SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Quarterly
Period Ended June 27, 2004
__ Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Transition
Period from __________to __________
Commission File No. 0-28258
SHELLS SEAFOOD RESTAURANTS, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 65-0427966
------------------------------ ------------------------------------
(State or other jurisdiction of (IRS) Employer Identification Number
incorporation or organization)
16313 North Dale Mabry Highway, Suite 100, Tampa, FL 33618
-----------------------------------------------------------
(Address of principal executive offices) (zip code)
(813) 961-0944
---------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes x No ____
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Class Outstanding at July 29, 2004
----------------------------- -----------------------------
Common stock, $0.01 par value 4,812,740
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
Index
Part I. Financial Information Page Number
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income (Unaudited) 4-5
Consolidated Statements of Cash Flows (Unaudited) 6-7
Consolidated Statement of Stockholders' Equity (Unaudited) 8
Notes to Consolidated Financial Statements - (Unaudited) 9-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Item 4. Controls and Procedures 17
Part II. Other Information 18-19
Signatures 20
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
------------------- -------------------
June 27, 2004 December 28, 2003
------------------- -------------------
ASSETS
Cash $ 1,053,119 $ 723,939
Inventories 402,777 382,549
Other current assets 607,271 265,891
Receivables from related parties 87,599 110,147
------------------- -------------------
Total current assets 2,150,766 1,482,526
Property and equipment, net 6,679,567 6,996,095
Other assets 620,805 663,189
Goodwill 2,474,407 2,474,407
------------------- -------------------
TOTAL ASSETS $ 11,925,545 $ 11,616,217
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 1,807,706 $ 2,390,685
Accrued expenses 2,352,825 2,295,290
Sales tax payable 197,998 168,385
Notes and deferred interest payable
to related parties (Note 4) 2,182,536 -
Current portion of long-term debt 273,979 234,247
------------------- -------------------
Total current liabilities 6,815,044 5,088,607
Deferred rent 895,154 1,053,531
Long-term debt, less current portion 1,639,991 1,558,245
Notes and deferred interest payable
to related parties (Note 4) - 2,267,416
------------------- -------------------
Total liabilities 9,350,189 9,967,799
Minority partner interest 473,173 465,836
------------------- -------------------
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value;
authorized 2,000,000 shares; 35,275
and 63,548 shares issued and
outstanding, respectively 353 635
Common stock, $.01 par value; authorized
20,000,000 shares; 4,812,740 and
4,631,375 shares issued and outstanding,
respectively 48,128 46,314
Additional paid-in-capital 14,318,419 14,303,151
Accumulated deficit (12,264,717) (13,167,518)
------------------- -------------------
Total stockholders' equity 2,102,183 1,182,582
------------------- -------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 11,925,545 $ 11,616,217
=================== ===================
See accompanying notes to consolidated financial statements.
3
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
13 Weeks Ended
--------------------------------------
June 27, 2004 June 29, 2003
------------------ ------------------
REVENUES $ 10,996,898 $ 11,901,337
------------------ ------------------
COST AND EXPENSES:
Cost of revenues 3,730,111 3,926,727
Labor and other related expenses 3,249,954 3,496,061
Other restaurant operating expenses 2,509,812 2,880,211
General and administrative expenses 866,163 874,015
Depreciation and amortization 282,593 263,293
------------------ ------------------
10,638,633 11,440,307
------------------ ------------------
INCOME FROM OPERATIONS 358,265 461,030
------------------ ------------------
OTHER INCOME (EXPENSE):
Interest expense (104,926) (118,843)
Interest income 889 3,531
Other income (expense), net 74,645 (31,585)
------------------ ------------------
(29,392) (146,897)
------------------ ------------------
INCOME BEFORE ELIMINATION OF MINORITY
PARTNER INTEREST AND INCOME TAXES 328,873 314,133
ELIMINATION OF MINORITY PARTNER INTEREST (70,722) (69,953)
------------------ ------------------
INCOME BEFORE PROVISION FOR INCOME TAXES 258,151 244,180
PROVISION FOR INCOME TAXES - -
------------------ ------------------
NET INCOME $ 258,151 $ 244,180
================== ==================
NET INCOME PER SHARE OF COMMON STOCK:
Basic $ 0.05 $ 0.05
================== ==================
Diluted $ 0.02 $ 0.02
================== ==================
AVERAGE WEIGHTED NUMBER OF COMMON SHARES
OUTSTANDING:
Basic 4,720,756 4,561,797
================== ==================
Diluted 10,445,374 11,466,292
================== ==================
See accompanying notes to consolidated financial statements.
4
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Continued)
26 Weeks Ended
--------------------------------------
June 27, 2004 June 29, 2003
------------------ ------------------
REVENUES $ 23,588,270 $ 24,913,322
------------------ ------------------
COST AND EXPENSES:
Cost of revenues 7,840,779 8,149,567
Labor and other related expenses 6,997,919 7,352,669
Other restaurant operating expenses 5,321,266 5,709,736
General and administrative expenses 1,659,557 1,713,754
Depreciation and amortization 578,786 524,086
------------------ ------------------
22,398,307 23,449,812
------------------ ------------------
INCOME FROM OPERATIONS 1,189,963 1,463,510
------------------ ------------------
OTHER INCOME (EXPENSE):
Interest expense (207,124) (245,665)
Interest income 2,194 8,145
Other income (expense), net 57,320 (53,370)
------------------ ------------------
(147,610) (290,890)
------------------ ------------------
INCOME BEFORE ELIMINATION OF MINORITY
PARTNER INTEREST AND INCOME TAXES 1,042,353 1,172,620
ELIMINATION OF MINORITY PARTNER INTEREST (139,522) (144,357)
------------------ ------------------
INCOME BEFORE PROVISION FOR INCOME TAXES 902,801 1,028,263
PROVISION FOR INCOME TAXES - -
------------------ ------------------
NET INCOME $ 902,801 $ 1,028,263
================== ==================
NET INCOME PER SHARE OF COMMON STOCK:
Basic $ 0.19 $ 0.23
================== ==================
Diluted $ 0.09 $ 0.09
================== ==================
AVERAGE WEIGHTED NUMBER OF COMMON SHARES
OUTSTANDING:
Basic 4,677,384 4,507,906
================== ==================
Diluted 10,618,336 11,413,529
================== ==================
See accompanying notes to consolidated financial statements.
5
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
26 Weeks Ended
------------------------------------
June 27, 2004 June 29, 2003
----------------- -----------------
OPERATING ACTIVITIES:
Net income $ 902,801 $ 1,028,263
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization 578,786 524,086
(Gain) loss on sale of assets (89,161) 2,352
Loss on sale of assets applied against reserves 24,776 -
Minority partner interest 7,337 31,647
Changes in current assets and
liabilities (658,456) (1,429,249)
Decrease in other assets 18,798 22,442
Changes in other liabilities:
Decrease in income taxes payable - (3,300)
Increase in accrued interest to
related parties - 70,998
Decrease in deferred rent (49,489) (21,391)
----------------- -----------------
Total adjustments (167,414) (802,415)
----------------- -----------------
Net cash provided by operating
activities 735,392 225,848
----------------- -----------------
INVESTING ACTIVITIES:
Proceeds from sale of assets 88,776 -
Purchase of property and equipment (467,951) (393,180)
----------------- -----------------
Net cash used in investing activities (379,175) (393,180)
----------------- -----------------
FINANCING ACTIVITIES:
Proceeds from debt financing 162,298 578,585
Repayment of debt (206,135) (626,616)
Proceeds from the issuance of stock 16,800 -
----------------- -----------------
Net cash used in financing activities (27,037) (48,031)
----------------- -----------------
Net increase (decrease) in cash 329,180 (215,363)
CASH AT BEGINNING OF PERIOD 723,939 2,468,809
----------------- -----------------
CASH AT END OF PERIOD $ 1,053,119 $ 2,253,446
================= =================
See accompanying notes to consolidated financial statements.
6
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Continued)
26 Weeks Ended
------------------------------------
June 27, 2004 June 29, 2003
----------------- -----------------
Cash flows (outflows) from changes in
current assets and liabilities:
Inventories $ (20,228) $ (40,810)
Receivables from related parties 22,548 975
Other current assets (341,381) (675,429)
Accounts payable (582,979) (460,098)
Accrued expenses 153,535 (299,950)
Sales tax payable 29,613 46,063
Increase in accrued interest to
related parties 80,435 -
----------------- -----------------
Change in current assets and
liabilities $ (658,456) $ (1,429,249)
================= =================
Supplemental disclosure of cash flow
information:
Cash paid for interest $ 122,336 $ 179,964
Non-cash operating and investing activities:
Accrued interest to related parties of $165,315 was refinanced through
a second mortgage in June 2004 and classified as long-term debt.
Insurance reserves of $96,000 have been applied to asset impairment
charges in June 2004.
Loss on sale of assets applied against reserves of $24,776 reduced
net book value of property and equipment by $19,062 and deferred
rent by $5,714 in June 2004.
Deferred rent of $114,602 was applied to gain in sale of restaurant in
April 2004.
Asset impairment charges of $110,000 were applied against gain on
sale of restaurant in April 2004.
Bonuses of $64,315 were paid in common stock during the second quarter
of 2003.
See accompanying notes to consolidated financial statements.
7
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
ADDITIONAL RETAINED
PREFERRED STOCK COMMON STOCK PAID-IN EARNINGS
Shares Amount Shares Amount CAPITAL (DEFICIT) TOTAL
--------- ---------- ---------- ---------- ------------ ------------ -------------
Balance at
December 28, 2003 63,548 $ 635 4,631,375 $ 46,314 $14,303,151 $(13,167,518) $1,182,582
Net income 902,801 902,801
Preferred stock converted
to common stock (28,273) (282) 141,365 1,414 (1,132) -
Stock options converted to
common stock 40,000 400 16,400 16,800
---------- ---------- ---------- ---------- ------------ ------------ -------------
Balance at June 27, 2004 35,275 $ 353 4,812,740 $ 48,128 $14,318,419 $(12,264,717) $2,102,183
========== ========== ========== ========== ============ ============ =============
See accompanying notes to consolidated financial statements.
8
SHELLS SEAFOOD RESTAURANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions for Form 10-Q and,
therefore, these statements do not include all of the information and
footnotes required by accounting principles generally accepted in the
United States of America for complete financial statements. In the
opinion of management, all material adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation
have been included.
The consolidated financial statements of Shells Seafood Restaurants,
Inc. (the "Company") should be read in conjunction with the audited
consolidated financial statements and notes thereto contained in the
Form 10-K for the year ended December 28, 2003 filed with the
Securities and Exchange Commission. Company management believes that
the disclosures are sufficient for interim financial reporting
purposes. Certain prior year amounts have been reclassified in the
accompanying condensed consolidated financial statements to conform
with the current year presentation.
NOTE 2. EARNINGS PER SHARE
The following table represents the computation of basic and diluted
earnings per share of common stock as required by Financial Accounting
Standards Board ("FASB") Statement No. 128, "Earnings Per Share":
13 Weeks Ended June 27, 2004 June 29, 2003
-------------------------------------
Net income applicable to common stock $ 258,151 $ 244,180
=====================================
Weighted common shares outstanding 4,720,756 4,561,797
Basic net income per share of common stock $ 0.05 $ 0.05
Effect of dilutive securities:
Warrants 5,690,683 6,450,642
Stock options 33,935 453,853
-------------------------------------
Diluted weighted common shares outstanding 10,445,374 11,466,292
-------------------------------------
Diluted net income per share of common stock $ 0.02 $ 0.02
=====================================
26 Weeks Ended June 27, 2004 June 29, 2003
-------------------------------------
Net income applicable to common stock $ 902,801 $ 1,028,263
=====================================
Weighted common shares outstanding 4,677,384 4,507,906
Basic net income per share of common stock $ 0.19 $ 0.23
Effect of dilutive securities:
Warrants 5,875,509 6,450,642
Stock options 65,443 454,981
-------------------------------------
Diluted weighted common shares outstanding 10,618,336 11,413,529
-------------------------------------
Diluted net income per share of common stock $ 0.09 $ 0.09
=====================================
The earnings per share calculations excluded warrants and options to
purchase an aggregate of 781,583 and 545,588 shares of common stock
during the 13 weeks ended June 27, 2004 and June 29, 2003,
respectively, and warrants and options to purchase an aggregate of
621,177 and 541,172 shares of common stock during the 26 weeks ended
June 27, 2004 and June 29, 2003, respectively, as the exercise price
of the warrants and options were greater than the average market price
of the common shares.
9
NOTE 3. STOCK COMPENSATION PLANS
At June 27, 2004, we have four stock-based employee compensation
plans. We account for these plans under the recognition and
measurement principles of Accounting Principles Board Opinion 25,
"Accounting for Stock Issued to Employees," and related
interpretations. No stock-based compensation cost is reflected in net
income, as all options granted under these plans had an exercise price
equal to the market value of the underlying common stock on the date
of grant. Had compensation cost for our stock option plans been
determined based on the fair value at the grant dates consistent with
recognition provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," the effect on net income and earnings per
share on a pro forma basis would have been immaterial.
NOTE 4. SUBSEQUENT EVENT
On August 4, 2004, our $2,000,000 aggregate principal amount of
secured promissory notes set to mature on January 31, 2005 were
extended to be due on January 31, 2007, under the same terms as the
original notes. As an inducement to extend the maturity date of the
notes, warrants to purchase 2,000,000 shares of Common Stock at an
exercise price of $0.50 per share were issued to the note holders in
proportion to the value of their respective notes. These newly issued
warrants are exercisable from January 31, 2005 through January 31,
2007. The Company recognized a one-time, non-cash charge of $446,000
relating to this transaction.
NOTE 5. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued a pronouncement, Financial
Interpretation Number 46 ("FIN 46"), "Consolidation of Variable
Interest Entities." This FIN deals with Off-Balance Sheet Assets,
Liabilities, and Obligations and gives guidance for determining which
entities should consolidate the respective assets and liabilities
associated with the obligations. Corporations must fully consolidate
assets and liabilities covered by FIN 46 in their Financial Statements
in the first fiscal year or interim period beginning after June 15,
2003. Full disclosure, as well as consolidation, if applicable, of any
newly created agreements after January 31, 2003 must begin
immediately. Adoption of FIN 46 did not materially impact our
consolidated financial statements.
In April 2003, the FASB issued Statement No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," This
Statement amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives)
and for hedging activities under FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities. This Statement is
effective for contracts entered into or modified after June 30, 2003,
and for hedging relationships designated after June 30, 2003. In
addition, all provisions of this Statement should be applied
prospectively. Adoption of FASB Statement 149 did not materially
impact our consolidated financial statements.
10
In May 2003, the FASB issued Statement No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities
and Equity." This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. Many of those
instruments were previously classified as equity. This Statement is
effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. Adoption of FASB
Statement No. 150 did not materially impact our consolidated financial
statements.
In December 2003, the FASB revised Statement No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" which
amended FASB Statements No. 87, 88, and 106. Statement No. 132
requires additional disclosures about the assets, obligations, cash
flows, and net periodic benefit cost of defined benefit pension plans
and other defined benefit post-retirement plans. The required
information should be provided separately for pension plans and for
other post-retirement benefit plans. Adoption of revised FASB
Statement No. 132 did not materially impact our consolidated financial
statements.
11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
During the second quarter of Fiscal 2004, we continued to take
significant steps aimed at updating the Shells concept and elevating
our customer service and restaurant-level execution. We revamped our
management and hourly training programs, and began retraining and
certifying our employees to drive service improvements. We continued
to refine the new menu which was rolled out during the first quarter
of fiscal 2004. The success of our new recruiting program helped
increase the caliber of our restaurant manager candidates. We also
introduced a new beverage program during the second quarter, resulting
in increased beverage alcohol sales.
The various improvements have been well received by customers, as
measured by our guest satisfaction survey system. Customer ratings for
service, food quality and cleanliness all improved during the second
quarter of fiscal 2004.
Sales trends continued to lag prior year levels as same store sales
declined 4.2% from the second quarter of 2003. We believe sales trends
continue to reflect customer perceptions of our restaurants' physical
environment, which we are working to update and enhance. We have
developed a new color, lighting and decor package which gives our
restaurants a much brighter and more contemporary atmosphere. During
the quarter, we completed the remodeling of our West Palm Beach
restaurant with the new design and held a grand reopening event in
May. Since remodeling, this restaurant has achieved increases in sales
and customer traffic relative to comparable chain-wide performance.
During July, we completed remodeling of a second restaurant, in
Redington Shores, marking the first restaurant in the Tampa area to
feature Shells' new look.
We believe that the ongoing enhancements to the Shells concept,
coupled with operational performance improvements, will provide a more
compelling dining experience. Our marketing is focused on attracting
new customers to experience these changes. During the quarter, we
initiated a marketing promotion of new menu offerings supported by
television and radio in select markets, and point of purchase
materials in all restaurants. We have also increased our direct
marketing efforts through the use of e-mail. Several of our units,
mostly in coastal areas, have enjoyed year-over-year sales
improvements as tourism continued to strengthen through the summer
months of 2004.
In January 2004, we closed an under-performing restaurant which was
sold in the second quarter of 2004 at a net gain of $89,000. In May,
we chose not to renew a costly lease and closed a second under-
performing store. A third restaurant was closed in August as the
lease expired and the building is set for demolition. The closure of
these units will reduce our overall sales going forward, but the net
affect to our net income and cash flow from operations is expected to
be favorable. Once we achieve desired levels of financial
performance, we will again look to increase our number of operating
restaurants.
There are no assurances that the implementation of our strategies will
result in sales and customer traffic gains which are required to meet
our contemplated cash flow requirements. If cash flow requirements
are not met, there are no assurances that financing options will be
available to us or that our business plan will not be significantly
hampered by our cash position.
On June 23, 2004, GCM Shells Seafood Partners, LLC and Trinad Capital,
LP purchased from Shells Investment Partners, LLC ("SIP") a $1,000,000
principal amount promissory note issued by Shells in January 2002, in
connection with our $2,000,000 financing. Deferred interest payable
to SIP of $165,000 was refinanced and secured by a mortgage on certain
real estate owned by us. The deferred interest owed to SIP is to be
repaid in 24 equal monthly payments commencing in June 2005. The
balance of the deferred interest owed to the other note holders has
been deferred until January 31, 2007.
12
On August 4, 2004, our $2,000,000 aggregate principal amount of
secured promissory notes set to mature on January 31, 2005 were
extended to be due on January 31, 2007, under the same terms as the
original notes. As an inducement to extend the maturity date of the
notes, warrants to purchase 2,000,000 shares of Common Stock at an
exercise price of $0.50 per share were issued to the note holders in
proportion to the value of their respective notes. These newly issued
warrants are exercisable from January 31, 2005 through January 31,
2007. The Company recognized a one-time, non-cash charge of $446,000
relating to this transaction.
The following table sets forth, for the periods indicated, the
percentages which the items in the Company's Consolidated Statements
of Income bear to total revenues.
13 Weeks Ended 26 Weeks Ended
--------------------------------- -------------------------------
June 27, 2004 June 29, 2003 June 27, 2004 June 29, 2003
----------------- --------------- --------------- ---------------
REVENUES 100.0% 100.0% 100.0% 100.0%
----------------- --------------- --------------- ---------------
COST AND EXPENSES:
Cost of revenues 33.9% 33.0% 33.2% 32.7%
Labor and other related expenses 29.6% 29.4% 29.7% 29.5%
Other restaurant operating expenses 22.8% 24.2% 22.6% 22.9%
----------------- --------------- --------------- ---------------
Total restaurant costs and expenses 86.3% 86.6% 85.5% 85.1%
----------------- --------------- --------------- ---------------
General and administrative expenses 7.9% 7.3% 7.0% 6.9%
Depreciation and amortization 2.6% 2.2% 2.5% 2.1%
----------------- --------------- --------------- ---------------
Income from operations 3.2% 3.9% 5.0% 5.9%
----------------- --------------- --------------- ---------------
Interest expense, net -0.9% -1.0% -0.9% -1.0%
Other expense, net 0.7% -0.3% 0.2% -0.2%
Elimination of minority partner interest -0.6% -0.6% -0.6% -0.6%
----------------- --------------- --------------- ---------------
Income before provision for taxes 2.4% 2.0% 3.7% 4.1%
Provision for income taxes 0.0% 0.0% 0.0% 0.0%
----------------- --------------- --------------- ---------------
Net income 2.4% 2.0% 3.7% 4.1%
================= =============== =============== ===============
RESULTS OF OPERATIONS
13 weeks ended June 27, 2004 and June 29, 2003
Revenues. Total revenues for the second quarter of 2004 were
$10,997,000 as compared to $11,901,000 for the second quarter of 2003.
The $904,000, or 7.6%, decrease in revenues was due to a 4.2% decrease
in comparable store sales and the closing of two restaurants during
the first half of 2004. Comparisons of same store sales include only
stores which were open 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.
Cost of revenues. The cost of revenues as a percentage of revenues
increased to 33.9% for the second quarter of 2004 from 33.0% for the
second quarter of 2003. This increase primarily related to increases
in dairy and chicken commodity prices, which are expected to remain
elevated in the near term. There was a non-recurring write-down of
inventory of $36,000 in the second quarter of 2003. Exclusive of the
non-recurring item, cost of revenues was 32.7% for the second quarter
of 2003. The Company is continually attempting to anticipate and
reacting to fluctuations in food costs by purchasing seafood directly
from numerous suppliers, promoting certain alternative menu selections
in response to price and availability of supply and adjusting its menu
prices accordingly to help control the cost of revenues.
13
Labor and other related expenses. Labor and other related expenses as
a percentage of revenues increased to 29.6% during the second quarter
of 2004 as compared to 29.4% for the second quarter of 2003. This
increase was due to increases in cleaning costs and benefits and taxes
compared to the prior year. The increase in cleaning costs resulted
from services being performed by our employees this year compared to
outsourcing last year. We benefited from second quarter non-recurring
reductions in benefits and taxes relating to workers compensation
insurance reserve reductions and corresponding refunds of $161,000 and
$197,000 in 2004 and 2003, respectively, of which $142,000 and
$182,000 were allocated to restaurant labor costs. Exclusive of the
non-recurring items, labor and other related expenses as a percentage
of revenues was 30.8% and 30.9% for the second quarters of 2004 and
2003, respectively.
Other restaurant operating expenses. Other restaurant operating
expenses as a percentage of revenues decreased to 22.8% for the second
quarter of 2004 as compared with 24.2% for the second quarter of 2003.
The decrease primarily was due to decreases in contract cleaning
services and repairs and maintenance.
General and administrative expenses. General and administrative
expenses were $866,000, or 7.9% as a percentage of revenues, for the
second quarter of 2004 compared to $874,000, or 7.3% as a percentage
of revenues, for the second quarter of 2003. There was a one-time
non-recurring charge for severance of $39,000 in the second quarter of
2004 for downsizing of administrative personnel. Exclusive of this
one-time charge, general and administrative expenses were 7.5% as a
percentage of revenues for the second quarter of 2004. Excluding the
one-time charge, the decrease in dollar expenditures was primarily due
to decreases in consulting fees.
Depreciation and amortization. Depreciation and amortization expense
as a percentage of revenues was 2.6% and 2.2% for the second quarters
of 2004 and 2003, respectively.
Interest expense, net. Interest expense was $104,000 in the second
quarter of 2004 compared to $115,000 in the second quarter of 2003.
The decrease was primarily related to the reduction of loan balances
outstanding.
Provision for income taxes. No provision or benefit for income taxes
was recognized for the second quarter of 2004 or 2003 based on annual
projected taxable income, as adjusted for net operating loss carry
forwards.
Income from operations and net income. As a result of the factors
discussed above, we had income from operations of $358,000 for the
second quarter of 2004 compared to $461,000 for the second quarter of
2003. Exclusive of non-recurring items noted above, income from
operations was $236,000 and $300,000 for the second quarters of 2004
and 2003, respectively. Shells had net income of $258,000 for the
second quarter of 2004 compared to $244,000 for the second quarter of
2003. Exclusive of nonrecurring charges, net income was $47,000 and
$83,000 for the second quarters of 2004 and 2003, respectively. A
non-recurring item affecting net income for the second quarter of 2004
included an $89,000 gain on the sale of property.
26 weeks ended June 27, 2004 and June 29, 2003
Revenues. Total revenues for the 26 weeks ended June 27, 2004 were
$23,588,000 as compared to $24,913,000 for the 26 weeks ended June 29,
2003. The $1,325,000, or 5.3%, decrease primarily was due to a
reduction in same store sales of 2.8% in addition to the closing of
two units in the first half of 2004.
Cost of revenues. The cost of revenues as a percentage of revenues
increased to 33.2% for the 26 weeks ended June 27, 2004 from 32.7% for
the comparable period in 2003. This increase primarily related to
increases in dairy and chicken commodity prices, which are expected to
remain elevated in the near term. There was a non-recurring write-
down of inventory of $36,000 in 2003. Exclusive of the non-recurring
item, cost of revenues was 32.6% for the 26 weeks ended June 29, 2003.
14
Labor and other related expenses. Labor and other related expenses
increased to 29.7% as a percentage of revenues for the 26 weeks ended
June 27, 2004 as compared to 29.5% for the same period in 2003. This
increase was due to increases in cleaning costs and benefits and taxes
compared to the prior year. The increase in cleaning costs resulted
from services being performed by our employees this year compared to
outsourcing last year. We benefited from second quarter non-recurring
reductions in benefits and taxes relating to workers compensation
insurance reserve reductions and corresponding refunds of $161,000 and
$197,000 in 2004 and 2003, respectively, of which $142,000 and
$182,000 were allocated to restaurant labor costs. Exclusive of the
non-recurring items, labor and other related expenses as a percentage
of revenues was 30.3% and 30.2% for the 26 weeks of 2004 and 2003,
respectively.
Other restaurant operating expenses. Other restaurant operating
expenses decreased to 22.6% as a percentage of revenues for the 26
weeks ended June 27, 2004 as compared with 22.9% for the same period
in 2003. The decrease primarily was due to decreases in contract
cleaning services and repairs and maintenance.
General and administrative expenses. General and administrative
expenses were $1,659,000, or 7.0% as a percentage of revenues, for the
26 weeks ended June 27, 2004 compared to $1,714,000, or 6.9% as a
percentage of revenues, for the same period in 2003. This decrease in
dollar expenditures was primarily due to decreases in consulting fees.
A non-recurring charge of $39,000 for severance pay occurred in 2004.
Exclusive of this non-recurring item, general and administrative
expenses were 6.9% as a percentage of revenues for the first six
months of 2004.
Depreciation and amortization. Depreciation and amortization expenses
as a percentage of revenues was 2.5% for the 26 weeks ended June 27,
2004 compared to 2.1% for the prior year.
Interest expense, net. Interest expense was $205,000 in the 26 weeks
ending June 27, 2004 compared to $238,000 in the same period of 2003.
The decrease was primarily related to the reduction of loan balances
outstanding.
Income from operations and net income. As a result of the factors
discussed above, the Company's income from operations was $1,190,000
for the 26 weeks ended June 27, 2004 compared to $1,464,000 for the
same period in 2003. Exclusive of non-recurring items noted above,
the Company's income from operations was $1,068,000 and $1,303,000 for
the 26 weeks ended June 27, 2004 and June 29, 2003, respectively. The
Company's net income for the 26 weeks ended June 27, 2004 was $903,000
compared to $1,028,000 in the same period in 2003. Exclusive of non-
recurring items, the Company's net income was $692,000 and $867,000
for the 26 weeks ended June 27, 2004 and June 29, 2003, respectively.
A non-recurring item affecting net income for the 26 weeks ended June
27, 2004 included an $89,000 gain on the sale of property.
LIQUIDITY AND CAPITAL RESOURCES
On August 4, 2004, our $2,000,000 aggregate principal amount of
secured promissory notes set to mature on January 31, 2005 were
extended to be due on January 31, 2007, under the same terms as the
original notes. As an inducement to extend the maturity date of the
notes, warrants to purchase 2,000,000 shares of Common Stock at an
exercise price of $0.50 per share were issued to the note holders in
proportion to the value of their respective notes. These newly issued
warrants are exercisable from January 31, 2005 through January 31,
2007. The Company recognized a one-time, non-cash charge of $446,000
relating to this transaction.
15
On June 23, 2004, GCM Shells Seafood Partners, LLC and Trinad Capital,
LP purchased from Shells Investment Partners, LLC ("SIP") a $1,000,000
principal amount promissory note issued by Shells in January 2002, in
connection with our $2,000,000 financing. Deferred interest payable
to SIP of $165,000 was refinanced and secured by a mortgage on certain
real estate owned by us. The deferred interest owed to SIP is to be
repaid in 24 equal monthly payments commencing in June 2005. The
balance of the deferred interest owed to the other note holders has
been deferred until January 31, 2007.
As of June 27, 2004, the Company's current liabilities of $6,815,000
exceeded its current assets of $2,151,000, resulting in a working
capital deficiency of $4,664,000. In comparison, the December 28,
2003 working capital deficiency was $3,606,000. The increase in the
working capital deficiency primarily related to the reclassification
of the $2,000,000 debt, originally maturing January 31, 2005, as
current debt. Subsequent to second quarter of 2004 end, the
$2,000,000 debt was refinanced and now matures on January 31, 2007.
Our operating leverage has decreased. We may still encounter
operating pressures from declining sales, increasing food, labor or
other operating costs or additional restaurant disposition costs.
Historically, we have generally operated with minimal or negative
working capital as a result of the investment 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.
Cash provided by operating activities for the 26 weeks ended June 27,
2004 was $735,000 compared to $226,000 for the comparable period in
2003. The net increase of $509,000 compared to the same period in
2003 primarily related to favorable variances in other current assets
associated with a reduction in prepaid insurance, the timing of
payments for accounts payable, accrued expenses relating to payroll
and bonuses and a gain on the sale of assets, partially offset by a
decrease in net income.
The cash used in investing activities was $379,000 for the 26 weeks
ended June 27, 2004 compared to $393,000 for the same period in 2003;
or a net decrease of $14,000. Proceeds from the sale of assets of
$89,000 related to the sale of a restaurant location in the second
quarter of 2004, which discontinued operations in the first quarter of
2004. The increase in capital expenditures to $468,000 for the 26
weeks ended June 27, 2004 compared to $393,000 for the same period in
2003, primarily related to restaurant remodelings.
The cash used in financing activities was $27,000 for the 26 weeks
ended June 27, 2004 compared to $48,000 for the comparable period in
2003. The net decrease of $21,000 primarily related to a change in
how we acquire and finance insurance, partially offset by a reduction
in required debt payments and proceeds from the exercise of common
stock options. In 2004, the annual premium for general liability and
property insurance is being paid ratably throughout the year, as
compared to 2003 when the annual premium was financed as a lump sum at
the beginning of the year.
During October 2002, we refinanced through Colonial Bank two of our
restaurant locations, Melbourne and Winter Haven, with notes of
$635,000 and $667,000, respectively. The principal balances owed on
these two notes as of June 27, 2004 were $559,000 and $593,000,
respectively. Relative to these two promissory notes, we are
required to meet a financial covenant relating to debt coverage. As
of June 27, 2004, we were not in compliance in meeting this loan
covenant. We received a loan covenant waiver from Colonial Bank,
which is to be applied through the second quarter of Fiscal 2004.
There can be no assurances that Colonial Bank will continue to provide
us with a waiver to the extent we do not meet our financial covenants.
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 expenses
are higher than anticipated, and in the event projected cash flow
proves to be insufficient to fund operations, we could be required to
seek additional third party financing. In addition, remodeling our
restaurants chain-wide would require significant capital investment.
There can be no assurance that third party financing will be available
to us when needed, on acceptable terms, or at all.
16
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 full concentration of restaurants 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. Many of our restaurant 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 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.
Item 3. 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 $1,152,000 in outstanding debt with banks that is based
on variable rates. Borrowings under these loan agreements bear
interest at the rate equal to the applicable bank's base rate.
Item 4. Controls and Procedures
We maintain "disclosure controls and procedures," as such term is
defined under Securities Exchange Act Rule 13a-15(e), that are
designed to ensure that information required to be disclosed in our
Exchange Act reports is recorded, processed, summarized, and reported
within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosures. In designing and evaluating the disclosure controls and
procedures, our management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives and
our management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and
procedures. As required by SEC Rule 13a-15(b), we have carried out an
evaluation, as of the end of the period covered by this report, under
the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of our disclosure
controls and procedures. Based upon their evaluation and subject to
the foregoing, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective
in ensuring that material information relating to Shells is made known
to the Chief Executive Officer and Chief Financial Officer by others
within our company during the period in which this report was being
prepared.
There were no changes in our internal controls over financial
reporting that occurred during our most recent fiscal quarter that
have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
17
Part II. OTHER INFORMATION
Item 1. 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. We are continuing to take steps to vigorously
pursue collection of this judgment.
On May 24, 2004, we received a notice from the Equal Employment
Opportunity Commission (EEOC) that a former employee in a Ft.
Lauderdale Shells restaurant had filed a charge of discrimination with
the EEOC. Shells terminated the employment of this person in May
2004. Specifically, this former employee claimed race and national
origin discrimination under Title VII of the Civil Rights Act of 1964.
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 and may be a
party to various 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 2. Changes in Securities and Use of Proceeds
During April 2004, a former employee acquired 20,000 shares of
Common Stock by exercising stock options, resulting in net proceeds to
the Company of $8,400. The proceeds were used for working capital
requirements.
During June 2004, an accredited investor converted 28,273 shares
of Preferred Stock into 141,365 shares of Common Stock. There were no
proceeds to the Company for this transaction.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders held on May 5,
2004, the following directors were elected by the votes indicated:
Philip R. Chapman: 4,235,592 For, 14,400 Against or Withheld, 0 Abstaining
J. Stephen Gardner:4,235,592 For, 14,400 Against or Withheld, 0 Abstaining
John N. Giordano: 4,235,592 For, 14,400 Against or Withheld, 0 Abstaining
Michael R. Golding: 4,235,092 For, 14,900 Against or Withheld, 0 Abstaining
Christopher D. Illick: 4,235,592 For, 14,400 Against or Withheld,0 Abstaining
Thomas R. Newkirk: 4,235,592 For, 14,400 Against or Withheld, 0 Abstaining
18
Item 5. Other Information
On July 29, 2004, the Board of Directors appointed our President
and Chief Executive Officer, Leslie J. Christon, as a seventh board
member. Additionally, the Board of Directors rescinded the status of
William Hattaway and George Heaton as Board Observers.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer under Rule 13a-14(a)
31.2 Certification of Chief Financial Officer under Rule 13a-14(a)
32.1 Certification of Chief Executive Officer and
Chief Financial Officer under Section 906
(b) Current reports on Form 8-K filed during the fiscal quarter
ended June 27, 2004:
The Company filed a current report on Form 8-K, Items 1 and 7, on
April 27, 2004 announcing that Frederick R. Adler purchased a
$1,000,000 promissory note issued by the Company to Banyon
Investments, LLC on January 31, 2002.
The Company filed a current report on Form 8-K, Item 12, regarding
a press release on April 30, 2004 announcing operating results for
the quarter ended March 28, 2004.
The Company filed a current report on Form 8-K, Item 5, regarding
a press release on May 19, 2004 announcing the grand reopening of
the West Palm Beach location.
The Company filed a current report on Form 8-K, Items 1 and 7, on
June 23, 2004 announcing that GCM Shells Seafood Partners, LLC and
Trinad Capital, LP purchased a $1,000,000 promissory note issued
by the Company to Shells Investment Partners, LLC on January 31,
2002.
The Company filed a current report on Form 8-K, Item 12, regarding
a press release on July 23, 2004 announcing operating results for
the quarter ended June 27, 2004.
The Company filed a current report on Form 8-K, Items 5 and 7,
regarding a press release on August 4, 2004 announcing the
extension of the secured senior notes and the appointment
of Leslie J. Christon to the Board of Directors.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SHELLS SEAFOOD RESTAURANTS, INC.
(Registrant)
/s/ Leslie J. Christon
President and Chief Executive Officer
August 11, 2004
/s/ Warren R. Nelson
Executive Vice President and Chief Financial Officer
August 11, 2004
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