CKE RESTAURANTS INC – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of financial statements with a narrative from the perspective of management on the financial condition, results of operations, liquidity and certain other factors that may affect future results. MD&A is presented in the following sections:
• Overview • Operating Review • Liquidity and Capital Resources • Critical Accounting Policies
• Significant Known Events, Trends, or Uncertainties Expected to Impact
Fiscal 2012 Comparisons with Fiscal 2011 • New Accounting Pronouncements Not Yet Adopted and Adoption of New Accounting Pronouncements • Presentation of Non-GAAP Measures • Certain Financial Information ofCKE Holdings, Inc.
The MD&A should be read in conjunction with the unaudited Condensed Consolidated Financial Statements contained herein and the
Overview
CKE Restaurants, Inc. ("CKE"), through its wholly-owned subsidiaries is an international owner, operator and franchisor of quick-service restaurants ("QSR"), operating principally under the Carl's Jr.®, Hardee's®, Green Burrito® and Red Burrito® concepts. Carl's Jr. restaurants are primarily located in the Western andSouthwestern United States . Hardee's restaurants are primarily located throughout the Southeastern and Midwestern United States. Green Burrito restaurants are primarily located in dual-branded Carl's Jr. restaurants. The Red Burrito concept is located in dual-branded Hardee's restaurants. OnJuly 12, 2010 , CKE completed a merger withColumbia Lake Acquisition Corp. ("Merger Sub"), aDelaware corporation and wholly-owned subsidiary ofCKE Holdings, Inc. ("Parent"), aDelaware corporation, providing for the merger of Merger Sub with and into CKE (the "Merger"), with CKE surviving the Merger as a wholly-owned subsidiary of Parent, pursuant to the Agreement and Plan of Merger, datedApril 18, 2010 ("Merger Agreement"). Parent is indirectly controlled by investment entities managed byApollo Management VII, L.P. ("Apollo Management"). As a result of the Merger, shares of CKE common stock ceased to be traded on theNew York Stock Exchange after the close of market onJuly 12, 2010 . The aggregate consideration for all equity securities of the Company was$704,065 , including$10,587 of post-combination share-based compensation expense, and the total debt assumed and refinanced in connection with the Merger was$270,487 . The Merger was funded by (i) equity contributions from affiliates of Apollo Management of$436,645 , (ii) equity contributions from our senior management of$13,355 , (iii) proceeds of$588,510 from the issuance of$600,000 senior secured second lien notes (the "Notes"), and (iv) a senior secured revolving credit facility of$100,000 (the "Credit Facility"), which was undrawn at closing.
The aforementioned transactions, including the Merger and payment of costs related to these transactions, are collectively referred to as the "Transactions."
For the purposes of presentation and disclosure, all references to "Predecessor" relate to CKE and its consolidated subsidiaries for periods prior to the Merger. All references to "Successor" relate to CKE and its consolidated subsidiaries merged with Merger Sub for periods subsequent to the Merger. References to "we", "us", "our" and the "Company" relate to the Predecessor for the periods prior to the Merger and to the Successor for periods subsequent to the Merger. 21
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) We have prepared our discussion of the results of operations and cash flows by comparing the Successor forty weeks endedNovember 7, 2011 to the combined results of operations and cash flows for the Successor sixteen weeks endedNovember 1, 2010 and Predecessor twenty-four weeks endedJuly 12, 2010 . Although this combined presentation does not comply with accounting principles generally accepted inthe United States ("GAAP"), we believe that it provides a meaningful method of comparison. The combined operating results have not been prepared on a pro forma basis under applicable regulations and may not reflect the actual results we would have achieved absent the Transactions and may not be predictive of future results of operations.
Operating Review
The following tables present the change in our restaurant portfolios, consolidated and by brand, for the trailing-13 periods endedNovember 7, 2011 : Company- operated Franchised Licensed Total Consolidated: Open at November 1, 2010 892 1,908 353 3,153 New 7 43 52 102 Closed (8 ) (21 ) (7 ) (36 ) Divested - (3 ) - (3 ) Acquired 3 - - 3 Open at November 7, 2011 894 1,927 398 3,219 Company- operated Franchised Licensed Total Carl's Jr.: Open at November 1, 2010 424 675 146 1,245 New 5 24 31 60 Closed (4 ) (7 ) (2 ) (13 ) Divested - - - - Acquired - - - - Open at November 7, 2011 425 692 175 1,292 Company- operated Franchised Licensed Total Hardee's: Open at November 1, 2010 467 1,222 207 1,896 New 2 19 21 42 Closed (3 ) (13 ) (5 ) (21 ) Divested - (3 ) - (3 ) Acquired 3 - - 3 Open at November 7, 2011 469 1,225 223 1,917 22
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Consolidated Fiscal Quarter Successor Twelve Twelve Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 Revenue: Company-operated restaurants $ 256,976 $ 250,097 Franchised and licensed restaurants and other 35,643 34,690 Total revenue 292,619 284,787 Operating costs and expenses: Restaurant operating costs 214,174 207,336 Franchised and licensed restaurants and other 17,907 16,995 Advertising 15,698 14,880 General and administrative 30,570 30,033 Facility action charges, net 262 822 Other operating expenses - 167 Total operating costs and expenses 278,611 270,233 Operating income 14,008 14,554 Interest expense (17,415 ) (18,055 ) Other (expense) income, net (252 ) 803 Loss before income taxes (3,659 ) (2,698 ) Income tax benefit (2,142 ) (2,743 ) Net (loss) income $ (1,517 ) $ 45 Company-operated restaurant-level adjusted EBITDA(1): Company-operated restaurants revenue $ 256,976 $ 250,097 Less: restaurant operating costs (214,174 ) (207,336 ) Add: depreciation and amortization expense 16,376 15,180 Less: advertising expense (15,698 ) (14,880 ) Company-operated restaurant-level adjusted EBITDA $ 43,480 $ 43,061 Company-operated restaurant-level adjusted EBITDA margin 16.9 % 17.2 % Franchise restaurant adjusted EBITDA(1): Franchised and licensed restaurants and other revenue $ 35,643 $ 34,690 Less: franchised and licensed restaurants and other expense (17,907 ) (16,995 ) Add: depreciation and amortization expense 1,884 1,888 Franchise restaurant adjusted EBITDA $ 19,620 $ 19,583
and franchise restaurant adjusted EBITDA under the heading "Presentation of
Non-GAAP Measures" in this Item 2. 23
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Consolidated Year to Date Successor/ Successor Predecessor Successor Predecessor Forty Forty Sixteen Twenty-Four Weeks Ended Weeks Ended Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 November 1, 2010 July 12, 2010 Revenue: Company-operated restaurants $ 871,571 $ 836,579 $ 336,048 $ 500,531 Franchised and licensed restaurants and other 121,360 197,356 45,768 151,588 Total revenue 992,931 1,033,935 381,816 652,119 Operating costs and expenses: Restaurant operating costs 726,356 691,710 277,539
414,171
Franchised and licensed restaurants and other 62,225 137,377 22,257 115,120 Advertising 51,158 49,375 19,728 29,647 General and administrative 100,876 109,620 49,761 59,859 Facility action charges, net 703 1,549 959 590 Other operating expenses, net 545 30,077 19,828
10,249
Total operating costs and expenses 941,863 1,019,708 390,072
629,636
Operating income (loss) 51,068 14,227 (8,256 ) 22,483 Interest expense (59,626 ) (32,652 ) (24,035 ) (8,617 ) Other (expense) income, net (1,668 ) (12,641 ) 968
(13,609 )
(Loss) income before income taxes (10,226 ) (31,066 ) (31,323 ) 257 Income tax (benefit) expense (3,877 ) (708 ) (8,480 ) 7,772 Net loss $ (6,349 ) $ (30,358 ) $ (22,843 ) $ (7,515 )
Company-operated restaurant-level adjusted EBITDA(1): Company-operated restaurants revenue
$ 871,571 $ 836,579 $ 336,048 $ 500,531 Less: restaurant operating costs (726,356 ) (691,710 ) (277,539 ) (414,171 ) Add: depreciation and amortization expense 54,363 50,624 20,212 30,412 Less: advertising expense (51,158 ) (49,375 ) (19,728 ) (29,647 ) Company-operated restaurant-level adjusted EBITDA $ 148,420 $ 146,118 $ 58,993
$ 87,125
Company-operated restaurant-level adjusted EBITDA margin 17.0 % 17.5 % 17.6 %
17.4 %
Franchise restaurant adjusted EBITDA(1): Franchised and licensed restaurants and other revenue $ 121,360
$ 197,356 $ 45,768
$ 151,588 Less: franchised and licensed restaurants and other expense
(62,225 ) (137,377 ) (22,257 ) (115,120 ) Add: depreciation and amortization expense 5,942 3,831 2,443
1,388
Franchise restaurant adjusted EBITDA $ 65,077 $ 63,810 $ 25,954 $ 37,856
(1) Refer to definitions of company-operated restaurant-level non-GAAP measures
and franchise restaurant adjusted EBITDA under the heading "Presentation of
Non-GAAP Measures" in this Item 2. 24
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Carl's Jr. Fiscal Quarter Successor Twelve Twelve Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 Company-operated restaurants revenue $ 136,111 $ 131,367 Franchised and licensed restaurants and other revenue 13,855 13,338 Total revenue 149,966 144,705 Restaurant operating costs: Food and packaging 40,929 38,397 Payroll and other employee benefits 38,102 37,171 Occupancy and other 35,594 34,776 Total restaurant operating costs 114,625 110,344 Franchised and licensed restaurants and other expense 7,842 7,214 Advertising expense 8,792 7,893 General and administrative expense 14,447 14,117 Facility action charges, net (63 ) 170 Operating income $ 4,323 $ 4,967 Company-operated average unit volume (trailing-52 weeks) $ 1,405 $ 1,375 Franchise-operated average unit volume (trailing-52 weeks) $ 1,094 $ 1,096 Company-operated same-store sales increase (decrease) 2.0 % (5.0 )% Franchise-operated same-store sales decrease (2.5 )% (4.3 )% Company-operated same-store transaction decrease (0.5 )% (3.0 )% Company-operated average check (actual $) $ 6.90 $ 6.73 Restaurant operating costs as a percentage of company-operated restaurants revenue: Food and packaging 30.1 % 29.2 % Payroll and other employee benefits 28.0 % 28.3 % Occupancy and other 26.2 % 26.5 % Total restaurant operating costs 84.2 % 84.0 % Advertising expense as a percentage of company-operated restaurants revenue 6.5 % 6.0 % Company-operated restaurant-level adjusted EBITDA(1): Company-operated restaurants revenue $ 136,111 $ 131,367 Less: restaurant operating costs (114,625 ) (110,344 ) Add: depreciation and amortization expense 7,760 7,557 Less: advertising expense (8,792 ) (7,893 ) Company-operated restaurant-level adjusted EBITDA $ 20,454 $ 20,687 Company-operated restaurant-level adjusted EBITDA margin 15.0 % 15.7 % Franchise restaurant adjusted EBITDA(1): Franchised and licensed restaurants and other revenue $ 13,855 $ 13,338 Less: franchised and licensed restaurants and other expense (7,842 ) (7,214 ) Add: depreciation and amortization expense 788 844 Franchise restaurant adjusted EBITDA $ 6,801 $ 6,968
(1) Refer to definitions of company-operated restaurant-level non-GAAP measures
and franchise restaurant adjusted EBITDA under the heading "Presentation of
Non-GAAP Measures" in this Item 2. 25
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Carl's Jr. Year to Date Successor/ Successor Predecessor Successor Predecessor Forty Forty Sixteen Twenty-Four Weeks Ended Weeks Ended Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 November 1, 2010 July 12, 2010
Company-operated restaurants revenue $ 462,769 $
447,891 $ 176,512 $ 271,379 Franchised and licensed restaurants and other revenue 45,645 129,623 17,768 111,855 Total revenue 508,414 577,514 194,280 383,234 Restaurant operating costs: Food and packaging 139,869 131,182 51,427 79,755 Payroll and other employee benefits 130,820 126,447 49,619 76,828 Occupancy and other 117,291 112,771 46,055 66,716 Total restaurant operating costs 387,980 370,400 147,101 223,299 Franchised and licensed restaurants and other expense 25,335 107,667 9,632 98,035 Advertising expense 28,289 27,262 10,642 16,620 General and administrative expense 48,055 51,845 23,322 28,523 Facility action charges, net 127 378 210 168 Gain on sale of Distribution Center assets - (3,442 ) - (3,442 ) Operating income $ 18,628 $ 23,404 $ 3,373 $ 20,031 Company-operated same-store sales increase (decrease) 2.0 % (6.2 )% Franchise-operated same-store sales decrease (0.8 )% (4.2 )% Company-operated same-store transaction decrease (0.2 )% (3.9 )% Company-operated average check (actual $) $ 6.98 $
6.80
Restaurant operating costs as a percentage of company-operated restaurants revenue: Food and packaging 30.2 % 29.3 % Payroll and other employee benefits 28.3 % 28.2 % Occupancy and other 25.3 % 25.2 % Total restaurant operating costs 83.8 % 82.7 % Advertising expense as a percentage of company-operated restaurants revenue 6.1 %
6.1 %
Company-operated restaurant-level adjusted EBITDA(1): Company-operated restaurants revenue $ 462,769 $
447,891 $ 176,512 $ 271,379 Less: restaurant operating costs
(387,980 ) (370,400 ) (147,101 ) (223,299 ) Add: depreciation and amortization expense 26,487 24,918 10,084 14,834 Less: advertising expense (28,289 ) (27,262 ) (10,642 ) (16,620 ) Company-operated restaurant-level adjusted EBITDA $ 72,987 $ 75,147 $ 28,853 $ 46,294 Company-operated restaurant-level adjusted EBITDA margin 15.8 % 16.8 % 16.3 % 17.1 % Franchise restaurant adjusted EBITDA(1): Franchised and licensed restaurants and other revenue $ 45,645 $ 129,623 $ 17,768 $ 111,855 Less: franchised and licensed restaurants and other expense (25,335 ) (107,667 ) (9,632 ) (98,035 ) Add: depreciation and amortization expense 2,640 1,862 1,110 752 Franchise restaurant adjusted EBITDA $ 22,950 $ 23,818 $ 9,246 $ 14,572
(1) Refer to definitions of company-operated restaurant-level non-GAAP measures
and franchise restaurant adjusted EBITDA under the heading "Presentation of
Non-GAAP Measures" in this Item 2. 26
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Hardee'sFiscal Quarter Successor Twelve Twelve Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 Company-operated restaurants revenue $ 120,865 $ 118,680 Franchised and licensed restaurants and other revenue 21,664 21,232 Total revenue 142,529 139,912 Restaurant operating costs: Food and packaging 37,835 35,461 Payroll and other employee benefits 34,381 34,499 Occupancy and other 27,326 26,956 Total restaurant operating costs 99,542 96,916 Franchised and licensed restaurants and other expense 10,065 9,781 Advertising expense 6,906 6,987 General and administrative expense 16,124 15,917 Facility action charges, net 326 651 Operating income $ 9,566 $ 9,660 Company-operated average unit volume (trailing-52 weeks) $ 1,102 $ 1,039 Franchise-operated average unit volume (trailing-52 weeks) $ 1,045 $ 1,002 Company-operated same-store sales increase 1.8 % 8.3 % Franchise-operated same-store sales increase 1.3 % 7.4 % Company-operated same-store transaction (decrease) increase (1.5 )% 3.3 % Company-operated average check (actual $) $ 5.30 $ 5.16 Restaurant operating costs as a percentage of company-operated restaurants revenue: Food and packaging 31.3 % 29.9 % Payroll and other employee benefits 28.4 % 29.1 % Occupancy and other 22.6 % 22.7 % Total restaurant operating costs 82.4 % 81.7 % Advertising expense as a percentage of company-operated restaurants revenue 5.7 % 5.9 % Company-operated restaurant-level adjusted EBITDA(1): Company-operated restaurants revenue $ 120,865 $ 118,680 Less: restaurant operating costs (99,542 ) (96,916 ) Add: depreciation and amortization expense 8,616 7,623 Less: advertising expense (6,906 ) (6,987 ) Company-operated restaurant-level adjusted EBITDA $ 23,033
$ 22,400
Company-operated restaurant-level adjusted EBITDA margin 19.1 % 18.9 % Franchise restaurant adjusted EBITDA(1): Franchised and licensed restaurants and other revenue $ 21,664 $ 21,232 Less: franchised and licensed restaurants and other expense (10,065 ) (9,781 ) Add: depreciation and amortization expense 1,096 1,044 Franchise restaurant adjusted EBITDA $ 12,695 $ 12,495
(1) Refer to definitions of company-operated restaurant-level non-GAAP measures
and franchise restaurant adjusted EBITDA under the heading "Presentation of
Non-GAAP Measures" in this Item 2. 27
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Hardee's Year to Date Successor/ Successor Predecessor Successor Predecessor Forty Forty Sixteen Twenty-Four Weeks Ended Weeks Ended Weeks Ended Weeks Ended November 7, 2011
388,513 $ 159,470 $ 229,043 Franchised and licensed restaurants and other revenue 75,289 67,321 27,841 39,480 Total revenue 483,979 455,834 187,311 268,523 Restaurant operating costs: Food and packaging 127,980 116,575 47,733 68,842 Payroll and other employee benefits 118,563 116,912 46,414 70,498 Occupancy and other 91,654 87,569 36,191 51,378 Total restaurant operating costs 338,197 321,056 130,338 190,718 Franchised and licensed restaurants and other expense 36,890 29,710 12,625 17,085 Advertising expense 22,869 22,113 9,086 13,027 General and administrative expense 52,823 57,706 26,440 31,266 Facility action charges, net 573 1,117 748 369 Operating income $ 32,627 $ 24,132 $ 8,074 $ 16,058 Company-operated same-store sales increase 5.0 % 4.0 % Franchise-operated same-store sales increase 3.4 % 3.1 % Company-operated same-store transaction increase 0.5 % 1.7 % Company-operated average check (actual $) $ 5.34 $
5.13
Restaurant operating costs as a percentage of company-operated restaurants revenue: Food and packaging 31.3 % 30.0 % Payroll and other employee benefits 29.0 % 30.1 % Occupancy and other 22.4 % 22.5 % Total restaurant operating costs 82.8 % 82.6 % Advertising expense as a percentage of company-operated restaurants revenue 5.6 %
5.7 %
Company-operated restaurant-level adjusted EBITDA(1): Company-operated restaurants revenue $ 408,690 $
388,513 $ 159,470 $ 229,043 Less: restaurant operating costs
(338,197 ) (321,056 ) (130,338 ) (190,718 ) Add: depreciation and amortization expense 27,876 25,706 10,128 15,578 Less: advertising expense (22,869 ) (22,113 ) (9,086 ) (13,027 ) Company-operated restaurant-level adjusted EBITDA $ 75,500 $ 71,050 $ 30,174 $ 40,876 Company-operated restaurant-level adjusted EBITDA margin 18.5 % 18.3 % 18.9 % 17.8 % Franchise restaurant adjusted EBITDA(1): Franchised and licensed restaurants and other revenue $ 75,289 $ 67,321 $ 27,841 $ 39,480 Less: franchised and licensed restaurants and other expense (36,890 ) (29,710 ) (12,625 ) (17,085 ) Add: depreciation and amortization expense 3,302 1,969 1,333 636 Franchise restaurant adjusted EBITDA $ 41,701 $ 39,580 $ 16,549 $ 23,031
(1) Refer to definitions of company-operated restaurant-level non-GAAP measures
and franchise restaurant adjusted EBITDA under the heading "Presentation of
Non-GAAP Measures" in this Item 2. 28
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Carl's Jr.
Company-Operated Restaurants Revenue
Revenue from company-operated Carl's Jr. restaurants increased$4,744 , or 3.6%, to$136,111 during the twelve weeks endedNovember 7, 2011 , as compared to the twelve weeks endedNovember 1, 2010 . This increase was primarily due to the 2.0% increase in company-operated same-store sales for the quarter and revenues generated from new company-operated restaurants opened since the end of the third quarter of fiscal 2011, partially offset by a decrease in revenues from restaurants closed since the end of the third quarter of fiscal 2011. Revenue from company-operated Carl's Jr. restaurants increased$14,878 , or 3.3%, to$462,769 during the forty weeks endedNovember 7, 2011 , as compared to the prior year period. This increase was primarily due to the 2.0% increase in company-operated same-store sales from the comparable prior year period and revenues generated from new company-operated restaurants opened since the end of the third quarter of fiscal 2011, partially offset by a decrease in revenues from restaurants closed since the end of the third quarter of fiscal 2011.
Company-Operated Restaurant-Level Adjusted EBITDA Margin
The changes in the company-operated restaurant-level adjusted EBITDA margin are summarized as follows: Twelve Forty Weeks Weeks
Company-operated restaurant-level adjusted EBITDA margin for the period ended
15.7 % 16.8 % Increase in food and packaging costs (0.8 ) (0.9 ) Payroll and other employee benefits Decrease in labor costs, excluding workers' compensation 0.2
0.2
Decrease (increase) in workers' compensation expense 0.1
(0.2 ) Occupancy and other (excluding depreciation and amortization): Decrease in rent expense
0.4
0.1
Increase in biscuit roll-out costs (0.5 ) (0.2 ) Decrease in repairs and maintenance expense 0.3
0.2
Increase in credit card and banking fees (0.2 ) (0.2 ) Other, net 0.3 - Advertising expense (0.5 ) -
Company-operated restaurant-level adjusted EBITDA margin for the period ended
15.0 % 15.8 % Food and Packaging Costs Food and packaging costs increased as a percentage of company-operated restaurants revenue during the twelve and forty weeks endedNovember 7, 2011 , as compared to the prior year periods, due primarily to increased commodity costs for beef, oil and cheese products.
Occupancy and Other Costs
Rent expense decreased as a percentage of company-operated restaurants revenue during the twelve weeks endedNovember 7, 2011 , from the comparable prior year period, due primarily to increased sales leverage. Biscuit roll-out costs increased as a percentage of company-operated restaurants revenue during the twelve weeks endedNovember 7, 2011 , from the comparable prior year period, due to the additional costs incurred in connection with the roll-out of Hardee's Made From Scratch breakfast biscuits at Carl's Jr. in theLos Angeles market. Repairs and maintenance expense decreased as a percentage of company-operated restaurants revenue during the twelve weeks endedNovember 7, 2011 , from the comparable prior year period, due primarily to decreased spending on contract services and repairs of restaurant equipment in the current year period. 29
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Advertising Expense Advertising expense as a percentage of company-operated restaurants revenue increased from 6.0% to 6.5% during the twelve weeks endedNovember 7, 2011 as compared to the twelve weeks endedNovember 1, 2010 . The increase as a percentage of company-operated restaurants revenue was mainly due to incremental print and media spending to promote the roll-out of Hardee's Made From Scratch breakfast biscuits at Carl's Jr. in theLos Angeles market and incremental media spending in select markets.
Carl's Jr. Fiscal Quarter Successor Twelve Twelve Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 Franchised and licensed restaurants and other revenue: Royalties $ 7,813 $ 7,527 Rent and other occupancy 5,387 5,671 Franchise fees 655 140 Total franchised and licensed restaurants and other revenue $ 13,855 $ 13,338 Franchised and licensed restaurants and other expense: Administrative expense (including provision for bad debts) $ 2,950 $ 2,252 Rent and other occupancy 4,892 4,962 Total franchised and licensed restaurants and other expense $ 7,842 $ 7,214 Total franchised and licensed restaurants and other revenue increased$517 , or 3.9%, to$13,855 during the twelve weeks endedNovember 7, 2011 , as compared to the prior year period. Royalty revenues increased$286 , or 3.8%, to$7,813 , due primarily to the net increase of 46 franchised and licensed restaurants since the end of the third quarter of fiscal 2011, partially offset by a 2.5% decrease in franchise-operated same-store sales. Franchise fees increased$515 to$655 during the twelve weeks endedNovember 7, 2011 , as compared to the prior year period, due primarily to the opening of new franchised and licensed restaurants. Rent and other occupancy revenues decreased$284 , or 5.0%, mainly due to the impact of franchisees entering into lease arrangements directly with landlords and a decrease in contingent rent revenue from franchisees. Franchised and licensed restaurants and other expense increased$628 , or 8.7%, to$7,842 during the twelve weeks endedNovember 7, 2011 , from the comparable prior year period. Administrative expense increased$698 , or 31.0%, from the comparable prior year period, due primarily to increased franchise operations and administration costs related to our international growth strategy. 30
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Successor/ Carl's Jr. Year to Date Successor Predecessor Successor Predecessor Forty Forty Sixteen Twenty-Four Weeks Ended Weeks Ended Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 November 1, 2010 July 12, 2010 Franchised and licensed restaurants and other revenue: Royalties $ 26,608 $ 25,087 $ 10,019 $ 15,068 Distribution centers - food, packaging and supplies - 86,891 - 86,891 Rent and other occupancy 17,400 16,936 7,515 9,421 Franchise fees 1,637 709 234 475 Total franchised and licensed restaurants and other revenue $ 45,645 $ 129,623 $ 17,768 $ 111,855 Franchised and licensed restaurants and other expense: Administrative expense (including provision for bad debts) $ 9,016 $ 6,230 $ 3,038 $ 3,192 Distribution centers - food, packaging and supplies - 86,170 - 86,170 Rent and other occupancy 16,319 15,267 6,594 8,673 Total franchised and licensed restaurants and other expense $ 25,335 $ 107,667 $ 9,632 $ 98,035 Total franchised and licensed restaurants revenue decreased$83,978 , or 64.8%, to$45,645 during the forty weeks endedNovember 7, 2011 , as compared to the forty weeks endedNovember 1, 2010 . Distribution center sales of food, packaging and supplies to franchisees decreased by$86,891 , due to the outsourcing of our Carl's Jr. distribution center operations onJuly 2, 2010 . This decrease was partially offset by an increase in royalty revenues of$1,521 , or 6.1%, due primarily to the net increase of 46 franchised and licensed restaurants since the end of the third quarter of fiscal 2011, partially offset by a 0.8% decrease in franchise-operated same-store sales. Franchise fees increased$928 to$1,637 during the forty weeks endedNovember 7, 2011 , as compared to the prior year period, due primarily to the opening of new franchised and licensed restaurants. Rent and other occupancy revenues increased$464 , or 2.7%, mainly due to impact of the amortization of favorable and unfavorable leases, which were recorded in connection with the Merger, partially offset by the impact of franchisees entering into lease arrangements directly with landlords. Franchised and licensed operating and other expenses decreased$82,332 , or 76.5%, to$25,335 during the forty weeks endedNovember 7, 2011 , as compared to the prior year period. This decrease is mainly due to an$86,170 decrease in distribution center costs resulting from the outsourcing of our Carl's Jr. distribution center operations. This decrease was partially offset by an increase of$2,786 , or 44.7%, increase in administrative expense from the comparable prior year period, primarily caused by an increase of$1,141 in amortization expense related to the franchise agreement intangible asset recorded in connection with the Merger and increased franchise operations and administration costs related to our international growth strategy. Rent and other occupancy expense increased$1,052 , or 6.9%, to$16,319 due primarily to the impact of the amortization of favorable and unfavorable leases, which were recorded in connection with the Merger.
Hardee's
Company-Operated Restaurants Revenue
Revenue from company-operated Hardee's restaurants increased$2,185 , or 1.8%, to$120,865 during the twelve weeks endedNovember 7, 2011 , over the comparable prior year period, primarily due to the 1.8% increase in company-operated same-store sales. During the forty weeks endedNovember 7, 2011 , revenue from company-operated restaurants increased$20,177 , or 5.2%, to$408,690 as compared to the forty weeks endedNovember 1, 2010 . The increase is primarily due to the 5.0% increase in company-operated same-store sales. 31
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
Company-Operated Restaurant-Level Adjusted EBITDA Margin
The changes in the company-operated restaurant-level adjusted EBITDA margin are summarized as follows: Twelve Weeks Forty Weeks Company-operated restaurant-level adjusted EBITDA margin for the period ended November 1, 2010 18.9 % 18.3 % Increase in food and packaging costs (1.4 ) (1.3 ) Payroll and other employee benefits: Decrease in labor costs, excluding workers' compensation 0.4 1.0 Decrease in workers' compensation expense 0.2 0.1 Occupancy and other (excluding depreciation and amortization): Decrease in property tax expense 0.2 0.1 Decrease in general liability insurance expense 0.2 0.1 Decrease in asset disposal expense 0.2 0.1 Other, net 0.2 - Advertising expense 0.2 0.1 Company-operated restaurant-level adjusted EBITDA margin for the period ended November 7, 2011 19.1 % 18.5 % Food and Packaging Costs Food and packaging costs increased as a percentage of company-operated restaurants revenue during the twelve weeks endedNovember 7, 2011 , as compared to the prior year period, mainly due to an increase in commodity costs for beef, oil, dairy and pork products. Food and packaging costs increased as a percentage of company-operated restaurants revenue during the forty weeks endedNovember 7, 2011 , as compared to the prior year period, mainly due to an increase in commodity costs for beef, oil, pork and flour products. Labor Costs Labor costs, excluding workers' compensation expense, decreased as a percentage of company-operated restaurants revenue during the twelve and forty weeks endedNovember 7, 2011 , as compared to the prior year periods, due primarily to more efficient use of labor in the restaurants and sales leverage.
Occupancy and Other Costs
Depreciation and amortization expense increased as a percentage of company-operated restaurants revenue during the twelve weeks ended
32
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
Hardee's Fiscal Quarter Successor Twelve Twelve Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 Franchised and licensed restaurants and other revenue: Royalties $ 13,753 $ 13,214 Distribution centers - equipment 4,472 4,729 Rent and other occupancy 3,095 3,102 Franchise fees 344 187 Total franchised and licensed restaurants and other revenue $ 21,664 $ 21,232 Franchised and licensed restaurants and other expense: Administrative expense (including provision for bad debts) $ 2,958 $ 2,453 Distribution centers - equipment 4,433 4,759 Rent and other occupancy 2,674 2,569 Total franchised and licensed restaurants and other expense $ 10,065 $ 9,781 Total franchised and licensed restaurants and other revenue increased$432 or 2.0%, to$21,664 during the twelve weeks endedNovember 7, 2011 , as compared to the prior year period. Royalty revenues increased$539 , or 4.1%, to$13,753 , from the comparable prior year period, due primarily to a net increase of 19 franchised and licensed restaurants since the end of the third quarter of fiscal 2011 and an increase in franchise-operated same-store sales of 1.3%. The decrease in distribution center sales of equipment of$257 , or 5.4%, from the comparable prior year period, was primarily due to a decrease in equipment sales to third parties. Franchised and licensed restaurants and other expense increased$284 , or 2.9%, to$10,065 , during the twelve weeks endedNovember 7, 2011 , as compared to the prior year period. The increase in administrative expense of$505 , or 20.6%, to$2,958 was primarily due to an increase in administration costs to support our long-term growth strategy. The decrease in distribution center costs of$326 , or 6.9%, resulted directly from the decrease in distribution center sales of equipment to third parties. 33
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Table of Contents CKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Successor/ Hardee's Year to Date Successor Predecessor Successor Predecessor Forty Forty Sixteen Twenty-Four Weeks Ended Weeks Ended Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 November 1, 2010 July 12, 2010 Franchised and licensed restaurants and other revenue: Royalties $ 45,565 $ 42,285 $ 17,583 $ 24,702 Distribution centers - equipment 18,682 15,089 5,869 9,220 Rent and other occupancy 10,105 9,289 4,102 5,187 Franchise fees 937 658 287 371 Total franchised and licensed restaurants and other revenue $ 75,289 $ 67,321 $ 27,841 $ 39,480 Franchised and licensed restaurants and other expense: Administrative expense (including provision for bad debts) $ 9,744 $ 7,330 $ 3,303 $ 4,027 Distribution centers - equipment 18,545 15,103 5,897 9,206 Rent and other occupancy 8,601 7,277 3,425 3,852 Total franchised and licensed restaurants and other expense $ 36,890 $ 29,710 $ 12,625 $ 17,085 Total franchised and licensed restaurants revenue increased$7,968 , or 11.8%, to$75,289 during the forty weeks endedNovember 7, 2011 , as compared to the prior year period. Distribution center revenues increased$3,593 , or 23.8%, primarily due to an increase in equipment sales to franchisees. Royalty revenues increased by$3,280 , or 7.8%, from the comparable prior year period, due primarily to a net increase of 19 franchised and licensed restaurants since the end of the third quarter of fiscal 2011 and an increase in our franchise-operated same-store sales of 3.4%. Rent and other occupancy revenue increased$816 , or 8.8%, primarily due to the impact of the amortization of favorable and unfavorable leases, which were recorded in connection with the Merger. Franchised and licensed operating and other expenses increased$7,180 , or 24.2%, to$36,890 , during the forty weeks endedNovember 7, 2011 , as compared to the prior year period. Distribution center expenses increased$3,442 , or 22.8%, resulting directly from the increase in distribution center sales to franchisees. The increase in administrative expense of$2,414 was primarily due to increased franchise operations and administration costs to support our long-term growth strategy and an increase of$878 in amortization expense related to the franchise agreement intangible asset recorded in connection with the Merger. Rent and other occupancy expense increased$1,324 , or 18.2%, due primarily to the impact of the amortization of favorable and unfavorable leases, which were recorded in connection with the Merger.
Consolidated Expenses
General and Administrative Expense
General and administrative expense decreased$8,744 , or 8.0%, to$100,876 , for the forty weeks endedNovember 7, 2011 , as compared to the forty weeks endedNovember 1, 2010 . This was mainly due to a$13,175 decrease in share-based compensation expense resulting primarily from the expense recorded in the prior year period for the acceleration of vesting of stock options and restricted stock awards in connection with the Merger. This decrease was partially offset by an increase of$2,269 in bonus expense, which is based on our performance relative to executive management and operations bonus criteria, and an increase of$1,279 in management service fees paid to Apollo Management.
Other Operating Expenses, Net
During the twelve weeks ended
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) During the forty weeks endedNovember 7, 2011 , other operating expenses, net decreased$29,532 from the comparable prior year period to$545 . This decrease was primarily due to a decrease in transaction-related costs for accounting, investment banking, legal and other costs associated with the Transactions, which decreased from$33,519 for the forty weeks endedNovember 1, 2010 to$545 for the forty weeks endedNovember 7, 2011 . Additionally, during the forty weeks endedNovember 1, 2010 , we recorded a gain of$3,442 on the sale of our Distribution Center assets.
Interest Expense
During the twelve weeks endedNovember 7, 2011 , the decrease in interest expense of$640 , to$17,415 , as compared to the twelve weeks endedNovember 1, 2010 was primarily due to a decrease of$1,122 in interest expense associated with our Notes caused by a reduction in the principal amount of our Notes since the prior year period. This decrease was partially offset by the additional interest incurred on financing method sale-leaseback transactions entered into during fiscal 2012. During the forty weeks endedNovember 7, 2011 , interest expense increased$26,974 to$59,626 , as compared to the forty weeks endedNovember 1, 2010 . This increase was primarily caused by the interest incurred on our Notes and financing method sale-leaseback transactions entered into during fiscal 2012. Interest expense during the forty weeks endedNovember 1, 2010 included a charge of$3,113 to adjust the carrying value of our Predecessor interest rate swap agreements to fair value.
See Note 7 of Notes to Condensed Consolidated Financial Statements included herein for additional detail of the components of interest expense.
Other (Expense) Income, Net
During the twelve weeks endedNovember 7, 2011 , we recorded$252 of other expense, net as compared to other income, net of$803 during the twelve weeks endedNovember 1, 2010 . This change was primarily due to expenses incurred related to previously disposed businesses and a loss of$286 recognized on the early extinguishment of$8,170 of the principal amount of our Notes during the twelve weeks endedNovember 7, 2011 . During the forty weeks endedNovember 7, 2011 , we recorded$1,668 of other expense, net as compared to other expense, net of$12,641 during the forty weeks endedNovember 1, 2010 . During the forty weeks endedNovember 7, 2011 , we recognized a loss of$2,927 on the early extinguishment of$48,170 of the principal amount of our Notes. During the forty weeks endedNovember 1, 2010 , we recorded a termination fee to terminate a prior merger agreement with an affiliate ofThomas H. Lee Partners, L.P. of$9,283 and$5,000 in reimbursable costs.
Income Tax (Benefit) Expense
Our effective income tax rate for the twelve and forty weeks endedNovember 7, 2011 differs from the federal statutory rate primarily as a result of non-deductible share-based compensation expense, state income taxes, federal income tax credits and the release of$237 of unrecognized tax benefits due to statute closures. Our effective income tax rate for the twelve and forty weeks endedNovember 1, 2010 differs from the federal statutory rate primarily as a result of non-deductible transaction-related costs, non-deductible share-based compensation expense, state income taxes and the release of$1,501 of unrecognized tax benefits due to statute closures.
Liquidity and Capital Resources
Overview
Our cash requirements consist principally of our food and packaging purchases, labor and occupancy costs; capital expenditures for restaurant remodels, new restaurant construction and replacement of equipment; debt service requirements; advertising expenditures; and general and administrative expenses. We expect that our cash on hand and future cash flows from operations will provide sufficient liquidity to allow us to meet our operating and capital requirements and service our existing debt. As ofNovember 7, 2011 , we have$61,075 in cash and cash equivalents and$68,537 in available commitments under our Credit Facility to help meet our operating and capital requirements. We believe our most significant cash uses during the next 12 months will be for capital expenditures, debt service requirements and the partial redemption of our Notes. Based on our current capital spending projections, we expect capital expenditures to be between$55,000 and $60,000 for fiscal 2012. As discussed below, we commenced a tender offer to purchase up to$27,871 of the principal amount of our Notes ("Tender Offer") at a redemption price of 103%, which expiresDecember 29, 2011 . In addition to the Tender Offer, onDecember 1, 2011 , we elected to redeem up to$20,000 aggregate principal amount of the Notes outstanding onJanuary 4, 2012 ("Redemption") at a redemption price of 103%. The terms of the Redemption provide that the combined principal amount of the notes purchased in the Tender Offer and Redemption will not exceed$30,000 . In addition to the Redemption and Tender Offer, we may elect to redeem up to an additional$60,000 of the principal amount of our Notes during the twelve month period commencingJuly 15, 2012 . 35
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
Assuming the aggregate outstanding principal amount of our Notes remains unchanged from
Credit Facility
Our Credit Facility provides for senior secured revolving facility loans, swingline loans and letters of credit, in an aggregate amount of up to$100,000 . The Credit Facility bears interest at a rate equal to, at our option, either: (1) the higher ofMorgan Stanley's "prime rate" plus 2.75% or the federal funds rate, as defined in our Credit Facility, plus 3.25%, or (2) theLIBOR plus 3.75%. The Credit Facility matures onJuly 12, 2015 , at which time all outstanding revolving facility loans and accrued and unpaid interest must be repaid. As ofNovember 7, 2011 , we had no outstanding loan borrowings,$31,463 of outstanding letters of credit, and remaining availability of$68,537 under our Credit Facility. Pursuant to the terms of our Credit Facility, during each fiscal year our capital expenditures cannot exceed the sum of (1) the greater of (i)$100,000 and (ii) 8.5% of our consolidated gross total tangible assets as of the end of such fiscal year plus, without duplication, (2) 10% of certain assets acquired in permitted acquisitions during such fiscal year (the "Acquired Assets Amount") and, (3) 5% of the Acquired Assets Amount for the preceding fiscal year, calculated on a cumulative basis. In addition, the annual base amount of permitted capital expenditures may be increased by an amount equal to any cumulative credit (as defined in the Credit Facility) which the Company elects to apply for this purpose and may be carried-back and/or carried-forward subject to the terms set forth in the Credit Facility. The Credit Facility contains covenants that restrict our ability and the ability of our subsidiaries to: incur additional indebtedness; pay dividends on our capital stock or redeem, repurchase or retire our capital stock or indebtedness; make investments, loans, advances and acquisitions; create restrictions on the payment of dividends or other amounts to us from our subsidiaries; sell assets, including capital stock of our subsidiaries; consolidate or merge; create liens; enter into sale and leaseback transactions; amend, modify or permit the amendment or modification of any senior secured second lien note documents; engage in certain transactions with our affiliates; issue capital stock; create subsidiaries; and change the business conducted by us or our subsidiaries. The terms of our Credit Facility also include financial performance covenants, which include a maximum secured leverage ratio and a specified minimum interest coverage ratio. Our Credit Facility defines our secured leverage ratio as the ratio of our: (1) Total Secured Debt plus eight times our Net Rent less Unrestricted Cash and Permitted Investments; over (2) Adjusted EBITDAR, each as defined in our Credit Facility. In determining our Total Secured Debt for the purpose of our financial covenants, we include our Notes and other long-term secured debt, capital lease obligations and the portion of the proceeds from financing method sale-leaseback transactions equal to the net book value of the associated properties. As ofNovember 7, 2011 , the net book value of the assets associated with financing method sale-leaseback transactions was$31,825 . See Note 8 of Notes to Condensed Consolidated Financial Statements included herein for further discussion of these sale-leaseback transactions. Our Credit Facility defines our interest coverage ratio as the ratio of Adjusted EBITDA to Cash Interest Expense, each as defined in our Credit Facility. As ofNovember 7, 2011 , our financial performance covenants did not limit our ability to draw on the remaining availability of$68,537 under our Credit Facility.
We were in compliance with the covenants of our Credit Facility as of
The terms of our Credit Facility are not impacted by any changes in our credit rating. We believe the key company-specific factors affecting our ability to maintain our existing debt financing relationships and to access such capital in the future are our present and expected levels of profitability, cash flows from operations, capital expenditures, asset collateral bases and the level of our Adjusted EBITDA relative to our debt obligations. In addition, as noted above, our Credit Facility includes significant restrictions on future financings including, among others, limits on the amount of indebtedness we may incur or which may be secured by any of our assets.
Senior Secured Second Lien Notes
OnJuly 15, 2011 , we redeemed$40,000 of the principal amount of our Notes at a redemption price of 103% of the principal amount of the Notes pursuant to the terms of the indenture governing the Notes. OnOctober 4, 2011 , we purchased$8,170 of the principal amount of our Notes at a price of 100% of the principal amount of the Notes in an open market transaction and paid the associated accrued and unpaid interest on these purchased Notes of$212 . Subsequent to the redemption and purchase, and as ofNovember 7, 2011 , the aggregate principal amount of our Notes outstanding was$551,830 . The Notes bear interest at a rate of 11.375% per annum, payable semi-annually in arrears onJanuary 15 andJuly 15 . As ofNovember 7, 2011 , the carrying value of the notes was$542,413 , which is presented net of the remaining unamortized original issue discount of$9,417 . The Notes mature onJuly 15, 2018 . 36
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) The indenture governing the Notes contains restrictive covenants that limit our and our guarantor subsidiaries' ability to, among other things: incur or guarantee additional debt or issue certain preferred equity; pay dividends, make capital stock distributions or other restricted payments; make certain investments; sell certain assets; create or incur liens on certain assets to secure debt; consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; enter into certain transactions with affiliates; and designate subsidiaries as unrestricted subsidiaries. Additionally, the indenture contains certain reporting covenants, which requires us to provide all such information required to be filed by theSecurities and Exchange Commission ("SEC") in accordance with the reporting requirements of Section 13 or 15(d) of the Exchange Act of 1934, as amended ("Exchange Act"), as a non-accelerated filer, even if we are not specifically required to comply with such sections of the Exchange Act. Failure to comply with these covenants constitutes a default and may lead to the acceleration of the principal amount and accrued but unpaid interest on the Notes.
We were in compliance with the covenants included in the indenture governing the Notes as of
We may redeem the Notes prior to the maturity date based upon the following conditions: (1) prior toJuly 15, 2013 , we may redeem up to 35% of the original aggregate principal amount of the Notes, or$210,000 , with the proceeds of certain equity offerings at a redemption price of 111.375% of the aggregate principal amount of the Notes plus accrued and unpaid interest, (2) during, in each of the 12-month periods beginningJuly 15, 2011 ,July 15, 2012 , andJuly 15, 2013 , we may redeem up to 10% of the original aggregate principal amount of the Notes, or$60,000 , at a redemption price of 103% of the aggregate principal amount of the Notes plus accrued and unpaid interest, (3) on or afterJuly 15, 2014 , we may redeem all or any portion of the Notes during the 12-month periods commencingJuly 15, 2014 ,July 15, 2015 ,July 15, 2016 andJuly 15, 2017 and thereafter at a redemption price of 105.688%, 102.844%, 101.422% and 100%, respectively, of the aggregate principal amount of the Notes plus accrued and unpaid interest, and (4) prior toJuly 15, 2014 , we may redeem all or any portion of the Notes at a price equal to 100% of the aggregate principal amount of the Notes plus a make-whole premium and accrued and unpaid interest. Upon a change in control, the Note holders each have the right to require us to redeem their Notes at a redemption price of 101% of the aggregate principal amount of the Notes plus accrued and unpaid interest. In accordance with the indenture governing the Notes, we are required to make an offer to repurchase our Notes at 103% of the principal amount of the Notes with a portion of the net proceeds received from sale-leaseback transactions. Pursuant to these requirements, onDecember 1, 2011 , we commenced the Tender Offer to purchase up to$27,871 of the principal amount of our Notes at a redemption price of 103%, which expires onDecember 29, 2011 . In addition to the Tender Offer, onDecember 1, 2011 , the holders of the Notes were notified that CKE will redeem onJanuary 4, 2012 , conditioned in part on the results of the Tender Offer, up to$20,000 aggregate principal amount of the Notes outstanding onJanuary 4, 2012 at a redemption price of 103% pursuant to the terms of the indenture governing the Notes. Pursuant to the Redemption, the Notes to be redeemed will be reduced so that the total principal amount of Notes purchased in both the Tender Offer and Redemption will not exceed$30,000 .
OnMarch 14, 2011 ,CKE Holdings, Inc. issued$200,000 aggregate principal amount of senior unsecured PIK toggle notes dueMarch 14, 2016 (the "Parent Notes"). The net proceeds, after payment of offering expenses, were distributed to the corporate parent of Parent. The Parent Notes were issued with an original issue discount of 1.885%, or$3,770 . The interest on the Parent Notes, which will be paid semi-annually onMarch 15 andSeptember 15 of each year, can be paid (1) entirely in cash, at a rate of 10.50% ("Cash Interest"), (2) entirely by increasing the principal amount of the Parent Note or by issuing new notes for the entire amount of the interest payment, at a rate per annum equal to the cash interest rate of 10.50% plus 0.75% ("PIK Interest") or (3) with a 25%/75%, 50%/50% or 75%/25% combination of Cash Interest and PIK Interest. Parent paid theSeptember 15, 2011 interest payment entirely in PIK Interest. Parent will also pay theMarch 15, 2012 interest payment entirely in PIK Interest. During the twelve weeks endedNovember 7, 2011 , CKE purchased$9,948 principal amount of Parent Notes for$8,362 , which represents a weighted average price of 84.06% of the principal amount of the purchased Parent Notes. For accounting purposes, we have recorded our investment in Parent Notes as a reduction of stockholder's equity. See Note 7 of Notes to Condensed Consolidated Financial Statements included herein for further discussion. 37
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) We have not guaranteed the Parent Notes, nor have we pledged any of our assets or stock as collateral for the Parent Notes. The covenants included within the indenture governing our Notes and our Credit Facility are not directly impacted by the obligations ofCKE Holdings, Inc. Because the Parent Notes contain a PIK feature, the interest obligations can be added to the principal amount of the Parent Note and Parent has the ability to defer cash payments of interest throughMarch 14, 2016 . At or prior to maturity, we expect Parent will evaluate all available options for redemption of the Parent Notes, including refinancing the Parent Notes, receiving dividends, and other options. Our Credit Facility and indenture governing our Notes contain restrictive covenants which limit our ability to pay dividends to Parent.
Cash Flows
During the forty weeks endedNovember 7, 2011 , cash provided by operating activities totaled$90,997 , an increase of$56,151 from the comparable prior year period. This increase is primarily attributable to significant cash payments made during the prior year period for transaction related costs and the Predecessor interest rate swap agreements, partially offset by the impact of cash paid for interest related to the Notes during the forty weeks endedNovember 7, 2011 . Our working capital account balances, including accounts payable and other current and long-term liabilities, can vary significantly from quarter to quarter, depending upon the timing of large customer receipts, payments to vendors and semi-annual interest payments, and are not anticipated to be a significant source or use of cash over the long term. Cash used in investing activities during the forty weeks endedNovember 7, 2011 totaled$41,842 , which principally consisted of purchases of property and equipment of$44,440 , partially offset by$1,749 of proceeds from the sale of property and equipment.
Capital expenditures were as follows:
Successor/ Successor Predecessor Forty Forty Weeks Ended Weeks Ended November 7, 2011 November 1, 2010 Remodels: Carl's Jr. $ 2,698 $ 2,582 Hardee's 9,763 14,883 Capital maintenance: Carl's Jr. 9,671 8,479 Hardee's 10,406 11,749 New restaurants and rebuilds: Carl's Jr. 5,828 8,277 Hardee's 2,125 2,607 Dual-branding: Carl's Jr. 419 672 Hardee's 1,760 2,120 Real estate and franchise acquisitions 667 20 Corporate and other 1,103 914 Total $ 44,440 $ 52,303
Capital expenditures for the forty weeks ended
Cash used in financing activities during the forty weeks endedNovember 7, 2011 totaled$30,666 as compared to cash provided by financing activities during the forty weeks endedNovember 1, 2010 of$719,207 . During the forty weeks endedNovember 7, 2011 , we made payments of$49,370 in connection with the early extinguishment of$48,170 principal amount of our Notes. Additionally, we made payments of$8,362 to purchase$9,948 principal amount of Parent Notes and there was a net decrease in our bank overdraft of$6,767 . This usage was partially offset by the proceeds from financing method sale-leaseback transactions of$40,702 . During the forty weeks endedNovember 1, 2010 , we received proceeds from the issuance of Notes, net of discount, of$588,510 and equity contributions of$450,000 in connection with the Transactions. Additionally, we made net payments of$277,432 to fully repay our Predecessor term loan and borrowings under our Predecessor revolving credit facility during the forty weeks endedNovember 1, 2010 . 38
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
Critical Accounting Policies
Our reported results are impacted by the application of certain accounting policies that require us to make subjective or complex judgments. These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact our consolidated financial position and results of operations. See our Annual Report on Form 10-K for the year endedJanuary 31, 2011 for a description of our critical accounting policies. Specific risks associated with these critical accounting policies are described in the following paragraphs.
Impairment of Restaurant-Level Long-Lived Assets
In connection with analyzing restaurant-level long-lived assets to determine if they have been impaired, we make certain estimates and assumptions, including estimates of future cash flows, assumptions of future same-store sales and projected operating expenses for each of our restaurants over their estimated useful life in order to evaluate recoverability and estimate fair value. Future cash flows are estimated based upon experience gained, current intentions about refranchising restaurants and closures, recent and expected sales trends, internal plans, the period of time since the restaurant was opened or remodeled and other relevant information. If our future cash flows or same-store sales do not meet or exceed our forecasted levels, or if restaurant operating cost increases exceed our forecast and we are unable to recover such costs through price increases, the carrying value of certain of our restaurants may prove to be unrecoverable, and we may incur additional impairment charges in the future.
Impairment of Goodwill and Indefinite-Lived Intangible Assets
As ofNovember 7, 2011 , our goodwill consisted of$199,166 for our Carl's Jr. reporting unit and$9,719 for our Hardee's reporting unit. The goodwill for both reporting units resulted primarily from the Merger onJuly 12, 2010 . During the fourth quarter of fiscal 2011, we performed our goodwill impairment test for our Carl's Jr. and Hardee's reporting units. As of the date of the annual impairment test, the fair value of the Carl's Jr. and Hardee's reporting units exceeded their respective carrying values. In order to evaluate the sensitivity of the fair value calculation on the goodwill impairment test, we applied hypothetical decreases to the fair value of each reporting unit. We determined that hypothetical decreases in fair value of greater than 10% would be required before either reporting unit would have a carrying value in excess of its fair value. The excess of the fair value as compared to the carrying value is attributed primarily to the general improvement in financial markets between the date of the acquisition and the date of the impairment test. However, future declines in market conditions and the actual future performance of our reporting units could negatively impact the results of future impairment tests. As ofNovember 7, 2011 , our indefinite-lived intangible assets consisted of Carl's Jr. trademarks / tradenames of$144,000 and Hardee's trademarks / tradenames of$134,000 . During the fourth quarter of fiscal 2011, we performed our impairment test for trademarks / tradenames at both Carl's Jr. and Hardee's and concluded that no impairment charge was required. However, any future declines in our system-wide restaurant portfolio at either concept, declines in company-operated or franchised and licensed revenues or increases to the discount rate used in our impairment test could negatively impact the results of future impairment tests.
Estimated Liability for
In determining the amount of the estimated liability for closed restaurants, we estimate the cost to maintain leased vacant properties until the lease can be abated. If the costs to maintain properties increase, or it takes longer than anticipated to sublease or terminate leases, we may need to record additional estimated liabilities. If the leases on the vacant restaurants are not terminated or subleased on the terms that we used to estimate the liabilities, we may be required to record losses in future periods. Conversely, if the leases on the vacant restaurants are terminated or subleased on more favorable terms than we used to estimate the liabilities, we reverse previously established estimated liabilities, resulting in an increase in operating income.
Estimated Liability for
If we experience a higher than expected number of claims or the costs of claims rise more than the estimates used by management, developed with the assistance of our actuary, our reserves would require adjustment and we would be required to adjust the expected losses upward and increase our future self-insurance expense. 39
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Our actuary provides us with estimated unpaid losses for each loss category, upon which our analysis is based. As ofNovember 7, 2011 andJanuary 31, 2011 , our estimated liability for self-insured workers' compensation, general and auto liability losses was$39,452 and$39,581 , respectively.
Franchised and Licensed Operations
We have sublease agreements with some of our franchisees on properties for which we remain principally liable for the lease obligations. If sales trends or economic conditions deteriorate for our franchisees, their financial health may worsen, our collection rates may decline and we may be required to assume the responsibility for additional lease payments on franchised restaurants.
Income Taxes
When necessary, we record a valuation allowance to reduce our net deferred tax assets to the amount that is more likely than not to be realized. In considering the need for a valuation allowance against some portion or all of our deferred tax assets, we must make certain estimates and assumptions regarding future taxable income, the feasibility of tax planning strategies and other factors. Changes in facts and circumstances or in the estimates and assumptions that are involved in establishing and maintaining a valuation allowance against deferred tax assets could result in adjustments to the valuation allowance in future quarterly or annual periods. We use an estimate of our annual income tax rate to recognize a provision for income taxes in financial statements for interim periods. However, changes in facts and circumstances could result in adjustments to our effective tax rate in future quarterly or annual periods.
Significant Known Events, Trends, or Uncertainties Expected to Impact Fiscal 2012 Comparisons with Fiscal 2011
The factors discussed below impact comparability of operating performance for the twelve and forty weeks endedNovember 7, 2011 andNovember 1, 2010 , and for the remainder of fiscal 2012. Merger and Transactions In connection with the Transactions, we incurred significant additional indebtedness, including$600,000 of aggregate principal amount of senior secured second lien notes that bear interest at a rate of 11.375% per annum, payable semi-annually in arrears onJanuary 15 andJuly 15 . OnJuly 15, 2011 andOctober 4, 2011 , we redeemed$40,000 and$8,170 , respectively, of the aggregate principal amount of our Notes, reducing the outstanding aggregate principal amount of our Notes to$551,830 as ofNovember 7, 2011 . In addition, our Credit Facility provides for aggregate borrowings up to$100,000 in senior secured revolving facility loans, swingline loans and letters of credit. Immediately prior to the Transactions, our indebtedness was significantly less. The changes in our indebtedness have caused our interest expense to be significantly higher following the Transactions than experienced in periods prior to the Transactions. The acquisition ofCKE Restaurants, Inc. was accounted for as a business combination using the acquisition method of accounting, whereby the purchase price was allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair market values as ofJuly 12, 2010 . The fair value changes in our tangible and intangible assets acquired and liabilities assumed are expected to cause changes to our future operating results when compared to our historical results. The discussion and analysis of the Company's historical financial condition and results of operations covers periods prior to the Transactions. Accordingly, the discussion and analysis of such periods does not reflect the significant impact of the Transactions. 40
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
Sale-Leaseback Transactions
During the forty weeks endedNovember 7, 2011 , we entered into agreements with independent third parties under which we sold and leased back 29 restaurant properties. The initial minimum lease terms are 20 years, and the leases include renewal options and right of first offer provisions that, for accounting purposes, constitute continuing involvement with the associated restaurant properties. Due to this continuing involvement, these sale-leaseback transactions are accounted for under the financing method, rather than as completed sales. Under the financing method, we include the net sales proceeds received in other long-term liabilities until our continuing involvement with the properties is terminated, report the associated property as owned assets, continue to depreciate the assets over their remaining useful lives, and record the rental payments as interest expense. As ofNovember 7, 2011 , the net book value of the assets associated with these transactions was$31,825 . When and if our continuing involvement with a property terminates and the sale of that property is recognized for accounting purposes, we expect to record a gain equal to the excess of the net proceeds received over the remaining net book value of the associated restaurant property. As ofNovember 7, 2011 , the net proceeds received of$40,702 exceeded the net book value of the associated restaurant properties by$8,877 . We expect that we will sell and leaseback additional restaurant properties in future quarters; however, there can be no assurance as to the number of transactions we will be able to complete, the amount of proceeds we will generate or whether we will be able to complete additional sale-leaseback transactions at all. See Note 8 of Notes to Condensed Consolidated Financial Statements included herein for further discussion.
Sale of Carl's Jr. Distribution Center Assets
OnJuly 2, 2010 , we entered into an agreement to sell to MBM our Carl's Jr. Distribution Center assets. Simultaneously, onJuly 2, 2010 , we and our franchisees entered into distribution agreements with MBM to provide distribution services to our Carl's Jr. restaurants. As a result of the outsourcing of our Carl's Jr. distribution services, beginningJuly 2, 2010 , we no longer generate revenues and incur the related expenses associated with the Carl's Jr. distribution centers. Refer to further discussion of the Carl's Jr. operating segment included within our "Operating Review" section of Management's Discussion and Analysis. Fiscal Year and Seasonality We operate on a retail accounting calendar. Our fiscal year ends the last Monday in January and typically has 13 four-week accounting periods. The first quarter of our fiscal year has four periods, or 16 weeks. All other quarters generally have three periods, or 12 weeks. The fiscal year endedJanuary 31, 2011 contains 53 weeks, whereby the additional week was included in the fourth quarter. Our restaurant sales, and therefore our profitability, are subject to seasonal fluctuations and are traditionally higher during the spring and summer months because of factors such as increased travel upon school vacations and improved weather conditions, which affect the public's dining habits.
New Accounting Pronouncements Not Yet Adopted and Adoption of New Accounting Pronouncements
See Note 3 of Notes to Condensed Consolidated Financial Statements included herein for a description of new accounting pronouncements not yet adopted and the adoption of new accounting pronouncements.
Presentation of Non-GAAP Measures
We have included in this report measures of financial performance that are not defined by GAAP. Company-operated restaurant-level adjusted EBITDA, company-operated restaurant-level adjusted EBITDA margin and franchise restaurant adjusted EBITDA are non-GAAP measures utilized by management internally to evaluate and compare our operating performance for company-operated restaurants and franchised and licensed restaurants between periods. In addition, management believes that these financial measures provide useful information to potential investors and analysts because they provide insight into management's evaluation of our results of operations. Each of these non-GAAP financial measures is derived from amounts reported within our Condensed Consolidated Financial Statements, and the computations of each of these measures have been included within our "Operating Review" section of MD&A. 41
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
These non-GAAP measures should be viewed in addition to, and not in lieu of, the comparable GAAP measures. These non-GAAP measures have certain limitations including the following:
• Because not all companies calculate these measures identically, our presentation of such measures may not be comparable to similarly titled measures of other companies; • These measures exclude certain general and administrative and other operating costs, which should also be considered when assessing our operating performance; and
• These measures exclude depreciation and amortization, and although they
are non-cash charges, the assets being depreciated or amortized will often
have to be replaced and new investments made to support the operations of
our restaurant portfolio.
Company-Operated Restaurant-Level Non-GAAP Measures
We define company-operated restaurant-level adjusted EBITDA, which is expressed in dollars, as company-operated restaurants revenue less restaurant operating costs excluding depreciation and amortization expense and including advertising expense. Restaurant operating costs are the expenses incurred directly by our company-operated restaurants in generating revenues and do not include advertising costs, general and administrative expenses or facility action charges. We define company-operated restaurant-level adjusted EBITDA margin, which is expressed as a percentage, as company-operated restaurant-level adjusted EBITDA divided by company-operated restaurants revenue.
Franchise Restaurant Adjusted EBITDA
We define franchise restaurant adjusted EBITDA, which is expressed in dollars, as franchised and licensed restaurants and other revenue less franchised and licensed restaurants and other expense excluding depreciation and amortization expense.
Certain Financial Information of
OnMarch 14, 2011 ,CKE Holdings, Inc. issued$200,000 aggregate principal amount of 10.50%/11.25% senior unsecured PIK toggle notes dueMarch 14, 2016 . The net proceeds, after the payment of offering expenses, were distributed to the corporate parent of Parent. We have not guaranteed the obligations of Parent under the Parent Notes, nor have we pledged any of our assets or stock as collateral for the Parent Notes. The covenants included within the indenture governing our Notes and our Credit Facility are not directly impacted by the obligations ofCKE Holdings, Inc. During the twelve weeks endedNovember 7, 2011 , we purchased$9,948 principal amount of Parent Notes ("Purchased Parent Notes") for$8,362 , which represents a weighted average price of 84.06% of the principal amount of the Parent Notes. See Note 7 of Notes to Condensed Consolidated Financial Statements included herein for additional discussion. As ofNovember 7, 2011 , the principal amount of Parent's total long-term debt on a stand-alone basis was$211,313 , including the$9,948 principal amount of the Purchased Parent Notes. As ofNovember 7, 2011 , the carrying amount of Parent's total long-term debt on a stand-alone basis, including the current portion and the Purchased Parent Notes, was$207,789 , which is presented net of the unamortized portion of the original issue discount of$3,524 . During the twelve and forty weeks endedNovember 7, 2011 , Parent incurred interest expense on a stand-alone basis of$5,727 and$15,795 , respectively. Parent's consolidated interest expense was$23,032 and$75,311 during the twelve and forty weeks endedNovember 7, 2011 , respectively. Since the Purchased Parent Notes continue to be held by CKE,$110 of Parent's stand-alone interest expense, which is associated with the Purchased Parent Notes, has been eliminated in Parent's consolidated interest expense for both the twelve and forty weeks endedNovember 7, 2011 . 42
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Table of ContentsCKE RESTAURANTS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) Forward Looking Statements This Quarterly Report on Form 10-Q includes statements relating to future plans and developments, financial goals and operating performance that are based on our current beliefs and assumptions. These statements constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties that are often difficult to predict, are beyond our control, and which may cause results to differ materially from expectations. Factors that could cause our results to differ materially from those described include, but are not limited to, our ability to compete with other restaurants, supermarkets and convenience stores for customers, employees, restaurant locations and franchisees; changes in consumer preferences, perceptions and spending patterns; changes in food, packaging and supply costs; the ability of our key suppliers to continue to deliver premium-quality products to us at moderate prices; our ability to successfully enter new markets, complete construction of new restaurants and complete remodels of existing restaurants; changes in general economic conditions and the geographic concentration of our restaurants, which may affect our business; our ability to attract and retain key personnel; our franchisees' willingness to participate in our strategy; the operational and financial success of our franchisees; the willingness of our vendors and service providers to supply us with goods and services pursuant to customary credit arrangements; risks associated with operating in international locations; the effect of the media's reports regarding food-borne illnesses, food tampering and other health-related issues on our reputation and our ability to procure or sell food products; the seasonality of our operations; the effect of increasing labor costs including healthcare related costs; our ability to comply with existing and future health, employment, environmental and other government regulations; our ability to adequately protect our intellectual property; the potentially conflicting interests of our sole stockholder and our creditors; our substantial leverage, which could limit our ability to raise capital, react to economic changes or meet obligations under our indebtedness; the effect of restrictive covenants in our indenture and credit facility on our business; and other factors as discussed under the heading "Risk Factors" in our Annual Report on Form 10-K, which was filed with theSEC onApril 15, 2011 , and in our other filings with theSEC .
You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly update or revise any forward looking statement, whether as a result of new information, future events or circumstances arising after the date of this report, except as required by law.
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