ITEM 1. BUSINESS
Upon its formation in 1981, The Hallwood Group Incorporated ("Hallwood" or the "Company") (NYSE:HWG) became engaged in the ownership, operation and management of the real estate portfolios of its corporate predecessors and in the merchant banking business, specializing in assisting troubled companies to implement plans of financial restructuring. After 1981, the Company disposed of a substantial portion of its initial real estate portfolio and significantly expanded the range of its merchant banking activities. The Company has acquired substantial investment positions in a number of previously unaffiliated enterprises and has thereby become a diversified holding company engaged in three principal activities: asset management, operating subsidiaries and investments in associated companies. The Company, its operating subsidiaries and associated company are currently engaged in the commercial and industrial real estate, energy, textile products, hotel and restaurant businesses. For financial reporting purposes, Hallwood considers itself to operate in five business segments: real estate, energy, textile products, hotels and restaurants. The Company is no longer engaged in the merchant banking business, other than in connection with the businesses in which its operating subsidiaries or associated company are engaged. Financial information for each industry segment in which the Company operates is set forth in Note 19 to the Company's consolidated financial statements.
Asset Management. The Company's asset management division consists of real estate and energy business segments.
Real Estate. Real estate activities are conducted primarily through the Company's wholly-owned subsidiaries, Hallwood Realty Corporation ("HRC") and Hallwood Management Company ("HMC"). In addition, the Company's wholly-owned Hallwood Investment Company subsidiary owns and operates an office-retail property in the United Kingdom. HRC is the sole general partner of Hallwood Realty Partners, L.P. ("HRP"), a publicly-traded real estate master limited partnership (AMEX:HRY). HRC owns a 1% general partnership interest and Hallwood owns a 5% limited partnership interest in HRP. HRC is responsible for asset management, financing, acquiring and disposing of HRP properties as it deems appropriate. In addition, HRC provides general operating and administrative services to HRP. HRP owns 11 commercial properties, of which 7 are office building properties and 4 are industrial park properties. HMC was formed in June 1991 and acquired the rights under the property management agreements related to the HRP properties. HMC is responsible for on-site property management and receives various fees for the managing and leasing of such properties. See Note 13 to the Company's consolidated financial statements.
The Company also has an investment in a mortgage loan portfolio secured by residential lots and condominiums. The carrying value of this portfolio continues to decline due to normal loan amortization and early loan payoffs. The portfolio is substantially pledged to collateralize a term loan on the Lido Beach Holiday Inn hotel.
In fiscal 1994, real estate accounted for 4% of the Company's total revenues, compared to 6% in fiscal 1993 and 5% in fiscal 1992.
Energy. Energy operations were established in May 1990, when the Company increased its common stock ownership of Hallwood Energy Corporation ("HEC") (AMEX:HWEC) from 11% to 53%, through the conversion of its preferred stock into common stock and the purchase of additional common stock. Since May 1990, HEC has been accounted for as a consolidated subsidiary of the Company. As a result of HEC's subsequent purchases of its own stock for treasury, the Company's percentage ownership of HEC's common stock has increased to 70%. See Note 14 to the Company's consolidated financial statements.
HEC is engaged in the development, production and sale of oil and gas, and in the acquisition, exploration, development and operation of additional oil and gas properties. HEC is the sole general partner of Hallwood Energy Partners, L.P. ("HEP"), a publicly-traded oil and gas master limited partnership (AMEX:HEP), and conducts substantially all of its operations through HEP. At July 31, 1994, HEC owned an approximate 12% partnership interest in HEP (including general and limited partnership interests). In addition, HEP is the general partner of several other affiliated partnerships and a 40% stockholder in Hallwood Consolidated Resources Corporation (NASDAQ: HCRC), a publicly-traded oil and gas company.
HEC accounts for its ownership of HEP using the proportionate consolidation method, whereby HEC records its proportional share of HEP's revenues and expenses, current assets, current liabilities, noncurrent assets, long-term obligations and fixed assets.
In fiscal 1994, energy accounted for 6% of the Company's total revenues, compared to 7% in fiscal 1993 and 6% in fiscal 1992.
Operating Subsidiaries. The Company's operating subsidiaries division consists of textile products and hotels business segments.
Textile Products. Textile products operations are conducted through the Company's wholly-owned Brookwood Companies Incorporated ("Brookwood") subsidiary. Brookwood is a complete textile service firm that develops and produces innovative fabrics and related products through specialized finishing, treating and coating processes. See Note 15 to the Company's consolidated financial statements.
In fiscal 1994, textile products accounted for 67% of the Company's total revenues, compared to 60% in fiscal 1993 and 62% in fiscal 1992.
Hotels. Hotel operations are conducted through the Company's wholly-owned, The Lido Beach Hotel, Inc., Hallwood Hotels, Inc. ("Hallwood Hotels") and Hallwood-Integra Holding Company, Inc. ("Integra Hotels") subsidiaries, and consist of: (i) a fee interest in the Lido Beach Holiday Inn, Sarasota, Florida, which the Company purchased from Integra-A Hotel and Restaurant Company ("Integra") in December 1989 (the "Lido Beach Property"); (ii) leasehold interests in two other hotel properties, the Longboat Key Holiday Inn, Sarasota, Florida (the "Longboat Key Property"), and the Embassy Suites, Oklahoma City, Oklahoma, both of which were purchased from Integra in June 1991 and; (iii) a fee interest in a Residence Inns by Marriott, Inc. in Tulsa, Oklahoma, leasehold interests in two Residence Inns by Marriott, Inc. in Greenville, South Carolina and Huntsville, Alabama, two management contracts and other hotel-related assets acquired by the newly-formed Integra Hotels subsidiary upon consummation of Integra's Amended Plan of Reorganization in March 1994.
The hotels are operated under license agreements with Holiday Inns Franchising, Inc., Embassy Suites, Inc. and Residence Inn by Marriott, Inc. The license agreements permit the licensor to prescribe, at such times as it determines, standards for the operation and maintenance of the various properties and their furnishings, equipment and facilities. Substantial capital expenditures may be required from time to time to comply with license standards. During the last three fiscal years approximately $4,000,000 in capital expenditures was invested in hotel properties.
In fiscal 1994, hotel revenues accounted for 20% of the Company's total revenues, compared to 15% in fiscal 1993 and 17% in fiscal 1992. For those hotels owned by the Company for a full year in fiscal 1993, combined hotel revenues increased by 0.9% and the average daily room rate increased by 6.4% during fiscal 1994.
Associated Companies. Hallwood's investment in associated companies consists of its 15% common stock investment in ShowBiz Pizza Time, Inc. ("ShowBiz")(NASDAQ:SHBZ). The Company formerly had investments in Oakhurst Capital, Inc. ("Oakhurst") (NASDAQ:OAKC) and Integra.
ShowBiz operates a system of 330 Chuck E. Cheese's and ShowBiz Pizza children's specialty restaurants, of which 224 are company-operated. The Company sold 425,000 ShowBiz shares during fiscal 1993 for $13,500,000 resulting in a $9,705,000 gain. The latest financial statements of ShowBiz are also included elsewhere in this document. The Company accounts for ShowBiz on the equity basis.
The Company formerly owned a 15% interest in Oakhurst (20% assuming exercise of warrants) which, through its Steel City Products, Inc. ("Steel City") subsidiary (NASDAQ:SCPI), supplies automotive products and accessories to independent retailers. In February 1994, the Company completed a cash sale of its entire investment for $1,250,000, resulting in a gain of $30,000.
The Company formerly owned a 24% interest (39% assuming exercise of warrants) in Integra. The Company resolved to dispose of its Integra investment in July 1990 and reclassified it as an asset held for sale for financial reporting purposes. In connection with the planned disposition and in anticipation of a successful restructuring of Integra, the Company provided additional financing to Integra; however, the continuation of the recession resulted in a deterioration of Integra's financial position, and eventually its July 14, 1992 chapter 11 bankruptcy protection filing.
On October 5, 1993, Integra filed a first amended plan of reorganization (the "Plan") and disclosure statement. The Plan, which was confirmed by the bankruptcy court on February 11, 1994, incorporated a settlement agreement by and between Integra, the Company, the Unsecured Creditors' Committee and others (the "Settlement") and a supplemental settlement agreement by and between Integra, the Unsecured Creditors' Committee, and the plaintiffs in the Reese lawsuit (the "Supplemental Settlement"). The Plan and Settlement provided for the reorganized Integra to continue in business as a wholly-owned subsidiary of the Company under its new name, Integra Hotels, Inc.
On March 8, 1994, all of Integra's common and preferred stock was cancelled and new common stock of Integra Hotels, Inc. was issued to Hallwood-Integra Holding Company Incorporated, a newly-incorporated, wholly owned subsidiary of the Company, for $1,000,000. Integra Hotels, Inc. paid the administrative and priority tax claims of the bankruptcy case and funded a trust for the unsecured creditors, by transferring the $1,000,000 and all potential litigation claims which Integra may have had against the Company and certain others to the trust. The cash and claims were transferred in full satisfaction of the claims of all of Integra's unsecured creditors.
Pursuant to the Settlement and Supplemental Settlement, the trust released all of the transferred claims which relate to the Company and certain related parties, for an immediate payment from the Company to the trust of $9,000,000, consisting of $5,000,000 in cash and a $4,000,000 note secured by 344,828 shares of ShowBiz stock. The Supplemental Settlement resolved a dispute and allowed the bankruptcy court to enter an order that determined that Integra is the owner and holder of certain claims described in the Settlement as "Core Claims", (which Core Claims have been asserted in certain state court proceedings identified as the Reese, European American and Hermitage Hotel lawsuits). As a consequence, all Core Claims pending against the Company in existing or future litigation, or asserted against the Company in the future, are released and permanently enjoined by the Plan and the order confirming the Plan.
In fiscal 1994, associated companies accounted for 1% of the Company's revenues, compared to 11% in fiscal 1993 and 8% in fiscal 1992.
Competition. The Company's real estate operations are subject to competition from other entities, many of which have more experience and substantially greater financial resources.
The energy industry is highly competitive. Major oil and gas companies, independent drilling and production programs and individual producers and operators are active bidders for oil and gas properties, as well as for the equipment and labor required to operate such properties. The market for oil and gas depends on a number of factors, including the level of domestic production, pace of the general economy, supply of imported oil and gas, actions of foreign oil-producing nations and the extent of governmental regulation and taxation.
Textile products operations encounter competition in all regions in which they are conducted. In the volume areas of the textile business, competition is sometimes based on price, particularly during a soft economy.
Hotel operations are subject to competition from similar types of properties in the vicinities in which they are located. In the current economic climate, the sale of hotels may be impacted by the inability of prospective purchasers to obtain equity capital or suitable financing.
The business of the Company's ShowBiz associated company is subject to competition from other restaurant chains operating in the same marketplace with substantially greater financial resources.
Environmental Compliance. A number of jurisdictions in which the Company operates have adopted laws and regulations relating to environmental matters. Such laws and regulations may require the Company to secure governmental permits and approvals and undertake measures to comply therewith. Compliance with the requirements imposed may be time-consuming and costly. While environmental considerations, by themselves, have not materially affected the Company's business to date or that of its associated companies, it is possible that such considerations may have a material and adverse impact in the future. The Company actively monitors its environmental compliance, and is currently not aware of any material compliance issues.
Number of Employees. The Company had 1,152 and 926 employees as of September 30, 1994 and 1993, respectively, comprised as follows:
A substantial portion of the salaries and related costs of HEC, HMC and HRC employees are reimbursed by the respective energy and real estate Partnership Affiliates.
ITEM 2.
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Second Quarter 1994 Compared to Second Quarter 1993
Revenues for the second quarter of 1994 decreased 1.0% to $64.0 million from $64.7 million in the second quarter of 1993 due to the sale of the Company's Monterey's Tex-Mex Cafe restaurants effective May 5, 1994. Revenue generated by the Company's Chuck E. Cheese's restaurants increased to $62.5 million in the second quarter of 1994 from $59.8 million in 1993 due to the net addition of six Company restaurants in the first six months of 1994 and 33 Company restaurants in 1993. Comparable store sales from the Company's Chuck E. Cheese's restaurants for the quarter ended July 1, 1994 declined by 4.5% from the comparable period of the prior year. Revenues from the Company's Monterey's Tex-Mex Cafe restaurants were $1.5 million in the second quarter of 1994 compared to $4.9 million in the second quarter of 1993.
Operating income decreased to $2.5 million in the second quarter of 1994 from $3.0 million in the second quarter of 1993. Included in operating income is a gain of $5.5 million related to the sale of the Company's Monterey's Tex-Mex Cafe restaurants and a $1.9 million loss associated with the valuation of fixed assets used in certain Chuck E. Cheese's restaurants. The decline in operating income is primarily due to the decline in comparable store sales and operating margins in the Company's Chuck E. Cheese's restaurants. A material portion of operating costs are fixed resulting in an erosion of operating margins at lower sales levels.
A summary of the results of operations of the Company as a percentage of revenues for the two quarters is shown below.
Revenues
Revenues from the Company's Chuck E. Cheese's restaurants increased by 4.6% to $62.5 million in the second quarter of 1994 from $59.8 million in the second quarter of 1993 primarily due to new restaurant development which occurred throughout 1993 and the first six months of 1994. Comparable store sales of such restaurants which were open during all of the second quarters of both 1994 and 1993 declined by 4.5% between the two periods. Menu prices were not increased between the two periods.
Management believes that several factors may have contributed to the comparable store sales decline including increased competition and to a lesser extent, a decrease in the number of restaurants remodeled since 1992 and the impact of newly opened restaurants on comparable store sales of existing restaurants in certain markets. Some of the factors impacting comparable store sales are believed to be negatively impacting sales volumes of newer restaurants opened since 1990. During the second quarter of 1994, the average sales volume of the 70 new Chuck E. Cheese's restaurants opened in 1991 through 1993 was 3.3% lower than the average sales volume of existing restaurants during the same period.
Revenues from the Company's Monterey's Tex-Mex Cafe restaurants were $1.5 million in the second quarter of 1994 compared to $4.9 million in the second quarter of 1993 due to the sale of substantially all of the assets of the Monterey's Tex-Mex Cafe restaurants on May 5, 1994.
Costs and Expenses
Costs and expenses as a percentage of revenues increased to 96.0% in the second quarter of 1994 from 95.4% in the second quarter of 1993.
Cost of sales increased as a percentage of revenues to 51.8% in the second quarter of 1994 from 51.2% in the comparable period of 1993. Cost of food, beverage, prize and merchandise items for Chuck E. Cheese's restaurants as a percentage of restaurant sales increased to 18.5% in the second quarter of 1994 from 18.3% in the second quarter of 1993 primarily due to an increase in costs relating to the enhancement of certain prize and merchandise items. Labor expenses for Chuck E. Cheese's restaurants as a percentage of restaurant sales increased to 30.3% during the second quarter of 1994 from 29.5% in the second quarter of 1993 primarily due to the decline in the comparable store sales.
Selling, general and administrative expenses as a percentage of revenues increased to 19.1% in the second quarter of 1994 from 16.2% in the comparable period of 1993 primarily due to increased advertising expense as a percentage of revenues. Corporate overhead costs were impacted by an increase of approximately $384,000 as a result of increasing the number of operational regional and district managers to provide a more concentrated focus on guest satisfaction.
Depreciation and amortization expenses as a percentage of revenues increased to 9.6% in the second quarter of 1994 from 8.9% in the second quarter of 1993 primarily due to higher depreciation and amortization expense of new restaurants relative to older restaurants and the decline in comparable store sales.
Other operating expenses increased as a percentage of revenues to 21.0% in the second quarter of 1994 from 18.9% in the second quarter of 1993 primarily due to increased rent and utility costs as a percentage of revenues and the decline in comparable store sales.
The Company had a net gain on property transactions of $3.5 million in the second quarter of 1994 compared to a loss on property transactions of $114,000 in the second quarter of 1993. In the second quarter of 1994, the Company recognized a gain of $5.5 million from the sale of substantially all of the assets of its Monterey's Tex-Mex Cafe restaurants on May 5, 1994. The gain was partially offset by a loss of approximately $1.9 million in the second quarter of 1994. The loss was a result of the Company's decision to close one Chuck E. Cheese's restaurant and the decline in fair value of the fixed assets of eight Chuck E. Cheese's restaurants due to the Company's decision not to renew the leases as a result of the deterioration of site characteristics. The Company will consider possible relocation of some of the restaurants. The Company provided for an additional loss on property transactions of approximately $100,000 in the second quarter of 1994 compared to $114,000 in the second quarter of 1993 due to the replacement of certain assets in conjunction with the enhancement of facilities and entertainment packages of restaurants.
Operating Income
As a result of the changes in revenues and expenses discussed above, the Company had operating income of $2.5 million in the second quarter of 1994 compared to $3.0 million in the second quarter of 1993. Included in operating income are the operations of Monterey's Tex-Mex Cafe restaurants through May 5, 1994. Operating income in the second quarter of 1994 for Monterey's Tex-Mex Cafe restaurants was $5.6 million, including a gain on property transactions of $5.5 million, compared to operating income of $260,000 in the second quarter of 1993.
Net Income
Interest expense increased to $430,000 in the second quarter of 1994 from $169,000 in the second quarter of 1993 due primarily to an increase in long-term debt of $24 million since the second quarter of 1993 primarily to fund the Company's repurchase of its common stock. The Company's net income decreased to $1.2 million in the second quarter of 1994 from $1.8 million in the second quarter of 1993 due to the changes in revenues and expenses discussed above. The Company's primary and fully diluted earnings per share decreased to $.10 per share in the second quarter of 1994 from $.13 per share in the second quarter of 1993.
First Six Months of 1994 Compared to First Six Months of 1993
Revenues increased 1.7% to $140.4 million in the first six months of 1994 from $138.1 million in the comparable period of 1993. Revenue generated by the Company's Chuck E. Cheese's restaurants increased by 4.4% to $134.2 million in the first six months of 1994 from $128.5 million in the first six months of 1993 due to the net addition of six Company restaurants in the first six months of 1994 and 33 Company restaurants in 1993. Comparable store sales from the Company's Chuck E. Cheese's restaurants declined 7.0% between the periods. Revenues from the Company's Monterey's Tex-Mex Cafe restaurants declined to $6.2 million in the first six months of 1994 from $9.6 million in the first six months of 1993 due to the sale of substantially all of the assets of the Company's Monterey's Tex-Mex Cafe restaurants on May 5, 1994.
Operating income decreased to $8.3 million in the first six months of 1994 from $13.8 million in the first six months of 1993. Included in operating income is a gain of $5.5 million related to the sale of the Company's Monterey's Tex-Mex Cafe restaurants and a $1.9 million loss associated with the valuation of fixed assets used in certain Chuck E. Cheese's restaurants. The decline in operating income is primarily due to the decline in comparable store sales and operating margins in the Company's Chuck E. Cheese's restaurants. A material portion of operating costs are fixed resulting in an erosion of operating margins at lower sales levels.
A summary of the results of operations of the Company as a percentage of revenues for the six month periods is shown below.
Revenues
Revenues from the Company's Chuck E. Cheese's restaurants increased by 4.4% to $134.2 million in the first six months of 1994 from $128.5 million in the first six months of 1993 primarily due to new restaurant development which occurred throughout 1993 and the first six months of 1994. Comparable store sales of such restaurants which were open during all of the first six months of both 1994 and 1993 declined by 7.0% between the two periods. Menu prices were increased approximately .2% between the two periods.
Management believes that several factors may have contributed to the comparable store sales decline including increased competition and to a lesser extent, a decrease in the number of restaurants remodeled since 1992; the impact of newly opened restaurants on comparable store sales of existing restaurants in certain markets; and an ineffective advertising campaign that was replaced with a new advertising campaign effective February 1994. Some of the factors impacting comparable store sales are believed to be negatively impacting sales volumes of newer restaurants opened since 1990. During the first six months of 1994, the average sales volume of the 70 new Chuck E. Cheese's restaurants opened in 1991 through 1993 was 1.3% lower than the average sales volume of existing restaurants during the same period.
Revenues from Monterey's Tex-Mex Cafe restaurants were $6.2 million in the first six months of 1994 compared to $9.6 million in the first six months of 1993 due to the sale of substantially all of the assets of the Company's Monterey's Tex-Mex Cafe restaurants on May 5, 1994.
Costs and Expenses
Costs and expenses as a percentage of revenues increased to 94.1% in the first six months of 1994 from 90.0% in the first six months of 1993.
Cost of sales increased as a percentage of revenues to 50.7% in the first six months of 1994 from 49.4% in the comparable period of 1993. Cost of food, beverage, prize and merchandise items for Chuck E. Cheese's restaurants as a percentage of restaurant sales increased to 18.3% in the first six months of 1994 from 17.8% in the first six months of 1993 primarily due to an increase in cheese costs and in costs relating to the enhancement of certain prize and merchandise items. Labor expenses for Chuck E. Cheese's restaurants as a percentage of restaurant sales increased to 29.1% during the first six months of 1994 from 28.3% in the first six months of 1993 primarily due to the decline in the comparable store sales.
Selling, general and administrative expenses as a percentage of revenues increased to 17.3% in the first six months of 1994 from 15.3% in the comparable period of 1993 primarily due to increased advertising expense as a percentage of revenues. Corporate overhead costs were impacted by an increase of approximately $700,000 as a result of increasing the number of operational regional and district managers to provide a more concentrated focus on guest satisfaction.
Depreciation and amortization expenses as a percentage of revenues increased to 8.9% in the first six months of 1994 from 8.1% in the comparable period of 1993 primarily due to higher depreciation and amortization expense of new restaurants relative to older restaurants and the decline in comparable store sales.
Other operating expenses increased as a percentage of revenues to 19.7% in the first six months of 1994 from 17.1% in the first six months of 1993 primarily due to increased rent, insurance and utility costs as a percentage of revenues and the decline in comparable store sales.
The Company had a net gain on property transactions of $3.5 million in the first six months of 1994 compared to a loss on property transactions of $115,000 the first six months of 1993. In the first six months of 1994, the Company recognized a gain of $5.5 million from the sale of substantially all of the assets of its Monterey's Tex-Mex Cafe restaurants on May 5, 1994. The gain was partially offset by a loss of approximately $1.9 million in the first six months of 1994. The loss was a result of the Company's decision to close one Chuck E. Cheese's restaurant and the decline in fair value of the fixed assets of eight Chuck E. Cheese's restaurants due to the the Company's decision not to renew the leases as a result of the deterioration of site characteristics. The Company will consider possible relocation of some of the restaurants. The Company provided for an additional loss on property transactions of approximately $100,000 compared to $115,000 in the first six months of 1993 due to the replacement of certain assets in conjunction with the enhancement of facilities and entertainment packages of restaurants.
Operating Income
As a result of the changes in revenues and expenses discussed above, operating income declined to $8.3 million in the first six months of 1994 from $13.8 million in the first six months of 1993. Included in operating income are the operations of Monterey's Tex-Mex Cafe restaurants through May 5, 1994. Operating income in the first six months of 1994 for Monterey's Tex-Mex Cafe restaurants was $5.9 million, including a gain on property transactions of 5.5 million, compared to $485,000 in the first six months of 1993.
Net Income
Interest expense increased to $792,000 in the first six months of 1994 from $348,000 in the first six months of 1993 due primarily to an increase in long-term debt of $24 million since the second quarter of 1993 primarily to fund the Company's repurchase of its common stock. The Company's net income decreased to $4.7 million in the first six months of 1994 from $8.4 million in the first six months of 1993 due to the changes in revenues and expenses discussed above. The Company's primary and fully diluted earnings per share decreased to $.37 per share in the first six months of 1994 from $.60 per share in the first six months of 1993.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operations decreased to $18.3 million in the first six months of 1994 from $26.1 million in the comparable period of 1993. The Company's primary requirements for cash relate to planned capital expenditures and debt service.
During the first six months of 1994, the Company made approximately $15.4 million in capital expenditures related to the opening of seven new Chuck E. Cheese's restaurants and the enhancement of facilities and entertainment packages of ten restaurants. The Company plans to make additional capital expenditures of approximately $14 million during the remainder of 1994 primarily related to the construction of approximately six new Chuck E. Cheese's restaurants and the enhancement of existing facility and entertainment packages at a total of 30 Chuck E. Cheese's restaurants. In the event certain site characteristics considered essential for the success of a restaurant deteriorate, the Company will consider relocating the restaurant to a more desirable site or closing the restaurant.
The Company previously announced that it planned to repurchase shares of the Company's common stock at an aggregate purchase price of up to $30 million. As of July 1, 1994, the Company had repurchased shares of its common stock in the open market for an aggregate purchase price of approximately $24.8 million. The Company has purchased treasury shares up to the limit permitted under its revolving loan agreement and intends to use its future cash flow for new store development and the enhancement of existing facility and entertainment packages. The Company expects that it will satisfy its capital expenditure and debt service requirements from cash provided by operations and funds available under its revolving loan agreement.
The Company's revolving loan agreement was amended effective July 1994 to provide the Company with a credit line of up to $32 million which declines by $100,000 each month beginning on January 31, 1995 and is due on January 31, 1996. Available borrowings under the credit line are reduced by outstanding letters of credit which totaled $1.5 million at July 1, 1994. The revolving loan agreement previously provided for borrowings up to $50 million through 1997. The interest rate payable under the revised loan agreement was increased by 50 basis points over prior levels. The Company is required to comply with certain financial ratio tests during the term of the revolving loan agreement.
The Company believes that the success of its facility and entertainment enhancement program in addition to new restaurant development will continue to be significant factors in its ability to generate increased revenues over the foreseeable future. The Company plans to open approximately 25 new Chuck E. Cheese's restaurants in 1994 and 1995, with approximately 13 of such restaurants to be opened in 1994. If the decline in comparable store sales of the Company's Chuck E. Cheese's restaurants experienced in 1993 and the first six months of 1994 continue to be experienced over the longer term, an adverse impact on the Company's operating margins and results of operations could continue.
The Company is implementing several strategies designed to strengthen the sales vitality of its existing unit base in what management believes will become an increasingly competitive market. The Company has appointed a new advertising agency; accelerated its commitment of capital to existing stores; increased the number of its operational regional and district managers to provide a more concentrated focus on guest satisfaction; and is limiting its 1994 new unit development to approximately 13 new stores in order to ensure that new unit growth and the sales vitality of the Company's existing unit base are both given equal priority. The Company believes that certain operating costs will increase as a result of implementing these strategies designed to strengthen existing unit sales.
The Company is involved in a number of lawsuits. The Company presently believes that it will continue to incur expense to defend against and resolve such litigation, and anticipates that it will satisfy such expense with cash flow from operations.
The Company believes it will realize substantial benefit from utilization of approximately $73 million in net operating loss carryforwards to reduce its federal income tax liability. Such net operating loss carryforwards expire from years 1999 through 2002. Although the use of such carryforwards could, under certain circumstances, be limited, the Company is presently unaware of the occurrence of any event which would result in the imposition of such limitation. The Company has adopted an amendment to its Restated Articles of Incorporation which is intended to prevent changes in ownership of its common stock that would cause such limitation. In addition, the Company has investment tax credit, job tax credit and alternative minimum tax credit carryforwards of approximately $7 million expiring from years 1997 through 2008. Tax credit carryforwards can be utilized by the Company only after all net operating loss carryforwards have been realized. If the Company's results of operations continue to decline, a portion of the net operating loss and tax credit carryforwards could expire prior to utilization resulting in a charge against income.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
In December 1991, the Company, The Hallwood Group Incorporated ("Hallwood"), Integra-A Hotel and Restaurant Company ("Integra"), and their individual directors were named defendants in two separate but related lawsuits brought in the 14th and 134th District Courts of Dallas County, Texas. In April 1993, the Company and its two directors who are also employees of the Company, were dismissed as defendants in the lawsuit brought in the 134th District Court by an Integra common stockholder. Integra owned approximately 90% of the outstanding Common Stock of the Company prior to Integra's distribution of such Common Stock in December 1988 (the "1988 Distribution") to its shareholders of record. The plaintiffs in the remaining lawsuit constitute certain holders of warrants, options and preferred stock of Integra who seek to serve as representatives of proposed classes of other holders of such securities. The plaintiffs allege that the Company has (i) violated Texas statutes related to securities fraud and the fraudulent transfer of assets, (ii) committed common law fraud, and (iii) breached fiduciary and other duties to the plaintiffs. As amended, this suit seeks rescission of the 1988 Distribution, actual damages in excess of $184 million, and punitive damages in excess of $500 million. In May 1993, further action in this case was abated by order of the Court pending the resolution of disciplinary proceedings in process against the plaintiffs' counsel in a separate court action in Dallas County, Texas. The Company believes that the claims made against it in this suit are without merit and intends to vigorously defend against such claims.
In July 1992, Integra sought protection from its creditors under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court ("Bankruptcy Court") in Denver, Colorado (the "Integra Bankruptcy"). Integra, its Bankruptcy Court-appointed Unsecured Creditors Committee, Hallwood and other parties including certain of the Company's officers and directors and the individual plaintiffs in the lawsuit discussed above, are parties to either one or both Settlement Agreements (the "Settlement Agreements") in conjunction with a modified plan of reorganization of Integra approved by the Bankruptcy Court in February 1994. One of the Settlement Agreements provides for the creation of a trust to which certain claims of Integra are to be transferred. The trust will retain the right to investigate, compromise or adjudicate the claims transferred from Integra against defendants other than the parties released under the Settlement Agreements. The Company and many of its shareholders are not parties to the Settlement Agreements.
In April 1993, the Company, Hallwood and certain directors of the Company individually were named as defendants in a lawsuit brought in the 68th District Court of Dallas County, Texas, by Hermitage Hotel, Ltd., L.P. claiming to be an unsecured creditor of Integra and seeking to serve as a representative of a class of all unsecured creditors of Integra. In November 1993, the Court entered an order closing the lawsuit in light of the pending Integra bankruptcy. In May 1994, Hermitage Hotel, Ltd., L.P. filed a new lawsuit against the same defendants in the 101st District Court of Dallas County, Texas. No longer filed as a class action, the new lawsuit seeks recovery on behalf of plaintiff under theories of successor liability, tortious interference with contract, fraud, negligent misrepresentation and breach of contract. The plaintiff is seeking approximately $10.2 million in actual damages, $30 million in exemplary damages, attorneys fees and court costs. The Company believes this lawsuit is without merit and intends to vigorously defend this lawsuit.
In June 1993, the Company was named as a nominal defendant in a shareholders' derivative action in the 68th Judicial District Court in Dallas County, Texas in which three of the Company's executive officers, four of the Company's outside directors and Hallwood were named defendants. The plaintiffs in this lawsuit have alleged the individual defendants (i) breached their fiduciary duties to stockholders, (ii) committed constructive fraud and (iii) unjustly enriched themselves as a result of alleged violations of federal securities laws and illegal insider trading between July 13, 1992 and June 11, 1993. The Company does not believe that this action will result in any significant damages to the Company.
In July, 1993, the Company was named a defendant in a lawsuit brought in the Circuit Court for Davidson County, Nashville, Tennessee by Third National Bank in Nashville, as Trustee pursuant to a municipal bond issuance of $6.4 million made in 1980, for which Integra executed a guaranty. The plaintiff alleged that Integra's guaranty of the municipal bond issuance was binding on successors of Integra and that the Company is the legal successor to Integra. The plaintiff sought to recover a judgment against the Company in the full amount of its claim against Integra, which is unspecified, as well as attorneys' fees and costs. In April 1994, the Court dismissed the plaintiff's complaint for failure to state a claim upon which relief can be granted. Plaintiff has filed a notice of appeal. The Company believes the allegations made in this suit to be without merit and will offer a vigorous defense in this lawsuit.
In January 1994, the Company was named a defendant in a lawsuit brought in the Supreme Court of the State of New York, County of Queens, by Big Six Towers, Inc., in its purported capacity as a landlord to the Company with regard to a restaurant/entertainment center location in Queens County, New York which the Company had contracted to lease from the plaintiff. The plaintiff has alleged that the Company has breached the lease and is seeking total damages in excess of $4.0 million against the Company. The Company believes it validly terminated the lease in question pursuant to an agreement with the plaintiff and believes the allegations made in this suit to be without merit and therefore intends to vigorously defend this lawsuit.
Certain other pending legal proceedings exist against the Company which the Company believes are not material in amount or have arisen in the ordinary course of its business.
Item 2. Changes in Securities.
None to report during quarter for which this report is filed.
Item 3.
Item 3. Defaults Upon Senior Securities.
None to report during quarter for which this report is filed.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
On June 2, 1994, at the Company's annual meeting of shareholders, the Company's shareholders re-elected J. Thomas Talbot (10,314,172 shares in favor and 207,901 shares against) and Brian M. Troup (10,312,925 shares in favor and 209,148 shares against) as Class III Directors. Richard M. Frank, Michael H. Magusiak, Anthony J. Gumbiner, Charles A. Crocco, Jr. and Robert L. Lynch also continue to serve as Directors. No other matters were voted upon by the shareholders at such meeting.
Item 5.
Item 5. Other Information.
On July 27, 1994, a Chuck E. Cheese's restaurant owned an operated by a franchisee of the Company opened for business in Santiago, Chile under a development agreement which calls for six such stores to be opened by that franchisee in Chile during the next ten years.
Item 6.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Number Description
10 (a) Second Amendment to Secomd Amendended and Restated Revolving Credit Agreement dated as of July 1, 1994 by and between The First National Bank of Boston and the Company.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed in the quarter for which this report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SHOWBIZ PIZZA TIME, INC.
Dated: August 15, 1994 By: /s/Michael H. Magusiak Michael H. Magusiak President and Chief Financial Officer (Principal Financial Officer)
INDEX TO EXHIBITS