**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, DC 20549-1004**

 

**FORM 10-Q**

 

| **ý**                                           | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------|------------|--------------------------------------------------------------------------------------|
|                                                 |       |                                                                                 |
| **For the quarterly period ended  January 26, 2006** |
|                                                 |       |                                                                                 |
| **OR**                                               |
|                                                 |       |                                                                                 |
| **o**                                                | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom                    to                    **

 

**Commission file number333-117263**

 

**VICORP RESTAURANTS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **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)                             |

 

** (303) 296-2121**

(Registrant’s telephone number, includingarea code)

 

Securities registered pursuant to Section12(b) of the Act:

**None**

 

Securities registered pursuant to Section12(g) of the Act:

**None**

 

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  o    NO  ý

 

Indicate by check mark if the registrant isnot required to file reports pursuant to Section 13 or Section 15(d) of theExchange Act. YES  ý    NO  o

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months and (2) has beensubject to such filing requirements for the past 90 days. YES  ý    NO  o

 

Indicate by check mark if disclosure ofdelinquent filers, pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of the registrant’s knowledge,in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this form 10-K:  ý

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer.See definition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.
| Large accelerated filer     o |   |   |   | Accelerated filer     o |   | Non-accelerated  filer   ý |
|----------------------------------------------|--------|--------|--------|----------------------------------------|--------|------------------------------------------------|

 

Indicate by check mark whether the registrantis a shell Company (as defined in Rule 12b-2 of the Exchange Act).   YES  o  NO  ý

 

Number of sharesof Common Stock, $.0001 par value, outstanding at February 13, 2006: 1,370,616,excluding treasury shares.

 

 

----

 

**VICORP RESTAURANTS, INC.**

**January 26, 2006**

**INDEX**

 

 

 
| **PART I - FINANCIAL INFORMATION** | ** **                                                                                                        |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------|
| ** **                         | ** **                                                                                                        |
| Item 1.                            | Consolidated Financial Statements                                                                                 | ** ** |
|                               |                                                                                                              | ** ** |
|                               | Consolidated Balance Sheets as of  January 26, 2006 and November 3, 2005                                          |   |
|                               |                                                                                                              |   |
|                               | Consolidated Statements of  Operations for the 84 days ended January 26, 2006 and 91 days ended January  27, 2005 |   |
|                               |                                                                                                              |   |
|                               | Consolidated Statements of  Cash Flows for the 84 days ended January 26, 2006 and 91 days ended January  27, 2005 |   |
|                               |                                                                                                              |   |
|                               | Notes to Consolidated  Financial Statements                                                                       |   |
|                               |                                                                                                              |   |
| Item 2.                            | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                       |   |
|                               |                                                                                                              |   |
| Item 3.                            | Quantitative  and Qualitative Disclosures About Market Risk                                                       |   |
|                               |                                                                                                              |   |
| Item 4.                            | Controls and  Procedures                                                                                          |   |
|                               |                                                                                                              |   |
| **PART II - OTHER INFORMATION**    |                                                                                                              |
|                               | ** **                                                                                                        |   |
| Item  1.                           | Legal Proceedings                                                                                                 |   |
|                               |                                                                                                              |   |
| Item 2.                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                                      |   |
|                               |                                                                                                              |   |
| Item 3.                            | Defaults  Upon Senior Securities                                                                                  |   |
|                               |                                                                                                              |   |
| Item 4.                            | Submission  of Matters to a Vote of Security Holders                                                              |   |
|                               |                                                                                                              |   |
| Item  5.                           | Other Information                                                                                                 |   |
|                               |                                                                                                              |   |
| Item 6.                            | Exhibits                                                                                                          |   |
|                               |                                                                                                              |   |
| **SIGNATURES**                     |                                                                                                              |

 

2

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. CONSOLIDATED FINANCIAL STATEMENTS**

 

**VI Acquisition Corp.**

**Consolidated Balance Sheets**

**(In Thousands, Except Share Data**)

**(Unaudited)**

 

 
| ** **                                                                                                                                                                                                                            | ** ** | **January 26, 2006** | ** ** | **November 3, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                            | ** ** | ** **           | ** ** | ** **           | ** ** |
| **Assets**                                                                                                                                                                                                                            |       |                 |       |                 |       |
| Current assets:                                                                                                                                                                                                                       |       |                 |       |                 |       |
| Cash and cash equivalents                                                                                                                                                                                                             |       | $                    | 1,851      |                 | $          | 2,099 |   |
| Receivables, net                                                                                                                                                                                                                      |       | 6,574                |       | 15,756               |       |
| Inventories                                                                                                                                                                                                                           |       | 10,698               |       | 12,425               |       |
| Deferred income taxes, short-term                                                                                                                                                                                                     |       | 1,837                |       | 1,431                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                             |       | 2,133                |       | 3,175                |       |
| Prepaid rent                                                                                                                                                                                                                          |       | 171                  |       | 2,172                |       |
| Income tax receivable                                                                                                                                                                                                                 |       | 3,966                |       | 733                  |       |
| Total current assets                                                                                                                                                                                                                  |       | 27,230               |       | 37,791               |       |
| Property and equipment, net                                                                                                                                                                                                           |       | 87,980               |       | 86,459               |       |
| Assets under deemed landlord financing  liability, net                                                                                                                                                                                |       | 130,139              |       | 126,146              |       |
| Goodwill                                                                                                                                                                                                                              |       | 91,881               |       | 91,881               |       |
| Trademarks and tradenames                                                                                                                                                                                                             |       | 42,600               |       | 42,600               |       |
| Franchise rights, net                                                                                                                                                                                                                 |       | 10,605               |       | 10,765               |       |
| Deferred income taxes                                                                                                                                                                                                                 |       | —               |       | 3,010                |       |
| Other assets, net                                                                                                                                                                                                                     |       | 12,916               |       | 13,613               |       |
| Total assets                                                                                                                                                                                                                          |       | $                    | 403,351    |                 | $          | 412,265 |   |
|                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                         |       |                 |       |                 |       |
| Current liabilities:                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Current maturities of long-term debt and  capitalized lease obligations                                                                                                                                                               |       | $                    | 46         |                 | $          | 63 |   |
| Cash overdraft                                                                                                                                                                                                                        |       | —               |       | 6,341                |       |
| Accounts payable                                                                                                                                                                                                                      |       | 12,240               |       | 13,291               |       |
| Accrued compensation                                                                                                                                                                                                                  |       | 7,804                |       | 8,066                |       |
| Accrued taxes                                                                                                                                                                                                                         |       | 8,822                |       | 7,746                |       |
| Other accrued expenses                                                                                                                                                                                                                |       | 14,333               |       | 12,992               |       |
| Total current liabilities                                                                                                                                                                                                             |       | 43,245               |       | 48,499               |       |
| Long-term debt                                                                                                                                                                                                                        |       | 140,388              |       | 147,013              |       |
| Capitalized lease obligations                                                                                                                                                                                                         |       | 184                  |       | 185                  |       |
| Deemed landlord financing liability                                                                                                                                                                                                   |       | 134,640              |       | 132,038              |       |
| Deferred income taxes, long-term                                                                                                                                                                                                      |       | 313                  |       | —               |       |
| Other noncurrent liabilities                                                                                                                                                                                                          |       | 12,327               |       | 11,596               |       |
| Total liabilities                                                                                                                                                                                                                     |       | 331,097              |       | 339,331              |       |
|                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Commitments and contingencies                                                                                                                                                                                                         |       |                 |       |                 |       |
|                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Stock subject to repurchase                                                                                                                                                                                                           |       | 1,055                |       | 1,063                |       |
|                                                                                                                                                                                                                                  |       |                 |       |                 |       |
| Stockholders’ equity:                                                                                                                                                                                                            |       |                 |       |                 |       |
| Preferred stock, $0.0001 par value:                                                                                                                                                                                                   |       |                 |       |                 |       |
| Series A, 100,000 shares authorized, 68,942  shares issued and outstanding at January 26, 2006 and 68,944 shares issued  and outstanding at November 3, 2005 (aggregate liquidation preference of  $90,297 and $88,178, respectively) |       | 90,891               |       | 89,287               |       |
| 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,  1,343,163 shares issued and outstanding at January 26, 2006 and 1,395,255  shares issued and outstanding at November 3, 2005                                                                   |       | —               |       | —               |       |
| Paid-in capital                                                                                                                                                                                                                       |       | 2,362                |       | 2,465                |       |
| Treasury stock, at cost, 1,371.11 shares of  preferred stock and 132,695 shares of common stock at January 26, 2006 and  923.87 shares of preferred stock and 80,603 shares of common stock at  November 3, 2005                      |       | (1,057               | )          | (1,004               | )          |
| Accumulated deficit                                                                                                                                                                                                                   |       | (20,997              | )          | (18,877              | )          |
| Total stockholders’ equity                                                                                                                                                                                                       |       | 71,199               |       | 71,871               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                       |       | $                    | 403,351    |                 | $          | 412,265 |   |

 

*See accompanying notes to consolidated financial statements.*

 

3

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**VI Acquisition Corp.**

**Consolidated Statements of Operations**

**(In Thousands)**

**(Unaudited)**

 
| ** **                                             | ** ** | **84 Days Ended  January 26,  2006** | ** ** | **91 Days Ended  January 27,  2005** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                                             | ** ** | ** **                           | ** ** | ** **                           | ** ** |
| **Revenues:**                                          |       |                                 |       |                                 |       |
| Restaurant operations                                  |       | $                                    | 104,126    |                                 | $          | 104,523 |   |
| Franchise operations                                   |       | 1,166                                |       | 1,229                                |       |
| Manufacturing operations                               |       | 7,012                                |       | 9,583                                |       |
|                                                   |       | 112,304                              |       | 115,335                              |       |
| **Costs and expenses:**                                |       |                                 |       |                                 |       |
| Restaurant costs:                                      |       |                                 |       |                                 |       |
| Food                                                   |       | 28,317                               |       | 28,543                               |       |
| Labor                                                  |       | 32,941                               |       | 32,240                               |       |
| Other operating expenses                               |       | 30,127                               |       | 27,766                               |       |
| Franchise operating expenses                           |       | 483                                  |       | 511                                  |       |
| Manufacturing operating expenses                       |       | 7,513                                |       | 9,251                                |       |
| General and administrative expenses                    |       | 5,821                                |       | 6,607                                |       |
| Transaction expenses                                   |       | —                               |       | 15                                   |       |
| Asset impairments                                      |       | 308                                  |       | —                               |       |
| Management fees                                        |       | 196                                  |       | 196                                  |       |
| Operating profit                                       |       | 6,598                                |       | 10,206                               |       |
| Interest expense                                       |       | (6,939                               | )          | (6,978                               | )          |
| Other income, net                                      |       | 171                                  |       | 88                                   |       |
| Income (loss) before income taxes                      |       | (170                                 | )          | 3,316                                |       |
| Provision for income taxes (benefits)                  |       | (235                                 | )          | 1,047                                |       |
| Net income                                             |       | 65                                   |       | 2,269                                |       |
| Preferred stock dividends and accretion                |       | (2,185                               | )          | (2,047                               | )          |
| Net income (loss) attributable to common  stockholders |       | $                                    | (2,120     | )                                    | $          | 222 |   |

 

*See accompanying notes to consolidated financial statements.*

 

4

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**VI Acquisition Corp.**

**Consolidated Statements of Cash Flow**

**(In Thousands)**

**(Unaudited)**

 
| ** **                                                                                      | ** ** | **84 Days Ended  January 26,  2006** | ** ** | **91 Days Ended  January 27,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                      | ** ** | ** **                           | ** ** | ** **                           | ** ** |
| **Operating activities:**                                                                       |       |                                 |       |                                 |       |
| Net income                                                                                      |       | $                                    | 65         |                                 | $          | 2,269 |   |
| Reconciliation to net cash provided by  operating activities:                                   |       |                                 |       |                                 |       |
| Depreciation and amortization                                                                   |       | 5,143                                |       | 4,480                                |       |
| Asset impairments                                                                               |       | 308                                  |       | —                               |       |
| Amortization of financing costs and  original issue discounts                                   |       | 287                                  |       | 288                                  |       |
| Loss on disposition of assets                                                                   |       | 10                                   |       | 28                                   |       |
| Deferred income tax expense                                                                     |       | 2,917                                |       | (1,022                               | )          |
| Accretion of interest on deemed landlord  financing obligations                                 |       | 126                                  |       | 99                                   |       |
| Changes in operating assets and  liabilities:                                                   |       |                                 |       |                                 |       |
| Receivables, net                                                                                |       | 3,528                                |       | 3,071                                |       |
| Inventories                                                                                     |       | 1,727                                |       | 2,935                                |       |
| Cash overdraft                                                                                  |       | (6,341                               | )          | (3,190                               | )          |
| Accounts payable, trade                                                                         |       | (1,051                               | )          | (2,145                               | )          |
| Accrued compensation                                                                            |       | (262                                 | )          | (1,356                               | )          |
| Other current assets and liabilities                                                            |       | 5,466                                |       | 5,791                                |       |
| Other noncurrent assets and liabilities                                                         |       | 1,096                                |       | 1,618                                |       |
| Net cash provided by operating activities                                                       |       | 13,019                               |       | 12,866                               |       |
| **Investing activities:**                                                                       |       |                                 |       |                                 |       |
| Acquisition of franchisee restaurants                                                           |       | (650                                 | )          | —                               |       |
| Purchase of property and equipment                                                              |       | (3,965                               | )          | (2,835                               | )          |
| Purchase of assets under deemed landlord  financing liability                                   |       | (5,239                               | )          | (2,122                               | )          |
| Proceeds from disposition of property                                                           |       | —                               |       | 25                                   |       |
| Collection of notes receivable                                                                  |       | —                               |       | 55                                   |       |
| Net cash used in investing activities                                                           |       | (9,854                               | )          | (4,877                               | )          |
| **Financing activities:**                                                                       |       |                                 |       |                                 |       |
| Payments of debt, capital lease  obligations, and deemed landlord financing obligations         |       | (13,014                              | )          | (9,045                               | )          |
| Proceeds from issuance of debt                                                                  |       | 6,275                                |       | 7,600                                |       |
| Proceeds from deemed landlord financing                                                         |       | 4,071                                |       | 540                                  |       |
| Payments for repurchase of stock                                                                |       | (745                                 | )          | —                               |       |
| Net cash used in financing activities                                                           |       | (3,413                               | )          | (905                                 | )          |
| Increase (decrease) in cash and cash  equivalents                                               |       | (248                                 | )          | 7,084                                |       |
| Cash and cash equivalents at beginning of  period                                               |       | 2,099                                |       | 1,332                                |       |
| Cash and cash equivalents at end of period                                                      |       | $                                    | 1,851      |                                 | $          | 8,416 |   |
|                                                                                            |       |                                 |       |                                 |       |
| **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) |       | $                                    | 3,772      |                                 | $          | 3,418 |   |
| Income taxes                                                                                    |       | 74                                   |       | 83                                   |       |
|                                                                                            |       |                                 |       |                                 |       |
| **Supplemental disclosures of non-cash  investing and financing activities:**                   |       |                                 |       |                                 |       |
| Build-to-suit reimbursements not yet received                                                   |       | $                                    | 4,609      |                                 | $          | 5,795 |   |
| Deemed landlord financing—third party  direct pays                                         |       | 872                                  |       | —                               |       |
|                                                                                            |       |                                 |       |                                 |       |
| Dividends                                                                                       |       | $                                    | 2,185      |                                 | $          | 2,047 |   |

 

*See accompanying notes to consolidated financial statements.*

 

5

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**VI Acquisition Corp.**

**Notes to Consolidated Financial Statements**

**January 26, 2006**

**(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-ownedby VI Acquisition Corp. As a holding company, VI Acquisition Corp. does not haveany independent operations and consequently its consolidated statements ofoperations are substantially equivalent to those of VICORP Restaurants, Inc.

 

The Company operates family style restaurants under the brand names “BakersSquare” and “Village Inn,” and franchises restaurants under the Village Innbrand name. At January 26, 2006, the Company operated 295 Company-ownedrestaurants in 17 states. Of the Company-owned restaurants, 151 are BakersSquare restaurants and 144 are Village Inn restaurants, with an additional 96franchised Village Inn restaurants in 19 states. The Company-owned andfranchised restaurants are concentrated in Arizona, California, Florida, theRocky Mountain region, and the upper Midwest. In addition, the Company operatesthree pie manufacturing facilities located in Santa Fe Springs, California; OakForest, Illinois; and Chaska, 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-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of theinformation and footnotes required by GAAP for complete financial statements. Inthe opinion of management, the financial statements include all adjustments, consistingof normal recurring adjustments, necessary for a fair presentation. However,operating results for the 84-day period ended January 26, 2006 are notnecessarily indicative of the results that may be expected for the fiscal yearending November 2, 2006. Additionally, operating results for the first quarterof the fiscal year include increased sales due to the holidays in November andDecember. The consolidated balance sheet at November 3, 2005, has been derivedfrom the audited consolidated financial statements at that date but does notinclude all of the information and footnotes required by GAAP for completefinancial statements. For further information, refer to the auditedconsolidated financial statements and footnotes thereto for the year ended November3, 2005 included in our Annual Report on Form 10-K.

 

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 Company haselected not to adopt the fair value method and instead has elected to followAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued 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 November 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 151, “Inventory Costs, an amendment of ARBNo. 43, Chapter 4.”  SFAS No. 151 clarifies the accounting forabnormal amounts of idle facility expense, freight, handling costs and wastedmaterial and requires that such items be recognized as current-period chargesregardless of whether they meet the “so abnormal” criterion outlined in ARBNo. 43.  SFAS No. 151 also introduces the concept of “normalcapacity” and requires the allocation of fixed production overheads toinventory based on the normal capacity of the production facilities. Unallocated overheads must be recognized as an expense in the periodincurred.  SFAS No. 151 is effective for inventory costs incurredduring fiscal years beginning after June 15, 2005.  The Companyimplemented SFAS No. 151 and because we did not have abnormal costs, theimplementation did not have a material impact on our financial position,results of operations or cash flows during the quarter ended January 26, 2006.

 

On December 16, 2004, the FASB issuedSFAS No. 123 (revised 2004), Share-Based Payment, which is a revision ofSFAS No. 123. SFAS 123(R) supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statementof Cash Flows. Generally, the approach in SFAS 123(R) is similar to theapproach described in SFAS 123. However, SFAS 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. Pro formadisclosure is no longer an alternative.

 

7

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SFAS 123(R) permits public companies toadopt its requirements using one of two methods:

 

1. A “modified prospective” method in whichcompensation cost is recognized beginning with the effective date(a) based on the requirements of SFAS 123(R) for all share-basedpayments granted after the effective date and (b) based on therequirements of SFAS 123 for all awards granted to employees prior to theeffective date of SFAS 123(R) that remain unvested on the effective date.

 

2. A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder SFAS 123 for purposes of pro forma disclosures for either(a) all prior periods presented or (b) prior interim periods of theyear of adoption.

 

The Company will use the modified prospectivemethod when it adopts.  SFAS 123(R) is effective for non-publicfilers, with the first annual reporting period that begins afterDecember 15, 2005. For purposes of this Statement, the Company isconsidered a non-public filer because it is an entity that has only debtsecurities trading in a public market. As permitted by SFAS 123, the Companyhad accounted for share-based payments to employees using APB Opinion 25’sintrinsic value method and, as such, generally recognize no compensation costfor employee stock options. Simultaneously with the closing of the Company’ssale transaction in June 2003, all options became immediately vested, thusthe Company did not recognize any compensation expense. Consequently, theadoption of SFAS 123(R) will only impact the Company’s results ofoperations if the Company grants share-based payments subsequent toNovember 2, 2006, the beginning of the Company’s 2007 fiscal year.

 

In May 2005, the FASB issued SFASNo. 154, Accounting Changes and Error Corrections (“SFAS 154)”. SFAS 154replaces APB No. 20, Accounting Changes, and SFAS No. 3, ReportingAccounting changes in Interim Financial Statements, and changes therequirements for the accounting for and reporting of a change in accountingprinciple. SFAS 154 requires retrospective application of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS 154 defines retrospectiveapplication as the application of a different accounting principle to prioraccounting periods as if that principle had always been used or as theadjustment of previously issued financial statements to reflect a change in thereporting entity. SFAS 154 also redefines restatement as the revising ofpreviously issued financial statements to reflect the correction of anerror.  SFAS 154 is effective for accounting changes and correction oferrors made in fiscal years beginning after December 15, 2005.

 

8

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In October 2005, the FASB issued FSPNo. FAS 13-1, “Accounting for Rental Costs Incurred during a ConstructionPeriod.” FSP No. FAS 13-1 requires rental costs associated with operatingleases that are incurred during a construction period to be recognized asrental expense. FSP No. FAS 13-1 is effective for reporting periodsbeginning after December 15, 2005. The transition provisions of FSPNo. FAS 13-1 permit early adoption and retrospective application of theguidance. The Company historically capitalized rental costs incurred during aconstruction period.  The Company implemented FSP No. FAS 13-1 duringthe first quarter of fiscal 2006 and it did not have a material impact upon theCompany’s financial position, results of operations or cash flows. The Companycapitalized $0.1 million in the first quarter of fiscal 2005 and expensed $0.1million in the first fiscal quarter of 2006.

 

**Reclassifications**

 

Certain prior period amounts in the accompanying consolidated financialstatements have been reclassified to conform to the presentation in fiscal 2006.These reclassifications had no effect on the Company’s consolidated net income.

 

**Fiscal Periods**

 

The Company’s fiscal year is comprised of 52 or53 weeks divided into four fiscal quarters of 12 or 13, 12, 12, and 16 weeks. Thefirst quarter of fiscal 2006 consisted of 12 weeks, or 84 days and ended onJanuary 26, 2006. The first quarter of fiscal 2005 consisted of 13 weeks, or 91days and ended on January 27, 2005.

 

**2. Inventories**

 

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

 
| ** **                                                                   | ** ** | **January 26,  2006** | ** ** | **November 3,  2005** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| Inventories  at pie production facilities and third-party storage locations: |       |                  |       |                  |       |
| Raw materials                                                                |       | $                     | 5,074      |                  | $          | 4,408 |   |
| Finished goods                                                               |       | 2,568                 |       | 5,059                 |       |
|                                                                         |       | 7,642                 |       | 9,467                 |       |
| Restaurant  inventories                                                      |       | 3,056                 |       | 2,958                 |       |
|                                                                         |       | $                     | 10,698     |                  | $          | 12,425 |   |

 

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**3.Receivables, net**

 

Receivables,net consisted of the following:

 
| **(In thousands)**               | ** ** | **January 26,  2006** | ** ** | **November 3,  2005** | ** ** |
|----------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                       | ** ** | ** **            | ** ** | ** **            | ** ** |
| Trade  receivables               |       | $                     | 1,676      |                  | $          | 5,799 |   |
| Construction  receivables        |       | 4,609                 |       | 7,030                 |       |
| Indemnification  receivable      |       | —                |       | 2,557                 |       |
| Other  receivables               |       | 586                   |       | 721                   |       |
| Notes  receivable                |       | 7                     |       | 7                     |       |
| Allowance  for doubtful accounts |       | (304                  | )          | (358                  | )          |
| Receivables,  net                |       | 6,574                 |       | 15,756                |       |
| Less:  long-term portion         |       | —                |       | —                |       |
| Current  portion                 |       | $                     | 6,574      |                  | $          | 15,756 |   |

 

**4. Debt**

 

On April 14, 2004, the Company completed a private placement of $126.5million aggregate principal amount of 101⁄2% senior unsecured notes maturing onApril 15, 2011. The notes were issued at a discounted price of 98.791% of facevalue, resulting in net proceeds before transaction expenses of $125.0 million.The senior unsecured notes were issued by VICORP Restaurants, Inc. and areguaranteed by VI Acquisition Corp. and Village Inn Pancake House ofAlbuquerque, Inc. In August 2004, the Company’s registration statement with theSecurities and Exchange Commission on Form S-4 was declared effective and thesenior unsecured notes and guarantees were exchanged for registered notes andguarantees having substantially the same terms and evidencing the sameindebtedness. Interest is payable semi-annually on April 15 and October 15until maturity.

 

The Company entered into an Amended and Restated Senior Secured CreditFacility on April 14, 2004 consisting of a $15.0 million term loan and a $30.0million revolving credit facility, with a $15.0 million sub-limit for lettersof credit. As of January 26, 2006, the Company had issued letters of creditaggregating $7.4 million and had no borrowings outstanding under the seniorsecured revolving credit facility. Interest on both the term loan and revolvingcredit facility are payable on the first of each month. The senior securedrevolving credit facility permits borrowings equal to the lesser of (a) $30.0million and (b) 1.2 times trailing twelve months Adjusted EBITDA (as defined inthe senior secured credit agreement) minus the original amount of the newsenior secured term loan. Under this formula, as of January 26, 2006, the Companyhad the ability to borrow the full $30.0 million, less the amount ofoutstanding letters of credit and borrowings under the senior secured revolvingcredit facility, or $22.6 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 January 26, 2006, the interestrate was 7.3% for term loan borrowings. Both facilities are secured by a lien onall of the assets of VICORP Restaurants, Inc., and guaranteed by VI AcquisitionCorp. In addition, the guarantees also are secured by the pledge of all of theoutstanding 

 

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capital stock of VICORP Restaurants, Inc. by VI Acquisition Corp. Theterm loan does not require periodic principal payments, but requires mandatoryrepayments under certain events, including proceeds from sale of assets,issuance of equity and issuance of new indebtedness. Both facilities mature onApril 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. As of January 26, 2006, the Company was in compliancewith these requirements.

 

**5. Commitments and Contingencies**

 

***Insurance reserves***

 

The Companyretains a significant portion of certain insurable risks primarily in themedical, dental, workers’ compensation and general liability areas. The Companyhad an insurance reserve liability of $9.9 million and $9.3 million recorded asof January 26, 2006 and November 3, 2005, respectively. Traditionalinsurance coverage is obtained for catastrophic losses. Provisions for lossesexpected under these programs are recorded based upon the Company’s estimatesof liabilities for claims incurred, including those not yet reported. Suchestimates utilize prior company history and actuarial assumptions followed inthe insurance industry. As of January 26, 2006, the Company had placed lettersof credit totaling approximately $7.3 million, associated with its insuranceprograms.

 

***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 believes the ultimate disposition of thesematters will not have a material adverse effect on the Company’s consolidatedfinancial position or results of operations.

 

***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 $2.2 million as of January 26, 2006. The Companyhas not made any payments due to default under these agreements, and managementbelieves the guarantee has no fair value. 

 

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Managementbelieves the ultimate disposition of these matters will not have a materialadverse effect on the Company’s consolidated financial position or results ofoperations.

 

Contractualobligations, primarily for restaurants under construction, amounted toapproximately $12.4 million as of January 26, 2006.

 

***Indemnifications***

 

In the normalcourse of business, the Company is party to a variety of agreements under whichit may be obligated to indemnify the other party for certain matters. Theseobligations typically arise in contracts where the Company customarily agree tohold the other party harmless against losses arising from a breach ofrepresentations or covenants for certain matters such as title to assets. The Companyalso has indemnification obligations to its officers and directors. Theduration of these indemnifications varies, and in certain cases, is indefinite.In each of these circumstances, payment by the Company depends upon the otherparty making an adverse claim according to the procedures outlined in theparticular agreement, which procedures generally allow the Company to challengethe other party’s claims. In certain instances, the Company may have recourseagainst third parties for payments that we make.

 

The Company isunable to reasonably estimate the maximum potential amount of future paymentsunder these or similar agreements due to the unique facts and circumstances ofeach agreement and the fact that certain indemnifications provide for nolimitation to the maximum potential future payments under the indemnification.The Company has not recorded any liability for these indemnifications in the accompanyingconsolidated balance sheets; however, the Company does accrue losses for anyknown contingent liability, including those that may arise from indemnificationprovisions, when the obligation is both probable and reasonably estimable.

 

**6. 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.,whereby certain management, financial and other consulting services would beprovided to the Company. Under the terms of the agreement, the Company pays anannual fee to both partnerships in the aggregate amount of $850,000. Managementfees expensed under this agreement totaled approximately $196,000 during eachof the 84 day and 91 day periods ended January 26, 2006 and January 27, 2005. Managementfees paid to Wind Point Partners, IV, L.P. and Wind Point Investors V, L.P.under this agreement totaled $0, and $213,000 during the 84 day and 91 dayperiods ended January 26, 2006 and January 27, 2005, respectively.

 

**7. Assetimpairments, asset disposals and related costs**

 

During the quarter ended January 26, 2006, the Company recorded a $0.3million pretax impairment charge related to the writedown of assets for 3restaurant locations. Management assessed various factors relevant to theassets, including projected negative cash flows, and concluded the historicalperformance trends at the operating locations were unlikely to improvematerially. Therefore an impairment charge was recognized to reduce thecarrying value of the assets to fair market value, which was estimated basedupon management’s historical experience associated with such assets. There wasno impairment charge in the first quarter of fiscal 2005.

 

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As of January 26, 2006 and November 3, 2005, the Company had recorded areserve for closed/subleased restaurant locations of approximately $0.9 millionand $1.0 million, respectively, primarily representing estimated future minimumlease payments related to the restaurant facilities, net of expected subleaseincome. Of the seven restaurant locations to which this reserve relates, fourof such locations were subleased as of January 26, 2006.

 

**8. Deemedlandlord financing liability**

 

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 of these construction projects, asale-leaseback could be deemed to occur in certain situations and theseller-lessee would record the sale, remove all property and related liabilitiesfrom its balance sheet and recognize gain or loss from the sale, which isgenerally deferred and amortized as an adjustment to rent expense over the termof the lease.  However, many of our real estate transactions andbuild-to-suit projects have not qualified for sale-leaseback accounting becauseof our deemed continuing involvement with the buyer-lessor, which results inthe transaction being recorded under the financing method.  Under thefinancing method, the assets remain on the consolidated balance sheet and aredepreciated over their useful life, and the proceeds from the transaction arerecorded as a financing liability.  A portion of lease payments areapplied as payments of deemed principal and imputed interest.

 

**9. Acquisitions**

 

The Companypurchased the assets of four restaurants during the first quarter from afranchisee in Oklahoma for $650,000. The Company also plans to purchase oneadditional restaurant from the same franchisee by the end of March 2006. Theimpact of this transaction was immaterial to the Company's financialstatements.

 

**10. StockRepurchase**

 

In January2006 the Company agreed to repurchase shares of our common stock and preferredstock that had been previously acquired by former officers. The aggregatepurchase price paid to the former officers was approximately $745,000.

 

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**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

*Statements included in Management’s Discussion and Analysis of FinancialCondition and Results of Operations and elsewhere in this report are, or may bedeemed to be, “forward-looking statements” within the meaning of Section 27A ofthe Securities Act and Section 21E of the Securities Exchange Act of 1934, asamended (the “Exchange Act”). These forward-looking statements include allmatters that are not historical facts. By their nature, forward-lookingstatements involve risks and uncertainties because they relate to events anddepend on circumstances that may or may not occur in the future. We caution youthat forward-looking statements are not guarantees of future performance andthat our actual results of operations, financial condition and liquidity, andthe development of the industry in which we operate may differ materially fromthose made in or suggested by the forward-looking statements contained in thisinformation report. See the “Risk Factors” section of our Annual Report on Form10-K for the year ended November 3, 2005, for a discussion of some of thefactors that may affect the Company and its operations. Such factors includethe following: competitive pressures within the restaurant industry; changes inconsumer preferences; the level of success of our operating strategy and growthinitiatives; the level of our indebtedness and the terms and availability ofcapital; fluctuations in commodity prices; changes in economic conditions;government regulation; litigation; and seasonality and weather conditions. Inaddition, even if our results of operations, financial condition and liquidity,and the development of the industry in which we operate are consistent with theforward-looking statements contained in this announcement, those results ordevelopments may not be indicative of results or developments in subsequent periods.Any forward-looking statements which we make in this report speak only as ofthe date of such statement, and we undertake no obligation to update suchstatements. 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.*

 

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**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 391 restaurants in 25 states as of January 26, 2006, consisting of 295Company-operated restaurants and 96 franchised restaurants. We also producepremium pies that we serve in our restaurants or sell to third parties at threestrategically located facilities.

 

The following table sets forth the changes to the number of Company-operatedand franchised restaurants for the periods presented below.

 
| **(Units)**                                 | ** ** | **84 Days Ended  January 26,  2006** | ** ** | **91 Days Ended  January 27,  2005** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| Village Inn Company-operated restaurants:   |       |                                 |       |                                 |       |
| Beginning of period                         |       | 135                                  |       | 121                                  |       |
| Openings/Purchases                          |       | 10                                   |       | 3                                    |       |
| Closings                                    |       | (1                                   | )          | —                               |       |
| End of period                               |       | 144                                  |       | 124                                  |       |
| Bakers Square Company-operated restaurants: |       |                                 |       |                                 |       |
| Beginning of period                         |       | 152                                  |       | 150                                  |       |
| Openings                                    |       | —                               |       | —                               |       |
| Closings                                    |       | (1                                   | )          | (1                                   | )          |
| End of period                               |       | 151                                  |       | 149                                  |       |
| Total Company-operated restaurants          |       | 295                                  |       | 273                                  |       |
| Village Inn franchised restaurants:         |       |                                 |       |                                 |       |
| Beginning of period                         |       | 100                                  |       | 103                                  |       |
| Closings/Sales                              |       | (4                                   | )          | —                               |       |
| End of period                               |       | 96                                   |       | 103                                  |       |
| Total restaurants                           |       | 391                                  |       | 376                                  |       |

 

**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 important indicator within the restaurantindustry because small changes in same unit sales can have a proportionallyhigher impact on operating margins because of the high degree of fixed costsassociated with operating restaurants.

 

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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 attractive price-to-valuerelationship that is a fundamental characteristic of our concepts. We generallyhave increased prices in line with increases in the consumer price index, andexpect to continue to do so in the future. Same unit sales performance is alsoaffected by other factors, such as food quality, the level and consistency ofservice within our restaurants, the attractiveness and physical condition ofour restaurants, as well as local and national economic factors.

 

As of January26, 2006, we had 96 franchised Village Inn restaurants in nineteen states,operated by 25 franchisees which operate one to eleven restaurants each. Althoughwe may increase franchise revenues by increasing the number of franchisedVillage Inn restaurants, we expect that our franchise revenues will decline asa percentage of our total revenue as we emphasize growth in the number of Company-operatedunits.

 

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

 

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 May 2005 and again on January 1, 2006, theminimum wage rate for the state of Florida increased.  The state of Oregon’sminimum wage increased in both 2005 and 2006 and the states of Minnesota andWisconsin increased their minimum wage during the first quarter of 2006.

 

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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.

 

Although amajority of the pies we produce at our VICOM manufacturing facilities are forVillage Inn and Bakers Square, our third-party pie sales have increased overtime. The overall results of operations of our pie manufacturing historicallyhave not had, and currently do not have, a material impact on our operatingprofit. We show the results of operations associated with our VICOM third partysales separately on our income statement. The net costs associated withinternal “sales” to our restaurants are included with restaurant food cost. Aspart of our overall effort to optimize total Company food cost, we have beenfocusing on various measures to improve the net margins within our piemanufacturing operations, including increasing third-party sales, renegotiatingour distribution contracts and rebalancing the production among our threeplants to increase efficiency.

 

Otheroperating expenses principally include occupancy costs, depreciation, supplies,repairs and maintenance, utility costs, marketing expenses, insurance expensesand workers’ compensation costs. Historically, these costs have increased overtime and many are not directly related to the level of sales in ourrestaurants. We have experienced increases in many of these items throughoutthe last three fiscal years, particularly utility costs and insurance expenses.In order to maintain our operating performance levels, and to address expectedcost increases, we will be required to increase efficiency in restaurantoperations and increase sales, although there is no assurance that we will beable to offset future cost increases.

 

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Our 2006 firstquarter financial results included:

 

•                              Declineof revenues in the first quarter by 2.6% to $112.3 million. The decrease wasprimarily due to seven additional days in the first quarter of fiscal 2005,offset by an average increase of 18 new units. When calculated on a comparative84 day basis, same store sales decreased by 0.1% from 2005 to 2006.

 

•                              Declinein operating income from $10.2 million to $6.6 million in 2006.

 

•                              Netincome also declined to $0.1 million in the first quarter of fiscal 2006compared to $2.3 million in income in the first quarter of fiscal 2005.

 

**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.

 

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

 

**Inventories**

 

Inventories are stated at the lower of costor market value. Cost is principally determined by the first-in, first-outmethod. The valuation of inventory requires us to estimate obsolete or excessinventory as well as inventory that is not of saleable quality. Both ourmanufactured pie inventories and individual store food inventories are subjectto spoilage. We use estimates of future demand as well as historical trendinformation to schedule manufacturing and ordering. If our demand forecastfor specific products is greater than actual demand, we could be required torecord additional inventory reserves or losses which would have a negativeimpact on our gross margin.

 

**Property and equipment, build-to-suit projects and assets under deemedlandlord financing liability**

 

Property and equipment is recorded at costand is depreciated on the straight-line basis over the estimated useful livesof such assets or through the applicable lease expiration, if shorter. Leasehold improvements added subsequent to the inception of a lease areamortized over the shorter of the useful life of the assets or a term thatincludes lease renewals, if such renewals are considered reasonably assured. The useful lives of assets range from 20 to 40 years for buildings and three toten years for equipment and improvements. Changes in circumstances such as theclosing of units within 

 

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underproductive markets or changes in ourcapital structure could result in the actual useful lives of these assetsdiffering from our estimates.

 

For many of our build-to-suit projects, weare considered the owner of the project during the construction period inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 97-10, “TheEffect of Lessee Involvement in Asset Construction,” because we are deemed tohave substantially all of the construction period risk.  At the end ofthese construction projects, a sale-leaseback could be deemed to occur incertain situations and the seller-lessee would record the sale, remove allproperty and related liabilities from its balance sheet and recognize gain orloss from the sale, which is generally deferred and amortized as an adjustmentto rent expense over the term of the lease.  However, many of our realestate transactions and build-to-suit projects have not qualified forsale-leaseback accounting because of our deemed continuing involvement with thebuyer-lessor, which results in the transaction being recorded under thefinancing method.  Under the financing method, the assets remain on theconsolidated balance sheet and are depreciated over their useful life, and theproceeds from the transaction are recorded as a financing liability.  Aportion of lease payments are applied as payments of deemed principal andimputed interest.

 

We review long-lived assets, including land,buildings and building improvements, for impairments on a quarterly basis orwhenever events or changes in circumstances indicate that the carrying amountof such assets may not be recoverable. Management evaluates individualrestaurants, which are considered to be the lowest level for which there areidentifiable cash flows for impairment. A specific restaurant is deemed to beimpaired if a forecast of undiscounted future operating cash flows directlyrelating to that restaurant, including disposal value, if any, is less than thecarrying amount of that restaurant. If a restaurant is determined to beimpaired, the loss is measured as the amount by which the carrying amount ofthe restaurant exceeds its fair value. Management determines fair value basedon quoted market prices in active markets, if available. If quoted marketprices are not available, management estimates the fair value of a restaurantbased on either the estimates provided by real estate professionals and/or ourpast experience in disposing of restaurant properties. Our estimates ofundiscounted cash flows may differ from actual cash flows due to economicconditions or changes in operating performance.  During the first quarterof fiscal 2006, we recognized a $0.3 million impairment charge primarily relatedto two restaurants.  During the first quarter of fiscal 2005 we did not recognizean impairment charge.

 

**Leases**

 

We lease a substantial amount of ourrestaurant properties and one of our pie production plants.  We accountfor our leases under the provisions of Statement of Financial AccountingStandards No. 13, “Accounting for Leases,” and subsequent amendments,which require leases to be evaluated and classified as operating or capitalizedleases for financial reporting purposes.  We record the difference betweenthe cash rent paid and the straight-line rent as a deferred rent liability.Incentive payments received from landlords are recorded as deferred rentliabilities and are amortized on a straight-line basis over the lease term as areduction of rent.  Certain of our leases are accounted for under thefinancing method as discussed above.

 

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In October 2005, the FASB issued FSPNo. FAS 13-1, “Accounting for Rental Costs Incurred during a ConstructionPeriod.” FSP No. FAS 13-1 requires rental costs associated with operatingleases that are incurred during a construction period to be recognized asrental expense. FSP No. FAS 13-1 is effective for reporting periodsbeginning after December 15, 2005. The transition provisions of FSPNo. FAS 13-1 permit early adoption and retrospective application of theguidance. The Company historically capitalized rental costs incurred during aconstruction period.  We implemented FSP No. FAS 13-1 during thefirst quarter of fiscal 2006 and it did not have a material impact upon the Company’sfinancial position, results of operations or cash flows. We capitalized $0.1million in the first quarter of fiscal 2005 and expensed $0.1 million in thefirst fiscal quarter of 2006.

 

**Insurance reserves**

 

We self-insure a significant portion of ouremployee medical insurance, workers’ compensation and general liabilityinsurance plans.  We had an insurance reserve liability of $9.9 millionand $9.3 million recorded as of January 26, 2006 and November 3, 2005,respectively.  We have obtained stop-loss insurance policies to protectfrom individual losses over specified dollar values ($175,000 for employeehealth insurance claims, $250,000 workers’ compensation and $150,000 forgeneral liability for fiscal 2005 and 2006). The full extent of certain claims,especially workers’ compensation and general liability claims, may not becomefully determined for several years. Therefore, we estimate potentialobligations for liabilities that have been incurred but not yet reported basedupon historical data, experience, and use of outside consultants. Althoughmanagement believes that the amounts accrued for these obligations arereasonably estimated, any significant increase in the number of claims or costsassociated with claims made under these plans could have a material adverseeffect on our financial results.

 

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**Loss contingencies**

 

We maintain accrued liabilities and reservesrelating to certain contingent obligations.  Significant contingenciesinclude those related to litigation.  We account for contingentobligations in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 5, “Accounting for Contingencies,” as interpreted by FASBInterpretation No. 14 which requires that we assess each contingency todetermine estimates of the degree of probability and range of possiblesettlement.  Contingencies which are deemed to be probable and where theamount of such settlement is reasonably estimable are accrued in our financialstatements.  If only a range of loss can be determined, we accrue to thebest estimate within that range; if none of the estimates within that range isbetter than another, we accrue to the low end of the range.

 

The assessment of loss contingencies is ahighly subjective process that requires judgments about future events. Contingencies are reviewed at least quarterly to determine the adequacy of theaccruals and related financial statement disclosure.  The ultimatesettlement of loss contingencies may differ significantly from amounts we have accruedin our financial statements.

 

**Income taxes**

 

 Deferred income tax assets and liabilities arerecognized for the expected future income tax consequences of carryforwards andtemporary differences between the book and tax basis of assets and liabilities.Valuation allowances are established for deferred tax assets that are deemedunrealizable.  As of January 26, 2006, we had gross deferred tax assets whichincluded $14.4 million of FICA tip credit carryforwards, expiring at variousdates through 2026.  Approximately $9.9 million of the FICA tip creditcarryforwards were generated prior to our acquisition in June 2003 and aresubject to an annual use limitation of $0.7 million.

 

We must assess the likelihood that we will beable to recover our deferred tax assets. If recovery is not likely, valuationallowances are established. The valuation allowance is based on our estimatesof future taxable 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 indetermining our effective tax rate and in evaluating our tax positions. Weestablish reserves when, despite our belief that our tax return positions aresupportable, we believe that certain positions are likely to be successfullychallenged. We adjust these reserves in light of changing facts andcircumstances, such as the progress of a tax audit. Our effective tax rateincludes the impact of reserve provisions and changes to reserves that weconsider appropriate.

 

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**New Accounting Pronouncements**

 

In November 2004, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “InventoryCosts, an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 clarifies the accounting for abnormal amounts of idlefacility expense, freight, handling costs and wasted material and requires thatsuch items be recognized as current-period charges regardless of whether theymeet the “so abnormal” criterion outlined in ARB 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 overheads must be recognized as an expensein the period incurred. SFAS No. 151 is effective for inventory costs incurredduring fiscal years beginning after June 15, 2005. We implemented SFAS No. 151 duringthe first quarter of fiscal 2006. We determined that we did not have abnormalcosts during the period and thus had no impact from the implementation.

 

On December 16, 2004, the FASB issued SFAS No. 123 (revised2004), *Share-Based Payment*, which is a revisionof SFAS No. 123. SFAS 123(R) supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and amends SFASNo. 95, *Statement of Cash Flows*. Generally, the approach in SFAS 123(R) issimilar to the approach described in SFAS 123. However, SFAS 123(R)requires all share-based payments to employees, including grants of employeestock options, to be recognized in the income statement based on their fairvalues. Pro forma disclosure is no longer an alternative.

 

SFAS 123(R) permits public companies to adopt its requirementsusing one of two methods:

 

1. A *“**modified prospective”*method in which compensation cost is recognized beginning with the effectivedate (a) based on the requirements of SFAS 123(R) for all share-basedpayments granted after the effective date and (b) based on therequirements of SFAS 123 for all awards granted to employees prior to theeffective date of SFAS 123(R) that remain unvested on the effective date.

 

2. A *“**modified retrospective”*method which includes the requirements of the modified prospective methoddescribed above, but also permits entities to restate based on the amountspreviously recognized under SFAS 123 for purposes of pro forma disclosuresfor either (a) all prior periods presented or (b) prior interimperiods of the year of adoption.

 

We will use the modified prospective method when we adoptSFAS 123(R). SFAS 123(R) is effective for non-public filers with thefirst annual reporting period that begins after December 15, 2005. For purposesof this Statement, we are considered a non-public filer because we are anentity that has only debt securities trading in a public market. As permittedby SFAS 123, we had accounted for share-based payments to employees usingAPB Opinion 25’s intrinsic value method and, as such, generally recognize nocompensation cost for employee stock options. Simultaneously with the closingof our sales transaction in June 2003, all options became immediately vested,thus we would not have recognized compensation expense. Consequently, theadoption of SFAS 123(R) will only impact our results of operations if wegrant share-based payments subsequent to November 2, 2006, the beginning of our2007 fiscal year.

 

22

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In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS 154)”. SFAS 154 replaces APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 requires retrospective application of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. SFAS 154 also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005.

 

**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 quarter of fiscal 2006consisted of 12 weeks, or 84 days and fiscal 2006 will consist of 52 weeks or364 total days. The first quarter of fiscal 2005 ended January 27, 2005consisted of 13 weeks, or 91 days, and fiscal 2005 consisted of 53 weeks, or371 days. The additional week in fiscal 2005 coincides with one of the Company’shigher volume sales weeks for both store level and manufacturing operations.

 

**Seasonality**

 

Our sales fluctuate seasonally and as mentioned previously our quartersdo not all have the same time duration. Specifically, our fourth quartergenerally has an extra three to four weeks compared to our other quarters ofthe fiscal year. Historically, our average daily sales are highest in our firstquarter (November through January) as a result of holiday pie sales while ourfourth quarter (mid-July through October) recorded our lowest average dailysales. Therefore, our quarterly results are not necessarily indicative ofresults that may be achieved for the full fiscal year. Factors influencingrelative sales variability in addition to those noted above include thefrequency and popularity of advertising and promotions, the relative saleslevel of new and closed locations, holidays and weather.

 

23

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**Results of Operations**

**(Unaudited)**

 

** **
| **(in Thousands)**                              | ** ** | **84 Days Ended  January 26,  2006** | ** ** | **91 Days Ended  January 27,  2005** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
|                                            |       |                                 |       |                                 |       |
| Revenues:                                       |       |                                 |       |                                 |       |
| Restaurant operations                           |       | $                                    | 104,126    |                                 | $          | 104,523 |   |
| Franchise operations                            |       | 1,166                                |       | 1,229                                |       |
| Manufacturing operations                        |       | 7,012                                |       | 9,583                                |       |
|                                            |       | 112,304                              |       | 115,335                              |       |
| Costs and expenses:                             |       |                                 |       |                                 |       |
| Restaurant costs:                               |       |                                 |       |                                 |       |
| Food                                            |       | 28,317                               |       | 28,543                               |       |
| Labor                                           |       | 32,941                               |       | 32,240                               |       |
| Other operating expenses                        |       | 30,127                               |       | 27,766                               |       |
| Franchise operating expenses                    |       | 483                                  |       | 511                                  |       |
| Manufacturing operating expenses                |       | 7,513                                |       | 9,251                                |       |
| General and administrative expenses             |       | 5,821                                |       | 6,607                                |       |
| Transaction expenses                            |       | —                               |       | 15                                   |       |
| Asset impairments                               |       | 308                                  |       | —                               |       |
| Management fees                                 |       | 196                                  |       | 196                                  |       |
|                                            |       | 105,706                              |       | 105,129                              |       |
| Operating profit                                |       | 6,598                                |       | 10,206                               |       |
| Interest expense                                |       | (6,939                               | )          | (6,978                               | )          |
| Other income, net                               |       | 171                                  |       | 88                                   |       |
| Income before income taxes                      |       | (170                                 | )          | 3,316                                |       |
| Provision for income taxes (benefits)           |       | (235                                 | )          | 1,047                                |       |
| Net income                                      |       | 65                                   |       | 2,269                                |       |
| Preferred stock dividends and accretion         |       | (2,185                               | )          | (2,047                               | )          |
| Net income attributable to common  stockholders |       | $                                    | (2,120     | )                                    | $          | 222 |   |

 
| ** **                                      | ** ** | **84 Days Ended  January 26,  2006** | ** ** | **91 Days Ended  January 27,  2005** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
|                                            |       |                                 |       |                                 |       |
| Revenues:                                       |       |                                 |       |                                 |       |
| Restaurant operations                           |       | 92.7                                 | %          | 90.6                                 | %          |
| Franchise operations                            |       | 1.0                                  |       | 1.1                                  |       |
| Manufacturing operations                        |       | 6.3                                  |       | 8.3                                  |       |
|                                            |       | 100.0                                |       | 100.0                                |       |
| Costs and  expenses:                            |       |                                 |       |                                 |       |
| Restaurant costs:                               |       |                                 |       |                                 |       |
| Food                                            |       | 25.2                                 |       | 24.7                                 |       |
| Labor                                           |       | 29.3                                 |       | 28.0                                 |       |
| Other operating expenses                        |       | 26.8                                 |       | 24.1                                 |       |
| Franchise operating expenses                    |       | 0.4                                  |       | 0.4                                  |       |
| Manufacturing operating expenses                |       | 6.7                                  |       | 8.0                                  |       |
| General and administrative expenses             |       | 5.2                                  |       | 5.7                                  |       |
| Transaction expenses                            |       | 0.0                                  |       | 0.0                                  |       |
| Asset impairments                               |       | 0.3                                  |       | —                               |       |
| Management fees                                 |       | 0.2                                  |       | 0.2                                  |       |
|                                            |       | 94.1                                 |       | 91.1                                 |       |
| Operating  profit                               |       | 5.9                                  |       | 8.9                                  |       |
| Interest  expense                               |       | (6.2                                 | )          | (6.1                                 | )          |
| Other  income, net                              |       | 0.1                                  |       | 0.1                                  |       |
| Income  before income taxes                     |       | (0.2                                 | )          | 2.9                                  |       |
| Provision  for income taxes (benefits)          |       | (0.2                                 | )          | 0.9                                  |       |
| Net income                                      |       | 0.0                                  |       | 2.0                                  |       |
| Preferred  stock dividends and accretion        |       | (1.9                                 | )          | (1.8                                 | )          |
| Net income  attributable to common stockholders |       | (1.9                                 | )%         | 0.2                                  | %          |

 

24

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**First Quarter of Fiscal 2006 Compared to First Quarter of Fiscal 2005**

 

***Total revenues***decreased by $3.0 million, or 2.6%, to $112.3 million in fiscal 2006’s firstquarter, from $115.3 million for the same period in fiscal 2005. The decreasewas primarily due to seven additional days in the first quarter of fiscal 2005,offset by an average increase of 18 new units. When calculated on a comparative84 day basis, same unit sales decreased 0.1%. For the same comparable period, VillageInn same unit sales increased 0.2% and Bakers Square same unit sales decreased 0.3%.Average guest spending increased 3.0% at Village Inn and 5.6% at Bakers Squarein the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005when calculated on the comparative 84 day basis. Third party pie sales decreased$2.6 million, or 27.1%, to $7.0 million primarily due to the additional sevendays in fiscal 2005 including a high volume sales week related to holiday piedeliveries and due to lower than expected outside sales during the fiscal 2006holiday season. Restaurant sales for the additional seven days in fiscal 2005were $7.5 million and third party pie sales were $1.5 million.

 

***Food costs***decreased by $0.2 million, or 0.7%, to $28.3 million in the first quarter of fiscal2006, from $28.5 million for the first quarter of fiscal 2005. Food costs as apercentage of total revenues increased to 25.2% for the first quarter of fiscal2006 from 24.7% in the first quarter of fiscal 2005, but as a percentage ofrestaurant revenues decreased slightly to 27.2% for the first quarter of fiscal2006 from 27.3% for the first quarter of fiscal 2005.

 

***Labor costs***increased by $0.7 million, or 2.2%, to $32.9 million in the first quarter of fiscal2006, from $32.2 million for the first quarter of fiscal 2005. Labor costs as apercentage of total revenues increased to 29.3% for the first quarter of fiscal2006 from 28.0% for the first quarter of fiscal 2005, but as a percentage of restaurantrevenues increased to 31.6% from 30.8% over these periods. The majority of theincrease is related to the increases in minimum wage and the cost of benefits.

 

***Other operatingexpenses*** increased by $2.3 million, or 8.3%, to $30.1million in the first quarter of fiscal 2006 from $27.8 million for the firstquarter of fiscal 2005. Other operating expenses as a percentage of totalrevenues increased to 26.8% for the first quarter of fiscal 2006 from 24.1% forthe first quarter of fiscal 2005, but as a percentage of restaurant revenues increasedto 28.9% from 26.6% over these periods. This increase was primarily driven byincreases in utility costs, advertising costs and preopening expensesassociated with our new restaurants.

 

***General andadministrative expenses*** decreased $0.8 million, or12.1%, to $5.8 million for the first quarter of fiscal 2006 from $6.6 millionfor the first quarter of fiscal 2005. The decrease resulted primarily from adecrease in both legal fees and legal settlement costs. As a percentage of totalrevenues, general and administrative expenses were 5.2% in the first quarter offiscal 2006 and 5.7% in the first quarter of fiscal 2005.

 

***Operating profit***decreased by $3.6 million, or 35.3%, to $6.6 million in the first quarter of fiscal2006, from $10.2 million for the first quarter of fiscal 2005. Operating profitas a percentage of total revenues for the first quarter of fiscal 2006 decreasedto 5.9% from 8.9% over the first quarter of fiscal 2005.

 

***Interest expense***decreased slightly to $6.9 million in the first quarter of fiscal 2006, from $7.0million for the first quarter of fiscal 2005. Interest expense as a percentageof total revenues remained constant over these periods.

 

25

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***Provision for incometaxes***for the first quarter of fiscal 2006 was abenefit of $0.2 million, compared to a provision of $1.0 million for the firstquarter of fiscal 2005. The effective tax rate was (138.2%) for the firstquarter of fiscal 2006 compared to 31.6% in fiscal 2005’s first quarter. Theprovisions differ from our statutory rate of 39.9% due to general businesscredits that we earn from FICA taxes paid on employee tips, partially offset bynondeductible amortization related to franchise rights.

 

***Net income***decreasedby $2.2 million to $0.1 million in the first quarter of fiscal 2006, from $2.3million in the first quarter of fiscal 2005. Net income as a percentage oftotal revenues decreased to 0% from 2.0% over these periods.

 

***Preferred stock dividendsand accretion*** increased by $0.2 million to $2.2million in fiscal 2006 from $2.0 million for fiscal 2005 as a result of thecompounding effect of unpaid preferred stock dividends.

 

**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 has historically been sufficient tofinance continuing operations and meet normal debt service requirements. However,we are highly leveraged and our ability to repay our debt borrowings atmaturity is likely to depend in part on our ability to refinance the debt whenit matures, which will be contingent on our continued successful operation ofthe business as well as other factors beyond our control, including the debtand capital market conditions at that time.

 

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

 

For the balance of fiscal 2006, we anticipate capital expenditures andnet build-to-suit construction (as discussed below) of approximately $22million, reflecting further acceleration of our new unit growth. Of thisamount, $9 million is expected to be spent on new store construction, $7million for remodels and the remainder on capital maintenance and other supportrelated projects. We currently expect to open an estimated 33 to 37 new storesin fiscal 2006, including the four franchise units that we acquired and the sixunits that we opened in the first quarter.

 

26

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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, wegenerally are responsible for the construction of the restaurant and remittingpayments to the contractors on the projects, which are subsequently reimbursedby the property owner. These amounts advanced and subsequently reimbursed arenot included in the anticipated capital spending totals above. On January 26,2006, we had outstanding receivables of $4.6 million relating to these types ofagreements. In certain of these agreements, we are obligated to purchase theproperty in the event that we are unable to complete the construction within aspecified time frame, and are also responsible for cost overruns abovespecified amounts.

 

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

 

On April 14, 2004, we completed a private placement of $126.5 aggregateprincipal amount of 101⁄2% senior unsecured notes maturing on April 15, 2011. Thenotes were issued at a discounted price of 98.791% of face value, resulting innet proceeds before transaction expenses of $125.0 million. The seniorunsecured notes were issued by VICORP Restaurants, Inc. and are guaranteed byVI Acquisition Corp. and our subsidiary Village Inn Pancake House ofAlbuquerque, 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 January 26, 2006, wehad issued letters of credit aggregating $7.4 million and had no borrowingsoutstanding under the senior secured revolving credit facility. The seniorsecured revolving credit facility permits borrowings equal to the lesser of (a)$30.0 million and (b) 1.2 times trailing twelve months Adjusted EBITDA (asdefined in the senior secured credit agreement) minus the original amount ofthe new senior secured term loan. Under this formula, as of January 26, 2006,we had the ability to borrow the full $30 million, less the amount ofoutstanding letters of credit, under the senior secured revolving creditfacility, or $22.6 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 new senior securedcredit agreement. Both facilities are secured by a lien on all of the assets ofVICORP Restaurants, Inc., and guaranteed by VI Acquisition Corp. and oursubsidiary Village Inn Pancake House of Albuquerque, Inc., the guarantees alsosecured by the pledge of all of the outstanding capital stock of VICORPRestaurants, Inc. 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.

 

27

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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 hedging agreements.In addition, our new senior secured credit facility requires us to maintain orcomply with a maximum total leverage ratio, a minimum interest coverage ratioand a maximum capital expenditures limitation. As of January 26, 2006, we werein compliance with these requirements.

 

We are subject to capital lease obligations related to two of ourleased properties. The principal component of our capital lease obligations was$0.2 million as of January 26, 2006. These capital leases have expiration datesranging from November 2008 to June 2011.

 

We are the prime lessee under various operating leases for land,building and equipment for Company-operated and franchised restaurants, pieproduction facilities and locations subleased to non-affiliated first parties.These leases have initial terms ranging from 15 to 30 years and, in mostinstances, provide for renewal options ranging from five to 20 years. Theseleases expire at various dates through November 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 $2.2 million asof January 26, 2006.

 

28

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As of January 26, 2006, our commitments with respect to the aboveobligations were as follows (in millions):

 
| ** **                                       | ** ** | **Payments due by periods** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **Total**                   | ** ** | **Less than   one year** | ** ** | **1-3   years** | ** ** | **3-5   years** | ** ** | **More than 5   years** | ** ** |
| Senior secured credit facility                   |       | $                           | 15.0       |   | $ | — |   | $ | — |   | $ | 15.0 |   | $ | — |   |
| 10-1/2% senior unsecured notes                   |       | 126.5                       |       | — |   | — |   | — |   | 126.5 |   |
| Total notes payable                              |       | 141.5                       |       | — |   | — |   | 15.0 |   | 126.5 |   |
| Capital lease obligations(1) (2)            |       | 0.3                         |       | 0.1 |   | 0.1 |   | 0.1 |   | 0.0 |   |
| Operating lease obligations(2)                   |       | 185.0                       |       | 19.8 |   | 36.2 |   | 29.9 |   | 99.1 |   |
| Deemed landlord financing liability (1) (2) |       | 346.0                       |       | 14.1 |   | 28.5 |   | 29.3 |   | 274.1 |   |
| Letters of credit (3)                            |       | 7.4                         |       | 7.4 |   | — |   | — |   | — |   |
| Purchase commitments(4)                          |       | 12.4                        |       | 12.4 |   | — |   | — |   | — |   |
| Total                                            |       | $                           | 692.6      |   | $ | 53.8 |   | $ | 64.8 |   | $ | 74.3 |   | $ | 499.7 |   |

 

----

(1)          Amountspayable under capital leases and the deemed landlord financing liabilityrepresent gross lease payments, including both deemed principal and imputedinterest components.

 

(2)          Manyof our leases and financing obligations contain provisions that requireadditional rent payments contingent on sales performance and the payment ofcommon area maintenance charges and real estate taxes. Amounts in this table donot reflect any of these additional amounts.

 

 (3)        We haveletters of credit outstanding primarily to guarantee performance underinsurance contracts. The letters of credit are irrevocable and have one-yearrenewable terms.

 

(4)          Wehave commitments under contracts for the purchase of property and equipment. Portionsof such contracts not completed at January 26, 2006 as noted in the table abovewere not reflected as assets or liabilities in our consolidated financialstatements.

 

**Sources and uses ofcash**

 

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

 
| ** **                                            | ** ** | **84 Days  Ended  January 26,  2006** | ** ** | **91 Days  Ended  January 27,  2005** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
|                                                  |       |                                  |       |                                  |       |
| Net cash provided by operating activities             |       | $                                     | 13.0       |                                  | $          | 12.9 |   |
| Net cash used in investing activities                 |       | (9.9                                  | )          | (4.9                                  | )          |
| Net cash used in financing activities                 |       | (3.4                                  | )          | (0.9                                  | )          |
| Net increase (decrease) in cash and cash  equivalents |       | (0.3                                  | )          | 7.1                                   |       |
|                                                       |            |                                       |            |                                       |            |  |  |

 

***Operating activities***

 

For the first quarter of fiscal 2006, cash flows from operatingactivities increased $0.1 million compared to the first quarter of fiscal 2005.The increase resulted primarily from increased collections on receivables andreduction of inventory levels, partially offset by payments related to newstore construction.

 

29

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***Investing activities***

 

Our capital expenditures, excluding amounts related to assets underfinancing obligations, for the first quarters of fiscal 2006 and 2005 werecomprised of the following (in millions):

 
| ** **                                   | ** ** | **84 days   Ended   January 26,   2006** | ** ** | **91 days   Ended   January 27,   2005** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
|                                         |       |                                     |       |                                     |       |
| New store  construction                      |       | $                                        | 2.1        |                                     | $          | 0.8 |   |
| Existing  store remodel and refurbishment    |       | 0.4                                      |       | 0.6                                      |       |
| Store  capital maintenance                   |       | 1.3                                      |       | 1.0                                      |       |
| Pie production  facility capital maintenance |       | 0.1                                      |       | 0.2                                      |       |
| Corporate  related                           |       | 0.1                                      |       | 0.2                                      |       |
| Purchase of  property and equipment          |       | $                                        | 4.0        |                                     | $          | 2.8 |   |

 

In addition tothe capital expenditures noted above, we spent $5.2 million for assets underdeemed finance liability during the first quarter of fiscal 2006 compared to$2.1 million in the first quarter of fiscal 2005. We opened ten new restaurantsin the first quarter of fiscal 2006, including the four units acquired from afranchisee and opened three new restaurants in the first quarter fiscal 2005.However, we also had an additional fifteen locations under construction at theend of the first quarter of fiscal 2006.

 

***Financing activities***

 

We used cash in financing activities of $3.4 million during the firstquarter of fiscal 2006, consisting principally of the repayment of all $6.7million of outstanding borrowings under our revolving line of credit atNovember 3, 2005, payments for the repurchase of stock of $0.7, partiallyoffset by $4.1 million of proceeds from deemed landlord financing transactions.

 

We used cash in financing activities of $0.9 million during the firstquarter of fiscal 2005, consisting principally of the repayment of all $1.4million of outstanding borrowings under our revolving line of credit at October28, 2004, partially offset by $0.5 million of proceeds from deemed landlord financingtransactions.

 

30

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**Cashmanagement**

 

We havehistorically funded the majority of our capital expenditures with cash providedby operating activities. We have on occasion obtained, and may in the future obtain,capitalized lease financing for certain expenditures related to equipment. Ourinvestment requirements for new restaurant development include requirements foracquisition of land, building and equipment. Historically we have eitheracquired all of these assets for cash, or purchased building and equipmentassets for cash and acquired a leasehold interest in land. We have entered intosale-leaseback arrangements for many of the land and building assets that wehave purchased in the past, many of which have been accounted for as financingtransactions. Since the initial net cash investment required for leased unitsis significantly lower than for owned properties, we intend to focus on leasingsites for future growth so that we only have to fund the equipment portion ofour new restaurant capital costs from our cash flows. We believe that this willreduce our upfront cash requirements associated with new restaurant growth andenable us to increase our return on these investments, although it will resultin significant long term obligations under either operating or capital leases.

 

### **Item 3. QuantitativeAnd Qualitative Disclosures About Market Risk**

### ** **

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

 

We are subjectto changes in interest rates on borrowings under our senior secured creditfacility that bear interest at floating rates. As of January 26, 2006, $15.0million, or 10.7% of our total debt and capitalized lease obligations of $140.6****million, bears interest at a floating rate.A hypothetical one hundred basis point increase in interest rates for ourvariable rate borrowings as of January 26, 2006, would increase our futureinterest expense by approximately $0.2 million per year. This sensitivityanalysis does not factor in potential changes in the level of our variableinterest rate borrowings, or any actions that we might take to mitigate ourexposure to changes in interest rates.

 

Many of the ingredients purchased for use in the products sold to ourguests are subject to unpredictable price volatility outside of our control. Wetry to manage this risk by entering into selective short-term agreements forthe products we use most extensively. Also, we believe that our commodity costrisk is diversified as many of our food ingredients are available from severalsources and we have the ability to modify recipes or vary our menu itemsoffered. Historically, we have also been able to increase certain menu pricesin response to food commodity price increases and believe the opportunity mayexist in the future. To compensate for a hypothetical price increase of 10% forfood ingredients, we would need to increase prices charged to our guests by anaverage of approximately 2.7%. We have not historically used financialinstruments to hedge our commodity ingredient prices.

 

31

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**Item 4. Controls and Procedures**

 

### **Evaluation ofDisclosure Controls and Procedures**

### ** **

Within the 84-day period prior tothe filing date of this report, our management, under the supervision of ourChief Executive Officer and Chief Financial Officer, carried out an evaluationof the effectiveness of the design and operation of our disclosure controls andprocedures pursuant to Rules 13a-14 and 15d-14 under the Securities ExchangeAct of 1934 (the “Exchange Act”), as amended. Based upon their evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective in alerting them timely tomaterial information required to be included in our Exchange Act filings. Therehave not been any significant changes in our internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof the evaluation.

 

### **Limitations onthe Effectiveness of Controls**

### ** **

A control system, no matter howwell designed and operated, can provide only reasonable, not absolute,assurance that the control system’s objectives will be met. Further, the designof a control system must reflect the fact that there are resource constraints,and the benefits of controls must be considered relative to their costs.Because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that all control issues and instancesof fraud, if any, within the Company have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty, that breakdowns can occur because of simple error or mistake, and that controlscan be circumvented by the acts of individuals or groups. Because of theinherent limitations in a cost-effective control system, misstatements due toerror or fraud may occur and not be detected.

 

### **PART II – OTHER INFORMATION**

### ** **

**Item1. 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 ofthese matters will not have a material adverse effect on our consolidatedfinancial position or results of operations.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

Not applicable.

 

**Item 3. Defaults Upon Senior Securities**

 

Not applicable.

 

32

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

 

Not applicable.

 

**Item5. Other Information**

 

Not applicable

 

**Item 6. Exhibits**

 

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

 

10.1                           Equity Purchase Agreementdated April 11, 2005 between VI Acquisition Corp. and Anthony Carroll.

 

10.2                           Letter Agreement dated as of March 10, 2006between VI Acquisition Corp. and Anthony Carroll.

 

14.1                           Business Conduct Policy

 

31.1                           Certification by our ChiefExecutive Officer with respect to our Form 10-Q for the quarterly period endedJanuary 26, 2006, pursuant to Rule 13a-14 or 15d-14 of the Securities Exchange Actof 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                           Certification by our ChiefFinancial Officer with respect to our Form 10-Q for the quarterly period endedJanuary 26, 2006, pursuant to Rule 13a-14 or 15d-14 of the Securities ExchangeAct of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

 

32.1                           Certifications by our ChiefExecutive Officer and Chief Financial Officer with respect to our Form 10-Q forthe quarterly period ended January 26, 2006, pursuant to 18 U.S.C. Section1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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

 

### **Duringthe first quarter of fiscal 2006 ended January 26, 2006, we filed the followingreports on Form 8-K:**

### ** **

### **Currentreport on Form 8-K on November 8, 2005, announcing the departure of Mr. RobertKaltenbach.**

### ** **

### **Currentreport on Form 8-K on December 14, 2005, announcing the agreement to settle theclaims against Midway Investors Holdings Inc.**

 

33

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**SIGNATURES**

 

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

 
|                 | VICORP Restaurants, Inc.                                  |
|----------------------|-----------------------------------------------------------|
|                 |                                                      |
| Date: March 13, 2006 |                                                      |
|                 |                                                      |
|                 | /s/ Debra Koenig                                          |   |
|                 | Debra Koenig                                              |
|                 | Chief Executive Officer                                   |
|                 | (Principal Executive Officer)                             |
|                 |                                                      |
| Date: March 13, 2006 |                                                      |
|                 |                                                      |
|                 | /s/ Anthony Carroll                                       |   |
|                 | Anthony Carroll                                           |
|                 | Chief Financial Officer and Chief   Adminstrative Officer |
|                 | (Principal Financial and Accounting Officer)              |

 

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