Overpricing at Landry's -- Not the Menu!

According to his online bio, Tilman J. Fertitta, the Chairman and CEO of Landry’s Restaurants, Inc. (LNY-$28.12), is a prominent Houston entrepreneur who grew up peeling shrimp and waiting tables at his father’s surfside eatery in Galveston, Texas.

A partner in the first Landry’s Seafood House Restaurant, which opened in 1980 in Katy, Texas, Feritta has been instrumental in helping to grow the Company into an operator of 179 full-service, casual dining restaurants, which include the brand names of Rainforest Café, Saltgrass Steakhouse, The Crab House, Charley’s Crab, and The Chart House.

Feritta has helped to launch Landry’s as a major player in the Texas hospitality industry, too, with the Company’s master-planned redevelopment of Galveston’s Seawall Boulevard – which includes the 2004 opening of the Galveston Island Convention Center. Albeit, his personal fortune(s) rose with this development, too [more on that later!].

And, in 2005, Landry’s moved into the gaming business, acquiring the Golden Nugget Hotel & Casinos in Las Vegas and Laughlin.

Financials

Restaurant and hospitality revenues increased $71.1 million, or 8.5%, to $902.9 million for the year ended December 31, 2006. Including gaming revenue, Landry earned $29.5 million, or $1.39 per share, in income from continuing operations, on net sales of $1.1 billion.

Nonetheless, this growth came with a price. In fiscal 2006, the interest coverage ratio of 1.76 times operating income (before taxes) fell precipitously, down from 5.08 times in December 2004 (prior to Golden Nugget acquisition).

The 10Q Detective looked behind Landry’s ‘Sales & Share-net” headlines. For example, compared to fiscal 2005, income from continuing operations actually fell 2.6 percent, due to higher labor expenses (gaming employees) and higher net interest expenses (increase in borrowings).

Contrary to management’s expectations, the Golden Nugget casinos are not making up for slower organic growth from the restaurant business.

In 2007, Landry had to delay its fiscal 2006 10-K filing with the SEC because the regulatory agency was investigating prior stock-option granting practices.

In addition, when Landry's failed to file its 2006 annual report on time, bondholders claimed that Landry's violated its debt covenants by failing to file the required SEC reports in a timely manner—and they demanded immediate repayment.

An internal audit did not uncover any intentional wrongdoing by management, and the SEC declined against conducting a formal investigation.

Last month, Landry’s reached an agreement with the creditors, reinstating the $400 million in 7.5% senior notes with a new, higher interest rate of 9.5 percent. The settlement also required the Company to pay at least $1.6 million in legal fees incurred by or on behalf of the bondholders and a one-time $3 million "consent" fee to reinstate the bonds.

This new debt agreement burdens an already highly leveraged capital structure with an additional debt servicing of $8.0 million per annum (not including the $4.6 million in one-time fees).

As of June 30, 2007, long-term debt stood at 192.0% of shareholder-equity—not including contractual obligations of $105.5 million , $42.3 million, and $61.1 million from operating leases, purchases obligations, and other long term obligations, respectively, coming due in 2007 – 2009.

Landry’s has a junk bond credit rating, with its senior secured credit facility rated 'BB-' by S&P and that of the aforementioned $400 million (unsecured) senior notes due 2014 rated ‘CCC+.’

Corporate Governance

Too often, an executive compensation package that initially was designed to reward innovative decision-making and bold leadership, mutates with age—due to Board complacency—and no longer serves the long-term interests of the company, its shareholders and employees.

Sadly, the existing pay package of Fertitta is a glaring example of Board indifference.

The Company compensated Fertitta handsomely for a mediocre fiscal 2006. According to its recently filed Annual Proxy Statement, Fertitta earned $15.3 million in fiscal 2006. This amount included salary, cash bonus, and stock awards of $1.45 million, $1.58 million, and $11.4 million, respectively.

Two of the four independent directors have served on the Board for more than five years, signaling that with longevity comes acquiescence.

1. In fiscal 2006, Landry spent $130,500, $246,912, respectively, for the use of Company personnel and security services provided to Mr. Fertitta.
2. The Company also spent $70,897 of shareholder funds on (i) boat fees, (ii) membership fees and dues for country clubs, and (iii) tax preparation fees, estate planning and legal or financial advice for Fertitta.
3. Fertitta serves on numerous boards and charitable organizations. Fertitta’s Employment Agreement dictates that the Company issue contributions to charities of Mr. Fertitta’s choice of at least $500,000, as well as match Mr. Fertitta’s charitable contributions in an amount not to exceed $250,000 per year. [Fertitta gets the accolades—and shareholders foot the bill!]

Experience being our teacher, the 10Q Detective has uncovered many a majority shareholder treating their public company like a fiefdom.

Now, if the greenbacks don't stack large on my side of the yard
I ain't f-ckin with it
This cake has got to be all icing baby
Now I know I'm taking the biggest piece
but god damn I'm the biggest fish with the biggest mouth bitch
You wanna be rich right? (Hell yeah)
Well stick with me, do as I does, and be as I be

Fertitta, the beneficial owner of 34.6% of the outstanding common stock, worth an estimated $187.8 million (not including 675,000 stock options, with a current market value of $20.3 million, vesting in January 2013 – 2016.), has steered profitable deals to Fertitta Hospitality, a private business he owns with his wife:

• $7,500 a month in management fees;
• $567,000 in leasing fees to operate a waterfront site the for its Rainforest Cafe restaurant in Galveston; and,
• $50,000 in promotional events, training seminars and conferences held at Fertitta-owned resort hotel properties.

Greed, give me everything that I need

In addition, none of the aforementioned agreements were the result of arm’s-length negotiations!

I own a mansion and a yacht, haha
We do it like it should be does ~ Ice Cube (War & Peace Vol. 1: The War Disc Album, Greed)

Irrespective of future performance, Fertitta has a severance package worth approximately $56.5 million, which includes a tax gross-up of $20.7 million.

Of course, such a generous exit package awaits none of Landry’s non-executive workers.

Editor David J. Phillips does not hold a financial interest in Landry's Restaurants. The 10Q Detective has a Full Disclosure Policy.