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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15 (d) of the Securities Exchange
Act of 1934 for the Fiscal Year (52 Weeks) ended December 29, 2002.
Or
[_] Transition Report pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the period from to .
Commission File Number 0-28258
SHELLS SEAFOOD RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 65-0427966
(State or other (IRS Employer
jurisdiction of Identification Number)
incorporation or
organization)
16313 North Dale Mabry Highway, Tampa, Florida 33618
(Address of principal executive offices) (Zip Code)
(813) 961-0944
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 par value.
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant (based upon the last sales price of the Common Stock reported on the
over-the-counter bulletin board and the assumption, for this computation only,
that all directors, executive officers, and ten-percent holders of stock are
affiliates of the Registrant) at June 30, 2002 (the last business day of the
Registrant's most recently completed second fiscal quarter) was $1,506,844.
As of February 14, 2003, the number of shares outstanding of the
Registrant's Common Stock, $.01 par value, was 4,470,585.
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DOCUMENTS INCORPORATED BY REFERENCE
(To the Extent Indicated Herein)
Our Proxy Statement to be filed with the Securities and Exchange Commission
in connection with solicitations of proxies for our upcoming Annual Meeting of
Stockholders scheduled to be held on June 3, 2003, is incorporated by reference
in Part III, Items 10, 11, 12 and 13 of this Form 10-K.
FORWARD LOOKING STATEMENTS
When used in this Annual Report on Form 10-K, the words "believes",
"anticipates", "expects", and similar expressions are intended to identify
forward-looking statements. These statements are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
projected.
In addition to seasonal fluctuations, our quarterly and annual operating
results are affected by a wide variety of other factors that could materially
and adversely affect our revenues and profitability, including changes in
consumer preferences, tastes and eating habits; increases in food and labor
costs; promotional timings and seasonality; the availability of qualified
labor; national, regional and local economic and weather conditions;
demographic trends and traffic patterns; changes in travel and tourism
tendencies, particularly in light of world events; competition from other
restaurants and food service establishments; and the timing, costs and charges
relating to restaurant openings and closings. As a result of these and other
factors, we may experience material fluctuations in future operating results on
a quarterly or annual basis, which could materially and adversely affect our
business, financial condition, operating results, and stock price. An
investment in our company involves various risks, including those which are
detailed in this document and from time-to-time in our other filings with the
Securities and Exchange Commission.
Any forward-looking statements included in this Annual Report speak only as
of the date of this document. We are not undertaking any obligation to publicly
release the results of any revisions to these forward-looking statements which
may be made to reflect events or circumstances after the date of this document
or to reflect the occurrence of unanticipated events.
PART I
ITEM 1. BUSINESS
Shells Seafood Restaurants, Inc. was incorporated under the laws of the
State of Florida in April 1993 and was reincorporated under the laws of the
State of Delaware in April 1996. Effective December 1994, Shells, Inc., a
company incorporated under the laws of the State of Florida, was merged with
and into our company and became our wholly owned subsidiary.
Concept and Strategy
As of December 29, 2002 (the last date of our 2002 fiscal year), we owned 23
Shells restaurants, owned a 51% ownership interest in one Shells restaurant and
managed four additional Shells restaurants pursuant to contractual
arrangements. All 28 of these Shells restaurants are located in Florida. During
2002, we discontinued operations in one Florida restaurant.
Shells is a full service, neighborhood concept, designed to appeal to a
broad range of customers, particularly families and young adults, by serving
generous portions of high-quality seafood and offering friendly and efficient
service. The menu was repositioned in the fourth quarter of 2001, reemphasizing
original entree customer favorites at more attractive price points. During
2002, local store marketing efforts were implemented. These changes were
instituted to stimulate customer traffic. Shells restaurants feature a wide
selection of seafood items, including shrimp, oysters, clams, scallops,
lobster, crab, crawfish, and daily fresh fish specials, cooked to order in a
variety of ways: steamed, sauteed, grilled, blackened and fried. In addition,
our restaurants offer a wide selection of signature pasta dishes, appetizers,
salads, and desserts and full bar service. All Shells restaurants are open for
dinner and 19 restaurant locations are also open for lunch.
In an effort to increase Shells' name recognition and benefit from customer
loyalty, our restaurants have a prototypical image. The restaurants are
identified by the exterior "Shells" logo sign and a common interior color
scheme and design. Our restaurants are decorated with a tropical flair, bright
colors and cheerful signage to create a high-energy, casual atmosphere
consistent with the Shells concept. Our commitment to promoting a casual, fun
dining experience is underscored by the design of our menu and by the colorful
"island" shirts worn by our service staff.
Consumer expectations continue to heighten in terms of food quality,
facilities and value. Our strategy includes emphasizing the Shells' concept
within our niche market, and then executing and delivering the entire dining
experience. As a local seafood joint that serves big portions of great seafood
for "not-a-lot-of-clams" some of our areas of focus are menu portion size,
offering friendly, attentive and courteous service, enhancing plate appearance,
and properly balancing the price-value relationship of our entrees.
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Restaurant Locations
Our 28 managed and operated restaurants are located in the following Florida
markets and cities/neighborhoods:
Tampa/Sarasota Orlando South Florida
- -------------- ------- -------------
Brandon Daytona Beach Coral Springs
Clearwater Kissimmee Davie
Holmes Beach New Smyrna Beach Ft. Lauderdale
Redington Shores Ocala Kendall
St. Petersburg Orlando Pembroke Pines
St. Pete Beach Winter Park Sunrise
Winter Haven Melbourne
Carrollwood
North Tampa
Sarasota
South Tampa
West Palm Beach Fort Myers
- --------------- ----------
Stuart Fort Myers
West Palm Beach Port Charlotte
From 1997 to 1999, in an attempt to diversify and minimize the seasonal
effect of the Florida market, we opened 18 restaurants in various Midwest
markets. We sustained operating losses in these Midwest markets and completed
the discontinuance of our Midwest operations in April 2001, closing the
remaining nine units. During 2002, we closed one under-performing unit in the
Florida market. We continuously review the performance of all restaurant unit
economics, and are investigating several new real estate sites in Florida for
possible expansion.
Restaurant Operations
Management and Employees. We currently employ five area directors. Each
area director is responsible for the management of several restaurants,
including management development, recruiting, training, quality of operations
and unit profitability. The staff of a typical dinner-only restaurant consists
of one general manager and two assistant managers and approximately 40 other
employees. The restaurants that are also open for lunch generally have 15 to 20
additional part-time employees. Restaurant management participates in a bonus
program based upon the financial results of their particular restaurant.
Restaurant Reporting. We maintain financial and accounting controls for
each restaurant through a central accounting system. Our financial systems and
controls allow us to access each restaurant's sales, inventory costs and other
financial data on a real-time basis, enabling both store-level management and
senior management to quickly react to changing sales trends, to effectively
manage food, beverage and labor costs, to minimize theft, and to improve the
quality and efficiency of accounting and audit procedures. Store level
management generally performs weekly inventories and compares weekly operating
results versus budget.
Recruitment and Training. We believe that achieving customer satisfaction
by providing knowledgeable, friendly, efficient service is critical to a
restaurants' long-term success. We attempt to recruit restaurant managers with
significant experience in the restaurant industry. During a 12-week training
program, restaurant managers are taught to promote our team-oriented atmosphere
among restaurant employees with emphasis on preparing and serving food in
accordance with strict standards and providing friendly, courteous and
attentive service. The restaurant staff, through our Team Trainer program, is
trained on site by restaurant managers and other staff members. A major
initiative in 2002 and 2003 is to attempt to reduce management and hourly
turnover.
Purchasing. Obtaining a reliable supply of quality seafood at competitive
prices is critical to our success. We have formed long-term relationships with
several seafood suppliers and purchase frozen seafood and certain
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other supplies used in restaurant operations in bulk. In addition, Shells' menu
has been designed to feature seafood varieties with stable sources of supply,
as well as to provide flexibility to adjust to shortages and to take advantage
of occasional purchasing opportunities. We believe our diverse menu selection
minimizes the effect of the shortage of any seafood products. We generally have
been able to anticipate and react to fluctuations in food costs through
selected menu price adjustments, purchasing seafood directly from numerous
suppliers and promoting certain alternative menu selections (in response to
availability and price of supply).
Performance Food Group of Florida replaced US Foodservice as our primary
distributor in October 2002. Performance Food Group distributes seafood and
most other products to our restaurants, minimizing the risks relating to
storing and distributing these products. Performance Food Group purchases and
takes delivery of all frozen seafood that we recommend for purchase according
to our specifications and subject to our inspections. Based on purchase orders
initiated by our restaurants, Performance Food Group then sells the frozen
seafood to us on a cost plus basis, and distributes the frozen seafood directly
to the restaurants. From time-to-time, at our direction to facilitate a forward
purchase opportunity, Performance Food Group also will acquire frozen seafood
inventory in excess of normal recurring restaurant delivery and re-supply,
which is defined as 30 days. We pay interest on inventory holdings above normal
supply levels, which is defined as 30 days, at an interest rate of 7.8% per
annum. In addition, Performance Food Group procures, on our behalf, many of the
supplies, other than seafood, used by the restaurants and distributes and sells
these products to the individual restaurants at agreed upon price mark-ups.
Although we believe that our relationship with Performance Food Group is good,
if the distribution program was terminated, we believe alternate arrangements
for warehousing and procurement of supplies could be made without a significant
interruption of our business. We generally have not experienced any significant
delays in receiving food and beverage inventories, restaurant supplies or
equipment.
Quality Control. We maintain a continuous inspection program for all of our
seafood purchases. Each shipment of frozen seafood is inspected through
statistical sampling methods upon receipt at Performance Food Group's
distribution center for quality and conformity to our written specifications,
prior to delivery to the restaurants. In addition, fresh fish purchased by the
individual restaurants must be purchased from one of our approved suppliers and
is inspected by a restaurant manager at the time of delivery. As part of our
training program, restaurant employees are educated as to the correct handling
and proper physical characteristics of each product.
Our area directors, general managers and assistant managers are all
responsible for properly training hourly employees and ensuring that Shells
restaurants are operated in accordance with strict health and quality
standards. Compliance with our quality standards is monitored by on-site visits
and formal inspections by the area directors. We believe that our inspection
procedures and employee training practices help to maintain a high standard of
quality for the food and service we provide.
Advertising and Marketing
Historically, we have employed a marketing strategy seeking visibility and
name recognition through the use of billboards, radio and television
advertisements, newsprint and direct mail. Part of our strategy has been to
cluster a significant number of restaurants in a market, to provide for
cost-effective use of media advertising and other marketing efforts. During
2002, we primarily employed local store marketing efforts, print media, direct
mail, in-store promotions and to a lesser extent, television in select markets.
Disclosure Controls
Consolidated subsidiaries are managed through a centralized Executive Office
in Tampa, Florida. Material information is discussed at various weekly and
monthly meetings with officers and directors. Generally, an open door policy is
observed by corporate officers to facilitate communication.
3
Joint Venture and Third-Party Owned Restaurants
The Shells restaurant system currently consists of (i) 23 restaurants that
are wholly owned by us; (ii) one restaurant, in Melbourne, Florida, in which we
have an interest of 51%; and (iii) four restaurants that we manage and operate,
but do not own. The remaining 49% interest in the Melbourne restaurant is
indirectly owned by Wanda L. Hattaway, wife of William E. Hattaway, a former
director and president of our company. In addition to the equity interest in
this restaurant, we receive a management and licensing fee of 6% of the
restaurant sales of the Melbourne restaurant.
Three of the managed restaurants are managed and operated by us pursuant to
management and license agreements, which became effective in July 1993.
Pursuant to these agreements, we provide management services and license
proprietary information required to operate these restaurants for a percentage
of that restaurant's sales. Of the total management fee received, 2% of sales
is placed in escrow and disbursed to satisfy each managed restaurants'
requirement to make third party royalty payments. The agreement, as amended in
October 2001, provides for a 4% management fee until such time as sales return
near to 1999 levels, and then returning to a 6% fee. The management agreements
grant us authority to determine the programs and policies affecting the
day-to-day operations of each of these managed restaurants. Although the
management agreements differ slightly, they generally have an initial term of
30 years and provide that the third-party owners are responsible for funding
all the restaurant expenses, including food and beverage costs, staffing,
training, recruiting, inventory, and working capital.
A major fire occurred at a managed restaurant in North Tampa on March 3,
2003; the restaurant will be closed for several months for renovations. The
managed restaurant has property insurance as well as business interruption
insurance; our management fees from this managed restaurant will not be
materially affected during Fiscal 2003.
We operate the fourth managed restaurant pursuant to the terms of an
agreement requiring that the restaurant is operated in conformity with the
policies and procedures established by us for Shells restaurants. The
restaurant is currently managed by Shells pursuant to an oral agreement. In
accordance with the amended management agreement, beginning in October 2001, we
receive a management fee of 2% of the restaurant's sales.
In the past, the enforceability of these management and license agreements
has been questioned by certain of the licensees. Although we believe the
agreements are enforceable, there can be no assurance that the agreements will
not be challenged in the future, and, if challenged, that the agreements will
be determined to be enforceable.
Competition
The restaurant industry is intensely competitive with respect to price,
service, location, food quality and variety, and there are many
well-established competitors with substantially greater financial and other
resources than us. Such competitors include national, regional and local
full-service casual dining chains, many of which specialize in or offer seafood
products. Some of our competitors have been in existence for substantially
longer periods than we have, and may be better established in the markets where
we have our restaurants. We believe that the full-service casual dining segment
is likely to attract a significant number of new entrants, some offering
seafood products. We also expect to face competition from a broad range of
other restaurants and foodservice establishments, including full-service, quick
service and fast food restaurants, which specialize in a variety of cuisines.
While we believe that Shells offers a broad variety of quality seafood
products, there can be no assurance that consumers will regard our product as
sufficiently distinguishable from competitive products, that substantially
equivalent food products will not be introduced by our competitors or that we
will be able to compete successfully.
Government Regulation
We are subject to extensive federal, state and local government regulation
by various governmental agencies, including state and local licensing, zoning,
land use, construction and environmental regulations and various regulations
relating to the sale of food and alcoholic beverages, sanitation, disposal of
refuse and waste products, public health, safety and fire standards. Our
restaurants are subject to periodic inspections by
4
governmental agencies to ensure conformity with such regulations. Difficulties
or failure in obtaining required licensing or other regulatory approvals could
delay or prevent the opening of a new restaurant, and the suspension of, or
inability to renew, a license at an existing restaurant could adversely affect
our operations. Restaurant operating costs are also affected by other
government actions, beyond our control, including increases in the minimum
hourly wage requirements, workers compensation insurance rates, health care
insurance costs and unemployment and other taxes.
Approximately 12% of our revenue is attributable to the sale of alcoholic
beverages. Alcoholic beverage control regulations require each of our
restaurants to apply to a state authority and, in certain locations, county or
municipal authorities for a license or a permit to sell alcoholic beverages on
the premises. Typically, licenses must be renewed annually and may be revoked
or suspended for cause at any time. Alcoholic beverage control regulations
relate to numerous aspects of daily operations of our restaurants, including
minimum age of patrons and employees, hours of operation, wholesale purchasing,
inventory control and handling, storage and dispensing of alcoholic beverages.
The failure of a restaurant to obtain or retain liquor or food service licenses
would adversely affect the restaurant's operations.
We are also subject to "dram-shop" statutes, which generally provide a
person injured by an intoxicated person the right to recover damages from an
establishment that wrongfully served alcoholic beverages to the intoxicated
person. We carry liquor liability coverage as part of our existing
comprehensive general liability insurance and have never been litigated as a
defendant in a lawsuit involving "dram-shop" statutes.
Our restaurants are subject to federal and state minimum wage laws governing
such matters as working conditions, overtime and tip credits. A significant
number of our restaurant personnel are paid at rates related to the federal
minimum wage and, accordingly, further increases in the minimum wage rate could
increase our labor costs.
The Americans with Disabilities Act prohibits discrimination in employment
and public accommodations on the basis of disability. Under the Act, which
became effective in 1992, to the extent that we elect to remodel a restaurant,
we could be required to expend funds to modify our restaurants to provide
service to, or make reasonable accommodations for the employment of, disabled
persons.
Service Marks and Proprietary Information
We have registered the service mark "Shells" with the Secretary of the State
of Florida and the "Shells" service mark and "jumping fish" logo with the
United States Patent and Trademark Office. We believe that our service marks
have significant value and are essential to our ability to create demand for,
and awareness of, our restaurants. There can be no assurance, however, that our
service marks do not or will not violate the proprietary rights of others, that
they would be upheld if challenged or that we would not be prevented, in such
an event, from using our service marks, any of which could have a material
adverse effect on us. Although there can be no assurance that we will have the
financial resources necessary to enforce or defend our service marks, we have
vigorously opposed, and intend to continue to oppose vigorously, any
infringement of our service marks.
We also rely on trade secrets and proprietary know-how and employ various
methods to protect our concepts and recipes. These methods may not afford
complete protection and there can be no assurance that others will not
independently develop similar know-how or obtain access to our know how,
concepts and recipes.
Employees
As of December 29, 2002, we employed approximately 1,600 persons, of whom
approximately 110 were management or administrative personnel employed on a
salaried basis and 1,490 were employed in non-management restaurant positions
on an hourly basis. Approximately 700 employees are employed on a full-time
basis. We consider our employee relations to be good. No employees are covered
by a collective bargaining agreement.
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Our Executive Officers
Our executive officers are:
Name Age Position
---- --- --------
David W. Head... 46 President, Chief Executive Officer and Director
John R. Ritchey. 57 Vice President of Operations
Warren R. Nelson 51 Executive Vice President of Finance, Chief Financial
Officer, Treasurer and Secretary
David W. Head currently serves as President and Chief Executive Officer,
positions he has held since joining us in April 2001. From December 1998 to
April 2001, Mr. Head was President, Chief Operating Officer and Member of Le
Carnassier LLC, D/B/A Red Robin Gourmet Burgers and Spirits; from August 1998
to April 1999, Mr. Head was President and Chief Operating Officer of Red River
Bar and Grill; from November 1997 to July 1998, Mr. Head was President, Chief
Executive Officer and Director of Houlihan's Restaurant Group.
John R. Ritchey currently serves as Vice President of Operations, a position
he has held since rejoining us in April 2001. From November 1999 to March 2001,
Mr. Ritchey was a private investor. From October 1993 to November 1999, Mr.
Ritchey was employed by us as Vice President of Operations and Vice President
of Corporate Development.
Warren R. Nelson currently serves as our Executive Vice President of
Finance, Chief Financial Officer, Treasurer, and Secretary, positions he has
held since June 1993.
Risk Factors Relating to the Business of the Company.
The risks and uncertainties described below are not the only risks we face.
In addition to the following risk factors, we refer you to those risk factors
described elsewhere in this Annual Report on Form 10-K and in various of our
publicly reported documents. Additional risks and uncertainties not presently
known to us or that we currently believe are immaterial could also impair our
business operations.
Keep these risk factors in mind when you read "forward-looking" statements
elsewhere in this Form 10-K. These are statements that relate to our
expectations for future events and time periods. Generally, the words
"anticipate," "expect," "intend" and similar expressions identify
forward-looking statements. Forward-looking statements involve risks and
uncertainties. Future events and circumstances could differ significantly from
those associated with the forward-looking statements.
We have significant capital requirements and may need additional
financing. Historically, our cash requirements have exceeded our cash flow
from operations. This has been due to costs associated with developing and
opening restaurants as well as the operating performance of many of our
restaurants. At December 30, 2001, the Company had a working capital deficiency
of $7,580,000 and a cash balance of $970,000. In 2002, we received
non-operational proceeds from a $2,000,000 financing transaction effective
January 31, 2002, income tax refunds of $1,176,000 related to the carry back of
net operating losses, and we refinanced or sold certain properties. At December
29, 2002, the Company had a working capital deficiency of $3,116,000 and a cash
balance of $2,469,000. We believe cash flow from operations will satisfy our
contemplated cash requirements for our existing operations for at least the
next 12 months. Additional cash will be needed if new restaurants are opened.
We may have to seek additional financing from other sources if:
. our projections or assumptions are inaccurate or because of unanticipated
expenses;
. projected cash flows are not sufficient to cover costs of operations or
restaurant renovations; or
. we open additional restaurants.
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We cannot be assured that third party financing will be available to us when
we need it or available on acceptable terms, if at all. If we cannot obtain
third party financing or other financing when we need it, this could materially
adversely affect our results of operations and possible expansion plans. If we
have to raise additional capital through the sale of our equity, our existing
stockholders could be substantially diluted.
Substantial dilution to our stockholders is possible. During January 2002,
we completed a $2,000,000 financing transaction pursuant to which, among other
things, we issued warrants to purchase 8,908,030 shares of our common stock, at
an exercise price of $0.16 per share. The warrants are exercisable from January
31, 2003 through January 31, 2005, and may be exercised by a "cashless
exercise". To the extent these warrants are exercised, our stockholders will
suffer substantial dilution. In addition, it is likely that until the warrants
are exercised, the number of shares which are issuable upon exercise of these
warrants, combined with the per share exercise price, will have a depressive
effect on the price of our stock.
Control by Management. Frederick R. Adler, a shareholder, together with
members of our executive management team and Board of Directors, own of record,
in the aggregate, approximately 38% of our outstanding common stock. As a
result, such persons, acting together, will be able to exert significant
influence and control over us, including the election of our directors,
regarding any proposed dissolution, merger or sale of our assets, and generally
in the direction of our affairs.
In addition, in conjunction with the $2,000,000 financing transaction in
2002, we issued warrants to purchase 8,908,030 shares of our common stock, at
an exercise price of $0.16 per share. The warrants, which may be exercised by a
"cashless excersise," are exercisable from January 31, 2003 through January 31,
2005. One half of these warrants are held by each of two investor groups, the
members of which are either members of our Board of Directors or persons
associated with or related to our Board members or Mr. Adler. If these warrants
are exercised in full, our corporate insiders, together with Mr. Adler, could
control approximately 79% of our outstanding voting stock, and thus control all
decisions affecting our company. Furthermore, as part of the financing, we
entered into an Investor Rights Agreement, dated as of January 31, 2002, with
these investor groups and certain other stockholders. Pursuant to this
agreement, the composition of our Board of Directors is fixed at seven members
and each of these investor groups is entitled to nominate three individuals to
serve on our Board. Additionally, each of these investor groups and Frederick
R. Adler, among others, have agreed to vote their respective shares, to cause
these slated nominees to be elected to our Board of Directors.
Operating results may require the closure of other restaurants. If we
continue to experience prolonged periods of unfavorable operating results at
existing restaurants or view the prospects for a restaurant to be less than
satisfactory, we may elect to close or relocate restaurants. The lack of
success or closing of any of our restaurants could have an adverse effect upon
our financial condition and results of operations. We closed one restaurant in
Fiscal 2002. We closed 16 restaurants during Fiscal 2001, of which 14 were
located in the Midwest and two were located in Florida. We are continuing to
monitor the operations and financial performance with respect to certain of our
other existing restaurants.
Our operating results fluctuate seasonally because of our geographic
concentration. The majority of our restaurants are located in primarily
residential areas in Florida. We have experienced fluctuations in our
quarter-to-quarter operating results because of factors including:
. the seasonal nature of our business; and
. weather conditions in Florida.
Our restaurants are all located in Florida and can be affected by the health
of Florida's economy in general, and of the tourism industry in particular,
which can further be affected by anticipated world events, as well as economic
trends.
Our restaurant sales generally increase from January through April and June
through August, the peaks of the Florida tourism season, and generally decrease
from September through mid-December. In addition, because
7
of our present geographic concentration, adverse publicity relating to our
restaurants or adverse weather conditions could have a more pronounced adverse
effect on our operating results than if our restaurants were more
geographically dispersed. Adverse weather conditions or a decline in tourism in
Florida, or in general economic conditions, which would likely affect the
Florida economy or tourism industry, particularly during the time of peak
sales, could materially adversely affect our operations and prospects. Because
of the seasonality of our business, our results for any quarter are not
necessarily indicative of the results that may be achieved for a full year.
The supply and quality of our seafood may fluctuate. In recent years, the
availability of certain types of seafood has fluctuated. This has resulted in a
corresponding fluctuation in prices. We maintain short-term contracts with
several of our suppliers. In addition, we purchase products through Performance
Food Group in the ordinary course of business. Performance Food Group
distributes and warehouses our frozen seafood supply and procures, distributes
and stores other supplies for us. We believe that our relationships with our
suppliers and Performance Food Group are satisfactory and that alternative
sources are readily available. However, the loss of some suppliers or of our
relationship with Performance Food Group could materially adversely affect us.
Also, substantial price increases imposed by these suppliers in the absence of
alternative sources of supply in a timely manner, could have a material adverse
effect on us.
Some species of seafood have become subject to adverse publicity because of
claims of contamination by lead, mercury or other chemicals that may exist in
the ocean or in an aquaculture environment. This can adversely affect both
market demand and supply for these food products. Customer demand may also be
negatively impacted by reports of medical or other risks resulting from eating
seafood. We maintain a continuous inspection program for our seafood purchases.
However, we cannot assure you that seafood contamination or consumer perception
of inadequate seafood quality, in the industry in general or as to us
specifically, will not have a material adverse effect on us. Our failure to
obtain adequate supplies of seafood or problems or difficulties resulting from
the contamination of seafood, in general, or at any of our restaurants in
particular, will have a material adverse effect on our operations and
profitability.
Our expenses for food and other costs fluctuate. Our profitability depends
on our ability to anticipate and to react to increases in food, labor, employee
benefits, and similar costs. We have limited control over these costs.
Specifically, our dependence on frequent deliveries of seafood, produce, dairy
and other products means we are at greater risk of shortages or interruptions
in supply because of adverse weather or other conditions. This could adversely
affect the availability and cost of these items. We have been able to
anticipate and react to fluctuations in food costs by:
. adjusting selected menu prices;
. purchasing seafood directly from numerous suppliers; and
. promoting alternative menu selections in response to price and
availability of supply.
However, we cannot assure you that we will be able to continue to anticipate
and respond to supply and price fluctuations or that we will not be subject to
significantly increased costs. A shortage of available seafood could cause our
cost of sales to increase. Because of our low pricing structure, this could
materially adversely affect our operations and profitability. In addition,
seafood suppliers and processors are subject to a program of inspection by the
Food and Drug Administration. This program may increase our seafood costs
because seafood suppliers' and processors' costs in complying with this program
may increase.
Our industry is highly competitive. The restaurant industry, particularly
the full-service casual dining segment, is highly competitive. We compete in
the areas of:
. price;
. service;
. food quality, including taste, freshness, healthfulness and nutritional
value; and
. location.
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We have numerous well-established competitors, some of which dominate the
industry. These competitors possess substantially greater financial, marketing,
personnel and other resources than we do. Many of our competitors have achieved
significant brand name and product recognition. They also engage in extensive
advertising and promotional programs, both generally and in response to efforts
by additional competitors to enter new markets or introduce new products. Our
competitors include national, regional and local full-service casual dining
chains, many of which specialize in or offer seafood products.
We believe that the full-service casual dining segment is likely to attract
a significant number of new entrants, some offering seafood products. We also
expect to face competition from a broad range of other restaurants and food
service establishments. These include full-service, quick-service and fast food
restaurants, which specialize in a variety of menu offerings. In addition, the
full-service restaurant industry is characterized by the frequent introduction
of new food products, which are accompanied by substantial promotional
campaigns. In recent years, numerous companies in the full-service restaurant
industry have introduced products, including seafood, intended to capitalize on
growing consumer preference for food products that are, or are perceived to be,
healthful, nutritious, low in calories and low in fat content. You can expect
that we will be subject to increasing competition from companies whose products
or marketing strategies address these consumer preferences. While we believe
that we offer a broad variety of quality seafood products, we cannot assure you
that:
. consumers will be able to distinguish our products from competitive
products;
. substantially equivalent food products will not be introduced by our
competitors; or
. we will be able to compete successfully.
Many factors affect our industry. We must respond to various factors
affecting the restaurant industry including:
. changes in consumer preferences, tastes and eating habits;
. demographic trends and traffic patterns;
. increases in food and labor costs;
. inflation; and
. national, regional and local economic conditions and the effect of world
events, in general, and the tourism industry in particular:
We face risks associated with government regulation. We are subject to
extensive state and local government regulation by various agencies, including:
. state and local licensing, zoning, land use, construction and
environmental regulations;
. various regulations relating to the sale of food and alcoholic beverages;
. regulations relating to sanitation, disposal of refuse and waste products;
. regulations relating to public health; and
. safety and fire standards.
Our restaurants are inspected periodically by governmental agencies to
ensure conformity with these regulations. The suspension of, or inability to
renew a license at an existing restaurant would adversely affect our
operations. A significant percentage of our revenue comes from sales of
alcoholic beverages. State and local regulation of the sale of alcoholic
beverages require us to obtain a license or permit for each of our restaurants.
The failure of a restaurant to obtain or retain a license to serve liquor would
materially adversely affect our operations. In addition, our failure or
difficulty in obtaining required licensing or other regulatory approvals could
delay or prevent new restaurant openings.
Restaurant operating costs are also affected by other government actions,
which are beyond our control, including increases in:
. the minimum hourly wage requirements;
. workers compensation insurance rates;
9
. health care insurance costs;
. other insurance costs, including general liability and property; and
. unemployment and other taxes.
Furthermore, the Americans with Disabilities Act may require us to make
certain modifications to certain of our restaurants to meet specified access
and use requirements. These and other initiatives could adversely affect our
results of operations.
We may have liability for sales of alcoholic beverages. We are also subject
to "dram-shop" statutes. These statutes generally provide a person injured by
an intoxicated person the right to recover damages from an establishment that
wrongfully served alcoholic beverages to the intoxicated person. In certain
states, statutes also provide that a vendor of alcoholic beverages may be held
liable in a civil cause of action for injury or damage caused by or resulting
from the intoxication of a minor under certain conditions. A vendor can be held
liable under certain conditions for damage caused by a person who was served
alcoholic beverages by that vendor. In addition, significant national attention
is currently focused on the problem of drunk driving, which could result in the
adoption of additional legislation. This could increase our potential liability
for damage or injury caused by our customers.
We may not be able to protect our service marks and proprietary
information. We own two United States registrations for the service marks that
we use, including the name "Shells." We believe that our service marks have
significant value and are essential to our ability to create demand for and
awareness of our restaurants. We cannot assure you, however, that our service
marks:
. do not or will not violate the proprietary rights of others;
. would be upheld if challenged; or
. that we would not be prevented from using our service marks.
Any of these occurrences could materially adversely affect us. In addition,
we cannot assure you that we will have the financial resources necessary to
enforce or defend our service marks. We believe that we own all of our
intellectual property and that the management and license agreements to which
we are a party are enforceable. In the past, the enforceability of these
management and license agreements has been questioned by certain of the
licensees. Although we believe the agreements are enforceable, there can be no
assurance that the agreements will not be challenged in the future, and, if
challenged, that the agreements will be determined to be enforceable and the
managed restaurants will be restricted from using the Shells service marks
independent of us.
We also rely on trade secrets and proprietary know-how. We employ various
methods to protect our concepts and recipes. However, these methods may not
completely protect us. We cannot assure you that others will not independently
develop similar know-how or obtain access to our know-how, concepts and
recipes. Although we generally enter into confidentiality agreements with our
executives and managers, we cannot assure you that these agreements will
adequately protect our trade secrets.
Our insurance coverage may not be adequate. We maintain insurance,
including insurance relating to personal injury, in amounts, which we currently
consider adequate. Nevertheless, a partially or completely uninsured claim
against us, if successful, could materially adversely affect us.
We depend on key personnel. Our success is largely dependent upon our
executive management and other key personnel. The loss of the services of one
of our executives or other key personnel could materially adversely affect us.
Our success may also depend on our ability to attract and retain qualified
management restaurant industry personnel.
Absence of Dividends. We have never paid cash dividends on our common
stock and do not anticipate paying any cash dividends in the foreseeable
future. In addition, our debt financings prohibit the payment of cash dividends
and any future financing agreements may also prohibit the payment of cash
dividends.
10
Provisions with Potential Anti-Takeover Effect. Our certificate of
incorporation provides that we may issue up to 2,000,000 shares of preferred
stock from time-to-time in one or more series. The Board of Directors is
authorized to determine the rights, preferences, privileges and restrictions
granted to and imposed upon any wholly unissued series of preferred stock. The
Board is authorized to fix the number of shares of any series of preferred
stock and the designation of any such series, without any vote or action by our
stockholders. The Board may authorize and issue preferred stock with voting,
dividend, liquidation, conversion or other rights that could adversely affect
the voting power or other rights of the holders of our common stock. In
addition, the potential issuance of preferred stock may have the effect of
delaying, deferring or preventing a change in control, may discourage bids for
our common stock at a premium over the market price of the common stock and may
adversely affect the market price of the common stock.
On October 24, 2001, the Company issued 66,862 shares of Series A 5%
Convertible Preferred Stock, par value $0.01 per share (the "Series A Preferred
Stock"), pursuant to an exemption from registration under Section 4(6) of the
Securities Act of 1933, as amended, in consideration for the cancellation of
$669,000 trade indebtedness by trade creditors of the Company. We have no
present intention to issue any additional shares of our preferred stock.
However, we cannot assure you that we will not do so in the future.
ITEM 2. PROPERTIES
We lease 6,800 square feet of space in Tampa, Florida for our executive
offices. The annual rent payable under the lease, which expires October 31,
2004, is approximately $100,000.
All but three of our existing restaurants in operation are leased
properties. One owned property was sold during 2002. In the future, we intend
to lease most of our properties but may from time-to-time acquire restaurant
locations based on individual site evaluation. Each of our leases provides for
a minimum annual rent and certain of these leases require additional rental
payments to the extent sales volumes exceed specified amounts. Generally, we
are required to pay the cost of insurance, taxes and a portion of the
landlord's operating costs to maintain common areas. Restaurant leases
generally have initial terms averaging 13 years and renewal options averaging
16 years, and rents averaging $15.00 per square foot.
ITEM 3. LEGAL PROCEEDINGS
On June 21, 2002 we brought legal action against The Lark Group LLC, Best
Que LLC, and Michael Sloane, II, in the United States District Court, Middle
District of Florida, Tampa Division, relating to their purchase of assets and
leasehold rights for two Midwest locations. Our complaint sought relief for
breaches of contract against each of the defendants. Defendants consented to a
final judgment in the amount of $188,201, which was filed with the Court on
January 22, 2003. Our intention is to vigorously purse collection of this
judgment.
On March 11, 2003, we received a notice from the Equal Employment
Opportunity Commission (EEOC) that a former employee in our Miami store had
dually filed a charge of discrimination with both the EEOC and the Florida
Commission on Human Relations. Shells terminated the employment of this person
in December 2002. Specifically, this former employee is claiming gender
discrimination and retaliation under Title VII of the Civil Rights Act of 1964
and age discrimination in violation of the Age Discrimination in Employment Act
of 1967. Based on our investigation to date we believe the charge is meritless
and intend to vigorously defend our position.
In the ordinary course of business, the Company is a party to several legal
proceedings, the outcome of which, singly or in the aggregate, is not expected
to be material to the Company's financial position, results of operations or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
None.
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Our common stock is traded on the over-the-counter bulletin board under the
symbol "SHLL". The following table sets forth the high and low per share price
of our common stock as reported by the OTC bulletin board.
Fiscal 2001 High Low
----------- ----- -----
First quarter. $0.81 $0.47
Second quarter $0.88 $0.44
Third quarter. $0.81 $0.29
Fourth quarter $0.35 $0.12
Fiscal 2002
-----------
First quarter. $0.65 $0.35
Second quarter $0.65 $0.45
Third quarter. $1.00 $0.41
Fourth quarter $0.58 $0.25
These over-the-counter market quotations reflect inter-dealer prices,
without retail markup, mark-down or commission and may not necessarily
represent actual transactions.
The number of stockholders of record of our common stock on February 14,
2003 was approximately 250. The Company's stock price as of February 14, 2003
was $0.55.
Our authorized capital stock consists of 20,000,000 shares of common stock,
par value $0.01 per share, and 2,000,000 shares of preferred stock, par value
$0.01 per share.
Dividend Policy
We have never declared or paid any cash dividends on our Common Stock. All
future earnings will be retained by us for the development of our business.
Accordingly, we do not anticipate paying cash dividends on the Common Stock in
the foreseeable future. We are subject to loan covenants containing certain
provisions prohibiting our ability to pay dividends.
Equity Compensation Plans
Securities authorized for issuance under equity compensation plans as of
December 29, 2002 were as follows:
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
warrants, and rights warrants and rights reflected in column [a])
Plan category [a] [b] [c]
- ------------- ----------------------- -------------------- -------------------------
Equity compensation plans approved by
security holders....................... 2,941,000 $0.73 896,790
Equity compensation plans not approved by
security holders....................... 8,908,030 $0.16 --
---------- -------
Total.................................... 11,849,030 896,790
========== =======
12
Equity compensation plans not approved by security holders consists of
warrants to purchase shares of common stock, issued on January 31, 2002, in
connection with a $2,000,000 private financing transaction. The warrants, which
may be exercised by a "cashless exercise", have an exercise price of $0.16 per
share and are exercisable from January 31, 2003 to January 31, 2005.
The number of securities and type of plans available for future issuance of
stock options as of December 29, 2002 was:
Options for Common Shares:
------------------------------------------
Plan Name Authorized Converted Outstanding Available
- --------- ---------- --------- ----------- ---------
Stock Option Plan for Non-Employee Directors 150,000 0 36,000 114,000
1995 Employee Stock Option Plan............. 840,000 0 672,733 167,267
1996 Employee Stock Option Plan............. 101,000 11,001 31,992 58,007
2002 Equity Incentive Plan.................. 1,850,000 0 1,292,484 557,516
--------- ------ --------- -------
Total....................................... 2,941,000 11,001 2,033,209 896,790
========= ====== ========= =======
13
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth, selected historical consolidated financial
data for our company. The historical consolidated financial data is for the
fiscal years (52 weeks) ended December 29, 2002, (our Fiscal 2002), December
30, 2001 (our Fiscal 2001), December 31, 2000 (our Fiscal 2000), January 2,
2000 (our Fiscal 1999), and the fiscal year (53 weeks) ended January 3, 1999
(our Fiscal 1998). This consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Form 10-K. (The amounts are presented in
thousands, except per share and number of restaurants data, and percentage
information).
Year
(53 Weeks)
Year (52 Weeks) Ended Ended
------------------------------------------------ ----------
December 29, December 30, December 31, January 2, January 3,
2002 2001 2000 2000 1999
------------ ------------ ------------ ---------- ----------
Statement of Operations Data:
Revenues
Restaurant sales......................... $47,065 $57,258 $90,023 $94,798 $83,734
Management fees.......................... 163 271 419 407 415
------- ------- ------- ------- -------
Total revenues........................... 47,228 57,529 90,442 95,205 84,149
------- ------- ------- ------- -------
Costs and expenses
Cost of sales............................ 15,778 21,239 33,984 34,356 29,342
Labor and other related expenses......... 14,585 17,628 28,028 27,839 23,749
Other restaurant operating expenses...... 10,773 12,047 19,635 20,623 17,317
General and administrative expenses...... 3,565 4,751 7,212 7,438 6,210
Depreciation and amortization............ 1,102 1,702 2,703 3,320 2,702
Pre-opening expenses..................... -- -- -- 215 2,306
Provision for store closings............. -- 1,333 1,027 -- --
Provision for impairment of goodwill..... 206 -- -- -- --
Provision for impairment of assets....... 110 2,259 3,978 4,595 620
------- ------- ------- ------- -------
Income (loss) from operations............... 1,108 (3,430) (6,125) (3,181) 1,903
Other income (expense):
Interest expense, net.................... (534) (482) (789) (789) (341)
Gain on preferred stock conversion....... -- 588 -- -- --
Other (expense) income, net.............. (3) (476) 145 (6) (18)
------- ------- ------- ------- -------
Income (loss) before elimination of minority
partner interest and income taxes......... 571 (3,799) (6,769) (3,976) 1,544
Elimination of minority partner interest.... (221) (221) (259) (250) (179)
------- ------- ------- ------- -------
Income (loss) before benefit (provision) for
income taxes.............................. 350 (4,020) (7,028) (4,226) 1,365
Income tax benefit (provision) (1).......... 327 1,001 (2,304) 1,512 158
Cumulative effect of change in accounting
principle for pre-opening costs, net of
income tax benefit........................ -- -- -- -- (692)
------- ------- ------- ------- -------
Net income (loss)........................... 677 (3,019) (9,332) (2,714) 831
Preferred shares accretion.................. -- -- -- -- (111)
------- ------- ------- ------- -------
Net income (loss) applicable to common
stock..................................... $ 677 $(3,019) $(9,332) $(2,714) $ 720
======= ======= ======= ======= =======
14
Fiscal Years Ended
-------------------------------------
December 29, December 30, December 31,
2002 2001 2000
------------ ------------ ------------
Basic net income (loss) per share.................................. $ 0.15 $ (0.68) $ (2.10)
Diluted net income (loss) per share................................ $ 0.07 $ (0.68) $ (2.10)
Operating Data:
System-wide sales:
Company-owned restaurants....................................... $47,065 $57,258 $ 90,023
Licensed restaurants............................................ 8,147 8,935 10,009
------- ------- --------
$55,212 $66,193 $100,032
======= ======= ========
Number of restaurants (at end of period):
Company-owned restaurants....................................... 24 25 41
Licensed restaurants............................................ 4 4 4
------- ------- --------
28 29 45
------- ------- --------
Average annual sales per Company-owned and joint venture restaurant
open for full period (2)......................................... $ 1,924 $ 2,047 $ 2,071
Decrease in Company-owned and joint venture restaurant same store
sales (2)........................................................ -7.2 % -13.1 % -0.4 %
December 29, December 30, December 31, January 2, January 3,
2002 2001 2000 2000 1999
------------ ------------ ------------ ---------- ----------
Balance sheet data:
Working capital (deficiency) $(3,116) $(7,580) $(7,500) $(3,925) $(4,047)
Total assets................ 13,858 14,847 21,461 30,668 34,895
Long-term debt.............. 3,883 1,633 5,700 5,656 5,189
Minority partner interest... 428 428 449 590 519
Preferred stock............. 1 1 -- -- --
Stockholders' equity........ 2,152 1,475 4,414 13,746 16,460
- --------
(1) The effective tax rates for fiscal years 2002, 2001, 2000, and 1999 include
the effect of recognizing valuation allowance adjustments relating to tax
benefits that were fully reserved prior to 1998. Income tax benefit
(provision) of 93.3%, 24.9% and (32.8)% for the fiscal years ended 2002,
2001, and 2000, respectively, differ from the amounts computed by applying
the effective income tax rate of 34% as a result of adjusting the valuation
allowance, primarily related to net operating loss carryforwards from prior
years. The valuation allowance in fiscal 2002 was increased by $1,403,000,
reserving for all tax assets that were deemed non-realizable. The valuation
allowance in fiscal 2001 was decreased by $706,000, reserving for all tax
assets except those subject to recovery through carrybacks resulting from
the March 9, 2002 Economic Stimulus Package. The fiscal 2000 taxes were
impacted by an increase in the valuation allowance as the tax assets were
deemed non-realizable.
(2) Includes only restaurants open during the full fiscal year shown and open
for a full comparable fiscal year and at least the full six months prior
thereto.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
As of December 29, 2002, we owned 23 Shells restaurants and a 51% ownership
interest in the Melbourne restaurant, and we managed and operated four
additional restaurants. All 28 restaurants are located in Florida. Average
annual restaurant sales during the fiscal year ended December 29, 2002 for the
24 owned restaurants were approximately $1,924,000.
During the fourth quarter of 2000, we began taking corrective action aimed
at mitigating those factors that management believed were contributing to our
operating losses. These actions included the closing of four under-performing
restaurants during our Fiscal 2000 and the closing of 16 under-performing
restaurants during our Fiscal 2001, consisting of 17 restaurants in the Midwest
and three restaurants in Florida. In Fiscal 2002, we closed one additional
under-performing restaurant in Florida. We continue to evaluate
under-performing restaurants.
The following table sets forth, for the periods indicated, the percentages
that the items in our Consolidated Statements of Operations bear to total
revenues, or where indicated, restaurant sales.
Fiscal Years Ended
-------------------------------------
December 29, December 30, December 31,
2002 2001 2000
------------ ------------ ------------
Revenues
Restaurant sales..................................... 99.7 % 99.5 % 99.5 %
Management fees...................................... 0.3 % 0.5 % 0.5 %
------ ------ ------
100.0 % 100.0 % 100.0 %
------ ------ ------
Cost and expenses
Cost of sales (1).................................... 33.5 % 37.1 % 37.8 %
Labor and other related expenses (1)................. 31.0 % 30.8 % 31.1 %
Other restaurant operating expenses (1).............. 22.9 % 21.0 % 21.8 %
------ ------ ------
Total restaurant costs and expenses (1).............. 87.4 % 88.9 % 90.7%
------ ------ ------
General and administrative expenses.................. 7.5 % 8.3 % 8.0 %
Depreciation and amortization........................ 2.3 % 3.0 % 3.0 %
Provision for store closings......................... 0.0 % 2.3 % 1.1 %
Provision for impairment of goodwill................. 0.4 % 0.0 % 0.0 %
Provision for impairment of assets................... 0.2 % 3.9 % 4.4 %
------ ------ ------
Income (loss) from operations........................... 2.3 % -6.0% -6.8%
Interest expense, net................................... -1.1 % -0.8 % -0.9 %
Gain on preferred stock conversion...................... 0.0 % 1.0 % 0.0 %
Other income (expense), net............................. 0.0 % -0.8 % 0.2 %
Elimination of minority partner interest................ -0.5 % -0.4 % -0.3 %
------ ------ ------
Income(loss) before benefit (provision) for income taxes 0.7 % -7.0 % -7.8 %
Income tax benefit (expense)............................ 0.7 % 1.7 % -2.5 %
------ ------ ------
Net income (loss)....................................... 1.4 % -5.3 % -10.3 %
====== ====== ======
- --------
(1) As a percentage of restaurant sales.
16
RESULTS OF OPERATIONS
Fiscal 2002 versus Fiscal 2001
Total revenues for Fiscal 2002 were $47,228,000 as compared to $57,529,000
for Fiscal 2001. The $10,301,000 or 17.9% decrease in revenues primarily was
due to operating one-third fewer restaurants during and after the second
quarter of Fiscal 2001, and, to a lesser extent, a 7.2% decrease in same store
sales. Our revenues consisted of restaurant sales of the Company-owned
restaurants and management and licensing fees on sales at the managed
restaurants. Our food sales and liquor sales accounted for 88% and 12% of
revenues, respectively, for the fiscal year ended December 29, 2002.
Comparisons of same store sales include only stores, which were operating
during the entire periods being compared and, due to the time needed for a
restaurant to become established and fully operational, at least six months
prior to the beginning of that period.
The cost of restaurant sales as a percentage of restaurant sales decreased
to 33.5% for Fiscal 2002 from 37.1% for Fiscal 2001. This decrease primarily
was due to the declining commodity costs of seafood, primarily shrimp, coupled
with a menu that emphasizes higher margin items. Additionally, we enhanced our
in-store controls of inventory through better utilization of a perpetual
inventory system. The cost of restaurant sales generally consists of the cost
of food, beverages, freight, and paper and plastic goods used in food
preparation and carry-out orders.
Labor and other related expenses as a percentage of restaurant sales
increased to 31.0% during Fiscal 2002 as compared to 30.8% for Fiscal 2001.
This increase primarily was due to an increase in management labor as a
percentage of sales caused by lower unit sales volumes and the implementation
of a management bonus program. Fiscal 2001 included $102,000 in severance pay
primarily related to Midwest store closings. Labor and other related expenses
generally consist of restaurant hourly and management payroll, benefits and
taxes.
Other restaurant operating expenses as a percentage of restaurant sales
increased to 22.9% for Fiscal 2002 as compared with 21.0% for Fiscal 2001. The
increase primarily was due to increased media advertising and local store
marketing costs along with an increase in expenditures in restaurant
maintenance. Other restaurant operating expenses generally consist of
advertising, costs associated with area directors, supplies, repairs and
maintenance, rent and other occupancy costs and utilities.
General and administrative expenses as a percentage of revenues decreased to
7.5% for Fiscal 2002 as compared with 8.3% for Fiscal 2001. The decrease was
primarily attributed to reorganization and downsizing of administrative and
supervisory staff in the second quarter of Fiscal 2001 which included a
one-time nonrecurring charge of $150,000 for severance pay. General and
administrative expenses relate to the operations of all Shells restaurants
owned by us and management services that we provide to the managed restaurants.
Depreciation and amortization expenses as a percentage of revenues were 2.3%
for Fiscal 2002 and 3.0% for Fiscal 2001. In Fiscal 2001, goodwill was
amortized under a straight-line, useful life concept; in Fiscal 2002, a
provision for impairment of goodwill was recognized. The provision for
impairment of goodwill was $206,000 or 0.4% of revenues during Fiscal 2002;
goodwill was evaluated for impairment and written down in accordance with FASB
Statement No. 142 which the Company adopted in 2002.
A provision for store closings of $1,333,000 or 2.3% of revenues was
recognized in Fiscal 2001. These one-time charges, which consist primarily of
real estate lease obligations incurred or anticipated to complete lease
terminations or continuing costs while new tenants are located, related
primarily to Shells restaurants closed in the Midwest.
The provision for impaired assets was $110,000 or 0.2% of revenues for
Fiscal 2002 as compared to $2,259,000 or 3.9% of revenues for Fiscal 2001. In
the fourth quarter of Fiscal 2002 and the first and fourth quarters of Fiscal
2001, we recorded the pre-tax charge relating to the write-down of impaired
assets to their
17
estimated fair value in accordance with Financial Accounting Standards Board
Statement No. 144. The asset impairment charge in the fourth quarter of Fiscal
2002 related to three Florida restaurants that were previously not written
down. We discontinued the operations of under-performing units, including
closing six units during each of the first and second quarters of Fiscal 2001
and licensing an additional three units to others during the second quarter of
Fiscal 2001. The asset impairment charge in the first quarter of Fiscal 2001 of
$1,582,000 related to the closure or licensing of these restaurants. The asset
impairment charge in the fourth quarter of Fiscal 2001 of $677,000 related to
four restaurants in Florida that were identified as under-performing units. The
write-downs were necessitated by the current period operating losses and the
projected cash flows of the restaurants, many of which were negative.
Interest expense was $570,000 in Fiscal 2002 compared to $500,000 in Fiscal
2001. The Company recorded a one-time charge of $106,000 in the first quarter
of Fiscal 2002 relating to the previously reported $2,000,000 financing
transaction. Exclusive of this non-recurring charge, interest expense was
$464,000 in Fiscal 2002. The reduction was primarily related to debt repayments
associated with store closures in Fiscal 2001 and related property dispositions
through Fiscal 2002.
In Fiscal 2001, a gain of $588,000 was recognized upon the cancellation of
$669,000 of trade indebtedness in exchange for preferred stock.
The Other Expense in Fiscal 2002 was $3,000 as compared to $476,000 in
Fiscal 2001. In Fiscal 2001, a loss of $283,000 was recognized on the sale of a
restaurant site in Delray Beach, Florida and $156,000 for settlements of
various general liability claims.
A benefit from income taxes of $327,000 was recognized in Fiscal 2002
compared to $1,001,000 in Fiscal 2001. The benefit in both years related to a
refund application to recover tax payments of $1,176,000 from prior years,
resulting from the Economic Stimulus Package signed into law in March 2002. The
refund was received in July 2002.
As a result of the factors discussed above, income from operations for
Fiscal 2002 was $1,108,000 compared to a loss from operations for Fiscal 2001
of $3,430,000. Exclusive of non-recurring items, the Company's income from
operations was $1,218,000 for Fiscal 2002 compared to $414,000 for Fiscal 2001.
The Company's net income for Fiscal 2002 was $677,000 compared to a net loss of
$3,019,000 for Fiscal 2001. Exclusive of non-recurring items, net income in
Fiscal 2002 was $575,000 compared to a net loss in Fiscal 2001 of $481,000.
The results for the Fiscal years of 2002 and 2001 included non-recurring
income of $102,000 and charges of $2,538,000, respectively. Non-recurring
income in Fiscal 2002 included the net effect of $318,000 in additional income
tax refunds received partially offset by a $110,000 write down of impaired
assets to their estimated fair value, and recognition of $106,000 in imputed
interest expense from the warrants issued as part of the financing transaction.
Non-recurring charges in Fiscal 2001 included the net effect of a $2,259,000
write down of impaired assets to their estimated fair value, store closing and
restructuring costs of $1,585,000 and a loss recognized from the disposition of
property of $283,000, offset in-part by an increase in income tax refunds
receivable of $1,001,000 and a $588,000 gain on debt forgiveness related to the
conversion of debt to preferred stock
Fiscal 2001 versus Fiscal 2000
Total revenues for Fiscal 2001 were $57,529,000 as compared to $90,442,000
for Fiscal 2000. The $32,913,000 or 36.4% decrease in revenues primarily was
due to the closing of 16 restaurants during the first seven months of Fiscal
2001 and, to a lesser extent, a 13.1% decrease in same store sales. Our food
sales and liquor sales accounted for 89% and 11% of revenues, respectively, for
the fiscal year ended December 30, 2001.
18
The cost of restaurant sales as a percentage of restaurant sales decreased
to 37.1% for Fiscal 2001 from 37.8% for Fiscal 2000. This decrease primarily
was due to the declining commodity costs of seafood, primarily shrimp and crab
products in the third and fourth quarters, coupled with a new menu rolled out
during the fourth quarter which emphasized higher margin items.
Labor and other related expenses as a percentage of restaurant sales
decreased to 30.8% during Fiscal 2001 as compared to 31.1% for Fiscal 2000.
This decrease was due to a reduction in hourly labor costs as Florida labor
wage rates were generally lower than Midwest wage rates, partially offset by an
increase in management labor as a percentage of sales caused by lower unit
sales volumes and $102,000 in severance pay primarily related to Midwest store
closings.
Other restaurant operating expenses as a percentage of restaurant sales
decreased to 21.0% for Fiscal 2001 as compared with 21.8% for Fiscal 2000. The
decrease primarily was due to decreased media advertising costs, partially
offset by an increase in utility costs caused by higher electricity and gas
rates.
General and administrative expenses as a percentage of revenues increased to
8.3% for Fiscal 2001 as compared with 8.0% for Fiscal 2000. The increase was
primarily attributed to inefficiencies resulting from lower sales volumes in
Fiscal 2001 and a one-time nonrecurring charge of $150,000 for severance pay
related to reorganization and downsizing of administrative personnel.
Depreciation and amortization expenses as a percentage of revenues were 3.0%
for Fiscal 2001 and Fiscal 2000.
The provision for store closings was $1,333,000 or 2.3% of revenues for
Fiscal 2001 as compared to $1,027,000 or 1.1% of revenues for Fiscal 2000.
These one-time charges, which consist primarily of real estate lease
obligations incurred or anticipated to complete lease terminations or
continuing costs while new tenants are located, related primarily to Shells
restaurants closed in the Midwest.
The provision for impaired assets was $2,259,000 or 3.9% of revenues for
Fiscal 2001 as compared to $3,978,000 or 4.4% of revenues for Fiscal 2000. In
the first and fourth quarters of Fiscal 2001 and the third quarter of Fiscal
2000, we recorded pre-tax charges relating to the write-down of impaired assets
to their estimated fair value in accordance with Financial Accounting Standards
Board Statement No. 144. We discontinued the operations of under-performing
units, including closing six units during each of the first and second quarters
of Fiscal 2001 and licensing an additional three units to others during the
second quarter of Fiscal 2001. The asset impairment charge in the first quarter
of Fiscal 2001 of $1,582,000 related to the closure or licensing of these
restaurants. The asset impairment charge in the fourth quarter of Fiscal 2001
of $677,000 related to four restaurants in Florida that were identified as
under-performing units. The asset impairment charge in Fiscal 2000 related to
eight restaurants, six in the Midwest and two in the Florida markets.
The Other Expense of $476,000 for Fiscal 2001 as compared to other income of
$145,000 for Fiscal 2000 was primarily attributable to the disposition of two
restaurants. In Fiscal 2001, a loss of $283,000 was recognized on the sale of a
restaurant site in Delray Beach, Florida and $156,000 for settlements of
various general liability claims. In Fiscal 2000, we recognized a $238,000 gain
on the disposition of our leasehold interest in the Western Hills, Ohio
restaurant.
A benefit from income taxes of $1,001,000 was recognized in Fiscal 2001
compared to a provision for income taxes of $2,304,000 for Fiscal 2000. The
$1,001,000 benefit related to the recognition of income tax refunds resulting
from the carry back of net operating losses, reflecting the recapture of taxes
paid as early as Fiscal 1996, as permitted under the Economic Stimulus Package
adopted March 2002. Of the tax benefit, Shells estimated $850,000 would be
refunded in Fiscal 2002; the refund of $1,176,000 was received in July 2002.
The $2,304,000 provision for income taxes in Fiscal 2000, despite the operating
losses, was due to the increase in the valuation allowance related to the
uncertainty of realizing certain tax assets.
19
As a result of the factors discussed above, our loss from operations
decreased by $2,696,000 to a loss from operations of $3,430,000 for Fiscal 2001
as compared with a loss from operations of $6,125,000 for Fiscal 2000.
Exclusive of non-recurring store closing and asset impairment charges of
$3,592,000 in Fiscal 2001 and $4,961,000 in Fiscal 2000, income from operations
for Fiscal 2001 was $414,000 and loss from operations for Fiscal 2000 was
$4,371,000.
The net loss for Fiscal 2001 was $3,019,000 as compared with a net loss of
$9,332,000 for Fiscal 2000. Exclusive of non-recurring items, net loss was
$481,000 in Fiscal 2001 compared to $2,875,000 in Fiscal 2000.
The results of the Fiscal years of 2001 and 2000 included non-recurring
charges of $2,538,000 and $6,457,000, respectively. Non-recurring charges in
Fiscal 2001 included the net effect of a $2,259,000 write down of impaired
assets to their estimated fair value, store closing and restructuring costs of
$1,585,000 and a loss recognized from the disposition of property of $283,000,
offset in-part by an increase in income tax refunds receivable of $1,001,000
and a $588,000 gain on debt forgiveness related to the conversion of debt to
preferred stock. Non-recurring charges in Fiscal 2000 included the net effect
of a $3,978,000 write down of impaired assets to their estimated fair value, a
deferred income tax charge of $1,734,000 and store closing costs of $983,000,
offset in-part by a $238,000 gain on the sale of property.
LIQUIDITY AND CAPITAL RESOURCES
The following table presents a summary of our cash flows for the last three
fiscal years (in thousands):
2002 2001 2000
------ ------- -------
Net cash provided by operating activities.......... $ 444 $ 780 $ 970
Net cash provided by (used in) investing activities 325 1,086 (1,774)
Net cash provided by (used in) financing activities 730 (2,158) (875)
------ ------- -------
Net increase (decrease) in cash.................... $1,499 $ (292) $(1,679)
====== ======= =======
As of December 29, 2002, our current liabilities of $6,313,000 exceeded our
current assets of $3,197,000, resulting in a working capital deficiency of
$3,116,000. In comparison, as of December 30, 2001, our working capital
deficiency was $7,580,000 from current liabilities of $10,068,000 exceeding
current assets of $2,488,000. Although our operating leverage has improved, we
may still encounter operating pressures from increasing seafood commodity costs
or additional restaurant disposition costs. Historically, we have generally
operated with minimal or marginally negative working capital as a result of the
investing of current assets into non-current property and equipment, as well as
the turnover of restaurant inventory relative to more favorable vendor terms in
accounts payable.
During Fiscal 2002, our cash position increased by $1,499,000. Net cash
provided by operating activities totaled $444,000 and cash provided by
investing activities was $325,000, which related to the disposition of one
restaurant site net of asset purchases. The net cash provided by financing
activities was $730,000, which resulted from $3,043,000 in borrowings
(consisting of the $2,000,000 private financing transaction, $667,000 from the
refinancing of a Florida property, and $377,000 in annually recurring insurance
financing arrangements) offset by $2,313,000 in debt repayments (consisting of
$842,000 from the sale and disposition of the Indianapolis, Indiana property,
$312,000 from the balloon payment of a mortgage on a Florida property, and
$1,159,000 for recurring loan and insurance financing payments).
Effective January 31, 2002, we raised $2,000,000 in a private financing
transaction, consisting of secured promissory notes and warrants to purchase
shares of our Common Stock. The two investors in this financing were Shells
Investment Partners, LLC and Banyon Investment, LLC. Shells Investment Partners
is an entity comprised of members previously unaffiliated with our company.
Banyon is an entity associated with Philip R. Chapman, Chairman of the Board,
and certain family members of Frederick R. Adler, a greater than 10%
stockholder. The proceeds of the financing will be used for working capital.
20
In connection with the financing, we issued to each of Shells Investment
Partners and Banyon (i) a $1,000,000 secured promissory note due January 31,
2005 which bears interest at 15% per annum, of which 8% is payable monthly in
arrears and 7% is deferred and payable when the principal is paid in full and
(ii) a warrant to purchase 4,454,015 shares of our common stock, at an exercise
price of $0.16 per share. The warrants are exercisable from January 31, 2003 to
January 31, 2005.
We had a $1,000,000 line of credit available until January 31, 2001, which
was re-extended to January 31, 2002, through Mr. Adler. As consideration for
granting a line of credit, the expiration date of certain then outstanding
warrants to purchase common stock held by Mr. Adler or related parties was
extended to January 31, 2002. In May 2001, the line of credit was withdrawn in
view of the closure of several restaurants and our restructuring of the
company, as well as our inability to supply security for any borrowing at that
time. Subsequently, the extended warrants were abandoned.
On March 9, 2002, the Economic Stimulus Package was signed into law. This
program allows for, among other initiatives, the lengthening of the carry back
period allowed for net operating losses from two years to five years. An income
tax refund of $1,176,000 was received in July 2002, relating to taxes paid in
Fiscal 1996 and Fiscal 1997.
During October 2002, we refinanced two of our restaurant locations,
Melbourne and Winter Haven, with notes of $635,000 and $667,000, respectively.
The loans, which bear interest at the bank's then base rate, are for terms of
five years with required annual principal payments based on a 15 year
amortization schedule, and a balloon payment of all then outstanding amounts
due at the end of the five years. The refinancing of the Winter Haven note
produced net funds to us of $375,000 after settlement of an existing mortgage.
These net funds were placed into segregated accounts, as inducement for
noteholder approval of the refinancing.
We believe that cash flows from operations, coupled with the funds available
from the January 31, 2002 financing transaction of $2,000,000, the income tax
refund received in July 2002, and the refinancing and sale of certain
properties, will be sufficient to satisfy our contemplated cash requirements
for at least 12 months. We may open a new restaurant or relocate an existing
restaurant in Fiscal 2003 depending on our ability to arrange additional third
party financing for the project.
We have, from time-to-time utilized, and to the extent applicable may
utilize real estate mortgage and restaurant equipment financing with various
banks or financing institutions as necessary. In the event that our plans
change, assumptions prove to be inaccurate, or due to unanticipated expenses,
and in the event projected cash flow or third party financing otherwise prove
to be insufficient to fund operations, we could be required to seek additional
financing from sources not currently anticipated. There can be no assurance
that third party financing will be available to us when needed, on acceptable
terms, or at all.
QUARTERLY FLUCTUATION OF FINANCIAL RESULTS
The restaurant industry in general is seasonal, depending on restaurant
location and the type of food served. We have experienced fluctuations in our
quarter-to-quarter operating results due, in large measure, to our high
concentration of restaurants in Florida (currently, all our restaurants are
located in Florida). Business in Florida is influenced by seasonality due to
various factors, which include but are not limited to weather conditions in
Florida relative to other areas of the U.S. and the health of Florida's economy
and the effect of world events in general and the tourism industry in
particular. Our restaurant sales are generally highest from January through
April and June through August, the peaks of the Florida tourism season, and
generally lower from September through mid-December. In many cases, locations
are in coastal cities, where sales are significantly dependent on tourism and
its seasonality patterns.
In addition, quarterly results have been substantially affected by the
timing of restaurant closings or openings. Because of the seasonality of our
business and the impact of restaurant closings, results for any quarter
21
are not generally indicative of the results that may be achieved for a full
fiscal year on an annualized basis and cannot be used to indicate financial
performance for the entire year.
IMPACT OF INFLATION AND PRICE CHANGES
We have not operated in a highly inflationary period and management does not
believe that inflation has had a material effect on sales or expenses. As
expenses increase, we expect to recover increased costs by increasing prices,
to the extent permitted by competition, or by modifying our menu and promoting
other less cost sensitive products. Many food products purchased by us are
affected by commodity pricing and are, therefore, subject to unpredictable
price volatility. Extreme changes in commodity prices and/or long-term changes
could affect us adversely. From time-to-time, competitive circumstances could
limit menu price flexibility, and in those cases margins would be negatively
impacted by increased commodity prices. Due to the fact that our business is
somewhat dependent on tourism in Florida, any significant decrease in tourism
due to inflation would likely have a material adverse effect on revenues and
profitability.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 141, "Accounting For Business Combinations," and Statement No.
142, "Goodwill And Other Intangible Assets." These Statements modify accounting
for business combinations after June 30, 2001. The Statements require that
goodwill existing at the date of adoption be reviewed for possible impairment
and that impairment tests be periodically repeated, with impaired assets
written-down to fair value. Additionally, existing goodwill and intangible
assets must be assessed and classified consistent with the Statements'
criteria. Intangible assets with estimated useful lives will continue to be
amortized over those periods. Amortization of goodwill and intangible assets
with indeterminate lives will cease. The adoption of Statements No. 141 and No.
142 is not expected to materially affect our consolidated financial statements.
In July 2001, the FASB issued Statement No. 143, "Accounting For Asset
Retirement Obligations." This Statement requires capitalizing any retirement
costs as part of the total cost of the related long-lived asset and
subsequently allocating the total expense to future periods using a systematic
and rational method. Adoption of this Statement is required for fiscal years
beginning after June 15, 2002. The adoption of Statement No. 143 is not
expected to materially affect our consolidated financial statements.
In October 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This Statement supersedes
Statement No. 121 but retains many of its fundamental provisions. Additionally,
this Statement expands the scope of discontinued operations to include more
disposal transactions. The provisions of this Statement are effective for
financial statements issued for fiscal years beginning after December 15, 2001.
The adoption of Statement No. 144 is not expected to materially affect our
consolidated financial statements.
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." The Statement updates, clarifies and simplifies existing
accounting pronouncements. Statement No. 145 rescinds Statement No. 4, which
required all gains and losses from extinguishment of debt to be aggregated and,
if material, classified as an extraordinary item, net of related income tax
effect. As a result, the criteria in Opinion 30 will now be used to classify
those gains and losses. Statement No. 64 amended Statement No. 4, and is no
longer necessary because Statement No. 4 has been rescinded. Statement No. 44
was issued to establish accounting requirements for the effects of transition
to the provisions of the Motor Carrier Act of 1980. Because the transition has
been completed, Statement No. 44 is no longer necessary. Statement No.145 also
amends Statement No. 13 to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions be accounted for in the
same manner as sale-leaseback transactions. This amendment is consistent with
the FASB's goal of requiring
22
similar accounting treatment for transactions that have similar economic
effects. Statement No. 145 also makes technical corrections to existing
pronouncements. The adoption of Statement No. 145 is not expected to materially
affect our consolidated financial statements.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities. " The Statement addresses costs
that are a result of exiting an activity, such as termination benefits, costs
to terminate a contract that is not a capital lease, and costs to consolidate
facilities or relocate employees. Under the Statement, a company may recognize
costs related to a restructuring only when the liability is incurred. Under
previous accounting principles generally accepted in the United States of
America, a liability for such costs was recognized on the date when a company
committed to an exit plan. The provisions of this statement are effective for
exits and disposal activities that are initiated after December 31, 2002. The
adoption of Statement No. 146 is not expected to materially affect our
consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others." Interpretation No. 45 supersedes
Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others," and provides guidance on the recognition and disclosures to be made by
a guarantor in its interim and annual financial statements about its
obligations under certain guarantees. The initial recognition and measurement
provisions of Interpretation No. 45 are effective for guarantees issued or
modified after December 31, 2002, and are to be applied prospectively. The
disclosure requirements are effective for financial statements for interim or
annual periods ending after December 15, 2002. The adoption of Interpretation
No. 45 is not expected to have a material affect on our consolidated financial
statements.
In November 2002, the FASB's Emerging Issues Task Force (EITF) discussed
Issue No. 02-16, "Accounting by a Reseller for Cash Consideration Received from
a Vendor." Issue No. 02-16 provides guidance on the recognition of cash
consideration received by a customer from a vendor. The consensus reached by
the EITF in November 2002 is effective for fiscal periods beginning after
December 15, 2002. Income statements for prior periods are required to be
reclassified to comply with the consensus. Adoption of the consensus reached in
November 2002 related to Issue No. 02-16 is not expected to materially impact
our consolidated financial statements.
In December 2002, the Company adopted FASB Statement No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure." Statement No. 148
amends Statement No. 123, "Accounting for Stock-Based Compensation," and
provides alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation.
Statement No. 148 also amends the disclosure requirements of Statement No. 123
to require more prominent and frequent disclosures in financial statements
about the effects of stock-based compensation. The transition guidance and
annual disclosure provisions of Statement No.148 are effective for financial
statements issued for fiscal years ending after December 15, 2002. The interim
disclosure provisions are effective for financial reports containing financial
statements for interim periods beginning after December 15, 2002. See Note 12
for disclosure under Statement No. 148.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on debt and
changes in commodity prices. Our exposure to interest rate risk relates to the
$1,286,000 in outstanding debt with banks that is based on variable rates.
Borrowings under the loan agreements bear interest at the rate equal to the
applicable bank's base rate.
23
ITEM 8. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report........................................................................ F-2
Consolidated Balance Sheets as of December 29, 2002 and December 30, 2001........................... F-3
Consolidated Statements of Operations for the years (52 weeks) ended December 29, 2002, December 30,
2001 and December 31, 2000........................................................................ F-4
Consolidated Statements of Stockholders' Equity for the years (52 weeks) ended December 29, 2002,
December 30, 2001 and December 31, 2000........................................................... F-5
Consolidated Statements of Cash Flows for the years (52 weeks) ended December 29, 2002, December 30,
2001 and December 31, 2000........................................................................ F-6
Notes to Consolidated Financial Statements.......................................................... F-8
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Shells Seafood Restaurants, Inc. and Subsidiaries
Tampa, Florida
We have audited the accompanying consolidated balance sheets of Shells
Seafood Restaurants, Inc. and Subsidiaries (the "Company") as of December 29,
2002 and December 30, 2001 and the related consolidated statements of
operations, stockholders' equity and cash flows for the fiscal years (52 weeks)
ended December 29, 2002, December 30, 2001 and December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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, such consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
at December 29, 2002 and December 30, 2001 and the results of its operations
and cash flows for the fiscal years (52 weeks) ended December 29, 2002,
December 30, 2001 and December 31, 2000 in conformity with accounting
principles generally accepted in the United States of America.
Kirkland, Russ, Murphy & Tapp P.A.
Clearwater, Florida
February 28, 2003
F-2
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 29, 2002 December 30, 2001
----------------- -----------------
ASSETS
Cash........................................................................ $ 2,468,809 $ 969,680
Inventories................................................................. 356,434 457,610
Other current assets........................................................ 266,228 84,465
Receivables from related parties............................................ 105,353 78,137
Deferred tax asset, net..................................................... -- --
Income tax refund receivable................................................ -- 898,338
------------ ------------
Total current assets........................................................ 3,196,824 2,488,230
Property and equipment, net................................................. 7,682,892 8,106,500
Property held for sale, net................................................. -- 1,022,060
Prepaid rent................................................................ 97,431 122,722
Other assets................................................................ 407,098 426,770
Goodwill.................................................................... 2,474,407 2,680,603
Deferred tax asset, net..................................................... -- --
------------ ------------
TOTAL ASSETS................................................................ $ 13,858,652 $ 14,846,885
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................................ $ 2,554,854 $ 4,079,396
Accrued expenses............................................................ 3,033,086 3,872,266
Sales tax payable........................................................... 191,853 207,913
Current portion of long-term debt........................................... 532,857 1,908,379
------------ ------------
Total current liabilities................................................ 6,312,650 10,067,954
Deferred rent............................................................... 1,082,761 1,243,057
Long-term debt, less current portion........................................ 1,760,054 1,633,073
Notes and deferred interest payable to related parties...................... 2,123,335 --
------------ ------------
Total liabilities........................................................ 11,278,800 12,944,084
Minority partner interest................................................... 427,852 427,642
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value; authorized 2,000,000 shares; 66,862 shares
issued and outstanding.................................................... 669 669
Common stock, $.01 par value; authorized 20,000,000 shares; 4,454,015
shares issued and outstanding............................................. 44,540 44,540
Additional paid-in-capital.................................................. 14,240,576 14,240,576
Accumulated deficit......................................................... (12,133,785) (12,810,626)
------------ ------------
Total stockholders' equity............................................... 2,152,000 1,475,159
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................. $ 13,858,652 $ 14,846,885
============ ============
See notes to consolidated financial statements and independent auditors' report.
F-3
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Years Ended
-------------------------------------
December 29, December 30, December 31,
2002 2001 2000
------------ ------------ ------------
REVENUES:.................................... $47,227,747 $57,529,015 $90,441,802
----------- ----------- -----------
COST AND EXPENSES:
Cost of sales............................. 15,777,572 21,238,497 33,984,212
Labor and other related expenses.......... 14,585,378 17,628,305 28,028,095
Other restaurant operating expenses....... 10,773,494 12,046,775 19,635,070
General and administrative expenses....... 3,564,828 4,751,248 7,212,051
Depreciation and amortization............. 1,102,221 1,701,518 2,702,630
Provision for store closings.............. -- 1,333,271 1,026,953
Provision for impairment of goodwill...... 206,196 -- --
Provision for impairment of assets........ 110,000 2,259,137 3,978,000
----------- ----------- -----------
46,119,689 60,958,751 96,567,011
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS................ 1,108,058 (3,429,736) (6,125,209)
----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest expense.......................... (569,928) (500,165) (977,329)
Interest income........................... 36,058 18,212 188,494
Gain on preferred stock conversion........ -- 588,386 --
Other (expense) income, net............... (2,743) (476,001) 145,857
----------- ----------- -----------
(536,613) (369,568) (642,978)
----------- ----------- -----------
INCOME (LOSS) BEFORE ELIMINATION OF MINORITY
PARTNER INTEREST AND INCOME TAXES.......... 571,445 (3,799,304) (6,768,187)
ELIMINATION OF MINORITY PARTNER INTEREST..... (221,319) (221,131) (259,428)
----------- ----------- -----------
INCOME (LOSS) BEFORE BENEFIT (PROVISION) FOR
INCOME TAXES............................... 350,126 (4,020,435) (7,027,615)
BENEFIT (PROVISION) FOR INCOME TAXES......... 326,715 1,001,415 (2,304,000)
----------- ----------- -----------
NET INCOME (LOSS)............................ $ 676,841 $(3,019,020) $(9,331,615)
=========== =========== ===========
BASIC NET INCOME (LOSS) PER SHARE OF COMMON
STOCK...................................... $ 0.15 $ (0.68) $ (2.10)
=========== =========== ===========
BASIC WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING................... 4,454,015 4,454,015 4,454,015
=========== =========== ===========
DILUTED NET INCOME (LOSS) PER SHARE OF COMMON
STOCK...................................... $ 0.07 $ (0.68) $ (2.10)
=========== =========== ===========
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING................... 10,259,188 4,454,015 4,454,015
=========== =========== ===========
See notes to consolidated financial statements and independent auditors' report.
F-4
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Preferred Stock Common Stock Additional Retained
--------------- ----------------- Paid-in Earnings
Shares Amount Shares Amount Capital (deficit) Total
------ ------ --------- ------- ----------- ------------ -----------
Balance at January 2, 2000.. 4,454,015 $44,540 $14,161,010 $ (459,991) $13,745,559
Net loss................. (9,331,615) (9,331,615)
--------- ------- ----------- ------------ -----------
Balance at December 31, 2000 4,454,015 44,540 14,161,010 (9,791,606) 4,413,944
Net loss................. (3,019,020) (3,019,020)
Issuance of preferred
stock.................. 66,862 $669 79,566 80,235
------ ---- --------- ------- ----------- ------------ -----------
Balance at December 30, 2001 66,862 669 4,454,015 44,540 14,240,576 (12,810,626) 1,475,159
Net income............... 676,841 676,841
------ ---- --------- ------- ----------- ------------ -----------
Balance at December 29, 2002 66,862 $669 4,454,015 $44,540 $14,240,576 $(12,133,785) $ 2,152,000
====== ==== ========= ======= =========== ============ ===========
See notes to consolidated financial statements and independent auditors' report.
F-5
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years Ended
----------------------------------------------------
December 29, 2002 December 30, 2001 December 31, 2000
----------------- ----------------- -----------------
OPERATING ACTIVITIES:
Net income (loss)....................................... $ 676,841 $(3,019,020) $(9,331,615)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization........................... 1,102,765 1,701,518 2,702,630
Provision for impairment of goodwill.................... 206,196 -- --
Provision for impairment of assets...................... 110,000 2,259,137 3,978,000
Loss (gain) on sale of assets........................... 6,956 279,743 (118,553)
Gain on preferred stock conversion...................... -- (588,386) --
Minority partner interest............................... 210 (21,369) (140,572)
Changes in assets and liabilities:
Decrease in inventories............................. 101,176 549,910 21,804
(Increase) decrease in receivables from related
parties........................................... (27,216) 118,018 (4,627)
(Increase) decrease in other assets................. (113,631) 392,290 348,161
Decrease (increase) in tax refunds
receivable........................................ 898,338 (898,338) --
Decrease in deferred tax assets..................... -- 855,000 2,304,000
Decrease in prepaid rent............................ 25,291 50,400 71,307
(Decrease) increase in accounts payable............. (1,524,542) 1,302,476 (309,684)
(Decrease) increase in accrued expenses............. (841,950) (1,512,352) 1,569,637
Decrease in sales tax payable....................... (16,060) (148,126) (113,022)
Decrease in deferred rent........................... (160,296) (540,937) (7,631)
----------- ----------- -----------
Total adjustments................................... (232,763) 3,798,984 10,301,450
----------- ----------- -----------
Net cash provided by operating activities............... 444,078 779,964 969,835
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INVESTING ACTIVITIES:
Proceeds from sale of assets............................ 1,091,324 2,892,146 251,383
Purchase of property and equipment...................... (766,772) (1,806,057) (2,025,742)
----------- ----------- -----------
Net cash provided by (used in) investing
activities............................................ 324,552 1,086,089 (1,774,359)
----------- ----------- -----------
FINANCING ACTIVITIES:
Proceeds from debt financing............................ 3,043,817 350,527 245,532
Repayment of debt....................................... (2,313,318) (2,508,837) (1,119,990)
----------- ----------- -----------
Net cash provided by (used in) financing
activities............................................ 730,499 (2,158,310) (874,458)
----------- ----------- -----------
Net increase (decrease) in cash......................... 1,499,129 (292,257) (1,678,982)
CASH AT BEGINNING OF PERIOD................................ 969,680 1,261,937 2,940,919
----------- ----------- -----------
CASH AT END OF PERIOD...................................... $ 2,468,809 $ 969,680 $ 1,261,937
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest.................................. $ 445,793 $ 451,028 $ 981,668
Cash (received) paid for income taxes, net.............. $(1,216,438) $ (941,299) $ 96,500
Note receivable on sale of assets....................... $ 100,000 $ -- $ --
See notes to consoli