Financial Statements Paper Part II

Financial Statements Paper Part II 1

Analyzing the company’s condition one has to utilize different tools such as those presented in the appendices, which shows that the company may have difficulty funding its proposed expansion program. Although management has outlined the available financing sources such as cash flows from operations, available cash on hand, and availability of credit facilities, these sources of financing, primarily the cash flows from operations, might be needed to pay the short term liabilities as they come due. Based on the company’s liquidity ratios, current assets are not sufficient in order to pay off current liabilities. Therefore, management needs to explore the additional financing options such as issuing long term debts and having additional equity.

Even though, these options may have negative consequences. Seeing that the cost of borrowing may be comparatively higher as the interest coverage ratio is extremely loweven if total debt are still less than half of total assets. Besides the additional borrowings could increase total debt’s percentage compared to total equity which could result to higher borrowing costs. The issuance of additional equity may not be approved by stockholders for this alternative could have a considerable impact on earnings per share, dividends per share and stock prices therefore if management fails to justify the expansion it will increase the shareholder wealth. In addition, the extra issuance of common stock for a financing source could possible is difficult at this timesince the company issued new stocks in 2002.

In simpler terms if the expansion takes place then the expected returns on the planned expansion should be comparatively higher than the company’s projected weighted average cost of capital.Therefore, management needs to analyze the working capital management policies and practices for areas that may need improvement. In looking at the long term financial feasibility of Landry’s to be promising their short term survivability must be guaranteed first. Therefore itwould be useless if the company has the money for expansion, but does not have enough cash to finance its operations.

The most intriguing part of the analysis is in Landry’s Restaurant’s management’s assessment of the financial condition of the company in which, its discussion on increased restaurant pre-operating expenses in 2003 from $4.6 million to $8.7 million. Management stated that the increase was recognizedby the increase in units opened 2003from those in 2002 that is 283 in 2003 and 267 in 2002. When computed in a per restaurant basis, the restaurant pre-operating expenses shows a considerable increase in which could not explained by the number of restaurants opened during the year which was not a significant increase. As shown in Appendix 3, the 2003 restaurant pre-operating expenses per restaurant opened is about $16 thousand while it was nearly $10 thousand in 2002. This represents a 60% increase per restaurant.

The significant increase in assets impairment increased by roughly 500% as shown in Appendix 2 which is shows an area of concern. According to Landry’s Restaurant’s management, this increase is due to the sales revenue and profitability deterioration of several restaurants as these restaurants’ deterioration are due to their market area and/or specific location. This is a concern not only because of its amount, but because of its implication in the operations of Landry’s as a whole. For example, since these restaurants’ market deteriorated and supposing that other restaurants of Landry serve the same market although in different locations, the operations and profitability of these other restaurants might also be affected. Therefore further disclosure needs to be addressed regarding the number of restaurants operating within the same market by Landry’s so that investors and other stakeholders can reasonably assess the future impact of this information.

The company’s management did not explain why several development projects were discarded in 2003 which resulted in the significant increase in other expenses for the year. The cost of abandonment of projects is based on the information provided within the annual report which estimated around $2 million. On the other hand, the entire cost of dropping these projects is greater than this especially if the total amount invested in these projects was taken into account.

Another weakness and concern that was not discussed by management is the revenues per employee. In the discussion on the increase in general and administrative expenses, management justified this by attributing the increase to the higher number of personnel necessary to run each expanded restaurant. However, management failed to rationalizethis increase in the number of employees by a corresponding with the increase in productivity as indicated by revenues per employee.

Another concern is that although management discussed the components of income individually and identified what components increased and decreased during the year, there was no further explanation on why net income, as a whole, decreased as a percentage of total revenues (see Appendix 3). In 2003, profit margin is 4.2% in 2002 it was 4.6% although in dollar amount the net income increased from $42 million to $46 million. This decrease in profit margin may have been due to several components such as unproductive pricing strategy and operations management for the restaurants. This can also be in inconsistency with management proclamation that its operations have not been significantly affected by inflation as the restaurants can always pass on increase in costs to menu prices. Therefore the increase in different direct costs to the restaurants such as cost of revenues, restaurant labor and other restaurant operating expenses must lower than the increase in revenues, but according to the trend analysis the revenues increased somewhat lower than the increase in the cost of revenues and restaurant labor.

Management did not discuss its plans on how to pay for its long-term debt. The careful analysis of the company’s statement of cash flows shows that the intended expansion and payment of the debt together could not be supported bythe company’s cash flows or by its operating activities.

In conclusion, management failed to discuss the different business and economic risks within the restaurant’s operating environment. Management even failed to discuss its perception of the company’s business environment in the near future which could have been done as it discussed the planned expansion. A simple discussion of what management requests to do in the future without a corresponding discussion on why it does, does not give sufficient information for stockholders to assess if continuing investing in the company’s business is the best course of action.

Appendix 1: Vertical Analysis

Vertical Analysis
2003 / 2002
Assets
Cash and cash equivalents / 3.19% / 1.49%
Accounts receivables - trade and other / 2.11% / 2.13%
Inventories / 4.33% / 4.38%
Deferred taxes / 0.62% / 0.67%
Other current assets / 0.68% / 1.26%
Total current assets / 10.94% / 9.93%
Property and equipment, net / 87.56% / 89.06%
Goodwill / 0.68% / 0.26%
Other assets / 0.82% / 0.75%
Total assets / 100.00% / 100.00%
Liabilities and Stockholders' Equity
Accounts payable / 7.52% / 7.69%
Accrued liabilities / 6.76% / 7.96%
Income taxes payable / 0.02% / 0.06%
Current portion of long-term notes and other obligations / 0.18% / 0.19%
Total current liabilities / 14.47% / 15.90%
Long-term notes, net of current portion / 27.18% / 20.30%
Deferred taxes / 2.12% / 1.24%
Other liabilities / 1.41% / 1.78%
Total liabilities / 45.18% / 39.22%
Commitments and Contingencies
Stockholders' Equity
Common stock / 0.03% / 0.03%
Additional paid-in capital / 39.86% / 47.30%
Deferred compensation / -0.17% / 0.00%
Retained earnings / 15.10% / 13.45%
Total stockholders' equity / 54.82% / 60.78%
Total liabilities and stockholders' equity / 100.00% / 100.00%
Vertical Analysis
2003 / 2002 / 2001
Revenues / 100.00% / 100.00% / 100.00%
Operating costs and expenses
Cost of revenues / 29.10% / 28.83% / 29.42%
Restaurant labor / 29.24% / 28.97% / 28.88%
Other restaurant operating expenses / 24.41% / 24.89% / 24.80%
General and administrative expenses / 4.68% / 4.85% / 5.09%
Depreciation and amortization / 4.42% / 4.52% / 4.65%
Asset impairment expenses / 1.19% / 0.25% / 0.32%
Restaurant pre-opening expenses / 0.78% / 0.51% / 0.35%
Total operating costs and expenses / 93.81% / 92.82% / 93.52%
Operating income / 6.19% / 7.18% / 6.48%
Other expenses
Interest expense, net / 0.86% / 0.56% / 1.26%
Other, net / 0.13% / -0.10% / -0.01%
1.00% / 0.46% / 1.25%
Income before income taxes / 5.19% / 6.73% / 5.23%
Provision for income taxes / 1.04% / 2.08% / 1.62%
Net income / 4.15% / 4.64% / 3.61%

Appendix 2: Trend Analysis

Trend Analysis
2003
Assets
Cash and cash equivalents / 153.72%
Accounts receivables - trade and other / 16.89%
Inventories / 16.86%
Deferred taxes / 10.13%
Other current assets / -36.38%
Total current assets / 30.14%
Property and equipment, net / 16.20%
Goodwill / 209.20%
Other assets / 30.04%
Total assets / 18.20%
Liabilities and Stockholders' Equity
Accounts payable / 15.53%
Accrued liabilities / 0.37%
Income taxes payable / -63.88%
Current portion of long-term notes and other obligations / 10.08%
Total current liabilities / 7.57%
Long-term notes, net of current portion / 58.25%
Deferred taxes / 102.73%
Other liabilities / -6.72%
Total liabilities / 36.15%
Commitments and Contingencies
Stockholders' Equity
Common stock / -0.42%
Additional paid-in capital / -0.39%
Deferred compensation / NA
Retained earnings / 32.73%
Total stockholders' equity / 6.61%
Total liabilities and stockholders' equity / 18.20%
Trend Analysis
2003 / 2002
Revenues / 23.58% / 19.84%
Operating costs and expenses
Cost of revenues / 24.75% / 17.42%
Restaurant labor / 24.72% / 20.19%
Other restaurant operating expenses / 21.21% / 20.26%
General and administrative expenses / 19.18% / 14.16%
Depreciation and amortization / 20.61% / 16.48%
Asset impairment expenses / 497.47% / -8.12%
Restaurant pre-opening expenses / 88.42% / 76.69%
Total operating costs and expenses / 24.90% / 18.94%
Operating income / 6.42% / 32.93%
Other expenses
Interest expense, net / 91.34% / -46.85%
Other, net / -264.94% / 1475.30%
168.20% / -56.02%
Income before income taxes / -4.63% / 54.24%
Provision for income taxes / -38.40% / 54.22%
Net income / 10.55% / 54.24%

Appendix 3: Ratio Analysis

Ratio Analysis
2003 / 2002 / 2001
Liquidity ratios
Current ratio / 0.76 / 0.62
Quick ratio / 0.46 / 0.35
Cash ratio / 0.22 / 0.09
Asset turnover ratios
Receivable turnover / 47.51 / 44.94
Average collection period / 7.68 / 8.12
Inventory turnover / 6.74 / 6.31
Inventory period / 54.19 / 57.85
Payable turnover / 3.88 / 3.60
Average payment period / 94.03 / 101.53
Financial leverage ratios
Debt ratio / 0.45 / 0.39
Debt-to-equity ratio / 0.82 / 0.65
Interest coverage / 7.00 / 13.04 / 5.15
Profitability ratios
Gross profit margin / 70.9% / 71.2% / 70.6%
Profit margin / 4.2% / 4.6% / 3.6%
Return on assets / 4.2% / 4.5%
Return on equity / 7.6% / 7.3%
EPS, basic / 1.66 / 1.60 / 1.24
EPS, diluted / 1.62 / 1.54 / 1.19
Stores opened / 287 / 267
Restaurant pre-opening expenses, per store / 15,996.42 / 9,731.43

Reference