<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 June 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 August 1, 1998
Common Stock, no par value 7,399,342
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<PAGE>
INDEX
<TABLE>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C>
Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheets --
June 30, 1998 and December 31, 1997 2
Condensed Consolidated Statements of
Income -- Three and Six Months Ended
June 30, 1998 and June 30, 1997 3
Condensed Consolidated Statements of
Stockholders' Equity -- Six Months Ended
June 30, 1998 and the year ended December 31, 1997 4
Condensed Consolidated Statements of
Cash Flows -- Six Months Ended
June 30, 1998 and June 30, 1997 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults Upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $13,720,818 $31,254,048
Temporary cash investments 1,435,906 18,000
Receivable from sales of Turnkey Program development 1,849,074 6,054,337
Royalties receivable 1,246,268 809,125
Other receivables 2,674,302 2,005,760
Prepaid expenses and other assets 760,092 584,510
Turnkey Program development 17,384,854 6,950,595
Notes receivable, current portion 2,291,679 2,574,588
Notes receivable from related parties, current portion 185,808 50,000
----------- -----------
Total current assets 41,548,801 50,300,963
Property, equipment and leasehold improvements, net 11,741,897 9,998,630
Real estate held for sale 848,981 1,063,592
Notes receivable, less current portion 8,496,628 1,972,470
Notes receivable from related parties, less current portion 2,411,557 2,565,399
Investments and advances 1,431,027 1,456,790
Deferred federal income tax asset 590,376 580,460
Intangible assets, net 11,218,140 11,113,213
Other noncurrent assets 469,069 469,069
----------- -----------
Total assets $78,756,476 $79,520,586
----------- -----------
----------- -----------
Liabilities and Stockholder's Equity
Current liabilities:
Current maturities of long-term debt $ 226,740 $ 250,625
Accounts payable 2,010,754 6,002,920
Accrued liabilities 1,530,540 1,484,715
----------- -----------
Total current liabilities 3,768,034 7,738,260
Deferred revenue, net 2,624,259 2,855,380
Long-term debt, less current maturities 1,936,387 1,936,387
----------- -----------
Total liabilities 8,328,680 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 7,391,727 issued and outstanding at December 31, 1997
and June 30, 1998, respectively 62,775 62,202
Additional paid-in capital 57,188,134 56,664,104
Retained earnings 13,176,887 10,264,253
----------- -----------
Total stockholders' equity 70,427,796 66,990,559
----------- -----------
Total liabilities and stockholders' equity $78,756,476 $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 SIX MONTHS ENDED
------------------------- -------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues
Royalties $4,719,538 $3,605,747 $8,978,556 $6,883,307
Franchise fees 380,000 240,000 720,000 592,500
Developer fees - - 125,000 - - 125,000
Restaurant sales 1,884,651 1,438,639 3,500,908 2,762,290
Brand contribution 1,005,571 807,177 1,865,887 1,341,823
Turnkey development 1,732,462 762,278 2,857,479 1,447,768
Other fees and revenue 590,803 361,674 844,487 522,379
----------- ---------- ----------- -----------
Total revenues 10,313,025 7,340,515 18,767,317 13,675,067
Expenses
Service Costs:
Royalties 1,799,891 1,305,235 3,420,513 2,507,957
Franchise fees 203,250 132,500 374,500 312,500
Restaurant Operations:
Cost of sales 600,974 443,146 1,135,326 840,875
Labor cost 761,532 558,814 1,516,418 1,088,381
Operating expenses 542,963 451,815 1,042,786 850,543
General and administrative 3,860,312 2,419,146 6,776,013 4,429,352
Depreciation and amortization 447,573 264,200 763,389 513,940
----------- ---------- ----------- -----------
Total expenses 8,216,495 5,574,856 15,028,945 10,543,548
----------- ---------- ----------- -----------
Income from operations 2,096,530 1,765,659 3,738,372 3,131,519
Other
Interest income, net 417,237 137,118 921,518 195,517
----------- ---------- ----------- -----------
Income before income taxes 2,513,767 1,902,777 4,659,890 3,327,036
Provision for federal and state income taxes 943,246 740,963 1,747,256 1,276,646
----------- ---------- ----------- -----------
Net Income $ 1,570,521 $1,161,814 $ 2,912,634 $ 2,050,390
----------- ---------- ----------- -----------
----------- ---------- ----------- -----------
Income per common share - basic:
Income per common share $.21 $.21 $.40 $.37
----------- ---------- ----------- -----------
----------- ---------- ----------- -----------
Weighted average shares outstanding 7,389,977 5,548,264 7,358,065 5,544,547
----------- ---------- ----------- -----------
Income per common share - diluted:
Income per common share $.21 $.20 $.38 $.36
----------- ---------- ----------- -----------
----------- ---------- ----------- -----------
Weighted average shares outstanding 7,605,953 5,720,652 7,602,320 5,695,591
----------- ---------- ----------- -----------
----------- ---------- ----------- -----------
</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
Shares Capital Paid-In Retained Stockholders'
Outstanding Amount Capital Earnings Equity
----------- ------ ------- -------- ------
<S> <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 33,874 339 299,269 - - 299,608
Warrants exercised 23,437 234 224,761 - - 224,995
Net income - - - - - - 2,912,634 2,912,634
--------- ------- ----------- ----------- -----------
Balance, June 30, 1998 7,391,727 $62,775 $57,188,134 $13,176,887 $70,427,796
--------- ------- ----------- ----------- -----------
--------- ------- ----------- ----------- -----------
</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>
SIX MONTHS ENDED
-----------------------------
JUNE 30, JUNE 30,
1998 1997
------------- -----------
<S> <C> <C>
Cash flows provided by/(used for) operating activities $ (7,254,739) $ 6,641,204
Cash flows from investing activities:
Issuance of notes receivable (less payments) (6,783,293) (342,853)
Acquisition of intangibles (185,934) (2,173,570)
Purchase of property, equipment and leasehold improvements (2,218,664) (2,275,200)
Purchase of temporary investments (1,417,906) - -
Other (173,412) (224,354)
------------ -----------
Net cash used for investing activities (10,779,209) (5,015,977)
Cash flows from financing activities:
Proceeds from issuance of long term debt - - 679,361
Principal payments on long term debt (23,885) (452,196)
Proceeds from exercises of options and warrants 524,603 110,238
------------ -----------
Net cash provided by financing activities 500,718 337,403
------------ -----------
Net increase/(decrease) in cash and cash equivalents (17,533,230) 1,962,630
Cash and cash equivalents at beginning of period 31,254,048 5,638,958
------------ -----------
Cash and cash equivalents at end of period $ 13,720,818 $ 7,601,588
------------ -----------
------------ -----------
</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)
June 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 six months ended June 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
TURNKEY PROGRAM DEVELOPMENT
Under the Turnkey Program, the Company works independently or with an area
developer to identify superior store sites within a territory. The Company may
purchase or lease a selected site, design and construct a Schlotzsky's Deli
restaurant on the site and sell, lease or sublease the completed store to a
franchisee. Where the Company does not sell the property to a franchisee, the
Company sells the improved property, or, in the case of a leased property,
assigns the lease and any sublease, to an investor. Additionally, the Company
may sell the site or assign its earnest money contract and lease with its
franchisee to a third party investor who then assumes responsibility for
developing the store. The Company typically provides a credit enhancement on the
franchisee's lease on leased locations. Upon sale of the site or assignment of
its earnest money contract, the Company realizes revenue based on the excess of
the sales price over its cost of securing or developing the property, if it has
provided no credit enhancement on the lease. When a guaranty exists, the Company
defers revenue and related costs of the site to a date when the guaranty is
terminated or the Company's exposure to loss under the guaranty has passed. The
third-party investor may contract with the Company in a separate agreement to
manage construction of the Schlotzsky's Deli restaurant on the site. The Company
typically charges a construction management fee, plus interim interest on the
Company's monies outstanding during construction. The cost of construction,
interim interest and the management fee are collected upon completion of the
restaurant. The Company believes the Turnkey Program enhances the Company's
ability to recruit qualified franchisees by securing and developing high profile
sites and achieving critical mass for advertising purposes more quickly in
selected markets.
Turnkey Program development is stated at the lower of cost or estimated net
realizable value. Land, site development, building and equipment costs,
including capitalized carrying costs (primarily interest incurred and property
taxes), are accumulated and accounted for on a site specific basis. Construction
costs incurred in connection with the development of properties are capitalized
and accounted for with respect to each project. Generally, interest incurred and
property taxes are capitalized until the related properties are ready for sale.
Thereafter, such costs are charged to expense as they are incurred.
6
<PAGE>
Turnkey development revenue consisted of the following:
<TABLE>
SIX MONTHS ENDED
--------------------------
JUNE 30, JUNE 30,
1998 1997
----------- ------------
<S> <C> <C>
Sales to investors and franchisees $ 8,880,614 $ 12,105,851
Development and construction management fees 130,000 100,000
----------- ------------
Gross Turnkey Program 9,010,614 12,205,851
Turnkey Program costs (6,260,683) (11,011,509)
----------- ------------
Net revenue from Turnkey Program
projects 2,749,931 1,194,342
Rental income 43,600 253,426
Interim construction interest 88,217 - -
Plus: Recognized deferred revenue 550,396 - -
Less: Deferred revenue, net (574,665) - -
----------- ------------
Total Turnkey Program revenue $ 2,857,479 $ 1,447,768
----------- ------------
----------- ------------
</TABLE>
The following table reflects system performance of the Turnkey Program for
the year ended December 31, 1997 and the six months ended June 30, 1998:
<TABLE>
NUMBER OF UNITS
----------------------
JUNE 30, DECEMBER 31,
1998 1997
-------- ------------
<S> <C> <C>
Sites in process at beginning of period 78 30
Sites beginning development during the period 28 90
Sites completed as Company-owned stores - - (1)
Sites sold - revenue recognized (20) (7)
Sites sold - revenue deferred (6) (33)
Other - - (1)
---- ----
Sites in process at end of period 80 78
---- ----
---- ----
INVESTED AT
JUNE 30, 1998
-------------
Opened (receiving rent & royalties) 2 2 $ 1,725,000
Investment Sites (under construction) 12 3 14,060,000
Predevelopment Site (prequalification) 66 73 1,600,000
---- ---- -----------
80 78 $17,385,000
---- ---- -----------
---- ---- -----------
</TABLE>
Turnkey Program sites in process at the end of a period are classified as
current assets as management expects to complete and sell such sites within
the next year.
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.
7
<PAGE>
Basic and diluted EPS computations for the three and six months ended
June 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------- ----------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Basic EPS
- ----------
Net income available to common stockholders $1,570,521 $1,161,814 $2,912,634 $2,050,390
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average common shares outstanding 7,389,977 5,548,264 7,358,065 5,544,547
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Basic EPS $.21 $.21 $.40 $.37
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted EPS
- -----------
Net income available to common stockholders $1,570,521 $1,161,814 $2,912,634 $2,050,390
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average common shares outstanding 7,389,977 5,548,264 7,358,065 5,544,547
Assumed conversion of common shares issuable
under stock option plan and exercise of warrants 215,976 172,388 244,255 151,044
---------- ---------- ---------- ----------
Weighted average common and common
equivalent shares outstanding 7,605,953 5,720,652 7,602,320 5,695,591
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted EPS $.21 $.20 $.38 $.36
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
RECENT PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Management does not believe the implementation of this recent accounting
pronouncement will have a material effect on its consolidated financial
statements.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998, COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
REVENUES. Total revenues increased 40.5% from $7,341,000 to $10,314,000.
Royalties increased 30.9% from $3,606,000 to $4,720,000. This increase was
due to the opening of 131 restaurants during the period from July 1, 1997 to
June 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 13.1% and
same store sales increased 3.9% during the second quarter of 1998.
Franchise fees increased 58.3% from $240,000 to $380,000. This increase
was principally a result of a greater number of stores and a higher average
franchise fee per unit opened during the three-month period ended June 30, 1998.
A higher number of primary restaurants, which have a higher franchise fee, were
opened during the second quarter of 1998 than during the corresponding period in
1997.
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 31.0% from $1,439,000 to $1,885,000. This
increase was attributable to the relocation and upgrade of two Company-owned
units in the Austin, Texas market, which were temporarily closed or
under-performing, during the second quarter of 1997.
Brand contributions, or private label licensing fees, increased 24.7% from
$807,000 to $1,006,000. 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 127.3% from $762,000 to $1,732,000.
The release of guaranties on five sites sold in 1997 resulted in approximately
$550,000 of revenue in the current quarter. Revenues from the sales of eleven
sites developed under the Turnkey Program comprise the balance of Turnkey
development revenue generated during this period. None of these sites included
any credit enhancement from the Company.
Other fees and revenues increased 63.3% from $362,000 to $591,000. 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
three months ended June 30, 1998 and 1997, which has been principally
responsible for the increased revenue as discussed above.
<TABLE>
<CAPTION>
SYSTEM PERFORMANCE THREE MONTHS ENDED
---------------------
JUNE 30, JUNE 30,
1998 1997
-------- --------
<S> <C> <C>
Units Opened
Domestic
Freestanding 25 14
End Cap 2 3
Other 3 2
------- -------
Total Domestic Openings 30 19
International 1 2
------- -------
Total Openings 31 21
Units Closed (7) (3)
------- -------
Net Unit Growth 24 18
------- -------
------- -------
System-wide Sales (in thousands) $86,737 $66,951
Average Weekly Sales $ 9,900 $ 8,756
Increase in Average Weekly Sales 13.1% 9.8%
Stores in Operation 722 612
Increase in Same Store Sales 3.9% 3.5%
</TABLE>
COSTS AND EXPENSES. Royalty service costs increased 37.9% from $1,305,000
to $1,800,000. This increase was a result of the increase in royalty revenue
for the three months ended June 30, 1998, as compared to the same period in the
prior year. Royalty service costs as a percentage of royalties grew from 36.2%
to 38.1%. 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.
Restaurant cost of sales, which consists of food, beverage and paper
costs, increased 35.7% from $443,000 to $601,000, and as a percentage of
restaurant sales increased from 30.8% to 31.9%. Likewise, restaurant labor
costs increased 36.3% from $559,000 to $762,000, and as a percentage of
restaurant sales increased from 38.8% to 40.4% for the same quarter in 1997.
Restaurant operating expenses increased 20.1% from $452,000 to $543,000, but
as a percentage of restaurant sales decreased from 31.4% to 28.8% for the
three months ended June 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 the six
months ended June 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 59.6% from $2,419,000 to
$3,860,000 and as a percentage of total revenues increased from 33.0% to 37.4%.
Costs associated with certain Turnkey Program sites no longer being considered
for development were expensed in the current quarter. The release of Company
guaranties on five sites sold in 1997 resulted in deferred costs associated with
those sites being recognized during the second quarter of 1998. Also, the
Company continued to add personnel at the corporate office to support the
growing franchise system, incurring certain one-time expenses related to the
hiring and relocation of new employees. These items, together with expenses
associated with the completion of certain contractual obligations performed for
franchisees, were the principal reasons for the increases over the corresponding
period in 1997.
Depreciation and amortization increased 69.7% from $264,000 to $448,000,
and as a percentage of total revenues increased from 3.6% to 4.3%. The increase
was principally due to the amortization of goodwill and other intangibles
acquired in late 1997 and depreciation related to the additional Company-owned
stores.
OTHER. Net interest income increased from $137,000 to $417,000. 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 June 30, 1998,
which was slightly lower than the effective combined tax rate of 38.9% for
10
<PAGE>
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
SIX MONTHS ENDED JUNE 30, 1998, COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
REVENUES. Total revenues increased 37.2% from $13,675,000 to $18,767,000.
Royalties increased 30.5% from $6,883,000 to $8,979,000. This increase was
due to the opening of 131 restaurants opened during the period from July 1, 1997
to June 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 12.7% and
same store sales increased 5.2% during the six months ended June 30, 1998.
Franchise fees increased 21.4% from $593,000 to $720,000. This increase
was attributable to the opening of 11 more stores during the six months ended
June 30, 1998, as compared to the same period in 1997.
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 26.8% from $2,762,000 to $3,501,000. This
increase was attributable to the relocation and upgrade of two units in the
Austin, Texas market, which were temporarily closed or under-performing, during
the six months ended June 30, 1997.
Brand contributions, or private label licensing fees, increased 39.1% from
$1,342,000 to $1,866,000. 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 97.3% from $1,448,000 to $2,857,000.
The release of guaranties on five sites sold in 1997 resulted in approximately
$550,000 of revenue in the current quarter. Revenues from the sales of twenty
sites developed under the Turnkey Program, which had no credit enhancement from
the Company associated with the transactions, comprise the balance of Turnkey
development revenue generated during this period. Six additional sites sold
during the period included guaranties by the Company, and the revenue from these
transactions was deferred.
Other fees and revenues increased 61.7% from $522,000 to $844,000. 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.
11
<PAGE>
The following table reflects the growth of the franchise system for the six
months ended June 30, 1998 and 1997, which has been principally responsible for
the increased revenue as discussed above.
<TABLE>
<CAPTION>
SYSTEM PERFORMANCE SIX MONTHS ENDED
--------------------
JUNE 30, JUNE 30,
1998 1997
-------- --------
<S> <C> <C>
Units Opened
Domestic
Freestanding 44 36
End Cap 10 7
Other 4 4
-------- --------
Total Domestic Openings 58 47
International 3 3
-------- --------
Total Openings 61 50
Units Closed (12) (11)
-------- --------
Net Unit Growth 49 39
-------- --------
-------- --------
System-wide Sales (in thousands) $164,781 $127,955
Average Weekly Sales $ 9,568 $ 8,487
Increase in Average Weekly Sales 12.7% 10.6%
Stores in Operation 722 612
Increase in Same Store Sales 5.2% 2.8%
</TABLE>
COSTS AND EXPENSES. Royalty service costs increased 36.4% from $2,508,000
to $3,421,000. This increase was a result of the increase in royalty revenue
for the six months ended June 30, 1998, as compared to the same period in the
prior year. Royalty service costs as a percentage of royalties grew from 36.4%
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 35.0% from $841,000 to $1,135,000, and as a percentage of restaurant
sales increased from 30.4% to 32.4%. Likewise, restaurant labor costs increased
39.3% from $1,088,000 to $1,516,000, and as a percentage of restaurant sales
increased from 39.4% to 43.3% for the same quarter in 1997. Restaurant
operating expenses have increased 22.6% from $851,000 to $1,043,000, but as a
percentage of restaurant sales decreased from 30.8% to 29.8% for the six months
ended June 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 six
months ended June 30, 1998. Operating expenses increased principally because of
the reopening of these restaurants.
General and administrative expenses grew 53.0% from $4,429,000 to
$6,776,000 and as a percentage of total revenues increased from 32.4% to 36.1%.
Costs associated with certain Turnkey Program sites no longer being considered
for development were expensed in the current quarter. The release of Company
guaranties on five sites sold in 1997 resulted in deferred costs associated with
those sites being recognized during the second quarter of 1998. Also, the
Company continued to add personnel at the corporate office to support the
growing franchise system, incurring certain one-time expenses related to the
hiring and relocation of new employees. These items, together with expenses
associated with the completion of certain contractual obligations performed for
franchisees, were the principal reasons for the increases over the corresponding
period in 1997.
Depreciation and amortization increased 48.4% from $514,000 to $763,000,
and as a percentage of total revenues decreased from 3.8% to 4.1%. These
increases were principally due to the amortization of goodwill and other
intangibles acquired in late 1997 and depreciation related to the additional
Company-owned restaurants.
OTHER. Net interest income increased from $196,000 to $922,000. This
increase was a result of the higher level of funds invested during the more
recent period because of the secondary offering.
INCOME TAX EXPENSE. Income tax expense reflected a combined federal and
state effective tax rate of 37.5% for the six months ended June 30, 1998, which
was slightly lower than the effective combined tax rate of 38.4% 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.
12
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities was $7,255,000 for the first six
months of 1998. The use of cash resulted from the fact that purchases and
development costs of Turnkey Program properties far exceeded the proceeds
generated from the sale of Turnkey Program properties. Activity during the
first six 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
franchisees through the origination of a mortgage or interim construction
loan. The 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 a mortgage for
qualified franchisees and subsequently sell the mortgage, a financial
instrument, to one of several financial institutions. Net cash of
$10,779,000 was used in investing activities primarily consisting of
expenditures of $2,219,000 on the completion of the relocation of two
Company-owned stores and the use of $6,783,000 to fund certain Turnkey
Development costs associated with mortgage financing or making interim
construction loans to franchisees. During the balance of 1998, it is
anticipated that the cash needed to fund the development of Turnkey Program
properties will exceed the proceeds from the sale of the mortgages to the
financial institutions.
During the first half of 1998, financing activities provided net cash of
approximately $501,000 due primarily to the exercise of stock options and
warrants.
At June 30, 1998, the Company had approximately $2,163,000 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 June 30, 1998, these contingent liabilities totaled
approximately $28,491,000. Included in this amount 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 $1,105,000 at
June 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. Eighty properties were under contract or in
various stages of development at June 30, 1998. The tables below provide a
summary of the Turnkey Program activity for the six months ended June 30, 1997
and 1998.
Turnkey Program revenue consisted of the following:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
--------------------------
JUNE 30, JUNE 30,
1998 1997
----------- ------------
<S> <C> <C>
Sales to investors and franchisees $ 8,880,614 $ 12,105,851
Development and construction management fees 130,000 100,000
----------- ------------
Gross Turnkey Program revenue 9,010,614 12,205,851
Turnkey Program development costs (6,260,683) (11,011,508)
----------- ------------
Net revenue from Turnkey Program projects 2,749,931 1,194,343
Rental income 43,600 253,426
Interim construction interest 88,217 - -
Plus: deferred revenue recognized 550,396 - -
Less: deferred revenue, net (574,665) - -
----------- ------------
Total Turnkey Program revenue $ 2,857,479 $ 1,447,768
----------- ------------
----------- ------------
</TABLE>
13
<PAGE>
The following table reflects system performance of the Turnkey Program for
the year ended December 31, 1997 and the six months ended June 30, 1998:
<TABLE>
<CAPTION>
NUMBER OF UNITS
--------------------------
JUNE 30, DECEMBER 31,
1998 1997
-------- ------------
<S> <C> <C>
Sites in process at beginning of period 78 30
Sites beginning development during the period 28 90
Sites completed as Company-owned stores -- (1)
Sites sold - revenue recognized (20) (7)
Sites sold - revenue deferred (6) (33)
Other -- (1)
---- ----
Sites in process at end of period 80 78
---- ----
---- ----
INVESTED AT
JUNE 30, 1998
-------------
Opened (receiving rent & royalties) 2 2 $ 1,725,000
Investment Sites (under construction) 12 3 14,060,000
Predevelopment Site (prequalification) 66 73 1,600,000
---- ---- -----------
80 78 $17,385,000
---- ---- -----------
---- ---- -----------
</TABLE>
The Company currently has a line of credit available 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 June 30, 1998,
the Company had not drawn upon this line of credit. However, the Company has
provided certain guaranties on notes to franchisees and area developers which
reduced the available balance of this line of credit to $6,883,000.
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 foreseeable 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 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 not be limited to, projections of revenues,
income, capital expenditures, plans for future operations, financing needs or
plans, 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, along with factors set
forth in the Company's Annual Report on Form 10-K/A in "Business," pages 1-15.
14
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None
ITEM 2. CHANGES IN SECURITIES.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of the Shareholders of the Company was held on May 29,
1998. At the meeting, the following items were voted on:
1) Election of directors, whose terms expired at the meeting.
<TABLE>
<CAPTION>
FOR WITHHELD
--------- --------
<S> <C> <C>
John C. Wooley 5,886,580 19,401
Azie Taylor Morton 5,884,735 21,246
Jeffrey J. Wooley 5,886,580 19,401
</TABLE>
The following directors' terms of office were not expired and continued
after the meeting:
John L. Hill, Jr.
Floor Mouthaan
John M. Rosillo
Raymond A. Rodriguez
2) Proposal to approve amendments to the Third Amended and Restated 1993 Stock
Option Plan.
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
--------- ------- -------
<S> <C> <C>
5,228,589 612,713 64,679
</TABLE>
Of the amount voted "for," 1,914,219 were broker non-votes voted in
accordance with the terms of the proxy.
3) Proposal to approve the Schlotzsky's, Inc. Employee Stock Purchase Pan.
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
--------- ------- -------
<S> <C> <C>
5,858,491 30,335 17,155
</TABLE>
Of the amount voted "for," 1,914,450 were broker non-votes voted in
accordance with the terms of the proxy.
15
<PAGE>
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits:
<TABLE>
<CAPTION>
Exhibit
No.
-------
<S> <C>
27 Financial Data Schedule.
</TABLE>
b. Current Reports on Form 8-K:
1) The Registrant filed a report on Form 8-K on May 7, 1998 related
to the resignation of the Company's independent accountant under
Item 4. Changes in Registrant's Certifying Accountant.
2) The Registrant filed a report on Form 8-K on June 9, 1998 related
to the appointment of the Company's independent accountant under
Item 4. Changes in Registrant's Certifying Accountant.
16
<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
August 13, 1998
17
<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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 15,156,724
<SECURITIES> 0
<RECEIVABLES> 8,579,323
<ALLOWANCES> (518,000)
<INVENTORY> 0
<CURRENT-ASSETS> 41,548,801
<PP&E> 13,371,911
<DEPRECIATION> (1,630,014)
<TOTAL-ASSETS> 78,756,476
<CURRENT-LIABILITIES> 3,768,034
<BONDS> 0
0
0
<COMMON> 62,775
<OTHER-SE> 70,365,021
<TOTAL-LIABILITY-AND-EQUITY> 78,756,476
<SALES> 3,500,908
<TOTAL-REVENUES> 18,767,317
<CGS> 1,135,326
<TOTAL-COSTS> 15,028,945
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 50,000
<INTEREST-EXPENSE> (921,518)
<INCOME-PRETAX> 4,659,890
<INCOME-TAX> 1,747,256
<INCOME-CONTINUING> 2,912,634
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,912,634
<EPS-PRIMARY> .40
<EPS-DILUTED> .38
</TABLE>
