**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 
| **(Mark One)** | ** ** | ** **                                                                                        |
|----------------|------------|---------------------------------------------------------------------------------------------------|
| **ý**     | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **     | ** ** | ** **                                                                                        |
| ** **     | ** ** | **For the quarterly period ended June 28, 2004**                                                  |

 

**OR**

 
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                     |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                             |
| ** ** | ** ** | **For the transition period from                     to                   ** |

 

**American Restaurant Group, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                    | ** ** | **33-48183**              | ** ** | **33-0193602**                        |
|-----------------------------------------------------------------|------------|---------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (Commission File  Number) |       | (I.R.S. employer  identification no.) |

 

**4410 ElCamino Real, Suite 201**

**Los Altos,CA  94022**

**(650) 949-6400**

(Address and telephone number of principalexecutive offices)

 

Former name, former address, and formerfiscal yearif changed since last report.

 

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

Yes ý    Noo

 

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

Yes o    Noý

 

The number of outstanding shares of the Company’s Common Stock (onecent par value) as of August 2, 2004 was 102,442.

 

 

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**AMERICAN RESTAURANT GROUP, INC.**

 

**INDEX**

 
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                  |   |
|--------------|---------------------------------------------------------------------------------------------|--------|
|         |                                                                                        |   |
| ITEM 1.      | FINANCIAL  STATEMENTS:                                                                      |   |
|         |                                                                                        |   |
|         | Consolidated Condensed Balance Sheets                                                       |   |
|         |                                                                                        |   |
|         | Consolidated Condensed Statements of  Operations                                            |   |
|         |                                                                                        |   |
|         | Consolidated Condensed Statements of Cash  Flows                                            |   |
|         |                                                                                        |   |
|         | Notes to Consolidated Condensed 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 3.      | DEFAULTS UPON SENIOR SECURITIES                                                             |   |
|         |                                                                                        |   |
| ITEM 6.      | EXHIBITS  AND REPORTS ON FORM 8-K                                                           |   |

 

2

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**PART I.****                 FINANCIALINFORMATION**

 

**ITEM 1.****                  FINANCIALSTATEMENTS:**

 

AMERICAN RESTAURANT GROUP, INC. ANDSUBSIDIARIES

 

CONSOLIDATED CONDENSEDBALANCE SHEETS

 

DECEMBER 29, 2003 AND JUNE 28, 2004

 
| ** **                           | ** ** | **December 29,  2003** | ** ** | **(Unaudited)  June 28,  2004** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **(dollars in thousands)**  | ** ** |
| ASSETS                               |       |                        |       |                            |       |
|                                 |       |                        |       |                            |       |
| CURRENT ASSETS:                      |       |                        |       |                            |       |
| Cash                                 |       | $                           | 2,068      |                            | $          | 1,444 |   |
| Rebates and other receivables, net   |       | 2,060                       |       | 1,420                           |       |
| Inventories                          |       | 2,823                       |       | 2,752                           |       |
| Prepaid expenses                     |       | 922                         |       | 1,429                           |       |
|                                 |       |                        |       |                            |       |
| Total current assets                 |       | 7,873                       |       | 7,045                           |       |
|                                 |       |                        |       |                            |       |
| PROPERTY AND EQUIPMENT, net:         |       |                        |       |                            |       |
| Land and land improvements           |       | 571                         |       | 512                             |       |
| Buildings and leasehold improvements |       | 34,614                      |       | 32,796                          |       |
| Fixtures and equipment               |       | 11,240                      |       | 10,335                          |       |
| Property held under capital leases   |       | 703                         |       | 613                             |       |
| Construction in progress             |       | 201                         |       | 154                             |       |
|                                 |       |                        |       |                            |       |
| Net property and equipment           |       | 47,329                      |       | 44,410                          |       |
|                                 |       |                        |       |                            |       |
| OTHER ASSETS:                        |       |                        |       |                            |       |
| Goodwill, net                        |       | 8,287                       |       | 8,287                           |       |
| Intangible assets, net               |       | 6,919                       |       | 5,834                           |       |
| Other                                |       | 2,414                       |       | 2,404                           |       |
|                                 |       |                        |       |                            |       |
| Net other assets                     |       | 17,620                      |       | 16,525                          |       |
|                                 |       |                        |       |                            |       |
| Total assets                         |       | $                           | 72,822     |                            | $          | 67,980 |   |

 

1

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| ** **                                                                                                                                      | ** ** | **December 29,  2003** | ** ** | **(Unaudited)  June 28,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                      | ** ** | **(dollars in thousands)**  | ** ** |
| CURRENT LIABILITIES:                                                                                                                            |       |                        |       |                            |       |
| Accounts payable                                                                                                                                |       | $                           | 8,659      |                            | $          | 6,493 |   |
| Accrued liabilities                                                                                                                             |       | 3,439                       |       | 2,069                           |       |
| Current portion of store-closure reserve                                                                                                        |       | 991                         |       | 419                             |       |
| Current portion of SRG Group bankruptcies  reserve                                                                                              |       | 4,239                       |       | 4,691                           |       |
| Gift-certificate liability                                                                                                                      |       | 1,890                       |       | 1,262                           |       |
| Gift-card liability                                                                                                                             |       | 7,568                       |       | 4,891                           |       |
| Self-insurance reserve                                                                                                                          |       | 3,267                       |       | 3,532                           |       |
| Accrued interest                                                                                                                                |       | 3,391                       |       | 12,926                          |       |
| Accrued employee costs                                                                                                                          |       | 3,929                       |       | 4,114                           |       |
| Accrued occupancy costs                                                                                                                         |       | 5,415                       |       | 5,944                           |       |
| Current portion of obligations under  capital leases                                                                                            |       | 218                         |       | 198                             |       |
| Current portion of long-term debt                                                                                                               |       | 6,158                       |       | 166,831                         |       |
|                                                                                                                                            |       |                        |       |                            |       |
| Total current liabilities                                                                                                                       |       | 49,164                      |       | 213,370                         |       |
|                                                                                                                                            |       |                        |       |                            |       |
| LONG-TERM LIABILITIES:                                                                                                                          |       |                        |       |                            |       |
| Obligations under capital leases                                                                                                                |       | 1,214                       |       | 1,112                           |       |
| Store-closure reserve                                                                                                                           |       | 6,051                       |       | 6,018                           |       |
| SRG Group bankruptcies reserve                                                                                                                  |       | 3,685                       |       | 2,825                           |       |
| Long-term debt, net of unamortized discount                                                                                                     |       | 162,528                     |       | 1,019                           |       |
|                                                                                                                                            |       |                        |       |                            |       |
| Total long-term liabilities                                                                                                                     |       | 173,478                     |       | 10,974                          |       |
|                                                                                                                                            |       |                        |       |                            |       |
| DEFERRED GAIN ON SALE-LEASEBACK                                                                                                                 |       | 3,586                       |       | 3,485                           |       |
|                                                                                                                                            |       |                        |       |                            |       |
| COMMON STOCKHOLDERS’ DEFICIT:                                                                                                              |       |                        |       |                            |       |
| Common stock, $0.01 par value; 1,000,000  shares authorized; 102,442 shares issued and outstanding at December 29,  2003 and June 28, 2004 |       | 1                           |       | 1                               |       |
| Paid-in capital                                                                                                                                 |       | 81,893                      |       | 81,893                          |       |
| Accumulated deficit                                                                                                                             |       | (235,300                    | )          | (241,743                        | )          |
|                                                                                                                                            |       |                        |       |                            |       |
| Total common stockholders’ deficit                                                                                                         |       | (153,406                    | )          | (159,849                        | )          |
|                                                                                                                                            |       |                        |       |                            |       |
| Total liabilities and common stockholders’  deficit                                                                                        |       | $                           | 72,822     |                            | $          | 67,980 |   |

 

The accompanying notes are an integral partof these consolidated condensed statements.

 

2

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AMERICAN RESTAURANT GROUP, INC. ANDSUBSIDIARIES

 

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

 

FOR THE THIRTEEN WEEKS AND THE TWENTY-SIXWEEKS ENDED JUNE 30, 2003 AND JUNE 28, 2004

(UNAUDITED)

 

 
| ** **                                     | ** ** | **Thirteen Weeks Ended**   | ** ** | **Twenty-Six Weeks Ended** | ** ** |
|------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                     | ** ** | **June 30,  2003**         | ** ** | **June 28,  2004**         | ** ** | **June 30,  2003** | ** ** | **June 28,  2004** | ** ** |
| ** **                                     | ** ** | **(dollars in thousands)** | ** ** | **(dollars in thousands)** | ** ** |
| REVENUES                                       |       | $                          | 71,176     |                       | $          | 70,224 |   | $ | 144,915 |   | $ | 144,749 |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| RESTAURANT COSTS:                              |       |                       |       |                       |       |   |   |   |   |
| Food and beverage                              |       | 23,791                     |       | 26,383                     |       | 46,832 |   | 52,201 |   |
| Payroll                                        |       | 22,283                     |       | 22,324                     |       | 44,383 |   | 45,670 |   |
| Direct operating                               |       | 16,664                     |       | 14,903                     |       | 35,699 |   | 30,380 |   |
| Depreciation and amortization                  |       | 1,817                      |       | 1,801                      |       | 3,632 |   | 3,560 |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| GENERAL AND ADMINISTRATIVE EXPENSES            |       | 2,377                      |       | 2,581                      |       | 5,144 |   | 5,460 |   |
| Loss on asset impairment                       |       | —                     |       | 2,366                      |       | — |   | 2,366 |   |
| Restructuring expense                          |       | —                     |       | 291                        |       | — |   | 291 |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| Operating profit (loss)                        |       | 4,244                      |       | (425                       | )          | 9,225 |   | 4,821 |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| INTEREST EXPENSE, net                          |       | 5,346                      |       | 5,714                      |       | 10,691 |   | 11,256 |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| Loss before provision for income               |       | (1,102                     | )          | (6,139                     | )          | (1,466 | ) | (6,435 | ) |
|                                           |       |                       |       |                       |       |   |   |   |   |
| PROVISION FOR INCOME TAXES                     |       | 46                         |       | 8                          |       | 48 |   | 8 |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| Loss from Continuing Operations                |       | (1,148                     | )          | (6,147                     | )          | (1,514 | ) | (6,443 | ) |
|                                           |       |                       |       |                       |       |   |   |   |   |
| Loss from Discontinued Operations              |       | (69                        | )          | —                     |       | (69 | ) | — |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| Net Loss                                       |       | (1,217                     | )          | (6,147                     | )          | (1,583 | ) | (6,443 | ) |
|                                           |       |                       |       |                       |       |   |   |   |   |
| PREFERRED STOCK DIVIDENDS, ISSUED AND  ACCRUED |       | 2,957                      |       | —                     |       | 5,812 |   | — |   |
|                                           |       |                       |       |                       |       |   |   |   |   |
| Loss to common stockholders                    |       | (4,174                     | )          | (6,147                     | )          | $ | (7,395 | ) | $ | (6,443 | ) |
|                                                |            |                            |            |                            |            |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedcondensed statements.

 

3

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AMERICAN RESTAURANT GROUP, INC. ANDSUBSIDIARIES

 

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

 

FOR THE TWENTY-SIX WEEKS ENDED MARCH 31,2003 AND JUNE 28, 2004

 

(UNAUDITED)

 
| ** **                                                                                  | ** ** | **June 30, 2003**          | ** ** | **June 28, 2004** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------|------------|
| ** **                                                                                  | ** ** | **(dollars in thousands)** | ** ** |
| CASH FLOWS FROM CONTINUING OPERATING  ACTIVITIES:                                           |       |                       |       |              |       |
|                                                                                        |       |                       |       |              |       |
| Net loss from continuing operating  activities                                              |       | $                          | (1,514     | )                 | $          | (6,443 | ) |
| Adjustments to reconcile net loss to net  cash provided by continuing operating activities: |       |                       |       |              |       |
| Depreciation and amortization                                                               |       | 3,632                      |       | 3,560             |       |
| Amortization of deferred gain on  sale/leaseback                                            |       | (101                       | )          | (101              | )          |
| Amortization of discount on New Notes                                                       |       | 933                        |       | 933               |       |
| Loss on impairment                                                                          |       | —                     |       | 2,366             |       |
| Decrease in assets                                                                          |       | 248                        |       | 204               |       |
| Increase in current liabilities                                                             |       | 869                        |       | 2,554             |       |
|                                                                                        |       |                       |       |              |       |
| Net cash provided by continuing operating  activities                                       |       | 4,067                      |       | 3,073             |       |
|                                                                                        |       |                       |       |              |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                       |       |                       |       |              |       |
| Capital expenditures                                                                        |       | (2,150                     | )          | (1,806            | )          |
|                                                                                        |       |                       |       |              |       |
| Net cash used in investing activities                                                       |       | (2,150                     | )          | (1,806            | )          |
|                                                                                        |       |                       |       |              |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                       |       |                       |       |              |       |
| Payments on indebtedness                                                                    |       | (3,429                     | )          | (1,769            | )          |
| Payments on capital-lease obligations                                                       |       | (441                       | )          | (122              | )          |
|                                                                                        |       |                       |       |              |       |
| Net cash used in financing activities                                                       |       | (3,870                     | )          | (1,891            | )          |
|                                                                                        |       |                       |       |              |       |
| NET DECREASE IN CASH FROM CONTINUING  OPERATIONS                                            |       | (1,953                     | )          | (624              | )          |
|                                                                                        |       |                       |       |              |       |
| NET DECREASE IN CASH FROM DISCONTINUED  OPERATIONS                                          |       | (69                        | )          | —            |       |
|                                                                                        |       |                       |       |              |       |
| NET CHANGE IN CASH, CURRENT PERIOD                                                          |       | (2,022                     | )          | (624              | )          |
|                                                                                        |       |                       |       |              |       |
| CASH, at beginning of period                                                                |       | 4,773                      |       | 2,068             |       |
|                                                                                        |       |                       |       |              |       |
| CASH, at end of period                                                                      |       | $                          | 2,751      |              | $          | 1,444 |   |
|                                                                                        |       |                       |       |              |       |
| Cash payments during the period:                                                            |       |                       |       |              |       |
| Interest                                                                                    |       | $                          | (9,905     | )                 | $          | (680 | ) |
| Income taxes                                                                                |       | (28                        | )          | (8                | )          |

 

The accompanying notes are an integral partof these consolidated condensed statements.

 

4

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AMERICAN RESTAURANTGROUP, INC. AND SUBSIDIARIES

NOTES TOCONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 

1.             BASIS OF PRESENTATION

 

The Consolidated Condensed Financial Statements included were prepared byAmerican Restaurant Group, Inc. without audit, in accordance with Securitiesand Exchange Commission Regulation S-X. (References to “the Company,” ‘the registrant,”  “we,” “us,” or “our” refer to AmericanRestaurant Group, Inc.)  In the opinionof our management, these Consolidated Condensed Financial Statements containall adjustments necessary to present fairly our financial position as ofDecember 29, 2003 and June 28, 2004, the results of our operations for thethirteen and twenty-six weeks ended June 30, 2003 and June 28, 2004, and ourcash flows for the twenty-six weeks ended June 30, 2003 and June 28, 2004.  Our results for an interim period are notnecessarily indicative of the results that may be expected for the year.

 

Although we believe that we included all adjustments necessary for afair presentation of the interim periods presented and that the disclosures areadequate to make the information presented not misleading, we suggest thatthese Consolidated Condensed Financial Statements be read in conjunction withthe Consolidated Financial Statements and related notes included in our annualreport on Form 10-K for the fiscal year ended December 29, 2003.

 

2.             GOING CONCERN

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. The Company is highly leveraged. The Company has historically used cash flow from operations togetherwith other liquidity sources to make required payments.  As of June 28, 2004, the Company had nofurther availability under its New Credit Facility (defined in Note 4), nofurther availability under its Junior Credit Facility (defined in Note 4), and$1.4 million in cash on hand.  TheCompany has suffered recurring losses from operations, has a negative working-capitalbalance of $206.3 million, and has a net capital deficiency of $159.8 millionas of June 28, 2004 that raise substantial doubt about its ability to continueas a going concern.  Management iscurrently evaluating alternatives for restructuring the Company’s overalloutstanding debt and the associated interest rate.  The Company does not, however, expect togenerate sufficient cash flows from operations in the future to pay fully atmaturity all of its senior debt obligations. Accordingly, the Company will need to refinance or restructure all orportions of such debt, obtain new financing, or possibly sell assets. There can be no assurance that any such plans will be successful or that futurefinancing or restructuring will be available or, if available, at a cost thatis acceptable to the Company.

 

On May 3, 2004, theCompany did not pay the $9.3 million semiannual interest payment (the “NoteInterest Default”), then due on the New Notes (defined in Note 4).  Under the provisions of the indenture governingthe New Notes, the Company had a grace period ending June 2, 2004 withinwhich to make the interest payment before there is an “Event of Default” (assuch term is defined in the indenture) that entitled the holders of the NewNotes to certain rights and remedies, including the right to accelerate theprincipal and interest due under the New Notes. In turn, under the provisions of each of the Company’s creditfacilities, the development of a right, irrespective of exercise, in theholders of the New Notes to accelerate the New Notes would cause an “Event ofDefault” (as such term is defined in each of the New Credit Facility and theJunior Credit Facility) that allows the respective lender to exercise certainrights and remedies, including acceleration, under its facility.

 

On June 1, 2004, theCompany entered into a forbearance agreement (the “Note Forbearance Agreement”)with holders in excess of  60% of the NewNotes (the “Signing Holders”) pursuant to which the Signing Holders agreed toforbear from exercising rights and remedies with respect to the Note InterestDefault.  The Note Forbearance Agreementhas been extended until September 3, 2004, subject to certain terms andconditions.  

** **

As of June 28, 2004, the Company’s cash borrowings and letters ofcredit, totaling $15.0 million, exceeded the then-available borrowing base ascalculated in the loan agreement governing the New Credit Facility.  In addition, the Company was in default ofthe New Credit Facility because of a cross-default caused by the Note InterestDefault and the Company’s failure to deliver financial statements carrying anopinion without qualifications from its auditors as required by the New CreditFacility.  

 

On August 5, 2004, the Company entered into a forbearance agreement(the “NCF Forbearance Agreement”) with the lender under the New Credit Facilitypursuant to which such lender agreed to forbear from exercising rights andremedies with respect to the certain defaults and events of default under theNew Credit Facility until September 3, 2004, subject to certain 

 

5

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terms and conditions.  Also onAugust 5, 2004, the Company increased the amount available under the New CreditFacility to $17.5 million.

 

As of June 28,2004, the Company was also in default of the Junior Credit Facility because ofa cross-default caused by the Note Interest Default and the Company’s failureto deliver financial statements carrying an opinion without qualifications fromits auditors as required by the Junior Credit Facility.

 

On August 12,2004, the Company entered into a forbearance agreement (the “Junior ForbearanceAgreement”) with the lender under the Junior Credit Facility pursuant to whichsuch lender agreed to forbear from exercising its rights and remedies withrespect to certain defaults and events of default under the Junior CreditFacility until September 3, 2004, subject to certain terms and conditions.  

 

There can beno assurances that any or all of the Note Forbearance Agreement, the NCFForbearance Agreement, or the Junior Forbearance Agreement will beextended beyond September 3, 2004 or that the Company will not need tonegotiate future forbearance agreements for any noncompliance with its debtdocuments.  

 

The Company has retained theconsulting firm of Alvarez and Marsal, Inc. to provide restructuring advisoryservices to its Board of Directors and to assist the Company in therestructuring process of its organization. The Company also has engaged investment bankers Houlihan Lokey Howard& Zukin to explore financial restructuring alternatives and assist withdiscussions with the Company’s creditors and shareholders.  Certain holders of the New Notes have formedan informal committee and have engaged a financial advisor and outside legalcounsel at the Company’s expense.  TheCompany has commenced restructuring negotiations with the committee’s advisors,the lender under the New Credit Facility, the lender under the Junior CreditFacility, and the Company’s majority shareholder group.  The Company is also in negotiations with thelessors of certain of the Company’s unfavorable leases.  There is the possibility that a restructuringmay be implemented through an out-of-court arrangement if the Company were toreach satisfactory agreements with many of the parties.  However, no restructuring agreements havebeen reached with any party, and there can be no assurance that the Companywill reach any such agreement with any particular party.   If no such agreements can be reached or ifany agreement(s) that may be reached cannot be implemented through anout-of-court transaction, the Company will likely seek protection under theUnited States Bankruptcy Code to further pursue its restructuring alternativesand/or to implement any agreement(s) that may be reached.

 

3.             OPERATIONS

 

The Company’s operations are affected by local and regional economicconditions, including competition in the restaurant industry.

 

4.             DEBT

 

On October 31, 2001, the Company consummated an exchange offer(the “Exchange”) pursuant to which the Company offered to exchange its 111⁄2%Senior Secured Notes due 2006 (the “New Notes”) for all of its $142.6 millionoutstanding 111⁄2% Senior Secured Notes due 2003 (the “Old Notes”) and anoffering (the “Offering”) of $30.0 million aggregate principal amount of NewNotes.  After the consummation of theExchange, the Offering, and related transactions (collectively, the“Refinancing”), the Company had no further payment obligations with respect toover 97.6% of the outstanding Old Notes (constituting all but $3.4 millionaggregate principal amount of the Old Notes) and assumed payment obligationsequivalent to $161.8 million of the New Notes. The Refinancing substantially eliminates debt principal payments untilNovember 2006.

 

The Company’s three wholly owned direct subsidiaries, ARG Enterprises,Inc., ARG Property Management Corporation, and ARG Terra, Inc. (collectively,the “Direct Subsidiaries”), jointly and severally guarantee, on a full andunconditional basis, the outstanding indebtedness of the Company evidenced bythe New Notes.  The Company has nomaterial assets or operations that are independent of the DirectSubsidiaries.  The Company’s non-guarantorindirect subsidiary is minor.  There areno restrictions on the ability of the Company to obtain funds from the DirectSubsidiaries by dividend or loan.

 

On May 3, 2004, the Company did not pay the $9.3 million semiannualinterest payment then due on the New Notes. Under the provisions of the indenture governing the New Notes, theCompany had a grace period ending June 2, 2004 within which to make theinterest payment before there is an “Event of Default” (as such term is definedin the indenture).  See Note 2.

 

6

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On June 1, 2004, the Company entered into the New Note ForbearanceAgreement pursuant to which the Signing Holders agreed to forbear fromexercising rights and remedies with respect to such “Event of Default.”  The New Note Forbearance Agreement has beenextended until September 3, 2004, subject to certain terms and conditions.

 

Due to the default, the long term debt related to the New Notes andJunior Credit Facility has been reclassified to current on the accompanyingbalance sheet.

 

In 2001, theCompany entered into a loan agreement with Wells Fargo Foothill, Inc. (thenknown as Foothill Capital Corporation) for a new revolving credit facility (the“New Credit Facility”).  The New CreditFacility presently provides for cash borrowings and letters of credit in anaggregate amount up to $17.5 million. The New Credit Facility provides for an unused-line fee payable monthlyin arrears, fees payable on outstanding letters of credit, as well as certainadditional fees.  Borrowings under theNew Credit Facility bear interest at the prime rate announced by Wells FargoBank, National Association plus 1.5%. The New Credit Facility terminates on December 17, 2005, and sharesin a first-priority lien on substantially all personal property and certainreal property leases.  The New CreditFacility includes certain restrictive covenants, including a requirement tomaintain certain financial ratios.  As ofJune 28, 2004, the Company had $10.7 million of letters of credit outstanding,primarily related to its self-insurance program, and $4.3 in cash borrowings,with no availability at that time under its New Credit Facility.  Such cash borrowings and letters of credit,totaling $15.0 million, exceeded the then-available borrowing base as calculatedin the loan agreement governing the New Credit Facility. 

 

On August 5,2004, the Company amended the New Credit Facility to increase the maximumamount available under the New Credit Facility to $17.5 million and to modifyboth the borrowing base and the financial covenants thereunder.  On August 5, 2004, the Company entered intothe NCF Forbearance Agreement with the lender under the New Credit Facilitypursuant to which such lender agreed to forbear from exercising rights andremedies with respect to certain defaults and events of default under the NewCredit Facility until September 3, 2004. See Note 2.

 

On October 31, 2003, the Company entered into a loan agreement fora junior credit facility (“Junior Credit Facility”) with TCW Shared OpportunityFund III, L.P., an entity related to a group of funds that constitute themajority shareholder group.  The Companyreceived proceeds of $4.6 million net of fees and costs.  The Junior Credit Facility bears an interest rateof 13% per annum.  The Junior CreditFacility expires February 24, 2006, and shares in a first-priority lien onsubstantially all personal property and certain real property leases.

 

On August 5, 2004, the Company amended the Junior Credit Facility topermit additional borrowing in amount up to $17.5 under the New Credit Facility.  On August 12, 2004, the Company entered intothe Junior Forbearance Agreement with the lender under the Junior CreditFacility pursuant to which such lender agreed to forbear from exercising itsrights and remedies with respect to certain defaults and events of defaultunder the Junior Credit Facility until September 3, 2004.  See Note 2.

 

Substantially all personal property and certain real property leases ofthe Company and its subsidiaries are pledged to senior lenders.  In connection with such indebtedness,contingent and mandatory prepayments may be required under certain specifiedconditions and events.  There are nocompensating-balance requirements.

 

7

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| ** **                                                                                                                                      | ** ** | **December 29,  2003** | ** ** | **June 28,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------|------------|
| ** **                                                                                                                                      | ** ** | **(dollars in thousands)**  | ** ** |
| New Notes, interest only due semiannually  beginning May 1, 2002 at 11.5%, principal due November 1, 2006*                                 |       | $                           | 161,774    |               | $          | 161,774 |   |
| Unamortized discount on New Notes                                                                                                               |       | (5,288                      | )          | (4,354             | )          |
| New Credit Facility, interest on borrowings  at prime rate plus 1.5%, facility expiring December 17, 2005*                                 |       | 6,087                       |       | 4,341              |       |
| Junior Credit Facility, interest only due  quarterly beginning December 31, 2003 at 13.0% interest, principal due  February 24, 2006* |       | 5,000                       |       | 5,000              |       |
| Other                                                                                                                                           |       | 1,113                       |       | 1,089              |       |
|                                                                                                                                            |       |                        |       |               |       |
|                                                                                                                                            |       | 168,686                     |       | 167,850            |       |
| Less – Current portion                                                                                                                     |       | (6,158                      | )          | (166,831           | )          |
|                                                                                                                                            |       |                        |       |               |       |
| Long-term portion                                                                                                                               |       | $                           | 162,528    |               | $          | 1,019 |   |

 

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*Because of the Event of Default, the obligation is deemed acceleratedand payable at the end of the respective forbearance agreement because it maybecome due at such time rather than at the respective maturity date absent suchacceleration.

 

Maturities of the debt (principal only) during the fiscal yearsfollowing fiscal year-end 2003 are the following (without giving effect to thedefaults described in Note 2):

 

| **(dollars  in thousands)**   | ** ** | **Principal  Payment** | ** ** |
|-------------------------------|------------|------------------------|------------|
|                          |       |                   |       |
| 2004                          |       | $                      | 6,158      |   |
| 2005                          |       | 44                     |       |
| 2006                          |       | 166,823                |       |
| 2007                          |       | 56                     |       |
| 2008                          |       | 63                     |       |
| Thereafter                    |       | 830                    |       |
|                          |       |                   |       |
| Total Loan Principal Payments |       | $                      | 173,974    |   |

 

5.             INCOME TAXES

 

The tax provision against the pre-tax income in 2003 and in 2004consisted of certain state income taxes and estimated federal income tax.  We previously established a valuationallowance against net-operating-loss carryforwards.

 

6.             SUBSIDIARY GUARANTORS

 

Separate financial statements of our subsidiaries are not included inthis report on Form 10-Q.  Thesubsidiaries are fully, unconditionally, jointly, and severally liable for ourobligations under the Company’s New Notes. Because the Company has no significant operations, the aggregate netassets, earnings, and equity (deficit) of such subsidiary guarantors aresubstantially equivalent to the net assets, earnings, and equity (deficit) ofthe Company (issuer) on a consolidated basis.

 

7.             INSURANCE

 

The Company self-insures certain risks, including medical, workers’compensation, property, and general liability, up to varying limits.  Deductible and self-insured limits havevaried historically, ranging from $0 to $1,000,000 per incident depending onthe type of risk.  The Company’s policydeductibles are $125,000 for annual medical and dental benefits perperson.  Reserves for losses areestablished on a claims-made basis plus an actuarially determined provision forincurred-but-not-reported claims and the deductible or self-insured retentionin place at the time of the loss.  Theself-insured reserves are reported on the balance sheet under Self-insurancereserve.

 

8

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8.             RECENT ACCOUNTING PRONOUNCEMENTS

 

In January 2003, the FASB issued FASB Interpretation Number(“FIN”) 46, *Consolidation of Variable Interest Entities*(“FIN 46”), which was subsequently revised in December 2003 (“FIN46R”).  FIN 46R requires avariable-interest entity to be consolidated by a company if that company is theprimary beneficiary of the entity.  A company is a primary beneficiary ifit is subject to a majority of the risk of loss from the variable-interestentity’s activities, entitled to receive a majority of the entity’s residualreturns, or both.  FIN 46R also requires disclosures aboutvariable-interest entities that a company is not required to consolidate but inwhich it has a significant variable interest. FIN 46R was applicable immediately to variable-interest entities createdafter January 31, 2003, and will be effective for all other existingentities in financial statements for periods ending after December 15,2004.  The Company has no material interest in any variable-interestentity, and does not expect the full adoption of FIN 46R to have a materialimpact on the Company’s consolidated financial condition or results ofoperations.

 

9.             ASSETIMPAIRMENT 

 

In the second quarter of2004, we recorded a total of $2.4 million in charges related to assetimpairments for four under-performing restaurants.  As required under SFAS No. 144, *“Accounting for the Impairment or Disposal ofLong-Lived Assets,”* $1.9 million in fixed assets and $0.5 million ofintangibles were written down for these locations.  The assets consisted of buildings/leaseholdimprovements, and fixtures /equipment. Fair market value of the leaseholdimprovements was determined based on discounted cash flows and the lower of thenet book value or an estimate of current liquidation value for fixtures andequipment.  

 

As discussed in Note 2, inconnection with the restructuring of the Company’s debt obligations, theCompany may seek protection under the United States Bankruptcy Code to furtherpursue its restructuring alternatives and/or to implement agreements that maybe reached.  In such an event, theCompany may elect to reject certain leases deemed unfavorable and may, inconnection thereto, have additional asset write-downs. 

 

10.           STORECLOSURE 

 

On June 20, 2004, we closedone of our locations.

 

11.           COMMITMENTSAND CONTINGENCIES

 

The Company is obligated under an employment agreement with anofficer.  The obligation under theagreement is $500,000 per year.

 

The Company has been named as defendant in various lawsuits.  Management’s opinion is that the outcome ofsuch litigation will not materially affect the Company’s financial position,results of operations, or cash flows.

 

9

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| **ITEM 2.** | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS  OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|------------|--------------------------------------------------------------------------------------------------|

 

Certain statements contained inthis Form 10-Q are forward-looking regarding cash flows from operations,restaurant openings, capital requirements, and other matters. Theseforward-looking statements involve risks and uncertainties and, consequently,could be affected by general business conditions, the impact of competition,governmental regulations, and inflation.

 

The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with the historical financial information included in theConsolidated Condensed Financial Statements.

 

**Resultsof Operations**

*Thirteen weeks ended June 30, 2003 and June 28, 2004:*

* *

*Revenues. *Total revenues decreased from$71.2 million in the second quarter of 2003 to $70.2 million in the secondquarter of 2004.  Same-store sales decreased by 0.6% in the second quarterof 2004 compared to 2003.  Of the salesdecrease, 1.6% resulted from a decrease in customer counts during the secondquarter of 2004 vs. the second quarter of 2003.  For the second quarter2004, the average check improved 0.6% compared to the second quarter2003.  Beverage sales improved 1.6% during the second quarter of 2004 vs.the second quarter of 2003.  The remaining change was a result of havingfive fewer stores operating during the quarter. There were 109 Black Angus restaurants operating as of June 30, 2003 and104 Black Angus restaurants operating as of June 28, 2004. 

 

*Food and Beverage Costs.*  As a percentageof revenues, food and beverage costs increased 4.2% from 33.4% in the secondquarter of 2003 to 37.6% in the second quarter of 2004.  Of the 4.2%increase, 3.3% was due to higher beef prices with the remainder of thedifference the result of an increase in promotional sales being a greater partof the overall sales mix.

 

*Payroll Costs.*  As a percentage ofrevenues, labor costs increased from 31.3% in the second quarter of 2003 to31.8% in the second quarter of 2004.  The increase results fromtransferring janitorial services from third-party contractors to our employees.

 

*Direct Operating Costs. *Direct operatingcosts consist of occupancy, advertising, and other expenses incurred byindividual restaurants.  Direct operating costs decreased from $16.7million in the second quarter of 2003 to $14.9 million in the second quarter of2004.  The decrease is the result of lower TV advertising expenses, thetransferring of janitorial services to our employees, and less occupancyexpenses as a result of operating fewer locations.

 

*Depreciation and Amortization.*  Depreciationand amortization consists of depreciation of fixed assets used by individualrestaurants and at the Black Angus and corporate offices, as well asamortization of intangible assets.  Depreciation and amortization remainedstable at $1.8 million in the second quarter of 2003 and 2004.

 

*General and Administrative Expenses.* General and administrative expenses increased slightly, from $2.4 million inthe second quarter of 2003 to $2.6 million in the second quarter of 2004. The increase is a result of higher legal and consulting services.

 

*Loss onAsset Impairment. *In the second quarter of 2004, we recorded a total of $2.4 million incharges related to asset impairments for four under-performingrestaurants.  As required under SFASNo. 144, *“Accounting for the Impairmentor Disposal of Long-Lived Assets,”* $1.9 million in fixed assets and$0.5 million of intangibles were written down for these locations.  The assets consisted of buildings/leaseholdimprovements, and fixtures/equipment. Fair market value was determined based on discounted cash flows of theleasehold improvements and the lower of the net book value or an estimate ofcurrent liquidation value for fixtures and equipment.

 

*Restructuring Expense*. We paid $0.3 million inthe second quarter of 2004 to advisors in connection with the possiblerestructuring of our New Notes (defined below under the segment captioned“Liquidity and Capital Resources”).

 

*Operating Profit(Loss).*  As a result ofthe above items, operating profit decreased from $4.2 million in the secondquarter of 2003 to a loss of $0.4 million in the second quarter of 2004.  

 

*InterestExpense — Net.* Our interest expense increased from $5.3 million in the second quarterof 2003 to $5.7 million in the second 

 

10

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quarter of 2004.  The increase is primarily the result of thenew Junior Credit Facility and default interest due as a result of not makingthe May 3rd interest payment on our New Notes.

 

*Twenty-Six Weeks ended June 30, 2003 and June 28, 2004*

* *

*Revenues. *Totalrevenues decreased slightly from $144.9 million in the first half of 2003 to$144.7 million in the first half of 2004. Same-store sales increased by 0.6% in the first half of 2004 compared to2003.  Of the sales increase, 1.8%resulted from an increase in customer counts during the first half of 2004 vs.the first half of 2003.  For the firsthalf of 2004, the average check decreased 1.7% compared to the first half of2003.  Beverage sales improved 3.8%during the first half of 2004 vs. the first half of 2003.  The remaining change was a result of havingfive fewer stores.  There were 109 BlackAngus restaurants operating as of June 30, 2003 and 104 Black Angus restaurantsoperating as of June 28, 2004.

 

*Food andBeverage Costs.* As a percentage of revenues, food and beverage costs increased from32.3% in the first half of 2003 to 36.1% in the first half of 2004.  Of the 3.8% increase, 2.3% was due to higherbeef prices with the remainder of the difference the result of an increase inpromotional sales being a greater part of the overall sales mix.

 

*Payroll Costs*.   As a percentage of revenues, labor costsincreased from 30.6% in the first half of 2003 to 31.6% in the first half of2004.  The increase results fromtransferring janitorial services from third-party contractors to our employees.

 

*DirectOperating Costs.* Direct operating costs consist of occupancy, advertising, and otherexpenses incurred by individual restaurants. Direct operating costs decreased from $35.7 million in the first half of2003 to $30.4 million in the first half of 2004.  The decrease is the result of lower TVadvertising expenses, the transferring of janitorial services to our employees,and less occupancy expenses as a result of operating fewer locations.

 

*Depreciationand Amortization.* Depreciation and amortization consists of depreciation of fixed assetsused by individual restaurants and at the Black Angus and corporate offices, aswell as amortization of intangible assets. Depreciation and amortization remained consistent at $3.6 million in thefirst half of 2003 and 2004.

 

*General and Administrative Expense.*  General and administrative expenses increasedfrom $5.1 million in the first half of 2003 to $5.5 million in the first halfof 2004.  The increase is a result ofhigher legal and consulting services.

 

*Loss onAsset Impairment. *We recorded a total of $2.4 million in charges related to assetimpairments for four under-performing restaurants.  As required under SFAS No. 144, *“Accounting for the Impairment or Disposal ofLong-Lived Assets,”* $1.9 million in fixed assets and $0.5 million ofintangibles were written down for these locations.  The assets consisted of buildings/leaseholdimprovements, and fixtures/equipment. Fair market value was determined based on discounted cash flows of theleasehold improvements and the lower of the net book value or an estimate ofcurrent liquidation value for fixtures and equipment.

 

*RestructuringExpense*. We paid $0.3 million in the first half of2004 to advisors in connection with the possible restructuring of our on ourNew Notes.

 

*OperatingProfit.*  As aresult of the above items, operating profit decreased from $9.2 million in thefirst half of 2003 to $4.8 million in the first half of 2004.  

 

*Interest Expense — Net.*  Our interest expense increased from $10.7million in the first half of 2003 to $11.3 million in the first half of2004.  The increase is primarily theresult of the new Junior Credit Facility and default interest due as a resultof not making the May 3rd interest payment on our New Notes.

 

## **Liquidity andCapital Resources**

## ** **

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. The Company is highly leveraged. We have historically used cash flow from operations together with otherliquidity sources to make required payments. As of June 28, 2004, we had no further availability under its loanagreement with Wells Fargo Foothill, Inc. (“New Credit Facility”), no furtheravailability under our loan agreement with TCW Shared Opportunity Fund III,L.P. (“Junior Credit Facility), and $1.4 million in cash on hand.  We have suffered recurring losses fromoperations, have a negative working-capital balance of $206.3 million, and havea net capital deficiency of $159.8 million as of June 28, 2004 that raisesubstantial doubt about our 

 

11

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ability to continue as a going concern. Management is currently evaluating alternatives for restructuring theCompany’s overall outstanding debt and the associated interest rate.  We do not, however, expect to generatesufficient cash flows from operations in the future to pay fully at maturityall of its senior debt obligations. Accordingly, we will need to refinance or restructure all or portions ofsuch debt, obtain new financing, or possibly sell assets.  There can be noassurance that any such plans will be successful or that future financing orrestructuring will be available or, if available, at a cost that is acceptableto us.

 

On May 3, 2004, we didnot pay the $9.3 million semiannual interest payment (the “Note InterestDefault”), then due on our 111⁄2% Senior Secured Notes due 2006 (“NewNotes”).  Under the provisions of theindenture governing the New Notes, we had a grace period ending June 2,2004 within which to make the interest payment before there was an “Event ofDefault” (as such term is defined in the indenture) that entitled the holdersof the New Notes to certain rights and remedies, including the right toaccelerate the principal and interest due under the New Notes.  In turn, under the provisions of each of ourcredit facilities, the development of a right, irrespective of exercise, in theholders of the New Notes to accelerate the New Notes would cause an “Event ofDefault” (as such term is defined in each of the New Credit Facility and theJunior Credit Facility) that allows the respective lender to exercise certainrights and remedies, including acceleration, under its facility.

 

On June 1, 2004, weentered into a forbearance agreement (the “Note Forbearance Agreement”) withholders in excess of 60% of the New Notes (the “Signing Holders”) pursuant towhich the Signing Holders agreed to forbear from exercising rights and remedieswith respect to the Note Interest Default. The Note Forbearance Agreement has been extended until September 3,2004, subject to certain terms and conditions. 

** **

As of June 28, 2004, our cashborrowings and letters of credit, totaling $15.0 million, exceeded the then-availableborrowing base as calculated in the loan agreement governing the New CreditFacility.  In addition, we were indefault of the New Credit Facility because of a cross-default caused by theNote Interest Default and our failure to deliver financial statements carryingan opinion without qualifications from our auditors as required by the NewCredit Facility.  

 

On August 5, 2004, we enteredinto a forbearance agreement (the “NCF Forbearance Agreement”) with the lenderunder the New Credit Facility pursuant to which such lender agreed to forbearfrom exercising rights and remedies with respect to the certain defaults andevents of default under the New Credit Facility until September 3, 2004,subject to certain terms and conditions. Also on August 5, 2004, we increased the amount available under the NewCredit Facility to $17.5 million.

 

As of June 28, 2004, we werealso in default of the Junior Credit Facility because of a cross-default causedby the Note Interest Default and our failure to deliver financial statementscarrying an opinion without qualifications from our auditors as required by theJunior Credit Facility.

 

On August 12, 2004, we enteredinto a forbearance agreement (the “Junior Forbearance Agreement”) with thelender under the Junior Credit Facility pursuant to which such lender agreed toforbear from exercising its rights and remedies with respect to certaindefaults and events of default under the Junior Credit Facility until September3, 2004, subject to certain terms and conditions.  

 

There can be no assurances thatany or all of the Note Forbearance Agreement, the NCF Forbearance Agreement,or the Junior Forbearance Agreement will be extended beyond September 3, 2004or that we will not need to negotiate future forbearance agreements for anynoncompliance with our debt documents.  

 

We have retained the consulting firm ofAlvarez and Marsal, Inc. to provide restructuring advisory services to ourBoard of Directors and to assist us in the restructuring process of ourorganization.  We also have engagedinvestment bankers Houlihan Lokey Howard & Zukin to explore financialrestructuring alternatives and assist with discussions with our creditors andshareholders.  Certain holders of the NewNotes have formed an informal committee and have engaged a financial advisorand outside legal counsel at the Company’s expense.  We have commenced restructuring negotiationswith the committee’s advisors, the lender under the New Credit Facility, thelender under the Junior Credit Facility, and our majority shareholdergroup.  We are also in negotiations withthe lessors of certain of our unfavorable leases.  There is the possibility that a restructuringmay be implemented through an out-of-court arrangement if we were to reachsatisfactory agreements with many of the parties.  However, no restructuring agreements havebeen reached with any party, and there can be no assurance that we will reachany such agreement with any particular party.  If no such agreements can be reached or if any agreement(s) that may bereached cannot be implemented through an out-of-court transaction, we willlikely seek protection under the United States Bankruptcy Code to furtherpursue our restructuring alternatives and/or to implement any agreement(s) thatmay be reached.

 

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Our primary sources of liquidity are cash flows from operations andborrowings under our revolving credit facilities.  We require capital principally for theacquisition and construction of new restaurants, the remodeling of existingrestaurants, and the purchase of new equipment and leasehold improvements, andfor our working capital.  As of June 28,2004, we had approximately $1.4 million of cash.

 

In general, restaurant businesses do not have significant accountsreceivable because sales are made for cash or by credit-card vouchers, whichare ordinarily paid within three to five days. Our receivables are primarily from vendor rebates and credit-cardtransactions.  The restaurants do notmaintain substantial inventory as a result of the relatively brief shelf lifeand frequent turnover of food products. Additionally, restaurants generally are able to obtain trade credit inpurchasing food and restaurant supplies. As a result, restaurants are frequently able to operate withworking-capital deficits, i.e., current liabilities exceed current assets.  As of June 28, 2004, our working-capitaldeficit was $206.3 million.

 

We estimate that capital expenditures of $4.0 million to $6.0 millionare required annually to maintain and refurbish our existing restaurants.  Other capital expenditures, which aregenerally discretionary, are primarily for the construction of new restaurants,for expanding, reformatting, and extending the capabilities of existing restaurants,and for general corporate purposes. Total capital expenditures were $2.2 million through the first half of2003 and $1.8 million through the first half of 2004.  When we open new restaurants, we intend to doso with small capital investments and to finance most of the expendituresthrough leases.

 

In 2001, we completed an exchange offer (the “Exchange”) in which weoffered to exchange our 111⁄2% Senior Secured Notes due 2006 (the “New Notes”)for all of our $142.6 million outstanding 111⁄2% Senior Secured Notes due 2003(the “Old Notes”).  We simultaneouslycompleted an offering (the “Offering”) of $30.0 million aggregate principalamount of New Notes.  After theconsummation of the Exchange, the Offering, and related transactions(collectively, the “Refinancing”), we had no further payment obligations withrespect to over 97.6% of the outstanding Old Notes (constituting all but $3.4million aggregate principal amount of the Old Notes, which we redeemed in fullon February 18, 2003) and assumed payment obligations equivalent to $161.8million of the New Notes.  TheRefinancing substantially eliminates senior debt principal payments untilNovember 2006.

 

The principal elements of the Refinancing were: (a) the Exchange(approximately $124 million aggregate principal amount of Old Notes wereexchanged for approximately $132 million aggregate principal amount New Notes);(b) the Offering (the issuance of $30 million aggregate principal amount of NewNotes); (c) the consent of the holders of our outstanding preferred stock toamend the terms of the preferred stock to provide that if we do not redeem thepreferred stock for cash on August 15, 2003 in accordance with its terms,then the preferred stock will automatically be converted to shares of ourcommon stock at that time and all the rights of the preferred stock willterminate, including any rights of acceleration; to eliminate provisions thatallow the holders to exchange preferred stock for new subordinate debt; and toamend the covenants of the preferred stock so that they are substantiallysimilar to the covenants under the New Notes; and, (d) the consent of thelender under our former revolving credit facility (“Old Credit Facility”) topermit the issuance of the New Notes and any other aspects of the Refinancingrequiring the lender’s consent.

 

None of the Old Notes were outstanding at June 28, 2004.  Under the Old Notes, we were obligated tomake semiannual interest payments on February 15 and August 15through February 2003.  Accordingly,we made the last interest payment of $0.2 million on February 18, 2003when the outstanding balance on the Old Notes of $3.4 million was fully retiredat the maturity date.

 

Under the New Notes, we are obligated to make semiannual interestpayments, on May 1 and November 1, through November 2006.

 

As discussed above, onMay 3, 2004, we did not pay the $9.3 million semiannual interest payment thendue on the New Notes.  Under theprovisions of the indenture governing the New Notes, the Company had a graceperiod ending June 2, 2004 within which to make the interest paymentbefore there is an “Event of Default” (as such term is defined in theindenture).

 

On June 1, 2004, weentered in the Note Forbearance Agreement with the Signing Holders pursuant towhich the Signing Holders agreed to forbear from exercising rights and remediesin respect to the Note Interest Default. The Note Forbearance Agreement has been extended until September 3,2004, subject to certain terms and conditions.

 

In 2001, we entered into a loanagreement with Wells Fargo Foothill, Inc. (then known as Foothill CapitalCorporation) for the New Credit Facility. The New Credit Facility presently provides for cash borrowings andletters of credit in an aggregate amount up to $17.5 million.  The New Credit Facility provides for anunused-line fee payable monthly in arrears, fees payable on outstanding lettersof credit, as well as certain additional fees. Borrowings under the New Credit Facility bear interest at the prime rateannounced by Wells Fargo Bank, National Association plus 1.5%.  The New Credit Facility terminates onDecember 17, 2005, and shares in a first-priority lien on substantiallyall our personal property and certain real property leases.  The New Credit Facility includes certainrestrictive covenants, including a requirement to maintain certain financialratios.  As of June 28, 2004, we had$10.7 million of letters of credit outstanding, primarily related to ourself-insurance program, and $4.3 in cash borrowings, with no availability underour New Credit Facility.  Such cashborrowings and letters of credit, totaling $15.0 million, exceeded thethen-available borrowing base as calculated in the loan agreement governing the

 

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New Credit Facility. 

 

On August 5, 2004, we amendedthe New Credit Facility to increase the maximum amount available under the NewCredit Facility to $17.5 million and to modify both the borrowing base and thefinancial covenants thereunder.  OnAugust 5, 2004, we entered into the NCF Forbearance Agreement with the lenderunder the New Credit Facility pursuant to which such lender agreed to forbearfrom exercising rights and remedies with respect to certain defaults and eventsof default under the New Credit Facility until September 3, 2004, subject tocertain terms and conditions.

 

On October 31, 2003, we entered into the Junior Credit Facilitywith TCW Shared Opportunity Fund III, L.P., an entity related to a group offunds that constitute the majority shareholder group.  We received proceeds of $4.6 million net offees and costs.  The Junior CreditFacility bears an interest rate of 13% per annum.  The Junior Credit Facility expiresFebruary 24, 2006, and shares in a first-priority lien on substantiallyall our personal property and certain real property leases.

 

On August 5, 2004, we amended the Junior Credit Facility to permitadditional borrowing in amount up to $17.5 under the New Credit Facility.  On August 11, 2004, we entered into theJunior Forbearance Agreement with the lender under the Junior Credit Facilitypursuant to which such lender agreed to forbear from exercising its rights andremedies with respect to certain defaults and events of default under theJunior Credit Facility until September 3, 2004, subject to certain terms andconditions.

 

American Restaurant Group, Inc. and its subsidiaries do not guarantythe borrowings of any other parties outside the consolidated group, but havecontingent obligations under certain contracts and leases, including some ofthose connected to operations sold to Spectrum Restaurant Group, Inc. (the “SRGGroup”).

 

We have $2.1 million in long-term debt that relates to mortgages andcapital leases for improvements and equipment.

 

Ourcontractual obligations (principal and interest) can be summarized as follows(dollars in thousands):

 
| **Contractual  Obligations**               | ** ** | **Paid in  Q1&2-2004** | ** ** | **Remainder  2004** | ** ** | **2 to 3  Years** | ** ** | **4 to 5  Years** | ** ** | **After 5  Years** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|----------------------------|------------|---------------------|------------|-------------------|------------|-------------------|------------|--------------------|------------|-----------|------------|
| Interest & principal – New Notes  |       | $                          | —     |                | $          | 217,586           |       | $                 | —     |               | $          | —    |       | $ | — |   | $ | 217,586 |   |
| Interest & principal — other debt |       | 2,468                      |       | 9,744               |       | 1,253             |       | 343               |       | 1,114              |       | 14,922    |       |
| Capital leases                             |       | 210                        |       | 180                 |       | 677               |       | 464               |       | 652                |       | 2,183     |       |
| Operating leases                           |       | 9,672                      |       | 9,278               |       | 32,779            |       | 30,905            |       | 178,498            |       | 261,132   |       |
| Total contractual cash                     |       | $                          | 12,350     |                | $          | 236,788           |       | $                 | 34,709     |               | $          | 31,712    |       | $ | 180,264 |   | $ | 495,823 |   |

 

Substantially all our personal property and certain real propertyleases are pledged to our senior lenders. In addition, our direct subsidiaries guarantee most of our indebtednessand such guarantees are secured by substantially all of the assets of thesubsidiaries.  In connection with suchindebtedness, contingent and mandatory prepayments may be required undercertain specified conditions and events. There are no compensating-balance requirements.

 

### **Critical Accounting Policies**

### ** **

*Revenue Recognition. * We record revenue from the sale of food, beverage, and alcohol as products are sold.  We record proceeds from the sale of a gift card or gift certificate in current liabilities and recognize income when a holder redeems a gift card or gift certificate.  We recognize unredeemed gift cards and gift certificates as revenue only after such a period of time indicates, based on our Company’s historical experience, the likelihood of redemption is remote.

 

*Use of Estimates. *Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires our management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities, and thereported amounts of revenues and expenses. Actual results could differ from those estimates.

 

We believe that our financial statements are a reasonablerepresentation of the realizable values of our assets, the level of ourliabilities, and the amounts of revenues and expenses incurred in any givenperiod.  There are estimates inherent inthese amounts.  If circumstances cause usto close restaurants or we experience a decline in revenues, we may not be ableto recover the represented 

 

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value of all of our assets, such as property and equipment orintangible assets.  Our actualliabilities for matters, such as self-insurance, store closing reserves, gift certificates,or the SRG Group bankruptcies, could possibly be significantly higher or lowerthan our estimates if conditions are ultimately different than the assumptionsused in determining the estimates.

 

*Leases*. We lease equipment and operating facilities under both operating andcapital leases.  In future periods,leases for similar equipment or facilities may not qualify for the accountingapplied historically because of changes in terms or our credit status.  This would mean that we might be required torecognize more leases as capital leases in the future than we have in the past,causing a corresponding increase in our assets and liabilities, and adjustmentsto the associated depreciation and interest expense.  Conversely, if many leases in the future wereclassified as operating leases, rental expense would increase.

 

*Valuation Allowance for Deferred Tax Assets. *We provided avaluation allowance of $56.0 million and $54.6 million against the entireamount of our net deferred tax assets as of December 29, 2003 and June 28,2004, respectively.  The valuationallowance was recorded given the losses we have incurred historically anduncertainties regarding future operating profitability and taxable income.

 

*Long-LivedAssets.*  Weperiodically review for impairment the carrying value of our long-livedassets.  We assess the recoverability ofthe assets based on the estimated, future, undiscounted cash flows of theassets.  If impairment is indicated, wewrite down the assets to fair market value based on estimated, future,discounted cash flows.  We periodicallyreview each restaurant property and determine which properties may beconsidered for closure.  Thisdetermination is made based on poor operating results, deteriorating propertyvalues, and other factors.  In addition,we periodically review all restaurants with negative cash flows forimpairment.  We assess the recoverabilityof the assets based on the restaurant’s estimated, future, undiscounted cashflows.  If impairment is indicated, wewrite down the assets to fair market value based on estimated, future,discounted cash flows.  In 2003, fiverestaurants were closed and two were impaired. In the second quarter of 2004, one restaurant was closed because of anexpiring term and four restaurants were impaired.

 

*AdvertisingCosts.*  Advertisingcosts are expensed either as incurred or the first time the advertising takesplace, in accordance with Statement of Position 93-7, *Reporting ofAdvertising Costs.*

 

*Self-Insurance Reserves.*  We self-insure certain risks, includingmedical, workers’ compensation, property, and general liability, up to varyinglimits.  Deductible and self-insuredretention limits have varied historically, ranging from $0 to $1,000,000 per incidentdepending on the type of risk.  Ourpolicy deductible is $125,000****for annualmedical and dental benefits per person. Reserves for losses are established on a claims-made basis plus anactuarially determined provision for incurred-but-not-reported claims and thedeductible or self-insured retention in place at the time of the loss.  The self-insured reserves are reported on theconsolidated balance sheet under Self-insurance reserve.

 

**ITEM 3.****          QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The market risk of our financial instruments as of June 28, 2004 hasnot materially changed since December 29, 2003.  The market risk profile on December 29,2003 is disclosed in our annual report on Form 10-K File No. 33-48183 for thefiscal year ended December 29, 2003.

 

**ITEM 4.****          CONTROLSAND PROCEDURES**

 

As of the end of the period covered by this Form 10-Q we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer along with our Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities andExchange Act of 1934).  Based upon thatevaluation, our Chief Executive Officer along with our Chief Financial Officerconcluded that our disclosure controls and procedures are effective in timelyalerting them to material information relating to the Company (including itsconsolidated subsidiaries) required to be included in our periodic SEC filings.There have been no significant changes in our internal control over financialreporting that occurred during the Company’s most recent fiscal quarter thathas materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**PART II.****        OTHERINFORMATION**

** **

**ITEM 3.****          DEFAULTS UPON SENIOR SECURITIES**

 

On May 3, 2004, we did not pay the $9.3 million interest payment thendue on our New Notes.  On the date ofthis report, the amount of interest (including defaulted interest of $178,290)accrued on the New Notes is $14,831,122.

 

**ITEM 6.****          EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)   List of Exhibits

 
| ** ** | **Exhibit  No.** | ** ** | **Description**                                                                                                      |
|------------|------------------|------------|----------------------------------------------------------------------------------------------------------------------|
|       |             |       |                                                                                                                 |
|       | 31.1             |       | Certificate (Section 302) of Chief Executive Officer.  (Filed herewith.)                                   |
|       |             |       |                                                                                                                 |
|       | 31.2             |       | Certificate (Section 302) of Chief Financial Officer.  (Filed herewith.)                                   |
|       |             |       |                                                                                                                 |
|       | 32.1             |       | Certificate (Section 906) of Chief Executive Officer and Chief  Financial Officer.  (Furnished  herewith.) |
|       |             |       |                                                                                                                 |
|       | 99.1             |       | Amendment No. 6 to the ARG/Wells Fargo Foothill Agreement.  (Filed herewith.)                                   |
|       |             |       |                                                                                                                 |
|       | 99.2             |       | First Amendment to the Eligible Credit Facility (ARG/TCW  Agreement.)  (Filed herewith.)                        |
|       |             |       |                                                                                                                 |
|       | 99.3             |       | Forbearance Agreement between Wells Fargo Foothill and ARG.  (Filed herewith.)                                  |
|       |             |       |                                                                                                                 |
|       | 99.4             |       | Forbearance Agreement between TCW Shared Opportunity Fund III and  ARG.  (Filed herewith.)                      |
|       |             |       |                                                                                                                 |
|       | 99.5             |       | Forbearance Agreement between bondholders and ARG.  (Filed herewith.)                                           |
|       |             |       |                                                                                                                 |
|       | 99.6             |       | Bondholder forbearance extension letter dated July 30, 2004.  (Filed herewith.)                                 |
|       |             |       |                                                                                                                 |
|       | 99.7             |       | Bondholder forbearance extension letter dated August 6, 2004.  (Filed herewith.)                                |

 

(b)   Form 8-K filed on May 3, 2004 – nonpayment ofsemiannual interest on notes.

 

(c)   Form 8-K filed on May 13, 2004 – announcement offirst quarter 2004 financial results.

 

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**SIGNATURE**

 

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.

 

 
|   |            | AMERICAN RESTAURANT GROUP, INC**.** | ** **                            |
|--------|-----------------|-------------------------------------|---------------------------------------|
|   |            | (Registrant)                        |                                  |
|   |            |                                |                                  |   |
|   |            |                                |                                  |   |
| Date:  | August 12, 2004 | By:                                 | */s/ Ralph S. Roberts*                | * * |
|   |            |                                |                                  |   |
|   |            |                                | Ralph S. Roberts                      |   |
|   |            |                                | Chief Executive Officer and President |   |
|   |            |                                |                                  |   |
|   |            |                                |                                  |   |
| Date:  | August 12, 2004 | By:                                 | */s/ William G. Taves*                | * * |
|   |            |                                |                                  |   |
|   |            |                                | William G. Taves                      |   |
|   |            |                                | Chief Financial Officer               |   |

 

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