**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549-1004**

 

**FORM 10-Q**

 

| **ý**                                                                                                                                                                                                    | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OF  THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                    | ** ** | ** **                                                                                |
| **For the quarterly period ended July 14, 2005**                                                                                                                                                         |
| ** **                                                                                                                                                                                                    | ** ** | ** **                                                                                |
| ** **                                                                                                                                                                                                    | ** ** | **OR**                                                                                    |
| ** **                                                                                                                                                                                                    | ** ** | ** **                                                                                |
| **o**                                                                                                                                                                                                         | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OF  THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                    | ** ** | ** **                                                                                |
| **For the transition period  from              to              ** |
| ** **                                                                                                                                                                                                    | ** ** | ** **                                                                                |
| **Commission file number 333-117263**                                                                                                                                                                         |

 

**VICORP RESTAURANTS, INC.**

(Exact name of registrant as specified in its charter)

 
| **STATE OF COLORADO**                       | ** ** | **84-0511072**      |
|---------------------------------------------|------------|---------------------|
| (State or other jurisdiction of             |       | (I.R.S. Employer    |
| incorporation or organization)              |       | Identification No.) |
|                                        |       |                |
| **400 WEST 48TH AVENUE, DENVER,  COLORADO** | ** ** | **80216**           |
| (Address of principal executive offices)    |       | (Zip Code)          |

 

Registrant’s telephone number, including area code: **(303) 296-2121**

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes  ý  No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct).

Yes  o  No  ý

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).  oYes  ýNo

 

Numberof shares of Common Stock, $.0001 par value, outstanding at August 29, 2005:1,427,602, excluding treasury shares.

 

 

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**VICORP RESTAURANTS, INC.**

**Form 10-Q**

**July 14, 2005**

**INDEX**

 
| **PART I - FINANCIAL INFORMATION** |       |
|-----------------------------------------|------------|
| ** **                              |       |
|                                    | Item 1.    | Consolidated Financial Statements |   |
|                                    |       |   |   |
|                                    |       | Consolidated Balance Sheets as of  July 14, 2005 and October 28, 2004 (As restated) |   |
|                                    |       |   |   |
|                                    |       | Consolidated Statements of  Operations for the 84 days ended July 14, 2005 and July 8, 2004 (As  restated) and the 259 days ended July 14, 2005 and the 256 days ended  July 8, 2004 (As restated) |   |
|                                    |       |   |   |
|                                    |       | Consolidated Statements of  Cash Flows for the 259 days ended July 14, 2005 and the 256 days ended  July 8, 2004 (As restated) |   |
|                                    |       |   |   |
|                                    |       | Notes to Consolidated  Financial Statements |   |
|                                    |       |   |   |
|                                    | Item 2.    | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   |
|                                    |       |   |   |
|                                    | Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk |   |
|                                    |       |   |   |
|                                    | Item 4.    | Controls and  Procedures |   |
|                                    |       |   |   |
| **PART II - OTHER INFORMATION**    |       |
| ** **                              |       |
|                                    | Item 1.    | Legal Proceedings |   |
|                                    |       |   |   |
|                                    | Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds |   |
|                                    |       |   |   |
|                                    | Item 3.    | Defaults  Upon Senior Securities |   |
|                                    |       |   |   |
|                                    | Item 4.    | Submission  of Matters to a Vote of Security Holders |   |
|                                    |       |   |   |
|                                    | Item 5.    | Other Information |   |
|                                    |       |   |   |
|                                    | Item 6.    | Exhibits |   |
|                                    |       |   |   |
| **SIGNATURES**                          | ** ** |

 

2

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. CONSOLIDATED FINANCIAL STATEMENTS**

 

**VI Acquisition Corp.**

**Consolidated Balance Sheets**

**(In Thousands, Except Share and Per ShareData**)

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                        | ** ** | **July 14, 2005** | ** ** | **October 28, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                                                                        | ** ** | ** **             | ** ** | ** **                | ** ** |
| **Assets**                                                                                                                                                                                                                                        |       |                   |       |                      |       |
| Current assets:                                                                                                                                                                                                                                   |       |                   |       |                      |       |
| Cash and cash equivalents                                                                                                                                                                                                                         |       | $                      | 12,595     |                      | $          | 1,332 |   |
| Receivables, net                                                                                                                                                                                                                                  |       | 6,376                  |       | 11,915                    |       |
| Inventories                                                                                                                                                                                                                                       |       | 10,480                 |       | 12,245                    |       |
| Deferred income taxes, short-term                                                                                                                                                                                                                 |       | 3,507                  |       | 4,673                     |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                         |       | 3,274                  |       | 3,432                     |       |
| Income tax receivable                                                                                                                                                                                                                             |       | 336                    |       | 270                       |       |
| Total current assets                                                                                                                                                                                                                              |       | 36,568                 |       | 33,867                    |       |
| Deferred income taxes, long-term                                                                                                                                                                                                                  |       | 2,771                  |       | —                    |       |
| Property and equipment, net                                                                                                                                                                                                                       |       | 82,015                 |       | 80,316                    |       |
| Assets under deemed landlord financing  liability, net                                                                                                                                                                                            |       | 117,800                |       | 110,342                   |       |
| Goodwill                                                                                                                                                                                                                                          |       | 91,881                 |       | 91,881                    |       |
| Trademarks and tradenames                                                                                                                                                                                                                         |       | 42,600                 |       | 42,600                    |       |
| Franchise rights, net                                                                                                                                                                                                                             |       | 10,948                 |       | 11,358                    |       |
| Other assets, net                                                                                                                                                                                                                                 |       | 11,808                 |       | 13,763                    |       |
| Total assets                                                                                                                                                                                                                                      |       | $                      | 396,391    |                      | $          | 384,127 |   |
|                                                                                                                                                                                                                                              |       |                   |       |                      |       |   |   |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                                     |       |                   |       |                      |       |
| Current liabilities:                                                                                                                                                                                                                              |       |                   |       |                      |       |
| Current maturities of long-term debt and  capitalized lease obligations                                                                                                                                                                           |       | $                      | 93         |                      | $          | 201 |   |
| Cash overdraft                                                                                                                                                                                                                                    |       | —                 |       | 3,190                     |       |
| Accounts payable                                                                                                                                                                                                                                  |       | 12,239                 |       | 13,174                    |       |
| Accrued compensation                                                                                                                                                                                                                              |       | 7,483                  |       | 7,138                     |       |
| Accrued taxes                                                                                                                                                                                                                                     |       | 11,119                 |       | 7,992                     |       |
| Other accrued expenses                                                                                                                                                                                                                            |       | 20,384                 |       | 18,520                    |       |
| Total current liabilities                                                                                                                                                                                                                         |       | 51,318                 |       | 50,215                    |       |
| Long-term debt                                                                                                                                                                                                                                    |       | 140,270                |       | 141,469                   |       |
| Capitalized lease obligations                                                                                                                                                                                                                     |       | 213                    |       | 248                       |       |
| Deemed landlord financing liability                                                                                                                                                                                                               |       | 122,164                |       | 114,670                   |       |
| Deferred income taxes, long-term                                                                                                                                                                                                                  |       | —                 |       | 1,360                     |       |
| Other noncurrent liabilities                                                                                                                                                                                                                      |       | 8,936                  |       | 7,057                     |       |
| Total liabilities                                                                                                                                                                                                                                 |       | 322,901                |       | 315,019                   |       |
|                                                                                                                                                                                                                                              |       |                   |       |                      |       |
| Commitments and contingencies                                                                                                                                                                                                                     |       |                   |       |                      |       |
|                                                                                                                                                                                                                                              |       |                   |       |                      |       |
| Stock subject to repurchase                                                                                                                                                                                                                       |       | 1,063                  |       | 1,063                     |       |
|                                                                                                                                                                                                                                              |       |                   |       |                      |       |
| Stockholders’ equity:                                                                                                                                                                                                                        |       |                   |       |                      |       |
| Preferred stock, $0.0001 par value:                                                                                                                                                                                                               |       |                   |       |                      |       |
| Series A, 100,000 shares authorized,  68,943 shares issued and outstanding at July 14, 2005 and 68,659 shares  issued and outstanding at October 28, 2004 (aggregate liquidation  preference of $85,199 and $78,951, respectively) |       | 86,310                 |       | 80,022                    |       |
| Unclassified preferred stock, 100,000  shares authorized, no shares issued or outstanding                                                                                                                                                         |       | —                 |       | —                    |       |
| Common stock $0.0001 par value:                                                                                                                                                                                                                   |       |                   |       |                      |       |
| Class A, 2,800,000 shares authorized,  1,392,354 shares issued and outstanding at July 14, 2005 and 1,386,552  shares issued and outstanding at October 28, 2004                                                                   |       | —                 |       | —                    |       |
| Paid-in capital                                                                                                                                                                                                                                   |       | 2,452                  |       | 2,426                     |       |
| Treasury stock, at cost, 923.87 shares of  preferred stock and 80,603 shares of common stock at July 14, 2005 and  October 28, 2004                                                                                                     |       | (1,004                 | )          | (1,004                    | )          |
| Accumulated deficit                                                                                                                                                                                                                               |       | (15,331                | )          | (13,399                   | )          |
| Total stockholders’ equity                                                                                                                                                                                                                   |       | 72,427                 |       | 68,045                    |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                   |       | $                      | 396,391    |                      | $          | 384,127 |   |

 

*See accompanying notes to consolidated financial statements.*

 

3

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**VI Acquisition Corp.**

**Consolidated Statements ofOperations**

**(In Thousands)**

**(Unaudited)**

 
| ** **                                        | ** ** | **84 Days Ended** | ** ** | **84 Days Ended** | ** ** | **259 Days Ended** | ** ** | **256 Days Ended** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                        | ** ** | **July 14,** | ** ** | **July 8,**  | ** ** | **July 14,**  | ** ** | **July 8,**   | ** ** |
| ** **                                        | ** ** | **2005**          | ** ** | **2004**          | ** ** | **2005**           | ** ** | **2004**           | ** ** |
| ** **                                        | ** ** | ** **        | ** ** | **(As restated)** | ** ** | ** **         | ** ** | **(As restated)**  | ** ** |
| **Revenues:**                                     |       |              |       |              |       |               |       |               |       |
| Restaurant operations                             |       | $                 | 91,225     |              | $          | 88,958             |       | $                  | 288,087    |   | $ | 280,347 |   |
| Franchise operations                              |       | 1,283             |       | 1,165             |       | 3,703              |       | 3,495              |       |
|                                              |       | 92,508            |       | 90,123            |       | 291,790            |       | 283,842            |       |
| **Costs and expenses:**                           |       |              |       |              |       |               |       |               |       |
| Restaurant costs:                                 |       |              |       |              |       |               |       |               |       |
| Food                                              |       | 23,702            |       | 24,571            |       | 76,307             |       | 76,667             |       |
| Labor                                             |       | 29,861            |       | 28,827            |       | 92,143             |       | 89,125             |       |
| Other operating expenses                          |       | 24,720            |       | 22,923            |       | 77,823             |       | 74,485             |       |
| Franchise operating expenses                      |       | 480               |       | 512               |       | 1,512              |       | 1,605              |       |
| General and administrative expenses               |       | 6,234             |       | 5,602             |       | 19,112             |       | 17,503             |       |
| Litigation settlement                             |       | (408              | )          | —            |       | (408               | )          | —             |       |
| Transaction expenses                              |       | —            |       | —            |       | 15                 |       | 45                 |       |
| Management fees – related party              |       | 196               |       | 196               |       | 588                |       | 897                |       |
| Asset impairment                                  |       | —            |       | —            |       | —             |       | 22                 |       |
|                                              |       | 84,785            |       | 82,631            |       | 267,092            |       | 260,349            |       |
| **Operating profit**                              |       | 7,723             |       | 7,492             |       | 24,698             |       | 23,493             |       |
| Interest expense                                  |       | (6,577            | )          | (6,383            | )          | (20,031            | )          | (18,488            | )          |
| Debt extinguishment costs                         |       | —            |       | —            |       | —             |       | (6,856             | )          |
| Other income, net                                 |       | 211               |       | 111               |       | 437                |       | 161                |       |
| **Income (loss) before income taxes**             |       | 1,357             |       | 1,220             |       | 5,104              |       | (1,690             | )          |
| Provision for income taxes (benefit)              |       | 49                |       | 247               |       | 1,072              |       | (1,043             | )          |
| **Net income (loss)**                             |       | 1,308             |       | 973               |       | 4,032              |       | (647               | )          |
| Preferred stock dividends and accretion           |       | (1,989            | )          | (1,778            | )          | (5,964             | )          | (5,244             | )          |
| **Net loss attributable to common  stockholders** |       | $                 | (681       | )                 | $          | (805               | )          | $                  | (1,932     | ) | $ | (5,891 | ) |

 

*See accompanying notes to consolidated financial statements.*

 

4

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**VI Acquisition Corp.**

**Consolidated Statements of Cash Flow**

**(In Thousands)**

**(Unaudited)**

 
| ** **                                                                                       | ** ** | **259 Days Ended** | ** ** | **256 Days Ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                       | ** ** | **July 14,**  | ** ** | **July 8,**   | ** ** |
| ** **                                                                                       | ** ** | **2005**           | ** ** | **2004**           | ** ** |
| ** **                                                                                       | ** ** | ** **         | ** ** | **(As restated)**  | ** ** |
| **Operating activities:**                                                                        |       |               |       |               |       |
| Net income (loss)                                                                                |       | $                  | 4,032      |               | $          | (647 | ) |
| Reconciliation of net income (loss) to net  cash provided by operating activities:               |       |               |       |               |       |
| Depreciation and amortization                                                                    |       | 13,744             |       | 12,983             |       |
| Amortization of financing costs and  original issue discounts                                    |       | 869                |       | 749                |       |
| Loss on disposition of assets                                                                    |       | 74                 |       | 138                |       |
| Deferred finance charge write-off                                                                |       | —             |       | 4,288              |       |
| Deferred income tax expense                                                                      |       | (2,965             | )          | (2,713             | )          |
| Interest on warrants                                                                             |       | —             |       | 88                 |       |
| Changes in operating assets and  liabilities:                                                    |       |               |       |               |       |
| Receivables, net                                                                                 |       | 3,608              |       | 2,943              |       |
| Inventories                                                                                      |       | 1,765              |       | 3,175              |       |
| Cash overdraft                                                                                   |       | (3,190             | )          | (4,866             | )          |
| Accounts payable                                                                                 |       | (935               | )          | (1,422             | )          |
| Accrued compensation                                                                             |       | 345                |       | (275               | )          |
| Other current assets and liabilities                                                             |       | 5,362              |       | 1,515              |       |
| Other noncurrent assets and liabilities                                                          |       | 2,565              |       | 2,484              |       |
| Net cash provided by operating activities                                                        |       | 25,274             |       | 18,440             |       |
| **Investing activities:**                                                                        |       |               |       |               |       |
| Purchase of property and equipment                                                               |       | (11,914            | )          | (8,888             | )          |
| Purchase of assets under deemed landlord  financing liability                                    |       | (10,469            | )          | (2,666             | )          |
| Proceeds from disposition of property                                                            |       | 102                |       | 346                |       |
| Collection of notes receivable                                                                   |       | 196                |       | 28                 |       |
| Other                                                                                            |       | —             |       | (132               | )          |
| Net cash used in investing activities                                                            |       | (22,085            | )          | (11,312            | )          |
| **Financing activities:**                                                                        |       |               |       |               |       |
| Payments of debt and capital lease  obligations                                                  |       | (9,093             | )          | (164,936           | )          |
| Proceeds from issuance of debt                                                                   |       | 7,600              |       | 162,301            |       |
| Proceeds from deemed landlord financing                                                          |       | 9,229              |       | 1,101              |       |
| Net proceeds from issuance of preferred  stock and common stock                                  |       | 350                |       | 264                |       |
| Debt issuance costs                                                                              |       | (12                | )          | (5,885             | )          |
| Repurchase of shares                                                                             |       | —             |       | (4                 | )          |
| Net cash provided by (used in) financing  activities                                             |       | 8,074              |       | (7,159             | )          |
| Increase (decrease) in cash and cash  equivalents                                                |       | 11,263             |       | (31                | )          |
| Cash and cash equivalents at beginning of  period                                                |       | 1,332              |       | 5,326              |       |
| Cash and cash equivalents at end of period                                                       |       | $                  | 12,595     |               | $          | 5,295 |   |
|                                                                                             |       |               |       |               |       |
| **Supplemental disclosures of cash flow  information:**                                          |       |               |       |               |       |
| Cash paid during the period for:                                                                 |       |               |       |               |       |
| Interest on long-term debt and deemed  landlord financing liability (net of amounts capitalized) |       | $                  | 16,470     |               | $          | 14,393 |   |
| Income taxes                                                                                     |       | 2,188              |       | 893                |       |

 

*See accompanying notes to consolidated financial statements.*

 

5

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**VI Acquisition Corp.**

**Notes to Consolidated Financial Statements**

**July 14, 2005**

**(Unaudited)**

 

**1.****     Descriptionof the Business and Basis of Presentation**

 

**Description of Business**

 

VI Acquisition Corp. (the “Company” or “VI Acquisition”), a Delawarecorporation, was organized in June 2003 by Wind Point Partners and otherco-investors.  VICORP Restaurants, Inc.(“VICORP”) and its subsidiaries are wholly-owned by VI Acquisition Corp.  As a holding company, VI Acquisition Corp.does not have any independent operations and, consequently, its consolidatedstatements of operations are substantially equivalent to those of VICORP.

 

The Company operates family style restaurants under the brand names “BakersSquare” and “Village Inn,” and franchises restaurants under the Village Inn brandname.  At July 14, 2005, the Companyoperated 279 Company-owned restaurants in 15 states.  Of the Company-owned restaurants, 149 areBakers Square restaurants and 130 are Village Inn restaurants, with anadditional 100 franchised Village Inn restaurants in 19 states.  The Company-owned and franchised restaurantsare concentrated in Arizona, California, Florida, the Rocky Mountain region,and the upper Midwest. In addition, the Company operates three pie manufacturingfacilities located in Santa Fe Springs, California; Oak Forest, Illinois; andChaska, Minnesota.

 

**Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with U.S. generally accepted accounting principles (“GAAP”)for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by GAAP for complete financial statements.  In the opinion of management, the financialstatements include all adjustments, consisting of normal recurring adjustments,necessary for a fair presentation. However, operating results for the 259-day period ended July 14,2005 are not necessarily indicative of the results that may be expected for thefiscal year ending November 3, 2005. The consolidated balance sheet at October 28, 2004, as restated,has been derived from the audited consolidated financial statements at thatdate but does not include all of the information and footnotes required by GAAPfor complete financial statements.  Forfurther information, refer to the audited consolidated financial statements andfootnotes thereto for the year ended October 28, 2004 included in ourAnnual Report on Form 10-K, which was amended on May 18, 2005 for therestatement of previously issued financial statements (see Note 2).

 

6

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**Stock-Based Compensation**

 

Financial Accounting Standards Board (“FASB”) Statement of FinancialAccounting Standards (“SFAS”) No. 123, “Accounting for Stock-BasedCompensation,” defines a fair value method of accounting for employee stockcompensation and encourages, but does not require, all entities to adopt thatmethod of accounting. Entities electing not to adopt the fair value method ofaccounting must make pro forma disclosures of net income as if the fair valuemethod of accounting defined in SFAS No. 123 had been applied. The Companyhas elected not to adopt the fair value method and instead has elected tofollow Accounting Principles Board (“APB”) Opinion No. 25, “Accounting forStock Issued to Employees,” and related interpretations (however, refer to thediscussion in the following paragraph related to the Company’s pending adoptionof SFAS No. 123R, “Share-Based Payment”). Under APB Opinion No. 25,compensation expense related to stock options is calculated as the difference,if any, between the exercise price of the option and the fair market value ofthe underlying stock at the date of grant. This expense is recognized over thevesting period of the option or at the time of grant if the options immediatelyvest. As a result of the minimal number of stock options outstanding during allperiods presented in the accompanying consolidated financial statements, thepro forma effects of applying the fair value method to outstanding options overtheir respective vesting periods had an immaterial effect on net income.

 

**New Accounting Pronouncements**

 

In December 2004, the FASB issued SFAS No. 123R, whichreplaces the prior SFAS No. 123 and supersedes APB Opinion No. 25.  SFAS 123R requires compensation costs relatedto share-based payment transactions to be recognized in the financialstatements.  With limited exceptions, theamount of compensation cost will be measured based on the grant-date fair valueof the equity or liability instruments issued. In addition, liability awards will be re-measured each reportingperiod.  Compensation cost will be recognizedover the period that an employee provides services in exchange for theaward.  This new standard will becomeeffective for the Company on November 4, 2005 (the first quarter of theCompany’s fiscal 2006), and while the Company is still evaluating the impact ofadopting SFAS No. 123R, the Company does not believe such adoption willhave a material impact on its consolidated financial statements because of theminimal number of stock options outstanding.

 

In November 2004, the FASB issued SFAS No. 151, “InventoryCosts, an amendment of ARB No. 43, Chapter 4.”  SFAS No. 151 clarifies the accountingfor abnormal amounts of idle facility expense, freight, handling costs, andwasted material, and requires that such items be recognized as current-periodcharges regardless of whether they meet the “so abnormal” criterion outlined inARB No. 43.  SFAS No. 151 alsointroduces the concept of “normal capacity” and requires the allocation offixed production overheads to inventory based on the normal capacity of theproduction facilities.  Unallocatedoverheads must be recognized as an expense in the period incurred.  SFAS No. 151 is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005.  While the Company is still evaluating theimpact of this statement, it does not currently believe it will have a materialimpact on its consolidated financial statements.

 

7

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**Reclassifications**

 

Certain prior period amounts in the accompanying consolidated financialstatements have been reclassified to conform to the presentation in fiscal2005.  These reclassifications had noeffect on the Company’s consolidated net income.

 

**Fiscal Periods**

 

The Company’s fiscal year is comprised of 52 or 53 weeks divided intofour fiscal quarters of 12 or 13, 12, 12, and 16 weeks.  The first three quarters of fiscal 2005 andfiscal 2004 consisted of 259 and 256 days, respectively, reflecting thedifference in duration of the first quarter of those years.  The second, third and fourth quarters offiscal 2005 and fiscal 2004 are the same in duration.  Fiscal 2005 will consist of 53 weeks, or 371total days, while fiscal 2004 consisted of 52 weeks and four days, or 368 totaldays.

 

**2.****     Restatementof Previously Issued Financial Statements**

 

The Company has restated its financialstatements for periods spanning from fiscal 2000 through fiscal 2004 to correctthe following accounting errors primarily as a result of a review of its leaseaccounting policies and practices prompted by the views expressed by the Officeof the Chief Accountant of the Securities and Exchange Commission (“SEC”) on February 7,2005 in a letter to the American Institute of Certified Public Accountants andother recent interpretations regarding certain operating lease issues and theirapplication under GAAP:

 

*(i)**       **Accounting for Real EstateTransactions*

 

Historically, the Company had accounted forcertain of its real estate transactions of restaurant properties assale-leaseback transactions.  The Companyhas restated its financial statements to now report these transactions as financingtransactions under SFAS No. 98, “Accounting for Leases,” rather than assale-leaseback transactions as previously reported due to a determination thatcertain lease agreement provisions reflect continuing involvement with thebuyer-lessor. Our continuing involvement for most of our leases now accountedfor under the financing method results from our ability to control the propertywith pre-determined rental payments through at least 90 percent of the economiclife of the property, even though lease renewals would need to be exercised bythe Company to effectuate such control. These “perpetual fixed-price renewal options” are considered continuinginvolvement because the seller-lessee is deemed to benefit from futureappreciation in the underlying property in a manner similar to a fixed-pricepurchase option.  Such continuinginvolvement precludes the use of sale-leaseback accounting until such time thatthe continuing involvement no longer exists. The affected real estate transactions related to an aggregate of 79existing restaurants in 1999, 2001 and 2003 and nine new restaurant locationsopened in 2003 and 2004.

 

8

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The impact of the restatement was to record onthe Company’s consolidated balance sheets the assets of the restaurants subjectto these transactions as if they had not been sold and record the proceeds fromthese transactions (including any gains previously deferred) as liabilitiesunder the caption “Deemed landlord financing liability”.  Operating results were restated to recognizedepreciation expense associated with the assets subject to these transactionsand re-characterize the lease payments previously reported as rent expense asprincipal repayments and imputed interest expense.  The rent expense reversal associated withthese transactions included the reversal of previously recorded expenses forstraight-line rents and rent reductions for certain purchase accountingadjustments made to account for the leases at fair market value.  In addition, the capital lease classificationfor three leased properties was re-characterized as deemed landlord financingassets and liabilities.

 

The net impact to correctly classify theaforementioned leases as financing transactions increased loss before incometaxes by $1,005,000 for the 84-day period ended July 8, 2004.  The correcting entries consisted of a$1,567,000 decrease in other operating expenses, a $41,000 decrease infranchise operating expenses and a $2,613,000 increase in interest expense.

 

The net impact to correctly classify theaforementioned leases as financing transactions increased loss before incometaxes by $3,101,000 for the 256-day period ended July 8, 2004.  The correcting entries consisted of a$4,855,000 decrease in other operating expenses, a $123,000 decrease infranchise operating expenses and a $8,079,000 increase in interest expense.

 

*(ii)**      **Understated Straight-Line RentExpense*

 

GAAP requires that leases for which there arescheduled rent increases over the term of the lease be accounted for at theaverage rent payment, or on a straight-line basis, over the applicable termwith the differences being recorded on the balance sheet as a deferred rentliability.  The Company did not appropriatelystraight-line its rents for certain locations, which resulted in understatedoperating expenses in prior financial reporting periods.  The net impact to correctly straight-linerents resulted in an increase in other operating expenses and an increase inthe loss before income taxes of $126,000 and $383,000 for the 84-day and 256-dayperiods ended July 8, 2004, respectively.

 

*(iii)**    **Understated Depreciation andAmortization Expense*

 

The Company generally has historicallydepreciated its buildings and leasehold improvements over the lesser of theasset’s useful life or the initial term of the associated lease unless aneconomic penalty would occur from not exercising renewal options, in whichcase, the assets are depreciated over the lesser of the asset’s useful life orthe reasonably assured lease term. However, in performing a detailed review of the Company’s depreciableassets, it was determined that buildings and leasehold improvements forapproximately 31 restaurant properties had incorrect depreciable livesresulting in an understatement of depreciation expense, predominantly inearlier periods.  The net impact of thecorrection of our leasehold improvement depreciable lives resulted in anincrease in other operating expenses and an increase in the loss before incometaxes of $21,000 and $50,000 for the 84-day and 256-day periods ended July 8,2004, respectively.

 

9

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*(iv)**     **Understated Interest Expense onPreferred Stock Warrant Accretion*

 

The Company also determined it was appropriate to record additionaladjustments which were previously deemed immaterial.  The adjustments related to interest expenseand preferred dividends imputed from the accretion of preferred stock warrantswith anti-dilutive provisions issued originally to certain debt holders at thetime of the Company’s June 2003 purchase. For the 84-day and 256-day periods ended July 8, 2004, additionalpreferred stock and interest expense of $0 and $88,000, respectively, wasrecorded as a result of the correction of this error, respectively.

 

*(v)**       Accountingfor Income Taxes*

 

In addition to the impact on the Company’s income tax provisionresulting from the accounting corrections discussed above, the Companydetermined that its accounting for income taxes related to our purchase businesscombinations was not correct.  Under FASBSFAS No. 109, “Accounting for Income Taxes,” companies are to recognizedeferred tax assets and liabilities for the tax effects of differences betweenassigned values in the purchase price allocation in a purchase businesscombination (except for the portion of goodwill that is not deductible for taxpurposes).  The provisions of SFAS No. 109apply to basis differences that arise in both taxable and nontaxable businesscombinations.  In both the Company’s 2001and 2003 business acquisitions, certain purchase price allocations were notcorrectly tax effected.  The correctionresulted in recognition of additional deferred tax liabilities and acorresponding increase in goodwill.  Theimpact of the corrections decreased the Company’s provision for income taxes by$427,000 and $1,584,000 for the for the 84-day and 256-day periods ended July 8,2004, respectively.

 

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The collective impact of these restatements on the Company’s results ofoperations for the 84-days and 256-days ended July 8, 2004 are summarizedbelow (in thousands):

 
| ** **                                             | ** ** | **84 Days Ended July 8, 2004 (Unaudited)** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                             | ** ** | **Previously**                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Reported**                                    | ** ** | **Corrections** | ** ** | **As restated** | ** ** |
| **Statement of Operations Data**                       |       |                                            |       |   |   |   |   |
| Other operating expenses                               |       | $                                               | 24,343     |   | $ | (1,420 | ) | $ | 22,923 |   |
| Franchise operating expenses                           |       | 553                                             |       | (41 | ) | 512 |   |
| Operating profit                                       |       | 6,031                                           |       | 1,461 |   | 7,492 |   |
| Interest expense                                       |       | (3,770                                          | )          | (2,613 | ) | (6,383 | ) |
| Income before income taxes                             |       | 2,372                                           |       | (1,152 | ) | 1,220 |   |
| Provision for income taxes                             |       | 674                                             |       | (427 | ) | 247 |   |
| Net income                                             |       | 1,698                                           |       | (725 | ) | 973 |   |
| Preferred stock dividends and accretion                |       | (1,733                                          | )          | (45 | ) | (1,778 | ) |
| Net income (loss) attributable to common  shareholders |       | (35                                             | )          | (770 | ) | (805 | ) |
|                                                        |            |                                                 |            |  |  |  |  |  |  |  |

 

 
| ** **                                             | ** ** | **256 Days Ended July 8, 2004 (Unaudited)** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                             | ** ** | **Previously**                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Reported**                                     | ** ** | **Corrections** | ** ** | **As restated** | ** ** |
| **Statement of Operations Data**                       |       |                                             |       |   |   |   |   |
| Other operating expenses                               |       | $                                                | 78,907     |   | $ | (4,422 | ) | $ | 74,485 |   |
|                                                   |       |                                             |       |   |   |   |   |
| Franchise operating expenses                           |       | 1,728                                            |       | (123 | ) | 1,605 |   |
| Operating profit                                       |       | 18,948                                           |       | 4,545 |   | 23,493 |   |
| Interest expense                                       |       | (10,321                                          | )          | (8,167 | ) | (18,488 | ) |
| Income (loss) before income taxes                      |       | 1,932                                            |       | (3,622 | ) | (1,690 | ) |
|                                                   |       |                                             |       |   |   |   |   |
| Provision for income taxes                             |       | 541                                              |       | (1,584 | ) | (1,043 | ) |
| Net income (loss)                                      |       | 1,391                                            |       | (2,038 | ) | (647 | ) |
|                                                   |       |                                             |       |   |   |   |   |
| Preferred stock dividends and accretion                |       | (5,199                                           | )          | (45 | ) | (5,244 | ) |
| Net income (loss) attributable to common  shareholders |       | (3,808                                           | )          | (2,083 | ) | (5,891 | ) |
|                                                   |       |                                             |       |   |   |   |   |
| **Statement of Cash Flows Data**                       |       |                                             |       |   |   |   |   |
| Net cash provided by operations                        |       | $                                                | 18,838     |   | $ | (398 | ) | $ | 18,440 |   |
|                                                   |       |                                             |       |   |   |   |   |
| Net cash used in investing activities                  |       | (11,147                                          | )          | (165 | ) | (11,312 | ) |
| Net cash used in financing activities                  |       | (7,722                                           | )          | 563 |   | (7,159 | ) |
| Net increase in cash and cash equivalents              |       | (31                                              | )          | — |   | (31 | ) |

 

The Company restated its annual consolidated financial statements withthe filing of an amended Annual Report on Form 10-K/A with the SEC for thefiscal year ended October 28, 2004.

 

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**3.****     Inventories**

 

Inventories are stated at the lower of cost (which is determined on afirst-in, first-out basis) or market and consist of food, paper products andsupplies.  Inventories consisted of thefollowing (in thousands):

 

| ** **                                                                   | ** ** | **July 14,** | ** ** | **October 28,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **2005**          | ** ** | **2004**             | ** ** |
| Inventories at pie production facilities  and third-party storage locations: |       |              |       |                 |       |
| Raw materials                                                                |       | $                 | 4,257      |                 | $          | 4,353 |   |
| Finished goods                                                               |       | 3,235             |       | 4,717                |       |
|                                                                         |       | 7,492             |       | 9,070                |       |
| Restaurant inventories                                                       |       | 2,988             |       | 3,175                |       |
|                                                                         |       | $                 | 10,480     |                 | $          | 12,245 |   |

 

**4.****     Debt**

 

On April 14, 2004, the Company completed a private placement of$126.5 million aggregate principal amount of 101⁄2% senior unsecured notesmaturing on April 15, 2011.  Thenotes were issued at a discounted price of 98.791% of face value, resulting innet proceeds before transaction expenses of $125.0 million.  The senior unsecured notes were issued byVICORP Restaurants, Inc. and are guaranteed by VI Acquisition Corp. andVillage Inn Pancake House of Albuquerque, Inc.  In August 2004, the Company’sregistration statement with the Securities and Exchange Commission on Form S-4was declared effective and the senior unsecured notes and guarantees wereexchanged for registered notes and guarantees having substantially the sameterms and evidencing the same indebtedness. Interest is payable semi-annually on April 15 and October 15until maturity.

 

The Company has an Amended and Restated Senior Secured Credit Facilityconsisting of a $15.0 million term loan and a $30.0 million revolving creditfacility, with a $15.0 million sub-limit for letters of credit.  As of July 14, 2005, the Company hadissued letters of credit aggregating $7.2 million and had no borrowingsoutstanding under the senior secured revolving credit facility.  The senior secured revolving credit facilitypermits borrowings equal to the lesser of (a) $30.0 million and (b) 1.2times trailing twelve months Adjusted EBITDA (as defined in the senior securedcredit agreement) minus the original amount of the new senior secured termloan.  Under this formula, as of July 14,2005, the Company had the ability to borrow the full $30.0 million, less theamount of outstanding letters of credit and borrowings under the senior securedrevolving credit facility, or $22.8 million.

 

Borrowings under both the revolving credit facility and the term loanof the Amended and Restated Senior Credit Facility bear interest at floatingrates tied to either the base rate of the agent bank under the credit agreementor LIBOR rates for a period of one, two or three months, in each case plus amargin that will adjust based on the ratio of our Adjusted EBITDA to totalindebtedness, as defined in the agreement. At July 14, 2005, the interest rates were 6.5% for term loanborrowings.  Both facilities are securedby a lien on all of the assets of VICORP, and guaranteed by VI AcquisitionCorp. and Village Inn Pancake House of Albuquerque, Inc. In addition, theguarantees also are secured by the pledge of all of the outstanding capitalstock of VICORP by VI Acquisition Corp. The term loan does not require periodicprincipal payments, but requires mandatory repayments under 

 

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certain events, including proceeds from sale of assets, issuance ofequity and issuance of new indebtedness. Both facilities mature on April 14, 2009.

 

The Amended and Restated Senior Secured Credit Facility and theindenture governing the 101⁄2% Senior Unsecured Notes contain a number ofcovenants that, among other things, restrict, subject to certain exceptions,the Company’s ability and the ability of its subsidiaries, to sell assets, incuradditional indebtedness, as defined, or issue preferred stock, repay otherindebtedness, pay dividends and distributions or repurchase our capital stock,create liens on assets, make investments, loans or advances, make certainacquisitions, engage in mergers or consolidations, enter into sale-leasebacktransactions, engage in certain transactions with affiliates, amend certainmaterial agreements governing our indebtedness, change the business conductedby us and our subsidiaries and enter into hedging agreements. In addition, theCompany’s Amended and Restated Senior Secured Credit Facility requires us tomaintain or comply with a maximum total leverage ratio, a minimum interestcoverage ratio and a maximum capital expenditures limitation.  On July 14, 2005, the Company was incompliance with these requirements.

 

In connectionwith the April 2004 refinancing, we incurred $6.9 million of debtextinguishment costs, including prepayment penalties of $2.3 million, $4.4million of noncash write-offs of unamortized deferred financing costs and $0.2million of costs relating to terminating interest rate swaps.

 

**5.****     Commitmentsand Contingencies**

 

***Insurance reserves***

 

The Companyretains a significant portion of certain insurable risks primarily in themedical, dental, workers’ compensation, general liability and property areas.Traditional insurance coverage is obtained for catastrophic losses.  Provisions for losses expected under theseprograms are recorded based upon the Company’s estimates of liabilities for claimsincurred, including those not yet reported. Such estimates utilize prior Company history and actuarial assumptionsfollowed in the insurance industry. Favorable workers compensation claims experience related to recent yearshas permitted a reduction in workers compensation expense accruals in fiscal2005 versus previous years.  Should thecurrent claims experience trends continue, it is likely further expensereductions will be made.  As of July 14,2005, the Company had recorded an insurance reserve liability of $9.7 millionand had placed letters of credit totaling approximately $7.2 million, primarilyassociated with its insurance programs.

 

***Litigation and tax contingencies***

 

From time-to-time, the Company has been involved in various lawsuitsand claims arising from the conduct of its business. Such lawsuits typicallyinvolve claims from customers and others related to operational issues andcomplaints and allegations from former and current employees. These matters arebelieved to be common for restaurant businesses. Additionally, the Company hasbeen party to various assessments of taxes, penalties and interest from federaland state agencies.  Management believesthe ultimate disposition of these matters will not have a material adverseeffect on the Company’s consolidated financial position, results of operations,or cash flows.

 

The Company was a defendant in two purported class action claims inCalifornia. The first class action claim was brought in October 2003 bytwo former employees and one current employee, and the second class actionclaim was brought in May 2004 by two former employees. The complaintsalleged that the Company violated California law with regard to rest and mealperiods, bonus 

 

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payment calculations (in the October 2003 complaint), overtimepayments (in the May 2004 complaint) and California law regarding unfairbusiness practices. The classes and subclasses alleged in the actions have notbeen certified by the respective courts at the current stages of thelitigation, but generally are claimed in the 2003 complaint to include personswho have been employed by the Company in California since October 17, 1999in the positions of food server, restaurant general manager and assistantrestaurant manager, and generally are claimed in the 2004 complaint to includepersons who have been employed by the Company in California since May 21,2000 in the positions of restaurant general manager and restaurant associatemanager. No dollar amount in damages was requested in either complaint, and thecomplaints sought statutory damages, compensatory damages, interest andattorneys’ fees in unspecified amounts.

 

The parties entered into a settlement agreement, which was approved June 1,2005. Under the terms of the settlements, the Company agreed to pay up to anaggregate of $6.55 million for the alleged claims and associated legal fees,subject to partial indemnification as noted below.  During the fourth quarter of fiscal 2004, theCompany established a reserve of $6.55 million in connection with the proposedsettlement of these class action lawsuits.

 

The Company filed a lawsuit on December 3, 2004 against the formershareholders of Midway (the former parent of VICORP) in the Circuit Court of CookCounty, Illinois seeking indemnification for all of the damages related to suchlitigation under the purchase agreement dated June 14, 2003 pursuant towhich VICORP was acquired, in addition to the assertion of other claims.  The former shareholders of Midway filed alawsuit on December 22, 2004 in Suffolk County Superior Court inMassachusetts.  The former shareholdersof Midway claim, among other allegations, that the Company has improperlysought indemnification and are denying liability for the portion of the damagesin the previously mentioned class action lawsuits that arose following theclosing of the June 2003 acquisition, and for certain settlements forwhich they claim they did not receive appropriate notice or approval rights.

 

The former shareholders of Midway Investors Holdings Inc. haveacknowledged they are liable to the Company for the pre-closing portion of classaction settlement agreements. Currently, the Company and the formershareholders are in discussions regarding the final settlement amount. Duringthe fourth quarter of fiscal 2004, the Company established a receivable of $3.4million on the Company’s consolidated balance sheet for the former shareholders’estimated portion of the settlement.

 

In the third quarter of 2005, the $6.55 million reserve mentioned abovewas reduced to $5.3 million, as the information regarding the ultimate costswas finalized by the trustee. The associated receivable was reduced by $0.8million, in conjunction with the reduction to the estimated reserve for thesettlement agreements.

 

***Guarantees and commitments***

 

VICORPguaranteed certain leases for restaurant properties sold in 1986 and restaurantleases of certain franchisees. Minimum future rental payments remaining underthese leases were approximately $2.4 million as of July 14, 2005.

 

Contractualobligations, primarily for restaurants under construction, amounted toapproximately $16.7 million as of July 14, 2005.

 

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**6.****     Otheraccrued expenses and other noncurrent liabilities**

 

Other accrued expenses consisted of the following (in thousands):

 
| ** **                             | ** ** | **July 14,  2005** | ** ** | **October 28,  2004** | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Legal settlements                      |       | $                       | 5,793      |                       | $          | 6,775 |   |
| Insurance                              |       | 4,398                   |       | 4,372                      |       |
| Rent                                   |       | 1,332                   |       | 1,611                      |       |
| Interest                               |       | 3,477                   |       | 729                        |       |
| Gift certificates and cards            |       | 1,508                   |       | 891                        |       |
| Advertising                            |       | 802                     |       | 869                        |       |
| Reserve for closed/subleased locations |       | 411                     |       | 556                        |       |
| Miscellaneous                          |       | 2,663                   |       | 2,717                      |       |
|                                   |       | $                       | 20,384     |                       | $          | 18,520 |   |

 

Accruedmiscellaneous expenses consisted primarily of accrued expenses for 401(k)employer contributions, credit card fees, royalty prepayments and legal,management and audit fees.

 

Othernoncurrent liabilities consisted of the following (in thousands):

 
| ** **                              | ** ** | **July 14,  2005** | ** ** | **October 28,  2004** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------------------------|------------|
|                                    |       |                    |       |                       |       |
| Reserve for closed/subleased properties |       | $                       | 653        |                       | $          | 714 |   |
| Deferred straight-line rent payable     |       | 2,172                   |       | 1,354                      |       |
| Insurance                               |       | 5,263                   |       | 4,477                      |       |
| Landlord incentive                      |       | 825                     |       | 466                        |       |
| Other                                   |       | 23                      |       | 46                         |       |
|                                    |       | $                       | 8,936      |                       | $          | 7,057 |   |

 

**7.****     RelatedParty Transactions**

 

On June 14, 2003, the Company entered into a professional servicesagreement with Wind Point Investors, IV, L.P. and Wind Point Investors V, L.P.(collectively “Wind Point”), whereby certain management, financial and otherconsulting services would be provided to the Company.  Under the terms of the agreement, the Companypays an annual fee to both partnerships in the aggregate amount of$850,000.  In connection with the April 14,2004 debt refinancing (Note 4), the Company also paid an additional $309,000 infees to Wind Point, which represented a deferral of a portion of thetransaction fee payable to Wind Point in connection with the June 2003acquisition.  Management fees accruedunder this agreement totaled approximately $226,000 at July 14, 2005 and July 8,2004.

 

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**Item 2.****    MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Statements included in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and elsewhere in this report are,or may be deemed to be, “forward-looking statements” within the meaning of Section 27Aof the Securities Act and Section 21E of the Securities Exchange Act of1934, as amended (the “Exchange Act”). These forward-looking statements include all matters that are nothistorical facts.  By their nature,forward-looking statements involve risks and uncertainties because they relateto events and depend on circumstances that may or may not occur in the future.  We caution you that forward-lookingstatements are not guarantees of future performance and that our actual resultsof operations, financial condition and liquidity, and the development of theindustry in which we operate may differ materially from those made in orsuggested by the forward-looking statements contained in this informationreport.  See the “Risk Factors” section ofour Annual Report on Form 10-K/A for the year ended October 28, 2004for a discussion of some of the factors that may affect the Company and itsoperations.  Such factors include thefollowing: competitive pressures within the restaurant industry; changes inconsumer preferences; the level of success of our operating strategy and growthinitiatives; the level of our indebtedness and the terms and availability ofcapital; fluctuations in commodity prices; changes in economic conditions;government regulation; litigation; and seasonality and weather conditions.  In addition, even if our results ofoperations, financial condition and liquidity, and the development of theindustry in which we operate are consistent with the forward-looking statementscontained in this announcement, those results or developments may not beindicative of results or developments in subsequent periods.  Any forward-looking statements which we makein this report speak only as of the date of such statement, and we undertake noobligation to update such statements. Comparisons of results for current and any prior periods are notintended to express any future trends or indications of future performance andshould only be viewed as historical data.*

 

**Company Profile**

 

VI Acquisition Corp. and its subsidiaries (referred to herein as the “Company”or “we”, “us” and “our”) operate family-dining restaurants under twowell-recognized brands, Village Inn and Bakers Square. Our Company, founded in1958, had 379 restaurants in 25 states as of July 14, 2005, consisting of279 company-operated restaurants and 100 franchised restaurants. We alsoproduce premium pies that we serve in our restaurants or sell to third partiesat three strategically located facilities.

 

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The following table sets forth the changes to the number ofcompany-operated and franchised restaurants for the periods presented below.

 
| ** **                                  | ** ** | **259 Days Ended**      | ** ** | **256 Days Ended**     | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **(Units)**                                 | ** ** | **July 14,  2005** | ** ** | **July 8,  2004** | ** ** |
| Village Inn company-operated restaurants:   |       |                    |       |                   |       |
| Beginning of period                         |       | 121                     |       | 118                    |       |
| Openings                                    |       | 9                       |       | 2                      |       |
| Closings                                    |       | —                  |       | (1                     | )          |
| End of period                               |       | 130                     |       | 119                    |       |
| Bakers Square company-operated restaurants: |       |                    |       |                   |       |
| Beginning of period                         |       | 150                     |       | 149                    |       |
| Openings                                    |       | 1                       |       | 1                      |       |
| Closings                                    |       | (2                      | )          | —                 |       |
| End of period                               |       | 149                     |       | 150                    |       |
| Total company-operated restaurants          |       | 279                     |       | 269                    |       |
| Village Inn franchised restaurants:         |       |                    |       |                   |       |
| Beginning of period                         |       | 103                     |       | 105                    |       |
| Closings                                    |       | (3                      | )          | (1                     | )          |
| End of period                               |       | 100                     |       | 104                    |       |
| Total restaurants                           |       | 379                     |       | 373                    |       |

 

**Management Overview**

 

Our restaurantrevenues are affected by restaurant openings and closings and same unit salesperformance. Same unit sales is a measure of the percentage increase ordecrease of the sales of units open at least 18 months relative to the sameperiod in the prior year. We do not use new restaurants in our calculation ofsame unit sales until they are open for 18 months in order to allow a newrestaurant’s operations and sales time to stabilize and provide more meaningfulresults.  Same unit sales is an importantindicator within the restaurant industry because small changes in same unitsales can have a proportionally higher impact on operating margins because ofthe high degree of fixed costs associated with operating restaurants.

 

Whereas same unit sales trends at the Village Inn operating unit havebeen consistently positive in recent years, the same unit trends at BakersSquare have been negative over this same period. The negative same unit salestrend at Bakers Square has been of significant concern to us.  Same unit sales were 2.5% negative in fiscal2003, 1.0% negative in fiscal 2004 and 3.7%, 5.5% and 2.0% negative in thefirst, second and third quarters of fiscal 2005, respectively.  We attribute much of the larger negative sameunit sales in fiscal 2005 to differences in advertising efforts, unfavorabletiming of adverse winter weather, a softer economy in the Midwest and higherfuel costs impacting guest decisions. Despite these factors, we believe that longer negative same unit salestrend indicates that our Bakers Square restaurants have not met our guests’expectations.

 

We have recently embarked on an effort we have labeled a “revitalization”to reverse this trend.  The first part ofthe revitalization project was completed in December 2004 and involvedidentifying our opportunities with the help of an outside consultant.  We have since been working on refining theexpected changes to Bakers Square and began to test these changes at a selectedBakers Square restaurant subsequent to the third quarter of fiscal 2005.  We expect to test the revitalization inseveral additional Bakers Square existing restaurants in fiscal 2006. Thechanges are reasonably extensive, and include changes to the physical store,menu and operations.  Most of therevitalization 

 

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efforts will be focused in our Midwest markets, although certainaspects of the efforts may be incorporated into our California market.

 

In addition tothe revitalization efforts, we have recently hired a new advertising agency,Ryan Partnership.  We began to see theirfirst efforts for advertising programs for both the Bakers Square and VillageInn concepts starting late in the third quarter of fiscal 2005.

 

With our newstrategic focus, we intend to increase the number of company-operated VillageInn and Bakers Square restaurants more significantly over the next severalyears. During the third quarter, we opened 5 new restaurants.  We have opened 10 new restaurants in thefirst three quarters of this year, nine Village Inn restaurants and one BakersSquare restaurant.  We plan to open atotal of 12 to 15 new restaurants in the fourth quarter, to bring the full yearopenings to 22 to 25 new restaurants, predominantly under the Village Innbrand.

 

Like much ofthe restaurant industry, we view same unit sales as a key performance metric,at the individual unit level, within regions, across each chain and throughoutour company. With our field-level and corporate information systems, we monitorsame unit sales on a daily, weekly and four-week period basis from the chainlevel down to the individual unit level. The primary drivers of same unit salesperformance are changes in the average per-person check and changes in thenumber of customers, or customer count. Average check performance is primarilyaffected by menu price increases and changes in the purchasing habits of ourcustomers. We also monitor entrée count, exclusive of take-out business, andsales of whole pies, which we believe is indicative of overall customer trafficpatterns. To increase average unit sales, we focus marketing and promotionalefforts on increasing customer visits and sales of particular products. We alsoselectively increase prices, but are constrained by the price sensitivity ofcustomers in our market segment and our desire to maintain an attractiveprice-to-value relationship that is a fundamental characteristic of ourconcepts. We generally have increased prices in line with increases in theconsumer price index, and expect to continue to do so in the future. Same unitsales performance is also affected by other factors, such as food quality, thelevel and consistency of service within our restaurants, the attractiveness andphysical condition of our restaurants, as well as local and national economicfactors.

 

As of July 14,2005, we had 100 franchised Village Inn restaurants in nineteen states,operated by 25 franchisees which operate one to eleven restaurants each.  Although we may increase franchise revenues byincreasing the number of franchised Village Inn restaurants, we expect that ourfranchise revenues will decline as a percentage of our total revenue as weemphasize growth in the number of Company-operated units.  Also, we expect that a certain number offranchise agreements will not be renewed at expiration for lower sales volumestores.

 

In addition tounit sales, the other major factor affecting the performance of our restaurantsis the cost associated with operating our restaurants. We monitor and assessthese costs principally as a percentage of a restaurant’s revenues, or on amargin basis. The operating margin of a restaurant is the profitability,expressed as a percentage of sales, of the restaurant after accounting for alldirect expenses of operating the restaurant. Another key performance metric isthe prime margin, which is the profitability, expressed as a percentage ofsales, of the restaurants after deducting the two most significant costs, laborand food. Due to the importance of both labor cost and food cost, we closelymonitor prime margin from the chain level down to the individual restaurant. Wehave systems in place at each restaurant to assist restaurant managers ineffectively managing these costs to improve prime margin.

 

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Labor is ourlargest cost element. The principal drivers of labor cost are wage rates,particularly for the significant number of hourly employees in our restaurants,and the number of labor hours utilized in serving our customers and operatingour restaurants, as well as medical and workers compensation insurance costsfor our employees. Wage rates are largely market driven, with increases tominimum wage rates causing corresponding increases in our pay scales.Differences in minimum wage laws among the various states impact the relativeprofitability of the restaurants in those states. In both January 2004 and2005, the minimum wage rate for the state of Illinois increased.  The state of Florida’s minimum wage increasedin May 2005 and the state of Minnesota’s minimum wage is scheduled toincrease August 2005.

 

While the wagerates are largely externally determined, labor utilization within ourrestaurants is more subject to our control and is closely monitored. We seek tostaff each restaurant to provide a high level of service to our customers,without incurring more labor cost than is needed. We have included laborscheduling tools in each of our company-operated restaurants’ back officesystems to assist our managers in improving labor utilization. We monitor laborhours actually incurred in relation to sales and customer count on arestaurant- by-restaurant basis throughout each week.

 

In managingprime margin, we also focus on percentage food cost, which is food costexpressed as a percentage of total revenues. Our food cost is affected byseveral factors, including market prices for the food ingredients, oureffectiveness at controlling waste and proper portioning, and shifts in ourcustomers’ buying habits between low-food-cost and high-food-cost menu items.Our food cost management system within each restaurant measures actualingredient costs and actual customer product purchases against an “ideal” foodcost standard. Ideal food cost is calculated within each restaurant based onthe cost of ingredients used, assuming proper portion size, adherence torecipes, limited waste and similar factors. We track variances from ideal foodcost within each restaurant and seek to address the causes of such variances,to the extent they are within our control, in order to improve our percentagefood cost. In addition, our centralized purchasing department buys a majorityof the products used in both Village Inn and Bakers Square (as well as our pieproduction operations), leveraging the purchasing volumes of our restaurantsand our franchisees to obtain favorable prices. We attempt to stabilizepotentially volatile prices for certain high-cost ingredients such as chicken,beef, coffee and dairy products for three to twelve month periods by enteringinto purchase contracts when we believe that this will improve our food cost.We also use “menu engineering” to promote menu items which have a lowerpercentage food cost. However, we are vulnerable to fluctuations in food costs.Given our customers’ sensitivity to price increases and since we only reprintour full menus every six months, our ability to adjust prices and featured menuitems in response to rapidly changing commodity prices is limited.

 

Since weproduce a majority of our pies for Village Inn and Bakers Square and since ourthird-party pie sales historically have not had, and currently do not have, amaterial impact on our operating profit, we include the net results of our pie manufacturingoperations as an offset to our food costs. As a result, any profit (or loss)from third-party pie sales has the effect of reducing (or increasing) our totalfood cost. As part of our overall effort to optimize total company food cost,we have been focusing on various measures to improve the net margins within ourpie manufacturing operations, including increasing third-party sales,renegotiating our distribution contracts and rebalancing the production amongour three plants to increase efficiency.

 

19

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Otheroperating expenses principally include occupancy costs, depreciation andamortization, supplies, repairs and maintenance, utility costs, marketingexpenses, insurance expenses and workers’ compensation costs. Historically,these costs have increased over time and many are not directly related to thelevel of sales in our restaurants. In order to maintain our operatingperformance levels, and to address expected cost increases, we will be requiredto increase efficiency in restaurant operations and increase sales, althoughthere is no assurance that we will be able to offset future cost increases.

 

Our 2005 thirdquarter financial results included:

 

•      Growthof revenues in the third quarter by 2.6% to $92.5 million from 2004 to 2005,reflecting the net addition of fourteen company-operated restaurants over thepast two years.  Same store salesdecreased by 0.8% from 2004 to 2005.

 

•      Operatingprofit increased to $7.7 million in 2005 from $7.5 million in 2004 (asrestated).

 

•      Netincome increased to $1.3 million in the third quarter of fiscal 2005 from a netincome of $1.0 million (as restated) in the third quarter of fiscal 2004.  Interest expense increased $0.2 million inthe third quarter of fiscal 2005 due to higher debt outstanding throughout thethird quarter of 2005 and a higher average interest rate on both the high-yieldfinancing consummated at the end of the second quarter of 2004 and the deemedlandlord financing obligations.

 

**Restatement of Previously Reported Financial Statements**

 

We have restated our financial statements forperiods spanning from fiscal 2000 through fiscal 2004 to correct the followingaccounting errors primarily as a result of a review of our lease accountingpolicies and practices prompted by the views expressed by the Office of theChief Accountant of the SEC on February 7, 2005 in a letter to theAmerican Institute of Certified Public Accountants and other recentinterpretations regarding certain operating lease issues and their applicationunder GAAP:

 

*(i)**       **Accounting for Real EstateTransactions*

 

Historically, we have accounted for certain ofour real estate transactions of restaurant properties as sale-leasebacktransactions.  We have restated ourfinancial statements to now report these transactions as financing transactionsunder Financial Accounting Standards Board (“FASB”) Statement of FinancialAccounting Standards (“SFAS”) No. 98, “Accounting for Leases,” rather thanas sale-leaseback transactions as previously reported due to a determinationthat certain lease agreement provisions reflect continuing involvement with thebuyer-lessor. Our continuing involvement for most of our leases now accountedfor under the financing method results from our ability to control the propertywith pre-determined rental payments through at least 90 percent of the economiclife of the property, even though lease renewals would need to be exercised byus to effectuate such control.  These “perpetualfixed-price renewal options” are considered continuing involvement because theseller-lessee is deemed to benefit from future appreciation in the underlyingproperty in a manner similar to a fixed-price purchase option.  Such continuing involvement precludes the useof sale-leaseback accounting until such time that the continuing involvement nolonger exists.  The affected real estatetransactions related to an aggregate of 79 existing restaurants in 1999, 2001and 2003 and nine new restaurant locations opened in 2003 and 2004.

 

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The impact of the restatement was to record onour consolidated balance sheets the assets of the restaurants subject to thesetransactions as if they had not been sold and record the proceeds from thesetransactions (including any gains previously deferred) as liabilities under thecaption “Deemed landlord financing liability”. Operating results were restated to recognize depreciation expenseassociated with the assets subject to these transactions and re-characterizethe lease payments previously reported as rent expense as principal repaymentsand imputed interest expense.  The rentexpense reversal associated with these transactions included the reversal ofpreviously recorded expenses for straight-line rents and rent reductions forcertain purchase accounting adjustments made to account for the leases at fairmarket value.  In addition, the capitallease classification for three leased properties was re-characterized as deemedlandlord financing assets and liabilities.

 

The net impact to correctly classify theaforementioned leases as financing transactions increased loss before incometaxes by $1,005,000 for the 84-day period ended July 8, 2004.  The correcting entries consisted of a$1,567,000 decrease in other operating expenses, a $41,000 decrease infranchise operating expenses and a $2,613,000 increase in interest expense.

 

The net impact to correctly classify theaforementioned leases as financing transactions increased loss before incometaxes by $3,101,000 for the 256-day period ended July 8, 2004.  The correcting entries consisted of a$4,855,000 decrease in other operating expenses, an $123,000 decrease infranchise operating expenses and a $8,079,000 increase in interest expense.

 

*(ii)**      **Understated Straight-Line RentExpense*

 

GAAP requires that leases for which there arescheduled rent increases over the term of the lease be accounted for at theaverage rent payment, or on a straight-line basis, over the applicable termwith the differences being recorded on the balance sheet as a deferred rent liability.  We did not appropriately straight-line itsrents for certain locations, which resulted in understated operating expensesin prior financial reporting periods. The net impact to correctly straight-line rents resulted in an increasein other operating expenses and an increase in the loss before income taxes of$126,000 and $383,000 for the 84-day and 256-day periods ended July 8,2004, respectively.

 

*(iii)**    **Understated Depreciation andAmortization Expense*

 

We generally have historically depreciated ourbuildings and leasehold improvements over the lesser of the asset’s useful lifeor the initial term of the associated lease unless an economic penalty wouldoccur from not exercising renewal options, in which case, the assets aredepreciated over the lesser of the asset’s useful life or the reasonablyassured lease term.  However, inperforming a detailed review of our depreciable assets, it was determined thatbuildings and leasehold improvements for approximately 31 restaurant propertieshad incorrect depreciable lives resulting in an understatement of depreciationexpense, predominantly in earlier periods. The net impact of the correction of our leasehold improvementdepreciable lives resulted in an increase in other operating expenses and anincrease in the loss before income taxes of $21,000 and $50,000 for the 84-dayand 256-day periods ended July 8, 2004, respectively.

 

21

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*(iv)**     **Understated Interest Expense onPreferred Stock Warrant Accretion*

 

We also determined it was appropriate to record additional adjustmentswhich were previously deemed immaterial. The adjustments related to interest expense and preferred dividendsimputed from the accretion of preferred stock warrants with anti-dilutive provisionsissued originally to certain debt holders at the time of our June 2003purchase.  For the 84-day and 256-dayperiods ended July 8, 2004, additional preferred stock and interestexpense of $0 and $88,000, respectively, was recorded as a result of thecorrection of this error.

 

*(v)**       Accountingfor Income Taxes*

 

In addition to the impact on our income tax provision resulting fromthe accounting corrections discussed above, we also determined that ouraccounting for income taxes related to its purchase business combinations wasnot correct.  Under FASBSFAS No. 109, “Accounting for Income Taxes,”companies are to recognize deferred tax assets and liabilities for the taxeffects of differences between assigned values in the purchase price allocationin a purchase business combination (except for the portion of goodwill that isnot deductible for tax purposes).  Theprovisions of SFAS No. 109 apply to basisdifferences that arise in both taxable and nontaxable businesscombinations.  In both our 2001 and 2003business acquisitions, certain purchase price allocations were not correctlytax effected.  The correction resulted inrecognition of additional deferred tax liabilities and a corresponding increasein goodwill.  The impact of thecorrections decreased our provision for income taxes by $427,000 and $1,584,000for the for the 84-day and 256-day periods ended July 8, 2004,respectively.

 

We restated our annual consolidated financial statements with thefiling of an amended Annual Report on Form 10-K/A with the SEC for ourfiscal year ended October 28, 2004.

 

See Note 2 to the Consolidated Financial Statements for furtherdiscussion of the restatement.  Allpreviously reported amounts affected by the restatement that appear in thisQuarterly Report on Form 10-Q have been restated.

 

**Critical Accounting Policies and Estimates**

 

In the ordinary course of business, our company makes a number ofestimates and assumptions relating to the reporting of results of operationsand financial condition in the preparation of our consolidated financialstatements in conformity with U.S. generally accepted accounting principles.Actual results could differ significantly from those estimates and assumptions.We believe that the following discussion addresses our most critical accountingpolicies, which are those that are most important to the portrayal of ourfinancial condition and results of operations and require management judgmentabout the effect of matters that are uncertain.

 

On an ongoing basis, management evaluates its estimates andassumptions, including those related to recoverability of long-lived assets,revenue recognition and goodwill. Management bases its estimates andassumptions on historical experience and on various other factors that arebelieved to be reasonable at the time the estimates and assumptions are made.Actual results may differ from these estimates and assumptions under differentcircumstances or conditions.

 

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We have discussed the development and selection of critical accountingpolicies and estimates with our audit committee.  The following is a summary of our criticalaccounting policies and estimates:

 

***Inventories***

 

Inventories are stated at the lower of cost or market value. Cost isprincipally determined by the first-in, first-out method. The valuation ofinventory requires us to estimate obsolete or excess inventory as well asinventory that is not of saleable quality. Both our manufactured pieinventories and individual store food inventories are subject to spoilage. Weuse estimates of future demand as well as historical trend information to schedule manufacturingand ordering. If our demand forecast for specific products is greater thanactual demand, we could be required to record additional inventory reserves orlosses which would have a negative impact on our gross margin.

 

***Property andequipment, build-to-suit projects and assets under deemed landlord financingliability***

 

Property and equipment is recorded at cost and is depreciated on thestraight-line basis over the estimated useful lives of such assets or throughthe applicable lease expiration, if shorter. Leasehold improvements addedsubsequent to the inception of a lease are amortized over the shorter of theuseful life of the assets or a term that includes lease renewals, if suchrenewals are considered reasonably assured. The useful lives of assets typically range from 20 to 40 years forbuildings and three to ten years for equipment and improvements. Changes incircumstances such as the closing of units in underproductive markets orchanges in our capital structure could result in the actual useful lives ofthese assets differing from our estimates.

 

For many of our build-to-suit projects, we are considered the owner ofthe project during the construction period in accordance with Emerging IssuesTask Force (“EITF”) Issue No. 97-10, “The Effectof Lessee Involvement in Asset Construction,” because we are deemed to havesubstantially all of the construction period risk.  At the end of these construction projects, asale-leaseback could be deemed to occur in certain situations and we wouldrecord the sale, remove all property and related liabilities from our balancesheet and recognize gain or loss from the sale, which is generally deferred andamortized as an adjustment to rent expense over the term of the lease.  However, many of our real estate transactionsand build-to-suit projects have not qualified for sale-leaseback accountingbecause of our deemed continuing involvement with the buyer-lessor,which results in the transaction being recorded under the financingmethod.  Under the financing method, theassets remain on the consolidated balance sheet and are depreciated over theiruseful life, and the proceeds from the transaction are recorded as a financingliability.  A portion of lease paymentsare applied as payments of deemed principal and imputed interest.

 

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We review long-lived assets, including land, buildings, building improvementsand assets under deemed landlord financing liability, for impairments on aquarterly basis or whenever events or changes in circumstances indicate thatthe carrying amount of such assets may not be recoverable. Management evaluatesindividual restaurants, which are considered to be the lowest level for whichthere are identifiable cash flows for impairment. A specific restaurant isdeemed to be impaired if a forecast of undiscounted future operating cash flowsdirectly relating to that restaurant, including disposal value, if any, is lessthan the carrying amount of that restaurant. If a restaurant is determined tobe impaired, the loss is measured as the amount by which the carrying amount ofthe restaurant exceeds its fair value. Management determines fair value basedon quoted market prices in active markets, if available. If quoted marketprices are not available, management estimates the fair value of a restaurantbased on either the estimates provided by real estate professionals and/or our pastexperience in disposing of restaurant properties. Our estimates of undiscountedcash flows may differ from actual cash flows due to economic conditions orchanges in operating performance.

 

***Leases***

 

We lease a substantial amount of our restaurant properties and one ofour pie production plants.  We accountfor our leases under the provisions of Statement of Financial AccountingStandards No. 13, “Accounting for Leases,” and subsequent amendments,which require leases to be evaluated and classified as operating or capitalizedleases for financial reporting purposes. In addition, the Company records leases with escalating rents on astraight-line basis over the initial term of the lease and those renewalperiods that have been exercised or are considered reasonably assured.  The difference between the rent paid and thestraight-line rent is recorded as a deferred rent liability. The initial leaseterm includes the “build-out”, or rent holiday period, for our leases where norent payments are due under the terms of the lease.  Such amounts are capitalized during theconstruction period, which starts when we take possession of the property andends when the property is certified for occupancy.  Incentive payments received from landlordsare recorded as deferred rent liabilities and are amortized on a straight-linebasis over the lease term as a reduction of rent.  Contingent rentals, based upon restaurantsales volume, are accrued each accounting period as the liabilities areincurred utilizing prorated periodic sales targets.  Certain of our leases are accounted for underthe financing method as discussed above. Future authoritative changes to the methods of accounting for leasescould have a material impact on the Company’s reported results of operationsand financial position.

 

***Insurance reserves***

 

We self-insure a significant portion of our employee medical insurance,workers’ compensation and general liability insurance plans. We have obtainedstop-loss insurance policies to protect from individual losses over specifieddollar values ($175,000 for employee health insurance claims, $250,000 workers’compensation and $150,000 for general liability for fiscal 2005). The fullextent of certain claims, especially workers’ compensation and generalliability claims, may not become fully determined for several years. Therefore,we estimate potential obligations for liabilities that have been incurred butnot yet reported based upon historical data and experience. Although managementbelieves that the amounts accrued for these obligations are sufficient, anysignificant increase in the number of claims or costs associated with claimsmade under these plans could have a material adverse effect on our financialresults. Favorable workers compensation claims experience related to recentyears has permitted a reduction in workers compensation expense accruals infiscal 2005 versus previous years. Should the current claims experience trends continue, it is likelyfurther expense reductions will be made.

 

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***Loss contingencies***

 

We maintain accrued liabilities and reserves relating to the resolutionof certain contingent obligations. Significant contingencies include those related to litigation.  We account for contingent obligations inaccordance with SFAS No. 5, “Accounting forContingencies,” as interpreted by FASB InterpretationNo. 14 which requires that we assess each contingency to determineestimates of the degree of probability and range of possible settlement.  Contingencies which are deemed to be probableand where the amount of such settlement is reasonably estimable are accrued inour financial statements.  If only arange of loss can be determined, we accrue to the best estimate within thatrange; if none of the estimates within that range is better than another, weaccrue to the low end of the range.

 

The assessment of loss contingencies is a highly subjective processthat requires judgments about future events. Contingencies are reviewed at least quarterly to determine the adequacyof the accruals and related financial statement disclosure.  The ultimate settlement of loss contingenciesmay differ significantly from amounts we have accrued in our financialstatements.

 

***Income taxes***

 

Deferred income tax assets and liabilities are recognized for theexpected future income tax consequences of carryforwardsand temporary differences between the book and tax bases of assets andliabilities. Valuation allowances are established for deferred tax assets thatare deemed unrealizable.

 

We must assess the likelihood that we will be able to recover ourdeferred tax assets. If recovery is not likely, valuation allowances areestablished. The valuation allowance is based on our estimates of futuretaxable income by each jurisdiction in which we operate, tax planningstrategies and the period over which our deferred tax assets will berecoverable. In the event that actual results differ from these estimates, weare unable to implement certain tax planning strategies or we adjust theseestimates in future periods, we may need to establish an additional valuationallowance which could have a material negative impact on our results ofoperations or financial position.

 

Significant judgment is required in determining our effective tax rateand in evaluating our tax positions. We establish reserves when, despite ourbelief that our tax return positions are supportable, we believe that certainpositions are likely to be successfully challenged. We adjust these reserves inlight of changing facts and circumstances, such as the progress of a tax audit.Our effective tax rate includes the impact of reserve provisions and changes toreserves that we consider appropriate.

 

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**New Accounting Pronouncements**

 

In December 2004, the FASB issued SFAS No. 123R which replaces the prior SFAS No. 123, “Accounting for Stock-BasedCompensation,” and supersedes APB Opinion No. 25, “Accounting for StockIssued to Employees.”  SFAS 123R requires compensation costs related toshare-based payment transactions to be recognized in the financialstatements.  With limited exceptions, theamount of compensation cost will be measured based on the grant-date fair valueof the equity or liability instruments issued. In addition, liability awards will be re-measured each reportingperiod.  Compensation cost will berecognized over the period that an employee provides services in exchange forthe award.  This new standard will becomeeffective for us on November 4, 2005 (the first quarter of our fiscal2006), and while we are still evaluating the impact of adopting SFAS No. 123R, we do not believe such adoption willhave a material impact on our consolidated financial statements because of theminimal number of stock options outstanding.

 

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.”  SFAS No. 151clarifies the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material, and requires that such items berecognized as current-period charges regardless of whether they meet the “soabnormal” criterion outlined in ARB No. 43.  SFAS No. 151also introduces the concept of “normal capacity” and requires the allocation offixed production overheads to inventory based on the normal capacity of theproduction facilities.  Unallocatedoverheads must be recognized as an expense in the period incurred.  SFAS No. 151is effective for inventory costs incurred during fiscal years beginning after June 15,2005.  While we are still evaluating theimpact of this statement, we do not currently believe it will have a materialimpact on our consolidated financial statements.

 

**Factors Affecting Comparability**

 

Our fiscal year is comprised of 52 or 53 weeks divided into four fiscalquarters of 12 or 13, 12, 12, and 16 weeks. The first three quarters of fiscal 2005 and fiscal 2004 consisted of 259and 256 days, respectively, reflecting the difference in duration of the firstquarter of those years.  The second,third and fourth quarters of fiscal 2005 and fiscal 2004 are the same induration.  Fiscal 2005 will consist of 53weeks, or 371 total days, while fiscal 2004 consisted of 52 weeks and fourdays, or 368 total days.

 

**Seasonality**

 

Our sales fluctuate seasonally and, as mentioned in the precedingparagraph, our quarters do not all have the same time duration.  Specifically, our fourth quarter generallyhas an extra three to four weeks compared to the other quarters of our fiscalyear.  Also, based on fiscal 2003 and2004, our average daily sales were highest in our first quarter (November throughJanuary) as a result of holiday pie sales while our fourth quarter (mid-July throughOctober) recorded our lowest average daily sales. Therefore, our quarterly resultsare not necessarily indicative of results that may be achieved for the fullfiscal year.  Factors influencingrelative sales variability in addition to those noted above include thefrequency and popularity of advertising and promotions, the relative saleslevel of new and closed locations, holidays and weather.

 

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**Results of Operations**
| ** **                                    | ** ** | **84 Days Ended**       | ** ** | **84 Days Ended**      | ** ** | **259 Days Ended**      | ** ** | **256 Days Ended**     | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|
| **(in Thousands)**                            | ** ** | **July 14,  2005** | ** ** | **July 8,  2004** | ** ** | **July 14,  2005** | ** ** | **July 8,  2004** | ** ** |
| ** **                                    | ** ** | ** **              | ** ** | **(As restated)**      | ** ** | ** **              | ** ** | **(As restated)**      | ** ** |
| Revenues:                                     |       |                    |       |                   |       |                    |       |                   |       |
| Restaurant operations                         |       | $                       | 91,225     |                   | $          | 88,958                  |       | $                      | 288,087    |   | $ | 280,347 |   |
| Franchise operations                          |       | 1,283                   |       | 1,165                  |       | 3,703                   |       | 3,495                  |       |
|                                          |       | 92,508                  |       | 90,123                 |       | 291,790                 |       | 283,842                |       |
| Costs and expenses:                           |       |                    |       |                   |       |                    |       |                   |       |
| Restaurant costs:                             |       |                    |       |                   |       |                    |       |                   |       |
| Food                                          |       | 23,702                  |       | 24,571                 |       | 76,307                  |       | 76,667                 |       |
| Labor                                         |       | 29,861                  |       | 28,827                 |       | 92,143                  |       | 89,125                 |       |
| Other operating expenses                      |       | 24,720                  |       | 22,923                 |       | 77,823                  |       | 74,485                 |       |
| Franchise operating expenses                  |       | 480                     |       | 512                    |       | 1,512                   |       | 1,605                  |       |
| General and administrative expenses           |       | 6,234                   |       | 5,602                  |       | 19,112                  |       | 17,503                 |       |
| Litigation settlement                         |       | (408                    | )          | —                 |       | (408                    | )          | —                 |       |
| Transaction expenses                          |       | —                  |       | —                 |       | 15                      |       | 45                     |       |
| Management fees                               |       | 196                     |       | 196                    |       | 588                     |       | 897                    |       |
| Impairment of assets                          |       | —                  |       | —                 |       | —                  |       | 22                     |       |
|                                          |       | 84,785                  |       | 82,631                 |       | 267,092                 |       | 260,349                |       |
| Operating profit                              |       | 7,723                   |       | 7,492                  |       | 24,698                  |       | 23,493                 |       |
| Interest expense                              |       | (6,577                  | )          | (6,383                 | )          | (20,031                 | )          | (18,488                | )          |
| Debt extinguishment costs                     |       | —                  |       | —                 |       | —                  |       | (6,856                 | )          |
| Other income, net                             |       | 211                     |       | 111                    |       | 437                     |       | 161                    |       |
| Income (loss) before income taxes             |       | 1,357                   |       | 1,220                  |       | 5,104                   |       | (1,690                 | )          |
| Provision for income taxes (benefit)          |       | 49                      |       | 247                    |       | 1,072                   |       | (1,043                 | )          |
| Net income (loss)                             |       | 1,308                   |       | 973                    |       | 4,032                   |       | (647                   | )          |
| Preferred stock dividends and accretion       |       | (1,989                  | )          | (1,778                 | )          | (5,964                  | )          | (5,244                 | )          |
| Net loss attributable to common  stockholders |       | $                       | (681       | )                      | $          | (805                    | )          | $                      | (1,932     | ) | $ | (5,891 | ) |

 
| ** **                                    | ** ** | **84 Days Ended**       | ** ** | **84 Days Ended**      | ** ** | **259 Days Ended**      | ** ** | **256 Days Ended**     | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **July 14,  2005** | ** ** | **July 8,  2004** | ** ** | **July 14,  2005** | ** ** | **July 8,  2004** | ** ** |
| ** **                                    | ** ** | ** **              | ** ** | **(As restated)**      | ** ** | ** **              | ** ** | **(As restated)**      | ** ** |
| Revenues:                                     |       |                    |       |                   |       |                    |       |                   |       |
| Restaurant operations                         |       | 98.6                    | %          | 98.7                   | %          | 98.7                    | %          | 98.8                   | %          |
| Franchise operations                          |       | 1.4                     |       | 1.3                    |       | 1.3                     |       | 1.2                    |       |
|                                          |       | 100.0                   |       | 100.0                  |       | 100.0                   |       | 100.0                  |       |
| Costs and expenses:                           |       |                    |       |                   |       |                    |       |                   |       |
| Restaurant costs:                             |       |                    |       |                   |       |                    |       |                   |       |
| Food                                          |       | 26.0                    |       | 27.6                   |       | 26.5                    |       | 27.3                   |       |
| Labor                                         |       | 32.8                    |       | 32.4                   |       | 32.0                    |       | 31.8                   |       |
| Other operating expenses                      |       | 27.1                    |       | 25.8                   |       | 27.0                    |       | 26.6                   |       |
| Franchise operating expenses                  |       | 0.5                     |       | 0.6                    |       | 0.5                     |       | 0.6                    |       |
| General and administrative expenses           |       | 6.7                     |       | 6.2                    |       | 6.5                     |       | 6.2                    |       |
| Litigation settlement                         |       | (0.4                    | )          | —                 |       | (0.1                    | )          | —                 |       |
| Transaction expenses                          |       | 0.0                     |       | 0.0                    |       | 0.0                     |       | 0.0                    |       |
| Management fees                               |       | 0.2                     |       | 0.2                    |       | 0.2                     |       | 0.3                    |       |
| Impairment of assets                          |       | —                  |       | 0.0                    |       | —                  |       | 0.0                    |       |
|                                          |       | 91.7                    |       | 91.7                   |       | 91.5                    |       | 91.7                   |       |
| Operating profit                              |       | 8.3                     |       | 8.3                    |       | 8.5                     |       | 8.3                    |       |
| Interest expense                              |       | (7.1                    | )          | (7.1                   | )          | (6.9                    | )          | (6.5                   | )          |
| Debt extinguishment costs                     |       | —                  |       | —                 |       | —                  |       | (2.4                   | )          |
| Other income, net                             |       | 0.2                     |       | 0.2                    |       | 0.1                     |       | 0.0                    |       |
| Income (loss) before income taxes             |       | 1.4                     |       | 1.4                    |       | 1.7                     |       | (0.6                   | )          |
| Provision for income taxes (benefit)          |       | 0.0                     |       | 0.3                    |       | 0.3                     |       | (0.4                   | )          |
| Net income (loss)                             |       | 1.4                     |       | 1.1                    |       | 1.4                     |       | (0.2                   | )          |
| Preferred stock dividends and accretion       |       | (2.1                    | )          | (2.0                   | )          | (2.0                    | )          | (1.8                   | )          |
| Net loss attributable to common  stockholders |       | (0.7                    | )%         | (0.9                   | )%         | (0.6                    | )%         | (2.0                   | )%         |

 

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**84 Days Ended July 14, 2005 (“Third Quarter of Fiscal 2005”)Compared to 84 Days Ended July 8, 2004 (“Third Quarter of Fiscal 2004”)**

 

***Total revenues***increased by $2.4 million, or 2.6%, to $92.5 million in fiscal 2005’s thirdquarter, from $90.1 million for the same quarter in fiscal 2004.  The increase was due principally to salesstemming from the net 10 additional restaurants opened since the end of thethird quarter of fiscal 2004.  However,we experienced a net 0.8% decrease in same unit sales for the third quarter offiscal 2005 over the third quarter of fiscal 2004. Village Inn same unit salesfor the third quarter of fiscal 2005 increased 0.6% over the third quarter offiscal 2004, but Bakers Square same unit sales decreased 2.0% over the sameperiod. Average guest spending, increased 3.5% at Village Inn and 2.8% at BakersSquare in the third quarter of fiscal 2005 compared to the third quarter offiscal 2004.

 

***Food costs***decreased by $0.9 million, or 3.7%, to $23.7 million in the third quarter offiscal 2005, from $24.6 million for the third quarter of fiscal 2004.  Food costs as a percentage of restaurantrevenues decreased to 26.0% in the third quarter of fiscal 2005 from 27.6% inthe third quarter of fiscal 2004, as the contribution at the Company’s piemanufacturing facilities improved significantly in the 2005 third quarter andcommodity cost increases at the restaurant level were more than offset by menuprice increases.

 

***Labor costs***increased by $1.1 million, or 3.8%, to $29.9 million in the third quarter offiscal 2005, from $28.8 million for the third quarter of fiscal 2004.  As a percentage of restaurant revenues, laborcosts increased to 32.8% from 32.4% over these periods. The increase inpercentage labor costs was due largely to negative leverage resulting from thelower same unit sales in the Bakers Square operating unit and minimum wageincreases in Florida and Illinois in May 2005.

 

***Other operatingexpenses*** increased by $1.8 million, or 7.9%, to$24.7 million in the third quarter of fiscal 2005 from $22.9 million for thethird quarter of fiscal 2004. Other operating expenses as a percentage ofrestaurant revenues increased to 27.1% from 25.8% over these periods. Thispercentage increase was primarily due to higher utility and occupancy costs, inaddition to higher advertising costs. The increased advertising costs were a result of incremental costsassociated with the hiring of an advertising agency to enhance the Company’sadvertising initiatives, in addition to incremental spending in the 2005 thirdquarter over that of the previous year’s third quarter reflecting efforts tospread our advertising expenditures more evenly over the fiscal 2005 year ascompared to fiscal 2004. Utility costs increased predominantly due to higherrates and higher usage from warmer weather. The increase in percentage occupancy costs was due to significantlyhigher pre-opening costs associated with the increased new restaurant openingactivity and to negative leverage stemming from normal occupancy costsincreases relative to the decline in comparable restaurant sales.

 

***General andadministrative expenses*** increased $0.6 million, or10.7%, to $6.2 million for the third quarter of fiscal 2005 from $5.6 millionfor the third quarter of fiscal 2004. The increase was a result of higher humanresources costs associated with the opening of new restaurants and legal feesrelated to on-going litigation, partially offset by lower bonus expense.  As a percentage of revenues, general andadministrative expenses were 6.7% in the third quarter of fiscal 2005 and 6.2%in the third quarter of fiscal 2004.

 

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***Operating profit***increased by $0.2 million, or 2.7%, to $7.7 million in the third quarter offiscal 2005, from $7.5 million for the third quarter of fiscal 2004. Operatingprofit as a percentage of total revenues for the third quarters of fiscal 2005and fiscal 2004 was 8.3%.  In addition tothe impacts noted above, operating profit in the third quarter of 2005 wasincreased by a $0.3 million reduction in workers compensation expense versusthe comparable period of 2004, due to favorable claims experience.

 

***Interest expense***increased by $0.2 million, or 3.1%, to $6.6 million in the third quarter offiscal 2005, from $6.4 million for the third quarter of fiscal 2004. Theincrease was due to higher debt outstanding throughout the third quarter of2005 and a higher average interest rate on both the high-yield financingconsummated at the end of the second quarter of 2004 and the deemed landlordfinancing obligations.

 

***Provision for incometaxes (benefit)***for the third quarter of fiscal2005 was $0.1 million, compared to $0.2 million for the third quarter of fiscal2004.  The effective tax rate was notsignificant for the third quarter of fiscal 2005 compared to 20.2% in fiscal2004’s third quarter, as restated.  Theprovisions differ from our blended federal and state statutory rate of 39.9%principally due to general business credits that we earn from FICA taxes paidon employee tips.

 

***Net income (loss)***increasedby $0.3 million to $1.3 million of income in the third quarter of fiscal 2005from $1.0 million in the third quarter of fiscal 2004.  Net income as a percentage of total revenuesincreased to 1.4% from 1.1% over these periods.

 

***Preferred stockdividends and accretion*** increased by $0.2 millionto $2.0 million in the third quarter of fiscal 2005 from $1.8 million for thethird quarter of fiscal 2004 as a result of the compounding effect of unpaidpreferred stock dividends.

 

**259 Days Ended July 14, 2005 (“First Three Quarters of Fiscal 2005”)Compared to 256 days Ended July 8, 2004 (“First Three Quarters of Fiscal2004”)**

 

***Total revenues***increased by $8.0 million, or 2.8%, to $291.8 million in the first threequarters of fiscal 2005, from $283.8 million for the first three quarters offiscal 2004.  The increase was partly dueto operating approximately ten more locations on average during the first threequarters of fiscal 2005 compared to the same quarters of fiscal 2004 and thethree extra operating days in the first three quarters of fiscal 2005.  However, we experienced a net 1.5% decreasein same unit sales for the first three quarters of fiscal 2005 over the samequarters of fiscal 2004 with Village Inn same unit sales increasing 1.3% andBakers Square same unit sales decreasing 3.8% over the same period.  Average guest spending, increased 3.3% atVillage Inn and 2.5% at Bakers Square in the first three quarters of fiscal2005 compared to the same quarters in fiscal 2004.

 

***Food costs***decreased by $0.4 million, or 0.5%, to $76.3 million in the first threequarters of fiscal 2005, from $76.7 million for the same quarters of fiscal2004.  Food costs as a percentage ofrestaurant revenues decreased to 26.5% for the first three quarters of fiscal2005 from 27.3% in the same quarters of fiscal 2004.  The first three quarters of fiscal 2004experienced a spike in commodity prices, especially dairy.

 

***Labor costs***increased by $3.0 million, or 3.4%, to $92.1 million in the first threequarters of fiscal 2005, from $89.1 million for the same quarter of fiscal 2004,but as a percentage of restaurant revenues increased only modestly to 32.0%from 31.8% over these periods.

 

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***Other operatingexpenses*** increased by $3.3 million, or 4.4%, to$77.8 million in the first three quarters of fiscal 2005 from $74.5 million forthe same quarters of fiscal 2004 and, as a percentage of restaurant revenuesincreased to 27.0% for the first three quarters of fiscal 2005 from 26.6% inthe same quarters of fiscal 2004.  Highercredit card fees, utility and occupancy costs were offset by lower advertisingcosts.

 

***General andadministrative expenses*** increased $1.6 million, or9.1%, to $19.1 million for the first three quarters of fiscal 2005 from $17.5million for the first three quarters of fiscal 2004. The increase wasprincipally a result of higher hiring and training costs related to theincreased growth in new restaurants and legal fees associated with on-goinglitigation.  As a percentage of revenues,general and administrative expenses increased to 6.5% in the first threequarters of fiscal 2005 from 6.2% in the same quarters of fiscal 2004.

 

***Operating profit***increased $1.2 million, or 5.1%, to $24.7 million in the first three quartersof fiscal 2005, from $23.5 million for the same quarters of fiscal 2004.Operating profit as a percentage of total revenues was 8.5% and 8.3% for thefirst three quarters of fiscal 2005 and fiscal 2004, respectively. Theimprovement was due largely to the increased restaurant sales and lower relativefood costs.

 

***Interest expense***increased by $1.5 million, or 8.1%, to $20.0 million in the first threequarters of fiscal 2005, from $18.5 million for the same quarters of fiscal2004. Interest expense as a percentage of total revenues increased to 6.9% from6.5% over these periods. This increase was due primarily to higher average debtbalances and interest rates on debt refinanced in April 2004.

 

***Debt extinguishmentcosts*** of $6.9 million were incurred in the secondquarter of fiscal 2004 in connection with our debt refinancing transaction thatclosed April 14, 2004.  Theseexpenses included $2.3 million of prepayment penalties, a write-off of deferredfinancing costs of $4.4 million associated with the previous obligations andsettlement of outstanding derivative obligations in the amount of $0.2million.  No debt extinguishment costswere incurred in fiscal 2005.

 

***Provision for incometaxes***for the first three quarters of fiscal 2005was $1.1 million, compared to a $1.0 million benefit for the same quarters offiscal 2004.  The effective tax rate was21.0% for the first three quarters of fiscal 2005 compared to 61.7% benefit infiscal 2004’s first three quarters.  Theprovisions differ from our blended federal and state statutory rate of 39.9%due to general business credits that we earn from FICA taxes paid on employeetips.

 

***Net income***increasedby $4.6 million to $4.0 million of income in the first three quarters of fiscal2005 from a loss of $0.6 million in the same quarters of fiscal 2004.  Net income as a percentage of total revenuesincreased to 1.4% from a negative 0.2% over these periods.  The increase largely resulted from debtextinguishment costs incurred in fiscal 2004.

 

***Preferred stockdividends and accretion*** increased by $0.8 millionto $6.0 million in first three quarters of fiscal 2005 from $5.2 million forfirst three quarters of fiscal 2004 as a result of the compounding effect ofunpaid preferred stock dividends.

 

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**Liquidity and Capital Resources**

 

***Cash requirements***

 

Our principal liquidity requirements are to continue to finance ouroperations, service our debt and fund capital expenditures for maintenance andexpansion.  Cash flow from operations hashistorically been sufficient to finance continuing operations and meet normaldebt service requirements.  However, weare highly leveraged and our ability to repay our borrowings at maturity islikely to depend in part on our ability to refinance the debt when it matures,which will be contingent on our continued successful operation of the businessas well as other factors beyond our control, including the debt and capitalmarket conditions at that time.

 

Our cash balance and working capital needs aregenerally low, as sales are made for cash or through credit cards that arequickly converted to cash, purchases of food and supplies and other operatingexpenses are generally paid within 30 to 60 days after receipt of invoices andlabor costs are paid bi-weekly.  Thetiming of our sales collections and vendor and labor payments are consistentwith other companies engaged in the restaurant industry.

 

For the balance of fiscal 2005, we anticipate capital expendituresbefore build-to-suit construction (as discussed below) of approximately $12million, reflecting an acceleration of our unit growth.  Of this amount, $7 million is expected to bespent on new restaurant construction, $3 million for remodels and the remainderon capital maintenance and other support related projects. We currently expectto open an estimated 22 to 25 new restaurants in fiscal 2005, including the tenwe opened through the third quarter.

 

We will also be required to make cash payments associated with certainlitigation settlements (refer to Note 5 to our unauditedconsolidated financial statements and Part II Item 1. Legal Proceedingsincluded elsewhere herein for further discussion).  We expect our ultimate maximum net cashoutlay for these litigation settlements to be $2.8 million reflectingindemnification of pre-acquisition activities by our predecessor for thebalance of the $5.3 million proposed settlements.  It is expected that the timing will requirethat the settlement be paid out in advance of receipt of the indemnificationproceeds.

 

In connection with our new restaurant development program, we haveentered into build-to-suit development agreements whereby third parties willpurchase property, fund the costs to develop new restaurant properties for usand lease the properties to us upon completion. Under these agreements, we generally are responsible for theconstruction of the restaurant and remitting payments to the contractors on theprojects, which are subsequently reimbursed by the property owner.  These amounts advanced and subsequentlyreimbursed are not included in the anticipated capital spending totalsabove.  On July 14, 2005, we hadoutstanding receivables of $1.2 million relating to these types ofagreements.  In certain of theseagreements, we are obligated to purchase the property in the event that we areunable to complete the construction within a specified time frame, and are alsoresponsible for cost overruns above specified amounts.

 

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***Debt and other obligations and liabilities***

 

On April 14, 2004, we completed a private placement of $126.5million aggregate principal amount of 101⁄2% senior unsecured notes maturing on April 15,2011.  The notes were issued at adiscounted price of 98.791% of face value, resulting in net proceeds beforetransaction expenses of $125.0 million. The senior unsecured notes were issued by VICORPRestaurants, Inc. and are guaranteed by VI Acquisition Corp. and oursubsidiary Village Inn Pancake House of Albuquerque, Inc.

 

Concurrent with the issuance of the 101⁄2% senior unsecured notes, weentered into an amended and restated senior secured credit facility consistingof a $15.0 million term loan and a $30.0 million revolving credit facility,with a $15.0 million sublimit for letters of credit.On July 14, 2005, we had issued letters of credit aggregating $7.2 millionand had no borrowings outstanding under the senior secured revolving creditfacility.  The senior secured revolvingcredit facility permits borrowings equal to the lesser of (a) $30.0million and (b) 1.2 times trailing twelve months Adjusted EBITDA (as defined in the senior secured credit agreement)minus the original amount of the senior secured term loan.  Under this formula, as of July 14, 2005,we had the ability to borrow the full $30 million, less the amount of outstandingletters of credit, under the senior secured revolving credit facility, or $22.8million.

 

Borrowings under both the revolving credit facility and the term loanbear interest at floating rates tied to either the base rate of the agent bankunder the credit agreement or LIBOR rates for a period of one, two or threemonths, in each case plus a margin that will adjust based on the ratio of ourAdjusted EBITDA to total indebtedness, as defined inthe senior secured credit agreement. At July 14, 2005, the interest rateswere 6.5% for term loan borrowings.  Bothfacilities are secured by a lien on all of the assets of VICORPRestaurants, Inc., and guaranteed by VI Acquisition Corp. and oursubsidiary Village Inn Pancake House of Albuquerque, Inc., the guaranteesalso secured by the pledge of all of the outstanding capital stock of VICORP Restaurants, Inc. by VI Acquisition Corp. Theterm loan does not require periodic principal payments, but requires mandatoryrepayments under certain events, including proceeds from sale of assets,issuance of equity and issuance of new indebtedness.  Both facilities mature on April 14,2009.

 

Our senior secured credit facility and the indenture governing thesenior unsecured notes contain a number of covenants that, among other things,restrict, subject to certain exceptions, our ability and the ability of oursubsidiaries, to sell assets, incur additional indebtedness or issue preferredstock, repay other indebtedness, pay dividends and distributions or repurchaseour capital stock, create liens on assets, make investments, loans or advances,make certain acquisitions, engage in mergers or consolidations, enter intosale-leaseback transactions, engage in certain transactions with affiliates,amend certain material agreements governing our indebtedness, change thebusiness conducted by us and our subsidiaries and enter into hedgingagreements. In addition, our senior secured credit facility requires us tomaintain or comply with a maximum total leverage ratio, a minimum interestcoverage ratio and a maximum capital expenditures limitation.  On July 14, 2005, we were in compliancewith these requirements.

 

We are subject to capital lease obligations related to five of ourleased properties. The principal component of our capital lease obligations was$0.3 million as of July 14, 2005. These capital leases have expirationdates ranging from October 2005 to June 2011.

 

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We are the prime lessee under various operating leases or agreementsunder deemed landlord financing liability transactions for land, building andequipment for company-operated and franchised restaurants, pie productionfacilities and locations subleased to non-affiliated third parties. Theseleases and agreements have initial terms ranging from 15 to 35 years and, inmost instances, provide for renewal options ranging from five to 20 years.These leases and agreements expire at various dates through September 2025.

 

We have guaranteed certain leases for restaurant properties sold in1986 and restaurant leases of certain franchisees. Estimated minimum futurerental payments remaining under these leases were approximately $2.4 million asof July 14, 2005.

 

As of July 14, 2005, our commitments with respect to the above obligationswere as follows (in millions):

 

| ** **                                        | ** ** | **Payments due by periods** | ** ** |
|---------------------------------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **Total**                   | ** ** | **Less than  one year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More than 5  years** | ** ** |
| Senior secured credit facility                    |       | $                           | 15.0       |   | $ | — |   | $ | — |   | $ | 15.0 |   | $ | — |   |
| 10-1/2% senior unsecured notes                    |       | 126.5                       |       | — |   | — |   | — |   | 126.5 |   |
| Total notes payable                               |       | 141.5                       |       | — |   | — |   | 15.0 |   | 126.5 |   |
| Capital lease obligations(1) (2)             |       | 0.3                         |       | 0.1 |   | 0.1 |   | 0.1 |   | — |   |
| Operating lease obligations(2)                    |       | 189.6                       |       | 19.2 |   | 34.0 |   | 27.2 |   | 109.2 |   |
| Deemed landlord financing liability  (1) (2) |       | 317.5                       |       | 13.0 |   | 26.3 |   | 27.0 |   | 251.2 |   |
| Letters of credit (3)                             |       | 7.2                         |       | 7.2 |   | — |   | — |   | — |   |
| Purchase commitments(4)                           |       | 16.7                        |       | 16.7 |   | — |   | — |   | — |   |
| Total                                             |       | $                           | 672.8      |   | $ | 56.2 |   | $ | 60.4 |   | $ | 69.3 |   | $ | 486.9 |   |

 

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(1)   Amounts payable under capital leases and thedeemed landlord financing liability represent gross lease payments, includingboth deemed principal and imputed interest components.

(2)   Many of our leases and financing obligationscontain provisions that require additional rent payments contingent on salesperformance and the payment of common area maintenance charges and real estatetaxes.  Amounts in this table do notreflect any of these additional amounts.

 (3)  We have letters of credit outstandingprimarily to guarantee performance under insurance contracts.  The letters of credit are irrevocable andhave one-year renewable terms.

(4)   We have commitments under contracts for thepurchase of property and equipment. Portions of such contracts not completed at July 14, 2005 as notedin the table above were not reflected as assets or liabilities in ourconsolidated financial statements.

 

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**Sources and uses ofcash**

 

The following table presents a summary of our cash flows fromoperating, investing and financing activities for the periods indicated (inmillions):

 

| ** **                                            | ** ** | **259 Days  Ended** | ** ** | **256 Days  Ended** | ** ** |
|-------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                            | ** ** | **July 14,**   | ** ** | **July 8,**    | ** ** |
| ** **                                            | ** ** | **2005**            | ** ** | **2004**            | ** ** |
| ** **                                            | ** ** | ** **          | ** ** | **(As restated)**   | ** ** |
| Net cash provided by operating activities             |       | $                   | 25.3       |                | $          | 18.4 |   |
| Net cash used in investing activities                 |       | (22.1               | )          | (11.3               | )          |
| Net cash provided by (used in) financing  activities  |       | 8.1                 |       | (7.1                | )          |
| Net increase (decrease) in cash and cash  equivalents |       | $                   | 11.3       |                | $          | 0.0 |   |

 

***Operating activities***

 

For the first three quarters of fiscal 2005, cash flows from operatingactivities increased $6.9 million compared to the same quarters of fiscal2004.  The increase resulted primarilyfrom payments of debt extinguishment costs in fiscal 2004 and favorable changesin working capital in the first three quarters of 2005 compared to the samequarters of 2004, primarily related to funding of cash overdraft balances.

 

***Investing activities***

 

Net cash used in our investing activities in the first three quartersof fiscal 2005 and 2004 consisted primarily of capital expenditures.  Our capital expenditures for property andequipment in the first three quarters of fiscal 2005 and 2004 were comprised ofthe following (in millions):

 
| ** **                               | ** ** | **July 14, 2005** | ** ** | **July 8, 2004** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | ** **             | ** ** | **(As restated)**     | ** ** |
| New store construction                   |       | $                      | 3.7        |                  | $          | 1.5 |   |
| Existing store remodel and refurbishment |       | 3.4                    |       | 3.3                   |       |
| Capital replacements                     |       | 3.2                    |       | 2.9                   |       |
| Corporate related                        |       | 1.6                    |       | 1.2                   |       |
| Purchase of property and equipment       |       | $                      | 11.9       |                  | $          | 8.9 |   |

 

In addition tothe capital expenditures noted above, we incurred $10.4 million for assetsunder deemed landlord finance liability during the first three quarters offiscal 2005 compared to $2.7 million in the same quarters of fiscal 2004.  We opened ten new restaurants in the firstthree quarters of fiscal 2005 and three restaurants in the same quarters offiscal 2004. Also, we had an additional nineteen locations under constructionat the end of the third quarter of fiscal 2005.

 

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***Financing activities***

 

Our financing activities provided cash of $8.1 million during the firstthree quarters of fiscal 2005, consisting principally of $9.2 million ofproceeds from deemed landlord financing transactions associated with our newrestaurant construction, partially offset by the repayment of all $1.4 millionof outstanding borrowings under our revolving line of credit at October 28,2004.

 

During thefirst three quarters of fiscal 2004, we used cash in financing activities of$7.1 million, consisting primarily of repayments of $9.8 million to reduce theamount of borrowings under our credit facility, debt issuance costs of $5.9million, the payment of our term loans in the amount of $132.5 millionpartially offset by proceeds from the issuance of debt of $140.0 million.

 

**Cashmanagement**

 

We havehistorically funded the majority of our capital expenditures with cash providedby operating activities. We have on occasion obtained, and may in the futureobtain, capitalized lease financing for certain expenditures related toequipment. Our investment requirements for new restaurant development include requirementsfor acquisition of land, building and equipment.  Historically we have either acquired all ofthese assets for cash, or purchased building and equipment assets for cash andacquired a leasehold interest in land. We have entered into sale-leasebackarrangements for many of the land and building assets that we have purchased inthe past, many of which have been accounted for as financing transactions.Since the initial net cash investment required for leased units issignificantly lower than for owned properties, we intend to focus on leasingsites for future growth so that we only have to fund the equipment portion ofour new restaurant capital costs from our cash flows. We believe that this willreduce our upfront cash requirements associated with new restaurant growth andenable us to increase our return on these investments, although it will resultin significant long term obligations under either operating or capital leases.

 

**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

We are exposed to market risk primarily from changes in interest ratesand changes in food commodity prices.

 

We are subjectto changes in interest rates on borrowings under our senior secured creditfacility that bear interest at floating rates. As of July 14, 2005, $15.0 million, or 10.7% of our total debt andcapitalized lease obligations of $140.6****million,bears interest at a floating rate.  Ahypothetical one hundred basis point increase in interest rates for ourvariable rate borrowings as of July 14, 2005, would increase our futureinterest expense by approximately $0.2 million per year.  This sensitivity analysis does not factor inpotential changes in the level of our variable interest rate borrowings, or anyactions that we might take to mitigate our exposure to changes in interestrates.

 

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Many of the ingredients purchased for use in the products sold to ourguests are subject to unpredictable price volatility outside of ourcontrol.  We try to manage this risk byentering into selective short-term agreements for the products we use mostextensively.  Also, we believe that ourcommodity cost risk is diversified as many of our food ingredients areavailable from several sources and we have the ability to modify recipes orvary our menu items offered. Historically, we have also been able to increase certain menu prices inresponse to food commodity price increases and believe the opportunity mayexist in the future.  To compensate for ahypothetical price increase of 10% for food ingredients, we would need toincrease prices charged to our guests by an average of approximately 2.6%.  We have not historically used financialinstruments to hedge our commodity ingredient prices.

 

**Item 4.  Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

Within the 90-day period prior to the filing date of this report, ourmanagement, under the supervision of our Chief Executive Officer and ChiefFinancial Officer, carried out an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures pursuant to Rules 13a-14and 15d-14 under the Securities Exchange Act of 1934 (the “Exchange Act”), asamended.  Based upon their evaluation,our Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective in alerting them timely tomaterial information required to be included in our Exchange Act filings dueprimarily to the lease restatement issue noted below.

 

On March 21, 2005, we announced that our financial statements werelikely to be restated, relating to certain lease accounting and leaseholdimprovement depreciation accounting practices, consistent with similaradjustments made by many other retailers and other publicly traded companiesconcerning these practices.  Thisrestatement is described elsewhere in this Form 10-Q and in the Form 10-K/Awe filed with the Securities and Exchange Commission (“SEC”) on May 18,2005.  Our conclusion to change our accountingpolicies and restate was made, among other things, in consideration of theviews of the Office of the Chief Accountant of the SEC expressed in its letterrelated to these matters dated February 7, 2005.  Accordingly, we concluded that our controlsover the selection of appropriate assumptions and factors affecting leaseaccounting practices and the calculation of deferred taxes in relation tobusiness combinations were not effective, which we believe represented amaterial weakness in internal control over financial reporting.

 

As ofJuly 14, 2005, we have remediated the materialweaknesses related to both our lease accounting practices and our accountingfor deferred taxes related to business combinations.  We have updated our internal controls to require an evaluation of theapplicable lease provisions that could affect, in the context of currentinterpretive guidance pertaining to the application of GAAPfor lease accounting, the classification and accounting for such transactions.  Wehave also adopted a policy to engage appropriate third party consulting supportin the event that we enter into different types of lease transactions orbusiness combinations with material tax effects.

 

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**Limitations on the Effectiveness of Controls**

 

A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the control system’s objectiveswill be met.  Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs.  Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, with the company have beendetected.  These inherent limitationsinclude the realities that judgments in decision-making can be faulty, thatbreakdowns can occur because of simple errors or mistakes, and that controlscan be circumvented by the acts of individuals or groups.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**PART II – OTHER INFORMATION**

** **

**Item 1. Legal Proceedings**

 

From time-to-time, we have been involved in various lawsuits and claimsarising from the conduct of our business. Such lawsuits typically involveclaims from customers and others related to operational issues and complaintsand allegations from former and current employees. These matters are believedto be common for restaurant businesses. We believe the ultimate disposition of these matters will not have amaterial adverse effect on our consolidated financial position or results ofoperations.

 

We were a defendant in two purported class action claims in California.The first class action claim was brought in October 2003 by two formeremployees and one current employee, and the second class action claim wasbrought in May 2004 by two former employees. The complaints alleged thatwe violated California law with regard to rest and meal periods, bonus paymentcalculations (in the October 2003 complaint), overtime payments (in the May 2004complaint) and California law regarding unfair business practices. The classesand subclasses alleged in the actions have not been certified by the respectivecourts at the current stages of the litigation, but generally are claimed inthe 2003 complaint to include persons who have been employed by us inCalifornia since October 17, 1999 in the positions of food server,restaurant general manager and assistant restaurant manager, and generally areclaimed in the 2004 complaint to include persons who have been employed by usin California since May 21, 2000 in the positions of restaurant generalmanager and restaurant associate manager. No dollar amount in damages wasrequested in either complaint, and the complaints sought statutory damages,compensatory damages, interest and attorneys’ fees in unspecified amounts.

 

The parties entered into a settlement agreement, which was approved on June 1,2005. Under the terms of the settlements, we agreed to pay up to an aggregateof $6.55 million for the alleged claims and associated legal fees, subject topartial indemnification as noted below.

 

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We filed a lawsuit on December 3, 2004 against the formershareholders of Midway (the former parent of VICORP)in the Circuit Court of Cook County, Illinois seeking indemnification for allof the damages related to such litigation under the purchase agreement dated June 14,2003 pursuant to which VICORP was acquired, inaddition to the assertion of other claims. The former shareholders of Midway filed a lawsuit on December 22,2004 in Suffolk County Superior Court in Massachusetts.  The former shareholders of Midway claim,among other allegations, that we improperly sought indemnification and aredenying liability for the portion of the damages in the previously mentionedclass action lawsuits that arose following the closing of the June 2003acquisition, and for certain settlements for which they claim they did notreceive appropriate notice or approval rights.

 

The former shareholders ofMidway Investors Holdings Inc. have acknowledged they are liable to the Companyfor the pre-closing portion of class action settlement agreements. Currently,the Company and the former shareholders are in discussions regarding the finalsettlement amount. During the fourth quarter of fiscal 2004, the Companyestablished a receivable of $3.4 million on the Company’s consolidated balancesheet for the former shareholders’ estimated portion of the settlement.

 

In the third quarter of 2005, the $6.55 million reserve mentioned abovewas reduced to $5.3 million, as the information regarding the ultimate costswas finalized by the trustee.  Theassociated receivable was reduced by $0.8 million, in conjunction with thereduction to the estimated reserve for the settlement agreements.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

Not applicable.

 

**Item 3. Defaults Upon Senior Securities**

 

Not applicable.

 

**Item 4. Submission of Matters to a Vote of Security Holders**

 

Not applicable.

 

**Item5.  Other Information**

 

Not applicable.

 

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**Item6.  Exhibits**

 

**(a)****           Exhibits**

 

31.1         Certificationby our Chief Executive Officer with respect to our Form 10-Q for thequarterly period ended July 14, 2005, pursuant to Rule 13a-14 or 15d-14of the Securities Exchange Act of 1934, as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

 

31.2         Certificationby our Chief Financial Officer with respect to our Form 10-Q for thequarterly period ended July 14, 2005, pursuant to Rule 13a-14 or 15d-14of the Securities Exchange Act of 1934, as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002.

 

32.1         Certificationsby our Chief Executive Officer and Chief Financial Officer with respect to our Form 10-Qfor the quarterly period ended July 14, 2005, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

 

**(b)****           Reports on Form 8-K**

 

During the third quarter of fiscal 2005 ended July 14, 2005, wefiled the following reports on Form 8-K:

 

Current report on Form 8-K on May 25, 2005, announcingfinancial results for our second quarter ended April 21, 2005.

 

Current report on Form 8-K on June 1, 2005, announcing thesettlement of the class action lawsuit.

 

Current report on Form 8-K on June 8, 2005, announcing change in registrant’s certifying accountant.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                       | VICORP  Restaurants, Inc.               |
|----------------------------|----------------------------------------------|
|                       |                                         |
|                       |                                         |
| Date: August 29, 2005 |                                         |
|                       |                                         |
|                       |                                         |
|                       | /s/ Debra  Koenig                            |   |
|                       | Debra Koenig                                 |
|                       | Chief Executive Officer                      |
|                       | (Principal Executive Officer)                |
|                       |                                         |
|                       |                                         |
| Date: August 29, 2005 |                                         |
|                       |                                         |
|                       |                                         |
|                       | /s/ Anthony  Carroll                         |   |
|                       | Anthony Carroll                              |
|                       | Chief Financial Officer                      |
|                       | (Principal Financial and Accounting Officer) |

 

40

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