23.5%, from 23.0%. Overall, the increase as a percentage of restaurant revenues was attributable to increases in certain food costs during 2003, including gourmet breads, hamburger, produce and pork.

 

Labor.    Labor expenses increased by $18.9 million, or 20.0%, to $112.9 million, from $94.0 million, due primarily to more restaurants being operated in 2003. Overall, labor expense as a percentage of restaurant revenues was 35.4% in 2003 and 2002. Labor as a percentage of restaurant revenues was 35.1% at our comparable restaurants and 37.1% at our non-comparable restaurants. Total wages as a percentage of restaurant revenues decreased 0.7% during 2003, due to improvements in controllable labor and floor supervisory wages at our non-comparable restaurants and the ten restaurants we acquired in 2002. However, these improvements were entirely offset by an increase of 0.4% for self-insured workers’ compensation expenses, 0.2% for bonus expenses and 0.1% for payroll tax expenses. The increase in bonus expenses was primarily due to higher bonuses earned as a result of improved comparable restaurant sales. Our workers’ compensation expense increased during 2003 due to a combination of higher claims experienced and higher per claim costs.

 

Operating.    Operating expenses increased by $7.7 million, or 18.9%, to $48.1 million, from $40.4 million, due primarily to more restaurants being operated in 2003. Operating expenses as a percentage of restaurant revenues decreased 0.1%, to 15.1%, from 15.2%. We believe the improvement as a percentage of restaurant revenues was due in part to our 4.1% increase in comparable restaurant sales and the discontinuance of one of our marketing funds midway through first quarter 2003, for which we had previously contributed 0.3% of restaurant revenues. These improvements were partially offset by higher utilities, paper packaging costs, telecommunications charges and credit card processing fees.

 

Occupancy.    Occupancy expenses increased by $3.4 million, or 19.2%, to $21.2 million, from $17.8 million, due primarily to more restaurants being operated in 2003. Occupancy expense as a percentage of restaurant revenues was 6.7% for both 2003 and 2002.

 

Restaurant closures and impairment.    We recorded a $1.4 million non-cash impairment charge in 2002 to fully write-down all of the long-lived assets related to one restaurant, which we continue to operate.

 

Depreciation and amortization.    Depreciation and amortization increased $3.2 million, or 24.2%, to $16.4 million, from $13.2 million. The increase was primarily due to the addition of 18 new restaurants opened in 2003 and a full year of depreciation related to the ten restaurants we opened during 2002. Depreciation and amortization expense as a percentage of total revenues increased 0.2%, to 5.0%, from 4.8%. The increase as a percentage of total revenues is primarily a result of newer restaurants having a higher depreciable costs basis than older restaurants.

 

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General and administrative.    General and administrative expenses increased by $1.8 million, or 8.6%, to $22.0 million, from $20.2 million, generally due to additional headcount, higher salaries and related costs attributable to operating more company-owned restaurants and to costs associated with our public company reporting requirements. General and administrative expenses as a percentage of total revenues, however, improved 0.7%, to 6.7%, from 7.4%. The improvement in general and administrative expenses as a percentage of total revenues is due primarily to a decrease in marketing expenditures and to our 4.1% increase in comparable restaurant sales. In addition, we had unfilled positions in 2003 that we did not fill until fourth quarter 2003 that positively impacted our results in 2003.

 

Franchise development.    Franchise development expenses decreased $407,900, or 12.5%, to $2.8 million, from $3.3 million. Franchise development expenses as a percentage of total revenues decreased 0.3%, to 0.9%, from 1.2%, due primarily to several unfilled positions that we did not fill until fourth quarter 2003 and to a related reduction in other franchise development expenses, including travel and legal.

 

Pre-opening costs.    Pre-opening costs increased $1.6 million, or 71.8%, to $3.9 million, from $2.3 million, due primarily to the fact that there were 18 company-owned restaurants opened during 2003, compared to ten during 2002. Pre-opening costs as a percentage of total revenues increased 0.4%, to 1.2%, from 0.8%. Pre-opening costs for the restaurants we opened in 2003 averaged $209,900 per restaurant compared to an average of $207,600 per restaurant for news restaurants we opened in 2002.

 

Gain on lease buy-out.    During 2002, we realized a non-recurring gain of $945,000 due to a landlord lease buy-out of one of our company-owned restaurants and, as a result, we relocated the restaurant to a new location during 2002.

 

Impairment of property held for sale.    During 2002, we recognized a $150,000 charge to reduce the carrying value of real estate held for sale to its estimated fair value less cost to sell. This property was subsequently sold in 2002 for its approximate carrying value.

 

Interest expense.    Interest expense decreased by $2.8 million, or 48.4%, to $3.0 million, from $5.8 million. The decrease was due primarily to lower average borrowings outstanding and a reduction in the overall interest rate of our debt in 2003, compared to 2002. Our average borrowings outstanding decreased because net proceeds from our July 2002 initial public offering and our November 2003 secondary offering were used to repay significant portions of our then outstanding borrowings.

 

Interest income.    Interest income decreased $57,200, or 14.4%, to $340,700, from $397,900. The 2003 results include interest income of $298,800 from related party notes receivable, compared to $252,200 in 2002. The remaining change was attributable to decreases in interest income from franchisees and interest earned on our overnight sweep accounts.

 

Loss on extinguishment of debt.    During 2003, we incurred $257,500 of charges related to debt extinguishment, which included a non-cash write-off of $186,400 of capitalized debt issuance costs. During 2002, we incurred $4.3 million of charges related to prepayment penalties of $1.9 million and a $2.4 million non-cash write-off of capitalized debt issuance costs. Debt extinguished in 2003 had a carrying value of $11.4 million compared to $52.9 million in 2002, excluding penalties and fees.

 

Other.    Other income was $14,200 in 2003, compared to other expense of $105,800 in 2002. Other expense principally includes holding costs associated with real estate held for sale, offset in 2003 by a gain on the sale of real estate.

 

Income before income taxes.    As a result of the above, income before income taxes increased $11.6 million, or 98.7%, to $23.3 million, from $11.7 million.

 

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Provision for income taxes.    The provision for income taxes increased $4.0 million, or 104.5%, to $7.9 million, from $3.9 million. The increase was due primarily to increased pre-tax earnings and an increase in our estimated effective income tax rate. Our effective income tax rate for 2003 was 33.8%, compared to 32.8% for 2002.

 

Net income.    As a result of the above, net income increased by $7.6 million, or 95.8%, to $15.4 million, from $7.9 million.

 

Liquidity and Capital Resources

 

Cash and cash equivalents increased by $109,300 in 2004. We attempt to keep only enough cash on hand to satisfy our working capital requirements, which can vary substantially as a result of seasonality, construction and other corporate needs. All available cash in excess of our estimated working capital needs is generally used to repay short-term borrowings under our revolving credit agreement. The change in cash and cash equivalents for the periods presented are as follows (in thousands):

 

     2004

    2003

    2002

 

Cash provided by operating activities

   $ 55,521     $ 40,044     $ 30,268  

Cash used by investing activities

     (69,551 )     (53,894 )     (46,178 )

Cash provided by financing activities

     14,139       13,924       1,715  
    


 


 


Increase (decrease) in cash and cash equivalents

   $ 109     $ 74     $ (14,195 )
    


 


 


 

Operating Activities

 

Cash provided by operating activities during 2004 increased $15.5 million, or 38.6%, to $55.5 million, compared to $40.0 million in 2003, reflecting increased cash flows from restaurant and franchise operations, lower cash payments for interest, increased cash from the gain on the sale of a property and increased cash flows from changes in operating assets and liabilities. These increases were offset by higher income tax payments.

 

Investing Activities

 

Cash used in investing activities during 2004 increased $15.7 million, or 29.1%, to $69.6 million, compared to $53.9 million in 2003. Our investing activities consist primarily of purchases of property and equipment related to the construction of restaurants as well as remodels and capital improvements of our existing restaurants. We may also have activity related to the acquisition of franchise restaurants. Cash provided by investing activities generally relates to proceeds generated from the sale of real estate, property and equipment.

 

Capital Expenditures.    In 2004, we invested $62.1 million for construction of restaurants and $7.5 million on remodels and capital improvements of our existing restaurants. In addition, we spent $1.1 million for corporate initiatives primarily related to information systems and computer equipment and our corporate relocation that occurred in March 2004. During 2003, we invested $42.4 million for construction of restaurants and $10.4 million on remodels and capital improvements of our existing restaurants including assets related to the exercise of three capital lease purchase options. In addition, we spent $2.0 million for corporate initiatives primarily related to information systems and computer equipment.

 

During 2005, we expect to open 26 to 28 new company-owned restaurants for a total cost of $79.0 million to $82.0 million, and we anticipate that we will spend $7.0 million to $8.0 million on restaurant remodels and capital improvements of our existing restaurants. In addition, we expect to invest $1.5 million to $2.0 million for corporate initiatives, including information systems and computer equipment. For 2005, we expect that our net cash used in investing activities will exceed our net cash provided by operating activities. As a result, we anticipate that we will continue to make additional borrowings under our revolving credit agreement

 

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Proceeds from Investing Activities.    Proceeds of $1.1 million in 2004 were generated primarily from the sale of one property compared to proceeds of $860,000 in 2003, which were generated primarily from the sale of one property.

 

Financing Activities

 

Cash provided by financing activities during 2004 increased $214,800. Our financing activities consist primarily of borrowings used to fund restaurant construction and other corporate needs in excess of cash provided by operations and proceeds we receive from sales of common stock. Cash used in financing activities is primarily related to the repayment of borrowings. During 2005, we expect our primary source of cash provided by financing activities will be obtained from additional borrowings under our revolving credit agreement.

 

Proceeds from the Issuance of Stock.    During 2004, we received $1.7 million from the exercise of stock options and purchases of stock under our employee stock purchase plan, compared to $695,000 in 2003.

 

Borrowings.    We maintain a revolving credit agreement with a maximum borrowing capacity to $85.0 million, which expires on May 19, 2006. This agreement is in place to fund the construction and acquisition of new restaurants, to refinance existing indebtedness and for general corporate purposes, including working capital. The amended revolving credit agreement is secured by a first priority pledge of all of the outstanding capital stock of our subsidiaries and a first priority lien on substantially all of our tangible and intangible assets. We are currently in compliance with all covenants related to the revolving credit agreement. Our borrowing activity in 2004 was as follows (in thousands):

 

     Additions

   Payments

    Total

 

Revolving credit agreement

   $ 22,948    $ (11,448 )   $ 11,500  

New capital lease obligations (non-cash)

     28      —         28  

Repayments of capital leases and collateralized notes payable

     —        (1,413 )     (1,413 )
    

  


 


     $ 22,976    $ (12,861 )   $ 10,115  
    

  


 


 

Debt outstanding during 2004 had stated interest rates ranging from 2.1% to 13.4% and maturities ranging from 2005 through 2021. As of December 26, 2004, borrowings outstanding under our revolving credit agreement bore interest at approximately 4.3%. Borrowings under our revolving credit agreement, as well as certain other existing borrowings, are subject to variable rates of interest as discussed further in “Quantitative and Qualitative Disclosures About Market Risk”. We expect that interest rates related to our variable rate borrowings will increase during 2005. Rising interest rates, combined with our anticipated increase in borrowings during 2005, will likely lead to higher financing costs.

 

On October 25, 2004, an irrevocable letter of credit issued under our revolving credit agreement was increased to approximately $2.7 million. This letter is being maintained to back our self-insured workers’ compensation program and reduces the amount of borrowings available on our revolving credit agreement.

 

Our total committed borrowing capacity, capacity used and unused borrowing capacity as of December 26, 2004 were as follows (in thousands):

 

     Committed
Capacity


  

Capacity

Used


   Unused
Capacity


Revolving credit agreement

   $ 85,000    $ 34,191    $ 50,809

 

The revolving credit agreement requires that capital expenditures, as defined, will not exceed specified amounts for each fiscal year. To the extent we do not exceed the annual limitations any unused amount up to $10.0 million in any fiscal year will be carried forward to the following fiscal year and will increase the limit in

 

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the succeeding year by such carry-forward amount. We did not carry-forward any amount from 2004 that would increase the limit for 2005 as set forth in the following table (in thousands):

 

     Amount

2005

   $ 75,000

2006

     75,000

 

The revolving credit agreement prohibits us from entering into or assuming any obligations for the payment of rent under operating leases which, with respect to all new restaurants opened in each fiscal year in the aggregate, would exceed $2.5 million in each of 2005 and 2006. In addition, the revolving credit agreement prohibits us from entering into obligations with respect to operating leases that would allow for an annual increase, on a year to year basis, of more than 20%.

 

At the end of 2004, we had $9.1 million outstanding under various real estate and equipment loans with GE Capital. These loans bear interest at the 30-day commercial paper rate plus 3.0% to 3.5%, mature from 2005 to 2016, and are secured by buildings, equipment and improvements on certain properties. In addition, we had $7.2 million outstanding under various real estate and equipment loans with other lenders. These loans bear interest at rates ranging from 2.1% to 13.4% and mature from 2006 to 2021. The GE Capital loans, together with certain of our other loans, require that we maintain a maximum debt to net worth ratio, a minimum debt coverage ratio, a minimum EBITDA ratio and a maximum funded indebtedness ratio. As of December 26, 2004, we were in compliance with all of these financial ratios.

 

Capital Resources.    We believe that anticipated cash flows from operations and funds available from our existing revolving credit agreement, together with cash on hand, will provide sufficient funds to finance our expansion plans and corporate initiatives through the remaining term of our revolving credit agreement, which expires on May 19, 2006. Based on current market conditions and the Company’s financial condition and expected cash flows, we believe we will be able to raise additional equity and/or restructure our debt financing prior to May 19, 2006. There can be no guarantee that financing will be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans and our financial condition and results of operations. Additional equity financing may be dilutive to the holders of our common stock and debt financing, if available, may involve significant cash payment obligations and covenants and/or financial ratios that restrict our ability to operate our business.

 

Contractual Obligations

 

We have contractual obligations which are recorded as liabilities in our consolidated financial statements. However, other items, including various purchase commitments and other executory contracts, are not recognized as liabilities in our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. For example, we are contractually committed to fulfill various operating lease obligations related to our company-owned restaurants and other properties.

 

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The following table summarizes the amounts of payments due under specified contractual obligations as of December 26, 2004 (in thousands):

 

     Payments due by period

     Total

   Less
than 1
year


  

1-3

years


  

3-5

years


  

More

than
5 years


Long-term debt obligations(1)

   $ 47,743    $ 3,148    $ 35,952    $ 2,663    $ 5,980

Capital lease obligations(2)

     12,000      1,066      3,281      1,914      5,739

Operating lease obligations(3)

     222,596      15,545      30,631      30,960      145,460

Purchase obligations(4)

     24,539      15,110      2,437      694      6,298

Other non current liabilities(5)

     3,219      320      1,354      464      1,081

(1)   Long-term debt obligations represent borrowings under our revolving credit agreement and other collateralized notes payable, excluding interest.
(2)   Capital lease obligations include interest of $4.9 million.
(3)   Operating lease obligations represent future minimum lease commitments payable for land, buildings and equipment used in our operations. This table excludes contingent rents, including amounts which are determined as a percentage of adjusted sales in excess of specified levels.
(4)   Purchase obligations include commitments for the construction of new restaurants and other capital improvement projects; lease commitments for company-owned restaurants where leases have been executed but construction has not begun; information technology contracts, including software licenses, maintenance and service agreements; commitments to purchase land related to new restaurants; employment agreements for two officers and other contractual obligations. Purchase obligations exclude food and beverage contracts for which no firm commitment exists.
(5)   Other non current liabilities include deferred revenue and deferred compensation.

 

Inflation

 

The primary inflationary factors affecting our operations are food and labor costs. A large number of our restaurant personnel are paid at rates based on the applicable minimum wage, and increases in the minimum wage directly affect our labor costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance and utilities, all of which are generally subject to inflationary increases. We believe inflation had a modest impact on our results of operations during 2004, 2003 and 2002 due primarily to rising commodity prices for certain foods we purchase at market rates. We also experienced higher costs for materials and labor related to construction of our new restaurants, which became somewhat more evident during 2004. Uncertainties related to future commodity prices, the supply of labor and construction materials make it difficult to predict what impact, if any, inflation may have during 2005 and beyond.

 

Critical Accounting Policies and Estimates

 

In the ordinary course of business, management has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, the judgments and uncertainties affecting the application of those policies, and the likelihood that materially different amounts would be reported under different conditions or using different assumptions.

 

Property and Equipment.    Property and equipment is recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the estimated useful life for owned assets and the shorter of the estimated useful life or the term of the underlying lease for leased assets. Changes in circumstances such as changes to our business model or changes in our capital strategy can result in the actual

 

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useful lives differing from our estimates. In those cases where management determines that the useful life of property and equipment should be shortened, we would depreciate the net book value over its revised remaining useful life thereby increasing depreciation and amortization expense. Factors such as changes in the planned use of fixtures or closing of facilities could also result in shortened useful lives.

 

Our accounting policies regarding property and equipment include judgments by management regarding the estimated useful lives of these assets, the expected lease term for assets related to properties under lease and the determination as to what constitutes enhancing the value of or increasing the life of existing assets. These judgments and estimates may produce materially different amounts of depreciation and amortization expense than would be reported if different assumptions were used. As discussed further below, these judgments may also impact management’s need to recognize an impairment charge on the carrying amount of these assets as the cash flows associated with the assets are realized.

 

Impairment of Long-Lived Assets.    Long-lived assets, including restaurant sites, leasehold improvements, other fixed assets, intangibles and goodwill are reviewed at least annually for impairment or sooner if events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. Expected cash flows associated with an asset is the key factor in determining the recoverability of the asset. Identifiable cash flows are generally measured at the restaurant level. The estimate of cash flows is based upon, among other things, certain assumptions about expected future operating performance. Management’s estimates of undiscounted cash flows may differ from actual cash flow due to, among other things, changes in economic conditions, changes to our business model or changes in operating performance. If the sum of the undiscounted cash flows is less than the carrying value of the asset, we recognize an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset.

 

Judgments made by management related to the expected useful lives of long-lived assets and our ability to realize undiscounted cash flows in excess of the carrying amounts of such assets are affected by factors such as the ongoing maintenance and improvements of the assets, changes in economic conditions, and changes in operating performance. As the ongoing expected cash flows and carrying amounts of long-lived assets are assessed, these factors could cause us to realize a material impairment charge. In 2002, we recognized a $1.4 million charge for the writedown of asset values related to one restaurant which we continue to operate. There were no asset impairment charges in 2004 and 2003.

 

We completed our most recent impairment test in December 2004, and determined that there were no impairment losses related to goodwill, other intangible assets or property and equipment.

 

Lease Accounting.    We are obligated under various lease agreements for certain land, restaurant facilities and office space. For operating leases, we recognize rent expense on a straight-line basis over the expected lease term. Capital leases are recorded as an asset and a liability at an amount equal to the present value of the future minimum lease payments during the lease term.

 

Under the provisions of certain of our leases, there are rent holidays and/or escalations in payments over the base lease term, as well as renewal periods. The effects of rent holidays and escalations have been reflected in rent costs on a straight-line basis over the expected lease term, which includes cancelable option periods when it is deemed to be reasonably assured that we will exercise such option periods due to the fact that we would incur an economic penalty for not doing so. The lease term commences on the date when we become legally obligated for the rent payments which generally coincides with the time when the landlord delivers the property for us to develop and we waive contract contingencies. Under generally accepted accounting principles, there are two acceptable methods for recognizing rent costs during a period of construction; the capitalization method and the expense method. Historically, we have used the expense method. Under the expense method, all rent costs recognized during construction periods are expensed immediately as pre-opening expenses. Using the expense method results in substantially higher current period costs compared to using the capitalization method because the construction period for our free-standing restaurants is typically 130-150 days, and as a result, the amount of rent costs that we recognize during construction periods is significant. Other companies in our industry may

 

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present their financial statements using the capitalization method and, as a result, our financial statements may not necessarily be comparable to other companies in our industry.

 

Leasehold improvements and property held under capital leases for each restaurant facility are amortized on the straight-line method over the shorter of the estimated life of the asset or the same expected lease term used for lease accounting purposes commencing when the restaurant opens. For each restaurant facility, the consolidated financial statements generally reflect the same lease term for amortizing leasehold improvements as management uses to determine capital versus operating lease classifications and in calculating straight-line rent expense. Percentage rent expense is generally based upon adjusted restaurant sales levels and is accrued at the point in time when we determine that it is probable that such adjusted restaurant sales levels will be achieved. Leasehold improvements paid for by the landlord are recorded as leasehold improvements and deferred rent.

 

Judgments made by management related to the probable term for each lease affect the classification and accounting for a lease as capital or operating; the rent holidays and/or escalations in payments that are taken into consideration when calculating straight-line rent; and the term over which leasehold improvements for each restaurant facility are amortized. These judgments may produce materially different amounts of depreciation, amortization and rent expense than would be reported if different assumed lease terms were used.

 

Insurance/Self-Insurance Liabilities.    We are self-insured for certain losses related to health, general liability and workers’ compensation and we maintain stop loss coverage with third party insurers to limit our total exposure. The self-insurance liability represents an estimate of the ultimate cost of claims incurred and unpaid as of the balance sheet date. The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates, and is closely monitored and adjusted when warranted by changing circumstances. Should a greater amount of claims occur compared to what was estimated or medical costs increase beyond what was expected, reserves might not be sufficient and additional expense may be recorded. Actual claims experience could also be more favorable than estimated, resulting in expense reductions. Unanticipated changes may produce materially different amounts of expense than that reported under these programs.

 

Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, Share-Based Payment, a revision of SFAS 123, Accounting for Stock-Based Compensation. SFAS 123R will require us to, among other things, measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. The provisions of SFAS 123R are effective for the first interim or annual reporting period that begins after June 15, 2005; therefore, we will adopt the new requirements no later than the beginning of our third quarter of 2005. Adoption of the expensing requirements will reduce our future reported earnings in a manner similar to that described in Note 1 to the accompanying notes to the consolidated financial statements under employee stock compensation plans. Management is currently evaluating the specific impacts of adoption, which include whether we should adopt the requirements on a retrospective basis and which valuation model is most appropriate.

 

In November 2004, the FASB issued SFAS 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have any impact on our consolidated financial position or results of operations.

 

In December 2003, the FASB issued FASB Interpretation No. (FIN) 46R, Consolidation of Variable Interest Entities and Interpretation of ARB No. 51. This interpretation, which replaces FASB Interpretation No. 46, Consolidation of Variable Interest Entities, clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of

 

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a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. This interpretation is required in financial statements for periods ending after March 15, 2004 for those companies that have yet to adopt the provisions of FIN 46. The Company has no variable interest in variable interest entities and, therefore, no entities were consolidated with our financial statements as a result of adopting FIN 46R.

 

Forward-Looking Statements

 

Certain information contained in this annual report on Form 10-K and the documents incorporated by reference into the Form 10-K includes forward-looking statements. Forward-looking statements include statements regarding our expectations, beliefs, intentions, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. These statements may be identified, without limitation, by the use of forward looking terminology such as “may”, “will”, “anticipates”, “expects”, “believes”, “intends”, “should” or comparable terms or the negative thereof. All forward-looking statements included in this annual report on Form 10-K and the documents incorporated by reference into the Form 10-K are based on information available to us on the date hereof. These statements involve risks and uncertainties that could cause actual results to differ materially from those described in the statements. These risks and uncertainties include, but are not limited to, the following:

 

    our ability to achieve and manage our planned expansion;

 

    our ability to raise capital in the future;

 

    the ability of our franchisees to open and manage new restaurants;

 

    our franchisees’ adherence to our practices, policies and procedures;

 

    changes in the availability and cost of food;

 

    potential fluctuation in our quarterly operating results due to seasonality and other factors;

 

    the continued service of key management personnel;

 

    the concentration of our restaurants in the Western United States;

 

    our ability to protect our name and logo and other proprietary information;

 

    changes in consumer preferences, general economic conditions or consumer discretionary spending;

 

    health concerns about our food products and food preparation;

 

    our ability to attract, motivate and retain qualified team members;

 

    the impact of federal, state or local government regulations relating to our team members or the sale of food or alcoholic beverages;

 

    the impact of litigation;

 

    the effect of competition in the restaurant industry;

 

    cost and availability of capital;

 

    additional costs associated with compliance, including the Sarbanes-Oxley Act and related regulations and requirements;

 

    the effectiveness of our internal controls over financial reporting;

 

    future changes in financial accounting standards;

 

    the continued listing of our common stock on the NASDAQ National Market; and

 

    other risk factors described from time to time in SEC reports filed by Red Robin.

 

Other risks, uncertainties and factors, including those discussed under “Risk Factors” could cause our actual results to differ materially from those projected in any forward-looking statements we make. The list of factors

 

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that may affect future performance and the accuracy of forward-looking statements is illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with the understanding of their inherent uncertainty.

 

We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

ITEM 7A.    Quantitative and Qualitative Disclosures About Market Risk

 

Market risk exposures for our assets are related to cash, cash equivalents and investments. We invest our excess cash in highly liquid short-term investments with maturities of less than one year. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations.

 

Under our amended revolving credit agreement, we are exposed to market risk from changes in interest rates on borrowings, which bear interest at one of the following rates we select: an ABR, based on the Prime Rate plus 1.0% to 1.75%, or a LIBOR, based on the relevant one, two, three or six-month LIBOR, at our discretion, plus 2.0% to 2.75%. The spread, or margin, for ABR and LIBOR loans under the revolving credit agreement are subject to quarterly adjustment based on our then current leverage ratio, as defined by the agreement.

 

Our objective in managing exposure to interest rate changes is to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve this objective, we may use interest rate swaps and caps to manage our net exposure to interest rate changes related to our borrowings. As appropriate, on the date derivative contracts are entered into, we designate derivatives as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), or a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).

 

We are party to a variable-to-fixed interest rate swap agreement which expires on January 30, 2006. The agreement has been designated as a cash flow hedge under which we will pay interest on $10.0 million of notional amount at a fixed rate and receive interest on $10.0 million of notional amount at a variable rate. The variable rate interest received by us was initially based on the 1-month LIBOR rate determined two banking days prior to the effective date. Thereafter, the interest rate resets according to the then current 1-month LIBOR rate determined two banking days prior to the first day of each monthly calculation period. This hedge is highly effective as defined by SFAS 133, and there were no gains or losses recognized in earnings during 2004 or 2003. At the end of 2004, the unrealized gain on derivative instruments designated and qualifying as cash flow hedging instruments that are reported in accumulated other comprehensive income was not material.

 

Our variable rate based loans with GE Capital bear interest at the 30-day commercial paper rate plus a fixed percentage of 3.0% to 3.5%.

 

As of December 26, 2004, we had $30.3 million of borrowings subject to variable interest rates, and a 1.0% change in the effective interest rate applied to these loans would have resulted in pre-tax interest expense fluctuating $303,000 on an annualized basis.

 

Primarily all of our transactions are conducted, and our accounts are denominated, in United States dollars. Accordingly, we are not exposed to foreign currency risk.

 

Many of the food products purchased by us are affected by changes in weather, production, availability, seasonality and other factors outside our control. In an effort to control some of this risk, we have entered into some fixed price purchase commitments with terms of no more than a year. In addition, we believe that almost all of our food and supplies are available from several sources, which helps to control food commodity risks.

 

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ITEM 8.    Financial Statements and Supplementary Data

 

RED ROBIN GOURMET BURGERS, INC. AND SUBSIDIARIES

INDEX

 

     Page

Report of Independent Registered Public Accounting Firm

   44

Consolidated Balance Sheets

   45

Consolidated Statements of Income

   46

Consolidated Statements of Stockholders’ Equity

   47

Consolidated Statements of Cash Flows

   48

Notes to Consolidated Financial Statements

   49

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

Red Robin Gourmet Burgers, Inc.

Greenwood Village, Colorado

 

We have audited the accompanying consolidated balance sheets of Red Robin Gourmet Burgers, Inc. and subsidiaries (the “Company”) as of December 26, 2004 and December 28, 2003, and the related consolidated statements of income, stockholders’ equity, and cash flows for the years ended December 26, 2004, December 28, 2003 and December 29, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 Red Robin Gourmet Burgers, Inc. and subsidiaries as of December 26, 2004 and December 28, 2003, and the results of their operations and their cash flows for the years ended December 26, 2004, December 28, 2003 and December 29, 2002 in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 3, the accompanying consolidated financial statements as of December 28, 2003 and for the years ended December 28, 2003 and December 29, 2002 have been restated.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 26, 2004, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 6, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an adverse opinion on the effectiveness of the Company’s internal control over financial reporting.

 

/s/ DELOITTE & TOUCHE LLP

 

Denver, Colorado

April 6, 2005

 

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RED ROBIN GOURMET BURGERS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

     December 26,
2004


    December 28,
2003


 
          

(As Restated,

See Note 3)

 

Assets:

                

Current Assets:

                

Cash and cash equivalents

   $ 4,980     $ 4,871  

Accounts receivable, net

     2,345       1,146  

Inventories

     5,422       4,357  

Prepaid expenses and other current assets

     4,401       3,977  

Income tax refund receivable

     1,779       1,172  

Deferred tax asset

     1,605       757  

Restricted current assets—marketing funds

     1,145       959  
    


 


Total current assets

     21,677       17,239  
    


 


Property and equipment, net

     205,304       154,410  

Deferred tax asset

     1,468       5,848  

Goodwill, net

     25,720       25,720  

Other intangible assets, net

     7,584       8,118  

Other assets, net

     2,748       3,047  
    


 


Total assets

   $ 264,501     $ 214,382  
    


 


Liabilities and Stockholders’ Equity:

                

Current Liabilities:

                

Trade accounts payable

   $ 9,759     $ 9,139  

Accrued payroll and payroll related liabilities

     14,637       12,161  

Unredeemed gift certificates

     5,646       3,997  

Accrued liabilities

     7,241       5,913  

Accrued liabilities—marketing funds

     1,145       959  

Current portion of long-term debt and capital lease obligations

     3,148       1,422  
    


 


Total current liabilities

     41,576       33,591  
    


 


Deferred rent payable

     13,378       10,655  

Long-term debt and capital lease obligations

     44,595       36,206  

Other non-current liabilities

     3,219       1,544  

Commitments and contingencies

     —         —    

Stockholders’ Equity:

                

Common stock; $.001 par value: 30,000,000 shares authorized; 16,146,486 and 15,969,723 shares issued and outstanding

     16       16  

Preferred stock, $.001 par value: 3,000,000 shares authorized; no shares issued and outstanding

     —         —    

Additional paid-in capital

     125,685       122,184  

Deferred stock compensation

     (50 )     (130 )

Receivables from stockholders/officers

     (4,155 )     (6,432 )

Accumulated other comprehensive loss, net of tax

     —         (108 )

Retained earnings

     40,237       16,856  
    


 


Total stockholders’ equity

     161,733       132,386  
    


 


Total liabilities and stockholders’ equity

   $ 264,501     $ 214,382  
    


 


 

See Notes to Consolidated Financial Statements.

 

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RED ROBIN GOURMET BURGERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

 

     Year Ended

 
     December 26,
2004


    December 28,
2003


    December 29,
2002


 
           (As Restated, See Note 3)  

Revenues:

                        

Restaurant

   $ 396,995     $ 318,878     $ 265,518  

Franchise royalties and fees

     11,769       9,320       8,565  

Rent revenue

     300       409       327  
    


 


 


Total revenues

     409,064       328,607       274,410  
    


 


 


Costs and expenses:

                        

Restaurant operating costs:

                        

Cost of sales

     93,280       75,067       61,009  

Labor

     136,817       112,872       94,030  

Operating

     57,158       48,085       40,428  

Occupancy

     25,242       21,248       17,830  

Restaurant closures and impairment

     —         —         1,393  

Depreciation and amortization

     21,070       16,395       13,198  

General and administrative

     28,675       21,990       20,239  

Franchise development

     4,063       2,848       3,256  

Pre-opening costs

     5,143       3,891       2,265  

Gain on lease buy-out

     —         —         (945 )

Impairment of property held for sale

     —         —         150  
    


 


 


Total costs and expenses

     371,448       302,396       252,853  
    


 


 


Income from operations

     37,616       26,211       21,557  

Other (income) expense:

                        

Interest expense

     2,706       2,974       5,769  

Interest income

     (322 )     (341 )     (398 )

Loss on extinguishment of debt

     —         258       4,336  

Gain on sale of property

     (257 )     —         —    

Other

     89       (14 )     106  
    


 


 


Total other expenses

     2,216       2,877       9,813  
    


 


 


Income before income taxes

     35,400       23,334       11,744  

Provision for income taxes

     12,019       7,888       3,857  
    


 


 


Net income

   $ 23,381     $ 15,446     $ 7,887  
    


 


 


Earnings per share:

                        

Basic

   $ 1.46     $ 1.02     $ 0.64  
    


 


 


Diluted

   $ 1.43     $ 1.00     $ 0.62  
    


 


 


Weighted average shares outstanding:

                        

Basic

     16,022       15,182       12,278  
    


 


 


Diluted

     16,406       15,465       12,660  
    


 


 


 

See Notes to Consolidated Financial Statements.

 

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RED ROBIN GOURMET BURGERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

    Common Stock

  Additional
Paid-in
Capital


  Deferred
Compensation


    Receivables
From
Stockholders/
Officers


    Accumulated
Other
Comprehensive
Loss, net of tax


    Retained
Earnings
(Accumulated
Deficit)


    Total

 
    Shares

  Amount

           

Balance, December 30, 2001 (as previously reported)

  10,090   $ 10   $ 53,455   $ —       $ (600 )   $ —       $ (5,887 )   $ 46,978  

Prior period adjustments (See Note 3)

  —       —       —       —         —         —         (590 )     (590 )
   
 

 

 


 


 


 


 


Balance, December 30, 2001 (as restated, see Note 3)

  10,090     10     53,455     —         (600 )     —         (6,477 )     46,388  

Deferred compensation

  —       —       289     (289 )     —         —         —         —    

Amortization of deferred compensation

  —       —       —       80       —         —         —         80  

Issuance of common stock for notes

  922     1     5,399     —         (5,400 )     —         —         —    

Interest on notes from stockholders/officers

  —       —       —       —         (252 )     —         —         (252 )

Shares issued upon initial public offering, net of offering costs of $5,203

  4,000     4     42,793     —         —         —         —         42,797  

Options exercised for common stock

  96     —       554     —         —         —         —         554  

Tax benefit on exercise of stock options

  —       —       652     —         —         —         —         652  

Net income (as restated, see Note 3)

  —       —       —       —         —         —         7,887       7,887  

Unrealized loss on cash flow hedge

  —       —       —       —         —         (84 )     —         (84 )
                                                   


Comprehensive income

                                                    7,803  
   
 

 

 


 


 


 


 


Balance, December 29, 2002 (as restated, see Note 3)

  15,108     15     103,142     (209 )     (6,252 )     (84 )   $ 1,410     $ 98,022  

Amortization of deferred compensation

  —       —       —       79       —         —         —         79  

Shares issued upon offering, net of offering costs of $1,912

  750     1     17,962     —         —         —         —         17,963  

Interest on notes from stockholders/officers

  —       —       —       —         (299 )     —         —         (299 )

Repayment of stockholders/officers notes and related interest

  —       —       —       —         119       —         —         119  

Options exercised for common stock

  103     —       597     —         —         —         —         597  

Tax benefit on exercise of stock options

  —       —       385     —         —         —         —         385  

Common stock issued through employee stock purchase plan

  9     —       98     —         —         —         —         98  

Net income (as restated, see Note 3)

  —       —       —       —         —         —         15,446       15,446  

Unrealized loss on cash flow hedge

  —       —       —       —         —         (24 )     —         (24 )
                                                   


Comprehensive income

                                                    15,422  
   
 

 

 


 


 


 


 


Balance, December 28, 2003 (as restated, see Note 3)

  15,970     16     122,184     (130 )     (6,432 )     (108 )   $ 16,856     $ 132,386  

Amortization of deferred compensation

  —       —       —       80       —         —         —         80  

Interest on notes from stockholders/officers

  —       —       —       —         (303 )     —         —         (303 )

Repayment of stockholders/officers notes and related interest

  —       —       —       —         2,580       —         —         2,580  

Options exercised for common stock

  161     —       1,434     —         —         —         —         1,434  

Tax benefit on exercise of stock options

  —       —       1,771     —         —         —         —         1,771  

Common stock issued through employee stock purchase plan

  15     —       296     —         —         —         —         296  

Net income

  —       —       —       —         —         —         23,381       23,381  

Unrealized gain on cash flow hedge

  —       —       —       —         —         108       —         108  
                                                   


Comprehensive income

                                                    23,489  
   
 

 

 


 


 


 


 


Balance, December 26, 2004

  16,146   $ 16   $ 125,685   $ (50 )   $ (4,155 )   $ —       $ 40,237     $ 161,733  
   
 

 

 


 


 


 


 


 

See Notes to Consolidated Financial Statements.

 

47


Table of Contents

RED ROBIN GOURMET BURGERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended

 
     December 26,
2004


    December 28,
2003


    December 29,
2002


 
           (As Restated, see Note 3)  

Cash Flows From Operating Activities:

                        

Net income

   $ 23,381     $ 15,446     $ 7,887  

Adjustments to reconcile net income to net cash provided by operating activities:

                        

Depreciation and amortization

     21,070       16,395       13,198  

Provision for deferred income taxes

     3,532       3,245       1,142  

Income tax benefit on exercise of stock options

     1,771       385       652  

Amortization of debt issuance costs

     546       493       360  

Write-off of unamortized debt issuance costs

     —         186       2,448  

Amortization of deferred stock-based compensation

     80       80       80  

Provision for doubtful accounts, net of charge-offs

     7       10       119  

(Gain) loss on sale of property and equipment

     (256 )     (43 )     17  

Accrued interest on stockholders/officers notes, net

     (44 )     (259 )     (252 )

Impairment of property held for sale

     —         —         150  

Non cash restaurant closure and impairment costs

     —         —         1,393  

Non-cash gain on lease buy-out

     —         —         (452 )

Changes in operating assets and liabilities:

                        

Accounts receivable

     (1,206 )     486       905  

Inventories

     (1,065 )     (1,068 )     (425 )

Prepaid expenses and other current assets

     (424 )     (859 )     (882 )

Income tax refund receivable

     (607 )     (1,017 )     (130 )

Other assets

     (458 )     (1,650 )     (237 )

Trade accounts payable and accrued liabilities

     7,856       7,149       2,746  

Deferred rent payable

     1,338       1,065       1,549  
    


 


 


Net cash provided by operating activities

     55,521       40,044       30,268  
    


 


 


Cash Flows From Investing Activities:

                        

Proceeds from sales of real estate, property and equipment

     1,101       860       921  

Purchases of property and equipment

     (70,652 )     (54,754 )     (40,803 )

Acquisition, net of cash acquired

     —         —         (6,296 )
    


 


 


Net cash used in investing activities

     (69,551 )     (53,894 )     (46,178 )
    


 


 


Cash Flows From Financing Activities:

                        

Borrowings of long-term debt

     22,948       38,000       18,769  

Payments of long-term debt and capital leases

     (12,861 )     (42,057 )     (58,876 )

Debt issuance costs

     —         (756 )     (1,529 )

Proceeds from sale of common stock, net of offering costs

     —         17,963       42,797  

Proceeds from exercise of stock options and employee stock purchase plan

     1,731       695       554  

Repayment of stockholders/officers note

     2,321       79       —    
    


 


 


Net cash provided by financing activities

     14,139       13,924       1,715  
    


 


 


Net increase (decrease) in cash and cash equivalents

   $ 109     $ 74     $ (14,195 )

Cash and cash equivalents, beginning of period

     4,871       4,797       18,992  
    


 


 


Cash and cash equivalents, end of period

   $ 4,980     $ 4,871     $ 4,797  
    


 


 


 

See Notes to Consolidated Financial Statements.

 

48


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.    Description of Business and Summary of Significant Accounting Policies

 

The first Red Robin® restaurant was opened in Seattle, Washington in September 1969. In 1979, the first franchised Red Robin® restaurant was opened in Yakima, Washington. Red Robin Gourmet Burgers, Inc. (Red Robin or the Company) was formed as a Delaware corporation in 2001. Red Robin Gourmet Burgers, Inc., together with its subsidiaries, is a casual dining restaurant chain, which as of December 26, 2004 operates 137 company-owned restaurants located in 17 states from facilities that are owned or leased. The Company also sells franchises and receives royalties from the operation of franchised restaurants. As of December 26, 2004, there were 118 restaurants operating under franchise or license agreements in 24 states and two Canadian provinces. Red Robin and its subsidiaries also own and lease to third parties certain land, buildings and equipment.

 

Principles of Consolidation—The consolidated financial statements of the Company include the accounts of Red Robin and its wholly owned subsidiaries after elimination of all material intercompany accounts and transactions.

 

Fiscal Year—The Company’s fiscal year ends on the last Sunday in December. The Company’s fiscal years ended December 26, 2004, December 28, 2003 and December 29, 2002 each included 52 weeks. For the purposes of the accompanying consolidated financial statements, the fiscal years ended December 26, 2004, December 28, 2003 and December 29, 2002 are referred to as 2004, 2003 and 2002, respectively. The fiscal year ending December 25, 2005 is referred to as 2005.

 

Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Some of the more significant estimates included in the preparation of the Company’s financial statements pertain to valuation of long-lived assets, fixed asset lives, impairment of goodwill and other intangible assets, income taxes, self-insurance and workers’ compensation reserves. Actual results could differ from those estimates.

 

Revenue Recognition—The Company typically grants franchise rights to private operators for a term of 20 years, with the right to extend the term for an additional ten years if various conditions are satisfied. The Company provides management expertise, training, pre-opening assistance and restaurant operating assistance in exchange for area development fees, franchise fees, license fees and royalties of 3% to 4% of the franchised restaurant’s adjusted sales. Franchise fee revenue from individual sales are recognized when all material obligations and initial services to be provided by the Company have been performed, generally upon the opening of the restaurant. Until earned, these fees are accounted for as deferred revenue. Deferred revenue totaled $1.1 million and $1.3 million as of December 26, 2004 and December 28, 2003, respectively. Area franchise fees are dependent upon the number of restaurants in the territory as are the Company’s obligations under the area franchise agreement. Consequently, as the Company’s obligations are met, area franchise fees are recognized proportionately with the opening of each new restaurant. Royalties are accrued as earned, and are calculated each period based on the franchisee’s reported adjusted sales.

 

Cash EquivalentsThe Company considers all highly liquid instruments purchased with a maturity of three months or less to be cash equivalents.

 

Accounts Receivable—Accounts receivables consist primarily of trade receivables due from franchisees for royalties. The allowance for doubtful accounts as of December 26, 2004 and December 28, 2003 was $15,800 and $13,300, respectively.

 

49


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Inventories—Inventories consist of food, beverages and supplies valued at the lower of cost (first-in, first-out method) or market. As of December 26, 2004 and December 28, 2003, food and beverage inventories were $2.3 million and $1.9 million, respectively, and supplies inventories were $3.1 million and $2.5 million, respectively.

 

Prepaid Expenses and Other Current Assets—Prepaid expenses consist primarily of rental payments and insurance. Prepaid expenses are recognized during the period in which goods or services are received.

 

Restricted Current Assets-Marketing Funds—Restricted current assets, which are comprised primarily of cash, are restricted solely for use by the Company’s marketing fund programs and have been segregated from the Company’s assets. Certain franchisees and Company restaurants contribute between 0.3% and 0.5% of adjusted sales to one or more marketing funds to be used for future advertising in accordance with the terms of each program. A liability related to the restricted current assets is recorded when the funds are received.

 

Property and Equipment—Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized, and minor replacements, maintenance and repairs are charged to expense as incurred. Depreciation is computed on the straight-line method for financial reporting purposes, based on the shorter of the estimated useful lives or the terms of the underlying leases of the related assets. The Company uses other depreciation methods, generally accelerated, for tax purposes where appropriate. Interest incurred on funds used to construct company-owned restaurants is capitalized and amortized over the estimated useful life of the related assets. Capitalized interest totaled $435,000 in 2004, $339,200 in 2003 and $167,500 in 2002.

 

Goodwill and Intangible Assets—Beginning with the adoption of Statement of Financial Accounting Standards (SFAS) 142 in 2002, the price paid over the net fair value of the tangible net assets and identifiable intangible assets of acquired businesses, or goodwill, is no longer amortized. Franchise rights are amortized over their estimated useful life of 20 years, using the straight-line method. Liquor licenses are amortized over their respective useful lives, generally ranging from one to five years. The recoverability of goodwill and other intangible assets is evaluated annually, at a minimum, or on an interim basis if events or circumstances indicate a possible inability to realize the carrying amount. Goodwill and other intangible assets are tested for impairment on an annual basis. There have been no impairment losses related to goodwill and other intangible assets during the years presented in the accompanying financial statements. In assessing the recoverability of goodwill and other intangible assets, market values and projections regarding estimated future cash flows and other factors are used to determine the fair value of the respective assets. If these estimates or related projections change in the future, the Company may be required to record impairment charges for these assets.

 

Valuation of Long-Lived Assets—The Company tests its long-lived assets, including property and equipment, for impairment at least annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. This assessment is performed on a restaurant-by-restaurant basis and the Company will recognize an impairment loss when it concludes that the sum of undiscounted expected future cash flows is less than the carrying amount of such assets. The measurement for such an impairment loss is then based on the fair value of the asset as determined by discounted cash flows or appraisals, if available.

 

Other Assets—Other assets consist primarily of trust assets related to the employee deferred compensation plan, unamortized debt issuance costs and deposits.

 

Debt Issuance Costs—Direct costs incurred for the issuance of debt are capitalized and amortized to interest expense using the interest method over the term of the debt. Debt issuance costs as of December 26, 2004

 

50


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

and December 28, 2003 was $2.1 million. Unamortized debt issuance cost as of December 26, 2004 and December 28, 2003 was $852,400 and $1.4 million, respectively.

 

Operating Leases—The Company leases land, restaurant facilities and office space under operating leases. Most lease agreements contain rent holidays, tenant improvement allowances, rent escalation clauses and/or contingent rent provisions. For purposes of recognizing incentives and minimum rental expenses on a straight-line basis over the terms of the leases, the Company uses the date it becomes legally obligated for future rental payments to begin amortization, which is generally when the Company waives contract contingencies and takes possession of the site to begin to make improvements in preparation for intended use.

 

For scheduled rent escalation clauses during the lease term the Company records minimum rental expenses on a straight-line basis over the lease term.

 

For rent holidays and tenant improvement allowances, the Company records a deferred rent liability in deferred rent payable and amortizes the deferred rent over the terms of the leases as reductions to rent expense. The Company recognizes rent costs incurred during a period of construction as a period costs in its statement of income. No rent costs are capitalized as a cost of the constructed asset.

 

Certain leases provide for contingent rents, which are determined as a percentage of adjusted sales in excess of specified levels. The Company records a contingent rent liability in accrued liabilities on the consolidated balance sheets and the corresponding rent expense when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable.

 

Deferred Rent Payable—Deferred rent payable represents rental expense, recorded on a straight-line basis, in excess of actual rental payments.

 

Advertising—Advertising costs are expensed as incurred. Advertising costs were $10.9 million, $10.1 million, and $10.9 million in 2004, 2003 and 2002, respectively, and are included in restaurant operating expenses and general and administrative expenses in the consolidated statements of income.

 

Self-Insurance Programs—The Company utilizes a paid loss self-insurance plan for health, general liability and workers’ compensation coverage. Predetermined loss limits have been arranged with insurance companies to limit the Company’s per occurrence cash outlay. Accrued liabilities and accrued payroll and payroll-related liabilities include the estimated incurred but unreported costs to settle unpaid claims and estimated future claims.

 

Pre-opening Costs—Pre-opening costs are expensed as incurred. Pre-opening costs include rental expenses through the date of opening for each restaurant.

 

Income Taxes—Deferred tax liabilities are recognized for the estimated effects of all taxable temporary differences, and deferred tax assets are recognized for the estimated effects of all deductible temporary differences and operating loss and tax credit carryforwards. Measurement of the Company’s current and deferred tax liabilities and assets is based on provisions of enacted tax laws. Current financial accounting standards do not require the Company to consider the effects of future changes in tax laws or rates when making its estimates. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

51


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Earnings Per Share—Basic earnings per share amounts are calculated by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted earnings per share amounts are calculated based upon the weighted average number of common and potentially dilutive common shares outstanding during the year. Potentially dilutive shares are excluded from the computation in periods in which they have an anti-dilutive effect. Diluted earnings per share reflect the potential dilution that could occur if holders of options exercised their holdings into common stock. During 2004, 2003 and 2002, a total of 7,000, 9,000 and 60,600 weighted-average stock options outstanding were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the periods presented. The Company uses the treasury stock method to calculate the impact of outstanding stock options.

 

The computations for basic and diluted earnings per share are as follows (in thousands, except per share data):

 

     2004

   2003

   2002

Net income

   $ 23,381    $ 15,446    $ 7,887
    

  

  

Basic weighted average shares outstanding

     16,022      15,182      12,278

Dilutive effect of stock options

     384      283      382
    

  

  

Diluted weighted average shares outstanding

     16,406      15,465      12,660
    

  

  

Earnings per share:

                    

Basic

   $ 1.46    $ 1.02    $ 0.64
    

  

  

Diluted

   $ 1.43    $ 1.00    $ 0.62
    

  

  

 

Unvested shares issued upon early exercise, as described in Note 14, are not considered outstanding for purposes of computing basic earnings per share because the employee is not entitled to the rewards of ownership. However, these unvested shares are included as potentially dilutive for purposes of calculating diluted earnings per share. Unvested shares issued upon early exercise totaled 22,989 as of December 26, 2004 and 34,483 as of December 28, 2003.

 

DerivativesThe Company follows SFAS 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133, as amended, requires derivative instruments to be recorded in the balance sheet at their fair value with changes in fair value being recognized in earnings unless specific hedge accounting criteria are met.

 

Comprehensive IncomeComprehensive income consists of the net income and other gains and losses affecting stockholders’ equity that, under accounting principles generally accepted in the United States, are excluded from net income. Other comprehensive income (loss) as presented in the consolidated statements of stockholders’ equity for 2004, 2003 and 2002 consisted of the unrealized gain or loss, net of tax, on our cash flow hedge.

 

Employee Stock Compensation PlansThe Company follows Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, in accounting for its stock based compensation to employees whereby any intrinsic value as determined on the measurement date results in compensation. Accordingly, compensation expense of $79,600 was recognized during each of 2004, 2003 and 2002, for options granted with intrinsic value on the date of grant. No compensation expense is recognized in the Company’s financial statements for employee stock options granted at a price equal to or greater than the market price of the Company’s common stock on the date of grant. If under SFAS 123, Accounting for Stock Based Compensation, the Company determined compensation costs based on the fair value at the date of grant for its stock options, net

 

52


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

income and earnings per share would have been reduced to the following pro forma amounts (in thousands, except per share data):

 

     2004

   2003

   2002

Net income, as reported

   $ 23,381    $ 15,446    $ 7,887

Add: Stock-based employee compensation costs included in reported net income, net of tax benefit

     53      53      53

Deduct: Stock-based employee compensation costs, net of tax benefit

     2,328      1,072      560
    

  

  

Pro forma net income

   $ 21,106    $ 14,427    $ 7,380
    

  

  

Basic earnings per share:

                    

As reported

   $ 1.46    $ 1.02    $ 0.64
    

  

  

Pro forma

   $ 1.32    $ 0.95    $ 0.60
    

  

  

Diluted earnings per share:

                    

As reported

   $ 1.43    $ 1.00    $ 0.62
    

  

  

Pro forma

   $ 1.29    $ 0.93    $ 0.58
    

  

  

 

The weighted average fair values of options at their grant date during 2004, 2003 and 2002, where the exercise price equaled the market price on the grant date were $12.08, $8.19 and $6.10, respectively. The estimated fair value of each option granted is calculated using the Black-Scholes multiple option-pricing model. The assumptions used in the model were as follows:

 

     2004

    2003

    2002

 

Risk-free interest rate

   3.4 %   3.1 %   4.3 %

Expected years until exercise

   5.5     5.5     5.5  

Expected stock volatility

   41.0 %   47.8 %   56.1 %

Dividend yield

   0.0 %   0.0 %   0.0 %

 

Fair Value of Financial Instruments—The following disclosure of the estimated fair value of financial instruments has been determined using available market information and appropriate valuation methodologies. The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair values due to the short-term maturities of these instruments. The fair value of the Company’s revolving credit agreement approximates its carrying amount, as the applicable interest rates approximate market rates. The fair values of the Company’s debt has been estimated using discounted cash flow analyses based on market rates obtained from independent third parties for similar type debt. The carrying amounts and related estimated fair values for the Company’s debt is as follows (in thousands):

 

     2004

   2003

     Carrying
Amount


   Fair Value

   Carrying
Amount


   Fair Value

Revolving credit agreement

   $ 31,500    $ 31,500    $ 20,000    $ 20,000

Collateralized notes and capital leases

     16,243      17,995      17,628      19,793

 

Concentration of RiskFinancial instruments that potentially subject the Company to concentrations of credit risk are cash equivalents and accounts receivable. The Company attempts to limit its credit risk associated with cash equivalents by placing the Company’s financial instruments with major financial institutions. The

 

53


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Company’s trade accounts receivable are comprised principally of amounts due from its franchisees. With respect to accounts receivable, the Company limits its credit risk by performing ongoing credit evaluations and, when deemed necessary, requiring letters of credit, guarantees or collateral. Management does not believe significant risk exists in connection with the Company’s concentrations of credit at December 26, 2004.

 

ReclassificationsCertain amounts in the 2003 and 2002 consolidated financial statements have been reclassified to conform to the 2004 presentation.

 

2.    Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R, Share-Based Payment, a revision of SFAS 123, Accounting for Stock-Based Compensation. SFAS 123R will require the Company to, among other things, measure all employee stock-based compensation awards using a fair value method and record such expense in the Company’s consolidated financial statements. The provisions of SFAS 123R are effective for the first interim or annual reporting period that begins after June 15, 2005; therefore, the Company will adopt the new requirements no later than the beginning of its third quarter of 2005. Adoption of the expensing requirements will reduce the Company’s future reported earnings in a manner similar to that described in Note 1 under employee stock compensation plans. Management is currently evaluating the specific impacts of adoption, which include whether the Company should adopt the requirements on a retrospective basis and which valuation model is most appropriate.

 

In November 2004, the FASB issued SFAS 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. The adoption of SFAS 151 is not expected to have any impact on the Company’s consolidated financial position or results of operations.

 

In December 2003, the FASB issued FASB Interpretation No. (FIN) 46R, Consolidation of Variable Interest Entities and Interpretation of ARB No. 51. This interpretation, which replaces FIN 46, Consolidation of Variable Interest Entities, clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. This interpretation is required in financial statements for periods ending after March 15, 2004 for those companies that have yet to adopt the provisions of FIN 46. The Company has no variable interest in variable interest entities and, therefore, no entities are consolidated with our financial statements as a result of adopting FIN 46R.

 

3.    Restatement of Financial Statements

 

On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (SEC) issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease-related accounting issues and their application under accounting principles generally accepted in the United States of America (GAAP). In light of this letter, the Company’s management initiated a review of its lease accounting and determined that its previous methods of accounting for rent holidays and for leasehold improvements funded by landlord incentives or allowances under operating leases (tenant improvement allowances) were not in accordance with GAAP. As a result, the accompanying consolidated financial statements for the fiscal years ended December 28, 2003 and December 29, 2002, have been restated from the amounts previously reported.

 

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Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Historically, when accounting for leases with renewal options, the Company recorded rent expense on a straight-line basis over the initial non-cancelable lease term, with the term commencing when rent payments began. In most instances, the period when rent payments began coincided with the date the Company’s restaurants opened. This generally had the effect of excluding the build-out period for restaurants from the calculation of the period over which rent was expensed, though the point where the Company became legally obligated for future rent payments had been reached. The Company generally depreciated its buildings, leasehold improvements and other long-lived assets on those properties over a period that included both the initial non-cancelable lease term and all option periods provided for in the lease (or the useful life of the assets if shorter) up to a maximum period of twenty years. However, in certain instances the Company amortized leasehold improvements over only the initial non-cancelable lease term. Further, the Company’s historical consolidated balance sheets had reflected the unamortized portion of tenant improvement allowances as a reduction of the related leasehold improvements and the subsequent amortization of those tenant improvement allowances as a reduction of depreciation and amortization expense in its consolidated statements of income over the period that began when the allowances were received and ended at the end of the related lease term.

 

The Company has restated its financial statements for the years ended December 28, 2003 and December 29, 2002 to recognize rent expense on a straight-line basis over the expected lease term, including cancelable option periods where failure to exercise such options would result in an economic penalty. The lease term commences on the date that the Company becomes legally obligated for future rent payments, which coincides with the date on which the landlord delivers the property to the Company for development and the Company waives contract contingencies. The Company’s restated financial statements include rental expenses in pre-opening costs for the period from inception through the date each restaurant opens. This had the effect of increasing pre-opening costs and decreasing restaurant occupancy costs.

 

The Company also has restated its financial statements to recognize tenant improvement allowances as deferred rent which is amortized over the lease term as a reduction of rent expense. This had the effect of increasing property and equipment, net and deferred rent payable in the consolidated balance sheets and increasing depreciation and amortization expense and decreasing restaurant occupancy costs in the consolidated statements of income. In addition, the Company has restated depreciation and amortization expenses in the financial statements to correct instances where the period of amortization of leasehold improvements did not match the lease term (or the useful life of the assets if shorter) up to a maximum period of twenty years. This generally led to an increase in property and equipment, net and a decrease in depreciation and amortization expense in the financial statements.

 

The Company’s restated financial statements also reflect certain immaterial adjustments to reflect corrections to the consolidated balance sheet classification of deferred tax assets and liabilities, accrued liabilities and other non-current liabilities and corrections to the consolidated income statements to reflect previously unrecorded activity related to a provision of our fountain beverage agreement.

 

The cumulative effect of this restatement resulted in an increase in the accumulated deficit of $590,000 as of December 30, 2001, and decreases in net income of $288,000 and $377,000 for the fiscal years ended December 28, 2003 and December 29, 2002, respectively.

 

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RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Following is a summary of the significant effects of the restatement on the Company’s consolidated balance sheet as of December 28, 2003 as well as the effects of these changes on the Company’s consolidated statements of income for the fiscal years ended December 28, 2003 and December 29, 2002 (in thousands, except per share data):

 

     Consolidated Balance Sheet

December 28, 2003


   As
Previously
Reported


   Adjustments

    As
Restated


Property and equipment, net

   $ 151,061    $ 3,349     $ 154,410

Current deferred tax asset

     1,075      (318 )     757

Non-current deferred tax asset

     4,710      1,138       5,848

Accrued payroll and payroll-related liabilities

     12,931      (770 )     12,161

Accrued liabilities

     6,622      (709 )     5,913

Deferred rent payable

     5,296      5,359       10,655

Other non-current liabilities

     —        1,544       1,544

Retained earnings

     18,111      (1,255 )     16,856

Total stockholders’ equity

     133,641      (1,255 )     132,386

Total liabilities and stockholders’ equity

     210,213      4,169       214,382
     Consolidated Statements of Income

Fiscal Year ended December 28, 2003


   As
Previously
Reported


   Adjustments

    As
Restated


Cost of sales

   $ 75,172    $ (105 )   $ 75,067

Occupancy costs

     21,637      (389 )     21,248

Depreciation and amortization

     16,126      269       16,395

General and administrative

     22,022      (32 )     21,990

Pre-opening costs

     3,165      726       3,891

Income from operations

     26,680      (469 )     26,211

Income before income taxes

     23,803      (469 )     23,334

Provision for income taxes

     8,069      (181 )     7,888

Net income

   $ 15,734    $ (288 )   $ 15,446
    

  


 

Earnings per share—Basic

   $ 1.04    $ (0.02 )   $ 1.02
    

  


 

Earnings per share—Diluted

   $ 1.02    $ (0.02 )   $ 1.00
    

  


 

Fiscal Year ended December 29, 2002


               

Cost of sales

   $ 61,084    $ (75 )   $ 61,009

Occupancy costs

     18,095      (265 )     17,830

Restaurant closures and impairment

     1,133      260       1,393

Depreciation and amortization

     12,883      315       13,198

General and administrative

     20,260      (21 )     20,239

Pre-opening costs

     1,879      386       2,265

Income from operations

     22,157      (600 )     21,557

Income before income taxes

     12,344      (600 )     11,744

Provision for income taxes

     4,081      (224 )     3,857

Net income

   $ 8,264    $ (377 )   $ 7,887
    

  


 

Earnings per share—Basic

   $ 0.67    $ (0.03 )   $ 0.64
    

  


 

Earnings per share—Diluted

   $ 0.65    $ (0.03 )   $ 0.62
    

  


 

 

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RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

4.    Franchise Acquisitions

 

On January 14, 2002, a wholly owned subsidiary of Red Robin acquired all of the outstanding stock of Western Franchise Development, Inc. (WFD) for $6.3 million in cash, net of $148,700 of cash acquired. WFD operated six restaurants in Northern California under franchise agreements with the Company. The Company acquired WFD after exercising its right of first refusal upon reviewing an offer between the franchisee and a third party. The final purchase price was equal to the amount agreed upon between the franchisee and the third party. WFD’s results of operations have been included in the accompanying consolidated statements of income from its date of acquisition. The Company accounted for the transaction as a purchase business combination and the purchase price has been allocated to the assets acquired and liabilities assumed based on their fair values at the date of acquisition as follows (in thousands):

 

Current assets

   $ 251  

Property and equipment

     1,736  

Goodwill

     2,471  

Intangible assets subject to amortization

     2,903  

Current liabilities

     (1,065 )
    


Cash paid for acquisition, net of cash acquired

   $ 6,296  
    


 

Intangible assets subject to amortization included franchise rights of $2.8 million and liquor licenses of $102,600.

 

On January 28, 2002, the Company acquired the assets of two restaurants for $2.8 million in cash from a franchisee. On February 11, 2002, the Company assumed operation of a restaurant which had been subleased by the Company to this franchisee. On February 19, 2002, the Company consummated the purchase of the assets of a restaurant from this same franchisee for $1.0 million in cash. The results of operations for each of these restaurants have been included in the accompanying consolidated statements of income from their respective date of acquisition. Pro forma statement of income information for 2002 is not material.

 

5.    Property and Equipment

 

Property and equipment consist of the following at December 26, 2004 and December 28, 2003 (in thousands):

 

     Estimated Lives

   2004

    2003

 

Land

   Indefinite    $ 22,113     $ 18,615  

Buildings

   5 to 20 years      36,273       24,846  

Leasehold improvements

   Shorter of lease term or estimated
useful life, not to exceed 20 years
     139,727       106,532  

Furniture, fixtures and equipment

   3 to 7 years      83,575       68,750  

Restaurant property leased to others

   3 to 20 years      6,132       6,132  

Construction in progress

          14,184       8,602  
         


 


            302,004       233,477  

Accumulated depreciation and amortization

          (96,700 )     (79,067 )
         


 


Property and equipment, net

        $ 205,304     $ 154,410  
         


 


 

Depreciation and amortization expense on property and equipment, including assets under capital lease, was $20.3 million in 2004, $15.7 million in 2003 and $12.6 million in 2002.

 

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RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

During 2004, we sold a parcel of land for $1.1 million, resulting in a pre-tax gain of $256,900. During 2002, real estate with a carrying value of $1.0 million was sold resulting in a loss of $162,700, including a $150,000 impairment of property held for sale that was recorded to adjust the property’s carrying value prior to its sale.

 

During 2002, management determined that the carrying value of the assets for a restaurant which had experienced losses from operations and negative cash flows would not be recoverable. As a result, an impairment charge of $1.4 million was recognized to write the carrying of those assets down to zero. There were no impairment charges recognized in 2004 or 2003.

 

6.    Goodwill and Other Intangible Assets

 

As of December 26, 2004 and December 28, 2003, goodwill was $25.7 million. The following table presents intangible assets subject to amortization as of December 26, 2004 and December 28, 2003 (in thousands):

 

     2004

    2003

 
     Gross Carrying
Amount


   Accumulated
Amortization


    Gross Carrying
Amount


   Accumulated
Amortization


 

Intangible assets subject to amortization:

                              

Franchise rights

   $ 8,600    $ (1,688 )   $ 8,600    $ (1,258 )

Liquor licenses

     1,868      (1,196 )     1,656      (880 )
    

  


 

  


     $ 10,468    $ (2,884 )   $ 10,256    $ (2,138 )
    

  


 

  


 

The following table presents aggregate amortization expense for 2004, and estimated aggregate amortization expense related to intangible assets subject to amortization for each of the five succeeding fiscal years (in thousands):

 

Aggregate amortization expense

      

For the year ended December 26, 2004

   $ 746

Estimated amortization expense

      

For the year ending December 25, 2005

     694

For the year ending December 31, 2006

     614

For the year ending December 30, 2007

     551

For the year ending December 28, 2008

     517

For the year ending December 27, 2009

     446

 

7.    Accrued Payroll and Payroll Related Liabilities and Accrued Liabilities

 

Accrued payroll and payroll related liabilities consist of the following at December 26, 2004 and December 28, 2003 (in thousands):

 

     2004

   2003

Payroll

   $ 3,672    $ 3,115

Corporate and restaurants bonuses

     3,609      3,005

Workers’ compensation

     2,394      1,916

Other

     4,962      4,125
    

  

     $ 14,637    $ 12,161
    

  

 

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Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Accrued liabilities consist of the following at December 26, 2004 and December 28, 2003 (in thousands):

 

     2004

   2003

State and city sales taxes

   $ 2,124    $ 2,145

Utilities

     981      734

Real estate and personal property taxes

     872      483

Percentage rents

     570      399

Other

     2,694      2,152
    

  

     $ 7,241    $ 5,913
    

  

 

8.    Borrowings

 

Borrowings at December 26, 2004 and December 28, 2003 are summarized below (in thousands):

 

     2004

    2003

 

Revolving credit agreement

   $ 31,500     $ 20,000  

Capital leases

     7,106       7,388  

Collateralized notes payable

     9,137       10,240  
    


 


       47,743       37,628  

Current portion

     (3,148 )     (1,422 )
    


 


Long-term debt

   $ 44,595     $ 36,206  
    


 


 

Maturities of long-term debt and capital lease obligations as of December 26, 2004 are as follows (in thousands):

 

2005

   $ 3,148

2006

     34,361

2007

     1,591

2008

     1,325

2009

     1,338

Thereafter

     5,980
    

     $ 47,743
    

 

On July 24, 2002, the Company entered into a three-year, $40.0 million revolving credit agreement with Wachovia Bank, N.A. and other financial institutions named therein. On May 20, 2003, the Company amended its revolving credit agreement to increase its maximum borrowing capacity to $85.0 million and to extend the term of the agreement through May 19, 2006. The amendment of the Company’s revolving credit agreement resulted in $755,700 of debt issuance costs that are amortized ratably over the remaining life of the agreement. As of December 26, 2004, $50.8 million remained available for future borrowings under the revolving credit agreement.

 

The Company was required under the revolving credit agreement to exercise the purchase options on three capital leases during 2003. These purchase options related to restaurant leases in Highlands Ranch, Colorado; Issaquah, Washington; and Grapevine, Texas. The exercise of the Highlands Ranch purchase option was completed in January 2003 for $4.0 million, the exercise of the Issaquah purchase option was completed in August 2003 for $3.7 million and the exercise of the Grapevine purchase option was completed in September 2003 for $3.5 million. In addition, during 2003, the Company elected to repay $3.1 million of various real estate and equipment loans. These real estate and equipment loans were payable monthly over remaining terms ranging

 

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Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

from three to eight years and were subject to fixed interest rates ranging from 7.9% to 9.7%. The exercise of the purchase options and prepayment of these real estate and equipment loans resulted in a $257,500 charge for loss on extinguishment of debt, including $186,400 of non-cash expense related to the write-off of capitalized debt issuance costs that were being amortized over the respective lives of the relevant agreements. The revolving credit agreement does not require the early extinguishment of any additional borrowings.

 

Borrowings under the amended revolving credit agreement bear interest at one of the following rates as selected by the Company: an Alternate Base Rate (ABR), which is based on the Prime Rate plus 1.0% to 1.75%, or a London Interbank Offered Rate (LIBOR), which is based on the relevant one, two, three or six month LIBOR, at the Company’s discretion, plus 2.0% to 2.75%. The spread, or margin, for ABR and LIBOR loans is adjusted quarterly based on the Company’s then current leverage ratio. Interest payments on ABR loans are due the last day of each March, June, September and December and on the maturity date. Interest payments on LIBOR loans having an interest period of three months or less are due the last day of such interest period. Interest payments on LIBOR loans having an interest period longer than three months are due every three months after the first day of the interest period and also on the last day of such interest period. In addition, the Company may borrow up to $3.0 million under a swingline loan subfacility if the sum of the outstanding ABR and LIBOR loans, swingline loans and letters of credit do not exceed $85.0 million. Swingline loans under the amended credit agreement bear interest at a per annum rate equal to the prime rate plus 1.0% to 1.75%. As of December 26, 2004, borrowings outstanding under the Company’s revolving credit agreement agreement bore interest at approximately 4.3%.

 

The amended revolving credit agreement is secured by a first priority pledge of all of the outstanding capital stock of the Company’s subsidiaries and a first priority lien on substantially all of the Company’s tangible and intangible assets. The amended revolving credit agreement requires that the Company comply with a maximum leverage ratio as well as a minimum fixed charge coverage ratio, and minimum earnings before interest, taxes, depreciation and amortization (EBITDA) requirements. In addition, the Company must comply with certain consolidated capital expenditure maximums and operating lease restrictions. The credit agreement restricts the Company’s ability to, among other things, engage in mergers, acquisitions, joint ventures and sale-leaseback transactions, and to sell assets, incur indebtedness, make investments and create liens. Additionally, the revolving credit agreement prohibits the Company from declaring or paying any dividends or making any other distributions on any shares of the Company’s stock, subject to specified exceptions. As of December 26, 2004, the Company is in compliance with all covenants related to the amended credit agreement.

 

The amended revolving credit agreement is also subject to a commitment fee of 0.5% per annum on the average daily unused portion of the revolver. In addition, the Company must pay a fee in consideration of letter of credit commitments equal to 2.0% to 2.75% on the average daily maximum amount available to be drawn under each letter of credit from the date of issuance to the date of expiration. The Company must also pay the reasonable and customary charges of its lenders with respect to the amendment, transfer, administration, cancellation and conversion of, and drawings under, letters of credit. Commitment and letter of credit fees are payable quarterly, in arrears on the 15th day following the last day of each calendar quarter.

 

At December 29, 2002, an irrevocable letter of credit totaling $841,000 was issued under the revolving credit agreement. On September 30, 2003, the letter of credit was increased to $2,041,000 and on October 25, 2004, the letter of credit was further increased to $2,691,000. This letter is being maintained to back the Company’s self-insured workers’ compensation program and reduces the amount of future borrowings available under the Company’s revolving credit agreement.

 

In July 2002, the Company used proceeds from its initial public offering, together with borrowings under the revolving credit agreement, to repay $48.0 million under its existing term loan, including a prepayment

 

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RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

penalty of $1.8 million and $289,000 of accrued interest. The term loan was originated on September 6, 2000, bore interest at 9.9% and was payable in equal monthly installments of $593,800 with the final payment due September 1, 2012. The Company also repaid its $5.0 million revolving credit facility with U.S. Bank. The facility was originated on April 25, 2002 and bore interest at LIBOR plus 3.0% payable monthly, in arrears. In addition, the Company repaid $1.6 million outstanding under a real estate loan, including a 1% prepayment penalty and $439,600 outstanding under three equipment loans. Termination of the term loan and the revolving credit facility resulted in additional non-cash charges of $2.4 million during 2002 resulting from the write-off of capitalized debt issuance costs that were being amortized over the respective lives of the relevant credit agreements. These agreements were terminated upon repayment and the Company has no remaining obligations under these agreements. The Company early adopted SFAS 145 in 2002 and consequently did not record the loss on extinguishment of debt as an extraordinary item.

 

The collateralized notes payable are secured by certain property and equipment of the Company. Under some of these agreements, the Company is required to maintain certain financial ratios. As of December 26, 2004, the Company is in compliance with all covenants for collateralized notes payable. The collateralized notes payable require monthly principle and interest payments through 2016, with a weighted average interest rate of 6.0% at December 26, 2004.

 

9.    Supplemental Disclosures to Consolidated Statements of Cash Flows

 

(In thousands)


   2004

   2003

   2002

Income taxes paid

   $ 7,424    $ 5,281    $ 1,816

Interest paid, net of amounts capitalized

     2,207      2,599      5,740

Capital lease obligations incurred for real estate and equipment purchases

     28      1,705      —  

Tenant improvement allowance paid directly by landlord to general contractor

     1,383      —        —  

Notes receivable from stockholders related to early exercise of stock options

     —        —        5,400

 

10.    Derivative Instruments

 

The Company’s objective in managing exposure to interest rate changes is to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve this objective, the Company may use interest rate swaps and caps to manage its net exposure to interest rate changes related to its portfolio of borrowings.

 

The Company has adopted SFAS 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133, as amended, requires that all derivative instruments be recorded on the balance sheet at fair value. As appropriate, on the date derivative contracts are entered into, the Company designates the derivatives as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge) or a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge).

 

In December 2002, the Company entered into a variable-to-fixed interest rate swap agreement with an effective date of January 29, 2003, which expires on January 30, 2006. The agreement has been designated as a cash flow hedge under which the Company will pay interest on $10.0 million of notional amount at a fixed rate and receive interest on $10.0 million of notional amount at a variable rate. The variable rate interest received by

 

61


Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

the Company is based on a 1-month LIBOR rate, initially determined two banking days prior to the effective date. Thereafter, the interest rate resets according to the then current 1-month LIBOR rate two days prior to the first day of each monthly calculation period. This hedge is highly effective as defined by SFAS 133, and there were no gains or losses recognized in earnings during the reporting periods presented.

 

11.    Income Taxes

 

The provision for income taxes consists of the following (in thousands):

 

     2004

    2003

    2002

Current:

                      

Federal

   $ 6,425     $ 3,340     $ 2,163

State

     2,130       1,300       553

Deferred:

                      

Federal

     3,686       3,335       892

State

     (222 )     (87 )     249
    


 


 

     $ 12,019     $ 7,888     $ 3,857
    


 


 

 

The reconciliation of income tax provision that would result from applying the federal statutory rate to income tax provision as shown in the accompanying consolidated statements of income is as follows:

 

     2004

    2003

    2002

 

Tax provision at federal statutory rate

   35.0 %   35.0 %   34.0 %

State income taxes

   4.5     3.5     5.0  

General business and other tax credits

   (5.6 )   (5.4 )   (8.9 )

Other

   0.1     0.7     2.7  
    

 

 

Effective tax rate

   34.0 %   33.8 %   32.8 %
    

 

 

 

The Company’s total deferred tax assets and liabilities at December 26, 2004 and December 28, 2003 are as follows (in thousands):

 

     2004

    2003

 

Deferred tax assets

   $ 12,910     $ 11,667  

Deferred tax liabilities

     (9,837 )     (5,062 )
    


 


Deferred tax assets, net General business and other tax credits

   $ 3,073     $ 6,605  
    


 


 

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Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company’s federal and state deferred taxes at December 26, 2004 and December 28, 2003 are as follows (in thousands):

 

     2004

    2003

 

Current deferred tax assets and liabilities, net:

                

Accrued compensation and related costs

   $ 1,775     $ 612  

General business and other tax credits

     487       487  

Net operating losses—state

     44       27  

Other, net

     351       370  

Supplies inventory Total current deferred tax assets

     (1,052 )     (739 )
    


 


Current deferred tax asset, net

     1,605       757  
    


 


Non-current deferred tax assets and liabilities, net:

                

Deferred rent

     5,435       4,256  

General business and other tax credits

     1,915       3,354  

Alternative minimum tax credits

     1,425       1,446  

Accrued compensation and related costs

     1,165       525  

Other, net

     271       520  

Net operating losses—state

     42       70  

Property and equipment

     (6,941 )     (2,436 )

Franchise rights

     (1,844 )     (1,887 )
    


 


Non-current deferred tax asset, net

     1,468       5,848  
    


 


     $ 3,073     $ 6,605  
    


 


 

Realization of net deferred tax assets are dependent upon profitable operations and future reversals of existing taxable temporary differences. Although realization is not assured, the Company believes it is more likely than not that the net recorded benefits will be realized through the reduction of future taxable income. The amount of the net deferred tax assets is considered realizable, however, it could be reduced in the near term if actual future taxable income is lower than estimated, or if there are differences in the timing or amount of future reversals of existing taxable temporary differences.

 

As of December 26, 2004, the Company has State net operating losses totaling $1.2 million available to reduce future taxes which expire through 2012. Additionally, the Company has federal alternative minimum tax credits of $1.4 million available with no expiration date. The Company also has general business and other tax credits totaling $2.4 million available to offset future taxes which expire through 2023.

 

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Table of Contents

RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

12.    Commitments and Contingencies

 

Leasing ActivitiesThe Company leases land, buildings and equipment used in its operations under operating leases. The Company’s operating leases have remaining non-cancelable terms ranging from less than one year to more than 20 years. These leases generally contain renewal options which permit the Company to renew the leases at defined contractual rates or prevailing market rates. Certain equipment leases also include options to purchase equipment at the end of the lease term. Certain leases provide for contingent rents, which are determined as a percentage of adjusted restaurant sales in excess of specified levels. The Company records a contingent rent liability and the corresponding rent expense when specified levels have been achieved or when management determines that achieving the specified levels during the fiscal year is probable. Certain lease agreements also require the Company to pay maintenance, insurance and property tax costs. Rental expense related to land, building and equipment leases, including related parties, is as follows (in thousands):

 

     2004

   2003

   2002

Minimum rent

   $ 16,287    $ 14,065    $ 12,150

Percentage rent

     1,445      993      1,010

Equipment rent under operating leases

     453      449      312
    

  

  

     $ 18,185    $ 15,507    $ 13,472
    

  

  

 

The Company leases certain of its owned land, buildings and equipment to outside parties under non-cancelable operating leases. Cost of the leased land, buildings and equipment at December 26, 2004 and December 28, 2003 was $6.1 million and related accumulated depreciation was $2.5 million and $2.3 million, respectively.

 

Future minimum lease commitments and minimum rental income under all leases as of December 26, 2004 are as follows (in thousands):

 

     Capital
Leases


    Operating
Leases


   Rental
Income


2005

   $ 1,066     $ 15,545    $ 245

2006

     2,342       15,383      245

2007

     939       15,248      245

2008

     954       15,422      182

2009

     960       15,538      25

Thereafter

     5,739       145,460      —  
    


 

  

Total

     12,000     $ 222,596    $ 942
            

  

Less amount representing interest at 3.8% to 13.4%

     (4,894 )             
    


            

Present value of future minimum lease payments

     7,106               

Less current portion

     (354 )             
    


            

Long-term capital lease obligations

   $ 6,752               
    


            

 

As of December 26, 2004 and December 28, 2003, property and equipment included $10.2 million and $9.4 million of assets under capital lease, respectively, and $2.5 million and $1.7 million of related accumulated depreciation, respectively.

 

ContingenciesIn the normal course of business, the Company has various claims in process, matters in litigation and other contingencies. While it is not possible to predict the outcome of these suits, other legal

 

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RED ROBIN GOURMET BURGERS, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

proceedings and claims with certainty, management is of the opinion that adequate provision for potential losses has been made in the accompanying consolidated financial statements and that the ultimate resolution of these matters will not have a material adverse effect on the Company’s financial position, results of operation or cash flows.

 

Lease Termination FeeDuring 2002, the Company realized a $945,000 non-recurring gain due to a landlord lease buy-out of an existing company-owned restaurant. As a result, the Company relocated the restaurant to a new location. The lease termination fee received of $1.4 million has been presented net of related charges of $235,600 for the disposal of property and equipment from the original restaurant that was non-transferable and other non-recurring charges associated with the relocation of $204,400.

 

13.    Franchise Operations

 

Results of franchise operations included in the consolidated statements of income consist of the following (in thousands):