10-Q 1 sept0210-qc.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 or the quarterly period ended September 29, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For transition period from to --------- -------- Commission file number 0-20040 --------------------------------- THE KRYSTAL COMPANY ----------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) TENNESSEE 62-0264140 --------- ---------- (State or other jurisdiction of (IRS Employer identification incorporation or organization) Number) One Union Square, Chattanooga, TN 37402 ----------------------------------------------------------------------------- (Address of principal executive offices, including zip code) (423) 757-1550 ----------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---- ---- This report is filed by the Company pursuant to Section 15(d) of the Securities Exchange Act of 1934. The Company has 100 shares of common stock outstanding held of record by Port Royal Holdings, Inc. as of November 8, 2002. THE KRYSTAL COMPANY ------------------- SEPTEMBER 29, 2002 ------------------ PART I. FINANCIAL INFORMATION ------------------------------ The condensed financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the Company's latest annual report on Form 10-K. In the opinion of management of the Company, all normal and recurring adjustments necessary to present fairly (1) the financial position of The Krystal Company and Subsidiary as of September 29, 2002 and December 30, 2001, and (2) their change in shareholder's equity for the nine months ending September 29, 2002 and (3) the results of their operations for the three and nine months ended September 29, 2002 and September 30, 2001 and (4) their cash flows for the nine months ended September 29, 2002 and September 30, 2001 have been included. The results of operations for the interim period ended September 29, 2002 are not necessarily indicative of the results for the full year. Certain written and oral statements made by or on behalf of the Company may constitute "forward-looking" statements as defined under the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). The PSLRA contains a safe harbor in making such disclosures. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the Company's historical experience and its present expectations or projections. These risks and uncertainties include, but are not limited to, unanticipated economic changes, interest rate movements, changes in governmental policies, the impact of competition, changes in consumer tastes, increases in costs for food and/or labor, the availability and adequate supply of hourly-paid employees, the ability of the Company to attract and retain suitable franchisees, the Company's ability to obtain funding sufficient to meet operational requirements and capital expenditures and the impact of governmental regulations. The Company cautions that such factors are not exclusive. Caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date of the making of such statements and are based on certain expectations and estimates of the Company which are subject to risks and changes in circumstances that are not within the Company's control. The Company does not undertake to update forward-looking statements other than as required by law. The information provided herein should be read in conjunction with information provided in the Company's Form 10-K for the fiscal year ended December 30, 2001. PART I. FINANCIAL INFORMATION ----------------------------- Item I. Financial Statements THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED BALANCE SHEETS --------------------------- (In thousands) September 29, December 30, 2002 2001 --------- ---------- ASSETS (Unaudited) ------ CURRENT ASSETS: Cash and temporary investments $ 8,566 $ 13,042 Receivables, net 1,590 1,418 Inventories 1,649 2,033 Deferred income taxes 2,877 2,877 Prepayments and other 1,003 823 -------- -------- Total current assets 15,685 20,193 -------- -------- PROPERTY, BUILDINGS, AND EQUIPMENT, net 94,595 112,498 -------- -------- LEASED PROPERTIES, net 5,722 9,144 -------- -------- OTHER ASSETS: Goodwill, net 37,968 37,968 Prepaid pension asset 8,284 8,754 Deferred financing costs, net 2,281 2,735 Other 1,021 1,605 Non-current assets held for sale 4,977 5,093 -------- -------- Total other assets 54,531 56,155 -------- -------- TOTAL ASSETS $170,533 $197,990 ======== ======== See accompanying notes to consolidated condensed financial statements. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED BALANCE SHEETS (CONTINUED) --------------------------------------- (In thousands) September 29, December 30, 2002 2001 LIABILITIES AND SHAREHOLDER'S EQUITY ----------- ---------- ------------------------------------ (Unaudited) CURRENT LIABILITIES: Accounts payable $ 3,826 $ 5,175 Accrued liabilities 26,799 22,719 Current portion of long-term debt 1,480 1,361 Current portion of capital lease obligations 1,179 2,133 -------- -------- Total current liabilities 33,284 31,388 -------- -------- LONG-TERM DEBT, excluding current portion 83,451 118,581 -------- -------- CAPITAL LEASE OBLIGATIONS, excluding current portion 5,551 8,170 -------- -------- DEFERRED INCOME TAXES 7,364 8,912 -------- -------- OTHER LONG-TERM LIABILITIES 5,459 1,501 -------- -------- SHAREHOLDER'S EQUITY: Common stock, without par value; 100 shares authorized, issued and outstanding, at September 29, 2002, and at December 30, 2001 35,000 35,000 Retained earnings (deficit) 424 ( 5,562) -------- -------- Total shareholder's equity 35,424 29,438 -------- -------- TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $170,533 $197,990 ======== ======== See accompanying notes to consolidated condensed financial statements.

THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- (In thousands) (Unaudited) For The Three For The ~~Six~~Nine Months Ended Months Ended -------------------- -------------------- ~~June~~Sept. 3029, ~~July~~Sept. 130, ~~June~~Sept. 3029, ~~July~~Sept. 130, 2002 2001 2002 2001 -------- -------- -------- -------- REVENUES: Restaurant sales $ 6261,~~941~~555 $ 6361,~~337~~703 $~~123~~185,~~937~~492 $~~122~~184,~~635~~311 Franchise fees ~~302~~257 ~~145~~173 ~~597~~854 ~~503~~676 Royalties 1,~~756~~683 1,~~485~~541 35,~~340~~023 24,~~836~~377 ~~Other revenue 1,722 1,791 3,349 3,508~~ ------- ------- ------- -------- 6663,~~721~~495 6663,~~758~~417 ~~131~~191,~~223~~369 ~~129~~189,~~482~~364 ------- ------- -------- -------- COST AND OTHER EXPENSES: Cost of restaurant sales 50,~~739~~600 5352,~~628~~085 ~~100~~151,~~697~~297 ~~104~~156,~~264~~322 Advertising expense 2,~~643~~586 2,~~659~~591 57,~~205~~791 57,~~150~~741 Depreciation and amortization expenses 2,~~764~~747 3,~~622~~542 58,~~539~~192 710,~~265~~652 General and administrative expenses 4,~~711~~548 3,~~205~~865 913,~~100~~448 711,~~582~~277 Other expenses, net ~~1,062~~376 ~~1,092~~200 ~~2,072~~129 ~~2,191~~( 58) ------- ------- ------- -------- 6160,~~919~~857 6462,~~206~~283 ~~122~~180,~~613~~857 ~~126~~185,~~452~~934 ------- ------- ------- -------- OPERATING INCOME 42,~~802~~638 21,~~552~~134 810,~~610~~512 3,~~030~~430 GAIN (LOSS) ON SALE OF ASSETS 11( ~~566~~69) 11( ~~596~~48) ( 69) 548 INTEREST EXPENSE, net (2,~~410~~303) (3,~~254~~184) ( 47,~~901~~205) ( 69,~~559~~747) ------- ------- ------- ------- INCOME (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY ITEM ~~2,403~~266 ( ~~136~~2,098) 3,~~720~~238 ( 25,~~933~~769) (PROVISION FOR) BENEFIT FROM INCOME TAXES ( ~~566~~63) 656 ( 39854) ( 1,~~067)~~769 ~~833~~ ------- ------- ------- ------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEM ~~1,837~~203 ( ~~175~~1,442) 2,~~653~~384 ( 24,~~100~~000) INCOME FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES OF $414 IN 2002 244 210 716 668 EXTRAORDINARY ITEM: Gain on early retirement of debt, net of applicable income tax expense of $1,~~663~~769 in 2002 2174 -- 2,~~712~~886 -- ------- ------- ------- ------- Net income (loss) $ ~~1,839~~621 $ ( ~~175~~1,232) $ 5,~~365~~986 $( 23,~~100~~332) ======= ======= ======= ======= See accompanying notes to consolidated condensed financial statements.

THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY ----------------------------------------------- FOR THE NINE MONTHS ENDED ------------------------- September 29, 2002 ------------------ (In thousands) (Unaudited) Retained Common Earnings Stock (Deficit) -------- -------- BALANCE, December 30, 2001 $35,000 $( 5,562) Net income -- 5,986 ------- ------- BALANCE, September 29, 2002 $35,000 $ 424 ======= ======= See accompanying notes to consolidated condensed financial statements. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- (In thousands) (Unaudited) For The Nine Months Ended --------------------------- Sept. 29, Sept. 30, 2002 2001 --------- --------- OPERATING ACTIVITIES: Net income (loss) $ 5,986 $ (3,332) Adjustments to reconcile net income (loss) to net cash provided by operating activities- Depreciation and amortization 8,332 10,884 Change in deferred taxes ( 1,441) ( 120) Gain on early retirement of debt ( 4,655) -- (Gain) loss on sale of assets 58 ( 548) Loss on impairment of assets 496 345 Changes in operating assets and liabilities: Receivables, net ( 172) 140 Inventories 384 3 Prepayments and other ( 180) ( 166) Accounts payable ( 1,349) ( 4,187) Accrued liabilities 3,973 ( 612) Other, net 1,410 729 -------- -------- Net cash provided by operating activities 12,842 3,136 -------- -------- INVESTING ACTIVITIES: Additions to property, buildings, and equipment ( 7,118) ( 4,801) Proceeds from sale of property, buildings, and equipment 23,729 2,224 -------- ------- Net cash provided by (used in) investing activities 16,611 ( 2,577) -------- ------- FINANCING ACTIVITIES: Net borrowings under revolving credit facility ( 4,979) 254 Repayments of long-term debt (25,377) ( 120) Outstanding checks in excess of bank balance -- 202 Principal payments of capital lease obligations ( 3,573) ( 1,486) -------- ------- Net cash used in financing activities (33,929) ( 1,150) -------- -------- NET DECREASE IN CASH AND TEMPORARY INVESTMENTS ( 4,476) ( 591) CASH AND TEMPORARY INVESTMENTS, beginning of period 13,042 4,979 --------- ------- CASH AND TEMPORARY INVESTMENTS, end of period $ 8,566 4,388 ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 5,991 $ 6,587 ======= ======= Income taxes $ 2,248 $ 97 ======= ======= See accompanying notes to consolidated condensed financial statements. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED) ---------------------------------------------------------------- 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Business Activities -- The Krystal Company (a Tennessee corporation) ("Krystal") is engaged primarily in the development, operation and franchising of quick-service restaurants in the southeastern United States. Until its assets were sold on October 17, 2002, Krystal's wholly-owned subsidiary, Krystal Aviation Co. ("Aviation"), operated a fixed base airport hangar operation in Chattanooga, Tennessee. Aviation's revenues provide less than 3% of the Company's total revenues. Sale of Aviation-- On September 2, 2002, the Company entered into a letter of intent with Truman Arnold Companies for the sale of substantially all of the assets of the Company's fixed base operation in Chattanooga, Tennessee. The sale was finalized on October 17, 2002 for a sale price of $10,786,000 and resulted in a gain on the sale of $2,127,000, net of tax. The assets of Aviation which were sold subsequent to September 29, 2002 are classified as assets held for sale in the accompanying balance sheets. In addition the operating results of Aviation for all periods presented are classified as discontinued operations. Principles of Consolidation -- The accompanying consolidated financial statements include the accounts of Krystal and Aviation (hereinafter referred to collectively as "the Company"). All significant intercompany balances and transactions have been eliminated. Cash and temporary investments -- The Company considers repurchase agreements and other temporary cash investments with a maturity of three months or less to be temporary investments. Inventories -- Inventories are stated at cost and consist primarily of food, paper products and other supplies. Property, Buildings, and Equipment -- Property, buildings and equipment are stated at cost. Expenditures which materially increase useful lives are capitalized, whereas ordinary maintenance and repairs are expensed as incurred. Depreciation of fixed assets is computed using the straight-line method for financial reporting purposes and accelerated methods for tax purposes over the estimated useful lives of the related assets as follows: Buildings and improvements 10-39 years Equipment 3-10 years Leaseholds Life of lease up to 20 years Long-lived assets -- The Company periodically evaluates the carrying value of long-lived assets when events or changes in circumstances warrant such a review. When an asset is determined to be impaired, its carrying value is reduced and a charge is recognized in the Consolidated Statement of Operations. During the third quarter of 2002 and 2001, the Company recorded an impairment charge of $496,000 and $345,000, respectively, related to the impairment of property and equipment at underperforming stores. Leased property -- The lower of fair market value or the discounted value of that portion of a capital lease attributable to building costs is capitalized and amortized by the straight-line method over the term of such leases and included with depreciation expense. The portions of such leases relating to land are accounted for as operating leases. Intangibles -- In June 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" (collectively the "Standards"). The Standards are effective for fiscal years beginning after December 15, 2001. SFAS No. 141 requires companies to recognize acquired identifiable intangible assets separately from goodwill if certain conditions are met. The Standards require the value of separately identifiable intangible assets to be measured at fair value. SFAS No. 142 requires that goodwill not be amortized, but that amounts recorded as goodwill be periodically tested for value impairment. Upon adoption of SFAS No. 142, if the value of goodwill is determined to be impaired, the Company is required to reduce goodwill through a charge to earnings. The Company adopted the Standards effective December 31, 2001. The adoption of the Standards has the effect of eliminating the amortization of goodwill. Based on an independent valuation of the Company as of December 31, 2001, the Company has determined there is no impairment of its goodwill asset as of that date. Prior to the adoption of SFAS 142, the Company amortized goodwill over 25 years. Had the Company accounted for goodwill consistent with the provisions of SFAS 142 in prior periods, the Company's loss from continuing operations would have been affected as follows (in thousands): For the Three For the Nine Months Ended Months Ended ------------------ ------------------ Sept. 29, Sept. 30, Sept. 29, Sept. 30, 2002 2001 2002 2001 -------- ------- -------- ------- Income (loss) from continuing operations $ 203 $(1,442) $2,384 $(4,000) Add back: Goodwill amortization -0- 492 -0- 1,476 ------ ------- ------ ------- Adjusted income (loss) from continuing operations $ 203 $( 950) $2,384 $(2,524) ====== ======= ====== ======= The consolidated balance sheet includes deferred financing costs of $5,778,700 at September 29, 2002. Deferred financing costs are amortized over the life of the debt agreement. The financing costs related to the Senior Notes are amortized over 10 years. The financing costs associated with the Company's Credit Facility are being amortized in part through May 2004 and in part through January 2007. Amortization expense for deferred financing costs for the three months ended September 29, 2002 was $154,700 and for the three months ended September 30, 2001 was $135,900. Amortization expense for deferred financing costs for the nine months ended September 29, 2002 was $507,600 and for the nine months ended September 30, 2002 was $407,600. Accumulated amortization of deferred financing costs at September 29, 2002 and September 30, 2001 was $3,498,100 and $2,914,100, respectively. Franchise and License Agreements -- Franchise or license agreements are available for single and multi-unit restaurants. The multi-unit agreement establishes the number of restaurants the franchisee or licensee is to construct and open in the franchised area during the term of the agreement. At September 29, 2002, there were 177 franchised or licensed restaurants and at September 30, 2001, there were 155 franchised or licensed restaurants. Franchisees and licensees are required to pay the Company an initial franchise or license fee plus a weekly royalty and service fee of either 4.5% or 6.0% of the restaurants' gross receipts, depending on the duration of the franchise agreement. The initial franchise and license fees are recorded as income as related restaurants begin operations. Royalty and service fees, which are based on restaurant sales of franchisees and licensees, are recognized as earned. Franchise fees received prior to the opening of the restaurant are deferred and included in accrued liabilities on the consolidated balance sheets. At September 29, 2002 and September 30, 2001, total deferred franchise and license fees were approximately $958,500 and $1,050,000, respectively. Fair Market Value of Financial Instruments -- Unless otherwise indicated elsewhere in the notes to the consolidated financial statements, the carrying values of the Company's financial instruments approximate their fair values. Benefit Plans -- The determination of obligations and expenses under the Company's retirement and post retirement benefit plans is dependent on the selection of certain assumptions used by actuaries in calculating such amounts. In accordance with generally accepted accounting principles, actual results that differ from assumptions are accumulated and amortized over future periods and therefore, generally affect our recognized expense and the recorded obligation in such periods. Significant differences in actual experience or significant changes in the assumptions used may materially affect the pension and post retirement obligations and future expenses. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications-- Certain reclassifications have been made to prior year financial statements to conform with the 2002 presentation. Income Taxes -- During the second quarter of 2002, the Company revised its estimate of certain tax liability contingencies resulting in a reduction of income tax expense of $200,000. New Accounting Pronouncements -- In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," referred to herein as SFAS 145. SFAS 145 rescinds Statement of Financial Accounting Standards No. 4, "Reporting Gains and Losses from Extinguishment of Debt" ("SFAS 4"), which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. As a result, the criteria in Accounting Principles Board Opinion No. 30 will now be used to classify those gains and losses. The provisions of SFAS 145 are effective for financial statements issued for fiscal years beginning after May 15, 2002, and interim periods within those fiscal years. During the first, second and third quarters of 2002, prior to the required adoption of SFAS 145, the Company reported extraordinary charges aggregating $2,886,000 associated with the extinguishment of the Company's debt. Under SFAS 145, any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. The Company plans to adopt SFAS 145 on January 1, 2003. Accordingly, in financial reporting periods after adoption, the extraordinary charges reported in the first, second, and third quarters of 2002 will be reclassified. In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" ("Issue 94-3"). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. Adoption of SFAS 146 is not expected to have a material impact on the Company's financial statements. 2. SUMMARIZED FINANCIAL INFORMATION - SUBSIDIARY GUARANTORS The Company's subsidiaries have fully and unconditionally guaranteed the Notes (See Note 4) of the Company. The guarantees do not restrict the ability of the subsidiary guarantors to declare dividends, or make loans or advances to the Company. As discussed in Note 1, on September 2, 2002, the Company entered into a letter of intent with Truman Arnold Companies for the sale of substantially all of the assets of the Company's fixed base operation in Chattanooga, Tennessee. The assets of Aviation which were sold subsequent to September 29, 2002 are classified as assets held for sale in the accompanying balance sheets and the results of operations for Aviation are classified as discontinued operations in the accompanying statements of operations. Set forth below are condensed consolidating financial statements for the Company and the Subsidiary Guarantors as of September 29, 2002 and December 30, 2001 and for the nine months ended September 29, 2002 and September 30, 2001. The equity method has been used by the Company with respect to investments in subsidiaries.

CONDENSED CONSOLIDATING BALANCE SHEET At ~~June~~September 3029, 2002 (Unaudited) The Krystal Company Subsidiary Consolidated (Parent) Guarantors Adjustments Total ----------- ---------- ----------- ----------- Current Assets: Cash and temporary investments $ 128,~~924~~271 $ 98295 $ -- $ 138,~~022~~566 Receivables, net (1311,~~225~~653) ~~360~~404 1412,~~458~~839 1,~~593~~590 Inventories 1,~~659~~593 7056 -- 1,~~729~~649 Deferred income taxes 2,876 1 -- 2,877 Prepayments and other ~~934~~995 318 -- ~~965~~1,003 -------- ------- ------- -------- Total current assets 52,~~168~~082 ~~560~~764 1412,~~458~~839 2015,~~186~~685 -------- ------- ------- -------- Property, buildings, and equipment ~~128~~130,~~513~~380 52,~~731~~583 -- ~~134~~132,~~244~~963 Accumulated depreciation (3537,~~410~~792) (~~1,474~~ 576) -- ( 3638,~~884~~368) -------- ------- ------- -------- Net property, buildings, and equipment 9392,~~103~~588 42,~~257~~007 -- 9794,~~360~~595 -------- ------- ------- -------- Leased Properties, net 65,~~038~~722 -- -- 65,~~038~~722 -------- ------- ------- -------- Investment in Subsidiary 1 1 (2) -- -------- ------- ------- -------- Other Assets: Goodwill, net 4037,~~759~~968 -- -- 4037,~~759~~968 Prepaid pension asset 8,~~374~~284 -- -- 8,~~374~~284 Deferred financing costs, net 2,~~435~~281 -- -- 2,~~435~~281 Other 1,~~025~~006 1615 1,~~041~~021 Non-current assets held for sale -- 4,977 -- 4,977 -------- ------- ------- -------- Total other assets 5249,~~593~~539 164,992 -- 5254,~~609~~531 -------- ------- ------- -------- Total Assets $~~156~~149,~~903~~932 $ 47,~~834~~764 $1412,~~456~~837 $~~176~~170,~~193~~533 ======== ======= ======= ======== Current Liabilities: Accounts payable $ (710,~~701~~419) $( 1,~~234)~~406 $1412,~~458~~839 $ 53,~~523~~826 Accrued liabilities 26,~~295~~260 ~~300~~539 -- 26,~~595~~799 Current portion of long-term debt 1,250 ~~229~~230 -- 1,~~479~~480 Current portion of capital lease obligations 1,~~214~~179 -- -- 1,~~214~~179 -------- ------- ------- -------- Total current liabilities 2118,~~058~~270 (2,175 ~~705) 14~~12,~~458~~839 3433,~~811~~284 -------- ------- ------- -------- Long Term Debt, excluding current portion 8682,~~313~~001 1,~~507~~450 -- 8783,~~820~~451 -------- ------- ------- -------- Capital Lease Obligations, excluding current portion 5,~~813~~551 -- -- 5,~~813~~551 -------- ------- ------- -------- Deferred Income Taxes 7,487 ( 16123) -- 7,~~471~~364 -------- ------- ------- -------- Other Long-Term Liabilities 5,~~475~~459 -- -- 5,~~475~~459 -------- ------- ------- -------- Shareholder's Equity: Common Stock 35,000 2 (2) 35,000 Retained Earnings (4deficit) (3,~~243~~836) 4,~~046~~260 -- (424 ~~197)~~ -------- ------- ------- -------- Total shareholder's equity 3031,~~757~~164 4,~~048~~262 (2) 3435,~~803~~424 -------- ------- ------- -------- Total Liabilities and Shareholder's Equity $~~156~~149,~~903~~932 $ 47,~~834~~764 $1412,~~456~~837 $~~176~~170,~~193~~533 ======== ======= ======= ========

CONDENSED CONSOLIDATING BALANCE SHEET At December 30, 2001 The Krystal Company Subsidiary Consolidated (Parent) Guarantors Adjustments Total ---------- ---------- ----------- ----------- Current Assets: Cash and temporary investments $ 12,965 $ 77 $ -- $ 13,042 Receivables, net (11 8,~~734~~943) 234 1210,~~918~~127 1,418 Inventories 1,971 62 -- 2,033 Deferred income taxes 2,876 1 -- 2,877 Prepayments and other 756 67 -- 823 -------- ------- ------- -------- Total current assets 69,~~834~~625 441 1210,~~918~~127 20,193 -------- ------- ------- -------- Property, Buildings, and Equipment 144,654 52,~~716~~560 ~~150~~147,~~370~~214 Accumulated depreciation (34,289) (~~1,281~~ 427) (3534,~~570~~716) -------- ------- ------- -------- Net property, buildings, and equipment 110,365 42,~~435~~133 -- ~~114~~112,~~800~~498 -------- ------- ------- -------- Leased Properties, net 9,144 -- -- 9,144 -------- ------- ------- -------- Investment in Subsidiary 1 1 (2) -- -------- ------- ------- -------- Other Assets: Goodwill, net 4037,~~759~~968 -- -- 4037,~~759~~968 Prepaid pension asset 8,754 -- -- 8,754 Deferred financing costs, net 2,735 -- -- 2,735 Other 1,588 17 -- 1,605 Non-current assets held for sale -- 5,093 -- 5,093 -------- ------- ------- -------- Total other assets 5351,~~836~~045 175,110 -- 5356,~~853~~155 -------- ------- ------- -------- Total Assets $180,180 $ 47,~~894~~685 $1210,~~916~~125 $197,990 ======== ======= ======= ======== Current Liabilities: Accounts payable $( 6,795) $ (1,843 ~~948)~~ $1210,~~918~~127 $ 5,175 Accrued liabilities 22,339 380 -- 22,719 Current portion of long-term debt 1,138 223 -- 1,361 Current portion of capital lease obligations 2,133 -- -- 2,133 -------- ------- ------- -------- Total current liabilities 18,815 (2,446 ~~345) 12~~10,~~918~~127 31,388 -------- ------- ------- -------- Long Term Debt, excluding current portion 116,957 1,624 -- 118,581 -------- ------- ------- -------- Capital Lease Obligations, excluding current portion 8,170 -- -- 8,170 -------- ------- ------- -------- Deferred Income Taxes 8,928 ( 16) -- 8,912 -------- ------- ------- -------- Other Long-Term Liabilities 1,501 -- -- 1,501 -------- ------- ------- -------- Shareholder's Equity: Common Stock 35,000 2 (2) 35,000 Retained Earnings ( 9,191) 3,629 -- ( 5,562) -------- ------- ------- -------- Total shareholder's equity 25,809 3,631 (2) 29,438 -------- ------- ------- -------- Total Liabilities and Shareholder's Equity $180,180 $ 47,~~894~~685 $1210,~~916~~125 $197,990 ======== ======= ======= ========

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS For the ~~six~~nine months ended ~~June~~September 3029, 2002 (Unaudited) The Krystal Company Subsidiary Consolidated (Parent) Guarantors Adjustments Total -------- ------- ------- -------- Revenues: Restaurant sales $~~123~~185,~~937~~492 $ -- $ -- $~~123~~185,~~937~~492 Franchise fees ~~597~~854 -- -- ~~597~~854 Royalties 35,~~340~~023 -- -- 35,~~340~~023 ~~Other revenue~~ -- ~~3,349~~ -- ~~3,349~~ ----~~----~~ ------- ------- -------- Total revenues ~~127~~191,~~874~~369 ~~3,349~~-- -- ~~131~~191,~~223~~369 -------- ------- ------- -------- Cost and Expenses: Cost of restaurant sales ~~100~~151,~~697~~297 -- -- ~~100~~151,~~697~~297 Advertising expense 57,~~205~~791 -- -- 57,~~205~~791 Depreciation and amortization expense 58,~~346~~043 ~~193~~149 -- 58,~~539~~192 General and administrative expenses 813,~~950~~521 ~~150~~( 73) -- 913,~~100~~448 Other expenses, net (129 ~~247)~~-- ~~2,319~~ -- ~~2,072~~129 -------- ------- ------- -------- Total operating expenses ~~119~~180,~~951~~781 ~~2,662~~76 -- ~~122~~180,~~613~~857 -------- ------- ------- -------- Operating ~~Income~~income 710,~~923~~588 ~~687~~( 76) -- 810,~~610~~512 ~~Gain~~Loss on ~~Sale~~sale of ~~Assets~~assets ( 69) -- 11 -- 11( 69) Interest ~~Expense~~expense, net (47,~~863~~147) ( 3858) -- ( 47,~~901~~205) -------- ------- ------- -------- Income ~~Before~~(loss) ~~Provision~~before ~~for~~income ~~Income~~taxes ~~Taxes~~ and ~~Extraordinary~~extraordinary ~~Item~~item 3,~~060~~372 ~~660~~( 134) -- 3,~~720~~238 (Provision for) ~~Income~~benefit ~~Taxes~~from (income ~~824)~~taxes ( ~~243~~903) 49 -- ( ~~1,067~~854) -------- ------- ------- -------- Income ~~Before~~(loss) ~~Extraordinary~~from ~~Item~~continuing operations and extraordinary item 2,~~236~~469 ~~417~~( 85) -- 2,~~653~~384 Income from discontinuing operations, net of income taxes of $414 in 2002 -- 716 -- 716 Extraordinary ~~Item~~item: Gain on early retirement of debt, net of applicable income tax expense of $1,~~663~~769 in 2002 2,~~712~~886 -- -- 2,~~712~~886 -------- ------- ------- -------- Net ~~Income~~income $ 45,~~948~~355 $ ~~417~~631 $ -- $ 5,~~365~~986 ======== ======= ======= ========

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS For the ~~six~~nine months ended ~~July~~September 130, 2001 (Unaudited) The Krystal Company Subsidiary Consolidated (Parent) Guarantors Adjustments Total -------- ------- ------- -------- Revenues: Restaurant sales $~~122~~184,~~635~~311 $ -- $ -- $~~122~~184,~~635~~311 Franchise fees ~~503~~676 -- -- ~~503~~676 Royalties 24,~~836~~377 -- -- 24,~~836~~377 ~~Other revenue~~ -- ~~3,508~~ -- ~~3,508~~ ----~~----~~ ------- ------- -------- Total revenues ~~125~~189,~~974~~364 ~~3,508~~-- -- ~~129~~189,~~482~~364 -------- ------- ------- -------- Cost and ~~Expenses~~expenses: Cost of restaurant sales ~~104~~156,~~264~~322 -- -- ~~104~~156,~~264~~322 Advertising expense 57,~~150~~741 -- -- 57,~~150~~741 Depreciation and amortization expense 710,~~010~~504 ~~255~~148 -- 710,~~265~~652 General and administrative expenses 711,~~455~~339 ~~127~~( 62) -- 711,~~582~~277 Other expenses, net ( ~~258~~58) ~~2,449~~-- -- ~~2,191~~( 58) -------- ------- ------- -------- Total operating expenses ~~123~~185,~~621~~848 ~~2,831~~86 -- ~~126~~185,~~452~~934 -------- ------- ------- -------- Operating ~~Income~~income 23,~~353~~516 ~~677~~( 86) -- 3,~~030~~430 Gain on ~~Sale~~sale of ~~Assets~~assets ~~596~~548 -- -- ~~596~~548 Interest ~~Expense~~expense, net ( 69,~~486~~638) ( 73109) -- ( 69,~~559~~747) -------- ------- ------- -------- ~~Income~~Loss before income taxes, and extraordinary item (~~Loss~~ 5,574) ~~Before~~( 195) -- (~~Provision~~ ~~For~~5,769) Benefit ~~From~~from ~~Income~~income ~~Taxes~~taxes (1,694 375 -- 1,~~537)~~769 ~~604~~-------- ------- ------- -------- Loss from continuing operations before extraordinary item ( 23,~~933~~880) (~~Provision~~ ~~For~~120) ~~Benefit~~-- ~~From~~( 4,000) Income ~~Taxes~~from ~~1,062~~discontinuing (operations ~~229)~~-- 668 -- ~~833~~668 -------- ------- ------- -------- Net ~~Income~~income (~~Loss~~loss) $( 23,~~475~~880) $ ~~375~~548 $ -- $( 23,~~100~~332) ======== ======= ======= ========

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the ~~six~~nine months ended ~~June~~September 3029, 2002 (Unaudited) The Krystal Company Subsidiary Consolidated (Parent) Guarantors Adjustments Total -------- -------- ------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 45,~~948~~355 $ ~~417~~631 $ -- $ 5,~~365~~986 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization 58,~~346~~043 ~~193~~289 -- 58,~~539~~332 Change in deferred income taxes (1,441) -- -- (1,441) Gain on early extinguishment of debt (4,~~375~~655) -- -- (4,~~375~~655) (Gain) loss on sale of assets --69 ( 11) -- (58 ~~11)~~Loss on impairment of assets 496 -- -- 496 Changes in operating assets and liabilities: Receivables, net ( 492) ( ~~126~~170) -- ( ~~175~~172) Inventories ~~312~~378 (6 8) -- ~~304~~384 Prepayments and other ( ~~178~~239) 3659 -- ( ~~142~~180) Accounts payable ~~634~~( 912) ( ~~286~~437) -- ~~348~~(1,349) Accrued liabilities 3,~~956~~921 (52 ~~80)~~ -- 3,~~876~~973 Other, net 1,~~166~~408 12 -- 1,~~167~~410 -------- -------- ------- ------- Net cash provided by operating activities 1012,~~319~~421 ~~136~~421 -- 1012,~~455~~842 -------- ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, buildings and equipment ( 47,~~250~~071) ( 1547) -- ( 47,~~265~~118) Proceeds from the sale property, buildings and equipment 23,~~323~~718 11 -- 23,~~334~~729 -------- ------- -------- ------- Net cash provided by (used in) investing activities 1916,~~073~~647 ( 436) -- 1916,~~069~~611 -------- ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under revolving credit facility ( 34,~~417~~979) -- -- ( 34,~~417~~979) Repayments of long-term debt (2225,~~740~~210) ( ~~111~~167) -- (2225,~~851~~377) Principal payments of capital lease obligations ( 3,~~276~~573) -- -- ( 3,~~276~~573) -------- ------- ------- ------- Net cash used in financing activities (2933,~~433~~762) ( ~~111~~167) -- (2933,~~544~~929) -------- ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND TEMPORARY INVESTMENTS ( 414,694) 21218 -- ( 204,476) CASH AND TEMPORARY INVESTMENTS, beginning of period 12,965 77 -- 13,042 -------- ------- ------- ------- CASH AND TEMPORARY INVESTMENTS, end of period $ 128,~~924~~271 $ 98295 $ -- $ 138,~~022~~566 ======== ======= ======= =======

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS For the ~~six~~nine months ended ~~July~~September 130, 2001 (Unaudited) The Krystal Company Subsidiary Consolidated (Parent) Guarantors Adjustments Total -------- ------- ------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $( 23,~~475~~880) $ ~~375~~548 $ -- $( 23,~~100~~332) Adjustments to reconcile net income (loss) to net cash used in operating activities - Depreciation and amortization 710,~~010~~504 ~~255~~380 -- 710,~~265~~884 Change in deferred income taxes ( 80120) -- -- ( 80120) Gain on sale of assets ( ~~596~~548) -- -- ( ~~596~~548) Loss on impairment of assets 345 -- -- 345 Changes in operating assets and liabilities: Receivables, net ( 6290) ~~190~~230 -- ~~128~~140 Inventories 11 ( 498) -- --3 ~~( 49)~~ Prepayments and other ( ~~543~~233) 4567 -- ( ~~498~~166) Accounts payable ( 2,~~861~~897) ( 1,~~009~~290) -- ( 34,~~870~~187) Accrued liabilities ( ~~1,199~~571) ( ~~136~~41) -- ( ~~1,335~~612) Other, net ~~619~~728 --1 -- ~~619~~729 -------- ------- ------- -------- Net cash used in operating activities (3,249 ~~236)~~ ( ~~280~~113) -- (3,136 ~~516)~~ -------- ------- ------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, buildings and equipment ( 34,~~463~~669) ( ~~116~~132) -- ( 34,~~579~~801) Proceeds from the sale of property, buildings and equipment 12,~~984~~224 -- -- 12,~~984~~224 -------- ------- ------- -------- Net cash used in investing activities ( 12,~~479~~445) ( ~~116~~132) -- ( 12,~~595~~577) -------- ------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under revolving credit facility ~~2,075~~254 -- -- ~~2,075~~254 Repayments of long-term debt ( 5) ( 71115) -- ( 76120) Outstanding checks in excess of bank balance ~~758~~202 42-- -- ~~800~~202 Principal payments of capital lease obligations ( ~~981~~1,486) -- -- ( ~~981~~1,486) -------- -------- -------- -------- Net cash provided by (used in) financing activities ( 1,~~847~~035) ( 29115) -- ( 1,~~818~~150) -------- -------- ------- -------- NET INCREASE (DECREASE) IN CASH AND TEMPORARY INVESTMENTS ~~132~~( 231) ( ~~425~~360) -- ( ~~293~~591) CASH AND TEMPORARY INVESTMENTS, beginning of period 4,554 425 -- 4,979 -------- -------- ------- -------- CASH AND TEMPORARY INVESTMENTS, end of period $ 4,~~686~~323 $ --65 $ -- $ 4,~~686~~388 ======== ======== ======= ========

3. Segment Reporting The Company has historically operated in three defined reportable segments: restaurants, franchising, and fixed base airport hanger operations ("FBO"). The restaurant segment consists of the operations of all Company-owned restaurants and derives its revenues from retail sales of food products to the general public. The franchising segment consists of franchise sales and support activities and derives its revenues from fees related to the sales of franchise and development rights and collection of royalties from franchisees of the Krystal brand. The FBO operation, which was sold subsequent to the end of the third quarter and is now referred to as subsidiary held for sale, consists primarily of aircraft fuel sales and the leasing of aircraft hanger space. All of the Company's revenues are derived within the United States. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies. Segment information is as follows: ---------------------------------------------------------------------------- Sept. 29, Sept. 30, (in thousands) 2002 2001 ---------------------------------------------------------------------------- Revenues: Restaurants $185,492 $184,311 Franchising 5,877 5,053 Discontinued operations 5,084 5,106 ---------------------------------------------------------------------------- Total segment revenues $196,453 $194,470 ============================================================================ Depreciation and Amortization Restaurants $ 7,964 $ 10,426 Franchising 3 3 Discontinued operations 140 232 ---------------------------------------------------------------------------- Total segment depreciation and amortization $ 8,107 $ 10,661 ============================================================================ Earnings before Interest, Taxes, Depreciation, and Amortization ("EBITDA") Restaurant $ 14,098 $ 10,037 Franchising 4,166 3,580 Discontinued operations 1,257 1,304 ---------------------------------------------------------------------------- Total segment EBITDA $ 19,521 $ 14,921 ============================================================================ Sept. 29, December 30, 2002 2001 ----------------------------------------------------------------------------- Capital Expenditures: Restaurants $ 7,071 $ 5,665 Franchising 0 0 Discontinued operations 25 166 ------------------------------------------------------------------------------- Total segment capital expenditures $ 7,096 $ 5,831 =============================================================================== Total Assets: Restaurants $159,208 $186,904 Franchising 1,959 1,718 Assets held for sale 5,739 5,513 ------------------------------------------------------------------------------- Total segment assets $166,906 $194,135 =============================================================================== A reconciliation of segment depreciation and amortization to consolidated depreciation and amortization is as follows: ------------------------------------------------------------------------------- Sept. 29, Sept. 30, 2002 2001 ------------------------------------------------------------------------------- Segment depreciation and amortization $ 8,107 $ 10,661 Unreported segments (1) 225 223 ------------------------------------------------------------------------------- Total consolidated depreciation and amortization $ 8,332 $ 10,884 =============================================================================== A reconciliation of segment EBITDA to consolidated EBITDA is as follows: Segment EBITDA $ 19,521 $ 14,921 Unreported segments (1) 440 465 ------------------------------------------------------------------------------- Total consolidated EBITDA $ 19,961 $ 15,386 =============================================================================== A reconciliation of segment total assets to consolidated total assets is as follows: ------------------------------------------------------------------------------- Sept. 29, Dec. 30, 2002 2001 ------------------------------------------------------------------------------- Total segment assets $166,906 $194,135 Unreported segments (1) 3,627 3,855 ------------------------------------------------------------------------------- Total consolidated assets $170,533 $197,990 =============================================================================== (1) Unreported segments do not meet the quantitative thresholds for segment reporting. 4. INDEBTEDNESS Senior Secured Credit Agreement-- 0n January 28, 2002, the Company entered into a $25.0 million credit agreement (the "Credit Facility"). The Credit Facility provides for $10.0 million in revolving loan commitments and a $15.0 million term loan commitment, with maturity dates of June 1, 2004 and January 28, 2007, respectively. Borrowings under the revolving loan commitment bear interest rates, at the option of the Company, and depending on the certain financial covenants, equal to either (a) the greater of the prime rate, or the federal funds rate plus 0.5%, plus a margin (which ranges from 0.25% to 2.0%) or (b) the rate offered in the Eurodollar market for amounts and periods comparable to the relevant loan, plus a margin (which ranges from 1.75% to 3.5% and is determined by certain financial covenants). Borrowings under the term loan commitment bear interest rates equal to the rate offered in the Eurodollar market for 30 day borrowings, plus an applicable margin (which ranges from 3.5% to 4.0% and is determined by certain financial covenants). The Credit Facility contains restrictive covenants including, but not limited to (a) the Company's required maintenance of a minimum amount of tangible net worth; (b) the Company's required maintenance of certain levels of funded debt coverage; (c) limitations regarding additional indebtedness; (d) the Company's required maintenance of a minimum amount of fixed charges coverage; (e) limitations regarding consolidated capital expenditures and (f) limitations regarding liens on assets. The Company was in compliance with all such covenants during the nine months ended September 29, 2002. Essentially all assets of the Company are pledged as collateral on the Credit Facility. Additionally, the Credit Facility is guaranteed by Port Royal through a secured pledge of all of the Company's common stock held by Port Royal and the common stock of each existing and future subsidiary of the Company. Senior Notes-- In September 1997, the Company issued $100.0 million in unsecured 10.25% senior notes ("the Notes") which mature on October 1, 2007. The Notes pay interest semi-annually on April 1 and October 1 of each year. The Notes are redeemable at the option of the Company at prices decreasing from 105 1/8% of the principal amount on April 1, 2002 to 100% of the principal amount on April 1, 2005. Additionally, upon a change of control of the Company, the holders of the Notes will have the right to require the Company to purchase all or a portion of the Notes at a price equal to 101% of the original principal amount. The proceeds of the Notes were used to fund the acquisition of the Company by Port Royal. On December 31, 2001, May 30, 2002 and August 14, 2002, the Company purchased $27.0 million, $20,000 and $4.0 million, respectively, aggregate principal amount of its Notes. These Notes were retired resulting in an extraordinary gain of $2.9 million. The extraordinary gain resulted from retirement discounts of $5.7 million, offset by fees, taxes and other costs of approximately $2.8 million. 5. SALE AND LEASEBACK TRANSACTION On December 31, 2001, the Company entered into a real estate sale and leaseback transaction in which it sold commercial real property and improvements of 32 restaurant locations to an unaffiliated third party and leased the properties back for a period of twenty years. Proceeds from this transaction were approximately $23,317,000, net of expenses of $950,000. The Company has the option to extend the leases past the original twenty years for four additional periods of five years each. The leases are accounted for as operating leases. The net proceeds of this transaction were used to repurchase Notes with an aggregate principal of $27.0 million on December 31, 2001. The gain that the Company realized on the above real estate transactions was approximately $4,101,000 and has been deferred and classified in the balance sheets in Other Long-Term Liabilities, and will be amortized as a reduction of rental expense over the life of the leases. 6. COMMITMENTS AND CONTINGENCIES The Company is a party to various legal proceedings incidental to its business. The ultimate disposition of these matters is not presently determinable but will not, in the opinion of management and the Company's legal counsel, have a material adverse effect on the Company's financial condition or results of operations. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements of the Company (including the notes thereto) contained elsewhere in this report. Cash operating profit -- Cash operating profit (net income or loss before interest, taxes, depreciation, amortization and other non-operating gains, losses or expenses) is one of the key standards used by the Company to measure operating performance. Cash operating profit is used to supplement operating income as an indicator of operating performance and cash flows from operating activities as a measure of liquidity, and not as an alternative to measures defined and required by generally accepted accounting principles. Cash operating profit may not be comparable to similarly titled measures reported by other companies. Cash operating profit for the three months ended September 29, 2002 was $5.4 million compared to $4.7 million for the three months ended September 30, 2001, an increase of 14.9%. This increase in cash operating profit was primarily attributable to a decrease in cost of labor and food as a percent of restaurant sales. The following table reflects certain key operating statistics which impact the Company's financial results:

KEY OPERATING STATISTICS (Dollars in thousands, except average check) For The Three For the ~~Six~~Nine Months Ended Months Ended -------------------- --------------------- ~~June~~Sept. 3029, ~~July~~Sept. 130, ~~June~~Sept. 3029, ~~July~~Sept. 130, 2002 2001 2002 2001 --------- -------- --------- -------- RESTAURANT SALES: Company owned $ 6261,~~941~~555 $ 6361,~~337~~703 $~~123~~185,~~937~~492 $~~122~~184,~~635~~311 Franchise 36,~~671~~784 3132,~~263~~473 70107,~~499~~283 5991,~~429~~902 -------- -------- -------- -------- SYSTEMWIDE RESTAURANT SALES $ 9998,~~612~~339 $ 94,~~600~~176 $~~194~~292,~~436~~775 $~~182~~276,~~064~~213 Percent change 54.3342% 23.7799% 6.8100% 3.7078% COMPANY RESTAURANT STATISTICS: Number of restaurants 246 247 246 247 Restaurant Sales $ 6261,~~941~~555 $ 6361,~~337~~703 $~~123~~185,~~937~~492 $~~122~~184,~~635~~311 Percent change (0.6324%) (43.6729%) 10.0664% (43.2695%) Percent change in same restaurant sales (0.1504%) (10.3828%) 21.1138% (1.9539%) Selected components are -- Cost of restaurant sales $ 50,~~739~~600 $ 5352,~~628~~085 $~~100~~151,~~697~~297 $~~104~~156,~~264~~322 As a percent of restaurant sales 8082.6321% 84.6742% 81.2456% 8584.0281% Food and paper cost $ 1918,~~078~~631 $ 20,~~953~~243 $ 3756,~~748~~379 $ 3960,~~800~~043 As a percent of restaurant sales 30.3127% 3332.0881% 30.4639% 32.4558% Direct labor $ 13,~~718~~574 $ 1413,~~345~~938 $ 2740,~~034~~608 $ 2842,~~363~~301 As a percent of restaurant sales 2122.8005% 22.6559% 21.8189% 2322.1395% Other labor costs $ 4,~~506~~417 $ 4,~~927~~677 $ 913,~~193~~610 $ 914,~~996~~673 As a percent of restaurant sales 7.1618% 7.7858% 7.4234% 87.1596% Average check $ 4.7577 $ 4.6965 $ 4.7274 $ 4.64 Percent change 12.2858% 1.9653% 12.7216% 32.3465% FRANCHISE SYSTEM STATISTICS: Number of restaurants ~~173~~177 ~~148~~155 ~~173~~177 ~~148~~155 Restaurant Sales $ 36,~~671~~784 $ 3132,~~263~~473 $ 70107,~~499~~283 $ 5991,~~429~~902 Percent change 1713.3028% 2221.0534% 1816.6374% 2523.1678% Percent change in same restaurant sales (2.2979%) (31.4515%) (01.6341%) (32.1346%) Average check $ 5.0609 $ 4.9799 $ 5.0305 $ 4.9294 Percent change 12.8100% 54.5261% 2.2423% 6.7201%

Comparison of the Three Months Ended September 29, 2002 ------------------------------------------------------- to the Three Months Ended September 30, 2001 -------------------------------------------- RESULTS OF OPERATIONS --------------------- Total systemwide Krystal restaurant sales, which included restaurant sales of $61.5 million for Company-owned units and $36.8 million for franchised units, for the three months ended September 29, 2002 increased 4.4% to $98.3 million compared to $94.2 million for the same period in 2001. Total Company revenues increased $78,000 to $63.5 million in the three months ended September 29, 2002 compared to the same period in 2001. The increase was comprised of a $226,000 increase in royalty and franchise revenue, offset by a $148,000 decrease in restaurant sales. The decrease in restaurant sales was primarily due to one fewer Company owned restaurants in operation during the period and a 0.04% decrease in same restaurant sales for the period. The Company operated 246 restaurants at September 29, 2002 compared to 247 restaurants at September 30, 2001. Company-owned same restaurant sales decreased 0.04%, compared to the same period in 2001. The decrease was primarily attributable to a decrease in restaurant volume, offset by an increase in average check amount for the three months ended September 29, 2002 compared to the same period in 2001. The average customer check for Company owned restaurants increased 2.58% to $4.77 for the three months ended September 29, 2002, compared to $4.65 for the same period in 2001. This increase resulted primarily from price increases implemented by the Company in the fourth quarter of 2001. Franchise fee income was $257,000 in the three months ended September 29, 2002 compared to $173,000 in the same period in 2001. The increase in franchise fees, which are collected upon the opening, transfer or renewal of new franchise restaurants, related primarily to renewals and extensions of franchise agreements. The Company's franchisees opened five franchised restaurants in the three months ended September 29, 2002. During the three months ended September 30, 2001, franchisees opened five new restaurants and re-opened four additional restaurants that had been temporarily closed. There were no franchise fees associated with the re-opened restaurants. Royalty revenue increased 9.2% to $1.7 million in the three months ended September 29, 2002 from $1.5 million in the same period in 2001. The increase in royalty revenue, which is earned based on a percentage of sales by franchise restaurants, was due to a 13.3% increase in franchise restaurant sales resulting from an increase in the number of franchise restaurants in operation. The franchise system operated 177 restaurants at September 29, 2002 compared to 155 at September 29, 2001. Cost of restaurant sales was $50.6 million for the three months ended September 29, 2002 compared to $52.1 million for the same period in 2001. Food and paper costs as a percent of restaurant sales decreased to 30.3% in the three months ended September 29, 2002 from 32.8% in the same period in 2001. The decrease in food and paper costs as a percent of restaurant sales resulted primarily from improved restaurant level controls over food and paper usage, a shift in menu mix to higher margin offerings and the effect of the Company's 1.4% price increase effected in the fourth quarter of 2001. Direct labor as a percent of restaurant sales decreased to 22.0% for the three months ended September 29, 2002 from 22.6% for the same period in 2001. Average hourly wage increased 0.6% to $6.37 for the three months ended September 29, 2002 from $6.33 for the same period in 2001. This increase was more than offset by operating efficiencies from improvements in the utilization of store level labor tracking systems. Advertising expense was $2.6 million in the three months ended September 29, 2002 and September 30, 2001. Advertising expense is accrued based on 4.2% of restaurant sales and will vary with the volume of such sales. Depreciation and amortization expenses decreased $795,000, or 22.4%, to $2.7 million in the three months ended September 29, 2002 compared to the same period in 2001. The decrease resulted primarily from a reduction in depreciation as a result of the sale and leaseback of 32 restaurants on December 31, 2001 and the elimination of goodwill amortization expense resulting from the adoption by the Company of SFAS 142 as of December 31, 2001. Goodwill amortization expense for the three months ended September 30, 2001 was approximately $491,900. General and administrative expenses for the three months ended September 29, 2002 was $4.5 million compared to $3.9 million for the same period in fiscal 2001. The increase resulted primarily from an increase of approximately $579,000 in accruals for the management incentive plan, and an increase of approximately $106,000 in expense associated with the Company's defined benefit plan. In the first nine months of 2001, the Company's performance failed to meet the criteria for payment of management incentive bonuses and, accordingly, no provision was made for such bonuses. In the first nine months of 2002, the Company's year-to-date performance warranted an accrual for the anticipated payment of such bonuses. The increase in expense associated with the defined benefit plan resulted from the actuarial impact of lower investment returns and lower interest rates assumed in the actuarial valuation performed for fiscal 2002 compared to the 2001 valuation. Because the Company's defined benefit plan is currently over funded under the requirements of the Employee Retirement Income Act of 1974, the increase in expense does not impact the Company's funding policy for the defined benefit plan. Other expenses, net, increased $176,000, or 88.0%, to $376,000 in the three months ended September 29, 2002 compared to the same period in 2001. This increase resulted primarily from a $496,200 charge for the impairment of certain assets in the three months ended September 29, 2002 compared to a $344,900 charge in the same period of 2001. The Company recognized a $69,000 loss on sale of assets for the three months ended September 29, 2002 compared to a loss of $48,000 for the same period in 2001. The loss in the third quarter of 2002 and 2001 resulted from the sale of non-operating properties. Interest expense, net of interest income, decreased $881,000 to $2.3 million in the three months ended September 29, 2002 from $3.2 million in the same period in 2001. This decrease resulted primarily from the Company's retirement of $31.0 million of the Notes during fiscal 2002 and lower borrowings under its Credit Facility during the quarter ended September 29, 2002. The Company's income taxes benefit from continuing operations decreased for the three months ended September 29, 2002 by $719,000, to a $63,000 expense from a $656,000 benefit, in the same period in 2001. In the quarter ended September 29, 2002, the Company recognized an extraordinary gain of $174,000, net of income taxes of $106,000, resulting from the repurchase and retirement $4.0 million aggregate principal amount of the Company's Notes. Comparison of the Nine Months Ended September 29, 2002 ------------------------------------------------------ to the Nine Months Ended September 30, 2001 ------------------------------------------- RESULTS OF OPERATIONS --------------------- Total systemwide Krystal restaurant sales, which included restaurant sales of $185.5 million for Company-owned units and $107.3 million for franchised units, for the nine months ended September 29, 2002 increased 6.0% to $292.8 million compared to $276.2 million for the same period in 2001. Total Company revenues increased 1.1% to $191.4 million in the nine months ended September 29, 2002 compared to $189.4 million in the same period in 2001. The $2.0 million increase was comprised of a $1.2 million increase in restaurant sales and a $824,000 increase in royalty and franchise revenue. The increase in restaurant sales was primarily due to an increase in sales volumes and check average, resulting in an increase in same restaurant sales. The Company operated 246 restaurants at September 29, 2002 compared to 247 restaurants at September 29, 2001. Company-owned same restaurant sales increased 1.4%, compared to the same period in 2001. The increase was primarily attributable to an increase in average check amount, offset by a decrease in sales volumes, for the nine months ended September 29, 2002 compared to the same period in 2001. The average customer check for Company owned restaurants increased 2.2% to $4.74 for the nine months ended September 29, 2002, compared to $4.64 for the same period in 2001. This increase resulted primarily from price increases of approximately 1.4% implemented by the Company in the fourth quarter of 2001 and a shift in menu mix to higher priced offerings. Franchise fee income was $854,000 in the nine months ended September 29, 2002 compared to $676,000 in the same period in 2001. The increase in franchise fees, which are collected upon the opening, transfer or renewal of franchise restaurants, related primarily to the collection of franchise renewals, transfer, and extension fees, offset by a reduction in the number of franchise restaurants opened in the first nine months of 2002 compared to 2001. Franchise renewal, transfer and extension fees were approximately $304,000 for the first nine months of 2002 compared to $26,000 in the same period in 2001. The Company's franchisees opened 17 franchised restaurants in the nine months ended September 29, 2002 compared to 24 in the same period in 2001. Royalty revenue increased 14.8% to $5.0 million in the nine months ended September 29, 2002 from $4.4 million in the same period in 2001. The increase in royalty revenue, which is earned based on a percentage of sales by franchise restaurants, was due to a 16.7% increase in franchise restaurant sales resulting primarily from an increase in the number of franchise restaurants in operation. The franchise system operated 177 restaurants at September 29, 2002 compared to 155 at September 30, 2001. Cost of restaurant sales was $151.3 million for the nine months ended September 29, 2002 compared to $156.3 million for the same period in 2001. Food and paper costs as a percent of restaurant sales decreased to 30.4% in the nine months ended September 29, 2002 from 32.6% in the same period in 2001. The decrease in food and paper costs as a percent of restaurant sales resulted primarily from improved restaurant level controls over food and paper usage and the effect of the Company's 1.4% price increase effected in the fourth quarter of 2001. Direct labor as a percent of restaurant sales decreased to 21.9% in the first nine months of 2002 from 23.0% in the same period in 2001. Average hourly wage increased 0.3% to $6.36 for the first nine months of 2002 from $6.34 for the first nine months of 2001. This increase was more than offset by operating efficiencies gained with increased sales volumes and improvements in the utilization of store level labor tracking systems. Advertising expense increased 0.7% to $7.8 million in the nine months ended September 29, 2002 from $7.7 million in the same period in 2001. Advertising expense is accrued based on 4.2% of restaurant sales and will vary with the volume of such sales. Depreciation and amortization expenses decreased $2.5 million, or 23.1%, to $8.2 million in the nine months ended September 29, 2002 compared to the same period in 2001. The decrease resulted primarily from a reduction in depreciation as a result of the sale and leaseback of 32 restaurants on December 31, 2001 and the elimination of goodwill amortization expense resulting from the adoption by the Company of SFAS 142 as of December 31, 2001. Goodwill amortization expense for the nine months ended September 29, 2001 was approximately $1.5 million. General and administrative expenses for the nine months ended September 29, 2002 were $13.4 million compared to $11.3 million for the same period in fiscal 2001. The $2.1 million increase resulted primarily from an increase of approximately $1.4 million in accruals for the management incentive plan and an increase of approximately $734,000 in expense associated with the Company's defined benefit plan. In the first nine months of 2001, the Company's performance failed to meet the criteria for payment of management incentive bonuses and, accordingly, no provision was made for such bonuses. In the first nine months of 2002, the Company's year-to-date performance warranted an accrual for the anticipated payment of such bonuses. The increase in expense associated with the defined benefit plan resulted from the actuarial impact of lower investment returns and lower interest rates assumed in the actuarial valuation performed for fiscal 2002 compared to the 2001 valuation. Because the Company's defined benefit plan is currently over funded under the requirements of the Employee Retirement Income Security Act of 1974, the increase in expense does not impact the Company's funding policy for the defined benefit plan. Other expenses increased $187,000, or 222.4%, to $129,000 in the nine months ended September 29, 2002 compared to the same period in 2001. This increase resulted primarily from a $496,200 charge to the impairment of certain assets in the nine months ended September 29, 2001 compared to $344,900 for the same period in 2001. The Company recognized an $69,000 loss on sale of assets for the nine months ended September 29, 2002 compared to gains of $548,000 for the same period in 2001. The loss in the first nine months of 2002 resulted from the sale of non-operating properties and the gains in same period of 2001 resulted from the sale of a restaurant to a franchisee and the sale of other non-operating properties. Interest expense, net of interest income, decreased $2.5 million to $7.2 million in the nine months ended September 29, 2002 from $9.7 million in the same period in 2001. This decrease resulted primarily from the Company's retirement of $27.0 million of the Notes on December 31, 2001 and lower borrowings under its Credit Facility during the nine months ended September 29, 2002. The Company's provision for income taxes from continuing operations for the nine months ended September 29, 2002 increased $2.6 million, to a $0.8 million tax expense from a $1.8 million tax benefit in the same period in 2001. The effective rate was 31% in both periods. During the second quarter of 2002, the Company revised its estimate of certain tax liability contingencies resulting in a reduction of income tax expense of $200,000. During the nine months ended September 29, 2002, the Company recorded an extraordinary gain of $2.9 million, net of income taxes of $1.8 million, resulting from the repurchase and retirement of approximately $31.0 million aggregate principal value of the Company's Notes. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company does not maintain significant inventory or accounts receivables since substantially all of its restaurants' sales are for cash. Royalties from franchisees, which are payable weekly, and other receivables from franchisees are closely monitored by the Company. The Company typically receives several weeks of trade credit in purchasing food and supplies which is standard in the restaurant business. The Company normally operates with working capital deficits (current liabilities exceeding current assets) and had a working capital deficit of $17.4 million at September 29, 2002, compared to a working capital deficit of $11.2 million at December 30, 2001. Capital expenditures totaled approximately $7.1 million in the nine months ended September 29, 2002 as compared to $4.8 million in the same period in 2001. The Company opened no new restaurants during the nine months ended September 29, 2002 or September 30, 2001. Approximately $2.7 million of the Company's capital expenditures in the first nine months of 2002 resulted from the purchase of leased assets previously recorded as capital leases. Management estimates that capital expenditures will be approximately $1.5 million during the remainder of 2002. Capital expenditures for the remainder of the current year are expected to include the refurbishment and remodeling of certain restaurants, ongoing capital improvements, and the implementation of new restaurant cash register systems. On December 31, 2001, May 28, 2002 and August 14, 2002, the Company purchased $27.0 million, $20,000 and 4.0 million, respectively, aggregate principal amount of its Notes. These Notes were retired resulting in an extraordinary gain of $2.9 million. The extraordinary gain resulted from retirement discounts of $5.6 million, offset by fees, taxes and other costs of approximately $2.7 million. During the second quarter of 2002, the Company exercised its option to purchase certain leased assets that were previously classified as capital leases on the balance sheet. The assets were purchased for $2.7 million. 0n January 28, 2002, the Company entered into a $25.0 million credit agreement (the "Credit Facility"). The Credit Facility provides for $10.0 million in revolving loan commitments and a $15.0 million term loan commitment, with maturity dates of June 1, 2004 and January 28, 2007, respectively. At September 29, 2002, the Company had available cash of approximately $8.6 million, receivables of $1.6 million, and $6.9 million available under the Company's line of credit. In the opinion of management, these funds and funds from operations will be sufficient to meet operating requirements, anticipated capital expenditures and other obligations for the foreseeable future. On October 17, 2002, the Company completed its sale of substantially all of the assets of its fixed based hangar operations to Truman Arnold Companies for $10.8 million. The Company expects that after taxes, fees and expenses the estimated net proceeds from the sale will be approximately $7.0 million. Approximately $2.4 million of the net proceeds was used to retire outstanding senior debt, with the balance of the net proceeds being retained by the Company for future capital expenditures or further reduction of indebtedness. The following table represents the Company's outstanding contractual obligations of the types described below at September 29, 2002, excluding letters of credit of approximately $3.5 million. The letters of credit are maintained primarily to support the Company's insurance program and are renewed on an annual basis. Payments Due by Period (Thousands of dollars) --------------------------------------------------------------------------- Less Contractual than 1 1-3 4-5 After 5 Obligations Total year years years years ---------------- -------- -------- -------- -------- -------- Senior Notes and Other Borrowings $ 70,660 $ 2,565 $ 455 $ 67,155 $ 485 Lines of Credit 14,271 1,250 2,500 2,500 8,021 Capital Lease Obligations 6,751 1,179 1,256 1,124 3,192 Operating Leases 85,404 8,033 13,485 11,036 52,850 Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. The Company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings under the Exchange Act. (b) Changes in Internal Controls. Since the Evaluation Date, there have not been any significant changes in the Company's internal controls or in other factors that could significantly affect such controls. PART II OTHER INFORMATION Item 1. Legal Proceedings The Company is party to various legal proceedings incidental to its business. The ultimate disposition of these matters is not presently determinable but will not, in the opinion of management, have a material adverse effect on the Company's financial condition or results of operations. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits- No exhibit is filed with this 10-Q. (b) Reports on Form 8-K- Form 8-K dated as of September 4, 2002, was filed by the Company during the third quarter of 2002 to report that the Company had entered into a letter of intent to sell substantially all the assets of Krystal Aviation Co. THE KRYSTAL COMPANY AND SUBSIDIARY ---------------------------------- 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 the undersigned thereunto duly authorized. THE KRYSTAL COMPANY (Registrant) Dated: 11/8/02 /s/Larry D. Bentley --------------- ------------------------ Larry D. Bentley (Vice President, Chief Financial Officer and Principal Accounting Officer) CERTIFICATIONS -------------- I, Philip H. Sanford, Chairman and Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Krystal Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 8, 2002 /s/Philip H. Sanford --------------------------- Philip H. Sanford, Chairman and Chief Executive Officer I, Larry D. Bentley, Vice President and Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Krystal Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 8, 2002 /s/Larry D. Bentley ----------------------- Larry D. Bentley, Vice President and Chief Financial Officer

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