<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
Commission File Number: 0-27008
SCHLOTZSKY'S, INC.
(Exact name of registrant as specified in its charter)
Texas 74-2654208
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
203 Colorado Street
Austin, Texas 78701
(address of principal executive offices)
(512) 236-3600
(Registrant's telephone number)
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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Shares Outstanding at November 1, 1998
Common Stock, no par value 7,391,942
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<PAGE>
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C> <C>
Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheets --
September 30, 1998 and December 31, 1997 2
Condensed Consolidated Statements of
Income -- Three and Nine Months Ended
September 30, 1998 and September 30, 1997 3
Condensed Consolidated Statements of
Stockholders' Equity -- Nine Months Ended
September 30, 1998 and the year ended December 31, 1997 4
Condensed Consolidated Statements of
Cash Flows -- Nine Months Ended
September 30, 1998 and September 30, 1997 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities 14
Item 3. Defaults Upon Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 15
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 6,139,428 $ 31,254,048
Temporary cash investments 1,439,077 18,000
Receivable from sales of Turnkey Program development 3,646,307 6,054,337
Royalties receivable 1,052,152 809,125
Other receivables 2,761,085 2,005,760
Prepaid expenses and other assets 684,741 584,510
Turnkey Program development 12,619,451 6,950,595
Mortgage notes receivable, current portion 125,383 - -
Notes receivable, current portion 11,596,445 2,574,588
Notes receivable from related parties, current portion 185,808 50,000
------------ ------------
Total current assets 40,250,077 50,300,963
Property, equipment and leasehold improvements, net 18,925,511 9,998,630
Real estate held for sale 843,982 1,063,592
Mortgage notes receivable, less current portion 6,933,744 - -
Notes receivable, less current portion 1,481,222 1,972,470
Notes receivable from related parties, less current portion 2,455,687 2,565,399
Investments and advances 1,334,714 1,456,790
Deferred federal income tax asset 590,376 580,460
Intangible assets, net 12,339,724 11,113,213
Other noncurrent assets 469,069 469,069
------------ ------------
Total assets $ 85,624,106 $ 79,520,586
------------ ------------
------------ ------------
Liabilities and Stockholder's Equity
Current liabilities:
Current maturities of long-term debt $ 406,127 $ 250,625
Accounts payable 2,701,434 6,002,920
Income tax payable 660,318 27,473
Accrued liabilities 1,882,638 1,457,242
------------ ------------
Total current liabilities 5,650,517 7,738,260
Deferred revenue, net 1,731,940 2,855,380
Long-term debt, less current maturities 6,236,753 1,936,387
------------ ------------
Total liabilities 13,619,210 12,530,027
Commitments and contingencies
Stockholders' equity:
Preferred stock:
Class C--no par value; authorized--1,000,000 shares; issued--none
Common stock, no par value, 30,000,000 shares authorized, 7,334,416
and 7,401,942 issued at December 31, 1997 and
September 30, 1998, respectively 62,877 62,202
Additional paid-in capital 57,288,040 56,664,104
Retained earnings 14,758,979 10,264,253
Treasury stock (10,000 shares) (105,000) - -
------------ ------------
Total stockholders' equity 72,004,896 66,990,559
------------ ------------
Total liabilities and stockholders' equity $ 85,624,106 $ 79,520,586
------------ ------------
------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
2
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues
Royalties $ 4,874,853 $ 3,819,957 $ 13,853,409 $ 10,703,264
Franchise fees 340,000 410,835 1,060,000 1,003,335
Developer fees - - - - - - 125,000
Restaurant sales 1,744,790 1,636,335 5,245,698 4,398,625
Brand contribution 1,052,341 790,477 2,918,227 2,132,301
Turnkey development 2,844,877 1,374,288 5,702,355 2,822,056
Other fees and revenue 206,886 312,271 1,051,373 834,649
------------ ------------ ------------ ------------
Total revenues 11,063,747 8,344,163 29,831,062 22,019,230
Expenses
Service Costs:
Royalties 1,861,054 1,397,352 5,281,567 3,905,309
Franchise fees 167,500 218,750 542,000 531,250
Restaurant Operations:
Cost of sales 581,908 538,541 1,717,234 1,379,416
Labor cost 728,128 642,884 2,244,545 1,731,264
Operating expenses 484,068 549,311 1,526,853 1,399,854
General and administrative 4,711,312 2,789,509 11,487,325 7,218,862
Depreciation and amortization 517,935 268,770 1,281,324 782,710
------------ ------------ ------------ ------------
Total expenses 9,051,905 6,405,117 24,080,848 16,948,665
------------ ------------ ------------ ------------
Income from operations 2,011,842 1,939,046 5,750,214 5,070,565
Other
Interest income, net 519,829 88,632 1,441,347 284,148
------------ ------------ ------------ ------------
Income before income taxes 2,531,671 2,027,678 7,191,561 5,354,713
Provision for federal and state income taxes 949,579 793,010 2,696,835 2,069,656
------------ ------------ ------------ ------------
Net Income $ 1,582,092 $ 1,234,668 $ 4,494,726 $ 3,285,057
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Income per common share - basic:
Income per common share $ 0.21 $ 0.22 $ 0.61 $ 0.59
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average shares outstanding 7,400,417 5,589,138 7,380,388 5,559,629
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Income per common share - diluted:
Income per common share $ 0.21 $ 0.21 $ 0.59 $ 0.57
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average shares outstanding 7,560,876 5,888,774 7,593,529 5,769,633
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock
------------------------
Stated Additional Total
Number of Capital Paid-In Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
--------- ----------- ----------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 5,539,922 $ 44,257 $26,493,165 $ 5,774,599 $ - - $ 32,312,021
Public sale of stock 1,731,825 17,318 29,615,201 - - - - 29,632,519
Options exercised 57,201 572 485,802 40,239 - - 526,613
Warrants exercised 5,468 55 69,936 - - - - 69,991
Net income - - - - - - 4,449,415 - - 4,449,415
--------- ----------- ----------- ------------ --------- -------------
Balance, December 31, 1997 7,334,416 62,202 56,664,104 10,264,253 - - 66,990,559
Options exercised 44,089 441 399,175 - - - - 399,616
Warrants exercised 23,437 234 224,761 - - - - 224,995
Treasury stock purchase
(10,000 shares) - - - - - - - - (105,000) (105,000)
Net income - - - - - - 4,494,726 - - 4,494,726
--------- ----------- ----------- ------------ --------- ------------
Balance, September 30, 1998 7,401,942 $ 62,877 $57,288,040 $ 14,758,979 $(105,000) $ 72,004,896
--------- ----------- ----------- ------------ --------- ------------
--------- ----------- ----------- ------------ --------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------ ------------
<S> <C> <C>
Cash flows provided by/(used for) operating activities $(19,468,404) $ 9,439,910
Cash flows from investing activities:
Issuance of notes receivable (less payments) (2,016,966) (1,506,070)
Acquisition of intangibles (1,665,471) (2,773,932)
Purchase of property, equipment and leasehold improvements (9,578,092) (2,881,203)
Purchase of temporary investments (1,421,077) - -
Other (79,020) (226,019)
------------ ------------
Net cash used for investing activities (10,726,694) (7,387,224)
Cash flows from financing activities:
Proceeds from issuance of long term debt 4,700,000 1,112,710
Principal payments on long term debt (244,132) (2,336,802)
Proceeds from exercises of options and warrants 624,611 365,379
Proceeds from sale of common stock - - 25,890,705
------------ ------------
Net cash provided by financing activities 5,080,478 25,031,992
------------ ------------
Net increase/(decrease) in cash and cash equivalents (25,114,620) 27,084,678
Cash and cash equivalents at beginning of period 31,254,048 5,638,958
------------ ------------
Cash and cash equivalents at end of period $ 6,139,428 $ 32,723,636
------------ ------------
------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THE CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998
NOTE 1. -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the nine months ended September 30, 1998,
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1998. This information should be read in connection with the
consolidated financial statements and footnotes thereto incorporated by
reference in the Schlotzsky's, Inc. Annual Report on Form 10-K/A for the year
ended December 31, 1997.
NOTE 2. -- SIGNIFICANT ACCOUNTING POLICIES
EARNINGS PER SHARE
In March 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 supersedes Accounting Principles Board ("APB") Opinion No.
15, "Earnings Per Share", and changes the computation of earnings per share
("EPS") by replacing the "primary" EPS requirements of APB 15 with a "basic" EPS
computation based upon weighted average shares outstanding. It also requires
dual representation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures. SFAS No. 128 is effective for
financial statements issued for periods ending after December 15, 1997, thus the
Company has adopted SFAS No. 128 for the year ended December 31, 1997.
Previously reported EPS have been restated to conform to SFAS No. 128.
Basic and diluted EPS computations for the three and nine months ended
September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-----------------------------------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
BASIC EPS
Net income available to common stockholders $ 1,582,092 $ 1,234,668 $ 4,494,726 $ 3,285,057
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
Weighted average common shares outstanding 7,400,417 5,589,138 7,380,388 5,559,629
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
Basic EPS $ 0.21 $ 0.22 $ 0.61 $ 0.59
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
DILUTED EPS
Net income available to common stockholders $ 1,582,092 $ 1,234,668 $ 4,494,726 $ 3,285,057
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
Weighted average common shares outstanding 7,400,417 5,589,138 7,380,388 5,559,629
Assumed conversion of common shares issuable
under stock option plan and exercise of warrants 160,459 299,636 213,141 210,004
------------ ------------- ------------ ------------
Weighted average common and common
equivalent shares outstanding 7,560,876 5,888,774 7,593,529 5,769,633
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
Diluted EPS $ 0.21 $ 0.21 $ 0.59 $ 0.57
------------ ------------- ------------ ------------
------------ ------------- ------------ ------------
</TABLE>
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
REVENUES. Total revenues increased 32.6% from $8,343,000 to $11,064,000.
Royalties increased 27.6% from $3,820,000 to $4,875,000. This increase
was due to the opening of 127 restaurants during the period from October 1, 1997
to September 30, 1998. Also driving the increase was the growing influence of
larger freestanding units, particularly the prototype units, which are the focus
of the new unit development. Furthermore, average weekly sales increased 11.8%
and same store sales increased 3.0% during the third quarter of 1998.
Franchise fees decreased 17.3% from $411,000 to $340,000. This decrease
was principally a result of fewer store openings and lower average franchise
fees per unit opened during the three-month period ended September 30, 1998.
However, both primary and secondary fee structures were increased during the
quarter, so it is not contemplated that this will recur during the next
twelve months. A higher number of secondary restaurants, which have a lower
franchise fee, were opened during the third quarter of 1998 than during the
corresponding period in 1997.
Restaurant sales increased 6.7% from $1,636,000 to $1,745,000. This
increase was principally attributable to the relocation and upgrade of two
Company-owned units in the Austin, Texas market, which were temporarily
closed, during the third quarter of 1997.
Brand contributions, or private label licensing fees, increased 33.2%
from $790,000 to $1,052,000. The increase was principally the result of the
increasing volume of system-wide sales, which generated more purchases of
private label products, and greater franchisee participation in the Company's
purchasing programs.
Turnkey development revenue increased 107.1% from $1,374,000 to $2,845,000.
The termination of guaranties on thirteen sites sold in previous periods
resulted in the recognition of approximately $1,377,000 of revenue in the
current quarter. The Company purchased these sites from one of the real estate
investment trusts which had acquired them during prior periods. Five of these
stores were subsequently resold for no material gain or loss to franchisees
through the Company's mortgage program. It is contemplated that most of these
mortgages will be marketed to financial institutions. Most of the remaining
stores will be resold to franchisees during the next six months. Revenues from
sales of sites developed under the Turnkey Program, assignments of earnest money
contracts and consulting services comprise the balance of Turnkey development
revenue generated during the quarter and none of these sites included any credit
enhancement from the Company.
7
<PAGE>
The following table reflects the growth of the franchise system for the
three months ended September 30, 1998 and 1997, which has been principally
responsible for the increased revenue as discussed above.
<TABLE>
<CAPTION>
SYSTEM PERFORMANCE THREE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
<C> <C> <C>
Units Opened
Domestic
Freestanding 23 19
End Cap 1 4
Other - - 4
------------- -------------
Total Domestic Openings 24 27
International - - 1
------------- -------------
Total Openings 24 28
Units Closed (10) (4)
------------- -------------
Net Unit Growth 14 24
------------- -------------
------------- -------------
System-wide Sales (in thousands) $ 90,023 $ 70,457
Average Weekly Sales $ 10,011 $ 8,958
Increase in Average Weekly Sales 11.8% 10.2%
Stores in Operation 736 636
Increase in Same Store Sales 3.0% 4.6%
</TABLE>
COSTS AND EXPENSES. Royalty service costs increased 33.2% from
$1,397,000 to $1,861,000. This increase was a result of the increase in royalty
revenue for the three months ended September 30, 1998, as compared to the same
period in the prior year. Royalty service costs as a percentage of royalties
grew from 36.6% to 38.2%. This increase reflected the growing percentage of
stores serviced by the area developer system. Area developers receive
approximately 42% of the royalties from stores in their territories.
Franchise fee costs decreased 23.3% from $219,000 to $168,000, as a
result of lower franchise fee revenue for the quarter.
Restaurant cost of sales, which consists of food, beverage and paper
costs, increased 8.0% from $539,000 to $582,000, and as a percentage of
restaurant sales increased from 32.9% to 33.4%. Likewise, restaurant labor costs
increased 13.2% from $643,000 to $728,000, and as a percentage of restaurant
sales increased from 39.3% to 41.7% for the same quarter in 1997. Restaurant
operating expenses decreased 11.8% from $549,000 to $484,000, and as a
percentage of restaurant sales decreased from 33.6% to 27.7% for the three
months ended September 30, 1998, as compared to the corresponding period in
1997. The percentage increases in restaurant cost of sales and restaurant labor
cost were primarily attributable to operating inefficiencies related to the
relocation and reopening of two Company-owned restaurants during 1998. The
percentage decrease in restaurant operating expenses was attributable to the
improving sales outpacing the increase in operating costs, particularly at the
two reopened stores.
General and administrative expenses grew 68.9% from $2,790,000 to
$4,711,000 and as a percentage of total revenues increased from 33.4% to 43.6%.
The termination of Company guaranties on thirteen Turnkey sites sold in previous
periods resulted in deferred costs associated with those sites in the amount of
approximately $650,000 being recognized during the current quarter. Turnkey
development activity on new sites declined during the quarter resulting in
approximately $300,000 of Turnkey development overhead costs being expensed in
the current period rather than deferred. Also, the Company continued to add
personnel at the corporate office to support the growing franchise system,
resulting in greater expenses related to the hiring and relocation of new
employees when compared to the previous period. In addition, legal expenses were
higher during the current period principally a result of a higher incidence of
litigation and mediation compared to the prior period.
8
<PAGE>
Depreciation and amortization increased 93.3% from $268,000 to $518,000,
and as a percentage of total revenues increased from 3.2% to 4.8%. The
increase was principally due to the amortization of goodwill and other
intangibles acquired in late 1997 and the nine months ended September 30,
1998 and depreciation related to the additional Company-owned stores.
OTHER. Net interest income increased 484.3% from $89,000 to $520,000.
This increase was a result of the higher level of funds invested during the more
recent period.
INCOME TAX EXPENSE. Income tax expense reflected a combined federal and
state effective tax rate of 37.5% for the three months ended September 30, 1998,
which was slightly lower than the effective combined tax rate of 39.1% for the
comparable period in 1997. Based on projections of taxable income, the Company
anticipates that its effective combined rate for federal and state taxes will be
approximately 37.5% for 1998.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998, COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1997
REVENUES. Total revenues increased 35.5% from $22,019,000 to $29,830,000.
Royalties increased 29.4% from $10,703,000 to $13,853,000. This increase
was due to the opening of 127 restaurants during the period from October 1,
1997 to September 30, 1998. Also driving the increase was the growing
influence of larger freestanding units, particularly the prototype units,
which are the focus of the new unit development. Furthermore, average weekly
sales increased 12.0% and same store sales increased 3.8% during the nine
months ended September 30, 1998.
Developer fees decreased from $125,000 to $0. Substantially, all
development rights to domestic territories have been sold and only limited
sales, as a result of re-marketing a territory, are anticipated in the future.
Restaurant sales increased 19.3% from $4,399,000 to $5,246,000. This
increase was principally attributable to the relocation and upgrade of two units
in the Austin, Texas market, which were temporarily closed or under-performing,
during the nine months ended September 30, 1997.
Brand contributions, or private label licensing fees, increased 36.9%
from $2,132,000 to $2,918,000. The increase was principally the result of the
increasing volume of system-wide sales, which generated more purchases of
private label products, and greater franchisee participation in the Company's
purchasing programs.
Turnkey development revenue increased 102.1% from $2,822,000 to $5,702,000.
The release and termination of guaranties on sixteen sites sold in previous
periods resulted in the recognition of approximately $1,816,000 of revenue in
the current period. The Company purchased twelve of these sites from one of the
real estate investment trusts which had acquired them during 1997. Guaranties on
the other five sites were unconditionally released by another real estate
investment trust. Five stores purchased by the Company were subsequently resold
for no material gain or loss to franchisees through the Company's mortgage
program. It is contemplated that most of these mortgages will be marketed to
financial institutions and that most of the remaining stores will be resold to
franchisees during the next six months. Revenues from sales of sites developed
under the Turnkey Program, assignments of earnest money contracts and consulting
services comprise the balance of Turnkey development revenue generated during
the period. Five additional sites sold during the period included guaranties by
the Company, and the revenue from these transactions was deferred.
Other fees and revenues increased 25.9% from $835,000 to $1,051,000.
This change was primarily due to the increased level of supplier contributions
to the Company's annual convention held in July 1998 and revenue associated with
completion of certain contractual obligations performed for franchisees.
9
<PAGE>
The following table reflects the growth of the franchise system for the
nine months ended September 30, 1998 and 1997, which has been principally
responsible for the increased revenue as discussed above.
<TABLE>
<CAPTION>
SYSTEM PERFORMANCE THREE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
<C> <C> <C>
Units Opened
Domestic
Freestanding 67 55
End Cap 11 11
Other 4 8
------------- -------------
Total Domestic Openings 82 74
International 3 4
------------- -------------
Total Openings 85 78
Units Closed (22) (15)
------------- -------------
Net Unit Growth 63 63
------------- -------------
------------- -------------
System-wide Sales (in thousands) $ 254,804 $ 198,412
Average Weekly Sales $ 9,695 $ 8,654
Increase in Average Weekly Sales 12.0% 10.7%
Stores in Operation 736 636
Increase in Same Store Sales 3.8% 3.4%
</TABLE>
COSTS AND EXPENSES. Royalty service costs increased 35.3% from
$3,905,000 to $5,282,000. This increase was a result of the increase in royalty
revenue for the nine months ended September 30, 1998, as compared to the same
period in the prior year. Royalty service costs as a percentage of royalties
grew from 36.5% to 38.1%. This increase reflected the growing percentage of
restaurants serviced by the area developer system. Area developers receive
approximately 42% of the royalties from stores in their territories.
Restaurant cost of sales, which consists of food, beverage and paper
costs, increased 24.5% from $1,379,000 to $1,717,000, and as a percentage of
restaurant sales increased from 31.3% to 32.7%. Likewise, restaurant labor costs
increased 29.7% from $1,731,000 to $2,245,000, and as a percentage of restaurant
sales increased from 39.3% to 42.8% for the same quarter in 1997. Restaurant
operating expenses have increased 9.1% from $1,400,000 to $1,527,000, but as a
percentage of restaurant sales decreased from 31.8% to 29.1% for the nine months
ended September 30, 1998, as compared to the corresponding period in 1997. These
percentage increases in restaurant cost of sales and restaurant labor cost were
primarily attributable to pre-opening costs and operating inefficiencies related
to the relocation and reopening of two Company-owned restaurants during the nine
months ended September 30, 1998. The percentage decrease in restaurant operating
expenses was attributable to the improving sales outpacing the increase in
operating costs, particularly at the two reopened stores.
General and administrative expenses grew 59.1% from $7,219,000 to
$11,487,000 and as a percentage of total revenues increased from 32.8% to 38.5%.
The termination of Company guaranties on seventeen sites sold in previous
periods resulted in deferred costs associated with those sites of approximately
$833,000 being recognized during the second and third quarters of 1998. Also,
the Company continued to add personnel at the corporate office to support the
growing franchise system, resulting in greater expenses related to the hiring
and relocation of new employees when compared to the previous period. In
addition, legal expenses were higher during the current period principally a
result of a higher incidence of litigation and mediation compared to the prior
period.
10
<PAGE>
Depreciation and amortization increased 63.6% from $783,000 to
$1,281,000, and as a percentage of total revenues decreased from 3.6% to
4.3%. These increases were principally due to the amortization of goodwill
and other intangibles acquired in late 1997 and the nine months ended
September 30, 1998 and depreciation related to the additional Company-owned
restaurants.
OTHER. Net interest income increased 407.4% from $284,000 to
$1,441,000. This increase was a result of the higher level of funds invested
during the more recent period because of the secondary offering completed in
September 1997.
INCOME TAX EXPENSE. Income tax expense reflected a combined federal and
state effective tax rate of 37.5% for the nine months ended September 30, 1998,
which was slightly lower than the effective combined tax rate of 38.7% for the
comparable period in 1997. Based on projections of taxable income, the Company
anticipates that its effective combined rate for federal and state taxes will be
approximately 37.5% for 1998.
YEAR 2000 IMPACT. The Company's computer software programs utilize four
digits to define the applicable calendar year and therefore the Company believes
that it has no material internal risk concerning the Year 2000 issue. The
Company has received preliminary responses from many of its major restaurant
equipment suppliers indicating that they and the products they sell to the
Company's restaurant system also have no material internal risk from the Year
2000 issue. To date, none of the Company's major suppliers have indicated that
they anticipate material internal risks. The Company is in the process of a more
in-depth inquiry concerning the readiness of its major suppliers and those of
the restaurant system. The Company will assess and, where practicable, attempt
to mitigate its risks with respect to the failure of these entities to be Year
2000 compliant. The Company plans to educate its franchise system during the
next two quarters to prepare them to anticipate Year 2000 issues which could
affect them locally. The Company does not anticipate that its costs associated
with monitoring readiness and mitigating risks concerning the Year 2000 issue
will be material. However, even if favorable responses are received, there can
be no assurance that third parties will be Year 2000 compliant. The impact on
the Company's operations, if any, from the inability of any of its suppliers and
franchisees to become Year 2000 compliant is not reasonably estimable (except
that if there is a national or regional crisis in the financial, transportation
or utility infrastructure, it would likely adversely affect most commercial
enterprises, including the Company).
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities was $19,468,000 for the first nine
months of 1998. The use of cash resulted from the fact that purchases and
development costs of Turnkey Program properties exceeded the proceeds
generated from the sale of Turnkey Program properties. Activity during the
first nine months of 1998 reflected a transition in the Turnkey Program from
a focus on leases with franchisees combined with a sale of the real estate to
third party investors, to the sale of Turnkey Program properties directly to
investors or to franchisees through the origination of a mortgage or interim
construction loan. The Company's new mortgage program is intended to allow
franchisees the opportunity to own the land and building rather than lease it
at approximately the same monthly cost. The Company anticipates that it will
originate mortgages for qualified franchisees and subsequently sell the
mortgage, a financial instrument, to one of several financial institutions.
Net cash of $10,727,000 was used in investing activities primarily consisting
of expenditures of $4,354,000 relating to the acquisition and development of
Company-owned stores and $5,224,000 relating to investments in restaurants
acquired from franchisees or investors, which the Company intends to
re-market. During the next several quarters, it is anticipated that the cash
needed to fund the development of Turnkey Program properties could exceed the
proceeds from the sale of the properties to investors and franchisees and
sales of mortgages to financial institutions.
During the first nine months of 1998, financing activities provided net
cash of approximately $5,080,000 due primarily to the $4,700,000 drawn on the
Company's line of credit and the exercise of stock options and warrants.
11
<PAGE>
At September 30, 1998, the Company had approximately $6,643,000 of debt
outstanding. As discussed in the "Notes to Financial Statements," the Company
guaranties certain real estate leases, equipment leases and other obligations
of franchisees. At September 30, 1998, these contingent liabilities totaled
approximately $23,845,000. Included in contingent liabilities is a
construction loan for a limited partnership in which the Company and its
subsidiary, Schlotzsky's Real Estate, Inc., own a combined 40% interest in
capital and profits. The loan, for which the Company is liable for the full
amount, had a balance of $1,099,000 at September 30, 1998, bears interest at
prime plus 1.25% and matures April 2001. Monthly payments are being made by
the limited partnership.
The Company continues to expand and refine its Turnkey Program and
expects that it will have 50 to 100 sites under contract or at various stages
of development at any given time. The Company has used the net proceeds from
its public offerings and the proceeds from sites sold and earnest money
contracts assigned to finance the activity of the Turnkey Program. With the
anticipated growth in the Turnkey Program, particularly the introduction of
the mortgage program described above, the capital required to finance the
Turnkey Program will increase significantly. Seventy-nine properties were
under contract or in various stages of development at September 30, 1998. The
tables below provide a summary of the Turnkey Program activity for the nine
months ended September 30, 1997 and 1998.
Turnkey Program revenue consisted of the following:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------ ------------
<S> <C> <C>
Sales to investors and franchisees $ 20,642,134 $ 20,495,608
Development and construction management fees 135,000 130,000
------------ ------------
Gross Turnkey Program revenue 20,777,134 20,625,608
Turnkey Program development costs (16,516,626) (18,090,100)
------------ ------------
Net revenue from Turnkey Program projects 4,260,508 2,535,508
Rental income 96,933 286,548
Interim construction interest 109,046 --
Deferred revenue recognized 1,815,868 --
Deferred revenue (580,000) --
------------ ------------
Total Turnkey Program revenue $ 5,702,355 $ 2,822,056
------------ ------------
------------ ------------
</TABLE>
The following table reflects system performance of the Turnkey Program for
the year ended December 31, 1997 and the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
NUMBER OF UNITS
--------------------------------
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -----------
<S> <C> <C>
Sites in process at beginning of period 78 30
Sites beginning development during the period 47 90
Sites completed as Company-owned stores (1) (1)
Sites sold - revenue recognized (39) (7)
Sites sold - revenue deferred (5) (33)
Other (1) (1)
------------- -----------
Sites in process at end of period 79 78
------------- -----------
------------- -----------
<CAPTION>
INVESTED AT
SEPTEMBER 30,
1998
-----------
<S> <C> <C> <C>
Opened (receiving rent & royalties) 1 2 $ 663,000
Investment Sites (under construction) 7 3 10,711,000
Predevelopment Site (prequalification) 71 73 1,245,000
------------- ----------- -----------
79 78 $12,619,000
------------- ----------- -----------
------------- ----------- -----------
</TABLE>
12
<PAGE>
The Company currently has a line of credit from a financial institution
which may be used to finance Turnkey Program capital requirements. The line
of credit can be drawn upon to fund up to $12,000,000, bears interest at the
bank's prime lending rate and expires April 2000. As of September 30, 1998,
the Company had drawn $4,700,000 of this line of credit. In addition, the
Company has provided certain guaranties on notes to franchisees and area
developers which reduced the available balance of this line of credit to
$25,000.
The Company believes that cash flow from operations, together with the
proceeds of the Turnkey Program, collections from notes receivable and
borrowings under existing credit facilities described above and the proceeds
from its secondary public offering of common stock, will be sufficient to
meet the Company's anticipated cash needs for the immediate future. To the
extent that the net proceeds from the Turnkey Program, credit facilities,
cash flow from operations and the proceeds from its secondary offering are
insufficient to finance the Company's future expansion plans, the Company
intends to seek additional funds for this purpose from future borrowings or
additional offerings of debt or equity securities. However, there can be no
assurance of the availability of such funds on acceptable terms in the future.
FORWARD LOOKING STATEMENTS
This report contains forward looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the Securities Exchange Act of 1934, as amended, that are not historical
facts. Such statements may include, but are not limited to, projections of
revenues, income, capital expenditures, plans for future operations,
financing needs or plans (including those relating to Turnkey Program real
estate transactions and financings), and plans relating to products or
services of the Company, as well as assumptions relating to the foregoing.
These statements involve management assumptions and are subject to risks and
uncertainties such as changes in interest rates, availability of favorable
financing for the Company or its franchisees, intense competition, future
restaurant openings and changes in development plans or strategies, along
with factors set forth in the Company's Annual Report on Form 10-K/A in
"Business," pages 1-15. The Company undertakes no obligation to update
forward looking statements that may be contained in this report.
13
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On August 26, 1998, the Lone Star Ladies Investment Club filed a class action
lawsuit in federal court in the Western district of Texas against Registrant
and six of its offers and directors (Monica Gill, Chief Financial Officer;
Azie Taylor Morton, director; Raymond A. Rodriguez, director; John M.
Rosillo, director; Jeffrey J. Wooley, Senior Vice President and director; and
John C. Wooley, President and Chairman of the Board of Directors). The
complaint, alleges securities fraud arising out of a change in the timing of
recognition of revenue from the sale of real estate properties in connection
with which Registrant provided a limited guaranty on lease payments from
franchisees who had leased the properties. In April 1998, Registrant
announced that 1997 earnings would be lower than previously announced because
it would defer revenue received in the fourth quarter from such real estate
transactions rather than recognizing it as previously contemplated.
Plaintiffs seek monetary damages in an unspecified amount. Registrant
believes that the allegations are without merit and intends to vigorously
defend against the suit.
ITEM 2. CHANGES IN SECURITIES.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION
Pursuant to a recent amendment to Rule 14a-4 promulgated by the Securities
and Exchange Commission, notice is hereby given of Registrant's intention to
confer discretionary authority to the persons named in its proxy for the 1999
Annual Meeting of Shareholders to vote with respect to shareholder proposals
which are not included in the Registrant's proxy statement and which are not
the subject of a prior written notice in advance of the date for last year's
annual meeting or the proxy statement therefor in accordance with the
Registrant's Bylaws, as amended.
14
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
<TABLE>
<S> <C>
a. Exhibits:
Exhibit
No
-------
10.36(a) Employment Agreement, dated as of March 1, 1998, by and
between Registrant and John C. Wooley.
10.36(b) Employment Agreement, dated as of March 1, 1998, by and
between Registrant and Jeffrey J. Wooley.
27 Financial Data Schedule.
b. Current Reports on Form 8-K:
1) The Registrant filed a report on Form 8-K on September 18,
1998 related to the Board of Directors approval of the Company's
repurchase of up to 380,000 shares of its common stock.
</TABLE>
15
<PAGE>
SIGNATURE
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.
SCHLOTZSKY'S, INC.
By: /s/ John C. Wooley
---------------------------------------
John C. Wooley, President
and Chief Executive Officer
By: /s/ Monica Gill
---------------------------------------
Monica Gill
Chief Financial Officer
Austin, Texas
November 16, 1998
16
<PAGE>
EXHIBIT 10.36(A)
EMPLOYMENT AGREEMENT
AGREEMENT dated to be effective as of March 1, 1998, made and
entered into by and between Schlotzsky's, Inc., a Texas corporation (the
"Company") and John C. Wooley ("Wooley").
The Board of Directors of the Company has determined that it is in
the best interest of the Company to set forth the terms of employment of
Wooley as President of the Company and Wooley has agreed to such terms. The
Company and Wooley wish to promote their mutual best interest by setting
forth the terms and conditions in writing.
NOW, THEREFORE, in consideration of the covenants and agreements set
forth in this Agreement, the parties agree as follows:
1. EMPLOYMENT. The Company employs Wooley and Wooley agrees to the
terms and conditions set forth in this Agreement. Wooley agrees to serve as
President and Chief Executive Officer of the Company to be responsible for
general management of the affairs of the Company, reporting directly to the
Board of Directors, and to devote good faith efforts on behalf of the Company.
2. TERM OF EMPLOYMENT. Wooley's employment with the Company shall
continue for three years from the effective date hereof, provided that such
term shall be automatically extended from year to year thereafter, unless
terminated by Wooley or the Company in accordance herewith.
3. BASE SALARY, BONUS AND OTHER COMPENSATION. The Company shall pay
to Wooley a base salary at the annual rate of $200,000 for the balance of
1998, $225,000 during 1999, $250,000 during 2000 and for each year
thereafter, unless increased by agreement between the parties. Wooley's
salary shall be payable on the same schedule that salary is paid to other
employees. Wooley shall be entitled to a cash bonus for 1998, based from
$16,666 if only one of the criteria is met, to $200,000 if all of the
criteria, calculated in accordance with the attached Exhibit A, are met.
Wooley shall also be entitled to such other bonuses and compensation as the
Compensation Committee of the Board of Directors shall approve for each year
thereafter.
4. BENEFITS. Wooley shall receive, in addition to the base salary
and the bonuses set forth in Section 3 hereof, such other benefits as are
provided by the Company to its executive officers, such as group life,
medical and disability insurance. In addition, Wooley is receiving stock
options to acquire shares of Common Stock of the Company, certain of such
options being subject to approval by the shareholders of an increase in the
number of shares issuable under the Company's stock option plan at the 1998
Annual Meeting of Shareholders.
5. WOOLEY COVENANTS.
(a) CONFIDENTIAL INFORMATION. Wooley acknowledges that the
information, observations and data obtained by him while employed by the
Company (including
Page 1
<PAGE>
those obtained by him while employed at the Company prior to the date of this
Agreement) concerning the business or affairs of the Company ("Confidential
Information") are the property of the Company. Therefore, Wooley agrees that
he shall not disclose to any unauthorized person or use for his own account
any Confidential Information, unless and to the extent that the
aforementioned matters become generally known to and available for use by the
public other than as a result of Wooley's act or omissions to act. Wooley
shall deliver to the Company at the termination of employment, or at any
other time the Company may request, all memoranda, notes, plans, records,
reports and other documents (and copies thereof) relating to the Confidential
Information or the business of the Company which he may then possess or have
under this control.
(b) INVENTIONS AND PATENTS.
(i) Wooley agrees that all inventions, innovations,
improvements, developments, methods, designs, analyses, drawings, reports,
and all similar or related information which relates to the Company's actual
or anticipated business, research and development or existing or future
products or services and which are conceived, developed or made by Wooley
while employed by the Company ("Work Product") belong to the Company. Wooley
will promptly disclose such Work Product to the Company and perform all
actions reasonably requested by the President or the Board of Directors to
establish and confirm such ownership.
(ii) Wooley is hereby advised that Section 5(b)(i) of this
Agreement regarding the Company's ownership of intellectual property does not
apply to any invention for which no equipment, supplies, facilities or trade
secret information of the Company was used and which was developed entirely
on Wooley's own time, unless (i) the invention relates to the business of the
Company or to the Company's actual or demonstrably anticipated research or
developments, or (ii) the invention results from any work performed by Wooley
of the Company.
(c) NON-COMPETE, NON-SOLICITATION
(i) Wooley acknowledges that in the course of his employment
with the Company he will become familiar, and during his employment with the
Company he has become familiar, with the Company's trade secrets and with
other confidential information concerning the Company and that his services
will be of special, unique and extraordinary value to the Company. Therefore,
Wooley agrees that, during employment and for twenty-four months thereafter,
he shall not directly or indirectly own, manage, control, participate in,
consult with, render services for, or in any manner engage in any business
competing with the business of the Company or any foreign country where the
Company is authorized to do business. For purposes of this Agreement, a
business shall be deemed competitive if it is a restaurant, sandwich shop or
food service operation offering principal menu entrees or items which are the
same or confusingly similar to those then offered at any Schlotzsky's
restaurant or outlet worldwide. Nothing herein shall prohibit Wooley from
being a passive owner of not more than 5% of the outstanding stock of any
class of a corporation which is publicly
Page 2
<PAGE>
traded, so long as Wooley has no active participation in the business of such
corporation.
(ii) During employment Wooley shall not, except in the course of
properly dispensing his duties (i) induce or attempt to induce any employee
of the Company to leave the employ of the Company or in any way interfere
with the relationship between the Company and any employee thereof, (ii) hire
directly or through another entity any person who was an employee of the
Company at any time during employment or (iii) induce or attempt to induce
any customer, supplier, licensee or other business relation of the Company to
cease doing business with the Company or in any way interfere with the
relationship between any such customer, supplier, licensee or business
relation and the Company.
(d) FULL-TIME. Wooley agrees to devote his best efforts to the
business and affairs of the Company. Wooley shall seek written consent from
the Compensation Committee of the Board of Directors of the Company to
provide service to a third party for compensation. Consent to such activities
may be withheld in the sole judgment of the Compensation Committee. Consents
granted may be referenced in an addendum to this Agreement.
(e) ENFORCEMENT. If, at the time of enforcement of paragraphs 5(a),
(b), (c), or (d) of this Agreement, a court holds that the restrictions
stated herein are unreasonable under circumstances then existing, the parties
hereto agree that the maximum period, scope or geographical area reasonable
under such circumstances shall be substituted for the stated period, scope or
area. Because Wooley's services are unique and because Wooley has access to
Confidential Information and Work Product, the parties hereto agree that
money damages would be inadequate remedy for any breach of this Agreement.
Therefore, in the event a breach or threatened breach of this Agreement, the
Company or its successors or assigns may, in addition to other rights and
remedies existing in their favor, apply to any court of competent
jurisdiction for specific performance or injunction or other relief in order
to enforce, or prevent any violations of, the provisions hereof.
6. TERMINATION.
(a) Wooley or the Company may terminate the employment of Wooley
for cause or without cause by giving written notice at least 60 days in
advance of the effective date of termination. For purposes of this Agreement
"for cause" means termination by the Company of the employment of Wooley upon
any of the following grounds and no others: (i) any act of dishonesty or
violation of law on the part of Wooley resulting or intended to result
directly or indirectly in personal gain or benefit at the expense of the
Company, fraud, misappropriation, embezzlement or willful and material damage
of or to property of the Company; (ii) any intentional act on the part of
Wooley preventing him from discharging his duties for a material length of
time; or (iii) a material breach of this Agreement, including willful and
habitual neglect of duties, which is not cured within ten days following
receipt of written notice.
Page 3
<PAGE>
(b) Upon termination of Wooley's employment for any reason, he
shall be entitled to receive the base salary and any bonuses earned through
the date of termination. In addition, the Company shall continue to use good
faith efforts to remove Wooley from all guaranties in favor of the Company as
soon as practicable.
(c) Upon termination of Wooley's employment without cause, he
shall be entitled to receive the base salary and any bonuses earned through
the date of termination, plus the base salary through the end of the term
then in effect, or for one year, whichever is longer. Wooley may elect to
treat a substantial reduction in responsibilities and duties as termination
without cause. In the event of any dispute between the Company and Wooley
concerning the status of a reduction in responsibilities and duties as
"substantial," the dispute shall be submitted to an independent third party
arbitrator acceptable to the Company and Wooley for a determination which
shall be binding on both parties.
7. DISABILITY OR DEATH.
(a) If as a result of illness, injury or other disability,
Wooley is unable to perform his duties hereunder on a substantially full time
basis for any period of twelve months or more, the Company may at its option
terminate Wooley's employment hereunder and shall pay to Wooley the base
salary and any bonuses through the date of termination, plus the base salary
through the end of the term then in effect, or for one year, whichever is
longer.
(b) If Wooley shall die during the term of this employment by
the Company, the Company shall pay to Wooley's estate the base salary and any
bonuses through the date of his death, plus the base salary through the end
of the term then in effect, or for one year, whichever is longer.
8. MISCELLANEOUS. This Agreement contains the entire agreement of
the parties regarding the subject matter hereof. This Agreement may not be
changed orally but only by an agreement in writing signed by the parties
hereto. This Agreement shall be binding upon and inure to the benefit of the
parties and, to their respective successors and assigns. This Agreement shall
be construed under and enforced in accordance with the laws of the State of
Texas, and shall be performable in Travis County, Texas.
IN WITNESS WHEREOF, the parties have executed this Agreement as
of the date set forth above.
COMPANY:
SCHLOTZSKY'S, INC.
Page 4
<PAGE>
By: /s/
--------------------------------
Its:
-------------------------------
WOOLEY:
/s/
-----------------------------------
John C. Wooley
Page 5
<PAGE>
EXHIBIT A
1998 CEO BONUS PROGRAM
CEO's PERFORMANCE MEASURES
AND TARGET INCENTIVE OPPORTUNITIES
<TABLE>
<CAPTION>
- ----------------------------------------------------------------- -----------------------------------------
THREE PLANS AND 1998 PERFORMANCE MEASURES TARGET INCENTIVE OPPORTUNITY
- ----------------------------------------------------------------- -----------------------------------------
<S> <C>
- ----------------------------------------------------------------- -----------------------------------------
- - "Quality" Store Openings $33,334
- ----------------------------------------------------------------- -----------------------------------------
- ----------------------------------------------------------------- -----------------------------------------
- - System-Wide Weighted Average Weekly Sales $33,333
- ----------------------------------------------------------------- -----------------------------------------
- ----------------------------------------------------------------- -----------------------------------------
- - Earnings Per Share $33,333
- ----------------------------------------------------------------- -----------------------------------------
</TABLE>
Page 1
<PAGE>
CEO's PLAN #1
QUALITY STORE OPENINGS
<TABLE>
<S> <C>
- - Two-aspects.
- Number of store openings.
- Weighted average weekly sales (new stores).
- - Target number of store openings: 150
- - Target weighted average weekly sales (new stores): $15,400
THRESHOLD, TARGET AND MAXIMUM OPPORTUNITIES
- - Threshold cash incentive $16,667
- - Target cash incentive $33,367
- - Maximum cash incentive $66,667
</TABLE>
Page 2
<PAGE>
CEO's PLAN #1
QUALITY STORE OPENINGS PERFORMANCE MATRIX
- - The following table summarizes the cash incentive opportunity for number of
store openings and weighted average weekly sales ("AWS").
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE WEEKLY SALES
(NEW UNITS)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
THRESHOLD* TARGET* MAXIMUM*
$14,500/UNIT $15,000/UNIT $16,324/UNIT
- --------------------------- -------------------------- -------------------------- --------------------------
MAXIMUM
170 NEW UNITS $33,334 $50,000 $66,667
- --------------------------- -------------------------- -------------------------- --------------------------
TARGET
150 NEW UNITS $25,000 $33,334 $50,000
- --------------------------- -------------------------- -------------------------- --------------------------
THRESHOLD
130 NEW UNITS $16,667 $25,000 $33,334
- ------------------------------------------------------------------------------------------------------------
</TABLE>
- - The objective of the Plan is to achieve both the number and quality of
openings expected.
- - Reward pay-out is subject to interpolation at levels of performance between
Threshold and Maximum by reference to the cash incentive for the number of
new units and weighted average weekly sales in the foregoing table that are
closest to the actual performance without going over (the base incentive)
and determining the additional cash incentive by reference to the amounts
in the table which are nearest the base incentive. For example, if 140 units
were opened with weighted average weekly sales of $14,750/unit, the cash
incentive would be calculated as follows:
1. The base incentive is $16,667. The spread between Threshold and Target
units = 20 (150 - 130). 140 units is 10 more than the Threshold, or 50%
(10 divided by 20) of the spread. Target incentive ($25,000) less
Threshold incentive for new units ($16,667) multiplied by the percentage
of the spread is:
($25,000 - $16,667) x 50% = $4,166.50
Therefore, the additional incentive for 140 units is $4,166.50 more
than the base incentive for new units.
2. The spread between AWS Threshold and AWS Target is $500. $14,750 AWS
is $250 more than Threshold, or 50% ($250 divided by $500) of the spread.
Target incentive for AWS ($25,000) less Threshold incentive for AWS
($16,667) multiplied by the spread is ($25,000 - $16,667) x 50% =
$4,166.50. Therefore, the additional incentive for $14,750 AWS is
$4,166.50 more than the base incentive for AWS.
3. Accordingly, the bonus = $16,667 (base incentive) + $4,166.50 (new unit
additional incentive) + $4,166.50 (AWS additional incentive) = $25,000.
Page 3
<PAGE>
CEO's PLAN #2
SYSTEM-WIDE WEIGHTED AVERAGE WEEKLY SALES
- - This Plan rewards the CEO for achieving consistent growth in system-wide
sales. The following table summarizes the incentive opportunity under this
Plan.
<TABLE>
<CAPTION>
- ----------------------------- ------------------------------------------- -----------------------------------
LEVEL SYSTEM-WIDE PERFORMANCE/UNIT/YR. REWARD
- ----------------------------- ------------------------------------------- -----------------------------------
<S> <C> <C>
Threshold $9,200 $16,666
- ----------------------------- ------------------------------------------- -----------------------------------
- ----------------------------- ------------------------------------------- -----------------------------------
Target $9,800 $33,333
- ----------------------------- ------------------------------------------- -----------------------------------
- ----------------------------- ------------------------------------------- -----------------------------------
Maximum $10,400 $66,666
- ----------------------------- ------------------------------------------- -----------------------------------
</TABLE>
- - Reward pay-out is subject to interpolation at levels of performance between
threshold and maximum by reference to the system-wide performance per unit,
per year, sales in the foregoing table which are nearest to actual
performance. Accordingly, if actual system-wide weighted average weekly
sales were $10,000 per unit, the Reward would be calculated as follows:
The spread between Target and Maximum performance is $600 ($10,400 - $9,800).
Actual performance ($10,000) less target performance ($9,800) = $200. $200
is one-third of the spread. Since the maximum Reward minus the Target Reward
is $33,333 ($66,666 - $33,333), the actual Reward is $44,444 (one-third of
$33,333 -- the difference between the maximum and the Target Reward =
$11,111; $11,111 + $33,333 = $44,444).
Page 4
<PAGE>
CEO's PLAN #3
EARNINGS PER SHARE
- - This Plan rewards the CEO for achieving earnings per share objectives.
<TABLE>
<CAPTION>
- ----------------------------- ------------------------------------------- -----------------------------------
LEVEL 1998 EARNINGS PER SHARE REWARD
- ----------------------------- ------------------------------------------- -----------------------------------
<S> <C> <C>
Threshold $1.02 $16,666
- ----------------------------- ------------------------------------------- -----------------------------------
- ----------------------------- ------------------------------------------- -----------------------------------
Target $1.05 $33,333
- ----------------------------- ------------------------------------------- -----------------------------------
- ----------------------------- ------------------------------------------- -----------------------------------
Maximum $1.10 $66,666
- ----------------------------- ------------------------------------------- -----------------------------------
</TABLE>
- - Reward pay-out is subject to interpolation at levels of performance between
threshold and maximum by reference to the earnings per share reflected in
the foregoing table which are nearest to actual performance.
Page 5
<PAGE>
EXHIBIT 10.36(B)
EMPLOYMENT AGREEMENT
AGREEMENT dated to be effective as of March 1, 1998, made and
entered into by and between Schlotzsky's, Inc., a Texas corporation (the
"Company") and Jeffrey J. Wooley ("Wooley").
The Board of Directors of the Company has determined that it is in
the best interest of the Company to set forth the terms of employment of
Wooley as Sr. Vice President and Secretary of the Company and Wooley has
agreed to such terms. The Company and Wooley wish to promote their mutual
best interest by setting forth the terms and conditions in writing.
NOW, THEREFORE, in consideration of the covenants and agreements set
forth in this Agreement, the parties agree as follows:
1. EMPLOYMENT. The Company employs Wooley and Wooley agrees to the
terms and conditions set forth in this Agreement. Wooley agrees to serve as
Sr. Vice President and Secretary of the Company to be responsible for general
management of the affairs of the Company, reporting directly to President of
the Company, and to devote good faith efforts on behalf of the Company.
2. TERM OF EMPLOYMENT. Wooley's employment with the Company shall
continue for three years from the effective date hereof, provided that such
term shall be automatically extended from year to year thereafter, unless
terminated by Wooley or the Company in accordance herewith.
3. BASE SALARY, BONUS AND OTHER COMPENSATION. The Company shall pay
to Wooley a base salary at the annual rate of $160,000 for the balance of
1998, $170,000 during 1999, $185,000 during 2000 and for each year
thereafter, unless increased by agreement between the parties. Wooley's
salary shall be payable on the same schedule that salary is paid to other
employees. Wooley shall be entitled to a cash bonus for 1998 calculated in
accordance with the attached Exhibit A. Wooley shall also be entitled to such
other bonuses and compensation as the Compensation Committee of the Board of
Directors shall approve for each year thereafter.
4. BENEFITS. Wooley shall receive, in addition to the base salary
and the bonuses set forth in Section 3 hereof, such other benefits as are
provided by the Company to its executive officers, such as group life,
medical and disability insurance. In addition, Wooley is receiving stock
options to acquire shares of Common Stock of the Company, certain of such
options being subject to approval by the shareholders of an increase in the
number of shares issuable under the Company's stock option plan at the 1998
Annual Meeting of Shareholders.
5. WOOLEY COVENANTS.
(a) CONFIDENTIAL INFORMATION. Wooley acknowledges that the
information, observations and data obtained by him while employed by the
Company (including
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<PAGE>
those obtained by him while employed at the Company prior to the date of this
Agreement) concerning the business or affairs of the Company ("Confidential
Information") are the property of the Company. Therefore, Wooley agrees that
he shall not disclose to any unauthorized person or use for his own account
any Confidential Information, unless and to the extent that the
aforementioned matters become generally known to and available for use by the
public other than as a result of Wooley's act or omissions to act. Wooley
shall deliver to the Company at the termination of employment, or at any
other time the Company may request, all memoranda, notes, plans, records,
reports and other documents (and copies thereof) relating to the Confidential
Information or the business of the Company which he may then possess or have
under this control.
(b) INVENTIONS AND PATENTS.
(i) Wooley agrees that all inventions, innovations,
improvements, developments, methods, designs, analyses, drawings, reports,
and all similar or related information which relates to the Company's actual
or anticipated business, research and development or existing or future
products or services and which are conceived, developed or made by Wooley
while employed by the Company ("Work Product") belong to the Company. Wooley
will promptly disclose such Work Product to the Company and perform all
actions reasonably requested by the President or the Board of Directors to
establish and confirm such ownership.
(ii) Wooley is hereby advised that Section 5(b)(i) of this
Agreement regarding the Company's ownership of intellectual property does not
apply to any invention for which no equipment, supplies, facilities or trade
secret information of the Company was used and which was developed entirely
on Wooley's own time, unless (i) the invention relates to the business of the
Company or to the Company's actual or demonstrably anticipated research or
developments, or (ii) the invention results from any work performed by Wooley
of the Company.
(c) NON-COMPETE, NON-SOLICITATION
(i) Wooley acknowledges that in the course of his employment
with the Company he will become familiar, and during his employment with the
Company he has become familiar, with the Company's trade secrets and with
other confidential information concerning the Company and that his services
will be of special, unique and extraordinary value to the Company. Therefore,
Wooley agrees that, during employment and for twenty-four months thereafter,
he shall not directly or indirectly own, manage, control, participate in,
consult with, render services for, or in any manner engage in any business
competing with the business of the Company or any foreign country where the
Company is authorized to do business. For purposes of this Agreement, a
business shall be deemed competitive if it is a restaurant, sandwich shop or
food service operation offering principal menu entrees or items which are the
same or confusingly similar to those then offered at any Schlotzsky's
restaurant or outlet worldwide. Nothing herein shall prohibit Wooley from
being a passive owner of not more than 5% of the outstanding stock of any
class of a corporation which is publicly
Page 2
<PAGE>
traded, so long as Wooley has no active participation in the business of such
corporation.
(ii) During employment Wooley shall not, except in the course of
properly dispensing his duties (i) induce or attempt to induce any employee
of the Company to leave the employ of the Company or in any way interfere
with the relationship between the Company and any employee thereof, (ii) hire
directly or through another entity any person who was an employee of the
Company at any time during employment or (iii) induce or attempt to induce
any customer, supplier, licensee or other business relation of the Company to
cease doing business with the Company or in any way interfere with the
relationship between any such customer, supplier, licensee or business
relation and the Company.
(d) FULL-TIME. Wooley agrees to devote his best efforts to the
business and affairs of the Company. Wooley shall seek written consent from
the Compensation Committee of the Board of Directors of the Company to
provide service to a third party for compensation. Consent to such activities
may be withheld in the sole judgment of the Compensation Committee. Consents
granted may be referenced in an addendum to this Agreement.
(e) ENFORCEMENT. If, at the time of enforcement of paragraphs 5(a),
(b), (c), or (d) of this Agreement, a court holds that the restrictions
stated herein are unreasonable under circumstances then existing, the parties
hereto agree that the maximum period, scope or geographical area reasonable
under such circumstances shall be substituted for the stated period, scope or
area. Because Wooley's services are unique and because Wooley has access to
Confidential Information and Work Product, the parties hereto agree that
money damages would be inadequate remedy for any breach of this Agreement.
Therefore, in the event a breach or threatened breach of this Agreement, the
Company or its successors or assigns may, in addition to other rights and
remedies existing in their favor, apply to any court of competent
jurisdiction for specific performance or injunction or other relief in order
to enforce, or prevent any violations of, the provisions hereof.
6. TERMINATION.
(a) Wooley or the Company may terminate the employment of Wooley
for cause or without cause by giving written notice at least 60 days in
advance of the effective date of termination. For purposes of this Agreement
"for cause" means termination by the Company of the employment of Wooley upon
any of the following grounds and no others: (i) any act of dishonesty or
violation of law on the part of Wooley resulting or intended to result
directly or indirectly in personal gain or benefit at the expense of the
Company, fraud, misappropriation, embezzlement or willful and material damage
of or to property of the Company; (ii) any intentional act on the part of
Wooley preventing him from discharging his duties for a material length of
time; or (iii) a material breach of this Agreement, including willful and
habitual neglect of duties, which is not cured within ten days following
receipt of written notice.
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<PAGE>
(b) Upon termination of Wooley's employment for any reason, he shall
be entitled to receive the base salary and any bonuses earned through the
date of termination. In addition, the Company shall continue to use good
faith efforts to remove Wooley from all guaranties in favor of the Company as
soon as practicable.
(c) Upon termination of Wooley's employment without cause, he shall
be entitled to receive the base salary and any bonuses earned through the
date of termination, plus the base salary through the end of the term then in
effect, or for one year, whichever is longer. Wooley may elect to treat a
substantial reduction in responsibilities and duties as termination without
cause. In the event of any dispute between the Company and Wooley concerning
the status of a reduction in responsibilities and duties as "substantial,"
the dispute shall be submitted to an independent third party arbitrator
acceptable to the Company and Wooley for a determination which shall be
binding on both parties.
7. DISABILITY OR DEATH.
(a) If as a result of illness, injury or other disability,
Wooley is unable to perform his duties hereunder on a substantially full time
basis for any period of twelve months or more, the Company may at its option
terminate Wooley's employment hereunder and shall pay to Wooley the base
salary and any bonuses through the date of termination, plus the base salary
through the end of the term then in effect, or for one year, whichever is
longer.
(b) If Wooley shall die during the term of this employment by
the Company, the Company shall pay to Wooley's estate the base salary and any
bonuses through the date of his death, plus the base salary through the end
of the term then in effect, or for one year, whichever is longer.
8. MISCELLANEOUS. This Agreement contains the entire agreement of
the parties regarding the subject matter hereof. This Agreement may not be
changed orally but only by an agreement in writing signed by the parties
hereto. This Agreement shall be binding upon and inure to the benefit of the
parties and, to their respective successors and assigns. This Agreement shall
be construed under and enforced in accordance with the laws of the State of
Texas, and shall be performable in Travis County, Texas.
IN WITNESS WHEREOF, the parties have executed this Agreement as
of the date set forth above.
COMPANY:
SCHLOTZSKY'S, INC.
Page 4
<PAGE>
By: /s/
--------------------------------
Its:
--------------------------------
WOOLEY:
/s/
------------------------------------
Jeffrey J. Wooley
Page 5
<PAGE>
EXHIBIT A
Mr. Wooley shall be entitled to a cash bonus for 1998, based on the following
criteria: (i) $60,000 if at least 34 units developed by the Company's Turnkey
real estate development department are opened by June 30, 1998 (Milestone 1),
51 units are opened by September 30, 1998 (Milestone 2), or 68 units are
opened by December 31, 1998 (Milestone 3); (ii) $80,000 if at least 38 units
developed by the Company's Turnkey real estate development department are
opened by Milestone 1, 56 units are opened by Milestone 2 or 75 units are
opened by Milestone 3; (iii) $80,000 if two of the three criteria in (i)
above are met; (iv) $100,000 if two of the three criteria in (ii) above are
met; (v) $100,000 if all three of the criteria in (i) above are met; or (vi)
$160,000 if all three of the criteria in (ii) above are met. Wooley shall be
entitled to the cash bonus in items (i) through (vi) above which yields the
highest amount, but shall not be entitled to more than the amount reflected
in the single item for which he has met the highest applicable criteria
(i.e., no aggregation of the bonuses is permitted).
Page 6
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF
INCOME ON PAGES TWO AND THREE OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 7,578,505
<SECURITIES> 0
<RECEIVABLES> 19,699,572
<ALLOWANCES> (518,000)
<INVENTORY> 0
<CURRENT-ASSETS> 40,250,077
<PP&E> 20,852,726
<DEPRECIATION> (1,927,215)
<TOTAL-ASSETS> 85,624,106
<CURRENT-LIABILITIES> 5,650,517
<BONDS> 0
0
0
<COMMON> 62,877
<OTHER-SE> 71,942,019
<TOTAL-LIABILITY-AND-EQUITY> 85,624,106
<SALES> 5,245,698
<TOTAL-REVENUES> 29,831,062
<CGS> 1,717,234
<TOTAL-COSTS> 24,080,848
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,441,347)
<INCOME-PRETAX> 7,191,561
<INCOME-TAX> 2,696,835
<INCOME-CONTINUING> 4,494,726
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,494,726
<EPS-PRIMARY> .61
<EPS-DILUTED> .59
</TABLE>
