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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 September 27, 2004
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
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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
incorporation or organization) Identification No.)
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 November 12, 2004, the registrant had 9,378,349 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.
Unaudited Consolidated Balance Sheets as of September 27, 2004 and December 29, 2003 4
Unaudited Consolidated Statements of Operations for the three- and nine-month periods ended
September 27, 2004 and September 29, 2003 5
Unaudited Consolidated Statements of Stockholders' Equity for the nine-month periods ended
September 27, 2004 and September 29, 2003 6
Unaudited Consolidated Statements of Cash Flows for the nine-month periods ended
September 27, 2004 and September 29, 2003 7
Notes to Unaudited Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk. 32
Item 4. Controls and Procedures. 33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 34
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. 34
Item 3. Defaults Upon Senior Securities. 34
Item 4. Submission of Matters to a Vote of Security Holders. 34
Item 5. Other Information. 34
Item 6. Exhibits and Reports on Form 8-K. 34
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 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
Unaudited Consolidated Balance Sheets
(dollar amounts in thousands, except share and per share data)
September 27, December 29,
2004 2003 (a) (b)
---- ------------
Assets
Current assets:
Cash and cash equivalents................................................................. $ 1,186 $ 2,181
Short-term investments.................................................................... 173 1,055
Accounts receivable, less allowance for doubtful accounts of $94 and $95
at September 27, 2004 and December 29, 2003,respectively.................................. 3,168 2,680
Merchandise inventory..................................................................... 4,992 4,749
Prepaid expenses and other current assets................................................. 1,107 845
-------- ------
Total current assets...................................................................... 10,626 11,510
Property and equipment, net................................................................. 69,406 61,532
Goodwill, net............................................................................... 6,886 6,886
Licensing agreement, net.................................................................... 3,679 3,338
Other assets................................................................................ 4,518 3,941
--------- ---------
Total assets.............................................................................. $ 95,115 $ 87,207
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of long-term debt......................................................... $ 3,326 $ 2,121
Accounts payable and accrued expenses..................................................... 16,948 11,922
--------- ---------
Total current liabilities................................................................. 20,274 14,043
Obligations under capital lease............................................................. 10,093 9,991
Long-term debt, net of current portion...................................................... 10,354 6,099
Deferred rent............................................................................... 5,145 4,793
--------- ---------
Total liabilities......................................................................... 45,866 34,926
Interest in consolidated variable interest entity........................................... (1,613) (1,680)
Commitments and contingencies
Stockholders' equity:
Common stock (par value $.01; authorized 40,000,000 shares; 9,378,349 and 9,376,249
shares issued and outstanding at September 27, 2004 and December 29, 2003, respectively).. 94 94
Additional paid-in capital................................................................ 69,952 69,940
Accumulated deficit....................................................................... (19,241) (16,089)
Accumulated other comprehensive income ................................................... 57 16
--------- ---------
50,862 53,961
--------- ---------
Total liabilities and stockholders' equity................................................ $ 95,115 $ 87,207
========= =========
(a.) Restated to reflect the adoption of FASB Interpretation No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN 46
(R)"). (See Note 1(b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1 (a))
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 Nine Months Ended
September 27, September 29, September 27, September 29,
2004 2003 (a)(b) 2004 2003 (a)(b)
---- ----------- ---- -----------
Consolidated restaurant sales...................................... $ 24,480 $ 23,110 $ 85,142 $ 74,550
---------- --------- -------- ---------
Cost of consolidated restaurant sales:
Food and beverage costs.......................................... 7,759 7,206 27,274 22,877
Salaries and related benefit expenses............................ 8,374 7,212 25,796 21,681
Restaurant operating expenses.................................... 4,724 4,390 14,280 12,566
Occupancy and related expenses................................... 1,561 1,288 4,641 4,377
Marketing and promotional expenses............................... 1,295 1,069 3,919 3,061
Depreciation and amortization expenses........................... 1,117 1,006 3,195 2,955
----- ----- ----- -----
Total cost of consolidated restaurant sales................... 24,830 22,171 79,105 67,517
---------- --------- -------- ---------
Income (loss) from consolidated restaurant operations.............. (350) 939 6,037 7,033
Management fee income.............................................. 260 215 891 659
---------- --------- -------- ---------
Income (loss) from consolidated and managed restaurants............ (90) 1,154 6,928 7,692
General and administrative expenses................................ 2,336 2,277 7,239 7,363
Royalty expense.................................................... 360 329 1,236 1,046
---------- --------- -------- ---------
Operating loss .................................................... (2,786) (1,452) (1,547) (717)
Interest expense................................................... (331) (362) (987) (765)
Amortization of deferred debt financing costs...................... (32) (13) (76) (39)
Interest income.................................................... 1 16 1 90
---------- --------- -------- ---------
Interest and other expense, net.................................... (362) (359) (1,062) (714)
---------- --------- -------- ---------
Loss before provision for income taxes............................. (3,148) (1,811) (2,609) (1,431)
Provision for income taxes......................................... 52 35 155 160
---------- --------- -------- ---------
Loss before (income) loss of consolidated
variable interest entity....................................... (3,200) (1,846) (2,764) (1,591)
(Income) loss of consolidated variable interest entity 41 149 (388) 155
---------- --------- -------- ---------
Net loss .......................................................... $ (3,159) $ (1,697) $ (3,152) $ (1,436)
=========== ========== ========= =========
Net loss per common share:
Basic and diluted:............................................ $ (0.34) $ (0.18) $ (0.34) $ (0.15)
========== ========== ========== ==========
Weighted average common shares outstanding:
Basic and 9,377,960 9,371,907 9,377,100 9,360,212
diluted............................................. ========= --------- ========= =========
(a.) Restated to reflect the adoption of FASB Interpretation No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN 46
(R)"). (See Note 1(b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1 (a))
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)
Nine months ended September 27, 2004 and September 29, 2003
Common Stock Accumulated
------------ Additional other
paid-in Accumulated comprehensive Stockholders'
Shares Amount capital deficit income (loss) equity
------ ------ ------- ------- ------------- ------
Balance at December 30, 2002(a)
9,354,266 $94 $69,854 $(14,820) $ (51) $55,077
Stock options exercised............. 20,800 81 81
Comprehensive income on
investments, net of tax effect...... 48 48
Net loss (a) (b) ................... -- -- -- (1,436) -- (1,436)
--------- ---- ------- -------- ------- -------
Total comprehensive loss (a)(b) (1,388)
Balance at September 29, -------
2003(a)(b).......................... 9,375,066 $94 $69,935 $(16,256) $ (3) $53,770
========= ==== ======= ======== ======= =======
Balance at December 29,
2003(a)(b).......................... 9,376,249 $94 $69,940 $(16,089) $16 $53,961
Stock options exercised............ 2,100 12 12
Comprehensive income on
investments, net of tax effect...... 41 41
Net loss.......................... -- -- -- (3,152) -- (3,152)
--------- ---- ------- -------- ------- -------
Total comprehensive loss (3,111)
=======
Balance at September 27, 2004 9,378,349 $ 94 $69,952 $(19,241) $ 57 $50,862
========= ==== ======= ======== ======= =======
(a.) Restated to reflect the adoption of FASB Interpretation No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN 46
(R)"). (See Note 1(b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1 (a))
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)
Nine months ended September 27, 2004 and September 29, 2003
September 27, September 29,
2004 2003(a)(b)
---- ----------
Cash flows from operating activities:
Net loss $ (3,152) $ (1,436)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization................................................... 3,451 3,184
Amortization of deferred financing costs................................ 76 39
Accretive interest on capital lease obligation ................................. 102 59
Income (loss) of consolidated variable interest entity.............. 388 (155)
Changes in operating assets and liabilities:
Accounts receivable.................................................... (488) (1,092)
Merchandise inventory.................................................. (243) (438)
Prepaid expenses and other current assets.............................. (262) 355
Other assets........................................................... (603) (252)
Accounts payable and accrued expenses.................................. 3,223 1,127
Deferred rent.......................................................... 352 70
------- --------
Net cash provided by operating activities.................... 2,844 1,461
Cash flows from investing activities:
Purchase of property and equipment.......................................... (9,389) (5,762)
Purchase of nondepreciable assets........................................... (68) (134)
Purchase of investments..................................................... - (3,319)
Proceeds from sale of investments........................................... 923 6,660
Payments under licensing agreement.......................................... (457) (224)
------- --------
Cash flows used in investing activities...................... (8,991) (2,779)
Cash flows from financing activities:
Proceeds from issuance of long-term debt.................................... 6,000 -
Principal payments of long-term debt........................................ (540) (995)
Net proceeds from exercise of options 12 81
Distribution to owners of consolidated variable interest entity............. (320) (240)
------- --------
Cash flows provided by (used in) financing activities........ 5,152 (1,154)
------- --------
Net change in cash and cash equivalents..................................... (995) (2,472)
Cash and cash equivalents at beginning of period............................ 2,181 4,226
------- --------
Cash and cash equivalents at end of period................... $ 1,186 $ 1,754
========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest..................................................... $ 845 $ 653
========= =========
Income taxes................................................. $ 82 $ 126
======= =========
Noncash investing and financing activities:
Assets under capital lease................................... $ 102 $ 8,044
===== =======
Obligations under capital lease.............................. $ - $ 9,956
===== =======
Capitalization of deferred rent.............................. $ 252 $ -
===== =======
Accrued leasehold improvements......................... $1,800 $ -
====== =======
(a.) Restated to reflect the adoption of FASB Interpretation No. 46 (revised
December 2003), "Consolidation of Variable Interest Entities" ("FIN 46
(R)"). (See Note 1(b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1(a))
See accompanying notes to unaudited consolidated financial statements.
7
THE SMITH & WOLLENSKY RESTAURANT GROUP, INC.
AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(dollar amounts in thousands, except per share amounts and where noted)
September 27, 2004 and September 29, 2003
(1) General
The Smith & Wollensky Restaurant Group, Inc. and its wholly-owned
subsidiaries (collectively, "SWRG") develop, own, operate and manage a
diversified portfolio of upscale tablecloth restaurants. At September 27, 2004,
SWRG owned and operated thirteen restaurants, including ten Smith & Wollensky
restaurants. The newest restaurant, a 450 seat Smith & Wollensky in Boston,
Massachusetts, opened on September 20, 2004. SWRG also manages five restaurants.
The accompanying unaudited consolidated financial statements of 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 29, 2003 filed by SWRG on Form 10-K
with the Securities and Exchange Commission on March 26, 2004. 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 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. Certain
reclassifications were made to prior period amounts to conform to current period
classifications.
The consolidated balance sheet data presented herein for December 29,
2003 was derived from SWRG's consolidated financial statements for the fiscal
year then ended and has been restated to include the effect of consolidating the
entity that owns the Maloney & Porcelli restaurant ("M&P") that SWRG manages in
New York City and the restatement for the change in accounting treatment
described below, but does not include all disclosures required by accounting
principles generally accepted in the United States.
SWRG utilizes a 52- or 53-week reporting period ending on the Monday
nearest to December 31st. The three months ended September 27, 2004 and
September 29, 2003 represent 13-week reporting periods and the nine months ended
September 27, 2004 and September 29, 2003 represent 39-week reporting periods.
(a.) On October 29, 2004, it was determined that the accounting
treatment for the April 2003 amendment to the lease for SWRG's Las
Vegas property was inaccurately reflected in SWRG's financial
statements included in its Annual Report on Form 10-K for the year
ended December 29, 2003, and its Quarterly Reports on Form 10-Q
for the respective quarters ended June 30, 2003, September 29,
2003, March 29, 2004 and June 28, 2004 and that, therefore, a
restatement of SWRG's financial statements for the periods
referenced above should be made to prevent future reliance on
those filings.
SWRG's management and Audit Committee discussed the matters
referenced above with SWRG's predecessor and current independent
registered public accounting firms and determined that it is
necessary to restate the balance sheets and statements of
operations for such periods. SWRG will issue a restated Annual
Report on Form 10-K for the fiscal year ended December 29, 2003,
which will reflect the change to the annual results and the
quarterly results for the quarters ended June 30, 2003 and
September 29, 2003, and a restated Quarterly Report on Form 10-Q
for each of the respective quarters ended March 29, 2004 and June
28, 2004, as soon as practicable.
8
The following table sets forth the effect of this restatement on SWRG's balance
sheet at December 29, 2003 and statement of operations for three and nine-months
ended September 29, 2003:
December 29,
2003
----
Balance sheet effect:
Property and equipment, net - as previously reported (a) $ 63,386
Effect of restatement (See Note 1(a)) (1,854)
-------
Property and equipment, net - as restated $ 61,532
=========
Deferred rent - as previously reported (a) $ 6,399
Effect of restatement (See Note 1(a)) (1,606)
-------
Deferred rent - as restated $ 4,793
========
Accumulated deficit - as previously reported (a) $ (15,841)
Effect of restatement (See Note 1(a)) (248)
-----
Accumulated deficit - as restated ($ 16,089)
=========
Three Months Nine Months
Ended Ended
September 29, September 29,
2003 2003
---- ----
Statement of operations effect:
Occupancy and related expenses - as previously reported (a) $ 1,195 $ 4,222
Effect of restatement (See Note 1(a)) 93 155
-- ---
Occupancy and related expenses - as restated $ 1,288 $ 4,377
Net loss - as previously reported (a) $ (1,604) $ (1,281)
Effect of restatement (See Note 1(a)) (93) (155)
---- -----
Net loss - as restated $ (1,697) $ (1,436)
========== ==========
Net loss per common share - as previously reported (a) $ (0.17) $ (0.14)
Effect of restatement (See Note 1(a)) (0.01) (0.01)
------ ------
Net loss per common share - as restated $ (0.18) $ (0.15)
========= =========
(a) Reflects the restatement under the adoption of FIN 46 (R). (See
Note 1(b))
On November 3, 2004, a letter was signed by Morgan Stanley confirming
the exclusion of the elimination of the non-cash income derived from the
amortization of the deferred rent liability relating to the Las Vegas lease from
the financial covenants contained in our term loan agreements and line of credit
facilities for the periods referenced above.
(b.) In accordance with Financial Accounting Standards Board ("FASB")
Interpretation No. 46 (revised December 2003), Consolidation of
Variable Interest Entities, ("FIN 46(R)"),SWRG's consolidated
financial statement results include the accounts and results of
the entity that owns M&P. SWRG manages the operations of M&P
pursuant to the terms of a restaurant management agreement (the
"Maloney Agreement"). FIN 46(R) addresses the consolidation by
business enterprises of variable interest entities. All variable
interest entities, regardless of when created, are required to be
evaluated under FIN 46(R) no later than the first period ending
after March 15, 2004. An entity shall be subject to consolidation
according to the provisions of FIN 46(R) if, by design, 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 consolidated
the financial statements of the entity that owns M&P because the
holders of the equity investment lacked one of the above
characteristics.
9
The presented consolidated financial statements relating to prior
periods have been restated to consolidate the accounts and results
of the entity that owns M&P as a direct result of the adoption of
FIN 46(R). In connection with the restatement under FIN 46(R),
SWRG's net investment in the Maloney Agreement, previously
classified under "Management contract, net" and management fees
and miscellaneous charges receivable classified under "Accounts
receivable" have been eliminated in consolidation and, instead,
the separable assets and liabilities of M&P are presented. In
connection with the restatement under FIN 46(R), the consolidated
statements of operations for the fiscal year ended December 30,
2002 reflect a cumulative effect of an accounting change. In
addition, amortization expense related to the Maloney Agreement
for previous periods classified under "General and administrative
expense", and fees received pursuant to the Maloney Agreement and
classified under "Management fee income" have been removed from
the consolidated statements of operations. The consolidation of
the entity that owns M&P has changed SWRG's current assets by
($147) and $144, non-current assets by ($606) and ($593) current
liabilities by $558 and $840, and non-current liabilities by $389
and $392 at September 27, 2004 and December 29, 2003,
respectively. The consolidation of the entity that owns M&P
increased consolidated sales by $2,242 and $2,038, and increased
restaurant operating costs by $2,067 and $2,070 for the three
months ended September 27, 2004 and September 29, 2003,
respectively. The consolidation of the entity that owns M&P
increased consolidated sales by $7,724 and $6,807, and increased
restaurant operating costs by $6,526 and $6,277 for the nine
months ended September 27, 2004 and September 29, 2003,
respectively.
(2) Recently Issued Accounting Pronouncements
In September 2004, the Emerging Issues Task Force ("EITF") reached a
consensus on EITF Issue 04-10 Applying Paragraph 19 of FASB Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FASB No.
131") in Determining Whether to Aggregate Operating Segments that do not meet
the Quantitative Thresholds. The consensus concluded that operating segments
that do not meet certain quantitative thresholds can be aggregated if the
criteria set forth in paragraph 17 of FASB No. 131 is met. This consensus
affects how the Company assesses the impairment of goodwill. Upon adoption of
Statement of Financial Accounting Standard No. 142 Goodwill and Other Intangible
Assets ("SFAS No. 142"), the Company had determined that certain restaurants
with assigned goodwill were separate reporting units and goodwill was assessed
for impairment at the reporting unit level. During 2002, the Company recorded an
impairment of goodwill of $75,000 related to one of its reporting units. As a
result of the consensus, the Company reassessed the reporting units with
goodwill and determined that under the aggregation criteria, the separate
reporting units could be viewed as one single reporting unit for purposes of
assessing goodwill impairment. This change in accounting principle requires
restatement of previously issued financial statements, however, as permitted in
the consensus the prior periods were not restated as the change does not have a
material impact on previously issued financial statements.
(3) Net Loss per Common Share
SWRG calculates net loss per common share in accordance with SFAS No.
128, Earnings Per Share. Basic net loss per common share is computed by dividing
the net loss by the weighted average number of common shares outstanding.
Diluted net loss per common share assumes the exercise of stock options using
the treasury stock method, if dilutive.
The following table sets forth the calculation for net loss per common share on
a weighted average basis:
10
Three Months Ended Nine Months Ended
- ----------------------------------------------------------------------------------------------------------------------------
September 27, September 29, September 27, September 29,
2004 2003 (a)(b) 2004 2003 (a)(b)
---- ----------- ---- -----------
Numerator:
Net loss $ (3,159) $ (1,697) $ (3,152) $(1,436)
======== ======== ======== =======
Total Weighted Weighted Weighted Weighted
----- -------- -------- -------- --------
Shares Average Average Average Average
------ ------- ------- ------- -------
Shares Shares Shares Shares
------ ------ ------ ------
Denominator - Weighted Average Shares:
Beginning common shares........................... 9,376,249 9,376,249 9,371,907 9,376,249 9,360,212
Options excercised during the nine months ended
September 27, 2004.............................. 2,100 1,711 -- 851 --
--------- --------- --------- --------- ---------
Basic and diluted ................................ 9,378,349 9,377,960 9,371,907 9,377,100 9,360,212
========= ========= ========= ========= =========
Per common share:
Basic and diluted................................ $ (0.34) $ (0.18) $ (0.34) $ (0.15)
======== ======== ======== ==========
(a.) Restated to reflect the adoption of FIN 46(R). (See Note 1 (b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1(a))
SWRG applies the intrinsic value-based method of accounting prescribed by
Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued
to Employees, and related interpretations, including FASB Interpretation No. 44,
Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25, issued in March 2000, to account for its
stock based employee compensation. Under this method, compensation expense is
recorded on the date of grant of the option only if the current market price of
the underlying stock exceeded the exercise price of the option. SFAS No. 123,
Accounting for Stock-Based Compensation ("SFAS No. 123"), established accounting
and disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plans. In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation Transition and Disclosure, an
amendment of SFAS No. 123. This Statement provides alternative methods of
transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation. SWRG has adopted the pro forma disclosure
requirements of SFAS No. 123. The following table illustrates the effect on net
loss as if SWRG had applied the fair value recognition provisions of SFAS No.
123 to its stock-based employee compensation:
11
Three Months Ended Nine Months Ended
------------------ -----------------
September 27, September 29, September 27, September 29,
------------- ------------- ------------- -------------
2004 2003(a) (b) 2004 2003(a)(b)
---- ----------- ---- ----------
Net loss ..................................................... $ (3,159) $ (1,697) $ (3,152) $ (1,436)
============ ============ ============ ============
Add stock-based employee compensation expense included in
reported net income ........................................ -- -- -- 22
Deduct total stock-based employee compensation expense
determined under fair value based method for all awards, net
of tax ..................................................... (55) (218) (226) (480)
--------- --------- ------ ------
Pro forma net loss ........................................... $ (3,212) $ (1,915) $ (3,378) $ (1,894)
============ ============ ============ ============
\/
----
Pro forma net loss Per common share I
Basic and diluted ......................................... $ (0.34) $ (0.20) $ (0.36) $ (0.20)
Weighted average common shares outstanding:
Basic and dilutive ........................................... 9,377,960 9,371,907 9,377,100 9,360,212
(a.) Restated to reflect the adoption of FIN 46 (R). (See Note 1 (b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1
(a))
(4) Investment Securities
The amortized cost, gross unrealized holding gains, gross unrealized
holding losses, and fair value of available for sale debt securities by major
security type and class of security at September 27, 2004 was as follows:
Gross unrealized Gross unrealized Fair value
Amortized ---------------- ---------------- ----------
Cost holding gains holding losses
---- ------------- --------------
At September 27, 2004
Available for sale short-term:
Equity securities $116 $57 $-- $173
==== === === ====
Proceeds from the sale of investment securities available for
sale were $923 and $6,660 for the nine months ended September 27, 2004 and
September 29, 2003, respectively, and gross realized gains for the nine months
ended September 27, 2004 and September 29, 2003, respectively, were $20 and $10,
respectively.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities ("SFAS No. 149"). SFAS No.
149 amends and clarifies accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133. In particular, SFAS No. 149 clarifies under what
circumstances a contract within an initial net investment meets the
characteristic of a derivative and when a derivative contains a financing
component that warrants special reporting in the statement of cash flows. SFAS
No. 149 was generally effective for contracts entered into or modified after
September 29, 2003. SWRG is exposed to market fluctuations in the prices of
various commodities. SWRG closely monitors the potential impacts of price
changes in beef and, where appropriate, enters into contracts to protect margins
for a portion of future sales. SWRG used commodity instruments, such as futures
and options, as economic hedges for beef purchases. SWRG hedged exposures to the
price variability of beef for a maximum of 10 months. The amount recognized for
transactions that did not qualify as cash flow hedges was a loss of $77 for the
year ending December 29, 2003. SWRG sold all its derivative instruments during
the three months ended March 29, 2004. The realized gain on the sale of these
instruments was $61 for the three-month period ended March 29, 2004. SWRG had no
derivative instruments or hedging activities during the three months ended
September 27, 2004.
12
(5) Property and Equipment
Property and equipment consists of the following:
September 27, December 29, 2003
2004 (a)(b)
Land.............................................................. $11,261 $11,261
Building and building improvements................................ 7,317 7,317
Machinery and equipment........................................... 11,835 10,183
Furniture and fixtures............................................ 8,416 7,399
Leasehold improvements............................................ 54,090 40,814
Leasehold rights.................................................. 3,376 3,376
Construction-in-progress.......................................... 44 4,787
---- --------
96,339 85,137
Less accumulated depreciation and amortization.................... (26,933) (23,605)
-------- --------
$ 69,406 $ 61,532
======== ========
(a.) Restated to reflect the adoption of FIN 46 (R). (See Note 1 (b))
(b.) Restated to reflect a change in accounting treatment. (See Note 1
(a))
Land includes $8,044 of assets under the capital lease relating to the
property in Las Vegas (see Note 8), net of the application of the deferred rent
liability (see Note 1(a)). Depreciation and amortization expense of property and
equipment was $3,328 and $4,028, for the nine months ended September 27, 2004
and the fiscal year ended December 29, 2003, respectively. SWRG capitalizes
interest cost as a component of the cost of construction in progress. In
connection with SWRG's assets under construction for the nine months ended
September 27, 2004 and the fiscal year ended December 29, 2003, SWRG capitalized
$112 and $111 of interest costs, respectively, in accordance with SFAS No. 34,
Capitalization of Interest Cost.
(6) 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 to SWRG through common management and
ownership.
The Licensing Agreement provides SWRG with the exclusive right to
utilize the names "Smith & Wollensky" and "Wollensky's Grill" (the "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 do 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.
The future minimum royalty payments as of September 27, 2004
relating to (ii) and (iii) above are as follows:
Fiscal year:
------------
2004........................................................... $ --
2005........................................................... 800
2006........................................................... 800
2007........................................................... 800
2008........................................................... 800
2009 and each year thereafter.................................. 800
13
During the nine-month period ended September 27, 2004, SWRG paid $229
in connection with the opening of the Smith & Wollensky units in Houston, Texas
and Boston, Massachusetts, respectively.
(7) Long-Term Debt
Long-term debt consists of the following:
September 27, December 29,
2004 2003
---- ----
Mortgage and loan payable (a)................................................... $1,573 $1,643
Term loan(b)...................................................................... 3,467 3,767
Promissory note(c)................................................................ 1,100 1,100
Term loan(d)...................................................................... 1,567 1,710
Line of credit (e).............................................................. 2,000 -
Promissory note (f)............................................................. 1,973 -
Line of credit (g).............................................................. 2,000 -
----- -----
13,680 8,220
Less current portion............................................................ 3,326 2,121
----- -----
$10,354 $6,099
======= ======
- -----------
(a.) 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 was obligated to
make quarterly and annual payments over a six-year period. These
obligations generally bore interest at rates ranging from 9% to
12%. The final payment for these obligations was made in 2003. In
addition, SWRG assumed a mortgage on the property that requires
monthly payments and bears interest at 5.00% per year. On April
30, 2004, a letter was signed by the financial institution that
holds the mortgage for the property extending the term of the
mortgage three additional years, with the final principal payment
due in June 2007. The extension became effective June 2004. In
Fiscal 1997, SWRG also assumed a loan payable to a financing
institution that requires monthly payments through the year 2014,
and bears interest at a fixed rate of 7.67% per year.
(b.) 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 the Borrower. 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. The
ability to draw down this balance expired on May 31, 2003. SWRG
did not draw down the remaining balance because, as an alternative
to purchasing the land, SWRG signed an amendment to its lease
agreement, as discussed in Note 8. On November 3, 2004, a letter
was signed by Morgan Stanley confirming the exclusion of the
elimination of the non-cash income derived from the amortization
of the deferred rent liability relating to the Las Vegas lease
from the financial covenants contained in
14
our term loan agreement for the periods described in Note 1(a). On
November 11, 2004, Morgan Stanley amended, among other things, the
interest coverage ratio covenant of the term loan agreement
effective as of September 27, 2004. As a result, at September 27,
2004, SWRG was in compliance with all the financial covenants
contained in this amended loan agreement. The costs in connection
with the amendment were approximately $20.
(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 installments
originally due on October 9, 2004 and October 9, 2005,
respectively. SWRG received a 60-day extension on the installment
due on October 9, 2004. The promissory note is secured by a first
mortgage relating to the Dallas property.
(d.) 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 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, 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. On
November 3, 2004, a letter was signed by Morgan Stanley confirming
the exclusion of the elimination of the non-cash income derived
from the amortization of the deferred rent liability relating to
the Las Vegas lease from the financial covenants contained in our
term loan agreement for the periods described in Note 1(a). On
November 11, 2004, Morgan Stanley amended, among other things, the
interest coverage ratio covenant of the term loan agreement
effective as of September 27, 2004. As a result, at September 27,
2004, SWRG was in compliance with all the financial covenants
contained in this amended loan agreement. The costs in connection
with the amendment were approximately $20.
(e.) On January 30, 2004, SWRG entered into a $2.0 million secured line
of credit facility with Morgan Stanley. Under the agreement, SWRG
is the guarantor of borrowings by the Borrower. Through the
Borrower, SWRG has the ability to borrow up to $2.0 million under
the agreement for working capital purposes. Advances under this
line of credit will bear interest at a fixed rate of LIBOR plus 3%
per annum, payable on a monthly basis. SWRG is also subject to an
unused availability fee of 1.75% for any unused portion of this
line, payable on a quarterly basis. SWRG may at anytime repay
advances on this line without penalty. SWRG is obligated to repay
the principal portion of this line on January 30, 2006, the
termination date of this line. This line is secured by a leasehold
mortgage relating to the Las Vegas property and all of the
personal property and fixtures of the Borrower. On November 3,
2004, a letter was signed by Morgan Stanley confirming the
exclusion of the elimination of the non-cash income derived from
the amortization of the deferred rent liability relating to the
Las Vegas lease from the financial covenants contained in our line
of credit facility for the periods described in Note 1(a). On
November 11, 2004, Morgan Stanley amended, among other things, the
interest coverage ratio covenant of the line of credit agreement
effective as of September 27, 2004. As a result, at September 27,
2004, SWRG was in compliance with all the financial covenants
contained in this amended line of credit facility. The costs in
connection with the amendment were approximately $20.
(f.) On May 26, 2004, S&W New Orleans, L.L.C. ("New Orleans"), a wholly
owned subsidiary of SWRG, signed a $2.0 million promissory note
with Hibernia National Bank ("Hibernia"). The $2.0 million was
used by SWRG for construction costs related to the new Smith &
Wollensky restaurant in Boston. The note bears interest at a fixed
rate of 6.27% per annum. Principal payments for this note
commenced June 26, 2004. Pursuant to the terms of the promissory
note, New Orleans is obligated to make monthly payments of $17 for
this note over the term of the note with a balloon payment of
approximately $1,548 on May 26, 2009, the maturity date of the
note. This note is secured by a first mortgage relating to the New
Orleans property. At September 27, 2004, New Orleans was in
compliance with the financial covenant contained in the loan
agreement between New Orleans and Hibernia.
(g.) On July 21, 2004, SWRG entered into a $2.0 million secured line of
credit facility with Morgan Stanley. Under the agreement, SWRG and
Smith & Wollensky of Boston LLC are the guarantors of borrowings
by the Borrower. The
15
$2.0 million was used by SWRG for construction costs related to
the new Smith & Wollensky restaurant in Boston. Advances under
this line of credit bears interest at a fixed rate of LIBOR plus
3% per annum, payable on a monthly basis. SWRG is also subject to
an unused availability fee of 1.75% for any unused portion of this
line, payable on a quarterly basis. SWRG may at anytime repay
advances on this line without penalty. SWRG is obligated to repay
the principal portion of this line on May 31, 2005, the
termination date of this line. This line is secured by a leasehold
mortgage relating to the Las Vegas property and all of the
personal property and fixtures of the Borrower. On November 3,
2004, a letter was signed by Morgan Stanley confirming the
exclusion of the elimination of the non-cash income derived from
the amortization of the deferred rent liability relating to the
Las Vegas lease from the financial covenants contained in our line
of credit facility for the periods described in Note 1(a). On
November 11, 2004, Morgan Stanley amended, among other things, the
interest coverage ratio covenant of the line of credit agreement
effective as of September 27, 2004. As a result, at September 27,
2004, SWRG was in compliance with all the financial covenants
contained in this amended line of credit facility. The costs in
connection with the amendment were approximately $20.
(8) 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 was approximately $10.0 million at May 1, 2003, and escalates
to approximately $12.1 million at the end of five years. 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 as of September 27, 2004 will be as follows:
Fiscal year
-----------
2004 $ 74
2005 298
2006 328
2007 360
2008 123
---
$1,183
======
If SWRG exercises the option, the Lessor is obligated to 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.
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. In the event of the
exercise of the put option, the Lessor is obligated to provide SWRG with
financing in the amount of the purchase price applicable at that time. 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.
On October 29, 2004, it was determined that the accounting treatment
for this Agreement was inaccurately reflected in SWRG's financial statements
included in its Annual Report on Form 10-K for the year ended December 29, 2003,
and its Quarterly Reports on Form 10-Q for the respective quarters ended June
30, 2003, September 29, 2003, March 29, 2004 and June 28, 2004 and that,
therefore, a restatement of SWRG's financial statements for the periods
referenced above should be made to prevent future reliance on those filings (See
Note 1 (a)).
(9) Legal Matters
16
On or about September 5, 2001, Mondo's of Scottsdale, L.C. ("Mondo's")
filed a suit against SWRG alleging that it 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 had been set to go to jury trial in March 2004. The plaintiff
requested damages of approximately $2.0 million. On March 18, 2004 the parties
tentatively agreed to settle the matter for $525 and a reserve of $525 was
established as of December 29, 2003. On April 9, 2004 a final settlement was
reached between the parties and, in accordance with the settlement, SWRG made
the first payment of $225, with the final payment of $300 due on April 11, 2005.
SWRG is involved in various 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.
(10) Subsequent Events
On November 1, 2004, SWRG informed certain of its employees that
ONEc.p.s., a restaurant that SWRG manages, will close effective January 1, 2005
in connection with a decision by the Plaza Operating Partners, Ltd., owners of
the restaurant and of the Plaza Hotel to sell the hotel in which the restaurant
is located. As a result, SWRG will no longer accrue additional quarterly
management fees under its agreement with Plaza Operating Partners, Ltd. with
respect to any periods following January 1, 2005.
On November 11, 2004, Morgan Stanley amended, among other things,
the interest coverage ratio covenant of our term loan and line of credit
agreements. The costs in connection with the amendment were approximately $20.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
As of September 27, 2004, we operated 18 high-end, high volume
restaurants in the United States. We believe that the particularly large size of
the markets we entered warranted investment in restaurants with seating
capacities ranging from 290 to 675. On September 20, 2004, we opened a 450 seat,
four level, Smith & Wollensky in Boston, Massachusetts. We currently do not have
any leases signed other than leases relating to our existing locations and will
not actively pursue new locations in 2005. We plan to move ahead cautiously with
our future expansion as management evaluates and monitors economic and security
conditions, and we expect to resume our new restaurant growth in 2006. When we
do resume our growth, we expect additional locations to have seating capacities
ranging from 375 to 450 seats, but would consider locations with larger or
smaller seating capacities where appropriate. We believe new restaurants will
require, on average, a total cash investment of $2.5 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 and is
dependent on the size of the location and the amount of the landlord
contribution. Our newest unit in Boston significantly exceeded this range
primarily because of its physical size and to undetected defects directly
associated with the renovations to the building, which is over 100 years old and
which has been lightly used over the last 20 years, as well as the additional
cost related to the adherence to a stricter building code than originally
anticipated. Some locations that we choose will be outside our preferred cash
investment range, but are nevertheless accepted based on our evaluation of the
potential returns.
17
As a result of our recent expansion and when our locations opened,
period-to-period comparisons of our financial results may not be 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 restaurant base once it has been in operation for 15 months.
Pursuant to management contracts and arrangements, we also operate, but
do not own, the original Smith & Wollensky, The Post House, Maloney & Porcelli
and ONEc.p.s. restaurants in New York and the Mrs. Parks Tavern in Chicago.
The consolidated financial statements include our accounts and results
and, as a result of Financial Accounting Standards Board ("FASB") Interpretation
No.46 (revised December 2003), Consolidation of Variable Interest Entities
("FIN46(R)"), the accounts and results of the entity that owns the Maloney &
Porcelli restaurant ("M&P") that we manage in New York City. We manage the
operations of M&P pursuant to the terms of a restaurant management agreement
(the "Maloney Agreement"). Under the provisions of the Maloney Agreement, we
receive a management fee equal to the sum of 3% of restaurant sales and a fee
equal to 50% of the unit's net operating cash flow generated during each fiscal
year, provided that the M&P owner receives a minimum amount of operating cash
flow per year ranging from $360,000 to $480,000. Either party can terminate the
Maloney Agreement for cause and we have a right to purchase the restaurant under
specified conditions and amounts. The restaurant owner can preempt the purchase
option by remitting a specified cash payment to us. The Maloney Agreement
expires on December 31, 2011.
Consolidated restaurant sales include gross sales less sales taxes and
other discounts. Costs of consolidated 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 based on a percentage of sales from the managed units,
ranging from 2.3% to 6.0%. 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 was to expire 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 we receive an
annual fee of $12,000. 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 could include fees from ONEc.p.s.
equal to 40% of the restaurant's operating cash flows, if any, 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
increases to 50% of the restaurant's operating cash flows. On December 31, 2003,
we amended our agreement with Plaza Operating Partners, Ltd. (the "Plaza
Operating Partners"). Effective January 1, 2004, Plaza Operating Partners agreed
to pay us $50,000 per quarter as a minimum base management fee. The minimum base
management fee will be credited against any management fee that we earn under
the agreement. This amendment also gives either party the right to fund or
refuse to fund any necessary working capital requirements. If neither party is
willing to fund the required additional working capital contributions, as
defined, then either party may terminate the agreement. We have been notified by
the Plaza Operating Partners that they have sold the Plaza Hotel, the property
in which the restaurant is located. On November 1, 2004, we informed certain of
our employees that ONEc.p.s. will close effective January 1, 2005. As a result,
we will no longer accrue additional quarterly management fees under our
agreement with Plaza Operating Partners with respect to any periods following
January 1, 2005.
General and administrative expenses include all corporate and
administrative functions that support existing consolidated and managed
operations and provide infrastructure to our organization. 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.
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.
18
Royalty expense represents fees paid pursuant to a 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 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.
Change in accounting principles: The presented consolidated financial
statements relating to prior periods have been restated to consolidate the
accounts and results of the entity that owns M&P as a direct result of the
adoption of FIN 46(R). FIN 46(R) addresses the consolidation by business
enterprises of variable interest entities. All variable interest entities,
regardless of when created, are required to be evaluated under FIN 46 (R) no
later than the first period ending after March 15, 2004. An entity shall be
subject to consolidation according to the provisions of this Interpretation if,
by design, 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. We consolidated the
financial statements of the entity that owns M&P because the holders of the
equity investment lacked one of the above characteristics.
In connection with the restatement under FIN 46 (R), our net investment
in the Maloney Agreement, previously classified under "Management contract, net"
and management fees and miscellaneous charges receivable classified under
"Accounts receivable" have been eliminated in consolidation and, instead, the
separable assets and liabilities of the entity that owns M&P are presented. In
connection with the restatement under FIN 46 (R), the consolidated statements of
operations for the fiscal year ended December 30, 2002 reflect a cumulative
effect of an accounting change. In addition, amortization expense related to the
Maloney Agreement for previous periods classified under "General and
administrative expense", and fees received pursuant to the Maloney Agreement and
classified under "Management fee income" have been removed from the consolidated
statements of operations. The consolidation of the entity that owns M&P has
changed our current assets by ($147,000) and $144,000, non-current assets by
($606,000) and ($593,000) current liabilities by $558,000 and $840,000, and
non-current liabilities by $389,000 and $392,000 at September 27, 2004 and
December 29, 2003, respectively. The consolidation of the entity that owns M&P
increased consolidated sales by $2.2 million and $2.0 million, and increased
restaurant operating costs by $2.0 million for each of the three months ended
September 27, 2004 and September 29, 2003, respectively. The consolidation of
the entity that owns M&P increased consolidated sales by $7.7 million and $6.8
million, and increased restaurant operating costs by $6.5 million and $6.3
million for the nine months ended September 27, 2004 and September 29, 2003,
respectively. Certain reclassifications were made to prior period amounts to
conform to current period classifications.
Change in accounting treatment: On October 29, 2004, it was determined
that the accounting treatment for the April 2003 amendment to the lease for
SWRG's Las Vegas property was inaccurately reflected in the SWRG's financial
statements included in our Annual Report on Form 10-K for the year ended
December 29, 2003, and our Quarterly Reports on Form 10-Q for the respective
quarters ended June 30, 2003, September 29, 2003, March 29, 2004 and June 28,
2004 and that, therefore, a restatement of our financial statements for the
periods referenced above should be made to prevent future reliance on those
filings.
Our management and Audit Committee discussed the matters referenced
above with our predecessor and current independent registered accounting firms
and determined that it is necessary to restate the balance sheets and statements
of operations for such periods. We will issue a restated Annual Report on Form
10-K for the fiscal year ending December 29, 2003, which will reflect the
19
change for the annual results and the quarterly results for the quarters ended
June 30, 2003 and September 29, 2003, and a restated Quarterly Report on Form
10-Q for each of the respective quarters ended March 29, 2004 and June 28, 2004,
as soon as practicable.
The following table sets forth the effect of this restatement on SWRG's
balance sheet at December 29, 2003 and statement of operations for three and
nine-months ended September 29, 2003:
December 29,
2003
----
Balance sheet effect:
Property and equipment, net - as previously reported (a) $ 63,386
Effect of restatement (See Note 1(a)) (1,854)
-------
Property and equipment, net - as restated $ 61,532
=========
Deferred rent - as previously reported (a) $ 6,399
Effect of restatement (See Note 1(a)) (1,606)
-------
Deferred rent - as restated $ 4,793
========
Accumulated deficit - as previously reported (a) $ (15,841)
Effect of restatement (See Note 1(a)) (248)
-----
Accumulated deficit - as restated ($ 16,089)
=========
Three Months Nine Months
Ended Ended
September 29, September 29,
2003 2003
---- ----
Statement of operations effect:
Occupancy and related expenses - as previously reported (a) $ 1,195 $ 4,222
Effect of restatement (See Note 1(a)) 93 155
-- ---
Occupancy and related expenses - as restated $ 1,288 $ 4,377
======== ========
Net loss - as previously reported (a) $ (1,604) $ (1,281)
Effect of restatement (See Note 1(a)) (93) (155)
---- -----
Net loss - as restated $ (1,697) $ (1,436)
========== ==========
Net loss per common share - as previously reported (a) $ (0.17) $ (0.14)
Effect of restatement (See Note 1(a)) (0.01) (0.01)
------ -----
Net loss per common share - as restated $ (0.18) $ (0.15)
========= =========
(a) Restated to reflect the adoption of FIN 46 (R). See Notes to the
Unaudited Consolidated Financial Statements, Note 1 (b).
We believe the following is a summary of our critical accounting policies:
Revenue recognition: Consolidated restaurant sales 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 credit card processing companies or individuals that
have good historical track 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.
20
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. We assess the recoverability of goodwill
at the end of each year through a fair value evaluation performed for the
aggregation of all units as one reporting unit having goodwill. The fair value
valuation is calculated using various methods, including an analysis based on
projected discounted future operating cash flows of aggregate group 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 aggregate group and actual results at comparable
groups. 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 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 September 27, 2004 and December 29, 2003 was $6.9
million.
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 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 September 27, 2004 and December 29, 2003
was $3.7 million and $3.3 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. The net carrying value of our artwork as of
September 27, 2004 and December 29, 2003 was $2.1 million and $2.0 million,
respectively.
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 a change of
approximately $50,000 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
remote and can be reasonably estimated, a liability is recorded in the
consolidated financial statements.
21
Income taxes and income tax valuation allowances: We estimate certain
components of our provision for income taxes. These estimates include, but are
not limited to, effective state and local income tax rates, estimates related to
depreciation expense allowable for tax purposes and estimates related to the
ultimate realization of net operating losses and tax credit carryforwards and
other deferred tax assets. 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.
At September 27, 2004, we have recorded a valuation allowance of $9.2
million to reduce the tax benefit resulting from future utilization of our net
operating loss and tax credit carryforwards of $7.6 million and other timing
differences of $1.6 million to an amount that will more likely than not be
realized. These net operating loss and tax credit carryforwards existfor 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.
22
Results of Operations
Three Months Ended Nine Months Ended
September 27, September 29, September 27, September 29,
2004 2003(a)(b) 2004 2003(a)(b)
Consolidated restaurant sales $ 24,480 100.0% $ 23,110 100.0% $ 85,142 100.0% $ 74,550 100.0%
Cost of consolidated restaurant sales:
Food and beverage costs 7,759 31.7 7,206 31.2 27,274 32.0 22,877 30.7
Salaries and related benefit expenses 8,374 34.2 7,212 31.2 25,796 30.3 21,681 29.1
Restaurant operating expenses 4,724 19.3 4,390 19.0 14,280 16.8 12,566 16.8
Occupancy and related expenses 1,561 6.4 1,288 5.6 4,641 5.5 4,377 5.9
Marketing and promotional expenses 1,295 5.3 1,069 4.6 3,919 4.6 3,061 4.1
Depreciation and amortization expenses 1,117 4.5 1,006 4.3 3,195 3.7 2,955 4.0
------ ----- ------ ---- ------ ---- ------ ----
Total cost of consolidated restaurant sales 24,830 101.4 22,171 95.9 79,105 92.9 67,517 90.6
------ ----- ------ ---- ------ ---- ------ ----
Income (loss) from consolidated restaurant
operations (350) (1.4) 939 4.1 6,037 7.1 7,033 9.4
Management fee income 260 1.1 215 0.9 891 1.0 659 0.9
------ ----- ------ ---- ------ ---- ------ ----
Income (loss) from consolidated and managed
Restaurants (90) (0.3) 1,154 5.0 6,928 8.1 7,692 10.3
General and administrative expenses 2,336 9.5 2,277 9.9 7,239 8.5 7,363 9.9
Royalty expense 360 1.5 329 1.4 1,236 1.4 1,046 1.4
Operating loss (2,786) (11.3) (1,452) (6.3) (1,547) (1.8) (717) (1.0)
Interest and other expense, net (362) (1.5) (359) (1.6) (1,062) (1.2) (714) (1.0)
------ ----- ------ ---- ------ ---- ------ ----
Loss before provision for income taxes (3,148) (12.8) (1,811) (7.9) (2,609) (3.0) (1,431) (2.0)
Provision for income taxes 52 0.2 35 0.1 155 0.2 160 0.2
------ ----- ------ ---- ------ ---- ------ ----
Loss before (income) loss of consolidated
variable interest entity (3,200) (13.0) (1,846) (8.0) (2,764) (3.2) (1,591) (2.2)
(Income) loss of consolidated variable interest
entity 41 0.2 149 0.6 (388) (0.5) 155 0.2
--- --- --- --- ----- --- ----- ---
Net loss $ (3,159) (12.8)% $ (1,697) 7.4% $ (3,152) (3.7)% $(1,437) (2.0)%
========= ======= ========= ==== ========= ====== ======== ======
(a.) Restated to reflect the adoption of FIN 46 (R). See Notes to the
Unaudited Consolidated Financial Statements, Note 1 (b).
(b.) Restated to reflect a change in accounting treatment. See Notes to
the Unaudited Consolidated Financial Statements, Note 1 (a).
Three Months Ended September 27, 2004 Compared to the Three Months Ended
September 29, 2003
Consolidated Restaurant Sales. Consolidated restaurant sales increased $1.4
million, or 5.9%, to $24.5 million for the three months ended September 27, 2004
from $23.1 million for the three months ended September 29, 2003. The increase
in consolidated restaurant sales was primarily due to a combined net increase of
$1.8 million from our new Smith & Wollensky unit in Houston, Texas, which opened
in January 2004, and our new unit in Boston, Massachusetts, which opened in
September 2004. The net increase was negatively impacted by a decrease in
comparable consolidated restaurant sales of $468,000, or a decrease of 2.0%. The
net decrease in comparable consolidated restaurant sales was due to a decrease
in sales of $361,000 from our owned Smith & Wollensky units open for the entire
period,primarily as a result of extreme weather patterns and conditions that
caused our Miami Beach unit and New Orleans unit to close for several days for
the safety of our employees and guests. The weather also significantly reduced
sales at both locations for much of the fiscal month of September due to lack of
visitors and displacement of residents. This decrease in comparable consolidated
restaurant sales was also partially due to a decrease in net sales of $107,000
from our consolidated New York units, which includes the sales of the entity
that owns M&P, a restaurant we manage. The Republican National Convention held
23
in New York City, during the fiscal month of September, had a negative impact on
owned locations in New York City as many customers, tourists and business
travelers avoided Manhattan while the convention was being held.
Food and Beverage Costs. Food and beverage costs increased $553,000 to $7.8
million for the three months ended September 27, 2004 from $7.2 million for the
three months ended September 29, 2003. Food and beverage costs as a percentage
of consolidated restaurant sales increased to 31.7% in 2004 from 31.2% in 2003.
The increase in cost is primarily related to approximately $643,000 in food and
beverage costs for the new Smith & Wollensky unit in Houston, Texas, which
opened in January 2004, and our new unit in Boston, Massachusetts, which opened
in September 2004. The increase in food and beverage costs was partially offset
by the decrease in food cost at our comparable consolidated units of
approximately $90,000. This decrease related primarily to a net decrease in
customer volume at our comparable units during the three months ended September
27, 2004 as compared to the three months ended September 29, 2003. The new Smith
& Wollensky unit in Boston 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 Boston matures, 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 $1.2
million to $8.4 million for the three months ended September 27, 2004 from $7.2
million for the three months ended September 29, 2003. This increase was
primarily due to the new Smith & Wollensky unit in Houston, Texas, which opened
in January 2004, and our new unit in Boston, Massachusetts, which opened in
September 2004. The increase relating to these new units was $960,000 and
includes the salaries and related benefits incurred prior to the opening of the
new unit in Boston. Salaries and related benefits as a percent of consolidated
restaurant sales increased to 34.2% for the three months ended September 27,
2004 from 31.2% for the three months ended September 29, 2003. The increase in
salaries and related benefits as a percentage of consolidated restaurant sales
was primarily due to the additional staffing required at the new Smith &
Wollensky unit in Boston, Massachusetts both prior to and 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, operating efficiency is expected to improve as we expect that
staffing will be reduced through efficiencies and salaries and wages as a
percentage of consolidated sales for that unit will decrease due to the lower
staffing requirement and higher revenue base. The increase in salaries and
related benefits is also attributable to an increase in the cost of health
insurance provided to employees and paid for in part by us and increases in
employer contributions for other payroll taxes.
Restaurant Operating Expenses. Restaurant operating expenses increased $334,000
to $4.7 million for the three months ended September 27, 2004 from $4.4 million
for the three months ended September 29, 2003. The increase primarily related to
$343,000 incurred in connection with the opening of the new Smith & Wollensky
units in Houston, Texas, and Boston, Massachusetts. The total increase was
offset by decreases in certain costs that are directly related to the decreased
sales volume such as credit card charges and linen costs. These decreases were
partially offset by increases in property and liability insurance premiums and
professional fees at the units open the entire period. Restaurant operating
expenses as a percentage of consolidated restaurant sales increased to 19.3% for
2004 from 19.0% in 2003.
Occupancy and Related Expenses. Occupancy and related expenses increased
$273,000 to $1.6 million for the three months ended September 27, 2004 from $1.3
million for the three months ended September 29, 2003 . The increase related to
the combined increase of $72,000 in occupancy and related expenses including
real estate and occupancy taxes for the new Smith & Wollensky units in Houston,
Texas and Boston, Massachusetts and by increases in percentage of sales rent at
applicable units. Occupancy and related expenses as a percentage of consolidated
restaurant sales was 6.4% and 5.6% for the three months ended September 27, 2004
and September 29, 2003, respectively.
Marketing and Promotional Expenses. Marketing and promotional expenses increased
$226,000 to $1.3 million for the three months ended September 27, 2004 from $1.1
million for the three months ended September 29, 2003. The increase was
primarily related to the opening of the Smith & Wollensky units in Houston,
Texas and Boston, Massachusetts, and to a lesser extent, an increase in
advertising in support of our owned New York restaurants. Marketing and
promotional expenses as a percent of consolidated restaurant sales increased to
5.3% for the three months ended September 27, 2004 from 4.6% for the three
months ended September 29, 2003.
Depreciation and Amortization. Depreciation and amortization was $1.1 million
and $1.0 million for the three months ended September 27, 2004 and September 29,
2003, respectively.
Management Fee Income. Management fee income increased $45,000 to $260,000 for
the three months ended September 27, 2004 from $215,000 for the three months
ended September 29, 2003, primarily due to an increase in fees received from one
of our managed units relating to a minimum base management fee that we began
receiving during the three months ended March 29, 2004. We have
24
been notified by the Plaza Operating Partners that they have sold the Plaza
Hotel, the property in which ONEc.p.s, a restaurant we manage, is located.
ONEc.p.s. will close effective January 1, 2005. As a result, we will no longer
accrue additional quarterly management fees under our agreement with Plaza
Operating Partners with respect to any periods following January 1, 2005. Total
income accrued during the three months ended September 27, 2004 amounted to
approximately $53,000.
General and Administrative Expenses. General and administrative expenses were
$2.3 million for the three months ended September 27, 2004 and September 29,
2003, respectively. General and administrative expenses as a percent of
consolidated restaurant sales decreased to 9.5% for the three months ended
September 27, 2004 from 9.9% for three months ended September 29, 2003. 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 consolidated and managed restaurant sales decreased to 7.1%
for the three months ended September 27, 2004 from 7.3% for the three months
ended September 29, 2003.
Royalty Expense. Royalty expense increased $31,000 to $360,000 for the three
months ended September 27, 2004 from $329,000 for the three months ended
September 29, 2003 primarily due to the increase in sales of $1.8 million from
our Smith & Wollensky unit in Houston, Texas, which opened in January 2004 and
our new unit in Boston, Massachusetts, which opened in September 2004.
Interest and Other Expense -Net of Interest Income. Interest and other expense,
net of interest income, increased $3,000 to $362,000 for the three months ended
September 27, 2004 from $359,000 for the three months ended September 29, 2003,
primarily due to the interest incurred for general corporate purposes and in
connection with the financing of our new Smith & Wollensky units in Dallas,
Texas, and Houston, Texas. Interest and other expense, net of interest income,
was also impacted by the reduction in interest income related to the use of cash
for capital improvements, which had been invested in short and long term
interest bearing investments during the three months ended September 29, 2003.
Provision for Income Taxes. The income tax provision for the three months ended
September 27, 2004 and September 29, 2003, respectively, represents certain
state and local taxes.
(Income) Loss in Consolidated Variable Interest Entity. In accordance with our
adoption of FIN 46 (R), the operating results of the entity that owns M&P are
now consolidated and the net (income) or loss of this variable interest entity
is presented as a separate item after the provision for income taxes.
Nine Months Ended September 27, 2004 Compared to the Nine Months Ended September
29, 2003
Consolidated Restaurant Sales. Consolidated restaurant sales increased $10.5
million, or 14.2%, to $85.1 million for the nine months ended September 27, 2004
from $74.6 million for the nine months ended September 29, 2003. The increase in
consolidated restaurant sales was partially due to a net increase in comparable
consolidated restaurant sales of $4.4 million, or 6.2%. The net increase in
comparable owned restaurant sales was due to an increase in sales of $3.5
million from our owned Smith & Wollensky units open for the entire period. The
improvement is primarily a result of an increase in our average check, due
primarily to price increases, and, to a lesser extent, tourism, business travel
and banquet sales at our units outside of New York. This increase in comparable
owned unit sales was also partially due to an increase in net sales of $898,000
from our consolidated New York units, which includes the increase in sales of
$917,000 for the entity that owns M&P. This increase in sales for the entity
that owns M&P was attributable to an increase in customer volume, our average
check and, to a lesser extent, an increase in banquet sales. The increase in
consolidated restaurant sales also includes a combined sales increase of $6.1
million from our Smith & Wollensky unit in Dallas, Texas, which opened in March
2003, our unit in Houston, Texas, which opened in January 2004 and our unit in
Boston, Massachusetts, which opened in September 2004.
Food and Beverage Costs. Food and beverage costs increased $4.4 million to $27.3
million for the nine months ended September 27, 2004 from $22.9 million for the
nine months ended September 29, 2003. Food and beverage costs as a percentage of
consolidated restaurant sales increased to 32.0% in 2004 from 30.7% in 2003. The
increase in cost is primarily related to an increase in food cost at our
comparable units of approximately $2.1 million. This increase related primarily
to the continued increase in the cost of beef during the nine months ended
September 27, 2004 as compared to the nine months ended September 29, 2003, and
to a net increase in customer volume at our comparable units. The increase in
food and beverage costs also related to approximately $3.9 million in food and
beverage costs for the new Smith & Wollensky unit in Dallas, Texas, which opened
in March 2003, Houston, Texas, which opened in January 2004 and our new unit in
Boston, Massachusetts, which opened in September 2004. The new Smith & Wollensky
units in Houston and Boston 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 units in Houston and Boston
mature, 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.
25
Salaries and Related Benefits. Salaries and related benefits increased $4.1
million to $25.8 million for the nine months ended September 27, 2004 from $21.7
million for the nine months ended September 29, 2003. This increase was
partially due to our new Smith & Wollensky units in Dallas, Texas, which opened
in March 2003, our new unit in Houston, Texas, which opened in January 2004 and
our new unit in Boston Massachusetts, which opened in September 2004. The
increase relating to these new units was $2.3 million. Salaries and related
benefits as a percent of consolidated restaurant sales increased to 30.3% for
the nine months ended September 27, 2004 from 29.1% for the nine months ended
September 29, 2003. The increase in salaries and related benefits as a
percentage of consolidated restaurant sales was primarily due to the additional
staffing required at the new Smith & Wollensky units in Houston, Texas and
Boston, Massachusetts during the units openings. 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, operating efficiency
is expected to improve as we expect that staffing will be reduced through
efficiencies and salaries and wages as a percentage of consolidated sales for
that unit will decrease due to the lower staffing requirement and higher revenue
base. The increase in salaries and related benefits is also attributable to the
payroll and related benefits associated with the increase in comparable unit
sales, to an increase in the cost of health insurance provided to employees and
paid for in part by us and to increases in employer contributions for other
payroll taxes.
Restaurant Operating Expenses. Restaurant operating expenses increased $1.7
million to $14.3 million for the nine months ended September 27, 2004 from $12.6
million for the nine months ended September 29, 2003. The increase includes $1.1
million that was due to the opening of the new Smith & Wollensky units in
Dallas, Texas, Houston, Texas and Boston, Massachusetts. The remaining increase
is related to certain costs associated with upgrades of operating supplies,
ongoing repairs and maintenance, certain costs that are directly related to the
increased sales volume such as credit card charges and linen costs, increases in
property and liability insurance premiums and professional fees at the units
open the entire period. Restaurant operating expenses as a percentage of
consolidated restaurant sales remained constant at 16.8% for 2004 and 2003.
Occupancy and Related Expenses. Occupancy and related expenses increased
$264,000 to $4.6 million for the nine months ended September 27, 2004 from $4.4
million for the nine months ended September 29, 2003 primarily due to the
combined increase of $495,000 in occupancy and related expenses including real
estate and occupancy taxes for the new Smith & Wollensky units in Dallas, Texas,
Houston, Texas and Boston, Massachusetts, and to a lesser extent, an increase in
percentage of sales rent at applicable units. These increases were partially
offset by a decrease of $369,000 due to the treatment of the lease in Las Vegas
as a capital lease. Occupancy and related expenses as a percentage of
consolidated restaurant sales decreased to 5.5% for the nine months ended
September 27, 2004 from 5.9% for the nine months ended September 29, 2003.
Marketing and Promotional Expenses. Marketing and promotional expenses increased
$858,000 to $3.9 million for the nine months ended September 27, 2004 from $3.1
million for the nine months ended September 29, 2003. The increase was related
primarily to the opening of the Smith & Wollensky units in Dallas, Texas,
Houston, Texas and Boston, Massachusetts, and, to a lesser extent, an increase
in advertising in support of our owned New York restaurants. Marketing and
promotional expenses as a percent of consolidated restaurant sales increased to
4.6% for the nine months ended September 27, 2004 from 4.1% for the nine months
ended September 29, 2003.
Depreciation and Amortization. Depreciation and amortization increased $240,000
to $3.2 million for the nine months ended September 27, 2004 from, $3.0 million
for the nine months ended September 29, 2003, primarily due to the increase
relating to the property and equipment additions for the new Smith & Wollensky
units in Dallas, Texas and Houston, Texas, being partially offset by a reduction
in depreciation from items which became fully depreciated during 2004.
Management Fee Income. Management fee income increased $232,000 to $891,000 for
the nine months ended September 27, 2004 from $659,000 for the nine months ended
September 29, 2003, primarily due to an increase in fees received from one of
our managed units relating to a minimum base management fee that we began
receiving during the nine months ended September 27, 2004 and increased sales
volume in the other managed units. We have been notified by the Plaza Operating
Partners that they have sold the Plaza Hotel, the property in which ONEc.p.s, a
restaurant we manage, is located. ONEc.p.s. will close effective January 1,
2005. As a result, we will no longer accrue additional quarterly management fees
under our agreement with Plaza Operating Partners with respect to any periods
following January 1, 2005. Total income accrued during the nine months ended
September 27, 2004 amounted to approximately $190,000.
General and Administrative Expenses. General and administrative expenses
decreased $124,000 to $7.2 million for the nine months ended September 27, 2004
from $7.4 million for the nine months ended September 29, 2003. General and
administrative expenses as a percent of consolidated restaurant sales decreased
to 8.5% for the nine months ended September 27, 2004 from 9.9% for nine months
ended September 29, 2003. 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 consolidated and managed
restaurant sales
26
decreased to 6.4% for the nine months ended September 27, 2004 from 7.4% for the
nine months ended September 29, 2003. The decrease was primarily due to a
decrease in professional fees and consulting expenses related to corporate
matters.
Royalty Expense. Royalty expense increased $190,000 to $1.2 million for the nine
months ended September 27, 2004 from $1.0 million for the nine months ended
September 29, 2003 primarily due to the increase in sales of $3.5 million from
our owned Smith & Wollensky units open for the comparable period together with a
combined increase in sales of $6.1 million from our Smith & Wollensky unit in
Dallas, Texas, which opened in March 2003, our unit in Houston, Texas, which
opened in January 2004 and our new unit in Boston, Massachusetts, which opened
in September 2004.
Interest and Other Expense -Net of Interest Income. Interest and other expense,
net of interest income, increased $348,000 to $1.1 million for the nine months
ended September 27, 2004 from $714,000 for the nine months ended September 29,
2003, primarily due to the interest related to the capital lease for the Smith &
Wollensky unit in Las Vegas, Nevada and, to a lesser extent, the interest
expense on debt incurred for general corporate purposes and in connection with
the financing of our new Smith & Wollensky units in Dallas, Texas, Houston,
Texas, and Boston, Massachusetts. Interest and other expense, net of interest
income, was also impacted by the reduction in interest income related to the use
of cash for capital improvements, which had been invested in short and long term
interest bearing investments during the nine months ended September 29, 2003.
Provision for Income Taxes. The income tax provision for the nine months ended
September 27, 2004 and September 29, 2003, respectively, represents certain
state and local taxes.
(Income) Loss in Consolidated Variable Interest Entity. In accordance with our
adoption of FIN 46 (R), the operating results of the entity that owns M&P are
now consolidated and the net (income) or loss of this variable interest entity
is presented as a separate item after the provision for income taxes.
Risk Related to Certain Management Agreements and Lease Agreements
We are subject to various covenants and operating requirements contained in
certain of our management agreements that, if not complied with or otherwise
met, provide for the right of the other party to terminate these agreements.
With respect to management agreements, we are subject to the right of Plaza
Operating Partners to terminate, at any time, the management agreement relating
to ONEc.p.s., We have been notified by the Plaza Operating Partners that they
have sold the Plaza Hotel, the property in which the restaurant is located.
ONEc.p.s. will close effective January 1, 2005. As a result, we will no longer
accrue additional quarterly management fees under our agreement with Plaza
Operating Partners with respect to any periods following January 1, 2005.
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 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 the lease agreement which would result in the
loss of the 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 the lease agreement has taken any
action to terminate the 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, third-party financing and an IPO. Net cash provided by
operating activities amounted to $2.8 million for the nine months ended
September 27, 2004 and $1.5 million for the nine month period ended September
29, 2003.
27
Net cash provided by financing activities was $5.2 million for the nine
month period ended September 27, 2004 and net cash used in financing activities
was ($1.2 million) for the nine month period ended September 29, 2003. Net cash
provided by financing activities for the nine month period ended September 27,
2004 includes $4.0 million in proceeds from the line of credit facilities with
Morgan Stanley Dean Witter Commercial Financial Services, Inc. ("Morgan
Stanley"), $2.0 million in proceeds from the promissory note with Hibernia
National Bank ("Hibernia"), $540,000 of principal payments on long-term debt and
distributions of $320,000 to the minority interest in the consolidated variable
interest entity. Net cash used in financing activities for the nine month period
ended September 29, 2003 includes $995,000 of principal payments on long-term
debt and distributions of $240,000 to the minority interest in the consolidated
variable interest entity.
During the nine months ended September 27, 2004 and September 29, 2003,
we used cash primarily to fund the development and construction of new
restaurants and expansion of existing restaurants. Net cash used in investing
activities was $9.0 million and $2.8 million for the nine months ended September
27, 2004 and September 29, 2003, respectively. The total capital expenditures
were $9.4 million and $5.8 million for the nine months ended September 27, 2004
and September 29, 2003, respectively. Cash used in investing activities also
included net proceeds from the sale of investments of $923,000 and $6.7 million
for the nine months ended September 27, 2004 and September 29, 2003,
respectively, and purchases of investments of $3.3 million for the nine months
ended September 29, 2003.
On September 20, 2004, we opened our newest Smith & Wollensky unit in
Boston, Massachusetts. The restaurant has approximately 450 seats on four
levels. As of September 27, 2004, total remaining capital expenditures for 2004
were expected to be approximately $2.2 million and will be used primarily to pay
for the completion of the construction of our new restaurant in Boston,
Massachusetts, and for general maintenance of existing restaurants. The increase
in the remaining capital expenditures for Boston from those previously disclosed
relates primarily to undetected defects directly associated with the renovations
to the building, which is over 100 years old and which has been lightly used
over the last 20 years, as well as the additional cost related to the adherence
to a stricter building code than originally anticipated. We currently do not
have any leases signed other than leases relating to our existing locations and
will not actively pursue new locations in 2005. We plan to move ahead cautiously
with our future expansion as management evaluates and monitors economic and
security conditions, and we expect to resume our new restaurant growth in 2006.
As of September 27, 2004, the average cost of opening the last three Smith &
Wollensky restaurants, net of landlord contributions, has been approximately
$5.8 million, excluding the purchase of land and pre-opening costs. When we do
resume our growth , we expect additional locations to have seating capacities
ranging from 375 to 450 seats, but would consider locations with larger or
smaller seating capacities where appropriate. We intend to develop restaurants
that will require, on average, a total cash investment of $2.5 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
and is dependent on the size of the location and the amount of the landlord
contribution. Our newest unit in Boston significantly exceeded this range
primarily because of its physical size and the reasons noted above. Some
locations that we choose will be outside our preferred cash investment range,
but are nevertheless accepted based on our evaluation of the potential returns.
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
bore interest at rates ranging from 9.0% to 12.0%. The final payment for these
obligations was made in 2003. In addition, we assumed a mortgage on the Miami
property that requires monthly payments and bears interest at 5.00% per year. On
April 30, 2004, a letter was signed by the financial institution that holds the
mortgage for the property extending the term of the mortgage three additional
years, with the final principal payment due in June 2007. The extension became
effective June 18, 2004. In 1997, we also assumed a loan payable to a financing
institution that requires monthly payments through the year 2014 and bears
interest at a fixed rate of 7.67% per year. The aggregate balance of the
mortgage and loan payable was approximately $1.6 million on September 27, 2004.
On August 23, 2002, we entered into a $14.0 million secured term loan
agreement with Morgan Stanley. Under the agreement we are the guarantor of
borrowings by our wholly owned subsidiary, S&W Las Vegas, LLC. We have 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 $33,333 commencing June 30, 2003
over the term of the loan with 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. 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
28
draw down this balance expired on May 31, 2003. We did not draw down the
remaining balance because, as an alternative to purchasing the land, we signed
an amendment to our lease agreement, as discussed below. On November 3, 2004, a
letter was signed by Morgan Stanley confirming the exclusion of the elimination
of the non-cash income derived from the amortization of the deferred rent
liability relating to the Las Vegas lease from the financial covenants contained
in our term loan agreement for the periods described in Note 1(a). On November
11, 2004, Morgan Stanley amended, among other things, the interest coverage
ratio covenant of the term loan agreement effective as of September 27, 2004. As
a result, at September 27, 2004, SWRG was in compliance with all the financial
covenants contained in this amended term loan agreement. The costs in connection
with the amendment were approximately $20,000.
On April 29, 2003, we signed a second amendment to lease agreement
("Agreement") with The Somphone Limited Partnership ("Lessor"), the owner of the
property for our Las Vegas restaurant. The Agreement, which has been 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 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 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 as of September 27, 2004 will be as follows:
Fiscal year (dollar amounts in thousands)
----------- -----------------------------
2004.................................. $74
2005.................................. 298
2006.................................. 328
2007.................................. 360
2008.................................. 123
---
$1,183
======
If we exercise the option, the Lessor is obligated to 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. In the event of the
exercise of the put option, the Lessor is obligated to provide us with financing
in the amount of the purchase price applicable at that time. 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 29, 2004, it was determined that the accounting treatment
for this Agreement was inaccurately reflected in the financial statements
included in our Annual Report on Form 10-K for the year ended December 29, 2003,
and our Quarterly Reports on Form 10-Q for the respective quarters ended June
30, 2003, September 29, 2003, March 29, 2004 and June 28, 2004 and that,
therefore, a restatement of our financial statements for the periods referenced
above should be made to prevent future reliance on those filings (See Notes to
the Unaudited Consolidated Financial Statements, Note 1 (a)).
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. Part 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 $550,000. The first installment was prepaid on March 4, 2003, and
the subsequent two installments are due on October 9, 2004 and October 9, 2005,
respectively. We received a 60-day extension on the installment due on October
9, 2004. The promissory note is secured by a first mortgage relating to the
Dallas property.
29
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. On November 3, 2004, a letter was signed by Morgan Stanley confirming
the exclusion of the elimination of the non-cash income derived from the
amortization of the deferred rent liability relating to the Las Vegas lease from
the financial covenants contained in our term loan agreement for the periods
described in Note 1(a). On November 11, 2004, Morgan Stanley amended, among
other things, the interest coverage ratio covenant of the term loan agreement
effective as of September 27, 2004. As a result, at September 27, 2004, SWRG was
in compliance with all the financial covenants contained in this amended term
loan agreement. The costs in connection with the amendment were approximately
$20,000. The aggregate outstanding balance of this term loan was approximately
$1.6 million as of September 27, 2004.
On January 30, 2004, we entered into a $2.0 million secured line of
credit facility with Morgan Stanley ("January Financing"). Under the agreement
we are the guarantor of borrowings by our wholly owned subsidiary, S&W Las
Vegas, LLC. Through S&W Las Vegas, LLC, we have the ability to borrow up to $2.0
million under the agreement for working capital purposes. Advances under this
line of credit will bear interest at a fixed rate of LIBOR plus 3% per annum,
payable on a monthly basis. We are also subject to an unused availability fee of
1.75% for any unused portion of this line, payable on a quarterly basis. We may
at anytime repay advances on this line without penalty. We are obligated to
repay the principal portion of this line on January 30, 2006, the termination
date of this line. This line 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. The aggregate outstanding balance of this line of credit facility
was approximately $2.0 million as of September 27, 2004. On November 3, 2004, a
letter was signed by Morgan Stanley confirming the exclusion of the elimination
of the non-cash income derived from the amortization of the deferred rent
liability relating to the Las Vegas lease from the financial covenants contained
in our line of credit facility for the periods described in Note 1(a). On
November 11, 2004, Morgan Stanley amended, among other things, the interest
coverage ratio covenant of the term loan agreement effective as of September 27,
2004. As a result, at September 27, 2004, SWRG was in compliance with all the
financial covenants contained in this amended line of credit facility. The costs
in connection with the amendment were approximately $20,000.
On March 17, 2004, we signed a first amendment to covenants agreement
with Morgan Stanley. The amendment increased to $525,000 the amount that we may
exclude from the determination of any of our covenants, under our term loans and
line of credit facility, as a result of the settlement of the legal dispute
between the Company and Mondo's.
On May 26, 2004, S&W New Orleans, L.L.C. ("New Orleans"), a wholly
owned subsidiary, signed a $2.0 million promissory note with Hibernia ("May
Financing"). The $2.0 million was used by us for construction costs related to
the new Smith & Wollensky restaurant in Boston. The note bears interest at a
fixed rate of 6.27% per annum. Principal payments for this note commenced June
26, 2004. Pursuant to the terms of the promissory note, New Orleans is obligated
to make monthly payments of $17,272 for this note over the term of the note with
a balloon payment of approximately $1.5 million on May 26, 2009, the maturity
date of the note. This note is secured by a first mortgage relating to the New
Orleans property. At September 27, 2004, New Orleans was in compliance with the
financial covenant contained in the loan agreement between New Orleans and
Hibernia.
On July 21, 2004, we entered into a $2.0 million secured line of credit
facility with Morgan Stanley ("July Financing"). Under the agreement we and
Smith & Wollensky of Boston LLC are the guarantors of borrowings by our wholly
owned subsidiary, S&W Las Vegas, LLC. Through S&W Las Vegas, LLC, we have the
ability to borrow up to $2.0 million under the agreement for working capital
purposes. Advances under this line of credit will bear interest at a fixed rate
of LIBOR plus 3% per annum, payable on a monthly basis. We are also subject to
an unused availability fee of 1.75% for any unused portion of this line, payable
on a quarterly basis. SWRG may at anytime repay advances on this line without
penalty. We are obligated to repay the principal portion of this line on May 31,
2005, the termination date of this line. This line is secured by a leasehold
mortgage relating to the Las Vegas property and all of the personal property and
fixtures of the Borrower. The aggregate outstanding balance of this line of
credit facility was approximately $2.0 million as of September 27, 2004. On
November 3, 2004, a letter was signed by Morgan Stanley confirming the exclusion
of the elimination of the non-cash income derived from the amortization of the
deferred rent liability relating to the Las
30
Vegas lease from the financial covenants contained in our line of credit
facility for the periods described in Note 1(a). On November 11, 2004, Morgan
Stanley amended, among other things, the interest coverage ratio covenant of the
term loan agreement effective as of September 27, 2004. As a result, at
September 27, 2004, SWRG was in compliance with all the financial covenants
contained in this amended loan agreement. The costs in connection with the
amendment were approximately $20,000.
During 2003, we incurred a net loss of $1.1 million, primarily related
to the costs incurred for litigation and accrual of settlement costs on a
disputed lease matter and the costs incurred for the opening of a new restaurant
in Dallas. We used cash during 2003 primarily for the purchase of property and
equipment at our Dallas location and our Houston location. While we generated
cash from operating activities of $3.7 million for the year ended December 29,
2003, cash of $4.9 million and $1.1 million was used for investing and financing
activities, respectively, leaving us with cash and cash equivalents of
approximately $2.2 million as of December 29, 2003 (Restated to reflect the
adoption of FIN 46 (R). See Notes to the Unaudited Consolidated Financial
Statements, Note 1 (b)). As of September 27, 2004 we had cash and cash
equivalents of $1.2 million. We project remaining capital expenditures in 2004
to total approximately $2.2 million, primarily related to the final construction
cost payments related to our newest restaurant in Boston, which opened on
September 20, 2004. The increase in the remaining capital expenditures for
Boston from those previously disclosed relates primarily to undetected defects
directly associated with the renovations to the building, which is over 100
years old and which has been lightly used over the last 20 years, as well as the
additional cost related to the adherence to a stricter building code than
originally anticipated. The Houston location was opened in January 2004. We
incurred approximately $1.6 million in capital expenditures to complete this
project during the first quarter of 2004.
Because of these developments, we obtained the January Financing, May
Financing and July Financing. We also renegotiated the mortgage related to the
Miami restaurant property and extended the term of this mortgage, which now has
a final principal payment due in June 2007. As of September 27, 2004, we had
drawn down the entire $6.0 million available to us under the January Financing,
the May Financing and the July Financing. These funds were used to pay the
construction costs relating to the Smith & Wollensky restaurants in Houston and
Boston.
As of September 27, 2004, we believe that our cash and short-term
investments on hand, funds to be received in connection with a sale and
leaseback transaction relating to restaurant equipment located in our Dallas,
Houston and Boston units expected to close in the middle of November, projected
cash flow from operations and expected landlord construction contributions
should be sufficient to finance our planned capital expenditures and operations
throughout 2004, as well as allow us to meet our debt service obligations under
our loan agreements. Our cash resources, and therefore our liquidity, are
dependent upon the level of internally generated cash from operations. Changes
in our operating plans, lower than anticipated sales, increased expenses, or
other events would cause us to seek alternative financing or cease our capital
expenditure plans as early as December 2004. While we would seek to obtain
additional funds through commercial borrowings or the private or public issuance
of debt or equity securities, there can be no assurance that such funds would be
available when needed or be available on terms acceptable to us.
The following table discloses aggregate information as of
September 27, 2004 about our contractual obligations and the periods in which
payments in respect of the obligations are due:
PAYMENTS DUE BY PERIOD
----------------------
Contractual Obligations: Total Less than 1-3 years 3-5 years More than
- ------------------------ ----- 1 year --------- --------- 5 years
------ -------
(dollars in thousands)
Minimum royalty payments licensing agreement(1).......... $ 4,000 $ 0 $ 1,600 $ 1,600 $800(2)
Minimum distributions management agreement(1)............ $ 3,480 $ 120 $ 960 $ 960 $ 1,440
Minimum payments on employment agreements(1)............. $ 2,276 $ 298 $ 1,978 $ -- $ --
Principal payments on long-term debt(1).................. $ 13,680 $ 743 $ 4,120 $ 6,806 $ 2,011
Payments under capital lease(1).......................... $ 11,213 $ 170 $ 1,426 $ 1,590 $ 8,027
Minimum annual rental commitments(1)(3).................. $ 68,423 $1,105 $ 8,839 $ 8,171 $50,308
-------- ------ ------- ------- -------
Total.................................................... $103,072 $2,436 $18,923 $19,127 $62,586
======== ====== ======= ======= =======
31
(1) Please refer to the discussion in the "Liquidity and Capital Resources"
section above and the Notes to Unaudited Consolidated Financial
Statements for additional disclosures regarding these obligations.
(2) 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 5.
(3) Restated to reflect the adoption of FIN 46 (R). See Notes to the
Unaudited Consolidated Financial Statements, Note 1 (b).
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.
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 September 2004, the Emerging Issues Task Force ("EITF") reached a
consensus on EITF Issue 04-10 Applying Paragraph 19 of FASB Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FASB No.
131") in Determining Whether to Aggregate Operating Segments that do not meet
the Quantitative Thresholds. The consensus concluded that operating segments
that do not meet certain quantitative thresholds can be aggregated if the
criteria set forth in paragraph 17 of FASB No. 131 is met. This consensus
affects how the Company assesses the impairment of goodwill. Upon adoption of
SFAS No. 142, the Company had determined that certain restaurants with assigned
goodwill were separate reporting units and goodwill was assessed for impairment
at the reporting unit level. During 2002, the Company recorded an impairment of
goodwill of $75,000 related to one of its reporting units. As a result of the
consensus, the Company reassessed the reporting units with goodwill and
determined that under the aggregation criteria, the separate reporting units
could be viewed as one single reporting unit for purposes of assessing goodwill
impairment. This change in accounting principle requires restatement of
previously issued financial statements, however, as permitted in the consensus
the prior periods were not restated as the change does not have a material
impact on previously issued 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 September 27, 2004.
32
Expected Maturity Date
----------------------
Fiscal Year Ended
-----------------
Fair Value
September 27,
Debt 2004 2005 2006 2007 2008 Thereafter Total 2004
- ---- ---- ---- ---- ---- ---- ---------- ----- ----
(dollars in thousands)
Long-term variable rate........ $12 $53 $56 $ 2,057 $ - $ - $2,177 $2,177
Average interest rate.......... 4.4%
Long-term fixed rate........... $731 $3,276 $736 $2,417 $2,333 $2,010 11,503 13,009
Average interest rate.......... 6.6%
----- ------
Total debt..................... $13,680 $15,186
======= =======
We have no derivative financial or derivative commodity instruments. We
do not hold or issue financial instruments for trading purposes.
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 Quarterly Report on Form 10-Q was made under the
supervision and with the participation of management, including our 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.
Subsequent to September 27, 2004 and in connection with the preparation
of the financial statements for the fiscal quarter ended September 27, 2004, it
was determined that the accounting treatment for the April 2003 amendment to the
lease for our Las Vegas property was inaccurately reflected in our Annual Report
on Form 10-K for the year ended December 29, 2003 and our Quarterly Report on
Form 10-Q for the respective quarters ended June 30, 2003, September 29, 2003,
March 29, 2004 and June 28, 2004. The amortization recorded under the previous
accounting treatment was included as non-cash income in occupancy and related
expenses and were derived from the reduction in deferred rent liability and
should have been treated as a reduction to the value of the land under the
capital lease, and a reduction in the deferred rent liability arising from the
operating lease included on the balance sheet. Our Chief Executive Officer and
Chief Financial Officer concluded that the problem that led to the previous
accounting treatment did not constitute a material weakness in internal control
over financial reporting and did not preclude a determination as stated above
that our disclosure controls and procedures were effective given that the
accounting treatment in question was limited to the conversion of the Las Vegas
property's operating lease to a capital lease and the misapplication the
accounting principle involved was isolated and at the time of the original
accounting for the conversion management had discussed the accounting treatment
for these transactions with our then independent auditors who concurred with
management's conclusions. These amounts were restated for the quarter and the
nine-month period ended September 29, 2003, respectively, and as of December 29,
2003, and such restatements are reflected in the financial statements included
in the Quarterly Report on Form 10-Q. We expect corresponding restatements of
the remaining periods listed above will be made as soon as practicable.
Changes in Internal Controls
33
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 1. LEGAL PROCEEDINGS.
On or about September 5, 2001, Mondo's of Scottsdale, L.C. ("Mondo's")
filed a suit against SWRG alleging that it 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 had been set to go to jury trial in March 2004. The plaintiff
requested damages of approximately $2.0 million. On March 18, 2004 the parties
tentatively agreed to settle the matter for $525 and a reserve of $525 was
established as of December 29, 2003. On April 9, 2004 a final settlement was
reached between the parties and, in accordance with the settlement, SWRG made
the first payment of $225, with the final payment of $300 due on April 11, 2005.
SWRG is involved in various 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.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE TO SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
10.96 Letter from The Smith & Wollensky Restaurant Group, Inc. to
Morgan Stanley Dean Witter dated November 3, 2004.
10.97 First Amendment to Covenants Agreement by and between S&W of
Las Vegas, L.L.C. as "Borrower", The Smith & Wollensky
Restaurant Group, Inc. and Dallas S&W, L.P. as "Guarantors"
and Morgan Stanley Dean Witter Commercial Financial Services,
Inc. as the "Lender" dated as of September 26, 2004.
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.
34
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 July 6, 2004 furnishing under
Items 7 and 12 a copy of the Company's press release
dated July 1, 2004, describing selected financial results
of the Company for the second quarter ended June 28,
2004.
Report on Form 8-K dated August 9, 2004 furnishing under
Items 7 and 12 a copy of the Company's press release
dated August 5, 2004, describing selected financial
results of the Company for the quarter ended June 28,
2004 and the six months ended June 28, 2004.
Report on Form 8-K dated October 1, 2004 furnishing under
Items 2.02 and 9.01 a copy of the Company's press release
dated September 30, 2004, describing selected financial
results of the Company for the third quarter ended
September 27, 2004.
Report on Form 8-K dated November 2, 2004 furnishing
under Item 8.01 disclosure of the plans for closing a
restaurant that the Company manages effective January 1,
2005.
Report on Form 8-K dated November 4, 2004 furnishing
under Item 4.02 disclosure of the Company's intention to
restate its financial statements for the year ended
December 29, 2003 and the quarterly periods ended June
30, 2003, September 29, 2003, March 29, 2004 and June 28,
2004, respectively.
Report on Form 8-K/A dated November 8, 2004 amending the
Form 8-K, dated October 29, 2004 and filed on November 4,
2004, to include Exhibits 7.1 and 7.2 and noting that
with respect to the determination on October 29, 2004,
which is referenced in Exhibit 7.2, such determination
was made following consultation with KPMG prior to such
date.
35
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.
November 12, 2004 By: /s/ ALAN N. STILLMAN
---------------------
Name: Alan N. Stillman
Title: Chairman of the Board, Chief
Executive Officer and Director
(Principal Executive Officer)
November 12, 2004 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)
36
Exhibit No. Description of Document
- ----------- -----------------------
10.96 Letter from The Smith & Wollensky Restaurant Group, Inc. to
Morgan Stanley Dean Witter dated November 3, 2004.
10.97 First Amendment to Covenants Agreement by and between S&W of
Las Vegas, L.L.C. as "Borrower", The Smith & Wollensky
Restaurant Group, Inc. and Dallas S&W, L.P. as "Guarantors"
and Morgan Stanley Dean Witter Commercial Financial Services,
Inc. as the "Lender" dated as of September 26, 2004.
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.
37