|• ANNUAL REPORT ON FORM 10-K • EX-10.2 • EX-10.3 • EX-10.70 • EX-21 • EX-23 • EX-31.1 • EX-31.2 • EX-32.1 • EX-32.2 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[ x ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 29, 2012
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-07323
FRISCH’S RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
2800 Gilbert Avenue
Cincinnati, Ohio 45206
(Address of principal executive offices)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ] No [ x ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [ x ]
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[ x ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [ x ]
The aggregate market value of voting common stock held by non-affiliates of the registrant on December 13, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $68,309,000, based upon the closing sales price of the registrant’s common stock as reported on NYSE MKT on that date. The registrant does not have any non-voting common equity.
As of July 24, 2012, there were 4,941,248 shares of registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for its Annual Meeting of Shareholders to be held October 3, 2012 are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Cautionary Statement Regarding Forward-Looking Information
Forward-looking statements are contained throughout this Annual Report on Form 10-K. Such statements may generally express management’s expectations with respect to its plans, or its assumptions and beliefs concerning future developments and their potential effect on the Company. There can be no assurances that such expectations will be met or that future developments will not conflict with management’s current beliefs and assumptions, which are inherently subject to risks and other uncertainties. Factors that could cause actual results and performance to differ materially from anticipated results that may be expressed or implied in forward-looking statements are included in, but not limited to, the discussion in this Form 10-K under Part I, Item 1A. “Risk Factors.” Risk factors and other uncertainties may also be discussed from time to time in the Company’s news releases, public statements or other filings with the Securities and Exchange Commission.
Sentences that contain words such as “should,” “would,” “could,” “may,” “plan(s),” “anticipate(s),” “project(s),” “believe(s),” “will,” “expect(s),” “estimate(s),” “intend(s),” “continue(s),” “assumption(s),” “goal(s),” “target” and similar words (or derivatives thereof) are generally used to distinguish forward-looking statements from statements pertaining to historical or present facts.
All forward looking information in this Form 10-K is provided by the Company pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 and should be evaluated in the context of all risk factors. Except as may be required by law, the Company disclaims any obligation to update any of the forward-looking statements that may be contained throughout this Form 10-K.
References to fiscal years used in this Form 10-K
In this Annual Report on Form 10-K, the Company’s fiscal year that ended May 29, 2012 may be referred to as fiscal year 2012. The Company’s fiscal year is the 52 week (364 days) or 53 week (371 days) period ending on the Tuesday nearest to the last day of the month of May. Fiscal year 2012 consisted of 52 weeks.
Also in this Annual Report on Form 10-K, the Company’s fiscal years that ended May 31, 2011, June 1, 2010, June 2, 2009 and June 3, 2008 may be referred to as fiscal years 2011, 2010, 2009 and 2008, respectively. All of these years consisted of 52 weeks, except for fiscal year 2008, which was a 53 week year. References to fiscal year 2013 refer to the 52 week year that began on May 30, 2012, which will end on Tuesday, May 28, 2013.
The first quarter of each fiscal year presented herein contained 16 weeks while the last three quarters contained 12 weeks, except for the fourth quarter of fiscal year 2008, which contained 13 weeks.
(Items 1 through 4)
Item 1. Business
The registrant, Frisch’s Restaurants, Inc. (together with its wholly owned subsidiaries, referred to as the “Company” or the “Registrant”), is a regional company that operates full service family-style restaurants under the name “Frisch’s Big Boy.” Frisch’s Big Boy restaurants operated by the Company during the last five years have been located entirely in various regions of Ohio, Kentucky and Indiana.
Incorporated in the state of Ohio in 1947, the Company’s stock has been publicly traded since 1960. Today it trades on NYSE MKT. The Company’s executive offices are located at 2800 Gilbert Avenue, Cincinnati, Ohio 45206. The telephone number is (513) 961-2660. The Company’s web site is www.frischs.com.
As of May 29, 2012, the Company operated 93 Frisch's Big Boy restaurants. Additionally, the Company licensed the rights to operate 25 Frisch's Big Boy restaurants to other operators. All of the restaurants licensed to other operators are located in various markets within the states of Ohio, Kentucky and Indiana.
The Company owns the trademark “Frisch’s.” The rights to the “Big Boy” trademark, trade name and service mark are exclusively and irrevocably owned by the Company for use in the states of Kentucky and Indiana, and in most of Ohio and Tennessee.
At the beginning of fiscal year 2012, the Company operated a second business segment, which consisted of 35 Golden Corral restaurants (Golden Corral) that were licensed to the Company by Golden Corral Corporation (GCC) of Raleigh, North Carolina. The Company closed six of the Golden Corrals in August 2011 due to under performance. In May 2012, the Company sold the remaining 29 Golden Corrals to GCC. Results for Golden Corral are now presented as discontinued operations for all periods and segment information is no longer reported. For additional financial information relating the Company's Golden Corral restaurants, refer to Note B - Discontinued Operations - to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K.
Frisch's Big Boy Restaurants
Frisch's Big Boy restaurants are full service family-style restaurants that offer quick, friendly service. All of the restaurants offer “drive-thru” service. The restaurants are generally open seven days a week, typically from 7:00 a.m. to 11:00 p.m. with extended weekend evening hours. Standardized menus offer a wide variety of items at moderate prices, featuring well-known signature items such as the original “Big Boy” double-deck hamburger sandwich, freshly made onion rings and hot fudge cake for dessert. Primetime Burgers featuring one-third pound of beef, available as the classic cheeseburger, bacon blue burger or a ham and cheese burger, were successfully introduced to the menu in fiscal year 2012. Awesome Burgers (non-beef) made their debut in fiscal year 2011. Other menu selections include many sandwiches, pasta, roast beef, chicken and seafood dinners, desserts, non-alcoholic beverages and many other items. In addition, a full breakfast menu is offered, and all of the restaurants utilize breakfast bars that are easily converted to soup and salad bars for lunch and dinner hours. Drive-thru and carryout menus emphasize combo meals that consist of a popular sandwich packaged with French fries and a beverage and sold at a lower price than if purchased separately.
Although customers have not shown any significant preference for highly nutritional, low fat foods, such items are available on the menu and salad bars. Customers are not discouraged from ordering customized servings to meet their dietary concerns. For example, a sandwich can be ordered without the usual dressing of cheese and tartar sauce. In addition, fried foods are fried only in trans fat-free shortening.
The operations of the Company are vertically integrated. A commissary and food manufacturing plant manufactures and prepares foods, and stocks food and beverages, paper products and other supplies for distribution to all of the Company's restaurants. Some companies in the restaurant industry operate commissaries, while others purchase directly from outside sources. Raw materials, principally consisting of food items, are generally plentiful and may be obtained from any number of reliable suppliers. Quality and price are the principal determinants of source. The Company believes that its restaurant operations benefit from centralized purchasing and food preparation through its commissary operation, which ensures uniform product quality, timeliness of distribution (two to three deliveries per week) to restaurants and ultimately results in lower food and supply costs. The commissary did not supply the Company’s former Golden Corral restaurants.
Substantially all licensed Frisch's Big Boy restaurants regularly purchase products from the commissary. Sales of commissary products to restaurants licensed to other operators were $9.4 million in fiscal year 2012 (4.6 percent of consolidated sales), $9.0 million in fiscal year 2011 (4.5 percent of consolidated sales) and $8.6 million in fiscal year 2010 (4.5 percent of consolidated
The Frisch's Big Boy marketing strategy - “What’s Your Favorite Thing?” – has been in place for more than ten years. Results from ongoing market research indicate its effectiveness has not diminished. Television commercials are broadcast on local network affiliates and local cable programming that emphasize Frisch's Big Boy’s distinct and signature menu items and unique dining experience.
Television and radio are the primary media to carry and promote Frisch's Big Boy’s key messages. Television reinforces the positioning of “Favorite Things” while radio provides a cost effective means to promote shorter-term menu items. New television commercials that debuted in fiscal year 2011 were created with flexibility in order to easily exchange products. Some of these commercials were updated in fiscal year 2012 to promote certain limited time offers. Outdoor billboards and targeted on-line advertising are used to complement the media plan, primarily to introduce and promote new menu items. The Company also utilizes social media as a means to develop two-way communication directly with the customer. Targeted social media communities are a cost effective way to reach a wide range of customers, but are a particularly important means to reach younger audiences.
The Company currently expends for advertising an amount equal to 2.5 percent of gross sales from its restaurant operations, plus fees paid into an advertising fund by restaurants licensed to other operators.
Designed with longevity in mind while also appealing to younger customers, newly constructed restaurants are marked with bold colors and bright environments, featuring sleek lines, cherry colored paneling and wood trim, accented with abundant natural light and company memorabilia covering much of the wall space. On average, the approximate cost to build and equip a typical restaurant currently ranges from $2,500,000 to $3,400,000, depending on land cost and land improvements, which can vary greatly from location to location, and whether the land is purchased or leased. Costs also depend on whether the new restaurant is constructed using basic plans for the original 2001 building prototype (5,700 square feet with seating for 172 guests) or its smaller adaptation, the 2010 building prototype (5,000 square feet with seating 148 guests), which is used in smaller trade areas.
As part of the Company’s commitment to serve customers in clean, pleasant surroundings, the Company renovates approximately one-fifth of its restaurant operations each year. The renovations are designed to not only refresh and upgrade the interior finishes, but also to synchronize the interiors and exteriors of older restaurants with that of newly constructed restaurants. The current cost to renovate a restaurant ranges from $100,000 to $200,000.
In addition, certain high-volume restaurants are regularly evaluated to determine a) whether their kitchens should be redesigned for increased efficiencies and b) if an expansion of the dining room is warranted.
The following tabulation recaps restaurant openings and closings over the five most recent fiscal years:
The two new Frisch's Big Boy restaurants that opened in fiscal year 2012 were: 1) July 2011 in suburban Cincinnati, and 2) October 2011 in Highland Heights, Kentucky (Cincinnati market). The restaurant in Highland Heights, Kentucky replaced a nearby older restaurant. Three other Frisch's Big Boy restaurants were closed during fiscal year 2012: one in each of the markets of Cincinnati and Columbus, Ohio, and Louisville, Kentucky.
One site was under construction as of May 29, 2012, which is scheduled to open in suburban Cincinnati, Ohio in August 2012. No other sites are currently in the pipeline for future construction.
The following tabulation recaps openings and closings for restaurants that are licensed to other operators over the five most recent fiscal years:
Franchise fees are charged to licensees for use of trademarks and trade names and licensees are required to make contributions to the Company’s general advertising account. These fees and contributions are calculated principally on percentages of sales. Total franchise and other service fee revenue earned by the Company from licensees was $1.2 million in fiscal year 2012, $1.2 million in fiscal year 2011 and $1.1 million in fiscal year 2010. Other service fees from licensees include revenue from accounting and payroll services that four of the licensed restaurants currently purchase from the Company.
The license agreements with licensees are not uniform, but most of the licenses for individually licensed restaurants that were in effect as of May 29, 2012 are covered by agreements containing the following provisions:
In addition, Licensees are required to conduct business on a high scale, in an efficient manner, with cleanliness and good service, all to the complete satisfaction of the Company. Licensees are required to serve only quality foods and must comply with all food, sanitary and other regulations.
Long standing area license agreements granted to other operators in northern Indiana and northwestern Ohio differ in various ways from license agreements covering individual restaurants. The most notable differences are significantly lower license and advertising fee percentages and lower initial fees paid by the area operators. Provisions for these lower fees have been perpetually in place since the 1950’s.
The Company provides equal opportunity employment without regard to age, race, religion, color, sex, national origin, disability, veteran status or any other legally protected class. The Company’s Equal Opportunity Employment Policy provides and maintains a work environment that is free from all forms of illegal discrimination including sexual harassment. The philosophy of the policy stresses the need to train and to promote the person who becomes the most qualified individual to do a particular job. The Company is committed to promoting “Diversity” in the workplace in order to enhance its Equal Opportunity Employment Policy.
The Company remains committed to providing employees with the best training possible, as management believes that investing in people is a strategic advantage. Comprehensive recruiting and training programs are designed to maintain the food and service quality necessary to achieve the Company’s goals for operating results. A management recruiting staff is maintained at the Company’s headquarters. Corporate training centers for new restaurant managers are operated in Cincinnati, Ohio and Covington, Kentucky. The training includes both classroom instruction and on-the-job training. A full time recruiter is on staff to attract high quality hourly-paid restaurant workers.
The Company’s incentive-based compensation program for restaurant managers, area supervisors and regional directors (collectively, operations management) ties compensation of operations management directly to the cash flows of their restaurant(s), which allows incentive compensation to be consistently earned. The incentive compensation that operations management can earn under the program is at a level the Company believes is above the average for competing restaurant concepts. The Company believes the program has reduced turnover in operations management, and has resulted in a strong management team that focuses on building same store sales and margins.
Employee selection software helps lower hourly employee turnover rates; an employee validation website is in place that measures employee job satisfaction; and an interactive employee training program uses training videos and quizzes. These digital videos are loaded directly onto the hard drive of a PC located at each restaurant that is networked to the point-of-sale system, allowing headquarters to access the interactive results.
Each of the Company’s restaurants is managed through standardized operating and control systems anchored by a point-of-sale (POS) system that allows management to instantly accumulate and utilize data for more effective decision making, while allowing restaurant managers to spend more time in the dining room focusing on the needs of customers. The system generates the guest check and provides functionality for settling the customer’s check using cash, credit or debit card, or gift card. The system provides a record of all items sold, the service time, and the server responsible for the customer. Employee time keeping is also kept on the POS system. Back office functionality provides employee master file data, employee scheduling, inventory control, sales forecasting, product ordering and many other management reports. Security measures include biometric sign-on devices to access the POS system. The system meets the security requirements of the Payment Card Industry (PCI). The Company received its attestations of compliance in June 2011 and again in June 2012. A finding of non-compliance could restrict the Company’s privileges to accept credit cards as a form of payment. A $2,000,000, five year plan to replace POS register equipment in Frisch's Big Boy restaurants is expected to begin in August 2012.
Standardized operating and control systems also include an automated drive-thru timer system in all Frisch's Big Boy restaurants that measures the time from when a customer’s car first enters the drive-thru station until the order is received and the customer exits the drive-thru. This information is provided to the restaurant manager in a real time environment, which reduces the amount of time required to serve customers. To replenish restaurant inventories, a “suggested order” automated system analyzes current inventory balances and sales patterns and then “suggests” a replenishment order from the commissary operation. This process optimizes in-store inventory levels, which results in better control over food costs, identifies waste and improves food quality.
In addition to electronic signature capture devices that process debit and credit card transactions, other paperless systems in Frisch's Big Boy restaurants include a) employee payroll advices that can be either emailed directly to the employee or provided electronically to each restaurant where the employees may print them on demand if desired, b) signatures have been captured on key employment documents such as 1-9's, Form W-4 and acknowledgments regarding employee handbooks, c) an on-line employment application is on the Company’s corporate web site (www.frischs.com) that provides direct feeds into the POS system and the enterprise reporting system at headquarters, and d) a portal/dashboard, accessed centrally on corporate information systems, provides "actionable" information to restaurant operations, with "critical" information presented graphically.
Originally installed in 2004, the enterprise reporting system that supports the Company’s information needs has three times been successfully upgraded to a new environment, most recently in August 2011. A secondary data storage appliance with supporting hardware and a VMware server were purchased in fiscal year 2011 to build an off-site storage area network (SAN). The SAN, which became operational in August 2011, has been designed to perform near real time replication of all data in the production environment, which allows for quick start-up of the disaster recovery environment should it be necessary to call it into service.
The sources and availability of food and supplies are discussed above under the "Frisch's Big Boy Restaurants" header. Other raw materials used in food processing include equipment for cooking and preparing food, refrigeration and storage equipment and various other fixtures. The Company currently purchases its restaurant equipment from a single vendor. Other reliable restaurant equipment suppliers are available should the Company choose to change vendors. In addition, no significant disruptions in the supply of electricity and natural gas used in restaurant operations have been experienced to date.
Trademarks and Service Marks
The Company has registered certain trademarks and service marks on the Principal Register of the United States Patent and Trademark Office, including “Frisch’s” and the tagline “What’s Your Favorite Thing?” Other registrations include, but are not limited to, “Brawny Lad,” “Buddie Boy,” “Just Right Favorites,” “Pie Baby,” “Fire & Ice,” “Frisch-ly Made,” “Bundle of Joy,” and “Tiers of Joy.” All of these registrations are considered important to the operations of Frisch's Big Boy, especially the primary mark “Frisch’s” and the tag line “What’s Your Favorite Thing?” The duration of each registration varies depending upon when registration was first obtained. The Company currently intends to renew all of its trademarks and service marks when each comes up for renewal.
Pursuant to a 2001 agreement with Big Boy Restaurants International, LLC, the Company acquired limited ownership rights and a right to use the “Big Boy” trademarks and service marks within the states of Indiana and Kentucky and in most of Ohio and Tennessee. A concurrent use registration was issued October 6, 2009 on the Principal Register of the United States Patent and Trademark Office, confirming these exclusive “Big Boy” rights.
The Company is not aware of any infringements on its registered trademarks and service marks, nor is the Company aware of any infringement on any of its territorial rights to use the proprietary marks that are owned by or licensed to the Company.
The Company’s business is moderately seasonal, with the third quarter of the fiscal year (mid-December through early March) normally accounting for a smaller share of annual revenues. Additionally, severe winter weather can have a marked negative impact upon revenue during the third quarter. Occupancy and other fixed operating costs have a greater negative impact on operating results during any quarter that may experience lower sales. Results for any quarter should not be regarded as indicative of the year as a whole, especially the first quarter, which contains 16 weeks. Each of the last three quarters normally contains 12 weeks.
Restaurant sales provide the Company’s principal source of cash. Funds from restaurant operations are immediately available to meet the Company’s working capital needs, as substantially all sales from restaurant operations are settled in cash or cash equivalents such as debit and credit cards. Other sources of cash may include borrowing against credit lines, proceeds from stock options exercised and occasional sales of real estate.
The Company uses its positive cash flows for debt service, capital spending (principally restaurant expansion), capital stock repurchases and cash dividends.
As there is no need to maintain significant levels of inventories, and accounts receivable are minimal in nature, the Company has historically maintained a strategic negative working capital position, which is not uncommon in the restaurant industry. The working capital deficit was $14,240,000 as of May 31, 2011. As significant, predictable cash flows are provided by operations, the deployment of a negative working capital strategy has not hindered the Company’s ability to satisfactorily retire any of its obligations when due. Additionally, a working capital revolving line of credit is readily available if needed.
The sale of the Company's remaining 29 Golden Corral restaurants in May 2012, from which proceeds amounted to $49.8 million (before closing adjustments), resulted in a positive working capital position of $37,753,000 as of May 29, 2012. On July 25, 2012, the Board of Directors declared a special one time dividend of $9.50 per share payable September 14, 2012 to shareholders of record at the close of business on August 31, 2012. The total amount of the special dividend payment will be approximately $46.9 million based on the present number of shares outstanding.
Customers, Backlog and Government Contracts
Because all of the Company’s retail sales are derived from food sales to the general public, there is no material dependence upon a single customer or any group of a few customers. No backlog of orders exists and no material portion of the business is subject to re-negotiation of profits or termination of contracts or subcontracts at the election of government authorities.
The restaurant industry is highly competitive and many of the Company’s competitors are substantially larger and possess greater financial resources than does the Company. The Company's restaurants have numerous competitors, including national chains, regional and local chains, as well as independent operators. None of these competitors, in the opinion of the Company's management, is dominant in the family-style sector of the restaurant industry. In addition, competition continues to increase from non-traditional competitors such as supermarkets that not only offer home meal replacement but also have in-store dining space, trends that continue to grow in popularity.
The principal methods of competition in the restaurant industry are brand name recognition and advertising; menu selection and prices; food quality and customer perceptions of value, speed and quality of service; cleanliness and fresh, attractive facilities in convenient locations. In addition to competition for customers, sharp competition exists for qualified restaurant managers, hourly restaurant workers and quality sites on which to build new restaurants.
Research and Development
The Company’s corporate staff includes a research and development chef whose responsibilities entail development of new menu items and enhancing existing products. From time to time, the Company also conducts consumer research to identify where future restaurants should be built, along with emerging industry trends and changing consumer preferences. While these activities are important to the Company, these expenditures have not been material during the Company's last three fiscal years and are not expected to be material to the Company’s future results.
The Company is subject to licensing and regulation by various Federal, state and local agencies. These licenses and regulations pertain to food safety, health, sanitation, safety, vendors’ licenses and hiring and employment practices including compliance with
the Fair Labor Standards Act and minimum wage statutes. All Company operations, including the commissary and food manufacturing plant, are believed to be in material compliance with all applicable laws and regulations. All of the Company’s restaurants substantially meet local and state building and fire codes, and the material requirements of the Americans with Disabilities Act. Although the Company has not experienced any significant obstacles to obtaining building permits, licenses or approvals from governmental bodies, increasingly rigorous requirements on the part of state, and in particular, local governments, could delay or possibly prevent expansion in desired markets.
The federal Patient Protection and Affordable Care Act (PPACA) was enacted in March 2010. The majority of its provisions were upheld in June 2012 by the United States Supreme Court. As the U.S. Health and Human Services Department and other federal agencies release their regulations, management continues to evaluate the future short and long term effects upon the Company while developing various strategies to mitigate the expected financial burden of compliance in order to maintain the existing health care plans that are sponsored by the Company.
PPACA will require calorie counts and other nutritional information to be posted on the Company’s menus. The nutritional information will be required to appear on menus no later than six months after the U.S. Food and Drug Administration publishes the final rule, which it had yet to do as of June 2012. Sales and profitability could be adversely affected if customers significantly alter their menu ordering habits as this information becomes readily available to them.
The Company is subject to the franchising regulations of the Federal Trade Commission and the franchising laws of Ohio, Kentucky and Indiana where it has licensed Frisch's Big Boy restaurants to other operators.
The Company does not believe that various federal, state or local environmental regulations will have any material effect upon the capital expenditures, earnings or competitive position of either the Company's operations. However, the Company cannot predict the effect of any future environmental legislation or regulations.
As of May 29, 2012, the Company and its subsidiaries employed approximately 6,050 active employees. Approximately 3,400 of the Company’s employees are considered part-time (those who work less than 30 hours per week). Although there is no significant seasonal fluctuation in employment levels, hours worked may vary according to sales patterns in individual restaurants. None of the Company’s employees is represented by a collective bargaining agreement. Management believes that employee relations are excellent and employee compensation is comparable with or better than competing restaurants.
The Company has no operations outside of the United States of America. The Company’s revenues, consisting principally of retail sales of food and beverages to the general public and certain wholesale sales to and license fees from restaurants licensed to other operators, were substantially generated in various markets in the states of Ohio, Kentucky and Indiana during each of the three fiscal years in the period ended May 29, 2012. Substantially all of the Company’s long-lived assets were deployed in service in the same states during the same periods stated above. Prior to being sold in May 2012, two Golden Corral restaurants were operated by the Company in western Pennsylvania and a third restaurant was operated in West Virginia.
The Securities Exchange Act of 1934, as amended, requires the Company to file periodic reports with the Securities and Exchange Commission (SEC) including its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Definitive 14A Proxy Statements, and certain other information. The Company’s periodic reports (and any amendments thereto) can be viewed by visiting the web site of the SEC (http://www.sec.gov). In addition, the SEC makes the Company’s periodic reports available for reading and copying in its Public Reference Room located at 100 F. Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.
The Company makes available the periodic reports that it files with the SEC through its corporate web site (www.frischs.com) via a hyperlink directly to the Company’s filings on the web site of the SEC. New information available through the hyperlink is generally provided within a few minutes from the time a report is filed. Information contained on or available through the Company’s website is not a part of, nor is it being incorporated into, this Annual Report on Form 10-K. In addition, printed copies of the reports that the Company files with the SEC may be obtained without charge by writing to Mark R. Lanning, Chief Financial Officer, Frisch’s Restaurants, Inc., 2800 Gilbert Avenue, Cincinnati, Ohio 45206-1206. Email requests may be sent to firstname.lastname@example.org.
Copies of the Company’s corporate governance documents are also available on the Company’s corporate web site
(www.frischs.com). The documents include the Company’s Code of Regulations, Corporate Governance Guidelines, Code of Conduct, Code of Ethics, Insider Trading Policy, Related Person Transaction Policy, the Charter of the Disclosure Controls and Risk Management Committee, and various charters of committees of the Board of Directors, including those of the Audit Committee, the Compensation Committee, the Nominating and Corporate Governance Committee and the Finance Committee.
The Audit Committee has established a procedure for the confidential, anonymous submission by employees and other concerned parties regarding the Company’s accounting, internal accounting controls or auditing matters. The toll free Corporate Governance Hotline number is 800-506-6424. The Hotline is managed by an independent third party and is available 24 hours a day, seven days a week. Messages are transcribed and referred electronically to the Audit Committee.
Executive Officers of the Registrant
The following table sets forth the names and certain information concerning the executive officers of the Company:
(a)Craig F. Maier and Karen F. Maier are siblings.
Item 1A. Risk Factors
The materialization of any of the operational and other risks and uncertainties identified herein, together with those risks not specifically listed or those that are presently unforeseen, could result in significant adverse effects on the Company’s financial position, results of operations and cash flows, which could include the permanent closure of any affected restaurant(s) with an impairment of assets charge taken against earnings, and could adversely affect the price at which shares of the Company’s common stock trade.
In addition to operating results, other factors can influence the volatility and price at which the Company’s common stock trades. The Company’s stock is thinly traded on NYSE MKT. Thinly traded stocks can be susceptible to sudden, rapid declines in price, especially when holders of large blocks of shares seek exit positions. Rebalancing of stock indices in which the Company’s shares are placed, such as the Russell 2000 Index, can also influence the price of the Company’s stock.
Food safety is the most significant risk to any company that operates in the restaurant industry. It is the focus of increased government regulatory initiatives at the local, state and federal levels. Failure to protect the Company’s food supplies could result in food borne illnesses and/or injuries to customers. If any of the Company’s customers become ill from consuming the Company’s products, the affected restaurants may be forced to close. An instance of food contamination originating at the commissary operation could have far reaching effects, as the contamination would affect substantially all Frisch's Big Boy restaurants.
Economic recessions can negatively influence discretionary consumer spending in restaurants and result in lower customer counts, as consumers become more price conscious, tending to conserve their cash amid unemployment and other economic uncertainty. The effects of higher gasoline prices can also negatively affect discretionary consumer spending in restaurants. Increasing costs for energy can affect profit margins in many other ways. Petroleum based material is often used to package certain products for distribution. In addition, suppliers may add surcharges for fuel to their invoices. The cost to transport products from the commissary to restaurant operations will rise with each increase in fuel prices. Higher costs for electricity and natural gas result in higher costs to a) heat and cool restaurant facilities, b) refrigerate and cook food and c) manufacture and store food at the Company’s food manufacturing plant.
Inflationary pressure, particularly on food costs, labor costs (especially associated with increases in the minimum wage) and health care benefits, can negatively affect the operation of the business. Shortages of qualified labor are sometimes experienced in certain local economies. In addition, the loss of a key executive could pose a significant adverse effect on the Company.
Future funding requirements of the defined benefit pension plan that is sponsored by the Company largely depend upon the performance of investments that are held in the trust that has been established for the plan. Equity securities comprise 70 percent of the target allocation of the plan's assets. Poor performance in equity securities markets can significantly lower the market values of the plan's investment portfolio, which, in turn, can result in a) material increases in future funding requirements, b) much higher net periodic pension costs to be recognized in future years, and c) increases in the underfunded status of the plan, requiring reduction in the Company’s equity to be recognized.
The restaurant industry is highly competitive and many of the Company’s competitors are substantially larger and possess greater financial resources than does the Company. Frisch's Big Boy restaurants have numerous competitors, including national chains, regional and local chains, as well as independent operators. None of these competitors, in the opinion of the Company’s management, presently dominates the family-style sector of the restaurant industry in any of the Company’s operating markets. That could change at any time due to:
Development Plans and Financing Arrangements
The Company’s business strategy and development plans also face risks and uncertainties. These include the inherent risk of poor quality decisions in the selection of sites on which to build restaurants, the ever rising cost and availability of desirable sites and increasingly rigorous requirements on the part of local governments to obtain various permits and licenses. Other factors that could impede plans to increase the number of restaurants operated by the Company include saturation in existing markets, limitations on borrowing capacity and the effects of higher interest rates.
In addition, the Company’s loan agreements include financial and other covenants with which compliance must be met or exceeded each quarter. Failure to meet these or other restrictions could result in an event of default under which the lender may accelerate the outstanding loan balances and declare them immediately due and payable.
The Supply and Cost of Food
Food purchases can be subject to significant price fluctuations that can considerably affect results of operations from quarter to quarter and year to year. Price fluctuations can be due to seasonality or any number of factors, such as weather, foreign demand
and demographic factors. The market for beef, in particular, continues to be highly volatile due in part to import and export restrictions. Beef costs can also be affected by bio-fuel initiatives and other factors that influence the cost to feed cattle. The Company depends on timely deliveries of perishable food and supplies. Any interruption in the continuing supply would harm the Company’s operations.
Litigation and Negative Publicity
Employees, customers and other parties bring various claims against the Company from time to time. Defending such claims can distract the attention of senior level management away from the operation of the business. Legal proceedings can result in significant adverse effects to the Company’s financial condition, especially if other potentially responsible parties lack the financial wherewithal to satisfy a judgment against them or the Company’s insurance coverage proves to be inadequate. Also, see “Legal Proceedings” elsewhere in Part I, Item 3 of this Form 10-K.
Negative publicity associated with legal claims against the Company, especially those related to food safety issues, could harm the Company's reputation and brand (whether or not such complaints are valid), which, in turn, could adversely affect operating results. Publicity surrounding food safety issues has caused irreparable harm to the reputations of certain operators in the restaurant industry in the past. The Company’s reputation and brand can also be harmed by food safety issues and other operational problems that may be experienced by Frisch's Big Boy restaurants that the Company licenses to other operators, as well as Big Boy restaurants (non Frisch's) that are operated by others outside of the Company's territories. Other negative publicity such as that arising from rumor and innuendo spread through social internet media and other sources can create adverse effects on the Company’s results of operations.
Governmental and Other Rules and Regulations
Governmental and other rules and regulations can pose significant risks to the Company. Examples include:
Unforeseen catastrophic events could disrupt the Company’s operations, the operations of the Company’s suppliers and the lives of the Company’s customers. In particular, the dependency of the Company's restaurants on the commissary operation could present an extensive disruption of products to restaurants should a catastrophe impair its ability to operate. Examples of catastrophic events include but are not limited to:
Technology and Information Systems
Technology and information systems are of vital importance to the strategic operation of the Company. Security violations such as unauthorized access to information systems, including breaches on third party servers, could result in the loss of proprietary data. Should consumer privacy be compromised, consumer confidence may be lost, which could adversely affect sales and profitability. To prevent credit card fraud, the Payment Card Security Standards Council requires an annual audit to certify the Company's compliance with the required internal controls of processing and storing of credit card data. A finding of non-compliance could restrict the Company's authorization to accept credit cards as a form of payment, which could adversely affect sales and profitability.
Other events that could pose threats to the operation of the business include:
Item 1B. Unresolved Staff Comments
Item 2. Properties
All of the Company’s Frisch's Big Boy restaurants are freestanding, well-maintained facilities. Older restaurants are generally located in urban or heavily populated suburban neighborhoods that cater to local trade rather than highway travel. A few of these restaurant facilities are now more than 40 years old. Restaurants that have been opened since the early 1990’s have generally been located near interstate highways. A typical restaurant built before 2001 contains on average approximately 5,600 square feet with seating capacity for 156 guests. The prototype that was introduced in 2001 has generally contained 5,700 square feet with seating for 172 guests. An adaptation of the 2001 prototype was introduced in 2010 for use in smaller trade areas. Its footprint approximates 5,000 square feet and has 148 dining room seats.
Most new restaurant construction requires approximately 18 weeks to complete, depending on the time of year and weather conditions. A competitive bidding process is used to award contracts to general contractors for all new restaurant construction. The general contractor selects and schedules sub-contractors, and is responsible for procuring most building materials. A Company project coordinator is assigned to coordinate all construction projects.
The following table summarizes the number and location of Company operated restaurants and restaurants licensed to others as of May 29, 2012:
Sites acquired for development of new Company operated restaurants are identified and evaluated for potential long-term sales and profits. A variety of factors is analyzed including demographics, traffic patterns, competition and other relevant information. Because control of property rights is important to the Company, it is the Company’s policy to own its restaurant locations whenever possible.
In recent years, it has sometimes become necessary to enter ground leases to obtain desirable land on which to build. In addition, many of the restaurants operated by the Company that opened prior to 1990 were financed with sale/leaseback transactions. Most of the leases have multiple renewal options. All of the leases generally require the Company to pay property taxes, insurance and maintenance. As of May 29, 2012, 14 restaurants were in operation on non-owned premises, 13 of which are classified as operating leases with one being treated as a capital lease. Three of the operating leases contain options to purchase the underlying properties, which become available over time. Under the terms of the lone capital lease, the Company is required to acquire the underlying land in fee simple estate at any time between the 10th (2020) and 15th (2025) years of the lease. The following table recaps the Company's restaurant operations by type of occupancy:
Four of the 14 leases in the above table will expire during the next five years, as detailed in the list below. While none of the four expiring leases has a purchase option, all four have renewal options available.
Construction of one new Frisch's Big Boy restaurant was in progress at May 29, 2012, on land owned by the Company in the Cincinnati market.
None of the real property owned by the Company is currently encumbered by mortgages or otherwise pledged as collateral. With the exception of certain delivery and other equipment utilized under capital leases expiring during periods through fiscal year 2019, the Company owns substantially all of the furnishings, fixtures and equipment used in the operation of the business.
The Company owns a 79,000 square foot building that houses its commissary in Cincinnati, Ohio. It is suitable and adequate to supply the Company's restaurant operations and the needs of restaurants licensed to others. As the facility normally operates one shift daily, additional productive capacity is readily available if needed.
The Company maintains its headquarters in Cincinnati on a well-traveled street in a mid-town business district. This administrative office space approximates 49,000 square feet and is occupied under an operating lease expiring December 31, 2022. During the term of the lease, the Company has been granted the right of first refusal in the event that the lessor receives a bona fide purchase offer from a third party. The Company has an option to purchase the property at the end of the term expiring December 31, 2022.
The Company owns seven undeveloped pieces of land, four of which may ultimately be developed into restaurant facilities while no specific plans have been made for the three other pieces. Two of theses sites are located in the Cincinnati market, two are in the Columbus, Ohio market, one is in the Dayton, Ohio market with the other two in outlying areas of Indiana. The Company also owns one former restaurant building in the Cincinnati market that it leases to a third party.
Seven surplus land locations owned by the Company were listed for sale with brokers as of May 29, 2012, four of which are located in the Columbus, Ohio area, one is located in the Louisville, Kentucky area, one is in the Dayton, Ohio area and the seventh is located in Toledo, Ohio.
Three former Frisch's Big Boy restaurants owned by the Company are also listed for sale with brokers, one in each of the Cincinnati, Dayton, and Louisville, Kentucky markets. In addition, four former Golden Corral restaurants (which ceased operating in August 2011) are listed for sale with brokers, three of which are in the Cincinnati market area and the other one is in the Cleveland, Ohio
The Company remains contingently liable under certain ground lease agreements relating to land on which seven of the Company's former Golden Corral restaurant operations are situated. The seven restaurant operations were sold to Golden Corral Corporation (GCC) in May 2012 at which time the seven operating leases were simultaneously assigned to GCC, with the Company contingently liable in the event of default by GCC. The amount remaining under contingent lease obligations totaled $7,591,000 as of May 29, 2012, for which the aggregate average annual lease payments approximate $644,000 in each of the next five years. The Company is also contingently liable for the performance of a certain ground lease (for property located in Covington, Kentucky on which a hotel once operated by the Company is situated) that was assigned to a third party in 2000; the annual obligation of the lease approximates $48,000 through 2020. Should either of these the third parties default, the Company generally has the right to re-assign the leases.
Item 3. Legal Proceedings
Employees, customers and other parties bring various claims and suits against the Company from time to time in the ordinary course of business. Management continually evaluates exposure to loss contingencies from pending or threatened litigation, and presently believes that the resolution of claims currently outstanding, whether or not covered by insurance, will not result in a material effect on the Company’s earnings, cash flows or financial position.
Item 4. Mine Safety Disclosures
(Items 5 through 9)
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is traded on NYSE MKT under the symbol “FRS.” The closing price of the Company’s common stock as reported by NYSE MKT on July 24, 2012 was $26.99. There were approximately 1,625 shareholders of record as of July 24, 2012. The following table sets forth the high and low sales prices for the common stock and the cash dividend declared for each quarter within the Company’s two most recent fiscal years:
Through July 10, 2012, the Company has paid 206 consecutive quarterly cash dividends during its 52 year history as a public company. The Company currently expects that regular quarterly cash dividends will continue to be paid for the foreseeable future at rates comparable with or slightly higher than those shown in the above table.
On July 25, 2012, the Board of Directors declared a special one time dividend of $9.50 per share payable September 14, 2012 to shareholders of record at the close of business on August 31, 2012. The total amount of the special dividend payment will be approximately $46.9 million based on the present number of shares outstanding.
Equity Compensation Plan Information
Information regarding equity compensation plans under which common stock of the Company is authorized for issuance is incorporated by reference to Item 12 of this Form 10-K.
Issuer Purchases of Equity Securities
The following table shows information pertaining to the Company’s repurchases of its common stock during its fourth quarter that ended May 29, 2012:
(1) In the period ended May 29, 2012, 93 shares were re-acquired at an average cost of $25.52 per share to cover withholding tax obligations in connection with vesting of restricted stock awards.
On July 25, 2012, the Board of Directors authorized the Company to purchase, on the open market and in privately negotiated transactions, up to 450,000 shares of its common stock representing approximately 9 percent of the Company's total outstanding shares. The authorization allows purchases to begin immediately and to occur from time to time over the next three years.
The following graph compares the yearly percentage change in the Company’s cumulative total stockholder return on its common stock over the five year period ending May 29, 2012 with the Russell 2000 Index and a group of the Company’s peer issuers, selected by the Company in good faith. The graph assumes an investment of $100 in the Company’s common stock, in the Index and in the common stock of each member of the peer group on May 29, 2007 and reinvestment of all dividends.
The Peer Group consists of the following issuers: Bob Evans Farms, Inc., Biglari Holdings, Inc. (Steak n Shake), CBRL Group, Inc. (Cracker Barrel Old Country Store), Denny’s, Inc. and DineEquity, Inc. (IHOP and Applebees).
Item 6. Selected Financial Data
FRISCH’S RESTAURANTS, INC. AND SUBSIDIARIES
SUMMARY OF OPERATIONS
All fiscal years presented contained 52 weeks consisting of 364 days, except for fiscal year 2008, which contained 53 weeks consisting of 371 days.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SAFE HARBOR STATEMENT under the PRIVATE SECURITIES LITIGATION REFORM ACT of 1995
Forward-looking statements are included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Such statements may generally express management’s expectations with respect to its plans, or its assumptions and beliefs concerning future developments and their potential effect on the Company. There can be no assurances that such expectations will be met or that future developments will not conflict with management’s current beliefs and assumptions, which are inherently subject to risks and other uncertainties. Factors that could cause actual results and performance to differ materially from anticipated results that may be expressed or implied in forward-looking statements are included in, but not limited to, the discussion in this Form 10-K under Part I, Item 1A. “Risk Factors.”
Sentences that contain words such as “should,” “would,” “could,” “may,” “plan(s),” “anticipate(s),” “project(s),” “believe(s),” “will,” “expect(s),” “estimate(s),” “intend(s),” “continue(s),” “assumption(s),” “goal(s),” “target” and similar words (or derivatives thereof) are generally used to distinguish forward-looking statements from historical or present facts.
All forward-looking information in this MD&A is provided by the Company pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 and should be evaluated in the context of all risk factors. Except as may be required by law, the Company disclaims any obligation to update any of the forward-looking statements that may be contained in this MD&A.
This MD&A should be read in conjunction with the consolidated financial statements. The Company has no off-balance sheet arrangements other than operating leases that are entered from time to time in the ordinary course of business. The Company does not use special purpose entities.
Frisch’s Restaurants, Inc. and Subsidiaries (Company) is a regional company that operates full service family style restaurants under the name "Frisch's Big Boy." As of May 29, 2012, 93 Frisch's Big Boy restaurants were owned and operated by the Company, located in various regions of Ohio, Kentucky and Indiana. The Company also licenses 25 Frisch's Big Boy restaurants to other operators who pay franchise and other fees to the Company.
Fiscal Year 2012 ended on Tuesday, May 29, 2012 (a period of 52 weeks comprised of 364 days). It compares with Fiscal Year 2011 that ended on Tuesday, May 31, 2011 and Fiscal Year 2010 that ended on Tuesday, June 1, 2010 (both of which were 52 week periods comprised of 364 days). Fiscal Year 2013 will end on Tuesday, May 28, 2013 (also a period of 52 weeks comprised of 364 days).
At the beginning of Fiscal Year 2012, the Company operated a second business segment, which consisted of 35 grill buffet style "Golden Corral" restaurants that were licensed to the Company by Golden Corral Corporation. The Company closed six of the Golden Corral restaurants in August 2011 due to under performance, which resulted in a pretax charge of $4,000,000 for impairment of long-lived assets that was recorded in the first quarter of Fiscal Year 2012. In May 2012, the Company sold the remaining 29 restaurants to Golden Corral Corporation for $49.8 million (before closing adjustments), which resulted in a pretax loss of $5,590,000, of which $5,257,000 was recorded in the fourth quarter of Fiscal Year 2012. Results for the Golden Corral segment are now reported as discontinued operations for all periods presented in the financial statements and segment information is no longer reported.
The following table recaps the earnings or loss components of the Company's consolidated statement of earnings. All diluted EPS calculations used the following diluted weighted average shares outstanding: 4,951,684 in Fiscal Year 2012, 5,068,466 in Fiscal Year 2011 and 5,192,419 in Fiscal Year 2010.
Factors having a notable effect on earnings from continuing operations before income taxes when comparing Fiscal Year 2012 with Fiscal Year 2011 and Fiscal Year 2010:
Income tax expense included in net earnings for Fiscal Year 2012 is an income tax benefit of $1,494,000, which is the result of applying available tax credits (principally federal credits allowed for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips and the Work Opportunity Tax Credit that will be realized on the Fiscal Year's 2012 tax return) against a very low level of pretax earnings for the year.
Underfunded status in the Company sponsored pension plans increased to $14,786,000 as of May 29, 2012, up from $8,946,000 at May 31, 2011. The higher underfunded position decreased equity by $3,943,000, net of tax, which was effected through a charge to accumulated other comprehensive loss.
RESULTS OF OPERATIONS
Except as where noted, the discussion of Results of Operations presented in this MD&A excludes the results from discontinued operations.
The Company’s sales are primarily generated through the operation of Frisch's Big Boy restaurants. Sales also include wholesale sales from the Company’s commissary to Frisch's Big Boy restaurants licensed to other operators and the sale of Frisch's signature brand tartar sauce to grocery stores. Same store sales comparisons are a key metric that management uses in the operation of the business. Same store sales are affected by changes in customer counts and menu price increases. Changes in sales also occur as new restaurants are opened and older restaurants are closed. Below is the detail of consolidated sales:
A breakdown of changes in Frisch's Big Boy same store sales by quarter follows:
The same store sales comparisons include average menu price increases of 1.2 percent, 1.0 percent, and 1.0 percent, implemented respectively near the ends of the third quarters of Fiscal Years 2012, 2011 and 2010. The first quarters of Fiscal Years 2012, 2011 and 2010 included average menu price increases of 1.5 percent, 1.0 percent, and 1.0 percent, respectively. Another increase is currently being planned for implementation in the first quarter of Fiscal Year 2013 (September 2012). Customer counts in same stores were 2.1 percent lower in Fiscal Year 2012 compared with Fiscal Year 2011, which was 2.0 percent lower than Fiscal Year 2010. While higher menu prices may contribute to the overall trend in lower customer traffic, management believes larger factors are the persistently high unemployment rate in the Midwest and the continuation of high gasoline prices, which continue to restrict the disposable income of the customer base, which in turn limits sales growth opportunities.
The Company operated 93 Big Boy restaurants as of May 29, 2012. The count of 93 includes the following openings and closings since the beginning of Fiscal Year 2010 (June 2009):
Fiscal Year 2012
Fiscal Year 2011
Fiscal Year 2010
Planned Big Boy Openings in Fiscal Year 2013
Proposed regulations of the menu labeling provisions of the federal Patient Protection and Affordable Care Act (enacted March 2010) were issued by the U.S. Food and Drug Administration (FDA) on April 1, 2011. Nutritional information will be required to appear on menus no later than six months after the FDA publishes the final rule, which it had yet to do as of June 2012. Sales volumes could be adversely affected if customers significantly alter their dining choices as a result of the requirement to add nutritional information to menus.
The Payment Card Industry Security Standards Council (PCI) has a data security standard with which all organizations that process card payments must comply. The standard is intended to prevent credit card fraud by focusing on the internal controls of processing and storing such data. PCI requires an annual audit to certify the Company's compliance with the required internal controls. The
Company received its Attestations of Compliance in June 2011 and again in June 2012. A finding of non-compliance could have restricted the Company’s ability to continue accepting credit and debit cards as a form of payment.
A plan is currently under development to significantly expand the Company's grocery line business by adding "Frisch's" brand of salad dressings in grocery stores, joining "Frisch's" brand tartar sauce, which has been a long-standing staple on grocery store shelves in Ohio, Kentucky and Indiana. The deletion of the reference to "Big Boy" will allow the "Frisch's" brand to enter previously restricted markets.
The determination of gross profit is shown with operating percentages in the following table. The table is intended to supplement the cost of sales discussion that follows. Cost of sales is comprised of food and paper costs, payroll and related costs, and other operating costs.
Food prices continued to sharply escalate in Fiscal Year 2012. Higher prices were paid for most commodities, especially beef and pork. Hamburger and bacon have the greatest consumption of all items in the menu mix. The price of hamburger continues at record highs driven by a) the high cost of corn, which is the primary feed ingredient for cattle, hogs and poultry, and b) record low beef supplies and strong demand for exports. The cost for beef and other commodities is expected to continue rising, especially given the 2012 drought conditions in the nation's corn belt.
Although the Company does not use financial instruments as a hedge against changes in commodity prices, purchase contracts for some commodities may contain provisions that limit the price the Company will pay. In addition, the effect of commodity price increases is actively managed with changes to the menu mix, together with periodic increases in menu prices. However, rapid escalations in the cost of food can be problematic to effective menu management, as evidenced by the rising percentages in the above table despite higher prices being charged to customers.
Food safety poses a major risk to the Company. Management rigorously emphasizes and enforces established food safety policies in all of the Company’s restaurants and in its commissary and food manufacturing plant. These policies are designed to work cooperatively with programs established by health agencies at all levels of governmental authority, including the federal Hazard Analysis of Critical Control Points (HACCP) program. In addition, the Company makes use of ServSafe Training, a nationally recognized program developed by the National Restaurant Association. The ServSafe program provides accurate, up-to-date science-based information to all levels of restaurant workers on all aspects of food handling, from receiving and storing to preparing and serving. All restaurant managers are required to be certified in ServSafe Training and are required to be re-certified every five years.
The across the board decreases in payroll and related costs (as a percentage of sales) shown in the above table were driven primarily by the combination of higher menu prices charged to customers and a reduction in labor hours commensurate with lower customer counts. In Fiscal Year 2011, payroll and related costs received the benefit from the federal Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, enacted March 2010) under which the Company did not have to pay the employer’s share of social security (FICA) taxes on certain new hires. FICA credits under the HIRE Act amounted to $472,000 during Fiscal Year 2011.
Notwithstanding the improvements shown in payroll and related cost percentages in the above table, payroll and related costs continue to be adversely affected by mandated increases in the minimum wage:
per hour, which represents an 81 percent increase over the five year period.
Although there is no seasonal fluctuation in employment levels, the number of hours worked by hourly paid employees has always been managed closely according to sales patterns in individual restaurants. However, the effects of paying the mandated higher hourly rates of pay have been and are continuing to be countered through the combination of reductions in the number of scheduled labor hours and higher menu prices charged to customers. Without benefit of reductions in labor hours, the Ohio minimum wage increase on January 1, 2012 would add an estimated $420,000 to annual payroll costs in Ohio restaurant operations.
Despite the savings that come from reductions in hours worked and higher menu prices charged to customers, other factors add to payroll and related costs. These factors include higher costs associated with benefit programs offered by the Company, including medical insurance premiums and pension related costs.
Medical insurance premiums for the 2012 calendar plan year are projected to be approximately $8,550,000, which is 3.1 percent higher than the previous year and 5.6 percent higher than two years ago. The Company has typically absorbed 80 percent of the cost for medical premiums, with employees contributing the remaining 20 percent. As costs continue to escalate, it is likely that employees will be asked to contribute a greater percentage in the future. Management continues to analyze and evaluate health care reform legislation (the federal Patient Protection and Affordable Care Act, enacted March 2010) to determine the future short and long term effects upon the Company, while developing various strategies to mitigate the expected financial burden.
Net periodic pension cost (including amounts charged to discontinued operations) was $2,746,000, $3,025,000 and $2,818,000 respectively, in Fiscal Years 2012, 2011 and 2010. Net periodic pension expense for Fiscal Year 2012 included a benefit in excess of $550,000 from changes in assumptions relating to retirement, termination and marriage. Fiscal Year 2012's net periodic pension cost also included the effect of a curtailment credit of $16,000 from the termination of Golden Corral employees. Settlement losses of $157,000 and $256,000 were included in the net periodic pension costs respectively for Fiscal Years 2012 and 2010. No settlement losses were incurred in Fiscal Year 2011. Settlement losses are triggered when the sum of all settlements (lump sum cash outs) exceed interest and service cost. No settlement losses are expected in Fiscal Year 2013.
The expected long-term rate of return on plan assets used to compute pension cost was 7.50 percent in Fiscal Year 2012 and 2011, which was lowered from 8.00 percent in Fiscal Year 2010. The assumption will remain at 7.50 percent for the determination of pension costs for Fiscal Year 2013. The discount rate used in the actuarial assumptions to compute pension costs was 5.25 percent in Fiscal Year 2012, which was lowered from 5.50 percent in Fiscal Year 2011 and from 6.50 percent in Fiscal Year 2010. The rate for Fiscal Year 2013 will be lowered to 4.25 percent. Net periodic pension cost will increase by approximately $135,000 for each decrease of 25 basis points in the discount rate. The rate of compensation increase used to calculate pension costs was 4.0 percent in Fiscal Years 2012, 2011 and 2010, It will remain at 4.0 percent for Fiscal Year 2013.
Net periodic pension cost for Fiscal Year 2013 is currently estimated at approximately $3,250,000. The primary drivers of the higher projected expense are a the lower discount rate and a negative return on plan assets that was experienced in Fiscal Year 2012.
Contributions made to Company sponsored plans were $2,100,000, $1,600,000 and $1,625,000 respectively, in Fiscal Years 2012, 2011 and 2010. Contributions for Fiscal Year 2013 are currently anticipated to be at least $2,100,000, which includes amounts to meet minimum legal funding requirements and potential discretionary contributions. Future funding of the pension plans largely depends upon the performance of investments that are held in trusts that have been established for the plans. Equity securities comprise 70 percent of the target allocation of the plans’ assets. The fair value of all plan assets was $26,684,000, $27,906,000 and $23,030,000 respectively at the end of Fiscal Years 2012, 2011 and 2010. Although equity markets have made significant rebounds since 2009 when market declines lowered the fair value of plan assets to $19,744,000 from $26,213,000 at the end of the previous year, funding requirements continue to be adversely affected and combined with low bond rates will likely require the continued recognition of significantly higher net periodic pension costs than had been incurred prior to 2009.
Pension accounting standards require the overfunded or underfunded status of defined benefit pension plans to be recognized as an asset or liability in the Company’s consolidated balance sheet. Funded status is measured as the difference between plan assets at fair value and projected benefit obligations (PBO). Underfunded status at May 29, 2012 increased to $14,786,000 (fair value of plan assets $26,684,000 versus PBO of $41,470,000), up from $8,946,000 (fair value of plan assets $27,906,000 versus PBO of $36,852,000) at May 31, 2011. The PBO at May 29, 2012 includes former Golden Corral employees measured at accumulated benefit obligation (no projections for future salary increases or additional years of credited service). The increase in the PBO at May 29, 2012 is the result of a decrease in the fair value of plan assets and the lowering of the discount rate to 4.25 percent from
5.25 percent at May 31, 2011. Each decrement of 25 basis points in the discount rate increases PBO by an estimated $1,250,000.
The Company’s equity was decreased $3,943,000, net of tax, at May 29, 2012 to establish underfunded status at $14,786,000. The decrease in equity was effected through a charge to accumulated other comprehensive loss. Equity was increased $1,538,000, net of tax, to establish underfunded status of $8,946,000 at May 31, 2011, which was effected through a credit to accumulated other comprehensive loss.
The Company self-insures a significant portion of expected losses from its Ohio workers’ compensation program. Initial self-insurance reserves are accrued based on prior claims history, including an amount developed for incurred but unreported claims. Active management of claims, which includes a requirement for post accident drug testing, keeps the number of claims and the average cost per claim to a minimum.
Payroll and related costs are also affected by adjustments that result each quarter when management performs a comprehensive review of claims experience in the Company's self-insured Ohio workers’ compensation program. Increases to the self-insured reserves result in charges to payroll and related costs, while decreases to the reserves result in credits to payroll and related costs. The reserves were increased (charged against payroll and related costs) by $26,000, $174,000 and 536,000 respectively, in Fiscal Years 2012, 2011 and 2010.
Other operating costs include occupancy costs such as maintenance, rent, depreciation, abandonment losses, property tax, insurance and utilities, plus costs relating to field supervision, accounting and payroll preparation costs, new restaurant opening costs, and many other restaurant operating costs. Opening costs can have a significant effect on the operating costs. Opening costs in Fiscal Years 2012, 2011 and 2010 were $398,000, $1,073,000, and $768,000 respectively. As most of the other typical expenses charged to other operating costs tend to be more fixed in nature, the percentages shown in the above table can be greatly affected by changes in same store sales levels. In other words, percentages will generally rise when sales decrease and percentages will generally decrease when sales increase.
To arrive at the measure of operating profit, administrative and advertising expense is subtracted from gross profit, while the line item for franchise fees and other revenue is added to it. Gains and losses from the sale of real property (if any) are then respectively added or subtracted. Charges for impairment of assets (if any) are also subtracted from gross profit to arrive at the measure of operating profit.
Administrative and advertising expense was $13,379,000, $12,517,000 and $12,258,000 respectively in Fiscal Years 2012, 2011 and 2010. Advertising expense represents the largest component of these costs. Advertising expense was $4,911,000, $4,910,000, and $4,665,000 respectively in Fiscal Years 2012, 2011 and 2010. Spending for advertising and marketing programs is proportionate to sales levels, reflecting the Company’s long-standing policy to spend a constant percentage of sales on advertising and marketing. All other administrative costs were $8,468,000, $7,607,000 and $7,593,000 respectively in Fiscal Years 2012, 2011 and 2010. The Chief Executive Officer’s (CEO) incentive compensation was included in other administrative costs as follows: zero, $265,000 and $511,000 respectively was accrued in Fiscal Years 2012, 2011 and 2010. Stock based compensation costs included in other administrative costs were $938,000, $421,000 and $356,000 respectively in Fiscal Years 2012, 2011 and 2010. Stock based compensation cost for Fiscal Year 2012 included $371,000 for an unrestricted stock award to the CEO. The unrestricted stock award was granted in exchange for the CEO's termination of an option to purchase 40,000 shares of the Company's common stock.
Revenue from franchise fees is based upon sales volumes generated by Frisch's Big Boy restaurants that are licensed to other operators. The fees are based principally on percentages of sales and are recorded on the accrual method as earned. As of May 29, 2012, 25 Frisch's Big Boy restaurants were licensed to other operators and paying franchise fees to the Company. No new licensed Big Boy restaurants opened during any of the periods presented in this MD&A; one closed during Fiscal Year 2010. Other revenue also includes certain other fees earned from Frisch's Big Boy restaurants licensed to others along with minor amounts of rent and investment income.
Gains and losses from the sale of assets consist of transactions involving real property and sometimes may include restaurant equipment that is sold together with real property as a package when closed restaurants are sold. Gains and losses reported on this line do not include abandonment losses that routinely arise when certain equipment is replaced before it reaches the end of its expected life; abandonment losses are instead reported in other operating costs.
Gains from sales of real property in Fiscal Year 2012 amounted to $200,000, primarily from the February 2012 sale of a former Frisch's Big Boy restaurant. Sales proceeds in Fiscal Year 2012 were $393,000. Losses from sales involving real property in Fiscal Year 2011 amounted to $40,000, primarily from the March 2011 sale of certain surplus property. Total sale proceeds in Fiscal Year 2011 were $386,000. No sales of real property occurred during Fiscal Year 2010.
One under performing Frisch's Big Boy restaurant (owned in fee simple) was permanently closed near the end of Fiscal Year 2012,
which resulted in a non-cash pretax impairment charge of $901,000 to lower its carrying value to estimated fair value. In addition, the continuation of soft market conditions resulted in a non-cash pretax impairment charge totaling $328,000 to lower the previous estimates of the fair values of two former Frisch's Big Boy restaurants that have been held for sale for several years. No charges for impairment of assets were recorded during Fiscal Years 2011 or 2010.
Interest expense was $1,414,000, $1,582,000 and $1,749,000 respectively, in Fiscal Years 2012, 2011 and 2010. The decreases are primarily the result of lower debt levels.
Income tax expense as a percentage of pre-tax earnings was 17.3 percent in Fiscal Year 2012, 27.7 percent in Fiscal Year 2011 and 31.0 percent in Fiscal Year 2010. The effective rates have been kept consistently low through the Company’s use of available tax credits, principally the federal credit allowed for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips and the federal Work Opportunity Tax Credit (WOTC). These credits are generally more favorable to the effective tax rate when pretax earnings decrease. The WOTC expired December 31, 2011. In addition, Fiscal Year 2012 includes a tax benefit of $112,000 in connection with a net operating loss in the state of Kentucky, which arose because the Company will begin reporting taxable income using the mandatory nexus consolidated filing method.
The Company believes it has no uncertain tax positions that have been filed or that are expected to be taken on a future tax return. The Internal Revenue Service completed its examination of the Company’s tax return for Fiscal Year 2009 in November 2010. The examination resulted in no changes.
On May 16, 2012, the Company closed on the sale of its Golden Corral restaurant operations to Golden Corral Corporation, from which the Company had previously been granted licenses to operate the 29 restaurants that comprised the assets that were sold in the transaction. The Company recorded a pretax loss on the sale of $5,590,000 ($5,257,000 in the fourth quarter) during the year ended May 29, 2012.
The Company had previously closed six under preforming Golden Corral restaurants in August 2011, which resulted in a non-cash pretax asset impairment charge (with related closing costs) of $4,000,000 that was recorded in the first quarter of Fiscal Year 2012 (ended September 20, 2011). The impairment charge lowered the carrying values of the six restaurant properties to their estimated fair values. Additional non-cash pretax impairment charges of $388,000 were subsequently recorded during Fiscal Year 2012: $94,000 in the third quarter ended March 6, 2012 based on a contract that was accepted for less than the original estimate of fair value, and $294,000 in the fourth quarter to reflect revised opinions of value from real estate brokers.
Results of discontinued operations are shown in the following table:
LIQUIDITY AND CAPITAL RESOURCES
Sources of Funds
Food sales to restaurant customers provide the Company’s principal source of cash. The funds from sales are immediately available for the Company’s use, as substantially all sales to restaurant customers are received in currency or are settled by debit or credit cards. The primary source of cash provided by operating activities is net earnings plus depreciation and impairment of assets, if any. Other sources of cash may include borrowing against credit lines, proceeds received when stock options are exercised and occasional sales of real estate. In addition to servicing debt, these cash flows are utilized for discretionary objectives, including capital projects (principally restaurant expansion), capital stock repurchases and dividends.
Proceeds from the May 2012 sale of the Company's 29 Golden Corral restaurants amounted to $49.8 Million (before closing adjustments). As of May 29, 2012, $42,000,000 had been invested in commercial paper with original maturities of 90 days or less. In addition, the sum of $3,118,000 from the proceeds was being held by a third party intermediary in anticipation of the completion of qualifying like kind exchanges in order to defer taxable gains pursuant to Section 1031 of the Internal Revenue Code.
Working Capital Practices
The Company's working capital was $37,753,000 as of May 29, 2012. A working capital deficit of $14,240,000 existed as of May 31, 2011. The improvement is directly attributable to the cash equivalents that were on hand at May 29, 2012 from the sale of the 29 Golden Corral restaurants in May 2012.
Aside from the May 2012 sale of the 29 Golden Corral restaurants, the Company has historically maintained a strategic negative working capital position, which is a common practice in the restaurant industry. As significant cash flows are consistently provided by operations and credit lines remain readily available, this practice should not hinder the Company’s ability to satisfactorily retire any of its obligations when due, including the aggregated contractual obligations and commercial commitments shown in the following table.
Aggregated Information about Contractual Obligations and Commercial Commitments as of May 29, 2012:
The Company has had a financing package of unsecured credit facilities in place for many years with the same lending institution. The financing package was amended and restated in April 2012 (2012 Loan Agreement). The 2012 Loan Agreement increased the amount available to be borrowed on the Construction Loan to $15,000,000, up $6,500,000 from the $8,500,000 that had remained available from the previous renewal cycle. As of May 29, 2012, $15,000,000 was available to be borrowed by the Company.
The 2012 Loan Agreement also renewed the $5,000,000 Revolving Loan, which provides financing to fund temporary working capital if needed (unused as of May 29, 2012).
All funds available under the 2012 Loan Agreement are readily accessible for borrowing through October 2013. The Company is in compliance with the covenants contained in the 2012 Loan Agreement.
Net cash provided by continuing operations was $14,257,000 in Fiscal Year 2012, which compares with $20,007,000 in Fiscal Year 2011 and $17,655,000 Fiscal Year 2010. Changes in assets and liabilities such as prepaid expenses, inventories, accounts payable and accrued, prepaid and deferred income taxes, all of which can and often do fluctuate widely from year to year, account for most of the changes.
Management has measured cash flows from continuing operations by simply adding back certain non-cash expenses to earnings from continuing operations. These non-cash expenses include items such as depreciation, losses (net of any gains) on dispositions of assets, charges for impairment of long-lived assets, stock based compensation costs and pension costs in excess of plan contributions. The result of this approach is shown as a sub-total in the consolidated statement of cash flows: $18,288,000 in Fiscal Year 2012, $18,469,000 in Fiscal Year 2011 and $16,422,000 in Fiscal Year 2010.
An automatic Change in Accounting Method was filed with the Internal Revenue Service (IRS) in Fiscal Year 2011, to allow immediate deduction of certain repairs and maintenance costs, replacing the previous treatment that had capitalized these costs. In December 2011, the IRS issued new temporary and proposed regulations on tangible property that significantly departs from the prior proposed regulations on which the Company's Change in Accounting Method was based. Management is currently reviewing the new temporary and proposed regulations to determine the effect, if any, upon the Company's Change in Accounting Method, which would have to be applied beginning in Fiscal Year 2013.
Net cash provided by discontinued operations in Fiscal Year 2012 was determined as follows: normal changes in assets and liabilities plus certain non-cash expenses, such as depreciation, the loss on the sale of 29 restaurants net of the gain on the sale of other properties, and charges for the impairment of long-lived assets, were added back to the loss from discontinued operations, net of tax. The same basic formula was used for Fiscal Years 2011 and 2010.
Capital spending is normally the principal component of the Company’s investing activities. Capital spending was $10,731,000
during Fiscal Year 2012 as fewer new restaurants were opened, down from $17,149,000 in Fiscal Year 2011 and $21,373,000 in Fiscal Year 2010. These capital expenditures consisted of site acquisitions for expansion, new restaurant construction, ongoing reinvestments in existing restaurants including remodel jobs, routine equipment replacements and other maintenance capital outlays.
Proceeds from sales of real property during Fiscal Year 2012 amounted to $393,000, primarily the result of the February 2012 sale of a Frisch's Big Boy restaurant that was permanently closed in October 2011. Proceeds from sales of real property during Fiscal Year 2011 amounted to $386,000, primarily the result of the March 2011 sale of certain surplus property. No sales of real property occurred in Fiscal Year 2010. Total proceeds from disposition of property as shown on the consolidated statement of cash flows include amounts received from completely separate transactions to sell used equipment and/or other operating assets. Three former Frisch's Big Boy restaurants, four former Golden Corral restaurants (permanently closed August 2011) and seven surplus land locations are currently held for sale at an aggregate asking price of approximately $9,800,000.
Net cash provided by discontinued investing activities amounted to $46,872,000 during Fiscal Year 2012, primarily from the sale proceeds of the 29 Golden Corral restaurants in May 2012, together with proceeds from the sale of two of the six Golden Corral restaurants (permanently closed August 2011) and net of all capital expenditures that occurred prior to the sale of the 29 restaurants and the six permanent closures. Net cash used in discontinued investing activities in prior years was principally for capital spending, which was mostly for remodel jobs and routine equipment replacements.
Borrowing against credit lines amounted to $2,000,000 during Fiscal Year 2012. Scheduled and other payments of long-term debt and capital lease obligations amounted to $11,542,000 during Fiscal Year 2012.
Regular quarterly cash dividends to shareholders amounted to $3,108,000 in Fiscal Year 2012, or $0.63 per share. The dividend per share was $0.58 in Fiscal Year 2011 and $0.51 in Fiscal Year 2010. A $0.16 per share quarterly dividend was declared on June 26, 2012. Its payment on July 10, 2012 was the 206th consecutive quarterly dividend paid by the Company. The Company currently expects to continue its 52 year practice of paying regular quarterly cash dividends.
During Fiscal Year 2012, 7,000 shares of the Company’s common stock were re-issued from the Company's treasury pursuant to the exercise of stock options, which yielded proceeds to the Company of approximately $131,000. As of May 29, 2012, 399,586 shares granted under the Company's two stock option plans remained outstanding, including 366,919 fully vested shares at a weighted average exercise price of $24.06 per share. The closing price of the Company's stock on May 29, 2012 was $27.60. The intrinsic value of 317,168 fully vested "In the Money" options was $1,647,000, which, if exercised, would yield $7,107,000 in proceeds to the Company. No stock options were granted during Fiscal Year 2012.
On June 15, 2011, the Chief Executive Officer (CEO) was granted an unrestricted stock award of 17,364 common shares and a group of executive officers and other key employees was granted an aggregate award of 7,141 restricted shares of common stock. The total value of the unrestricted award to the CEO amounted to $371,000. The total value of the restricted awards granted to executive officers and other key employees amounted to $150,000. On October 5, 2011, 14,560 shares of restricted stock were awarded to non-employee members of the Board of Directors and an award of 2,080 restricted shares was granted to the CEO pursuant to the terms of his employment agreement. The total value of all restricted awards issued on October 5, 2011 amounted to $320,000. All restricted shares vest in full on the first anniversary date of the award, unless accelerated by the Compensation Committee of the Board of Directors. Full voting and dividend rights are provided prior to vesting. Vested shares must be held until board service or employment ends, except that enough shares may be sold to satisfy tax obligations attributable to the grants. All unrestricted and restricted shares were awarded under the 2003 Stock Option and Incentive Plan (2003 Plan). As of May 29, 2012, 485,094 shares remained available for awards under the 2003 Plan.
The fair value of stock options granted and restricted stock issued is recognized as compensation cost on a straight-line basis over the vesting periods of the awards. Although no stock options were granted during Fiscal Year 2012, compensation cost continues from the run-out of options granted in previous years. Compensation cost from restricted shares issued as shown in the table below includes costs from the run-out of awards granted in October 2010 to non-employee members of the Board of Directors. The fair value of unrestricted stock issued to the CEO in June 2011 was recognized entirely during the first quarter of Fiscal Year 2012, which ended September 20, 2012. Compensation costs arising from all share-based payments are charged to administrative and advertising expense in the consolidated statement of earnings:
On June 13, 2012, the executive officers (excluding the CEO) and other key employees were granted an aggregate unrestricted stock award of 4,850 shares of common stock. The total value of the award amounted to $127,000, for which the Company will record a charge against its pretax earnings in the first quarter (ending September 18, 2012) of Fiscal Year 2013.
The stock repurchase program that was authorized by the Board of Directors in January 2010 expired on January 6, 2012. Up to 500,000 shares of the Company's common stock had been authorized to be repurchased in the open market or through block trades. During the two year life of the program, the Company acquired 289,528 shares at a cost of $6,107,000, of which 19,596 shares were acquired during Fiscal Year 2012 at a cost of $417,000. No repurchases were made after September 2011.
Separate from the repurchase program, the Company's treasury acquired 10,794 shares of its common stock during Fiscal Year 2012 at a cost of $225,000 to cover withholding tax obligations in connection with restricted and unrestricted stock awards. Most of these were acquired in June 2011 when 7,998 shares valued at $171,000 were surrendered by the CEO to cover the tax obligation on his unrestricted stock award.
The Company opened two new Frisch's Big Boy restaurants during Fiscal Year 2012. The first opened in July 2011 on land that was acquired in fee simple estate during Fiscal Year 2011. The second one opened in October 2011 on ground that is leased to the Company. It replaced an older nearby restaurant. One new restaurant was under construction as of May 29, 2012, which is scheduled to open in August 2012. Several other sites owned by the Company - including two that were acquired in Fiscal Year 2012 - have been "land banked" for possible future development.
Including land and land improvements, the cost required to build and equip each new Frisch's Big Boy restaurant currently ranges from $2,500,000 to $3,400,000. The actual cost depends greatly on the price paid for the land and the cost of land improvements, both of which can vary widely from location to location, and whether the land is purchased or leased. Costs also depend on whether the new restaurant is constructed using plans for the original 2001 building prototype (5,700 square feet with seating for 172 guests) or its smaller adaptation, the 2010 building prototype (5,000 square feet with seating for 148 guests), which is used in smaller trade areas. The larger 2001 building prototype plan was used to construct both of the new restaurants that opened during Fiscal Year 2012. The smaller 2010 building prototype is being used to build the restaurant that was under construction as of May 29, 2012.
Approximately one-fifth of the restaurants are routinely renovated or decoratively updated each year. The renovations not only refresh and upgrade interior finishes, but are also designed to synchronize the interiors and exteriors of older restaurants with that of newly constructed restaurants. The current average cost to renovate a restaurant ranges from $100,000 to $200,000. The Fiscal Year 2013 remodeling budget is $1,740,000 for 12 planned remodel jobs. Certain high-volume restaurants are regularly evaluated to determine whether their kitchens should be redesigned for increased efficiencies and whether an expansion of the dining room is warranted. Although there are currently no such plans in Fiscal Year 2013, a typical kitchen redesign costs approximately $125,000 and a dining room expansion can cost up to $750,000.
Part of the Company’s strategic plan entails owning the land on which it builds new restaurants. However, it is sometimes necessary to enter ground leases to obtain desirable land on which to build. Five restaurants that have opened since 2003, including one during Fiscal Year 2012, were built on leased land. As of May 29, 2012, 14 restaurants were operating on non-owned premises, 13 of which are being accounted for as operating leases with one treated as a capital lease. Two restaurants that operated on leased land were permanently closed when their leases expired during Fiscal Year 2012.
The Company remains contingently liable under certain ground lease agreements relating to land on which seven of the Company's former Golden Corral restaurants are situated. The seven leases were assigned to Golden Corral Corporation (GCC) as part of the transaction to sell the restaurants to GCC. The amount remaining under contingent lease obligations totaled $7,591,000 as of May 29, 2012, for which the aggregate average annual lease payments approximate $644,000 in each of the next five years. Since there is no reason to believe that GCC is likely to default, no provision has been made in the consolidated financial statements for amounts that would be payable by the Company.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use estimates and assumptions to measure certain items that affect the amounts reported in the financial statements and accompanying footnotes. These judgments are based on knowledge and experience about past and current events, and assumptions about future events. Accounting estimates can and do change as new events occur and additional information becomes available. Actual results may differ markedly from current judgment.
Two factors are required for an accounting policy to be deemed critical. The policy must be significant to the fair presentation of a company’s financial condition and its results of operations, and the policy must require management’s most difficult, subjective or complex judgments. Management believes the following to be the Company’s critical accounting policies.
The Company self-insures a significant portion of expected losses from its workers’ compensation program in the state of Ohio. The Company purchases coverage from an insurance company for individual claims in excess of $300,000. Reserves for claims expense include a provision for incurred but not reported claims. Each quarter, management reviews claims valued by the third party administrator (TPA) of the program and then applies experience and judgment to determine the most probable future value of incurred claims. As the TPA submits additional new information, management reviews it in light of historical claims for similar injuries, probability of settlement, and any other facts that might provide guidance in determining ultimate value of individual claims. Unexpected changes in any of these or other factors could result in actual costs differing materially from initial projections or values presently carried in the self-insurance reserves.
Pension plan accounting requires rate assumptions for future compensation increases and the long-term investment return on plan assets. A discount rate is also applied to the calculations of net periodic pension cost and projected benefit obligations. A committee consisting of executives from the Finance Department and the Human Resources Department, with guidance provided by the Company’s actuarial consulting firm, develops these assumptions each year. The consulting firm also provides services in calculating estimated future obligations and net periodic pension cost.
To determine the long-term rate of return on plan assets, the committee considers a weighted average of the historical broad market return and the forward looking expected return. The historical broad market return assumes a wide period of data available for each asset class. Domestic equity securities are allocated equally between large cap and small cap funds, with fixed income securities allocated equally between long-term corporate/government bonds and intermediate-term government bonds. The model for the forward looking expected return uses a range of expected outcomes over a number of years based on the mix of the plan assets and assumptions about the return, variance, and co-variance for each asset class. The weighted average of the historical broad market return and the forward looking expected return is rounded to the nearest 25 basis points to determine the overall expected rate of return on plan assets.
The discount rate is selected by matching the cash flows of the pension plan to that of a yield curve that provides the equivalent yields on zero-coupon bonds for each maturity. Benefit cash flows due in a particular year can be "settled" theoretically by "investing" them in the zero-coupon bond that matures in the same year. The discount rate is the single rate that produces the same present value of cash flows. The selection of the discount rate represents the equivalent single rate under a broad market AA yield curve. The yield curve is used to set the discount rate assumption using cash flows on an aggregate basis, which is then rounded to the nearest 25 basis points.
Pension plan assets are targeted to be invested 70 percent in equity securities, as these investments have historically provided the greatest long-term returns. Poor performance in equity securities markets can significantly lower the market values of the investment portfolios, which, in turn, can result in a) material increases in future funding requirements, b) much higher net periodic pension costs to be recognized in future years, and c) increases in underfunded plan status, requiring the Company’s equity to be reduced.
Long-lived assets include property and equipment, goodwill and other intangible assets. Judgments and estimates are used to determine the carrying value of long-lived assets. This includes the assignment of appropriate useful lives, which affect depreciation and amortization expense. Capitalization policies are continually monitored to assure they remain appropriate.
Management considers a history of cash flow losses on a restaurant-by-restaurant basis to be the primary indicator of potential impairment. Carrying values of property and equipment are tested for impairment at least annually, and whenever events or circumstances indicate that the carrying values of the assets may not be recoverable from the estimated future cash flows expected to result from the use and eventual disposition of the property. When undiscounted expected future cash flows are less than carrying values, an impairment loss is recognized equal to the amount by which carrying values exceed fair value, which is determined as either 1) the greater of the net present value of the future cash flow stream, or 2) by opinions of value provided by real estate
brokers and/or management's judgment as developed through its experience in disposing of unprofitable restaurant operations. Broker opinions of value and the judgment of management consider various factors in their fair value estimates such as the sales of comparable area properties, general economic conditions in the area, physical condition and location of the subject property, and general real estate activity in the area, among other factors. Future cash flows can be difficult to predict. Changing neighborhood demographics and economic conditions, and many other factors may influence operating performance, which affect cash flows.
Sometimes it becomes necessary to cease operating a certain restaurant due to poor operating performance. The ultimate loss can be significantly different from the original impairment charge, particularly if the eventual market price received from the disposition of the property differs materially from estimated fair values.
Acquired goodwill and other intangible assets are tested for impairment annually or whenever an impairment indicator arises.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company has no significant market risk exposure to interest rate changes as substantially all of its debt is currently financed with fixed interest rates, or will be converted to fixed rate term loans in the next six months. The Company does not currently use derivative financial instruments to manage its exposure to changes in interest rates. Any cash equivalents maintained by the Company have original maturities of 90 days or less. The Company does not use any foreign currency in its operations.
Operations are vertically integrated, using centralized purchasing and food preparation, provided through the Company’s commissary and food manufacturing plant. Management believes the commissary operation ensures uniform product quality and safety, timeliness of distribution to restaurants and creates efficiencies that ultimately result in lower food and supply costs.
Commodity pricing affects the cost of many of the Company’s food products. Commodity pricing can be extremely volatile, affected by many factors outside of the Company’s control, including import and export restrictions, the influence of currency markets relative to the U.S. dollar, supply versus demand, production levels and the impact that adverse weather conditions may have on crop yields. Certain commodities purchased by the commissary, principally beef, chicken, pork, dairy products, fish, French fries and coffee, are generally purchased based upon market prices established with vendors. Purchase contracts for some of these items may contain contractual provisions that limit the price to be paid. These contracts are normally for periods of one year or less but may have longer terms if favorable long-term pricing becomes available. Food supplies are generally plentiful and may be obtained from any number of suppliers, which mitigates the Company’s overall commodity cost risk. Quality, timeliness of deliveries and price are the principal determinants of source. The Company does not use financial instruments as a hedge against changes in commodity pricing.
REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of May 29, 2012. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of May 29, 2012 based upon criteria in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, management determined that the Company’s internal control over financial reporting was effective as of May 29, 2012 based on the criteria in Internal Control - Integrated Framework issued by the COSO.
The Board of Directors meets its responsibility for oversight of the integrity of the Company’s financial statements through its Audit Committee, which is composed entirely of three independent directors, none of whom are employees of the Company and two of whom are financial experts. The Audit Committee meets periodically with management and Internal Audit to review their work and confirm that their respective responsibilities are being properly discharged. In addition, Grant Thornton LLP, the Company’s independent registered public accounting firm, has full access to the Audit Committee to discuss the results of their audit work, the effectiveness of internal accounting controls and the quality of financial reporting.
The Company’s internal control over financial reporting as of May 29, 2012 has been audited by Grant Thornton LLP, as is stated in their report that is presented in these financial statements which appears herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Frisch’s Restaurants, Inc.
We have audited the accompanying consolidated balance sheets of Frisch’s Restaurants, Inc. (an Ohio corporation) and Subsidiaries (the “Company”) as of May 29, 2012 and May 31, 2011, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended May 29, 2012. 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Frisch’s Restaurants, Inc. and Subsidiaries as of May 29, 2012 and May 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended May 29, 2012, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of May 29, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated August 3, 2012 expressed an unqualified opinion therein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Frisch’s Restaurants, Inc.
We have audited Frisch’s Restaurants, Inc.’s (an Ohio Corporation) internal control over financial reporting as of May 29, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Frisch’s Restaurants, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Frisch’s Restaurants, Inc.’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Frisch’s Restaurants, Inc. maintained, in all material respects, effective internal control over financial reporting as of May 29, 2012, based on criteria established in Internal Control – Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Frisch’s Restaurants, Inc. and Subsidiaries as of May 29, 2012 and May 31, 2011, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for each of the three years in the period ended May 29, 2012 and our report dated August 3, 2012 expressed an unqualified opinion on those consolidated statements.
FRISCH’S RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
May 29, 2012 and May 31, 2011
The accompanying notes are an integral part of the consolidated financial statements.
FRISCH’S RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
May 29, 2012 and May 31, 2011
LIABILITIES AND SHAREHOLDERS’ EQUITY
FRISCH’S RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
Three years ended May 29, 2012
All three fiscal years contained 52 weeks consisting of 364 days. The accompanying notes are an integral part of the consolidated financial statements.
FRISCH’S RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Three years ended May 29, 2012