UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTIONS 13 AND 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2006
Commission file number 0-14030
New York 13-3156768
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
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Registrant's telephone number, including area code: (212) 206-8800
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the
Act: Common Stock, par value $0.01.
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No __
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes __ No _X_
Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes __ No _X_
The aggregate market value at December 14, 2006 of shares of the Registrant's Common Stock, $.01 par value (based upon the closing price per share of such stock on the Nasdaq National Market) held by non-affiliates of the Registrant was approximately $62,721,035. Solely for the purposes of this calculation, shares held by directors and officers of the Registrant have been excluded. Such exclusion should not be deemed a determination or an admission by the Registrant that such individuals are, in fact, affiliates of the Registrant.
At December 14, 2006, there were outstanding 3,569,299 shares of the Registrant's Common Stock, $.01 par value.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant's definitive proxy statement to be filed not later than 120 days after the end of the fiscal year covered by this form are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Report.
On one or more occasions, we may make statements in this Annual Report on Form
10-K regarding our assumptions, projections, expectations, targets, intentions
or beliefs about future events. All statements, other than statements of
historical facts, included or incorporated by reference herein relating to
management's current expectations of future financial performance, continued
growth and changes in economic conditions or capital markets are forward looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934.
Words or phrases such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "projects," "targets," "will likely result," "hopes," "will continue" or similar expressions identify forward looking statements. Forward-looking statements involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed. We caution that while we make such statements in good faith and we believe such statements are based on reasonable assumptions, including without limitation, management's examination of historical operating trends, data contained in records and other data available from third parties, we cannot assure you that our projections will be achieved. Factors that may cause such differences include: economic conditions generally and in each of the markets in which we are located, the amount of sales contributed by new and existing restaurants, labor costs for our personnel, fluctuations in the cost of food products, adverse weather conditions, changes in consumer preferences and the level of competition from existing or new competitors.
We have attempted to identify, in context, certain of the factors that we believe may cause actual future experience and results to differ materially from our current expectation regarding the relevant matter of subject area. In addition to the items specifically discussed above, our business, results of operations and financial position and your investment in our common stock are subject to the risks and uncertainties described in "Item 1A Risk Factors" of this Annual Report on Form 10-K.
From time to time, oral or written forward-looking statements are also included in our reports on Forms 10-K, 10-Q and 8-K, our Schedule 14A, our press releases and other materials released to the public. Although we believe that at the time made, the expectations reflected in all of these forward-looking statements are and will be reasonable, any or all of the forward-looking statements in this Annual Report on Form 10-K, our reports on Forms 10-Q and 8-K, our Schedule 14A and any other public statements that are made by us may prove to be incorrect. This may occur as a result of inaccurate assumptions or as a consequence of known or unknown risks and uncertainties. Many factors discussed in this Annual Report on Form 10-K, certain of which are beyond our control, will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from forward-looking statements. In light of these and other uncertainties, you should not regard the inclusion of a forward-looking statement in this Annual Report on Form 10-K or other public communications that we might make as a representation by us that our plans and objectives will be achieved, and you should not place undue reliance on such forward-looking statements.
We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, your attention is directed to any further disclosures made on related subjects in our subsequent periodic reports filed with the Securities and Exchange Commission on Forms 10-Q and 8-K and Schedule 14A.
Unless the context requires otherwise, references to "we," "us," "our," "ARKR" and the "Company" refer specifically to Ark Restaurants Corp. and its subsidiaries and predecessor entities.
ITEM 1. BUSINESS
Overview
We are a New York corporation formed in 1983. As of the fiscal year ended September 30, 2006, we owned and/or operated 23 restaurants and bars, 25 fast food concepts, catering operations, and wholesale and retail bakeries through its subsidiaries. Initially our facilities were located only in New York City. As of the fiscal year ended September 30, 2006, seven of our restaurants are located in New York City, four are located in Washington, D.C., eight are located in Las Vegas, Nevada, two are located in Atlantic City, New Jersey, and two are located at the Foxwoods Resort Casino in Ledyard, Connecticut. As of the fiscal year ended September 30, 2006, our Las Vegas operations included:
-- three restaurants within the New York-New York Hotel & Casino Resort, and operation of the resort's room service, banquet facilities, employee dining room and nine food court operations;
-- two restaurants, two bars and three food court facilities at the Venetian Casino Resort; and
-- one restaurant within the Forum Shops at Caesar's Shopping Center.
In 2004, we established operations in Florida which include five fast food facilities in Tampa, Florida and eight fast food facilities in Hollywood, Florida, each at a Hard Rock Hotel and Casino operated by the Seminole Indian Tribe at these locations. All pre-opening expenses were borne by outside investors who invested in a limited liability company established to develop, construct, operate and manage these facilities. We are the managing member of this limited liability company and, through this limited liability company, we lease and manage the operations of each of these facilities in exchange for a monthly management fee equal to five-percent of the gross receipts of these facilities. Neither us nor any of our subsidiaries contributed any capital to this limited liability company. None of the obligations of this limited liability company are guaranteed by us and investors in this limited liability company have no recourse against us or any of our assets.
In December 2005, we established operations in Atlantic City, New Jersey by opening a bar, LUNA LOUNGE, and a separate restaurant, a GALLAGHER'S STEAKHOUSE, in the Resorts Atlantic City Hotel and Casino.
During the fiscal year ended September 30, 2006, we established operations at the Foxwoods Resort Casino in Ledyard, Connecticut by opening a restaurant, THE FIFTH STREET CAFE, in its newly expanded poker room in March 2006 and a fast-casual restaurant, LUCKY SEVEN, in the Bingo Hall in May 2006. All pre-opening expenses were borne by outside investors who invested in a limited liability company established to develop, construct, operate and manage these facilities. We are the managing member of this limited liability company and, through this limited liability company, we lease and manage the operations of each of these facilities in exchange for a monthly management fee equal to five-percent of the gross receipts of these facilities. Neither we nor any of our subsidiaries contributed any capital to this limited liability company. None of the obligations of this limited liability company are guaranteed by us and investors in this limited liability company have no recourse against us or any of our assets.
In addition to the shift from a Manhattan-based operation to a multi-city operation, the nature of the facilities operated by us has shifted from smaller, neighborhood restaurants to larger, destination restaurants intended to benefit from high patron traffic attributable to the uniqueness of the restaurant's location. Most of our restaurants which are in operation and which have been opened in recent years are of the latter description. As of the fiscal year ended September 30, 2006, these include the restaurant operations at the New York-New York Hotel & Casino in Las Vegas, Nevada (1997); the STAGE DELI located at the Forum Shops in Las Vegas, Nevada; RED, located at the South Street Seaport in New York
(1998); THUNDER GRILL in Union Station, Washington, D.C. (1999); two restaurants and four food court facilities at the Venetian Casino Resort in Las Vegas, Nevada (2000); the 13 fast food facilities in Tampa, Florida and Hollywood, Florida, respectively (2004); the GALLAGHER'S STEAKHOUSE and LUNA LOUNGE in the Resorts Atlantic City Hotel and Casino in Atlantic City, New Jersey (2005); and THE FIFTH STREET CAFE and the fast-casual restaurant in the Bingo Hall at the Foxwoods Resort Casino in Ledyard, Connecticut (2006).
Further, in September 2006, we entered into an agreement to lease a to be named Mexican restaurant at the to be developed Planet Hollywood Resort and Casino (formerly known as the Aladdin Resort and Casino) in Las Vegas, Nevada, and entered into an agreement to purchase the restaurant known as the DURGIN PARK RESTAURANT AND THE BLACK HORSE TAVERN in Boston, Massachusetts. The obligation to pay rent for the to be named Mexican restaurant is not effective until the restaurant opens for business. We anticipate this restaurant to open during our third quarter of the 2007 fiscal year. The agreement to purchase the DURGIN PARK facility provides that we cannot take possession of the restaurant until we obtain a liquor license for the facility. We are currently in the process of obtaining such liquor license.
Finally, in December 2006, we expanded our operations at the Foxwoods Resort Casino by opening THE GRILL AT TWO TREES in the Two Trees Inn, a facility owned by the Mashantucket Pequot Tribal Nation and a part of the Foxwoods Resort Casino, in Ledyard, Connecticut.
The names and themes of each of our restaurants are different except for our two AMERICA restaurants, two SEQUOIA restaurants, two GONZALEZ Y GONZALEZ restaurants and two GALLAGHER'S STEAKHOUSE restaurants. The menus in our restaurants are extensive, offering a wide variety of high quality foods at generally moderate prices. Of our restaurants owned or managed as of September 30, 2006, only the LUTECE restaurant may be classified as expensive. The LUTECE restaurant was closed effective December 3, 2006. The atmosphere at many of the restaurants is lively and extremely casual. Most of the restaurants have separate bar areas. A majority of our net sales are derived from dinner as opposed to lunch service. Most of the restaurants are open seven days a week and most serve lunch as well as dinner.
While decor differs from restaurant to restaurant, interiors are marked by distinctive architectural and design elements which often incorporate dramatic interior open spaces and extensive glass exteriors. The wall treatments, lighting and decorations are typically vivid, unusual and, in some cases, highly theatrical.
The following table sets forth the facilities we lease and operate as of September 30, 2006:
Seating
Capacity(2)
Year Restaurant Size Indoor- Lease
Name Location Opened(1) (Square Feet) (Outdoor) Expiration(3)
---- -------- --------- ------------- --------- -------------
Metropolitan First Avenue 1982 4,000 180(50) 2006
Cafe(4) (between 52nd and 53rd
Streets)
New York, New York
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Seating
Capacity(2)
Year Restaurant Size Indoor- Lease
Name Location Opened(1) (Square Feet) (Outdoor) Expiration(3)
---- -------- --------- ------------- --------- -------------
Gonzalez y Broadway 1989 6,000 250 2007
Gonzalez (between Houston and
Bleecker Streets)
New York, New York
America Union Station 1989 10,000 400(50) 2009
Washington, D.C.
Center Cafe Union Station 1989 4,000 200 2009
Washington, D.C.
Sequoia Washington Harbour 1990 26,000 600(400) 2017
Washington, D.C.
Sequoia South Street Seaport 1991 12,000 300(100) 2008
New York, New York
Canyon Road First Avenue 1984 2,500 130 2014
(between 76th and 77th
Streets) New York, New York
Columbus Columbus Avenue 1988 3,000 75 2012
Bakery (between 82nd and 83rd
Streets)
New York, New York
Bryant Park Bryant Park 1995 25,000 180(820) 2025
Grill & Cafe(5) New York, New York
Columbus First Avenue 1995 2000 75 2006
Bakery(4) (between 52nd and 53rd
Streets)
New York, New York
America(6) New York-New York Hotel 1997 20,000 450 2017
and Casino
Las Vegas, Nevada
Gallagher's New York-New York 1997 5,500 260 2017
Steakhouse(6) Hotel & Casino
Las Vegas, Nevada
Gonzalez y New York-New York 1997 2,000 120 2017
Gonzalez(6) Hotel & Casino
Las Vegas, Nevada
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Seating
Capacity(2)
Year Restaurant Size Indoor- Lease
Name Location Opened(1) (Square Feet) (Outdoor) Expiration(3)
---- -------- --------- ------------- --------- -------------
Village Eateries New York-New York 1997 6,300 400(*) 2017
(6)(7) Hotel & Casino
Las Vegas, Nevada
The Grill Room (8) World Financial Center 1997 10,000 250 2011
New York, New York
The Stage Deli Forum Shops 1997 5,000 200 2008
Las Vegas, Nevada
Red South Street Seaport 1998 7,000 150(150) 2013
New York, New York
Thunder Grill Union Station 1999 10,000 500 2019
Washington, D.C.
Venetian Food Venetian Casino Resort 1999 3,980 300(*) 2014
Court(9) Las Vegas, Nevada
Tsunami Venetian Casino Resort 1999 13,000 300 2019
Grill(10)(11) Las Vegas, Nevada
Lutece(10) Venetian Casino Resort 1999 6,400 90(90) 2019
Las Vegas, Nevada
Vivid(12) Venetian Casino Resort 2001 9,700 250 2019
Las Vegas, Nevada
V-Bar Venetian Casino Resort 2000 3,000 100 2015
Las Vegas, Nevada
Gallagher's Resorts Atlantic City 2005 6,280 196 2020
Steakhouse Hotel and Casino
Atlantic City, New Jersey
Luna Lounge Resorts Atlantic City 2005 2,270 114 2020
Hotel and Casino
Atlantic City, New Jersey
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(1) Restaurants are, from time to time, renovated, renamed and/or converted from or to managed or owned facilities. "Year Opened" refers to the year in which we, or an affiliated predecessor of us, first opened, acquired or began managing a restaurant at the applicable location, notwithstanding that the restaurant may have been renovated, renamed and/or converted from or to a managed or owned facility since that date.
(2) Seating capacity refers to the seating capacity of the indoor part of a restaurant available for dining in all seasons and weather conditions. Outdoor seating capacity, if applicable, is set forth in parentheses and refers to the seating capacity of terraces and sidewalk cafes which are available for dining only in the warm seasons and then only in clement weather.
(3) Assumes the exercise of all available lease renewal options.
(4) These leases were terminated at the landlord's option effective October 1, 2006.
(5) The lease governing a substantial portion of the outside seating area of this restaurant expires on April 30, 2012.
(6) Includes two five-year renewal options exercisable by us if certain sales goals are achieved during the two year period prior to the exercise of the renewal option. Under the AMERICA lease, the sales goal is $6.0 million. Under the Gallagher's STEAKHOUSE lease the sales goal is $3.0 million. Under the lease for GONZALEZ Y GONZALEZ and the VILLAGE Eateries, the combined sales goal is $10.0 million. Each of the restaurants is currently operating at a level substantially in excess of the minimum sales level required to exercise the renewal option for each respective restaurant.
(7) We operate eight small food court restaurants in the VILLAGES EATERIES food court at the New York-New York Hotel & Casino. We also operate that hotel's room service, banquet facilities and employee cafeteria.
(8) This restaurant experienced damage in the attack on the World Trade Center on September 11, 2001. In addition, substantial damage was sustained by the World Financial Center in which the restaurant is located. The restaurant closed on September 11, 2001 and reopened in early December 2002.
(9) Our landlord for this facility paid us $200,000 for the unamortized portion of the non-removable improvements located in the facility and closed this facility on August 10, 2006.
(10) These restaurants were sold effective December 1, 2006.
(11) We shall continue to operate this restaurant until December 31, 2006.
(12) This bar changed its name from Venus to Vivid in January 2005.
(*) Represents common area seating.
The following table sets forth the facilities managed by us as of September 30, 2006:
Seating
Capacity(2)
Year Restaurant Size Indoor- Lease
Name Location Opened(1) (Square Feet) (Outdoor) Expiration(3)
---- -------- --------- ------------- --------- -------------
El Rio Grande Third Avenue 1987 4,000 160 2014
(4)(5) (between 38th and 39th
Streets)
New York, New York
The Saloon(6) Neonopolis Center 2002 6,000 200 2014
at Fremont Street
Las Vegas, Nevada
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Seating
Capacity(2)
Year Restaurant Size Indoor- Lease
Name Location Opened(1) (Square Feet) (Outdoor) Expiration(3)
---- -------- --------- ------------- --------- -------------
Tampa Food Hard Rock Hotel and 2004 4,000 250(*) 2029
Court(7) Casino
Tampa, Florida
Hollywood Food Hard Rock Hotel and 2004 5,000 250(*) 2029
Court(7) Casino
Hollywood, Florida
Fifth Street Foxwoods Resort Casino 2006 4,825 68 2026
Cafe(7) Ledyard, Connecticut
Lucky Seven(7) Foxwoods Resort Casino 2006 6,858 4,000 (**) 2026
Ledyard, Connecticut
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(1) Restaurants are, from time to time, renovated, renamed and/or converted from or to managed or owned facilities. "Year Opened" refers to the year in which we, or an affiliated predecessor of us, first opened, acquired or began managing a restaurant at the applicable location, notwithstanding that the restaurant may have been renovated, renamed and/or converted from or to a managed or owned facility since that date.
(2) Seating capacity refers to the seating capacity of the indoor part of a restaurant available for dining in all seasons and weather conditions. Outdoor seating capacity, if applicable, is set forth in parentheses and refers to the seating capacity of terraces and sidewalk cafes which are available for dining only in the warm seasons and then only in clement weather.
(3) Assumes the exercise of all available lease renewal options.
(4) Management fees earned are based on a percentage of cash flow of the restaurant.
(5) We own a 19% interest in the partnership that owns EL RIO GRANDE.
(6) We received $7,000 per month for managing the restaurant. This restaurant closed effective July 25, 2006.
(7) Management fees earned are based on a percentage of gross sales of the restaurant(s).
(*) Represents common area seating.
(**) Represents number of seats in the Bingo Hall.
Revenues from facilities managed by us are not included in our consolidated sales.
Restaurant Expansion
We opened a GALLAGHER'S STEAKHOUSE restaurant in the Resorts Atlantic City Hotel and Casino in Atlantic City, New Jersey in December 2005.
During the fiscal year ended September 30, 2006, we established operations at the Foxwoods Resort Casino in Ledyard, Connecticut by opening a restaurant, THE FIFTH STREET CAFE, in its newly expanded poker room in March 2006 and a fast-casual restaurant, LUCKY SEVEN, in the Bingo Hall in May 2006. All pre-opening expenses were borne by outside investors who invested in a limited liability company established to develop, construct, operate and manage these facilities. We are the managing member of this limited liability company and, through this limited liability company, we lease and manage the operations of each of these facilities in exchange for a monthly management fee equal to five-percent of the gross receipts of these facilities. Neither we nor any of our subsidiaries contributed any capital to this limited liability company. None of the obligations of this limited liability company are guaranteed by us and investors in this limited liability company have no recourse against us or any of our assets.
In addition, in September 2006, we entered into an agreement to lease a to be named Mexican restaurant at the to be developed Planet Hollywood Resort and Casino (formerly known as the Aladdin Resort and Casino) in Las Vegas, Nevada, and entered into an agreement to purchase the restaurant known as the DURGIN PARK RESTAURANT AND THE BLACK HORSE TAVERN in Boston, Massachusetts. The obligation to pay rent for the to be named Mexican restaurant is not effective until the restaurant opens for business. We anticipate this restaurant to open during our third quarter of the 2007 fiscal year. The agreement to purchase the DURGIN PARK facility provides that we cannot take possession of the restaurant until we obtain a liquor license for the facility. We are currently in the process of obtaining such liquor license.
Finally, in December 2006, we expanded our operations at the Foxwoods Resort Casino by opening THE GRILL AT TWO TREES in the Two Trees Inn, a facility owned by the Mashantucket Pequot Tribal Nation and a part of the Foxwoods Resort Casino, in Ledyard, Connecticut.
The opening of a new restaurant is invariably accompanied by substantial pre-opening expenses and early operating losses associated with the training of personnel, excess kitchen costs, costs of supervision and other expenses during the pre-opening period and during a post-opening "shake out" period until operations can be considered to be functioning normally. The amount of such pre-opening expenses and early operating losses can generally be expected to depend upon the size and complexity of the facility being opened. We incurred $15,000 in pre-opening expenses in fiscal 2006.
Our restaurants generally do not achieve substantial increases in revenue from year to year, which we consider to be typical of the restaurant industry. To achieve significant increases in revenue or to replace revenue of restaurants that lose customer favor or which close because of lease expirations or other reasons, we would have to open additional restaurant facilities or expand existing restaurants. There can be no assurance that a restaurant will be successful after it is opened, particularly since in many instances we do not operate our new restaurants under a trade name currently used by us, thereby requiring new restaurants to establish their own identity.
Apart from these agreements, we are not currently committed to any projects. We may take advantage of opportunities we consider to be favorable, when they occur, depending upon the availability of financing and other factors.
Recent Restaurant Dispositions and Charges
We entered into a sale and leaseback agreement with GE Capital in November 2000 to refinance the purchase of various restaurant equipment at our food and beverage facilities at Desert Passage, the retail
complex at the Aladdin Resort & Casino in Las Vegas, Nevada. In 2002, the operations at the Aladdin were abandoned. The lease matured in November 2005 and, in connection therewith, we made an unprovided for lump sum payment of $142,000 due under this lease. This lump sum payment is included in discontinued operations.
In fiscal 2003, we determined that our restaurant, Lutece, located in New York City, had been impaired by the events of September 11th and the continued weakness in the economy. Based upon the sum of the future undiscounted cash flows related to our long-lived fixed assets at Lutece, we determined that impairment had occurred. To estimate the fair value of such long-lived fixed assets, for determining the impairment amount, we used the expected present value of the future cash flows. We projected continuing negative operating cash flow for the foreseeable future with no value for subletting or assigning the lease for the premises. As a result, we determined that there was no value to the long-lived fixed assets. We had an investment of $667,000 in leasehold improvements, furniture fixtures and equipment. We believed that these assets would have nominal value upon disposal and recorded an impairment charge of $667,000 during fiscal 2003. Due to continued weak sales, we closed Lutece during the second quarter of 2004. We recorded a net operating loss of $27,000 during the fiscal year ended September 30, 2006 which is included in losses from discontinued operations. In fiscal 2004, we also incurred a one-time charge of $470,000 related to pension plan contributions required in connection with the closing of Lutece which is payable monthly over a nine year period beginning May 17, 2004 and bears interest at a rate of 8% per annum.
On December 1, 2003, we sold a restaurant, Lorelei, for approximately $850,000. The book value of inventory, fixed assets, intangible assets and goodwill related to this entity was approximately $625,000. We recorded a gain on the sale of approximately $225,000 during the first quarter of fiscal 2004.
Our restaurant, Ernie's, located on the upper west side of Manhattan opened in 1982. As a result of a steady decline in sales, we felt that a new concept was needed at this location. The restaurant was closed June 16, 2003 and reopened in August 2003. Total conversion costs were approximately $350,000. Sales at the new restaurant, La Rambla, failed to reach the level sufficient to achieve the results we required. As a result, we sold this restaurant on January 1, 2004 and realized a gain on the sale of this restaurant of approximately $214,000. Net operating income of $5,000 was included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Our restaurant Jack Rose located on the west side of Manhattan has experienced weak sales for several years. In addition, this restaurant did not fit our desired profile of being in a landmark destination location. As a result, we sold this restaurant on February 23, 2004. We realized a loss on the sale of this restaurant of $137,000 which was recorded during the second quarter of fiscal 2004. Net operating losses of $3,000 were included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Our restaurant, America, located in New York City has experienced declining sales for several years. In March 2004, we entered into a new lease for this restaurant at a significantly increased rent. We entered into this lease with the belief that due to the location and the uniqueness of the space the lease had value. On January 19, 2005, we signed a definitive agreement for the sale of this restaurant which closed on March 15, 2005. We realized a pre-tax gain of $644,000 on the sale of this restaurant. Net operating losses of $12,000 were included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Our bar/nightclub facility Venus, located at the Venetian Casino Resort, experienced a steady decline in sales and we felt that a new concept was needed at this location. During the first quarter of 2005, this
bar/nightclub facility was closed for re-concepting and re-opened as "Vivid" on February 4, 2005. Total conversion costs were approximately $400,000. Sales at the new bar/nightclub facility have failed to reach the level sufficient to achieve the results we required and we have identified a buyer for this facility. As of December 31, 2005, we classified the assets and liabilities of this bar/nightclub facility as "held for sale" in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") based on the fact that the facility has met the criteria under SFAS No. 144. Based on the initial offers made on this facility, we do not anticipate a loss on the sale. Net operating losses of $486,000 are included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Effective August 22, 2004, our lease for The Saloon at the Neonopolis Center at Fremont Street was converted into a management agreement whereby we received a management fee of $7,000 per month regardless of the results of operations of this restaurant. In June 2006, the owner of the Neonopolis Center at Fremont Street sold the building to a new entity who, on June 25, 2006, exercised its option to terminate the management agreement upon thirty days written notice to us.
On July 6, 2006, the landlord for the Vico's Burrito's fast food facility at the Venetian Casino Resort, General Growth Properties, notified us that the landlord was exercising an option granted to it pursuant to the lease for the facility to terminate the lease in exchange for the landlord providing us with the unamortized portion of the non-removable improvements located in the facility. On August 10, 2006, we and our landlord for this facility entered into a letter agreement pursuant to which the landlord agreed to pay us $200,000 for the unamortized portion of the non-removable improvements located in the facility. We realized a pre-tax loss of $70,000 on the closure of this restaurant. Net operating income of $35,000 is included in losses from discontinued operations for the fiscal year ended September 30, 2006.
As a result of the above mentioned sales or closures, we allocated $75,000 of goodwill to these restaurants and reduced goodwill by this amount in fiscal 2005.
Effective December 1, 2006, our subsidiaries that lease each of Lutece, Tsunami and our Vivid location at The Venetian Resort Hotel Casino in Las Vegas, Nevada, have entered into an agreement to sell Lutece, Tsunami and a portion of the Vivid location used by Lutece as a prep kitchen to Venetian Casino Resort, LLC for an aggregate of $14,000,000. Our Lutece location closed as of the close of business on December 3, 2006 and it is contemplated that our Tsunami location will close at the end of the calendar year. We do not anticipate a loss on the sale of these restaurants.
Restaurant Management
Each restaurant is managed by its own manager and has its own chef. Food products and other supplies are purchased primarily from various unaffiliated suppliers, in most cases by our headquarters' personnel. Our Columbus Bakery supplies bakery products to most of our New York City restaurants in addition to operating a retail bakery. Our Columbus Bakery in Las Vegas supplies bakery products to most of our Las Vegas restaurants in addition to operating a wholesale bakery. Each of our restaurants has two or more assistant managers and sous chefs (assistant chefs). Financial and management control is maintained at the corporate level through the use of automated systems that include centralized accounting and reporting.
Purchasing and Distribution
We strive to obtain quality menu ingredients, raw materials and other supplies and services for our operations from reliable sources at competitive prices. Substantially all menu items are prepared on each
restaurant's premises daily from scratch, using fresh ingredients. Each restaurant's management determines the quantities of food and supplies required and orders the items from local, regional and national suppliers on terms negotiated by our centralized purchasing staff. 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.
We attempt to negotiate short-term and long-term supply agreements depending on market conditions and expected demand. However, we do not contract for long periods of time for our fresh commodities such as produce, poultry, meat, fish and dairy items and, consequently, such commodities can be subject to unforeseen supply and cost fluctuations. Independent foodservice distributors deliver most food and supply items daily to restaurants. The financial impact of such supply agreements would not have a material adverse effect on our financial position.
Employees
At December 10, 2006, we employed 2,117 persons (including employees at managed facilities), 1,544 of whom were full-time employees, 573 of whom were part-time employees, 30 of whom were headquarters personnel, 214 of whom were restaurant management personnel, 586 of whom were kitchen personnel and 1,287 of whom were restaurant service personnel. A number of our restaurant service personnel are employed on a part-time basis. Changes in minimum wage levels may affect our labor costs and the restaurant industry generally because a large percentage of restaurant personnel are paid at or slightly above the minimum wage. Our employees are not covered by a collective bargaining agreement.
Government Regulation
We are subject to various federal, state and local laws affecting our business. Each restaurant is subject to licensing and regulation by a number of governmental authorities that may include alcoholic beverage control, health, sanitation, environmental, zoning and public safety agencies in the state or municipality in which the restaurant is located. Difficulties in obtaining or failures to obtain the required licenses or approvals could delay or prevent the development and openings of new restaurants, or could disrupt the operations of existing restaurants.
Alcoholic beverage control regulations require each of our restaurants to apply to a state authority and, in certain locations, county and municipal authorities for licenses and permits to sell alcoholic beverages on the premises. Typically, licenses must be renewed annually and may be subject to penalties, temporary suspension or revocation for cause at any time. Alcoholic beverage control regulations impact many aspects of the daily operations of our restaurants, including the minimum ages of patrons and employees consuming or serving such beverages; employee alcoholic beverages training and certification requirements; hours of operation; advertising; wholesale purchasing and inventory control of such beverages; seating of minors and the service of food within our bar areas; and the storage and dispensing of alcoholic beverages. State and local authorities in many jurisdictions routinely monitor compliance with alcoholic beverage laws. The failure to receive or retain, or a delay in obtaining, a liquor license for a particular restaurant could adversely affect our ability to obtain such licenses in jurisdictions where the failure to receive or retain, or a delay in obtaining, a liquor license occurred.
We are subject to "dram-shop" statutes in most of the states in which we have operations, which generally provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to such person. We carry liquor liability coverage as part of our existing comprehensive general liability insurance. A settlement or judgment against us under a "dram-shop" statute in excess of liability coverage could have a material adverse effect on our operations.
Various federal and state labor laws govern our operations and our relationship with employees, including such matters as minimum wages, breaks, overtime, fringe benefits, safety, working conditions and citizenship requirements. We are also subject to the regulations of the Immigration and Naturalization Service (INS). If our employees do not meet federal citizenship or residency requirements, this could lead to a disruption in our work force. Significant government-imposed increases in minimum wages, paid leaves of absence and mandated health benefits, or increased tax reporting, assessment or payment requirements related to employees who receive gratuities could be detrimental to our profitability.
Our facilities must comply with the applicable requirements of the Americans With Disabilities Act of 1990 ("ADA") and related state statutes. The ADA prohibits discrimination on the basis of disability with respect to public accommodations and employment. Under the ADA and related state laws, when constructing new restaurants or undertaking significant remodeling of existing restaurants, we must make them more readily accessible to disabled persons.
The New York State Liquor Authority must approve any transaction in which a shareholder of the licensee increases his holdings to 10% or more of the outstanding capital stock of the licensee and any transaction involving 10% or more of the outstanding capital stock of the licensee.
Seasonal Nature Of Business
Our business is highly seasonal. The second quarter of our fiscal year, consisting of the non-holiday portion of the cold weather season in New York and Washington (January, February and March), is the poorest performing quarter. We achieve our best results during the warm weather, attributable to our extensive outdoor dining availability, particularly at BRYANT PARK in New York and SEQUOIA in Washington, D.C. (our largest restaurants) and our outdoor cafes. However, even during summer months these facilities can be adversely affected by unusually cool or rainy weather conditions. Our facilities in Las Vegas generally operate on a more consistent basis through the year.
Terrorism and International Unrest
The terrorist attacks on the World Trade Center in New York and the Pentagon in Washington, D.C. on September 11, 2001 had a material adverse effect on our revenues. As a result of the attacks, one of our restaurants, THE GRILL ROOM, located at 2 World Financial Center, which is adjacent to the World Trade Center, experienced some damage. THE GRILL ROOM was closed from September 11, 2001 and reopened in early December 2002.
Our restaurants in New York, Las Vegas, Washington D.C. and Florida benefit from tourist traffic. Though the Las Vegas market has shown resiliency, the sluggish economy and the lingering effects of September 11, 2001 have had an adverse effect on our restaurants. Recovery depends upon a general improvement in economic conditions and the public's willingness and inclination to resume vacation and convention travel. Additional acts of terrorism in the United States or substantial international unrest may have a material adverse effect on our business and revenues.
ITEM 1A. RISK FACTORS.
The following are the most significant risk factors applicable to us:
OUR UNFAMILIARITY WITH NEW MARKETS MAY PRESENT RISKS, WHICH COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FUTURE GROWTH AND PROFITABILITY.
Due to higher operating costs caused by temporary inefficiencies typically associated with expanding into new regions and opening new restaurants, such as lack of market awareness and acceptance and limited availability of experienced staff, continued expansion may result in an increase in our operating costs. New markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets, which may cause our restaurants in these new markets to be less successful than our restaurants in our existing markets. We cannot assure you that restaurants in new markets will be successful.
Our ability to open new restaurants efficiently is subject to a number of factors beyond our control, including:
-- Selection and availability of suitable restaurant sites;
-- Negotiation of acceptable lease or purchase terms for such sites;
-- Negotiation of reasonable construction contracts and adequate supervision of construction;
-- Our ability to secure required governmental permits and approvals for both construction and operation;
-- Availability of adequate capital;
-- General economic conditions; and
-- Adverse weather conditions.
We may not be successful in addressing these factors, which could adversely affect our ability to open new restaurants on a timely basis, or at all. Delays in opening or failures to open new restaurants could cause our business, results of operations and financial condition to suffer.
TERRORISM AND WAR MAY HAVE MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, and other acts of violence or war in the United States or abroad, such as the war in Iraq, may affect the markets in which we operate and our business, results of operations and financial conditions. The potential near-term and long-term effects these events may have on our business operations, our customers, the markets in which we operate and the economy is uncertain. Because the consequences of any terrorist attacks, or any armed conflicts, are unpredictable, we may not be able to foresee events that could have an adverse effect on our markets or our business.
OUR PROFITABILITY IS DEPENDENT IN LARGE MEASURE ON FOOD, BEVERAGE 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, beverage and supply costs. Various factors beyond our control, including climatic changes and government regulations, may affect food and beverage 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, results of operations and financial condition.
THE RESTAURANT INDUSTRY IS AFFECTED BY CHANGES IN CONSUMER PREFERENCES AND DISCRETIONARY SPENDING PATTERNS THAT COULD RESULT IN A REDUCTION IN OUR REVENUES.
Consumer preferences could be affected by health concerns or by specific events such as the outbreak of or scare caused by "mad cow disease", the popularity of the Atkins diet and the South Beach diet and changes in consumer preferences, such as "carb consciousness". If we were to have to modify our restaurants' menus, we may lose customers who would be less satisfied with a modified menu, and we may not be able to attract a new customer base to generate the necessary revenues to maintain our income from restaurant operations. A change in our menus may also result in us having different competitors. We may not be able to successfully compete against established competitors in the general restaurant market. Our success also depends on various factors affecting discretionary consumer spending, including economic conditions, disposable consumer income, consumer confidence and the United States participation in military activities. Adverse changes in these factors could reduce our customer base and spending patterns, either of which could reduce our revenues and results of operations.
OUR GEOGRAPHIC CONCENTRATIONS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
We currently operate in six regions, New York City, Washington, D.C., Las Vegas, Nevada, Tampa and Hollywood, Florida, Atlantic City, New Jersey and Ledyard, Connecticut, and our Las Vegas, Florida, Atlantic City, and Connecticut operations are all located in casinos. We also expect to take over the Durgin Park location in Boston, Massachusetts in the second quarter of 2007. As a result, we are particularly susceptible to adverse trends and economic conditions in these markets, including its labor market, and the casino market in general, which could have a negative impact on our profitability as a whole. In addition, given our geographic concentration, negative publicity regarding any of our restaurants could have a material adverse effect on our business, results of operations and financial condition, as could other regional occurrences such as acts of terrorism, local strikes, natural disasters or changes in laws or regulations.
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;
-- Adverse weather;
-- 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;
-- Economic conditions generally and in each of the market in which we are located; and
-- Acceptance of a new or modified concept in each of the new markets in which we could be 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 business, results of operations and financial condition.
ANY EXPANSION MAY STRAIN OUR INFRASTRUCTURE, WHICH COULD SLOW RESTAURANT DEVELOPMENT.
Any expansion may place a strain on our management systems, financial controls, and information systems. To manage growth effectively, we must maintain the high level of quality and service at our existing and future restaurants. We must also continue to enhance our operational, information, financial and management systems and locate, hire, train and retain qualified personnel, particularly restaurant managers. We cannot predict whether we will be able to respond on a timely basis to all of the changing demands that any expansion will impose on management and those systems and controls. If we are not able to effectively manage any one or more of these or other aspects of expansion, our business, results of operations and financial condition could be materially adversely affected.
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 business, results of operations and financial condition. 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.
UNANTICIPATED COSTS OR DELAYS IN THE DEVELOPMENT OR CONSTRUCTION OF FUTURE RESTAURANTS COULD PREVENT OUR TIMELY AND COST-EFFECTIVE OPENING OF NEW RESTAURANTS.
We depend on contractors and real estate developers to construct our restaurants. Many factors may adversely affect the cost and time associated with the development and construction of our restaurants, including:
-- Labor disputes;
-- Shortages of materials or skilled labor;
-- Adverse weather conditions;
-- Unforeseen engineering problems;
-- Environmental problems;
-- Construction or zoning problems;
-- Local government regulations;
-- Modifications in design; and
-- Other unanticipated increases in costs.
Any of these factors could give rise to delays or cost overruns, which may prevent us from developing additional restaurants within our anticipated budgets or time periods or at all. Any such failure could cause our business, results of operations and financial condition to suffer.
WE MAY NOT BE ABLE TO OBTAIN AND MAINTAIN NECESSARY FEDERAL, STATE AND LOCAL PERMITS WHICH COULD DELAY OR PREVENT THE OPENING OF FUTURE RESTAURANTS.
Our business is subject to extensive federal, state and local government regulations, including regulations relating to:
-- Alcoholic beverage control;
-- The purchase, preparation and sale of food;
-- Public health and safety;
-- Sanitation, building, zoning and fire codes; and
-- Employment and related tax matters.
All of these regulations impact not only our current operations but also our ability to open future restaurants. We will be required to comply with applicable state and local regulations in new locations into which we expand. Any difficulties, delays or failures in obtaining licenses, permits or approvals in such new locations could delay or prevent the opening of a restaurant in a particular area or reduce operations at an existing location, either of which would materially and adversely affect our business, results of operations and financial condition.
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 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 may materially adversely affect us and our restaurants, regardless of whether such allegations are true or whether we are ultimately held liable. Such litigation, adverse publicity or damages could have a material adverse effect on our competitive position, business, results of operations and financial condition and results of operations.
MANY OF OUR OPERATIONS ARE LOCATED IN CASINOS AND MUCH OF OUR SUCCESS WILL BE DEPENDENT ON THE SUCCESS OF THOSE CASINOS.
The success of the business of our restaurants located in Las Vegas, Nevada, Atlantic City, New Jersey, Tampa and Hollywood, Florida, and Ledyard, Connecticut will be substantially dependent on the success of the casinos in which the company operates in these locations to attract customers for themselves and for our restaurants. The successful operation of the casinos in these locations is subject to various risks and uncertainties including:
-- The risk associated with governmental approvals of gaming;
-- The risk of a change in laws regulating gaming operations;
-- Operating in a limited market;
-- Competitive risks relating to casino operations; and
-- Risks of terrorism and war.
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 common stock is concentrated in the hands of a small number of individual and institutional investors and is thinly traded. An attempt to sell by a large holder could adversely affect the price of our stock.
OWNERSHIP OF APPROXIMATELY 66% OF OUR OUTSTANDING COMMON STOCK BY TWELVE STOCKHOLDERS WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE MATTERS.
A substantial majority of our capital stock is held by a limited number of stockholders. Twelve stockholders, including our officers and directors and parties affiliated with or related to such persons or to us, own approximately 66% of the shares of common stock outstanding. 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.
THE PRICE OF OUR COMMON STOCK MAY FLUCTUATE SIGNIFICANTLY.
The price at which our common stock will trade may fluctuate significantly. The stock market has from time to time experienced significant price and volume fluctuations. The trading price of our common stock could be subject to wide fluctuations in response to a number of factors, including:
-- Fluctuations in quarterly or annual results of operations;
-- Changes in published earnings estimates by analysts and whether our actual earnings meet or exceed such estimates;
-- Additions or departures of key personnel; and
-- Changes in overall stock market conditions, including the stock prices of other restaurant companies.
In the past, companies that have experienced extreme fluctuations in the market price of their stock have been the subject of securities class action litigation. If we were to be subject to such litigation, it could result in substantial costs and a diversion of our management's attention and resources, which may have a material adverse effect on our business, results of operations, and financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2. PROPERTIES
Our restaurant facilities and our executive offices are occupied under leases. Most of our restaurant leases provide for the payment of base rents plus real estate taxes, insurance and other expenses and, in certain instances, for the payment of a percentage of our sales at such facility. As of September 30, 2006,
these leases (including leases for managed restaurants) have terms (including any available renewal options) expiring as follows:
Years Lease Number of Terms Expire Facilities ------------ ---------- 2006-2010 7 2011-2015 8 2016-2020 11 2021-2025 1 2026-2030 4 |
Our executive, administrative and clerical offices are located in approximately 8,500 square feet of office space at 85 Fifth Avenue, New York, New York. Our lease for this office space expires in 2015.
Our lease for office space related to our Washington, D.C. catering operations expires in 2012.
For information concerning our future minimum rental commitments under non-cancelable operating leases, see Note 7 of the Consolidated Financial Statements.
See also "Item 1. Business - Overview" for a list of restaurant properties.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, we are a party to various lawsuits arising from accidents at our restaurants and workers' compensation claims, which are generally handled by our insurance carriers.
Our employment of management personnel, waiters, waitresses and kitchen staff at a number of different restaurants has resulted in the institution, from time to time, of litigation alleging violation by us of employment discrimination laws. We do not believe that any of such suits will have a materially adverse effect upon us, our financial condition or operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names and ages of our executive officers and all offices held by each person:
Name Age Positions and Offices
---- --- ---------------------
Michael Weinstein 63 Chairman, President and Chief
Executive Officer
Vincent Pascal 63 Senior Vice President
Robert Towers 59 Executive Vice President, Chief
Operating Officer and Treasurer
Paul Gordon 55 Senior Vice President
Robert Stewart 50 Chief Financial Officer
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Each of our executive officers serves at the pleasure of the Board of Directors and until his successor is duly elected and qualifies.
Michael Weinstein has been our President and a director since our inception in January 1983. During the past five years, Mr. Weinstein has been an officer, director and 25% shareholder of Easy Diners, Inc., RSWB Corp. and BSWR Corp. (since 1998). Mr. Weinstein is the owner of 24% of the membership interests in each of Dockeast, LLC and Dockwest, LLC. These companies operate four restaurants in New York City, and none of these companies is a parent, subsidiary or other affiliate of us. Mr. Weinstein spends substantially all of his business time on Company-related matters.
Vincent Pascal was elected our Vice President, Assistant Secretary and a director in October 1985. Mr. Pascal became a Senior Vice President in 2001.
Robert Towers has been employed by us since November 1983 and was elected Vice President, Treasurer and a director in March 1987. Mr. Towers became an Executive Vice President and Chief Operating Officer in 2001.
Paul Gordon has been employed by us since 1983 and was elected as a director in November 1996 and a Senior Vice President in 2001. Mr. Gordon is the manager of our Las Vegas operations. Prior to assuming that role in 1996, Mr. Gordon was the manager of our operations in Washington, D.C. since 1989.
Robert Stewart has been employed by us since June 2002 and was elected Chief Financial Officer effective as of June 24, 2002. For the three years prior to joining us, Mr. Stewart was a Chief Financial Officer and Executive Vice President at Fortis Capital Holdings. For eleven years prior to joining Fortis Capital Holdings, Mr. Stewart held senior financial and audit positions in Skandinaviska Enskilda Banken in their New York, London and Stockholm offices.
PART II
Market Information
Our Common Stock, $.01 par value, is traded in the over-the-counter market on the Nasdaq National Market under the symbol "ARKR." The high and low sale prices for our Common Stock from September 27, 2003 through September 30, 2005 are as follows:
Calendar 2004 High Low ------------- ---- --- Fourth Quarter $ 39.22 $ 27.07 Calendar 2005 ------------- First Quarter 41.88 29.61 Second Quarter 32.80 25.52 Third Quarter 34.59 27.26 Fourth Quarter 31.23 26.70 Calendar 2006 ------------- First Quarter 30.50 27.00 Second Quarter 30.50 27.11 Third Quarter 28.57 23.09 |
A quarterly cash dividend in the amount of $0.35 per share was declared on October 12, 2004. Subsequent to October 12, 2004, quarterly cash dividends in the amount of $0.35 per share were declared on January 12, April 12, July 12 and October 11, 2005 and on January 12, April 12, July 12, October 10, 2006 and December 20, 2006. In addition, we declared a special cash dividend in the amount of $3.00 per share on December 20, 2006. Prior to this, we had not paid any cash dividends since our inception. We intend to continue to pay such quarterly cash dividend for the foreseeable future, however, the payment of future dividends is at the discretion of our Board of Directors and is based on future earnings, cash flow, financial condition, capital requirements, changes in U.S. taxation and other relevant factors.
On August 22, 2006, our Board of Directors authorized a stock repurchase program under which up to four million dollars of our common stock may be acquired in the open market over the twelve months following such authorization at our discretion.
The shares may be purchased from time to time at prevailing market prices through open market or unsolicited negotiated transactions, depending on market conditions. Under the program, the purchases are to be funded from available working capital, and the repurchased shares will be held in treasury or used for ongoing stock issuances. At September 30, 2006, no shares had been purchased by us under the program. There is no guarantee as to the exact number of shares which we will repurchase, and we may discontinue the program at any time.
As of December 14, 2006, there were 40 holders of record of our Common Stock, $.01 par value. This does not include the number of persons whose stock is in nominee or "street name" accounts through brokers.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth certain financial data for the fiscal years ended in 2002 through 2006. During fiscal year 2004, we sold three of our restaurants and closed one restaurant. During fiscal year 2005, we sold one of our restaurants which was considered held for sale in accordance with FAS 144 during part of fiscal year 2004 and part of fiscal year 2005. During fiscal year 2006, we classified one of our restaurants as held for sale in accordance with FAS 144 and closed one restaurant. The operations of these restaurants have been presented as discontinued operations for the 2004, 2005 and 2006 fiscal years, and we have reclassified its statements of operations data for all periods presented, in accordance with FAS 144. This information should be read in conjunction with our Consolidated Financial Statements and the notes thereto beginning at page F-1.
YEARS ENDED
--------------------------------------------------------------------------------
SEPTEMBER 30, OCTOBER 1, OCTOBER 2, SEPTEMBER 27, SEPTEMBER 28,
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA:
Total revenues $ 115,969 $ 113,237 $ 112,271 $ 99,153 $ 99,709
Cost and expenses (108,253) (104,127) (102,824) (94,069) (92,663)
Operating income 7,716 9,110 9,447 5,084 7,046
Other (income) expense, net (795) (748) (542) (404) 611
Income from continuing operations
before provision for income taxes 8,511 9,858 9,989 5,488 7,657
Provision for income taxes 2,824 3,048 2,757 1,325 1,617
Income from continuing operations 5,687 6,810 7,232 4,163 6,040
Loss from discontinued
operations before benefit for
income taxes (699) (334) (794) (1,113) (787)
Benefit for income taxes (232) (103) (219) (269) (198)
Loss from discontinued operations (467) (231) (575) (844) (589)
NET INCOME 5,220 6,579 6,657 3,319 5,451
NET INCOME (LOSS) PER SHARE:
Continuing operations basic $ 1.64 $ 1.98 $ 2.19 $ 1.31 $ 1.52
Discontinued operations basic $ (0.14) $ (0.06) $ (0.18) $ (0.27) $ (0.19)
--------- --------- --------- --------- ---------
Net basic $ 1.50 $ 1.92 $ 2.01 $ 1.04 $ 1.33
Continuing operations diluted $ 1.60 $ 1.92 $ 2.10 $ 1.30 $ 1.50
Discontinued operations diluted $ (0.13) $ (0.07) $ (0.17) $ (0.27) $ (0.18)
--------- --------- --------- --------- ---------
Net diluted $ 1.47 $ 1.85 $ 1.93 $ 1.03 $ 1.32
Weighted average number of shares
Basic 3,472 3,436 3,305 3,181 3,181
Diluted 3,548 3,555 3,444 3,213 3,206
BALANCE SHEET DATA
(end of period):
Total assets $ 52,120 $ 47,435 $ 44,894 $ 43,635 $ 47,960
Working capital (deficit) 8,398 3,399 1,893 (4,802) (7,990)
Long-term debt -- -- 7,226 9,547
Shareholders' equity 39,753 37,413 34,200 24,826 21,446
Shareholders' equity per share 11.45 10.89 10.35 7.80 6.74
Facilities in operation--end of year,
Owned 43 44 45 40 40
Managed 5 4 3 1 1
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Accounting period
Our fiscal year ends on the Saturday nearest September 30. We report fiscal years under a 52/53-week format. This reporting method is used by many companies in the hospitality industry and is meant to improve year-to-year comparisons of operating results. Under this method, certain years will contain 53 weeks. The fiscal year ended October 1, 2005 and September 30, 2006 each included 52 weeks. The fiscal year ended October 2, 2004 included 53 weeks.
Overview
We have reclassified our statements of operations data for the prior periods presented below, in accordance with FAS 144, as a result of the sale of three of our restaurants and the closure of one restaurant during the fiscal year ended October 2, 2004, the sale of another restaurant during the fiscal year ended October 1, 2005 and the classification of another restaurant as held for sale and the closure of one restaurant during the fiscal year ended September 30, 2006. The operations of these restaurants have been presented as discontinued operations for the fiscal years ended October 2, 2004, October 1, 2005 and September 30, 2006. See "Item 1 -Recent Restaurant Dispositions and Charges", "Item 7 - Recent Restaurant Dispositions" and Note 2 of Consolidated Financial Statements.
Revenues
Total revenues increased by 2.4% from fiscal 2005 to fiscal 2006 and increased by 0.9% from fiscal 2004 to fiscal 2005. Revenues for fiscal 2006 were reduced by $1,159,000 and revenues for fiscal 2005 were reduced by $4,010,000 as a result of the sale of one facility, the classification of one facility as "held for sale", the closure of one facility and their reclassification to discontinued operations.
Same store sales increased 0.2%, or $244,000, on a Company-wide basis from fiscal 2005 to fiscal 2006. Same store sales in Las Vegas decreased by $63,000, or 0.1%, in fiscal 2006 compared to fiscal 2005 generally because of less than expected business at the Venetian Casino Resort. We sold our Tsunami and Lutece locations at the Venetian Casino Resort effective December 1, 2006. Same store sales in New York increased $1,862,000, or 5.8%, during fiscal 2006. Same store sales in Washington D.C. decreased by $1,364,000, or 7.6%, during fiscal 2006. The increase in New York was principally due to a general improvement in economic conditions and the public's willingness and inclination to resume vacation and convention travel. The decrease in Washington D.C. was principally due to poor weather.
During the fourth quarter of 2002 we abandoned our restaurant and food court operations at the Desert Passage, the retail complex at the Aladdin Resort & Casino in Las Vegas. From fiscal 2002 to fiscal 2001 sales decreased at this location from $4,999,000 to $2,853,000, or 42.9%, resulting in our decision to abandon these operations.
Of the $5,219,000 decrease in revenues from fiscal 2001 to fiscal 2002, $3,282,000 is attributable to the year long closure of the GRILL ROOM restaurant located in 2 World Financial Center, an office building adjacent to the World Trade Center site. This restaurant was damaged in the September 11, 2001 attack and reopened in early fiscal 2003. A $256,000 increase in sales is attributable to the opening of the SALOON at the Neonopolis Center in downtown Las Vegas.
Other operating income, which consists of the sale of merchandise at various restaurants, management fee income and door sales were $2,423,000 in fiscal 2006, $1,826,000 in fiscal 2005 and $742,000 in fiscal 2004.
Costs and Expenses
Food and beverage cost of sales as a percentage of total revenue was 25.3% in fiscal 2006, 25.2% in fiscal 2005 and 25.8% in fiscal 2004.
Total costs and expenses increased by $4,126,000, or 4.0%, from fiscal 2005 to fiscal 2006 primarily due to an increase in the minimum wage in New York and Washington, D.C., a $748,000 expense related to our share-based compensation plan and increased occupancy costs.
Total costs and expenses increased by $1,303,000, or 1.3%, from fiscal 2004 to fiscal 2005. The increase in the minimum wage in New York and Washington, D.C., the cost of compliance with the Sarbanes-Oxley Act and increased energy costs contributed to this increase. Other operating costs and expenses also increased in fiscal 2004 due to an increase in total revenue and a one time charge of $270,000 used to pay for casino entertainment tax liability. We had previously thought that certain of our operations at the VENETIAN HOTEL RESORT CASINO were exempt from casino entertainment tax due to the fact that such operations were not on the casino floor. As subsequent tax ruling by tax authorities determined that such operations were subject to casino entertainment tax and we determined to include such charge in other operating costs and expenses.
Payroll expenses as a percentage of total revenues was 32.3% in fiscal 2006 compared to 31.4% in fiscal 2005 and 31.5% in fiscal 2004. Payroll expense was $37,418,000, $35,550,000 and $35,363,000 in fiscal 2006, 2005 and 2004, respectively. In fiscal 2003, we had aggressively adapted our cost structure in response to lower sales expectations following September 11th. Due to the increase in sales during fiscal 2004, we had increased our payroll expenses incrementally. In fiscal 2005 and 2006, the increase of the minimum wage in New York and Washington, D.C. resulted in an increase in payroll expenses. We continually evaluate our payroll expenses as they relate to sales.
We typically incur significant pre-opening expenses in connection with our new restaurants that are expensed as incurred. Furthermore, it is not uncommon that such restaurants experience operating losses during the early months of operation.
In fiscal 2006, we established operations in Atlantic City, New Jersey by opening a bar, LUNA LOUNGE, and a separate restaurant, a GALLAGHER'S STEAKHOUSE, in the Resorts Atlantic City Hotel and Casino. We experienced $447,000 in pre-opening and early operating losses at these facilities in fiscal 2006. Further during fiscal 2006, we established operations at the Foxwoods Resort Casino in Ledyard, Connecticut by opening a restaurant, THE FIFTH STREET CAFE, in its newly expanded poker room in March 2006 and a fast-casual restaurant, LUCKY SEVEN, in the Bingo Hall in May 2006. All pre-opening expenses were borne by outside investors who invested in a limited liability company established to develop, construct, operate and manage these facilities. We did not open any new restaurants and no pre-opening expenses and early operating losses were incurred during fiscal 2005 and 2004.
General and administrative expenses, as a percentage of total revenue, were 6.2% in fiscal 2006, 6.5% in fiscal 2005 and 5.8% in fiscal 2004. The decrease in these expenses as a percentage of total revenue during fiscal 2004 is primarily due to increased total revenue during this period.
During the fiscal year ended September 30, 2006, we managed two restaurants we did not own (THE SALOON and EL RIO GRANDE) and also managed our Tampa and Hollywood Florida food court operations and our Foxwoods operations. We managed two restaurants we did not own (THE SALOON and EL RIO GRANDE) and also managed the Tampa and Hollywood Florida food court operations at October 1, 2005. We managed two restaurants we did not own (THE SALOON and EL RIO GRANDE) at October 2, 2004. Sales of EL RIO GRANDE, which are not included in consolidated sales, were $3,519,000 in fiscal 2006, $3,345,000 in fiscal 2005 and $2,786,000 in fiscal 2004. Our lease of THE SALOON was converted into a management agreement effective as of August 22, 2004, whereby we received a management fee of $7,000 per month regardless of the results of operations of this restaurant. This restaurant closed effective July 25, 2006. During fiscal 2004, we entered into agreements to manage 11 fast food restaurants located in the Hard Rock Casinos in Hollywood and Tampa, Florida. Sales from these operations totaled $10,469,000 during the 2006 fiscal year and $8,843,000 during the 2005 fiscal year. During fiscal 2006, we established operations at the Foxwoods Resort Casino in Ledyard, Connecticut by managing a restaurant, THE FIFTH STREET CAFE, in its newly expanded poker room in March 2006 and a fast-casual restaurant, LUCKY SEVEN, in the Bingo Hall in May 2006. Sales from these operations totaled $2,389,000 during the 2006 fiscal year.
Interest expense was $8,000 in fiscal 2006, $25,000 in fiscal 2005 and $190,000 in fiscal 2004. The significant decreases in interest expense during these periods was due to lower outstanding borrowings on our credit facility and the benefit from rate decreases in the prime-borrowing rate. As of September 30, 2006, we had no borrowings on its credit facility. Interest income was $90,000 in fiscal 2006, $101,000 in fiscal 2005 and $138,000 in fiscal 2004.
Other income, which generally consists of purchasing service fees and other income at various restaurants, was $713,000, $672,000 and $594,000 for fiscal 2006, 2005 and 2004, respectively.
Income Taxes
The provision for income taxes reflects Federal income taxes calculated on a consolidated basis and state and local income taxes calculated by each New York subsidiary on a non-consolidated basis. Most of the restaurants we own or manage are owned or managed by a separate subsidiary.
For state and local income tax purposes, the losses incurred by a subsidiary may only be used to offset that subsidiary's income, with the exception of the restaurants operating in the District of Columbia. Accordingly, our overall effective tax rate has varied depending on the level of losses incurred at individual subsidiaries. During fiscal 2002 we abandoned our restaurant and food court operations at the Desert Passage, the retail complex at the Aladdin Resort & Casino in Las Vegas. In fiscal 2002, we were able to utilize the deferred tax asset created in fiscal 2001 by the impairment of these operations. During the years ended October 2, 2004 and October 1, 2005, we decreased its allowance for the utilization of the deferred tax asset arising from state and local operating loss carryforwards by $395,000 and $125,000 in such years based on the merger of certain unprofitable subsidiaries into profitable ones.
Our overall effective tax rate in the future will be affected by factors such as the level of losses incurred at our New York facilities, which cannot be consolidated for state and local tax purposes, pre-tax income earned outside of New York City and the utilization of state and local net operating loss carry forwards. Nevada has no state income tax and other states in which we operate have income tax rates substantially lower in comparison to New York. In order to utilize more effectively tax loss carry forwards at restaurants that were unprofitable, we have merged certain profitable subsidiaries with certain loss subsidiaries.
The Revenue Reconciliation Act of 1993 provides tax credits to us for FICA taxes paid on tip income of restaurant service personnel. The net benefit to us was $733,000 in fiscal 2006, $779,000 in fiscal 2005 and $591,000 in fiscal 2004.
The settlement did not have a material effect on our consolidated financial statements. During fiscal 2006, we and the Internal Revenue Service finalized the adjustments to our Federal income tax returns for fiscal years 1999 through 2004. This settlement did not have a material effect on our consolidated financial statements.
Liquidity and Capital Resources
Our primary source of capital has been cash provided by operations and funds available from our main bank, Bank Leumi USA. We have, from time to time, also utilized equipment financing in connection with the construction of a restaurant and seller financing in connection with the acquisition of a restaurant. We utilize capital primarily to fund the cost of developing and opening new restaurants, acquiring existing restaurants owned by others and remodeling existing restaurants we own.
The net cash used in investing activities in fiscal 2006 of $4,934,000 was primarily used for the replacement of fixed assets at existing restaurants, the construction of a restaurant and bar in Atlantic City, New Jersey and the construction of a to be named Mexican restaurant at the to be developed Planet Hollywood Resort and Casino (formerly known as the Aladdin Resort and Casino) in Las Vegas, Nevada. The net cash used in investing activities in fiscal 2005 of $4,236,000 was primarily used for the replacement of fixed assets at existing restaurants and the construction of a restaurant and bar in Atlantic City, New Jersey. The net cash used in investing activities in fiscal 2004 of $1,336,000 was used for the replacement of fixed assets at existing restaurants.
The net cash used in financing activities in fiscal 2006 of $3,628,000 and fiscal 2005 of $4,397,000 was principally used for the payment of dividends. The net cash used in financing activities in fiscal 2004 of $5,106,000 was principally due to repayments of long-term debt on our main credit facility in excess of borrowings on such facility.
We had a working capital surplus of $8,398,000 at September 30, 2006 as compared to a working capital surplus of $3,399,000 at October 1, 2005.
Our Revolving Credit and Term Loan Facility (the "Facility") with our main bank (Bank Leumi USA), which included a $8,500,000 credit line to finance the development and construction of new restaurants and for working capital purposes at our existing restaurants, matured on March 12, 2005. We do not currently plan to enter into another credit facility and expect required cash to be provided by operations.
We entered into a sale and leaseback agreement with GE Capital for $1,652,000 in November 2000 to refinance the purchase of various restaurant equipment at our food and beverage facilities in a hotel and casino in Las Vegas, Nevada. The lease bore interest at 8.65% per annum and was payable in 48 equal monthly installments of $32,000 until maturity in November 2004 at which time we had an option to purchase the equipment for $519,000 or extend the lease for an additional 12 months at the same monthly payment until maturity in November 2005 and repurchase the equipment at such time for $165,000. In November 2004, we chose to extend the lease for an additional 12 months.
We originally accounted for this agreement as an operating lease and did not record the assets or the lease liability in the financial statements. During the year ended September 29, 2001, we recorded the entire amount payable under the lease as a liability of $1,600,000 based on the anticipated abandonment of the
Aladdin operations. In 2002, the operations at the Aladdin were abandoned and at September 30, 2006 the lease was fully paid.
A quarterly cash dividend in the amount of $0.35 per share was declared on October 12, 2004. Subsequent to October 12, 2004, quarterly cash dividends in the amount of $0.35 per share were declared on January 12, April 12, July 12 and October 11, 2005 and on January 12, April 12, July 12, October 10, and December 20, 2006. In addition, we declared a special cash dividend in the amount of $3.00 per share on December 20, 2006. Prior to this, we had not paid any cash dividends since our inception. We intend to continue to pay such quarterly cash dividend for the foreseeable future, however, the payment of future dividends is at the discretion of our Board of Directors and is based on future earnings, cash flow, financial condition, capital requirements, changes in U.S. taxation and other relevant factors.
Contractual Obligations and Commercial Commitments
To facilitate an understanding of our contractual obligations and commercial commitments, the following data is provided:
PAYMENTS DUE BY PERIOD
--------------------------------------------
WITHIN AFTER 5
TOTAL 1 YEAR 2-3 YEARS 4-5 YEARS YEARS
(IN THOUSANDS OF DOLLARS)
Contractual Obligations:
Operating Leases $58,086 $ 7,187 $12,525 $11,677 $26,697
------- ------- ------- ------- -------
Total Contractual Cash Obligations $58,086 $ 7,187 $12,525 $11,677 $26,697
======= ======= ======= ======= =======
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
--------------------------------------------
WITHIN AFTER 5
TOTAL 1 YEAR 2-3 YEARS 4-5 YEARS YEARS
(IN THOUSANDS OF DOLLARS)
Other Commercial Commitments:
Letters of Credit $ 466 $ -- $ 466 $ -- $ --
------- ------- ------- ------- -------
Total Commercial Commitments $ 466 $ -- $ 466 $ -- $ --
======= ======= ======= ======= =======
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Restaurant Expansion
We opened a GALLAGHER'S STEAKHOUSE restaurant the Resorts Atlantic City Hotel and Casino in Atlantic City, New Jersey in December 2005.
During the fiscal year ended September 30, 2006, we established operations at the Foxwoods Resort Casino in Ledyard, Connecticut by opening a restaurant, THE FIFTH STREET CAFE, in its newly expanded poker room in March 2006 and a fast-casual restaurant, LUCKY SEVEN, in the Bingo Hall in May 2006. All pre-opening expenses were borne by outside investors who invested in a limited liability company established to develop, construct, operate and manage these facilities. We are the managing member of this limited liability company and, through this limited liability company, we lease and manage the
operations of each of these facilities in exchange for a monthly management fee equal to five-percent of the gross receipts of these facilities. Neither we nor any of our subsidiaries contributed any capital to this limited liability company. None of the obligations of this limited liability company are guaranteed by us and investors in this limited liability company have no recourse against us or any of our assets.
In addition, in September 2006, we entered into an agreement to lease a to be named Mexican restaurant at the to be developed Planet Hollywood Resort and Casino (formerly known as the Aladdin Resort and Casino) in Las Vegas, Nevada, and entered into an agreement to purchase the restaurant known as the DURGIN PARK RESTAURANT AND THE BLACK HORSE TAVERN in Boston, Massachusetts. The obligation to pay rent for the to be named Mexican restaurant is not effective until the restaurant opens for business. We anticipate this restaurant to open during our third quarter of the 2007 fiscal year. The agreement to purchase the DURGIN PARK facility provides that we cannot take possession of the restaurant until we obtain a liquor license for the facility. We are currently in the process of obtaining such liquor license.
Finally, in December 2006, we expanded our operations at the Foxwoods Resort Casino by opening THE GRILL AT TWO TREES in the Two Trees Inn, a facility owned by the Mashantucket Pequot Tribal Nation and a part of the Foxwoods Resort Casino, in Ledyard, Connecticut.
The opening of a new restaurant is invariably accompanied by substantial pre-opening expenses and early operating losses associated with the training of personnel, excess kitchen costs, costs of supervision and other expenses during the pre-opening period and during a post-opening "shake out" period until operations can be considered to be functioning normally. The amount of such pre-opening expenses and early operating losses can generally be expected to depend upon the size and complexity of the facility being opened. We incurred $15,000 in pre-opening expenses in fiscal 2006.
Our restaurants generally do not achieve substantial increases from year to year in revenue, which we consider to be typical of the restaurant industry. To achieve significant increases in revenue or to replace revenue of restaurants that lose customer favor or which close because of lease expirations or other reasons, we would have to open additional restaurant facilities or expand existing restaurants. There can be no assurance that a restaurant will be successful after it is opened, particularly since in many instances we do not operate our new restaurants under a trade name currently used by us, thereby requiring new restaurants to establish their own identity.
Apart from these agreements, we are not currently committed to any projects. We may take advantage of opportunities we consider to be favorable, when they occur, depending upon the availability of financing and other factors.
Recent Restaurant Dispositions and Charges
We entered into a sale and leaseback agreement with GE Capital in November 2000 to refinance the purchase of various restaurant equipment at our food and beverage facilities at Desert Passage, the retail complex at the Aladdin Resort & Casino in Las Vegas, Nevada. In 2002, the operations at the Aladdin were abandoned. The lease matured in November 2005 and, in connection therewith, we made an unprovided for lump sum payment of $142,000 due under this lease. This lump sum payment is included in discontinued operations in fiscal 2006.
In fiscal 2003, we determined that our restaurant, Lutece, located in New York City, had been impaired by the events of September 11th and the continued weakness in the economy. Based upon the sum of the future undiscounted cash flows related to our long-lived fixed assets at Lutece, we determined that impairment had occurred. To estimate the fair value of such long-lived fixed assets, for determining the
impairment amount, we used the expected present value of the future cash flows. We projected continuing negative operating cash flow for the foreseeable future with no value for subletting or assigning the lease for the premises. As a result, we determined that there was no value to the long-lived fixed assets. We had an investment of $667,000 in leasehold improvements, furniture fixtures and equipment. We believed that these assets would have nominal value upon disposal and recorded an impairment charge of $667,000 during fiscal 2003. Due to continued weak sales, we closed Lutece during the second quarter of 2004. We recorded a net operating loss of $27,000 during the fiscal year ended September 30, 2006 which is included in losses from discontinued operations. In fiscal 2004, we also incurred a one-time charge of $470,000 related to pension plan contributions required in connection with the closing of Lutece which is payable monthly over a nine year period beginning May 17, 2004 and bears interest at a rate of 8% per annum.
On December 1, 2003, we sold a restaurant, Lorelei, for approximately $850,000. The book value of inventory, fixed assets, intangible assets and goodwill related to this entity was approximately $625,000. We recorded a gain on the sale of approximately $225,000 during the first quarter of fiscal 2004.
Our restaurant, Ernie's, located on the upper west side of Manhattan opened in 1982. As a result of a steady decline in sales, we felt that a new concept was needed at this location. The restaurant was closed June 16, 2003 and reopened in August 2003. Total conversion costs were approximately $350,000. Sales at the new restaurant, La Rambla, failed to reach the level sufficient to achieve the results we required. As a result, we sold this restaurant on January 1, 2004 and realized a gain on the sale of this restaurant of approximately $214,000. Operating income of $5,000 was included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Our restaurant Jack Rose located on the west side of Manhattan has experienced weak sales for several years. In addition, this restaurant did not fit our desired profile of being in a landmark destination location. As a result, we sold this restaurant on February 23, 2004. We realized a loss on the sale of this restaurant of $137,000 which was recorded during the second quarter of fiscal 2004. Operating losses of $3,000 were included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Our restaurant, America, located in New York City has experienced declining sales for several years. In March 2004, we entered into a new lease for this restaurant at a significantly increased rent. We entered into this lease with the belief that due to the location and the uniqueness of the space the lease had value. On January 19, 2005, we signed a definitive agreement for the sale of this restaurant which closed on March 15, 2005. We realized a pre-tax gain of $644,000 on the sale of this restaurant. Operating losses of $12,000 were included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Our bar/nightclub facility Venus, located at the Venetian Casino Resort, experienced a steady decline in sales and we felt that a new concept was needed at this location. During the first quarter of 2005, this bar/nightclub facility was closed for re-concepting and re-opened as "Vivid" on February 4, 2005. Total conversion costs were approximately $400,000. Sales at the new bar/nightclub facility have failed to reach the level sufficient to achieve the results we required and we have identified a buyer for this facility. As of December 31, 2005, we classified the assets and liabilities of this bar/nightclub facility as "held for sale" in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") based on the fact that the facility has met the criteria under SFAS No. 144. Based on the initial offers made on this facility, we do not anticipate a loss on the sale. Operating losses of $486,000 are included in losses from discontinued operations for the fiscal year ended September 30, 2006.
Effective August 22, 2004, our lease for The Saloon at the Neonopolis Center at Fremont Street was converted into a management agreement whereby we received a management fee of $7,000 per month regardless of the results of operations of this restaurant. In June 2006, the owner of the Neonopolis Center at Fremont Street sold the building to a new entity who, on June 25, 2006, exercised its option to terminate the management agreement upon thirty days written notice to us.
On July 6, 2006, the landlord for the Vico's Burrito's fast food facility at the Venetian Casino Resort, General Growth Properties, notified us that the landlord was exercising an option granted to it pursuant to the lease for the facility to terminate the lease in exchange for the landlord providing us with the unamortized portion of the non-removable improvements located in the facility. On August 10, 2006, we and our landlord for this facility entered into a letter agreement pursuant to which the landlord agreed to pay us $200,000 for the unamortized portion of the non-removable improvements located in the facility. We realized a loss of $70,000 on the closure of this restaurant which is included in discontinued operations. Operating income of $35,000 is included in discontinued operations for the fiscal year ended September 30, 2006.
As a result of the above mentioned sales, we allocated $75,000 of goodwill to these restaurants and reduced goodwill by this amount in fiscal 2005. No allocation was required during fiscal 2006.
Effective December 1, 2006, our subsidiaries that lease each of Lutece, Tsunami and our Vivid location at The Venetian Resort Hotel Casino in Las Vegas, Nevada, have entered into an agreement to sell Lutece, Tsunami and a portion of the Vivid location used by Lutece as a prep kitchen to Venetian Casino Resort, LLC for an aggregate of $14,000,000. Our Lutece location closed as of the close of business on December 3, 2006 and it is contemplated that our Tsunami location will close at the end of the calendar year. We do not anticipate a loss on the sale of these restaurants.
Critical Accounting Policies
Financial Reporting Release No. 60, published by the SEC, recommends that all companies include a discussion of critical accounting policies used in the preparation of their financial statements. Our significant accounting policies are more fully described in Note 1 to our consolidated financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our consolidated financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates.
We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our consolidated results of operations, financial position or cash flows for the periods presented in this report.
Below are listed certain policies that management believes are critical:
Use of Estimates
The preparation of financial statements requires the application of certain accounting policies, which may require us to make estimates and assumptions of future events. In the process of preparing its consolidated financial statements, we estimate the appropriate carrying value of certain assets and liabilities, which are not readily apparent from other sources. The primary estimates underlying our
financial statements include allowances for potential bad debts on accounts and notes receivable, the useful lives and recoverability of its assets, such as property and intangibles, fair values of financial instruments and share-based compensation, the realizable value of its tax assets and other matters. Management bases its estimates on certain assumptions, which they believe are reasonable in the circumstances and actual results could differ from those estimates.
Long-Lived Assets
We annually assess any impairment in value of long-lived assets to be held and used. We evaluate the possibility of impairment by comparing anticipated undiscounted cash flows to the carrying amount of the related long-lived assets. If such cash flows are less than carrying value we then reduce the asset to its fair value. Fair value is generally calculated using discounted cash flows. Various factors such as sales growth and operating margins and proceeds from a sale are part of this analysis. Future results could differ from our projections with a resulting adjustment to income in such period.
Leases
We are obligated under various lease agreements for certain restaurants. We recognize rent expense on a straight-line basis over the expected lease term, including option periods as described below. Within the provisions of certain leases there are escalations in payments over the base lease term, as well as renewal periods. The effects of the escalations have been reflected in rent expense on a straight-line basis over the expected lease term, which includes option periods when it is deemed to be reasonably assured that we would incur an economic penalty for not exercising the option. Percentage rent expense is generally based upon sales levels and is expensed as incurred. Certain leases include both base rent and percentage rent. We record rent expense on these leases based upon reasonably assured sales levels. The consolidated financial statements reflect the same lease terms for amortizing leasehold improvements as were used in calculating straight-line rent expense for each restaurant. Our judgments may produce materially different amounts of amortization and rent expense than would be reported if different lease terms were used.
Deferred Income Tax Valuation Allowance
We provide such allowance due to uncertainty that some of the deferred tax amounts may not be realized. Certain items, such as state and local tax loss carry forwards, are dependent on future earnings or the availability of tax strategies. Future results could require an increase or decrease in the valuation allowance and a resulting adjustment to income in such period.
Accounting for Goodwill and Other Intangible Assets
During 2001, the FASB issued FAS 142, which requires that for us, effective September 28, 2002, goodwill, including the goodwill included in the carrying value of investments accounted for using the equity method of accounting, and certain other intangible assets deemed to have an indefinite useful life, cease amortizing. FAS 142 requires that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques. Specifically, goodwill impairment is determined using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of the reporting unit (we is being treated as one reporting unit) with its net book value (or carrying amount), including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of the reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with
the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. The impairment test for other intangible assets consists of a comparison of the fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
Determining the fair value of the reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of the reporting unit (including unrecognized intangible assets) under the second step of the goodwill impairment test is judgmental in nature and often involves the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of other intangible assets. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge. To assist in the process of determining goodwill impairment, we obtain appraisals from independent valuation firms. In addition to the use of independent valuation firms, we perform internal valuation analyses and consider other market information that is publicly available. Estimates of fair value are primarily determined using discounted cash flows and market comparisons and recent transactions. These approaches use significant estimates and assumptions including projected future cash flows (including timing), discount rate reflecting the risk inherent in future cash flows, perpetual growth rate, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables. Based on the above policy no impairment charges were recorded during the fiscal years ended 2006, 2005 and 2004.
Share-Based Compensation
Effective October 2, 2005 the Company adopted Statement of Financial Accounting Standards No. 123R, "SHARE-BASED PAYMENT" ("SFAS No. 123R"), and related interpretations and began expensing the grant-date fair value of employee stock options. Prior to October 2, 2005, the Company applied Accounting Principles Board Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," and related interpretations in accounting for its stock option plans. Accordingly, prior to October 2, 2005, no compensation expense has been recognized in net income for employee stock options, as options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.
Upon adoption of SFAS 123R, the Company elected to value employee stock options using the Black-Scholes option valuation method that uses assumptions that relate to the expected volatility of the Company's common stock, the expected dividend yield of our stock, the expected life of the options and the risk free interest rate. The assumptions used for the options granted on December 21, 2004, which were unvested at the time of the adoption of SFAS 123R, included a risk free interest rate of 3.37%, volatility of 37%, a dividend yield of 3% and an expected life of three years.
The Company adopted SFAS No. 123R using the modified prospective transition method and therefore has not restated prior periods. Under this transition method, compensation cost associated with employee stock options recognized during fiscal 2006 includes amortization related to the remaining unvested portion of stock awards granted prior to October 2, 2005. No options were granted during fiscal year 2006.
Recently Issued Accounting Standards
The Financial Accounting Standards Board has recently issued the following accounting pronouncement:
In June 2005 the Emerging Issues Task Force (EITF) issued EITF No. 04-5, INVESTOR'S ACCOUNTING FOR AN INVESTMENT IN A LIMITED PARTNERSHIP WHEN THE INVESTOR IS THE SOLE GENERAL PARTNER AND THE LIMITED PARTNERS HAVE CERTAIN RIGHTS ("EITF 04-5"). EITF 04-5 presumes that a general partner controls a limited partnership and therefore should consolidate the partnership. This presumption can be overcome if the limited partners have kick-out or substantive participating rights. The Company is required to adopt the provisions of EITF 04-05 during fiscal years beginning after December 15, 2005. The Company is currently evaluating the impac