UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-16505
-----------
The Smith & Wollensky Restaurant Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware 58 2350980
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1114 First Avenue, New York, NY 10021
(Address of principal executive offices) (Zip code)
212-838-2061
(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 the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of August 14, 2003, the registrant had 9,375,066 shares of Common Stock, $.01
par value per share, outstanding.
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
INDEX
PART I - FINANCIAL INFORMATION PAGE
Item 1. Financial Statements.
Consolidated Balance Sheets as of June 30, 2003 (unaudited) and December 30, 2002 4
Unaudited Consolidated Statements of Operations for the three- and six-month periods
ended June 30, 2003 and July 1, 2002 5
Unaudited Consolidated Statements of Stockholders' Equity for the six-month periods ended
June 30, 2003 and July 1, 2002 6
Unaudited Consolidated Statements of Cash Flows for the six-month periods ended
June 30, 2003 and July 1, 2002 7
Notes to Unaudited Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk. 27
Item 4. Controls and Procedures. 28
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders. 28
Item 6. Exhibits and Reports on Form 8-K. 28
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
On one or more occasions, we may make statements in this Quarterly
Report on Form 10-Q regarding our assumptions, projections, expectations,
targets, intentions or beliefs about future events. All statements other than
statements of historical facts, included or incorporated by reference herein
relating to management's current expectations of future financial performance,
continued growth and changes in economic conditions or capital markets are
forward looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Words or phrases such as "anticipates," "believes," "estimates,"
"expects," "intends," "plans," "predicts," "projects," "targets," "will likely
result," "hopes", "will continue" or similar expressions identify forward
looking statements. Forward-looking statements involve risks and uncertainties,
which could cause actual results or outcomes to differ materially from those
expressed. We caution that while we make such statements in good faith and we
believe such statements are based on reasonable assumptions, including without
limitation, management's examination of historical operating trends, data
contained in records and other data available from third parties, we cannot
assure you that our projections will be achieved. Factors that may cause such
differences include: economic conditions generally and in each of the markets in
which we are located, the amount of sales contributed by new and existing
restaurants, labor costs for our personnel, fluctuations in the cost of food
products, changes in consumer preferences, the level of competition from
existing or new competitors in the high-end segment of the restaurant industry
and our success in implementing our growth strategy.
We have attempted to identify, in context, certain of the factors that
we believe may cause actual future experience and results to differ materially
from our current expectation regarding the relevant matter or subject area. In
addition to the items specifically discussed above, our business, results of
operations and financial position and your investment in our common stock are
subject to the risks and uncertainties described in Exhibit 99.1 of this
Quarterly Report on Form 10-Q.
From time to time, oral or written forward-looking statements are also
included in our reports on Forms 10-K, 10-Q and 8-K, our Schedule 14A, our press
releases and other materials released to the public. Although we believe that at
the time made, the expectations reflected in all of these forward-looking
statements are and will be reasonable, any or all of the forward-looking
statements in this Quarterly Report on Form 10-Q, our other reports on Forms
10-K, 10-Q and 8-K, our Schedule 14A and any other public statements that are
made by us may prove to be incorrect. This may occur as a result of inaccurate
assumptions or as a consequence of known or unknown risks and uncertainties.
Many factors discussed in this Quarterly Report on Form 10-Q, certain of which
are beyond our control, will be important in determining our future performance.
Consequently, actual results may differ materially from those that might be
anticipated from forward-looking statements. In light of these and other
uncertainties, you should not regard the inclusion of a forward-looking
statement in this Quarterly Report on Form 10-Q or other public communications
that we might make as a representation by us that our plans and objectives will
be achieved, and you should not place undue reliance on such forward-looking
statements.
We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. However, your attention is directed to any further
disclosures made on related subjects in our subsequent periodic reports filed
with the Securities and Exchange Commission on Forms 10-K, 10-Q and 8-K and
Schedule 14A.
Unless the context requires otherwise, references to "we," "us," "our,"
"SWRG" and the "Company" refer specifically to The Smith & Wollensky Restaurant
Group, Inc. and its subsidiaries and predecessor entities.
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(dollar amounts in thousands, except per share data)
June 30, December 30,
2003 2002
---- ----
(unaudited)
Assets
Current assets:
Cash and cash equivalents................................................. $ 3,170 $ 4,158
Short-term investments.................................................... 1,901 3,636
Accounts receivable, less allowance for doubtful accounts of
$55 at June 30, 2003 and December 30, 2002, respectively.................. 3,162 2,261
Merchandise inventory..................................................... 3,636 3,578
Prepaid expenses and other current assets................................. 1,247 1,465
-------- -------
Total current assets...................................................... 13,116 15,098
Property and equipment, net................................................. 58,690 46,693
Goodwill, net............................................................... 6,886 6,886
Licensing agreement, net.................................................... 3,411 3,258
Management contract, net.................................................... 779 829
Long-term investments....................................................... 1,552 1,684
Other assets................................................................ 3,603 3,407
-------- -------
Total assets.............................................................. $ 88,037 $ 77,855
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of long-term debt......................................... $ 1,596 $ 1,157
Accounts payable and accrued expenses..................................... 9,594 8,851
-------- -------
Total current liabilities................................................. 11,190 10,008
Obligations under capital lease............................................. 9,921 _
Long-term debt, net of current portion...................................... 6,967 8,232
Deferred rent............................................................... 5,203 5,209
-------- -------
Total liabilities......................................................... 33,281 23,449
Stockholders' equity:
Common stock (par value $.01; authorized 40,000,000 shares; 9,355,899 and
9,354,266 shares issued and outstanding at June 30, 2003 and December 30, 94 94
2002, respectively).......................................................
Additional paid-in capital................................................ 69,861 69,854
Accumulated deficit....................................................... (15,218) (15,491)
Accumulated other comprehensive income (loss)............................. 19 (51)
-------- -------
54,756 54,406
-------- -------
Commitments and contingencies
Total liabilities and stockholders' equity................................ $ 88,037 $ 77,855
======== ========
See accompanying notes to unaudited consolidated financial statements.
4
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
(dollar amounts in thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, July 1, June 30, July 1,
2003 2002 2003 2002
---- ---- ---- ----
Owned restaurant sales................................. $ 23,679 $ 18,725 $ 46,671 $ 38,242
-------- -------- -------- --------
Cost of owned restaurant sales:
Food and beverage costs.............................. 7,336 5,404 14,381 10,970
Salaries and related benefit expenses................ 6,689 5,672 13,054 11,153
Restaurant operating expenses........................ 3,901 2,816 7,452 5,728
Occupancy and related expenses....................... 1,123 1,485 2,581 2,851
Marketing and promotional expenses................... 928 829 1,832 1,533
Depreciation and amortization expenses............... 942 815 1,845 1,608
-------- -------- -------- --------
Total cost of owned restaurant sales.............. 20,919 17,021 41,145 33,843
-------- -------- -------- --------
Income from owned restaurant operations................ 2,760 1,704 5,526 4,399
Management fee income.................................. 504 641 1,012 1,262
-------- -------- -------- --------
Income from owned and managed restaurants.............. 3,264 2,345 6,538 5,661
General and administrative expenses.................... 2,346 2,489 5,068 4,793
Royalty expense........................................ 369 255 717 525
-------- -------- -------- --------
Operating income (loss)................................ 549 (399) 753 343
Interest expense....................................... (277) (36) (403) (75)
Amortization of deferred debt financing costs.......... (13) _ (26) _
Interest income........................................ 31 27 74 84
Interest income (expense), net......................... (259) (9) (355) 9
-------- -------- -------- --------
Income (loss) before provision for income taxes........ 290 (408) 398 352
Provision for income taxes............................. 75 51 125 101
-------- -------- -------- --------
Net income (loss)........................................ $ 215 $ (459) $ 273 $ 251
======== ======== ======== ========
Net income (loss) per common share basic and diluted:.. 4 0.02 $ (0.05) $ 0.03 $ 0.03
======== ======== ======== ========
Weighted average common shares outstanding:
Basic 9,354,481 9,354,266 9,354,374 9,354,266
========= ========= ========= =========
Diluted 9,806,731 9,354,266 9,667,470 9,428,798
========= ========= ========= =========
See accompanying notes to unaudited consolidated financial statements.
5
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
AND SUBSIDIARIES
Unaudited Consolidated Statements of Stockholders' Equity
(dollar amounts in thousands)
Six months ended June 30, 2003 and July 1, 2002
Accumulated
Common Stock Additional other
------------ paid-in Accumulated comprehensive Stockholders'
Shares Amount capital deficit income (loss) equity
------ ------ ------- ------- ------------- ------
Balance at December 31,
2001 9,354,266 $94 $69,854 $(13,364) $ -- $56,584
Net income.............. 251 -- 251
--------- ----- -------
Balance at July 1,
2002.................. 9,354,266 $ 94 $69,854 $(13,113) $ -- $56,835
========= ==== ======= ========= ===== =======
Balance at December 30,
2002.................. 9,354,266 $94 $69,854 $(15,491) $(51) $54,406
Stock options exercised 1,633 -- 7 7
Unrealized gain on
investments 70 70
Net income......... -- -- -- 273 -- 273
--------- ---- ------- --------- ----- -------
Total comprehensive income 350
=======
Balance at June 30,
2003.................. 9,355,899 $ 94 $69,861 $(15,218) $ 19 $54,756
========= ==== ======= ========= ===== =======
See accompanying notes to unaudited consolidated financial statements.
6
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
(dollar amounts in thousands)
Six months ended June 30, 2003 and July 1, 2002
June 30, July 1,
2003 2002
---- ----
Cash flows from operating activities:
Net income.................................................... $ 273 $ 251
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................... 2,066 1,827
Amortization of deferred debt financing costs.............. 26 --
Changes in operating assets and liabilities:
Accounts receivable...................................... (908) 501
Merchandise inventory.................................... (58) (466)
Prepaid expenses and other current assets................ 218 (113)
Other assets............................................. (161) (75)
Accounts payable and accrued expenses.................... 743 (286)
Deferred rent............................................ (19) 101
------- --------
Net cash provided by operating activities...... 2,180 1,740
Cash flows from investing activities:
Purchase of property and equipment........................... (3,994) (2,709)
Purchase of nondepreciable assets............................ (99) (161)
Purchase of investments...................................... (2,568) (3,466)
Proceeds from sale of investments............................ 4,513 2,376
Payments under licensing agreement........................... (224) (219)
------- --------
Cash flows used in investing activities........ (2,372) (4,179)
Cash flows from financing activities:
Principal payments of long-term debt.......................... (803) (158)
Proceeds from options exercised............................... 7 --
------- --------
Cash flows used in financing activities......... (796) (158)
------- --------
Net change in cash and cash equivalents....................... (988) (2,597)
Cash and cash equivalents at beginning of period.............. 4,158 4,561
------- --------
Cash and cash equivalents at end of period..... $ 3,170 $ 1,964
======= ========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest........................................ $ 328 $ 75
======= ========
Income taxes.................................... $ 44 $ 196
======= ========
Noncash investing and financing activities:
Purchase of land............................... $(9,921) --
======== ========
Obligations under capital lease................ $ 9,921 --
======== ========
See accompanying notes to unaudited consolidated financial statements.
7
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
June 30, 2003 and July 1, 2002
(1) General
The accompanying unaudited consolidated financial statements of The Smith &
Wollensky Restaurant Group, Inc. and its wholly-owned subsidiaries
(collectively, "SWRG") do not include all information and footnotes normally
included in financial statements prepared in conformity with accounting
principles generally accepted in the United States. In the opinion of
management, the unaudited consolidated financial statements for the interim
periods presented reflect all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of the financial position and
results of operations as of and for such periods indicated. These unaudited
consolidated financial statements and related notes should be read in
conjunction with the audited consolidated financial statements of SWRG for the
fiscal year ended December 30, 2002 filed by SWRG on Form 10-K with the
Securities and Exchange Commission on March 31, 2003. Results for the interim
periods presented herein are not necessarily indicative of the results, which
may be reported for any other interim period or for the entire fiscal year.
The consolidated balance sheet data presented herein for December 30, 2002
was derived from SWRG's audited consolidated financial statements for the fiscal
year then ended, but does not include all disclosures required by accounting
principles generally accepted in the United States. The preparation of unaudited
financial statements in accordance with accounting principles generally accepted
in the United States requires SWRG to make certain estimates and assumptions for
the reporting periods covered by the financial statements. These estimates and
assumptions affect the reported amounts of assets, liabilities, revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
SWRG utilizes a 52- or 53-week reporting period ending on the Monday nearest
to December 31st. The three months ended June 30, 2003 and July 1, 2002
represent 13-week reporting periods and the six months ended June 30, 2003 and
July 1, 2002 represent 26-week reporting periods. SWRG develops, owns, operates
and manages a diversified portfolio of upscale tablecloth restaurants. At June
30, 2003, SWRG owned and operated eleven restaurants, including eight Smith &
Wollensky restaurants. The newest restaurant, a 400 seat Smith & Wollensky in
Dallas, Texas, opened on March 17, 2003. SWRG also manages five restaurants.
(2) Effect of New Accounting Standards
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 amends existing guidance on reporting gains and losses
on the extinguishment of debt to prohibit the classification of the gain or loss
as extraordinary, as the use of such extinguishments have become part of the
risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13
to require sale-leaseback accounting for certain lease modifications that have
economic effects similar to sale-leaseback transactions. The provisions of the
Statement related to the rescission of Statement No. 4 is applied in fiscal
years beginning after May 15, 2002. The provisions of the Statement related to
Statement No. 13 were effective for transactions occurring after May 15, 2002.
The implementation of this standard had no material impact on SWRG's results of
operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 31, 2002. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and had no
material effect on SWRG's financial statements.
8
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation Transition and Disclosure, an amendment of FASB
Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based employee
compensation. SWRG accounts for stock-based compensation using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. SWRG has adopted the pro forma
disclosure requirements of SFAS No. 123, Accounting for Stock-Based
Compensation. The following table illustrates the effect on the net income
(loss) as if SWRG had applied the fair value recognition provisions of SFAS No.
123 to stock based compensation:
Three Months Ended Six Months Ended
------------------ ----------------
June 30, July 1, June 30, July 1,
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss), as reported $ 215 (459) 273 251
Add stock-based employee
compensation expense included in
reported net income 22 12 22 24
Deduct total stock-based employee
compensation expense determined
under fair value based method (131) -- (262) --
------------- ----------------------- ------------
Pro forma net income (loss) $ 106 (447) 33 275
=== ===== === ===
Per common share - basic and diluted
Pro forma net income (loss) $ 0.01 (0.05) 0.00 0.03
=========== ========== ========== ==========
Weighted average common shares
outstanding:
Basic 9,354,481 9,354,266 9,354,374 9,354,266
========= ========= ========= =========
Diluted 9,806,731 9,354,266 9,667,470 9,428,798
========= ========= ========= =========
In January 2003, the FASB issued Interpretation No.46, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51. This Interpretation addresses the consolidation by business enterprises
of variable interest entities as defined in the Interpretation. The
Interpretation applies immediately to variable interests in variable interest
entities created after January 31, 2003, and to variable interests in variable
interest entities obtained after January 31, 2003. For enterprises, such as
SWRG, with a variable interest in a variable interest entity created before
February 1, 2003, the Interpretation is applied to the enterprise no later than
the end of the first annual reporting period beginning after June 15, 2003. An
entity shall be subject to consolidation according to the provisions of this
Interpretation if, by design, the following conditions exists - As a group the
holders of the equity investment at risk lack any one of the following three
characteristics of a controlling financial interest: (1) the direct or indirect
ability to make decisions about an entity's activities through voting rights or
similar rights; (2) the obligation to absorb the expected losses of the entity
if they occur; or (3) the right to receive the expected residual returns of the
entity if they occur. SWRG is currently evaluating the impact of the application
of this Interpretation and the effect it may have on SWRG's financial
statements. SWRG believes it is possible that two of its managed restaurants,
which are owned by two separate partnerships, could be considered variable
interests that may need to be consolidated. SWRG believes that if such entities
were to be consolidated, these entities would gross up the consolidated sales
and restaurant operating costs of SWRG, but the impact on net income would be
immaterial.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
statement requires instruments that are mandatorily redeemable, among other
financial instruments, which embody an unconditional obligation requiring the
issuer to redeem them by transferring its assets at a specified or determinable
date or upon an event that is certain to occur, be classified as liabilities.
This statement is effective for financial instruments entered into or
9
modified after May 31, 2003 and is effective at the beginning of the first
interim period beginning after June 15, 2003. SWRG does not expect this
statement to have a material impact on its financial statements.
(3) Net Income (Loss) per Common Share
SWRG calculates net income (loss) per common share in accordance with
SFAS No. 128, Earnings Per Share. Basic net income (loss) per common share is
computed by dividing the net income (loss) by the weighted average number of
common shares outstanding. Diluted net income (loss) per common share assumes
the exercise of stock options using the treasury stock method, if dilutive.
Dilutive net income (loss) per common share for the three- and six- months ended
June 30, 2003 and July 1, 2002, respectively, was the same as basic net income
(loss) per common share.
The following table sets forth the calculation for net income (loss) per
common share on a weighted average basis:
Three Months Ended Six Months Ended
------------------ ----------------
June 30, July 1, June 30, July 1,
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net income (loss)............................. $ 215 $ (459) $ 273 $ 251
===== ======= ===== =====
Total Weighted Weighted Weighted Weighted
Shares Average Average Average Average
------ Shares Shares Shares Shares
------ ------ ------ ------
Denominator:
Beginning common shares 9,354,266 9,354,266 9,354,266 9,354,266 9,354,266
Options exercised on June 19, 2003 1,633 215 -- 108 --
--------- --------- --------- --------- ---------
Basic 9,355,899 9,354,481 9,354,266 9,354,374 9,354,266
=========
Dilutive options 452,250 - 313,096 74,532
--------- --------- --------- --------
Diluted.............................................. 9,806,731 9,354,266 9,667,470 9,428,798
========= ========= ========= =========
Per common share-basic and diluted:
Net income (loss)........................ $ 0.02 $ (0.05) $ 0.03 $ 0.03
========= ========= ========= =========
The Company excluded options to purchase approximately 149,000 shares of
common stock for the three months ended July 1, 2002 because they are considered
anti-dilutive.
10
(4) Licensing Agreements
On August 16, 1996, SWRG entered into a Licensing Agreement with St.
James Associates ("St. James"), the owner of the Smith & Wollensky restaurant in
New York. St. James is an entity related through common management and
ownership.
The Licensing Agreement provides SWRG with the exclusive right to
utilize the names "Smith & Wollensky" and "Wollensky's Grill" ("Names")
throughout the United States and internationally, with the exception of a
reserved territory, as defined. Consequently, SWRG may not open additional Smith
& Wollensky restaurants or otherwise utilize the Names in the reserved
territory. The Licensing Agreement requires SWRG to make additional payments to
St. James as follows: (i) $200 for each new restaurant opened (increasing
annually commencing in 1999 by the lesser of the annual increase in the Consumer
Price Index or a 5% increase of the fee required in the preceding year), (ii) a
royalty fee of 2% based upon annual gross sales for each restaurant utilizing
the Names, as defined, subject to certain annual minimums, and (iii) a royalty
fee of 1% of annual gross sales for any steakhouses opened in the future by SWRG
that does not utilize the Names. In addition, should SWRG terminate or default
on the license, as defined, it is subject to a fee of $2,000 upon termination or
$2,500 to be paid over four years.
There are future minimum royalty payments relating to (ii) and (iii)
above which are as follows:
Fiscal year:
- ------------
2003 $ -
2004 800
2005 800
2006 800
2007 800
2008 and each year thereafter..................................... 800
During the six-month period ended June 30, 2003, SWRG paid $224 in
connection with the opening of the Smith & Wollensky unit in Dallas, Texas.
(5) Management Agreements
Prior to December 2002, SWRG operated Park Avenue Cafe in Chicago, Mrs.
Park's Tavern and the other services of the food and beverage department of the
Doubletree Hotel in Chicago ("Doubletree") pursuant to a sub-management
agreement (the "Doubletree Agreement"). SWRG received a management fee equal to
the sum of 1.5% of sales and a percentage of earnings, as defined. The
Doubletree Agreement expires on the earlier of December 31, 2004 or the
termination of the related hotel management agreement between Chicago HSR
Limited Partnership ("HSR"), the owner of the Doubletree and Doubletree
Partners, the manager of the Doubletree. During December 2002, HSR closed the
Park Avenue Cafe restaurant in Chicago and discontinued SWRG's requirement to
provide other food and beverage department service for the Doubletree. As a
result, SWRG is no longer receiving the fees described above. During the
three-month period ended March 31, 2003, SWRG reached an agreement with HSR. The
agreement provides for the continued use by HSR of the name Mrs. Parks Tavern
and requires SWRG to provide management services to support that location. In
exchange for the use of the Mrs. Park's Tavern name and related management
support SWRG receives an annual fee of $50. The agreement will automatically
renew each year, unless notification of cancellation is given, by either party,
at least 90 days prior to December 31.
11
(6) Long-Term Debt
Long-term debt consists of the following:
June 30, Dec. 30,
2003 2002
---- ----
Term loan(a)............................................ $3,967 $4,000
Term loan(b)............................................ 1,805 1,900
Promissory note(c)...................................... 1,100 1,650
Other(d)................................................ 1,691 1,839
------ ------
8,563 9,389
Less current portion.................................... 1,596 1,157
------ ------
$6,967 $8,232
====== ======
- -----------
a. On August 23, 2002, SWRG entered into a $14.0 million secured term loan
agreement with Morgan Stanley Dean Witter Commercial Financial Services,
Inc. ("Morgan Stanley"). Under the agreement, SWRG is the guarantor of
borrowings by its wholly owned subsidiary, S&W Las Vegas, LLC
("Borrower"). SWRG, through the Borrower, borrowed $4.0 million under
the agreement for general corporate purposes, including its new
restaurant development program. This portion of the loan bears interest
at a fixed rate of 6.35% per annum. Principal payments for this portion
of the loan commenced June 30, 2003. Pursuant to the terms of the loan
agreement, SWRG is obligated to make monthly principal payments of
approximately $33 for this portion of the loan over the term of the loan
and a balloon payment of approximately $2,033 on May 31, 2008, the
maturity date of the loan. The term loan is secured by a leasehold
mortgage relating to the Las Vegas property and all of the personal
property and fixtures of S&W Las Vegas, LLC. At June 30, 2003 SWRG was
in compliance with the debt service coverage ratio and minimum liquidity
financial covenants contained in the loan agreement. SWRG was not
required to be in compliance with the senior leverage ratio and interest
coverage ratio contained in the loan agreement because SWRG was in
compliance with the minimum liquidity covenant. As previously disclosed,
the balance of the funds available under the agreement had been intended
to be used by SWRG to exercise its purchase option for the land and
building at 3767 Las Vegas Blvd. where SWRG operates its 675-seat,
30,000 square foot restaurant. SWRG did not draw down the remaining
balance because, as an alternative to purchasing the land, SWRG signed a
second amendment to its lease agreement as discussed in Note 6. The
ability to draw down this balance expired on May 31, 2003.
b. On December 24, 2002, SWRG entered into a $1.9 million secured term loan
agreement with Morgan Stanley. Under the agreement, SWRG and Dallas S&W
L.P., a wholly owned subsidiary of SWRG, are the guarantors of
borrowings by the Borrower. Of the $1.9 million borrowed by SWRG,
through the Borrower, under the agreement, $1.35 million was used for
its new restaurant development program, and $550 was used for the first
principal installment on the $1.65 million promissory note with Toll
Road Texas Land Company, L.P. described below. This loan bears interest
at a fixed rate of 6.36% per annum. Principal payments for this loan
commenced January 24, 2003. Pursuant to the terms of the loan agreement,
SWRG is obligated to make monthly principal payments of $16 for this
loan over the term of the loan and a balloon payment of approximately
$966 on December 24, 2007, the maturity date of the loan. The term loan
is secured by a second mortgage relating to the Dallas property and a
security interest in all of the personal property and fixtures of Dallas
S&W L.P. The term loan is also secured by the leasehold mortgage
relating to the Las Vegas property. The term loan is guaranteed by SWRG.
At June 30, 2003 SWRG was in compliance with the financial covenants as
described above.
c. On October 9, 2002, SWRG purchased the property for the Smith &
Wollensky unit in Dallas. The purchase price for this property was $3.75
million. A portion of the purchase price for this property was financed
through a $1.65 million promissory note that was signed by Dallas S&W,
L.P., a wholly owned subsidiary of SWRG. This loan bears interest at 8%
per annum and requires annual principal payments of $550 with the first
installment being prepaid on March 4, 2003, and the subsequent two
12
installments due on October 9, 2004 and October 9, 2005, respectively.
The promissory note is secured by a first mortgage relating to the
Dallas property.
d. In fiscal 1997, SWRG assumed certain liabilities in connection with the
acquisition of leasehold rights relating to its Smith & Wollensky Miami
location from two bankrupt corporations. Pursuant to the terms of the
bankruptcy resolution, SWRG is obligated to make quarterly and annual
payments over a six-year period. These obligations generally bear
interest at rates ranging from 9% to 12%. The aggregate balance
outstanding at June 30, 2003 and December 30, 2002 was $4 and $110,
respectively. In addition, SWRG assumed a mortgage on the property that
requires monthly payments, with a final principal payment of $958 in
June 2004. The mortgage bears interest at 5.75%. SWRG also assumed a
loan payable to a financing institution that requires monthly payments
through the year 2014, and bears interest at 7.67%. The aggregate
balance of the mortgage and loan payable outstanding at June 30, 2003
and December 30, 2002 was $1,687 and $1,729, respectively.
Principal payments on long-term debt are as follows:
Fiscal year:
- ------------
2003................................................................... $ 343
2004................................................................... 2,121
2005................................................................... 1,189
2006................................................................... 643
2007................................................................... 1,597
Thereafter............................................................. 2,670
------
$8,563
======
(7) Capital Lease Obligation
On April 29, 2003, SWRG signed a second amendment to its lease agreement
(the "Agreement") with The Somphone Limited Partnership ("Lessor"), the owner of
the property for the Las Vegas restaurant. The Agreement, which is being treated
as a capital lease, adjusts the annual fixed payment to $400 per year from May
1, 2003 to April 30, 2008 and to $860 per year from May 1, 2008 to April 30,
2018. The Agreement also amends the amount of the purchase price option
available to SWRG effective May 1, 2003. SWRG will have the option to purchase
the property over the next five years at an escalating purchase price. The
purchase price is approximately $10.0 million at May 1, 2003, and escalates to
approximately $12.1 million by the fifth year. SWRG is required to make down
payments on the purchase price of the property. Those payments, which escalate
annually, are payable in monthly installments into a collateralized sinking fund
based on the table below, and will be applied against the purchase price at the
closing of the option. If at the end of the five years SWRG does not exercise
the option, the Lessor receives the down payments that accumulated in the
sinking fund, and thereafter the purchase price for the property would equal
$10.5 million. The down payments for the purchase of the land over the next five
years will be as follows:
Fiscal year
-----------
2003 $125
2004 269
2005 298
2006 328
2007 360
Thereafter 123
---
$1,503
======
If SWRG exercises the option, the Lessor will provide SWRG with financing in the
amount of the purchase price applicable at the time of the closing, less the
down payment payable by SWRG, at an interest rate of 8% per annum, payable over
ten years.
13
The Agreement also provides the Lessor with a put right that would give the
Lessor the ability to require SWRG to purchase the property at any time after
June 15, 2008 at the then applicable purchase price. SWRG will then have two
months to close on the purchase of the property.
On May 14, 2003, a letter was signed by Morgan Stanley confirming that the
treatment of the Agreement as a capital lease does not violate the debt
restriction covenant of the secured term loan agreement and that the capital
lease and any imputed interest related to the capital lease are excluded from
the calculation of the financial covenants.
(8) Common Stock
The 2001 Stock Incentive Plan ("2001 Stock Incentive Plan") provides for
the granting of options to purchase shares of our Common Stock and stock awards.
Options may be incentive stock options, as defined in Section 422 of the
Internal Revenue Code (the "Code"), granted only to our employees (including
officers who are also employees) or non-qualified stock options granted to our
employees, directors, officers and consultants. Stock awards may be granted to
employees of, and other key individuals engaged to provide services to, SWRG and
its subsidiaries. The 2001 Stock Incentive Plan was adopted and approved by our
directors in March 2001 and our stockholders in April 2001.
The 2001 Stock Incentive Plan may be administered by our Board of
Directors or by our Compensation Committee, either of which may decide who will
receive stock option or stock awards, the amount of the awards, and the terms
and conditions associated with the awards. These include the price at which
stock options may be exercised, the conditions for vesting or accelerated
vesting, acceptable methods for paying for shares, the effect of corporate
transactions or changes in control, and the events triggering expiration or
forfeiture of a participant's rights. The maximum term for stock options may not
exceed ten years, provided that no incentive stock options may be granted to any
employee who owns ten percent or more of SWRG with a term exceeding five years.
The maximum number of shares of Common Stock available for issuance
under the 2001 Stock Incentive Plan is 583,333 shares, increased by 4% of the
total number of issued and outstanding shares of Common Stock (including shares
held in treasury) as of the close of business on December 31 of the preceding
year on each January 1, beginning with January 1, 2002, during the term of the
2001 Stock Incentive Plan. However, the number of shares available for all
grants under the 2001 Stock Incentive Plan is limited to 11% of SWRG's issued
and outstanding shares of capital stock on a fully-diluted basis. Accordingly,
the maximum number of shares of Common Stock available for issuance in 2003 is
382,800 shares. In addition options may not be granted to any individual with
respect to more than 500,000 total shares of Common Stock in any single taxable
year (taking into account options that were terminated, repriced, or otherwise
adjusted during such taxable year).
The 2001 Stock Incentive Plan provides that proportionate adjustments
shall be made to the number of authorized shares which may be granted under the
2001 Stock Incentive Plan and as to which outstanding options, or portions of
outstanding options, then unexercised shall be exercisable as a result of
increases or decreases in SWRG's outstanding shares of common stock due to
reorganization, merger, consolidation, recapitalization, reclassification, stock
split-up, combination of shares, or dividends payable in capital stock, such
that the proportionate interest of the option holder shall be maintained as
before the occurrence of such event. Upon the sale or conveyance to another
entity of all or substantially all of the property and assets of SWRG, including
by way of a merger or consolidation or a Change in Control of SWRG, as defined
in the 2001 Stock Incentive Plan, our Board of Directors shall have the power
and the right to accelerate the exercisability of any options.
Unless sooner terminated by our Board of Directors, the 2001 Stock
Incentive Plan will terminate on April 30, 2011, ten years from the date on
which the 2001 Stock Incentive Plan was adopted by our Board of Directors All
options granted under the 2001 Stock Incentive Plan shall terminate immediately
prior to the dissolution or liquidation of SWRG; provided, that prior to such
dissolution or liquidation, the vesting of any option shall automatically
accelerate as if such dissolution or liquidation is deemed a Change of Control,
as defined in the 2001 Stock Incentive Plan.
On September 5, 2002 SWRG granted options pursuant to an option exchange
program (the "Option Exchange Program") that SWRG initiated in February 2002 in
order to allow employees, officers and directors to cancel all or some stock
options to purchase its common stock having an exercise price greater than $5.70
per share granted under its 1996 Stock Option Plan, its 1997 Stock Option Plan
and its 2001 Stock Incentive Plan in exchange for new options granted under the
2001 Stock Incentive Plan. Under the Option Exchange Program, the new options
were issued on September 5, 2002 with an exercise price of $3.88. The exercise
price of each option
14
received under the exchange program equaled 100% of the price of SWRG's common
stock on the date of grant of the new options, determined in accordance with the
terms of the 2001 Stock Incentive Plan. An employee received options under the
exchange program with an exercise price of $4.27, or 110% of the fair market
value of SWRG's common stock on the date of grant. The new options vest over
periods ranging from four months to five years, in accordance with the vesting
schedule of the cancelled options. SWRG structured the Option Exchange Program
in a manner that did not result in any additional compensation charges or
variable award accounting. As of December 30, 2002, options to purchase 726,033
shares of common stock remained outstanding under the 2001 Stock Incentive Plan.
In June 2003, SWRG granted options to purchase 117,000 shares of common
stock under the 2001 Stock Incentive Plan. The exercise price of the options
granted were $5.04 per share, the estimated fair market value at the date of
grant. Each option granted in June 2003 will vest over a period of five years.
As of June 30, 2003, options to purchase 803,533 shares of common stock were
outstanding under the 2001 Stock Incentive Plan.
Activity relating to SWRG's option plans was as follows:
Number Weighted average
of shares of exercise price
common stock per share of
covered by common stock
options ------------
-------
Options outstanding at December 31, 2001........................ 728,016 $ 7.97
Option exchange program - cancelled............................. (445,800) 9.39
Option exchange program - issued................................ 445,800 3.97
Options granted during the year ended December 30, 2002......... 8,900 3.88
Options forfeited during the year ended December 30, 2002....... (10,883) 5.47
-------- ----
Options outstanding at December 30, 2002........................ 726,033 4.56
Options forfeited during the six-months ended June 30, 2003..... (37,867) 5.66
Options granted during the six-months ended June 30, 2003....... 117,000 5.04
Options exercised during the six-months ended June 30, 2003..... (1,633) 3.88
-------- -----
Options outstanding at June 30, 2003............................ 803,533 $4.58
======== =====
As of June 30, 2002 the weighted average remaining contractual life of
options outstanding was seven years. As of June 30, 2003, there were options
covering approximately 310,000 shares of common stock exercisable at a range of
$3.88 to $5.70 per share.
(9) Legal Matters
On or about September 5, 2001, Mondo's of Scottsdale, L.C. filed a suit
against SWRG alleging that SWRG had entered into an agreement to purchase all of
the leasehold interest in, and certain fixtures and equipment located at,
Mondo's restaurant located in Scottsdale, Arizona. The suit was filed in the
Superior Court of the State of Arizona in and for the County of Maricopa and has
been set to go to jury trial in October 2003. The plaintiff requested damages of
approximately $2.0 million. SWRG is vigorously contesting this suit. Management
believes, based on advice from local counsel, that SWRG has a significant
likelihood of prevailing in the suit and that the risk of loss is not probable.
Accordingly, SWRG has not established a reserve for loss in connection with this
suit. If SWRG were to lose the suit, the financial position, results of
operation and cash flows of SWRG may be adversely affected. There have been no
material changes with respect to this matter.
SWRG is involved in various other claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on SWRG's
consolidated financial position, results of operations or liquidity.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
As of June 30, 2003, we operated 16 high-end, high volume restaurants in
the United States. We believe that the size of each market we entered warranted
investment in restaurants with seating capacities ranging from 290 to 675. We
expect to open another Smith & Wollensky restaurant in the fourth quarter of
2003 in Houston, Texas. We expect the restaurant in Houston to have
approximately 400 seats on two levels. Although we expect to open two new Smith
& Wollensky restaurants in 2004 and two to three per year starting in 2005, we
plan to move ahead cautiously with our future expansion as management evaluates
and monitors economic and national security conditions. We expect additional
locations to have seating capacities ranging from 375 to 450 seats, but would
consider locations with larger seating capacities where appropriate. We believe
these new restaurants will require, on average, a total cash investment of $2.0
million to $5.0 million net of landlord contributions and excluding pre-opening
expenses. This range assumes that the property on which the new unit is located
is being leased.
As a result of our recent expansion, period-to-period comparisons of our
financial results may be less meaningful. When a new restaurant opens, we
typically incur higher than normal levels of food and labor costs as a
percentage of sales during the first year of its operation. In calculating
comparable restaurant sales, we introduce a restaurant into our comparable
quarterly restaurant base once it has been in operation for 15 months.
Pursuant to management contracts and arrangements, we operate, but do
not own, the original Smith & Wollensky, Maloney & Porcelli, The Post House and
ONEc.p.s. restaurants in New York and Mrs. Parks Tavern in Chicago.
Owned restaurant sales include gross sales less sales taxes and other
discounts. Cost of owned restaurant sales include food and beverage costs,
salaries and related benefits, restaurant operating expenses, occupancy and
related expenses, marketing and promotional expenses and restaurant level
depreciation and amortization. Salaries and related benefits include components
of restaurant labor, including direct hourly and management wages, bonuses,
fringe benefits and related payroll taxes. Restaurant operating expenses include
operating supplies, utilities, maintenance and repairs and other operating
expenses. Occupancy and related expenses include rent, real estate taxes and
other occupancy costs.
Management fee income relates to fees that we receive from our managed
units. These fees are primarily based on a percentage of sales from the managed
units, ranging from 2.3% to 6.0%. Management fee income also includes fees from
Maloney & Porcelli equal to 50% of the unit's net operating cash flow generated
during each fiscal year, provided that the Maloney & Porcelli owner receives a
minimum amount of operating cash flow per year ranging from $360,000 to
$480,000. Prior to December 2002, we operated Park Avenue Cafe in Chicago, Mrs.
Park's Tavern and the other services of the food and beverage department of the
Doubletree Hotel in Chicago ("Doubletree") pursuant to a sub-management
agreement (the "Doubletree Agreement"). We received a management fee equal to
the sum of 1.5% of sales and a percentage of earnings, as defined. The
Doubletree Agreement expires on the earlier of December 31, 2004 or the
termination of the related hotel management agreement between Chicago HSR
Limited Partnership ("HSR"), the owner of the Doubletree and Doubletree
Partners, the manager of the Doubletree. During December 2002, HSR closed the
Park Avenue Cafe restaurant in Chicago and discontinued our requirement to
provide other food and beverage department service for the Doubletree. As a
result, we no longer receive the fees described above. During the three-month
period ended March 31, 2003, we reached an agreement with HSR. The agreement
provides for the continued use by HSR of the name Mrs. Parks Tavern and requires
us to provide management services to support that location. In exchange for the
use of the Mrs. Park's Tavern name and related management support the Company
receives an annual fee of $50,000. The agreement will automatically renew each
year, unless notification of cancellation is given, by either party, at least 90
days prior to December 31. Management fee income also includes fees from
ONEc.p.s. equal to 40% of the restaurant's operating cash flows, as reduced by
the repayment of project costs and working capital contributions. After all the
project costs and working capital contributions have been repaid, the fee will
increase to 50% of the restaurant's operating cash flows.
16
General and administrative expenses include all corporate and
administrative functions that support existing owned and managed operations and
provide infrastructure to facilitate our growth. General and administrative
expenses are comprised of management, supervisory and staff salaries and
employee benefits, travel costs, information systems, training costs, corporate
rent, corporate insurance and professional and consulting fees. Certain
pre-opening costs incurred in connection with the opening of new restaurants are
expensed as incurred and are included in general and administrative expenses.
General and administrative expenses also include the depreciation of
corporate-level property and equipment and the amortization of corporate
intangible assets, such as licensing agreements and management contracts.
Royalty expense represents fees paid pursuant to the terms of the
licensing agreement with St. James Associates, based upon 2.0% of sales, as
defined, for restaurants utilizing the Smith & Wollensky name.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our unaudited consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements require us
to make significant estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities.
On an on-going basis, we evaluate our estimates and assumptions,
including those related to revenue recognition, allowance for doubtful accounts,
valuation of inventories, valuation of long-lived assets, goodwill and other
intangible assets, income taxes, income tax valuation allowances, self insurance
medical reserves and legal proceedings. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that can not
readily be determined from other sources. There can be no assurance that actual
results will not differ from those estimates.
We believe the following is a summary of our critical accounting
policies:
Revenue recognition: Sales from owned restaurants are recognized as
revenue at the point of the delivery of meals and services. Management fee
income is recognized as the related management fee is earned pursuant to the
respective agreements.
Allowance for doubtful accounts: Substantially all of our accounts
receivable are due from companies or individuals with good historical records of
payment. Accounts receivable are reduced by an allowance for amounts that may
become uncollectible in the future. Such allowance is established through a
charge to the provision for bad debt expenses.
Long-lived assets: We review long-lived assets to be held and used or to
be disposed of for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable through
future undiscounted net cash flows to be generated by the assets. Recoverability
of assets to be held and used is measured by restaurant comparing the carrying
amount of the restaurant's assets to undiscounted future net cash flows expected
to be generated by such assets. We limit assumptions about such factors as sales
and margin improvements to those that are supportable based upon our plans for
the unit, its individual results and actual results at comparable restaurants.
If such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Fair value would be calculated on a discounted cash
flow basis.
Goodwill: Goodwill represents the excess of fair value of certain
reporting units acquired in the formation of the Company over the book value of
those reporting units' identifiable net assets. Goodwill is tested for
impairment at least annually in accordance with the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets. SFAS No. 142 also requires that intangible
assets with estimable useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, Accounting for Impairment or Disposal of
Long-Lived Assets. We assess the recoverability of goodwill at the end of each
year through a fair value valuation performed for each reporting unit that has
goodwill. The fair value valuation is calculated using various methods,
including an analysis based on projected discounted future operating cash flows
of each reporting unit using a discount rate reflecting our average cost of
funds. We limit assumptions about such factors as sales and margin improvements
to those that are supportable based upon our plans for the unit and actual
results at comparable restaurants. The assessment of the recoverability of
goodwill will be impacted if estimated future operating cash flows are
negatively modified by us as a result of changes
17
in economic conditions, significant events that occur or other factors arising
after the preparation of any previous analysis. The net carrying value of
goodwill as of June 30, 2003 and December 30, 2002 was $6.9 million,
respectively.
Other intangible assets: We review other intangible assets, which
include costs attributable to a sale and licensing agreement and the cost of the
acquisition of management contracts, for impairment at a minimum, whenever
events or changes in circumstances indicate the carrying value of an asset may
not be recoverable. Recoverability of our intangible assets will be assessed by
comparing the carrying amount of the asset to the undiscounted expected net cash
flows to be generated by such assets. An intangible asset would be considered
impaired if the sum of undiscounted future cash flows is less than the book
value of the assets generating those cash flows. We limit assumptions about such
factors as sales and margin improvements to those that are supportable based
upon our plans for the unit and actual results at comparable restaurants. If
intangible assets are considered to be impaired, the impairment to be recognized
will be measured by the amount by which the carrying amount of the asset exceeds
the fair value of the assets. Fair value would be calculated on a discounted
cash flow basis. The assessment of the recoverability of these intangible assets
will be impacted if estimated future operating cash flows are negatively
modified by us as a result of changes in economic conditions, significant events
that occur or other factors arising after the preparation of any previous
analysis. The net carrying value of our intangible assets as of June 30, 2003
and December 30, 2002 was $4.2 million and $4.1 million, respectively.
Artwork: We purchase artwork and antiques for display in our
restaurants. We do not depreciate artwork and antiques since these assets have
cultural, aesthetic or historical value that is worth preserving perpetually and
we have the ability and intent to protect and preserve these assets. Such assets
are recorded at cost and are included in other assets in the accompanying
consolidated balance sheets.
Self-insurance liability: We are self insured for our employee health
program. We maintain stop loss insurance to limit our total exposure and
individual claims. The liability associated with this program is based on our
estimate of the ultimate costs to be incurred to settle known claims and claims
incurred but not reported as of the balance sheet date. Our estimated liability
is not discounted and is based on a number of assumptions and factors, including
historical medical claim patterns and known economic conditions. If actual
trends, including the severity or frequency of claims, differ from our
estimates, our financial results could be impacted. However, we believe that a
change in our current accrual requirement of 10% or less would cause an
immaterial change to our financial results.
Legal proceedings: We are involved in various claims and legal actions,
the outcomes of which are not within our complete control and may not be known
for prolonged periods of time. In some actions, the claimants seek damages,
which, if granted, would require significant expenditures. We record a liability
in our consolidated financial statements when a loss is known or considered
probable and the amount can be reasonably estimated. If the reasonable estimate
of a known or probable loss is a range, and no amount within the range is a
better estimate, the minimum amount of the range is accrued. If a loss is not
probable or cannot be reasonably estimated, a liability is not recorded in the
consolidated financial statements.
Income taxes and income tax valuation allowances: We estimate certain
components of our quarterly provision for income taxes. These estimates include,
but are not limited to, effective state and local income tax rates and estimates
related to depreciation expense allowable for tax purposes. Our estimates are
made based on the best available information at the time that we prepare the
provision. We usually file our income tax returns several months after our
fiscal year-end. All tax returns are subject to audit by federal and state
governments, usually years after the returns are filed and could be subject to
differing interpretations of the tax laws.
On June 30, 2003, we have a valuation allowance of $8.2 million to
reduce our net operating loss and tax credit carryforwards of $6.1 million and
other timing differences of $2.1 million to an amount that will more likely than
not be realized. These net operating loss and tax credit carryforwards exist in
federal and certain state jurisdictions and have varying carryforward periods
and restrictions on usage. The estimation of future taxable income for federal
and state purposes and our resulting ability to utilize net operating loss and
tax credit carryforwards can significantly change based on future events and
operating results. Thus, recorded valuation allowances may be subject to
material future changes.
This discussion and analysis should be read in conjunction with the
unaudited consolidated financial statements and related notes included elsewhere
in this Quarterly Report on Form 10-Q.
18
Results of Operations
Three Months Ended Six Months Ended
June 30, 2003 July 1, 2002 June 30, 2003 July 1, 2002
------------- ------------ ------------- ------------
(Dollars in Thousands)
Owned restaurant sales $ 23,679 100.0% $ 18,725 100.0% $ 46,671 100.0% $ 38,242 100.0%
Cost of owned restaurant
sales:
Food and beverage costs 7,336 31.0 5,404 28.9 14,381 30.8 10,970 28.7
Salaries and related
benefit expenses 6,689 28.2 5,672 30.3 13,054 28.0 11,153 29.2
Restaurant operating
expenses 3,901 16.5 2,816 15.0 7,452 16.0 5,728 15.0
Occupancy and related
expenses 1,123 4.7 1,485 7.9 2,581 5.5 2,851 7.5
Marketing and
promotional expenses 928 3.9 829 4.4 1,832 3.9 1,533 4.0
Depreciation and
amortization 942 4.0 815 4.4 1,845 4.0 1,608 4.2
------ ---- ------ ---- ------- ---- ------- ----
Total cost of owned
restaurant sales 20,919 88.3 17,021 90.9 41,145 88.2 33,843 88.5
------ ---- ------ ---- ------- ---- ------- ----
Income from owned
restaurant operations 2,760 11.7 1,704 9.1 5,526 11.8 4,399 11.5
Management fee income 504 2.1 641 3.4 1,012 2.2 1,262 3.3
---- --- --- --- ------ --- ------ ---
Income from owned and
managed restaurants 3,264 13.8 2,345 12.5 6,538 14.0 5,661 14.8
General and administrative
expenses 2,346 9.9 2,489 13.3 5,068 10.9 4,793 12.5
Royalty expense 369 1.6 255 1.4 717 1.5 525 1.4
--- --- --- --- --- --- --- ---
Operating income 549 2.3 (399) -2.1 753 1.6 343 0.9
Interest income (expense),
net (259) -1.1 (9) 0.0 (355) -.0.7 9 0.0
------ ---- ------ ---- ------- ---- ------- ----
Income (loss) before
provision for income taxes 290 1.2 (408) -2.2 398 0.9 352 0.9
Provision for income taxes 75 0.3 51 0.3 125 0.3 101 0.3
-- --- -- ---- ---- --- --- ---
Net income (loss) $ 215 0.9% $ (459) -2.5% $ 273 0.6% $ 251 0.6%
======== ==== ======== ===== ======== ==== ======== ====
Three Months Ended June 30, 2003 Compared to the Three Months Ended July 1, 2002
Owned Restaurant Sales. Owned restaurant sales increased $5.0 million, or 26.5%,
to $23.7 million for the three months ended June 30, 2003 from $18.7 million for
the three months ended July 1, 2002. The increase in owned restaurant sales
related primarily to an increase in comparable owned unit sales of $2.1 million,
or 11.7%. This included a net increase in sales of $2.5 million from our owned
Smith & Wollensky units open for the entire period. The improvement is primarily
a result of an increase in tourism, business travel and banquet sales at certain
locations as compared to 2002. The comparable owned unit sales net increases
were offset by a decrease in sales of $387,000 from our three owned New York
units due to the continued economic slowdown and decreased tourism that
continues in the New York metropolitan area. The increase also includes $2.8
million in combined sales from our Smith & Wollensky unit in Columbus, Ohio,
which opened in June 2002, and our new unit in Dallas, Texas, which opened in
March 2003.
Food and Beverage Costs. Food and beverage costs increased $1.9 million to $7.3
million for the three months ended June 30, 2003 from $5.4 million for the three
months ended July 1, 2002. Food and beverage costs as a percentage of owned
restaurant sales increased to 31.0% in 2003 from 28.9% in 2002. The increase was
primarily due to the continued higher beef costs for prime beef that
19
began in the fourth quarter of 2002 and continued through the second quarter of
2003, as compared to the three months ended July 1, 2002. Increased costs also
related to the new Smith & Wollensky unit in Columbus, Ohio, which opened in
June 2002, and the new Smith & Wollensky unit in Dallas, Texas, which opened in
March 2003. Food and beverage costs related to these new units accounted for
$925,000 of the increase for the three-months ended June 30, 2003. The new Smith
& Wollensky unit in Dallas, Texas experienced higher than normal food and
beverage costs as a percentage of sales as a result of initial startup
inefficiencies and a lower revenue base. As the Smith & Wollensky unit in
Dallas, Texas matures and revenues increase, operating efficiencies are expected
to continue to improve and the food and beverage costs as a percentage of sales
for that unit are expected to decrease.
Salaries and Related Benefits. Salaries and related benefits increased $1.0
million to $6.7 million for the three months ended June 30, 2003 from $5.7
million for the three months ended July 1, 2002. This increase was primarily due
to the new Smith & Wollensky unit in Columbus, Ohio, which opened in June 2002,
and the new Smith & Wollensky unit in Dallas, Texas, which opened in March 2003.
The increase relating to these new units was $737,000. Salaries and related
benefits as a percent of owned restaurant sales decreased to 28.2% for the three
months ended June 30, 2003 from 30.3% for the three months ended July 1, 2002.
The decrease in salaries and related benefits as a percentage of owned
restaurant sales was primarily due to the leveraging effect of sales increases
on the fixed portion of restaurant salaries and related benefits and to a lesser
extent improved results in the costs of claims for health insurance under our
self-insurance policy. This decrease was partially offset by the additional
staffing required at the new Smith & Wollensky unit in Dallas, Texas during the
unit opening. It is common for our new restaurants to experience increased costs
for additional staffing in the first six months of operations. Generally, as the
unit matures and revenues increase, operating efficiency is expected to improve
as we expect that staffing will be reduced through efficiencies and salaries and
wages as a percentage of sales for that unit will decrease due to the lower
staffing requirement and higher revenue base.
Restaurant Operating Expenses. Restaurant operating expenses increased
$1.1million to $3.9 million for the three months ended June 30, 2003 from $2.8
million for the three months ended July 1, 2002. Restaurant operating expenses
as a percentage of owned restaurant sales increased to 16.5% for 2003 from 15.0%
in 2002 primarily due to the new Smith & Wollensky units in Columbus, Ohio and
Dallas, Texas. The increase relating to these new units was $565,000. The
increase to a lesser extent relates to costs associated with upgrades of
operating supplies and increases in property and liability insurance premiums at
the units open the entire period.
Occupancy and Related Expenses. Occupancy and related expenses decreased
$362,000 to $1.1 million for the three months ended June 30, 2003 from $1.5
million for the three months ended July 1, 2002 primarily due to the reduction
in rent of $343,000 for the Smith & Wollensky unit in Las Vegas, Nevada and the
treatment of the lease as a capital lease. The lease was amended on April 29,
2003. Occupancy and related expenses as a percentage of owned restaurant sales
decreased to 4.7% for the three months ended June 30, 2003 from 7.9% for the
three months ended July 1, 2002.
Marketing and Promotional Expenses. Marketing and promotional expenses increased
$99,000 to $928,000 for the three months ended June 30, 2003 from $829,000 for
the three months ended July 1, 2002. The increase was related primarily to the
opening of the Smith & Wollensky unit in Dallas, Texas. Marketing and
promotional expenses as a percent of owned restaurant sales decreased to 3.9%
for the three months ended June 30, 2003 from 4.4% for the three months ended
July 1, 2002.
Depreciation and Amortization. Depreciation and amortization increased $127,000
to $942,000 for the three months ended June 30, 2003 from $815,000 for the three
months ended July 1, 2002, primarily due to the property and equipment additions
for the new Smith & Wollensky units in Columbus, Ohio and Dallas, Texas.
Management Fee Income. Management fee income decreased $137,000 to $504,000 for
the three months ended June 30, 2003 from $641,000 for the three months ended
July 1, 2002, primarily due to a net decrease in overall sales from managed
units, which are located in New York City and to a lesser extent the decrease in
the annual management fee we receive from the Chicago HSR Limited Partnership.
General and Administrative Expenses. General and administrative expenses
decreased by $143,000 to $2.3 million for the three months ended June 30, 2003
from $2.5 million for the three months ended July 1, 2002. General and
administrative expenses as a percent of owned restaurant sales decreased to 9.9%
for the three months ended June 30, 2003 from 13.3% for three months ended July
1, 2002. General and administrative expenses include corporate payroll and other
expenditures that benefit both owned and managed units. General and
administrative expenses as a percentage of owned and managed restaurant sales
decreased to 6.7% for the three months ended June 30, 2003 from 8.0% for the
three months ended July 1, 2002. The decrease was primarily due to a decrease in
travel and related expenditures, as well as decreases in payroll and related
benefits, certain professional fees and other miscellaneous expenses.
20
Royalty Expense. Royalty expense increased $114,000 to $369,000 for the three
months ended June 30, 2003 from $255,000 for the three months ended July 1, 2002
primarily due to the increase in sales of $2.5 million from our owned Smith &
Wollensky units open for the comparable period together with an increase of $2.8
million in combined sales from our Smith & Wollensky unit in Columbus, Ohio,
which opened in June 2002, and our new unit in Dallas, Texas, which opened in
March 2003.
Interest Expense -Net of Interest Income. Interest expense, net of interest
income, increased $250,000 to $259,000 for the three months ended June 30, 2003
from $9,000 for the three months ended July 1, 2002, primarily due to the
interest expense on debt incurred for general corporate purposes and in
connection with the financing of our new Smith & Wollensky unit in Dallas, Texas
combined with the interest related to the capital lease for the Smith &
Wollensky unit in Las Vegas, Nevada.
Provision for Income Taxes. The income tax provision for the three months ended
June 30, 2003 and July 1, 2002, respectively, represents certain state and local
taxes. No federal income tax was provided for the three months ended June 30,
2003 and July 1, 2002, respectively, due to the net operating loss carryforward.
Six Months Ended June 30, 2003 Compared to the Six Months Ended July 1, 2002
Owned Restaurant Sales. Owned restaurant sales increased $8.4 million, or 22.0%,
to $46.7 million for the six months ended June 30, 2003 from $38.2 million for
the six months ended July 1, 2002. The increase in owned restaurant sales
related primarily to an increase in comparable owned unit sales of $4.1 million,
or 10.9%. This included a net increase in sales of $4.9 million from our owned
Smith & Wollensky units open for the entire period. The improvement is primarily
a result of an increase in tourism, business travel and banquet sales at certain
locations as compared to 2002. The comparable owned unit sales net increases
were offset by a decrease in sales of $761,000 from our three owned New York
units due to the continued economic slowdown and decreased tourism that
continues in the New York metropolitan area. The increase also includes $4.3
million in combined sales from our Smith & Wollensky unit in Columbus, Ohio,
which opened in June 2002, and our new unit in Dallas, Texas, which opened in
March 2003.
Food and Beverage Costs. Food and beverage costs increased $3.4 million to $14.4
million for the six months ended June 30, 2003 from $11.0 million for the six
months ended July 1, 2002. Food and beverage costs as a percentage of owned
restaurant sales increased to 30.8% in 2003 from 28.7% in 2002. The increase was
primarily due to the continued higher beef costs for prime beef and certain
shellfish that began in the fourth quarter of 2002 and continued through the
first six months of 2003 as compared to the six-months ended July 1, 2002.
Increased costs also related to the new Smith & Wollensky unit in Columbus,
Ohio, which opened in June 2002 and the new Smith & Wollensky unit in Dallas,
Texas, which opened in March 2003. Food and beverage costs related to these new
units accounted for $1.5 million of the increase for the six-months ended June
30, 2003. The new Smith & Wollensky unit in Dallas, Texas experienced higher
than normal food and beverage costs as a percentage of sales as a result of
initial startup inefficiencies and a lower revenue base. As the new unit matures
and revenues increase, operating efficiency is expected to continue to improve
and the food and beverage costs as a percentage of sales for that unit is
expected to decrease.
Salaries and Related Benefits. Salaries and related benefits increased $1.9
million to $13.1 million for the six months ended June 30, 2003 from $11.2
million for the six months ended July 1, 2002. This increase was primarily due
to the new Smith & Wollensky unit in Columbus, Ohio, which opened in June 2002,
and the new Smith & Wollensky unit in Dallas, Texas, which opened in March 2003.
The increase relating to these new units was $1.4 million. Salaries and related
benefits as a percent of owned restaurant sales decreased to 28.0% for the six
months ended June 30, 2003 from 29.2% for the six months ended July 1, 2002. The
decrease in salaries and related benefits as a percentage of owned restaurant
sales was primarily due to the leveraging effect of sales increases on the fixed
portion of restaurant salaries and related benefits and to a lesser extent
improved results in the costs of claims for health insurance under our
self-insurance policy. This decrease was partially offset by the additional
staffing required at the new Smith & Wollensky unit in Dallas, Texas during the
unit opening. It is common for our new restaurants to experience increased costs
for additional staffing in the first six months of operations. Generally, as the
unit matures and revenues increase, operating efficiency is expected to improve
as we expect that staffing will be reduced through efficiencies and salaries and
wages as a percentage of sales for that unit will decrease due to the lower
staffing requirement and higher revenue base.
Restaurant Operating Expenses. Restaurant operating expenses increased $1.7
million to $7.4 million for the six months ended June 30, 2003 from $5.7 million
for the six months ended July 1, 2002. Restaurant operating expenses as a
percentage of owned restaurant sales increased to 16.0% for 2003 from 15.0% in
2002 primarily due to the opening of the new Smith & Wollensky units in
Columbus, Ohio and Dallas, Texas. The increase relating to these new units was
$884,000. The remaining increase is related to increases in insurance premiums,
charges related to the increased sales volume such as credit card charges, linen
costs and costs associated with upgrades of operating supplies at the units open
the entire period.
21
Occupancy and Related Expenses. Occupancy and related expenses decreased
$270,000 to $2.6 million for the six months ended June 30, 2003 from $2.9
million for the six months ended July 1, 2002, primarily due to the reduction of
rent of $439,000 for the Smith & Wollensky unit in Las Vegas, Nevada and the
treatment of the lease as a capital lease. The lease was amended on April 29,
2003. The decrease was offset by the combined increase of $189,000 in occupancy
and related expenses including real estate and occupancy taxes for the new Smith
& Wollensky units in Columbus, Ohio and Dallas, Texas. Occupancy and related
expenses as a percentage of owned restaurant sales decreased to 5.5% for the six
months ended June 30, 2003 from 7.5% for the six months ended July 1, 2002.
Marketing and Promotional Expenses. Marketing and promotional expenses increased
$299,000 to $1.8 million for the six months ended June 30, 2003 from $1.5
million for the six months ended July 1, 2002. The increase was related
primarily to the opening of the new Smith & Wollensky unit in Dallas, Texas that
was not open in the comparable six month period ended July 1, 2001 and, to a
lesser extent, the additional public relations expenditures at the comparable
units. Marketing and promotional expenses as a percent of owned restaurant sales
decreased to 3.9% for the six-months ended June 30, 2003 from 4.0% for the
six-months ended July 1, 2002.
Depreciation and Amortization. Depreciation and amortization increased $237,000
to $1.8 million for the six months ended June 30, 2003 from $1.6 million for the
six months ended July 1, 2002, primarily due to the property and equipment
additions for the new Smith & Wollensky units in Columbus, Ohio and Dallas,
Texas.
Management Fee Income. Management fee income decreased $250,000 to $1.0 million
for the six months ended June 30, 2003 from $1.3 million for the six months
ended July 1, 2002, primarily due to a net decrease in overall sales from
managed units and, to a lesser extent, the decrease in the annual management fee
we receive from the Chicago HSR Limited Partnership.
General and Administrative Expenses. General and administrative expenses
increased by $275,000 to $5.1 million for the six months ended June 30, 2003
from $4.8 million for the six months ended July 1, 2002. General and
administrative expenses as a percent of owned restaurant sales decreased to
10.9% for the six months ended June 30, 2003 and from 12.5% for six months ended
July 1, 2002. General and administrative expenses include corporate payroll and
other expenditures that benefit both owned and managed units. General and
administrative expenses as a percentage of owned and managed restaurant sales
decreased to 7.4% for the six months ended June 30, 2003 from 7.6% for the six
months ended July 1, 2002. The increase in general and administrative expenses
was primarily due to an increase in travel and related expenditures relating to
the opening of the Smith & Wollensky unit in Dallas, Texas, as well as increases
in directors and officers insurance premiums, professional fees and other
miscellaneous expenses.
Royalty Expense. Royalty expense increased $192,000 to $717,000 for the six
months ended June 30, 2003 from $525,000 for the six months ended July 1, 2002
primarily due to the increase in sales of $4.9 million from our owned Smith &
Wollensky units open for the comparable period and an increase of $4.3 million
in combined sales from our Smith & Wollensky unit in Columbus, Ohio, which
opened in June 2002, and our new unit in Dallas, Texas, which opened in March
2003.
Interest Expense -Net of Interest Income. Interest expense, net of interest
income, increased $364,000 to $355,000 of interest expense for the six months
ended June 30, 2003 from $9,000 of interest income for the six months ended July
1, 2002, primarily due to the interest expense on debt incurred for general
corporate purposes and in connection with the financing of our new Smith &
Wollensky unit in Dallas, Texas combined with the interest related to the
capital lease for the Smith & Wollensky unit in Las Vegas, Nevada.
Provision for Income Taxes. The income tax provision for the six months ended
June 30, 2003 and July 1, 2002, respectively, represents certain state and local
taxes. No federal income tax was provided for the six months ended June 30, 2003
and July 1, 2002, respectively, due to the net operating loss carryforward.
Risk Related to Certain Management Agreements and Lease Agreements
We are subject to a right of the other party to terminate, at any time,
the agreement relating to ONEc.p.s. We have not been notified by the other
parties to this agreement that they plan to terminate the agreement and
management has no reason to believe that the agreement will be terminated.
Pursuant to our lease agreement for Cite with Rockefeller Center North,
Inc., Rockefeller Center may terminate the lease agreement if Mr. Stillman does
not own at least 35% of the shares of each class of the tenants stock, or if
there is a failure to obtain
22
their consent to an assignment of the lease. We are currently in default with
respect to these requirements, although Rockefeller Center has not given us
notice of default. Rockefeller Center may also terminate the lease agreement if
Mr. Stillman does not have effective working control of the business of the
tenant. The default existing under the lease agreement for Cite could subject us
to renegotiation of the financial terms of the lease, or could result in a
termination of this agreement which would result in the loss of this restaurant
at this location. This event could have a material adverse effect on our
business and our financial condition and results of operations. To date, none of
the parties to this agreement has taken any action to terminate this agreement
and management has no reason to believe that the agreement will be terminated.
Liquidity and Capital Resources
We have funded our capital requirements in recent years through cash
flow from operations, a private placement of preferred stock, the sale of
subordinated notes, bank debt and an initial public offering of our common
stock. Net cash provided by operating activities amounted to $2.2 million and
$1.7 million for the six months ended June 30, 2003 and July 1, 2002,
respectively.
Net cash used in financing activities was $796,000 and $158,000 for the
six months ended June 30, 2003 and July 1, 2002, respectively. Funds used in
financing activities primarily represents principal payments on our long-term
debt for the six months ended June 30, 2003 and July 1, 2002, respectively.
We used cash primarily to fund the development and construction of new
restaurants and remodeling of existing restaurants. Net cash used in investing
activities was $2.4 million and $4.2 million for the six months ended June 30,
2003 and six months ended July 1, 2002, respectively. Total capital expenditures
were $4.0 million and $2.7 million for the six months ended June 30, 2003 and
six months ended July 1, 2002, respectively. On March 17, 2003, we opened the
Smith & Wollensky unit in Dallas, Texas.
The remaining capital expenditures are expected to be approximately $4.9
million in 2003. The increase in the remaining capital expenditures from those
previously disclosed relates primarily to an increase in the square footage and
seating capacity for the new Smith & Wollensky restaurant that we plan to open
in the fourth quarter of 2003 in Houston, Texas. We expect the restaurant to
have approximately 400 seats on two levels. Although we plan to open two new
Smith & Wollensky restaurants in 2004 and two to three per year starting in
2005, we plan to move ahead cautiously with our future expansion as management
evaluates and monitors economic and security conditions. We expect additional
locations to have seating capacities ranging from 375 to 450 seats, but would
consider locations with larger seating capacities where appropriate. We intend
to develop restaurants that will require, on average, a total cash investment of
$2.0 million to $5.0 million net of landlord contributions and excluding
pre-opening costs. This range assumes that the property on which the new unit is
located is being leased. The average cost of opening the last three Smith &
Wollensky restaurants, net of landlord contributions, has been approximately
$2.7 million, excluding the purchase of land and pre-opening costs.
In 1997, we assumed certain liabilities from two bankrupt corporations
in connection with the acquisition of our lease for the Smith & Wollensky in
Miami. Pursuant to the terms of the bankruptcy resolution, we are obligated to
make quarterly and annual payments over a six-year period. These obligations
bear interest at rates ranging from 9.0% to 12.0%. The aggregate outstanding
balance of such liabilities was approximately $4,000 as of June 30, 2003. In
addition, we assumed a mortgage on the Miami property that requires monthly
interest and principal payments, with a final principal payment of $1.0 million
in June 2004. The mortgage bears interest at 5.75% per year. We also assumed a
loan payable to a financing institution that requires monthly payments through
the year 2014 and bears interest at 7.67% per year. The aggregate balance of the
mortgage and loan payable was approximately $1.7 million on June 30, 2003.
On August 23, 2002, we entered into a $14.0 million secured term loan
agreement with Morgan Stanley Dean Witter Commercial Financial Services, Inc.
("Morgan Stanley"). Under the agreement we are the guarantors of borrowings by
our wholly owned subsidiary, S&W Las Vegas, LLC. We borrowed $4.0 million under
the agreement for general corporate purposes, including our new restaurant
development program. This portion of the loan bears interest at a fixed rate of
6.35% per annum. Principal payments for this portion of the loan commenced June
30, 2003. Pursuant to the terms of the loan agreement, we are obligated to make
monthly principal payments of $33,333for this portion of the loan over the term
of the loan and a balloon payment of approximately $2.0 million on May 31, 2008,
the maturity date of the loan. The term loan is secured by a leasehold mortgage
relating to the Las Vegas property and all of the personal property and fixtures
of S&W Las Vegas, LLC. At June 30, 2003 we were in compliance with the debt
service coverage ratio and minimum liquidity financial covenants contained in
the loan agreement. We were not required to be in compliance with the senior
leverage ratio and interest coverage ratio contained in the loan agreement
because we were in
23
compliance with the minimum liquidity covenant. As previously disclosed, the
balance of the funds available under the agreement had been intended to be used
by us to exercise our purchase option for the land and building at 3767 Las
Vegas Blvd. where we operate our 675-seat, 30,000 square foot restaurant. The
ability to draw down this balance expired on May 31, 2003. We no longer intend
to draw down the remaining balance because on April 29, 2003, as an alternative
to purchasing the land, we signed a second amendment to lease agreement
("Agreement") with The Somphone Limited Partnership ("Lessor"), the owner of the
land. The Agreement, which will be accounted for as a capital lease, adjusts the
annual fixed payment to $400,000 per year from May 1, 2003 to April 30, 2008 and
to $860,000 per year from May 1, 2008 to April 30, 2018. The Agreement also
amends the amount of the purchase price option available to us effective from
May 1, 2003. We will have the option to purchase the property over the next five
years at an escalating purchase price. The purchase price was approximately
$10.0 million at May 1, 2003, and escalates to approximately $12.1 million at
the end of five years. We are required to make down payments on the purchase of
the property. Those payments, which escalate annually, are payable in monthly
installments into a collateralized sinking fund based on the table below, and
will be applied against the purchase price at the closing of the option. If at
the end of the five years we do not exercise the option, the Lessor receives the
down payments that accumulated in the sinking fund, and thereafter the purchase
price for the property would equal $10.5 million. The down payments for the
purchase of the land over the next five years will be as follows:
Fiscal year
------------ (dollar amounts in thousands)
-----------------------------
2003 $125
2004 269
2005 298
2006 328
2007 360
Thereafter 123
-----
$1,503
======
If we exercise the option, the Lessor will provide us with financing in
the amount of the purchase price applicable at the time of the closing, less any
down payments already made, at an interest rate of 8% per annum, payable over
ten years.
The Agreement also provides the Lessor with a put right that would give
the Lessor the ability to require us to purchase the property at any time after
June 15, 2008 at the then applicable purchase price. We will then have two
months to close on the purchase of the property.
On May 14, 2003, a letter was signed by Morgan Stanley confirming that
the treatment of the Agreement as a capital lease does not violate the debt
restriction covenant of the secured term loan agreement and that the capital
lease and any imputed interest related to the capital lease are excluded from
the calculation of the financial covenants.
On October 9, 2002, we purchased the property for the Smith & Wollensky
unit in Dallas. The purchase price for this property was $3.75 million. A
portion of the purchase price for this property was financed through a $1.65
million promissory note that was signed by Dallas S&W, L.P., our wholly owned
subsidiary. This loan bears interest at 8% per annum and requires annual
principal payments of $550,000 with the first installment being prepaid on March
4, 2003, and the subsequent two installments due on October 9, 2004 and October
9, 2005, respectively. The promissory note is secured by a first mortgage
relating to the Dallas property.
On December 24, 2002 we entered into a $1.9 million secured term loan
agreement with Morgan Stanley. Under the agreement the Company and Dallas S&W
L.P., a wholly owned subsidiary are the guarantors of borrowings by our wholly
owned subsidiary, S&W Las Vegas, LLC. Of the $1.9 million borrowed by us under
the agreement, $1.35 million was used for our new restaurant development
program, and $550,000 was used for the first principal installment on the $1.65
million promissory note with Toll Road Texas Land Company, L.P. described above.
This loan bears interest at a fixed rate of 6.36% per annum. Principal payments
for this loan commenced January 24, 2003. Pursuant to the terms of the loan
agreement, we are obligated to make monthly principal payments of $15,833 for
this loan over the term of the loan and a balloon payment of approximately $1.0
million on December 24, 2007, the maturity date of the loan. The term loan is
secured by a second mortgage relating to the Dallas property and a security
interest in all of the personal property and fixtures of Dallas S&W L.P. The
term loan is also secured by the leasehold mortgage relating to the Las Vegas
property. The aggregate outstanding balance of this term loan was approximately
$1.8 million as of June 30, 2003. At June 30, 2003 we were in compliance with
the financial covenants contained in the loan agreement as described above.
24
We believe that our cash and short-term investments on hand, cash
expected from operations and expected landlord construction contributions should
be sufficient to finance our planned capital expenditures and other operating
activities, including funding working capital, throughout the remainder of 2003.
Changes in our operating plans, acceleration of our expansion plans, lower than
anticipated sales, increased expenses, potential acquisitions or other events
may cause us to seek additional financing sooner than anticipated. We may
require additional capital to fund our expansion plans after fiscal 2003 or to
satisfy working capital needs in the event that the general weakness in economic
conditions continues. As a result we would seek to obtain additional funds
through commercial borrowings or the private or public issuance of debt or
equity securities. However, there can be no assurance that such funds will be
available when needed or be available on terms acceptable to us. Failure to
obtain financing as needed could have a material adverse effect on our expansion
plans.
Below is a summary of certain of our contractual obligations as of June
30, 2003. Please refer to the discussion above and the Notes to Unaudited
Consolidated Financial Statements for additional disclosures regarding the
obligations described in the table below:
PAYMENTS DUE BY PERIOD
----------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
----- ------ --------- --------- -------
(dollars in thousands)
Minimum royalty payments licensing agreement .. $4,000 $0 $1,600 $1,600 $800(1)
Minimum distributions management agreement .... $3,540 $180 $960 $960 $1,440
Minimum payments on employment agreements ..... $4,842 $681 $2,758 $1,403 $0
Principal payments on long-term debt .......... $8,563 $343 $3,310 $2,240 $2,670
Payments under capital lease................... $12,037 $325 $1,367 $1,488 $8,857
Minimum annual rental commitments ............. $62,437 $1,853 $7,830 $7,279 $45,475
------- ------ -- ------ -- ------ -------
$95,419 $3,382 $17,825 $14,970 $59,242
======= ====== ======= ======= =======
- -----------
(1) The license agreement is irrevocable and perpetual unless terminated in
accordance with the terms of the agreement. See Notes to the Unaudited
Consolidated Financial Statements, Note 4.
Properties
We lease restaurant and office facilities and real property under
operating leases expiring in various years through 2028. As of June 30, 2003,
our future minimum lease payments of our headquarters and restaurants are as
follows: 2003--$1.9 million; 2004--$3.8 million; 2005--$4.0 million; and
thereafter--$52.8 million. In addition, certain leases contain contingent rental
provisions based upon the sales of the underlying restaurants.
Seasonality
Our business is seasonal in nature depending on the region of the United
States in which a particular restaurant is located, with revenues generally
being less in the third quarter than in other quarters due to reduced summer
volume and highest in the fourth quarter due to year-end and holiday events. As
we continue to expand in other locations, the seasonality pattern may change.
25
Inflation
Components of our operations subject to inflation include food,
beverage, lease and labor costs. Our leases require us to pay taxes,
maintenance, repairs, insurance, and utilities, all of which are subject to
inflationary increases. We believe inflation has not had a material impact on
our results of operations in recent years.
Effect of New Accounting Standards
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 amends existing guidance on reporting gains and losses
on the extinguishment of debt to prohibit the classification of the gain or loss
as extraordinary, as the use of such extinguishments have become part of the
risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13
to require sale-leaseback accounting for certain lease modifications that have
economic effects similar to sale-leaseback transactions. The provisions of the
Statement related to the rescission of Statement No. 4 is applied in fiscal
years beginning after May 15, 2002. The provisions of the Statement related to
Statement No. 13 were effective for transactions occurring after May 15, 2002.
The implementation of this standard had no material impact on our results of
operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The Interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 31, 2002. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and had no
material effect on our financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation Transition and Disclosure, an amendment of FASB
Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based employee
compensation. The Company accounts for stock-based compensation using the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees. The Company has adopted the
pro forma disclosure requirements of SFAS No. 123, Accounting for Stock-Based
Compensation.
In January 2003, the FASB issued Interpretation No.46, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51. This Interpretation addresses the consolidation by business enterprises
of variable interest entities as defined in the Interpretation. The
Interpretation applies immediately to variable interests in variable interest
entities created after January 31, 2003, and to variable interests in variable
interest entities obtained after January 31, 2003. For enterprises, such as
SWRG, with a variable interest in a variable interest entity created before
February 1, 2003, the Interpretation is applied to the enterprise no later than
the end of the first annual reporting period beginning after June 15, 2003. An
entity shall be subject to consolidation according to the provisions of this
Interpretation if, by design, the following conditions exists - As a group the
holders of the equity investment at risk lack any one of the following three
characteristics of a controlling financial interest: (1) the direct or indirect
ability to make decisions about an entity's activities through voting rights or
similar rights; (2) the obligation to absorb the expected losses of the entity
if they occur; or (3) the right to receive the expected residual returns of the
entity if they occur. The Company is currently evaluating the impact of the
application of this Interpretation and the effect it may have on our financial
statements. The Company believes it is possible that two of its managed
restaurants, which are owned by two separate partnerships, could be considered
variable interests that may need to be consolidated. The Company believes that
if such entities were to be
26
consolidated, these entities should gross up the consolidated sales and
restaurant operating costs of the Company, but the impact on net income would be
immaterial.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
statement requires instruments that are mandatorily redeemable, among other
financial instruments, which embody an unconditional obligation requiring the
issuer to redeem them by transferring its assets at a specified or determinable
date or upon an event that is certain to occur, be classified as liabilities.
This statement is effective for financial instruments entered into or modified
after May 31, 2003 and is effective at the beginning of the first interim period
beginning after June 15, 2003. The Company does not expect this statement to
have a material impact on our financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
We are exposed to changing interest rates on our outstanding mortgage in
relation to the Smith & Wollensky, Miami property that bears interest at prime
rate plus 1%. The interest cost of our mortgage is affected by changes in the
prime rate. The table below provides information about our indebtedness that is
sensitive to changes in interest rates. The table presents cash flows with
respect to principal on indebtedness and related weighted average interest rates
by expected maturity dates. Weighted average rates are based on implied forward
rates in the yield curve at June 30, 2003.
Expected Maturity Date
Fiscal Year Ended
-----------------
Fair Value
June 30,
Debt 2003 2004 2005 2006 2007 Thereafter Total 2003
- ---- ---- ---- ---- ---- ---- ---------- ----- ----
(dollars in thousands)
Long-term variable rate... $22 $936 $958 $958
Average interest rate..... 5.8%
Long-term fixed rate...... $321 $1,185 $1,189 $643 $1,597 $2,670 7,605 8,593
Average interest rate..... 6.7%
------ ------
Total debt................ $8,563 $9,551
------------- ====== ======
We have no derivative financial or derivative commodity instruments. We
do not hold or issue financial instruments for trading purposes.
27
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of the design and operation of our
"disclosure controls and procedures" (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end
of the period covered by this Report on Form 10-Q was made under the supervision
and with the participation of management, including its Chief Executive Officer
and Chief Financial Officer. Based upon this evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of the
period covered by this Quarterly Report on Form 10-Q, our disclosure controls
and procedures (a) are effective to ensure that information required to be
disclosed by us in reports filed or submitted under the Exchange Act is timely
recorded, processed, summarized and reported and (b) include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by us in reports filed or submitted under the Exchange Act is
accumulated and communicated to management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.
Changes in Internal Controls
There was no change in our internal controls over financial reporting
(as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the
period covered by this report that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE TO SECURITY HOLDERS.
The Company's Annual Meeting of Stockholders was held on May 22, 2003. The
proposals submitted to the stockholders for a vote are as follows:
1. A proposal to elect Robert D. Villency and Eugene I. Zuriff
as Class II directors to serve for a three year term and
until their successors are duly elected and qualified
("Proposal 1").
2. A proposal to ratify the selection of KPMG LLP as the
independent certified public accountants of The Smith &
Wollensky Restaurant Group, Inc. for the fiscal year ending
December 29, 2003 ("Proposal 2").
The following sets forth the number of votes for, the number of votes against,
the number of abstentions (or votes withheld in the case of the election of
directors) and broker non-votes with respect to each of the forgoing proposals.
Votes Abstentions Broker
Proposal Votes For Against (withheld) Non-Votes
- -------- --------- ------- ---------- ---------
Proposal 1
Robert D. Villency 8,440,689 -- 118,494 --
Eugene I. Zuriff 7,516,758 -- 1,042,425 --
Proposal 2 8,530,183 26,200 2,500 --
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
10.69 Modification of Lease Agreement between and among Beekman Tenants
Corporation and Atlantic and Pacific Grill
28
Associates, LLC.
10.70 Modification of the Sub-Management Agreement between and among
Doubletree Hotel in Chicago and Mrs. Park's Management Company.
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes - Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes - Oxley Act of 2002.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1 Risk Factors.
(b) Reports on Form 8-K.
Report on Form 8-K dated June 8, 2003 furnishing under Item 9
a copy of the Company's press release dated July 7, 2003,
describing selected financial results of the Company for the
three months ended June 30, 2003.
Report on Form 8-K dated August 11, 2003 furnishing under
Item 9 a copy of the Company's press release dated August 5,
2003, describing selected financial results of the Company
for the three and six months ended June 30, 2003.
29
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 SMITH & WOLLENSKY RESTAURANT GROUP, INC.
August 14, 2003 By: /s/ ALAN N. STILLMAN
---------------------
Name: Alan N. Stillman
Title: Chairman of the Board, Chief
Executive Officer and Director
(Principal Executive Officer)
August 14, 2003 By: /s/ ALAN M. MANDEL
-------------------
Name: Alan M. Mandel
Title: Chief Financial Officer,
Executive Vice President of
Finance, Secretary and
Treasurer (Principal Financial
and Accounting Officer)
30
Exhibits No. Description of Documents
- ------------ ------------------------
10.69 Modification of Lease Agreement between and among Beekman Tenants
Corporation and Atlantic and Pacific Grill Associates, LLC.
10.70 Modification of the Sub-Management Agreement between and among
Doubletree Hotel in Chicago and Mrs. Park's Management Company.
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes - Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes - Oxley Act of 2002.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1 Risk Factors.
31