**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549-1004**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORTPURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended April 21, 2005**

 

**OR**

 

**o****                                ****TRANSITION REPORTPURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe transition period from                   to                  **

 

**Commissionfile number 333-117263**

 

**VICORPRESTAURANTS, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **STATE OF  COLORADO**                                                            | ** ** | **84-0511072**                         |
|-----------------------------------------------------------------------------------|------------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization)                  |       | (I.R.S.  Employer  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 bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes ý  Noo

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

Yes o  No ý

 

Number of shares of Common Stock, $.0001 par value, outstanding at May 25,2005: 1,427,602, excluding treasury shares.

 

 

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**VICORPRESTAURANTS, INC.**

**Form 10-Q**

**April 21,2005**

**INDEX**

 
| **PART I - FINANCIAL INFORMATION** |
|-----------------------------------------|
| ** **                              |
| Item 1.                                 | Consolidated Financial Statements |   |   |
|                                    |   |   |   |
|                                    | Consolidated Balance Sheets  as of April 21, 2005 and October 28, 2004 (As restated) |   |   |
|                                    |   |   |   |
|                                    | Consolidated  Statements of Operations for the 84 days ended April 21, 2005 and April 15,  2004 (As restated)  and the 175 days  ended April 21, 2005 and the 172 days ended April 15, 2004 (As  restated) |   |   |
|                                    |   |   |   |
|                                    | Consolidated  Statements of Cash Flows for the 175 days ended April 21, 2005 and the  172 days ended  April 15,  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**

 

**VIAcquisition Corp.**

**ConsolidatedBalance Sheets**

**(InThousands, Except Share and Per Share Data**)

**(Unaudited)**

 
| ** **                                                                                                                                                                                                 | ** ** | **April 21, 2005** | ** ** | **October 28, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                                                                                                                                                                                                 | ** ** | ** **              | ** ** | **(As restated)**         | ** ** |
| **Assets**                                                                                                                                                                                                 |       |                    |       |                      |       |
| Current  assets:                                                                                                                                                                                           |       |                    |       |                      |       |
| Cash and  cash equivalents                                                                                                                                                                                 |       | $                       | 8,930      |                      | $          | 1,332 |   |
| Receivables,  net                                                                                                                                                                                          |       | 8,910                   |       | 11,915                    |       |
| Inventories                                                                                                                                                                                                |       | 9,295                   |       | 12,245                    |       |
| Deferred  income taxes, short-term                                                                                                                                                                         |       | 4,914                   |       | 4,673                     |       |
| Prepaid  expenses and other current assets                                                                                                                                                                 |       | 3,230                   |       | 3,432                     |       |
| Income tax  receivable                                                                                                                                                                                     |       | 273                     |       | 270                       |       |
| Total  current assets                                                                                                                                                                                      |       | 35,552                  |       | 33,867                    |       |
| Property and  equipment, net                                                                                                                                                                               |       | 79,508                  |       | 80,316                    |       |
| Assets under  deemed landlord financing liability, net                                                                                                                                                     |       | 111,366                 |       | 110,342                   |       |
| Goodwill                                                                                                                                                                                                   |       | 91,881                  |       | 91,881                    |       |
| Trademarks  and tradenames                                                                                                                                                                                 |       | 42,600                  |       | 42,600                    |       |
| Franchise  rights, net                                                                                                                                                                                     |       | 11,084                  |       | 11,358                    |       |
| Other  assets, net                                                                                                                                                                                         |       | 12,451                  |       | 13,763                    |       |
| Total assets                                                                                                                                                                                               |       | $                       | 384,442    |                      | $          | 384,127 |   |
| ** **                                                                                                                                                                                                 |       |                    |       |                      |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                             |       |                    |       |                      |       |
| Current  liabilities:                                                                                                                                                                                      |       |                    |       |                      |       |
| Current  maturities of long-term debt and capitalized lease obligations                                                                                                                                    |       | $                       | 127        |                      | $          | 201 |   |
| Cash  overdraft                                                                                                                                                                                            |       | —                  |       | 3,190                     |       |
| Accounts  payable                                                                                                                                                                                          |       | 11,106                  |       | 13,174                    |       |
| Accrued  compensation                                                                                                                                                                                      |       | 7,046                   |       | 7,138                     |       |
| Accrued  taxes                                                                                                                                                                                             |       | 9,194                   |       | 7,992                     |       |
| Other  accrued expenses                                                                                                                                                                                    |       | 18,955                  |       | 18,520                    |       |
| Total  current liabilities                                                                                                                                                                                 |       | 46,428                  |       | 50,215                    |       |
| Long-term  debt                                                                                                                                                                                            |       | 140,220                 |       | 141,469                   |       |
| Capitalized  lease obligations                                                                                                                                                                             |       | 224                     |       | 248                       |       |
| Deemed  landlord financing liability                                                                                                                                                                       |       | 116,183                 |       | 114,670                   |       |
| Deferred  income taxes, long-term                                                                                                                                                                          |       | 556                     |       | 1,360                     |       |
| Other  noncurrent liabilities                                                                                                                                                                              |       | 8,998                   |       | 7,057                     |       |
| Total  liabilities                                                                                                                                                                                         |       | 312,609                 |       | 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, 68,659 shares issued and outstanding at April 21,  2005 and October 28, 2004 (aggregate liquidation preference of $81,040  and $78,846, respectively) |       | 83,997                  |       | 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, 1,386,552 shares issued and outstanding at April 21,  2005 and October 28, 2004                                                                      |       | —                  |       | —                    |       |
| Paid-in  capital                                                                                                                                                                                           |       | 2,426                   |       | 2,426                     |       |
| Treasury  stock, at cost, 923.87 shares of preferred stock and 80,603 shares of common  stock at April 21, 2005 and October 28, 2004                                                             |       | (1,004                  | )          | (1,004                    | )          |
| Accumulated  deficit                                                                                                                                                                                       |       | (14,649                 | )          | (13,399                   | )          |
| Total  stockholders’ equity                                                                                                                                                                           |       | 70,770                  |       | 68,045                    |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                           |       | $                       | 384,442    |                      | $          | 384,127 |   |

 

*See accompanying notes to consolidated financial statements.*

 

3

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**VIAcquisition Corp.**

**Consolidated Statements of Operations**

**(InThousands)**

**(Unaudited)**

 
| ** **                                    | ** ** | **84 Days Ended**  | ** ** | **84 Days Ended**  | ** ** | **175 Days Ended** | ** ** | **172 Days Ended** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                    | ** ** | **April 21,** | ** ** | **April 15,** | ** ** | **April 21,** | ** ** | **April 15,** | ** ** |
| ** **                                    | ** ** | **2005**           | ** ** | **2004**           | ** ** | **2005**           | ** ** | **2004**           | ** ** |
| ** **                                    | ** ** | ** **         | ** ** | **(As restated)**  | ** ** | ** **         | ** ** | **(As restated)**  | ** ** |
| **Revenues:**                                 |       |               |       |               |       |               |       |               |       |
| Restaurant  operations                        |       | $                  | 92,339     |               | $          | 91,963             |       | $                  | 196,862    |   | $ | 191,389 |   |
| Franchise  operations                         |       | 1,191              |       | 1,162              |       | 2,420              |       | 2,330              |       |
|                                          |       | 93,530             |       | 93,125             |       | 199,282            |       | 193,719            |       |
| **Costs  and expenses:**                      |       |               |       |               |       |               |       |               |       |
| Restaurant  costs:                            |       |               |       |               |       |               |       |               |       |
| Food                                          |       | 24,394             |       | 24,799             |       | 52,605             |       | 52,096             |       |
| Labor                                         |       | 30,042             |       | 29,491             |       | 62,282             |       | 60,298             |       |
| Other  operating expenses                     |       | 25,336             |       | 25,027             |       | 53,102             |       | 51,562             |       |
| Franchise  operating expenses                 |       | 521                |       | 541                |       | 1,032              |       | 1,093              |       |
| General and  administrative expenses          |       | 6,271              |       | 5,699              |       | 12,878             |       | 11,900             |       |
| Transaction  expenses                         |       | —             |       | 23                 |       | 15                 |       | 45                 |       |
| Management  fees                              |       | 196                |       | 506                |       | 392                |       | 702                |       |
| Asset  impairment                             |       | —             |       | 22                 |       | —             |       | 22                 |       |
|                                          |       | 86,760             |       | 86,108             |       | 182,306            |       | 177,718            |       |
| Operating  profit                             |       | 6,770              |       | 7,017              |       | 16,976             |       | 16,001             |       |
| Interest  expense                             |       | (6,476             | )          | (5,899             | )          | (13,454            | )          | (12,105            | )          |
| Debt  extinguishment costs                    |       | —             |       | (6,856             | )          | —             |       | (6,856             | )          |
| Other  income, net                            |       | 138                |       | 27                 |       | 226                |       | 50                 |       |
| Income  (loss) before income taxes            |       | 432                |       | (5,711             | )          | 3,748              |       | (2,910             | )          |
| Provision  for income taxes (benefit)         |       | (24                | )          | (2,048             | )          | 1,023              |       | (1,290             | )          |
| Net income  (loss)                            |       | 456                |       | (3,663             | )          | 2,725              |       | (1,620             | )          |
| Preferred  stock dividends and accretion      |       | (1,928             | )          | (1,711             | )          | (3,975             | )          | (3,466             | )          |
| Net loss  attributable to common stockholders |       | $                  | (1,472     | )                  | $          | (5,374             | )          | $                  | (1,250     | ) | $ | (5,086 | ) |

 

*See accompanying notes to consolidated financial statements.*

 

4

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**VIAcquisition Corp.**

**Consolidated Statements of Cash Flow**

**(InThousands)**

**(Unaudited)**

 
| ** **                                                                                       | ** ** | **175 Days Ended** | ** ** | **172 Days Ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                       | ** ** | **April 21,** | ** ** | **April 15,** | ** ** |
| ** **                                                                                       | ** ** | **2005**           | ** ** | **2004**           | ** ** |
| ** **                                                                                       | ** ** | ** **         | ** ** | **(As restated)**  | ** ** |
| **Operating  activities:**                                                                       |       |               |       |               |       |
| Net income  (loss)                                                                               |       | $                  | 2,725      |               | $          | (1,620 | ) |
| Reconciliation  of net income (loss) to net cash provided by operating activities:               |       |               |       |               |       |
| Depreciation  and amortization                                                                   |       | 9,000              |       | 8,608              |       |
| Amortization  of financing costs and original issue discounts                                    |       | 579                |       | 469                |       |
| Loss on  disposition of assets                                                                   |       | 22                 |       | 85                 |       |
| Deferred  finance charge write-off                                                               |       | —             |       | 4,288              |       |
| Deferred  income tax expense                                                                     |       | (1,045             | )          | (2,116             | )          |
| Interest on  warrants                                                                            |       | —             |       | 88                 |       |
| Changes in  operating assets and liabilities:                                                    |       |               |       |               |       |
| Receivables,  net                                                                                |       | 1,125              |       | 1,564              |       |
| Inventories                                                                                      |       | 2,950              |       | 2,491              |       |
| Cash  overdraft                                                                                  |       | (3,190             | )          | (4,866             | )          |
| Accounts  payable                                                                                |       | (2,068             | )          | (1,235             | )          |
| Accrued  compensation                                                                            |       | (92                | )          | (40                | )          |
| Other  current assets and liabilities                                                            |       | 2,166              |       | 1,278              |       |
| Other  noncurrent assets and liabilities                                                         |       | 2,256              |       | 1,686              |       |
| Net cash  provided by operating activities                                                       |       | 14,428             |       | 10,680             |       |
| **Investing  activities:**                                                                       |       |               |       |               |       |
| Purchase of  property and equipment                                                              |       | (5,856             | )          | (5,931             | )          |
| Purchase of  assets under deemed landlord financing liability                                    |       | (2,977             | )          | (680               | )          |
| Proceeds  from disposition of property                                                           |       | 58                 |       | 72                 |       |
| Collection  of notes receivable                                                                  |       | 196                |       | 15                 |       |
| Other                                                                                            |       | —             |       | (78                | )          |
| Net cash  used in investing activities                                                           |       | (8,579             | )          | (6,602             | )          |
| **Financing  activities:**                                                                       |       |               |       |               |       |
| Payments of  debt and capital lease obligations                                                  |       | (9,048             | )          | (160,784           | )          |
| Proceeds  from issuance of debt                                                                  |       | 7,600              |       | 158,236            |       |
| Proceeds  from deemed landlord financing                                                         |       | 3,197              |       | 395                |       |
| Net proceeds  from issuance of preferred stock and common stock                                  |       | —             |       | 264                |       |
| Debt  issuance costs                                                                             |       | —             |       | (5,401             | )          |
| Repurchase  of shares                                                                            |       | —             |       | (4                 | )          |
| Net cash  provided by (used in) financing activities                                             |       | 1,749              |       | (7,294             | )          |
| Increase  (decrease) in cash and cash equivalents                                                |       | 7,598              |       | (3,216             | )          |
| Cash and  cash equivalents at beginning of period                                                |       | 1,332              |       | 5,326              |       |
| Cash and  cash equivalents at end of period                                                      |       | $                  | 8,930      |               | $          | 2,110 |   |
|                                                                                             |       |               |       |               |       |
| **Supplemental  disclosures of cash flow information:**                                          |       |               |       |               |       |
| Cash paid  during the period for:                                                                |       |               |       |               |       |
| Interest on  long-term debt and deemed landlord financing liability (net of amount  capitalized) |       | $                  | 13,303     |               | $          | 6,315 |   |
| Income taxes                                                                                     |       | 2,076              |       | 878                |       |

 

*See accompanying notes to consolidated financial statements.*

 

5

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**VIAcquisition Corp.**

**Notes to Consolidated Financial Statements**

**April 21,2005**

**(Unaudited)**

 

**1. Description of 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 Innbrand name.  At April 21, 2005, theCompany operated 274 Company-owned restaurants in 15 states.  Of the Company-owned restaurants, 148 areBakers Square restaurants and 126 are Village Inn restaurants, with an additional103 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 175-day period ended April 21,2005 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 differencebetween the exercise price of the option and the fair market value of theunderlying 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 berecognized over the period that an employee provides services in exchange forthe award.  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.  Unallocated overheadsmust 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 two quarters of fiscal 2005 andfiscal 2004 consisted of 175 and 172 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.  Restatement of Previously Issued Financial Statements**

 

The Company hasrestated its financial statements for periods spanning from fiscal 2000 throughfiscal 2004 to correct the following accounting errors primarily as a result ofa review of its lease accounting policies and practices prompted by the viewsexpressed by the Office of the Chief Accountant of the Securities and ExchangeCommission (“SEC”) on February 7, 2005 in a letter to the AmericanInstitute of Certified Public Accountants and other recent interpretationsregarding certain operating lease issues and their application under GAAP:

 

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

 

Historically, theCompany had accounted for certain of its real estate transactions of restaurantproperties as sale-leaseback transactions. The Company has restated its financial statements to now report thesetransactions as financing transactions under SFAS No. 98, “Accounting forLeases,” rather than as sale-leaseback transactions as previously reported dueto a determination that certain lease agreement provisions reflect continuinginvolvement with the buyer-lessor. Our continuing involvement for most of ourleases now accounted for under the financing method results from our ability tocontrol the property with pre-determined rental payments through at least 90percent of the economic life of the property, even though lease renewals wouldneed to be exercised by the Company to effectuate such control.  These “perpetual fixed-price renewal options”are considered continuing involvement because the seller-lessee is deemed tobenefit from future appreciation in the underlying property in a manner similarto a fixed-price purchase option.  Suchcontinuing involvement precludes the use of sale-leaseback accounting untilsuch time that the continuing involvement no longer exists.  The affected real estate transactions relatedto an aggregate of 79 existing restaurants in 1999, 2001 and 2003 and nine newrestaurant locations opened in 2003 and 2004.

 

8

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The impact of therestatement was to record on the Company’s consolidated balance sheets theassets of the restaurants subject to these transactions as if they had not beensold and record the proceeds from these transactions (including any gainspreviously deferred) as liabilities under the caption “Deemed landlordfinancing liability”.  Operating resultswere restated to recognize depreciation expense associated with the assetssubject to these transactions and re-characterize the lease payments previouslyreported as rent expense as principal repayments and imputed interestexpense.  The rent expense reversalassociated with these transactions included the reversal of previously recordedexpenses for straight-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 tocorrectly classify the aforementioned leases as financing transactionsincreased loss before income taxes by $1,042,000 for the 84-day period ended April 15,2004.  The correcting entries consistedof a $1,563,000 decrease in other operating expenses, a $41,000 decrease infranchise operating expenses and a $2,646,000 increase in interest expense.

 

The net impact tocorrectly classify the aforementioned leases as financing transactionsincreased loss before income taxes by $2,096,000 for the 172-day period ended April 15,2004.  The correcting entries consisted ofa $3,288,000 decrease in other operating expenses, an $82,000 decrease infranchise operating expenses and a $5,466,000 increase in interest expense.

 

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

 

GAAP requires thatleases for which there are scheduled rent increases over the term of the leasebe accounted for at the average rent payment, or on a straight-line basis, overthe applicable term with the differences being recorded on the balance sheet asa deferred rent liability.  The Companydid not appropriately straight-line its rents for certain locations, whichresulted in understated operating expenses in prior financial reportingperiods.   The net impact to correctlystraight-line rents resulted in increased loss before income taxes of $126,000and $257,000 for the 84-day and 172-day periods ended April 15, 2004,respectively.

 

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

 

The Company generallyhas historically depreciated its buildings and leasehold improvements over thelesser of the asset’s useful life or the initial term of the associated leaseunless an economic penalty would occur from not exercising renewal options, inwhich case, the assets are depreciated over the lesser of the asset’s usefullife or the 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 increasedloss before income taxes of $10,000 and $29,000 for the 84-day and 172-dayperiods ended April 15, 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 172-day periods ended April 15, 2004, additionalinterest expense of $44,000 and $88,000, respectively, was recorded as a resultof 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 purchasebusiness combinations was not correct. Under FASB SFAS No. 109, “Accounting for Income Taxes,” companiesare to recognize deferred tax assets and liabilities for the tax effects ofdifferences between assigned values in the purchase price allocation in apurchase business combination (except for the portion of goodwill that is notdeductible for tax purposes).  Theprovisions of SFAS No. 109 apply to basis differences that arise in bothtaxable and nontaxable business combinations. In both the Company’s 2001 and 2003 business acquisitions, certainpurchase price allocations were not correctly tax effected.  The correction resulted in recognition ofadditional deferred tax liabilities and a corresponding increase ingoodwill.  The impact of the correctionsdecreased the Company’s provision for income taxes by $656,000 and $1,157,000for the 84-day and 172-day periods ended April 15, 2004, respectively.

 

10

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The collective impact of these restatements on the Company’sconsolidated financial statements are summarized below (in thousands):

 
| ** **                                                              | ** ** | **As of October 28, 2004** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **Previously**                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | **reported**                    | ** ** | **Corrections** | ** ** | **As restated** | ** ** |
| ** **                                                              | ** ** | **(Unaudited)**                 | ** ** |
| **Balance  Sheet Data**                                                 |       |                            |       |   |   |   |   |
| Receivables,  net                                                       |       | $                               | 13,676     |   | $ | (1,761 | ) | $ | 11,915 |   |
| Deferred  income taxes, short-term                                      |       | 2,463                           |       | 2,210 |   | 4,673 |   |
| Total  current assets                                                   |       | 33,418                          |       | 449 |   | 33,867 |   |
| Property and  equipment, net                                            |       | 84,785                          |       | (4,469 | ) | 80,316 |   |
| Assets under  deemed landlord financing liability, net                  |       | —                          |       | 110,342 |   | 110,342 |   |
| Build-to-suit  construction-in-progress                                 |       | 6,258                           |       | (6,258 | ) | — |   |
| Deferred  income taxes, long-term                                       |       | 22,636                          |       | (22,636 | ) | — |   |
| Goodwill                                                                |       | 82,843                          |       | 9,038 |   | 91,881 |   |
| Other  assets, net                                                      |       | 6,482                           |       | 7,281 |   | 13,763 |   |
| Total assets                                                            |       | 290,380                         |       | 93,747 |   | 384,127 |   |
|                                                                    |       |                            |       |   |   |   |   |
| Current  maturities of long-term debt and capitalized lease obligations |       | 258                             |       | (57 | ) | 201 |   |
| Accounts  payable                                                       |       | 12,865                          |       | 309 |   | 13,174 |   |
| Current  liabilities                                                    |       | 49,963                          |       | 252 |   | 50,215 |   |
| Capitalized  lease obligations                                          |       | 3,490                           |       | (3,242 | ) | 248 |   |
| Deemed  landlord financing liability                                    |       | —                          |       | 114,670 |   | 114,670 |   |
| Build-to-suit  liability                                                |       | 6,258                           |       | (6,258 | ) | — |   |
| Deferred  income taxes, long-term                                       |       | —                          |       | 1,360 |   | 1,360 |   |
| Other  non-current liabilities                                          |       | 15,871                          |       | (8,814 | ) | 7,057 |   |
| Total  liabilities                                                      |       | 217,051                         |       | 97,968 |   | 315,019 |   |
| Preferred  stock                                                        |       | 79,769                          |       | 253 |   | 80,022 |   |
| Accumulated  deficit                                                    |       | (8,925                          | )          | (4,474 | ) | (13,399 | ) |
| Total  stockholders’ equity                                        |       | 72,266                          |       | (4,221 | ) | 68,045 |   |
| Total  liabilities and stockholders’ equity                        |       | 290,380                         |       | 93,747 |   | 384,127 |   |
|                                                                         |            |                                 |            |  |  |  |  |  |  |  |

 
| ** **                                    | ** ** | **84 Days Ended April 15,  2004** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                    | ** ** | **Previously**                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Reported**                           | ** ** | **Corrections** | ** ** | **As restated** | ** ** |
| ** **                                    | ** ** | **(Unaudited)**                        | ** ** |
| **Statement  of Operations Data**             |       |                                   |       |   |   |   |   |
| Other  operating expenses                     |       | $                                      | 26,454     |   | $ | (1,427 | ) | $ | 25,027 |   |
| Franchise  operating expenses                 |       | 582                                    |       | (41 | ) | 541 |   |
| Operating  profit                             |       | 5,549                                  |       | 1,468 |   | 7,017 |   |
| Interest  expense                             |       | (3,209                                 | )          | (2,690 | ) | (5,899 | ) |
| Loss before  income taxes                     |       | (4,489                                 | )          | (1,222 | ) | (5,711 | ) |
| Provision  for income taxes                   |       | (1,392                                 | )          | (656 | ) | (2,048 | ) |
| Net loss                                      |       | (3,097                                 | )          | (566 | ) | (3,663 | ) |
| Net loss  attributable to common shareholders |       | (4,808                                 | )          | (566 | ) | (5,374 | ) |
|                                               |            |                                        |            |  |  |  |  |  |  |  |

 

11

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| ** **                                    | ** ** | **172 Days Ended April 15,  2004** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                    | ** ** | **Previously**                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Reported**                            | ** ** | **Corrections** | ** ** | **As restated** | ** ** |
| ** **                                    | ** ** | **(Unaudited)**                         | ** ** |
| **Statement  of Operations Data**             |       |                                    |       |   |   |   |   |
| Other  operating expenses                     |       | $                                       | 54,564     |   | $ | (3,002 | ) | $ | 51,562 |   |
| Franchise  operating expenses                 |       | 1,175                                   |       | (82 | ) | 1,093 |   |
| Operating  profit                             |       | 12,917                                  |       | 3,084 |   | 16,001 |   |
| Interest  expense                             |       | (6,551                                  | )          | (5,554 | ) | (12,105 | ) |
| Loss before  income taxes                     |       | (440                                    | )          | (2,470 | ) | (2,910 | ) |
|                                          |       |                                    |       |   |   |   |   |
| Provision  for income taxes                   |       | (133                                    | )          | (1,157 | ) | (1,290 | ) |
| Net loss                                      |       | (307                                    | )          | (1,313 | ) | (1,620 | ) |
| Net loss  attributable to common shareholders |       | (3,773                                  | )          | (1,313 | ) | (5,086 | ) |
|                                          |       |                                    |       |   |   |   |   |
| **Statement  of Cash Flows Data**             |       |                                    |       |   |   |   |   |
| Net cash  provided by operations              |       | $                                       | 10,967     |   | $ | (287 | ) | $ | 10,680 |   |
| Net cash  used in investing activities        |       | (6,473                                  | )          | (129 | ) | (6,602 | ) |
| Net cash  used in financing activities        |       | (7,710                                  | )          | 416 |   | (7,294 | ) |
| Net increase  in cash and cash equivalents    |       | (3,216                                  | )          | — |   | (3,216 | ) |

 

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

 

**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):

 
| ** **                                                                   | ** ** | **April 21,** | ** ** | **October 28,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **2005**           | ** ** | **2004**             | ** ** |
| Inventories  at pie production facilities and third-party storage locations: |       |               |       |                 |       |
| Raw  materials                                                               |       | $                  | 4,029      |                 | $          | 4,353 |   |
| Finished  goods                                                              |       | 2,182              |       | 4,717                |       |
|                                                                         |       | 6,211              |       | 9,070                |       |
| Restaurant  inventories                                                      |       | 3,084              |       | 3,175                |       |
|                                                                         |       | $                  | 9,295      |                 | $          | 12,245 |   |
|                                                                              |            |                    |            |                      |            |  |  |  |  |

 

12

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**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.  The noteswere issued at a discounted price of 98.791% of face value, resulting in netproceeds before transaction expenses of $125.0 million.  The senior unsecured notes were issued byVICORP Restaurants, Inc. and are guaranteed by VI Acquisition Corp. and VillageInn Pancake House of Albuquerque, Inc. In August 2004, the Company’s registration statement with theSecurities and Exchange Commission on Form S-4 was declared effective andthe senior unsecured notes and guarantees were exchanged for registered notesand guarantees having substantially the same terms and evidencing the sameindebtedness.  Interest is payablesemi-annually on April 15 and October 15 until 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 April 21, 2005, the Company hadissued letters of credit aggregating $6.6 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 April 21,2005, 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 $23.4 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 April 21, 2005, the interest rates were 6.1% 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 certain events,including proceeds from sale of assets, issuance of equity and issuance of newindebtedness.  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 certainexceptions,  the Company’s ability andthe ability of its subsidiaries, to sell assets, incur additional indebtedness,as defined, or issue preferred stock, repay other indebtedness, pay dividendsand distributions or repurchase our capital stock, create liens on assets, makeinvestments, loans or advances, make certain acquisitions, engage in mergers orconsolidations, enter into sale-leaseback transactions, engage in certaintransactions with affiliates, amend certain material agreements governing ourindebtedness, change the business conducted by us and our subsidiaries andenter into hedging agreements. In addition, the Company’s Amended and RestatedSenior Secured Credit Facility requires us to maintain or comply with a maximumtotal leverage ratio, a minimum interest coverage ratio and a maximum capitalexpenditures limitation.  On April 21,2005, the Company was in compliance with these requirements.

 

13

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**5.  Commitments and 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 forclaims incurred, including those not yet reported.  Such estimates utilize prior Company historyand actuarial assumptions followed in the insurance industry.  As of April 21, 2005, the Company hadrecorded an insurance reserve liability of $10.3 million and had placed lettersof credit totaling approximately $6.6 million, primarily associated with itsinsurance 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 payment calculations (in the October 2003 complaint),overtime payments (in the May 2004 complaint) and California law regardingunfair business practices. The classes and subclasses alleged in the actionshave not been 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 have entered into a settlement agreement, which is subjectto the final approval of the court. Under the terms of the proposedsettlements, the Company has agreed to pay up to an aggregate of $6.55 millionfor the alleged claims and associated legal fees, subject to partialindemnification as noted below.

 

14

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The Company filed a lawsuit on December 3, 2004 against the formershareholders of Midway (the former parent of VICORP) in the Circuit Court ofCook County, Illinois seeking indemnification for all of the damages related tosuch litigation under the purchase agreement dated June 14, 2003 pursuantto which VICORP was acquired, in addition to the assertion of otherclaims.  The former shareholders ofMidway filed a lawsuit on December 22, 2004 in Suffolk County SuperiorCourt in Massachusetts.  The formershareholders of Midway claim, among other allegations, that the Company hasimproperly sought indemnification and are denying liability for the portion ofthe damages in the previously mentioned class action lawsuits that arosefollowing the closing of the June 2003 acquisition, and for certainsettlements for which they claim they did not receive appropriate notice orapproval rights.

 

While the Company believes that its claims against the formershareholders of Midway Investors Holdings Inc. are meritorious and that it willprevail, in the event the Company does not fully prevail on its indemnificationclaims, management estimates that the Company’s maximum exposure under thesettlement agreements is $3.2 million. During the fourth quarter of fiscal2004, the Company established a reserve of $3.2 million in connection with theproposed settlement of these class action lawsuits.  A receivable of $3.4 million was reflected atboth January 27, 2005 and October 28, 2004 on the Company’sconsolidated balance sheets for the difference between the aggregate amount ofthe settlement and the Company’s estimated exposure.

 

***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 $2.5 million as of April 21, 2005.

 

Contractualobligations, primarily for restaurants under construction, amounted toapproximately $8.1 million as of April 21, 2005.

 

**6.  Other accrued expenses and other noncurrent liabilities**

 

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

 
| ** **                              | ** ** | **April 21,  2005** | ** ** | **October 28,  2004** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| Legal  settlements                      |       | $                        | 7,076      |                       | $          | 6,775 |   |
| Insurance                               |       | 4,635                    |       | 4,372                      |       |
| Rent                                    |       | 977                      |       | 1,611                      |       |
| Interest                                |       | 443                      |       | 729                        |       |
| Gift  certificates and cards            |       | 1,566                    |       | 891                        |       |
| Advertising                             |       | 649                      |       | 869                        |       |
| Reserve for  closed/subleased locations |       | 428                      |       | 556                        |       |
| Miscellaneous                           |       | 3,181                    |       | 2,717                      |       |
|                                    |       | $                        | 18,955     |                       | $          | 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.

 

15

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Othernoncurrent liabilities consisted of the following (in thousands):

 
| ** **                               | ** ** | **April 21,  2005** | ** ** | **October 28,  2004** | ** ** |
|------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | ** **               | ** ** | **(As restated)**          | ** ** |
| Reserve for  closed/subleased properties |       | $                        | 690        |                       | $          | 714 |   |
| Deferred  straight-line rent payable     |       | 1,772                    |       | 1,354                      |       |
| Insurance                                |       | 5,674                    |       | 4,477                      |       |
| Landlord  incentive                      |       | 839                      |       | 466                        |       |
| Other                                    |       | 23                       |       | 46                         |       |
|                                     |       | $                        | 8,998      |                       | $          | 7,057 |   |

 

**7.  Related Party 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 expensedunder this agreement totaled approximately $196,000 and $506,000 during the 84day periods ended April 21, 2005 and April 15, 2004, respectively,and $392,000 and $702,000 during the 175 day and 172 day periods ended April 21,2005 and April 15, 2004, respectively. Management fees paid to Wind Point under this agreement totaled $213,000and $142,000 during the 84 day periods ended April 21, 2005 and April 15,2004, respectively, and $426,000 and $664,000 during the 175 day and 172 dayperiods ended April 21, 2005 and April 15, 2004, respectively.

 

16

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**Item 2.****           MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Statements included in Management’sDiscussion and Analysis of Financial Condition and Results of Operations andelsewhere in this report are, or may be deemed to be, “forward-lookingstatements” within the meaning of Section 27A of the Securities Act and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These forward-looking statements include allmatters that are not historical facts. By their nature, forward-looking statements involve risks anduncertainties because they relate to events and depend on circumstances thatmay or may not occur in the future.  Wecaution you that forward-looking statements are not guarantees of futureperformance and that our actual results of operations, financial condition andliquidity, and the development of the industry in which we operate may differmaterially from those made in or suggested by the forward-looking statementscontained in this information report. See the “Risk Factors” section of our Annual Report on Form 10-K/Afor the year ended October 28, 2004 for a discussion of some of thefactors that may affect the Company and its operations.  Such factors include the following: competitivepressures within the restaurant industry; changes in consumer preferences; thelevel of success of our operating strategy and growth initiatives; the level ofour indebtedness and the terms and availability of capital; fluctuations incommodity 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 377 restaurants in 25 states as of April 21, 2005, consisting of274 company-operated restaurants and 103 franchised restaurants. We alsoproduce premium pies that we serve in our restaurants or sell to third partiesat three strategically located facilities.

 

17

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

 
| ** **                                   | ** ** | **175 Days Ended**       | ** ** | **172 Days Ended**       | ** ** |
|----------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **(Units)**                                  | ** ** | **April 21,  2005** | ** ** | **April 15,  2004** | ** ** |
| Village Inn  company-operated restaurants:   |       |                     |       |                     |       |
| Beginning of  period                         |       | 121                      |       | 118                      |       |
| Openings                                     |       | 5                        |       | 2                        |       |
| Closings                                     |       | —                   |       | (1                       | )          |
| End of  period                               |       | 126                      |       | 119                      |       |
| Bakers  Square company-operated restaurants: |       |                     |       |                     |       |
| Beginning of  period                         |       | 150                      |       | 149                      |       |
| Openings                                     |       | —                   |       | 1                        |       |
| Closings                                     |       | (2                       | )          | —                   |       |
| End of  period                               |       | 148                      |       | 150                      |       |
| Total  company-operated restaurants          |       | 274                      |       | 269                      |       |
| Village Inn  franchised restaurants:         |       |                     |       |                     |       |
| Beginning of  period                         |       | 103                      |       | 105                      |       |
| Closings                                     |       | —                   |       | (1                       | )          |
| End of  period                               |       | 103                      |       | 104                      |       |
| Total  restaurants                           |       | 377                      |       | 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.

 

The negative same unit sales trend at Bakers Square has been ofsignificant concern to us.  Same unitsales were 2.5% negative in fiscal 2003, 1.0% negative in fiscal 2004 and 3.7%and 5.5% negative in the first and second quarters of fiscal 2005,respectively.  We attribute much of thelarger negative same unit sales in fiscal 2005 to differences in advertisingefforts, unfavorable timing of adverse winter weather, a softer economy in theMidwest and higher fuel costs impacting guest decisions.  Despite these factors, we believe that longernegative same unit sales trend indicates that our Bakers Square restaurantshave not met our guests’ expectations.

 

We have recently embarked on an effort we have labeled a “brand 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 expect to test these changes at selectstores in the third quarter of fiscal 2005 with continued roll-out in fiscal2006.  The changes are expected to bereasonably extensive and include changes to the physical plant, menu andoperations.  Most of the revitalizationefforts will be focused in our Midwest markets, although certain aspects of theefforts may be incorporated into our California market.

 

18

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In addition tothe revitalization efforts, we have recently hired a new advertisingagency.  We expect to see their firstefforts for both the Bakers Square and Village Inn concepts starting in thethird quarter of fiscal 2005.

 

We have notsubstantially increased the number of restaurants within either the Village Innor Bakers Square concepts for a number of years.  However, with our new strategic focus, weintend to increase the number of company-operated Village Inn and Bakers Squarerestaurants more significantly over the next several years.  We currently expect to open an estimated 23to 27 new restaurants in fiscal 2005 with most of the openings occurring in thelatter half of the fiscal year and primarily in our Village Inn concept.

 

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 April 21,2005, we had 103 franchised Village Inn restaurants in nineteen states,operated by 25 franchisees which operate one to eleven restaurants each.  Although we may increase franchise revenuesby increasing the number of franchised Village Inn restaurants, we expect thatour franchise revenues will decline as a percentage of our total revenue as weemphasize growth in the number of Company-operated units.  

 

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 in effectivelymanaging these costs to improve prime margin.

 

19

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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 health insurance costs for our employees. Wagerates are largely market driven, with increases to minimum wage rates causingcorresponding increases in our pay scales. Differences in minimum wage lawsamong the various states impact the relative profitability of the restaurantsin those states. In both January 2004 and 2005, the minimum wage rate forthe state of Illinois increased.  Thestate of Florida’s minimum wage increased in May 2005 and the state ofMinnesota’s minimum wage is scheduled to increase 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 piemanufacturing operations as an offset to our food costs. As a result, anyprofit (or loss) from third-party pie sales has the effect of reducing (orincreasing) our total food cost. As part of our overall effort to optimizetotal company food cost, we have been focusing on various measures to improvethe net margins within our pie manufacturing operations, including increasingthird-party sales, renegotiating our distribution contracts and rebalancing theproduction among our three plants to increase efficiency.

 

20

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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. We have experienced increases in many ofthese items throughout the last three fiscal years, particularly utility costsand insurance expenses. In order to maintain our operating performance levels,and to address expected cost increases, we will be required to increaseefficiency in restaurant operations and increase sales, although there is noassurance that we will be able to offset future cost increases.

 

Our 2005second quarter financial results included:

 

•            Growth of revenues inthe second quarter by 0.4% to $93.5 million from 2004 to 2005, reflecting thenet addition of five company-operated restaurants over the past two years.  Same store sales decreased by 2.6% from 2004to 2005.

•            Operating profitdecreased to $6.8 million from $7.0 million in 2004 (as restated).

•            Net income improved to$0.5 million in the second quarter of fiscal 2005 from a net loss of $3.7 million(as restated) in the second quarter of fiscal 2004.  Debt extinguishment costs of $6.9 millionwere included in the second quarter of fiscal 2004’s results.  Interest expense increased $0.6 million inthe second quarter of fiscal 2005 due to greater debt outstanding throughoutthe second quarter of 2005 and a higher average interest rate, both a result ofthe high-yield financing consummated at the end of the second quarter of 2004.

 

**Restatement of Previously Reported FinancialStatements**

 

We have restated ourfinancial statements for periods spanning from fiscal 2000 through fiscal 2004to correct the following accounting errors primarily as a result of a review ofour lease accounting policies and practices prompted by the views expressed bythe Office of the Chief Accountant of the SEC on February 7, 2005 in aletter to the American Institute of Certified Public Accountants and otherrecent interpretations regarding certain operating lease issues and theirapplication under GAAP:

 

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

 

Historically, we haveaccounted for certain of our real estate transactions of restaurant propertiesas sale-leaseback transactions.  We haverestated our financial statements to now report these transactions as financingtransactions under Financial Accounting Standards Board (“FASB”) Statement ofFinancial Accounting Standards (“SFAS”) No. 98, “Accounting for Leases,”rather than as sale-leaseback transactions as previously reported due to adetermination that certain lease agreement provisions reflect continuinginvolvement with the buyer-lessor. Our continuing involvement for most of ourleases now accounted for under the financing method results from our ability tocontrol the property with pre-determined rental payments through at least 90percent of the economic life of the property, even though lease renewals wouldneed to be exercised by us to effectuate such control.  These “perpetual fixed-price renewal options”are considered continuing involvement because the seller-lessee is deemed tobenefit from future appreciation in the underlying property in a manner similarto a fixed-price purchase option.  Suchcontinuing involvement precludes the use of sale-leaseback accounting untilsuch time that the continuing involvement no longer exists.  The affected real estate transactions relatedto an aggregate of 79 existing restaurants in 1999, 2001 and 2003 and nine newrestaurant locations opened in 2003 and 2004.

 

21

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The impact of therestatement was to record on our consolidated balance sheets the assets of therestaurants subject to these transactions as if they had not been sold andrecord the proceeds from these transactions (including any gains previouslydeferred) as liabilities under 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 tocorrectly classify the aforementioned leases as financing transactionsincreased loss before income taxes by $1,042,000 for the 84-day period ended April 15,2004.  The correcting entries consistedof a $1,563,000 decrease in other operating expenses, a $41,000 decrease infranchise operating expenses and a $2,646,000 increase in interest expense.

 

The net impact tocorrectly classify the aforementioned leases as financing transactionsincreased loss before income taxes by $2,096,000 for the 172-day period ended April 15,2004.  The correcting entries consistedof a $3,288,000 decrease in other operating expenses, an $82,000 decrease infranchise operating expenses and a $5,466,000 increase in interest expense.

 

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

 

GAAP requires thatleases for which there are scheduled rent increases over the term of the leasebe accounted for at the average rent payment, or on a straight-line basis, overthe applicable term with the differences being recorded on the balance sheet asa deferred rent liability.  We did notappropriately straight-line its rents for certain locations, which resulted inunderstated operating expenses in prior financial reporting periods.   The net impact to correctly straight-linerents resulted in increased loss before income taxes of $126,000 and $257,000for the 84-day and 172-day periods ended April 15, 2004, respectively.

 

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

 

We generally havehistorically depreciated our buildings and leasehold improvements over thelesser of the asset’s useful life or the initial term of the associated leaseunless an economic penalty would occur from not exercising renewal options, inwhich case, the assets are depreciated over the lesser of the asset’s usefullife or the reasonably assured lease term. However, in performing a detailed review of our depreciable assets, itwas determined that buildings and leasehold improvements for approximately 31restaurant properties had incorrect depreciable lives resulting in anunderstatement of depreciation expense, predominantly in earlier periods.  The net impact of the correction of ourleasehold improvement depreciable lives resulted in increased loss beforeincome taxes of $10,000 and $29,000 for the 84-day and 172-day periods ended April 15,2004, respectively.

 

22

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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-dilutiveprovisions issued originally to certain debt holders at the time of our June 2003purchase.  For the 84-day and 172-dayperiods ended April 15, 2004, additional interest expense of $44,000 and$88,000, respectively, was recorded as a result of the correction of thiserror.

 

*(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 FASB SFAS No. 109,“Accounting for Income Taxes,” companies are to recognize deferred tax assetsand liabilities for the tax effects of differences between assigned values inthe purchase price allocation in a purchase business combination (except forthe portion of goodwill that is not deductible for tax purposes).  The provisions of SFAS No. 109 apply tobasis differences 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 $646,000 and $1,157,000for the for the 84-day and 172-day periods ended April 15, 2004, respectively.

 

We restated our annual consolidated financial statements with thefiling of an amended Annual Report on Form 10-K 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 of theseassets 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 Effect of Lessee Involvement inAsset Construction,” because we are deemed to have substantially all of theconstruction period risk.  At the end ofthese construction projects, a sale-leaseback could be deemed to occur incertain situations and we would record the sale, remove all property andrelated liabilities from our balance sheet and recognize gain or loss from thesale, which is generally deferred and amortized as an adjustment to rentexpense over the term of the lease. However, many of our real estate transactions and build-to-suit projectshave not qualified for sale-leaseback accounting because of our deemedcontinuing involvement with the buyer-lessor, which results in the transactionbeing recorded under the financing method. Under the financing method, the assets remain on the consolidatedbalance sheet and are depreciated over their useful life, and the proceeds fromthe transaction are recorded as a financing liability.  A portion of lease payments are applied aspayments of deemed principal and imputed interest.

 

24

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We review long-lived assets, including land, buildings, buildingimprovements and assets under deemed landlord financing liability, forimpairments on a quarterly basis or whenever events or changes in circumstancesindicate that the carrying amount of such assets may not be recoverable.Management evaluates individual restaurants, which are considered to be thelowest level for which there are identifiable cash flows for impairment. Aspecific restaurant is deemed to be impaired if a forecast of undiscountedfuture operating cash flows directly relating to that restaurant, includingdisposal value, if any, is less than the carrying amount of that restaurant. Ifa restaurant is determined to be impaired, the loss is measured as the amountby which the carrying amount of the restaurant exceeds its fair value.Management determines fair value based on quoted market prices in activemarkets, if available. If quoted market prices are not available, managementestimates the fair value of a restaurant based on either the estimates providedby real estate professionals and/or our past experience in disposing ofrestaurant properties. Our estimates of undiscounted cash flows may differ fromactual cash flows due to economic conditions or changes in operatingperformance.

 

***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 Accounting StandardsNo. 13, “Accounting for Leases,” and subsequent amendments, which requireleases to be evaluated and classified as operating or capitalized leases forfinancial reporting purposes.  Inaddition, the Company records leases with escalating rents on a straight-linebasis over the initial term of the lease and those renewal periods that havebeen 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.

 

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***Loss contingencies***

 

We maintain accrued liabilities and reserves relating to the resolutionof certain contingent obligations.  Significantcontingencies include those related to litigation.  We account for contingent obligations inaccordance with SFAS No. 5, “Accounting for Contingencies,” as interpretedby FASB Interpretation No. 14 which requires that we assess eachcontingency to determine estimates of the degree of probability and range ofpossible settlement.  Contingencies whichare deemed to be probable and where the amount of such settlement is reasonablyestimable are accrued in our financial statements.  If only a range of loss can be determined, weaccrue to the best estimate within that range; if none of the estimates withinthat range is better than another, we accrue 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 carryforwards and temporarydifferences between the book and tax bases of assets and liabilities. Valuationallowances are established for deferred tax assets that are deemedunrealizable.

 

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 whichreplaces the prior SFAS No. 123, “Accounting for Stock-Based Compensation,”and supersedes APB Opinion No. 25, “Accounting for Stock Issued toEmployees.”  SFAS 123R requirescompensation costs related to share-based payment transactions to be recognizedin the financial statements.  Withlimited exceptions, the amount of compensation cost will be measured based onthe grant-date fair value of the equity or liability instruments issued.  In addition, liability awards will bere-measured each reporting period. Compensation cost will be recognized over the period that an employeeprovides services in exchange for the award. This new standard will become effective for us on November 4, 2005(the first quarter of our fiscal 2006), and while we are still evaluating theimpact 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, “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 we are still evaluating the impact ofthis statement, we do not currently believe it will have a material impact onour 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 two quarters of fiscal 2005 and fiscal 2004 consisted of 175and 172 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 results are notnecessarily indicative of results that may be achieved for the full fiscalyear.  Factors influencing relative salesvariability in addition to those noted above include the frequency andpopularity of advertising and promotions, the relative sales level of new andclosed locations, holidays and weather.

 

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**Results of Operations**

 
| ** **                                    | ** ** | **84 Days Ended**        | ** ** | **84 Days Ended**        | ** ** | **175 Days Ended**       | ** ** | **172 Days Ended**       | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|
| **(in Thousands)**                            | ** ** | **April 21,  2005** | ** ** | **April 15,  2004** | ** ** | **April 21,  2005** | ** ** | **April 15,  2004** | ** ** |
| ** **                                    | ** ** | ** **               | ** ** | **(As restated)**        | ** ** | ** **               | ** ** | **(As restated)**        | ** ** |
| Revenues:                                     |       |                     |       |                     |       |                     |       |                     |       |
| Restaurant  operations                        |       | $                        | 92,339     |                     | $          | 91,963                   |       | $                        | 196,862    |   | $ | 191,389 |   |
| Franchise  operations                         |       | 1,191                    |       | 1,162                    |       | 2,420                    |       | 2,330                    |       |
|                                          |       | 93,530                   |       | 93,125                   |       | 199,282                  |       | 193,719                  |       |
| Costs and  expenses:                          |       |                     |       |                     |       |                     |       |                     |       |
| Restaurant  costs:                            |       |                     |       |                     |       |                     |       |                     |       |
| Food                                          |       | 24,394                   |       | 24,799                   |       | 52,605                   |       | 52,096                   |       |
| Labor                                         |       | 30,042                   |       | 29,491                   |       | 62,282                   |       | 60,298                   |       |
| Other  operating expenses                     |       | 25,336                   |       | 25,027                   |       | 53,102                   |       | 51,562                   |       |
| Franchise  operating expenses                 |       | 521                      |       | 541                      |       | 1,032                    |       | 1,093                    |       |
| General and  administrative expenses          |       | 6,271                    |       | 5,699                    |       | 12,878                   |       | 11,900                   |       |
| Transaction  expenses                         |       | —                   |       | 23                       |       | 15                       |       | 45                       |       |
| Management  fees                              |       | 196                      |       | 506                      |       | 392                      |       | 702                      |       |
| Impairment  of assets                         |       | —                   |       | 22                       |       | —                   |       | 22                       |       |
|                                          |       | 86,760                   |       | 86,108                   |       | 182,306                  |       | 177,718                  |       |
| Operating  profit                             |       | 6,770                    |       | 7,017                    |       | 16,976                   |       | 16,001                   |       |
| Interest  expense                             |       | (6,476                   | )          | (5,899                   | )          | (13,454                  | )          | (12,105                  | )          |
| Debt  extinguishment costs                    |       | —                   |       | (6,856                   | )          | —                   |       | (6,856                   | )          |
| Other  income, net                            |       | 138                      |       | 27                       |       | 226                      |       | 50                       |       |
| Income  (loss) before income taxes            |       | 432                      |       | (5,711                   | )          | 3,748                    |       | (2,910                   | )          |
| Provision  for income taxes (benefit)         |       | (24                      | )          | (2,048                   | )          | 1,023                    |       | (1,290                   | )          |
| Net income  (loss)                            |       | 456                      |       | (3,663                   | )          | 2,725                    |       | (1,620                   | )          |
| Preferred  stock dividends and accretion      |       | (1,928                   | )          | (1,711                   | )          | (3,975                   | )          | (3,466                   | )          |
| Net loss  attributable to common stockholders |       | $                        | (1,472     | )                        | $          | (5,374                   | )          | $                        | (1,250     | ) | $ | (5,086 | ) |

 
| ** **                                    | ** ** | **84 Days Ended**        | ** ** | **84 Days Ended**        | ** ** | **175 Days Ended**       | ** ** | **172 Days Ended**       | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                    | ** ** | **April 21,  2005** | ** ** | **April 15,  2004** | ** ** | **April 21,  2005** | ** ** | **April 15,  2004** | ** ** |
| ** **                                    | ** ** | ** **               | ** ** | **(As restated)**        | ** ** | ** **               | ** ** | **(As restated)**        | ** ** |
| Revenues:                                     |       |                     |       |                     |       |                     |       |                     |       |
| Restaurant  operations                        |       | 98.7                     | %          | 98.8                     | %          | 98.8                     | %          | 98.8                     | %          |
| Franchise  operations                         |       | 1.3                      |       | 1.2                      |       | 1.2                      |       | 1.2                      |       |
|                                          |       | 100.0                    |       | 100.0                    |       | 100.0                    |       | 100.0                    |       |
| Costs and  expenses:                          |       |                     |       |                     |       |                     |       |                     |       |
| Restaurant  costs:                            |       |                     |       |                     |       |                     |       |                     |       |
| Food                                          |       | 26.1                     |       | 26.6                     |       | 26.4                     |       | 26.9                     |       |
| Labor                                         |       | 32.1                     |       | 31.7                     |       | 31.3                     |       | 31.1                     |       |
| Other  operating expenses                     |       | 27.1                     |       | 26.9                     |       | 26.6                     |       | 26.6                     |       |
| Franchise  operating expenses                 |       | 0.6                      |       | 0.6                      |       | 0.5                      |       | 0.6                      |       |
| General and  administrative expenses          |       | 6.7                      |       | 6.1                      |       | 6.5                      |       | 6.1                      |       |
| Transaction  expenses                         |       | 0.0                      |       | 0.0                      |       | 0.0                      |       | 0.0                      |       |
| Management  fees                              |       | 0.2                      |       | 0.6                      |       | 0.2                      |       | 0.4                      |       |
| Impairment  of assets                         |       | —                   |       | 0.0                      |       | —                   |       | 0.0                      |       |
|                                          |       | 92.8                     |       | 92.5                     |       | 91.5                     |       | 91.7                     |       |
| Operating  profit                             |       | 7.2                      |       | 7.5                      |       | 8.5                      |       | 8.3                      |       |
| Interest  expense                             |       | (6.9                     | )          | (6.3                     | )          | (6.7                     | )          | (6.3                     | )          |
| Debt  extinguishment costs                    |       | —                   |       | (7.3                     | )          | —                   |       | (3.5                     | )          |
| Other  income, net                            |       | 0.2                      |       | 0.0                      |       | 0.1                      |       | 0.0                      |       |
| Income  (loss) before income taxes            |       | 0.5                      |       | (6.1                     | )          | 1.9                      |       | (1.5                     | )          |
| Provision  for income taxes (benefit)         |       | 0.0                      |       | (2.2                     | )          | 0.5                      |       | (0.7                     | )          |
| Net income  (loss)                            |       | 0.5                      |       | (3.9                     | )          | 1.4                      |       | (0.8                     | )          |
| Preferred  stock dividends and accretion      |       | (2.1                     | )          | (1.9                     | )          | (2.0                     | )          | (1.8                     | )          |
| Net loss  attributable to common stockholders |       | (1.6                     | )%         | (5.8                     | )%         | (0.6                     | )%         | (2.6                     | )%         |

 

Net rental expense totaled $4.5 million and $4.4 million forthe 84 day periods ended April 21, 2005 and April 15, 2004,respectively, and $9.4 million and $8.9 million for the 175 dayperiod ended April 21, 2005 and 172 day period ended April 15, 2004,respectively.

 

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**84 Days Ended April 21, 2005 (“SecondQuarter of Fiscal 2005”) Compared to 84 Days Ended April 15, 2004 (“SecondQuarter of Fiscal 2004”)**

 

***Total revenues***increased by $0.4 million, or 0.4%, to $93.5 million in fiscal 2005’s secondquarter, from $93.1 million for the same quarter in fiscal 2004.  The increase was due largely to operatingapproximately five more locations on average during the second quarter offiscal 2005 compared to the second quarter of fiscal 2004.  However, we experienced a net 2.6% decreasein same unit sales for the second quarter of fiscal 2005 over the secondquarter of fiscal 2004. Village Inn same unit sales for the second quarter offiscal 2005 increased 0.9% over the second quarter of fiscal 2004, but BakersSquare same unit sales decreased 5.5% over the same period. Average guestspending, increased 3.8% at Village Inn and 2.5% at Bakers Square in the secondquarter of fiscal 2005 compared to the second quarter of fiscal 2004.

 

***Food costs***decreased by $0.4 million, or 1.6%, to $24.4 million in the second quarter offiscal 2005, from $24.8 million for the second quarter of fiscal 2004.  Food costs as a percentage of total revenuesdecreased to 26.1% for the second quarter of fiscal 2005 from 26.6% in thesecond quarter of fiscal 2004.  The firsthalf of fiscal 2004 experienced a spike in commodity prices, especially dairy.

 

***Labor costs***increased by $0.5 million, or 1.7%, to $30.0 million in the second quarter offiscal 2005, from $29.5 million for the second quarter of fiscal 2004 and as apercentage of total revenues increased to 32.1% from 31.7% over theseperiods.  The relative increase in laborcosts was due largely to inefficiencies resulting from the lower same unitsales and an increase in minimum wage in Illinois in January 2005.

 

***Other operating expenses***increased by $0.3 million, or 1.2%, to $25.3 million in the second quarter offiscal 2005 from $25.0 million for the second quarter of fiscal 2004. Otheroperating expenses as a percentage of total revenues slightly increased to27.1% from 26.9% over these periods. This increase was primarily due to higherutility, credit card fee and occupancy costs, partially offset by loweradvertising costs.  Advertising costsdecreased as a result of the decision in fiscal 2005 to spread our advertisingexpenditures more evenly over the fiscal year as compared to fiscal 2004.  Utility costs increased predominantly due tohigher rates and higher usage from colder weather.

 

***General andadministrative expenses*** increased $0.6 million, or10.5%, to $6.3 million for the second quarter of fiscal 2005 from $5.7 millionfor the second quarter of fiscal 2004. The increase resulted from highersupport wages, legal fees and settlements and professional fees, partiallyoffset by lower bonus expense and direct construction oversight and supportexpenses due to increased capitalization of such costs as we emphasize growthin the number of Company-operated units. As a percentage of revenues, general and administrative expenses were6.7% in the second quarter of fiscal 2005 and 6.1% in the second quarter offiscal 2004.

 

***Operating profit***decreased by $0.2 million, or 2.9%, to $6.8 million in the second quarter offiscal 2005, from $7.0 million for the second quarter of fiscal 2004. Operatingprofit as a percentage of total revenues for the second quarter of fiscal 2005decreased to 7.2% from 7.5% in the second quarter of fiscal 2004. The decreasewas due largely to the decline in our same unit sales and its effect onprofits.

 

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***Interest expense***increased by $0.6 million, or 10.2%, to $6.5 million in the second quarter offiscal 2005, from $5.9 million for the second quarter of fiscal 2004. Interestexpense as a percentage of total revenues increased to 6.9% from 6.3% overthese periods. This increase was due primarily to higher average debt balancesand 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 the second quarter of fiscal 2005.

 

***Provision for incometaxes (benefit)***for the second quarter of fiscal2005 was a $24,000 benefit, compared to $2.0 million benefit for the secondquarter of fiscal 2004.  The effectivetax rate was not significant for the second quarter of fiscal 2005 compared to35.9% in fiscal 2004’s second quarter, as restated.  The provisions differ from our statutory rateof 39.9% due to general business credits that we earn from FICA taxes paid onemployee tips.

 

***Net income (loss)***increasedby $4.2 million to $0.5 million of income in the second quarter of fiscal 2005from a loss of $3.7 million in the second quarter of fiscal 2004.  Net income as a percentage of total revenuesincreased to 0.5% from a negative 3.9% over these periods.  The increase was driven by the debtextinguishment costs incurred in fiscal 2004 and an absence of such costs infiscal 2005.

 

***Preferred stockdividends and accretion*** increased by $0.2 millionto $1.9 million in the second quarter of fiscal 2005 from $1.7 million for thesecond quarter of fiscal 2004 as a result of the compounding effect of unpaidpreferred stock dividends.

 

**175 Days Ended April 21, 2005 (“FirstTwo Quarters of Fiscal 2005”) Compared to 172 days Ended April 15, 2004 (“FirstTwo Quarters of Fiscal 2004”)**

 

***Total revenues***increased by $5.6 million, or 2.9%, to $199.3 million in the first two quartersof fiscal 2005, from $193.7 million for the first two quarters of fiscal2004.  The increase was partly due tooperating approximately five more locations on average during the first twoquarters of fiscal 2005 compared to the same quarters of fiscal 2004 and thethree extra operating days in the first two quarters of fiscal 2005.  However, we experienced a net 1.9% decreasein same unit sales for the first two quarters of fiscal 2005 over the samequarters of fiscal 2004 with Village Inn same unit sales increasing 1.6% andBakers Square same unit sales decreasing 4.6% over the same period.  Average guest spending, increased 3.3% atVillage Inn and 2.3% at Bakers Square in the first two quarters of fiscal 2005compared to the same quarters in fiscal 2004.

 

***Food costs***increased by $0.5 million, or 1.0%, to $52.6 million in the first two quartersof fiscal 2005, from $52.1 million for the same quarters of fiscal 2004.  Food costs as a percentage of total revenuesdecreased to 26.4% for the first two quarters of fiscal 2005 from 26.9% in thesame quarters of fiscal 2004.  The firsttwo quarters of fiscal 2004 experienced a spike in commodity prices, especiallydairy.

 

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***Labor costs***increased by $2.0 million, or 3.3%, to $62.3 million in the first two quartersof fiscal 2005, from $60.3 million for the same quarter of fiscal 2004, but asa percentage of total revenues increased only modestly to 31.3% from 31.1% overthese periods.

 

***Other operatingexpenses*** increased by $1.5 million, or 2.9%, to$53.1 million in the first two quarters of fiscal 2005 from $51.6 million forthe same quarters of fiscal 2004 and, as a percentage of total revenues, stayedconstant at 26.6% for these periods. Higher credit card fee, utility and occupancy costs were offset by loweradvertising costs.

 

***General andadministrative expenses*** increased $1.0 million, or8.4%, to $12.9 million for the first two quarters of fiscal 2005 from $11.9million for the first two quarters of fiscal 2004. The increase resulted fromhigher support wages, legal fees and settlements, and professional feespartially offset by lower direct construction oversight and support expensesdue to increased capitalization of such costs as we emphasize growth in thenumber of Company-operated units.  As apercentage of revenues, general and administrative expenses increased to 6.5%in the first two quarters of fiscal 2005 from 6.1% in the same quarters offiscal 2004.

 

***Operating profit***increased $1.0 million, or 6.3%, to $17.0 million in the first two quarters offiscal 2005, from $16.0 million for the same quarters of fiscal 2004. Operatingprofit as a percentage of total revenues was 8.5% and 8.3% for the first twoquarters of fiscal 2005 and fiscal 2004, respectively. The improvement was duelargely to the increased restaurant sales and lower relative food costs.

 

***Interest expense***increased by $1.4 million, or 11.6%, to $13.5 million in the first two quartersof fiscal 2005, from $12.1 million for the same quarters of fiscal 2004.Interest expense as a percentage of total revenues increased to 6.7% from 6.3%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 two quarters of fiscal 2005was $1.0 million, compared to a $1.3 million benefit for the same quarters offiscal 2004.  The effective tax rate was27.3% for the first two quarters of fiscal 2005 compared to 44.3% in fiscal2004’s first two quarters.  Theprovisions differ from our statutory rate of 39.9% due to general businesscredits that we earn from FICA taxes paid on employee tips.

 

***Net income***increasedby $4.3 million to $2.7 million of income in the first two quarters of fiscal2005 from a loss of $1.6 million in the same quarters of fiscal 2004.  Net income as a percentage of total revenuesincreased to 1.4% from a negative 0.8% over these periods.  The increase largely resulted from debtextinguishment costs incurred in fiscal 2004.

 

***Preferred stockdividends and accretion*** increased by $0.5 millionto $4.0 million in first two quarters of fiscal 2005 from $3.5 million forfirst two 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 andworking capital needs are generally low, as sales are made for cash or throughcredit cards that are quickly converted to cash, purchases of food and suppliesand other operating expenses are generally paid within 30 to 60 days afterreceipt of invoices and labor costs are paid bi-weekly.  The timing of our sales collections andvendor and labor payments are consistent with other companies engaged in therestaurant industry.

 

For the balance of fiscal 2005, we anticipate capital expendituresbefore build-to-suit construction (as discussed below) of approximately $21million, reflecting an acceleration of our unit growth.  Of this amount, $10 million is expected to bespent on new restaurant construction, $5 million for remodels and the remainderon capital maintenance and other support related projects.  We may also have capital expenditures infiscal 2005 related to our Bakers Square brand repositioning, although atpresent such plans have not been finalized. We currently expect to open an estimated 23 to 27 new restaurants infiscal 2005, including the three we opened through the second quarter.

 

We may also be required to make cash payments associated with certainlitigation settlements (refer to Note 5 to our unaudited consolidated financialstatements and Part II Item 1. Legal Proceedings included elsewhere hereinfor further discussion).  We expect ourmaximum net cash outlay for these litigation settlements to be $3.2 millionreflecting indemnification of pre-acquisition activities by our predecessor forthe balance of the $6.55 million proposed settlements.  Timing may require that the settlement bepaid out in advance of receipt of the indemnification proceeds.

 

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 April 21, 2005, we hadoutstanding receivables of $2.8 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 VICORP Restaurants, Inc.and are guaranteed by VI Acquisition Corp. and our subsidiary Village InnPancake House of Albuquerque, Inc.

 

Concurrently 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 April 21, 2005, wehad issued letters of credit aggregating $6.6 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 senior secured termloan.  Under this formula, as of April 21,2005, we had the ability to borrow the full $30 million, less the amount ofoutstanding letters of credit, under the senior secured revolving creditfacility, or $23.4 million.

 

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 in the senior secured creditagreement. At April 21, 2005, the interest rates were 6.1% for term loanborrowings.  Both facilities are securedby a lien on all of the assets of VICORP Restaurants, Inc., and guaranteedby VI Acquisition Corp. and our subsidiary Village Inn Pancake House ofAlbuquerque, Inc., the guarantees also secured by the pledge of all of theoutstanding capital stock of VICORP Restaurants, Inc. by VI AcquisitionCorp. The term loan does not require periodic principal payments, but requiresmandatory repayments under certain events, including proceeds from sale ofassets, 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 April 21, 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$0.4 million as of April 21, 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 $2.5 million asof April 21, 2005.

 

As of April 21, 2005, our commitments with respect to the aboveobligations were as follows (in millions):

 

**Payments due by periods**

 
| ** **                                       | ** ** | ** ** | ** ** | **Less than** | ** ** | **1-3**   | ** ** | **3-5**   | ** ** | **More than 5** | ** ** |
|--------------------------------------------------|------------|------------|------------|---------------|------------|-----------|------------|-----------|------------|-----------------|------------|
| ** **                                       | ** ** | **Total**  | ** ** | **one year**  | ** ** | **years** | ** ** | **years** | ** ** | **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)            |       | 0.4        |       | 0.2           |       | 0.1       |       | 0.1       |       | —          |       |
| Operating lease  obligations(2)                  |       | 125.3      |       | 16.9          |       | 28.2      |       | 21.2      |       | 59.0            |       |
| Deemed landlord financing  liability(1) (2) |       | 299.5      |       | 12.3          |       | 24.9      |       | 25.4      |       | 236.9           |       |
| Letters of credit (3)                            |       | 6.6        |       | 6.6           |       | —    |       | —    |       | —          |       |
| Purchase commitments(4)                          |       | 8.1        |       | 8.1           |       | —    |       | —    |       | —          |       |
| Total                                            |       | $          | 581.4      |          | $          | 44.1      |       | $         | 53.2       |            | $          | 61.7 |   | $ | 422.4 |   |
|                                                  |            |            |            |               |            |           |            |           |            |                 |            |  |  |  |  |  |  |

 

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| (1)    |   | Amounts payable under capital leases and the deemed landlord  financing liability represent gross lease payments, including both deemed  principal and imputed interest components.                                                                                                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                     |
| (2)    |   | Many of our leases and financing obligations contain provisions that  require additional rent payments contingent on sales performance and the  payment of common area maintenance charges and real estate taxes. Amounts in  this table do not reflect any of these additional amounts. |
|   |   |                                                                                                                                                                                                                                                                                     |
| (3)    |   | We have letters of credit outstanding primarily to guarantee  performance under insurance contracts. The letters of credit are irrevocable  and have one-year renewable terms.                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                     |
| (4)    |   | We have commitments under contracts for the purchase of property and  equipment. Portions of such contracts not completed at April 21, 2005 as  noted in the table above were not reflected as assets or liabilities in our  consolidated financial statements.                     |

 

 

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**Sources anduses of cash**

 

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

 
| ** **                                            | ** ** | **175 Days  Ended** | ** ** | **172 Days  Ended** | ** ** |
|-------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| ** **                                            | ** ** | **April 21,**  | ** ** | **April 15,**  | ** ** |
| ** **                                            | ** ** | **2005**            | ** ** | **2004**            | ** ** |
| ** **                                            | ** ** | ** **          | ** ** | **(As restated)**   | ** ** |
| Net cash  provided by operating activities            |       | $                   | 14.4       |                | $          | 10.7 |   |
| Net cash  used in investing activities                |       | (8.6                | )          | (6.6                | )          |
| Net cash  provided by (used in) financing activities  |       | 1.8                 |       | (7.3                | )          |
| Net increase  (decrease) in cash and cash equivalents |       | $                   | 7.6        |                | $          | (3.2 | ) |

 

***Operating activities***

 

For the first two quarters of fiscal 2005, cash flows from operatingactivities increased $3.7 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 two 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 two quarters offiscal 2005 and 2004 consisted primarily of capital expenditures.  Our capital expenditures for property andequipment in the first two quarters of fiscal 2005 and 2004 were comprised ofthe following (in millions):

 
| ** **                                | ** ** | **April 21,  2005** | ** ** | **April 15,  2004** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                | ** ** | ** **               | ** ** | **(As restated)**        | ** ** |
| New store  construction                   |       | $                        | 1.8        |                     | $          | 1.4 |   |
| Existing  store remodel and refurbishment |       | 1.3                      |       | 2.0                      |       |
| Capital replacements                      |       | 2.5                      |       | 1.9                      |       |
| Corporate  related                        |       | 0.3                      |       | 0.6                      |       |
| Purchase of  property and equipment       |       | $                        | 5.9        |                     | $          | 5.9 |   |

 

In addition tothe capital expenditures noted above, we spent $3.0 million for assets underdeemed landlord finance liability during the first two quarters of fiscal 2005compared to $0.7 million in the same quarters of fiscal 2004.  We opened five new restaurants in the firsttwo quarters of fiscal 2005 and three restaurants in the same quarters offiscal 2004. Also, we had an additional nine locations under construction atthe end of the second quarter of fiscal 2005.

 

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***Financing activities***

 

Our financing activities provided cash of $1.8 million during the firsttwo quarters of fiscal 2005, consisting principally of $3.2 million of proceedsfrom deemed landlord financing transactions associated with our new restaurantconstruction, partially offset by the repayment of all $1.4 million ofoutstanding borrowings under our revolving line of credit at October 28,2004.

 

During thefirst two quarters of fiscal 2004, we used cash in financing activities of $7.3million, consisting primarily of repayments of $9.8 million to reduce theamount of borrowings under our credit facility, debt issuance costs of $5.4million, 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 includerequirements for 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.

 

### **Item3.  Quantitative and QualitativeDisclosures 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 April 21, 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 April 21, 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 2.7%.  We have not historically used financialinstruments to hedge our commodity ingredient prices.

 

### **Item4.  Controls and Procedures**

 

### **Evaluation of 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 not effective in alerting them timelyto material 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 ouraccounting policies and restate was made, among other things, in considerationof the views of the Office of the Chief Accountant of the SEC expressed in itsletter related 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 represents amaterial weakness in internal control over financial reporting.  There have not been any significant changesin our internal controls or in other factors that could significantly affectthese controls subsequent to the date of the evaluation, except as described inthe following paragraph.

 

We have enhanced 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 GAAP for leaseaccounting, the classification and accounting for such transactions.

 

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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 have entered into a settlement agreement, which is subjectto the final approval of the court. Under the terms of the proposedsettlements, we have agreed to pay up to an aggregate of $6.55 million for thealleged claims and associated legal fees, subject to partial indemnification asnoted 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 ofCook County, Illinois seeking indemnification for all of the damages related tosuch litigation under the purchase agreement dated June 14, 2003 pursuantto which VICORP was acquired, in addition to the assertion of otherclaims.  The former shareholders ofMidway filed a lawsuit on December 22, 2004 in Suffolk County SuperiorCourt in Massachusetts.  The formershareholders of Midway claim, among other allegations, that we 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.

 

While we believe that our claims against the former shareholders ofMidway Investors Holdings Inc. are meritorious and that we will prevail, in theevent we do not fully prevail on our indemnification claims, we estimate thatour maximum exposure under the settlement agreements is $3.2 million.Therefore, during the fourth quarter of fiscal 2004, we established a reserveof $3.2 million in connection with the proposed settlement of these classaction lawsuits.  A receivable of $3.4million was reflected at both April 21, 2005 and October 28, 2004 forthe difference between the aggregate amount of the settlement and our estimatedexposure.

 

**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.

 

**Item 5. 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 April 21, 2005, pursuant to Rule 13a-14 or15d-14 of 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 April 21, 2005, pursuant to Rule 13a-14 or15d-14 of 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 April 21, 2005, pursuant to 18 U.S.C. Section 1350,as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

**(b)****                               Reportson Form 8-K**

 

### **During the second quarter of fiscal 2005 ended April 21,2005, we filed the following reports on Form 8-K:**

 

### **Current report on Form 8-K on March 21, 2005,announcing a delay in the filing of our Form 10-Q for our first quarterended January 27, 2005.**

 

### **Current report on Form 8-K on April 11, 2005,announcing financial results for our first quarter ended January 27, 2005and adjustments to prior period financial results for lease accounting errors,including non-reliance on previously issued financial statements.**

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                           | VICORP Restaurants, Inc.                 |
|--------------------------------|-----------------------------------------------|
|                           |                                          |
|                           |                                          |
| Date:   May 27, 2005 |                                          |
|                           |                                          |
|                           | /s/  Debra Koenig                        |   |
|                           | Debra Koenig                                  |
|                           | Chief Executive Officer                       |
|                           | (Principal Executive Officer)                 |
|                           |                                          |
| Date:   May 27, 2005 |                                          |
|                           |                                          |
|                           | /s/   Anthony Carroll                    |   |
|                           | Anthony Carroll                               |
|                           | Chief Financial Officer                       |
|                           | (Principal Financial and Accounting  Officer) |

 

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