10-Q 1 l84101ae10-q.txt MORGAN'S FOODS, INC. 10-Q 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended August 13, 2000 ---------------------------------------------------------- Commission file number 0-3833 --------------------------------------------------------- Morgan's Foods, Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-0562210 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 24200 Chagrin Boulevard, Suite 126, Beachwood, Ohio 44122 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (216) 360-7500 ------------------------- -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ...X... No ....... As of September 22, 2000, the issuer had 2,937,572 shares of common stock outstanding. 1 2 PART I FINANCIAL INFORMATION Item 1. Financial Statements. Morgan's Foods, Inc. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) -------------------------------------------------------------------------------- QUARTER ENDED --------------------------------- AUGUST 13, 2000 AUGUST 15, 1999 --------------- --------------- REVENUES ................................... $ 19,282,000 $ 13,193,000 COST OF SALES: FOOD, PAPER AND BEVERAGE .................. 6,194,000 4,028,000 LABOR AND BENEFITS ........................ 4,951,000 3,382,000 RESTAURANT OPERATING EXPENSES .............. 4,512,000 3,114,000 DEPRECIATION AND AMORTIZATION .............. 899,000 493,000 GENERAL AND ADMINISTRATIVE EXPENSES ........ 1,316,000 893,000 LOSS ON SALE OR DISPOSAL OF RESTAURANT ASSETS ...................... 197,000 79,000 ------------ ------------ OPERATING INCOME ........................... 1,213,000 1,204,000 INTEREST EXPENSE: BANK DEBT AND NOTES PAYABLE ............... (1,103,000) (612,000) CAPITAL LEASES ............................ (19,000) (24,000) OTHER INCOME AND EXPENSE, NET .............. 18,000 10,000 ------------ ------------ INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ....................... 109,000 578,000 PROVISION FOR INCOME TAXES ................. 4,000 3,000 ------------ ------------ INCOME FROM CONTINUING OPERATIONS .......... 105,000 575,000 LOSS FROM DISCONTINUED OPERATIONS (NOTE 3) . - (291,000) ------------ ------------ NET INCOME ................................. $ 105,000 $ 284,000 ============ ============ INCOME (LOSS) PER COMMON SHARE (NOTE 4): INCOME FROM CONTINUING OPERATIONS ......... $ .04 $ .20 LOSS FROM DISCONTINUED OPERATIONS ......... - (.10) ------------ ------------ NET INCOME PER SHARE ...................... $ .04 $ .10 ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING ........................ 2,925,024 2,910,839 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 2 3 PART I FINANCIAL INFORMATION Item 1. Financial Statements. Morgan's Foods, Inc. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) -------------------------------------------------------------------------------- TWENTY-FOUR WEEKS ENDED --------------------------------- AUGUST 13, 2000 AUGUST 15, 1999 --------------- --------------- REVENUES ................................... $ 36,848,000 $ 21,297,000 COST OF SALES: FOOD, PAPER AND BEVERAGE .................. 11,597,000 6,538,000 LABOR AND BENEFITS ........................ 9,834,000 5,479,000 RESTAURANT OPERATING EXPENSES .............. 8,952,000 5,139,000 DEPRECIATION AND AMORTIZATION .............. 1,787,000 818,000 GENERAL AND ADMINISTRATIVE EXPENSES ........ 2,574,000 1,667,000 LOSS ON SALE OR DISPOSAL OF RESTAURANT ASSETS ...................... 216,000 79,000 ------------ ------------ OPERATING INCOME ........................... 1,888,000 1,577,000 INTEREST EXPENSE: BANK DEBT AND NOTES PAYABLE ............... (2,246,000) (893,000) CAPITAL LEASES ............................ (38,000) (36,000) OTHER INCOME AND EXPENSE, NET .............. 66,000 26,000 ------------ ------------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ....................... (330,000) 674,000 PROVISION (BENEFIT) FOR INCOME TAXES ....... 7,000 (1,000) ------------ ------------ INCOME (LOSS) FROM CONTINUING OPERATIONS ... (337,000) 675,000 LOSS FROM DISCONTINUED OPERATIONS (NOTE 3) . - (629,000) ------------ ------------ NET INCOME (LOSS) .......................... $ (337,000) $ 46,000 ============ ============ INCOME (LOSS) PER COMMON SHARE (NOTE 4): INCOME (LOSS) FROM CONTINUING OPERATIONS .. $ (.12) $ .23 LOSS FROM DISCONTINUED OPERATIONS ......... - (.21) ------------ ------------ NET INCOME (LOSS) PER SHARE ............... $ (.12) $ .02 ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING ........................ 2,923,876 2,910,839 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 3 4 MORGAN'S FOODS, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED) --------------------------------------------------------------------------------
AUGUST 13, 2000 FEBRUARY 27, 2000 --------------- ----------------- ASSETS CURRENT ASSETS: CASH AND EQUIVALENTS ......................... $ 3,975,000 $ 4,612,000 RECEIVABLES .................................. 78,000 112,000 INVENTORIES .................................. 662,000 583,000 PREPAID EXPENSES ............................. 132,000 357,000 ASSETS HELD FOR SALE (NOTE 3) ................ 589,000 653,000 ------------ ------------ 5,436,000 6,317,000 PROPERTY AND EQUIPMENT: (NOTE 2) LAND ......................................... 10,861,000 10,861,000 BUILDINGS AND IMPROVEMENTS ................... 17,690,000 16,560,000 PROPERTY UNDER CAPITAL LEASES ................ 1,171,000 1,171,000 LEASEHOLD IMPROVEMENTS ....................... 7,314,000 6,837,000 EQUIPMENT, FURNITURE AND FIXTURES ............ 17,977,000 17,158,000 CONSTRUCTION IN PROGRESS ..................... 209,000 425,000 ------------ ------------ 55,222,000 53,012,000 LESS ACCUMULATED DEPRECIATION AND AMORTIZATION 13,032,000 12,179,000 ------------ ------------ 42,190,000 40,833,000 OTHER ASSETS .................................. 1,648,000 1,748,000 FRANCHISE AGREEMENTS .......................... 2,337,000 2,242,000 DEFERRED TAXES ................................ 600,000 600,000 ACQUIRED FRANCHISE RIGHTS ..................... 10,200,000 10,448,000 ------------ ------------ $ 62,411,000 $ 62,188,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: CURRENT MATURITIES OF LONG-TERM DEBT ....... $ 1,875,000 $ 1,762,000 CURRENT MATURITIES OF CAPITAL LEASE OBLIGATIONS (NOTE 3) ..................... 939,000 969,000 ACCOUNTS PAYABLE ........................... 3,673,000 4,089,000 ACCRUED LIABILITIES ........................ 3,528,000 3,725,000 ------------ ------------ 10,015,000 10,545,000 LONG-TERM DEBT ............................... 50,155,000 49,968,000 LONG-TERM CAPITAL LEASE OBLIGATIONS .......... 697,000 745,000 ADVANCE ON SUPPLY AGREEMENTS ................. 916,000 - SHAREHOLDERS' EQUITY PREFERRED SHARES, 1,000,000 SHARES AUTHORIZED, NO SHARES OUTSTANDING COMMON STOCK AUTHORIZED SHARES - 25,000,000 ISSUED SHARES - 2,969,405 ..................... 30,000 30,000 TREASURY STOCK - 31,833 IN FISCAL 2001, 46,678 IN FISCAL 2000 ....................... (76,000) (111,000) CAPITAL IN EXCESS OF STATED VALUE .............. 28,875,000 28,875,000 ACCUMULATED DEFICIT ............................ (28,201,000) (27,864,000) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY ..................... 628,000 930,000 ------------ ------------ $ 62,411,000 $ 62,188,000 ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 4 5 Morgan's Foods, Inc. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (unaudited)
CAPITAL IN TOTAL COMMON SHARES TREASURY SHARES EXCESS OF ACCUMULATED SHAREHOLDERS' ----------------------- --------------------------- SHARES AMOUNT SHARES AMOUNT STATED VALUE DEFICIT EQUITY --------- ------------ ------------ ------------ ------------ ------------ ------------ Balance, February 28, 1999 ... 2,969,405 $ 30,000 (58,566) $ (139,000) $ 28,875,000 $(27,518,000) $ 1,248,000 Net loss ..................... - - - - - (346,000) (346,000) Issue of treasury shares for 401(k) contributions ........ - - 11,888 28,000 - - 28,000 --------- ------------ ------------ ------------ ------------ ------------ ------------ Balance, February 27, 2000 ... 2,969,405 30,000 (46,678) (111,000) 28,875,000 (27,864,000) 930,000 Net loss ..................... - - - - - (337,000) (337,000) Issue of treasury shares for 401(k) contributions ....... - - 14,845 35,000 - - 35,000 --------- ------------ ------------ ------------ ------------ ------------ ------------ Balance, August 13, 2000 ..... 2,969,405 $ 30,000 (31,833) $ (76,000) $ 28,875,000 $(28,201,000) $ 628,000 ========= ============ ============ ============ ============ ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5 6 Morgan's Foods, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
TWENTY-FOUR WEEKS ENDED ---------------------------------- AUGUST 13, 2000 AUGUST 15, 1999 --------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES: NET INCOME (LOSS) ............................ $ (337,000) $ 46,000 ADJUSTMENTS TO RECONCILE TO NET CASH PROVIDED BY OPERATING ACTIVITIES: DEPRECIATION AND AMORTIZATION ............. 1,787,000 818,000 AMORTIZATION OF SUPPLY AGREEMENT ADVANCES . (55,000) - FUNDING FROM SUPPLY AGREEMENTS ............ 971,000 - LOSS ON SALE OR DISPOSAL OF RESTAURANT ASSETS ........................ 216,000 79,000 CHANGE IN ASSETS AND LIABILITIES: DECREASE IN RECEIVABLES .................. 34,000 32,000 INCREASE IN INVENTORIES .................. (79,000) (397,000) DECREASE IN PREPAID EXPENSES ............. 225,000 215,000 (INCREASE) DECREASE IN OTHER ASSETS ...... 32,000 (1,224,000) INCREASE (DECREASE) IN ACCOUNTS PAYABLE .. (416,000) 2,478,000 INCREASE (DECREASE) IN ACCRUED LIABILITIES (216,000) 2,614,000 ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES .... 2,162,000 4,661,000 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: CAPITAL EXPENDITURES ........................ (2,847,000) (23,862,000) PURCHASE OF FRANCHISE AGREEMENTS AND ACQUIRED FRANCHISE RIGHTS .................. (175,000) (11,338,000) PROCEEDS FROM SALE OF RESTAURANT ASSETS ..... 1,000 4,000 ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES ....... (3,021,000) (35,196,000) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: PROCEEDS FROM ISSUANCE OF LONG-TERM DEBT, NET OF FINANCING COSTS ..................... 1,200,000 34,718,000 PRINCIPAL PAYMENTS ON LONG-TERM DEBT ........... (900,000) (261,000) PRINCIPAL PAYMENTS ON CAPITAL LEASE OBLIGATIONS ........................... (78,000) (213,000) ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES .... 222,000 34,244,000 ------------ ------------ NET CHANGE IN CASH AND EQUIVALENTS ........... (637,000) 3,709,000 CASH AND EQUIVALENTS, BEGINNING BALANCE ...... 4,612,000 2,655,000 ------------ ------------ CASH AND EQUIVALENTS, ENDING BALANCE ......... $ 3,975,000 $ 6,364,000 ============ ============ NONCASH INVESTING AND FINANCING ACTIVITIES - CAPITAL LEASES ................................. $ - $ 435,000 ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 6 7 Morgan's Foods, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS QUARTERS ENDED AUGUST 13, 2000 AND AUGUST 15, 1999 (unaudited) NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The interim consolidated financial statements of Morgan's Foods, Inc. have been prepared without audit. In the opinion of Company Management, all adjustments have been included. Unless otherwise disclosed, all adjustments consist only of normal recurring adjustments necessary for a fair statement of results of operations for the interim periods. In the second quarter of fiscal year 2001, the Company adopted the operating statement classification requirements of EITF 00-14, Accounting for Certain Sales Incentives. Such sales incentives have been reclassified from revenues to operating expenses for all periods presented. The classification change has no affect on previously reported results of operations. These unaudited financial statements have been prepared using the same accounting principles that were used in preparation of the Company's annual report on Form 10-K for the year ended February 27, 2000 except for the adoption of EITF 00-14. During the quarter the Company received $971,000 from its largest beverage distributor for signing a twelve year beverage supply and marketing agreement. The Company amortizes these advances as a reduction of beverage cost of sales over the term of the related contract using the straight-line method. NOTE 2. ACQUISITION OF KFC AND TACO BELL RESTAURANTS On July 14, 1999 Morgan's Restaurants of Pennsylvania, Inc., Morgan's Restaurants of Ohio, Inc., Morgan's Restaurants of West Virginia, Inc. and Morgan's Foods of Missouri, Inc., all wholly owned subsidiaries of Morgan's Foods, Inc., acquired the assets of fifty-four (54) existing KFC and Taco Bell restaurants and the land and building of a non-operating KFC restaurant from various subsidiaries of Tricon Global Restaurants, Inc. for cash in the amount of $33,740,000. The acquisition was recorded as a purchase and, accordingly, assets were recorded at fair value. The allocation of the purchase price is as follows: Land $ 6,950,000 Buildings 6,475,000 Leasehold Improvements 3,455,000 Equipment 4,550,000 Franchise Agreements 1,615,000 Acquired Franchise Rights 10,695,000 ----------- Total $33,740,000 =========== The following unaudited pro forma results for the twelve and twenty-four weeks ended August 15, 1999, were developed assuming that all of the acquired units previously described had been acquired at the beginning of the period. The unaudited pro forma data shown below is not necessarily indicative of the consolidated results that would have occurred had the acquisition taken place at the beginning of the period nor are they necessarily indicative of results that may occur in the future. 7 8
PRO FORMA RESULTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED AUGUST 15, 1999 AUGUST 15, 1999 --------------- --------------- Total revenue .................................... $ 23,739 $ 40,961 Net loss from continuing operations .............. (180) (520) Net loss per share from continuing operations .... (.06) (.18)
NOTE 3. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE The Company expects to sell the one remaining former East Side Mario's location and the liquor license and equipment during the third quarter of fiscal 2001. The cash received as a result of these transactions will be used to pay off the capital lease obligations, purchase the leased property and other expenses of the transactions. Certain assets of the East Side Mario's operations are shown in the Consolidated Balance Sheet as "Assets held for sale". The results of operations of the discontinued segment are shown in the Consolidated Statements of Operations as "Loss from discontinued operations" and there is no tax effect of the loss. The Company believes there will not be a loss on the disposal of the remaining assets. The East Side Mario's restaurants formerly operated by the Company began in March 1993 and encompassed six locations by April 1995. Comparable restaurant revenues for the East Side Mario's segment had declined since fiscal 1996 and the restaurant concept was not appropriately supported by the franchisor. The assets being held for sale and the related capitalized lease obligations have been classified as current assets and current liabilities respectively. The Consolidated Balance Sheets at August 13, 2000 and February 27, 2000, include assets and liabilities related to the former East Side Mario's restaurants, which are being accounted for as a discontinued operation, the details of which are listed below: AUGUST 13, 2000 FEBRUARY 27, 2000 --------------- ----------------- Current assets $ - $ 11,000 Assets held for sale 589,000 653,000 ----------- ----------- Total assets 589,000 664,000 Current liabilities 1,065,000 1,236,000 ----------- ----------- Net liabilities $ (476,000) $ (572,000) =========== =========== The results of operations for the East Side Mario's segment, reported separately as a loss from discontinued operations in the Consolidated Statement of Operations, are as follows: TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED ------------------ ----------------------- AUGUST 15, 1999 AUGUST 15, 1999 --------------- --------------- Total Revenue $ 1,556,000 $ 3,092,000 =========== =========== Loss from operations of discontinued East Side Mario's restaurants $ (291,000) $ (629,000) =========== =========== 8 9 NOTE 4. INCOME (LOSS) PER COMMON SHARE Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is based on the combined weighted average number of shares outstanding, which includes the assumed exercise, or conversion of options. In computing diluted net income (loss) per common share, the Company has utilized the treasury stock method. Since the average share price during the periods presented was below the exercise price of any outstanding stock options, the calculation of diluted net income (loss) per common share does not include the effect of the assumed exercise of outstanding options, as its effect would be anti-dilutive. 9 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. DESCRIPTION OF BUSINESS. Morgan's Foods, Inc. ("the Company") operates through wholly-owned subsidiaries Kentucky Fried Chicken ("KFC") restaurants under franchises from KFC Corporation, Taco Bell restaurants under franchises or licenses from Taco Bell Corporation and Pizza Hut Express restaurants under licenses from Pizza Hut Corporation. As of September 25, 2000, the Company operates 79 KFC restaurants, 11 Taco Bell restaurants, 16 KFC/Taco Bell "2n1's" under franchises from KFC Corporation and franchises or licenses from Taco Bell Corp., and 2 Taco Bell/Pizza Hut Express "2n1's". The Company formerly operated six East Side Mario's restaurants, a business segment which the Company had previously chosen to discontinue (see Note 3). The Company's fiscal year is a 52 - 53 week year ending on the Sunday nearest the last day of February. REVENUES. Revenues for the quarter ended August 13, 2000 were $19,282,000 compared to $13,193,000 for the quarter ended August 15, 1999. This increase of $6,089,000 was due to $6,538,000 in revenues generated by 56 KFC's and Taco Bells which were acquired, two new KFC's/Taco Bell "2n1's" which were built since the second quarter of fiscal 2000 and two Taco Bell's which were converted to KFC/Taco Bell "2n1's". The increase was partially offset by a 1.6% decrease in comparable restaurant revenues and $325,000 in lost sales due to restaurants being permanently or temporarily closed. The decline in comparable restaurant revenues was primarily the result of ineffective product promotions by the franchisor during the quarter. Revenues for the twenty-four weeks ended August 13, 2000 were $36,848,000 compared to $21,297,000 for the twenty-four weeks ended August 15, 1999. The increase was attributable to $16,580,000 of revenues generated by the 56 KFC's and Taco Bell's which were acquired, two new KFC's which were built and two Taco Bell's which were converted to KFC/Taco Bell "2n1's". This increase was partially offset by a 3.5% decrease in comparable restaurant revenues and $494,000 in lost sales due to restaurants being permanently or temporarily closed. COSTS OF SALES - FOOD, PAPER AND BEVERAGES. Food, paper and beverage costs for the fiscal 2001 second quarter increased as a percentage of revenue from 30.5% in fiscal 2000 to 32.1%. This increase was primarily the result of the inefficiencies from lower average restaurant volumes, an increase in chicken prices and unfavorable contract pricing due to the Company's primary supplier entering Chapter 11 bankruptcy. Food, paper and beverage costs for the twenty-four weeks ended August 13, 2000 increased to 31.5% of revenue compared to 30.7% in the year earlier period for the reasons discussed above. COST OF SALES - LABOR AND BENEFITS. Labor and benefits were substantially unchanged as a percentage of revenue for the quarter ended August 13, 2000 at 25.7% compared to 25.6% for the year earlier quarter. The labor and benefit amount for the quarter ended August 13, 2000, however, contains a credit of $160,000 resulting from an improvement in workers' compensation rates which was offset by higher direct labor rates. Labor and benefits increased as a percentage of revenue for the twenty-four weeks ended August 13, 2000 to 26.7% from 25.7% in the year earlier period. The increase was primarily due to higher labor and benefit costs in the newly acquired restaurants and additional labor costs due to new systems implementation. RESTAURANT OPERATING EXPENSES. Restaurant operating expenses decreased as a percentage of revenue to 23.4% in the second quarter of fiscal 2001 compared to 23.6% in the second quarter of fiscal 2000. This was primarily the result of $145,000 in credits taken for estimated repair and enhancement costs for projects which were completed at lower costs. Restaurant operating expenses for the twenty-four weeks ended August 13, 2000 increased to 24.3% of revenue compared 24.1% of revenue in the comparable prior year period primarily due to the first quarter advertising expenses to promote the introduction of five new sandwiches. 10 11 DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the fiscal 2001 second quarter increased to $899,000 compared to $493,000 in the prior year second quarter. The increase is primarily due to the addition of the KFC and Taco Bell restaurants discussed above. Depreciation and amortization for the twenty-four weeks ended August 13, 2000 increased to $1,787,000 from $818,000 for the year earlier period for the reasons discussed above. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased to $1,316,000 in the second quarter of fiscal 2001 from $893,000 in the second quarter of fiscal 2000. The increase of $423,000 was mainly the result of adding the costs and resources necessary to support the additional restaurants but G&A expense as a percentage of sales remained consistent at 6.8% even though average revenues per restaurant declined in the current year quarter. General and administrative expenses for the twenty-four weeks ended August 13, 2000 increased to $2,574,000 compared to $1,667,000 for the year earlier period but due to the larger number of restaurants, G&A expense declined as a percentage of revenues to 7.0% compared to 7.8% in the prior year period. LOSS ON SALE OR DISPOSAL OF RESTAURANT ASSETS. The loss on disposal of restaurant assets of $197,000 in the second quarter of fiscal 2001 and $216,000 in fiscal 2000, was the result of assets disposed of during the image enhancement of several KFC restaurants as well as reserving for the closing of two restaurants which are expected to close in the third quarter of fiscal 2001. OPERATING INCOME. Operating income in the second quarter of fiscal 2001 increased to $1,213,000 or 6.3% of revenue compared to $1,204,000 or 9.1% for the second quarter of fiscal 2000. Operating income for the twenty-four weeks ended August 13, 2000 increased to $1,888,000 or 5.1% of revenue from $1,577,000 or 7.4%. INTEREST EXPENSE. Interest expense on bank debt increased to $1,103,000 in the second quarter of fiscal 2001 from $612,000 in fiscal 2000 due to higher debt balances during the fiscal 2001 quarter necessary to fund the acquisition and construction of restaurants during the past year. Interest expense on bank debt for the twenty-four weeks ended August 13, 2000 increased to $2,246,000 from $893,000 for the same reasons discussed above. Interest expense on capitalized leases was substantially unchanged from the prior year second quarter and for the twenty-four weeks. OTHER INCOME. Other income for the quarter ended August 13, 2000 increased to $18,000 from $10,000 in the prior year second quarter. The increase is due mainly to increased discounts on the payment of sales tax which resulted from the increased sales volumes generated by the operation of additional restaurants. Other income for the twenty-four weeks ended August 13, 1999 increased to $66,000 from $26,000 due to the reasons discussed above. PROVISION FOR INCOME TAXES. The provision for income taxes was substantially unchanged from the prior year second quarter and for the twenty-four weeks. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE. On September 3, 1999, Management made the decision to discontinue the operation of its East Side Mario's restaurant segment. The Company expects to sell the one remaining former East Side Mario's location and the liquor license and equipment during the third quarter of fiscal 2001. The cash received as a result of these transactions will be used to pay off the capital lease obligations, purchase the leased property and other expenses of the transactions. Certain assets of the East Side Mario's operations are shown in the Consolidated Balance Sheet as "Assets held for sale". The results of operations of the discontinued segment are shown in the Consolidated Statements of Operations as "Loss from discontinued 11 12 operations" and there is no tax effect of the loss. The Company believes there will not be a loss on the disposal of the remaining assets. LIQUIDITY AND CAPITAL RESOURCES. Cash flow activity for the twenty-four weeks of fiscal 2001 and fiscal 2000 is presented in the Consolidated Statements of Cash Flows. Cash provided by operating activities was $2,162,000 for the twenty-four weeks ended August 15, 2000. The Company paid scheduled long-term bank and capitalized lease debt of $978,000 in the first half of fiscal 2001 and received financing of $1,200,000 to fund the building of a KFC/Taco Bell "2n1", the conversion of a Taco Bell to a KFC/Taco Bell "2n1" and the installation of new point of sale devices in several restaurants. The Company also received $971,000 from its largest beverage distributor for signing a twelve year beverage supply and marketing agreement. The KFC operations of the Company have historically provided sufficient cash flow to service the Company's debt, refurbish and upgrade KFC restaurant properties and cover administrative overhead. Management believes that operating cash flow will provide sufficient capital to continue to operate and maintain the KFC and Taco Bell restaurants, service the Company's debt and support required corporate expenses. In addition to the Company's operating cash flow, management believes that additional financing, including long term leases of build-to-suit restaurants and development lines of credit can be obtained for use in the acquisition of new KFC and Taco Bell properties and refurbishment of existing ones. The Company is currently not in full compliance with the American Stock Exchange financial condition guidelines for continued listing. Specifically, the guidelines indicate that any company with shareholders' equity less than $4,000,000 and losses in 3 of its last 4 fiscal years may be considered for delisting. This condition has been reviewed with representatives of the American Stock Exchange who indicated that the Company's performance will continue to be monitored by the Exchange. SEASONALITY. The operations of the Company are affected by seasonal fluctuations. Historically, the Company's revenues and income have been highest during the summer months with the fourth fiscal quarter representing the slowest period. This seasonality is primarily attributable to weather conditions in the Company's marketplace, which consists of portions of Ohio, Pennsylvania, Missouri, Illinois, West Virginia and New York. PART II OTHER INFORMATION ITEM 6. EXHIBITS & REPORTS ON FORM 8-KA (a) Exhibit 27 - Financial Data Schedule 12 13 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. Morgan's Foods, Inc. ---------------------- (Registrant) Dated: September 27, 2000 By: /s/ Kenneth L. Hignett ----------------------- Kenneth L. Hignett Senior Vice President, Chief Financial Officer & Secretary 13