ITEM 1. BUSINESS.
Unless otherwise stated in this document or unless the context otherwise requires, references herein to the “Company,” “we,” “our” and “us” include Steakhouse Partners, Inc. and its wholly owned subsidiaries, namely Paragon Steakhouse Restaurants, Inc. and its subsidiaries (“Paragon”). “Steakhouse” refers to Steakhouse Partners, Inc., not including any of its wholly owned subsidiaries.
Overview
We own and operate 25 full-service steakhouse restaurants located in eight states. Our restaurants principally operate under the brand names of Hungry Hunter, Hunter Steakhouse, Mountain Jack’s and Carvers. Our restaurants specialize in complete steak and prime rib meals, and also offer fresh fish and other lunch and dinner dishes. Our average check is $26.10 per guest (including alcoholic beverages) and our 25 restaurants serve approximately 2.0 million meals annually. Our management believes that our emphasis on quality service and our concentration on fresh cut, high quality USDA graded steaks and prime ribs distinguishes our restaurants from our competitors, presenting an opportunity for growth.
By way of background, on February 15, 2002, we filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Central District of California (the “Bankruptcy Court”). On February 19, 2002, Paragon also filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court (together, the “Filing”).
Effective December 31, 2003, we confirmed a Plan of Reorganization, which provided for us to assume the core 25 profitable restaurants. For all the other units, either our leasehold interests were sold or the leases were rejected as of the Effective Date. Any claims associated with the rejected leases were provided for in the Plan.
In connection with our emergence from bankruptcy protection, we implemented fresh-start accounting under the provisions of SOP 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code.” Under SOP 90-7, our reorganization fair value was allocated to our assets and liabilities, our accumulated deficit was eliminated, and our new equity was issued according to the Plan as if we were a new reporting entity.
As per the Plan of Reorganization we paid to the Unsecured Creditors $1,000,000 within 30 days of the Effective Date of the Plan, and were scheduled to make periodic payments under a $5,030,000 note payable. The note is non-interest-bearing and the last payment was due on or before December 2006. In addition, the general unsecured creditors are to receive 500,000 shares of common stock. Currently, the Trustee for the Unsecured Creditors and the Company have modified the payments terms (now $4,855,000) to provide for payments either 1) payments over a longer period of time so the payments conform more closely to available cash flow or 2) the refinancing of the debt by securing a long term loan to satisfy the entire note in a lump sum payment. Thus far the Company has not been able to secure the required financing.
Also, per the Plan of Reorganization we have made scheduled periodic payments under a $1,289,533 note payable to the Secured Creditor. The note is interest bearing at 9.0% and the last payment was due on or before January, 2008. We had made all regular scheduled payments (principal and interest) until June, 2006, when the Company suspended payments as cash flow during the summer months was too restrictive. The Company and the Secured Creditor are in dialog regarding a revised payment schedule over a longer period of time so the payments conform more closely to available cash flow for the balance due on the Note (currently at $863,627). As of February 2007, the Company has resumed payments.
On October 11, 2006 the Company entered into a Membership Interest Purchase Agreement to acquire 7 steakhouses in New England subject to certain financing contingencies. The agreement included a 60-day exclusive to consummate the transaction. On January 23, 2007 the Company was notified the Membership Interest Purchase Agreement was terminated. However, the Company and the Seller are still actively in trying to successfully conclude the transaction as per the terms in the original Membership Interest Purchase Agreement.
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Company Background
We were incorporated in the State of Delaware on June 3, 1996 under the name “Texas Loosey’s Steakhouse & Saloon, Inc.” On December 19, 1996, our Board of Directors adopted a resolution to change our name to “Galveston’s Steakhouse Corp.” Up until December 21, 1998, Galveston’s Steakhouse Corp. owned two steakhouse restaurants and operated two others in Southern California, which together formerly comprised all of the restaurants known as “Texas Loosey’s Chili Parlor & Saloon” (“Texas Loosey’s”).
Galveston’s Steakhouse Corp. first acquired two of the four Texas Loosey’s restaurants on August 19, 1996 pursuant to an Asset Purchase Agreement, dated April 10, 1996 (which was subsequently amended on November 1, 1998), and acquired the remaining two Texas Loosey’s restaurants on May 1, 1999.
On December 21, 1998, Galveston’s Steakhouse Corp. acquired Paragon Steakhouse Restaurants, Inc. and its subsidiaries (Paragon of Michigan, Inc., Paragon of Nevada, Inc., and Paragon of Wisconsin, Inc.) through its acquisition of all of the outstanding capital stock of Paragon. Paragon also owned Pacific Basin Foods, Inc. (“PBF”), a company which was engaged in purchasing and selling food and other restaurant supplies to Paragon and nonaffiliated companies. On October 11, 2002 PBF filed for voluntary protection under Chapter 7 of the United States Bankruptcy Court. PBF ceased operations effective as of the filing date thereof.
During the year ended December 31, 1999, Galveston’s Steakhouse Corp.’s name was changed to Steakhouse Partners, Inc.
We maintain an Internet website at www.paragonsteak.com. This website offers free access to our press releases and filings with the U.S. Securities and Exchange Commission (the “SEC”), including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after these reports are filed with or furnished to the SEC.
Our Business Background
The steakhouse industry is expected to continue to expand over the next several years. We believe that this industry is highly fragmented and, if we are successful in implementing our plan of reorganization, we may have the opportunity to grow our business by expanding one of Paragon’s brand-name steakhouses, Carvers.
Our overall steakhouse operations have historically experienced seasonal fluctuations, with the fourth quarter and first quarter of each year being our strongest quarters, reflecting both the Christmas season and the colder weather at our Mid-west operations, and the third quarter being the slowest, as people tend to eat less steak in restaurants in the summer months. This seasonality, however, is less pronounced at our California locations, which do not experience the same seasonal changes in weather that occur at our Mid-west locations.
Restaurant Concepts
All of our restaurants are positioned as destination restaurants that attract loyal clientele. Destination restaurants are restaurants situated as the primary destination of our clientele, rather than a destination or activity ancillary to another activity, such as shopping or sight seeing. All but one of our restaurants are full-service steakhouses. We hand-cut our steaks in-house from whole loins of beef for superior freshness and taste. Prime rib is our “signature product” and is the basis for our distinctive merchandising commitment to “The Best Prime Rib in Town.” Our prime rib, which is served in a herb crust, is slow roasted for eighteen hours to enhance its favor and tenderness. Portions are deliberately generous. Prime Rib and steaks account for approximately 67.5% of our food revenue. Full liquor, wine and bar service are available. Alcoholic beverage sales account for approximately 19.0% of our total net sales. Our
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restaurants are generally open seven days a week with typical hours of operation being from 4:30 p.m. to 9:30 p.m. on weekdays and from 4:00 p.m. to 10:00 p.m. on weekends. Some restaurants are open for lunch beginning at 11:30 a.m. on weekdays; most of these restaurants are closed for lunch on weekends.
We intend to continue our efforts to differentiate our restaurants by emphasizing personal and attentive service, consistent high-quality, fresh products and position in the mid-priced, full service steakhouse segment of the restaurant industry.
We currently operate in three distinctive steakhouse markets:
Hungry Hunter, Hunter Steakhouse and Mountain Jack’s
We have 17 steakhouses operating under our core registered trade names, Hungry Hunter, Hunter Steakhouse and Mountain Jack’s, for which the average dinner check is approximately $27.41 per guest. Many of these steakhouses have been in business for over 25 years, and, as such, have loyal clientele and the “look and feel” of a classic special occasion restaurant. For this reason, we have been able to position our Hungry Hunter, Hunter Steakhouse and Mountain Jack’s steakhouses as a step-above the lower ticket restaurant chains such as Outback Steakhouse and Lone Star Steakhouse & Saloon.
Our core menu also features fresh fish, seafood, pasta and chicken in addition to prime rib and steaks. A complete meal includes salad and a choice of two side dishes including soup, choice of potato, and steamed vegetables. The menu also includes appetizers and desserts. The restaurant menus have recently been revised and expanded to respond to changing guest palates and diets, and to increase variety and emotional value. The change included the addition of new appetizers, seafood, specialty steaks, prime rib combinations and revisions to all plate presentations.
Our Hungry Hunter, Hunter Steakhouse and Mountain Jack’s restaurants are typically free-standing buildings with dinner seating capacities ranging from 150 to 220 seats and an average seating capacity of approximately 180 seats. Unlike an Outback Steakhouse or Lone Star Steakhouse & Saloon, our restaurants typically have one or more banquet rooms to accommodate private parties and corporate events. The bar in each restaurant is generally located adjacent to the dining room primarily to accommodate customers waiting for dining tables and up to approximately 30 additional diners.
Carvers
We have four steakhouses operating in the upscale steakhouse-dining segment under the Carvers brand name with an average dinner check per guest of slightly more than $37.14. Carvers is a sophisticated, upper tier yet mid-priced restaurant specializing in complete steak, chop, prime rib and seafood meals. Most Carvers are divided into distinctive dining areas to provide greater intimacy. Prices at the Carvers restaurants are slightly higher than those of our other restaurants, but are substantially lower than high-end steakhouses such as Morton’s and Ruth’s Chris.
Our Carvers restaurants are also typically housed in freestanding buildings with dinner seating capacities ranging from 180 to 240 seats and an average seating capacity of approximately 220 seats. Our Carvers restaurants also have one or more banquet rooms to accommodate private parties and corporate events. We are currently developing the next generation lunch and dinner menus for Carvers.
Concept Restaurants
Paragon operates four concept (unique) properties, with average checks ranging from $27.00 to $37.00 per guest:
The Tippecanoe Place is an upscale restaurant located in a 24,000 square foot historical building formerly known as the Studebaker Mansion, in South Bend, Indiana. Both the menu (featuring 60% of Paragon core entrées complimented by gourmet and local favorites) and the structure are South Bend landmarks. Tippecanoe Place is regularly voted the best steakhouse, dining location and wedding site in northern Indiana.
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The Cliffhouse, in Folsom, California, overlooks the American River, and attracts both “locals” as well as tourists with its beef and seafood specialties and panoramic patio seating. The restaurant is approximately 10,000 square feet in size, and attracts a younger dining clientele with expansive bar offerings and regular karaoke and dancing opportunities.
The Whaling Company, our only seafood restaurant, is situated in colonial Williamsburg, Virginia. Fresh catches and local-tradition offerings are presented on a “daily catch board.” Tourists visiting historical Williamsburg and the Busch Gardens amusement park enhance the strong community use of this venture.
We operate our final unique restaurant under the name Carvers Creek in Raleigh, North Carolina. When we entered the southeast region of the country, the names Carvers Creek and Carvers were tested for market appeal. This former Mountain Jack’s was renamed Carvers Creek, but retained substantially all of the core concept attributes except certain full meal add-ons (such as salad and soup).
Strategy
Our goal for the future is to enhance our position in the steakhouse restaurant industry by building through internal growth (Carvers and local store marketing) and through the potential acquisition of steakhouse (step-up casual) restaurants. Key components of this strategy include leveraging established brands, achieving operating efficiencies, cost savings through volume discounts on purchases, and efficiently penetrating new markets, as well as, disposing of underperforming units.
Marketing
We use a combination of national, local and “four walls” marketing initiatives to enhance our consumer appeal and to promote increased guest counts.
On a national scale, we encourage trial by new guests and seek to increase weekday customer counts with both print and electronic media. Our targeted advertisements consist of freestanding newspaper inserts and limited discount coupons such as bulk mailers. In certain markets, we feature local image advertising and spot radio ads. Our print marketing is supplemented by an electronic guest loyalty outreach in partnership with the Fishbowl organization. This restaurant-industry email service is utilized to disseminate regular, targeted dining opportunities to interested guests.
These nationally directed marketing campaigns are complemented by local marketing efforts that feature unique programs responsive to our local communities. Our restaurant management teams participate in community activities, partner with local charities, and seek opportunities to serve the communities that have supported our businesses. They also coordinate birthday and anniversary programs, hotel relationships, catering outreach, and community-unique guest relations programs.
Within our four walls, we rely on delivering an excellent-price value to retain those customers who respond to our trial invitations or return for a meal. A collection of in-store print materials promotes quarterly seasonal food and beverage selections, and new dining features.
Restaurant Operations and Management
We maintain quality and consistency in our restaurants through the careful hiring, training and supervision of personnel and the establishment of standards relating to food and beverage preparation, maintenance of facilities and conduct of personnel. To achieve our service goals, each service employee completes a training program, which teaches employees to provide the level of quality service that encourages guests to return and request the same server on subsequent visits.
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We maintain financial and accounting controls for each of our restaurants through the use of centralized accounting and management information systems. All levels of our management participate in the ongoing process of strategic and financial planning and our systems are continuously refined to allow management to compare actual results with budgets and projections.
We also utilize management information systems to allow timely information analysis and response. Our computerized point-of-sale (POS) data management system and related telecommunication equipment permits daily polling of restaurant operations and rapid collection of sales data and cash management information. Transaction level data is electronically transferred from each restaurant location via POS systems on a daily basis. By consolidating individual restaurant’s sales, purchasing, payroll, operating expenses, guest related statistics and other data, we can regularly monitor restaurant operations. Our management uses real-time information and control systems to reduce labor costs, to maintain constant surveillance of inventory usage and to analyze various aspects of restaurant operations including ideal food costs, sales mix, labor, minutes per meal, promotional programs, restaurant costs and general marketing data. However, because of the age, reliability and serviceability issues of our existing POS system, we have begun to upgrade this critical feature. The POS conversion (Aloha software) is underway which includes tools to view “real time” data. It also includes a full set of inventory controls and food cost measures that will insure we are buying, storing and producing in the most cost efficient ways. The new POS system has cut training costs and reduced downtime while proving to be a very stable platform. We currently have six units converted and plan to convert another six or more in 2007 depending on availability of funds.
Our management team for a typical steakhouse restaurant generally consists of one general manager, one or two leaders and a kitchen manager. Each restaurant also employs a staff consisting of approximately 40 to 70 hourly employees, many of whom work part-time. Typically, each general manager reports directly to either a district leader or one of our two regional vice presidents of operations, who each supervise five to seven restaurants. Our restaurant managers complete an extensive training program during which they are instructed in areas including food quality and preparation, customer satisfaction, alcoholic beverage service, governmental regulations compliance, liquor liability management and employee relations. Our restaurant managers are also provided with an operations manual relating to food and beverage preparation, all areas of restaurant management and compliance with governmental regulations. Working in concert with the individual restaurant managers, our senior management defines operations and performance objectives for each restaurant and monitors implementation. Our senior management regularly visits our restaurants and meets with the respective management teams to ensure compliance with our strategies and standards of quality in all respects of our restaurant operations and personnel development.
Each of our new restaurant employees participates in a training program during which the employee works under the close supervision of a restaurant manager or an experienced key employee. Each general manager is required to attend the annual conference, which is held in San Diego, California, for individualized training and the opportunity to hear directly from their peer group. Our management continuously solicits employee feedback concerning restaurant operations and strives to be responsive to our employees’ concerns.
Purchasing
During 2006 and 2005, we had a major meat vendor that accounted for approximately $5.0 million (11%) of our total purchases in each year respectively. We did not have any supplier concentrations in 2004. We purchase our food and beverage products from a number of food distributors, including Southwest Traders on the West Coast and U.S. Foodservice in the Midwest. Food and supplies are shipped directly to the restaurants, although invoices for purchases are sent to the corporate support center for payment. Our emphasis on high-quality food requires frequent deliveries of fresh food supplies. Tops, strips and porterhouse steaks are “angus” beef.
Sources and Availability of Raw Materials
We strive to obtain quality menu ingredients, raw materials and other supplies and services for our operations from reliable sources at competitive prices. We concentrate our distribution to achieve more favorable terms, but believe we could replace any distributor,
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if necessary, on a timely basis. Substantially all menu items are prepared on each restaurant’s premises daily from scratch, which includes fresh (non-frozen) beef. Each restaurant’s management determines the quantities of food and supplies required and orders items from regional suppliers on terms negotiated by us. Restaurant level inventories are maintained at a minimum dollar-value level in relation to sales due to the relatively rapid turnover of the perishable produce, poultry, meat, fish and dairy commodities that are used in operations.
Trademarks and Service Marks
We have registered various service marks, including Hungry Hunter, Hunter Steakhouse, Mountain Jack’s and Carvers and their related designs with the United States Patent and Trademark Office. All of our trademarks and service marks have stated expiration dates ranging from 2008 to 2012. However, they are renewable for an unlimited number of additional 10-year terms at our option.
The names Hungry Hunter, Mountain Jack’s and Carvers represent our core concept restaurants. The termination of our right to use this name or our failure to maintain any of our other existing trademarks could materially and adversely affect our growth and marketing strategies.
Competition
The restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established competitors with substantially greater financial and other resources than us. The food service is often impacted by changes in the taste and eating habits of the public, economic and political conditions affecting spending habits, population and traffic patterns. The principal bases of competition in the industry are the quality and price of the food products offered. Our restaurants compete with other mid-priced, full service restaurants, which are not necessarily steakhouse restaurants, primarily on the basis of quality of food and service, ambiance, location and price-value relationship. We also compete with a number of other steakhouse restaurants within our markets, including both locally owned restaurants and regional or national chains. Although, we believe that the quality of our service, our well-regarded brands, attractive price-value relationship and quality of food will enable us to differentiate ourselves from our competitors and place us in an excellent competitive position, many of our competitors are well established in the mid-priced dining segment and certain competitors have substantially greater financial, marketing and other resources than we do. We also compete with other restaurants and retail establishments for sites. We believe that our ability to compete effectively will continue to depend upon our ability to offer high-quality, mid-priced food in a full service, distinctive dining environment.
Research
We engage an outside company to do two secret shops per month for each of our locations answering sixty-six questions regarding food, service, quality, value and suggestions for improvement. We also regularly provide “bounce-back” cards to its guests to solicit dining experience information in return for discounts or free desserts.
Government Regulation
Our restaurants are subject to numerous federal, state and local laws affecting health, sanitation and safety standards, as well as to state and local licensing regulation of the sale of alcoholic beverages. Each restaurant currently has appropriate licenses from regulatory authorities allowing it to sell liquor, beer and wine, and each restaurant has food service licenses from local health authorities. We are required to renew these licenses annually. In addition, these licenses may be suspended or revoked at any time for cause, including violation by us or our employees of any law or regulation pertaining to alcoholic beverage control. Our failure to obtain or retain liquor or food service licenses would likely cause significant harm to our operations. In order to reduce this risk, each of our restaurants is expected to be operated in accordance with standardized procedures designed to assure compliance with all applicable codes and regulations. Training of all restaurant employees on alcohol awareness and related laws is mandatory.
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We are subject in certain states to “dram-shop” statutes, which generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. Our training covers prevention of such occurrences and we carry liquor liability coverage as part of our comprehensive general liability insurance.
Our restaurant operations are also subject to federal and state employment and wage laws governing such matters as working conditions, overtime, meal breaks, rest breaks and tip credits and other employee matters. Significant numbers of our employees are paid at rates related to the federal minimum wage. Government-imposed increases in minimum wages, paid leaves of absence and mandated health benefits, or increased tax reporting and tax payment requirements for employees who receive gratuities, could be detrimental to the economic viability of our restaurants.
Our restaurants are also subject to numerous laws related to the fair treatment of employees, these laws are designed to ensure a harassment free and safe environment. Among others, the Federal Americans With Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment. We review plans and specifications and make periodic inspections to ensure our restaurants will comply with the ADA. We believe that we are in substantial compliance with all current applicable regulations relating to restaurant accommodations for the disabled. We do not anticipate that such compliance will require us to expend substantial funds.
Employees
At January 9, 2007, we employed approximately 1,300 individuals, of which 111 occupy executive, managerial or clerical positions, and 1,189 hold non-managerial restaurant-related positions. None of our employees is covered by a collective bargaining agreement.
We consider our relations with our employees to be good and have not experienced any interruption of operations due to labor disputes.
Information as to Classes of Similar Products or Services
We operate in only one industry segment. All significant revenues and pre-tax earnings are related to retail sales of food and beverages to the general public through Company-operated restaurants. At December 31, 2006, we had no operations outside the continental United States.
ITEM 1A.
ITEM 1A. RISK FAC TORS.
Forward-Looking Information
You should consider each of the following factors as well as the other information in this Annual Report in evaluating our business and our prospects. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations. If any of the following risks actually occur, our business and financial results could be harmed. In that case, the trading price of our common stock could decline. You should also refer to the other information set forth in this Annual Report, including our financial statements and the related notes.
Risk factors that may affect future results and financial condition
Our prior bankruptcy could hinder our ability to negotiate effectively with third parties and could adversely affect our operations going forward.
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In February 2002, we and Paragon (our only wholly owned subsidiary) filed for voluntary reorganization under Chapter 11 of the Bankruptcy Code. We officially emerged from bankruptcy on December 31, 2003. However, our Chapter 11 reorganization and financial condition and performance could adversely affect our operations going forward. Our bankruptcy filings had an adverse affect on our credit standing with our lenders, certain suppliers and other trade creditors. This can increase our costs of doing business and can hinder our negotiating power with our lenders, certain suppliers and other trade creditors. The failure to negotiate favorable terms could adversely affect our financial performance.
If we are unable to obtain additional funds in a timely manner or on acceptable terms or the plan of reorganization is unsuccessful, we may have to curtail or suspend certain or all of our operations, which could adversely affect our financial condition, results of operations and prospects.
We cannot be certain that additional financing will be available when and to the extent required or that, if available, it will be on acceptable terms. If we are unable to obtain additional funds in a timely manner or on acceptable terms to fund our deferred capital expense, it will seriously affect our ability to meet the objectives of our plan of reorganization, and we may have to curtail or suspend the expansion of our operations and possibly terminate existing operations, which could lead to overall lower revenues and adversely affect our financial results and prospects. If adequate funds are not available on acceptable terms, we may not be able to fund our expansion or respond to competitive pressures, which could lead to our inability to continue as a going concern.
We have incurred losses from inception and may never generate substantial profits.
We were organized in May 1996 and have incurred significant losses since inception. We may never generate profits. We incurred net losses in the following approximate amounts: $1.7 million for the fiscal year ended December 31, 2006; $0.5 million for the fiscal year ended December 31, 2005; $0.6 million for the fiscal year ended December 31, 2004; $4.9 million for the fiscal year ended December 31, 2003; and $6.6 million for the fiscal year ended December 31, 2002. If we do not achieve and maintain profitability, we will be unable to continue our operations and you may lose the value of your entire investment in our common stock.
We will need additional capital for expansion.
The development of new restaurants requires funds for construction, tenant improvements, furniture, fixtures, equipment, training of employees, permits, initial franchise fees, and other expenditures. We will require funds to develop additional restaurants and to pursue any additional restaurant development or restaurant acquisition opportunities that may develop.
In the future, we may seek additional equity or debt financing to provide funds so that we can develop or acquire additional restaurants. Such financing may not be available or may not be available on satisfactory terms. If financing is not available on satisfactory terms, we may be unable to expand our restaurant operations. While debt financing will enable us to add more restaurants than we otherwise would be able to add, debt financing increases expenses and is limited as to availability due to our financial results and bankruptcy history, and we must repay the debt regardless of our operating results. Future equity financings could result in dilution to our stockholders.
We may not have sufficient cash reserves to maintain and fund our operations and fund our obligations.
We may not have sufficient cash reserves to maintain our operations and fund our obligations. In such event, we may need to seek additional financing. Any required additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available on acceptable terms, we may be unable to fund our plan of reorganization and may be required to sell core assets or dissolve the business. If we raise additional funds by issuing equity securities, shareholders may experience dilution of their ownership interest and the newly issued securities may have a rights superior to those of the common stock. If we issue or incur debt to raise funds, we may be subject to limitations on our operations.
If we default on our obligations related to our indebtedness, our creditors could assume possession and control of our assets.
We have substantial debt and have pledged all of our assets to secure certain obligations with respect to our indebtedness, including obligations entered pursuant to our Plan of Reorganization. We have defaulted on certain obligations related to our indebtedness in the past and may default on obligations related to our indebtedness in the future. We are currently behind on payments with respect to indebtedness related to our Plan of Reorganization and we have appointed a director to our Board to represent our creditors. If we are unable to satisfy our obligations under our indebtedness, our creditors will be entitled to exercise all remedies available to them under the terms of the instruments governing our indebtedness and applicable law, which could include declaring all amounts outstanding with respect to our indebtedness immediately due and payable and assuming possession and control of all of our assets.
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If we lose or are unable to obtain key personnel, our ability to effectively operate our business could be hindered.
Our ability to maintain or enhance our competitive position will depend to a significant extent on the efforts and ability of our executive officers, particularly our chief executive officer. Our future success and our ability to manage future growth will depend in large part upon the efforts of our management team and on our ability to attract and retain other highly qualified personnel. Competition for personnel is intense, and we may not be successful in attracting and retaining our personnel. Our inability to retain our current management team and attract and retain other highly qualified personnel could adversely affect our results of operations and hinder our ability to effectively manage our business.
Changing consumer preferences and discretionary spending patterns, potential outbreaks of “mad cow disease” or “foot/mouth disease” and other factors affecting the availability of beef could force us to modify our restaurants’ concept and menu and could result in a reduction in our revenues.
Even if we are able to successfully compete with other restaurant companies with similar concepts, we may be forced to make changes in one or more of our concepts in order to respond to changes in consumer tastes or dining patterns. Consumer preferences could be affected by health concerns about the consumption of beef, the primary item on our Hungry Hunter, Hunter Steakhouse, Mountain Jack’s, Carvers restaurants’ menus, or by specific events such as the recently confirmed cases of “mad cow disease” by the Canadian government in August 2006 or “foot/mouth disease” which occurred in the United Kingdom in 2001. In addition, these events could reduce the available supply of beef or significantly raise the price of beef. If we were to modify the emphasis on beef in our restaurants’ menus, we may lose additional customers who do not prefer the new concept and menu, and we may not be able to attract a sufficient new customer base to generate the necessary revenues needed to make the restaurant profitable. In addition, we may have different or additional competitors for our intended customers as a result of such a concept change and may not be able to successfully compete against such competitors. Our success also depends on numerous factors affecting discretionary consumer spending, including economic conditions, the cost of gasoline, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce guest traffic or impose practical limits on pricing, either of which could reduce revenues and operating income.
We face risks associated with changes in general economic conditions that affect consumer spending.
If the U.S. economy falters, our customers may reduce their level of discretionary spending. We believe that a decrease in discretionary spending could impact the frequency with which our customers choose to dine out or the amount they spend on meals while dining out, thereby decreasing our revenues. Adverse economic conditions and any related decrease in discretionary spending by our customers could have an adverse effect on our revenues and operating results.
Our profitability is dependent in large measure on food and supply costs which are not within our control.
Our profitability is dependent in large measure on our ability to anticipate and react to changes in food and supply costs. Various factors beyond our control, including climatic changes and government regulations, may affect food costs. Specifically, our dependence on frequent, timely deliveries of fresh beef, poultry, seafood and produce subjects us to the risks of possible shortages or interruptions in supply caused by adverse weather or other conditions, which could adversely affect the availability and cost of any such items. We cannot assure you that we will be able to anticipate or react to increasing food and supply costs in the future. The failure to react to these increases could materially and adversely affect our business and result of operations.
Our ability to execute our expansion plans depends on securing suitable locations at favorable prices.
Our strategy for expansion of our operations includes the construction of new restaurant properties and/or acquisition of existing properties. Our ability to open additional restaurants will depend upon our ability to identify and acquire available new construction sites or restaurant conversions at favorable prices. We must also have sufficient available funds from operations or otherwise to support this expansion.
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If we cannot successfully construct new restaurant properties or convert acquired restaurant properties to our established brands within projected budgets or time periods, our business and our ability to continue as a going concern will be adversely affected. Even with the success of our plan of reorganization and sufficient funds, plans to expand our business may fail due to construction delays or cost overruns, which could be caused by numerous factors, such as shortages of materials and skilled labor, labor disputes, weather interference, environmental problems and construction or zoning problems.
We face risks associated with the expansion of our operations.
The success of our business depends on our ability to expand the number of our restaurants, either by developing or acquiring additional restaurants. Our success also depends on our ability to operate and manage successfully our growing operations. Our ability to expand successfully will depend upon a number of factors, including the following:
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the availability and cost of suitable restaurant locations for development;
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the availability of restaurant acquisition opportunities;
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the hiring, training, and retention of additional management and restaurant personnel;
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the availability of adequate financing;
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the continued development and implementation of management information systems;
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competitive factors; and
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general economic and business conditions.
Increased construction costs and delays resulting from governmental regulatory approvals, strikes, or work stoppages, adverse weather conditions, and various acts of God may also affect the opening of new restaurants. Newly opened restaurants may operate at a loss for a period following their initial opening. The length of this period will depend upon a number of factors, including the time of the year the restaurant is opened, the sales volume, and our ability to control costs.
We may not successfully achieve our expansion goals. Additional restaurants that we develop or acquire may not be profitable. In addition, the opening of additional restaurants in an existing market may have the effect of drawing customers from and reducing the sales volume of our existing restaurants in those markets.
Successful mergers, acquisitions, divestitures and other strategic transactions are important to our future growth and profitability.
We intend to evaluate potential mergers, acquisitions, joint venture investments, and divestitures as part of our strategic planning initiative, including our potential acquisition of seven steakhouses in New England. These transactions involve various inherent risks, including, among other things,
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our ability to identify suitable acquisition targets, including assessing the value, future growth potential, strengths, weaknesses, contingent and other liabilities and potential profitability of any acquisition candidate;
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our ability to negotiate favorable acquisition terms for such targets;
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our ability to prevail over competing bidders for any acquisition candidate;
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our ability to secure financing necessary to complete such acquisitions in a timely manner and on acceptable terms;
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our ability to achieve projected economic and operating synergies from any acquired business;
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unanticipated changes in business and economic conditions affecting any acquired business;
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our ability to complete divestitures on acceptable terms and at or near the prices estimated as attainable by us; and
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our ability to integrate successfully the operations and management of any business we acquire into our business.
Given that our growth strategy is heavily dependent on acquiring new businesses, if we are unable to execute on this strategy for any reason our future operating results may be harmed materially.
We depend on key food product distributors.
We have a major meat vendor that accounted for $5.0 million (11%) of our total purchases in 2006 and 2005 respectively. We purchase our food and beverage products from a number of food distributors, including Southwest Traders on the West Coast and U.S. Foodservice in the Midwest. If any of our vendors is unable to continue providing us with a high level of quality and dependability in the receipt of our supplies, at the cost advantages resulting from our volume purchases, this could have a material impact on our business.
We believe that all essential products are available from other national suppliers as well as from local suppliers in the cities in which our restaurants are located in the event we must purchase our products from other suppliers; however, there can be no assurance that we will be able to match quality, price or dependability of supply.
We face commodity price and availability risk.
We purchase energy and agricultural products that are subject to price volatility caused by weather, market conditions and other factors that are not predictable or within our control. Increases in commodity prices could result in lower restaurant-level operating margins for our restaurant concepts. Occasionally, the availability of commodities can be limited due to circumstances beyond our control. If we are unable to obtain such commodities, we may be unable to offer related products, which would have a negative impact on our profitability.
Increases in federal and state statutory minimum wages will increase our expenses, which could adversely affect our results of operations.
The recent increases in the state statutory minimum wage and the federal minimum wage increases will raise minimum wages above the current wages of some of our employees. As a result, competitive factors could require us to make corresponding increases in our employees’ wages. Increases in our wage rates increase our expenses, which could adversely affect our results of operations.
The failure to enforce and maintain our trademarks and trade names could adversely affect our ability to establish and maintain brand awareness.
Our current operations and marketing strategy depend significantly on the strength of trademarks and service marks. Our wholly owned subsidiary, Paragon of Michigan, Inc., has registered, among others, the names Hungry Hunter, Mountain Jack’s and Carvers. The success of our growth strategy depends on our continued ability to use our existing trademarks and service marks in order to increase brand awareness and further develop our branded products. Although we are not aware of any infringing uses of any of the trademarks or service marks that we believe could materially affect us; we cannot assure you that we will be free from such infringements in the future.
The names Hungry Hunter, Mountain Jack’s and Carvers represent our core concept restaurants. The termination of our right to use this name or our failure to maintain any of our other existing trademarks could materially and adversely affect our growth and marketing strategies.
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Because we maintain a small number of restaurants, the negative performance of a single restaurant could have a substantial impact on our operating results.
We currently own and operate 25 restaurants. Due to this relatively small number of restaurants, poor financial performance at any one restaurant could have a significant negative impact on our profitability as a whole. The results achieved to date by our relatively small restaurant base may not be indicative of the results of a larger number of restaurants in a more geographically dispersed area with varied demographic characteristics. We cannot assure you that we will be able to operate our existing restaurants at higher sales levels that generate equal or higher operating profits or increase the number of our restaurants sufficiently to offset the impact of poor performance at any one restaurant.
Our operating results may fluctuate significantly due to seasonality and other factors beyond our control.
Our business is subject to seasonal fluctuations, which may vary greatly depending upon the region of the United States in which a particular restaurant is located. In addition to seasonality, our quarterly and annual operating results and comparable unit sales may fluctuate significantly as a result of a variety of factors, including:
•
the amount of sales contributed by new and existing restaurants;
•
the timing of new openings;
•
increases in the cost of key food or beverage products;
•
labor costs for our personnel;
•
our ability to achieve and sustain profitability on a quarterly or annual basis;
•
consumer confidence and changes in consumer preferences;
•
health concerns, including adverse publicity concerning food-related illness;
•
the level of competition from existing or new competitors in our segment of the restaurant industry; and
•
economic conditions generally and in each of the markets in which we are located.
These fluctuations make it difficult for us to predict and address in a timely manner factors that may have a negative impact on our results of operations.
We could face labor shortages, increased labor costs and other adverse effects of varying labor conditions.
The development and success of our restaurants depend, in large part, on the efforts, abilities, experience and reputations of the general managers and chefs at such restaurants. In addition, our success depends in part upon our ability to attract, motivate and retain a sufficient number of qualified employees, including restaurant managers, kitchen staff and wait staff. Qualified individuals needed to fill these positions are in short supply and the inability to recruit and retain such individuals may delay the planned openings of new restaurants or result in high employee turnover in existing restaurants. A significant delay in finding qualified employees or high turnover of existing employees could materially and adversely affect our results of operations or business. Also, competition for qualified employees could require us to pay higher wages to attract sufficient qualified employees, which could result in higher, labor costs. In addition, increases in the minimum hourly wage, employment tax rates and levies, related benefits costs, including health insurance, and similar matters over which we have no control may increase our operating costs. Further, the United States Congress is considering changes to Federal immigration-related laws. Changes to these laws may adversely affect our operations by increasing our compliance and oversight obligations and making it more expensive and difficult for us to hire qualified employees.
The restaurant industry is affected by litigation and publicity concerning food quality, health and other issues, which can cause guests to avoid our restaurants and result in liabilities.
Health concerns, including adverse publicity concerning food-related illness, although not specifically related to our restaurants, could cause guests to avoid our restaurants, which would have a negative impact on our sales. We may also be the subject of complaints or
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litigation from guests alleging food-related illness, injuries suffered on the premises or other food quality, health or operational concerns. A lawsuit or claim could result in an adverse decision against us that could have a material adverse effect on our business and results of operations. We may also be subject to litigation, which, regardless of the outcome, could result in adverse publicity. Adverse publicity resulting from such allegations or related litigation may interfere with our management’s ability to focus on operating our restaurants, result in reduced business at our restaurants, harm our reputation, and generally have a negative impact on our business and operations, regardless of whether such allegations are true or whether we are ultimately held liable.
Compliance with environmental laws may affect our financial condition.
We are subject to various federal, state and local environmental laws. These laws govern discharges to air and water, as well as handling and disposal practices for solid and hazardous wastes. These laws may also impose liability for damages from and the costs of cleaning up sites of spills, disposals or other releases of hazardous materials. We may be responsible for environmental conditions or contamination relating to our restaurants and the land on which our restaurants are located, regardless of whether we lease or own the restaurant or land in question and regardless of whether such environmental conditions were created by us or by a prior owner or tenant. The costs of any cleanup could be significant and have a material adverse effect on our financial position and results of operations.
We face increased expenditures of time and money associated with compliance with changing regulation of corporate governance and public disclosure.
Keeping abreast of, and in compliance with, changing laws, regulations, and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, and new SEC regulations, has required an increased amount of management attention and external resources. We remain committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.
Risks Related To Our Common Stock
Since our shares are thinly traded, and trading on the OTC Bulletin Board may be sporadic because it is not an exchange, stockholders may have difficulty reselling their shares.
Our common stock is currently quoted on the OTC Bulletin Board. The fact that our common stock is not listed on a major exchange is likely to make trading more difficult for broker-dealers, shareholders and investors, potentially leading to further declines in share price. An investor may find it more difficult to sell our common stock or to obtain accurate quotations of the share price of our common stock.
The price of our common stock may fluctuate significantly.
The market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of other companies, trading volume in our common stock, dilution systemic to financing operations, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.
In the past, following periods of volatility in the market price of a company’s securities, securities class-action litigation has often been instituted. Such litigation, if initiated, could result in substantial costs, a material adverse effect on our business, and a diversion of management’s attention and resources.
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Failure of our common stock to appreciate in value could affect our ability to raise working capital and adversely impact our ability to continue our normal operations.
A prolonged period in which our common stock trades at current levels could result in our inability to raise capital and may force us to reallocate funds from other planned uses, which would have a significant negative effect on our business plans and operations. If our stock price does not recover from its current levels, there can be no assurance that we can raise additional capital or generate funds from operations sufficient to meet our obligations. If we are unable to raise sufficient capital in the future, we may not be able to have the resources to continue our normal operations.
The large number of shares of our common stock eligible for public sale and the fact that a relatively small number of investors hold our publicly traded common stock could cause our stock price to fluctuate.
The market price of our common stock could fluctuate as a result of sales by our existing stockholders of a large number of shares of our common stock in the market or the perception that such sales could occur. A large number of shares of our stock are eligible for public sale and our common stock is concentrated in the hands of a small number of investors and is thinly traded. An attempt to sell by a large holder could adversely affect the price of our common stock. These sales or the perception that these sales might occur could also make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
Trading of our stock may be restricted by the SEC’s penny stock regulations, which may limit a stockholder’s ability to buy and sell our stock.
The SEC has adopted regulations which generally define “penny stock” to be any equity security that has a market price (as defined) less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our securities are covered by the penny stock rules, which impose additional sales practice requirements on broker-dealers who sell to persons other than established customers and “accredited investors.” The term “accredited investor” refers generally to institutions with assets in excess of $5.0 million or individuals with a net worth in excess of $1.0 million or annual income exceeding $200,000 or $300,000 jointly with their spouse. The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a form prepared by the SEC, which provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities. We believe that the penny stock rules discourage investor interest in and limit the marketability of our common stock.
NASD sales practice requirements may also limit a stockholder’s ability to buy and sell our stock.
In addition to the “penny stock” rules described above, the National Association of Securities Dealers, Inc. (the “NASD”) has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, the NASD believes that there is a high probability
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that speculative low priced securities will not be suitable for at least some customers. The NASD requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
Delaware law contains anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable.
Because we are a Delaware corporation, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, or Delaware Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future, resulting in the market price being lower than it might be without these provisions.
Ownership of approximately 44% of our outstanding common stock by five stockholders will limit your ability to influence corporate matters.
A substantial portion of our capital stock is held by a limited number of stockholders. Five stockholders, including our officers and directors and parties affiliated with or related to such persons or to us, own approximately 44% of the outstanding shares of common stock. Accordingly, such stockholders will likely have a strong influence on major decisions of corporate policy, and the outcome of any major transaction or other matters submitted to our stockholders or board of directors, including potential mergers or acquisitions, and amendments to our Amended and Restated Certificate of Incorporation. Stockholders other than these principal stockholders are therefore likely to have little influence on decisions regarding such matters.
ITE M 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2. PROPERTIES.
We lease all of our restaurant locations. Lease terms are generally 10 to 35 years, with renewal options. All of our leases provide for a minimum annual rent and some leases provide for additional rent based on sales volume at the particular location over specified minimum levels. Generally, the leases are net leases that require us to pay the costs of insurance, taxes and maintenance. We intend to continue to lease restaurant locations where cost-effective if cash flow permits.
The following table sets forth the location of our existing Hungry Hunter, Hunter Steakhouse, and Mountain Jack’s restaurants as of March 27, 2007:
The following table sets forth the location of our existing Carvers restaurants as well as our concept (unique) restaurants:
Carvers Locations
Concept (Unique) Restaurant Locations
Glendale, Arizona
Folsom, California
Centerville, Ohio
South Bend, Indiana
Roseville, California
Williamsburg, Virginia
Sandy, Utah
Raleigh, North Carolina
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Our executive offices are located at 10200 Willow Creek Road, San Diego, California 92131. Our executive offices have a three-year lease expiring in May 2007 at very competitive rates with an option to renew. Our telephone number is (858) 689-2333. We believe that there is space available to satisfy our current and anticipated needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are periodically a defendant in cases involving personal injury and other matters that arise in the normal course of business. While any pending or threatened litigation has an element of uncertainty, we believe that the outcome of any pending lawsuits or claims, individually or combined, will not materially affect the financial condition or results of operation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock traded on the NASDAQ Small Cap Market under the symbol “SIZL” from February 27, 1998, the date of our initial public offering, until December 19, 2001, the day it was delisted. Our common stock was then listed on the over-the-counter market and traded on the Pink Sheets under the symbol “SIZLQ.PK”. As of the December 31, 2003, all of our outstanding capital stock was cancelled and new shares of common stock were issued. On May 3, 2004, our common stock began trading on the Pink Sheets as a reorganized company under the symbol STPK.PK. Currently, our common stock is traded on the OTC Bulletin Board under the symbol STPK.OB.
The following table sets forth the range of high and low closing prices for our common stock for each quarterly period indicated, as reported by brokers and dealers making a market in the stock. Such quotations reflect inter-dealer prices without retail markup, markdown or commission, and may not necessarily represent actual transactions:
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Holders
As of January 4, 2007 there were approximately 133 record holders of our common stock.
Dividends
We have not paid any cash or other dividends on our common stock since our inception and do not anticipate paying any such dividends in the foreseeable future. We intend to retain any earnings for use in our operations and to finance our plan of reorganization.
Stock Performance Graph
The following graph compares on a cumulative basis the yearly percentage change, assuming dividend reinvestment, over the last twenty months (i.e., since shares of common stock of the reorganized company began trading on the Pink Sheets) (a) the total shareholder return on our common stock, (b) the total return on the Russell 2000 Index and (c) the total return on a peer group index. The peer group selected is: J. Alexander Corp.; Landry’s Restaurants, Inc.; Lone Star Steakhouse Inc.; O Charley’s Inc; Rare Hospitality International Inc, and Ryans Restaurant Group Inc.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data for the five years ended December 31, 2006 has been derived from our Consolidated Financial Statements. This data should be read in conjunction with Consolidated Financial Statements and related Notes for the year ended December 31, 2006, and the Management’s Discussion and Analysis of Financial Condition and Results of Operations. We report our operations on a 52-53 week fiscal year ending on the Tuesday closest to December 31. For financial statement purposes, we report all years as ending December 31.
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ITEM 7.
ITEM 7. MANA GEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
This Annual Report on Form 10-K contains forward-looking statements. These statements relate to future events or future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.
Although we believe that expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no obligation to update any forward-looking statements after the filing of this Annual Report to conform such statements to actual results or to changes in our expectations.
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes and other financial information appearing elsewhere in this Annual Report. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption “Risk Factors” in Item 1A of Part I of this Annual Report. Risk factors that could cause actual results to differ from those contained in the forward-looking statements include but are not limited to: risks related to our operating expenses; sales and operations; anticipated cash needs; our operating strategy and growth strategy; needs for additional financing; ability to attract customers; anticipated trends and challenges in our business; the adequacy of our facilities; the impact of economic conditions on our customers and our business; the benefits, risks and synergies that could be achieved from our acquisitions; the impact of competitive products and pricing; our ability to negotiate with third parties; our failure to obtain additional funds in a timely manner or on acceptable terms; losses incurred from inception; failure to obtain additional capital needed for expansion; insufficient cash reserves to maintain and fund our operations;
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loss of key personnel; our ability to attract key employees; changing consumer preferences and discretionary spending patterns; changes in general economic and political conditions effecting consumer spending; increase in food and supply costs; failure to execute our expansion plans; failure to successfully execute mergers, acquisitions, divestitures and other strategic transactions; our dependence on key food product distributors; commodity and availability risk; increases in federal and state statutory minimum wages; failure to enforce and maintain our trademarks and trade names; negative performance of a single restaurant; our operating results may fluctuate due to seasonality; labor shortages and increased labor costs; adverse litigation and publicity concerning food quality and health issues; our compliance with environmental laws; our compliance with changing regulation of corporate governance and public disclosure; and failure to maintain an effective system of internal controls.
Company Overview
On December 21, 1998, we acquired Paragon Steakhouse Restaurants, Inc. and its subsidiaries (“Paragon”) and Pacific Basin Foods, Inc. (“PBF”). Prior to the acquisition of Paragon, we owned and operated four restaurants. Therefore, as of that date, we had three business units, which had separate management and reporting infrastructures that offered different products and services. The business units were aggregated into two reportable segments, restaurant services and food service distribution, since the long-term financial performance of these reportable segments is affected by similar economic conditions. The restaurant services segment consisted of two business units - Paragon Steakhouse Restaurants, Inc. and Steakhouse Partners, Inc. - that operated specialty restaurants around the country. Our food service distribution segment, which operated as PBF, performed distribution of restaurant foods and restaurant-related products for internal operations, as well as customers outside our internal operations.
As Paragon downsized and reduced the total number of restaurants serviced by PBF, the volume required to maintain its economic feasibility also diminished. Therefore, on October 11, 2002, PBF ceased operations and filed under Chapter 7 with the United States Bankruptcy Court in Riverside, California.
Effective December 31, 2003, we confirmed a Plan of Reorganization, which provided for us to assume the core 25 profitable restaurants. For all the other units, either our leasehold interests were sold or the leases were rejected as of the Effective Date. Any claims associated with the rejected leases were provided for in the Plan.
In connection with our emergence from bankruptcy protection, we implemented fresh-start accounting under the provisions of SOP 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code.” Under SOP 90-7, our reorganization fair value was allocated to our assets and liabilities, our accumulated deficit was eliminated, and our new equity was issued according to the Plan as if we were a new reporting entity.
In accordance with fresh-start accounting, all assets and liabilities were recorded at their respective fair market values upon emergence from Chapter 11. Such fair values represented our estimates based on independent appraisals and valuations. Immaterial differences between estimated pre-petition liabilities assumed by us as a reorganized company and the final settlement amounts are recognized as they occur.
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the continuation of operations, realization of assets, and liquidation of liabilities in the ordinary course of business. As a result of the Filing, realization of certain of our assets and liquidation of certain of our liabilities are subject to significant uncertainty. Furthermore, the Plan materially changed the amounts and classifications reported in the December 30, 2003 consolidated financial statements, which did not give effect to any adjustments to the carrying value or classification of assets or liabilities that were necessary as a consequence of the Plan.
As of December 31, 2006, we operated 25 full-service restaurants located in eight states. We operate under the brand names of Carvers, Hungry Hunter Steakhouse, Hunter Steakhouse and Mountain Jack’s. We believe that our restaurants are well positioned in a high quality, moderately priced segment of the restaurant industry. Our Carvers restaurants represent an upscale restaurant market
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specializing in complete steak, chop, prime rib and seafood meals. Our growth strategy is based on internal growth and growth through acquisition. Internal growth focuses on improvement in same store sales and construction of new restaurant properties. Acquisition growth focuses on either a conversion of acquired restaurant properties to our steakhouse brand names or the targeted acquisition of one or more large steakhouse chains. Now that we have emerged from our reorganization, we are focused on acquisitions.
To the extent we establish or build steakhouses in new locations, there is likely to be a time lag between the time expenses of the startup are incurred and the time newly constructed steakhouses are opened and begin to generate revenues, which time lag could affect quarter-to-quarter comparisons and results.
Our overall steakhouse operations tend to experience seasonal fluctuations, with the fourth quarter and first quarter of each year being our strongest quarters, reflecting both the Christmas season and the colder weather at our Midwest operations, and the third quarter being the weakest, as people tend to eat less steak in restaurants in the summer months. This seasonality, however, is less pronounced at our California locations, in which we do not experience the same seasonal changes in weather that occur at our Midwest locations.
The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the years ended December 31, 2006 and 2005, the Company maintained a current ratio of 0.15-to1 and 0.21-to-1, respectively. In addition, during the years ended December 31, 2006 and 2005, the Company had a working capital deficit of approximately $11.9 million and $9.7 million, respectively. The Company is negotiating with the trustee for the unsecured creditors to consolidate the debt, per the Plan. The company plans on refinancing the Plan debt by securing a term loan to satisfy the unsecured creditors who will provide a discount. Also, in fiscal 2005, the Company successfully completed the first phase (minimum) of a Private Placement for approximately $1.4 million. If the Company is unable to generate profits and unable to obtain additional financing for its working capital requirements, it may have to curtail its business sharply or cease business altogether.
Results of Operations
Results of Operations-Selected Items as a Percentage of Net Sales
The following table sets forth, as a percentage of revenue, certain items in our condensed consolidated statements of operations for the indicated periods:
Factors that have affected the results of operations for fifty-two weeks of fiscal 2006 for us as compared to the fifty-two weeks of fiscal 2005 for us are discussed below.
52 Weeks Ended December 31, 2006 Compared to the 52 Weeks Ended December 31, 2005
Net revenues for the fifty-two week period ended December 31, 2006 decreased approximately $1.8 million or 3.5% from $52.0 million for the fifty-two week period ended December 31, 2005 to $50.2 for the same period in 2006. The decrease was the result total entree counts decreasing 2.2% and the price per entree decreasing 1.1%. The latter was the effect of the Company increasing its catering business, which has a lower average selling price than in store pricing.
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Food and beverage costs for the fifty-two week period ended December 31, 2006 decreased approximately $0.3 million or 2.0% from $17.0 million for the fifty-two week period ended December 31, 2005 to $16.7 million for the same period in 2006. The major reason for this decrease was the decline in net revenue partially offset by the effect of the decrease in the average entrée price and relatively stable food cost with 2005. Food and beverage costs as a percentage of net revenues for the twenty-five restaurants were 33.2% for the fifty-two week period ended December 31, 2006 compared to 32.7% for the same period in 2005. The major reason for this increase was the effect of a decrease in the average entrée price in total 1.1% as mentioned above, as well as, average meat prices remaining relatively stable with 2005.
Payroll and payroll related costs for the fifty-two week period ended December 31, 2006 decreased approximately $0.6 million or 3.3% from $17.9 million for the fifty-two week period ended December 31, 2005 to $17.3 million for the same period in 2006. The total payroll and payroll related costs as a percentage of net revenues were 34.4% for the fifty-two week period ended December 31, 2006 compared to 34.3% for the same period in 2005. We were able to successfully reduce payroll and payroll related cost proportionately with the decrease in revenue while providing the minimum staffing required per unit to maintain guest services and a positive dining experience. Also contributing to the proportionate decrease as a percent of net revenue, was the mid year reduction in our workmen compensation rates. Partially offsetting these proportionate changes was the effect of a decrease in net revenue.
Direct operating costs include all other unit-level operating costs, the major components of which are operating supplies, repairs and maintenance, advertising expenses, utilities, rent, insurance and other occupancy costs. A substantial portion of these expenses are fixed or indirectly variable. Direct operating costs for the fifty-two week period ended December 31, 2006 decreased by almost $0.06 million or 0.5% from $11.23 million for the fifty-two week period ended December 31, 2005 to $11.17 million for the same period in 2006. The costs as a percentage of net revenues were 22.3% for the fifty-two week period ended December 31, 2006 compared to 21.6% for the same period in 2005. The major reason for this increase as a percentage relationship to revenue is the impact of the decrease in the restaurants’ net revenue, which was greater than reductions in the fixed or indirectly variable expenses. In fact, utilities, rents, property taxes and credit card fees are costs that continue to rise and make the decrease in the restaurants’ net revenue more disproportionate. Also contributing to these increases was the effect of a decrease in the average entrée price in total of 1.1%.
Depreciation and amortization for the fifty-two week period ended December 31, 2006 increased slightly from $1.2 million for the fifty-two week period ended December 31, 2005 to $1.3 million for the same period in 2006. The major reason for this change is a result of the capital spending on property, equipment and the POS system since mid-2005.
General and administrative expenses for the fifty-two week period ended December 31, 2006 increased $0.08 million or 1.9% from $4.22 million for the fifty-two week period ended December 31, 2005 to $4.3 million for the same period in 2006. General and administrative expenses as a percentage of net revenues was 8.6% for the fifty-two week period ended December 31, 2006 compared to 8.1% for the same period in 2005. The primary reasons for the increase as a percentage relationship to revenue was the increase in non-cash compensation expense (“SFAS 123R”) for employee stock options of $0.4 million for the fifty-two week period ended December 31, 2006 compared to $0.26 million for the same period in 2005. Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) 123R (revised 2004), Share-Based Payment (“SFAS 123R”), using the modified prospective method.
Total other and interest expense, net, for the fifty-two week period ended December 31, 2006 increased approximately $0.13 million or 14.9% from $0.87 million for the fifty-two week period ended December 31, 2005 to $1.0 million for the same period in 2006. The increase is principally due to penalties and interest for the delay in filing the registration statement required by a Registration Rights Agreement we entered into January 2005. The registration statement was filed in September 2006 and declared effective on November 3, 2006. Through the fifty-two week period ended December 31, 2006, we had incurred approximately $0.1 million in such penalties. Also contributing to the increase was our recognition of all the capitalized costs of approximately $0.19 million associated with our proposed acquisition of Roadhouse Grill, which we abandoned in 2006.
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Total reorganization items, net, for the fifty-two week period ended December 31, 2006 increased $0.17 million as compared to the same period in 2005. The primary reason for the increase was bankruptcy related legal fees of approximately $0.15 million.
Net loss for the fifty-two week period ended December 31, 2006 increased $1.3 million from $0.5 million for the fifty-two week period ended December 31, 2005 to approximately $1.8 million for the same period in 2006. The increase in net loss for the fifty-two week period ended December 31, 2006 was principally the result of soft revenue for the period compounded by increasing utility, rents, property taxes and credit card fees and the adoption of non-cash expense for SFAS 123R, which reduced profits. Also increasing the loss was the payment of penalties and interest for the delay in filing the registration statement required by a Registration Rights Agreement we entered into January 2005, as described above and our recognition of all the capitalized costs of approximately $0.19 million associated with our proposed acquisition of Roadhouse Grill, which we abandoned in 2006.
Weeks Ended December 31, 2005 Compared to the 52 Weeks Ended December 31, 2004
Net revenues for the fifty-two week period ended December 31, 2005 decreased approximately $3.0 million or 5.6% from $55.1 million for the fifty-two week period ended December 31, 2004 to $52.0 million for the same period in 2005. A portion of the decrease is attributable to the decrease in total operating units. Three operating units were disposed of in February 2004 and contributed almost $0.6 million in net revenue before their disposition. The major reason for the decrease in net revenue was that the same store sales for the core twenty-five units that were open at the end of the year reflected a decrease of 4.5% for the 52 weeks ended December 31, 2005 versus the same period in 2004. We believe this was the result of a 4.8% increase in total average guest check, which in turn negatively affected the total guest count. These changes were additive to significant changes to the menu and menu prices from the same period in 2004. The total price increases and changes in the menu were required as we had deferred any changes through the entire bankruptcy process and to offset beef cost and labor cost increases during that time.
Food and beverage costs for the fifty-two week period ended December 31, 2005 decreased approximately $1.7 million or 9.3% from $18.7 million for the fifty-two week period ended December 31, 2004 to $17.0 million for the same period in 2005. Food and beverage costs as a percentage of net revenues for the core twenty-five restaurants were 32.7% for the fifty-two week period ended December 31, 2005 compared to 33.5% for the same period in 2004. The major reason for this decrease was the effect of a mid-year major menu price increase coupled with a reengineering of the menu that increased the average entrée price in total 4.8%. Also the record high beef prices that affected us through the first half of fiscal year 2004 declined in the summer of 2004 and stabilized for most of 2005.
Payroll and payroll related costs for the fifty-two week period ended December 31, 2005 decreased approximately $0.9 million or 4.7% from $18.6 million for the fifty-two week period ended December 31, 2004 to $17.7 million for the same period in 2005. The total payroll and payroll related costs as a percentage of net revenues were 34.3% for the fifty-two week period ended December 31, 2005 compared to 33.6% for the same period in 2004 or a 0.7% increase. The major reason for this increase as a percentage relationship to revenue is the impact of the decrease in the restaurants’ net revenue was slightly greater than the minimum staffing required per unit to maintain guest services and create a positive dining experience. During the year the management teams at a number of units were reduced to minimize (where ever possible) this effect. Partially offsetting these increases were the effect of a mid-year major menu price increase coupled with a reengineering of the menu that increased the average entrée price in total 4.8%.
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Direct operating costs include all other unit-level operating costs, the major components of which are operating supplies, repairs and maintenance, advertising expenses, utilities, rent, insurance and other occupancy costs. A substantial portion of these expenses is fixed or indirectly variable. Direct operating costs for the fifty-two week period ended December 31, 2005 decreased by almost $0.2 million or 1.7% from $11.4 million for the fifty-two week period ended December 31, 2004 to $11.2 million for the same period in 2005. The costs as a percentage of net revenues were 21.6% for the fifty-two week period ended December 31, 2005 compared to 20.5% for the same period in 2004 or a 0.9% increase. The major reason for this increase as a percentage relationship to revenue is the impact of the decrease in the restaurants’ net revenue, which was greater than reductions in the fixed or indirectly variable expenses. Also contributing to this increase is an asset impairment write-off of the Troy, Michigan, location for $51,000. This location has experienced losses over the past two years and an immediate turnaround is not likely. Partially offsetting these increases was the effect of a mid-year major menu price increase coupled with a reengineering of the menu that increased the average entrée price in total 4.8%.
Depreciation and amortization for the fifty-two week period ended December 31, 2005 increased slightly from $1.2 million for the fifty-two week period ended December 31, 2004 to $1.3 million for the same period in 2005. The major reason for this change is a result of the capital spending on property, equipment and the POS system since mid-2004.
General and administrative expenses for the fifty-two week period ended December 31, 2005 decreased $0.2 million or 4.4% from $4.5 million for the fifty-two week period ended December 31, 2004 to $4.3 million for the same period in 2005. General and administrative expenses as a percentage of net revenues was 8.1% for the fifty-two week period ended December 31, 2005 compared to 7.3% for the same period in 2004. The primary reasons for the increase as a percentage relationship to revenue (even though in absolute dollars general and administrative expenses declined) are higher legal and outside accounting fees associated with resolving stock option deferred compensation issues and the restatement of prior period reports. Partially offsetting this increase was lower non-cash deferred compensation expense for employee stock options ($0.3 million) for the fifty-two week period ended December 31, 2005 compared to $0.6 million for the same period in 2004. We granted the stock options in April 2004 to help retain and attract management talent.
Total other income and interest expense, net, for the fifty-two week period ended December 31, 2005 decreased approximately $0.3 million or 26.9% from $1.2 million for the fifty-two week period ended December 31, 2004 to almost $0.9 million for the same period in 2005. The decrease is principally due to increases in other income as the Workers Compensation premium rebate for the fifty-two week period ended December 31, 2005 was significantly greater than the rebate for the same period in 2004.
Total reorganization items, net, for the fifty-two week period ended December 31, 2005 was a slight loss of $21,000 as compared to a gain of $26,000 for the same period in 2004. The primary reason for the decrease was a bankruptcy related net adjustment for sales tax of $47,000.
Net loss for the fifty-two week period ended December 31, 2005 decreased almost $0.2 million from $0.6 million for the fifty-two week period ended December 31, 2004 to approximately $0.4 million for the same period in 2005. Net loss as a percentage of net revenues was 0.9% for the fifty-two week period ended December 31, 2005 compared to a net loss of 1.2% for the same period in 2004. The primary reason for this decrease as a percentage relationship to revenue was the increase of other income as the Workers Compensation premium rebate for the fifty-two week period ended December 31, 2005 was significantly greater than the rebate for the same period in 2004. Also contributing to the decrease was the positive effect of the net operating loss (“NOL”) on the tax provision, which resulted in a tax credit for the year ended December 31, 2005. Partially offsetting these decreases was the disproportionate expenses of labor and direct operating costs versus the lower revenue.
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Liquidity and Capital Resources
Our principal source of liquidity is from our restaurant sales, which, as noted above, are primarily derived from cash or credit/debit cards. Principal uses of cash are operating expenses, which have been discussed in the preceding sections and capital expenditures.
A comparison of our sources and uses of funds for 2006 and 2005 follow (in millions):
The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the years ended December 31, 2006 and 2005, the Company maintained a current ratio of 0.15-to1 and 0.21-to-1, respectively. In addition, during the years ended December 31, 2006 and 2005, the Company had a working capital deficit of approximately $11.9 million and $9.7 million, respectively. The Company is negotiating with the trustee for the unsecured creditors to consolidate the debt, per the Plan. The company plans on refinancing the Plan debt by securing a term loan to satisfy the unsecured creditors who will provide a discount. Also, in fiscal 2005, the Company successfully completed the first phase (minimum) of a Private Placement for approximately $1.4 million. If the Company is unable to generate profits and unable to obtain additional financing for its working capital requirements, it may have to curtail its business sharply or cease business altogether.
Management has evaluated its current operations, and it has focused the Company’s efforts and developed plans to generate operating income to continue the Company’s operations through the year ending December 31, 2007.
Management’s plans include the following:
•
Restructuring and consolidating its long-term debt position;
•
Improving the Company’s financial performance through local marketing sales generation, cost-reduction and restructuring of administrative overhead; and
•
Raising money through equity financings.
The Company continues to explore options with the trustee for the unsecured creditors to consolidate the debt, per its Plan of Reorganization, which was confirmed effective December 31, 2003 (the “Plan”). Currently, the Company plans on refinancing the Plan debt by securing a term loan to satisfy the unsecured creditors. Also, the Company and the Secured Creditor are in dialog regarding a revised payment schedule over a longer period of time so the payments conform more closely to available cash flow for the balance due on the their Note (currently at $863,627).
The Company is uncertain whether its current capital resources will be sufficient to meet our 2007 requirements.
Off-Balance Sheet Arrangements
None.
Contractual Obligations
Our contractual obligations at December 31, 2006 were as follows:
Our long-term debt and operating leases are described in Financial Notes 5 and 6, respectively, of the accompanying consolidated financial statements.
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Critical Accounting Principles
Our critical accounting principles are described in Financial Note 3 of the accompanying consolidated financial statements.
Accounting Change
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective method and therefore has not restated results for prior periods. Under this transition method, the Company recognizes compensation expense for all stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimate in accordance with the provisions of SFAS 123R.
Prior to the adoption of SFAS 123R on January 1, 2006, the Company recognized stock-based compensation in accordance with APB 25, and provided pro forma disclosure amounts in accordance with SFAS 148, as if the fair value method defined by SFAS 123 had been applied to its stock-based compensation. Under the fair value recognition provisions of SFAS 123R, the Company recognizes stock-based compensation expense for those shares expected to vest on a straight-line basis over the requisite service period of the award.
New Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, (“FIN 48”), Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes, (“SFAS No. 109”). This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of adopting FIN 48 on its consolidated financial statements.
In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements (“FAS 157”), which defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States America, and expands disclosures about fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to the opening balance of retained earnings. The Company is currently evaluating the impact of adopting FAS 157 on its consolidated financial statements.
On September 29, 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“FAS 158”). Upon adoption, this standard requires an employer to recognize the funded status of its pension and other postretirement benefit plans in the statement of financial position. Changes in the funded status of the plans will be recognized in the period in which they occur as a component of comprehensive income, net of tax. This standard also requires an employer to measure the funded status of its plans as of the end of its fiscal year. FAS 158 became effective for the company in the fourth quarter of 2006, except for the provisions regarding the required change in measurement date, which are effective for fiscal years ending after December 15, 2008. The Company is currently evaluating FAS 158 to determine the potential impact of its adoption on the consolidated financial statements.
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Impact of Inflation
Our operating costs that may be affected by inflation consist principally of food, minimum wage increases in payroll and utility costs. A significant number of our restaurant team members are paid at the federal minimum wage or, if higher, the applicable state minimum wage and, accordingly, legislated changes to the minimum wage rates affect our payroll costs. If such increases cannot be offset through changes in menu pricing or menu reengineering, we expect that payroll costs, as a percent of sales, would increase.
We consider our current price structure to be very competitive. We consider this factor, among others, when passing cost increases on to our customers. Although we selectively raised prices nominally on several beef items and liquor, through consumer choices our average sales price decreased a little over 1.0% in 2006. Sales prices were effectively increased 4.8% in fiscal 2005, 4.0% in fiscal 2004 and 0.0 % in fiscal 2003.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market Risk. Our exposure to market risk is principally confined to cash in the bank, money market accounts, and notes payable, which have short maturities and, therefore, minimal and immaterial market risk.
Interest Rate Sensitivity. As of December 31, 2006, we had cash in checking and money market accounts. Because of the short maturities of these instruments, a sudden change in market interest rates would not have a material impact on the fair value of these assets.
Foreign Currency Exchange Risk. We do not have any foreign currency exposure because we currently do not transact business in foreign currencies.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The response to this item is included in a separate section of this report. See “Index to Consolidated Financial Statements” on Page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.
None
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily is required to apply their judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this annual report on Form 10-K, have concluded that as of the end of such period, our disclosure controls and procedures are effective to ensure that information we are required to disclose is timely reported.
There were no other changes in our internal controls over financial reporting during our most recent quarter that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
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ITEM 9B.
ITEM 9B. OTHER INFORMATION
On February 9, 2007, pursuant to the terms approved by the Bankruptcy Court between the Company and the Unsecured Creditors Trust, Scott Avila, the Unsecured Creditors Trustee, was nominated and elected to the Company’s Board of Directors.
PART III
ITEM 10.
ITEM 10. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Our Bylaws provide for a Board consisting of no less than three and no more than seven members, the exact number within this range being determined by the Board. The number of directors is currently set at three. Each director holds office until the next annual meeting of stockholders and until such director’s successor is duly elected and qualified, or until such director’s earlier death, resignation or removal.
The following table sets forth certain information regarding our directors and executive officers.
(1) Member of the Nominating Committee.
(2) Member of the Compensation Committee.
(3) Member of the Audit Committee.
The following is a brief summary of the background of the Company’s directors and executive officers. Each executive officer holds office until his successor is elected or qualified, or until his earlier death, resignation or removal.
A. STONE DOUGLASS. Mr. Douglass was appointed as our President, Chief Executive Officer and Secretary, and as one of our directors, effective as of July 20, 2003, pursuant to the terms of a post-petition debtor-in-possession financing agreement entered into by us and pursuant to the order of the Bankruptcy Court, entered on August 13, 2003. He was named Chairman in December 31, 2003. Mr. Douglass is an experienced merchant banker and distressed business management consultant. Mr. Douglass has over 30 years of experience in finance and managing public and private companies, including acting as director and/or interim chief executive officer of companies reorganized in bankruptcy. Mr. Douglass is a Managing Director of Compass Partners, L.L.C., a merchant bank specializing in restructuring and bankruptcy reorganization. Mr. Douglass is also Chairman of Duck’s Nest Investments, Inc., a private investment and merchant bank. From July 2002 to May 2003, Mr. Douglass was Chief Operating Officer of ACE Audiovisual, Inc., a commercial integrator of audiovisual products. From June 2001 to June 2002, Mr. Douglass was President of Inline Orthodontix, an orthodontic productions distribution company. From October 2000 to August 2001, Mr. Douglass was President and Chief Executive Officer of VisionAmerica, Inc. (AMEX: VISN), an optometric physicians practice management company. From August 1998 to May 2001, Mr. Douglass was also President and Chief Executive Officer of Apple Orthodontix, Inc. (AMEX: AOI), an orthodontic practice management company. Mr. Douglass also has served as a director of Neocork Technologies, Inc., since February 2004. Mr. Douglass earned a Bachelor of Science degree in Business Management from Farleigh Dickinson University in 1970.
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JOSEPH L. WULKOWICZ. Mr. Wulkowicz was appointed as our Vice President and Chief Financial Officer and Assistant Secretary in December 2003 upon confirmation of the bankruptcy Plan. Since November 1999, Mr. Wulkowicz has served as Chief Financial Officer and Assistant Secretary of Paragon Steakhouse Restaurants, Inc. Mr. Wulkowicz served as the Chief Financial Officer of McArthur/HTC International, a leading importer and marketer of sports and promotional products, from January 1997 through November 1999. Mr. Wulkowicz earned a Masters in Business Administration in Finance from DePaul University Graduate School of Business in 1976.
SUSAN SCHULZE-CLAASEN. Ms. Schulze-Claasen was appointed as our Vice President and General Counsel in December 2003 upon confirmation of the bankruptcy Plan, and was named Executive Vice President, Chief Administrative Officer and General Counsel effective March 1, 2005. Ms. Schulze-Claasen has served as Vice President-General Counsel and Assistant Secretary of Paragon Steakhouse Restaurants, Inc. since June 1985, and now serves as President. Ms. Schulze-Claasen holds a Juris Doctorate from Valparaiso University, School of Law in 1979.
EDGAR TOD LINDNER. Mr. Lindner has been one of our directors since February 1999. Mr. Lindner has been the Director - Private Placements with Jane Capital Partners since April 2003. Prior to joining Jane Capital Partners, Mr. Lindner was the managing director of Pentech Capital Markets Group since May 1999. Prior to joining Pentech Capital Markets Group, Mr. Lindner was a managing director of Ally Capital Group Inc., an investment-banking firm, from May 1996 to April 1999. Mr. Lindner also served as a director of Neocork Technologies, Inc., from August 2002 until December 2003 and was reappointed to that board in March of 2005. Mr. Lindner received his Bachelor of Science in Finance and Banking from the University of Oregon in 1966.
THOMAS A. EDLER. Mr. Edler has been one of our directors since May 1998. Mr. Edler has been President and Chief Executive Officer of Pacific Coast Advisers, Inc. since September 1999. In addition, Mr. Edler served as Senior Vice President of Capitol Bay Securities, a regional investment-banking firm, from May 1999 to January 2001. Mr. Edler received his Bachelor of Science degree from Indiana University in 1966, with subsequent post-graduate studies at the University of Southern California in 1969. Mr. Edler served as an officer in the United States Air Force for four years immediately following college.
T. SCOTT AVILA. Mr. Avila has been one of our directors since February 2007. Mr. Avila is a Managing Partner of Corporate Revitalization Partners, LLC (CRP) since June 2003. Prior to joining CRP, Mr. Avila was a Principal of XRoads Solutions Group, LLC since 1997. In these roles, Mr. Avila has served as Chief Restructuring Officer for many prominent companies on an interim basis. Mr. Avila received his Bachelor of Science from California State University at Hayward in 1984 and his Masters of Business Administration from the University of Southern California in 1989. Currently, Mr. Avila also serves on the Board of Directors of Innovative Micro Technology; he was elected to the Board pursuant to the Plan of Reorganization terms.
Committees of the Board of Directors
The Board of Directors has established three standing committees: an Audit Committee; a Compensation Committee; and a Nominating Committee.
The members of our Audit Committee are Edgar Tod Lindner and Thomas A. Edler. Mr. Lindner is an Audit Committee financial expert, as defined in the rules of the Securities and Exchange Commission (“SEC”). The Audit Committee oversees, reviews and evaluates our financial statements, accounting and financial reporting processes, internal control functions and the audits of our financial statements. The Audit Committee is responsible for the appointment, compensation, retention and oversight of our independent auditors. All members of the Audit Committee are independent (as independence is defined in the NASDAQ Stock Market qualitative listing standards). The Audit Committee acts pursuant to a written charter.
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The members of our Compensation Committee are Edgar Tod Lindner and Thomas A. Edler. The Compensation Committee reviews and makes recommendations to our Board of Directors concerning the compensation and benefits of our executive officers, including the Chief Executive Officer, and directors, oversees the administration of our stock option and employee benefits plans, and reviews general policy relating to compensation and benefits. All members of the Compensation Committee are independent (as independence is defined in the NASDAQ Stock Market qualitative listing standards). The Compensation Committee acts pursuant to a written charter.
The members of our Nominating Committee are Edgar Tod Lindner and Thomas A. Edler. The Nominating Committee identifies prospective candidates to serve on the Board of Directors, recommends nominees for election to the Board of Directors, develops and recommends Board member selection criteria, considers committee member qualification, recommends corporate governance principles to the Board of Directors, and provides oversight in the evaluation of the Board of Directors and each committee. All members of the Nominating Committee are independent (as independence is defined in the NASDAQ Stock Market qualitative listing standards). The Nominating Committee acts pursuant to a written charter.
Board Member Independence
The Board of Directors has determined that, except for Mr. Douglass, all of the members of the Board of Directors are “independent” as independence is defined in the NASDAQ Stock Market qualification standards. Mr. Douglass is not considered independent because he is either currently, or has within the last three years been, employed by the Company.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our executive officers and directors, and persons who own more than ten percent of our common stock, to file reports of beneficial ownership and changes in beneficial ownership with the SEC. Regulations promulgated by the SEC require the Company to disclose any reporting violations with respect to the 2006 fiscal year, which came to our attention based on a review of the applicable filings required by the SEC to report the status of an officer or director, or the changes in beneficial ownership as submitted to us. Based solely on review of such forms we received, we believe that all required reports for the 2006 fiscal year have been timely filed, except that (i) Mr. Lindner made one late filing with respect to a transaction in October 2006, (ii) Mr. Edler made one late filing with respect to a transaction in October 2006, (iii) Mr. Douglass made one late filing with respect to a transaction in October 2006 and (iv) Mr. Wulkowicz made one late filing with respect to a transaction in October 2006.
Code of Ethics
We adopted a Code of Conduct that applies to all employees, including all executive officers and senior financial officers and directors. A copy of the Code of Conduct is available on our website at www.paragonsteak.com and print copies are available to any shareholder that requests a copy.
Code of Conduct
We adopted a Code of Conduct that applies to all employees, including all executive officers and senior financial officers and directors. Print copies of our Code of Conduct are available to any shareholder that requests a copy.
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ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item regarding executive compensation will be contained in, and is hereby incorporated by reference to, our 2007 Proxy Statement under the captions “Election of Directors-Compensation of Directors,” “Executive Compensation” and “Election of Directors-Compensation Committee Interlocks and Insider Participation.”
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ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth, as of December 31, 2006, the beneficial ownership of our common stock with respect to: (i) each person who was known by us to own beneficially more than 5% of the outstanding shares of our common stock; (ii) each director; (iii) each of our current named executive officers; and (iv) all directors
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and executive officers as a group. As of December 31, 2006, we had 6,635,669 shares of common stock issued and outstanding, which was the only class of voting securities authorized or outstanding. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned. However, under the laws of some states, personal property owned by a married person may be community property which either spouse may manage and control, and we have no information as to whether any shares shown in the following table are subject to such community property laws. Unless otherwise indicated, the address of each beneficial owner is c/o Steakhouse Partners, Inc. 10200 Willow Creek Road, San Diego, California 92131. The information provided in this table is based on our records, information filed with the SEC and information provided to us.
The number of shares beneficially owned by each entity, person, director or executive officer is determined under the rules of the SEC, and the information is not necessarily indicative of beneficial ownership for any other purpose. Under such rules, beneficial ownership includes any shares as to which the individual has the sole or shared voting power or investment power and also any shares that the person has the right to acquire within 60 days of December 31, 2006 through the exercise of any stock option or other right. Shares that a person has the right to acquire are deemed to be outstanding for the purpose of computing the percentage ownership of that person, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person.
(1) Includes 180,036 shares of common stock owned directly by Mr. Douglass and options to purchase 166,667 shares of common stock granted pursuant to our 2004 Stock Incentive Plan, which are currently exercisable within 60 days of December 31, 2006.
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(2) The named individual’s beneficial ownership is of options to purchase 66,667 shares of common stock granted pursuant to our 2004 Stock Incentive Plan, which are currently exercisable within 60 days of December 31, 2006.
(3) The named individual’s beneficial ownership is of options to purchase 50,000 shares of common stock granted pursuant to our 2004 Stock Incentive Plan, which are currently exercisable within 60 days of December 31, 2006.
(4) The shares referred to consist of 885,000 shares directly owned by Eye of the Round, LLC and 150,000 shares of common stock issuable upon exercise of a Common Stock Purchase Warrant, dated December 30, 2003, issued to Critical Capital Growth Fund, LP in connection with the Plan of Reorganization. Mr. Sands disclaims beneficial ownership of all 1,035,000 shares. Based on Amendment No. 1 to Schedule 13G dated January 31, 2005, Mr. Sands is (i) manager of Eye of the Round, LLC and (ii) chairman of the general partner of Critical Capital Growth Fund, LP. Does not include warrants to purchase 63,000 shares of common stock acquired by a registered broker-dealer with which Mr. Sands is registered, of which Mr. Sands also disclaims beneficial ownership.
(5) Refers to 885,000 shares of common stock, which are directly owned by Eye of the Round, LLC and included in Mr. Sands’ beneficial ownership under note (4) above. Does not include 150,000 shares of common stock issuable upon exercise of a Common Stock Purchase Warrant, dated December 30, 2003, issued to Critical Capital Growth Fund, LP in connection with the Plan of Reorganization. Eye of the Round, LLC disclaims beneficial ownership of such Common Stock Purchase Warrant. Also does not include warrants to purchase 63,000 shares of common stock acquired by a registered broker-dealer with which Mr. Sands is registered, of which Eye of the Round, LLC disclaims beneficial ownership.
(6) The shares referred to include 359,964 shares directly owned by George Rich and 540,000 shares directly owned by GRI Fund, LP. George Rich is the sole member and manager of Stevenson Partners, LLC, which is the 1% general partner of GRI Fund, LP. George Rich disclaims beneficial ownership of shares owned by GRI Fund, LP. Also includes options to purchase 166,667 shares of common stock granted to Mr. Rich pursuant to our 2004 Stock Incentive Plan, which are currently exercisable within 60 days of December 31, 2006.
(7) Refers to 540,000 shares which are directly owned by GRI Fund, LP and included in Mr. Rich’s beneficial ownership under note (6) above. Does not include 359,964 shares directly owned by George Rich and options to purchase 166,667 shares of common stock granted to Mr. Rich pursuant to our 2004 Stock Incentive Plan, which are currently exercisable. George Rich is the sole member and manager of Stevenson Partners, LLC, which is the 1% general partner of GRI Fund, LP. GRI Fund, LP disclaims beneficial ownership of shares owned by George Rich, including the options to purchase our common stock.
Equity Compensation Plan Information
Information about our equity compensation plans at December 31, 2006 that were either approved or not approved by our stockholders was as follows:
(1) The 2004 Stock Option Incentive Plan (the “Option Plan”) was approved by our Board of Directors in April 2004 and by our shareholders in January 2005. The Option Plan was intended to provide incentive to our key employees, officers, directors and consultants who provide significant services to us. There are 2.0 million shares authorized for issuance under the Option Plan. The number of shares available under the Option Plan may automatically increase on January 1 of each year (starting in 2005), at the discretion of the Board, by a number equal to the lesser of (i) 25% of the fully diluted total number of shares of common stock then outstanding, or (ii) 2.0 million shares. Options generally vest over a three-year period and the Board determines the option exercise price at the time of grant.
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ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, DIRECTOR INDEPENDENCE.
Critical Capital Growth Fund, LP (“CCGF”) is a private Small Business Administration licensed equity fund. Based on Amendment No. 1 to Schedule 13G dated January 31, 2005, Mr. Sands is (i) manager of Eye of the Round, LLC and (ii) chairman of the general partner of CCGF. Pursuant to and accordance with the terms and conditions of the Plan, we delivered a $1,535,000 principal amount unsecured promissory note to CCGF, dated October 19, 2003 (the “CCGF Note”). The CCGF note is payable in full over a period of six years. Interest only will be paid over the first three years, and the principal will be paid over the remaining three years. Additionally, we issued to CCGF a Common Stock Purchase Warrant, dated December 30, 2003, exercisable into 150,000 shares of our common stock at an initial exercise price of $1.11 (the “CCGF Warrant”). The CCGF Warrant became exercisable, either in whole or in part, after April 1, 2005.
On December 23, 2005, George Rich was granted options to purchase 250,000 shares of our common stock under our 2004 Stock Incentive Plan in exchange for his services to us as an adviser. Such options become exercisable a third as of the grant date, the second third on March1, 2006 and the final third on March 1, 2007.
The disclosure required by Item 407(a) of Regulation SK is included under Item 10 of this Annual Report on Form 10-K.
Our policy is to require that any transaction with a related party required to be reported under applicable Securities and Exchange Commission rules, other than compensation-related matters and waivers of our code of business conduct and ethics, be reviewed and approved or ratified by a majority of independent, disinterested directors. We have not adopted procedures for review of, or standards for approval of, these transactions, but instead review such transactions on a case-by-case basis. Our policy is to require that all compensation-related matters be recommended for board approval by the Compensation Committee and that any waiver of our code of business conduct and ethics be reviewed and approved by the Nominating Committee and be reported under applicable SEC rules.
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ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Audit and Audit Related Fees
Mayer Hoffman McCann P.C. (“MHM”) was our independent accountant for the fiscal years ended December 31, 2006, December 31, 2005 and December 31, 2004. Services provided to us by MHM with respect to the fiscal years ended December 31, 2006, December 31, 2005 and December 31, 2004 consisted of the audit of our consolidated financial statements and limited reviews of our Quarterly Reports on Form 10-Q for the interim periods included therein which they were paid fees totaling $130,874 for 2006, $207,793 for 2005 and $107,000 for 2004.
Services provided by Singer Lewak Greenbaum & Goldstein LLP (“SLGG”) in 2006 consisted of limited review of both our Annual Report on Form 10-K for the year ended December 31, 2005, December 31, 2004 and the Registration Statement (See Note-6) declared effective on November 3, 2006 therein which they were paid fees totaling $0 for 2006, $41,147 for 2005 and $25,582 for 2004.
Tax Fees
SLGG has provided services to us with respect to the preparation of corporate income tax returns and tax planning matters. Tax fees were $26,272 for 2006, $18,424 for 2005 and $15,000 for 2004. MHM did not provide any services to us with respect to tax matters.
All Other Fees
MHM did not provide any services with respect to any matters other than described above.
Pre-Approval Policies and Procedures
The Audit Committee meets periodically to review and approve the scope of the services to be provided to us by our independent accountant, as well to review and discuss any issues that may arise during an engagement. Any non-audit services provided to us would have to be approved by the Audit Committee. There are currently no such additional services performed. The Audit Committee considers various issues with respect to the services to be provided by its independent accountant, including the complexity of any engagement, its expected cost, the knowledge and expertise of the independent accountant’s staff, any complex accounting or disclosure issues, new accounting pronouncements, and the capability of the Company’s financial staff.
The Audit Committee is responsible for appointing, setting compensation for and overseeing the work of the independent registered public accounting firm. The Audit Committee has established a policy requiring its pre-approval of all audit and permissible non-audit services provided by the independent registered public accounting firm, except for de minimis non-audit services that may be performed without pre-approval under applicable law. The Audit Committee has sole authority to make such approvals, although such approval may be delegated to any Committee member so long as the approval is presented to the full Committee at a later time.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
The following documents are filed as part of this report:
1. The Consolidated Financial Statements commencing on page.
2. The Financial Statement Schedule.
The following documents are filed as exhibits to this report:
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# Indicates management contract or compensatory plan or arrangement.
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SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 28, 2007
STEAKHOUSE PARTNERS, INC.
STEAKHOUSE PARTNERS, INC.
/s/ A. STONE DOUGLASS
/s/ JOSEPH L. WULKOWICZ
A. STONE DOUGLASS
JOSEPH L. WULKOWICZ
President, Chief Executive Officer, and
Vice President and Chief Financial Officer
Chairman of the Board of Directors
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints A. Stone Douglass and Joseph L. Wulkowicz, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.
In accordance with the requirements of the Exchange Act, this report is signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
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STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 2006, 2005 AND 2004
STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONTENTS
December 31, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Steakhouse Partners, Inc. and Subsidiaries
San Diego, California
We have audited the accompanying consolidated balance sheets of Steakhouse Partners, Inc. and its subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. We have also audited the financial statement schedule of valuation and qualifying accounts. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 2006 and 2005 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Steakhouse Partners, Inc. and its subsidiaries as of December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 4 to the consolidated financial statements, the Company has been unable to earn a profit during any year. The Company also maintained a current ratio of 0.15:1 and 0.21:1 for December 31, 2006 and 2005, respectively. Additionally, the Company had a working capital deficit of approximately $11,900,000 and $9,700,000 in 2006 and 2005, respectively. Those conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Mayer Hoffman McCann P.C.
San Diego, California
March 23, 2007
STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
ASSETS
STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
LIABILITIES AND STOCKHOLDERS’ EQUITY
STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
STEAKHOUSE PARTNERS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except shares)
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOW
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOW
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 1-COMPANY BACKGROUND AND OPERATIONS
Steakhouse Partners, Inc. (“Steakhouse”), a Delaware corporation, was incorporated on June 3, 1996 under the name “Texas Loosey’s Steakhouse & Saloon, Inc.” On December 19, 1996, the Board of Directors adopted a resolution to change its name to “Galveston’s Steakhouse Corp.” Up until December 21, 1998, Galveston’s Steakhouse Corp. owned two steakhouse restaurants and operated two others in Southern California, which together formerly comprised all of the restaurants known as “Texas Loosey’s Chili Parlor & Saloon” (“Texas Loosey’s”).
Galveston’s Steakhouse Corp. first acquired two Texas Loosey’s restaurants on August 19, 1996 pursuant to an Asset Purchase Agreement, dated April 10, 1996, which was subsequently amended on November 1, 1998, and closed escrow on the remaining two Texas Loosey’s restaurants on May 1, 1999.
On December 21, 1998, Galveston’s Steakhouse Corp. acquired Paragon Steakhouse Restaurants, Inc. and subsidiaries (Paragon of Michigan, Inc., Paragon of Nevada, Inc., and Paragon of Wisconsin, Inc.) (collectively, “PSR”) through its acquisition of all of the outstanding capital stock of PSR. PSR owns and operates restaurants located primarily throughout California, Arizona, and the Great Lakes Region. PSR also owned Pacific Basin Foods, Inc. (“PBF”), a company which was engaged in purchasing and selling food and other restaurant supplies to PSR and nonaffiliated companies. As discussed in Note 3, on October 11, 2002, PBF filed for protection under Chapter 7 of the United States Bankruptcy Court. PBF ceased operations effective as of the filing date.
During the year ended December 31, 1999, Galveston’s Steakhouse Corp.’s name was changed to Steakhouse Partners, Inc. (Steakhouse Partners, Inc. and its subsidiaries PSR and PBF are referred to herein collectively as the “Company.”)
On December 31, 2003, the effective date of the Company’s Plan of Reorganization (the “Plan”), all of the outstanding preferred stock, common stock, stock options, and warrants of the Company before confirmation were canceled and Steakhouse Investors, LLP (“Steakhouse Investors”) received 90% of the new common stock of the reorganized company in exchange for a full and complete release of the Company’s obligations under the Debtors in Possession agreement other than interest.
NOTE 2-GOING CONCERN
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the years ended December 31, 2006 and 2005, the Company maintained a current ratio of 0.15-to1 and 0.21-to-1, respectively. In addition, during the years ended December 31, 2006 and 2005, the Company had a working capital deficit of approximately $11.9 million and $9.7 million, respectively. The Company is negotiating with the trustee for the unsecured creditors to consolidate the debt, per the Plan. The company plans on refinancing the Plan debt by securing a term loan to satisfy the unsecured creditors who will provide a discount. Also, in fiscal 2005, the Company successfully completed the first phase (minimum) of a Private Placement for approximately $1.4 million. If the Company is unable to generate profits and unable to obtain additional financing for its working capital requirements, it may have to curtail its business sharply or cease business altogether.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company’s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to restructure its current financing, to obtain additional financing, and ultimately to attain profitability.
Management has evaluated its current operations, and it has focused the Company’s efforts and developed plans to generate operating income to continue the Company’s operations through the year ending December 31, 2007.
Management’s plans include the following:
•
Restructuring and consolidating its long-term debt position;
•
Improving the Company’s financial performance through local marketing sales generation, cost-reduction and restructuring of administrative overhead; and
•
Raising money through equity financings.
The Company continues to explore options with the trustee for the unsecured creditors to consolidate the debt, per its Plan of Reorganization, which was confirmed effective December 31, 2003 (the “Plan”). Currently, the Company plans on refinancing the Plan debt by securing a term loan to satisfy the unsecured creditors. Also, the Company and the Secured Creditor are in dialog regarding a revised payment schedule over a longer period of time so the payments conform more closely to available cash flow for the balance due on the their Note (currently at $863,627).
NOTE 3-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following discussion addresses the Company’s most critical accounting policies, which are those that are most important to the portrayal of the Company’s financial condition and results and that require significant judgment.
Principles of Consolidation
The Company’s consolidated financial statements include the accounts of Steakhouse and its subsidiary, PSR. Significant intercompany amounts and transactions have been eliminated in consolidation.
Fiscal Year-End
The Company reports its operations on a 52-53 week fiscal year ending on the Tuesday closest to December 31. For financial statement purposes, the Company reports all years as ending December 31 (the “fiscal year end”).
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Revenue Recognition
Revenues are generally recognized when services are rendered.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and in banks. The Company maintains its cash deposits at numerous banks located throughout the United States deposits at each bank are insured by the Federal Deposit Insurance Corporation up to $100,000. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risk on cash and cash equivalents.
Accounts Receivable
Accounts receivable consist primarily of amounts due from customers and credit card receivables. The Company has provided for an allowance for doubtful accounts, which management believes to be sufficient to account for all uncollectible amounts. Trade receivables are evaluated on an item-by-item basis and written off if deemed uncollectible.
Inventories
Inventories, consisting principally of food, beverages, and restaurant supplies, are valued at the lower of cost (first-in, first-out) or market.
Property, Plant, and Equipment
Property, plant, and equipment, including leasehold improvements, are recorded at cost, less accumulated depreciation and amortization. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets as follows:
Buildings: 20 years
Furniture, fixtures, and equipment: 5 years
Improvements to leased property are amortized over the lesser of the life of the lease or the life of the improvements. Amortization expense on assets acquired under capital leases is included with depreciation and amortization expense on owned assets.
Maintenance and minor replacements are charged to expense as incurred. Gains and losses on disposals are included in the results of operations.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future net cash flows expected to be generated by the assets. In evaluating long-lived assets for impairment, a number of factors are considered:
A) Restaurants sales trends;
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
B) Local competition;
C) Changing demographic profiles;
D) Local economic conditions;
E) New laws and government regulations that adversely effect sales and profits; and
F) The ability to recruit and train skilled restaurant employees.
If the assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets. During 2005 fiscal year, the Company recorded an impairment charge of $51,000 to reduce the fair value of the furniture, fixtures and equipment, located at its Troy, Michigan, location to net realizable values. No impairment was recorded for the year ended 2006.
Self-Insurance
In the past the Company was self-insured for certain losses related to general liability and workers’ compensation. The Company maintained stop loss coverage with third party insurers to limit its total exposure. The self-insurance liability represents an estimate of the ultimate cost of old claims incurred as of the balance sheet date. The estimated liability is based upon analysis of historical data and actuarial estimates, and is reviewed by the Company on a quarterly basis to ensure that the liability is appropriate. If for any reason in the final settlement of these old claims, the results differ from our estimates, our financial results could be impacted.
Goodwill
In June 2001, the FASB issued SFAS 141, “Business Combinations,” and SFAS 142, “Goodwill and Other Intangible Assets.” SFAS 141 superseded APB Opinion No. 16, “Business Combinations.” The provisions of SFAS 141 require that the purchase method of accounting be used for all business combinations initiated after June 30, 2001; provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill; and, require that unamortized negative goodwill be written off immediately as an extraordinary gain instead of being deferred and amortized. SFAS 141 also requires that upon adoption of SFAS 142, certain intangible assets be reclassified into or out of goodwill based on certain criteria. SFAS 142 supersedes APB Opinion No. 17, Intangible Assets, and is effective for fiscal years beginning after December 15, 2001. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. The provisions of SFAS 142 prohibit the amortization of goodwill and indefinite-lived intangible assets and require that such assets be tested annually for impairment (and in interim periods if events or circumstances indicate that the related carrying amount may be impaired), require that reporting units be identified for purposes of assessing potential impairments, and remove the forty-year limitation on the amortization period of intangible assets that have finite lives.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
SFAS 142 requires that goodwill be tested for impairment using a two-step process. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test must be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
Identifiable Intangible Assets
The identifiable intangible assets consist of the tradenames (Carvers, Hungry Hunter’s, Hunter’s Steakhouse, Mountain Jack’s, Carvers Creek, Cliffhouse, The Whaling Company and Tippecanoe Place) valued at approximately $13.9 million. The Company has determined the tradenames to have an indefinite useful life and therefore is not amortizing the balance. In accordance with FAS 142, the Company will review the useful life each reporting period, and will test the asset for impairment at least annually, or more frequently if there are indications that the asset is impaired. No impairment existed as of December 31, 2006.
Unearned Revenue
The Company sells gift cards and recognizes a liability, which is included in unearned revenue, for gift cards outstanding until the gift cards is redeemed or considered to be unredeemable. These gift cards do not carry an expiration date, so if all outstanding gift cards are redeemed at once, our financial results (cash) would be impacted.
Deferred Rent
The leases on various facilities include certain rent relief and scheduled increasing monthly payments thereafter. In accordance with accounting principles generally accepted in the United States of America, the Company has accounted for these leases to provide for even charges to operations over the lives of the leases.
Stock-Based Compensation
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective method and therefore has not restated results for prior periods. Under this transition method, the Company recognizes compensation expense for all stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimate in accordance with the provisions of SFAS 123R.
Prior to the adoption of SFAS 123R on January 1, 2006, the Company recognized stock-based compensation in accordance with APB 25, and provided pro forma disclosure amounts in accordance with SFAS 148, as if the fair value method defined by SFAS 123 had been applied to its stock-based compensation. Under the fair value recognition provisions of SFAS 123R, the Company recognizes stock-based compensation expense for those shares expected to vest on a straight-line basis over the requisite service period of the award.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of subjective assumptions. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and the Company uses different assumptions, our stock-based compensation expense could be materially different in the future. See Note 8 to the Consolidated Financial Statements for a further discussion on stock-based compensation.
The Company is required to disclose the pro forma effect of accounting for stock options based on the fair value method. The Company uses the Black-Scholes option-pricing model to calculate the fair value of options. The table below represents a reconciliation of the Company’s pro forma net loss giving effect to the estimated compensation expense related to stock options that would have been reported if the Company utilized the fair value:
The Company recognizes stock-based compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. For the fifty-two weeks ended December 31, 2006, total stock-based compensation expense included in the consolidated statements of operations was approximately $0.57 million.
The Company has a 100% valuation allowance recorded against its deferred tax assets; therefore the stock-based compensation has no tax effect on the consolidated statement of operations.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The weighted-average fair value per share of options granted during fiscal 2005 and 2004 was $0.13 and $1.62, respectively, using the Black-Scholes option-pricing model with the following assumptions:
The weighted average fair value per share of options granted in 2006 is $0.32, using the Black-Scholes options pricing model with the following valuation assumptions:
Expected Volatility - The volatility factor is based on the Company’s historical stock price fluctuations for a period matching the expected life of the options.
Dividend Yield - The Company has not, and does not, intend to pay dividends.
Risk-free Interest Rate - The Company applies the risk-free interest rate based on the U.S. Treasury yield in effect at the time of the grant.
Expected Term in Years - The expected term is based upon management’s consideration of the historical life of options, the vesting period of the option granted and the contractual period of the option granted.
Forfeitures - Stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.
Fair Value of Financial Instruments
For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, the carrying amounts approximate fair value due to their short maturities. The amounts shown for notes payable also approximate fair value because current interest rates offered to the Company for debt of similar maturities are substantially the same.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Advertising and Promotional Costs
Advertising and promotional costs are charged to expense as incurred. Advertising and promotional costs for the fiscal years ended 2006, 2005 and 2004, were $0.7 million, $0.7 million, and $0.9 million respectively.
Direct Operating Costs
Direct operating costs consist of those direct costs associated with operating the restaurant locations, exclusive of depreciation and amortization expense.
Income Taxes
The Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.
Net Loss Per Share
The Company utilizes SFAS No. 128, “Earnings per Share.” Basic loss per share is computed by dividing loss available to common stockholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive. As such, basic and diluted loss per share is the same.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Recently Issued Accounting Pronouncement
In July 2006, the FASB issued FASB Interpretation No. 48, (“FIN 48”), Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes, (“SFAS No. 109”). This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of adopting FIN 48 on its consolidated financial statements.
In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements (“FAS 157”), which defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States America, and expands disclosures about fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to the opening balance of retained earnings. The Company is currently evaluating the impact of adopting FAS 157 on its consolidated financial statements.
On September 29, 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (“FAS 158”). Upon adoption, this standard requires an employer to recognize the funded status of its pension and other postretirement benefit plans in the statement of financial position. Changes in the funded status of the plans will be recognized in the period in which they occur as a component of comprehensive income, net of tax. This standard also requires an employer to measure the funded status of its plans as of the end of its fiscal year. FAS 158 became effective for the company in the fourth quarter of 2006, except for the provisions regarding the required change in measurement date, which are effective for fiscal years ending after December 15, 2008. The Company is currently evaluating FAS 158 to determine the potential impact of its adoption on the consolidated financial statements.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 4-PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment consisted of the following (in thousands):
Depreciation and amortization expense was $1.3 million; $1.3 million and $1.2 million for the fiscal years ended December 2006, 2005 and 2004, respectively. Depreciation includes amortization of property and buildings under capital leases of approximately $0.6 million, $0.6 million and $0.6 million for the fiscal years ended 2006, 2005 and 2004, respectively. During fiscal year 2005, the Company recorded an impairment charge of $0.05 million to reduce the fair value of the furniture, fixtures and equipment, located at its Troy, Michigan, location to net realizable values.
During 2004, the Company completed the sale of four restaurant leases and related property, plant and equipment for gross proceeds of $0.6 million. The sale of these restaurants was conducted through the Company’s bankruptcy proceeding and was not finalized until February 2004. As a result of the Company’s adoption of “fresh start” accounting as of December 31, 2003, the gain realized by the Company in connection with this transaction has been recorded as a reduction of goodwill.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 5-NOTES PAYABLE
Notes payable consisted of the following (in thousands):
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE 5-NOTES PAYABLE (CONTINUED)
As of December 31, 2006, the Company is in arrears on the Secured loan and has not made payments since June 2006, amounting to $0.25 million in principle and $0.03 million in interest.
Notes payable future payments:
NOTE 6-COMMITMENTS AND CONTINGENCIES
Leases
The Company leased land and building sites for its restaurant operations. These leases had initial terms generally ranging from 10 to 35 years and, in certain instances, provide for renewal options ranging from five to 25 years. Certain of these leases required additional (contingent) rental payments by the Predecessor Company if sales volumes at the related restaurants exceed specified levels. Most of these lease agreements required payments of taxes, insurance, and maintenance costs by the Company.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
The Company also leased restaurant and transportation equipment under operating and capital leases. Those leases had initial terms generally ranging from four to seven years and required a fixed monthly payment or, in the case of transportation equipment, additional payments on a per mile basis.
Future minimum lease payments for all leases with initial or remaining terms of one year or more at December 31, 2006 were as follows (in thousands):
For the fiscal years ended 2006, 2005, and 2004, rent expense was $2.7 million, $2.6 million, and $2.6 million respectively.
Self Insurance
There are two outstanding general liability claims the Company still has potential liability for, and as of December 31, 2006, the maximum liability could be $0.06 million. The Company believes at this point the claims are fully reserved.
Supplier Concentration
During 2006, the Company had a major vendor that accounted for approximately $4.95 million (11%) of the Company’s total purchases. At December 31, 2006, the amount payable to this vendor was approximately $0.3 million. During 2005, the Company had a major vendor that accounted for approximately $5.0 million (11%) of the Company’s total purchases. At December 31, 2005, the amount payable to this vendor was approximately $0.2 million. The Company did not have any supplier concentrations in 2004. While the Company believes other suppliers are available if the vendor unexpectedly stops supplying the product, the Company could experience an interruption in its ability to supply its customers.
STEAKHOUSE PARTNERS, INC
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
Litigation
The Company is periodically a defendant in cases involving personal injury and other matters that arise in the normal course of business. While any pending or threatened litigation has an element of uncertainty, the Company believes that the outcome of any pending lawsuits or claims, individually or combined, will not materially affect the financial condition or results of operations.
Employment Agreements
On April 16, 2004, the Company’s Board of Directors ratified the decisions of the Compensation Committee to enter into employment agreements with three executives for three-year terms and adopted the 2004 Stock Option Incentive Plan, subject to shareholder approval.
The employment agreements with the three executive officers require annual gross salary payments of $200,000, $156,000 and $150,000 respectively, for the three executives each of whom may be terminated without cause. However, in the event any agreement is terminated without cause, the Company is obligated to pay twelve months salary to the executive. The employment agreements also provide a set number of stock options subject to shareholder approval of the 2004 Stock Incentive Plan and an annual bonus for specific performance criteria, subject to the approval of the Compensation Committee of the Board of Directors.
NOTE 7-STOCKHOLDERS’ EQUITY
Preferred Stock
The Company has authorized 5.0 million shares of preferred stock, which may be issued from time to time in one or more series by the Board of Directors. In addition, the Board is authorized to set the rights, preferences, privileges, and restrictions of these shares, including dividend rights, conversion rights, voting rights, and liquidation preferences. These shares may have rights senior to those of the Company’s common stock holders. As of December 31, 2006, the Company did not have any preferred shares outstanding.
Common Stock and Warrants
On January 19, 2005, in a transaction exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) of such Act and Regulation D promulgated thereunder, the Company completed an initial closing with respect to the sale, pursuant to the Private Placement Memorandum, of 700,000 shares of common stock and common stock purchase warrants (the “Warrants”) to purchase 350,000 shares of common stock, at an initial exercise price of $2.00 per share (the “Exercise Price”), for an aggregate of $1,050,000 of gross proceeds (the “Private Placement”). Following the delivery of the Company’s audited financial statements for the year ended December 31, 2005 (“Fiscal 2005”), the Exercise Price of the Warrants were reduced to $1.00 per share based on the Company’s earnings from recurring operations before interest payments, income tax, depreciation and amortization (“EBITDA”) for
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DECEMBER 31, 2006
Fiscal 2005. The Exercise Price was adjusted as follows upon the date of exercise: (i) increased by 5% (but in no event will the Exercise Price exceed $2.50) for every $100,000 by which EBITDA for Fiscal 2005 exceeds $3.5 million (the “EBITDA Threshold”) and (ii) decreased by 10% (but in no event will the Exercise Price be less than $1.00) for every $100,000 by which Fiscal 2005 EBITDA is below the EBITDA Threshold.
In connection with the common stock offering described above, The Company paid to an advisor engaged in connection with such offerings (the “Agent”) commissions of $94,500 (nine percent (9%) of the gross proceeds raised in such offerings) and issued to the Agent five (5) year warrants to purchase 63,000 shares of common stock (the “Agent Warrant Shares”) at an exercise price of $2.00 per share. The Company also granted to the Agent certain registration rights with respect to the Agent Warrant Shares. Following the delivery of the Company’s audited financial statements for the year ended December 31, 2005 (“Fiscal 2005”), the Exercise Price of the Warrants were reduced to $1.78 per share.
The Company is required to disclose the pro forma effect of warrants based on the fair value method. The value of the warrants using the Black-Scholes pricing model is $46,215. The weighted-average assumptions to derive that value are: dividend yield of 0%, expected volatility of 35%, risk-free interest rate 3.4%, and expected life of five years.
On April 7, 2005 in a transaction exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) of such Act and Regulation D promulgated there under, the Company issued to an investor 173,915 shares of common stock and warrants (the “April Warrants”) to purchase 86,958 shares of common stock (the “April Warrant Shares”), at an initial exercise price of $2.00 per share (the “April Exercise Price”), in full and complete satisfaction of the Company’s obligation to pay such investor $200,002.25. Following the delivery of the Company’s audited financial statements for Fiscal 2005, the April Exercise Price of the April Warrants was decrease to $1.00 per share based on the Company’s EBITDA for Fiscal 2005. The April Exercise Price was adjusted as follows upon the date of exercise: (i) increased by 5% (but in no event will the April Exercise Price exceed $2.50) for every $100,000 by which EBITDA for Fiscal 2005 exceeds $3.5 million and (ii) decreased by 10% (but in no event will the Exercise Price be less than $1.00) for every $100,000 by which Fiscal 2005 EBITDA is below the EBITDA Threshold.
On September 30, 2005, in a transaction exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) of such Act and Regulation D promulgated there under, the Company completed an initial closing with respect to the sale of 761,765 shares of common stock for an aggregate of $647,500 of gross proceeds (the “Offering”). The Shares contain certain price protection provisions. The Shares were issued with restricted security legends.
In connection with the Common Stock offering described above, the Company paid to an advisor engaged in connection with such offerings (the “Agent”) commissions of $58,275 nine percent (9%) of the gross proceeds raised in such offerings) and issued to the Agent five (5) year warrants to purchase 68,559 shares of common stock (the “Agent Warrant Shares”) at an exercise price of $1.0625 per share.
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DECEMBER 31, 2006
The Company is required to disclose the pro forma effect of warrants based on the fair value method. The value of the warrants using the Black-Scholes pricing model is $13,239. The weighted-average assumptions to derive that value are: dividend yield of 0%, expected volatility of 50%, risk-free interest rate 4.2%, and expected life of five years.
On November 3, 2006, the registration statement that the Company was required to file (by September 2005) pursuant to the registration rights agreement we entered into in January 2005 and April 2005 was declared effective.
NOTE 8-STOCK-BASED COMPENSATION
The 2004 Stock Incentive Plan (the “Incentive Plan”) was approved by the Company’s Board of Directors in April 2004 and by the Company’s shareholders in January 2005. The Incentive Plan was intended to attract and retain persons eligible to participate in the Incentive Plan, to motivate Participants to achieve long-term Company goals and to further align participants’ interest with those of the Company’s other stockholders. The number of shares available under the Incentive Plan may automatically increase on January 1 of each year during the term of the Incentive Plan, at the discretion of the Board, by a number equal to the lesser of (i) 25% of the fully diluted total number of shares of common stock then outstanding, or (ii) 2,000,000 shares. Options vest over a period determined by the Board of Directors and expire up to ten years from the date of grant. The exercise price of options granted under the Incentive Plan are determined by the Board of Directors, provided that the exercise price is not less than fair market value of the Reorganized Company’s common stock on the date of grant.
At December 31, 2006 there were 140,000 shares available for grant under the 2004 Stock Option Incentive Plan. Stock option activity during the periods indicated was as follows:
As of December 31, 2006, 2005 and 2004, the number of options exercisable was 928,333, 492,582 and 0, respectively, and the weighted average exercise prices of those options were 1.11, 1.11 and 0, respectively.
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DECEMBER 31, 2006
The following table sets forth information regarding options outstanding and exercisable under the Option Plans at December 31, 2006:
As of April 2004, the Company granted options to purchase in the aggregate 1,075,000 shares of common stock to employees and two members of its board of directors with an exercise price of $1.11 per share. One-third of the options become exercisable on the last day of each year starting April 1, 2005. The Company recorded deferred compensation charge of $1.544 million, in connection with the issuance as the exercise price of the stock options was less than the fair market value of the Company’s stock price as of the date of grant. The Company amortized the deferred compensation charge over the vesting period of the options. During 2005 and 2004 the Company expensed approximately $0.388 million and $0.5 million, respectively. The Company adopted SFAS 123R effective January 1, 2006 and as a result the remaining unearned deferred compensation was reclassified to additional paid in capital. The unvested portion is now being accounted for under the provisions of SFAS 123R.
As of December 2005, the Company granted options to purchase 250,000 shares of common stock to one of its stockholders for services to be rendered over a period of two years. The options have an exercise price of $1.11 per share. One-third of the options were vested immediately upon grant with the remaining two-thirds vesting on the last day of each year starting March 1, 2006. The Company uses the fair value method to measure the value of stock-based compensation issued to non-employees in accordance with SFAS 123 and EITF Issue No. 96-18. In accordance with such pronouncements all transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, which ever is more reliable measurable. In connection with the issuance, the Company determined that the fair value of the stock options granted was a more reliable measure of value than the value of consideration received. In accordance with SFAS 123R and EITF Issue No. 96-18 the Company recalculated the fair value of these stock options granted to a stockholder.
The weighted average fair value per share of these options in 2006 is $0.28, using the Black-Scholes options pricing model with the following valuation assumptions:
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DECEMBER 31, 2006
Consistent with the adoption of the fair value recognition provisions of SFAS 123R and based on the Company’s historical experience, the Company estimates that 30,000 options currently outstanding will be forfeited.
The aggregate intrinsic value of options outstanding and exercisable at December 31, 2006 was $0.08 million and $0.0 respectively. The aggregate intrinsic value represents the total intrinsic value based on the Company’s average stock price of $0.53 during the twelve months ended December 31, 2006.
A summary of the Company’s unvested stock options as of December 31, 2006 and changes during the twelve months ended December 31, 2006, were as follows:
As of December 31, 2006, there was approximately $0.345 million of total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Option Plans. The cost is expected to be recognized over a weighted-average period of one and a half years.
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DECEMBER 31, 2006
NOTE 9-INCOME TAXES
Significant components of the provision for taxes based on income for the fiscal years ended 2006, 2005 and 2004 were as follows (in thousands):
A reconciliation of the provision for income tax expense with the expected income tax computed by applying the federal statutory income tax rate to income before provision for income taxes for the fiscal years ended 2006, 2005, and 2004 was as follows:
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DECEMBER 31, 2006
Significant components of the Company’s deferred tax assets and liabilities for federal income taxes consisted of the following at the fiscal years ended 2006 and 2005 (in thousands):
The Company has net operating loss carry-forwards of approximately $5.8 million for federal and $6.7 million for state, which will expire through 2025.
In addition, the Company has Federal credit carry-forwards of about $1.5 million, which will expire through 2025.
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DECEMBER 31, 2006
NOTE 10-QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following tables list the Company’s quarterly financial information for the fiscal years ended 2006, 2005, and 2004 (in thousands, except per share amounts):
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DECEMBER 31, 2006
NOTE 11-SUBSEQUENT EVENTS (Unaudited)
On February 9, 2007, Mr. Scott Avila, Trustee representing the Company’s Unsecured Creditors, was elected to the Board of Directors. Pursuant to the terms of the Company’s Plan of Reorganization and collateral agreements between the Company and the Trust, the Trust has had the right, among other things, to Board representation. The Trust Committee determined to seek a representative on the Board of Directors, and upon notice to the Company, Mr. Avila was appointed.
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VALUATION AND QUALIFYING ACCOUNTS-SCHEDULE II
Year Ended December 31, 2006, 2005, 2004
(in thousands)
SUPPLEMENTAL INFORMATION