LANDRYS RESTAURANTS INC 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended December 31, 2006
For the transition period from to .
* Commission file number 000-22150
LANDRYS RESTAURANTS, INC.
(Exact Name of the Registrant as Specified in Its Charter)
(Registrants Telephone Number, Including Area Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 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 ¨ No x
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 registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Aggregate market value of voting stock held by non-affiliates of the Registrant as of June 30, 2006. $532,700,000.
As of July 31, 2007, there were 19,352,203 shares of the registrants common stock outstanding.
LANDRYS RESTAURANTS, INC.
TABLE OF CONTENTS
In light of published reports concerning the pricing of stock options and the timing of stock option grants at numerous other companies, in 2006, we undertook a voluntary internal review of our past practices in connection with grants of stock options. The voluntary review was overseen by our Board of Directors, including our independent directors. The Board engaged legal counsel, which in turn engaged a forensic accounting expert to assist with the review. The voluntary review did not find any intentional backdating of options. The review found administrative errors and that the granting process for certain stock option grants had not been complete, resulting in incorrect measurement dates for certain stock option awards. In addition, the review found certain accounting errors which needed to be corrected.
Our Board of Directors formed a Special Litigation Committee of independent directors to commence an investigation of our past stock option granting practices and related accounting issues from the time of our initial public offering to the present. After completion of our own internal review, we requested the Special Litigation committee conduct an independent review of our option granting practices. The Special Committee was composed of the members of the Audit Committee of the Board of Directors. The Special Committee retained the law firm of King & Spalding LLP as its independent legal counsel and UHY Advisors FLVS, Inc. as forensic accountant to aid in the investigation.
In connection with this investigation by the Special Committee, we voluntarily informed the SEC of our inquiry into our historical option granting practices. On August 3, 2007, the SEC informed us that it was terminating this matter and that it would not be recommending any action.
The Special Committee did determine that there were some deficiencies in the administration and oversight of the stock option grant processes and found that certain grants probably did not occur on the dates reflected in the minutes.
At the conclusion of the Special Committees investigation on July 30, 2007, the Special Committee reported its findings and conclusions to the Board. The Special Committee made no finding of fraud by any current or former officer or director. The Special Committee did not conclude that the incorrect dating of stock options grants or the other deficiencies in the determination of and accounting for stock options grants were the result of intentional misconduct or were for the purpose of generating false financial statements. The Special Committee concluded that the stock option prices during the period reviewed were characterized by a pervasive lack of formality: inattention to legal and plan requirements; failure to adopt and implement consistent practices; and inordinate delays. As a result, certain options were granted in the money. The Special Committee did not recommend termination of any member of senior management or resignations of any directors. Moreover, some members of senior management have agreed to repay the difference between their options price and the price determined by the Special Committee to be the correct measurement date price. The Compensation Committee will determine the appropriate method for this repayment.
Although we have not issued any stock options since 2004, we have changed our option granting approval policies and procedures and will be implementing further changes to comply with the recommendations and conclusions of the Special Committee, including changes to centralize records and make sure documentation is accurately and timely prepared and that grants are made at regularly scheduled times.
Primarily due to not knowing the financial impact of the Special Committees investigation, we were unable to timely file this annual report on Form 10-K and the quarterly report on Form 10-Q for the quarter ended March 31, 2007.
Based on the revised measurement dates, the Company recorded an aggregate non-cash, after tax charge of $10.9 million for the period from 1993 to 2005. The financial statement impact for the years 2002 through 2005 was not material to any period. Therefore, in this Form 10-K, we recorded a non-cash after tax charge of $1.8
million in the fourth quarter of 2006. The December 31, 2003 balance of additional paid-in capital was increased $9.1 million with a corresponding decrease to retained earnings to reflect the cumulative effect from prior years. The effect in each of the years 1993 to 2001 is set fourth in Note 2 of the Notes to Consolidated Financial Statements.
In March 2007, we received notice from the Indenture Trustee of our $400.0 million 7.5% Senior Notes that in the Indenture Trustees opinion, our failure to file a 10K Report for the fiscal year ending December 31, 2006, was an event of default under the Indenture. We contested the appropriateness of the Indenture Trustees notice at that time. On July 24, 2007, we received a further notice from the Indenture Trustee, stating that acting upon a direction of a majority of the Senior Noteholders, it had accelerated the unpaid principal, premium, if any, and unpaid interest on all Senior Notes outstanding. We have obtained a temporary restraining order in U.S. District Court requiring the Indenture Trustee to rescind the attempted acceleration pending a preliminary injunction hearing on August 16, 2007.
FORWARD LOOKING STATEMENTS
This report contains 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. All statements other than statements of historical fact are forward-looking statements for purposes of federal and state securities laws. Forward-looking statements may include the words may, will, plans, believes, estimates, expects, intends and other similar expressions. Our forward-looking statements are subject to risks and uncertainty, including, without limitation, our ability to continue our expansion strategy, our ability to make projected capital expenditures, as well as general market conditions, competition, and pricing. Forward-looking statements include statements regarding:
Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate, and, therefore, we cannot assure you that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in our forward-looking statements, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Some of these and other risks and uncertainties that could cause actual results to differ materially from such forward-looking statements are more fully described under Item 1A. Risk Factors and elsewhere in this report, or in the documents incorporated by reference herein. We assume no obligation to modify or revise any forward looking statements to reflect any subsequent events or circumstances arising after the date that the statement was made.
LANDRYS RESTAURANTS, INC.
ITEM 1. BUSINESS
We are a national, diversified restaurant, hospitality and entertainment company principally engaged in the ownership and operation of full-service, casual dining restaurants, primarily under the names of Rainforest Cafe, Saltgrass Steak House, Landrys Seafood House, The Crab House, Charleys Crab and The Chart House. As of December 31, 2006, we owned and operated over 179 full-service and certain limited-service restaurants in 29 states. Our portfolio of restaurants consists of a broad array of formats, menus and price-points that appeal to a wide range of markets and customer tastes. We offer concepts ranging from upscale steak and seafood restaurants to casual theme-based restaurants. We are also engaged in the ownership and operation of select hospitality businesses including hotel and casino resorts that provide our customers with unique dining, leisure and entertainment experiences, including the Golden Nugget Hotels and Casinos in downtown Las Vegas and Laughlin, Nevada.
We opened the first Landrys Seafood House restaurant in 1980. In 1993, we became a public company. Our stock is listed on the New York Stock Exchange under the symbol LNY. In 1994, we acquired the first Joes Crab Shack (Joes) restaurant and in 1996, acquired the Crab House chain of restaurants. We acquired Rainforest Cafe, Inc., a publicly traded restaurant company, in 2000. During 2001, we changed our name to Landrys Restaurants, Inc. to reflect our expansion and broadening of operations. During 2002, we acquired 15 Charleys Crab seafood restaurants located primarily in Michigan and Florida, and 27 Chart House seafood restaurants, located primarily on the East and West Coasts of the United States. In October 2002, we purchased 27 Texas-based Saltgrass Steak House restaurants. In September 2005, we acquired the Golden Nugget Hotels and Casinos in downtown Las Vegas and Laughlin, Nevada (Golden Nugget). In February 2006, we acquired 80% of T-Rex Cafe, Inc. (T-Rex) from Schussler Creative, Inc. (SCI) and committed to the construction of at least four restaurants, two of which are to be located at high profile Disney properties.
During the third quarter of fiscal 2006, as part of a strategic review of our operations, we initiated a plan to divest certain restaurants, including 136 Joes units. In November 2006, we completed the sale of 120 Joes restaurants to a non-affiliated entity, JCS Holdings, LLC, a newly formed entity created by J.H. Whitney Capital Partners, LLC.
We will continue to add to our base of restaurants, opening primarily Saltgrass Steak House and Signature Group restaurants (defined below). The majority of our remaining new restaurant expansion will be in areas where we are already located so we can take advantage of advertising and other economies of scale, including our existing labor force. In addition, we plan to selectively pursue other hospitality businesses that are complementary to our current operations.
Core Restaurant Concepts
Our portfolio of restaurant concepts consist of a variety of formats ranging from upscale steak and seafood restaurants to casual theme-based restaurants, each providing our guests with a distinct dining experience.
We currently operate our restaurants through the following divisions:
Landrys Division. The Landrys Division is comprised of Landrys Seafood House, The Crab House, Chart House and C.A. Muer restaurants and a few distinct concept restaurants that offer an upscale dining experience in a unique and memorable setting that we call our Signature Group. Our Signature Group of restaurants includes Grotto, Pesce, Vic & Anthonys Steakhouse, Willie Gs Seafood and Steak House, La Griglia and Brenners Steakhouse.
Rainforest Cafe. The Rainforest Cafe restaurants provide full-service casual dining in a visually and audibly stimulating and entertaining rainforest-themed environment that appeal to a broad range of customers. Each Rainforest Cafe consists of a restaurant and a retail village. The restaurant provides an attractive value to customers by offering a full menu of high-quality food and beverage items served in a simulated rainforest complete with thunderstorms, waterfalls and active wildlife. In the retail village, we sell complementary apparel, toys and gifts with the Rainforest Cafe logo in addition to other items reflecting the rainforest theme. Entree prices range from $8.99 to $22.99. During the year ended December 31, 2006, retail sales and alcoholic beverage sales accounted for approximately 22% of the concepts total restaurant revenues. Rainforest Cafe restaurants typically are larger units and generate higher unit volumes than restaurants in our other concepts, and have operating profit margins that are comparable to our other restaurants.
Saltgrass Steak House. The Saltgrass Steak House restaurants offer full-service casual dining in a Texas-Western theme. Prototype buildings welcome guests into a stone and wood beam ranch house complete with a fireplace and a saloon-style bar. Menu options extend from filet mignon to chicken fried steak to fresh fish to grilled chicken breast. Dinner entree prices range from $7.99 to $25.99 and lunch prices range from $7.99 to $14.99. During the year ended December 31, 2006, alcoholic beverage sales accounted for approximately 12% of the concepts total restaurant revenues.
Specialty Growth Division
Our Specialty Growth Division consists of hospitality and amusement properties that provide ancillary revenue streams and opportunities complementary to our core restaurant business. The Specialty Growth Division includes the following properties:
Kemah BoardwalkGalveston County, Texas. Our Specialty Growth Division commenced operations with the opening in 1999 of the Kemah Boardwalk, our owned amusement, entertainment and retail complex located on approximately 40 acres in Galveston Countys Kemah, Texas. The Kemah Boardwalk has multiple attractions; including specialty retail shops, a boutique hotel, a marina, and carnival-style rides and games. The Kemah Boardwalks activities are based upon and complementary to the business and traffic generated at our eight wholly owned and operated high-volume restaurants situated at that location, which include units from most of our core restaurant concepts described above as well as the original Aquarium Restaurant.
Downtown AquariumHouston, Texas. The Downtown Aquarium in Houston, Texas opened in 2003. The Downtown Aquarium features our second Aquarium Underwater Dining Adventure restaurant. In addition, the Downtown Aquarium also features a public aquarium complex with over 200 species of fish, a giant acrylic shark tank, dancing water fountains, a mini-amusement park and a bar/lounge.
Downtown AquariumDenver, Colorado. In 2003, we acquired Ocean Journey, a 12-acre aquarium complex located adjacent to downtown Denver, Colorado. This world-class facility, which is wholly owned and operated, and is home to over 500 species of fish, was built by a non-profit organization in 1999 at a cost of approximately $93.0 million. We purchased this ongoing aquarium enterprise in federal bankruptcy proceedings for $13.6 million with no outstanding debt or other obligations. Upon assumption of ownership, we reduced the complexs workforce, keeping personnel necessary for ongoing operations and significantly reduced corporate overhead. We opened an up-scale Aquarium Restaurant in 2005, which transformed the aquarium into a recreational destination, and renamed the facility, adding a second Downtown Aquarium to the Specialty Growth Division.
Galveston Island Convention Center. The revitalization of the Galveston seawall on the Gulf of Mexico, an area that includes a significant number of our restaurants, is underway with our development of the Galveston Island Convention Center. The convention center is housed on a 26-acre beachfront locale. The facility accommodates a 43,000 square foot exhibition hall, a 15,500 square foot ballroom and over 12,000 square feet of smaller breakout rooms. The convention center is owned by the City of Galveston and managed and operated by us.
Holiday Inn on the BeachGalveston, Texas. In 2003, we acquired the Holiday Inn on the Beach, a 180 room beachfront resort hotel located along Galvestons seawall and near the new Galveston Island Convention Center. This property is wholly owned and operated by us.
Inn at the BallparkHouston, Texas. The Inn at the Ballpark is located in downtown Houston directly across the street from Minute Maid Park, home of the Houston Astros baseball team. This new luxury hotel has over 200 rooms and opened in early 2004. The hotel offers visitors to Houston easy access to all of downtown Houstons amenities, including the newly expanded George R. Brown Convention Center, the new Toyota Center, home of the Houston Rockets basketball team, the theater district, and our own Downtown Aquarium. The hotel is wholly owned and operated by us.
Flagship Inn and Pleasure PierGalveston, Texas. In 2003, we purchased the Galveston Flagship Hotel from the City of Galveston for $500,000, subject to an existing lease. Upon expiration of the existing lease, we plan to transform the hotel into a 1800s-style inn located on a pier overlooking Galveston Bay and the Gulf of Mexico. The surrounding pier is expected to provide an assortment of entertainment and boardwalk games, including a roller coaster, ferris wheel and lighthouse reminiscent of an earlier historical leisure-time period.
Tower of the AmericasSan Antonio, Texas. In 2004, we entered into a 15-year lease agreement with the City of San Antonio to renovate and operate the 750-foot landmark Tower of the Americas, a major tourist attraction in San Antonio. In the summer of 2006 this redevelopment culminated in the opening of Eyes Over Texas, an upscale revolving restaurant, an open air observation deck at the top of the tower, and a Texas-themed 4-D multi-sensory theater on the ground level.
T-Rex Cafe. In February 2006, we acquired 80% of T-Rex Cafe, Inc. (T-Rex). T-Rex is a unique concept that features an interactive prehistoric environment with life-size animatronic dinosaurs. Under the agreement, we guaranteed the funding for the construction, development and pre-opening of at least three T-Rex Cafes, the first of which opened in July 2006 in Kansas City. The next unit is expected to open in 2008 at Downtown Disney World.
Yak &Yeti. In February 2006, we also acquired the majority interest in a new Asian themed eatery which is expected to open in Disneys Animal Kingdom Theme Park in 2007. In a setting reminiscent of a rural Himalayan village, the Asian-Fusion concept will offer both full-service table dining and quick service food as well as feature a retail component offering Asian goods ranging from Sushi plates to chopsticks and fine teapots.
In 2005, we acquired the Golden Nugget Hotels and Casinos in Las Vegas and Laughlin, Nevada. We believe that the Golden Nugget brand name is one of the most recognized in the gaming industry and we expect to continue to capitalize on the strong name recognition and high level of quality and value associated with it. Demonstrating a long-standing commitment to quality and service, the Golden NuggetLas Vegas has received the prestigious AAA Four Diamond Award for thirty consecutive years, which is a record for any lodging establishment in Nevada. Presented by the American Automobile Association, a North American motoring and leisure travel organization, the 2007 award was given to only 19 Nevada hotels of the approximately 50,000 eligible lodging establishments in the United States evaluated by the AAA. According to the AAA, establishments that receive the AAA Four Diamond Award are upscale in all areas and offer an extensive array of amenities and a high degree of hospitality, service and attention to detail.
Our business strategy is to create the best possible gaming and entertainment experience for our customers by providing a combination of comfortable and attractive surroundings with attentive service from friendly, experienced employees. We target out-of-town customers at both of our properties while also catering to the local customer base. We believe that the Golden NuggetLas Vegas is the leading downtown destination for our out-of-town customers. The property offers the same complement of services as our Las Vegas Strip competitors, but we believe that our customers prefer the boutique experience we offer and the downtown environment. We emphasize the propertys wide selection of amenities to complement guests gaming experience and provide a luxury room product and personalized services at an attractive value. At the Golden NuggetLaughlin, we focus on providing a high level of customer service, a quality dining experience at an appealing value, a slot product with highly competitive pay tables and a superior player rewards program.
Our objective is to develop and operate a diversified restaurant, hospitality and entertainment company offering customers unique dining, leisure and entertainment experiences. We believe that this strategy creates a loyal customer base, generates a high level of repeat business and provides superior returns to our investors. By focusing on high-quality food, superior value and service, and the ambiance of our locations, we strive to create an environment that fosters repeat patronage and encourages word-of-mouth recommendations. Our operating strategy focuses on the following:
The following is a summary of our major acquisitions:
Rainforest Cafe (2000). Since our acquisition of Rainforest Cafe, we have focused on stabilizing this concepts operations. We have closed unprofitable locations, renegotiated leases, reduced general and administrative expenses and refreshed the concepts menu with proven menu items from our other concepts. Overall sales trends at Rainforest Cafe units at tourist destinations have improved, resulting in positive comparative sales for 2006.
Chart House and C.A. Muer (2002). The Chart House and C.A. Muer restaurant acquisitions enabled us to purchase a collection of valuable restaurant locations, many of which are situated on premium waterfront properties on the Pacific and Atlantic Oceans. We have remodeled many of these units, freshening and updating
the look of these venues. In addition, these restaurants have undergone menu evaluations and re-engineering in order for us to feature successful dishes from previous menus side-by-side with bold, fresh ideas from our culinary experts. The remodeling and menu changes have been met with favorable results as evidenced by strong sales trends. No significant near-term expansion of these concepts is currently planned, and future growth will be dependent upon profitability and unit economics.
Saltgrass Steak House (2002). The nearly seamless integration of Saltgrass Steak House restaurants into our systems in late 2002 was highlighted by the conversion of all 27 restaurants to our financial tools within 60 days of acquisition. These tools include our point-of-sale system and also implementation of our profitability and labor/payroll programs. Since the acquisition, we have expanded the concept, opening two new steak houses in 2003, four in 2004, two in 2005 and five in 2006. Also, in 2006 we initiated a plan to convert a number of Joes Crab Shack restaurants into Saltgrass Steak Houses and we also opened our first unit outside of Texas. Further expansion of this concept into our existing markets and development of new markets is planned in 2007.
Golden Nugget (2005). The Golden Nugget acquisition allowed us to enter the gaming business with one of the most recognized brands in the industry and in the preeminent gaming city, Las Vegas, Nevada. We also acquired the Golden Nugget property in Laughlin, Nevada.
In 2005, we initiated a major renovation and expansion of the Las Vegas property designed to create additional excitement, improved amenities and dining options while maintaining the warmth and high level of personalized service for which the Golden Nugget is known. The first phase of the renovation was completed in 2006 and included opening a new spa, buffet, swimming pool, lounge, poker room, race and sports book and showroom. We also replaced several existing casino restaurants with restaurants from our existing portfolio of concepts. The second phase of the renovation will include the completion of a new event center, nightclub and an expansion of the gaming floor. The Golden Nugget Las Vegas occupies approximately eight acres in downtown Las Vegas with approximately 42,000 square feet of gaming area. The property also features three towers containing 1,907 rooms, the largest number of guestrooms in downtown Las Vegas, approximately 1,153 slot machines and 59 table games. The Golden NuggetLaughlin has approximately 32,000 square feet of gaming space, 996 slot machines, 14 table games and 300 hotel rooms.
T-Rex (2006). In February 2006, we acquired 80% of T-Rex Cafe, Inc. (T-Rex) and committed to the construction of at least four restaurants, two of which are to be located at high profile Disney properties.
Our restaurants generally range in size from 5,000 square feet to 16,000 square feet, with an average restaurant size of approximately 8,000 square feet. The seafood restaurants generally have dining room floor seating for approximately 215 customers and additional patio seating on a seasonal basis. Saltgrass Steak House restaurants seat approximately 260 guests on average. Both formats offer bar seating for approximately 10 to 20 additional customers.
The Rainforest Cafe restaurants are larger, generally ranging in size from approximately 15,000 to 30,000 square feet with an average restaurant size of approximately 20,000 square feet. The Rainforest Cafe restaurants have between 300 and 600 restaurant seats with an average of approximately 400 seats.
The following table enumerates by state the location of our restaurants as of December 31, 2006:
We own and operate the Golden Nugget Hotels and Casinos in Las Vegas and Laughlin, Nevada.
We are also the developer and operator of the Kemah Boardwalk located south of Houston, Texas. We own and operate substantially all of the 40-acre Kemah Boardwalk development, which includes eight restaurants (included in the table above), a hotel, retail shops, amusement attractions, and a marina.
We own and operate several additional limited menu restaurants, hospitality venues and other properties which are excluded from the numerical counts due to materiality.
Our seafood restaurants offer a wide variety of high quality, broiled, grilled, and fried seafood items at moderate prices, including red snapper, shrimp, crawfish, crab, lump crabmeat, lobster, oysters, scallops, flounder, and many other traditional seafood items, many with a choice of unique seasonings, stuffings and toppings. Menus include a wide variety of seafood appetizers, salads, soups and side dishes. We provide high quality beef, fowl, pastas, and other American food entrees as alternatives to seafood items. Our restaurants also feature a unique selection of desserts often made fresh on a daily basis at each location. Many of our restaurants offer complimentary salad with each entree, as well as certain lunch specials and popularly priced childrens entrees. The Rainforest Cafe menu offers traditional American fare, including beef, chicken and seafood. Saltgrass Steak House offers a variety of Certified Angus Beef, prime rib, pork ribs, fresh seafood, chicken and other Texas cuisine favorites at moderate prices.
Management and Employees
We staff our operating units with management that has experience in our industry. We believe our strong team-oriented culture helps us attract highly motivated employees who provide customers with a superior level of service. We train our kitchen employees, wait staff, hotel staff and casino employees to take great pride serving our customers in accordance with our high standards. Managers and staff are trained to be courteous and attentive to customer needs, and the managers, in particular, are instructed to regularly visit with customers. Senior corporate management hosts weekly meetings with our general managers to discuss individual unit
performance and customer comments. Moreover, we require general managers to hold weekly meetings at their individual operating units. We monitor compliance with our quality requirements through periodic on-site visits and formal periodic inspections by regional field managers and supervisory personnel from our corporate offices.
Our typical seafood unit has a general manager and several kitchen and floor managers. We have internally promoted many of the general managers after training them in all areas of restaurant management with a strong emphasis on kitchen operations. The general managers typically spend a portion of their time in the dining area of the restaurant, supervising the staff and providing service to customers.
The Rainforest Cafe unit management structure is more complex due generally to higher unit level sales, larger facilities, more sophisticated rainforest theming, including animatronics, aquariums, and complementary retail business activity. A management team consisting of floor, kitchen, retail, facility and outside sales managers supports the general manager.
Each restaurant management team is eligible to receive monthly incentive bonuses. These employees typically earn between 15% and 25% of their total cash compensation under this program.
We have spent considerable effort in developing employee growth programs whereby a large number of promotions occur internally. We require each trainee to participate in a formal training program that utilizes departmental training manuals, examinations and a scheduled evaluation process. We require newly hired wait staff to spend from five to ten days in training before they serve our customers. We utilize a program of background checks for prospective management employees, such as criminal checks, credit checks, driving record and drug screening. Management training encompasses three general areas:
Due to our enhanced training program, management training customarily lasts approximately 8 to 12 weeks, depending upon the trainees prior experience and performance relative to our objectives. As we expand, we will need to hire additional management personnel, and our continued success will depend in large part on our ability to attract, train, and retain quality management employees. As a result of the enhanced training programs, we attract and retain a greater proportion of management personnel through our existing base of employees and internal promotions and advancements.
As of December 31, 2006, there were approximately 46 individuals involved in regional management functions generally performing on-site visits, formal inspections and similar responsibilities. As we grow, we plan to increase the number of regional managers, and to have each regional manager responsible for a limited number of restaurants within their geographic area. We plan to promote successful experienced restaurant level management personnel to serve as future regional managers. Regional management is continuously evaluated for performance and effectiveness.
As of December 31, 2006, in the restaurant division, we employed approximately 17,000 persons, of whom 1,264 were restaurant managers or manager-trainees, 307 were salaried corporate and administrative employees, approximately 46 were operations regional management employees, 25 were development and construction employees and the rest were hourly employees. Typical restaurant employment for us is at a seasonal low at December 31, and may increase by 30% or more in the summer months. Our restaurants generally employ an average of approximately 60 to 100 people, depending on seasonal needs. The larger Rainforest Cafe restaurants generally have 160 to 200 employees on average, with certain larger volume units having in excess of 400 people. We believe that our management level employee turnover for 2006 was within industry standards.
In the Gaming Division, we employed approximately 3,055 persons, of whom 276 were management, 355 were salaried employees and the rest were hourly employees. Approximately 1,377 employees are covered by collective bargaining agreements at our Golden Nugget Hotel and Casino in Las Vegas, Nevada.
We consider our relationship with employees to be satisfactory.
We provide our customers prompt, friendly and efficient service by keeping table-to-wait staff ratios low and staffing each operating unit with an experienced management team to ensure attentive customer service and consistently high food quality as well as providing an excellent room and gaming experience. Through the use of comment cards, a toll-free telephone number, and a web-based customer response site, senior management receives valuable feedback from customers and demonstrates a continuing interest in customer satisfaction by responding promptly.
We strive to obtain consistent, quality items at competitive prices from reliable sources. We continually search for and test various product sizes, species, and origins, in order to serve the highest quality products possible and to be responsive to changing customer tastes. In order to maximize operating efficiencies and to provide the freshest ingredients for our food products, while obtaining the lowest possible prices for the required quality, each restaurants management team determines the daily quantities of food items needed and orders such quantities from our primary distributors and major suppliers at prices negotiated primarily by our corporate office. We emphasize availability of the items on our menu, and if an item is in short supply, restaurant level management is expected to procure the item immediately.
We use many suppliers and obtain our seafood products from global sources in order to ensure a consistent supply of high-quality food and supplies at competitive prices. While the supply of certain seafood species is volatile, we believe that we have the ability to identify alternative seafood products and to adjust our menus as required. We routinely inventory bulk purchases of seafood products and retail goods for distribution to our restaurants to take advantage of buying opportunities, leverage our buying power, and hedge against price and supply fluctuations. As we continue to grow, our ability to improve our purchasing and distribution efficiencies will be enhanced.
We believe that our essential food products and retail goods are available, or can be made available upon relatively short notice, from alternative qualified suppliers and distributors. We primarily use one national distributor in order to achieve certain cost efficiencies, although such services are available from alternative qualified distributors. We have not experienced any significant delays in receiving our food and beverage products, restaurant supplies or equipment.
Advertising and Marketing
We employ a marketing strategy to attract new customers, to increase the frequency of visits by existing customers, and to establish a high level of name recognition through television and radio commercials, billboards, travel and hospitality magazines, print advertising and newspaper drops. Our advertising expenditures for 2006 were approximately 2.8% of revenues from continuing operations. We expect to cross market our restaurant, hospitality and gaming locations to leverage our advertising spend. We anticipate that future advertising and marketing expenses will decrease slightly as a percentage of revenues due to the sale of the 120 Joes Crab Shack units which relied heavily on television marketing.
Landrys Seafood House, Rainforest Cafe, Chart House, Charleys Crab, Saltgrass Steak House and Golden Nugget are each registered as a federal service mark on the Principal Register of the United States Patent and Trademark Office. The Crab House is a registered design mark. We pursue registration of our important service marks and trademarks and vigorously oppose any infringement upon them.
The restaurant, hospitality and entertainment industries are intensely competitive with respect to price, service, the type and quality of product offered, location and other factors. We compete with both locally owned facilities, as well as national and regional chains, some of which may be better established in our existing and future markets. Many of these competitors have a longer history of operations with substantially greater financial resources. We also compete with other restaurant, hospitality and gaming, and retail establishments for real estate sites, personnel and acquisition opportunities.
Changes in customer tastes, economic conditions, demographic trends and the location, number of, and type of food and amenities served by competing businesses could affect our business as could a shortage of experienced management and hourly employees.
We believe our business units enjoy a high level of repeat business and customer loyalty due to high food quality, good perceived price-value relationship, comfortable atmosphere, and friendly efficient service.
Other factors relating to our competitive position in the industry are addressed under the sections entitled Strategy, Purchasing, and Advertising and Marketing elsewhere in this report.
Rainforest International License and Joint Venture Agreements
Rainforest Cafe has entered into exclusive license arrangements relating to the operations and development of Rainforest Cafes in the United Kingdom, Japan, France, Mexico, Canada, Egypt and Turkey. There are eight international units, including seven franchised units and one Company owned and operated unit in Toronto, Canada. The Egyptian and Turkey units are expected to open in 2007. We have signed agreements for four additional units in the Middle East over the next four years. Four international franchised units were closed between 2002 and early 2003 due to declining sales and profitability. We own various equity interests in several of the international locations, which were included when we acquired Rainforest Cafe in 2000. We do not anticipate revenues from international franchises to be significant.
Information as to Classes of Similar Products or Services
We operate in only two reportable industry segments: restaurant and hospitality and gaming operations.
ITEM 1A. RISK FACTORS
Because of the following factors, as well as other variables affecting our operating results and financial condition, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.
Some of our restaurants have limited operating histories, which makes it difficult for us to predict their future results of operations.
A number of our restaurants have been open for less than two years. Consequently, the earnings achieved to date by such restaurants may not be indicative of future operating results. Should enough of these restaurants underperform our estimate of their performance, it could have a material adverse effect on our operating results.
Because many of our restaurants are concentrated in single geographic areas, our results of operations could be materially adversely affected by regional events.
Many of our existing and planned restaurants are concentrated in the southern half of the United States. This concentration in a particular region could affect our operating results in a number of ways. For example, our results of operations may be adversely affected by economic conditions in that region and other geographic areas into which we may expand. Also, given our present geographic concentration, adverse publicity relating to our restaurants could have a more pronounced adverse effect on our overall revenues than might be the case if our restaurants were more broadly dispersed. In addition, as many of our existing restaurants are in the Gulf Coast area from Texas to Florida, we are particularly susceptible to damage caused by hurricanes or other severe weather conditions. While we maintain property and business interruption insurance, we carry large deductibles, and there can be no assurance that if a severe hurricane or other natural disaster should affect our geographical areas of operations, we would be able to maintain our current level of operations or profitability, or that property and business interruption insurance would adequately reimburse us for our losses.
Moreover, in response to higher insurance costs for our property and casualty coverage due to our large concentration of coastal properties, we significantly reduced our aggregate insurance policy limits and purchased individual windstorm policies for the majority of our operating units located along the Texas gulf coast. Although, we have never had an insurance claim in excess of our existing coverage, there is no assurance that we will have adequate insurance coverage to recover losses that may result from a catastrophic event.
Our gaming activities rely heavily on certain markets, and changes adversely impacting those markets could have a material adverse effect on our gaming business.
The Golden Nugget properties are both located in Nevada and, as a result, our gaming business is subject to greater risks than a more diversified gaming company. These risks include, but are not limited to, risks related to local economic and competitive conditions, changes in local and state governmental laws and regulations (including changes in laws and regulations affecting gaming operations and taxes) and natural and other disasters. Any economic downturn in Nevada or any terrorist activities or disasters in or around Nevada could have a significant adverse effect on our business, financial condition and results of operations. In addition, there can be no assurance that gaming industry revenues in, or leisure travel to and throughout, Nevada or the surrounding local markets will continue to grow.
We also draw a substantial number of customers from other geographic areas, including southern California, Hawaii and Texas. A recession or downturn in any region constituting a significant source of our customers could result in fewer customers visiting, or customers spending less at, the Golden Nugget properties, which would adversely affect our results of operations. Additionally, there is one principal interstate highway between Las Vegas and southern California, where a large number of our customers reside. Capacity restraints of that highway or any other traffic disruptions may affect the number of customers who visit our facilities.
If we are unable to obtain a seafood supply in sufficient quality and quantity to support our operations, our results of operations could be materially adversely affected.
In the recent past, certain types of seafood have experienced fluctuations in availability. We have in the past utilized several seafood suppliers and have not experienced any difficulty in obtaining adequate supplies of fresh seafood on a timely basis. In addition, some types of seafood have been subject to adverse publicity due to certain levels of contamination at their source, which can adversely affect both supply and market demand. We maintain an in-house inspection program for our seafood purchases and, in the past, have not experienced any detriment from contaminated seafood. However, we can make no assurances that in the future either seafood contamination or inadequate supplies of seafood might not have a significant and materially adverse effect on our operating results and profitability.
If we are unable to anticipate and react to changes in food and other costs, our results of operations could be materially adversely affected.
Our profitability is dependent on our ability to anticipate and react to increases in food, labor, employee benefits, and similar costs over which we have limited or no control. Specifically, our dependence on frequent deliveries of fresh seafood and produce subjects us to the risk of possible shortages or interruptions in supply caused by adverse weather or other conditions that could adversely affect the availability and cost of such items. Our business may also be affected by inflation. In the past, management has been able to anticipate and avoid any adverse effect on our profitability from increasing costs through our purchasing practices and menu price adjustments, but there can be no assurance that we will be able to do so in the future.
We use significant amounts of electricity, natural gas and other forms of energy, and energy price increases may adversely affect our results of operations.
We use significant amounts of electricity, natural gas and other forms of energy. While no shortages of energy have been experienced, any substantial increases in the cost of electricity and natural gas in the United States will increase our cost of operations, which would negatively affect our operating results. The extent of the impact is subject to the magnitude and duration of the energy price increases, but this impact could be material. In addition, higher energy and gasoline prices affecting our customers may increase their cost of travel to our hotel-casinos and result in reduced visits to our properties and a reduction in our revenues.
The restaurant, hospitality and gaming industries are particularly affected by trends and fluctuations in demand and are highly competitive. If we are unable to successfully surmount these challenges, our business and results of operations could be materially adversely affected.
The restaurant industry is intensely competitive and is affected by changes in consumer tastes and by national, regional, and local economic conditions and demographic trends. The performance of individual restaurants may be affected by factors such as:
We have many well established competitors with greater financial resources and longer histories of operation than ours, including competitors already established in regions where we are planning to expand, as well as competitors planning to expand in the same regions. We face significant competition from mid-priced, full-service, casual dining restaurants offering seafood and other types and varieties of cuisine. Our competitors include national, regional, and local chains as well as local owner-operated restaurants. We also compete with other restaurants and retail establishments for restaurant sites.
The United States gaming industry is intensely competitive and features many participants, including many world class destination resorts with greater name recognition, different attractions, amenities and entertainment options than our facilities. In a broader sense, gaming operations face competition from all manner of leisure and entertainment activities.
Our competitors have more gaming industry experience, and many are larger and have significantly greater financial, selling and marketing, technical and other resources. Our competitors include multinational corporations that enjoy widespread name recognition, established brand loyalty, decades of casino operation experience and a diverse portfolio of gaming assets.
We face ongoing competition as a result of the upgrading or expansion of facilities by existing market participants, the entrance of new gaming participants into a market or legislative changes. Certain states have recently legalized, and several other states are currently considering legalizing, casino gaming in designated areas. Legalized casino gaming in these states and on Indian reservations would increase competition and could adversely affect any future gaming operations.
Our growth strategy depends on opening new restaurants. Our ability to expand our restaurant base is influenced by factors beyond our control, which may slow restaurant development and expansion and impair our growth strategy.
We are pursuing a moderate and disciplined growth strategy which, to be successful, will depend in large part on our ability to open new restaurants and to operate these restaurants on a profitable basis. We anticipate that our new restaurants will generally take several months to reach planned operating levels due to inefficiencies typically associated with new restaurants, including lack of market awareness, the need to hire and train sufficient personnel and other factors. We cannot guarantee that we will be able to achieve our expansion goals or operating results similar to those of our existing restaurants. One of our biggest challenges in meeting our growth objectives will be to locate and secure an adequate supply of suitable new restaurant sites. We have experienced delays in opening some of our restaurants and may experience delays in the future. Delays or failures in opening new restaurants could materially and adversely affect our planned growth. The success of our planned expansion will depend upon numerous factors, many of which are beyond our control, including the following:
In addition, we contemplate entering new markets in which we have no operating experience. These new markets may have different demographic characteristics, competitive conditions, consumer tastes and discretionary spending patterns than our existing markets, which may cause the new restaurants to be less successful in these new markets than in our existing markets.
Our growth strategy may strain our management, financial and other resources. For instance, our existing systems and procedures, restaurant management systems, financial controls, information systems, management resources and human resources may be inadequate to support our planned expansion of new restaurants. We may not be able to respond on a timely basis to all of the changing demands that the planned expansion will impose on our infrastructure and other resources.
The expansion of our business through acquisitions poses risks that may reduce the benefits we anticipate and could harm our business and our financial condition.
We have historically been, and we expect to continue to be, an active acquirer of restaurants, hospitality and entertainment properties and other related businesses. Part of our strategy involves acquisitions of restaurants and restaurant concepts and businesses involved in the hospitality, amusement and entertainment (including gaming) industries designed to expand and enhance our core operations. We have evaluated and expect to continue to evaluate possible acquisition and investment transactions on an ongoing basis and, at any given time, may be engaged in discussions with respect to possible acquisitions, business combinations or investments. Certain of these transactions, if consummated, could be material to our operations and financial condition.
Our ability to benefit from acquisitions depends on many factors, including our ability to identify acquisition prospects, access capital markets at an acceptable cost of capital, negotiate favorable transaction terms and successfully integrate any businesses we acquire. Integrating businesses we acquire into our operational framework may involve unanticipated delays, costs and other operational problems. If we encounter unexpected problems with one of our acquisitions or alliances, our senior management may be required to divert attention away from other aspects of our businesses to address these problems. Acquisitions also pose the risk that we may be exposed to successor liability relating to actions by an acquired company and its management before the acquisition. The due diligence we conduct in connection with an acquisition, and any contractual guarantees or indemnities that we receive from the sellers of acquired companies, may not be sufficient to protect us from, or compensate us for, actual liabilities. A material liability associated with an acquisition could adversely affect our reputation and results of operations and reduce the benefits of the acquisition.
The cost of compliance with the significant governmental regulation to which we are subject or our failure to comply with such regulation could materially adversely affect our results of operations.
The restaurant industry is subject to extensive state and local government regulation relating to the sale of food and alcoholic beverages and to sanitation, public health, fire and building codes. Alcoholic beverage control regulations require each of our restaurants to apply for and obtain from state authorities a license or permit to sell alcohol on the premises. Typically, licenses must be renewed annually and may be revoked or suspended for cause at any time. Alcoholic beverage control regulations affect various aspects of daily operations of our restaurants, including minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, storage and dispensing of alcoholic beverages. In certain states, we may be subject to dram shop statutes, which generally provide a person injured by an intoxicated person the right to recover damages from the establishment which wrongfully served alcoholic beverages to the intoxicated person. We carry liquor liability coverage as part of our comprehensive general liability insurance.
Our operations may be impacted by changes in federal and state taxes and other federal and state governmental policies which include many possible factors such as:
There are various federal, state and local governmental initiatives to increase the level of minimum wages which would increase our labor costs.
Difficulties or failures in obtaining required licensing or other regulatory approvals could delay or prevent the opening of a new restaurant. The suspension of, or inability to renew a license could interrupt operations at an existing restaurant, and the inability to retain or renew such licenses would adversely affect the operations of
such restaurant. Our operations are also subject to requirements of local governmental entities with respect to zoning, land use and environmental factors which could delay or prevent the development of new restaurants in particular locations.
At the federal and state levels, there are from time to time various proposals and initiatives under consideration to further regulate various aspects of our business and employment regulations. These and other initiatives could adversely affect us as well as the restaurant industry in general. In addition, seafood is harvested on a world-wide basis and, on occasion, imported seafood is subject to federally imposed import duties.
We conduct licensed gaming operations in Nevada, and various regulatory authorities, including the Nevada State Gaming Control Board and the Nevada Gaming Commission, require us to hold various licenses and registrations, findings of suitability, permits and approvals to engage in gaming operations and to meet requirements of suitability. These gaming authorities also control approval of ownership interests in gaming operations. These gaming authorities may deny, limit, condition, suspend or revoke our gaming licenses, registrations, findings of suitability or the approval of any of our ownership interests in any of the licensed gaming operations conducted in Nevada, any of which could have a significant adverse effect on our business, financial condition and results of operations, for any cause they may deem reasonable. If we violate gaming laws or regulations that are applicable to us, we may have to pay substantial fines or forfeit assets. If, in the future, we operate or have an ownership interest in casino gaming facilities located outside of Nevada, we may also be subject to the gaming laws and regulations of those other jurisdictions.
If additional gaming regulations are adopted or existing ones are modified in Nevada, those regulations could impose significant restrictions or costs that could have a significant adverse effect on us. From time to time, various proposals are introduced in the federal and Nevada state and local legislatures that, if enacted, could adversely affect the tax, regulatory, operational or other aspects of the gaming industry and our business. Legislation of this type may be enacted in the future. If there is a material increase in federal, state or local taxes and fees, our business, financial condition and results of operations could be adversely affected.
Our officers, directors and key employees are required to be licensed or found suitable by gaming authorities and the loss of, or inability to obtain, any licenses or findings of suitability may have a material adverse effect on us.
Our officers, directors and key employees are required to file applications with the gaming authorities in the State of Nevada, Clark County, Nevada and the City of Las Vegas and are required to be licensed or found suitable by these gaming authorities. If any of these gaming authorities were to find an officer, director or key employee unsuitable for licensing or unsuitable to continue having a relationship with us, we would have to sever all relationships with that person. Furthermore, the gaming authorities may require us to terminate the employment of any person who refuses to file the appropriate applications. Either result could significantly impair our gaming operations.
Our business is subject to seasonal fluctuations, and, as a result, our results of operations for any given quarter may not be indicative of the results that may be achieved for the full fiscal year.
Our business is subject to seasonal fluctuations. Historically, our highest earnings have occurred in the second and third quarters of the fiscal year, as our revenues in most of our restaurants have typically been higher during the second and third quarters of the fiscal year. As a result, results of operations for any single quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. Quarterly results have been, and in the future will continue to be, significantly impacted by the timing of new restaurant openings and their respective pre-opening costs.
Our international operations subject us to certain external business risks that do not apply to our domestic operations.
Rainforest Cafe has license arrangements relating to the operations and development of Rainforest Cafes in the United Kingdom, Japan, France, Mexico, Canada, Egypt and Turkey. These agreements include a per unit development fee and restaurant royalties ranging from 3% to 7% of revenues. There are nine international units; one is owned outright, and the rest are franchises. We own various equity interests in several of the international franchise locations. Our international operations will be subject to certain external business risks such as exchange rate fluctuations, political instability and the significant weakening of a local economy in which a foreign unit is located. In addition, it may be more difficult to register and protect our intellectual property rights in certain foreign countries.
If we are unable to protect our intellectual property rights, it could reduce our ability to capitalize on our brand names, which could have an adverse affect on our business and results of operations.
Landrys Seafood House, Rainforest Cafe, Charleys Crab, Saltgrass Steak House, Chart House and Golden Nugget are each registered as a federal service mark on the Principal Register of the United States Patent and Trademark Office. The Crab House is a registered design mark. We pursue registration of our important service marks and trademarks and vigorously oppose any infringement upon them. There is no assurance that any of our rights in any of our intellectual property will be enforceable, even if registered, against any prior users of similar intellectual property or against any of our competitors who seek to utilize similar intellectual property in areas where we operate or intend to conduct operations. The failure to enforce any of our intellectual property rights could have the effect of reducing our ability to capitalize on our efforts to establish brand equity.
We face the risk of adverse publicity and litigation, the cost or adverse results of which could have a material adverse effect on our business and results of operations.
We may from time to time be the subject of complaints or litigation from customers alleging illness, injury or other food quality, health or operational concerns. Publicity resulting from these allegations may materially adversely affect us, regardless of whether the allegations are valid or whether we are liable. In addition, employee claims against us based on, among other things, wage and hour violations, discrimination, harassment or wrongful termination may divert our financial and management resources that would otherwise be used to benefit the future performance of our operations. A significant increase in the number of these claims or an increase in the number of successful claims could materially adversely affect our business, prospects, financial condition, operating results and/or cash flows.
In connection with certain of our discontinued operations, we remain the guarantor or assignor under a number of leased locations. In the event of future defaults under any of such leased locations we may be responsible for significant damages to existing landlords which may materially affect our financial condition, operating results and / or cash flows.
Unfavorable publicity relating to one or more of our restaurants in a particular brand may taint public perception of the brand.
Multi-unit restaurant businesses can be adversely affected by publicity resulting from poor food quality, illness or other health concerns or operating issues stemming from one or a limited number of restaurants.
Labor shortages or increases in labor costs could slow our growth or harm our business.
Our success depends in part upon our ability to attract, motivate and retain a sufficient number of qualified employees, including regional operational managers and regional chefs, restaurant general managers, executive chefs and casino employees, necessary to continue our operations and keep pace with our growth. Qualified
individuals that we need to fill these positions are in short supply and competition for these employees is intense. If we are unable to recruit and retain sufficient qualified individuals, our business and our growth could be adversely affected. Additionally, competition for qualified employees could require us to pay higher wages, which could result in higher labor costs. If our labor costs increase, our results of operations will be negatively affected.
Health concerns relating to the consumption of seafood, beef and other food products could affect consumer preferences and could negatively impact our results of operations.
Consumer food preferences could be affected by health concerns about the consumption of various types of seafood, beef or chicken. In addition, negative publicity concerning food quality or possible illness and injury resulting from the consumption of certain types of food, such as negative publicity concerning the levels of mercury or other carcinogens in certain types of seafood, e-coli, mad cow and foot-and-mouth disease relating to the consumption of beef and other meat products, avian flu related to poultry products and the publication of government, academic or industry findings about health concerns relating to food products served by any of our restaurants could also affect consumer food preferences. These types of health concerns and negative publicity concerning the food products we serve at any of our restaurants may adversely affect the demand for our food and negatively impact our results of operations.
In addition, we cannot guarantee that our operational controls and employee training will be effective in preventing food-borne illnesses, such as hepatitis A, and other food safety issues that may affect our restaurants. Food-borne illness incidents could be caused by food suppliers and transporters and, therefore, would be outside of our control. Any publicity relating to health concerns or the perceived or specific outbreaks of food-borne illnesses or other food safety issues attributed to one or more of our restaurants, could result in a significant decrease in guest traffic in all of our restaurants and could have a material adverse effect on our results of operations. We face the risk of litigation in connection with any outbreak of food-borne illnesses or other food safety issues at any of our restaurants. If a claim is successful, our insurance coverage may not be adequate to cover all liabilities or losses and we may not be able to continue to maintain such insurance, or to obtain comparable insurance at a reasonable cost, if at all. If we suffer losses, liabilities or loss of income in excess of our insurance coverage or if our insurance does not cover such loss, liability or loss of income, there could be a material adverse effect on our results of operations.
Expanding our restaurant base by opening new restaurants in existing markets could reduce the business of our existing restaurants.
Our growth strategy includes opening restaurants in markets in which we already have existing restaurants. We may be unable to attract enough customers to the new restaurants for them to operate at a profit. Even if we are able to attract enough customers to the new restaurants to operate them at a profit, those customers may be former customers of one of our existing restaurants in that market and the opening of new restaurants in the existing market could reduce the revenue of our existing restaurants in that market.
Restaurant companies have been the target of class actions and other lawsuits alleging, among other things, violation of federal and state law.
We are subject to a variety of claims arising in the ordinary course of our business brought by or on behalf of our customers or employees, including personal injury claims, contract claims, and employment-related claims. In recent years, a number of restaurant companies have been subject to lawsuits, including class action lawsuits, alleging violations of federal and state law regarding workplace, employment and similar matters. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. We are currently defending purported collective and class action lawsuits alleging violations, among other things, of minimum wage and overtime provisions of federal and state labor laws. Regardless of whether any claims against us are valid or whether we are ultimately determined to be liable, claims may be expensive to defend and
may divert time and money away from our operations and hurt our performance. A judgment for any claims could materially adversely affect our financial condition or results of operations (especially if there is no insurance coverage), and adverse publicity resulting from these allegations may materially adversely affect our business. We offer no assurance that we will not incur substantial damages and expenses resulting from lawsuits, which could have a material adverse effect on our business.
Rising interest rates would increase our borrowing costs, which could have a material adverse effect on our business and results of operations.
We currently have, and may incur, additional indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will our interest costs, which may have an adverse effect on our business, results of operations and financial condition.
Certain holders of our Senior Notes have attempted to accelerate our Senior Notes. If we are unsuccessful in showing that the attempted acceleration is inappropriate and also unsuccessful in curing such attempted acceleration, obtaining alternative financing in the current credit market could materially adversely affect our business and results of operations.
The Indenture Trustee of our Senior Notes notified us that due to our inability to file our fiscal year end December 31, 2006 10K Report, the Indenture Trustee, acting upon a direction of holders of a majority of Senior Noteholders, had accelerated the $400.0 million of unpaid principal, premium if any, and unpaid interest on all outstanding Senior Notes. We have obtained a temporary restraining order in U.S. District Court requiring the Indenture Trustee to rescind the attempted acceleration pending a preliminary injunction hearing on August 16, 2007.
If we are unsuccessful in permanently rescinding the acceleration, we may be required to obtain alternative financing during this period of credit market disruption which will likely result in higher interest rates and more restrictive terms than could be obtained in a stable market and the resulting higher interest expense could have a materially adverse effect on our business and results of operations, as well as our acquisition strategy.
The capital costs of our specialty growth and gaming divisions are extremely high. As a result, the failure of any one of these could have a material adverse effect on our operations.
In connection with our specialty growth and gaming divisions, we incur significant capital expenditures. As a result, the failure of one or more of these projects could have a significant affect on our financial condition and operations.
The loss of Tilman J. Fertitta could have a material adverse effect on our business and development.
We believe that the development of our business has been, and will continue to be, dependent on Tilman J. Fertitta, our Chief Executive Officer, President, and Chairman of the Board. The loss of Mr. Fertittas services could have a material adverse effect upon our business and development, and there can be no assurance that an adequate replacement could be found for Mr. Fertitta in the event of his unavailability.
Changes in our tax rates could affect our future results
Our future effective tax rates could be affected by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or their interpretation. In addition we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision, however there can be no assurance that we will accurately predict the outcomes of these audits and the actual outcomes of these audits could have a material impact on our net income. In addition, the carrying values of deferred tax assets are dependent on our ability to generate future taxable income.
The matters relating to the investigation of our historical stock option granting practices and the restatement of our consolidated financial statements have resulted in our being named as a party in a derivative legal action and may result in future litigation, which could harm our business and financial condition.
As a result of our voluntary internal review of our historical stock option granting practices, we recorded additional non-cash compensation expense. To correct these accounting errors, we restated our consolidated financial statements for certain applicable periods. The investigation and restatements have exposed us to greater risks associated with litigation. Publicity resulting from these actions may materially adversely affect us, regardless of the cause or effect of the actions. Since December 31, 2006, one derivative action has been filed naming a number of current and former officers and directors as defendants. The Company is a nominal defendant. We cannot assure you about the outcome of this derivative lawsuit or any future litigation. The conduct and resolution of litigation could be time consuming, expensive, cause us to have to pay legal expenses in certain instances to current and former officers and directors, and may distract management from the conduct of our business. In addition, damages and other remedies awarded in any such litigating could harm our business and financial condition.
Other risk factors may adversely affect our financial performance.
Other risk factors that could cause our actual results to differ materially from those indicated in the Forward-Looking Statements in this report include, without limitation, changes in travel and outside dining habits as a result of terrorist activities perceived or otherwise, weather and other acts of God.
There are inherent limitations in all control systems, and misstatements due to error that could seriously harm our business may occur and not be detected.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls and disclosure controls will prevent all possible error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, in our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Further, controls can be circumvented by the individual acts of some persons or by collusion of two or more persons. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may be inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
ITEM 2. PROPERTIES
For information concerning the location of our restaurants see BusinessRestaurant Locations.
Our corporate office in Houston, Texas is a multi-story building owned by us and includes meeting and training facilities, and a research and development test kitchen. We also own and operate approximately 75,000
square feet of warehouse facilities used primarily for construction activities and related storage and retail goods storage and distribution related activities.
The Golden NuggetLas Vegas (GNLV) occupies approximately eight acres and GNLV owns the buildings and approximately 90% of the land. GNLV leases the remaining land under three ground leases that expire (given effect to their options to renew) on dates ranging from 2025 to 2102. The Golden NuggetLaughlin (GNL) occupies approximately 13.5 acres, all of which is owned by GNL.
ITEM 3. LEGAL PROCEEDINGS
On April 4, 2006, a purported class action lawsuit was filed against Joes Crab Shack San Diego, Inc. in the Superior Court of California in San Diego by Kyle Pietrzak and others similarly situated. The lawsuit alleges that the defendant violated wage and hour laws, including the failure to pay hourly and overtime wages, failure to provide meal periods and rest periods, failing to provide minimum reporting time pay, failing to compensate employees for required expenses, including the expense to maintain uniforms, and violations of the Unfair Competition Law. In June 2006, the lawsuit was amended to include Kristina Brask as a named plaintiff and named Crab Addison, Inc. and Landrys Seafood HouseArlington, Inc. as additional defendants. The Company denies Plaintiffs claims. We have reached a tentative settlement agreement which we expect to submit to the court and fully accrued the amount, which is not believed to be material to our financial position. There is no certainty, however, that the settlement agreement, when submitted, will be approved by the court.
On February 18, 2005, and subsequently amended, a purported class action lawsuit against Rainforest Cafe, Inc. was filed in the Superior Court of California in San Bernardino by Michael D. Harrison, et. al. Subsequently, on September 20, 2005, another purported class action lawsuit against Rainforest Cafe, Inc. was filed in the Superior Court of California in Los Angeles by Dustin Steele, et. al. On January 26, 2006, both lawsuits were consolidated into one action by the state Superior Court in San Bernardino. The lawsuits allege that Rainforest Cafe violated wage and hour laws, including not providing meal and rest breaks, uniform violations and failure to pay overtime. The Plaintiffs seek to recover damages, including unpaid wages, reimbursement for uniform expenses and penalties imposed by state law. The Company denies Plaintiffs claims and intends to vigorously defend this matter. As the litigation is in the early stages of the legal process, and given the inherent uncertainties of litigation, the ultimate outcome cannot be predicted at this time, nor can the amount of any potential loss be reasonably estimated.
On August 21, 2006 and subsequently amended on January 5, 2007, a purported shareholder derivative action entitled Albert D. Hulliung, derivatively on Behalf of Nominal Defendant Landrys Restaurants, Inc. was brought against certain members of our Board of Directors and certain of our current and former executive officers in the District Court of Harris County, Texas. The lawsuit alleges breach of fiduciary duties, unjust enrichment and other violations of law relating to the Companys historical stock option practices. Plaintiff seeks to recover damages in favor of the Company for damages sustained by the Company, disgorgement of profits, and attorneys fees and expenses. The Company has formed an independent special committee of the Board of Directors to investigate the allegations and has filed a motion with the court to stay the proceedings pending the outcome of the investigation.
On August 1, 2007, we filed a lawsuit in Federal District Court in the Southern District of TexasGalveston Division against U.S. Bank, National Association, et. al., the Indenture Trustee under the Companys $400.0 million Senior Notes (Notes) for wrongful acceleration of the Notes due to an alleged event of default resulting from our failure to timely file our Form 10-K with the Securities and Exchange Commission and deliver this Form 10-K to the Indenture Trustee, all within the time period specified by the rules and regulations of the Securities & Exchange Commission. We obtained a Temporary Restraining Order halting the acceleration and reinstating the Notes pending a temporary injunction hearing currently scheduled for August 16, 2007. We are seeking a declaratory judgment that the Notes were improperly accelerated and damages.
We are subject to other legal proceedings and claims that arise in the ordinary course of business. Management does not believe that the outcome of any of those matters will have a material adverse effect on our financial position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2006.
Price Range of Common Stock
Our common stock trades on the New York Stock Exchange under the symbol LNY. As of July 31, 2007, there were approximately 1,061 stockholders of record of the common stock.
The table below sets forth, for the periods indicated, the high and low sale prices as reported on the New York Stock Exchange.
Comparison of Five-Year Cumulative Total Return Among
Landrys Restaurants, Inc., Dow Jones Global Index
And Dow Jones Restaurant Index
Commencing in 2000, we began paying an annual $0.10 per share dividend, declared and paid in quarterly installments of $0.025 per share. In April 2004, the annual dividend was increased to $0.20 per share, declared and paid in quarterly installments of $0.05 per share. While we have paid a dividend every quarter since April 2000, the actual declaration and payment of cash dividends depends upon our actual earnings levels, capital requirements, financial condition, and other factors deemed relevant by the Board of Directors. The indenture under which our senior notes due 2014 were issued and our bank credit facility limit increases in dividends on our common stock to specified levels.
In November 1998, we announced the authorization of an open market stock buy back program, which was renewed in April 2000, for an additional $36.0 million. In October 2002, we authorized a $50.0 million open market stock buy back program and in September 2003, we authorized another $60.0 million open market stock repurchase program. In October 2004, we authorized a $50.0 million open market stock repurchase program. In March 2005, we announced a $50.0 million authorization to repurchase common stock. In May 2005, we announced a $50.0 million authorization to repurchase common stock. These programs have resulted in our aggregate repurchasing of approximately 17.6 million shares of common stock for approximately $290.5 million through December 31, 2005.
We purchased 0.2 million shares of our common stock during 2006, and have approximately $55.5 million at December 31, 2006 that may yet be purchased under existing programs.
The following table sets forth our selected consolidated financial data as of and for the years ended December 31, 2006, 2005, 2004, 2003, and 2002. The financial data as of and for the years ended December 31, 2006, 2005 and 2004 are derived from our audited consolidated financial statements which are incorporated by reference herein, and should be read in conjunction with our consolidated financial statements and the notes thereto, which have been audited by Grant Thornton LLP for the years ended December 31, 2006, 2005 and 2004. The financial data as of and for the years ending December 31, 2003 and 2002 has been derived from our consolidated financial statements which were previously audited by Ernst & Young LLP. The financial data for 2002 and 2003 does not agree to the previously audited financial statements as it reflects certain reclassification for discontinued operations that have not been audited.
As previously disclosed, in 2006 we initiated a voluntary review of our historical stock option granting process from 1993 to 2005 which we completed in 2007. The review identified certain employee stock option awards for which the Company had historically used an incorrect measurement date or failed to record compensation expense due to materiality. As a result, we have determined that a restatement of our financial statements for the years 2001 and prior is appropriate. The cumulative unrecorded stock compensation expense for the years 2002 to 2005 is not material. The aggregate impact of the additional compensation expense for the years 2001 and prior was $14.2 million dollars on a pre-tax basis or $9.1 million after tax and is reflected as an increase to additional paid-in capital with a corresponding decrease to retained earnings in the 2002 stockholders equity included in the following table. The cumulative effect of the additional compensation expense for the years 2002 to 2005 of $2.8 million pre-tax, or $1.8 million after tax, is not material in any fiscal year and is included as a non-cash charge in the fourth quarter of 2006. A component of this non-cash charge, or $1.1 million pre-tax and $0.8 million after tax, is classified as discontinued operations and the remainder is included in general and administrative expense in the statement of income.
During 2006, as part of a strategic review of our operations, we initiated a plan to divest certain restaurants, including 136 Joes Crab Shack units. Results of operations for all units included in the disposal plan have been reclassified as discontinued operations in the statements of income for all periods presented.
The data set forth below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations, Risk Factors and our Consolidated Financial Statements and Notes. All amounts are in thousands, except per share data.
SELECTED CONSOLIDATED FINANCIAL INFORMATION
EBITDA is not a generally accepted accounting principles (GAAP) measurement and is presented solely as a supplemental disclosure because we believe that it is a widely used measure of operating performance. EBITDA is not intended to be viewed as a source of liquidity or as a cash flow measure as used in the statement of cash flows. EBITDA is simply shown above as it is a commonly used non-GAAP valuation statistic. EBITDA as shown differs from that used in our credit agreements primarily due to non guarantor subsidiaries and other specifically defined calculations.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following presents an analysis of the results and financial condition of our continuing operations. Except where indicated otherwise, the results of discontinued operations are excluded from this discussion.
We primarily own and operate full-service, casual dining restaurants and two casinos. As of December 31, 2006, we operated 179 full service restaurants. In addition to these units, there were several limited menu restaurants and other properties (as described in Item 1. Business), and the Golden Nugget Hotels and Casinos in Las Vegas and Laughlin, Nevada as more fully described below.
During 2006, as part of a strategic review of our operations, we initiated a plan to divest certain restaurants, including 136 Joes Crab Shack units. Results of operations for all units included in the disposal plan have been reclassified to discontinued operations in the statements of income for all periods presented.
On November 17, 2006, we completed the sale of 120 Joes Crab Shack restaurants to JCS Holdings, LLC, an unaffiliated new entity created by J.H. Whitney Capital Partners, LLC for approximately $192.0 million, including the assumption of certain working capital liabilities to be finalized in 2007. In connection with the sale, we recorded pre-tax impairment charges and other losses totaling $49.2 million ($29.8 million after tax). Under the terms of the sale, we are providing JCS Holdings, LLC transitional support services for a period not expected to exceed twelve months. These services include, among other things, IT and purchasing support, as well as office space. Following cessation of these activities, we do not anticipate any significant continuing involvement with or cash flows from JCS Holdings, LLC.
We recorded additional pre-tax impairment charges totaling $24.9 million for the year ended December 31, 2006 to write down carrying values of assets pertaining to the remaining stores included in our disposal plan. We expect to sell the land and improvements belonging to these remaining restaurants, or abandon those locations, within the next 12 to 18 months.
In connection with our strategic review, we also identified certain restaurants that we believe are suitable for conversion into other Landrys concepts. As a result of this review, we took a charge of $8.6 million to impair certain assets relating to these conversion units to reflect our best estimates of their fair market value. The results of operations for these restaurants are included in continuing operations.
On September 27, 2005, Landrys Gaming, Inc., an unrestricted subsidiary, purchased the Golden Nugget Hotels and Casinos in downtown Las Vegas and Laughlin, Nevada (GN) for $163.0 million in cash, the assumption of $155.0 million of Senior Secured Notes due 2011 and the assumption of approximately $27.0 million under an existing senior revolving credit facility and the further assumption of certain working capital including $27.5 million in cash. Under the terms of the purchase agreement, the currently outstanding Senior Secured Notes due 2011 remain outstanding obligations of GN following the closing. The Golden NuggetLas Vegas occupies approximately eight acres in downtown Las Vegas with approximately 38,000 square feet of gaming area. The property also features three towers containing 1,907 rooms, the largest number of guestrooms in downtown Las Vegas. The Golden NuggetLaughlin is located on 13 acres on the Colorado River with 32,000 square feet of gaming space and 300 rooms. The results of operations for these properties are included in our financial statements from the date of acquisition.
The Specialty Growth Division is primarily engaged in operating complementary entertainment and hospitality activities, such as miscellaneous beverage carts and various kiosks, amusement rides and games and some associated limited hotel properties, generally at locations in conjunction with our core restaurant operations. The total assets, revenues, and operating profits of these complementary specialty business activities are considered not material to the overall business and below the threshold of a separate reportable business segment under SFAS No. 131.
We are in the business of operating restaurants, two casinos and the above-mentioned complementary activities. We do not engage in real estate operations other than those associated with the ownership and operation of our business. We own a fee interest (own the land and building) in a number of properties underlying our businesses, but do not engage in real estate sales or real estate management in any significant fashion or format. The Chief Executive Officer, who is responsible for our operations, reviews and evaluates both core and non-core business activities and results, and determines financial and management resource allocations and investments for all business activities.
The restaurant and gaming industries are intensely competitive and affected by changes in consumer tastes and by national, regional, and local economic conditions and demographic trends. The performance of individual restaurants or casinos may be affected by factors such as: traffic patterns, demographic considerations, marketing, weather conditions, and the type, number, and location of competing restaurants and casinos.
We have many well established competitors with greater financial resources, larger marketing and advertising budgets, and longer histories of operation than ours, including competitors already established in regions where we are planning to expand, as well as competitors planning to expand in the same regions. We face significant competition from other casinos in the markets in which we operate and from other mid-priced, full-service, casual dining restaurants offering or promoting seafood and other types and varieties of cuisine. Our competitors include national, regional, and local restaurant chains and casinos as well as local owner-operated restaurants and casinos. We also compete with other restaurants, retail establishments and gaming companies for restaurant and casino sites. We intend to pursue an acquisition strategy.
This report contains 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. All statements other than statements of historical fact are forward-looking statements for purposes of federal and state securities laws. Forward-looking statements may include the words may, will, plans, believes, estimates, expects, intends and other similar expressions. Our forward-looking statements are subject to risks and uncertainty, including, without limitation, our ability to continue our expansion strategy, our ability to make projected capital
expenditures, as well as general market conditions, competition, and pricing. Forward-looking statements include statements regarding: potential acquisitions of other restaurants, gaming operations and lines of businesses in other sectors of the hospitality and entertainment industries; future capital expenditures, including the amount and nature thereof; potential divestitures of restaurants, restaurant concepts and other operations or lines of business, business strategy and measures to implement such strategy; competitive strengths; goals; expansion and growth of our business and operations; future commodity prices; availability of food products, materials and employees; consumer perceptions of food safety; changes in local, regional and national economic conditions; the effectiveness of our marketing efforts; changing demographics surrounding our restaurants, hotels and casinos; the effect of changes in tax laws; actions of regulatory, legislative, executive or judicial decisions at the federal, state or local level with regard to our business and the impact of any such actions; our ability to maintain regulatory approvals for our existing businesses and our ability to receive regulatory approval for our new businesses; our expectations of the continued availability and cost of capital resources; same store sales; earnings guidance; the seasonality of our business; weather and acts of God; food, labor, fuel and utilities costs; plans; references to future success; the risks described in Risk Factors.
Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate, and, therefore, we cannot assure you that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in our forward-looking statements, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Some of these and other risks and uncertainties that could cause actual results to differ materially from such forward-looking statements are more fully described under Item 1A. Risk Factors and elsewhere in this report, or in the documents incorporated by reference herein. We assume no obligation to modify or revise any forward looking statements to reflect any subsequent events or circumstances arising after the date that the statement was made.
Results of Operations
The following table sets forth the percentage relationship to total revenues of certain operating data for the periods indicated:
Year ended December 31, 2006 Compared to the Year ended December 31, 2005
Restaurant and hospitality revenues increased $71,104,296, or 8.5%, from $831,818,786 to $902,923,082 for the year ended December 31, 2006 compared to the year ended December 31, 2005. The total increase/change in revenue is comprised of the following approximate amounts: 2006 restaurant openingsincrease of $48.3 million; 2006 restaurant closingsdecrease of $9.0 million; locations open 2006 and 2005 including honeymoon periodsincrease of $34.8 million; units closed for an extended period as a result of the hurricanedecrease of $4.7 million; and the remainder of the difference is attributable to the change in sales for stores not open a full comparable period. The total number of units open as of December 31, 2006 and 2005 increased from 177 as of December 31, 2005 to 179 as of December 31, 2006.
Gaming revenues increased $165,737,338 for the year ended December 31, 2006 as a result of the acquisition of the Golden Nugget. The results of the Golden Nugget are included from the September 27, 2005 acquisition date.
As a result of increased revenues, cost of revenues increased $25,403,610, or 10.9%, from $233,590,929 to $258,994,539 in the year ended December 31, 2006, compared to the same period in the prior year. Cost of revenues as a percentage of revenues for the year ended December 31, 2006, decreased to 22.8% from 26.0% in 2005. The decrease in cost of revenues as a percentage of revenues resulted primarily from the acquisition of the Golden Nugget since gaming revenues are generally derived from higher labor and other operating expenses and lower cost of revenues than restaurant and hospitality revenues.
Labor expenses increased $99,930,996, or 37.0%, from $269,824,500 to $369,755,496 in the year ended December 31, 2006, compared to the same period in the prior year, primarily as a result of increased revenues. Labor expenses as a percentage of revenues for the year ended December 31, 2006 increased to 32.6% from 30.1% in 2005, principally due to the acquisition of the Golden Nugget since gaming revenues are generally derived from higher labor and other operating expenses and lower cost of revenues than restaurant and hospitality revenues.
Other operating expenses increased $64,588,497, or 28.9%, from $223,589,627 to $288,178,124 in the year ended December 31, 2006, compared to the same period in the prior year, principally as a result of increased revenues. Such expenses increased as a percentage of revenues to 25.4% in 2006 from 24.9% in 2005, as a primary result of the acquisition of the Golden Nugget since gaming revenues are generally derived from higher labor and other operating expenses and lower cost of revenues than restaurant and hospitality revenues.
General and administrative expenses increased $10,534,765, or 22.2%, from $47,442,596 to $57,977,361 in the year ended December 31, 2006, compared to the same period in the prior year. General and administrative expenses decreased as a percentage of revenues to 5.1% in 2006 from 5.3% in 2005. This percentage decrease is primarily attributable to the increase in revenues, offset by increased stock-based compensation expense as compared to the prior year comparable period.
Depreciation and amortization expense increased $12,704,419, or 28.4%, from $44,760,700 to $57,465,119 in the year ended December 31, 2006, compared to the same period in the prior year. The increase for 2006 was primarily due to an increase in depreciation related to the addition of new restaurants and equipment and the acquisition of the Golden Nugget.
As part of our strategic review of operations in 2006, we identified certain Joes restaurants that we believe are suitable for conversion into other Landrys concepts. As a result of this review, we took a charge of $8.6 million to impair certain assets relating to these conversion units to reflect our best estimates of their fair market value. Assets that were impaired are primarily leasehold improvements and to a lesser extent equipment. We did not take any impairment charges in 2005.
Restaurant pre-opening expenses were $6,230,465 for the year ended December 31, 2006, compared to $3,030,611 for the same period in the prior year. The increase resulted from our opening a greater number of larger scale restaurants during 2006 as compared to units opened in 2005.
The increase in net interest expense for the year ended December 31, 2006 as compared to the prior year is primarily due to higher borrowings, as well as an increase in our average borrowing rate.
Other income, net for 2006 was $2,421,901 and consisted primarily of gains recognized on the sale of a restaurant property and insurance proceeds.
Provision for income taxes decreased by $3,138,141 to $10,750,064 in the year ended December 31, 2006. Our effective tax rate for 2006 was 26.7% compared to 31.4% in 2005.
Year ended December 31, 2005 Compared to the Year ended December 31, 2004
Restaurant and hospitality revenues increased $26,915,734, or 3.3%, from $804,903,052 to $831,818,786 for the year ended December 31, 2005 compared to the year ended December 31, 2004. The total increase/change in revenue is comprised of the following approximate amounts: 2005 restaurant openingsincrease of $19.6 million; restaurant closingsdecrease of $5.2 million; locations open 2005 and 2004 including honeymoon periodsincrease of $ 16.1 million; day lost due to leap yeardecrease of $1.8 million; units closed for an extended period as a result of the hurricanedecrease of $1.9 million; and the remainder of the difference is attributable to the change in sales for stores not open a full comparable period. The total number of units open as of December 31, 2005 and 2004 were 177 and 175, respectively.
Gaming revenues increased $65,640,727 for the year ended December 31, 2005 as a result of the acquisition of the Golden Nugget. The results of the Golden Nugget are included from the September 27, 2005 acquisition date.
As a primary result of increased revenues, cost of revenues increased $8,152,260, or 3.6%, from $225,438,669 to $233,590,929 in the year ended December 31, 2005, compared to the same period in the prior year. Cost of revenues as a percentage of revenues for the year ended December 31, 2005, decreased to 26.0% from 28.0 % in 2004. The decrease in cost of revenues as a percentage of revenues primarily reflects a moderate menu price increase, stable commodities prices, a shift in product mix and the acquisition of the Golden Nugget.
Labor expenses increased $37,497,160, or 16.1%, from $232,327,340 to $269,824,500 in the year ended December 31, 2005, compared to the same period in the prior year, principally as a result of increased revenues. Labor expenses as a percentage of revenues for the year ended December 31, 2005 increased to 30.1% from 28.9% in 2004, principally due to increased hourly wage rates and higher overtime and the acquisition of the Golden Nugget.
Other operating expenses increased $23,929,045, or 12.0%, from $199,660,582 to $223,589,627 in the year ended December 31, 2005, compared to the same period in the prior year, principally as a result of increased revenues. Such expenses increased as a percentage of revenues to 24.9% in 2005 from 24.8% in 2004, as a primary result of the acquisition of the Golden Nugget.
General and administrative expenses decreased $1,003,014, or 2.1%, from $48,445,610 to $47,442,596 in the year ended December 31, 2005, compared to the same period in the prior year, and decreased as a percentage of revenues to 5.3% in 2005 from 6.0% in 2004. The decrease is due to lower professional fees related to Sarbanes-Oxley and leverage associated with the acquisition of the Golden Nugget.
Depreciation and amortization expense increased $5,801,663, or 14.9%, from $38,959,037 to $44,760,700 in the year ended December 31, 2005, compared to the same period in the prior year. The increase for 2005 was primarily due to the acquisition of the Golden Nugget and an increase in depreciation related to the addition of new restaurants and equipment.
Asset impairment expense of approximately $1.7 million relating to one underperforming restaurant was recorded for 2004. The charge was taken due to sales declines combined with deterioration in this particular restaurants profitability and managements lowered outlook for improvement in the specific property. Assets that were impaired were primarily leasehold improvements and to a lesser extent equipment. No asset impairment was recorded in 2005.
Restaurant pre-opening expenses were $3,030,611 for the year ended December 31, 2005, compared to $3,234,018 for the same period in the prior year. The decrease for the 2005 period was attributable to a decrease in units opened in 2005 as compared to 2004.
The increase in net interest expense for the year ended December 31, 2005 as compared to the prior year is primarily due to higher borrowings, as well as an increase in our average borrowing rate.
Other income, net for 2005 was immaterial. Other expense, net for 2004 was $13,176,474 and was comprised primarily of $14.6 million in pre-payment penalties and related fees associated with the pay down of our $150.0 million senior notes and bank credit facility, both of which were entered into in 2003, partially offset by $1.1 million in business interruption insurance recoveries.
Provision for income taxes increased by $23,437,686 to $13,888,205 in the year ended December 31, 2005 compared to a tax benefit of $9,549,481 in 2004. In 2004 we generated a net $18.5 million income tax benefit from the reversal of the remaining valuation allowance attributable to tax benefits associated with the Rainforest Cafe acquisition deemed realizable. The previously established valuation allowance was reversed at December 31, 2004, due to the strong 2004 and future forecasted profitability of the Rainforest Cafe restaurants, a successful transition from a tax-loss incurring stand-alone public company to a highly profitable and taxable income producing wholly-owned subsidiary, coupled with the approaching end of specific recognition limitations on allowable deductions and tax assets and the 2004 resolution of certain tax issues, which caused management to believe the remaining deferred tax assets previously reserved would more likely than not be realized.
Liquidity and Capital Resources
On July 24, 2007, we were notified by U.S. Bank, Indenture Trustee for our $400.0 million Senior Notes, that such notes were accelerated, to be due and payable immediately as a result of our inability to file and deliver to the Indenture Trustee this Form 10-K pending completion of our stock option review. We believe the attempt to accelerate is inappropriate and we have received a Temporary Restraining Order (TRO) from the U.S. District Federal Court sitting in Galveston County, Texas requiring the Trustee to rescind the acceleration pending a hearing on August 16, 2007. We believe we will be successful in obtaining a permanent rescission of the acceleration, or will negotiate a consent from the note holders or will obtain alternative financing sources. If we are unsuccessful in obtaining a permanent rescission of the accelerations, it is likely that any alternative financing will carry significantly higher interest rates and the associated higher interest expense. Furthermore, such alternative financing may well place substantially more restrictions on our ability to execute our strategies and business plan.
On June 14, 2007, our wholly owned unrestricted subsidiary, Golden Nugget, Inc. (Golden Nugget), completed a new $545.0 million Credit Facility consisting of a $330.0 million first lien term loan which includes a $120.0 million delayed draw component to finance the construction expansion at the Golden Nugget Hotel and Casino in Las Vegas, Nevada, plus a $50.0 million revolving credit facility, and a $165.0 million second lien term loan with terms ranging from 6 to 7 years. The first lien term loan bears interest at Libor or the Banks base rate, plus a financing spread, 2.0% for Libor and .75% for base rate borrowings. In addition, the Credit Facility requires a commitment fee on the unfunded portion for both the $50.0 million revolving credit facility and the $120.0 million delayed draw term loan. The financing spread and commitment fee for the revolving credit facility increases or decreases depending on the leverage ratio as defined in the Credit Facility. The second lien term facility bears interest at Libor or the Banks base rate, plus a financing spread, 3.25% for Libor and 2% for base rate borrowings. The second lien term facility matures on December 31, 2014. Interest is paid quarterly. Both the first and second lien term loans are subject to customary banking covenants and conditions, including minimum EBITDA, interest charge and financial leverage ratios, limitations on acquisitions, debt, investments and other restricted payments as defined in the Credit Facility, plus certain restrictions and conditions to access funds under the $120.0 million delayed draw term loan to finance the construction expansion. The Credit Facility provides for the payment of a one-time dividend of up to $187.5 million to the Company or a designated subsidiary of the Company representing repayment of amounts previously expended on the Golden Nugget. The $187.5 million will be available for acquisitions, debt repayment, stock repurchases and general corporate purposes.
On June 14, 2007, the proceeds from the new $545.0 million Credit Facility were used to repay all of the Golden Nuggets outstanding debt, including its 8 ¾% Senior Secured Notes due 2011 totaling $155.0 million, plus the outstanding balance of approximately $10.0 million on its former $43.0 million revolving credit facility with Wells Fargo Foothill, Inc. In addition, the proceeds were used to pay associated tender premiums of
approximately $8.8 million due to the early redemption of the Senior Secured Notes, plus accrued interest and related transaction fees and expenses.
In December 2004, we refinanced our existing revolving credit facility and existing senior notes by entering into a new five year $300.0 million Bank Credit Facility and a six year $150.0 million Term Loan. In November 2006, we utilized proceeds from the Joes sale to pay down approximately $109.5 million on the term loan, leaving a balance outstanding of approximately $37.8 million as of December 31, 2006. The Bank Credit Facility matures in December 2009 and the Term Loan matures in December 2010. Interest on the Bank Credit Facility is payable monthly or quarterly at Libor or the banks base rate plus a financing spread. Interest on the Term Loan is payable quarterly at Libor plus a financing spread. The financing spread under the Bank Credit Facility and the Term Loan is currently 2.0% for Libor borrowings and 1.0% for base rate borrowings. As of December 31, 2006, we had approximately $216.7 million available under the existing credit facility for expansion and working capital purposes.
Concurrent with the closing of the Bank Credit Facility and Term Loan in December 2004, we also issued $400.0 million in senior notes through a private placement offering. The senior notes are general unsecured obligations of the Company and mature December 2014. Interest is payable semi-annually at 7.5%. On June 16, 2005, we completed an exchange offering whereby substantially all of the senior notes issued under the private placement were exchanged for senior notes registered under the Securities Act of 1933.
Net proceeds from the Bank Credit Facility and senior notes totaled $536.6 million and were used to repay all outstanding liabilities under the existing credit facility and senior notes. These debt repayments resulted in a pre-tax charge of $16.6 million in the fourth quarter of 2004.
The Bank Credit Facility and Term Loan are secured by substantially all real and personal property of subsidiaries and governed by certain financial covenants, including minimum fixed charge, net worth, and our financial leverage ratios as well as limitations on dividend payments, capital expenditures and other restricted payments as defined in the agreements.
A wholly-owned subsidiary of ours assumed an $11.4 million, 9.39% non-recourse, long-term note payable (due May 2010) in connection with an asset purchase in March 2003. Principal and interest payments under this note aggregate $102,000 monthly.
Working capital, excluding discontinued operations, increased from a deficit of $63.2 million as of December 31, 2005 to a deficit of $74.9 million as of December 31, 2006 primarily due to the purchase of the Golden Nugget Hotels and Casinos and repurchase of our common stock during 2005. Cash flow to fund future operations, new restaurant development, stock repurchases, and acquisitions will be generated from operations, available capacity under our credit facility and additional financing, if appropriate.
From time to time, we review opportunities for restaurant acquisitions and investments in the hospitality, entertainment (including gaming), amusement, food service and facilities management and other industries. Our exercise of any such investment opportunity may impact our development plans and capital expenditures. We believe that adequate sources of capital are available to fund our business activities through December 31, 2007.
As a primary result of our 2004 refinancing, we have incurred higher interest expense. To manage our interest rate exposure, we entered into fair value hedges with a notional amount of $100.0 million, whereby we swapped the fixed interest rate of the 7.5% senior notes due 2014 for floating interest rates equal to six month Libor plus a financing spread of 2.34% to 2.38%.
Since April 2000, we have paid an annual $0.10 per share dividend, declared and paid in quarterly amounts. We increased the annual dividend to $0.20 per share in April 2004.
In 2006, we incurred $205.6 million for capital expenditures including $81.6 million on the remodel of the Golden Nugget Hotel and Casino in downtown Las Vegas, Nevada, the opening of 10 new restaurants and $19.7 million on land for future development. In 2006, we also spent $7.8 million to acquire an 80% interest in the T-Rex restaurant. In 2007, we expect to incur approximately $103.4 million, including opening 8 units, $42.0 million to complete the renovation and expansion of the Golden Nugget Hotel and Casino and approximately $18.0 million on the construction of a new T-Rex and Yak & Yetis restaurant at two Disney properties.
Off Balance Sheet Arrangements
As of December 31, 2006, we had contractual obligations as described below. These obligations are expected to be funded primarily through cash on hand, cash flow from operations, working capital, the Bank Credit Facility and additional financing sources in the normal course of business operations. Our obligations include off balance sheet arrangements whereby the liabilities associated with non cancelable operating leases, unconditional purchase obligations and standby letters of credit are not fully reflected in our balance sheets.
Seasonality and Quarterly Results
Our business is seasonal in nature. Our reduced winter volumes cause revenues and, to a greater degree, operating profits to be lower in the first and fourth quarters than in other quarters. We have and will continue to open restaurants in highly seasonal tourist markets. Periodically, our sales and profitability may be negatively affected by adverse weather. The timing of unit openings can and will affect quarterly results.
Critical Accounting Policies
Restaurant and other properties are reviewed on a property by property basis for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. The recoverability of properties that are to be held and used is measured by comparison of the estimated future undiscounted cash flows associated with the asset to the carrying amount of the asset. Goodwill and other non-amortizing intangible assets are reviewed for impairment at least annually using estimates of future operating results. If such assets are considered to be impaired, an impairment charge is recorded in the amount by which the carrying amount of the assets exceeds their fair value. Properties to be disposed of are reported at the lower of their carrying amount or fair values, reduced for estimated disposal costs, and are included in other current assets.
We operate approximately 179 properties and periodically we expect to experience unanticipated individual unit deterioration in revenues and profitability, on a short-term and occasionally longer-term basis. When such events occur and we determine that the associated assets are impaired, we will record an asset impairment expense in the quarter such determination is made. Due to our average restaurant net investment cost, excluding the owned land component, of approximately $2.0 million, such amounts could be significant when and if they occur. However, such asset impairment expense does not affect our financial liquidity, and is usually excluded from many valuation model calculations.
We maintain a large deductible insurance policy related to property, general liability and workers compensation coverage. Predetermined loss limits have been arranged with insurance companies to limit our per occurrence cash outlay. Accrued expenses and other liabilities include estimated costs to settle unpaid claims and estimated incurred but not reported claims using actuarial methodologies.
We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires the recognition of deferred tax assets, net of applicable reserves, related to net operating loss carryforwards and certain temporary differences. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be recognized. We regularly assess the likelihood of realizing the deferred tax assets based on forecasts of future taxable income and available tax planning strategies that could be implemented and adjust the related valuation allowance if necessary.
Our income tax returns are subject to examination by the Internal Revenue Service and other tax authorities. We regularly assess the potential outcomes of these examinations in determining the adequacy of our provision for income taxes and our income tax liabilities. Inherent in our determination of any necessary reserves are assumptions based on past experiences and judgments about potential actions by taxing authorities. Our estimate of the potential outcome for any uncertain tax issue is highly judgmental. We believe that we have adequately provided for any reasonable and foreseeable outcome related to uncertain tax matters.
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payment, (SFAS 123R), using the modified prospective application method. Under this transition method, we will record compensation expense for all stock option awards granted after the date of adoption and for the unvested portion of previously granted stock option awards that remain outstanding at the date of adoption. The amount of compensation cost recognized was based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123. Under the provisions of SFAS 123R, the recognition of unearned compensation, a contra-equity account representing the amount of unrecognized restricted stock compensation expense, is no longer required. Therefore, in the first quarter of 2006 the unearned compensation amount that was included in our December 31, 2005 consolidated balance sheet in the amount of $6.4 million was reduced to zero with a corresponding decrease to capital in excess of par value. Results for prior periods have not been restated upon adoption of 123R.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, the recognition and measurement of current and deferred income tax assets and liabilities; the assessment of recoverability of long-lived assets and costs to settle unpaid claims. Actual results may differ materially from those estimates.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109. FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken
in a tax return, as well as guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of FIN 48 to have a material impact on our financial statements.
In June 2006, the FASB ratified the consensus reached on EITF Issue No. 06-03, How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (that is, Gross Versus Net Presentation) (EITF 06-03). The EITF reached a consensus that the presentation of taxes on either a gross or net basis is an accounting policy decision that requires disclosure. EITF 06-03 is effective for the first interim reporting period beginning after December 15, 2006. We pay gross receipts tax on liquor sales in certain jurisdictions. Our policy is to present these taxes gross within revenues and expenses. The adoption of EITF 06-03 will not have any effect on our financial position or results of operations.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108), Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. SAB 108 addresses the diversity in practice of quantifying and assessing materiality of financial statement errors. It is effective for fiscal years ending after November 15, 2006 and allows for a one-time transitional cumulative effect adjustment to the opening balance of retained earnings for errors that were not previously deemed material. The adoption of SAB 108 did not have an impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 157 is not expected to have a material impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that the adoption of SFAS 159 will have on our consolidated financial statements.
Impact of Inflation
We do not believe that inflation has had a significant effect on our operations during the past several years. We believe we have historically been able to pass on increased costs through menu price increases, but there can be no assurance that we will be able to do so in the future. Future increases in labor costs, including expected future increases in federal and state minimum wages, energy costs, and land and construction costs could adversely affect our profitability and ability to expand.
We are exposed to a variety of market risks including risks related to potential adverse changes in interest rates and commodity prices. We actively monitor exposure to market risk and continue to develop and utilize appropriate risk management techniques. We do not use derivative financial instruments for trading or to speculate on changes in commodity prices.
Interest Rate Risk
Total debt at December 31, 2006 included $239.4 million of floating-rate debt attributed to borrowings at an average interest rate of 7.7%. As a result, our annual interest cost in 2007 will fluctuate based on short-term interest rates.
In connection with the 7.5% senior notes due 2014, we entered into two interest swap agreements with the objective of managing our exposure to interest rate risk and lowering interest expense. The agreements were effective December 2004 and March 2005, and mature in December 2014 for an aggregate notional amount of $100.0 million.
The impact on annual cash flow of a ten percent change in the floating-rate (approximately 0.8%) would be approximately $1.8 million annually based on the floating-rate debt and other obligations outstanding at December 31, 2006; however, there are no assurances that possible rate changes would be limited to such amounts. Certain holders of our Senior Notes have attempted to accelerate the Notes. If we are unsuccessful in permanently rescinding the attempted acceleration, we will be required to obtain alternative financing which will result in higher interest rates.
The financial statement schedule is set forth commencing on page 66.
We have had no disagreements with our accountants on any accounting or financial disclosures.
Evaluation of Controls and Procedures
We carried out an evaluation, with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures as of December 31, 2006. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of December 31, 2006, our disclosure controls and procedures, as defined in Rule 13a-15(e), were not effective to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 (the Exchange Act) are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f). Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2006 based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. In connection with this evaluation, management and Grant Thornton LLP, the independent registered public accounting firm that audited our consolidated financial statements included in this Annual Report on Form 10-K, have identified material weaknesses in our internal control over financial reporting. As a result of the material weaknesses set forth below, our principal executive officer and our principal financial officer have concluded that, as of the end of the period covered by this report, our internal control over financial reporting was not effective.
Grant Thornton LLP has audited our managements assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006, as stated in their report which is included herein.
Disclosure Control Ineffectiveness
An investigation over the Companys stock-based compensation practices disclosed deficiencies that include an absence of formality, incomplete authorization and documentation of stock option grants, inappropriate accounting for stock option grants, and insufficient internal controls governing the stock option granting, exercise and accounting processes. Additionally, an adjustment for $1.0 million was initiated by the principal financial officer that corresponded in timing and amount to an audit adjustment proposed by the auditors. The adjustment was recorded in the Companys records with the effect of offsetting the proposed adjustment. The timing and complete facts surrounding the adjustment may not have been fully communicated or understood by all approving parties prior to the adjustment being recorded. The adjustment was subsequently reversed after the Company completed its analysis.
Internal Control Over Financial Reporting Weaknesses
A material weakness was identified with respect to deficiencies related to the documentation, authorization, accounting and related processes for stock option grants and adjustments in the financial reporting close process. Absent control improvements including oversight, a material misstatement could occur in the annual or interim financial statements. While we have identified additional control improvements, such controls were not operating effectively at December 31, 2006.
Changes in Internal Control Over Financial Reporting
Our management carried out an evaluation, with the participation of our principal executive officer and principal financial officer, of changes in our internal control over financial reporting, as defined in Rule 13a-15(f). Based on this evaluation, our management determined that no change in our internal control over financial reporting occurred during the fourth quarter of fiscal 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The anticipated changes in our internal control over financial reporting necessary to remedy the weaknesses identified above will be implemented subsequent to the year ended December 31, 2006.
ITEM 9B. OTHER INFORMATION
We have disclosed all information required to be disclosed in a current report on Form 8-K during the fourth quarter of the year ended December 31, 2006 in previously filed reports on Form 8-K.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following information is set forth with respect to our directors and the persons nominated for election as a director.
Mr. Fertitta has served as our President and Chief Executive Officer since 1987. In 1988, he became the controlling stockholder and assumed full responsibility for all of our operations. Prior to serving as our President and CEO, Mr. Fertitta devoted his full time to the control and operation of a hospitality and development company. Mr. Fertitta serves on numerous boards and charitable organizations.
Mr. Scheinthal has served as our Executive Vice President or Vice President of Administration, General Counsel and Secretary since September 1992. He devotes a substantial amount of time to lease and contract negotiations and is primarily responsible for our compliance with all federal, state and local ordinances. Prior to joining us, he was a partner in the law firm of Stumpf & Falgout in Houston, Texas. Mr. Scheinthal represented us for approximately five years before becoming part of our company. He has been licensed to practice law in the state of Texas since 1984.
Mr. Brimmer is the CEO and Chairman of the Board of STEN Corporation, a publicly-traded, diversified business. Mr. Brimmer has served as a director of STEN Corporation since 1998 and has been CEO of STEN Corporation since October 2003. From April 2000 until June 2003, he served as Chairman and Director of Active IQ Technologies, Inc. and was CEO from April 2000 until December 2001. Previously, Mr. Brimmer was President of Rainforest Cafe, Inc. from April 1997 until April 2000 and was Treasurer from its inception in 1995 until April 2000. Prior to that, Mr. Brimmer was employed by Grand Casinos, Inc. and its predecessor from 1990 until April 1997. Mr. Brimmer also is a director and serves on both the Audit and Compensation Committees of Hypertension Diagnostics. He has a degree in accounting and worked as a CPA in the audit division of Arthur Andersen & Co. from 1977 through 1981. Mr. Brimmer was elected to our Board of Directors in 2004.
Mr. Chadwick has been engaged in the commercial and investment banking businesses since 1975. From 1988 to 1994, Mr. Chadwick was President of Chadwick, Chambers & Associates, Inc., a private merchant investment banking firm in Houston, Texas, which he founded in 1988. In 1994, Mr. Chadwick joined Sanders Morris Harris, an investment banking and financial advisory firm, as Senior Vice President and a Managing Director in the Corporate Finance Group. Mr. Chadwick was elected to our Board of Directors in 2001.
Mr. Richmond currently serves as a Director and Vice Chairman of Woodforest National Bank, a Houston area-based bank. Prior to joining Woodforest National Bank in January 2003, Mr. Richmond worked for The
Woodlands Operating Company, L.P., a developer specializing in master-planned communities, commercial and investment properties, from 1972 to 2002. Mr. Richmond served as President and CEO from 1998-2002 and held such other titles as COO, Senior Vice President of Financial Operations, Treasurer, and Controller. Mr. Richmond has been a certified public accountant since the 1970s. Mr. Richmond was elected to our Board of Directors in 2003.
Mr. Taylor was formerly the chief law enforcement administrator for Galveston County, Texas. He has served as a Director and Executive Committee member of American National Insurance Company, a publicly-traded insurance company, for ten years and served on the Board of Directors of Moody Gardens, a hospitality and entertainment complex located in Galveston, Texas. Mr. Taylor was elected to our Board of Directors in 1993.
In addition to Messrs. Fertitta and Scheinthal, for which information is provided above, the following persons are executive officers:
Mr. Liem serves as Executive Vice President and Chief Financial Officer and has served as Senior Vice President of Finance since June 2004. He started with us in 1999 as the Vice President of Accounting or Corporate Controller. Mr. Liem joined us from Carrols Corporation, a restaurant company located in Syracuse, NY, where he was the Vice President of Financial Operations from 1994 to 1999. He was with the audit division of Price Waterhouse, L.L.P. from 1983 to 1994. Mr. Liem is a certified public accountant.
Mr. Cantwell serves as Senior Vice President of Development and has served as Vice President of Development, and Director of Design and Construction. He was promoted to an executive officer in 2006. He has been employed by us since his graduation from Southwest Texas State University in June, 1992. While in college, he worked in many of our restaurants and developed a significant understanding of restaurant operations.
Mr. Roberts serves as Chief Administration Officer Hospitality and Gaming Division and has served as Chief Financial Officer Hotel Division and Controller Hotel Division. He has been employed by the Company since 1996. He has over 25 years experience in the hospitality business in finance and operations working for various hotel chains and independent management companies. He also currently serves on the executive board of the Greater Houston Convention and Visitors Bureau.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our directors, executive officers and holders of more than 10% of our common stock to file with the SEC initial reports of ownership and reports of changes in ownership of common stock. We believe, based solely on a review of the copies of such reports furnished to us and on written representations from our existing directors and executive officers, that all existing directors and executive officers and holders of more than 10% of our common stock subject to the reporting requirements of Section 16(a) have filed on a timely basis all reports required during, or with respect to, the year ended December 31, 2006.
Codes of Business Conduct and Ethics
We have adopted a Code of Business Conduct and Ethics that is applicable to all of our directors, officers and other employees. The Code is posted under the Corporate Governance portion of the Investor Relations section on our website at www.LandrysRestaurants.com and is available to any stockholder upon request. We have also adopted a Code of Ethics Statement by the CEO and senior financial officers, which is filed with the SEC as an exhibit to our 2003 Annual Report on Form 10-K. If there are any changes or waivers of the Code of Business Conduct and Ethics which applies to the CEO and senior financial officers, we will disclose it on our website in the same location. Our Code of Business Conduct and Ethics or Code of Ethics Statement can also be obtained free of charge by directing a written request to Steven L. Scheinthal, Secretary, Landrys Restaurants, Inc., 1510 West Loop South, Houston, Texas, 77027.
Communications to Non-Employee Directors
The Board provides a process for stockholders and other interested persons to send communications to the non-employee directors as a group or any of the other directors, including the entire Board. Stockholders and other interested persons may send written communications to the non-employee directors or any of the other directors to Steven L. Scheinthal, Secretary, Landrys Restaurants, Inc. 1510 West Loop South, Houston, Texas, 77027. The Secretary will review, sort and summarize the communications and forward them to the intended recipient(s) on a periodic basis, but no less frequently than every calendar quarter.
As set forth in the Companys Corporate Governance Guidelines, which are available on our website at www.LandrysRestaurants.com under Corporate Governance, it is the policy of the Board of Directors that a majority of the members of the Board be independent of the Companys management. For a director to be deemed independent, each independent director must meet the independence requirements of the New York Stock Exchange and applicable state and federal law, including the rules and regulations of the SEC, including the following requirements:
The definition of independence and compliance with these guidelines will be reviewed periodically by the Nominating and Corporate Governance Committee. The Board believes that directors who are also employees of the Company should be limited only to those officers whose positions make it appropriate for them to sit on the Board.
Our Board of Directors has determined that the following majority of directorsKenneth Brimmer, Michael S. Chadwick, Michael Richmond and Joe Max Taylorqualify as independent under the applicable New York Stock Exchange standards as well as the Companys standards for director independence.
One of the Companys independent non-employee directors serves as the Presiding Director of executive sessions of the non-employee directors of the Company, which are held at every meeting of the Board of Directors.
COMMITTEES OF THE BOARD OF DIRECTORS
We have an Executive Committee, an Audit Committee, a Compensation Committee, and a Nominating and Corporate Governance Committee. We have reviewed our committee structure in order to fully satisfy the existing rules of the SEC and NYSE and believe that it satisfies all of such rules. Copies of the Audit Committee, Compensation Committee, and Nominating and Corporate Governance Committee Charters are available under the Corporate Governance portion of the Corporate Relations section of our website at www.LandrysRestaurants.com.
There were ten meetings of the Executive Committee, five meetings of the Audit Committee, three meetings of the Compensation Committee, two meetings of the Nominating and Corporate Governance Committee and eleven meetings of the Companys Board of Directors held during 2006. All of the current Board members attended 75% or more of the meetings of the Board and of the committees of the Board on which they were members. It is the policy of the Board that, to the extent possible, all Directors attend the Annual Meeting of Stockholders. All Directors attended the 2006 Annual Meeting of Stockholders.
The Audit Committee consists of three independent Non-Employee Directors. The members of the Audit Committee during 2006 were Michael Chadwick (Chairman), Michael Richmond and Kenneth Brimmer. The Audit Committees primary purpose is to assist the Board of Directors oversight of (a) the integrity of our financial statements and disclosures; (b) our compliance with legal and regulatory requirements; (c) the independent auditors qualifications and independence; and (d) the performance of our internal audit and independent auditors. The Audit Committee has the sole authority to appoint and terminate our independent auditors. In addition, during 2006-2007, the Audit Committee has acted as a special committee to conduct an internal investigation with respect to the Companys past stock option granting practices and derivative lawsuit. Our Board of Directors has determined that Mr. Chadwick, Chairman of the Audit Committee, is an audit committee financial expert as described in Item 401(h) of the SECs Regulation S-K. In addition, the Board of Directors has determined that each member of the Audit Committee is independent, as independence for audit committee members is defined in the listing standards of the NYSE. The Audit Committee is established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act.
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee consists of two Independent Non-Employee Directors. The current members of the Nominating and Corporate Governance Committee are Mr. Taylor (Chairman) and Mr. Brimmer. The Nominating and Corporate Governance Committee is charged with identifying and making recommendations to the Board of Directors of individuals suitable to become members of the Board of Directors and in overseeing the administration of our various policies related to corporate
governance matters. The Board of Directors has determined that each member of the Nominating and Corporate Governance Committee is independent, as independence for nominating committee members is defined in the listing standards of the NYSE.
Nominating and Corporate Governance Committee Director Nominations
The Nominating and Corporate Governance Committee has established criteria for the selection and recommendation of candidates to become nominees submitted by the Board of Directors for election to the Board of Directors by our stockholders. The Committee selects each recommended nominee based on the nominees experience, independence and availability. As set forth in our Corporate Governance Guidelines, the following criteria are considered in selecting candidates for the Board of Directors: a high degree of personal and professional ethics, integrity and values, an independent mind and mature judgment. In addition, candidates are to be involved only in activities or interests that would not create a conflict with potential directorial responsibilities to us and our stockholders.
When soliciting candidates for Director, the Nominating and Corporate Governance Committee may solicit suggestions from incumbent Directors, management and stockholders. While the Committee has authority under its charter to retain a search firm for this purpose, no such firm was utilized in 2006. If the Committee believes a candidate would be a valuable addition to the Board of Directors, it will recommend that candidates election to the full Board of Directors.
The Charter of the Nominating and Corporate Governance Committee provides that the Committee will consider proposals for nominees for Director from stockholders. Stockholder nominations for Director should be made in writing to Mr. Steven L. Scheinthal, Secretary, Landrys Restaurants, Inc., 1510 West Loop South, Houston, Texas 77027. In order to nominate a Director at the Annual Meeting, we require that a stockholder follow the procedures set forth herein. In order to recommend a nominee for a Director position, a stockholder must be a stockholder of record at the time he, she or it gives notice of recommendation and must be entitled to vote for the election of Directors at the meeting at which such nominee will be considered. Stockholder recommendations must be made pursuant to written notice delivered to the Secretary at our principal executive offices (i) in the case of a nomination for election at an annual meeting, not less than 60 days prior to the first anniversary of the date of our notice of annual meeting for the preceding years annual meeting; and (ii) in the case of a special meeting at which Directors are to be elected, not later than the close of business on the later of the 90th day prior to such special meeting or the tenth day following the day on which public announcement is first made of the date of the meeting and of the nominees proposed by the Board of Directors to be elected at the special meeting. In the event that the date of the annual meeting is changed by more than 30 days from the anniversary date of the preceding years annual meeting, the stockholder notice described above will be deemed timely if it is received not later than the close of business on the later of the 90th day prior to such annual meeting or the tenth day following the day on which public announcement of the date of such meeting is first made.
The stockholder notice must set forth the following:
In addition to complying with the foregoing procedures, any stockholder nominating a director must also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder.
The Compensation Committee is comprised entirely of independent Non-Employee Directors, as defined by the NYSE, and the Exchange Act and independent outside directors as defined under Section 162(m) of the Internal Revenue Code. The members of the Compensation Committee during 2006 were Michael Chadwick, Michael Richmond and Joe Max Taylor (Chairman). The Compensation Committee is responsible for our executive compensation program. Generally, the Compensation Committee is charged with the authority, to review and approve our compensation philosophy and our executive compensation programs, levels, plans and awards. The Compensation Committee also administers our incentive plans and other stock-based plans and reviews and approves general employee benefit plans on an as-needed basis. The Compensation Committee also has the authority to retain, approve fees and other terms for, and terminate any compensation consultant, outside counsel, accountant or other advisor hired to assist the Compensation Committee in the discharge of its responsibilities.
ITEM 11. COMPENSATION DISCUSSION AND ANALYSIS
This Compensation Discussion and Analysis explains the philosophy underlying our compensation strategy and the fundamental elements of compensation paid to our Chief Executive Officer, Chief Financial Officer, and other individuals, whom we refer to as executive officers, included in the Summary Compensation Table for the 2006 calendar year. Specifically, this Compensation Discussion and Analysis addresses the following:
Objectives of Our Compensation Program. Our business strategy is to develop and operate a diversified restaurant, hospitality and entertainment company offering customers unique dining, leisure and entertainment experiences. We believe that this strategy creates a loyal customer base, generates a high level of repeat business and provides superior returns to our investors. Our compensation program is designed to attract, retain and motivate employees in order to effectively execute our business strategy.
What Our Compensation Program Is Designed to Reward. Our compensation program is designed to reward performance of executive officers that contributes to the achievement of our business strategy on both a short-term and long-term basis. We reward qualities that we believe help achieve our strategy such as teamwork, individual performance in light of general economic and industry specific conditions, individual performance that supports our core values, resourcefulness, the ability to manage our business, level of job responsibility and tenure with us.
Elements of Our Compensation Program and Why We Pay Each Element. The Compensation Committee believes that the compensation packages for executive officers should consist of the following components:
We pay base salary in order to recognize each executive officers unique value and historical contributions to our success in light of salary norms in the industry and the general marketplace, to match competitors for executive talent, to provide executives with regularly-paid income, and to reflect position and level of responsibility.
We include an annual cash bonus as part of our compensation program because we believe this element of compensation helps to motivate management to achieve key corporate objectives by rewarding the achievement of these objectives. We also provide an annual cash bonus in order to be competitive from a total remuneration standpoint.
Long-term equity-based incentive compensation in the form of options and restricted stock is an element of our compensation policy because we believe it aligns executives interests with the interests of our stockholders, rewards long-term performance, is required in order for us to be competitive from a total remuneration standpoint, to encourage executive retention, and to give executives the opportunity to share in our long-term performance. These types of awards also provide a form of compensation that we believe is transparent and easy for stockholders to understand.
Deferred compensation benefits are intended to promote retention by providing a long-term savings opportunity on a tax-efficient basis.
We provide perquisites to our executive officers, since we believe this compensation helps us achieve our compensation objectives of recruiting and retaining executive officers and generally allows our executives to work more efficiently and protects the well being of our executives.
We offer broad-based employee benefits such as payment of insurance premiums in order to provide a competitive remuneration package and as an essential component of recruiting and retaining executive talent.
How We Determine Each Element of Compensation.
Role of Our Compensation Committee and CEO. The Compensation Committee regularly reviews and approves our executive compensation strategy and principles to ensure that they are aligned with our business strategy and objectives, stockholder interests, desired behaviors and corporate culture. The primary responsibilities of the Compensation Committee are to:
The Compensation Committee considers multiple factors when it determines the amount of total direct compensation (the sum of base salary, incentive bonus and long-term compensation delivered through equity awards) to award to executive officers each year. Among these factors are:
The Compensation Committee relies upon its judgment in making compensation decisions, after reviewing our performance and carefully evaluating an executives performance during the year. The Committee generally does not adhere to rigid formulas or necessarily react to short-term changes in business performance in determining the amount and mix of compensation elements. We incorporate flexibility into our compensation programs and in the assessment process to respond to and adjust for the evolving business environment. As a result, the Compensation Committee has not adopted any policy or guidelines for allocating compensation between long-term and currently paid out compensation, between cash and non-cash compensation, or among different forms of non-cash compensation.
In addition, the CEO recommends to the Compensation Committee annual pay increases, annual bonus amounts and long-term incentive grants for other executive officers. To assist it in carrying out its responsibilities, the Compensation Committee may also receive reports and recommendations from outside compensation consultants, and may consult with its own legal, accounting or other advisors. However, to date the Compensation Committee has not used independent legal or accounting advisors. The Compensation Committee has the sole authority, to the extent deemed necessary and appropriate, to retain and terminate any compensation consultants, outside counsel or other advisors, including having the sole authority to approve the firms or advisors fees and other retention.
Compensation Consultant. In 2006, the Compensation Committee engaged Pearl Meyer & Partners as a compensation consultant to assist the Committee with its administration of compensation programs. Pearl Meyer & Partners performed market analyses of executive compensation practices from which it made recommendations to the Compensation Committee as to the form and amount of certain executive compensation for the CEO. Pearl Meyer & Partners is independent of us, reports directly to the Compensation Committee and has no other business relationship with us other than assisting the Compensation Committee with its executive compensation practices. Pearl Meyer & Partners is a subsidiary of Clark Consulting which administrates the Companys deferred compensation plan.
Benchmarking. The Compensation Committee does not use benchmarking to set executive compensation. However, the Compensation Committee does utilize survey data and publicly available information to evaluate compensation for specific positions when necessary.
Base Salary. Base salaries for executive officers are reviewed on an annual basis and at the time of promotion or other change in responsibilities. Increases in salary are based on cost of living adjustments as well as subjective evaluation of such factors as the level of responsibility, individual performance, our overall performance, level of pay both of the executive in question and other similarly situated executives pay levels within the Company.
The base salary for our CEO was established in an employment agreement we entered into with him in 2003. The initial base salary under the employment contract was based on a previous report prepared by Pearl Meyer & Partners and factors taken into account in determining the CEOs base salary were his leadership position with the Company, his level of responsibility and the integral, dynamic role he plays in guiding the Company. Since 2003, his base salary has increased based primarily on cost of living increases, as well as the other factors set forth under Base Salary above. The CEOs salary was increased from $1,350,000 in 2005 to $1,450,000 for 2006.
The Compensation Committee discusses the remaining executive officers base salaries with the CEO, who presents his suggestions for adjustment, if necessary. For 2006, except for the CFO, the base salaries of the executive officers named in the Summary Compensation Table, whom we sometimes refer to as the named executive officers, were adjusted primarily to take into account a cost of living increase as well as the other factors set forth under Base Salary above. In addition, the Committee has the discretion to periodically approve additional salary adjustments it feels are warranted based on general compensation changes within the industry, individual performance or significant changes in duties and responsibilities and input from the CEO. The
Compensation Committee increased the base salary of our CFO to take into account the same cost of living increase as well as to make his salary more competitive with similarly situated executives.
Annual Bonus. Executive officers, senior management and other personnel have the potential to receive a significant portion of their annual cash compensation as a cash bonus. Annual bonuses are generally granted based on each executive officers base salary, tenure, individual performance and our financial and market performance. The Compensation Committee does not establish any particular guidelines or financial measures. Rather, the Compensation Committee prefers to make a subjective determination after considering all measures collectively but bases much of its determination upon input from the CEO. The Compensation Committee approves each annual bonus. Typically, bonuses are awarded for prior year results in the following year, when actual results for the entire year are known.
When awarding 2006 bonuses, in addition to the above factors the Compensation Committee in particular considered the executive officers performance and outstanding contribution with respect to the acquisition, renovation and subsequent increase in value of the Golden Nugget, Inc. as well as their contributions to the disposition of less profitable businesses such as the Joes Crab Shack chain. Each of these transactions were accomplished by a small group of executives in a short period of time and added significantly, in the Compensation Committees view, to the long-term value of the Company.
Long-Term Incentive Compensation. The Compensation Committee administers our incentive plans and performs functions that include selecting award recipients, determining the timing of grants and assigning the number of shares awarded, fixing the time and manner in which awards are exercisable, setting option exercise prices and vesting and expiration dates, and from time to time adopting rules and regulations for carrying out the purposes of our plans. For compensation decisions regarding the grant of equity compensation to executive officers, the Compensation Committee typically considers the competitive environment associated with longer- term compensation and recommendations from our CEO. Beginning in 2006, the Committee adopted a general policy to grant restricted stock in lieu of options due to the many variables in valuing option awards.
In connection with this new policy, the Company amended its employment agreement with the CEO effective March 14, 2006. Previously, the employment agreement provided that the CEO was entitled to an aggregate of 800,000 stock options over the term of the agreement, of which 250,000 were issued in 2004. After the Committee determined it was in the Companys best interest to issue restricted stock rather than options, the Committee, based on the recommendation of Pearl Meyer & Partners, issued 275,000 shares of restricted stock to the CEO in place of the remaining 550,000 options. The restricted shares vest seven years from the date of grant. On February 1, 2006, the CEO was granted 100,000 shares of restricted stock in accordance with the terms of the employment agreement.
Except for under the CEOs employment agreement, we have no set formula for the granting of equity awards to individual executives or employees. In April 2006, the Compensation Committee approved the award of an aggregate of 137,412 shares of common stock representing approximately .62% of the outstanding common shares on the date of grant.
In determining the size of restricted stock grants awarded to executive officers, the Compensation Committee based its determinations on such considerations as tenure, the strategic long-term importance of the executive to us, historical equity compensation awards and the recommendation of the Compensation Committees compensation consultant, Pearl Meyer & Partners. In general, the restricted stock granted to executive officers vests in five equal annual installments beginning April 6, 2007. Our equity compensation plans are generally limited to our executive and more senior management, with approximately 75 employees receiving restricted stock awards in fiscal 2006.
We do not have any program, plan or obligation that requires us to grant equity compensation on specified dates. However, our Committee does follow a policy of not granting equity incentives when material non-public
information exists that may affect the short-term price of our stock. Information about unvested restricted stock and outstanding options held by our named executive officers and directors is contained in the Outstanding Equity Awards at December 31, 2006 and Director Compensation tables.
Deferred Compensation Plan. Executive officers and our most highly compensated senior management are eligible to participate in our deferred compensation plan, which provides an opportunity for eligible employees to defer up to 90% of their annual base salary and 100% of bonus compensation into an account that will be credited with earnings at the same rate as one or mere investment indices chosen by the employees, which are similar to the investment funds available under our 401(k) plan. We also make a matching contribution of up to 30%, depending on the position of the employee with us.
Perquisites. We also provide certain personal benefits to executive officers, which are reflected in the All Other Compensation column of the Summary Compensation Table. These benefits include executive life and disability insurance and a car allowance. We believe these benefits are reasonable, competitive and consistent with our overall executive compensation program. Under a program to enhance the safety and effectiveness of management in support of our business and operations, corporate-owned aircraft is made available for essential business trips and other company activities. The CEO, the chief financial officer and other members of management with the approval of the CEO, are permitted limited personal use of the corporate-owned aircraft. Also, the CEO is provided security services, including home security systems and monitoring and personal security services. These security services are provided for our benefit, and the Compensation Committee considers the related expenses to be appropriate business expenses rather than personal benefits. In general, the perquisites our CEO is entitled to receive are contained in his employment agreement and are described in more detail under Employment Agreements.
Broad-Based Employee Benefits. Our executive officers are eligible to participate in company-sponsored benefit programs on the same terms and conditions as those generally provided to our employees. We believe that the offering of broad-based employee benefits to our executive officers is essential to achieving our goal of recruiting and retaining executive talent. These benefits include basic health benefits, dental benefits, disability protection, life insurance, and similar programs. The cost of company-sponsored benefit programs are negotiated by us with the providers of such benefits and the executive officers contribute to the cost of the benefits. We have a 401(k) plan and make annual matching contributions to the 401(k) plan on behalf of eligible employees. These contributions are discretionary and historically limited to 25% on up to 5% of contributed funds.
Other Compensation Policies Affecting the Executive Officers
Compliance with Section 162(m) of the Internal Revenue Code. Section 162(m) disallows a federal income tax deduction to publicly held companies for certain compensation paid to our CEO and four other most highly compensated executive officers to the extent that compensation exceeds $1 million per executive officer covered by Section 162(m) in any fiscal year. The limitation applies only to compensation that is not considered performance based as defined in the Section 162(m) rules.
In designing our compensation programs, the Compensation Committee considers the effect of Section 162(m) together with other factors relevant to our business needs. We have historically taken, and intend to continue taking, appropriate actions, to the extent we believe desirable, to preserve the deductibility of annual incentive and long-term performance awards. However, the Compensation Committee has not adopted a policy that all compensation paid must be tax-deductible and qualified under Section 162(m).
We believe that the 2006 base salary, annual bonus and restricted stock grants paid to the individual executive officers covered by Section 162(m) will not exceed the Section 162(m) limit and will be fully deductible under Section 162(m), except for a portion paid to the CEO.
Other compensation paid to the executive officers covered by Section 162(m) that is not considered performance-based is not deductible to the extent that it, together with other non-performance based
compensation, exceeds $1 million in any fiscal year. For fiscal 2006, these amounts included the CEOs income imputed for personal use of corporate aircraft and life and insurance premiums paid by us.
Stock Ownership Requirements. The Compensation Committee does not maintain a policy relating to stock ownership guidelines or requirements for our executive officers because the Compensation Committee does not feel that it is necessary to impose such a policy on our executive officers. If circumstances change, the Compensation Committee will review whether such a policy is appropriate for executive officers.
Financial Restatement. In the event of a material restatement our financial results, we believe it would be prudent to carefully review the facts and circumstances that caused the restatement before determining the appropriate course of action. Upon completion of an investigation of the facts and circumstances surrounding a material restatement, we would consider: (1) whether any compensation was paid or awarded on the basis of having achieved performance targets, (2) whether a particular employee or officer was engaged in misconduct that contributed to the restatement, and (3) whether the compensation paid to the employee or officer would have been reduced had the financial results been properly reported. If it is determined that an employee or officer did engage in misconduct, the Board of Directors would take action as it deems appropriate.
Employment Agreements. In general, our executive officers do not have employment, severance or change-of-control agreements. Our executive officers serve at the will of the Board, which enables us to terminate their employment with discretion as to the terms of any severance arrangement. This is consistent with our compensation philosophy. However, in 2003, we determined that the loss of our CEOs services could materially and adversely affect our business, financial condition and development. Accordingly, we entered into an employment agreement with our CEO. This employment agreement contains change of control provisions that provide for severance benefits upon a change of control. The provisions of this employment agreement are discussed more under the caption Employment Agreements and Potential Payments Upon Termination or Change of Control below.
COMPENSATION COMMITTEE REPORT
The Compensation Committee of the Board of Directors acts on behalf of the Board to establish and oversee our executive compensation program in a manner that serves our interests and those of our shareholders. Our management has prepared the Compensation Discussion and Analysis of the compensation program for named executive officers. The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis for fiscal year 2006 (included in this Form 10-K) with our management. Based on this review and discussion, the Compensation Committee recommended to our Board of Directors that the Compensation Discussion and Analysis be included in this Form 10-K for filing with the Securities and Exchange Commission.
Joe Max Taylor, Chair
SUMMARY COMPENSATION TABLE
The following table sets forth in summary, compensation paid by us and our subsidiaries for the year ended December 31, 2006 to our CEO, CFO and our other most highly compensated executive officers whose cash compensation exceeded $100,000:
All Other Compensation
The following table describes each component of the All Other Compensation column in the Summary Compensation Table. All numbers are in dollars.
GRANTS OF PLAN-BASED AWARDS
The following table provides details regarding equity grants in 2006 to executive officers named in the Summary Compensation Table. No stock options were granted to executive officers last year and thus any reference to options in the table below have been omitted.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table contains information with respect to outstanding equity awards at our fiscal year end on December 31, 2006.
Section 409A Compliance
Section 409A of the Internal Revenue Code imposes certain restrictions and additional taxes on the recipients of discounted options in the United States. Prior to December 31, 2006, the final date allowable under Section 409A, Mr. Scheinthal and Mr. Ervin, agreed to reprice upward unexercised discounted options that vested after December 31, 2004 to the closing price on what was believed to be the actual accounting measurement date for the option granted. The repricing did not affect the vesting schedules of the options, which continue to vest based on the original grant date. Where applicable in this Form 10-K, exercise prices will reflect the exercise price as amended.
OPTION EXERCISES AND STOCK VESTED
The following table contains information with respect to the options exercised by the executive officers named above during the fiscal year ended December 31, 2006.
NON-QUALIFIED DEFERRED COMPENSATION
The following table contains information with respect to the non-qualified deferred compensation plan by the executive officers named above during the fiscal year ended December 31, 2006.
The following describes the material features of our non-qualified deferred compensation plan in which the executive officers participate.
The deferred compensation plan went into effect in 2004. Executive contributions are made from base salary or bonus. Under the deferred compensation plan, a participant receives his prior deferrals and vested matching contributions, along with any accumulated earnings thereon, following his termination of employment, disability (as defined by the plan), death (in which case the designated beneficiary will receive the benefit), or upon a change of control. Participants may also receive unplanned in-service distributions in limited emergency situations. The Participant may elect to defer a minimum of $2,000 of base salary and/or bonus, and is subject to a maximum contribution of 90% of the participants base salary and 100% of the bonus.
We have hired Clark Consulting to help manage the deferred compensation plan. Clark Consulting has set up an investment vehicle, similar to our 401(k) plan offered to non-executives. The deferred compensation plan allows the participants to allocate and/or reallocate the balance in their account daily among available measurement funds. Therefore, the annual earnings will be dependant upon the portfolio selections made by each participant. During 2006, there was a selection of 14 measurement funds available with a combined average return of 13.95%. The best performing fund was AIM VI Real Estate: SI Fund with an annual return of 42.60%. The worst performing fund was the PIMC VIT Real Return: AC with an annual return of 0.57%. The Maxim Money Market had a return of 4.58%.
We have the discretion to make matching contributions to a participants account. In 2006, we matched either 25% or 30% of each participants 2006 contributions. The executive officers each received a 30% matching contribution in 2006 for 2005 deferrals. The matching contribution is subject to a five (5) year vesting
schedule at a rate of 20% per year. Notwithstanding the vesting schedule, a participant will become fully vested upon reaching the age of 62.
The deferred compensation plan allows participants to elect the form in which the retirement benefit will be paid (lump-sum or installments). The participant has the opportunity to change the form of the retirement benefit payment subject to certain requirements.
We have adopted a rabbi trust to protect the assets of the deferred compensation plan.
EMPLOYMENT AGREEMENTS AND POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE OF CONTROL
Effective January 1, 2003, we entered into an employment agreement with Tilman Fertitta, our CEO, that sets forth the general terms and conditions of his employment for the term commencing January 1, 2003. The initial term of the contract expires at the end of 2007. The contract automatically extends for an additional period of five years unless either party provides written notice of its election not to extend.
Under the agreement, Mr. Fertitta agrees to serve as our President, CEO and Chairman of the Board for an annual base salary of not less than $1,250,000. The Compensation Committee is required to review Mr. Fertittas salary at least annually to determine if any salary increases are warranted. The agreement provides that Mr. Fertitta shall be entitled to participate in any cash bonus programs established by the Company and, in the absence of a cash bonus program, to receive an annual bonus as determined by the Compensation Committee and in the range of up to two times Mr. Fertittas base salary. The Agreement provides that,
In addition, the agreement grants to Mr. Fertitta the right to receive stock options and 500,000 shares of restricted stock, to be issued in the amount of 100,000 shares a year over the term of the agreement and which vests 10 years from the effective date of the grant. Beginning in 2006, the Company adopted a general policy to grant restricted stock in lieu of options due to the many variables in valuing option awards. In connection with this new policy, the Company amended the employment agreement effective March 14, 2006. Previously, the employment agreement provided that Mr. Fertitta was entitled to an aggregate of 800,000 stock options over the
term of the agreement, of which 250,000 were issued in 2004. After the Committee determined it was in the Companys best interest to issue restricted stock rather than options, the Committee, based on the recommendation of Pearl Meyer & Partners, issued 275,000 shares of restricted stock to the CEO in place of the remaining 550,000 options. The conversion factor was determined by the Compensation Committee based on a report by Pearl Meyer & Partners. The restricted stock will not vest until seven years from the date of the grant.
The Company does not have employment agreements with any of its other executive officers.
In the event Mr. Fertittas employment is terminated as a result of his death or disability (as defined in the employment agreement), he, or his legal representative, is entitled to receive all compensation he would otherwise have been entitled to receive throughout the remaining term of the employment period as well as other death or disability benefits we provide. In addition, any stock options or restricted stock immediately vest. In the event Mr. Fertittas employment is terminated (i) by him other than for good reason, or (ii) by us for cause, Mr. Fertitta will receive all accrued compensation and other amounts owed to him as of the date of termination. In the event Mr. Fertittas employment is terminated (i) by us other than for cause, (ii) by Mr. Fertitta for good reason or (iii) within one year of a change in control, all of Mr. Fertittas stock options and restricted stock immediately vest and Mr. Fertitta is entitled to receive, among other things, (a) a lump sum payment of $5,000,000 in consideration of his agreement not to compete with us, (b) an amount equal to three times 180% of his base salary, (c) an additional lump sum payment necessary to pay the life insurance policy and (d) a continuation of certain other benefits.
Potential Payments on Termination Following a Change in Control
As described above, our CEO is party to an employment agreement with us and each executive officer is a party to equity award agreements relating to options and restricted stock granted and various plans. These agreements and plans provide that an executive officer is entitled to additional consideration in the event of a termination event. The following sets forth the incremental compensation that would be payable by us to each of our executive officers in the event of the executive officers termination of employment with us under various scenarios, which we refer to as termination events, including the executive officers voluntary resignation, involuntary termination for cause, involuntary termination without cause, termination by the executive for good reason, termination in connection with a change in control, termination in the event of disability, termination in the event of death, and termination in the event of retirement. In accordance with applicable SEC rules, the following discussion assumes:
The analysis contained in this section does not consider or include payments made to an executive officer with respect to contracts, agreements, plans or arrangements to the extent they do not discriminate in scope, terms or operation, in favor of our executive officers and that are available generally to all salaried employees. The actual amounts that would be paid upon an executive officers termination of employment can only be determined at the time of such executive officers termination. Due to the number of factors that affect the nature and amount of any compensation or benefits provided upon the termination event, any actual amounts paid or distributed may be higher or lower than reported below. Factors that could affect these amounts include the timing during the year of any such event, our stock price at such time and the executive officers age and service.
Tilman J. Fertitta. In addition to the amounts listed below, Mr. Fertitta is entitled to all accrued compensation, unreimbursed expenses and other benefits through the date of termination in the event of his termination.
Richard H. Liem. Mr. Liem does not have an employment agreement. Therefore, he is not entitled to any compensation payable or benefits upon a termination event except as provided in his equity award agreements.
Steven L. Scheinthal. Mr. Scheinthal does not have an employment agreement. Therefore, he is not entitled to any compensation payable or benefits upon a termination event except as provided in his equity award agreements.
Jeffery L. Cantwell. Mr. Cantwell does not have an employment agreement. Therefore, he is not entitled to any compensation payable or benefits upon a termination event except as provided in his equity award agreements.
K. Kelly Roberts. Mr. Roberts does not have an employment agreement. Therefore, he is not entitled to any compensation payable or benefits upon a termination event except as provided in his equity award agreements.
COMPENSATION OF DIRECTORS
Our Directors who are not executive officers received Directors fees of $36,000 for 2006, plus the expenses incurred by them on our behalf. Non-employee directors also receive $1,000 for each Audit, Compensation and Nominating and Corporate Governance Committee meeting attended, as well as other committee meetings they attend. In addition, Mr. Taylor received $60,000 for consulting and governmental support services, which amount is reflected in the All Other Compensation column. Historically, each non-employee director has received stock options to acquire shares of common stock. In the past, a non-employee director would receive an option to purchase 10,000 of shares of common stock upon their initial election to the Board and 2,000 shares each time such person was re-elected for an additional term as director. No options were awarded to any of the non-employee directors upon their re-election in 2005. The Board of Directors obtained shareholder approval in 2006 to provide for the issuance of shares of restricted stock upon a non-employee directors election to the Board or subsequent re-election in lieu of stock options. In 2006, each non-employee director received 2,000 shares of restricted stock with a two year vesting schedule. While normally a non-employee director will receive 1,000 shares of restricted stock upon their election or re-election to the Board, the Board made the decision to issue an additional 1,000 shares to each non-employee director in 2006 due to the fact that no equity compensation was issued to any non-employee director re-elected to the Board in 2005. All Other Compensation reflects dividend compensation paid on the stock awards. None of the directors have any perquisites over $10,000.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Taylor, Chadwick and Richmond served as members of the Compensation Committee during 2006. No member of the Compensation Committee is or has been an officer or employee of ours or any of our subsidiaries. The members of the Compensation Committee had no other relationships with us requiring disclosure pursuant to Item 404 of SEC Regulation S-K. No executive officer of ours served as a member of the Compensation Committee (or other Board committee performing similar functions or, in the absence of any such committee, the entire Board of Directors) of another corporation whose executive officer served on the Compensation Committee. None of our executive officers served as a director of another corporation whose executive officers served on the Compensation Committee. None of our executive officers served as a member of the Compensation Committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire Board of Directors) of another corporation whose executive officers served as one of our directors.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL HOLDERS AND MANAGEMENT
The following table sets forth, as of July 31, 2007, certain information regarding the beneficial ownership of our common stock by (a) each person we know to own beneficially more than five percent of the outstanding shares of our common stock, (b) each of our directors, (c) each executive officer named in the Summary Compensation Table above, and (d) all of our executive officers and directors as a group. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned. The address of each of Messrs. Fertitta, Scheinthal, Liem, Chadwick, Taylor, Richmond, Brimmer, Cantwell and Roberts is 1510 West Loop South, Houston, Texas 77027.
Equity Compensation Plan Information
The following table provides information as of December 31, 2006 regarding the number of shares of Common Stock that may be issued under the Companys equity compensation plans.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Our policy is, to the extent practicable, to avoid transactions (except those which are employment related) with officers, directors, and affiliates. In any event, any such transactions will be entered into on terms which we believe are no less favorable to us than could be obtained from third parties, and such transactions will be approved by a majority of our disinterested directors.
In 2003, we entered into a Management Agreement (the Agreement) with Fertitta Hospitality, L.L.C. (Fertitta Hospitality), which is jointly owned by our President and CEO and his wife. Pursuant to the Agreement, we provide services to Fertitta Hospitality with respect to management and operational matters, administrative, personnel and transportation matters and receives a fee of $7,500 a month, plus reimbursement of expenses. The Management Agreement provides for a renewable three year term. The terms of the Management Agreement were approved by the Non-Employee Directors, who received an opinion of an independent consultant that the economic and non-economic terms of the Management Agreement were a fair-market transaction.
In 1999, we entered into a ground lease agreement with 610 Loop Venture, LLC, a company wholly-owned by our President and CEO, on land adjacent to our corporate headquarters. The ground lease was for a term of five years with one option renewal period. Under the terms of the ground lease, 610 Loop Venture pays us base rent of $12,000 per month plus pro-rata real property taxes and insurance. 610 Loop Venture also has the option to purchase certain property based upon an appraised or predetermined value. In 2004, the ground lease agreement was extended for another five (5) years.
In 2002, in connection with the construction of a Rainforest Cafe restaurant on a prime tract of waterfront property in Galveston, Texas, we entered into a 20-year, with option renewals, ground lease agreement with
Fertitta Hospitality having a base rent of $96,000 per year. Pursuant to the terms of the lease, the annual rent is equal to the greater of the base rent or sliding scale percentage rent from four to six percent of revenues, plus real property taxes and insurance. The terms of the lease were approved by the Non-Employee Directors, who received the opinion of an independent real estate firm that the economic and non-economic terms of the lease were a fair-market transaction. In 2006, we paid total base and percentage rent in the amount of $567,000.
As permitted by the employment contract between us and our CEO, we made a charitable contribution in the amount of $91,000 to a charitable foundation that our CEO served on as trustee in 2006.
On a routine basis we hold or host promotional events, training seminars and conferences for our personnel. In connection therewith, in 2006, we incurred expenses in the amount of $50,000 at resort hotel properties owned by our CEO and to which we provide management services. The amount that we paid is below the amount that would have been paid by an unaffiliated third party.
We jointly sponsor events and promotional activities with Fertitta Hospitality which result in shared costs and use of our personnel or Fertitta Hospitality employees and assets.
The above agreements were entered into between related parties and were not the result of arms-length negotiations. Accordingly, the terms of each transaction may have been more or less favorable to us than might have been obtained from unaffiliated third parties. We believe that the terms of each transaction were at least as favorable to us as that which could have been obtained in arms-length transactions with an unaffiliated party.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
REPORT OF THE AUDIT COMMITTEE
FOR THE YEAR ENDED DECEMBER 31, 2006
The Audit Committee is composed of three Non-Employee Directors and acts under a written charter adopted by the Board of Directors. The Audit Committee has the sole responsibility for the appointment and retention of the Companys independent auditors and the approval of all audit and engagement fees. The Audit Committee meets periodically with management, the internal auditors and the independent auditors regarding accounting policies and procedures, audit results and internal accounting controls. The internal auditors and the independent auditors have free access to the Audit Committee, without managements presence to discuss the scope and results of their audit work. The Companys management is primarily responsible for the Companys financial statements and the quality and integrity of the reporting process, including establishing and maintaining the systems of internal controls over financial reporting and assessing the effectiveness of those controls. The independent auditors, Grant Thornton LLP (GT), are responsible for auditing those financial statements and internal controls over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States) and for expressing an opinion on the conformity of the financial statements with accounting principles generally accepted in the United States as well as reporting on the effectiveness of the Companys internal controls over financial reporting. On behalf of the Board of Directors, the Audit Committee monitors the Companys financial reporting processes and systems of internal control, the independence and the performance of the independent accountants, and the performance of the internal auditors.
Management has represented to the Audit Committee that the Companys consolidated financial statements were prepared in accordance with generally accepted accounting principles, and the Audit Committee has reviewed and discussed the consolidated financial statements with management and the independent accountants. The Audit Committee has discussed with the independent accountants their evaluation of the accounting principles, practices and judgments applied by management, and the Audit Committee has discussed any items required to be communicated to it by the independent accountants in accordance with standards established by the American Institute of Certified Public Accountants.
In fulfilling its oversight responsibilities, the Audit Committee has reviewed and discussed the audited financial statements for the year ended December 31, 2006, and matters related to Section 404 of the Sarbanes-Oxley Act of 2002 with the Companys management and representatives of GT. The Audit Committee discussed with GT the matters required to be discussed by Statement on Auditing Standards No. 61, Communication with Audit Committees, as amended. In addition, the Audit Committee discussed with GT their independence from the Company and its management, including the matters in the written disclosures required by Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees, and has received from GT the written disclosure required by Standard No. 1.
Based on the reviews and discussions described above, the Audit Committee has recommended to the Companys Board of Directors that the Companys audited financial statements be included in the Companys Annual Report on Form 10-K for the year ended December 31, 2006.
Michael S. Chadwick, Chairman
The Audit Committee has again retained GT as the Companys independent registered public accounting firm for the fiscal year ending December 31, 2007. A representative of GT will be present at the annual meeting. The representative will be given an opportunity to make a statement, if he or she desires to do so, and to respond to appropriate questions.
During the year ended December 31, 2006, the aggregate fees billed by GT for the audit of the Companys financial statements for such year and for the reviews of the Companys interim financial statements were $1,619,215.
The aggregate fees billed by GT for the audit of the Companys financial statements for 2005 and for the reviews of the Companys interim financial statements were $841,815.
The Company did not pay any Audit-Related Fees for the fiscal year ended December 31, 2006 or 2005 to GT.
The Company did not pay any fees for professional services rendered by GT for tax compliance, tax advice and tax planning for the fiscal years ended December 31, 2006 or 2005.
All Other Fees
The aggregate fees billed for services rendered by GT not reportable as Audit Fees, Audit-Related Fees or Tax Fees for the fiscal year, ended December 31, 2006 and December 31, 2005 were $0.
Audit Committee Pre-Approval Policies and Procedures
The Audit Committee annually reviews and pre-approves the audit, review, attest and permitted non-audit services to be provided during the next audit cycle by the independent registered public accounting firm. To the extent practicable, at the same meeting the Audit Committee also reviews and approves a budget for each of such
services. Services proposed to be provided by the independent registered public accounting firm that have not been pre-approved during the annual review and the fees for such proposed services must be pre-approved by the Audit Committee. Additionally, fees for previously approved services that are expected to exceed the previously approved budget must also be approved by the Audit Committee.
All requests or applications for the independent registered public accounting firm to provide services to the Company must be submitted to the Audit Committee by the independent registered public accounting firm and management and state as to whether, in their view, the request or application is consistent with applicable laws, rules and regulations relating to independent registered public accounting firm independence. In the event that any member of management or the independent registered public accounting firm becomes aware that any services are being, or have been, provided by the independent registered public accounting firm to the Company without the requisite pre-approval, such individual must immediately notify the Chief Financial Officer, who must promptly notify the Chairman of the Audit Committee and appropriate management so that prompt action may be taken to the extent deemed necessary or advisable.
All of the services provided by the Companys independent registered public accounting firm during 2005 and 2006 were pre-approved by the Audit Committee.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following financial statements are set forth herein commencing on page 70:
Report of Independent Registered Public Accounting Firm Grant Thornton LLP
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Stockholders Equity for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004.
Notes to Consolidated Financial Statements
2. Financial Statement SchedulesNot applicable.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Landrys Restaurants, Inc.
We have audited managements assessment, included in the accompanying Managements Report on Internal Control Over Financial Reporting, appearing under Item 9A, that Landrys Restaurants, Inc. and subsidiaries did not maintain effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Landrys Restaurants, Inc. and subsidiaries management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in managements assessment. A material weakness was identified with respect to deficiencies related to the documentation, authorization, accounting and related processes for stock option grants and adjustments in the financial reporting close process. Absent control improvements including oversight, a material misstatement could occur in the annual or interim financial statements. While the Company has identified additional control improvements, the Company was not able to evaluate whether such controls were operating effectively at December 31, 2006. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 financial statements, and this report does not affect our report dated on such consolidated financial statements and financial statement schedules.
In our opinion, managements assessment that Landrys Restaurants, Inc. and subsidiaries did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material
respects, based on criteria established in Internal ControlIntegrated Framework (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Landrys Restaurants, Inc. and subsidiaries have not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Landrys Restaurants, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2006 and our report dated August 9, 2007 expressed an unqualified opinion on those consolidated financial statements.
/s/ Grant Thornton LLP
August 9, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Landrys Restaurants, Inc.
We have audited the accompanying consolidated balance sheets of Landrys Restaurants, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Landrys Restaurants, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 9 to the consolidated financial statements, effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payments.
As discussed in Note 2 to the consolidated balance sheet and statement of stockholders equity as of December 31, 2005 have been restated for adjustments related to stock options.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Landrys Restaurants, Inc. and subsidiaries internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated August 9, 2007 expressed an unqualified opinion on managements assessment of the effectiveness of internal control over financial reporting and an adverse opinion on the effectiveness of internal control over financial reporting.
/s/ Grant Thornton LLP
August 9, 2007
LANDRYS RESTAURANTS, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
LANDRYS RESTAURANTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
LANDRYS RESTAURANTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
LANDRYS RESTAURANTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS