At December 31, 2001, Tumbleweed, Inc. (the "Company") owned, franchised or
licensed 65 Tumbleweed Southwest Mesquite Grill & Bar ("Tumbleweed")
restaurants. We owned and operated 36 Tumbleweed restaurants in Kentucky,
Indiana and Ohio including one restaurant which was 50% owned through a joint
venture until the other owner's interest was acquired by the Company subsequent
to December 31, 2001. There were 21 franchised Tumbleweed restaurants located in
Indiana, Illinois, Kentucky, Michigan, Virginia and Wisconsin, and eight
licensed restaurants located outside the United States in Germany, Jordan,
Egypt, Saudi Arabia, England and Turkey. Tumbleweed restaurants feature
sophisticated Southwest and mesquite grilled food served in a casual dining
atmosphere evoking the American Southwest. Tumbleweed restaurants are open seven
days a week (excluding certain holidays) for lunch and dinner and generally
offer a full service bar.
THE TUMBLEWEED CONCEPT
The Tumbleweed menu offers both distinctively seasoned, spicier versions of
popular Mexican dishes, as well as an assortment of grilled steaks, ribs, pork
chops, chicken and seafood selections. The Tumbleweed concept is designed to
appeal to a broad range of customers by offering a wide selection of distinctive
items at a broad range of price points while, in management's view, providing a
consistent level of food quality and friendly and efficient service comparable
or superior to that of other casual dining restaurants. Use of a centralized
commissary system enhances Tumbleweed's ability to maintain consistently high
food quality, minimizes restaurant kitchen space and equipment, reduces the need
for skilled cooking personnel, and simplifies restaurant operations. The key
elements of the Tumbleweed concept include the following:
ONE CONCEPT OFFERING AMERICAN SOUTHWEST GRILLED ITEMS AND MEXICAN FOOD. The
Tumbleweed menu is intended to distinguish Tumbleweed from competing Mexican and
casual dining concepts by offering both distinctively seasoned, spicier versions
of burritos, enchiladas, tacos, salads, and other popular Mexican dishes, as
well as an assortment of grilled steaks, ribs, pork chops, chicken and seafood
selections. Management believes this approach appeals to a broader segment of
the population and encourages customers to visit the restaurants more often.
The Tumbleweed menu features distinctively seasoned versions of popular Mexican
dishes and mesquite grilled selections. Customers receive complementary chips
and salsa, and can choose from a selection of appetizers including such
Tumbleweed specialties as chile con queso and chili, as well as nachos,
quesadillas, buffalo chicken strips, Southwest eggrolls and turkey wings. The
Mexican menu offers burritos, enchiladas, tacos, chimichangas and other items
served both individually and in various combination dinners accompanied by rice
and refried or baked beans. Customers may also choose from an assortment of
fajitas, ribs, chicken, steak, pork chops, and seafood prepared over an open
gas- fired mesquite wood grill and served with Texas Toast, salad, and a choice
of baked potato, baked sweet potato, southwest fries, smashed taters, corn on
the cob, grilled veggies, rice, and refried or baked beans. Mesquite grilled
items are available as sandwiches as well as entrees. A variety of salads
featuring refried beans, seasoned beef, shredded or fried strips of chicken,
mesquite grilled chicken or seafood, and other traditional ingredients rounds
out the menu. The Company periodically introduces new items that complement its
present menu selections, a lunch menu as well as seasonal menus to increase the
frequency of guest visits.
Tumbleweed restaurants typically contain full-service bars offering a wide
assortment of mixed drinks, wines, domestic and imported beers and featuring the
Tumbleweed margarita and Texas Tea. Alcoholic beverages accounted for
approximately 10.8% of restaurant sales during 2001.
Tumbleweed's menu pricing is designed to create a strong perception of value by
consumers. Prices for Mexican dishes range from $4.39 for two tacos to $11.99
for the "Need the 'Weed" sampler dinner. Mesquite grilled items range from $5.99
for a hamburger to $19.99 for a 22 oz. USDA-choice ribeye steak dinner.
Tumbleweed also offers several daily lunch specials for less than $6.00.
- 2 -
TARGETED ATMOSPHERE. Tumbleweed restaurants offer relaxed and comfortable
surroundings where guests can enjoy a quality dining experience. Decorative
features such as American Indian artifacts, cowboy memorabilia, wildlife
replicas, rough-hewn timber and a creek stone fireplace in larger stores are
used to evoke the feeling of the Great Southwest.
MAINTAINING A FAVORABLE PRICE-TO-VALUE RELATIONSHIP. Tumbleweed's pricing
strategy is intended to appeal to value- driven customers as well as traditional
casual dining customers. Tumbleweed offers a wide selection of distinctive items
at a broad range of price points while, in management's view, providing a level
of food quality and service comparable or superior to that of other casual
dining restaurants. For 2001, the average check at a full-service Tumbleweed
restaurant, including beverages, was $8.77 for lunch and $11.26 for dinner.
Management believes that this pricing approach, together with Tumbleweed's
emphasis on variety and quality, creates a favorable price-to-value perception
that can increase customer volume and generate more frequent repeat visits.
ACHIEVING TOTAL GUEST SATISFACTION. We are committed to providing prompt,
friendly and attentive service and consistent food quality to our customers. We
use a "mystery shopper" program to compare actual performance of restaurants to
Tumbleweed standards and solicit comment cards from customers to monitor and
modify restaurant operations.
OPERATING STRATEGY
We use the following key operating strategies to make certain that we exceed the
expectations of our customers:
TARGET FOR TOTAL GUEST SATISFACTION. Tumbleweed's organizational and management
philosophy is based on five core values and a commitment to Total Guest
Satisfaction ("TGS"). Our training procedures are intended to instill in all
managers and employees an appreciation of the core values and to encourage a
shared commitment to TGS and teamwork.
COMMITMENT TO ATTRACTING AND RETAINING QUALITY EMPLOYEES. By providing extensive
training and attractive compensation, and by emphasizing clearly defined
organizational values, we foster a strong corporate culture and encourage a
sense of personal commitment from our employees. We have a monthly cash bonus
program based on attaining sales growth and related performance goals on a
restaurant-by-restaurant basis for each restaurant's management team.
CONSISTENT HIGH QUALITY FOOD PREPARATION. We are committed to offering
distinctive Mexican and mesquite grilled foods to customers at reasonable prices
through the use of a commissary-based system. Management believes that the use
of a central commissary provides a significant strategic and competitive
advantage by enhancing our ability to maintain consistently high food quality,
minimizing restaurant kitchen space and equipment, and reducing the number of
skilled cooking positions. The system also enables restaurant managers and
kitchen staff to focus on the final preparation of menu items to Tumbleweed
standards.
Whenever feasible, the cooked ingredients used in Tumbleweed menu selections,
such as ground beef, chile con queso, and Mexican beans, are prepared in advance
at the commissary according to procedures designed to extend shelf life without
the addition of preservatives. The kitchen staff at each restaurant uses
commissary-supplied and other fresh ingredients for the final preparation of
individual orders. Management believes this system enhances our ability to
maintain rigorous operational and food preparation procedures and stringent
product shelf life standards. The commissary operates according to stringent
quality control standards and is subject to a daily inspection by a USDA
inspector on the premises. We maintain a contingency plan under which
centralized food preparation could be quickly resumed at another company's
facility should the commissary be rendered inoperative by weather or other
disaster.
GROWTH STRATEGY
Our strategy for growth will focus on the further development of new and
existing markets by both the Company and franchisees. Since acquiring the
Tumbleweed concept in 1995, we have added new Company-owned and franchised
restaurants, while developing the infrastructure necessary to support our growth
strategy. This approach has given management an opportunity to validate the
Tumbleweed concept, refine operating systems, design and develop prototype
restaurant buildings of different sizes and build a team of experienced
corporate managers needed to support future internal and franchise growth. The
following are key elements of our expansion strategy:
- 3 -
OPENING RESTAURANTS IN TARGET MARKETS. We target mid-sized metropolitan markets,
initially concentrating in the Midwest, Mid-Atlantic and Southeast regions,
where income levels and the presence of shopping and entertainment centers,
offices and/or colleges and universities indicate that a significant base of
potential customers exists. Management considers the feasibility of opening
multiple restaurants in a target market, which offers greater operating and
advertising efficiency. As we add additional restaurants in a target market,
there may be short-term decreases in same store sales. However, management
believes this clustering strategy can enhance long-term performance through
economies of scale and shared advertising expenses. Management also views
smaller markets with fewer competing casual dining restaurants as presenting
growth opportunities for the Company. Management believes that its target
markets are less competitive than major metropolitan markets in terms of both
site acquisition costs and number of casual dining restaurant options. In 2002,
the Company closed four restaurants locations. The restaurants were located in
Cincinnati, Ohio (2), Columbus, Ohio (1), and Evansville, Indiana (1). The
restaurant closings were part of a strategic management decision to eliminate
lower sales volume restaurants that were unprofitable in 2001 and to focus its
energies on the continued improvement of per-store average sales volumes. Also
subsequent to year end, the Company purchased from its joint venture partner its
50% interest in a restaurant location. In the next 12 months, the Company
expects to construct one or two additional restaurant facilities.
SELECTING AND DEVELOPING QUALITY RESTAURANT SITES. In selecting potential
restaurant sites, management analyzes a variety of factors, including, but not
limited to, local market demographics, site visibility, competition in the
vicinity, and accessibility and proximity of significant generators of potential
customers such as major retail centers, hotels, universities, and sports and
entertainment facilities. The acquisition of sites may involve leases,
purchases, and joint venture arrangements, and will require either the
construction of new buildings or the conversion of existing buildings. The site
selection process is conducted by our management and other employees, as well as
with the assistance of consultants when deemed advisable. We believe that our
site selection strategy and procedures, together with our menu and pricing
strategies, our commitment to quality food products and excellent service, and
our advertising, marketing and promotional efforts, will enhance our ability to
generate our anticipated customer volumes.
FRANCHISING. We expect that continued growth will come from the further
development of new and existing markets by us and by franchisees. We intend to
pursue an active franchising program with current and new franchisees under
controlled guidelines. We offer franchisees both rights to develop individual
restaurants as well as area development rights for the establishment of more
than one new restaurant over a defined period of time and in a defined
geographic area. The specific locations of the restaurants are subsequently
designated by us and the franchisee in separate franchise agreements. Under the
standard area development agreement currently in use, a franchisee is required
to pay at the time the agreement is signed a non-refundable fee of $5,000 per
potential restaurant in the defined geographic area, to be applied against the
initial franchise fee payable for each restaurant. Our current area development
agreement also provides for a franchise fee of $40,000 for each restaurant. The
franchise fee is due when the franchise agreement for a restaurant is signed.
Each franchise agreement generally provides for royalties of three to five
percent of restaurant sales, minimum marketing expenditures of 2.0% of gross
sales, and a twenty-year term. All franchisees are required to operate their
Tumbleweed restaurants in compliance with our policies, standards and
specifications, including matters such as menu items, ingredients, materials,
supplies, services, fixtures, furnishings, decor and signs. Under our criteria
for selecting new franchisees, Tumbleweed requires that potential franchisees
have adequate capital, experience in the restaurant industry, and access to
locations suitable for development. Except for locations managed directly by us,
we generally require that a franchisee have a principal operator with at least a
ten percent ownership interest who must devote full time to the restaurant
operation. In addition, we may acquire restaurants from our franchisees from
time to time.
MATCHING INVESTMENT TO SALES POTENTIAL. When developing a new Tumbleweed
restaurant, we generally use one of three prototype designs management believes
is best suited to a particular site. Our Mini, Midi and Maxi prototype
restaurants accommodate approximately 150, 225, and 265 guests, respectively.
Each size restaurant offers full service casual dining and a menu containing a
wide assortment of Mexican and mesquite grilled selections. Management believes
that the use of multiple prototypes permits us to more closely match the
investment in a restaurant site with the site's estimated sales potential. These
factors allow for more efficient utilization of financial resources by us and
our franchisees.
INTERNATIONAL. In 2002, the Company purchased Tumbleweed International, LLC. The
acquisition gives the Company direct control and benefit of the international
licensing of the Tumbleweed concept.
- 4 -
During the year ended December 31, 2001, 3 new franchised restaurants were
opened in Jeffersonville, Indiana, Fredericksburg, Virginia and Park Place,
Wisconsin, and a franchisee elected to close its Charleston, West Virginia
restaurant.
RESTAURANT DESIGN
USING PROTOTYPE RESTAURANT DESIGNS. Tumbleweed full service restaurants have
historically proven successful in several different formats and sizes. It is
anticipated that new units will be full service restaurants employing one of
three basic prototype designs. Management believes using multiple prototype
designs allows greater flexibility to match the investment by us or our
franchisees with the revenue potential of a particular restaurant site. Each
prototype generally contains a full-service bar and utilizes the distinctive
"Old West" logo and motif that has characterized Tumbleweed restaurants for
several years.
Management believes our prototype designs can be adapted for developing
Tumbleweed restaurants in existing structures. This capability may give us
access to quality sites not otherwise available and may reduce the time or
expense of development in certain circumstances.
RESTAURANT OPERATIONS
RESTAURANT MANAGEMENT. We employ area directors who are responsible for
supervising the operations of Tumbleweed restaurants within their geographic
region and the continuing development of each restaurant's managers and
employees. Through regular visits to the restaurants, the area directors ensure
that the Tumbleweed concept, strategies, core values and standards of quality
are being observed in all aspects of restaurant operations. Area directors are
chiefly responsible for the implementation of the TGS program.
Each of our restaurants has one general manager, one kitchen manager and from
one to three assistant managers, based on restaurant volume. The general manager
of each restaurant has primary responsibility for the day-to-day operations of
the entire restaurant, including sales, physical plant, financial controls and
training, and is responsible for maintaining the standards of quality and
performance established by us. In selecting managers, we generally seek persons
who have significant prior experience in the restaurant industry as well as
employees who have demonstrated managerial potential and a commitment to the
Tumbleweed concept and philosophy. We seek to attract and retain high caliber
managers and hourly employees by providing them with competitive salaries,
monthly bonuses and a casual, entertaining and challenging working environment.
COMPREHENSIVE TRAINING AND DEVELOPMENT. We have developed a comprehensive
training program for managers and hourly employees. Managers are required to
complete a ten-week initial training course and regular training programs. The
course emphasizes our culture, commitment to TGS, operating procedures and
standards, and internal controls.
The general managers and the area directors are responsible for selecting and
training hourly employees at each restaurant. We employ training coordinators to
assist with training and development of employees. Before the opening of each
new restaurant, one of our training managers leads a team of experienced
employees to train and educate the new employees. The training period for new
employees includes 10 days of general training prior to opening and one week of
on-the-job supervision at the new Tumbleweed restaurant. Ongoing employee
training remains the responsibility of the general manager and training
coordinator of each restaurant under the supervision of the area director.
RESTAURANT REPORTING. We closely monitor sales, costs of food and beverages, and
labor at each of our restaurants. Management analyzes daily and weekly
restaurant operating results to identify trends at each location, and acts
promptly to remedy negative trends where possible. We use an accounting and
management information system that operates at the restaurant level to ensure
the maintenance of financial controls and operations. Administrative staff
prepare daily reports of sales, labor and customer counts. Cost of sales and
condensed profit and loss statements compiled weekly by store-level personnel
and at the end of each reporting period by our accounting department are
provided to management for analysis and comparison to past performance and
budgets. We use a specialized software system to measure theoretical food costs
against actual costs.
SEASONALITY. We consider restaurant operations to be somewhat seasonal in nature
with the second and third quarters being the peak sales periods.
- 5 -
SUPPORT OPERATIONS
COMMISSARY OPERATIONS. Use of a centralized commissary system enhances
Tumbleweed's ability to maintain consistently high food quality, minimizes the
kitchen space and equipment needed at each restaurant, reduces the need for
highly skilled cooking personnel, and simplifies restaurant operations. Managers
and kitchen staff at each restaurant focus on the final preparation of menu
items to Tumbleweed standards. We currently operate our commissary principally
to enhance food quality and operational efficiency of Company-owned and
franchised restaurants. Management believes this approach increases Tumbleweed's
ability to offer its customers a consistently high level of food quality at a
moderate price.
The commissary charges an amount approximately equal to its cost for the items
it supplies to Company-owned and franchised restaurants. The Commissary
sometimes contracts for the production of food products for other companies, and
has granted the right to an outside food producer to produce and market in
grocery stores a chili con queso product utilizing the "Tumbleweed" name and
recipe for which we receive a royalty based upon production and sales.
DEVELOPMENT AND CONSTRUCTION. The President, Vice President and Chief Financial
Officer and Vice President-Company Operations of the Company oversee the
construction process utilizing outside architectural services and construction
services. Individual site selection analysis is handled by Company management
with final approval by the President of the Company.
ADVERTISING AND MARKETING. We use radio, print, billboard, and direct mail
advertising in our various markets, as well as television advertising in certain
larger markets. We also engage in a variety of other promotional activities,
such as contributing goods, time and money to charitable, civic and cultural
programs, in order to increase public awareness of our restaurants. The cost
associated with these promotional activities in 2001 was approximately 3.4% of
sales.
RESTAURANT LOCATIONS
As of December 31, 2001, we owned and operated 36 Tumbleweed restaurants
including one Louisville, Kentucky restaurant which was 50% owned through a
joint venture. The following table sets forth the markets (including the number
of restaurants in each market) of these 36 restaurants:
NO. OF
STATE LOCATION RESTAURANTS
----- -------- -----------
Indiana Evansville 4
Indiana Ft. Wayne 2
Indiana Terre Haute 1
Kentucky Bowling Green 1
Kentucky Louisville 10
Ohio Cincinnati 7
Ohio Columbus 6
Ohio Dayton 3
Ohio Cleveland 2
--
TOTAL 36
==
- 6 -
Subsequent to December 31, 2001, the Company closed four restaurant locations.
The restaurants were located in Cincinnati, Ohio (2), Columbus, Ohio (1), and
Evansville, Indiana (1). The restaurant closings were part of a strategic
management decision to eliminate lower sales volume restaurants that were
unprofitable in 2001 and to focus its energies on the continued improvement of
per-store average sales volumes. Also subsequent to year end, the Company
purchased from its joint venture partner its 50% interest in a Louisville,
Kentucky restaurant.
FRANCHISED RESTAURANTS
As of December 31, 2001, we had ten franchisees that owned and operated 21
Tumbleweed restaurants. The following table sets forth the franchisee and the
location (including the number of restaurants at each location) of these 21
restaurants:
No. of Total By
Franchisee State Location Restaurants Franchisee
---------- ----- -------- ----------- ----------
TW-Indiana, LLC Indiana Floyd Knobs 1
Indiana New Albany 2
Indiana Salem 1
Indiana Jeffersonville 1
Kentucky Lexington 1
-
6
Diamondback
Management Corp. Illinois Rockford 1
Wisconsin Appleton 1
Wisconsin Franklin 1
Wisconsin Madison 1
Wisconsin Milwaukee 1
Wisconsin New Berlin 1
Wisconsin Park Place 1
-
7
TW-Seymour, LLC Indiana Seymour 1
-
1
TW-Glasgow, Inc. Kentucky Glasgow 1
-
1
TW-Shelbyville, Inc. Kentucky Shelbyville 1
1
TW-Bullitt, Inc. Kentucky Hillview 1
1
TW-Rivertown, LLC Michigan Grandville 1
-
1
Tumble South, Inc. Virginia Mechanicsville 1
Virginia Fredericksburg 1
-
2
TW-Somerset, LLC Kentucky Somerset 1
-
1
--
21
==
- 7 -
INTERNATIONAL LICENSING AGREEMENT
As of December 31, 2001, we had a license agreement (the "International
Agreement") with Tumbleweed International, LLC ("International"), a restaurant
developer based in Hanau, Germany, to develop Tumbleweed restaurants outside of
the Western Hemisphere. During 2001, International had licensed the following
locations to operate Tumbleweed restaurants: Frankfurt and Vilseck, Germany,
Essex and London, England, Amman, Jordan, Jeddah, Saudi Arabia, Istanbul, Turkey
and Cairo, Egypt. See Item 13 "Certain Relationships and Related Transactions"
for additional information regarding International.
The International Agreement granted us a right of first refusal if International
proposed to sell or assign its rights under the Agreement, or to sell equity
interests in International. Subsequent to December 31, 2001, the Company
purchased International for $1.5 million from TW-International Investors, Inc.
and Chi-Chi's International Operations, Inc. ("CCIO"). CCIO owned 40% of
International. The President and Chief Executive Officer of the Company is the
sole shareholder of CCIO. Members of TW-International Investors, Inc. include
three current directors of the Company. The acquisition will now give the
Company direct control and benefit of the international licensing of the
Tumbleweed concept. In connection with the acquisition, the Company assumed an
existing $1.4 million bank loan of TW- International Investors, Inc. and will
issue 76,923 shares of its common stock to CCIO. The Company will also enter
into a commission agreement with CCIO in connection with the sale of
international regional licenses by International.
SERVICE MARKS
A wholly-owned subsidiary of the Company owns and licenses to the Company
various service marks and trademarks that are registered on the Principal
Register of the United States Patent and Trademark Office. We regard our service
marks and trademarks as having significant value and being an important factor
in the development of the Tumbleweed concept. Our policy is to pursue and
maintain registration of our service marks and trademarks whenever possible and
to oppose vigorously any infringement or dilution of our service marks and
trademarks.
GOVERNMENT REGULATION
We are subject to a variety of federal, state and local laws. Our commissary is
licensed and subject to regulation by the USDA. Each of our restaurants is
subject to permitting, licensing and regulation by a number of government
authorities, including alcoholic beverage control, health, safety, sanitation,
building and fire agencies in the state or municipality in which the restaurant
is located. Difficulties in obtaining or failure to obtain required licenses or
approvals could delay or prevent the development of a new restaurant in a
particular area.
Approximately 10.8% of our restaurant sales were attributable to the sale of
alcoholic beverages for the year ended December 31, 2001. Alcoholic beverage
control regulations require each of our restaurants to apply to a state
authority and, in certain locations, county or municipal authorities for a
license or permit to sell alcoholic beverages on the premises. Typically,
licenses must be renewed annually and may be revoked or suspended for cause at
any time. Alcoholic beverage control regulations relate to numerous aspects of
restaurant operations, including minimum age of patrons and employees, hours of
operation, advertising, wholesale purchasing, inventory control and handling,
storage and dispensing of alcoholic beverages.
The failure of a restaurant to obtain or retain liquor or food service licences
would have a material adverse effect on the restaurant's operations. To reduce
this risk, each of our restaurants are operated in accordance with procedures
intended to assure compliance with applicable codes and regulations.
The Federal Americans With Disabilities Act (The "ADA") prohibits discrimination
on the basis of disability in public accommodations and employment. The ADA
became effective as to public accommodations in January 1992 and as to
employment in July 1992. We currently design our new restaurants to be
accessible to the disabled, and believe that we are in substantial compliance
with all current applicable regulations relating to restaurant accommodations
for the disabled. We intend to comply with future regulations relating to
accommodating the needs of the disabled, and we do not currently anticipate that
such compliance will require us to expend substantial funds.
We are subject in certain states to "dram shop" statutes, which generally
provide a person injured by an intoxicated person the right to recover damages
from an establishment that wrongfully served alcoholic beverages to the
intoxicated
- 8 -
person. We carry liquor liability coverage as part of our existing comprehensive
general liability insurance, as well as excess liability coverage. We have never
been named as a defendant in a lawsuit involving "dram shop" liability.
Our restaurant operations are also subject to federal and state laws governing
such matters as the minimum hourly wage, unemployment tax rates, sales tax and
similar matters, over which we have no control. Significant numbers of our
service, food preparation and other personnel are paid at rates related to the
federal minimum wage, and increases in the minimum wage could increase our labor
costs.
The development and construction of additional restaurants are subject to
compliance with applicable zoning, land use and environmental laws and
regulations.
EMPLOYEES
As of December 31, 2001, we had approximately 2,000 employees, of whom 34 are
executive and administrative personnel, 120 are restaurant management personnel,
and the remainder are hourly restaurant and commissary personnel. Many of our
hourly restaurant employees work part-time. None of our employees are covered by
a collective bargaining agreement. We consider our employee relations to be
good.
FORWARD-LOOKING STATEMENTS/RISK FACTORS
We make various forward-looking statements about our business in this report.
When making these forward-looking statements, we use words such as expects,
believes, estimates, anticipates, plans and similar expressions to identify
them. We also identify important cautionary factors that could cause our actual
results to differ materially from those projected in forward-looking statements
made by us. Factors that realistically could cause results to differ materially
from those projected in the forward-looking statements include the availability
and cost of financing and other events that affect our restaurant expansion
program, changes in food and other costs, changes in national, regional or local
economic conditions, changes in consumer tastes, competitive factors such as
changes in the number and location of competing restaurants, the availability of
experienced management and hourly employees, and other factors set forth below.
We do not have any obligation to revise any of these forward-looking statements
for events occurring after the date of this report or for unanticipated events.
EXPANSION RISKS. Since 1995, we have grown while developing the operational
systems, internal controls, and management personnel that management believed
was necessary to support our plans for continued expansion. In the course of
expanding our business, we will enter new geographic regions in which we have no
previous operating experience. There can be no assurance that the Tumbleweed
concept will be viable in new geographic regions or particular local markets. In
addition, when feasible, we intend to open multiple restaurants in a target
market to achieve operating and advertising efficiencies. Although such
"clustering" of restaurants in a market may adversely affect same store sales in
the short-term, management believes clustering can enhance long-term
performance.
The continued growth of our business will depend upon our ability to open and
operate additional restaurants profitably, which in turn will depend upon
several factors, many of which are beyond our control. These factors include,
among other things, the selection and availability of suitable locations,
negotiations of acceptable lease, purchase and/or financing terms, the timely
construction of restaurants, the securing of required governmental permits and
approvals, the employment and training of qualified personnel, and general
economic and business conditions. Our ability to expand into new geographic
regions is also dependent upon our ability to expand our existing commissary
facilities or open and successfully operate additional commissaries, as may be
necessary to support additional restaurants. There can be no assurance that we
will be successful in achieving our growth plans or managing our expanding
operations effectively, nor can there be any assurance that new restaurants we
open will be operated profitably.
RESTAURANT BASE. As of December 31, 2001, we operated 36 Tumbleweed restaurants
including one restaurant which was 50% owned through a joint venture. Because of
the number of restaurants we currently operate, poor operating results at a
small number of restaurants could negatively affect the profitability of the
entire Company. An unsuccessful new restaurant or unexpected difficulties
encountered during expansion could have a greater adverse effect on our results
of operations than would be the case in a restaurant company with more
restaurants. In addition, we lease certain of our restaurants. Each lease
agreement provides that the lessor may terminate the lease for a number of
reasons, including if we default in payment of any rent or taxes or breach any
covenants or agreements contained in the lease. Termination of any of our leases
pursuant to such terms could adversely affect our results of operations.
- 9 -
CHANGES IN FOOD AND OTHER COSTS; SUPPLY RISKS. Our profitability is
significantly dependent on our ability to anticipate and react to changes in
food, labor, employee benefits and similar costs over which we have no control.
Specifically, we are dependent on frequent deliveries of produce and fresh beef,
pork, chicken and seafood. As a result, we are subject to the risk of possible
shortages or interruptions in supply caused by adverse weather or other
conditions which could adversely affect the availability, quality and cost of
such items. While in the past we have been able to anticipate and react to
changing costs through our purchasing practices or menu price adjustments
without a material adverse effect on profitability, there can be no assurance
that we will be able to do so in the future.
INDUSTRY RISKS. The restaurant business is affected by changes in consumer
tastes, national, regional and local economic conditions, demographic trends,
traffic patterns and the type, number and location of competing restaurants. In
addition, factors such as inflation, increased food, labor, energy and employee
benefit costs, fluctuating insurance rates, national, regional and local
regulations, regional weather conditions, and the availability of experienced
management and hourly employees also may adversely affect the restaurant
industry in general and our restaurants in particular.
COMPETITION. The restaurant industry is intensely competitive with respect to
price, service, location and food quality. We will compete with a variety of
other casual full-service dine-in restaurants, fast food restaurants, take-out
food service companies, delicatessens, cafeteria-style buffets, and other food
service establishments. The number of value-oriented, casual dining restaurants
has increased in the past few years, and competitors include national and
regional chains, franchisees of other restaurant chains, and local
owner-operated restaurants. Many competitors have been in existence longer, have
a more established market presence, and substantially greater financial,
marketing, and other resources than us. A significant change in pricing or other
business strategies by one or more of our competitors, including an increase in
the number of restaurants in our territories, could have a materially adverse
impact on our sales, earnings and growth.
GOVERNMENT REGULATION. The restaurant business is subject to extensive national,
state, and local laws and regulations relating to the development and operation
of restaurants, including those regarding the sale of alcoholic beverages,
building and zoning requirements, the preparation and sale of food and
employer-employee relationships, such as minimum wage requirements, overtime,
working and safety requirements, and citizenship requirements. In addition, we
are subject to regulation by the Federal Trade Commission and must comply with
certain state laws that govern the offer, sale, and termination of franchises,
the refusal to renew franchises, and the scope of noncompetition provisions. The
failure to obtain or retain food or beverage licenses or approvals to sell
franchises, or an increase in the minimum wage rate, employee benefits costs
(including costs associated with mandated health insurance coverage), or other
costs associated with employees, could adversely affect us.
EXECUTIVE OFFICERS
The following table lists the executive officers of the Company as of December
31, 2001, who serve at the pleasure of the Board of Directors. There are no
family relationships among any officers of the Company.
Name Age Position
---- --- --------
Terrance A. Smith. ..... 56 President, Chief Executive Officer, and Director
Glennon F. Mattingly ... 50 Vice President and Chief Financial Officer
Gary T. Snyder.......... 47 Vice President - Company Operations
Lynda J. Wilbourn....... 39 Vice President and Controller
Terrance A. Smith has served as President and Chief Executive Officer of the
Company since August 2000, and is a Director of the Company. Mr. Smith was
elected as a director of the Company in September 1997. Since 1997, Mr. Smith
has also served as the President of Tumbleweed International, LLC. From 1987 to
1997, Mr. Smith was the President and CEO of Chi-Chi's International Operations,
Inc.
Glennon F. Mattingly joined Tumbleweed, LLC, the Company's predecessor, as
Controller in March 1995 and was named Vice President-Controller in April 1998
and Chief Financial Officer in August 2001. Mr. Mattingly continues
- 10 -
to serve the Company in that capacity. Before coming to Tumbleweed, Mr.
Mattingly held various positions with Chi- Chi's, Inc. including six years as
Director of Budgeting and Financial Analysis.
Gary T. Snyder joined Tumbleweed, LLC, the Company's predecessor, as Director of
Training and Human Resources in June 1996 and was appointed Vice President of
Company Operations in April 1998. Mr. Snyder continues to serve the Company in
that capacity. He previously served for 17 years with Bob Evans Farms, Inc.
Lynda J. Wilbourn joined Tumbleweed, Inc. in March 1999 as Director of
Accounting and was named Vice President and Controller in November 2001. Ms.
Wilbourn continues to serve the Company in that capacity. From 1987 to 1999, Ms.
Wilbourn held various positions with NTS Corporation, a regional real estate
development firm headquartered in Louisville, Kentucky, including five years as
Vice President of Accounting.
SEGMENT INFORMATION
Segment information for the years ended December 31, 2001, 2000 and 1999 are
presented in Note 17 to our Consolidated Financial Statements contained in Item
8.
ITEM 2. PROPERTIES
Of the 36 Company-owned restaurants in operation at December 31, 2001, including
one restaurant which was 50% owned through a joint venture, 17 are owned by us
in fee simple while the remainder are leased. Two of the leased locations are
owned by entities whose principals are affiliated with us. Restaurant lease
expirations range from 2004 to 2018, with the majority of the leases providing
for an option to renew for additional terms ranging from five to twenty years.
All of our leases provide for a specified annual rental, and some leases call
for additional rental based on sales volume at the particular location over
specified minimum levels. Generally, the leases are net leases which require us
to pay the cost of insurance and taxes. Our executive offices and our commissary
are located in Louisville, Kentucky. Our commissary and warehouse space are
owned in fee simple by us. Our executive offices are located in leased space.
The lease expires in 2007 and has two 5-year renewal options.
ITEM 3. LEGAL PROCEEDINGS
The Company guaranteed renewals of certain guaranteed indebtedness and any
replacement indebtedness of TW- Tennessee, LLC, a former franchisee
(TW-Tennessee) of the Company in which the Company and David M. Roth, a Director
of the Company, were formerly members, to the extent and in amounts not to
exceed the amounts guaranteed as of September 30, 1998. The Company had
guaranteed certain TW-Tennessee obligations as follows, jointly and severally
with TW-Tennessee common members: a) up to $1,200,000 under a bank line of
credit, b) approximately $2,800,000 of a lease financing agreement, and c)
equipment leases with a bank.
In March 2001, the bank which held the line of credit extended to TW-Tennessee
filed suit in the Circuit Court of Jefferson County, Kentucky against the
Company, the Director and others to enforce certain limited guaranty agreements
(the "Tennessee Litigation"). The Company paid the sum of $195,044 against its
line of credit guarantee in September 2000. The Company undertook settlement
discussions with the bank and the other guarantors during 2001. On December 28,
2001, the court entered summary judgment against the Company and certain other
guarantors including the affected Director. The amount of the judgment against
the Company was $1,004,956. Prior to enforcement of the judgment by the bank,
the parties continued settlement discussions which resulted in the settlement
described below.
By complaint dated October 4, 2001, Douglas H. Morris, II and Michael R. Greene,
plaintiffs, filed an action (the "Morris and Greene Lawsuit") in the Circuit
Court of Jefferson County, Kentucky against the Company, Tumbleweed
International, LLC and others, including David Roth, a current Director of the
Company, alleging damage to the plaintiffs as a result of (i) the management of
the TW-Tennessee restaurants by the Company, (ii) the alleged wrongful
application of proceeds of the Company's purchase of the Medina, Ohio restaurant
and (iii) the alleged wrongful conversion of loan proceeds belonging to
TW-International, LLC to TWED-Charleston, Inc. Prior to answering the complaint,
the Company entered into settlement discussions with the plaintiffs which
resulted in the settlement described below.
Beginning in 2001, the Company had settlement discussions with the bank holding
the TW-Tennessee line of credit, the other guarantors of that line of credit,
the plaintiffs in the Morris and Greene Lawsuit and certain of the shareholders
of
- 11 -
TW International Investors, Inc. and TWI-B, Inc. regarding the resolution of the
Tennessee Litigation, the Morris and Greene Lawsuit and related matters.
On February 28, 2002, the Company entered into a Confidential Settlement
Agreement and Mutual Release (the "Settlement Agreement") which resolved the
Tennessee Litigation, the Morris and Greene Lawsuit and related matters. The
Settlement Agreement provided for a cash payment by the Company to the bank
holding the TW-Tennessee line of credit of $75,000 and the execution of a
promissory note, payable to the bank, in the face amount of $300,000. In
addition, subject to certain conditions, the Company will pay to the bank an
additional amount of up to $200,000 in the event Tumbleweed International, LLC
successfully sells regional international licenses and receives proceeds in
excess of the $1,400,000 in indebtedness assumed by the Company in connection
with its acquisition of the interests of TW International Investors, Inc. and
TWI-B, Inc. in Tumbleweed International, LLC. The completion of the acquisition
of the interests of TW International Investors, Inc. and TWI-B, Inc. in
Tumbleweed International, LLC is included in the Settlement Agreement.
As a result of the Settlement Agreement, the Tennessee Litigation and the Morris
and Greene Lawsuit were dismissed. In addition, the parties to the settlement,
including certain Directors of the Company (George Keller, David M. Roth and
Minx M. Auerbach), granted mutual releases to one another regarding all matters,
other than those specifically excluded. Among the matters excluded from the
mutual release contained in the Settlement Agreement are claims asserted by the
holder of the equipment leases granted to TW-Tennessee relative to guarantees by
the Company and others, including David M. Roth, a Director of the Company,
relative to such equipment leases. The Company is in negotiation with the bank
under the equipment leases and the other guarantors to resolve the Company's
obligations relative to the equipment leases. The Company believes that it will
be obligated to assume and pay one of the equipment leases totaling
approximately $125,000 and will remain contingently liable on two other
equipment leases which the Company believes will be assumed and paid by other
guarantors. These negotiations are ongoing and no agreement has been reached. If
no agreement is reached, the Company would have additional exposure totaling
approximately $180,000.
In the fourth quarter of 2001, as a result of the settlement discussions, the
Company increased a reserve established in 2000 by the additional amount of
$565,000, for a total of $1,290,000, of which $725,000 had been paid out as of
December 31, 2001. The Company increased this reserve to cover its portion of
the settlement payments to the bank holding the TW-Tennessee line of credit and
pay related costs, including legal expenses. The reserve also includes an
additional charge for the equipment lease which the Company expects to assume,
and for payments made by the Company in 2001 on other lease financing claims
related to TW-Tennessee. The Company's management believes it will not incur
significant additional losses in connection with these matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the shareholders during the fourth
quarter ended December 31, 2001.
- 12 -
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of March 20, 2002, 5,839,230 shares of Common Stock were issued and
outstanding. There were approximately 1,300 stockholders, including beneficial
owners of shares held in nominee name.
On January 11, 1999, Tumbleweed, Inc. completed its initial public offering of
common stock. We sold 776,630 shares at the offering price of $10 per share in a
direct offering of our common stock to the public, raising a total of
$7,766,300.
On January 1, 1999, the merger of Tumbleweed, LLC into Tumbleweed, Inc. became
effective. The merger reorganized Tumbleweed, LLC, which had owned, franchised
or licensed 43 Tumbleweed Southwest Mesquite Grill & Bar restaurants, into a
corporation for purposes of the stock offering. In the reorganization, the
membership interests of the approximately 80 former members of Tumbleweed, LLC
were converted into a total of 5,105,000 shares of Company common stock. As
required by the Tumbleweed, LLC operating agreement, the former Class B members
made additional cash contributions of $747,500 in connection with the
reorganization.
The Company received net proceeds of approximately $6,800,000 from the stock
offering. The Company used the offering proceeds, plus the additional cash
contributions of $747,500 we received in the reorganization, to repay bank
indebtedness totaling $7,043,366 and to pay offering expenses. The bank
indebtedness was an obligation of the former Class A members of Tumbleweed, LLC,
including certain directors and officers of the Company, and had been accounted
for as redeemable members' equity. Offering expenses totaled approximately
$1,000,000, none of which were commissions or other underwriting expenses.
The registration statement for the stock offering also included the 5,105,000
shares issued in the reorganization, which may be sold from time to time in the
future by the former members of Tumbleweed, LLC for their own accounts.
Our common stock trades on the Nasdaq Stock Market's National Market under the
symbol "TWED." The following table shows quarterly high and low closing prices
for the Common Stock during 2001 and 2000 for the periods indicated, as reported
by the Nasdaq National Market.
2001 2000
---- ----
High Low High Low
First Quarter $ 3.13 $ 1.81 $ 6.94 $4.75
Second Quarter 2.99 2.17 6.37 2.62
Third Quarter 2.30 1.30 4.09 2.62
Fourth Quarter 1.50 0.92 3.37 2.00
We have never paid a dividend on our Common Stock nor do we expect to pay a cash
dividend in the foreseeable future. We currently intend to retain any future
earnings to finance the development of additional restaurants and the growth of
our business generally. We are also prohibited from paying dividends under the
terms of our two mortgage revolving lines of credit.
- 13 -
ITEM 6. SELECTED FINANCIAL DATA
Effective January 1, 1999, Tumbleweed, LLC was merged into Tumbleweed, Inc. as a
result of the sale of common stock in an initial public offering. Tumbleweed,
Inc. had not conducted any operations prior to the merger. In the following
table, the income statement and balance sheet data of Tumbleweed, Inc. for the
years ended December 31, 2001, 2000 and 1999 and Tumbleweed, LLC for the years
ended December 31, 1998 and 1997 have been derived from financial statements
which have been audited by Ernst & Young LLP, independent auditors, whose report
thereon is included elsewhere in this filing. The information set forth on the
following page should be read in conjunction with, and are qualified in their
entirety by the financial statements (and the notes thereto) and other financial
information appearing elsewhere in this filing and the information contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
- 14 -
Years Ended December 31
-----------------------------------------------------------------------
Tumbleweed, Tumbleweed,
Inc. LLC
----------------------------------------- ----------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Statement of Operations Data:
Revenues:
Restaurant sales $ 56,025,886 $ 51,820,600 $ 48,578,123 $ 40,490,933 $ 27,891,128
Commissary sales 1,781,252 1,663,208 1,168,836 1,041,266 1,007,011
Franchise fees and royalties 1,227,300 1,271,251 1,064,952 770,806 563,056
Gain from insurance proceeds due to
involuntary conversion of non-
monetary assets - 554,864 - - -
Other revenues 418,744 990,843 532,976 504,639 365,054
------------- ------------ ------------ ------------ -------------
Total revenues 59,453,182 56,300,766 51,344,887 42,807,644 29,826,249
Operating expenses:
Restaurant cost of sales 17,426,315 15,275,817 14,232,564 11,788,578 8,191,928
Commissary cost of sales 1,562,049 1,460,704 1,053,083 905,814 887,793
Operating expenses 30,567,705 27,456,791 24,377,631 20,881,212 14,035,693
Selling, general and administrative
expenses 6,107,159 6,598,299 4,981,721 4,150,303 3,051,740
Preopening expenses - 490,394 395,768 816,604 544,723
Depreciation and amortization 2,285,452 2,147,408 1,804,757 1,442,011 971,863
Special charges 4,294,539 - - - -
Loss on guarantees of indebtedness 565,000 725,000 - - -
------------- ------------ ------------ ------------ -------------
Total operating expenses 62,808,219 54,154,413 46,845,524 39,984,522 27,683,740
------------- ------------ ------------ ------------ -------------
Income (loss) from operations (3,355,037) 2,146,353 4,499,363 2,823,122 2,142,509
Interest expense, net (1,276,903) (1,458,650) (1,128,906) (869,712) (428,598)
Equity in income (loss) of TW-
Springhurst 81,318 (58,903) - - -
------------- ------------ ------------ ------------ -------------
Income (loss) before income taxes
and cumulative effect of a change in
accounting principle (4,550,622) 628,800 3,370,457 1,953,410 1,713,911
Provision (benefit) for income taxes:
Current and deferred (1,178,144) 65,439 1,179,659 - -
Deferred taxes related to change in
tax status (3) - - 639,623 - -
------------- ------------ ------------ ------------ -------------
Total provision (benefit) for income
taxes (1,178,144) 65,439 1,819,282 - -
------------- ------------ ------------ ------------ -------------
Income (loss) before cumulative
effect of a change in accounting
principle (3,372,478) 563,361 1,551,175 1,953,410 1,713,911
Cumulative effect of a change in
accounting principle, net of tax - - (341,035) - -
------------- ------------ ------------ ------------ -------------
Net income (loss) $ (3,372,478)$ 563,361 $ 1,210,140 $ 1,953,410 $ 1,713,911
============= ============ ============ ============ =============
Basic and diluted earnings (loss)
per share:
Income (loss) before cumulative
effect of a change in accounting
principle $ (0.58)$ 0.10 $ 0.27
Cumulative effect of a change in
accounting principle, net of tax - - (0.06)
------------- ------------ ------------
Net income (loss) $ (0.58)$ 0.10 $ 0.21
============= ============ ============
- 15 -
Years Ended December 31
-----------------------------------------------------------------------
Tumbleweed, Tumbleweed,
Inc. LLC
----------------------------------------- ----------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Pro forma income data (unaudited):
Income before income taxes
and cumulative effect of a change
in accounting principle as reported $ 3,370,457 $ 1,953,410 $ 1,713,911
Pro forma income taxes (1) 1,179,659 683,693 599,896
------------ ------------ -------------
Pro forma income before cumulative
effect of a change in accounting
principle 2,190,798 1,269,717 1,114,015
Cumulative effect of a change in
accounting principle, net of tax (341,035) - -
------------ ------------ -------------
Pro forma net income $ 1,849,763 $ 1,269,717 $ 1,114,015
============ ============ =============
Pro forma basic and diluted earnings
per share (2):
Pro forma income before cumulative
effect of a change in accounting
principle $ 0.37 $ 0.25 $ 0.22
Cumulative effect of a change in
accounting principle, net of tax (0.06) - -
------------ ------------ -------------
Pro forma net income $ 0.31 $ 0.25 $ 0.22
============ ============ =============
As of December 31
-------------------------------------------------------------------------
Tumbleweed, Tumbleweed,
Inc. LLC
---------------------------------- -------------------------------------
Pro
Forma
2001 2000 1999 1998 (3) 1998 1997
---- ---- ---- -------- ---- ----
(In thousand)
Balance Sheet Data:
Total assets $ 34,897 $ 39,453 $ 36,597 $ 33,681 $ 33,681 $ 26,068
Long-term debt and capital lease
obligations, including current
maturities 15,435 16,998 15,145 13,363 13,363 8,542
Total liabilities 20,398 21,581 19,035 24,743 24,103 10,725
Redeemable members' equity - - - - 18,925 23,420
Members' equity - - - - 354 7
Members' retained earnings (deficit) - - - - (9,701) (8,083)
Stockholders' equity 14,499 17,872 17,563 - - -
Pro forma stockholders' equity - - - 8,938 - -
(1) Prior to Reorganization, the Company operated as a limited liability company
and was not subject to corporate income taxes through December 31, 1998. Pro
forma adjustment has been made to net income to give effect to federal and state
income taxes as though the Company had been subject to corporate income taxes
for the periods presented with an effective tax rate of 35%.
(2) Shares outstanding gives effect to the Reorganization as if it had occurred
as of January 1, 1997.
(3) Reflects the establishment of a deferred tax liability of $639,623 related
to the termination of Tumbleweed, LLC's limited liability company status and the
conversion of Tumbleweed, LLC's members' interests into 5,105,000 shares of
Company common stock effective January 1, 1999.
- 16 -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
We make various forward-looking statements about our business in the following
discussion. When making these forward-looking statements, we use words such as
expects, believes, estimates, anticipates, plans and similar expressions to
identify them. We also identify important cautionary factors that could cause
our actual results to differ materially from those projected in forward-looking
statements made by us. Factors that realistically could cause results to differ
materially from those projected in the forward-looking statements include the
availability and cost of financing and other events that affect our restaurant
expansion program, changes in food and other costs, changes in national,
regional or local economic conditions, changes in consumer tastes, competitive
factors such as changes in the number and location of competing restaurants, the
availability of experienced management and hourly employees, and other factors
set forth below and in "Forward-Looking Statements/Risk Factors" in Item 1.
Business.
As of December 31, 2001, we owned, franchised or licensed 65 Tumbleweed
restaurants. We owned and operated 36 restaurants in Kentucky, Indiana and Ohio,
including one restaurant which was 50% owned through a joint venture. There were
21 franchised restaurants located in Indiana, Illinois, Kentucky, Michigan,
Virginia and Wisconsin and eight licensed restaurants located outside the United
States in Germany, Jordan, Egypt, Saudi Arabia, England and Turkey. The
following table reflects changes in the number of Company-owned, franchised and
licensed restaurants for the years presented.
Company-owned Restaurants 2001 2000 1999
------------------------- ---- ---- ----
In operation, beginning of year 36 29 25
Restaurants opened - 4 4
Joint venture restaurant opened - 1 -
Restaurants purchased from franchisee - 2 -
---- ---- ----
In operation, end of year 36 36 29
---- ---- ----
Franchise and Licensed Restaurants
In operation, beginning of year 27 22 18
Restaurants opened 3 10 8
Restaurants closed (1) (3) (4)
Restaurants sold to Tumbleweed, Inc. - (2) -
---- ---- ----
In operation, end of year 29 27 22
---- ---- ----
System total 65 63 51
==== ==== ====
Subsequent to December 31, 2001, the Company closed four Company-owned
restaurant locations. The restaurants were located in Cincinnati, Ohio (2),
Columbus, Ohio (1), and Evansville, Indiana (1). The restaurant closings were
part of a strategic management decision to eliminate lower sales volume
restaurants that were unprofitable in 2001 and to focus its energies on the
continued improvement of per-store average sales volumes. See below for a
discussion regarding a special charge which was recorded in 2001 as a result of
these restaurant closings. Also subsequent to year end, the Company purchased
from its joint venture partner its 50% interest in a restaurant location.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires the
Company to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, the
- 17 -
Company evaluates these estimates. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. Actual results may differ from these estimates.
The Company believes the following critical accounting policies affect its more
significant assumptions and estimates used in the preparation of its
consolidated financial statements.
Valuation of Long-Lived Assets and Goodwill
We assess the impairment of long-lived assets and goodwill whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors we consider important that could trigger an impairment
review include the following:
o a significant underperforming store relative to expected historical or
projected future operating results;
o a significant change in the manner of our use of the acquired asset or
the strategy for our overall business;
o a significant negative industry or economic trend;
o our market capitalization relative to net book value.
Through December 31, 2001, we determined whether the carrying value of
long-lived assets and goodwill may not be recoverable based upon the existence
of one or more indicators of impairment. Then, if it was determined that there
was an impairment based on the estimated undiscounted future cash flows of
assets, we measured any impairment based on the asset's current fair value. This
fair value was generally determined on a projected discounted cash flow method
using a discount rate determined by our management to be commensurate with the
risk inherent in our current business model for assets held for use or net
realizable value for assets held for sale. Net long-lived assets and goodwill
amounted to approximately $31.4 million as of December 31, 2001. See "Recently
Issued Accounting Standards" below for a discussion of new accounting standards
for goodwill and other intangibles and long-lived assets.
The Company recorded special charges of $4,294,539 in the fourth quarter of
2001. The special charges include a $3,683,353 charge to earnings in accordance
with Statement of Financial Accounting Standards (SFAS) No. 121, "Impairment of
Long-Lived Assets." This charge reflects the write-down of assets associated
with six restaurants, four of which closed in the first quarter of 2002. The
Company plans to sell one of the remaining two restaurants to a current
franchisee and will continue to operate the other restaurant for the present.
The restaurant closings were part of a strategic management decision to
eliminate lower sales volume restaurants that were unprofitable in 2001 and to
focus its energies on the continued improvement of per-store average sales
volumes. The special charges also include $611,186 for lease obligations and
other costs related to the decision to close these restaurants. Although we do
not anticipate significant changes, the actual net proceeds from anticipated
sales of assets and store closing costs may differ from the estimated amounts.
Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." These statements established new accounting and reporting standards for
business combinations and associated goodwill and intangible assets. SFAS No.
141, effective July 1, 2001, eliminates the pooling of interest method of
accounting and amortization of goodwill for business combinations initiated
after June 30, 2001. SFAS No. 142, effective January 1, 2002, requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually.
The Company adopted the new rules on accounting for goodwill and other
intangibles as of January 1, 2002 and is currently completing the transitional
impairment test required by the new rules. Any impairment loss resulting from
the transitional impairment test will be recorded as a cumulative effect of a
change in accounting principle during the first quarter of 2002. The Company
currently expects an impairment write-down of goodwill of approximately
$2,300,000
- 18 -
in the first quarter of 2002. Goodwill amortization amounted to $135,000 for
2001. As noted above, goodwill will no longer be amortized under the new rules.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," and the accounting and reporting provisions of Accounting
Principles Board (APB) Opinion No. 30, "Reporting Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144
requires that one accounting model be used for long-lived assets to be disposed
of by sale, whether previously held and used or newly acquired, and it broadens
the presentation of discontinued operations to include more disposal
transactions. The Company adopted the provisions of SFAS No. 144 as of January
1, 2002 and is currently evaluating the impact that SFAS No. 144 may have on its
financial position and results of operations.
The following section should be read in conjunction with "Selected Financial
Data" included above in Item 6 and our financial statements and the related
notes included below in Item 8.
- 19 -
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to total revenues of
certain operating statement data, except where noted, for the periods indicated.
Years Ended December 31
2001 2000 1999
--------------------------------
Revenues:
Restaurant sales 94.2% 92.0% 94.6%
Commissary sales 3.0 3.0 2.3
Franchisee fees and royalties 2.1 2.2 2.1
Gain from insurance proceeds due to involuntary
conversion of non-monetary assets - 1.0 -
Other revenues 0.7 1.8 1.0
--------------------------------
Total revenues 100.0 100.0 100.0
Operating expenses:
Restaurant cost of sales (1) 31.1 29.5 29.3
Commissary cost of sales (2) 87.7 87.8 90.1
Operating expenses (1) 54.6 53.0 50.2
Selling, general and administrative 10.3 11.7 9.7
Preopening expenses - 0.9 0.8
Depreciation and amortization 3.8 3.8 3.5
Special charges 7.2 - -
Loss on guarantees of indebtedness 1.0 1.3 -
--------------------------------
Total operating expenses 105.6 96.2 91.2
--------------------------------
Income (loss) from operations (5.6) 3.8 8.8
Other expense, net (2.1) (2.7) (2.2)
--------------------------------
Income (loss) before income taxes and cumulative
effect of a change in accounting
principle (7.7) 1.1 6.6
Provision (benefit)for income taxes:
Current and deferred (2.0) 0.1 2.3
Deferred taxes related to a change in tax status - - 1.3
--------------------------------
Total provision (benefit) for income taxes (2.0) 0.1 3.6
--------------------------------
Income (loss) before cumulative effect
of a change in accounting principle (5.7) 1.0 3.0
Cumulative effect of a change in
accounting principle, net of tax - - (0.7)
--------------------------------
Net income (loss) (5.7)% 1.0% 2.3%
================================
Pro forma income data (unaudited):
Income before income taxes and
cumulative effect of a change in
accounting principle as reported 6.6%
Pro forma income taxes (3) 2.3
-----------
Pro forma income before cumulative
effect of a change in accounting
principle 4.3
Cumulative effect of a change in
accounting principle, net of tax (0.7)
-----------
Pro forma net income 3.6%
===========
(1) As percentage of restaurant sales.
(2) As percentage of commissary sales.
- 20 -
(3) Effective January 1, 1999, Tumbleweed, LLC converted from a limited
liability company into a C corporation by merging with Tumbleweed, Inc.,
a Delaware corporation formed on December 17, 1997. Pro forma income
taxes excludes the deferred tax effects related to the change in tax
status as of January 1, 1999.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Total revenues increased by $3,152,416 or 5.6% in 2001 compared to 2000
primarily as a result of the following:
Restaurant sales increased by $4,205,286 or 8.1% in 2001 compared to
2000. The increase in restaurant sales is due primarily to 42 additional
Company-owned restaurant store months during 2001 compared to 2000. The
increase in restaurant sales is also attributable in part to a 0.7% increase
in same store sales.
Commissary sales to franchised and licensed restaurants increased by
$118, 044 or 7.1% in 2001 compared to 2000. The increase is due primarily to
38 additional franchised or licensed restaurant store months in 2001 compared
to 2000.
Franchise fees and royalties decreased by $43,951 or 3.5% in 2001
compared to 2000. Franchise fees decreased by $145,000 in 2001 compared to
2000. The decrease in franchise fee income is a result of having seven
franchise restaurant openings in 2000 compared to three franchise restaurant
openings in 2001. The decrease in franchise fees is partially offset by a
$101,049 increase in royalty income from 2000 to 2001. Royalty income
increased primarily as a result of 38 additional franchised or licensed
restaurant store months in 2001 compared to 2000.
The gain of $554,864 from insurance proceeds during 2000 was due to the
involuntary conversion of non-monetary assets from a fire at a Company-owned
restaurant . See Note 12 of the accompanying consolidated financial
statements for a detail discussion. There was no similar income during 2001.
Other revenues decreased by $572,099 or 57.7% in 2001 compared to 2000
primarily due to a decrease in volume related purchasing rebates in 2001
compared to 2000. The decrease in other revenues is also due to a decrease in
insurance proceeds which relate to a business interruption as a result of a
fire which occurred in June 2000 at a Company-owned restaurant. Other
revenues includes $100,000 and $280,000 of insurance proceeds in 2001 and
2000, respectively. See Note 12 of the accompanying consolidated financial
statements for a detail discussion.
Restaurant cost of sales increased by $2,150,498 or 14.1% in 2001 compared to
2000. The increase was principally due to 42 additional Company-owned restaurant
store months in 2001 compared to 2000. Restaurant cost of sales increased as a
percentage of sales by 1.6% to 31.1% in 2001 compared to 29.5% in 2000. The 1.6%
increase in cost of sales is primarily the result of a temporary increase in the
cost of beef and pork (primarily steaks and ribs, respectively) and as a result
of improving the quality of the beef product served in the restaurants.
Commissary cost of sales increased $101,345 or 6.9% in 2001 compared to 2000.
The increase in commissary cost of sales is due primarily to 38 additional
franchised and licensed restaurant store months in 2001 compared to 2000. As a
percentage of commissary sales, commissary cost of sales were 87.7% and 87.8% in
2001 and 2000, respectively.
Restaurant operating expenses increased by $3,110,914 or 11.3% in 2001 compared
to 2000. The increase in operating expenses reflects 42 additional Company-owned
restaurant store months in 2001 compared to 2000. Operating expenses increased
as a percentage of restaurant sales by 1.6% to 54.6% in 2001 from 53.0% in 2000
primarily due to a 0.6% increase in utilities and a 0.4% increase in payroll
costs.
Selling, general and administrative expenses decreased by $491,140 or 7.4% in
2001 compared to 2000. The decrease in selling, general and administrative
expenses is primarily due to decreased payroll costs for corporate personnel.
The decrease in payroll costs is partially offset by increased advertising
costs, the cost of implementing a new menu during the first quarter of 2001and
increased legal costs. As a percentage to total revenues, selling, general and
administrative expenses were 10.3% and 11.7% for 2001 and 2000, respectively.
Preopening expenses are start-up costs which are incurred in connection with
opening new restaurant locations. These costs are expensed as incurred and will
fluctuate based on the number of restaurant locations which are in the process
- 21 -
of being prepared for opening. There were no preopening expenses incurred during
2001. Preopening expenses were $490,394 in 2000.
Depreciation and amortization expense increased $138,044 or 6.4% in 2001
compared to 2000 due primarily to 42 additional Company-owned restaurant store
months in 2001 compared to 2000.
The Company recorded special charges of $4,294,539 in the fourth quarter of
2001. The special charges include a $3,683,353 charge to earnings in accordance
with SFAS No. 121, "Impairment of Long-Lived Assets." This charge reflects the
write-down of assets associated with six restaurants, four of which closed in
the first quarter of 2002. The Company plans to sell one of the remaining two
restaurants to a current franchisee and will continue to operate the other
restaurant for the present. The restaurant closings were part of a strategic
management decision to eliminate lower sales volume restaurants that were
unprofitable in 2001 and to focus its energies on the continued improvement of
per-store average sales volumes. The special charges also include $611,186 for
lease obligations and other costs related to the decision to close these
restaurants. The Company has made payments of $10,000 as of December 31, 2001
related to the closing costs and expects most of the remaining costs will be
disbursed in 2002.
Net interest expense decreased $181,747 or 12.5% in 2001 compared to 2000. The
decrease in net interest expense is the result of decreases in the prime
interest rate during 2001 partially offset by higher borrowings incurred during
2000 to fund the growth in Company-owned restaurants.
The equity in income of TW-Springhurst was $81,318 in 2001 compared to equity in
losses of $58,903 in 2000. TW- Springhurst experienced a loss in 2000 primarily
as a result of pre-opening costs.
The combined effective federal and state income tax rate was approximately 26%
and 10% for the years ended December 31, 2001 and 2000, respectively. The
effective tax rate is lower than the statutory federal tax rate of 34% as a
result of the impact of employment tax credits and state income taxes on the
effective rate, as well as the impact on the rate in 2001 of the valuation
allowance against deferred income tax assets.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND 1999
Total revenues increased by $4,955,879 or 9.6% in 2000 compared to 1999
primarily as a result of the following:
Restaurant sales increased by $3,242,477 or 6.7% in 2000 compared to 1999.
The increase is due primarily to the addition of six Company-owned
restaurants during 2000. The increase is partially offset by a 3.3% decrease
in same store sales.
Commissary sales to franchised and licensed restaurants increased by $494,372
or 42.3% in 2000 compared to 1999. The increase is due primarily to five
additional franchised or licensed restaurants during 2000.
Franchise fees and royalties increased by $206,299 or 19.4% in 2000 compared
to 1999 as a result of an increase in royalty income due primarily to five
additional franchise restaurants. Franchise fees were approximately the same
in both periods.
The gain of $554,864 from insurance proceeds was due to the involuntary
conversion of non-monetary assets from a fire at a Company-owned restaurant.
See Note 12 of the accompanying financial statements for a detail
discussion.
Other revenues increased by $457,867 or 85.9% in 2000 compared to 1999
primarily due to $280,000 of insurance proceeds as it relates to a business
interruption as a result of a fire at a Company-owned restaurant. See Note 12
of the accompanying financial statements for a detail discussion. There was
no similar income in 1999. In addition, other revenues increased in 2000
compared to 1999 as a result of an increase in volume related purchasing
rebates.
Restaurant cost of sales increased by $1,043,253 or 7.3% in 2000 compared to
1999. The increase was principally due to the addition of six Company-owned
restaurants during 2000. Restaurant cost of sales increased as a percentage of
sales by 0.2% to 29.5% for 2000 compared to 29.3% for 1999.
- 22 -
Commissary cost of sales increased $407,621 or 38.7% in 2000 compared to 1999.
The increase in commissary cost of sales is due primarily to five additional
franchised or licensed restaurants during 2000. As a percentage of commissary
sales, commissary cost of sales decreased by 2.3% in 2000 compared to 1999 due
to lower manufactured food costs in 2000.
Restaurant operating expenses increased by $3,079,160 or 12.6% in 2000 compared
to 1999. The increase reflects the addition of six Company-owned restaurants
during 2000. Operating expenses increased as a percentage of restaurant sales to
53.0% during 2000 from 50.2% in 1999 primarily due to a 0.3% increase in
promotional costs and a 1.7% increase in total restaurant payroll costs.
Selling, general and administrative expenses increased by $1,616,578 or 32.4% in
2000 compared to 1999. The increase was due in part to additional payroll costs
of approximately $280,000 which were incurred as a result of the retirement of
the former President and CEO of the Company and the restructuring of the
corporate staff. The increase in selling, general and administrative expenses in
2000 as compared to 1999 is also due in part to the addition of management
personnel to support the growing restaurant base and increased advertising and
outside professional service costs. As a percentage to total revenues, selling,
general and administrative expenses were 11.7% and 9.7% of revenues for the
years ended December 31, 2000 and 1999, respectively.
Preopening expenses were $490,394 and $395,768 for the years ended December 31,
2000 and 1999, respectively. Preopening expenses are start-up costs which are
incurred in connection with opening new restaurant locations. These costs are
expensed as incurred and will fluctuate based on the size of the restaurant and
the number of restaurant locations which are in the process of being prepared
for opening.
Depreciation and amortization expense increased $342,651 or 19.0% in 2000
compared to 1999 due primarily to the addition of six Company-owned restaurants
during 2000.
Net interest expense increased $333,458 or 29.5% in 2000 compared to 1999. The
increase resulted from increased borrowings to fund the growth in Company-owned
restaurants and increases in the prime interest rate during 2000.
The equity in losses of TW-Springhurst was $58,903 for the year ended December
31, 2000. The TW-Springhurst restaurant location opened in 2000.
The combined effective federal and state income tax rate was approximately 10%
and 35% for the years ended December 31, 2000 and 1999, respectively, excluding
the charge related to change in tax status. The effective tax rate is lower in
2000 as a result of lower profitability and the resulting impact of employment
tax credits and state income taxes on the effective rate. As a result of a
change in tax status from a limited liability corporation to a C corporation
effective January 1, 1999, we recorded a net deferred income tax liability and
income tax expense of $639,623 in 1999.
LIQUIDITY AND CAPITAL RESOURCES
In 2002, the Company expects to construct one to two additional restaurant
facilities. Our ability to expand our number of restaurants will depend on a
number of factors, including the selection and availability of quality
restaurant sites, the negotiation of acceptable lease or purchase terms, the
securing of required governmental permits and approvals, the adequate
supervision of construction, the hiring, training and retaining of skilled
management and other personnel, the availability of adequate financing and other
factors, many of which are beyond our control. The hiring and retention of
management and other personnel may be difficult given the low unemployment rates
in the areas in which we intend to operate. There can be no assurance that we
will be successful in opening the number of restaurants anticipated in a timely
manner. Furthermore, there can be no assurance that our new restaurants will
generate sales revenue or profit margins consistent with those of our existing
restaurants, or that these new restaurants will be operated profitably.
Our capital needs during 2001 arose from the reconstruction of a restaurant
facility which was damaged by fire during June 2000, and to a lesser extent,
maintenance and improvement of existing restaurant facilities. The source of
capital to fund the reconstruction was insurance proceeds received during 2000.
The maintenance and improvement expenditures were funded by internally generated
cash flow. Our capital needs for 2000 and 1999 arose from the development of new
restaurants, and to a lesser extent, maintenance and improvement of existing
restaurant facilities.
- 23 -
The principal sources of capital to fund these expenditures were internally
generated cash flow, bank borrowings, lease financing and an equity offering in
1999. The table below provides certain information regarding our sources and
uses of capital for the years presented:
Years
Ended December 31
-----------------
2001 2000 1999
---- ---- ----
Net cash provided by operations $ 3,294,158 $ 2,262,548 $ 3,592,419
Purchases of property and equipment (1,255,406) (3,090,936) (6,915,544)
Business acquisitions - (1,806,333) -
Insurance proceeds for property and equipment - 1,299,352 -
Proceeds from common stock offering - - 7,766,300
Net borrowings (payments) on long-term debt and
capital lease obligations (1,563,315) 1,431,705 1,781,865
Payment on short-term borrowings - - (6,990,34)
The table below provides information regarding our contractual obligations and
commitments as of December 31, 2001.
Our largest use of funds during 2001 was for the reconstruction of a restaurant
facility which was damaged by fire during 2000 and for payments on long-term
debt and capital lease obligations. Our largest use of funds during 2000 and
1999 was for capital expenditures consisting of land, building and equipment and
for payments on long-term debt and capital lease obligations. The growth of the
Company during the 2000 and 1999 periods did not require significant additional
working capital. Sales are predominantly for cash and the business does not
require the maintenance of significant receivables or inventories. In addition,
it is common within the restaurant industry to receive trade credit on the
purchase of food, beverage and supplies, thereby reducing the need for
incremental working capital to support sales increases.
The Company guaranteed renewals of certain guaranteed indebtedness and any
replacement indebtedness of TW- Tennessee, LLC, a former franchisee
(TW-Tennessee) of the Company in which the Company and David M. Roth, a Director
of the Company, were formerly members, to the extent and in amounts not to
exceed the amounts guaranteed as of September 30, 1998. The Company had
guaranteed certain TW-Tennessee obligations as follows, jointly and severally
with TW-Tennessee common members: a) up to $1,200,000 under a bank line of
credit, b) approximately $2,800,000 of a lease financing agreement, and c)
equipment leases with a bank.
Beginning in 2001, the Company had settlement discussions with the bank holding
the TW-Tennessee line of credit, the other guarantors of that line of credit and
certain of the shareholders of TW International Investors, Inc. and TWI-B, Inc.
regarding the resolution of the Tennessee Litigation and related matters.
On February 28, 2002, the Company entered into a Confidential Settlement
Agreement and Mutual Release (the "Settlement Agreement") which resolved the
Tennessee Litigation and related matters. The Settlement Agreement provided for
a cash payment by the Company to the bank holding the TW-Tennessee line of
credit of $75,000 and the execution of a promissory note, payable to the bank,
in the face amount of $300,000. In addition, subject to certain conditions, the
Company will pay to the bank an additional amount of up to $200,000 in the event
Tumbleweed International, LLC successfully sells regional international licenses
and receives proceeds in excess of the $1,400,000 in indebtedness assumed by the
Company in connection with its acquisition of the interests of TW International
Investors,
- 24 -
Inc. and TWI-B, Inc. in Tumbleweed International, LLC. The completion of the
acquisition of the interests of TW International Investors, Inc. and TWI-B, Inc.
in Tumbleweed International, LLC is included in the Settlement Agreement.
As a result of the Settlement Agreement, the Tennessee Litigation was dismissed.
In addition, the parties to the settlement, including certain Directors of the
Company (George Keller, David M. Roth and Minx M. Auerbach), granted mutual
releases to one another regarding all matters, other than those specifically
excluded. Among the matters excluded from the mutual release contained in the
Settlement Agreement are claims asserted by the holder of the equipment leases
granted to TW-Tennessee relative to guarantees by the Company and others,
including David M. Roth, a Director of the Company, relative to such equipment
leases. The Company is in negotiation with the bank under the equipment leases
and the other guarantors to resolve the Company's obligations relative to the
equipment leases. The Company believes that it will be obligated to assume and
pay one of the equipment leases totaling approximately $125,000 and will remain
contingently liable on two other equipment leases which the Company believes
will be assumed and paid by other guarantors. These negotiations are ongoing and
no agreement has been reached. If no agreement is reached, the Company would
have additional exposure totaling approximately $180,000.
In the fourth quarter of 2001, as a result of the settlement discussions, the
Company increased a reserve established in 2000 by the additional amount of
$565,000, for a total of $1,290,000, of which $725,000 had been paid out as of
December 31, 2001. The Company increased this reserve to cover its portion of
the settlement payments to the bank holding the TW-Tennessee line of credit and
pay related costs, including legal expenses. The reserve also includes an
additional charge for the equipment lease which the Company expects to assume,
and for payments made by the Company in 2001 on other lease financing claims
related to TW-Tennessee. The Company's management believes it will not incur
significant additional losses in connection with these matters.
We both own and lease our restaurant facilities. Management determines whether
to acquire or lease a restaurant facility based on our evaluation of the
financing alternatives available for a particular site.
In the next 12 months, the Company expects the demand on future liquidity to be
principally from the ongoing maintenance and improvement of existing restaurant
facilities and from the construction of one to two additional restaurant
facilities. As of December 31, 2001, the Company had no material commitments for
the construction of new restaurants, maintenance or improvement of existing
restaurant facilities. We will utilize mortgage, sale/leaseback and/or landlord
financing, as well as equipment leasing and financing, for a portion of the
development costs of restaurants we plan to open in 2002. The remaining costs
will be funded by available cash reserves, cash provided from operations and
borrowing capacity. Management believes such sources will be sufficient to fund
our expansion plans through 2002. Should our actual results of operations fall
short of, or our rate of expansion significantly exceed plans, or should our
costs of capital expenditures exceed expectations, we may need to seek
additional financing in the future. In negotiating such financing, there can be
no assurance that we will be able to raise additional capital on terms
satisfactory to us.
The Company has a $5,960,000 mortgage revolving line of credit with a bank. As
of December 31, 2001, we had outstanding borrowings under the line of credit of
$5,726,148. The note bears interest at the prime rate plus .25% (5.0% at
December 31, 2001) and is due December 31, 2003. The Company also has a $975,000
mortgage revolving line of credit with a bank. As of December 31, 2001, we had
outstanding borrowings under the line of credit of $964,868. The note bore
interest at the prime rate plus .25% (5.0% at December 31, 2001) through March
31, 2002 and increased to the prime rate plus 2.0% thereafter. The note matures
April 1, 2003. Both of the revolving lines of credit impose restrictions on the
Company with respect to the maintenance of certain financial ratios, the
incurrence of indebtedness, the sale of assets, mergers, capital expenditures
and the payment of dividends.
During the year ended December 31, 2001, the Company was not in compliance with
certain financial covenants pertaining to long-term totalling $9,408,520 as of
December 31, 2001. The Company obtained appropriate waivers, and in one instance
a Forbearance Agreement, from the lenders to cure the non-compliance at December
31, 2001. The Company also obtained covenant amendments from certain of the
lenders which management believes will enable compliance with financial
covenants in the future for all of its debt agreements. The contractual
obligations and commitments schedule above reflects the revised terms of the
loan agreements.
- 25 -
SUBSEQUENT EVENTS
As of December 31, 2001, the Company had a 50% interest in a Louisville,
Kentucky Tumbleweed restaurant location. The remaining 50% was held by
TW-Springhurst Investors, LLC, which is owned by a current and former director
of the Company. Subsequent to December 31, 2001, the Company acquired the
remaining 50% interest from TW- Springhurst Investors, LLC for $267,000. The
Company also assumed TW-Springhurst, LLC's note payable to a bank which had a
balance of approximately $161,000 on the date of purchase. An independent
business valuation appraisal was used to assist Company management in
determining the purchase price.
Subsequent to December 31, 2001, the Company purchased International for $1.5
million from TW-International Investors, Inc. and CCIO. CCIO owned 40% of
International. The President and Chief Executive Officer of the Company is the
sole shareholder of CCIO. Members of TW-International Investors, Inc. include
three current directors of the Company. The acquisition will give the Company
direct control and benefit of the international licensing of the Tumbleweed
concept. In connection with the acquisition, the Company assumed an existing
$1.4 million bank loan of TW-International Investors, Inc. and will issue 76,
923 shares of its common stock to CCIO. The Company will also enter into a
commission agreement with CCIO in connection with the sale of international
regional licenses by International.
Also subsequent to December 31, 2001, the Company implemented a 401(k) plan. All
employees who are at least 21 years of age with one year of service in which
they worked a minimum of 1,000 hours are eligible. An employee can contribute up
to 15% of their gross salary. The Company will match 25% of the first 4% an
employee contributes. The employee becomes vested in the Company contribution
based on a five-year vesting schedule.
OTHER EVENTS
TW Funding, LLC is an entity owned by certain current and former officers and
directors of the Company. The members of TW Funding, LLC guaranteed a loan from
Gerald Mansbach incurred by TW Funding to finance its purchase of 400,000 shares
of Common Stock in the Company's initial public offering in January 1999. The
shares of Common Stock held by TW Funding, as well as 1,900,000 shares of
Company Common Stock owned by the guarantors were pledged to secure the loan and
the guarantee. The pledge totaled 2,300,000 shares of Common Stock. The loan, as
extended, matured on March 31, 2001. On or about May 5, 2001, the obligation of
approximately $4,900,000 ($4,000,000 principal and $900,000 interest) of TW
Funding, LLC was declared in default. The Company has been informed that the
parties related to the TW Funding matter have reached a settlement. As a result
of a settlement between Mr. Mansbach and the guarantors, Mr. Mansbach has become
the legal and beneficial owner of 2,398,002 shares of Common Stock of the
Company (which includes 98,002 shares which were previously owned by Mr.
Mansbach) constituting approximately 41.1% of the outstanding shares of Common
Stock.
The Company has been notified by Nasdaq that it has not met the minimum public
float requirement of $5 million over 30 consecutive trading days as required by
Nasdaq's National Market rules. Nasdaq has given the Company until May 15, 2002
to regain compliance. If the Company does not regain compliance by May 15, 2002,
Nasdaq will delist the Company's securities from Nasdaq's National Market
System. The Company is currently evaluating its options in the event it cannot
regain compliance.
IMPACT OF INFLATION
The impact of inflation on the cost of food, labor, equipment, land and
construction costs could harm our operations. We pay a majority of our employees
hourly rates related to federal and state minimum wage laws. As a result of
increased competition and the low unemployment rates in the markets in which our
restaurants are located, we have continued to increase wages and benefits in
order to attract and retain management personnel and hourly workers. In
addition, most of our leases require us to pay taxes, insurance, maintenance,
repairs and utility costs, and these costs are subject to inflationary
pressures. Most of the leases provide for increases in rent based on increases
in the Consumer Price Index when the leases are renewed. We may attempt to
offset the effect of inflation through periodic menu price increases, economies
of scale in purchasing and cost controls and efficiencies at existing
restaurants.
- 26 -
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not enter into derivative transactions or speculate on the future
direction of interest rates. We are exposed to interest rate changes primarily
as a result of our variable rate debt instruments. As of December 31, 2001,
approximately $11,500,000 of our debt bore interest at variable rates. A 1%
change in the variable interest rate on this debt equates to an approximate
$100,000 change in interest for a twelve month period.
- 27 -
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Auditors 29
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999 30
Consolidated Balance Sheets as of December 31, 2001 and 2000 31
Statements of Redeemable Members' Equity, Members' Equity,
Members' Retained Earnings (Deficit) and Stockholders' Equity
for the years ended December 31, 2001, 2000 and 1999 32
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 33
Notes to Consolidated Financial Statements 34
- 28 -
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Tumbleweed, Inc.
We have audited the accompanying consolidated balance sheets of Tumbleweed, Inc.
as of December 31, 2001 and 2000, and the related consolidated statements of
operations, redeemable members' equity, members' equity, members' retained
earnings (deficit) and stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2001. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Tumbleweed, Inc.
at December 31, 2001 and 2000 and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2001, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
taken as a whole, presents fairly in all material respects the information set
forth therein.
As discussed in Note 2 to the consolidated financial statements, in 1999 the
Company changed its method of accounting for pre-opening and other start-up
costs by adopting the American Institute of Certified Public Accountants'
Statement of Position 98-5, "Reporting the Costs of Start-Up Activities".
/s/ Ernst & Young LLP
Louisville, Kentucky
April 4, 2002
- 29 -
Tumbleweed, Inc.
Consolidated Statements of Operations
Years Ended December 31
2001 2000 1999
--------------------------------------
Revenues:
Restaurant sales $ 56,025,886 $ 51,820,600 $ 48,578,123
Commissary sales 1,781,252 1,663,208 1,168,836
Franchise fees and royalties 1,227,300 1,271,251 1,064,952
Gain from insurance proceeds due to involuntary conversion
of non-monetary assets - 554,864 -
Other revenues 418,744 990,843 532,976
----------- ----------- -----------
Total revenues 59,453,182 56,300,766 51,344,887
Operating expenses:
Restaurant cost of sales 17,426,315 15,275,817 14,232,564
Commissary cost of sales 1,562,049 1,460,704 1,053,083
Operating expenses 30,567,705 27,456,791 24,377,631
Selling, general and administrative expenses 6,107,159 6,598,299 4,981,721
Preopening expenses - 490,394 395,768
Depreciation and amortization 2,285,452 2,147,408 1,804,757
Special charges 4,294,539 - -
Loss on guarantees of indebtedness 565,000 725,000 -
----------- ----------- -----------
Total operating expenses 62,808,219 54,154,413 46,845,524
----------- ----------- -----------
Income (loss) from operations (3,355,037) 2,146,353 4,499,363
Other income (expense):
Interest expense, net (1,276,903) (1,458,650) (1,128,906)
Equity in income (loss) of TW-Springhurst 81,318 (58,903) -
----------- ----------- -----------
Total other expense (1,195,585) (1,517,553) (1,128,906)
----------- ----------- -----------
Income (loss) before income taxes and cumulative effect of a
change in accounting principle (4,550,622) 628,800 3,370,457
Provision (benefit) for income taxes:
Current and deferred (1,178,144) 65,439 1,179,659
Deferred taxes related to change in tax status - - 639,623
----------- ----------- -----------
Total provision (benefit) for income taxes (1,178,144) 65,439 1,819,282
----------- ----------- -----------
Income (loss) before cumulative effect of a change in accounting principle (3,372,478) 563,361 1,551,175
Cumulative effect of a change in accounting principle, net of tax - - (341,035)
----------- ----------- -----------
Net income (loss) $ (3,372,478)$ 563,361 $ 1,210,140
=========== =========== ===========
Basic and diluted earnings (loss) per share:
Income (loss) before cumulative effect of a change in accounting
principle $ (0.58)$ 0.10 $ 0.27
Cumulative effect of a change in accounting principle, net of tax - - (0.06)
----------- ----------- -----------
Net income (loss) $ (0.58)$ 0.10 $ 0.21
=========== =========== ===========
Pro forma income data (unaudited):
Income before income taxes and cumulative effect of a
change in accounting principle as reported $ 3,370,457
Pro forma income taxes 1,179,659
-----------
Pro forma income before cumulative effect of a change
in accounting principle 2,190,798
Cumulative effect of a change in accounting principle, net of tax (341,035)
-----------
Pro forma net income $ 1,849,763
===========
Pro forma basic and diluted earnings per share:
Pro forma income before cumulative effect of a change
in accounting principle $ 0.37
Cumulative effect of a change in accounting principle, net of tax (0.06)
-----------
Pro forma net income $ 0.31
===========
See accompanying notes.
- 30 -
Tumbleweed, Inc.
Consolidated Balance Sheets
December 31
2001 2000
---------------- --------------
Assets
Current assets:
Cash and cash equivalents $ 757,266 $ 281,829
Accounts receivable, net allowance of $4,202 in 2001
and $68,464 in 2000 350,586 757,956
Inventories 1,785,481 1,780,577
Deferred income taxes 123,318 -
Prepaid expenses and other assets 517,280 586,023
---------------- --------------
Total current assets 3,533,931 3,406,385
Property and equipment, net 28,380,038 31,795,454
Goodwill, net of accumulated amortization of
$723,897 in 2001 and $669,395 in 2000 2,349,646 3,476,617
Investment in TW-Springhurst 126,415 141,097
Other assets 507,320 633,335
---------------- --------------
Total assets $ 34,897,350 $ 39,452,888
================ ==============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,269,967 $ 1,113,443
Accrued liabilities 3,542,511 2,489,727
Deferred income taxes - 210,342
Current maturities on long-term
debt and capital leases 1,601,374 2,040,667
---------------- --------------
Total current liabilities 6,413,852 5,854,179
Long-term liabilities:
Long-term debt, less current maturities 11,843,939 12,422,904
Capital lease obligations, less current maturities 1,989,820 2,534,877
Deferred income taxes 30,716 629,427
Other liabilities 120,000 140,000
---------------- --------------
Total long-term liabilities 13,984,475 15,727,208
---------------- --------------
Total liabilities 20,398,327 21,581,387
Commitments and contingencies (Note 19)
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000
shares authorized; no shares issued
and outstanding - -
Common stock, $.01 par value, 16,500,000
shares authorized; 5,881,630 shares issued 58,818 58,818
Paid-in capital 16,294,006 16,294,006
Treasury stock, 42,400 shares (254,695) (254,695)
Retained earnings (deficit) (1,599,106) 1,773,372
---------------- --------------
Total stockholders' equity 14,499,023 17,871,501
---------------- --------------
Total liabilities and stockholders' equity $ 34,897,350 $ 39,452,888
================ ==============
See accompanying notes.
- 31 -
Tumbleweed, Inc.
Consolidated Statements of Redeemable Members' Equity, Members' Equity,
Members' Retained Earnings (Deficit) and Stockholders' Equity
Years Ended December 31, 2001, 2000 and 1999
Redeemable
Members Retained
Common Paid-In Treasury Equity-Class A Members' Earnings
Stock Capital Stock Members Equity (Deficit) Total
--------------------------------------------------------------------------------------
Balance at December 31, 1998 $ - $ - $ - $ 18,924,688 $ 354,459 $(9,701,460) $ 9,577,687
Merger of Tumbleweed, LLC
into Tumbleweed, Inc. 51,050 9,526,637 - (18,924,688) (354,459) 9,701,460 -
Tumbleweed, Inc. balances as
of January 1, 1999 1 129 - - - (129) 1
Proceeds from common stock
offering 7,767 7,758,533 - - - - 7,766,300
Public offering costs - (991,293) - - - - (991,293)
Net income - - - - - 1,210,140 1,210,140
--------------------------------------------------------------------------------------
Balance at December 31, 1999 58,818 16,294,006 - - - 1,210,011 17,562,835
Net income - - - - - 563,361 563,361
Purchase of treasury stock - - (254,695) - - - (254,695)
--------------------------------------------------------------------------------------
Balance at December 31, 2000 58,818 16,294,006 (254,695) - - 1,773,372 17,871,501
Net loss - - - - - (3,372,478) (3,372,478)
--------------------------------------------------------------------------------------
Balance at December 31, 2001 $ 58,818 $16,294,006$ (254,695)$ - $ - $(1,599,106) $14,499,023
======================================================================================
See accompanying notes.
- 32 -
Tumbleweed, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31
2001 2000 1999
-------------- -------------- ---------------
Operating activities:
Net income (loss) $ (3,372,478) $ 563,361 $ 1,210,140
Adjustment to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 2,285,452 2,147,408 1,804,757
Provision for doubtful accounts 4,202 68,464 -
Deferred income taxes (1,027,371) 63,015 776,754
Loss on guarantees of indebtedness 565,000 725,000 -
Special charges 4,294,539 - -
quity in (income) loss of TW-Springhurst, net of
Edistributions received of $96,000 in 2001 14,682 58,903 -
Gain from insurance proceeds due to involuntary
conversion of non-monetary assets - (554,864) -
Loss on disposition of property and equipment 66,841 38,250 38,455
Changes in operating assets and liabilities:
Accounts receivable 403,168 2,035 (172,411)
Inventories (177,928) (121,404) (264,203)
Deferred preopening expenses - - 524,669
Prepaid expenses (57,997) (286,157) 7,563
Other assets 52,379 (89,452) (198,598)
Accounts payable 156,524 11,418 (177,212)
Accrued liabilities (123,402) (41,178) (84,033)
Income taxes 230,547 (302,251) 61,376
Other liabilities (20,000) (20,000) 65,162
-------------- -------------- ---------------
Net cash provided by operating activities 3,294,158 2,262,548 3,592,419
Investing activities:
Purchases of property and equipment (1,255,406) (3,090,936) (6,915,544)
Insurance proceeds for property and equipment - 1,299,352 -
Business acquisitions - (1,806,333) -
Investment in TW-Springhurst - (200,000) -
-------------- -------------- ---------------
Net cash used in investing activities (1,255,406) (3,797,917) (6,915,544)
Financing activities:
Proceeds from common stock offering - - 7,766,300
Proceeds from issuance of long-term debt 3,704,120 6,423,960 8,193,436
Payments on long-term debt and capital lease obligations (5,267,435) (4,992,256) (6,411,571)
Payment on short-term borrowings - - (6,990,348)
Purchase of treasury stock - (254,695) -
Payment of public offering costs - - (493,476)
-------------- -------------- ---------------
Net cash provided by (used in) financing activities (1,563,315) 1,177,009 2,064,341
-------------- -------------- ---------------
Net increase (decrease) in cash and cash equivalents 475,437 (358,360) (1,258,784)
Cash and cash equivalents at beginning of year 281,829 640,189 1,898,973
-------------- -------------- ---------------
Cash and cash equivalents at end of year $ 757,266 $ 281,829 $ 640,189
============== ============== ===============
Supplemental cash flow information:
Cash paid for interest, net of amount capitalized $ 1,287,461 $ 1,477,172 $ 1,166,934
============== ============== ===============
Cash paid for income taxes $ 4,085 $ 304,674 $ 798,670
============== ============== ===============
Noncash investing and financing activities:
Equipment acquired by capital lease obligations $ - $ 224,906 $ -
============== ============== ===============
See accompanying notes.
- 33 -
TUMBLEWEED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Merger of Tumbleweed, LLC and Tumbleweed, Inc.
Tumbleweed, Inc. (the Company) was legally formed in December 1997 and
capitalized on June 23, 1998 with the issuance of 13 shares of Company common
stock at $10 per share. Effective January 1, 1999, and as a result of the sale
of 776,630 shares of common stock in an initial public offering (IPO),
Tumbleweed, LLC (Tumbleweed) was merged into the Company. The interests of
Tumbleweed members at the time of the merger were converted into a total of
5,105,000 shares of Company common stock.
Prior to the merger, Tumbleweed and its owners (Members) operated pursuant to an
Operating Agreement dated September 19, 1994. Members of Tumbleweed consisted of
Common Members, Class A Members, Class B Members and a Class C Member. The
capital accounts of the Common, Class B and Class C Members were $(394,000),
$747,959 and $500, respectively, as of December 31, 1998. Class A Members had,
in addition to their cash contributions, provided financing which was accounted
for as redeemable members' equity prior to Tumbleweed's assumption of the debt
on December 31, 1998 (see Note 7). Certain Common Members acted as the Managers
of Tumbleweed and, acting unanimously, generally had voting control of
Tumbleweed.
Restaurant Facilities
As of December 31, 2001, the Company owned, franchised or licensed 65 Tumbleweed
restaurants. The Company owned and operated 36 restaurants in Kentucky, Indiana
and Ohio, including one restaurant which was 50% owned through a joint venture
(see below). There were 21 franchised restaurants located in Indiana, Illinois,
Kentucky, Michigan, Virginia, and Wisconsin and eight licensed restaurants
located outside the United States in Germany, Jordan, Egypt, Saudi Arabia,
England and Turkey. The following table reflects changes in the number of
Company-owned, franchise and licensed restaurants during the years presented.
2001 2000 1999
---- ---- ----
Company-owned restaurants:
In operation, beginning of year 36 29 25
Restaurants opened - 4 4
Joint venture restaurant opened - 1 -
Restaurants purchased from franchisee - 2 -
-- -- --
In operation, end of year 36 36 29
-- -- --
Franchise and licensed restaurants:
In operation, beginning of year 27 22 18
Restaurants opened 3 10 8
Restaurants closed (1) (3) (4)
Restaurants sold to Tumbleweed, Inc. - (2) -
- -- --
In operation, end of year 29 27 22
-- -- --
System Total 65 63 51
== == ==
Subsequent to December 31, 2001, the Company closed four Company-owned
restaurant locations. The restaurants were located in Cincinnati, Ohio (2),
Columbus, Ohio (1), and Evansville, Indiana (1). The restaurant closings were
part of a strategic management decision to eliminate lower sales volume
restaurants that were unprofitable in 2001 and to focus its energies on the
continued improvement of per-store average sales volumes. See Note 13 for a
discussion regarding special charges which were recorded in 2001 as a result of
these restaurant closings. Also subsequent to year end, the Company purchased
from its joint venture partner its 50% interest in a restaurant location. See
Note 10 for a further discussion of this transaction.
- 34 -
1. Basis of Presentation (continued)
Pro forma Financial Information (unaudited)
Pursuant to the rules and regulations of the Securities and Exchange Commission,
the pro forma net income in the accompanying pro forma income data for the year
ended December 31, 1999 reflects a pro forma adjustment to income taxes for 1999
to exclude the deferred tax effects of Tumbleweed changing from a limited
liability company (which is taxed as a partnership) to a regular corporate
taxable status. Pro forma basic and diluted earnings per share is computed based
upon the weighted average number of shares of common stock outstanding for 1999.
Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." These statements
established new accounting and reporting standards for business combinations and
associated goodwill and intangible assets. SFAS No. 141, effective July 1, 2001,
eliminates the pooling of interest method of accounting and amortization of
goodwill for business combinations initiated after June 30, 2001. SFAS No. 142,
effective January 1, 2002, requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually.
The Company adopted the new rules on accounting for goodwill and other
intangibles as of January 1, 2002 and is currently completing the transitional
impairment test required by the new rules. Any impairment loss resulting from
the transitional impairment test will be recorded as a cumulative effect of a
change in accounting principle during the first quarter of 2002. The Company
currently expects an impairment write-down of goodwill of approximately
$2,300,000 in the first quarter of 2002. Goodwill amortization amounted to
$135,000 for 2001. As noted above, goodwill will no longer be amortized under
the new rules.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement supercedes SFAS No. 121,"
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," and the accounting and reporting provisions of Accounting
Principles Board (APB) Opinion No. 30, "Reporting Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144
requires that one accounting model be used for long-lived assets to be disposed
of by sale, whether previously held and used or newly acquired, and it broadens
the presentation of discontinued operations to include more disposal
transactions. The Company will adopt the provisions of SFAS No. 144 as of
January 1, 2002 and is currently evaluating the impact that SFAS No. 144 may
have on its financial position and results of operations.
2. Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary. Intercompany accounts and transactions have been
eliminated in consolidation. The Company's investment in TW-Springhurst (see
Note 10) is accounted for using the equity method, under which the Company's
share of earnings or losses are reflected in income as earned.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in these financial statements
and accompanying notes. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and deposits at financial
institutions with maturities of less than three months when purchased.
- 35 -
2. Significant Accounting Policies (continued)
Inventories
Inventories, which consist of smallwares, food, beverages and supplies, are
stated at the lower of average cost or market.
Deferred Preopening Expenses
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 98-5, "Reporting the Costs of Start-Up Activities."
The SOP was effective beginning January 1, 1999 and requires that start-up costs
capitalized prior to January 1, 1999 be written-off and any future start-up
costs be expensed as incurred. Prior to 1999, the Company capitalized its
preopening costs incurred in connection with opening new restaurant locations.
The unamortized balance of the Company's deferred preopening costs ($524,669 as
of December 31, 1998) was written-off (net of income taxes of $183,634) as a
cumulative effect of a change in accounting principle on January 1, 1999.
Deferred preopening expenses included the direct costs typically associated with
opening a new restaurant. These costs consisted primarily of costs incurred to
develop the new restaurant management team, marketing and training.
Property and Equipment
Property and equipment are stated at cost and depreciated on the straight-line
method. Buildings and leasehold improvements are amortized over the lesser of
the life of the leases, including renewal options, or the estimated useful lives
of the assets, which range from ten to thirty years. Equipment is depreciated
over the estimated useful lives of the assets, which range from five to ten
years. Maintenance and repairs which do not enhance the value of or increase the
life of the assets are charged to costs and expenses as incurred.
Construction in Progress
The Company capitalizes all direct costs incurred in the construction of new
restaurants. Upon opening, these costs are depreciated or amortized and charged
to expense based upon their property classification.
Goodwill
Goodwill is amortized on the straight-line method over thirty years. See Note 1
regarding changes in the accounting for goodwill beginning January 1, 2002.
Long-Lived Assets
The carrying amount of long-lived assets, including goodwill, is reviewed if
facts and circumstances suggest that it may be impaired. If this review
indicates that long-lived assets will not be recoverable, as determined based on
the estimated undiscounted cash flows of the asset over the remaining
amortization period, the carrying amount of long-lived assets would be written
down to current fair value, which is generally determined from estimated
discounted future net cash flows (assets held for use) or net realizable value
(assets held for sale). See Note 13 for a discussion regarding a write-down of
assets.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments approximate their
fair value.
Revenue Recognition
Franchise fees are recognized when all material services, primarily site
approval and management and staff training, have been substantially performed by
the Company and the restaurant has opened for business. Fees received pursuant
to development agreements, which grant the right to develop franchised
restaurants in future periods in specific geographic areas, are deferred and
recognized on a pro rata basis as the franchised restaurants subject to the
development agreements begin operations. Franchise royalties, which are based on
a percentage of monthly sales, are recognized as income when earned. Costs
associated with franchise operations are expensed as incurred.
- 36 -
2. Significant Accounting Policies (continued)
Advertising Costs
Advertising costs include Company-owned restaurant contributions to the
Tumbleweed Marketing Fund, Inc. and TW- Louisville Marketing Fund, Inc. ("the
Marketing Funds") and developing and conducting advertising activities,
including the placement of electronic and print materials developed by the
Tumbleweed Marketing Fund, Inc. All advertising and related costs are expensed
as incurred. Contributions by Company-owned and franchised restaurants to the
Marketing Funds are based on an established percentage of monthly restaurant
revenues. The Tumbleweed Marketing Fund, Inc. is responsible for the development
of marketing and advertising materials for use throughout the Company's system.
The Marketing Funds are accounted for separately and are not consolidated with
the financial statements of the Company. Company contributions to the Marketing
Funds for the years ended December 31, 2001, 2000 and 1999 were $415,611,
$123,435 and $117,362, respectively. Advertising expense, which includes the
Company's contributions to the Marketing Funds, for the years ended December 31,
2001, 2000 and 1999 were $1,915,577, $1,570,179 and $1,253,392, respectively.
Income Taxes
Concurrent with the merger as described in Note 1, Tumbleweed converted from a
limited liability company into a C corporation and is now subject to federal and
state income taxes. As of the date of the merger, the Company recorded a net
deferred tax liability and corresponding income tax expense for cumulative
temporary differences between the tax basis and the reported amounts of the
Company's assets and liabilities. At the date of the merger, the net differences
equaled approximately $1,780,000 resulting in a net deferred tax liability and
corresponding income tax expense of $639,623 which is included in the deferred
income tax provision in the accompanying consolidated statement of operations
for the year ended December 31, 1999.
Reclassification of Financial Statements
Certain reclassifications have been made to the December 31, 2000 consolidated
financial statements to conform with December 31, 2001 classifications. These
reclassifications have no effect on previously reported operating results.
3. Property and Equipment
Property and equipment as of December 31 consist of:
2001 2000
---- ----
Land and land improvements $ 9,048,317 $ 9,135,805
Building and improvements 13,010,660 13,929,153
Leasehold improvements 2,195,482 2,294,324
Equipment 7,383,451 7,662,479
Building and equipment under capital leases 4,139,892 4,496,593
Construction in progress 13,011 659,511
-----------------------------
35,790,813 38,177,865
Less accumulated depreciation and amortization (7,410,775) (6,382,411)
-----------------------------
$ 28,380,038 $ 31,795,454
=============================
- 37 -
4. Accrued Liabilities
Accrued liabilities as of December 31 consist of:
2001 2000
---- ----
Accrued payroll, severance and related taxes $ 946,545 $ 897,841
Accrued insurance and fees 192,978 282,281
Accrued taxes, other than payroll 683,449 548,703
Gift certificate liability 475,914 470,652
Reserve for loss on guarantees of indebtedness 565,000 9,265
Reserve for store closing costs 601,186 -
Deferred income related to involuntary conversion of
non-monetary assets - 204,893
Other 77,439 76,092
------------------------------
$ 3,542,511 $ 2,489,727
==============================
5. Long-Term Debt
Long-term debt as of December 31 consists of:
2001 2000
Secured $5,960,000 mortgage revolving line of
credit note, bearing interest at prime rate
plus .25% (5.0% at December 31, 2001), due
December 31, 2003 $ 5,726,148 $ 5,496,148
Secured mortgage note payable, bearing interest
at commercial paper rate plus 2.65% (4.43% at
December 31, 2001), due April 1, 2003 2,299,567 2,501,399
Secured mortgage note payable, bearing interest
at prime rate plus 1% (5.75% at December 31,
2001), payable in monthly installments through
October 1, 2017 1,009,847 1,039,068
Secured mortgage note payable, bearing interest
at 8.75%, payable in monthly installments through
February 15, 2008 881,933 921,756
Secured $975,000 mortgage revolving line of
credit note, bearing interest at prime rate plus
.25% (5.0% at December 31, 2001) through March 31,
2002 andincreased to prime rate plus 2.0%
thereafter, due April 1, 2003 964,868 915,868
Secured mortgage note payable, bearing interest at
prime rate (4.75% at December 31, 2001), payable
in monthly installments through March 1, 2006 613,632 644,185
Secured mortgage note payable, bearing interest
at prime rate plus 1.25% (6.0% at December 31,
2001), payable in monthly installments through
November 27, 2016 559,375 596,875
(Continued next page)
- 38 -
5. Long-Term Debt (continued)
2001 2000
------------------------------
Secured mortgage note payable, bearing interest at
10.52%, payable in monthly installments through
August 18, 2005 $ 417,937 $ 506,700
Secured mortgage note payable, bearing interest at
commercial paper rate plus 2.65% (4.43% at
December 31, 2001), due April 1, 2003 224,611 800,000
Other installment notes payable 206,167 415,633
------------------------------
12,904,085 13,837,632
Less current maturities 1,060,146 1,414,728
------------------------------
Long-term debt $ 11,843,939 $ 12,422,904
==============================
Property and equipment with a net book value of approximately $21,700,000 at
December 31, 2001 collateralize the Company's long-term debt.
The aggregate annual maturities of long-term debt for the years subsequent to
December 31, 2001 are as follows:
The terms of certain loan agreements include various provisions which require
the Company to (i) maintain defined net worth and coverage ratios, (ii) limit
the incurrence of certain liens or encumbrances in excess of defined amounts,
(iii) maintain defined leverage ratios and (iv) prohibit the payment of
dividends. Management does not believe that compliance with the credit terms
will adversely impact the Company's future operations.
During the year ended December 31, 2001, the Company was not in compliance with
certain financial covenants pertaining to long-term totalling $9,408,520 as of
December 31, 2001. The Company obtained appropriate waivers, and in one instance
a Forbearance Agreement, from the lenders to cure the non-compliance at December
31, 2001. The Company also obtained covenant amendments from certain of the
lenders which management believes will enable compliance with financial
covenants in the future for all of its debt agreements. The contractual
obligations and commitments schedule above reflects the revised terms of the
loan agreements. The long-term debt and annual maturities schedules above
reflect the revised terms of the loan agreements.
Interest costs capitalized during the construction period of restaurants were
approximately $0 in 2001, $32,000 in 2000 and $50,900 in 1999.
6. Leases
The Company leases certain buildings and equipment under capital lease
agreements with related and third parties. The equipment leases have five to
seven year terms. The building leases expire in 2016 and 2017. Future minimum
lease payments under the capital leases and the net present value of the future
minimum lease payments at December 31, 2001 were as follows:
- 39 -
6. Leases (continued)
Related Other
Party Lease Leases Total
2002 $ 84,000 $ 689,510 $ 773,510
2003 84,000 622,040 706,040
2004 84,000 314,338 398,338
2005 84,000 118,279 202,279
2006 84,000 88,509 172,509
Thereafter 924,000 877,714 1,801,714
----------------------------------------------
Total minimum lease payments $ 1,344,000 $ 2,710,390 4,054,390
==============================
Less amount representing interest
at 6.25% to 11.78% (1,523,342)
-------------
Net present value of lease payments 2,531,048
Less current maturities (541,228)
-------------
Long-term portion of capital lease obligations $ 1,989,820
=============
The Company leases certain restaurants and equipment under operating leases
having terms expiring between 2002 and 2017. Most of the restaurant facility
leases have renewal clauses of five to twenty years exercisable at the option of
the Company and one of the leases is with a related party. Certain leases
require the payment of contingent rentals based on a percentage of gross
revenues. The related party operating lease requires the payment of contingent
rent based on 30% of the restaurant's positive net cash flow. Future minimum
lease payments on operating leases at December 31, 2001 were as follows:
Total rental expense was approximately $2,302,000 in 2001, $1,975,700 in 2000
and $1,654,700 in 1999 and included contingent rent of approximately $204,000 in
2001,$244,000 in 2000 and $207,000 in 1999. Rental expense for related party
leases was approximately $348,000 in 2001, $388,000 in 2000 and $407,900 in
1999.
7. Redeemable Class A Member Units and Bank Line of Credit
As of December 31, 1998, Tumbleweed had a $7,500,000 line of credit with a bank
for borrowing at the bank's prime rate plus 1/4%. Under a related assumption
agreement, the Class A Members directly assumed the total liability on a pro
rata basis until December 31, 1998 at which time Tumbleweed assumed the total
liability of $6,990,348. Prior to Tumbleweed assuming this line of credit, the
amounts borrowed under the line of credit were, in the first instance,
obligations of the Class A Members and, accordingly, were accounted for as
redeemable members' equity, and any interest and other related costs on the debt
funded by Tumbleweed were accounted for as distributions to the Class A Members.
The $6,990,348 borrowed under the line of credit as of December 31, 1998 was
repaid on January 5, 1999 out of the gross proceeds of $7,766,300 from the IPO
(see Note 1). If an IPO had not occurred, any Class A Member had the right to
sell to Tumbleweed their interest in Tumbleweed at any time after the fifth
anniversary of the date that a Class A Member was
- 40 -
7. Redeemable Class A Member Units and Bank Line of Credit (continued)
admitted to Tumbleweed. The selling price was to be the sum of cash contributed
by the Class A Member and an amount equal to an annual 30% internal rate of
return on the Class A Member's cash contributions and pro rata assumed principal
portion of the line of credit, taking into account all prior distributions to
such Class A Member. Redeemable members' equity in the accompanying Consolidated
Statement of Redeemable Members' Equity, Members' Equity, Members' Retained
Earnings (Deficit) and Stockholders' Equity for the year ended December 31, 1998
includes the accretion of the annual 30% internal rate of return. Through
December 31, 1998, capital contributions by the Class A Members were limited to
their initial cash contributions in 1995 which amounted to $7,034,375 and
borrowings under the line of credit assumed by the Class A Members.
8. Income Taxes
The components of the provision (benefit) for income taxes for the years ended
December 31, 2001, 2000 and 1999 related to income (loss) before cumulative
effect of a change in accounting principle consists of the following:
2001 2000 1999
----------- ----------- ------------
Current - federal $ (150,773) $ 2,424 $ 798,303
Current - state - - 55,345
Deferred (1,027,371) 63,015 326,011
Deferred taxes resulting from
a change in tax status - - 639,623
----------- ----------- ------------
$ (1,178,144) $ 65,439 $ 1,819,282
=========== =========== ============
The provision (benefit) for income taxes for the years ended December 31, 2001,
2000 and 1999 on income (loss) before income taxes and cumulative effect of a
change in accounting principle differs from the amount computed by applying the
statutory federal income tax rate due to the following:
2001 2000 1999
----------- ----------- ------------
U.S. federal income taxes at 34% $ (1,547,212) $ 213,792 $ 1,145,956
State income taxes, net of federal tax effect (180,205) (138,034) 81,405
Valuation allowance against deferred income tax assets 655,770 - -
Employment tax credits (139,632) (97,483) (74,723)
Deferred taxes resulting from a change
in tax status - - 639,623
Other items 33,135 87,164 27,021
----------- ----------- ------------
Provision (benefit) for income taxes $ (1,178,144) $ 65,439 $ 1,819,282
=========== =========== ============
Significant components of the Company's deferred tax assets and liabilities as
of December 31 are as follows:
2001 2000 1999
----------- ----------- ------------
Deferred tax assets:
Asset impairment and store closings $ 1,550,753 $ - $ -
Tax credit and state net operating loss
carryforwards 661,139 339,763 -
Unearned revenue and other 419,441 246,282 200,429
Book over tax amortization - 1,127 45,767
----------- ----------- ------------
Total deferred tax assets 2,631,333 587,172 246,196
Deferred tax liabilities:
Deferred expenses and other (930,752) (733,287) (458,896)
Tax over book depreciation (867,259) (693,654) (564,054)
Tax over book amortization (84,950) - -
----------- ----------- ------------
Total deferred tax liabilities (1,882,961) (1,426,941) (1,022,950)
Valuation allowance (655,770) - -
----------- ----------- ------------
Net deferred tax asset (liability) $ 92,602 $ (839,769) $ (776,754)
=========== =========== ============
8. Income Taxes (continued)
As of December 31, 2001, the Company has state net operating loss carryforwards
of approximately $5,200,000 which begin expiring in 2016. Also, as of December
31, 2001, the Company has a $263,000 alternative minimum tax credit carryforward
which has no expiration date, as well as $298,000 of employment tax credit
carryforwards which begin expiring in 2020, available to offset future U.S.
federal income taxes. In 2001, management concluded that it is more likely than
not that certain of the Company's deferred tax assets related to state net
operating loss carryforwards and general business tax credits will not be
realized. Accordingly, these deferred tax assets have been offset by a valuation
allowance at December 31, 2001.
9. Related Party Transactions
On April 1, 1999, the Company purchased the land and building, including
improvements, of the Springdale, Ohio restaurant from Keller, LLC (a limited
liability company in which a director of the Company owns a substantial
interest), the lessor of the property, for $1,625,000. The purchase was made for
an amount substantially equal to the costs originally expended by Keller, LLC in
the purchase of the land and construction of the improvements, which
approximated the fair market value as determined by an independent appraisal. At
the time of the purchase, the Company's capital lease obligation to Keller, LLC
was terminated. Prior to the purchase, the Company leased the Springdale, Ohio
restaurant from Keller, LLC and during 1999 the Company paid rent totaling
$46,700 to Keller, LLC.
On July 1, 1999, the Company purchased the land and building, including
improvements, of the Bowling Green, Kentucky restaurant from Douglass Ventures
(a Kentucky general partnership and stockholder of the Company in which a
director of the Company is a general partner) and an unrelated third party, the
co-lessors of the property, for $884,640. The purchase price was calculated in
accordance with the lease agreement which approximated the fair market value as
determined by an independent appraisal. At the time of the purchase, the
Company's lease obligation was terminated. Prior to the purchase, the Company
leased the Bowling Green, Kentucky restaurant from Douglass Ventures and during
1999 the Company paid rent totaling $26,000 to Douglass Ventures.
In February 1997, Tumbleweed invested a nominal amount in TW-Tennessee, LLC
(TW-Tennessee), a newly formed Tennessee limited liability company, in exchange
for a 9.5% common member interest. On September 30, 1998, Tumbleweed sold its
interest in TW-Tennessee to certain members of TW-Tennessee for $25,000.
TW-Tennessee was organized to open and operate Tumbleweed full service
restaurants as a franchisee of Tumbleweed.
The Company guaranteed renewals of certain guaranteed indebtedness and any
replacement indebtedness to TW-Tennessee, to the extent and in amounts not to
exceed the amounts guaranteed as of September 30, 1998. The Company had
guaranteed certain TW-Tennessee obligations as follows, jointly and severally
with TW-Tennessee common members: a) up to $1,200,000 under a bank line of
credit, b) approximately $2,800,000 of a lease financing agreement, and c)
equipment leases with a bank. See Note 19 for additional information regarding
this matter.
Franchise fees and royalties recorded by the Company in relation to TW-Tennessee
were approximately $0, $36,800 and $160,800 in 2001, 2000 and 1999,
respectively. The Company also provided management and accounting services for
TW- Tennessee for which fees were charged. Such management and accounting fees
recorded in other revenues totaled approximately $0, $12,200 and $40,500 in
2001, 2000 and 1999, respectively.
During the year ended December 31, 2000, the Company assumed a TW-Tennessee
equipment lease which it had previously guaranteed (see discussion above). The
equipment is being utilized in the Company-owned restaurant which was destroyed
as result of a fire (see Note 12). The capital lease had a balance of
approximately $225,000 on the date the lease was assumed.
In August 1997, Tumbleweed, LLC entered into the International Agreement with
Tumbleweed International, LLC (International), a restaurant developer based in
Hanau, Germany. The International Agreement grants certain licensing and
franchising rights to International for the development of Tumbleweed
restaurants outside of the Western Hemisphere. International is a limited
liability company owned by three corporations which are controlled by certain
directors and stockholders of the Company. In 2001, 2000 and 1999, International
paid approximately $10,600, $7,400 and $18,700, respectively, in fees to the
Company under the International Agreement. The Company acquired International
subsequent to December 31, 2001 (see Note 20).
- 42 -
9. Related Party Transactions (continued)
Two common stockholders, one of which is also a director of the Company, are
members in TW-Indiana, LLC, which in April 1998 acquired the franchise rights to
five full-service Tumbleweed restaurants in Indiana and Kentucky from a third
party. As of December 31, 2001, TW-Indiana, LLC operated six full-service
Tumbleweed restaurants. Franchise fees and royalties recorded by the Company in
relation to this entity were approximately $448,000, $300,000 and $311,000 in
2001, 2000 and 1999, respectively. As of December 31, 2001 and 2000, the Company
had an interest free note receivable of $45,000 and $50,000, respectively, from
TW-Indiana, LLC with a maturity date of December 31, 2002.
TW-Indiana, LLC and a director of the Company are also members of TW-Seymour,
LLC, a franchisee of the Company which opened a full-service Tumbleweed
restaurant in Indiana during 1999. Franchise fees and royalties recorded by the
Company in relation to this entity were approximately $59,000, $45,000 and
$76,000 in 2001, 2000 and 1999, respectively.
During the years ended December 31, 2000 and 1999, the Company entered into
management agreements with five companies who own Tumbleweed franchise
restaurants with respect to five restaurant locations. The management agreements
require the franchisees to pay certain fees to the Company in exchange for the
Company providing operations management and accounting services to the
franchisees. Certain directors and officers of the Company own substantial
interests in these companies. Franchise fees and royalties recorded by the
Company in 2001, 2000 and 1999 in relation to these entities were approximately
$11,000, $227,000 and $90,000, respectively. Management and accounting fees
recorded in other revenues by the Company in 2001, 2000 and 1999 in relation to
these entities were approximately $4,300, $65,000 and $13,000, respectively.
During the year ended December 31, 2000, the Company purchased the assets of two
of these companies. See Note 11 for information regarding these transactions.
Also during 2000, one of the five restaurant locations discussed above ceased
operations. During 2001, the Company received equipment in exchange for an
approximately $79,000 note receivable from a related party franchisee.
A provision for doubtful accounts of approximately $68,000 was recorded during
2000 for the write-off of the balance due from a related party franchisee
(discussed in the paragraph above) for accounting fees, royalties and franchise
fees.
See Note 10 for additional related party transactions.
10. Investment in TW-Springhurst
During the year ended December 31, 2000, the Company made a $200,000 investment
in TW-Springhurst, LLC ("TW- Springhurst"), the owner and operator of a
Tumbleweed restaurant in Louisville, Kentucky. During the year ended December
31, 2001, the Company received a cash distribution of $96,000 from
TW-Springhurst. Through December 31, 2001, the Company had a 50% interest with
the remaining 50% held by TW-Springhurst Investors, LLC. A current and former
director of the Company own TW-Springhurst Investors, LLC. The Company's share
of TW-Springhurst's net income (loss) was $81,318 and ($58,903) for the years
ended December 31, 2001 and 2000, respectively. On January 1, 2002, the Company
acquired the remaining 50% interest held by TW-Springhurst Investors for
$267,000. The Company also assumed TW-Springhurst, LLC's note payable to a bank
which had a balance of approximately $161,000 on the date of purchase. An
independent business valuation appraisal was used to assist Company management
in determining the purchase price.
11. Business Acquisitions
On August 14, 2000, the Company purchased the assets of an Evansville, Indiana
Tumbleweed restaurant from TW- Evansville, LLC (a limited liability company in
which former directors and officers of the Company owned a substantial interest)
for $929,400. The Company also assumed TW-Evansville, LLC's equipment capital
lease which had a balance of approximately $197,000 on the date of purchase. The
purchase price for the business and property was at fair market value as
determined by an independent business valuation appraisal.
- 43 -
11. Business Acquisitions (continued)
The purchase price has been allocated as follows based upon the fair values of
the assets acquired and liabilities assumed:
On October 1, 2000, the Company purchased the assets of the Medina, Ohio
Tumbleweed restaurant from TW-Medina, LLC (a limited liability company in which
a certain director of the Company owns a substantial interest) for $876,933. The
purchase price for the business and property was at fair market value as
determined by an independent business valuation appraisal. The purchase price
has been allocated as follows based upon the fair values of the assets acquired
and liabilities assumed:
The acquisitions have been accounted for as purchases and, accordingly, the
results of operations of the acquired businesses are included in the Company's
results of operations since the date of each acquisition.
12. Involuntary Conversion of Non-Monetary Assets
As a result of a fire which occurred June 7, 2000 at a Company-owned restaurant
in Kentucky, an involuntary conversion of non-monetary assets occurred which
resulted in a $554,864 gain. The gain represents the difference between the
carrying amount of the restaurant's assets which were destroyed (building,
equipment and inventories of $744,488, in total, at the time of the fire) and
the amount collected from the insurance company ($1,299,352). In addition, the
Company had received approximately $605,000 from the insurance company for
business interruption ($280,000) and continuing expenses ($120,000) through
December 31, 2000. The additional $205,000 received was for estimated business
interruption and continuing expenses in 2001. Accordingly, the Company recorded
this as deferred income in the accompanying consolidated balance sheet as of
December 31, 2000 and subsequently recognized the $205,000 as other income
during 2001.
13. Special Charges
The Company recorded special charges of $4,294,539 in the fourth quarter of
2001. The special charges include a $3,683,353 charge to earnings in accordance
with SFAS No. 121, "Impairment of Long-Lived Assets." This charge reflects the
write-down of assets associated with six restaurants, four of which closed in
the first quarter of 2002. The Company plans to sell one of the remaining two
restaurants to a current franchisee and will continue to operate the other
restaurant for the present. The restaurant closings were part of a strategic
management decision to eliminate lower sales volume restaurants that were
unprofitable in 2001 and to focus its energies on the continued improvement of
per-store average sales volumes. The special charges also include $611,186 for
lease obligations and other costs related to the decision to close these
restaurants.
- 44 -
13. Special Charges (continued)
The following is a summary of the impairment charges:
Carrying Value Value at
at Commitment December 31,
Date Charge 2001
--------------- ------------- --------------
Property and equipment $ 4,260,428 $ 2,485,428 $ 1,775,000
Goodwill 993,811 993,811 -
Other assets 215,837 204,114 11,723
--------------- ------------- --------------
$ 5,470,076 $ 3,683,353 $ 1,786,723
=============== ============= ==============
The value at December 31, 2001 was determined as follows. For stores being
disposed of, the value is based on the estimated net proceeds from the sale of
the assets. For the other store being operated, the Company estimated the fair
value of the restaurant based on estimated future discounted cash flows from its
use and eventual disposition.
The operating results of the restaurants to be disposed of before the special
charges included in the accompanying consolidated statements of operations are
as follows:
2001 2000 1999
--------------- ------------- --------------
Revenues $ 5,513,743 $ 4,324,921 $ 3,974,121
Loss from operations (378,843) (209,863) (42,892)
14. Treasury Stock
On January 14, 2000, the Board of Directors approved the repurchase from time to
time of up to $500,000 of the Company's common stock. Purchases may be made in
the open market as well as by private transaction at times and prices considered
appropriate by the Company, subject to applicable rules and regulations. The
purchases will be funded by cash reserves. Through December 31, 2001, the
Company has repurchased 42,400 shares at a total cost of $254,695.
15. Stock Incentive Plan
In June 1998, the Company adopted a Stock Option and Incentive Compensation Plan
(the "Plan"). The Plan provides for the granting of any of the following awards
to eligible employees or directors of the Company and its subsidiaries: (i)
employee stock options, including both "incentive stock options" within the
meaning of Section 422 of the Internal Revenue Code ("ISOs") and options that do
not qualify as ISOs; (ii) automatic grants of options to nonemployee directors;
(iii) stock appreciation rights; and (iv) restricted stock and performance stock
awards. The Plan is intended to provide incentives and rewards for employees and
directors to support the implementation of the Company's business plan and to
align the interests of employees and directors with those of the Company's
stockholders.
The Plan is administered by the Compensation Committee of the Company's Board of
Directors (the "Committee"). The Committee is comprised of three independent
directors, who are not current employees of the Company and who do not receive
any remuneration from the Company in any capacity other than as a director. The
Committee is authorized, among other things, to determine employees to whom
grants of awards will be made and take such action as it deems necessary or
advisable for the administration of the Plan.
The common stock subject to the Plan will be authorized but unissued shares or
previously acquired shares. The number of shares of common stock available for
grant of awards under the Plan equals the greater of 1,235,000 shares, or 10% of
the number of shares of common stock outstanding from time to time, including
170,000 shares reserved for options automatically granted to nonemployee
directors under the Plan.
As of December 31, 2001, cumulative total options to purchase 1,462,077 shares
of the Company's common stock had been granted to employees and directors of the
Company at prices ranging from $0.93 to $10.00 per share which expire at various
dates from 2009 to 2011 with a contractual life of 10 years. Initial grants of
approximately 492,000 options were
- 45 -
15. Stock Incentive Plan (continued)
made at a price equal to the initial public offering price of $10.00 per share .
The exercise price of subsequent grants were equal to the market price at the
time of the grant.
Stock options granted under the Plan will be exercisable for a term of not more
than ten years, as determined by the Committee. The option grants, with the
exception of those granted to the Company's President and Chief Executive
Officer in August 2000, are exercisable for 33% of the number of shares subject
to the option on each of the first, second and third anniversaries of the date
of grant and expire ten years from the date of grant. In August 2000, 367,236
options were granted to the Company's President and Chief Executive Officer at
prices ranging from $2.69 to $3.88 which become immediately vested and
exercisable in the event of a change in control of the Company.
Activity in the Plan during the years ended December 31, 2001, 2000 and 1999
was:
2001 2000 1999
--------------------------- ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
------- -------------- ------- -------------- ------- --------------
Outstanding at the
beginning of the year 1,044,454 $9.52 532,666 $9.34 - -
Granted 85,000 1.80 811,636 3.73 565,411 $9.38
Exercised - - - - - -
Forfeited (148,069) 5.75 (299,848) 8.28 (32,755) 10.00
--------- ---------- ---------
Outstanding at the
end of the year 981,385 $4.87 1,044,454 $5.30 532,666 $9.34
========= ========== =========
Exercisable at the end
of the year 383,251 $6.04 112,948 $9.52 - $ -
========= ========== =========
The following table summarizes information about employee stock options
outstanding at December 31, 2001:
Range of Number Weighted Average
Exercise Prices Outstanding Exercise Price
--------------- ------------- ----------------
$10.00 206,890 $10.00
$4.50 - $5.50 53,492 $5.41
$0.93 - $3.88 721,003 $3.37
-------------
981,385
=============
The remaining contractual life of the outstanding stock options ranges from 7.1
years to 9.9 years.
The Company accounts for the Plan in accordance with APB 25, "Accounting for
Stock Issued to Employees," as permitted by SFAS No. 123, "Accounting and
Disclosure of Stock-Based Compensation." The Company has not recognized
compensation expense for stock options granted because the exercise price of the
options equals the fair value of the underlying stock on the date of grant,
which is the measurement date. If the alternative method of accounting for stock
incentive plans prescribed by SFAS 123 had been followed, the Company's net
income and earnings per share for 2001, 2000 and 1999 would have been reduced to
the pro forma amounts shown in the following table. For purposes of these pro
forma disclosures, the estimated fair value of the options is recognized as
compensation expense over the options' vesting period. The weighted average fair
value of options granted was determined using the Black-Scholes option pricing
model with the indicated assumptions.
2001 2000 1999
---- ---- ----
Net income (loss) as reported $ (3,372,478) $ 563,361 $1,210,140
Pro forma net income (loss) (4,576,100) (21,368) 619,803
Pro forma basic and diluted earnings
(loss) per common share (0.78) (0.00) 0.11
-46-
15. Stock Incentive Plan (continued)
The following assumptions were used: (1) risk-free interest rate of 6.50 %; (2)
dividend yield of 0%; (3) expected life of 6.5 years; and (4) volatility of
.842% in 2001, .885% in 2000 and .655% in 1999. Results may vary depending on
the assumptions applied within the model. The weighted average fair value per
share of options granted was $1.38, $3.68 and $6.31 for 2001, and 2000 and 1999,
respectively.
16. Earnings per Share
The following is a reconciliation of the Company's basic and diluted earnings
per share for the years ended December 31, 2001, 2000 and 1999 in accordance
with SFAS No. 128, "Earnings per Share."
2001 2000 1999
---------------------------------------
Numerator:
Income (loss) before cumulative effect of a change in accounting
principle $ (3,372,478) $ 563,361 $ 1,551,175
Cumulative effect of a change in accounting principle, net of tax - - (341,035)
------------ ---------- -----------
Net income (loss) $ (3,372,478) $ 563,361 $ 1,210,140
============ ========== ===========
Pro forma income data (unaudited):
Pro forma income before cumulative effect of a change in
accounting principle $ 2,190,798
Cumulative effect of a change in accounting principle, net of tax (341,035)
-----------
Pro forma net income $ 1,849,763
===========
Denominator (1):
Weighted average shares
outstanding - basic 5,839,230 5,839,230 5,881,630
Effect of dilutive securities:
Director and employee stock options 10,509 52,706 565
---------------------------------------
Denominator for diluted earnings per
share - adjusted weighted
average and assumed conversions 5,849,739 5,891,936 5,882,195
=======================================
(1) Actual for 2001 and 2000 and pro forma for 1999.
17. Segment Information
The Company has three reportable segments: restaurants, commissary and
corporate. The restaurant segment consists of the operations of all
Company-owned restaurants and derives its revenues from the sale of food
products to the general public. The commissary segment derives its revenues from
the sale of food products to Company-owned and franchised restaurants. The
corporate segment derives revenues from sales of franchise rights, franchise
royalties and related services used in restaurant operations, and contains the
selling, general and administrative activities of the Company. Generally, the
Company evaluates performance and allocates resources based on pre-tax income.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
- 47 -
17. Segment Information (continued)
Segment information for the years ended December 31 is as follows:
2001:
Restaurant Commissary Corporate Totals
------------- -------------- ------------- ---------------
Revenues from external customers $ 56,025,886 $ 1,781,252 $ 1,646,044 $ 59,453,182
Intersegment revenues - 2,671,213 - 2,671,213
General and administrative expenses - - 4,191,582 4,191,582
Advertising expenses - - 1,915,577 1,915,577
Depreciation and amortization 1,797,889 106,596 380,967 2,285,452
Special charges 4,294,539 - - 4,294,539
Loss on guarantees of indebtedness - - 565,000 565,000
Net interest expense - 176,100 1,100,803 1,276,903
Equity in income of TW-Springhurst 81,318 - - 81,318
Income (loss) before income taxes 1,346,244 105,724 (6,002,590) (4,550,622)
Fixed assets 26,537,963 993,509 848,566 28,380,038
Expenditures for long-lived assets 1,182,303 - 73,103 1,255,406
2000:
Restaurant Commissary Corporate Totals
------------- -------------- ------------ -------------
Revenues from external customers $ 51,820,600 $ 1,663,208 $ 2,816,958 $ 56,300,766
Intersegment revenues - 2,494,802 - 2,494,802
Gain from insurance proceeds due to
involuntary conversion of non-
monetary assets - - 554,864 554,864
General and administrative expenses - - 5,028,120 5,028,120
Advertising expenses - - 1,570,179 1,570,179
Depreciation and amortization 1,689,740 117,326 340,342 2,147,408
Loss on guarantees of indebtedness - - 725,000 725,000
Net interest expense - 176,100 1,282,550 1,458,650
Equity in losses of TW-Springhurst (58,903) - - (58,903)
Income (loss) before income taxes 6,380,060 85,112 (5,836,372) 628,800
Fixed assets 29,758,242 1,072,609 964,603 31,795,454
Expenditures for long-lived assets 2,779,337 13,978 297,621 3,090,936
1999:
Restaurant Commissary Corporate Totals
------------- -------------- ------------- ------------
Revenues from external customers $ 48,578,123 $ 1,168,836 $ 1,597,928 $ 51,344,887
Intersegment revenues - 2,727,283 - 2,727,283
General and administrative expenses - - 3,728,329 3,728,329
Advertising expenses - - 1,253,392 1,253,392
Depreciation and amortization 1,450,288 118,752 235,717 1,804,757
Net interest expense - 172,900 956,006 1,128,906
Income before income taxes
and cumulative effect of a change
in accounting principle 7,338,467 93,911 (4,061,921) 3,370,457
Fixed assets 28,160,697 1,147,975 838,887 30,147,559
Expenditures for long-lived assets 6,312,460 237,175 365,909 6,915,544
- 48 -
18. Selected Quarterly Data
The following is a summary of certain unaudited quarterly results of operations
for the years ended December 31, 2001 and 2000.
2001:
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
Total revenues $ 14,634,264 $ 14,946,045 $ 15,189,795 $ 14,683,078 $ 59,453,182
Income (loss) from operations 192,617 396,850 392,233 (4,336,737)(a) (3,355,037)
Net income (loss) (118,404) 47,251 88,214 (3,389,539) (3,372,478)
Basic and diluted net income
(loss) per share (0.02) 0.01 0.02 (0.58) (0.58)
2000:
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
Total revenues $ 13,632,368 $ 14,391,655 $ 14,441,597 $ 13,835,146 $ 56,300,766
Income (loss) from operations 960,475 853,043(b) (13,792)(c) 346,627(d) 2,146,353
Net income (loss) 418,130 337,793 (257,740) 65,178(e) 563,361
Basic and diluted net income
(loss) per share 0.07 0.06 (0.04) 0.01 0.10
(a) Includes loss on guarantees of indebtedness of $565,000 and special charges
of $4,294,539.
(b) Includes gain from insurance proceeds due to involuntary conversion of
non-monetary assets of approximately $434,000 and loss on guarantees of
indebtedness of $475,000.
(c) Includes estimated additional loss on guarantees of indebtedness of $250,000.
(d) Includes additional gain from insurance proceeds due to involuntary
conversion of non-monetary assets of approximately $121,000.
(e) Includes a change in estimate of approximately $190,000 reducing the
Company's provision for income taxes.
19. Commitments and Contingencies
The Company guaranteed renewals of certain guaranteed indebtedness and any
replacement indebtedness of TW- Tennessee, LLC, a former franchisee
(TW-Tennessee) of the Company in which the Company and David M. Roth, a Director
of the Company, were formerly members, to the extent and in amounts not to
exceed the amounts guaranteed as of September 30, 1998. The Company had
guaranteed certain TW-Tennessee obligations as follows, jointly and severally
with TW-Tennessee common members: a) up to $1,200,000 under a bank line of
credit, b) approximately $2,800,000 of a lease financing agreement, and c)
equipment leases with a bank.
In March 2001, the bank which held the line of credit extended to TW-Tennessee
filed suit in the Circuit Court of Jefferson County, Kentucky against the
Company, the Director and others to enforce certain limited guaranty agreements
(the "Tennessee Litigation"). The Company paid the sum of $195,044 against its
line of credit guarantee in September 2000. The Company undertook settlement
discussions with the bank and the other guarantors during 2001. On December 28,
2001, the court entered summary judgment against the Company and certain other
guarantors including the affected Director. The amount of the judgment against
the Company was $1,004,956. Prior to enforcement of the judgment by the bank,
the parties continued settlement discussions which resulted in the settlement
described below.
- 49 -
19. Commitments and Contingencies (continued)
By complaint dated October 4, 2001, Douglas H. Morris, II and Michael R. Greene,
plaintiffs, filed an action (the "Morris and Greene Lawsuit") in the Circuit
Court of Jefferson County, Kentucky against the Company, Tumbleweed
International, LLC and others, including David Roth, a current Director of the
Company, alleging damage to the plaintiffs as a result of (i) the management of
the TW-Tennessee restaurants by the Company, (ii) the alleged wrongful
application of proceeds of the Company's purchase of the Medina, Ohio restaurant
and (iii) the alleged wrongful conversion of loan proceeds belonging to
TW-International, LLC to TWED-Charleston, Inc. Prior to answering the complaint,
the Company entered into settlement discussions with the plaintiffs which
resulted in the settlement described below.
Beginning in 2001, the Company had settlement discussions with the bank holding
the TW-Tennessee line of credit, the other guarantors of that line of credit,
the plaintiffs in the Morris and Greene Lawsuit and certain of the shareholders
of TW International Investors, Inc. and TWI-B, Inc. regarding the resolution of
the Tennessee Litigation, the Morris and Greene Lawsuit and related matters.
On February 28, 2002, the Company entered into a Confidential Settlement
Agreement and Mutual Release (the "Settlement Agreement") which resolved the
Tennessee Litigation, the Morris and Greene Lawsuit and related matters. The
Settlement Agreement provided for a cash payment by the Company to the bank
holding the TW-Tennessee line of credit of $75,000 and the execution of a
promissory note, payable to the bank, in the face amount of $300,000. In
addition, subject to certain conditions, the Company will pay to the bank an
additional amount of up to $200,000 in the event Tumbleweed International, LLC
successfully sells regional international licenses and receives proceeds in
excess of the $1,400,000 in indebtedness assumed by the Company in connection
with its acquisition of the interests of TW International Investors, Inc. and
TWI-B, Inc. in Tumbleweed International, LLC (see Note 20). The completion of
the acquisition of the interests of TW International Investors, Inc. and TWI-B,
Inc. in Tumbleweed International, LLC is included in the Settlement Agreement.
As a result of the Settlement Agreement, the Tennessee Litigation and the Morris
and Greene Lawsuit were dismissed. In addition, the parties to the settlement,
including certain Directors of the Company (George Keller, David M. Roth and
Minx Auerbach), granted mutual releases to one another regarding all matters,
other than those specifically excluded. Among the matters excluded from the
mutual release contained in the Settlement Agreement are claims asserted by the
holder of the equipment leases granted to TW-Tennessee relative to guarantees by
the Company and others, including David M. Roth, a Director of the Company,
relative to such equipment leases. The Company is in negotiation with the bank
under the equipment leases and the other guarantors to resolve the Company's
obligations relative to the equipment leases. The Company believes that it will
be obligated to assume and pay one of the equipment leases totaling
approximately $125,000 and will remain contingently liable on two other
equipment leases which the Company believes will be assumed and paid by other
guarantors. These negotiations are ongoing and no agreement has been reached. If
no agreement is reached, the Company would have additional exposure totaling
approximately $180,000.
In the fourth quarter of 2001, as a result of the settlement discussions, the
Company increased a reserve established in 2000 by the additional amount of
$565,000, for a total of $1,290,000, of which $725,000 had been paid out as of
December 31, 2001. The Company increased this reserve to cover its portion of
the settlement payments to the bank holding the TW- Tennessee line of credit and
pay related costs, including legal expenses. The reserve also includes an
additional charge for the equipment lease which the Company expects to assume,
and for payments made by the Company in 2001 on other lease financing claims
related to TW-Tennessee. The Company's management believes it will not incur
significant additional losses in connection with these matters.
20. Subsequent Events
Subsequent to December 31, 2001, the Company purchased International for $1.5
million from TW-International Investors, Inc. and Chi-Chi's International
Operations, Inc. ("CCIO"). CCIO owned 40% of International. The President and
Chief Executive Officer of the Company is the sole shareholder of CCIO. Members
of TW-International Investors, Inc. include three current directors of the
Company. The acquisition will give the Company direct control and benefit of the
international licensing of the Tumbleweed concept. In connection with the
acquisition, the Company assumed an existing $1.4 million bank loan of
TW-International Investors, Inc. and will issue 76, 923 shares of its common
stock to CCIO. The Company will also enter into a commission agreement with CCIO
in connection with the sale of international regional licenses by International.
- 50 -
20. Subsequent Events (continued)
Also subsequent to December 31, 2001, the Company implemented a 401(k) plan. All
employees who are at least 21 years of age with one year of service in which
they worked a minimum of 1,000 hours are eligible. An employee can contribute up
to 15% of their gross salary. The Company will match 25% of the first 4% an
employee contributes. The employee becomes vested in the Company contribution
based on a five-year vesting schedule.
- 51 -
Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The Proxy Statement issued in connection with the shareholders meeting to be
held on May 22, 2002, to be filed with the Securities and Exchange Commission
pursuant to Rule 14a-6b, contains under the caption "Election of Directors"
information required by Item 10 of Form 10-K as to directors of the Company and
is incorporated herein by reference. Pursuant to General Instruction G(3),
certain information concerning executive officers of the Company is included in
Part I of this Form 10-K, under the caption "Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The Proxy Statement issued in connection with the shareholders meeting to be
held on May 22, 2002, to be filed with the Securities and Exchange Commission
pursuant to Rule 14a-6(b), contains under the caption "Executive Compensation"
information required by Item 11 of Form 10-K and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Proxy Statement issued in connection with the shareholders meeting to be
held on May 22, 2002, to be filed with the Securities and Exchange Commission
pursuant to Rule 14a-6(b), contains under caption "Beneficial Ownership Of
Common Stock"and "Election of Directors" information required by Item 12 of Form
10-K and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Proxy Statement issued in connection with the shareholders meeting to be
held on May 22, 2002, to be filed with the Securities and Exchange Commission
pursuant to Rule 14a-6(b) contains under the caption "Certain Relationships and
Related Transactions" information required by Item 13 of Form 10-K and is
incorporated herein by reference.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements: See Item 8.
(2) Financial Statement Schedules:
Schedule II- Valuation and Qualifying Accounts Page 55
All other schedules for which provision is made in the
applicable accounting regulation of the Securities and
Exchange Commission are not required under the related
instructions or are inapplicable and, therefore, have been
omitted.
(3) Listing of Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
2.1 Agreement and Plan of Merger, dated as of June 23, 1998,
between Tumbleweed, LLC and Registrant**
3.1 Certificate of Incorporation of Tumbleweed, Inc., as amended**
3.2 Bylaws of Registrant*
10.1 Master International License Agreement, dated August 29, 1997,
between Tumbleweed International LLC and Tumbleweed, LLC*
10.2 Employment Agreement between John A. Butorac, Jr. and
Tumbleweed, Inc.*
10.3 Employment Agreement between James M. Mulrooney and Tumbleweed,
Inc.*
10.4 Sublease Agreement, dated February 5, 1997, between
TW-Dixie Bash, LLC and Tumbleweed, LLC (for Bardstown Road
restaurant)*
10.5 Sublease Agreement, dated February 5, 1997, between TW-Dixie
Bash, LLC and Tumbleweed, LLC (for Valley Station restaurant)*
10.6 Commitment Letter, dated June 12, 1997, between CNL Fund
Advisors, Inc. and TW Tennessee, LLC*
10.7 Tumbleweed, Inc. 1998 Stock Option and Incentive Compensation
Plan*
10.8 Form of Standard Franchise Agreement for Tumbleweed, LLC*
10.9 Articles of Incorporation of Tumbleweed Marketing Fund, Inc.*
10.10 By-laws of Tumbleweed Marketing Fund, Inc.*
10.11 Bonus Compensation Plan for Senior Executives*
10.12 Revolving Line of Credit Note, dated April 21, 1999, between
Tumbleweed, Inc. and National City Bank of Kentucky and related
Loan Agreement***
99 Registration Rights Agreement between Tumbleweed, Inc. and
Tumbleweed, LLC*
-----------------
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* Incorporated by reference to exhibits filed with the Commission on
September 29, 1998, in Form S-1 Registration No. 333-57931.
** Incorporated by reference to exhibits filed with the Commission in
Form 8-A filed by Tumbleweed, Inc. on February 25, 1999.
*** Incorporated by reference to exhibits filed with the Commission on
May 12, 1999 in Form 10-A, File No. 333-57931.
(b) During the quarter ended December 31, 2001, the Company did not file
any reports on Form 8-K
- 54 -
Tumbleweed, Inc.
Schedule II - Valuation and Qualifying Accounts
Additions
------------------------------------
Balance at Charged to Other
Beginning of Charged to Costs Accounts - Deductions - Balance at End
Description Year and Expenses Describe Describe of Year
----------- ---- ------------ -------- -------- -------
Year Ended December 31, 2001:
Reserves and allowances deducted
from asset accounts:
Allowance for uncollectible
accounts $68,464 $4,202 $- $(68,464) (a) $4,202
Year Ended December 31, 2000:
Reserves and allowances deducted
from asset accounts:
Allowance for uncollectible
accounts - 68,464 - - 68,464
Year Ended December 31, 1999:
Reserves and allowances deducted
from asset accounts:
Allowance for uncollectible
accounts - - - - -
(a) Account was written off in 2001.
- 55 -
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Louisville,
State of Kentucky.
TUMBLEWEED, INC.
/s/ Terrance A. Smith
------------------------------------
By: Terrance A. Smith
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons in capacities and on the dates
indicated.
Title Date
/s/ Terrance A. Smith
--------------------
Terrance A. Smith President, Chief Executive Officer April 4, 2002
and Director
/s/ Glennon F. Mattingly
-------------------
Glennon F. Mattingly Chief Financial Officer, and April 4, 2002
Vice President
(Principal Accounting Officer)
/s/ David M. Roth
-------------------
David M. Roth Director April 4, 2002
/s/ Minx Auerbach
-------------------
Minx Auerbach Director April 4, 2002
/s/ Lewis Bass
--------------------
Lewis Bass Director April 4, 2002
/s/ George R. Keller
--------------------
George R. Keller Director April 4, 2002
/s/ James F. Koch
--------------------
James F. Koch Director April 4, 2002
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