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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-27008
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SCHLOTZSKY'S, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2654208
(State or other Jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
203 COLORADO STREET, AUSTIN, TEXAS 78701
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (512) 236-3600
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange
Title of each class on which registered
COMMON STOCK, NO PAR VALUE NASDAQ NATIONAL MARKET
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NOT APPLICABLE
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes _X_ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K / /.
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 20, 1998 was approximately $118,835,000 based upon the
last sales price on March 20, 1998 on the NASDAQ National Market System for the
Company's common stock. For purposes of this computation, all officers,
directors and 10% beneficial owners of the registrant are deemed to be
affiliates. Such determination should not be deemed an admission that such
officers, directors or 10% beneficial owners are, in fact, affiliates of the
Registrant. Registrant had 7,378,567 shares of Common Stock outstanding on March
20, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission not later than 120 days after the close of
the registrant's fiscal year are incorporated by reference into Part III of this
Form 10-K.
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SCHLOTZSKY'S, INC.
INDEX TO FORM 10-K
YEAR ENDED DECEMBER 31, 1997
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PART I
Item 1. Business..................................................................................... 1
Item 2. Properties................................................................................... 15
Item 3. Legal Proceedings............................................................................ 15
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 16
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................ 16
Item 6. Selected Consolidated Financial Data......................................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation......... 18
Item 8. Financial Statements and Supplementary Data.................................................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure......... 28
PART III
Item 10. Directors and Executive Officers of the Registrant........................................... 28
Item 11. Executive Compensation....................................................................... 28
Item 12. Security Ownership of Certain Beneficial Owners and Management............................... 28
Item 13. Certain Relationships and Related Transactions............................................... 28
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................. 28
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PART I
ITEM 1. BUSINESS
Schlotzsky's, Inc. (the "Company") was formed effective January 1, 1993,
when Schlotzsky's Franchising Limited Partnership, Schlotzsky's-Houston, Ltd.,
Schlotzsky's-San Antonio, Ltd., Schlotzsky's Restaurant Management Corporation,
and Schlotzsky's, Inc. (collectively, the "Predecessor Entities") were merged
into the Company and its two wholly-owned subsidiaries, Schlotzsky's
Restaurants, Inc. and Schlotzsky's Real Estate, Inc. (the "1993 Merger"). In
June 1993, the Company raised $5 million through the sale of Class A Preferred
Stock and used the proceeds to redeem the preferred stock issued in the 1993
Merger to the investors in the Predecessor Entities other than John C. Wooley
and Jeffrey J. Wooley. The Company's other subsidiaries, which are wholly-owned,
are Schlotzsky's Brands, Inc., Schlotzsky's Equipment Corporation, DFW
Restaurant Transfer Corporation, 56th and 6th, Inc., and SREI Turnkey
Development, L.L.C. The Company and its subsidiaries are Texas corporations, and
references to the "Company" include its predecessors, and its and their
subsidiaries, unless the context otherwise requires.
The Company's principal executive offices are located at 203 Colorado
Street, Austin, Texas 78701, and its telephone number is (512) 236-3600.
GENERAL
The Company is a franchisor of quick service restaurants that feature
made-to-order sandwiches with unique sourdough buns. At December 31, 1997, the
Schlotzsky's system included seven Company-owned stores and 666 franchised
stores located in 39 states, the District of Columbia and 14 foreign countries.
System-wide sales were approximately $202.4 million for 1996 and $270.4 million
for 1997. Average unit volumes were $410,000 in 1996 and $455,000 for 1997.
STRATEGY
John C. Wooley and Jeffrey J. Wooley acquired the Company in 1981. They were
attracted to the Company by the unique characteristics of The Schlotzsky's
Original sandwich, the only sandwich sold at Schlotzsky's restaurants at that
time, and the strong brand loyalty that had developed for this sandwich in the
Company's markets. From 1981 to 1991, management tested different strategies to
expand the Company's business, including the development of Company-owned stores
and expanded store menus.
In 1991, the Company began implementing a strategy to achieve its objective
of becoming a leader in the specialty sandwich segment of the restaurant
industry in the United States. The key elements of this strategy are to: offer
an expanded menu of consistent, high quality foods featuring the Company's
proprietary bread recipes, complemented by excellent customer service; expand
the Turnkey Program to develop new stores in high visibility, free-standing
locations; utilize area developers to decentralize franchisee recruiting and
support; develop a strong network of motivated owner-operator franchisees; and
increase awareness of the Schlotzsky's brand through enhanced marketing and
private label products. Recently, the Company revised its strategy to include
the acquisition and development of a limited number of Company-owned stores,
principally for concept development.
MENU OF DISTINCTIVE, HIGH QUALITY PRODUCTS. Schlotzsky's Deli restaurants
offer an expanded menu of consistent, high quality foods featuring the Company's
proprietary bread recipes, complemented by excellent customer service. The menu
features made-to-order sandwiches with bread that is baked fresh from scratch
every day in each restaurant. The Schlotzsky's Original sandwich, which was
introduced in 1971, is a variation of the muffaletta sandwich made with three
meats (lean ham, Genoa salami and cotto salami), three cheeses (mozzarella,
cheddar and parmesan), garlic butter, mustard, marinated black olives, onion,
lettuce and tomato on a toasted sourdough bun. The Schlotzsky's Original
sandwich continues to be the most popular item on the Schlotzsky's menu.
Schlotzsky's Deli restaurants now offer an expanded menu with 15 sandwiches on
four types of bread, 10 sourdough crust pizzas, five salads, soups, chips and
other side items, fresh baked cookies and other desserts, and beverages. At most
locations, sandwiches
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range in price from $2.90 to $4.75 ($7.00 for an oversized Original), and
eight-inch gourmet pizzas are priced between $3.50 and $4.50.
TURNKEY PROGRAM; HIGH VISIBILITY STORES. The Company and its area
developers encourage franchisees to develop free-standing stores with high
visibility and easy access. The Company believes the location of a store is as
important to its success as the efforts of the franchisee, and works with area
developers to assist franchisees in identifying and acquiring superior store
locations. The Company implemented its Turnkey Program as a means of
accelerating the development of high visibility stores and capitalizing on the
Company's experience in evaluating store sites by providing a variety of
services from securing the site, to development and construction of the store.
The Turnkey Program also enhances the quality and consistency of the
free-standing stores developed for franchisees by the Company because of its
experience building prototype stores and its purchasing power with suppliers and
contractors.
AREA DEVELOPERS. The Company has 35 area developers trained to assist the
Company in achieving its expansion goals in the United States. Area developers
provide the following services: they recruit and qualify franchisees; they
assist franchisees in site selection, training, financing, building and opening
stores; they provide ongoing operational support; they monitor product and
service quality; and they help coordinate local advertising. Prior to 1991,
these functions were performed by Company personnel. By utilizing its area
developer network, the Company believes that it can effectively support a
growing number of franchised stores while controlling its overhead costs. Area
developers receive a portion of franchise fees and royalties from each store in
their territories and are motivated to develop their markets and monitor
operating performance. Area developers must meet specific store opening
schedules under their agreements with the Company in order to maintain their
development rights.
MOTIVATED OWNER-OPERATOR FRANCHISEES. The Company is developing a strong
network of owner-operator franchisees. The Company believes that a motivated
owner-operator is an essential key to the success of a store. The Schlotzsky's
system consists almost exclusively of franchised stores, owned and managed by
entrepreneurial franchisees. The Company seeks franchisees who are committed to
providing on-site supervision of store operations and prefers to limit
franchisees to three or four locations in relatively close proximity. As of
December 31, 1997, out of 416 franchisees with stores, 13 franchisees have more
than five stores each and, in the aggregate, account for approximately 12.8% of
the stores in the system.
INCREASED BRAND AWARENESS. The Company seeks to increase awareness of the
Schlotzsky's brand through enhanced marketing and private label products. The
Company is directing its franchising efforts to establish a sufficient number of
stores in larger markets to allow expanded cooperative advertising through
newspaper, radio and television. The Company has developed a complete line of
private label products to increase Schlotzsky's brand awareness. Private label
products are used by franchisees in preparing foods and are displayed at stores
as part of the standard decor package. Some private label products are sold by
franchisees for home consumption.
COMPANY-OWNED STORES. The Company's flagship store in Austin, Texas opened
in 1995, and two stores were acquired from franchisees by the Company in 1996,
one in New York City (Manhattan) and one in Houston. In addition in 1997, the
Company developed or acquired and began operating another store in Houston, one
in Illinois, one in Mississippi, and one in Georgia. In 1998, the Company
completed the relocation of two additional units in Austin, Texas. The Company
operates these stores primarily for product development, concept refinement and
prototype testing and training and to build brand awareness. The Company may
acquire or develop a limited number of other Company-owned stores in the future
for these purposes and may acquire or develop others from time to time with the
intent of transferring them to franchisees.
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EXPANSION
At December 31, 1997, the Schlotzsky's system consisted of 673 stores in 39
states, the District of Columbia, and 14 foreign countries. At December 31, 1995
and 1996, the system included 463 and 573 stores, respectively.
STORE LOCATIONS AS OF DECEMBER 31, 1997
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NUMBER OF
LOCATION STORES
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UNITED STATES:
Texas........................................................... 205
Arizona......................................................... 35
Georgia......................................................... 32
California...................................................... 29
Florida......................................................... 28
Michigan........................................................ 24
Tennessee....................................................... 24
Indiana......................................................... 23
Illinois........................................................ 20
Oklahoma........................................................ 18
Wisconsin....................................................... 17
Alabama......................................................... 15
Colorado........................................................ 15
New Mexico...................................................... 15
North Carolina.................................................. 15
South Carolina.................................................. 14
Nebraska........................................................ 11
Ohio............................................................ 11
Missouri........................................................ 10
Louisiana....................................................... 9
Utah............................................................ 9
Arkansas........................................................ 8
Kansas.......................................................... 8
Minnesota....................................................... 8
Nevada.......................................................... 6
Oregon.......................................................... 6
Virginia........................................................ 6
Washington...................................................... 6
Idaho........................................................... 3
Iowa............................................................ 3
Mississippi..................................................... 3
North Dakota.................................................... 3
West Virginia................................................... 3
Hawaii.......................................................... 2
New York........................................................ 2
Pennsylvania.................................................... 2
South Dakota.................................................... 2
Connecticut..................................................... 1
District of Columbia............................................ 1
Kentucky........................................................ 1
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TOTAL U.S....................................................... 653
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INTERNATIONAL:
Argentina....................................................... 3
Japan........................................................... 3
Turkey.......................................................... 3
Australia....................................................... 1
Canada.......................................................... 1
Germany......................................................... 1
Guatemala....................................................... 1
Korea........................................................... 1
Lebanon......................................................... 1
Malaysia........................................................ 1
Mexico.......................................................... 1
Saudi Arabia.................................................... 1
Sweden.......................................................... 1
United Kingdom.................................................. 1
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TOTAL INTERNATIONAL:............................................ 20
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TOTAL STORES:................................................... 673
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</TABLE>
TURNKEY PROGRAM
The Company instituted the Turnkey Program to further assist franchisees in
obtaining superior sites and to achieve more rapid penetration in those selected
major markets where the Company believes there is strong demand by franchisees
for good locations. Under the Turnkey Program, the Company works independently
or with an area developer to identify superior store sites within a territory.
The Company will typically 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.
From time to time, the Company will assign its earnest money contract on a site
and the franchisee's lease to a third-party investor who then assumes the
responsibility for developing the store.
The Company anticipates that the total investment in each developed
free-standing location will be approximately $1,000,000 to $1,500,000 (less for
leased locations). Since the inception of the Turnkey Program, the Company has
typically provided a credit enhancement in the form of a guaranty on the
franchisee's lease for leased locations. In 1997, upon sale of the site or
assignment of its earnest money contract, the Company deferred revenue generated
(even though proceeds were received in cash) and allocable costs incurred in
connection with the property. When a guaranty is terminated, or the Company's
exposure to loss under the guaranty has passed, the Company will recognize the
revenue and allocable costs related to the site. Generally, if no credit
enhancement is provided in connection with such transactions, the Company may
recognize the revenue and allocable expenses in the periods in which the
transactions occur. The Company believes that 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. In addition, the Company charges a fee when it is
requested to manage construction of a store on property owned by a franchisee or
an investor. This construction management fee is recognized when the store is
opened.
MENU
The Schlotzsky's Deli menu provides customers with popular food items which
the Company believes are fresher, more flavorful and of greater variety than
those offered by competitors. The key menu groups are made-to-order sandwiches
and pizzas, salads, soups, cookies and other desserts, and beverages. Sandwiches
and pizzas are made with delicatessen-style meats, grilled chicken and specialty
cheeses, all of which are purchased ready for use from approved suppliers. The
Company's distinctive sandwich buns and
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pizza crusts are baked daily from scratch, rather than with pre-mixed or frozen
dough, to ensure the highest quality and freshness.
FRANCHISING
The Company has adopted a strategy of franchising, rather than owning
stores. The Company believes that franchisees who own and operate stores are
more highly motivated and manage stores more efficiently than typical
manager-employees. Moreover, franchising allows the Company to expand the number
of stores and penetrate markets more quickly and with less capital than
developing Company-owned stores. Area developers play a role in the Company's
franchising program by recruiting qualified franchisees and by monitoring and
providing a high level of support to franchised stores.
AREA DEVELOPERS. The Company's 35 area developers recruit and qualify
franchisees according to criteria developed by the Company. Once a franchisee is
approved by the Company, the area developer works with the Company to assist the
franchisee in site selection, training, store design and layout, construction
and financing. The area developer provides store opening assistance, monitors
store performance and compliance with product and service quality standards
established by the Company and helps to coordinate cooperative advertising
within his territory. The Company generally pays area developers 50% of all
franchise fees paid by franchisees in their territories, although some area
developers have received up to 100% of certain franchise fees as an inducement
to develop their territories more quickly. In addition, the Company also pays
area developers approximately 42% of the royalties received under franchise
agreements providing for 6% royalties and 12.5% to 25% of royalties received
under franchise agreements providing for 4% royalties, in each case with respect
to franchisees in their territories. Area developers are not required to own or
operate stores, although some of the Company's area developers are also
franchisees, or have investments in franchisees, under separate franchise
agreements. Area developers are granted exclusive rights to one or more
television markets in the United States, typically for a term of 50 years. Each
area developer pays the Company a nonrefundable fee for the exclusive
development rights for a market. The Company typically receives 25% to 50% of
the area developer fee when the area development agreement is signed with the
balance payable with interest over an 18 to 36-month period under a promissory
note from the area developer.
Area development agreements are nonassignable without the prior written
consent of the Company, and consents have been granted from time to time. The
Company retains rights of first refusal with respect to any proposed sale by the
area developer. Area developers are not permitted to compete with the Company.
Area developers typically commit to a store opening schedule for each territory.
If an area developer fails to meet its obligations, the Company can terminate or
repurchase its territory for resale, although the Company has agreed to extend
or waive these store opening schedules for certain area developers.
FRANCHISEES. The Company believes the involvement of owners in daily store
operations is critical to the success of a franchise. The Company prefers
franchisees who will operate no more than three or four stores, located within a
single market. Franchisees are selected on the basis of various factors,
including business background, experience and financial resources. Because the
cost of building and equipping a Schlotzsky's Deli restaurant is somewhat higher
than for some other specialty sandwich franchise operations, the Company's
franchisees must make certain minimum investments into their stores, and
typically must have substantial cash resources or a relatively high net worth to
obtain financing to build and equip stores. While area developers identify and
recruit potential franchisees, all franchisees must be approved by the Company.
FRANCHISE AGREEMENTS. The Company enters into one or more agreements with
each franchisee granting the franchisee the right to develop one or more stores
within a territory over a defined period of time. Once a site for a store has
been selected by the franchisee and accepted by the Company, additional
documentation specifying that site is signed. Under the Company's current
standard franchise agreement, the franchisee is required to pay a franchise fee
of $20,000 for the franchisee's first store and $10,000 for any additional
store. The franchise fee is payable at the time of signing the agreement. The
current
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standard franchise agreement provides for a term of 20 years (with one ten-year
renewal option) and payment of a royalty of 6% of sales. As of December 31,
1997, 127 stores operated under franchise agreements entered into prior to 1991
were paying a royalty of 4% of sales.
The Company has the right to terminate any franchise agreement for certain
specific reasons, including a franchisee's failure to make payments when due or
failure to adhere to the Company's policies and standards. Many state franchise
laws, however, limit the ability of a franchisor to terminate or refuse to renew
a franchise. See "--Government Regulation."
FRANCHISEE TRAINING AND SUPPORT. Each franchisee is required to have a
principal operator approved by the Company who satisfactorily completes the
Company's training program and who devotes full business time and efforts to the
operation of the franchisee's stores. Franchisees may also enroll each store
manager in the Company's training program. The Company provides training at
operating Schlotzsky's Deli restaurants in various locations. In November 1995,
the Company opened its new flagship Schlotzsky's Deli restaurant in Austin,
Texas, which includes training facilities. Most franchisee training is being
conducted at that location. Franchisees are required to pass a minimum skills
test before they can begin operating their first store. An on-site training crew
is provided by the Company or an area developer for three days before and two
days after the opening of a franchisee's first store. Company management and
area developers maintain ongoing communication with franchisees, exchanging
operating and marketing information.
FRANCHISE OPERATIONS. All franchisees are required to operate their stores
in compliance with the Company's policies, standards and specifications,
including matters such as menu items, ingredients, materials, supplies,
services, fixtures, furnishings, decor and signs. Food preparation is
standardized and is limited to baking bread, slicing pre-cooked meats, cheese
and produce, melting cheese and heating sandwiches. Because they usually operate
no more than three stores, franchisees are expected to be actively involved in
monitoring operations at each store. Each franchisee has full discretion to
determine the prices to be charged to its customers. Franchise stores are
periodically inspected by area developers and the Company's field service
representatives. Area developers are responsible for monitoring the Company's
standards and specifications as set forth in the franchise agreement and the
Company's manuals on a continuous basis.
REPORTING. Most Schlotzsky's Deli restaurant franchisees are required to
report weekly sales and other data to the Company. Other franchisees are
required to report monthly. Generally, 6% royalties are payable weekly by
automatic bank drafts and 4% royalties are payable monthly by check. The Company
is evaluating point-of-sale software for use by franchisees to record and report
sales and other operating information and anticipates that new franchisees may
be required to use this point-of-sale software beginning at some point in 1998.
Although the Company has the right to audit franchisees, it relies primarily on
voluntary compliance by franchisees to accurately report sales and remit
royalties.
INTERNATIONAL MASTER LICENSEES. In addition to the Company's expansion in
the United States, the Company has granted nonassignable rights to develop
stores in international markets to master licensees. A master licensee is
typically licensed for 50 years to use the Schlotzsky's trademarks in designated
foreign territories and may grant area development rights and franchises in
those territories. Unlike area developers, master licensees contract directly
with franchisees, and the Company delegates the selection of franchisees and
approval of sites to the master licensees. When a master license is granted, the
master licensee pays the Company a negotiated, nonrefundable license fee. In
some instances, the Company will negotiate a territorial agreement pursuant to
which a foreign territory is reserved and the principal economic terms of the
master license agreement are agreed upon in return for a nonrefundable fee to be
applied toward the master license fee. The Company normally receives 15% to 35%
of the master license fee in cash when the master license or territorial
agreement is signed, with the balance payable with interest over a term of up to
48 months under a promissory note from the master licensee. Typically, the
Company also receives one-third to one-half of any sublicense and franchise fees
and one-third of any royalties received by the master licensee. All amounts
payable to the Company by the master licensees must be paid in U.S. dollars. As
of December 31, 1997, the Company had executed master licenses or
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territorial agreements covering 51 foreign countries. As with area developers,
if master licensees fail to meet their obligations, the Company can terminate
their rights or repurchase their territories for resale. Master licensees are
subject to various laws and regulations regarding franchising and licensing in
their territories and are responsible for complying with these laws and
regulations.
SITE SELECTION
The Company trains area developers to assist franchisees in selecting their
sites and developing their stores. Each franchisee is responsible for selecting
store locations acceptable to the Company. Site selection criteria are based on
accessibility and visibility of the site and selected demographic factors,
including population, residential and commercial density, income, age and
traffic patterns. The Company prefers that franchisees select sites for
free-standing or end-cap stores to maximize store visibility and sales
potential. As the table below indicates, the mix of store sites has changed
since the Company adopted a new strategy in 1991 focusing on higher visibility
stores.
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STORES OPENED BETWEEN
AS OF AS OF JANUARY 1, 1992 AND
STORE SITE DECEMBER 31, 1991 DECEMBER 31, 1997 DECEMBER 31, 1997
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Free-Standing............................. 24% 46% 53%
End-Cap................................... 31 29 26
In-Line................................... 28 12 7
Other..................................... 17 13 14
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Total..................................... 100% 100% 100%
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</TABLE>
The Company has developed a series of prototype store designs and
specifications for free-standing and end-cap stores which its area developers
make available for use by franchisees. These specifications may be adapted to
existing restaurants and other retail spaces.
UNIT ECONOMICS
The Company believes that the Schlotzsky's Deli restaurant concept offers
attractive unit economics. The cost to a franchisee of developing and opening a
prototype Schlotzsky's Deli restaurant (excluding restaurants like the Company's
flagship store) in leased space has recently ranged from approximately $300,000
to $500,000, including leasehold improvements, equipment, fixtures and initial
working capital. During the twelve months ended December 31, 1997, the average
store sales for Schlotzsky's Deli restaurants (excluding non-Deli restaurant
format stores) that were open for the entire period was approximately $442,000,
although store revenue varies significantly depending upon the type, size and
location of the store. The Company believes that food and paper costs for the
Schlotzsky's Deli menu items are relatively low as a percentage of gross store
sales as compared to many quick service restaurant concepts.
FINANCING
The Company typically does not, and is not obligated to, provide financing
to franchisees for the costs of developing and opening stores. Both the Company
and area developers assist franchisees in obtaining financing by identifying
third party financing sources. Certain financial institutions have designed
equipment leasing programs specifically for Schlotzsky's franchisees and have
developed guidelines for sale and leaseback financing for Schlotzsky's stores.
The Company has also identified Small Business Administration lenders which have
made loans to Schlotzsky's franchisees. These lenders are not committed to
provide any financing to franchisees and there can be no assurance that
franchisees will be able to finance their costs of opening stores on suitable
terms.
The Company from time to time agrees to guarantee its franchisees'
obligations to equipment and real property lessors or subordinates all or a
portion of its royalties to the obligations of franchisees on such
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leases. These guaranties provide for a limited number of payments or limited
time period for which the Company may be required to perform on its guaranty. As
of December 31, 1997, the Company had guaranteed an aggregate of approximately
$23.3 million which is principally comprised of real estate and equipment leases
and other obligations of its franchisees.
The Company plans to implement a mortgage financing program pursuant to
which franchisees selected by the Company may obtain financing for the purchase
of real estate, construction costs and equipment. The Company may provide
assistance in the form of a limited guaranty to facilitate the financing.
PURCHASING; PRIVATE LABELING
Franchisees are required to purchase equipment, furniture, smallwares,
merchandising displays and food from suppliers approved by the Company.
Approximately 80% of overall purchases of goods used in daily operations by the
Company's franchised stores are from International Multifoods Corporation, which
provides volume discounts to franchisees based upon system-wide purchases. The
Company believes that comparable goods are available at competitive prices from
numerous other suppliers.
The Company has licensed certain manufacturers to sell Schlotzsky's private
label meats, cheeses, potato chips and other products. The Company receives
licensing fees from these manufacturers based on their sales of private label
products to franchisees. While franchisees are not required to purchase private
label products, other than the Company's proprietary flour mixes, the Company
believes that most franchisees prefer them because they are of equal or superior
quality compared to other brand name products and generally are less expensive
than the supplies available from other approved sources. In addition, some
private label products can be sold separately at stores for home consumption,
enhancing brand awareness and providing franchisees with additional sales and
profit opportunities.
MARKETING
Franchised stores contribute 1% of gross sales to Schlotzsky's N.A.M.F.,
Inc. ("NAMF"), a non-profit corporation administered by the Company. In
addition, franchisees are required by the terms of their franchise agreements to
spend at least 3% of gross sales on advertising. To take advantage of critical
mass in certain television markets, franchisees are encouraged to form
cooperatives where advertising funds can be pooled to maximize the benefits of
advertising for members, or the Company may organize one or more cooperatives to
facilitate the coordinated expenditure of advertising funds for the benefit of
the franchisees. NAMF funds are used principally to develop and produce radio
and television commercials and print advertising for use in local markets,
in-store graphics and displays, and promotions, but such funds may also be used
to pay for media space or time. NAMF has developed advertising campaigns for use
by franchisees centered around different slogans, such as FUNNY NAME. SERIOUS
SANDWICH-Registered Trademark-; ACCEPT NO SUBSTITUTESKY'S-Registered Trademark-;
BEST BUNS IN TOWN-Registered Trademark-; and ORIGINAL TASTE EVERY DAY-TM-.
NAMF's field marketing representatives coordinate advertising campaigns and
promotions for area developers and franchisees.
COMPETITION
The food service industry is intensely competitive with respect to concept,
price, location, food quality and service. There are many well established
competitors with substantially greater financial and other resources than the
Company. Such competitors include a large number of national, regional and local
food service companies, including fast food and quick-service restaurants,
casual full-service restaurants, delicatessens, pizza restaurants and other
convenience dining establishments. Some of the Company's competitors have been
in existence longer than the Company and are better established in markets where
Schlotzsky's stores are or may be located. The Company believes that it competes
for franchisees with franchisors of other restaurants and various concepts.
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<PAGE>
Schlotzsky's stores compete primarily on the basis of distinctive, high
quality food and convenience, rather than price. The Company believes that
Schlotzsky's stores provide the quick service and convenience of fast food
restaurants while offering more distinctive, higher quality products. Pricing is
designed so that customers perceive good value (high quality food at reasonable
prices), even though Schlotzsky's menu prices are typically higher than certain
competitors' prices.
Competition in the food service business is affected by changes in consumer
taste, economic and real estate conditions, demographic trends, traffic
patterns, the cost and availability of qualified labor, product availability and
local competitive factors. The Company's area developers attempt to assist
franchisees in managing or adapting to these factors, but no assurance can be
given that some or all of these factors will not adversely affect some or all of
the franchisees.
TRADEMARKS, SERVICE MARKS AND TRADE SECRETS
The Company owns a number of trademarks and service marks registered with
the United States Patent and Trademark Office. The Company has also registered
or made application to register trademarks in foreign countries where master
licenses have been granted. The flour and bread making recipes and techniques
currently used in Schlotzsky's stores are based on a modification of the
Company's original recipe developed jointly by the Company and Pillsbury
Company. The recipes and techniques are protected by the Company and its
suppliers as trade secrets. The Company has not sought patent protection for
these recipes, and it is possible that competitors could develop flour recipes
and baking procedures that duplicate or closely resemble the Company's. The
Company considers its trademarks, service marks and trade secrets to be critical
to the business and actively defends and enforces them.
GOVERNMENT REGULATION
The Company must comply with regulations adopted by the Federal Trade
Commission (the "FTC") and with several state laws that regulate the offer and
sale of franchises. The Company also must comply with a number of state laws
that regulate certain substantive aspects of the franchisor-franchisee
relationship. The FTC's Trade Regulation Rule on Franchising (the "FTC Rule")
requires that the Company furnish prospective franchisees with a franchise
offering circular containing information prescribed by the FTC Rule.
State laws that regulate the franchisor-franchisee relationship presently
exist in a substantial number of states. Those laws regulate the franchise
relationship, for example, by requiring the franchisor to deal with its
franchisees in good faith, by prohibiting interference with the right of free
association among franchisees, by regulating discrimination among franchisees
with regard to charges, royalties or fees, and by restricting the development of
other restaurants within certain proscribed distances from existing franchised
restaurants. Those laws also restrict a franchisor's rights with regard to the
termination of a franchise agreement (for example, by requiring "good cause" to
exist as a basis for the termination), by requiring the franchisor to give
advance notice to the franchisee of the termination and give the franchisee an
opportunity to cure any default, and by requiring the franchisor to repurchase
the franchisee's inventory or provide other compensation. To date, those laws
have not precluded the Company from seeking franchisees in any given area and
have not had a material adverse effect on the Company's operations.
Each Schlotzsky's store must comply with regulations adopted by federal
agencies and with licensing and other regulations enforced by state and local
health, sanitation, safety, fire and other departments. Difficulties or failures
in obtaining the required licenses or approvals can delay and sometimes prevent
the opening of a new store.
Schlotzsky's stores must comply with federal and state environmental
regulations, such as those promulgated under the Federal Water Pollution Act,
Federal Clean Water Act of 1977 and the Federal Resource and Conservation
Recovery Act of 1976, but the Company believes that those regulations have not
had a material effect on their operations. More stringent and varied
requirements of local governmental bodies with respect to zoning, land use, and
environmental factors can delay and sometimes prevent development of new stores
in particular locations.
9
<PAGE>
The Company and its franchisees must comply with the Fair Labor Standards
Act and various state laws governing various matters, such as minimum wages,
overtime and other working conditions. Significant numbers of the food service
personnel in Schlotzsky's stores receive compensation at rates related to the
federal minimum wage and, accordingly, increases in the minimum wage increase
labor costs at those locations.
The Company and its franchisees also must comply with the provisions of the
Americans with Disabilities Act, which requires that employers provide
reasonable accommodation for employees with disabilities and that restaurants be
accessible to customers with disabilities.
EMPLOYEES
As of December 31, 1997, the Company employed 122 persons at its corporate
headquarters. None of the Company's employees is covered by a collective
bargaining agreement or is represented by any labor union. The Company believes
its relationship with its employees is good.
RISK FACTORS
In addition to the other information contained in this report, the following
factors should be considered carefully in evaluating the Company:
FORWARD LOOKING STATEMENTS. This report contains statements that constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "Securities Act") (and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act")). The words
"expect," "estimate," "anticipate," "predict," "believe," "intend," "plan,"
"project" and similar expressions and variations thereof are intended to
identify forward-looking statements. Such statements appear in a number of
places in this Report and include statements regarding the intent, belief or
current expectations of the Company, its directors or its officers with respect
to, among other things: (i) trends affecting the Company's financial condition
or results of operations; (ii) the Company's financing plans; (iii) the
Company's business and growth strategies; and (iv) the declaration and payment
of dividends. Shareholders and prospective investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties, and that actual results may differ materially from
those projected in the forward-looking statements as a result of various
factors. The accompanying information contained in this Report including,
without limitation, the information set forth under the headings "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
"Business," as well as information contained in the Company's other filings with
the Securities and Exchange Commission (the "Commission"), identify important
factors that could cause such differences.
RAPID GROWTH STRATEGY. During 1997, 120 new Schlotzsky's stores were
opened. During 1995 and 1996, the Company and its franchisees opened 120 and 135
stores, respectively. This level of store openings is significantly greater than
that experienced by the Company prior to 1995. The Company will rely primarily
upon, its area developers, franchisees, the Turnkey Program, and new geographic
markets to maintain this level of expansion. The number of openings and the
performance of new stores will depend on various factors, including: (i) the
availability of suitable sites for new stores; (ii) the ability of area
developers to recruit qualified franchisees; (iii) the ability of franchisees to
negotiate acceptable lease or purchase terms for new locations, obtain capital
required to construct, build-out and operate new stores, meet construction
schedules, and hire and train qualified store personnel; (iv) the establishment
of brand awareness in new markets; and (v) the ability of the Company and its
area developers to manage this anticipated expansion. Not all of these factors
are within the control of the Company, and there can be no assurance that the
Company will be able to maintain or accelerate its growth or that the Company
will be able to manage its expanding operations effectively. See
"Business--Strategy."
TURNKEY PROGRAM. As of December 31, 1997, the Company had developed 57
stores under the Turnkey Program. In the future, the Company expects to
significantly increase the percentage of new store openings under the Turnkey
Program. The Company has limited experience in implementing this program
10
<PAGE>
and there can be no assurance that results experienced to date are indicative of
future performance under the program. In addition, the Company may be unable to
sell properties acquired under the Turnkey Program at a profit or at its cost,
and the Company could be required to sell properties at a loss or hold
properties indefinitely, diminishing the capital available to reinvest in the
Turnkey Program. See "--Credit Risk and Contingencies," "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" and "Business--Turnkey Program."
RELIANCE ON AREA DEVELOPERS. The Company relies on its area developers to
find qualified franchisees. Area developers are independent contractors, and are
not employees of the Company. Most area developer agreements specify a schedule
for opening stores in the territory covered by the agreement. In the past, the
Company has agreed to extend or waive development schedules for certain area
developers, and there can be no assurance that area developers will be able to
meet their contractual development schedules. These schedules form the basis for
the Company's expectations regarding the number and timing of new store
openings. Delays in store openings could adversely affect the future operations
of the Company.
From time to time, the Company relies extensively on its area developers,
many of whom do not have experience operating restaurants. In those instances,
the Company has less direct involvement in recruiting franchisees and in
monitoring the quality of franchised stores. The Company provides training and
support to area developers, but the quality of store operations and the ability
of area developers to meet development schedules may be diminished by their lack
of experience. It may be difficult for the Company to enforce its area
development agreements or to terminate the area development rights of area
developers who fail to meet development schedules or other standards and
requirements imposed by the Company, limiting the ability of the Company to
develop the territories of such area developers. See "Business--Franchising."
Between January 1, 1995 and December 31, 1997, 99 of the 375 new stores
opened were within territories controlled by only two area developers. As of
December 31, 1997, these two area developers controlled 14 territories having a
total of 216 stores. As these 14 territories mature, system-wide growth will
depend upon more activity in other territories. The Company believes that the
concentration of store openings among a relatively few area developers is due
primarily to the longer tenure of these area developers with the Company and the
size of the territories covered by their agreements.
DEPENDENCE ON FRANCHISING CONCEPT. Because royalties from franchisees'
sales are a principal component of the Company's revenue base, the Company's
performance depends upon the ability of its franchisees to promote and
capitalize upon the Schlotzsky's concept and its reputation for quality and
value. The Company believes that the cost to a franchisee of opening a
Schlotzsky's Deli restaurant is higher than the store opening costs incurred by
franchisees of many of the Company's competitors for franchisees. This
necessarily limits the number of persons who are qualified to be franchisees of
the Company. The Company has established criteria for area developers to use in
evaluating prospective franchisees, but there can be no assurance that area
developers will recruit franchisees who have the business abilities or financial
resources necessary to open Schlotzsky's stores on schedule or that franchisees
will conduct operations in a manner consistent with the Company's concepts and
standards. See "Business--Franchising."
The Company is subject to various state and federal laws relating to the
franchisor-franchisee relationship. The failure by the Company to comply with
these laws could subject the Company to liability to franchisees and to fines or
other penalties imposed by governmental authorities. The Company believes that
the franchising industry is experiencing an increasing trend of franchisees
filing complaints with state and federal governmental authorities and
instituting lawsuits against franchisors claiming that they have engaged in
unlawful or unfair trade practices or violated express or implied agreements
with franchisees. While the Company's experience is consistent with the trends
in the industry, the Company believes that it is in material compliance with
these laws and regulations and its agreements with franchisees, and that its
relations with its franchisees are generally good. See "Business--Government
Regulation" and "--Litigation."
11
<PAGE>
IMPORTANCE OF LICENSING FEES. During the past two years, the Company's
revenue from private label licensing fees (brand contribution) has increased
significantly as the volume of system sales has increased and franchisees have
increased their participation in the Company's purchasing programs. This revenue
is largely dependent upon the voluntary participation of the franchisees. The
Company believes its purchasing programs provide franchisees with significant
cost savings and other advantages. There can be no assurance that the Company's
suppliers will not increase prices to franchisees or that franchisees will not
negotiate more favorable terms from other approved suppliers. Some franchisees
may also object to these fees as a source of revenue to the Company. Any of
these developments could result in reduced purchases by franchisees of private
label products and declining private label licensing revenue to the Company.
This could have a material adverse effect on the financial condition and results
of operations of the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations."
CREDIT RISK AND CONTINGENCIES. The Company guarantees certain real estate
and equipment leases and other obligations of its franchisees. The Company
enters into guaranties with respect to most of the leases entered into between
its franchisees and the buyers of the sites developed under the Turnkey Program.
These guaranties typically cover lease payments or various other obligations of
the franchisee for a period ranging from 18 months to five years, and are
effective throughout the term of the 20 year lease. In addition, it is
contemplated that the Company will guarantee a limited portion of most of the
mortgages of certain franchisees who purchase Turnkey Program sites pursuant to
the mortgage financing program which the Company plans to implement during 1998.
See "Business--Turnkey Program." At December 31, 1997, the Company was
contingently liable for approximately $23.3 million which is principally
comprised of real estate and equipment leases and other obligations of its
franchisees.
The Company charges area developers and master licensees a fee ("developer
fee") for the rights to develop a defined territory. Typically, a portion of the
developer fee has been paid in cash and the balance paid with a promissory note
from the area developer or master licensee. The Company periodically evaluates
the credit risk and obtains annual valuations of these notes from an independent
financial services institution with expertise in valuing instruments of this
sort. As of December 31, 1997, the Company held notes receivable from area
developers and master licensees in an aggregate principal amount of
approximately $3.5 million. At December 31, 1997, the principal balance of these
notes had been reserved on the financial statements of the Company by
approximately $443,000, reflecting the fair market value of such notes based
upon valuations from the independent financial services institution. The Company
also holds notes receivable from certain franchisees related to the sale of
Company-owned stores and certain other obligations. As of December 31, 1997, the
outstanding principal amount of these notes was approximately $1,815,000. While
the Company considers it unlikely that there will be defaults on a significant
amount of the notes, such defaults could adversely affect the Company's
financial condition. Parties controlled by or related to directors, officers and
principal shareholders of the Company have provided financing to certain area
developers and master licensees and have guaranteed obligations of certain area
developers and master licensees to the Company. See "Certain
Transactions--Master License and Area Development Agreements" and
"Business--Franchising--International Master Licensees."
A wholly owned subsidiary of the Company is the general partner of a limited
partnership that developed a retail shopping center in the Austin area. The
Company and its subsidiary have guaranteed the repayment of a loan for this
project in the principal amount of $1.1 million due in April 2001. The Company
does not exercise control over the partnership and does not consider its
investment in the retail shopping center to represent a separate line of
business. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
LIMITED OPERATING HISTORY OF PROTOTYPES. Over the past several years, the
Company has refined its store prototypes and currently encourages franchisees to
develop larger, free-standing stores with higher visibility. This has increased
the costs to franchisees of opening and operating stores. The Company and
franchisees have a limited history of operating these larger stores, and results
achieved to date may not be indicative of future results. There can be no
assurance that, on a sustained basis, the Company will be able
12
<PAGE>
to attract and retain franchisees qualified to assume the increased debt and the
management responsibility associated with the larger operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements of the Company and the
Notes thereto.
GEOGRAPHIC CONCENTRATION. Of the 673 stores in the system at December 31,
1997, 205 were located in Texas. A downturn in the regional economy or other
significant adverse events in Texas could have a material adverse effect on the
Company's financial condition and results of operations.
CERTAIN FACTORS AFFECTING THE RESTAURANT INDUSTRY. The Company and its
franchisees may be affected by risks inherent in the restaurant industry,
including: adverse changes in national, regional or local economic or market
conditions; increased costs of labor (including increases in the minimum wage);
increased costs of food products; management problems; increases in the number
and density of competitors; limited alternative uses for properties and
equipment; changing consumer tastes, habits and spending priorities; changing
demographics; the cost and availability of insurance coverage; uninsured losses;
changes in government regulation; changing traffic patterns; weather conditions;
and local, regional or national health and safety matters. The Company and its
franchisees may be the subject of litigation based on discrimination, personal
injury or other claims, including claims which may be based upon legislation
that imposes liability on restaurants or their employees for injuries or damages
caused by the negligent service of alcoholic beverages to an intoxicated person
or to a minor. The Company can be adversely affected by publicity resulting from
food quality, illness, injury or other health concerns or operating issues
resulting from one restaurant or a limited number of restaurants in the
Schlotzsky's system. None of these factors can be predicted with any degree of
certainty, and any one or more of these factors could have a material adverse
effect on the Company's financial condition and results of operations.
COMPETITION. The food service industry is intensely competitive with
respect to concept, price, location, food quality and service. There are many
well-established competitors with substantially greater financial and other
resources than the Company. These competitors include a large number of
national, regional and local food service companies, including fast food and
quick service restaurants, casual full-service restaurants, delicatessens, pizza
restaurants and other convenience dining establishments. Some of the Company's
competitors have been in existence longer than the Company and may be better
established in markets where Schlotzsky's stores are or may be located. The
Company believes that it competes for franchisees against franchisors of other
restaurants and various other concepts.
Competition in the food service industry is affected by changes in consumer
taste, economic and real estate conditions, demographic trends, traffic
patterns, the cost and availability of qualified labor, product availability and
local competitive factors. The Company's area developers assist franchisees in
managing or adapting to these factors, but no assurance can be given that some
or all of these factors will not adversely affect some or all of the
franchisees. See "Business--Competition."
CONTROL BY PRINCIPAL SHAREHOLDERS. As of December 31, 1997, John C. Wooley
and Jeffrey J. Wooley beneficially owned an aggregate of approximately 12.5% of
the outstanding Common Stock. Additionally, Greenfield Capital Partners B.V. and
NethCorp Investments VI B.V., entities of which Floor Mouthaan, a director of
the Company is the managing director, beneficially owned an aggregate of 5.6% of
the outstanding Common Stock, and Getov Holding B.V. and Buxtehude Holding B.V.,
entities of which John M. Rosillo, a director of the Company, is the managing
director, beneficially owned an aggregate of 3.8% of the outstanding Common
Stock at December 31, 1997. As a result, these shareholders, if they were to act
in concert, would have the ability to influence the outcome of any issue
submitted to a vote of the shareholders. There are no agreements or
understandings among these shareholders regarding the voting of their shares,
but to date they have voted consistently on matters submitted to a vote of the
shareholders.
DEPENDENCE ON MANAGEMENT AND KEY PERSONNEL. The Company's success is highly
dependent upon the efforts of its management and key personnel, including its
Chairman of the Board and President, John C. Wooley. The Company has employment
agreements with John C. Wooley, Jeffrey J. Wooley, Kelly R. Arnold and Karl D.
Martin, each of which includes certain noncompetition provisions that survive
the
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termination of employment. The employment agreements with John C. Wooley and
Jeffrey J. Wooley were entered into effective February 1998 and will expire in
February 2001. The Company also has obtained certain noncompetition agreements
from several other members of management and key personnel who are not subject
to employment agreements. However, there can be no assurance such noncompetition
agreements will be enforceable. The loss of the services of John C. Wooley or
other management or key personnel could have a material adverse effect on the
Company. The Company does not carry key man life insurance on any of its
officers. See "Management."
GOVERNMENT REGULATION. The restaurant industry is subject to numerous
federal, state and local governmental regulations, including those relating to
the preparation and sale of food and zoning and building requirements. The
Company and its area developers and franchisees are also subject to laws
governing their relationships with employees, including wage and hour laws, and
laws and regulations relating to working and safety conditions and citizenship
or immigration status. The Company's franchise operations are subject to
regulation by the United States Federal Trade Commission and the Company must
also comply with state laws relating to the offer, sale and termination of
franchises and the refusal to renew franchises. The failure to obtain or
maintain approvals to sell franchises could adversely affect the Company.
Increases in the minimum wage rate, employee benefit costs or other costs
associated with employees, could adversely affect the Company's area developers
and franchisees and, therefore, adversely affect the Company. See
"Business--Government Regulation."
ABSENCE OF DIVIDENDS. The Company has never paid cash dividends on its
Common Stock and does not anticipate paying any cash dividends in the
foreseeable future.
POTENTIAL VOLATILITY OF STOCK PRICE. There have been periods of significant
volatility in the market price and trading volume of the Common Stock, which in
many cases were unrelated to the operating performance of, or announcements
concerning, the Company. General market price declines or market volatility in
the future could adversely affect the price of the Common Stock. In addition,
the trading price of the Common Stock has been and is likely to continue to be
subject to significant fluctuations in response to variations in quarterly
operating results, the results of the Turnkey Program, changes in management,
competitive factors, regulatory changes, general trends in the industry,
recommendations by securities industry analysts and other events or factors.
This volatility has been exacerbated by the lack of a significant public float
in the Common Stock. There can be no assurance that an adequate trading market
can be maintained for the Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE. As of December 31, 1997, the Company had
7,334,416 shares of Common Stock outstanding. A substantial number of shares
will become available for sale in the public market at various times. No
predictions can be made as to the effect, if any, that market sales or the
availability of shares for future sale will have on the market price of the
Common Stock. Sales of substantial amounts of Common Stock in the public market,
or the perception that such sales could occur, could adversely affect the
prevailing market price for the Common Stock and could impair the Company's
ability to raise capital through a public offering of equity securities.
ANTI-TAKEOVER PROVISIONS. The Texas Business Combination Law, which became
effective September 1, 1997, restricts certain transactions between a public
corporation and affiliated shareholders. The statute, which is applicable to the
Company, may have the effect of inhibiting a non-negotiated merger or other
business combinations involving the Company.
The Company's Articles of Incorporation and Bylaws include certain
provisions that may have the effect of discouraging or delaying a change in
control of the Company. Directors are elected for staggered three-year terms,
which has the effect of delaying the ability of shareholders to replace specific
directors or effect a change in a majority of the Board of Directors. All
shareholder action must be effected at a duly called annual or special meeting
of shareholders and shareholders must follow an advance notification procedure
for certain shareholder proposals and nominations of candidates for election to
the Board of Directors.
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The Board of Directors has the authority, without further action by the
shareholders, to issue up to 1,000,000 shares of Preferred Stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
and to issue authorized unissued shares of Common Stock. The issuance of
Preferred Stock or additional shares of Common Stock could adversely affect the
voting power of the Common Stockholders and could have the effect of delaying,
deferring or preventing a change in control of the Company. The issuance of
Preferred Stock also could adversely affect other rights of Common Stockholders,
including creation of a preference upon liquidation or upon the payment of
dividends in favor of the holders of Preferred Stock.
ITEM 2. PROPERTIES
In March 1997, the Company entered into a lease with a limited liability
company owned by John C. Wooley and Jeffrey J. Wooley for a new corporate
headquarters facility in Austin. This lease will expire in 2007. The new
facility consists of approximately 41,000 square feet of office and storage
space. The Company moved to this new facility in November 1997. The former
corporate headquarters facility, consisting of approximately 11,000 square feet
of office space in Austin, was sold by the Company in December 1997. See
"Management's Discussions and Analysis of Financial Condition and Results of
Operations--Results of Operations."
The Company leases approximately 10,000 square feet of space for the
flagship Schlotzsky's Deli restaurant and training facility in Austin and
approximately 7,100 square feet for a store opened in Austin in February 1998.
The Company has a ground lease for an additional 2,700 square foot store which
opened in Austin in February 1998. The Company leases approximately 3,000 square
feet each for two stores which it operates in Houston and the Company has plans
for two additional new stores in Houston. The Company also owns the site of its
store in North Lake, Illinois and leases approximately 1,800 square feet for its
store in New York City. It is contemplated that one of the Houston stores and
the North Lake, Illinois store will be sold, and that the other store in Houston
will be closed when one of the new stores currently in the planning stages for
Houston is opened.
As of December 31, 1997, the Company had 78 store sites in various stages of
development under the Turnkey Program. Construction was completed on two stores
and these stores are operating and under lease. Three of the sites in
development are in various stages of construction and 73 sites remain in the
pre-development stage. The Company also owns three sites, which it contemplates
remarketing. It is contemplated that stores developed under the Turnkey Program
will be sold as they are completed. See "Business--Turnkey Program."
Schlotzsky's Real Estate, Inc., a wholly-owned subsidiary of the Company, is
the general partner and the Company is a limited partner of a limited
partnership which owns a 17,600 square foot shopping center in suburban Austin.
Schlotzsky's Real Estate, Inc. and the Company have a combined 40% interest in
the capital and profits of this limited partnership. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
ITEM 3. LEGAL PROCEEDINGS
The State of New Mexico Taxation and Revenue Department has assessed the
Company $131,000 for gross receipts taxes, penalties and interest for the years
1987 through 1993. The assessment imposes gross receipts taxes on franchise fees
and royalties received by the Company from New Mexico franchisees and NAMF
contributions by those franchisees. The Company filed a protest with the New
Mexico Taxation and Revenue Department claiming that the assessment violates the
Commerce Clause of the United States Constitution because the Company does not
have any physical presence in or substantial nexus with New Mexico. The Company
has reserved a liability for taxes and attorneys' fees in respect of this
assessment. See the Consolidated Financial Statements of the Company and related
Notes included elsewhere in this Prospectus. If other state taxing authorities
attempt to impose taxes on receipts derived by the Company from franchisees in
those states, the Company's financial condition and results of operations could
be materially adversely affected.
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The Company is subject to routine litigation in the ordinary course of
business, including contract, franchisee, area developer and employment-related
litigation. In the course of enforcing its rights under existing and former
franchise agreements and area developer agreements, the Company is subject to
complaints and letters threatening litigation concerning the interpretation and
application of these agreements, for example, in cases of administration of the
NAMF advertising funds, default or termination of franchisees or area
developers, requirements or payments relating to products used in the stores
(such as private label licensing), and the Turnkey Program. The Company
endeavors to treat its franchisees and area developers reasonably and fairly and
in compliance with applicable contractual provisions with due regard for the
protection of the Company's trademarks, service marks and goodwill. None of
these routine matters, individually or in the aggregate, are believed by the
Company to be material to its business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The authorized capital stock of the Company consists of 30,000,000 shares of
Common Stock, no par value, and 1,000,000 shares of Class C Preferred Stock, no
par value. The Company's Common Stock is traded on the National Market of the
National Association of Securities Dealers Automated Quotation System ("NASDAQ")
under the Symbol "BUNZ". Trading began on December 15, 1995 in connection with
the Company's initial public offering. No public market existed for the Common
Stock prior to that time. As of March 20, 1998, 7,378,567 shares of outstanding
Common Stock were owned of record by 251 Shareholders.
The high and low bid prices as reported by NASDAQ for the period from
January 1, 1996 to December 31, 1997 are set forth below:
<TABLE>
<CAPTION>
HIGH LOW
-------- --------
<S> <C> <C>
FISCAL 1996:
First Quarter................................... 11 8 7/8
Second Quarter.................................. 13 3/4 9 1/2
Third Quarter................................... 12 3/4 9 3/4
Fourth Quarter.................................. 11 3/4 9 1/4
FISCAL 1997
First Quarter................................... 12 1/4 9 5/8
Second Quarter.................................. 14 1/4 10 3/4
Third Quarter................................... 20 3/8 13 1/4
Fourth Quarter.................................. 20 1/4 14 1/2
</TABLE>
These quotations may reflect inter-dealer prices, without retail mark-up,
mark-down or commissions and may not necessarily represent actual transactions.
The Company has never paid and has no current plans to pay cash dividends on its
Common Stock. The Company currently intends to retain earnings for use in the
operation and expansion of the Company's business and does not anticipate paying
cash dividends in the foreseeable future. The declaration and payment of future
dividends will be at the sole discretion of the Board of Directors and will
depend on the Company's profitability, financial condition, capital needs,
future prospects and other factors deemed relevant by the Board of Directors.
The Transfer Agent and Registrar for the Company's Common Stock is Harris
Trust and Savings Bank of Chicago, Illinois.
16
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data for the
Company for the periods and the dates indicated. The historical consolidated
financial data as of and for the years ended December 31, 1995, 1996 and 1997
have been derived from the audited consolidated financial statements of the
Company and its predecessor entities, included elsewhere herein. The balance
sheet data and statement of operations data as of and for the years ended
December 31, 1993 and 1994 have been derived from the Company's audited
financial statements not included or incorporated herein. The selected financial
data should be read in conjunction with, and are qualified in their entirety by,
the Consolidated Financial Statements of the Company and related Notes and other
financial information included elsewhere in this report.
<TABLE>
<CAPTION>
FISCAL YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Royalties................................................... $ 2,969 $ 4,657 $ 7,425 $ 10,747 $ 14,561
Franchise fees.............................................. 621 1,019 1,494 1,775 1,555
Developer fees.............................................. 2,170 2,793 2,666 1,993 325
Restaurant sales............................................ 623 428 505 3,610 6,364
Brand contribution.......................................... -- 150 397 1,295 2,915
Turnkey development......................................... -- -- 41 726 1,139
Other fees and revenue...................................... 141 256 324 568 1,110
--------- --------- --------- --------- ---------
Total revenue........................................... 6,524 9,303 12,852 20,714 27,969
Costs and expenses:
Service costs:
Royalties................................................. 372 1,122 2,405 3,791 5,373
Franchise fees............................................ 338 661 767 959 813
Restaurant operations:
Cost of sales............................................. 202 188 189 1,183 2,014
Labor costs............................................... 214 154 408 1,424 2,493
Operating expenses........................................ 380 260 251 1,040 1,952
General and administrative.................................. 3,679 4,199 5,751 7,028 8,054
Depreciation and amortization............................... 268 372 458 779 1,155
--------- --------- --------- --------- ---------
Total costs and expenses................................ 5,453 6,956 10,229 16,204 21,854
--------- --------- --------- --------- ---------
Income from operations.................................... 1,071 2,347 2,623 4,510 6,115
Other:
Interest income (expense)................................... (240) (201) (149) 455 753
Other income (expense)...................................... 232 226 138 132 195
--------- --------- --------- --------- ---------
Total other income (expense)............................ (8) 25 (11) 587 948
--------- --------- --------- --------- ---------
Income (loss) before income taxes and extraordinary gain.... 1,063 2,372 2,612 5,097 7,063
Provision for income taxes.................................. 56 927 1,017 1,902 2,614
Gain on extinguishment of debt, net of tax.................. -- 40 38 -- --
--------- --------- --------- --------- ---------
Net income (loss)........................................... $ 1,007 $ 1,485 $ 1,633 $ 3,195 $ 4,449
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net income per share--basic(1).............................. $ .26 $ .47 $ .47 $ .58 $ .74
Net income per share--diluted(1)............................ $ .26 $ .44 $ .42 $ .57 $ .71
CONSOLIDATED BALANCE SHEET DATA:
Working capital............................................. $ (2,397) $ 1,909 $ 18,750 $ 13,515 $ 42,563
Total assets................................................ 12,364 16,481 36,708 40,979 79,521
Long-term debt, less current maturities(2).................. 6,420 10,452 3,029 3,129 1,936
Stockholders' equity........................................ 584 1,614 28,974 32,312 66,991
</TABLE>
- --------------------------
(1) Earnings per share reflects retroactive application of Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earning Per Share."
(2) For 1993 and 1994, long-term debt includes $5,000,000 and $8,000,000,
respectively for redeemable preferred stock.
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company derives its revenue from several sources: royalties, franchise
fees, developer fees (consisting of area developer and master licensee fees),
Company-owned restaurant sales, turnkey development, brand contribution (private
label licensing fees), and other franchise-related activities. Between 1991 and
1994, developer fees and franchise fees grew to represent a significant portion
of total revenue as the Company sold development rights for most of the
television markets in the United States and certain international territories.
Franchise fees, turnkey development and brand contribution increased during this
period as the rate at which stores opened increased. Since the Company has sold
developer rights for virtually all of the United States, developer fees derived
from these non-recurring transactions have declined as a percentage of total
revenue, while franchise fees and royalties based on franchise store sales and
revenue from the Turnkey Program have increased.
Royalties are based on a percentage of franchisees' net sales and are
recognized by the Company in the same period that the franchise store sales
occur. Generally, royalties are earned at the rate of 6% of sales for stores
opened after the 1991 year end, and 4% of sales for stores opened before that
time. Royalties are paid by means of weekly automatic drafts by the Company on
franchisee bank accounts for 6% royalty stores. As of December 31, 1997, 127
franchised stores were paying royalties on a monthly basis at the rate of 4%.
This number of stores will decline as older franchise agreements expire (the
majority of which will expire after 1998). A portion of the royalties received
by the Company are paid to its area developers as royalty service costs for
providing on-going services to franchisees in their territories. As more stores
open under 6% franchise agreements, the Company expects that royalty service
costs will approach 42% of royalties. See "Business--Franchising--Area
Developers." Royalties have increased since 1992 due not only to the growth in
the number of stores, but also to increases in average weekly sales. The
increase in average weekly sales is due primarily to the conversion of older
franchise stores to the Schlotzsky's Deli restaurant concept, as well as the
selection of more free-standing locations for newer stores, which have better
visibility and generally experience higher sales than the smaller "in-line"
stores located in strip shopping centers which are characteristic of stores
opened prior to 1992.
Franchise fees are nonrefundable payments received by the Company from
franchisees and are typically recognized into revenue as stores open. The
franchise fee for a franchisee's initial store is currently $20,000. The
franchise fee for each additional store committed to and opened by a franchisee
is $10,000. Expenses associated with franchise fees are shown as franchise fee
service costs and include the portion of the franchise fee paid to area
developers. The Company generally pays area developers approximately one-half of
the franchise fees collected from franchisees in their development areas,
although the Company agreed to pay some area developers up to 100% of certain
franchise fees as an inducement to develop their territories more quickly. As
the number of stores covered by these enhanced arrangements begins to diminish
and as the Company reacquires a limited number of territories, the Company
expects that franchise fee service costs will decrease as a percentage of
franchise fees to approximately 50%.
Restaurant sales are reported from Company-owned stores, and declined
between 1991 and 1994 as a result of the Company's strategy adopted in 1991 to
develop only franchised stores. The number of Company-owned stores declined from
22 to two stores between 1990 and 1994. Restaurant sales increased significantly
in 1996 because the Company's flagship restaurant in Austin, Texas was in
operation the entire year and because two additional stores were acquired from
franchisees during 1996. Currently, Company stores are operated primarily for
product development, concept refinement and training franchisees. Management
does not believe that the operating cost of sales for Company-owned stores is
indicative of costs for franchised stores on a system-wide basis. Restaurant
sales should increase as the Company opens a limited number of additional
Company-owned stores. See "Business--Strategy--Company-Owned Stores."
18
<PAGE>
The Company charges developers a nonrefundable fee for the exclusive rights
to develop a defined territory for a specified term. Typically, a portion of the
developer fee is paid in cash and the balance is paid with a promissory note.
See "Business--Franchising--Area Developers" and "--International Master
Licensees." When the Company has fulfilled substantially all of its contractual
responsibilities and obligations, such as training, providing manuals, and, in
the case of master licensees, reasonable efforts to obtain trademark
registration, the Company recognizes as revenue the cash portion of the fee and
the value of the promissory note, as determined by an independent third party
valuation. These fees have declined in the last two years as most of the
remaining domestic territories have been sold and fees from the licensing of
international territories, which are not aggressively marketed by management,
remain sporadic.
Revenue is also generated from brand contribution (private label licensing
fees) and the Turnkey Program. The Company has licensed manufacturers to produce
Schlotzsky's private label products and began receiving licensing fees from
sales of private label foods to franchisees in late 1994. This revenue has
increased significantly to $1,295,000 for 1996 and $2,915,000 for 1997. The
Company believes that private label licensing fees will increase as system-wide
sales grow. See "Business--Purchasing; Private Labeling" and "Risk
Factors--Importance of Licensing Fees."
Under the Turnkey Program, the Company works independently or with an area
developer to identify superior store sites within a territory. The Company
typically purchases or leases a selected site, designs and constructs a
Schlotzsky's Deli restaurant on the site and sells, leases or subleases 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. The Company
typically guaranties a portion of the lease in favor of the investor, and is
indemnified by the franchisee in the event the guaranty is called upon. Revenue
and allocable expenses from these transactions have been deferred, even though
the Company typically receives cash when the property is sold. From time to
time, the Company may assign its earnest money contract on a site and the
franchisee's lease to a third party investor who then assumes responsibility for
developing the store. Upon assignment of its earnest money contract, the Company
has deferred revenue and allocable costs where it has provided credit
enhancement. The Company may charge a fee for managing the construction of a
store on a site which it does not own. This revenue is recognized when the fees
are earned and the Company has fulfilled its obligations. The Company believes
that 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. In addition,
while the Company may be called upon to perform on its guaranties, the Company
considers this a customary service benefitting franchisees and, ultimately, the
franchise system. The Company believes that the guaranties enhance the brand
image because they facilitate higher quality restaurants at superior sites which
would otherwise be unavailable to many franchisees. Also, the Company is
immediately benefitted by the increase in cash flows because it has typically
received cash of approximately $100,000 in excess of its costs associated with
each property, and because the Company receives royalties on these prototype
stores that tend to experience higher than average sales.
19
<PAGE>
The following table sets forth (i) the percentage relationship to total
revenue of the listed items included in the Company's consolidated statements of
operations, except as otherwise indicated, and (ii) selected store data.
<TABLE>
<CAPTION>
FISCAL YEARS ENDED DECEMBER 31,
----------------------------------------------
1995 1996 1997
-------------- -------------- --------------
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Royalties....................................... 57.8% 51.9% 52.1%
Franchise fees.................................. 11.6 8.6 5.6
Developer fees.................................. 20.7 9.6 1.2
Restaurant sales................................ 4.0 17.4 22.7
Brand contribution.............................. 3.1 6.3 10.4
Turnkey development............................. .3 3.5 4.1
Other fees and revenue.......................... 2.5 2.7 3.9
-------------- -------------- --------------
Total revenue................................. 100.0 100.0 100.0
Costs and expenses:
Service costs:
Royalties(1).................................. 32.4 35.3 36.9
Franchise fees(2)............................. 51.3 54.0 52.3
Restaurant operations:
Cost of sales(3).............................. 37.3 32.8 31.6
Labor costs(3)................................ 80.8 39.5 39.2
Operating expenses(3)......................... 49.7 28.8 30.7
General and administrative...................... 44.8 33.9 28.8
Depreciation and amortization................... 3.6 3.8 4.1
Total costs and expenses.................... 79.6 78.2 78.1
-------------- -------------- --------------
Income from operations........................ 20.4 21.8 21.9
-------------- -------------- --------------
Other:
Interest income (expense)....................... (1.2) 2.2 2.7
Other income(expense)........................... 1.1 0.6 0.7
-------------- -------------- --------------
Total other income (expense)................ (0.1) 2.8 3.4
-------------- -------------- --------------
Income (loss) before income taxes and
extraordinary gain............................ 20.3 24.6 25.2
Provision for income taxes...................... 7.9 9.2 9.3
Gain on extinguishment of debt, net of tax...... .3 -- --
-------------- -------------- --------------
Net income...................................... 12.7% 15.4% 15.9%
-------------- -------------- --------------
-------------- -------------- --------------
STORE DATA:
System-wide sales(4)............................ $ 142,500 $ 202,400 $ 270,400
Change in same store sales(5)................... 1.7% 3.3% 3.4%
Average annual store sales(6)................... $ 368,000 $ 410,000 $ 455,000
Weighted average weekly store sales(6).......... $ 7,086 $ 7,867 $ 8,753
Change in weighted average weekly store
sales(7)...................................... 12.9% 11.0% 11.3%
Number of stores opened during period........... 120 135 120
Number of stores closed during period........... 10 25 20
Number of stores in operation at end of
period........................................ 463 573 673
</TABLE>
- ------------------------
(1) Expressed as a percentage of royalties.
(2) Expressed as a percentage of franchise fees.
(3) Expressed as a percentage of restaurant sales.
20
<PAGE>
(4) In thousands. Includes sales for all stores, as reported by franchisees or
derived by the Company from other data reported by franchisees.
(5) Same store sales are based upon stores which were open for the entire period
indicated and for at least 18 months as of the end of the corresponding
prior period.
(6) In actual dollars (rounded in the case of average annual store sales).
(7) Percentage change in weighted average weekly store sales from previous
fiscal year.
RESULTS OF OPERATIONS
FISCAL YEAR 1997 COMPARED TO 1996
REVENUE. Total revenue increased 35.0% from $20,714,000 to $27,969,000.
Royalties increased 35.5% from $10,747,000 to $14,561,000. This increase was
due to the full year impact of stores opened in 1996 and the addition of 120
restaurants opened during the period from January 1, 1997 to December 31, 1997.
Also contributing to the increase was the growing influence of larger
freestanding stores with higher visibility, an 11.3% increase in average weekly
sales and a 3.4% increase in same store sales.
Franchise fees decreased 12.4% from $1,775,000 to $1,555,000. This decrease
was a result of 15 fewer openings during 1997, as compared to 1996. The fewer
number of openings is principally the result of the Company's increasing
emphasis on superior site selection for larger freestanding stores with higher
visibility and on more highly qualified and better capitalized franchisees.
Developer fees decreased 83.7% from $1,993,000 to $325,000. This decrease
was primarily the result of less emphasis on these transactional fees and the
fact that the development rights to most domestic markets have been sold. The
Company anticipates that developer fees received in the future will primarily
result from re-marketing development rights it re-acquires.
Restaurant sales increased 76.3% from $3,610,000 to $6,364,000. This
increase was attributable to a 17.4% increase in sales volume at the Company's
flagship store and the opening of two additional Company-owned stores in 1997.
In the future, it is contemplated that the Company will market to franchisees
certain of its Company-owned stores, but that several other Company-owned stores
will be developed, operated and maintained by the Company in certain key
markets.
Private label licensing fees (brand contributions) increased 125.1% from
$1,295,000 to $2,915,000. The increase was the result of more favorable terms
with certain major suppliers than terms in place in the prior year, as well as
the increasing volume of system-wide sales and greater franchisee participation
in the Company's purchasing programs.
Turnkey development revenue increased 56.9% from $726,000 to $1,139,000.
Cash received in excess of costs allocable to 1997 Turnkey Program transactions
in which the Company provided credit enhancement on franchisees' leases was
treated as deferred revenue, and accordingly, did not impact the current year's
revenue or net income. Revenue in 1997 included approximately $303,000 of rental
revenue from sites completed and under lease. Forty sites developed under the
Turnkey Program were sold during 1997, seven of which had no credit enhancement
associated with the transaction, and the revenues from that activity comprises
the balance of Turnkey development revenue generated during this period.
Other fees and revenues increased 95.4% from $568,000 to $1,110,000. This
change was primarily due to the increased level of supplier contributions to the
Company's annual convention held in July 1997.
COSTS AND EXPENSES. Royalty service costs increased 41.7% from $3,791,000
to $5,373,000. This increase was a direct result of the increase in royalty
revenue for 1997, as compared to 1996. Royalty service costs as a percentage of
royalties grew from 35.3% to 36.9%. This increase reflects the growing
percentage of restaurants serviced by the area developer system and whose area
developers receive approximately 42% of the royalties from stores in their
territories.
21
<PAGE>
Restaurant cost of sales, which consists of food, beverage and paper costs,
increased 70.2% from $1,183,000 to $2,014,000, but as a percentage of restaurant
sales decreased from 32.8% to 31.6%. Also, restaurant labor costs increased
75.1% from $1,424,000 to $2,493,000, but as a percentage of restaurant sales
decreased from 39.4% to 39.2% for the same period in 1996. These percentage
decreases were primarily due to the improving operational efficiencies attained
in the various Company-owned stores. Restaurant operating expenses have
increased 87.7% from $1,040,000 to $1,952,000, and as a percentage of restaurant
sales increased from 28.8% to 30.7% for 1997, as compared to 1996. The increase
in operating expenses is due to the additional facility costs for the additional
stores the Company operates.
General and administrative expenses increased 14.6% from $7,027,000 to
$8,054,000, but as a percentage of total revenue decreased from 33.9% to 28.8%.
The dollar increase was principally the result of additional personnel at the
corporate office, including certain one-time expenses related to the hiring and
relocation of the individuals. The percentage decrease is the result of revenue
increasing at a greater rate than these expenses for 1997. Turnkey Program costs
were included with general and administrative expenses in 1997 reflecting the
fact that allocable Turnkey costs were deferred along with the revenue deferred
on certain transactions. The remaining nonallocable Turnkey Program costs were
insignificant.
Depreciation and amortization increased 48.4% from $779,000 to $1,156,000,
and as a percentage of revenue increased from 3.8 to 4.1%. This increase was
principally due to amortization of goodwill and other intangibles acquired in
1996 and 1997, and depreciation related to the additional stores the Company was
operating during the year.
OTHER. Net interest income increased 65.5% from $455,000 to $753,000. This
increase was a result of a higher level of funds invested during the more recent
period because of the secondary offering.
INCOME TAX EXPENSE. Income tax expense reflects a combined federal and
state effective tax rate of 37.0% for 1997, which is slightly lower than the
effective combined tax rate for the comparable period in 1996. Based on
projections of taxable income, the Company anticipates that its effective
combined rate for federal and state taxes will be between 37% and 38% in 1998.
FISCAL YEAR 1996 COMPARED TO 1995
REVENUE. Total revenue increased 61.2% from $12,852,000 to $20,714,000.
Royalties and franchise fees increased 44.7% and 18.8% respectively, from
$7,425,000 to $10,747,000 and $1,494,000 to $1,775,000. These increases were
primarily due to the increased number of stores opened during the period as well
as the stronger sales volume of the newer stores. There were 135 store openings
in 1996 compared to 120 openings in 1995. Also, average annualized volumes for
stores opened in 1995 was $480,000 compared to $591,000 for stores opened in
1996.
Developer income decreased by 25.2% from $2,666,000 to $1,993,000 and
decreased as a percentage of revenue from 20.7% to 9.6%. This trend reflects the
Company's transition from one-time nonrecurring transactions to a revenue stream
driven principally by royalties and franchise fees.
During 1996, four territorial agreements were executed for 12 foreign
territories. In addition, six area developer agreements were executed for
domestic territories where the prior area development agreement had been
terminated due to failure to comply with the terms of the agreement or where the
Company bought back the development rights and subsequently resold the rights to
new area developers.
Restaurant sales increased from $506,000 to $3,610,000. Fiscal year 1996 was
the first full year of operations for the Company's flagship store in Austin,
Texas which opened in late 1995, and the Company operated two stores purchased
from franchisees during the second quarter of 1996. It is the Company's
intention to re-market the units acquired from franchisees once operations and
profitability are improved at those stores.
22
<PAGE>
Private label licensing fees increased 226.1% from $397,000 to $1,295,000
because of an increase in the volume of these products purchased by franchisees
and the re-negotiated terms of two contracts from major suppliers.
Turnkey development revenue rose from $41,000 to $726,000 in 1996 (of which
$364,000 was rental revenue for periods of operations prior to the sales of the
sites). The completion of 16 Turnkey Program sites and the sale of 10 of these
sites accounted for the increase in 1996.
Other fees and revenues increased 75.3% from $324,000 to $568,000 due
primarily to an increase in the overhead recovery from the Company's national
advertising fund and other nonrecurring miscellaneous fees.
COSTS AND EXPENSES. Royalty service costs increased 57.6% from $2,405,000
to $3,791,000. This increase was a result of the growth in royalty revenue and
the increasing percentage of Schlotzsky's restaurants under the area developer
program for the year ended December 31, 1996, as compared to the same period in
the prior year. Likewise, royalty service costs as a percentage of royalties
increased from 32.4% to 35.3%.
Franchise fee development costs increased 25.0% from $767,000 to $959,000.
This increase was a result of the number of stores opened during the period.
Restaurant cost of sales, which consists of food, beverage and paper costs,
increased 525.9% from $189,000 to $1,183,000. This increase reflects the impact
of full-year operations at the Company's flagship store which opened in Austin,
Texas in November 1995, and the operation of two stores acquired from
franchisees in the second quarter of 1996. The Company expects these costs to
increase only slightly in 1997 as expenses level off at the flagship store,
subject to opportunities to acquire, operate and improve other franchisee stores
that are not performing well. It is contemplated that the Company would
re-market such stores after improvements are made.
Restaurant labor cost and operating expenses also reflect the impact of
full-year operations at the Company's flagship store and the addition of the two
former franchisee restaurants now being operated by the Company. Labor costs
increased 249.0% from $408,000 to $1,424,000. Additionally, restaurant operating
expenses grew 314.3% from $251,000 to $1,040,000 for the twelve months ended
December 31, 1996. Due to the training and product development performed at the
flagship store, the Company does not anticipate these costs to be indicative of
those of a franchised restaurant.
General and administrative expenses increased 22.2% from $5,751,000 to
$7,027,000. This increase was primarily due to the addition of staff at the
corporate office, the strengthening of reserves for certain receivables, and
other administrative costs. In addition, a one-time expense related to the
exercise of certain stock options by a former employee was incurred in the
second quarter of 1996.
Depreciation and amortization increased 70.1% from $458,000 to $779,000. The
increase was primarily due to first time depreciation of improvements and
equipment at the Company's flagship store and the two additional stores acquired
from franchisees during the second quarter of 1996. Amortization of pre-opening
costs for the flagship store and the royalty value related to remarketing the
two newly acquired stores were the primary factors contributing to an increase
in amortization expense.
OTHER. A portion of the proceeds from the Company's initial public offering
was used to retire debt, with a portion invested in short-term liquid
securities. As a result, net interest income was $455,000 for 1996, a $604,000
improvement from the net interest expense incurred during 1995.
INCOME TAX EXPENSES. Income tax expense for the year reflects a combined
federal and state effective tax rate of 37.3% in 1996 compared to the prior
year's rate of 38.9%.
23
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $5,608,000 for 1997. Royalties
from the addition of new stores and increased private label licensing fees
(brand contributions) resulted in net income of $4,449,000 for the year.
Proceeds from the sales of Turnkey Program properties generated $29,977,000 of
cash flow while $28,355,000 of cash was used in purchasing and developing new
sites under the Turnkey Program. Accounts receivable increased $6,995,000 during
the year primarily because proceeds from a number of Turnkey Program projects
disposed of at the end of the year were not received until after year end.
Accounts payable and accrued liabilities increased $4,421,000 primarily because
of construction costs incurred during the fourth quarter that were due
subsequent to the end of the year. Net cash of $8,798,000 was used in investing
activities primarily consisting of expenditures of $7,436,000 on the completion
of Company-owned stores, three future sites of additional Company stores and the
construction of its new corporate headquarters. As a result of the sale of the
Company's former headquarters and a Company-owned store, sale of equipment
generated $1,655,000 of cash flow. Also, the Company used $2,722,000 to
re-acquire the development rights to several domestic territories and re-acquire
franchise rights in some selected markets. During 1997, financing activities
provided cash of approximately $28,805,000 due primarily to the issuance of
1,731,825 shares of common stock in the Company's secondary public offering. The
Company used proceeds from the offering to retire approximately $2,537,000 of
debt during the year.
Net cash used in operating activities in 1996 was $2,168,000. Net cash used
in investing activities was $4,246,000 in 1996 primarily as a result of
re-acquisition of several domestic development territories. The acquisition of
these territories along with the purchase of two stores from franchisees, was a
cash use of approximately $1,912,000. The Company also invested $1,664,000 in
the development of Company-owned stores. Additionally, the Company invested
$300,000 to acquire a preferred equity interest in a master licensee. In 1996,
financing activities used net cash of $292,000. The Company retired debt of
approximately $915,000 during the period. In connection with the purchase of two
stores and rights to several territories, the Company issued $584,000 of notes
payable and long-term debt.
At December 31, 1997, the Company had approximately $2,187,000 of debt
outstanding. During 1996, the Company borrowed approximately $584,000 in
connection with the re-acquisition of certain domestic development rights
described above. Notes payable were issued to the area developers whose
development rights were re-acquired. The interest rates on the notes range from
8.5% to 9.0% and all mature prior to the end of 1998. During 1997, the Company
borrowed an additional $1,113,000 primarily in connection with the
re-acquisition of certain domestic development rights. These notes bear interest
at rates ranging from 9.0% to 10.6% and all mature by the end of 2002. The
Company guarantees certain real estate leases, equipment leases and other
obligations of franchisees. At December 31, 1997, these contingent liabilities
totaled approximately $23,288,000. 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 $1,117,000 at December 31, 1997, bears interest at prime plus 1.25%
and matures April 2001. Monthly payments are being made by the limited
partnership.
The Company plans to develop additional Company-owned stores in the next 18
months in the Austin market and certain selected other markets. Funds of
approximately $8,000,000 are estimated to be required for the development of
Company-owned stores. Two stores have opened in the first quarter of 1998 and
the Company completed the construction of its new Company headquarters in the
fourth quarter of 1997. Proceeds from the secondary public offering were used to
complete these construction projects.
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 it has sold and contracts assigned
to finance the activity of the Turnkey Program. With the anticipated growth in
the Turnkey Program, the capital required to finance the Turnkey Program will
increase significantly. During 1997, the Company completed transactions
involving 41 sites under the Turnkey Program, which consisted of 33 completed
stores, 7 assignments of earnest money contracts and the completion of one
Company-owned store.
24
<PAGE>
Seventy-eight properties were under contract or in various stages of development
at December 31, 1997. The tables below provide a summary of the Turnkey Program
activity since its inception and a summary of the status of the Turnkey Program
at December 31, 1997.
Turnkey development revenue consists of the following:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER
31,
------------------------------
1996 1997
-------------- --------------
<S> <C> <C>
Sales to investors and franchisees................ $ 6,638,150 $ 23,022,364
Development and construction management fees...... 174,979 190,000
-------------- --------------
Gross Turnkey Program revenue................... 6,813,129 23,212,364
Turnkey Program costs............................. (6,455,618) (21,013,973)
-------------- --------------
Net revenue from Turnkey Program projects....... 357,511 2,198,391
Rental income..................................... 368,402 303,091
Interim construction interest..................... -- 1,270
Less: deferred revenue............................ -- (1,364,142)
-------------- --------------
Total Turnkey Program revenue................... $ 725,913 $ 1,138,610
-------------- --------------
-------------- --------------
</TABLE>
The following table reflects system performance of the Turnkey Program since
its inception in 1995.
<TABLE>
<CAPTION>
NUMBER OF UNITS
-------------------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C> <C>
Sites in process at beginning of year................................ -- 27 30
Sites beginning development during the year.......................... 32 19 90
Sites completed as Company-owned stores.............................. -- (1) (1)
Sites inventoried to real estate held for sale....................... -- (5) --
Sites sold--revenue recognized....................................... (5) (10) (7)
Sites sold--revenue deferred......................................... -- -- (33)
Other................................................................ -- -- (1)
--- --- ---
Sites in process at end of year...................................... 27 30 78
--- --- ---
--- --- ---
<CAPTION>
INVESTED AT
DECEMBER 31,
1997
------------
<S> <C> <C> <C> <C>
Opened (receiving rent & royalties).................................. 2 8 2 $1,646,000
Investment Sites (under construction)................................ 9 9 3 4,092,000
Predevelopment Site (prequalification)............................... 11 13 73 1,213,000
Other................................................................ 5 -- -- --
--- --- --- ------------
Total................................................................ 27 30 78 $6,951,000
--- --- --- ------------
--- --- --- ------------
</TABLE>
The Company currently has a line of credit available from a financial
institution 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 December 31, 1997, the Company had
not drawn upon this line of credit.
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 offering 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
25
<PAGE>
future debt financings or additional offerings of equity securities, although
there can be no assurance of the availability of such funds on acceptable terms
in the future.
YEAR 2000 COMPLIANCE
The year 2000 issue is a result of many computer problems being written
using two digits, e.g. "98", to define a year. Date-sensitive software may
recognize the year "00" as the year 1900 rather than the year 2000. This would
result in errors and miscalculations or even system failure causing disruptions
in business activities and transactions.
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. Any problems the
Company's suppliers and customers may have related to this issue are not
expected to materially adversely affect the Company. The Company has not
incurred any costs related to this issue and is not expected to incur any
material costs in connection with the year 2000 issue in the future.
RECENT ACCOUNTING STANDARDS. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Restated Information," which establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS No. 131
is effective for financial statements for periods beginning after December 15,
1997.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures and
Pensions and Other Postretirement Benefits", which significantly changes current
financial statement disclosure requirements from those that were required under
SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits", and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions". SFAS No. 132 does not change the
existing measurement of recognition provisions of SFAS Nos. 87, 88 or 106. SFAS
No. 132 is effective for fiscal years beginning after December 15, 1997.
Management does not believe the implementation of these recent accounting
pronouncements will have a material effect on its consolidated financial
statements.
QUARTERLY COMPARISONS
Since the adoption of the Schlotzsky's Deli restaurant concept in 1991, the
Company has experienced growth in royalties and franchise fees. Store openings
typically mark the recognition of franchise fees and the beginning of the
royalty stream to the Company. Accordingly, a large increase in store openings
has a significant impact on the amount and timing of revenue. The timing of
store openings can also affect the same store sales and other period-to-period
comparisons. There were 120 store openings in 1995, 135 in 1996 and 120 in 1997.
At January 1, 1995, the initial franchise fee was increased from $15,000 to
$17,500 and was further increased to $20,000 effective July 1, 1995. The net
profitability from developer fees is substantially higher than that derived from
royalties and franchise fees because of the relatively lower costs associated
with developer fees. Therefore, quarters in which the Company derived a high
percentage of total revenue from developer fees reflect substantially higher
margins. While developer fees have been a significant portion of revenue in past
quarters, it is anticipated that they will not be material in the future because
most of the attractive developer territories in the United States have been
sold. Moreover, the Company anticipates that royalty and other revenue will
continue to increase so that developer fees will decline as a percentage of
total revenue, resulting in more normalized margins. Also, the Company
26
<PAGE>
believes restaurant sales and private label licensing fees (brand contributions)
will continue to increase as a percentage of revenue.
The Company recorded a significant fourth quarter adjustment related to
activities within the Turnkey Program. The adjustment included the deferral of
approximately $1,889,000, representing the excess of proceeds received of
approximately $24,268,000 over the related development costs of approximately
$22,380,000, in connection with the transfer of title or assignment of earnest
money contracts on 33 Turnkey Program properties to various third-party
investors. Revenue is deferred only in those Turnkey Program transactions for
which the Company provides a credit enhancement to the third-party investor in
the form of a guaranty on the franchisee lease assigned at the same time that
the sale or assignment occurs. The Company has also deferred certain costs of
approximately $894,000 associated with the acquisition, development and, in some
instances, construction of the Turnkey Program properties. The applicable tax
effect of the adjustments was approximately $368,000.
Management believes that the Company experiences only moderate seasonality.
The Company attempts to make store sales less seasonal by offering a variety of
products which tend to sell better during various seasons.
The following table presents unaudited quarterly results of operations for
the 1995, 1996 and 1997 fiscal years.
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
PRESENTATION OF QUARTERLY FIGURES
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
1995 1996
------------------------------------------ ------------------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
--------- --------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Royalties.......................... $ 1,476 $ 1,858 $ 1,961 $ 2,130 $ 2,245 $ 2,675 $ 2,875 $ 2,953
Franchise fees..................... 368 390 228 508 348 475 400 553
Developer fees..................... 287 324 260 1,795 595 416 325 657
Restaurant sales................... 76 80 77 273 566 810 1,061 1,173
Brands contribution................ 7 145 65 180 121 238 511 424
Turnkey development................ -- 12 18 12 39 80 143 463
Other fees and revenue............. 90 154 38 40 168 214 123 63
--------- --------- --------- --------- --------- --------- --------- ---------
Total revenues................... 2,304 2,963 2,647 4,938 4,082 4,908 5,438 6,286
COSTS & EXPENSES................... 2,063 2,567 2,533 3,066 3,261 3,945 4,240 4,758
--------- --------- --------- --------- --------- --------- --------- ---------
OPERATING INCOME................... 241 396 114 1,872 821 963 1,198 1,528
NET INCOME......................... $ 178 $ 244 $ 58 $ 1,152 $ 629 $ 714 $ 798 $ 1,053
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Earnings per share--basic(1)....... $ 0.02 $ 0.05 $ (0.03) $ 0.43 $ 0.11 $ 0.13 $ 0.14 $ 0.20
Earnings per share--diluted(1)..... $ 0.02 $ 0.04 $ (0.03) $ 0.39 $ 0.11 $ 0.13 $ 0.14 $ 0.19
Store Openings..................... 29 27 25 39 28 33 31 43
<CAPTION>
1997
------------------------------------------
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES:
Royalties.......................... $ 3,278 $ 3,606 $ 3,820 $ 3,858
Franchise fees..................... 353 240 411 551
Developer fees..................... -- 125 -- 200
Restaurant sales................... 1,324 1,439 1,636 1,965
Brands contribution................ 535 807 791 783
Turnkey development................ 685 762 1,374 (1,683)
Other fees and revenue............. 160 361 312 276
--------- --------- --------- ---------
Total revenues................... 6,335 7,340 8,344 5,950
COSTS & EXPENSES................... 4,969 5,575 6,405 4,906
--------- --------- --------- ---------
OPERATING INCOME................... 1,366 1,765 1,939 1,044
NET INCOME......................... $ 889 $ 1,162 $ 1,234 $ 1,164
--------- --------- --------- ---------
--------- --------- --------- ---------
Earnings per share--basic(1)....... $ 0.16 $ 0.21 $ 0.22 $ 0.15
Earnings per share--diluted(1)..... $ 0.16 $ 0.20 $ 0.21 $ 0.14
Store Openings..................... 29 21 28 42
</TABLE>
- ------------------------------
(1) Earnings per share reflects retroactive application of Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share."
Earnings (loss) per share in 1995 were impacted by dividends on redeemable
preferred stock outstanding during 1995.
IMPACT OF INFLATION
The Company believes that inflation did not have a material impact on its
operations for the periods reported. Significant increases in labor, employee
benefits, food costs and other operating expenses could have a material adverse
effect on franchisees' store operations.
27
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements referred to in the index on
page F-1 setting forth the Consolidated Financial Statements of Schlotzsky's,
Inc. and Subsidiaries, together with the report of Coopers & Lybrand L.L.P.
dated April 10, 1998.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with regard to directors and executive officers and their
business experience is set forth under "Election of Directors" in the
Registrant's definitive Proxy Statement for the Annual Meeting of Shareholders
to be held on May 29, 1998, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information with regard to executive compensation and pension or similar
plans is set forth under "Compensation of Directors" and "Compensation of
Executive Officers" in the Registrant's definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 29, 1998, and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with regard to security ownership of certain beneficial owners
and management is set forth under "Security Ownership of Certain Beneficial
Owners and Management" in the Registrant's definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 29, 1998, and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with regard to certain relationships and related transactions is
set forth under "Election of Directors; Certain Relationships and Related
Transactions," in the Registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on May 29, 1998, and is incorporated herein
by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS. Reference is made to the index on page F-1 for a
list of all financial statements filed as part of this Report.
(a)(2) FINANCIAL STATEMENTS SCHEDULES. Reference is made to the index on page
F-1 for a list of all financial statement schedules filed as part of this
Report.
(a)(3) EXHIBITS
<TABLE>
<C> <C> <S>
3.1 -- Articles of Incorporation of the Registrant, as amended.(1)
3.2 -- Bylaws of the Registrant, as amended.(1)
4.1 -- Specimen stock certificate evidencing the Common Stock
</TABLE>
28
<PAGE>
<TABLE>
<C> <C> <S>
10.1 -- Form of Unit Franchise Agreement entered into by the Registrant and
franchisees.(1)
10.2 -- Form of Unit Development Agreement entered into by the Registrant and
franchisees.(1)
10.3 -- Form of Area Developer Agreement entered into by the Registrant and area
developers.(1)
10.4 -- Form of Master License Agreement entered into by the Registrant and area
developers.(1)
10.5 (a) -- Form of Territorial Agreement entered into by the Registrant and master
licensees.(1)
10.5 (b) -- Form of Master Development Agreement entered into by the Registrant and master
licensees.(1)
10.6 -- Preferred Stock Repurchase Agreement, dated October 1993, among the Company,
John C. Wooley, Jeffrey J. Wooley, and the purchasers of Class A Preferred
Stock.(1)
10.7 -- Preferred Stock Purchase Agreement, dated July 20, 1994, among the Registrant
and the purchasers.(1)
10.8 -- Registration Rights Agreement, dated July 20, 1994, by and between the
Registrant and the shareholders named therein.(1)
10.9 -- Second Amended Agreement among Shareholders, dated July 20, 1994, by and among
the Registrant and the Shareholders described therein.(1)
10.10 -- Loan/Compromise and Settlement Agreement, dated April 7, 1994, between the
Federal Deposit Insurance Corporation as Receiver of Bank of the Hills, Austin,
Texas, and the Registrant.(1)
10.11 -- Promissory Note, dated May 18, 1993, of the Registrant to First State Bank,
Austin, Texas in the original principal amount of $381,249.99.(1)
10.12(a) -- Promissory Note, dated April 15, 1993, of the Registrant to Janet P. Newberger
and Lester Baum, as trustees of the 1992 Newberger Family Trust, in the original
principal amount of $750,000.(1)
10.12(b) -- Promissory Note, dated March 31, 1994, by and between the Registrant and Janet
P. Newberger and Lester Baum, co-trustees of the 1992 Newberger Family Trust.(1)
10.12(c) -- Second Modification Agreement, dated effective December 31, 1994, by and between
the Registrant and Janet P. Newberger and Lester Baum, as trustees of the 1992
Newberger Family Trust.(1)
10.12(d) -- Promissory Note, dated September 6, 1995, of the Registrant to JanMor
Corporation, in the original principal amount of $400,000.(1)
10.13 -- Promissory Note, dated February 1, 1995, of the Registrant to Liberty National
Bank, Austin, Texas in the original principal amount $220,000, Security
Agreement, dated February 1, 1995 and Guarantee, dated February 1, 1995, by and
between John C. Wooley and Liberty National Bank.(1)
10.14 -- Real Estate Lien Note and Deed of Trust, Security Agreement and Financing
Statement, dated March 31, 1995, of the Registrant to Texas Bank, N.A. in the
original principal amount of $500,000.(1)
10.15 -- Promissory Note, dated April 14, 1995, between the Registrant and First State
Bank in the original principal amount of $2,000,000.(1)
10.16 -- Promissory Note and Security Agreement, dated July 15, 1993, of the Registrant
to R. M. Wilkin, Inc. in the original principal amount of $450,000.(1)
10.17 -- Commitment Letter, dated July 7, 1995, by and between AT&T Commercial Finance
Corporation and the Registrant in an amount not to exceed $1,100,000.(1)
10.18 -- Term Sheet, dated July 19, 1995 by and between BeneVent-Noro and the
Registrant.(1)
10.19 -- Promissory Note, dated December 1, 1994, by and between Bee Cave/Westbank, Ltd.
and Liberty National Bank in the original principal amount of $1,150,000.(1)
</TABLE>
29
<PAGE>
<TABLE>
<C> <C> <S>
10.20 -- Loan Commitment, dated July 18, 1995, by and between Manns Capital Corporation
and Bee Cave/Westbank, Ltd., and Letter Amendment to Permanent Loan Commitment,
dated July 28, 1995.(1)
10.21 -- Promissory Note, dated August 18, 1995, by and between the Registrant and First
State Bank in the original principal amount of $850,000.(1)
10.22 -- Operating Lease for 218 South Lamar, dated May 27, 1994, by and between William
C. Pfluger, et al. and Schlotzsky's Restaurants, Inc.(1)
10.23 -- Lease Agreement, September 8, 1995, by and between the Registrant and Austin CBD
29, Inc.(1)
10.24 -- Deed of Trust and Real Estate Lien Note, dated December 31, 1993, by and between
Schlotzsky's Real Estate, Inc. and Austin CBD Block 29, Ltd.(1)
10.25(a) -- Franchise Financing Program Procedures for Qualified Franchisees, dated April
15, 1994, by and between Captec Financial Group, Inc. and the Registrant.(1)
10.25(b) -- Ultimate Net Loss Agreement, dated April 15, 1994, by and between the Registrant
and Captec Financial Group, Inc.(1)
10.25(c) -- Amendment to Ultimate Net Loss Agreement, dated March 30, 1995.(1)
10.26(a) -- Franchise finance letter of understanding, dated February 21, 1994, by and
between Stephens Franchisee Finance and the Registrant.(1)
10.26(b) -- Franchisee Financing Agreement, dated September 1, 1994, between the Registrant
and Stephens Diversified Leasing, Inc.(1)
10.27 -- Agreement, dated July 1, 1994, by and among Thomas Development Corporation,
Micardo, Inc. and the Registrant.(1)
10.28 -- Earnest Money Contract, dated May 20, 1994, among Schlotzsky's Real Estate,
Inc., William C. Pfluger, et al., Schlotzsky's Restaurants, Inc., the Registrant
and John C. Wooley.(1)
10.29 -- Unsecured Promissory Note, dated June 29, 1993, from John C. Wooley payable to
the Registrant in the original principal amount of $280,000.(1)
10.30 -- Unsecured Promissory Note, dated June 29, 1993, from Jeffrey J. Wooley payable
to the Registrant in the original principal amount of $150,000.(1)
10.31 -- Unsecured Promissory Note, dated January 1, 1993, from John C. Wooley payable to
the Registrant in the original principal amount of $319,712.45.(1)
10.32 -- Unsecured Promissory Note, dated January 1, 1993, from Jeffrey J. Wooley payable
to the Registrant in the original principal amount of $76,540.93.(1)
10.33 -- Unsecured Promissory Note, dated February 6, 1995, from John C. Wooley payable
to the Registrant in the original principal amount of $131,000.(1)
10.34 -- Unsecured Promissory Note, dated February 6, 1995, from Jeffrey J. Wooley
payable to the Registrant in the original principal amount of $6,000.(1)
10.35 -- Schlotzsky's, Inc. 1993 Third Amended and Restated Stock Option Plan of the
Registrant.
10.36(a) -- Employment Agreement, dated as of December 21, 1995, by and between the
Registrant and John C. Wooley.
10.36(b) -- Employment Agreement, dated as of December 21, 1995, by and between the
Registrant and Jeffrey J. Wooley.
10.36(c) -- Employment Agreement, dated January 1, 1994, by and between the Registrant and
Kelly R. Arnold.(1)
10.36(d) -- Employment Agreement, dated January 1, 1994, by and between the Registrant and
Karl D. Martin.(1)
</TABLE>
30
<PAGE>
<TABLE>
<C> <C> <S>
10.37(a) -- Indemnity Agreement, dated June 30, 1993, by and between the Registrant and John
C. Wooley.(1)
10.37(b) -- Indemnity Agreement, dated June 30, 1993, by and between the Registrant and
Jeffrey J. Wooley.(1)
10.38 -- Form of Indemnification Agreement for Directors and Officers of the
Registrant.(1)
10.39 -- Schlotzsky's 1995 Nonemployee Directors Stock Option Plan, and form of Stock
Option Agreement.(1)
10.40 -- Warrant Certificate, dated March 31, 1994, of the Registrant to William C.
Pfluger for 75,000 warrants.(1)
10.41 -- Confidentiality Agreement, dated December 8, 1989, by and between Bunge Foods
Corporation and Schlotzsky's Franchising Limited Partnership.(1)
10.42 -- Real Estate Lien Note dated December 31, 1993, from CBD Block 29, Ltd. to
Schlotzsky's Real Estate, Inc. in the original principal amount of
$302,209.12.(1)
10.43 -- Promissory Note, dated October 4, 1995, from the Registrant to First State Bank,
Austin, Texas in the original principal amount of $576,000.(1)
10.44 -- Promissory Note dated October 25, 1995, from the Registrant to United Bank &
Trust in the original principal amount of $500,000.(1)
10.45 -- Promissory Note dated November 1995 from Registrant and Schlotzsky's
Restaurants, Inc. to AT&T Commercial Finance Corporation in the original
principal amount of $1,100,000.(1)
10.46 -- Promissory Note dated November 17, 1995 from Registrant to Comerica Bank--Texas
in the original principal amount of $245,000.(1)
10.47* -- Form of Guaranty between Schlotzsky's, Inc. and Landlord with respect to Turnkey
restaurants.
10.48* -- Form of Tenant Acknowledgment with Indemnification between Schlotzsky's Real
Estate, Inc. and Franchisee concerning Turnkey restaurants.
22.1 * -- List of subsidiaries of the Registrant.
24.1 * -- Consent of Coopers & Lybrand L.L.P.
25.1 -- Power of Attorney (contained on the signature page of this Registration
Statement).
27.1 * -- Financial Data Schedule--fiscal year ending 1997.
27.2 * -- Financial Data Schedule--restated data for fiscal years ending 1995, 1996 and
first, second and third quarters of 1996.
27.3 * -- Financial Data Schedule--restated data for first, second and third quarters of
1997.
</TABLE>
- ------------------------
* Filed herewith.
(1) Previously filed as an Exhibit to the Registrant's Registration Statement on
Form S-1 (File No. 33-98004) filed with the Securities and Exchange
Commission on October 12, 1995, as amended, and incorporated herein by
reference.
(2) Previously filed as an exhibit to the registrant's registration statement on
Form S-1 (File No. 333-34921) filed with the securities and exchange
commission on September 4, 1997, as amended, and incorporated herein by
reference.
(b) REPORTS ON FORM 8-K
The following is the date and description of the events reported on Form 8-K
covering events in the fourth quarter of fiscal year 1997: None
31
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934 as amended, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
SCHLOTZSKY'S, INC.
By: /s/ JOHN C. WOOLEY
-----------------------------------------
John C. Wooley,
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
Date: April 14, 1998
</TABLE>
Pursuant to the requirements of the Securities Act of 1934, this
Registration Statement has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE
- ------------------------------ -------------------------- -------------------
Chairman of the Board and
/s/ JOHN C. WOOLEY Chief Executive Officer
- ------------------------------ (Principal Executive April 14, 1998
John C. Wooley Officer)
Chief Financial Officer,
/s/ MONICA L. GILL Treasurer (Principal
- ------------------------------ Financial Officer and April 14, 1998
Monica L. Gill Principal Accounting
Officer)
/s/ JEFFREY J. WOOLEY
- ------------------------------ Senior Vice President and April 14, 1998
Jeffrey J. Wooley Secretary
/s/ JOHN L. HILL, JR.
- ------------------------------ Director April 14, 1998
John L. Hill, Jr.
/s/ AZIE TAYLOR MORTON
- ------------------------------ Director April 14, 1998
Azie Taylor Morton
/s/ JOHN M. ROSILLO
- ------------------------------ Director April 14, 1998
John M. Rosillo
/s/ RAYMOND A. RODRIGUEZ
- ------------------------------ Director April 14, 1998
Raymond A. Rodriguez
/s/ FLOOR MOUTHAAN
- ------------------------------ Director April 14, 1998
Floor Mouthaan
32
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Consolidated Financial Statements:
Report of Independent Accountants.......................................................................... F-2
Consolidated Balance Sheets at December 31, 1996 and 1997.................................................. F-3
Consolidated Statements of Income for the years ended December 31, 1995, 1996 and 1997..................... F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997....... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997................. F-6
Notes to Consolidated Financial Statements................................................................. F-7
Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts............................................................. S-1
</TABLE>
All other schedules are omitted as the required information is not
applicable or the information is presented in the consolidated financial
statements, related notes or other schedules.
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Schlotzsky's, Inc. and Subsidiaries
We have audited the consolidated financial statements and the financial
statement schedule of Schlotzsky's, Inc. and Subsidiaries listed in the index on
page F-1 of this Form 10-K. These consolidated financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Schlotzsky's, Inc. and Subsidiaries as of December 31, 1996 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Austin, Texas
April 10, 1998
F-2
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
Cash and cash equivalents.......................................................... $ 5,638,958 $ 31,254,048
Restricted certificate of deposit.................................................. 18,000 18,000
Receivable from sales of Turnkey Program development............................... -- 6,054,337
Royalties receivable............................................................... 580,470 809,125
Other receivables.................................................................. 1,293,329 2,005,760
Prepaid expenses and other assets.................................................. 247,762 584,510
Turnkey Program development........................................................ 8,458,301 6,950,595
Notes receivable, current portion.................................................. 557,332 2,574,588
Notes receivable from related parties, current portion............................. 595,000 50,000
------------- -------------
Total current assets......................................................... 17,389,152 50,300,963
Property, equipment and leasehold improvements, net................................ 5,440,882 9,998,630
Real estate held for sale.......................................................... 2,642,773 1,063,592
Notes receivable, less current portion............................................. 2,313,728 1,972,470
Notes receivable from related parties, less current portion........................ 2,523,230 2,565,399
Investments and advances........................................................... 1,265,862 1,456,790
Deferred federal income tax asset.................................................. 607,448 580,460
Intangible assets, net............................................................. 8,515,883 11,113,213
Other noncurrent assets............................................................ 280,154 469,069
------------- -------------
Total assets................................................................. $ 40,979,112 $ 79,520,586
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current maturities of long-term debt............................................... $ 482,205 $ 250,625
Accounts payable................................................................... 1,968,323 6,002,920
Accrued liabilities................................................................ 1,423,461 1,457,242
Federal income taxes payable....................................................... -- 27,473
------------- -------------
Total current liabilities.................................................... 3,873,989 7,738,260
Deferred revenue, net.............................................................. 1,663,765 2,855,380
Long-term debt, less current maturities............................................ 3,129,337 1,936,387
------------- -------------
Total liabilities............................................................ 8,667,091 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, 5,539,922 and 7,334,416
issued and outstanding at December 31, 1996 and 1997, respectively............. 44,257 62,202
Additional paid-in capital....................................................... 26,493,165 56,664,104
Retained earnings................................................................ 5,774,599 10,264,253
------------- -------------
Total stockholders' equity................................................... 32,312,021 66,990,559
------------- -------------
Total liabilities and stockholders' equity................................... $ 40,979,112 $ 79,520,586
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Revenue:
Royalties......................................................... $ 7,424,810 $ 10,747,238 $ 14,561,377
Franchise fees.................................................... 1,493,750 1,775,000 1,554,585
Developer fees.................................................... 2,665,562 1,992,750 325,000
Restaurant sales.................................................. 505,765 3,610,199 6,364,042
Brand contribution................................................ 397,064 1,294,982 2,915,233
Turnkey Program development....................................... 41,006 725,913 1,138,610
Other fees and revenue............................................ 323,708 568,250 1,110,289
------------- ------------- -------------
Total revenues................................................ 12,851,665 20,714,332 27,969,136
Expenses:
Service costs:
Royalties....................................................... 2,405,299 3,791,384 5,373,151
Franchise fees.................................................. 766,625 958,500 812,625
Restaurant operations:
Cost of sales................................................... 188,751 1,183,361 2,014,096
Labor costs..................................................... 408,575 1,424,434 2,493,478
Operating expenses.............................................. 250,962 1,039,591 1,951,618
General and administrative........................................ 5,751,154 7,027,258 8,053,514
Depreciation and amortization..................................... 457,938 779,284 1,155,600
------------- ------------- -------------
Total expenses................................................ 10,229,304 16,203,812 21,854,082
------------- ------------- -------------
Income from operations.............................................. 2,622,361 4,510,520 6,155,054
Other:
Interest income (expense), net.................................... (149,151) 454,670 752,960
Other income...................................................... 137,976 132,075 195,661
------------- ------------- -------------
Income before income taxes and extraordinary gain................... 2,611,186 5,097,265 7,063,675
Provision for income taxes.......................................... 1,016,596 1,902,290 2,614,260
------------- ------------- -------------
Income before extraordinary gain.................................... 1,594,590 3,194,975 5,076,233
Gain on extinguishment of debt, net of applicable income taxes of
$18,271 at December 31, 1995...................................... 38,307 -- --
------------- ------------- -------------
Net income.................................................... 1,632,897 3,194,975 4,449,415
Redeemable preferred stock dividends................................ (544,274) -- --
------------- ------------- -------------
Net income available to common stockholders................... $ 1,088,623 $ 3,194,975 $ 4,449,415
------------- ------------- -------------
------------- ------------- -------------
Income per common share--basic:
Income before extraordinary item.................................. $ 0.45 $ 0.58 $ 0.74
Extraordinary item................................................ 0.02 -- --
------------- ------------- -------------
Income per common share........................................... $ 0.47 $ 0.58 $ 0.74
------------- ------------- -------------
------------- ------------- -------------
Weighted average shares outstanding............................... 2,314,938 5,525,902 5,994,403
------------- ------------- -------------
------------- ------------- -------------
Income per common share--diluted:
Income before extraordinary item.................................. $ 0.41 $ 0.57 $ 0.71
Extraordinary item................................................ 0.01 -- --
------------- ------------- -------------
Income per common share........................................... $ 0.42 $ 0.57 $ 0.71
------------- ------------- -------------
------------- ------------- -------------
Weighted average shares outstanding............................... 3,440,643 5,639,225 6,226,834
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
---------------------- ADDITIONAL TOTAL
SHARES PAID-IN RETAINED STOCKHOLDERS'
OUTSTANDING AMOUNT CAPITAL EARNINGS EQUITY
----------- --------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1995................... 2,187,500 $ 10,733 $ -- $ 1,602,820 $ 1,613,553
Redeemable preferred stock dividends....... -- -- -- (544,274) (544,274)
Public sale of stock....................... 1,850,000 18,500 17,575,264 -- 17,593,764
Conversion of redeemable preferred stock... 1,354,167 13,542 7,964,883 -- 7,978,425
Conversion of redeemable preferred stock
dividends................................ 118,331 1,183 698,817 -- 700,000
Net income................................. -- -- -- 1,632,897 1,632,897
----------- --------- ------------- ------------- -------------
Balance, December 31, 1995................. 5,509,998 43,958 26,238,964 2,691,443 28,974,365
Options exercised.......................... 29,924 299 254,201 (111,819) 142,681
Net income................................. -- -- -- 3,194,975 3,194,975
----------- --------- ------------- ------------- -------------
Balance, December 31, 1996................. 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
----------- --------- ------------- ------------- -------------
----------- --------- ------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
------------- ------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income....................................................... $ 1,632,897 $ 3,194,975 $ 4,449,415
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization.................................. 457,938 779,284 1,155,600
Bad debt expense............................................... -- 187,774 100,000
Gain on sale of property and equipment......................... -- -- (308,632)
Gain on extinguishment of debt, net of tax..................... (38,307) -- --
Financed fees.................................................. (1,803,581) (1,860,796) (272,003)
Payments received on financed fees............................. 670,002 829,590 743,534
Non-recurring expense relating to the issuance of stock to a
non-employee................................................. -- 103,791 --
Changes in assets and liabilities:
Royalties and other receivable............................... (32,830) (971,614) (6,995,423)
Prepaid expenses and other assets............................ 70,711 45,118 (336,748)
Purchases under Turnkey Program.............................. (5,597,727) (8,725,306) (28,355,296)
Proceeds from Turnkey Program................................ 824,079 3,341,281 29,977,069
Other noncurrent assets...................................... -- (280,154) (188,915)
Deferred revenue............................................. 491,270 91,440 1,191,615
Deferred federal income tax asset............................ (183,694) (75,578) 26,988
Accounts payable and accrued liabilities..................... 747,377 1,172,539 4,420,923
------------- ------------- --------------
Net cash provided by operating activities.................. (2,761,865) (2,167,656) 5,608,127
------------- ------------- --------------
Cash flows from investing activities:
Expenditures for property and equipment.......................... (1,905,795) (1,664,363) (7,436,003)
Sale of property and equipment................................... -- -- 1,655,123
Acquisition of minority interest and intangible assets........... (1,181,369) (2,227,297) (2,721,814)
Redemption of restricted certificates of deposit................. 13,582 60,983 --
Issuance of notes receivable..................................... (590,790) (603,121) (693,100)
Collections on notes receivable.................................. 158,361 235,933 627,032
Acquisition of investments....................................... (66,788) (83,147) (190,928)
Advances to limited partnership, stockholders and affiliates..... (258,818) (45,014) (37,940)
Distributions and collections from limited partnership,
stockholders and affiliates.................................... 469,748 79,958 --
------------- ------------- --------------
Net cash used in investing activities........................ (3,361,869) (4,246,068) (8,797,630)
------------- ------------- --------------
Cash flows from financing activities:
Sale of stock.................................................... 18,925,500 -- 30,073,141
Stock issue costs................................................ (1,331,736) (51,180) (440,622)
Options and warrants exercised................................... -- 90,070 596,604
Proceeds from issuance of notes payable and long-term debt....... 7,012,174 583,774 1,112,709
Principal payments on notes payable and long-term debt........... (7,065,992) (914,664) (2,537,239)
Cash dividends on redeemable preferred stock..................... (124,274) -- --
------------- ------------- --------------
Net cash provided by (used in) financing activities.......... 17,415,672 (292,000) 28,804,593
------------- ------------- --------------
Net increase (decrease) in cash and cash equivalents............... 11,291,938 (6,705,724) 25,615,090
Cash and cash equivalents at beginning of year..................... 1,052,744 12,344,682 5,638,958
------------- ------------- --------------
Cash and cash equivalents at end of year........................... $ 12,344,682 $ 5,638,958 $ 31,254,048
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Schlotzsky's, Inc. and Subsidiaries (the "Company") is a franchisor of quick
service restaurants ("Schlotzsky's" or "Schlotzsky's Deli") that feature
made-to-order sandwiches, which has 673 stores located in 39 states, the
District of Columbia, Argentina, Australia, Canada, Germany, Guatemala, Korea,
Japan, Lebanon, Malaysia, Mexico, Saudi Arabia, Sweden, Turkey and the United
Kingdom. Approximately 30% of franchised stores are located in Texas. In
addition, the Company had granted territorial rights to Area Developers located
in all 50 states and to Master Licensees in 51 foreign countries for a fee which
is typically payable in cash and promissory notes receivable generally
collateralized by the related territorial rights.
The Company also operates a Turnkey Development Program (the "Turnkey
Program") to further assist franchisees in obtaining store sites.
ORGANIZATION
The Company's organization includes Schlotzsky's, Inc. (the parent
corporation) and its wholly-owned subsidiaries Schlotzsky's Restaurant, Inc.,
Schlotzsky's Real Estate, Inc., Schlotzsky's Equipment Corporation, Schlotzsky's
Brands, Inc. and DFW Restaurant Transfer Corp.
Schlotzsky's Restaurant, Inc. has one wholly-owned subsidiary 56th and 6th,
Inc., which was formed in connection with the purchase of a restaurant located
in New York. During 1997, Schlotzsky's Restaurants, Inc. sold its interest in
218 Beverage Corporation, a company formed in 1995.
During 1997, SREI Turnkey Development, L.L.C. was formed in connection with
the purchase and sale of real estate. This corporation is a wholly-owned
subsidiary of Schlotzsky's Real Estate, Inc.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Schlotzsky's, Inc., a Texas corporation, and its wholly-owned subsidiaries. All
significant intercompany balances and transactions are eliminated in
consolidation.
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 the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS
Cash equivalents include unrestricted highly liquid investments purchased
with an original maturity date of three months or less. At December 31, 1996 and
1997, cash equivalents totaling approximately $1,962,000 and $27,053,000,
respectively, consisted primarily of money market accounts and overnight
repurchase agreements.
F-7
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
RECEIVABLES FROM SALES OF TURNKEY PROGRAM DEVELOPMENT
Receivables from Turnkey Program development include amounts held in escrow
on behalf of the Company at title companies or institutional investors at year
end.
NOTES RECEIVABLE
The Company obtains annual valuations of all Area Developer and Master
Licensee promissory notes receivable from an independent financial services
institution. As of December 31, 1996 and 1997, the Company has recorded a
valuation allowance of approximately $343,000 and $443,000, respectively, to
adjust the cost basis of the promissory notes to the lower of cost or respective
appraised fair value.
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements are stated at cost, net of
accumulated depreciation and amortization. Expenditures for normal maintenance
of property and equipment are charged against income as incurred. Expenditures
which significantly extend the useful lives of the assets are capitalized. The
costs of assets retired or otherwise disposed of and the related accumulated
depreciation and amortization balances are removed from the accounts and any
resulting gain or loss is included in income. Depreciation and amortization is
calculated using the straight-line method and accelerated methods over the
estimated useful lives of the assets, or lease term for leasehold improvements,
if less.
REAL ESTATE HELD FOR SALE
Real estate held for sale consist of properties owned by the Company which
it does not intend to develop through the Turnkey Program. These properties are
stated at the lower of cost or net realizable value, and are not being
depreciated. The Company believes that no impairment of these assets has
occurred and that no reduction of the carrying amounts is warranted.
INVESTMENTS
Investments are stated at the lower of cost or market. Limited partnership
investments are accounted for under the equity method, and accordingly, the
Company's investment is adjusted for allocated profits, losses and
distributions.
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
typically purchases or leases a selected site, designs and constructs a
Schlotzsky's Deli restaurant on the site and sells, leases or subleases 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. See "Guaranties on
Franchise Operating Leases and Other Obligations". 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
F-8
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
guaranty exists, the Company defers revenue and related costs to 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 incurred. The Company considers
the Turnkey Program part of its services to its franchisees, accordingly, in
1997 the Company determined that cash flows related to the Turnkey Program
should be reported in cash flows from operating activities. Cash flows from
operating and investing activities were decreased and increased, respectively,
by approximately $5,384,000 and $4,774,000 in 1996 and 1995.
Turnkey development revenue consists of the following:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER
31,
-----------------------------
1996 1997
------------- --------------
<S> <C> <C>
Sales to investors and franchisees....................................... $ 6,638,150 $ 23,022,364
Development and construction management fees............................. 174,979 190,000
------------- --------------
Gross Turnkey Program revenue........................................ 6,813,129 23,212,364
Turnkey Program costs.................................................... (6,455,618) (21,013,973)
------------- --------------
Net revenue from Turnkey Program projects............................ 357,511 2,198,391
Rental income............................................................ 368,402 303,091
Interim construction interest............................................ -- 1,270
Less: Deferred revenue................................................... -- (1,364,142)
------------- --------------
Total Turnkey Program revenue........................................ $ 725,913 $ 1,138,610
------------- --------------
------------- --------------
</TABLE>
For the year ended December 31, 1997, the Company transferred title or
assigned earnest money contracts on nine other Turnkey Program properties
receiving proceeds of approximately $8,340,000, incurring development costs of
approximately $7,815,000 and deferring revenue of approximately $525,000. The
net revenue from these transactions has been deferred as of December 31, 1997
because the related franchisee leases assigned to the third-party investors are
subject to guaranties by the Company.
F-9
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
The following table reflects system performance of the Turnkey Program since
its inception in 1995.
<TABLE>
<CAPTION>
NUMBER OF UNITS
-------------------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C> <C>
Sites in process at beginning of year................................ -- 27 30
Sites beginning development during the year.......................... 32 19 90
Sites completed as Company-owned stores.............................. -- (1) (1)
Sites inventoried as real estate held for sale....................... -- (5) --
Sites sold--revenue recognized....................................... (5) (10) (7)
Sites sold--revenue deferred......................................... -- -- (33)
Other................................................................ -- -- (1)
--- --- ---
Sites in process at end of year...................................... 27 30 78
--- --- ---
--- --- ---
<CAPTION>
INVESTED AT
DECEMBER 31,
1997
------------
<S> <C> <C> <C> <C>
Opened (receiving rent & royalties).................................. 2 8 2 $1,646,000
Investment Sites (under construction)................................ 9 9 3 4,092,000
Predevelopment Site (prequalification)............................... 11 13 73 1,213,000
Other................................................................ 5 -- -- --
--- --- --- ------------
27 30 78 $6,951,000
--- --- --- ------------
--- --- --- ------------
</TABLE>
Turnkey Program sites in process at end of year are classified as current
assets as management expects to complete and sell such sites within the next
year.
Depreciation expense associated with Turnkey Program stores was
approximately $4,000, $76,000 and $88,000 for the years ended December 31, 1995,
1996 and 1997, respectively.
INTANGIBLE ASSETS
Intangible assets consist primarily of the Company's original franchise
rights, royalty values and goodwill, and developer and franchise rights related
to the Company's reacquiring of franchises and developer rights. Intangible
assets are amortized over their estimated useful lives ranging from four to 40
years.
The Company evaluates the propriety of the carrying amount of its intangible
assets, as well as the amortization period for each intangible when conditions
warrant. If an indicator of impairment is present, the Company compares the
projected undiscounted operating income for the related business with the
unamortized balance of the related intangible asset. If the undiscounted cash
flows are less than the carrying value, management estimates the fair value of
the intangible asset based on future operating cash flows for the next 10 years,
discounted at the Company's primary borrowing rate. The excess of the
unamortized balance of the intangible asset over the fair value, as determined,
is charged to impairment loss. The Company believes that no impairment of its
intangibles has occurred and that no reduction of the carrying amounts or
estimated useful lives is warranted.
REVENUE RECOGNITION
Royalties:
F-10
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
Royalties are paid to the Company by franchisees at 4% to 6% of gross
franchise sales. Royalties are recognized in the period the related gross
franchise sales are earned.
Franchise Fees:
Nonrefundable proceeds from the awarding of a franchise are recognized as
revenue when the Company has performed substantially all services for the
franchisee as stipulated in the franchise agreement, typically at store opening.
Franchise fees collected but not yet recognized are recorded, net of deferred
direct incremental expenses, as deferred revenue in the accompanying
consolidated financial statements.
Developer Fees:
The Company will convey rights to certain persons, under agreements ("Area
Developer Agreements") to act as an area developer within a specific development
area for a specified term. Developers within the United States ("Area
Developers") locate prospective new franchisees, perform site selection duties
and service the franchisees subsequent to the store opening. The Company charges
the Area Developers a nonrefundable fee for the rights conveyed. The Company
typically collects a portion of the fee in cash at closing of the Area Developer
Agreements, and extends terms on the remainder typically not exceeding three
years.
International developers ("Master Licensees") have the exclusive right to
develop and license the development and operation of Schlotzsky's Deli
restaurants using the Company's system and trademarks within the development
area. The rights to develop, operate and sublicense the development and
operation of Schlotzsky's Deli restaurants in the foreign territory are granted
pursuant to the terms and conditions under an agreement with a Master Licensee
("Master License Agreement").
The Company has also entered into Master Development Agreements or
Territorial Agreements (collectively the "Territorial Agreements") which, for a
nonrefundable reservation fee, grants the right to negotiate exclusive
territorial rights to develop Schlotzsky's Deli restaurants in the territory,
subject to and in accordance with terms and conditions of a Master License
Agreement; however, the right to develop, operate and sublicense the development
and operation of Schlotzsky's Deli restaurants in the territory is not granted
until the execution of the Master License Agreement. The Territorial Agreement
specifies the desired economic terms and basic form of the Master License
Agreement. The Company requires the Master Licensee to obtain clauses, covenants
and agreements to comply with and conform to the business practices or laws of
the respective territory. The cost of conforming the contract of the Master
License Agreement is the responsibility of Master Licensee. If the Company
cannot reasonably satisfy itself of the enforceability of such clauses,
covenants and agreements within the territory, the Company will not be obligated
to grant a Master License Agreement and any rights granted under the Territorial
Agreements will terminate immediately upon notice by the Company.
The Company ordinarily collects approximately 15% to 35% of cash at closing
of either a Territorial Agreement or Master License Agreement, with the
remainder financed typically over a term typically not exceeding four years,
depending on the creditworthiness of the maker and guarantor of the note.
With respect to Area Developers and Master Licensees, the Company recognizes
as revenue the nonrefundable fees received in cash and the fair value of the
financed portion as established by an independent third party and any incentive
fees due, upon fulfillment of substantially all of its contractual
responsibilities and obligations to the Area Developers and Master Licensees.
For Area Developers, this
F-11
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
includes providing manuals and sales offering materials, which typically
coincides with the execution of the Area Developer Agreement and the receipt of
cash and a promissory note. With respect to Master Licensees, the Company's
duties to the Master Licensees include providing manuals, initial training if
requested, and reasonable efforts to obtain registration of the Company's
trademarks in the applicable foreign territories. Completion of the Company's
duties typically coincides with the execution of a Territorial Agreement or
Master License Agreement and the receipt of cash and a promissory note.
Area Developers and Master Licensees are required to meet certain
performance requirements under their agreements which include minimum store
opening schedules, performance standards and compliance with the terms of their
notes to the Company, if any. Failure to meet these requirements could result in
the Company terminating their agreements.
In general, the Area Developers and Master Licensees then receive a fee for
recruitment and development, including advertising, soliciting, qualifying and
closing sales as well as consultation and advice in establishment, construction,
financing and opening of restaurants in their territory. Area Developers, in
general, receive a fee equal to one-half of franchise fee paid by franchisees to
the Company. Master Licensees collect the initial sublicense and developer fees
and then remit a portion of these fees back to the Company. The Company expects
to receive approximately one-third to one-half of these fees from the Master
Licensee.
In addition, Area Developers and Master Licensees receive a portion of the
ongoing royalties from the franchised restaurants for providing service and
support to the franchisees in their development area. Area Developers typically
receive 2.5% out of the 6% ongoing royalties and Master Licensees typically
retain two-thirds of ongoing royalties, remitting one-third to the Company.
ROYALTY SERVICE COSTS
In accordance with the Area Developer Agreements, the Company typically pays
Area Developers 2.5% out of the 6% royalties received from franchisees. Royalty
service costs are recognized in the period the related royalties are recognized.
FRANCHISE FEE DEVELOPMENT COSTS
In accordance with the Area Developer Agreements, the Company pays Area
Developers approximately one-half of the initial franchise fees collected from
franchise sales in a specified development area. These costs are recognized as
expenses when the Company has performed substantially all services for the
franchisee as stipulated in the franchise agreement, typically at store opening.
Franchise fee development costs paid, but not yet recognized, are recorded as a
reduction of gross deferred revenue in the accompanying consolidated financial
statements.
INCOME TAXES
The Company recognizes deferred tax assets or liabilities computed based on
the difference between the financial statement and income tax basis of assets
and liabilities using the enacted marginal tax rate. Deferred income tax
expenses or credits are based on the changes in the asset or liability from
period to period.
F-12
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents, a
restricted certificate of deposit, receivables, notes receivable, accounts
payable, accrued liabilities and debt. All financial instruments are accounted
for on a historical cost basis which approximates fair value at December 31,
1996 and 1997, except for notes receivable from Area Developers and Master
Licensees which are valued at the lower of cost or appraised fair value.
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 computation for the years ended December 31, 1995,
1996 and 1997 are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
BASIC EPS
Net income available to common stockholders................. $ 1,088,623 $ 3,194,975 $ 4,449,415
------------ ------------ ------------
------------ ------------ ------------
Weighted average common shares outstanding.................... 2,314,938 5,525,902 5,994,403
------------ ------------ ------------
------------ ------------ ------------
Basic EPS..................................................... $ 0.47 $ 0.58 $ 0.74
------------ ------------ ------------
------------ ------------ ------------
DILUTED EPS
Net income available to common stockholders, net of
redeemable preferred dividends totaling $340,261 for the
year ended December 31, 1995.............................. $ 1,428,884 $ 3,194,975 $ 4,449,415
------------ ------------ ------------
------------ ------------ ------------
Weighted average common shares outstanding.................... 2,314,938 5,525,902 5,994,403
Assumed conversion of common shares issuable under stock
option plan and exercise of warrants........................ 1,125,705 113,323 232,431
------------ ------------ ------------
Weighted average common and common equivalent shares
outstanding................................................. 3,440,643 5,639,225 6,226,834
------------ ------------ ------------
------------ ------------ ------------
Diluted EPS................................................... $ 0.42 $ 0.57 $ 0.71
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-13
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
RECENT ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
SFAS No. 130 is effective for fiscal years beginning after December 15, 1997.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products as services, geographic areas and major customers. SFAS No. 131
is effective for financial statements for periods beginning after December 15,
1997.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures and
Pensions and Other Postretirement Benefits", which significantly changes current
financial statement disclosure requirements from those that were required under
SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits", and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions". SFAS No. 132 does not change the
existing measurement of recognition provisions of SFAS Nos. 87, 88 or 106. SFAS
No. 132 is effective for fiscal years beginning after December 15, 1997.
Management does not believe the implementation of these recent accounting
pronouncements will have a material effect on its consolidated financial
statements.
RECLASSIFICATIONS
Certain reclassifications were made to previously reported amounts in the
accompanying consolidated financial statements and notes to make them consistent
with the current presentation format.
F-14
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. NOTES RECEIVABLE
Notes receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Notes receivable from Area Developers (under Area Development Agreements)
and Master Licensees (under Master License and Territorial Agreements),
collateralized by their respective territories, net of valuation allowance
of $343,000 and $443,000, respectively, bearing interest ranging from 6%
to 10% per annum due through July 2000.................................... $ 1,971,144 $ 1,386,252
Notes receivable from franchisees and area developers, bearing interest at
8% to 10% per annum, some notes collateralized by their restaurants,
others uncollateralized with monthly principal and interest installments
through January 2023...................................................... 257,106 1,814,981
Notes receivable from franchisees bearing interest ranging from 8.75% to
9.5% per annum, collateralized by franchisees' property and equipment with
payments due through December 2000........................................ 454,772 324,405
Notes receivable from various parties bearing interest ranging from 8% to
10% per annum, collateralized by an interest in a limited partnership and
certain other equity instruments with payments due through October 2000... 178,275 170,320
Notes receivable bearing interest at 8% per annum, collateralized by real
estate, principal and interest due by October 1998........................ -- 846,000
Other....................................................................... 9,763 5,100
------------ ------------
2,871,060 4,547,058
Current portion............................................................. (557,332) (2,574,588)
------------ ------------
Notes receivable, less current portion...................................... $ 2,313,728 $ 1,972,470
------------ ------------
------------ ------------
</TABLE>
During 1996, notes receivable from Area Developers and Master Licensees
totaling approximately $255,000 were extended beyond their original terms,
including approximately $230,000 which was due in 1996 and was extended beyond
December 31, 1996.
During 1997, a note receivable from a Master Licensee totaling approximately
$225,000 was extended beyond its original terms, including approximately
$125,000 which was due in 1997 and was extended beyond December 31, 1997.
F-15
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. NOTES RECEIVABLE FROM RELATED PARTIES
Notes receivable from related parties consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Note receivable from Master Licensee, an organization of which a member of
the Company's Board of Directors is Managing Director, bearing interest at
9% per annum due through December 1999.................................... $ 275,000 $ 275,000
Notes receivable from certain stockholders of the Company, bearing interest
at 7.5% per annum, principal and accrued interest due through 2001........ 237,618 237,618
Notes receivable from related entities controlled by stockholders of the
Company, bearing interest at 9% per annum, collateralized by real estate,
principal and accrued interest due through 2001........................... 541,527 579,466
Note receivable from Master Licensee, an organization of which a member of
the Company's management is a shareholder, bearing interest at 8% per
annum due through December 2006........................................... 875,000 455,000
Notes receivable from Master Licensee, an organization of which the Company
is a preferred shareholder, bearing interest at 9% per annum, principal
due ratably beginning December 1998 through December 2007. (see note on
"Related Party Transactions")............................................. 1,189,085 1,068,315
------------ ------------
3,118,230 2,615,399
Current portion............................................................. (595,000) (50,000)
------------ ------------
Notes receivable, less current portion...................................... $ 2,523,230 $ 2,565,399
------------ ------------
------------ ------------
</TABLE>
During 1996, notes receivable from Master Licensees, certain stockholders
and entities controlled by certain stockholders totaling approximately
$1,625,000 were extended beyond their original terms, including approximately
$540,000, which was due in 1996 and was extended beyond December 31, 1996.
From time to time, the Company makes advances to certain stockholders,
related partnerships and affiliates (see notes on "Investments and Advances" and
"Related Party Transactions").
F-16
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
DEPRECIABLE DEPRECIABLE ---------------------------
METHOD LIFE (YEAR) 1996 1997
--------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Building................................... Straight Line 32 $ 720,741 $ --
Furniture, fixtures and equipment.......... Straight Line 3 to 7 1,684,840 3,520,805
Leasehold improvements..................... Straight Line 20 to 32 3,452,202 7,229,286
------------ -------------
5,857,783 10,750,091
Accumulated depreciation and amortization................................. (808,612) (1,163,265)
------------ -------------
5,049,171 9,586,826
Land...................................................................... 391,711 411,804
------------ -------------
Property, equipment and leasehold improvements, net....................... $ 5,440,882 $ 9,998,630
------------ -------------
------------ -------------
</TABLE>
During 1997, the Company purchased leasehold improvements and furniture,
fixtures and equipment in connection with their relocating of the corporate
headquarters in the amounts of $917,000 and $322,000, respectively.
Additionally, in December 1997, the Company sold the building and improvements
of its previous offices for $1,171,000 which was comprised of cash of $325,000
and a note receivable for $846,000. (Note 2)
Depreciation and amortization of property, equipment and leasehold
improvements totaled approximately $169,000, $363,000 and $566,000 for the years
ended December 31, 1995, 1996 and 1997, respectively.
5. INVESTMENTS AND ADVANCES
Investments and advances consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Limited partnership:
Investment................................................................ $ 191,744 $ 189,798
Advances.................................................................. 511,047 507,046
------------ ------------
702,791 696,844
Building art................................................................ 263,071 263,071
Investments in Master Licensees............................................. 300,000 496,875
------------ ------------
Investments and advances.................................................... $ 1,265,862 $ 1,456,790
------------ ------------
------------ ------------
</TABLE>
F-17
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVESTMENTS AND ADVANCES (CONTINUED)
LIMITED PARTNERSHIP
The Company owns a 40% general and limited partnership interest in an entity
engaged in the acquisition, development and construction of certain commercial
real estate. The partnership has the following assets, liabilities and partners'
capital:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Assets...................................................................... $ 2,359,498 $ 2,289,572
Liabilities................................................................. 1,699,445 1,634,384
Partners' Capital........................................................... 660,053 655,188
</TABLE>
The partnership's net profits, losses and distributions are allocated based
upon methods set forth in the partnership agreement. The Company is allocated
25% of distributions and like amount of net profits until the other limited
partner has received an aggregate amount equal to its aggregate contribution.
Thereafter, remaining net profits and all losses are allocated 40% to the
Company.
The Company is the guarantor of all partnership indebtedness which consists
of borrowings under a $1,150,000 bank line of credit with an original maturity
date of December 31, 1995 with approximately $1,139,000 and $1,117,000
outstanding at December 31, 1996 and 1997, respectively. Principal and interest
of $10,850 is due monthly until April 2001 whereupon all outstanding principal
and interest is due. The line of credit bears interest at 1.25% above the bank's
prime rate until maturity and after. The indebtedness is collateralized by
project real estate, and related leases and rents. The partnership has entered
into leases for approximately 60% of the 17,600 square feet of its retail
shopping center for a term of 10 years at approximately $15.00 per square foot
per annum which began in September 1995. The partnership completed the
development of this project in February 1996.
INVESTMENTS IN MASTER LICENSEES
In November 1996, the Company paid $300,000 to a Master Licensee and also
agreed to serve as guarantor of additional financing not to exceed $400,000. At
December 31, 1996 and 1997, the outstanding balance on the additional financing
guaranteed by the Company was $300,000 and $400,000, respectively. See note on
"Related Party Transactions". During 1997, the Company made an investment of
approximately $197,000 in a Master Licensee.
6. INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
AMORTIZATION DECEMBER 31,
PERIOD ----------------------------
(YEARS) 1996 1997
------------ ------------- -------------
<S> <C> <C> <C>
Original franchise rights.................................. 40 $ 5,688,892 $ 5,688,892
Royalty value and goodwill................................. 20 1,982,844 2,222,938
Developer and franchise rights acquired.................... 20 to 40 1,915,630 4,668,200
Debt issue costs........................................... 5 to 25 107,328 98,964
Organization costs......................................... 4 to 10 29,021 29,021
Other intangible assets.................................... up to 5 272,794 345,037
------------- -------------
9,996,509 13,053,052
Less accumulated amortization............................ (1,480,626) (1,939,839)
------------- -------------
Intangible assets, net................................. $ 8,515,883 $ 11,113,213
------------- -------------
------------- -------------
</TABLE>
F-18
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INTANGIBLE ASSETS (CONTINUED)
In 1996, the Company reacquired franchises and developer and franchise
rights in New York and Texas. The purchase price of the New York franchise of
$250,000 exceeded the fair value of the identifiable assets acquired by
approximately $150,000. The purchase price of the Texas franchise of $350,000
exceeded the fair value of the identifiable assets acquired by approximately
$230,000. The franchise acquisitions were accounted for using the purchase
method of accounting and the resulting goodwill is being amortized on a
straight-line basis over 20 years. The developer rights acquired under these
transactions totaled approximately $986,000 and are being amortized on a
straight-line basis over 40 years.
In 1997, the Company reacquired the developer rights in Connecticut,
Maryland, Virginia and various western territories. The aggregate purchase price
of these developer rights was approximately $1,734,000. Also, the Company
reacquired franchise rights in Houston and Austin, Texas for approximately
$1,018,000. The developer rights acquired under these transactions are being
amortized on a straight-line basis over 40 years.
Amortization of intangible assets totaled approximately $285,000, $340,000
and $502,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
7. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Accrued taxes............................................................... $ 265,999 $ 224,643
Accrued legal and professional.............................................. 100,270 212,012
Developer service costs..................................................... 455,412 742,541
Other accrued liabilities................................................... 601,780 278,046
------------ ------------
$ 1,423,461 $ 1,457,242
------------ ------------
------------ ------------
</TABLE>
8. DEFERRED REVENUE
Franchise fees, developer fees, and revenue from the Turnkey Program
collected but not yet recognized into income less related direct incremental
costs paid but not yet charged to expense are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
Deferred franchise and developer fees..................................... $ 2,992,500 $ 2,037,500
Deferred direct incremental costs:
Deferred franchise fee development service costs........................ (1,547,125) (1,034,375)
Deferred commissions.................................................... (21,750) (13,750)
Other deferred costs.................................................... (23,850) (22,550)
Deferred revenue--Turnkey Program......................................... 263,990 1,888,555
------------- -------------
Total deferred revenue................................................ $ 1,663,765 $ 2,855,380
------------- -------------
------------- -------------
</TABLE>
F-19
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. NOTES PAYABLE
In June 1997, the Company secured an additional line of credit of up to
$12,000,000 from a financial institution. This line of credit bears interest at
the bank's prime lending rate and expires April 2000. As of December 31, 1997,
the Company has not drawn against this line of credit.
10. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Capitalized lease, bearing an effective interest rate of 11.24%,
collateralized by real property; monthly principal and interest
installments of $12,615 through 2020...................................... $ 1,250,583 $ 1,238,170
Note payable to a financial institution bearing interest at 9.47% per annum
through 2000. From 2000 through maturity, the note will bear interest at
the lesser of a certain bank's prime lending rate plus 1.75%, or a
mutually agreed upon rate. Payments are due in periodic principal and
interest installments through December 2002, at which time all remaining
principal and interest is due. The note is collateralized by equipment and
assignment of royalties from certain franchisees. The note was
extinguished in September 1997............................................ 1,024,696 --
Note payable to a bank, bearing interest at 9.25%, collateralized by certain
real property. Monthly installments of $2,778 plus interest are due
through March 2002, at which time all remaining principal and interest is
due. The note was extinguished in July 1997............................... 441,663 --
Various notes payable to individuals and corporations, bearing interest at
6% to 9% per annum, due in periodic principal and interest installments
through 1999, and collateralized by equipment and assignment of royalties
from certain franchisees.................................................. 694,600 791,607
Note payable to a limited partnership, bearing interest at 9%. One payment
of principal and interest totaling $240,168 due January 1998. The note was
extinguished in May 1997.................................................. 200,000 --
Note payable to a financial institution bearing interest at 10.6% per annum
through July 2002. Payments of principal and interest are due monthly. The
note is collateralized by equipment, furniture and fixtures of a
Company-owned restaurant.................................................. -- 157,235
------------ ------------
3,611,542 2,187,012
Current maturities........................................................ (482,205) (250,625)
------------ ------------
Long-term debt, less current maturities................................. $ 3,129,337 $ 1,936,387
------------ ------------
------------ ------------
</TABLE>
F-20
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. LONG-TERM DEBT (CONTINUED)
The aggregate annual maturities of long-term debt at December 31, 1997 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
- ----------------------------------------------------------------------
<S> <C>
1998.................................................................. $ 250,625
1999.................................................................. 394,048
2000.................................................................. 247,499
2001.................................................................. 41,362
2002.................................................................. 46,081
Thereafter............................................................ 1,207,397
------------
$ 2,187,012
------------
------------
</TABLE>
Interest expense, net of amounts capitalized, totaled approximately
$435,000, $331,000 and $297,000 for the years ended December 31, 1995, 1996 and
1997, respectively.
11. INCOME TAXES
The provision for federal and state income taxes consists of the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Federal:
Current provision........................................... $ 1,136,317 $ 1,886,719 $ 2,416,124
Deferred provision (benefit)................................ (183,694) (75,578) 26,988
------------ ------------ ------------
Total federal............................................. 952,623 1,811,141 2,443,112
State--current provision...................................... 63,973 91,149 171,148
------------ ------------ ------------
Provision for federal and state income taxes before
extraordinary gain.......................................... 1,016,596 1,902,290 2,614,260
------------ ------------ ------------
Tax provision of extraordinary gain........................... 18,271 -- --
------------ ------------ ------------
Total provision for income taxes.............................. $ 1,034,867 $ 1,902,290 $ 2,614,260
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The differences between the income tax expense from continuing operations
and the amount that would result if the statutory rates were applied to the
pretax financial income were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Expense at statutory rate of 34%.............................. $ 908,342 $ 1,733,070 $ 2,401,650
Nondeductible items, including amortization................... 66,540 86,915 99,653
State income taxes, net....................................... 42,222 60,158 112,957
Other......................................................... 17,763 22,147 --
------------ ------------ ------------
$ 1,034,867 $ 1,902,290 $ 2,614,260
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-21
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
The tax effects of the significant temporary differences which comprise the
deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Assets:
Non-current:
Deferred revenue............................................... $ 534,590 $ 475,924 $ 666,842
Accrued liabilities............................................ -- 145,451 21,809
Other.......................................................... 12,910 27,711 35,028
---------- ---------- ----------
Gross deferred tax assets...................................... 547,500 649,086 723,679
---------- ---------- ----------
Liabilities:
Current:
Deferred costs................................................. 15,630 -- --
Non-current:
Property, equipment and intangibles............................ -- 41,638 143,219
---------- ---------- ----------
Gross deferred tax liabilities................................... 15,630 41,638 143,219
---------- ---------- ----------
Net deferred tax asset....................................... $ 531,870 $ 607,448 $ 580,460
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
12. STOCKHOLDERS' EQUITY
PREFERRED STOCK
During December 1995, all of the Company's outstanding shares of preferred
stock were converted in connection with the sale in an initial public offering
of 1,850,000 shares of the Company's common stock at a conversion price of $5.34
and $7.20 for Class A and B, respectively. The preferred stock was convertible
to common stock, at the holder's option, any time prior to redemption, and was
also subject to automatic conversion on similar terms upon the registration and
sale of at least $5,000,000 of the Company's common stock or upon a two thirds
vote of preferred stockholders. Subsequently, the Company's amended Articles of
Incorporation provided that the Company's shares of Class A and Class B
preferred stock were effectively canceled.
COMMON STOCK
In September 1997, the Company sold in a secondary public offering 1,500,000
shares of its common stock which generated net proceeds of approximately $25.6
million. In October 1997, the over-allotment was exercised and the Company sold
an additional 231,825 shares of common stock which resulted in net proceeds of
approximately $4.0 million. The proceeds were used to repay certain bank debt of
approximately $1.7 million. A portion of the proceeds will be used to finance
the development of several Company-owned restaurants, with the majority of the
proceeds to be used to develop restaurants under the Turnkey Program.
F-22
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
WARRANTS
During 1994, the Company issued a warrant to purchase 23,438 shares of
common stock at an initial exercise price of $9.60 per share. The warrant
expires in 2001.
During 1995, the Company issued a warrant to purchase 5,468 shares of common
stock at an initial exercise price of $12.80. The warrant was exercised in
November 1997.
13. STOCK-BASED COMPENSATION PLANS
The Company sponsors the "Schlotzsky's, Inc. Third Amended and Restated
Stock Option Plan" (the "Plan"), which is a stock-based incentive compensation
plan, as described below. The Company applies APB Opinion No. 25 and related
Interpretations in accounting for the Plan. In 1995, the FASB issued SFAS No.
123 "Accounting for Stock-Based Compensation" which, if adopted by the Company,
would change the methods the Company applies in recognizing the cost of the
Plan. Adoption of the cost recognition provisions of SFAS No. 123 is optional
and the Company has decided not to elect these provisions of SFAS No. 123.
However, pro forma disclosures as if the Company adopted the cost recognition
provisions of SFAS No. 123 in 1995 are required by SFAS No. 123 and are
presented below.
THE STOCK OPTION PLAN
Under the Plan, the Company is authorized to issue 800,000 shares of common
stock pursuant to "Awards" granted in the form of incentive stock options
(qualified under Section 422 of the Internal Revenue Code of 1986, as amended)
and non-qualified stock options. Awards may be granted to key employees of the
Company. In February 1998, the Compensation Committee of the Board of Directors
amended the Plan to provide for an additional 150,000 shares of common stock to
be authorized for issuance as non-qualified stock options under its provisions.
According to the Plan, Awards may be granted with respect to a maximum of
950,000 shares of common stock. In 1995, 1996 and 1997 the Company granted a
total of 313,814, 82,850 and 200,500 awards, respectively, in the form of
incentive stock options under the Plan. Under the Plan, the options granted on
December 12, 1994, vest based on tenure, from the hire date to December 31,
1993. The vesting is as follows: the formula is 5% of total options per year of
tenure vesting on June 6, 1994 for those with five years of tenure or more, and
the remaining options vest over a five-year period, 20% per year, beginning on
the first anniversary of the date of grant. All other options vest over a
five-year period, 20% per year, beginning on the first anniversary of the hire
date, with the exception of 22,500 options granted during 1997 which vest over a
three-year period, 33% per year, beginning on the first anniversary of the date
of grant.
F-23
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
A summary of the status of the Company's stock options as of December 31,
1995, 1996 and 1997 and the changes during the years ended on those dates are
presented below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------
WEIGHTED AVERAGE
EXERCISE PRICES
SHARES PER SHARE
--------- -----------------
<S> <C> <C>
BALANCE, January 1, 1995................................................... 312,664 $ 7.03
Granted.................................................................. 313,814 $ 10.39
Exercised................................................................ -- --
Forfeited................................................................ (4,688) $ 11.20
Expired.................................................................. -- --
---------
BALANCE, December 31, 1995................................................. 621,790 $ 8.70
Granted.................................................................. 82,850 $ 10.50
Exercised................................................................ (29,924) $ 6.75
Forfeited................................................................ (79,752) $ 8.05
Expired.................................................................. -- --
---------
BALANCE, December 31, 1996................................................. 594,964 $ 9.13
Granted.................................................................. 200,500 $ 15.08
Exercised................................................................ (57,201) $ 8.50
Forfeited................................................................ (85,799) $ 9.88
Expired.................................................................. -- --
---------
BALANCE, December 31, 1997................................................. 652,464 $ 10.84
---------
---------
Exercisable at December 31, 1995........................................... 298,211 $ 8.43
Exercisable at December 31, 1996........................................... 339,981 $ 8.75
Exercisable at December 31, 1997........................................... 362,178 $ 9.19
Weighted-average fair value of options granted during 1995................. $ 2.73
Weighted-average fair value of options granted during 1996................. $ 4.96
Weighted-average fair value of options granted during 1997................. $ 6.81
</TABLE>
The fair value of each stock option granted in 1995, 1996 and 1997 when the
Company was public is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: no
dividend yield; risk-free interest rate of 6.37% for 1995 and 1996; 6.17% for
1997; the expected lives of the options are six years; and volatility of 37.01%
for 1995 and 1996; 32.50% for 1997. The fair value of each stock option granted
before the Company became publicly traded was determined using the following
assumptions: no dividend yield; risk-free rates are from 6.17% to 6.48%; and the
expected lives of the options are six years. In determining the "minimum value,"
SFAS No. 123 does not require the volatility of the Company's common stock
underlying the options to be calculated or considered because the Company was
not publicly-traded when the 1995 options were granted.
F-24
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- --------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AVERAGE
DECEMBER 31, REMAINING EXERCISE AT DECEMBER EXERCISE
RANGE OF EXERCISE PRICES 1997 CONTRACT LIFE PRICE 31, 1997 PRICE
- ------------------------------------ -------------- --------------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
$5.60 to $11.00..................... 407,948 3.10 $ 8.39 261,971 $ 7.79
$11.09 to $18.73.................... 244,516 4.96 14.94 100,747 12.81
------- --- ----------- ------------- -----------
$5.60 to $18.73..................... 652,464 3.80 $ 10.84 362,718 $ 9.19
</TABLE>
PRO FORMA NET INCOME AND NET INCOME PER COMMON SHARE
During 1996 and 1997, the Company did not incur any compensation costs for
the Plan under APB No. 25. Had the compensation cost for the Company's Plan been
determined consistent with SFAS No. 123, the Company's net income and net income
per common share for 1995, 1996 and 1997 would approximate the pro forma amounts
below:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1996 DECEMBER 31, 1997
------------------------ ------------------------ ------------------------
AS PRO AS PRO AS PRO
REPORTED FORMA REPORTED FORMA REPORTED FORMA
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
SFAS No. 123 charge, net of
applicable income taxes of
$120,126, $65,414 and $145,379
for 1995, 1996 and 1997,
respectively................... $ -- $ 188,681 $ -- $ 109,959 $ -- $ 247,537
Net income....................... $ 1,632,897 $ 1,444,216 $ 3,194,975 $ 3,085,016 $ 4,449,415 $ 4,201,878
Net income per common
share--basic................... $ 0.47 $ 0.39 $ 0.58 $ 0.56 $ 0.74 $ 0.70
Net income per common
share--diluted................. $ 0.42 $ 0.36 $ 0.57 $ 0.55 $ 0.71 $ 0.67
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1995 and the Company anticipates making awards in the future under its Plan. As
the Company's options typically vest over five years, the full impact of the pro
forma disclosure requirements will not be reflected until 2000.
14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest during the years ended December 31, 1995, 1996 and
1997 was approximately $435,000, $313,000 and $297,000, respectively, net of
approximately $250,000, capitalized in 1995.
Cash paid for taxes during the years ended December 31, 1995, 1996 and 1997
was approximately $1,450,000, $2,614,000 and $2,404,000, respectively.
During 1995, the Company had the following noncash activity:
Notes receivable totaling approximately $1,800,000 were issued for
nonrefundable Area Developer, Master Licensee, Territorial and other fees.
F-25
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (CONTINUED)
Mandatory redeemable preferred stock, totaling approximately $7,978,000
net of issue costs was converted to common stock.
Mandatory redeemable preferred stock dividends totaling $700,000 were
converted to common stock.
During 1996, the Company had the following noncash activity:
Notes receivable totaling approximately $1,785,000 were issued for
nonrefundable Area Developer, Master Licensee, Territorial and other fees.
During 1997, the Company had the following noncash activity:
Notes receivable totaling approximately $272,000 were issued for
nonrefundable Area Developer, Master Licensee, Territorial and other fees.
Notes receivable totaling approximately $1,400,000 were issued for sales
of real estate development properties.
Notes payable totaling approximately $525,000 were issued for
acquisition of developer rights.
15. RELATED PARTY TRANSACTIONS
Franchisees contribute 1% of gross sales to Schlotzsky's N.A.M.F., Inc.
("NAMF") to be used solely for the production of programs and materials for
marketing and advertising. The Company charges NAMF an amount equal to certain
cost allocations and salaries for administering NAMF. Advances to NAMF totaled
approximately $87,000 and $40,000 at December 31, 1996 and 1997, respectively,
and are included in other receivables in the accompanying consolidated balance
sheets.
One or more principal stockholders of the Company is guarantor of the
Company's notes payable and long-term debt, totaling approximately $2,983,000
and $1,460,000 at December 31, 1996 and 1997, respectively.
In 1995, the Company entered into a Master License Agreement with Buxtehude
Holdings, B.V., an organization of which a member of the Company's Board of
Directors is managing director. Pursuant to the terms of the agreement,
Buxtehude paid the Company $150,000 in cash and $350,000 by promissory note. The
Company recorded developer revenue totaling $500,000 in 1995 in connection with
this transaction.
In 1995, the Company entered into an Area Developer Agreement pursuant to
which the Area Developer paid the Company $50,000 in cash and $100,000 by
promissory note. The cash was paid to the Company from one or more loans made to
the Area Developer by Austin CBD 29, Inc. ("CBD 29") or its affiliates. Further,
CBD 29 or its affiliates could obtain a security interest in the rights of the
Area Developer to receive a portion of the royalties paid by certain franchisees
and could acquire these rights in the event of default by the Area Developer.
CBD 29 was controlled by Buxtehude Holdings, B.V.
Also in 1995, the Company entered into Master License Agreements pursuant to
which the Master Licensees paid the Company $75,000 in cash and $190,000 by
promissory note. The cash paid to the Company from one or more loans made to the
Master Licensee by an organization which is a significant stockholder of the
Company. In addition, one of the members of the Company's Board of Directors is
the managing director of the organization providing the funding to the Master
Licensee.
F-26
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. RELATED PARTY TRANSACTIONS (CONTINUED)
Effective January 1, 1996, the majority of assets and liabilities of CBD 29
were transferred and assumed by Third & Colorado 29, L.L.C., an entity owned by
two stockholders of the Company.
In 1996, the Company entered into a Territorial Agreement pursuant to which
Sino-Caribbean Development, Inc. ("Sino") paid $150,000 in cash and $600,000 by
a promissory note for the right to obtain a master license for certain
territories in the Pacific Rim. In addition, Sino agreed to assume a promissory
note in the amount of $275,000 in exchange for territorial rights under an
existing Master License Agreement. The outstanding balances on the combined
notes were $875,000 and $455,000 at December 31, 1996 and 1997, respectively.
Sino is an organization of which an officer of the Company held 60% of its
outstanding common stock at December 31, 1996. In 1997, Sino issued shares of
common stock to third parties which reduced the officer's interest in the
organization to less than 30%.
During 1996, the Company paid $300,000 to Bonner Carrington Corporation
European Market ("BCCE") and agreed to serve as guarantor for additional
financing not to exceed $400,000. In return, the Company received: (i) preferred
stock representing 7.5% of the total outstanding shares of BCCE; (ii) an option
to buy additional preferred stock representing an additional 10% of the total
outstanding shares of BCCE; and (iii) options to purchase BCCE and its
respective territories at predetermined prices effective during the period
covering December 1999 through December 2011. In a separate transaction in June
1996, the Company entered into a Master License Agreement pursuant to which BCCE
paid the Company $25,000 in cash and $75,000 by promissory note.
The Company and Third & Colorado 19, L.L.C. ("T&C 19"), a limited liability
company owned by two stockholders of the Company, entered into a lease agreement
effective March 21, 1997, under which the Company leases from T&C 19
approximately 29,410 square feet of office space and 11,948 square feet of
storage space, in Austin, Texas for the Company's corporate headquarters. Under
the terms of the lease, the Company pays annual net rental of $12.95 per square
foot for the office space and up to $2.50 per square foot for the storage space
for a term of 10 years beginning November 1997.
16. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office facilities and certain equipment for its
Company-owned stores. Rent expense for the years ended December 31, 1995, 1996
and 1997, consisted of approximately $73,000, $118,000 and $814,000,
respectively. Future minimum rental payments under operating leases that have
initial or remaining noncancelable lease terms in excess of one year as of
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -----------------------------------------------------------
<S> <C>
1998....................................................... $ 1,029,000
1999....................................................... 1,053,000
2000....................................................... 1,073,000
2001....................................................... 1,081,000
2002....................................................... 1,040,000
Thereafter................................................. 7,201,000
-------------
$ 12,477,000
-------------
-------------
</TABLE>
F-27
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
GUARANTIES ON FRANCHISE OPERATING LEASES AND OTHER OBLIGATIONS
The Company, and in some cases certain stockholders, guaranty certain real
estate and equipment leases and other obligations of its franchisees. Under the
Turnkey Program, the Company typically provides a credit enhancement in the form
of a guaranty on the franchisee's lease assigned to a third-party investor.
These guaranties typically cover lease payments and various other obligations of
the franchisee for a period ranging from 18 months to five years, and is
effective throughout the 20 year lease. At December 31, 1997, the Company was
contingently liable for approximately $15.3 million under these guaranties.
Additionally, at December 31, 1997 the Company was contingently liable for
approximately $8.0 million under guaranties of other franchisee real estate and
equipment leases and various obligations.
LITIGATION
The Company is a defendant in various lawsuits arising in the ordinary
course of business. Management is of the opinion that all such matters are
without merit or are of such kind, or involve such amounts, as would not have a
significant effect on the consolidated financial position, results of operations
or cash flows of the Company if disposed unfavorably. The Company's federal,
state and local tax assessments are periodically subject to review by regulatory
agencies. Management is of the opinion that where such liabilities are
estimable, they do not involve amounts which significantly exceed existing
provisions.
YEAR 2000 COMPLIANCE
The Company's computer software programs utilize four digits to define the
applicable calendar year and therefore the Company believes that it has no
internal risk concerning the Year 2000 issue. Any problems the Company's
suppliers and customers may have related to this issue are not expected to
materially adversely affect the Company. The Company has not incurred any costs
related to this issue and is not expected to incur any such costs in the future.
17. CONCENTRATION OF CREDIT RISK
The Company's financial instruments that are exposed to concentrations of
credit risk consist primarily of cash and cash equivalents, notes receivable
from Area Developers and Master Licensees and notes receivable from affiliates.
The Company places its cash and cash equivalents with high credit quality
financial institutions, which, at times, may exceed federally insured limits.
The Company has not experienced any losses in such accounts.
The Company grants notes receivable to individuals and licensees who have,
in the opinion of the Company, adequate reserves to repay the notes independent
of the franchise rights. Although the Company has extended terms on certain of
the notes receivable they have not experienced significant credit losses to
date.
F-28
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
COL. C
-----------------------------
COL. B ADDITIONS COL. E.
----------- ----------------------------- -----------
COL. A BALANCE AT CHARGE TO COL. D BALANCE AT
- --------------------------------------------- BEGINNING COSTS AND CHARGE TO ----------- END OF
DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS DEDUCTION PERIOD
- --------------------------------------------- ----------- ----------- ---------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Valuation allowance for Notes Receivable:
December 31, 1997
Valuation Allowance...................... $ (342,774) $ (100,000) $ -- $ -- $ (442,774)
----------- ----------- ---------------- ----- -----------
----------- ----------- ---------------- ----- -----------
December 31, 1996
Valuation Allowance...................... $ (155,000) (187,774) $ -- $ -- $ (342,774)
----------- ----------- ---------------- ----- -----------
----------- ----------- ---------------- ----- -----------
December 31, 1995
Valuation Allowance...................... $ -- $ -- $ (155,000)(A) $ -- $ (155,000)
----------- ----------- ---------------- ----- -----------
----------- ----------- ---------------- ----- -----------
Deferred Interest Income--Notes Receivable:
December 31, 1997
Deferred interest income................. $ -- $ -- $ -- $ -- $ --
----------- ----------- ---------------- ----- -----------
----------- ----------- ---------------- ----- -----------
December 31, 1996
Deferred interest income................. $ (35,235) $ -- $ 35,235(B) $ -- $ --
----------- ----------- ---------------- ----- -----------
----------- ----------- ---------------- ----- -----------
December 31, 1995
Deferred interest income................. $ (106,153) $ -- $ 70,918(B) $ -- $ (35,235)
----------- ----------- ---------------- ----- -----------
----------- ----------- ---------------- ----- -----------
</TABLE>
- ------------------------
(A) Valuation Allowance for certain Area Developer and Master Licensee
promissory notes receivable was charged directly to developer fee revenue.
(B) Deferred interest income was charged to interest income.
S-1
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------ ----------------------------------------------------------------------------------------------------
<C> <C> <S>
3.1 -- Articles of Incorporation of the Registrant, as amended.(1)
3.2 -- Bylaws of the Registrant, as amended.(1)
4.1 -- Specimen stock certificate evidencing the Common Stock
10.1 -- Form of Unit Franchise Agreement entered into by the Registrant and franchisees.(1)
10.2 -- Form of Unit Development Agreement entered into by the Registrant and franchisees.(1)
10.3 -- Form of Area Developer Agreement entered into by the Registrant and area developers.(1)
10.4 -- Form of Master License Agreement entered into by the Registrant and area developers.(1)
10.5 (a) -- Form of Territorial Agreement entered into by the Registrant and master licensees.(1)
10.5 (b) -- Form of Master Development Agreement entered into by the Registrant and master licensees.(1)
10.6 -- Preferred Stock Repurchase Agreement, dated October 1993, among the Company, John C. Wooley, Jeffrey
J. Wooley, and the purchasers of Class A Preferred Stock.(1)
10.7 -- Preferred Stock Purchase Agreement, dated July 20, 1994, among the Registrant and the purchasers.(1)
10.8 -- Registration Rights Agreement, dated July 20, 1994, by and between the Registrant and the
shareholders named therein.(1)
10.9 -- Second Amended Agreement among Shareholders, dated July 20, 1994, by and among the Registrant and
the Shareholders described therein.(1)
10.10 -- Loan/Compromise and Settlement Agreement, dated April 7, 1994, between the Federal Deposit Insurance
Corporation as Receiver of Bank of the Hills, Austin, Texas, and the Registrant.(1)
10.11 -- Promissory Note, dated May 18, 1993, of the Registrant to First State Bank, Austin, Texas in the
original principal amount of $381,249.99.(1)
10.12(a) -- Promissory Note, dated April 15, 1993, of the Registrant to Janet P. Newberger and Lester Baum, as
trustees of the 1992 Newberger Family Trust, in the original principal amount of $750,000.(1)
10.12(b) -- Promissory Note, dated March 31, 1994, by and between the Registrant and Janet P. Newberger and
Lester Baum, co-trustees of the 1992 Newberger Family Trust.(1)
10.12(c) -- Second Modification Agreement, dated effective December 31, 1994, by and between the Registrant and
Janet P. Newberger and Lester Baum, as trustees of the 1992 Newberger Family Trust.(1)
10.12(d) -- Promissory Note, dated September 6, 1995, of the Registrant to JanMor Corporation, in the original
principal amount of $400,000.(1)
10.13 -- Promissory Note, dated February 1, 1995, of the Registrant to Liberty National Bank, Austin, Texas
in the original principal amount $220,000, Security Agreement, dated February 1, 1995 and Guarantee,
dated February 1, 1995, by and between John C. Wooley and Liberty National Bank.(1)
10.14 -- Real Estate Lien Note and Deed of Trust, Security Agreement and Financing Statement, dated March 31,
1995, of the Registrant to Texas Bank, N.A. in the original principal amount of $500,000.(1)
10.15 -- Promissory Note, dated April 14, 1995, between the Registrant and First State Bank in the original
principal amount of $2,000,000.(1)
10.16 -- Promissory Note and Security Agreement, dated July 15, 1993, of the Registrant to R. M. Wilkin, Inc.
in the original principal amount of $450,000.(1)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------ ----------------------------------------------------------------------------------------------------
<C> <C> <S>
10.17 -- Commitment Letter, dated July 7, 1995, by and between AT&T Commercial Finance Corporation and the
Registrant in an amount not to exceed $1,100,000.(1)
10.18 -- Term Sheet, dated July 19, 1995 by and between BeneVent-Noro and the Registrant.(1)
10.19 -- Promissory Note, dated December 1, 1994, by and between Bee Cave/Westbank, Ltd. and Liberty National
Bank in the original principal amount of $1,150,000.(1)
10.20 -- Loan Commitment, dated July 18, 1995, by and between Manns Capital Corporation and Bee
Cave/Westbank, Ltd., and Letter Amendment to Permanent Loan Commitment, dated July 28, 1995.(1)
10.21 -- Promissory Note, dated August 18, 1995, by and between the Registrant and First State Bank in the
original principal amount of $850,000.(1)
10.22 -- Operating Lease for 218 South Lamar, dated May 27, 1994, by and between William C. Pfluger, et al.
and Schlotzsky's Restaurants, Inc.(1)
10.23 -- Lease Agreement, September 8, 1995, by and between the Registrant and Austin CBD 29, Inc.(1)
10.24 -- Deed of Trust and Real Estate Lien Note, dated December 31, 1993, by and between Schlotzsky's Real
Estate, Inc. and Austin CBD Block 29, Ltd.(1)
10.25(a) -- Franchise Financing Program Procedures for Qualified Franchisees, dated April 15, 1994, by and
between Captec Financial Group, Inc. and the Registrant.(1)
10.25(b) -- Ultimate Net Loss Agreement, dated April 15, 1994, by and between the Registrant and Captec
Financial Group, Inc.(1)
10.25(c) -- Amendment to Ultimate Net Loss Agreement, dated March 30, 1995.(1)
10.26(a) -- Franchise finance letter of understanding, dated February 21, 1994, by and between Stephens
Franchisee Finance and the Registrant.(1)
10.26(b) -- Franchisee Financing Agreement, dated September 1, 1994, between the Registrant and Stephens
Diversified Leasing, Inc.(1)
10.27 -- Agreement, dated July 1, 1994, by and among Thomas Development Corporation, Micardo, Inc. and the
Registrant.(1)
10.28 -- Earnest Money Contract, dated May 20, 1994, among Schlotzsky's Real Estate, Inc., William C.
Pfluger, et al., Schlotzsky's Restaurants, Inc., the Registrant and John C. Wooley.(1)
10.29 -- Unsecured Promissory Note, dated June 29, 1993, from John C. Wooley payable to the Registrant in the
original principal amount of $280,000.(1)
10.30 -- Unsecured Promissory Note, dated June 29, 1993, from Jeffrey J. Wooley payable to the Registrant in
the original principal amount of $150,000.(1)
10.31 -- Unsecured Promissory Note, dated January 1, 1993, from John C. Wooley payable to the Registrant in
the original principal amount of $319,712.45.(1)
10.32 -- Unsecured Promissory Note, dated January 1, 1993, from Jeffrey J. Wooley payable to the Registrant
in the original principal amount of $76,540.93.(1)
10.33 -- Unsecured Promissory Note, dated February 6, 1995, from John C. Wooley payable to the Registrant in
the original principal amount of $131,000.(1)
10.34 -- Unsecured Promissory Note, dated February 6, 1995, from Jeffrey J. Wooley payable to the Registrant
in the original principal amount of $6,000.(1)
10.35 -- Schlotzsky's, Inc. 1993 Third Amended and Restated Stock Option Plan of the Registrant.
10.36(a) -- Employment Agreement, dated as of December 21, 1995, by and between the Registrant and John C.
Wooley.
10.36(b) -- Employment Agreement, dated as of December 21, 1995, by and between the Registrant and Jeffrey J.
Wooley.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ------------ ----------------------------------------------------------------------------------------------------
<C> <C> <S>
10.36(c) -- Employment Agreement, dated January 1, 1994, by and between the Registrant and Kelly R. Arnold.(1)
10.36(d) -- Employment Agreement, dated January 1, 1994, by and between the Registrant and Karl D. Martin.(1)
10.37(a) -- Indemnity Agreement, dated June 30, 1993, by and between the Registrant and John C. Wooley.(1)
10.37(b) -- Indemnity Agreement, dated June 30, 1993, by and between the Registrant and Jeffrey J. Wooley.(1)
10.38 -- Form of Indemnification Agreement for Directors and Officers of the Registrant.(1)
10.39 -- Schlotzsky's 1995 Nonemployee Directors Stock Option Plan, and form of Stock Option Agreement.(1)
10.40 -- Warrant Certificate, dated March 31, 1994, of the Registrant to William C. Pfluger for 75,000
warrants.(1)
10.41 -- Confidentiality Agreement, dated December 8, 1989, by and between Bunge Foods Corporation and
Schlotzsky's Franchising Limited Partnership.(1)
10.42 -- Real Estate Lien Note dated December 31, 1993, from CBD Block 29, Ltd. to Schlotzsky's Real Estate,
Inc. in the original principal amount of $302,209.12.(1)
10.43 -- Promissory Note, dated October 4, 1995, from the Registrant to First State Bank, Austin, Texas in
the original principal amount of $576,000.(1)
10.44 -- Promissory Note dated October 25, 1995, from the Registrant to United Bank & Trust in the original
principal amount of $500,000.(1)
10.45 -- Promissory Note dated November 1995 from Registrant and Schlotzsky's Restaurants, Inc. to AT&T
Commercial Finance Corporation in the original principal amount of $1,100,000.(1)
10.46 -- Promissory Note dated November 17, 1995 from Registrant to Comerica Bank--Texas in the original
principal amount of $245,000.(1)
10.47* -- Form of Guaranty between Schlotzsky's, Inc. and Landlord with respect to Turnkey restaurants.
10.48* -- Form of Tenant Acknowledgment with Indemnification between Schlotzsky's Real Estate, Inc. and
Franchisee concerning Turnkey restaurants.
22.1 * -- List of subsidiaries of the Registrant.
24.1 * -- Consent of Coopers & Lybrand L.L.P.
27.1 * -- Financial Data Schedule--fiscal year ending 1997.
27.2 * -- Financial Data Schedule--restated data for fiscal years ending 1995, 1996 and first, second and
third quarters of 1996.
27.3 * -- Financial Data Schedule--restated data for first, second and third quarters of 1997.
</TABLE>
- ------------------------
* Filed herewith.
(1) Previously filed as an Exhibit to the Registrant's Registration Statement on
Form S-1 (File No. 33-98004) filed with the Securities and Exchange
Commission on October 12, 1995, as amended, and incorporated herein by
reference.
(2) Previously filed as an exhibit to the registrant's registration statement on
Form S-1 (File No. 333-34921) filed with the securities and exchange
commission on September 4, 1997, as amended, and incorporated herein by
reference.
<PAGE>
EXHIBIT 10.47
<PAGE>
GUARANTY OF SCHLOTZSKY'S, INC.
THIS GUARANTY AGREEMENT ("Guaranty") is entered into by and
between SCHLOTZSKY'S, INC., a Texas corporation (referred to herein as
"Guarantor"), a corporation (referred to herein as "Landlord"), and
_______________, a _________________ (referred to herein as "Tenant").
W I T N E S S E T H:
A. Landlord has entered into, or will enter into, a certain lease
agreement (the "Lease") with Tenant for those certain leased premises located
in _____________, __________ County, __________, reference to which Lease is
hereby made for all purposes.
B. In order to induce Landlord to execute and enter into the
above-described Lease, Guarantor desires to execute and deliver this Guaranty
to Landlord.
C. In order to induce Guarantor to execute and enter into this Guaranty
Agreement, Tenant desires to execute this Guaranty and agrees to perform all
obligations of Tenant set forth herein.
NOW, THEREFORE, for and in consideration of the premises, and of other
good and valuable consideration, the receipt and sufficiency of which are
hereby expressly acknowledged by the parties hereto, Guarantor, Landlord and
Tenant do hereby agree as follows:
1. Subject to the provisions below, Guarantor has guaranteed, and by
this instrument does hereby guarantee the prompt payment of all basic or
minimum rent, and any percentage or other kind of additional rent such as
that which might cover taxes, insurance or common area costs, if any, imposed
upon Tenant under the terms of the Lease, as fully and to the same extent as
if Guarantor has executed the Lease as the "Tenant" or "Lessee" thereunder;
provided, however, notwithstanding any provision herein to the contrary, in
no event shall Guarantor be liable for more than $________________ (such
amount being hereinafter referred to as the "Guaranty Maximum").
2. (a) Landlord hereby agrees to give Guarantor notice of any default
by Tenant under the Lease and agrees that Guarantor may cure any such default
within the time period permitted under the Lease for Tenant to cure any such
default. If, while this Guaranty is in effect, Landlord desires to terminate
the Lease or Tenant's right to possession of the leased premises (and has the
right under the Lease to do so), Landlord agrees to give Guarantor notice
thereof, and Guarantor shall have the right (but not the obligation), to be
exercised within ten (10) days after such notice from Landlord, to cure any
default and take possession of the leased premises without becoming the
"tenant" under the Lease. Guarantor agrees to give Landlord notice prior to
taking possession and agrees to notify Landlord when it no longer intends to
exercise its right of possession.
<PAGE>
(b) Notwithstanding any provision herein to the contrary, in the event
that Tenant is in default under the Lease and in the event that Guarantor has
requested that Landlord take steps to evict or otherwise remove Tenant from
the leased premises, any obligation of Guarantor to make payments to Landlord
pursuant to this Guaranty are expressly conditioned upon and are subject to
Landlord diligently pursuing all reasonable measures to deliver the leased
premises to Guarantor (or to such other licensed franchisee of Guarantor's as
Guarantor may designate), such measures to include, but not to be limited to,
as appropriate, the institution and prosecution of proceedings to evict or
otherwise remove Tenant. In addition to the Guaranty Maximum, Guarantor will
reimburse Landlord within ten (10) business days of receipt of each invoice
(such invoices not to be more frequently than one (1) invoice each thirty
(30) days), accompanied by reasonable and appropriate supporting
documentation, for all reasonable out-of-pocket costs and expenses incurred
by Landlord in connection therewith, including, but not limited to, court
costs, costs of service of process and attorney's fees.
(c) Such possession shall be subject to the terms and conditions of the
Lease and shall be for the period of time Guarantor elects to maintain
possession of the leased premises (Guarantor agreeing to notify Landlord
should it no longer desire to maintain possession, as set forth above);
provided, however, Guarantor shall have no obligation to operate the leased
premises and failure of the leased premises to be open for business during
this period shall not be a default under the Lease, notwithstanding any
prohibition against "going dark" in the Lease to the contrary (it being
understood that Guarantor's "taking possession" of the leased premises, for
the purposes of this paragraph, shall mean only that Guarantor has the right
to take physical possession of the leased premises, but not the obligation).
Failure of Guarantor to give Landlord notice of its exercise of such right of
possession within ten (10) days after such notice from Landlord shall
constitute an election by Guarantor not to take possession of the leased
premises and Landlord may thereupon terminate the Lease or Tenant's right to
possession as set forth in the Lease. Should Guarantor elect to take
possession of the leased premises, then all reasonable costs incurred by
Guarantor in complying with the terms of the Lease during the period when
Guarantor is in possession of the leased premises (including, without
limitation, any rent (basic or additional), taxes, insurance premiums or
common area costs, if any or repair or maintenance costs) shall be credited
toward Guarantor's payment of the Guaranty Maximum.
(d) Should Guarantor elect not to possess the leased premises after
initially doing so (Guarantor agreeing to notify Landlord of such decision,
as set forth above) and if no subtenant or assignee has executed a sublease
or assignment of Lease, respectively, during the period of Guarantor's
possession, then Landlord may thereupon terminate the Lease or Tenant's right
to possession, as set forth in the Lease. During the period of Guarantor's
possession, Guarantor may sublet the leased premises or assign the Lease
subject to and in accordance with the terms and condition of the Lease. The
provisions of this paragraph shall apply only in the event that Landlord
desires to terminate the Lease or Tenant's right to possession of the leased
premises as a result of default by Tenant and shall not limit Landlord's
exercise of Landlord's other rights or remedies existing under the Lease.
Except as expressly provided herein, nothing in this paragraph (including any
sublease of the leased premises or assignment of the Lease) shall
<PAGE>
limit Landlord's rights or Guarantor's obligations under this Guaranty with
respect to any default by Tenant under the Lease.
(e) Notwithstanding any provision set forth in (a) - (d) above,
Landlord and Guarantor agree as follows:
(i) Any possession of leased premises by Guarantor shall be
subject to all of the terms and conditions set forth in the Lease (provided,
however, Guarantor shall not be deemed to have become the "tenant" under the
Lease).
(ii) Upon three (3) business days notice to Guarantor, Landlord
may terminate the Lease (if allowed thereunder) at which time this Guaranty
shall be void and of no further force and effect. During said three (3)
business day period, Guarantor may, in its sole discretion, elect to assume
the Lease and in such event termination shall not occur.
(iii) Should Guarantor desire that another Schlotzsky's, Inc.
franchisee accept an assignment of the Lease, then Guarantor agrees that the
Guaranty Maximum will be reinstated to the full original amount (should any
amounts have been paid thereunder).
3. Guarantor further agrees that Landlord shall not be first required
to enforce against Tenant, or any other person, any obligation for payment of
rent guaranteed hereby before seeking enforcement thereof against Guarantor.
Suit may be brought and maintained against Guarantor by Landlord to enforce
any obligation for payment of rent guaranteed hereby (up to the Guaranty
Maximum) without joinder of Tenant or any other person. The liability of
Guarantor hereunder shall not be affected by any indulgence, compromise,
settlement or variation of terms which may be extended to Tenant by Landlord
or as may otherwise be agreed upon by Landlord and Tenant, and shall not be
impaired, modified, changed, released or limited in any manner whatsoever by
any impairment, modification, change, release or limitation of the liability
of Tenant, or its estate in bankruptcy, or of any remedy for the enforcement
thereof, resulting from the operation of any present or future provision of
the Federal Bankruptcy Code, or any similar law or statute of the United
States, or of any state thereof. Notwithstanding the above, in order for
Guarantor to be bound by any changes to the Lease entered into or agreed upon
between Landlord and Tenant (including, without limitation, any extension,
amendment, assignment or sublease), Guarantor must first have given consent
to the extension, amendment, assignment or modification.
4. It is understood that other agreements similar to this Guaranty may,
at Landlord's sole option and discretion, be executed by other persons or
parties with respect to the Lease. This Guaranty shall be cumulative of any
such agreements and the liabilities and obligations of the undersigned
Guarantor hereunder shall in no event be impaired, diminished or otherwise
affected by reason of such other agreements. Moreover, in the event Landlord
obtains additional guaranty agreements, Guarantor agrees that Landlord, in
Landlord's sole discretion, may (i) bring suit against all guarantors of the
Lease jointly and severally or against any one or more of them, (ii) compound
or settle with any one or more of the guarantors for such consideration as
Landlord may deem proper and (iii) release one or more of the
<PAGE>
guarantors from liability. Guarantor further agrees that no such action
shall impair the rights of Landlord to enforce the Lease against any
remaining guarantor or guarantors, including the undersigned Guarantor.
5. It is expressly agreed and acknowledged that Guarantor has not and
does not hereby waive or release (expressly or impliedly) any rights of
subrogation, reimbursement, or contribution which it may have against Tenant.
6. If the party executing this Guaranty is a corporation, then the
undersigned officer personally represents and warrants that the board of
directors of such corporation has determined that this Guaranty may
reasonably be expected to benefit the corporation.
7. Guarantor agrees that if Landlord shall employ an attorney to
present, enforce or defend Landlord's rights or remedies hereunder, Guarantor
shall pay any reasonable attorneys' fees, related legal expenses and costs of
court incurred by Landlord in connection herewith.
8. This Guaranty shall be binding upon and shall inure to the benefit
of Guarantor, Tenant and Landlord and their respective heirs, legal
representatives, successors and assigns.
9. This Guaranty shall terminate at such time as Guarantor has paid to
Landlord the Guaranty Maximum or upon termination of the Lease, if earlier,
at which time this Guaranty shall be void and of no further force and effect.
<PAGE>
EXECUTED this _____ day of _____________, 1998, to be effective the same
day as the effective date of the Lease.
ADDRESS OF GUARANTOR: GUARANTOR:
203 Colorado SCHLOTZSKY'S INC.
Austin, Texas 78701
By:
--------------------------------
Name:
------------------------------
Title:
-----------------------------
ADDRESS OF LANDLORD: LANDLORD:
- ------------------------------ By:
--------------------------------
- ------------------------------ Name:
------------------------------
Title:
-----------------------------
ADDRESS OF TENANT: TENANT:
- ------------------------------ By:
--------------------------------
- ------------------------------ Name:
------------------------------
Title:
-----------------------------
<PAGE>
ACKNOWLEDGMENTS
STATE OF TEXAS )
)
COUNTY OF TRAVIS )
This document was acknowledged before me on the _____ day of
______________________, 1998 by _____________________________,
_______________ of Schlotzsky's, Inc., a Texas corporation, on behalf of said
corporation.
-------------------------------------------
Notary Public, State of Texas
STATE OF )
)
COUNTY OF )
This document was acknowledged before me on the _____ day of
______________________, 1998 by _____________________________,
_______________ of corporation, on behalf of said corporation.
-------------------------------------------
Notary Public, State of
STATE OF )
)
COUNTY OF )
This document was acknowledged before me on the _____ day of
______________________, 1998 by _____________________________,
_______________ of corporation, on behalf of said corporation.
-------------------------------------------
Notary Public, State of
<PAGE>
EXHIBIT 10.48
<PAGE>
TENANT'S ACKNOWLEDGMENT WITH INDEMNIFICATION
__________, ___________
The undersigned, _________________, a _________ corporation ("Tenant") and
_____________________________ (collectively, "Tenant's Principals), for good
and valuable consideration, the sufficiency of which is hereby acknowledged,
including the agreement by SCHLOTZSKY'S REAL ESTATE, INC. ("Landlord") to
enter into a lease agreement with Tenant covering the real property (the
"Property") described in Exhibit "A" attached hereto and incorporated herein
by reference (the "Lease"), and the agreement by SCHLOTZSKY'S, INC., a Texas
corporation ("Guarantor") to enter into that certain guaranty of the Lease
Agreement, a copy of which is attached hereto as Exhibit "B" and incorporated
herein by reference (the "Guaranty"), hereby acknowledges and agrees with
Guarantor and Landlord as follows:
1. Tenant and Tenant's Principals have reviewed carefully and
understand the provisions of the Guaranty.
2. Tenant hereby agrees that if Guarantor makes any payment on behalf
of Tenant under the Guaranty, then the following shall apply: (i) Tenant
shall, upon demand by Guarantor, immediately relinquish to Guarantor (or to
any subtenant or assignee Guarantor may have found) its right to possession
of the Property; provided, however, Tenant shall not be released from any of
its obligations and liabilities under the Lease; (ii) Tenant shall allow
Guarantor to either operate out of the Property or to sublease the Property
or assign Tenant's rights under the Lease to a third party (who may be, but
is not required to be, a Schlotzsky's franchisee), Tenant hereby agreeing
that its signature is not necessary to effectuate any such sublease or
assignment; (iii) Tenant agrees that Guarantor may terminate Tenant's rights
under the franchise agreement between Tenant and Guarantor covering the
operations out of the Property without compensation to Tenant as franchisee;
(iv) Tenant shall, upon demand by Guarantor, immediately transfer to
Guarantor subject to any debt to third parties, all ownership rights to any
and all furniture, fixtures and equipment installed or located in the
Property and owned by Tenant without any compensation to Tenant.
3. Guarantor and Landlord may from time to time amend the provisions of
the Guaranty, including increasing or decreasing the term or any guaranty
maximum, without the joinder of the Tenant and any such amendment shall not
in any manner affect any obligations of Tenant and Tenant's Principals under
this Agreement.
4. Tenant and Tenant's Principals each acknowledge that it or they are
not a beneficiary of any term or provision of the Guaranty and may not
enforce any provision thereof against Landlord or Guarantor. Tenant and
Tenant's Principals further acknowledge that the full guaranty of the Lease
by Tenant's Principals shall have no effect on the obligations of Tenant and
Tenant's Principals under Paragraph 5 below.
<PAGE>
5. Tenant and Tenant's Principals, jointly and severally, each hereby
agree to defend, indemnify and hold Guarantor harmless from and against any
and all claims, demands, liabilities and expenses (including reasonable
attorneys' fees) incurred by, asserted against or suffered by Guarantor
arising, directly or indirectly, from the execution and delivery of the
Guaranty (as may be modified pursuant to Paragraph 3 above) or from the
enforcement thereof. Should Guarantor bring suit against Tenant or Tenant's
Principals concerning matters arising out of this paragraph, Guarantor shall
be entitled to recover from the other party court costs and reasonable
attorneys' fees and expenses incurred in connection with such suit.
6. Tenant acknowledges that the Lease requires that at all times during
the term of the Lease, Tenant must have no less than $________ in equity
invested in the Property ("Tenant's Minimum Equity"). Tenant shall not be
permitted to obtain any kind of financing or refinancing on the Property
which would exceed $_________ without the prior written consent of Guarantor.
Tenant hereby authorizes Landlord to communicate with and receive
information from any lender of Tenant loaning money in connection with the
Property.
7. Tenant agrees to secure its obligations under this Tenant's
Acknowledgment with Indemnification by executing a Deed to Secure Debt or
Leasehold Deed of Trust covering all of Tenant's interest as Tenant or lessee
in and to the leasehold estate in the Property. Landlord hereby consents to
the execution, delivery and recordation of such deed to secure debt and the
enforcement (if needed) thereof.
8. If any provision hereof shall be unenforceable or void for any
reason, the remaining provisions of this instrument shall be enforceable to
the greatest extent permissible under applicable law.
9. This instrument shall be construed in accordance with the laws of
the State of Texas.
10. This instrument may be executed in any number of counterparts with
the same effect as if all parties hereto had signed the same document. All
such counterparts shall be construed together and shall constitute one
instrument, but in making proof hereof it shall only be necessary to produce
one such counterpart.
<PAGE>
IN WITNESS WHEREOF, the undersigned have executed this instrument as of the
effective date of the Guaranty.
TENANT:
_____________ , a _______________ corporation
By:
--------------------------------------------
Name:
------------------------------------------
Title:
-----------------------------------------
Date:
------------------------------------------
TENANT'S PRINCIPALS:
By:
--------------------------------------------
Name:
------------------------------------------
Title:
-----------------------------------------
Date:
------------------------------------------
By:
--------------------------------------------
Name:
------------------------------------------
Title:
-----------------------------------------
Date:
------------------------------------------
LANDLORD:
SCHLOTZSKY'S REAL ESTATE, INC.,
a Texas corporation
By:
--------------------------------------------
Name:
------------------------------------------
Title:
-----------------------------------------
Date:
------------------------------------------
GUARANTOR:
SCHLOTZSKY'S INC., a Texas corporation
By:
--------------------------------------------
Name:
------------------------------------------
Title:
-----------------------------------------
Date:
------------------------------------------
<PAGE>
EXHIBIT 22.1
<PAGE>
SUBSIDIARIES OF THE COMPANY
NAME OF SUBSIDIARY STATE OF INCORPORATION
- ------------------------------------------------------------------------------
1. Schlotzsky's Real Estate, Inc. Texas
2. Schlotzsky's Restaurant, Inc. Texas
3. Schlotzsky's Brands, Inc. Texas
4. Schlotzsky's Equipment Corporation Texas
5. DFW Restaurant Transfer Corporation Texas
6. 56th & 6th, Inc. Texas
7. SREI Turnkey Development, L.L.C. Texas
<PAGE>
EXHIBIT 24.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
Schlotzsky's, Inc. and Subsidiaries on Form S-8 (File Nos. 333-03809 and
333-377785) of our report dated April 10, 1998, on our audits of the
consolidated financial statements and the financial statement schedule of
Schlotzsky's, Inc. and Subsidiaries as of December 31, 1996 and 1997, and for
the years ended December 31, 1995, 1996 and 1997, which report is included in
this Annual Report on Form 10-K.
/s/ Coopers & Lybrand LLP
COOPERS & LYBRAND L.L.P.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME ON PAGES F-3
AND F-4 OF THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 31,272,048
<SECURITIES> 0
<RECEIVABLES> 16,475,453
<ALLOWANCES> (443,774)
<INVENTORY> 0
<CURRENT-ASSETS> 50,300,963
<PP&E> 11,161,895
<DEPRECIATION> (1,163,265)
<TOTAL-ASSETS> 79,520,586
<CURRENT-LIABILITIES> 7,738,260
<BONDS> 0
0
0
<COMMON> 62,202
<OTHER-SE> 69,928,357
<TOTAL-LIABILITY-AND-EQUITY> 79,520,586
<SALES> 6,364,042
<TOTAL-REVENUES> 27,969,136
<CGS> 2,014,096
<TOTAL-COSTS> 21,854,082
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 100,000
<INTEREST-EXPENSE> (752,960)
<INCOME-PRETAX> 7,063,675
<INCOME-TAX> 2,614,260
<INCOME-CONTINUING> 4,449,415
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,449,415
<EPS-PRIMARY> .74
<EPS-DILUTED> .71
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<S> <C> <C> <C> <C>
<C>
<PERIOD-TYPE> YEAR YEAR 3-MOS 6-MOS
9-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1996 DEC-31-1996 DEC-31-1996
DEC-31-1996
<PERIOD-START> JAN-01-1995 JAN-01-1996 JAN-01-1996 JAN-01-1996
JAN-01-1996
<PERIOD-END> DEC-31-1995 DEC-31-1996 MAR-31-1996 JUN-30-1996
SEP-30-1996
<CASH> 12,423,665 5,656,958 9,260,174 7,187,207
4,498,149
<SECURITIES> 0 0 0 0
0
<RECEIVABLES> 5,946,550 8,486,017 6,654,901 7,480,311
8,041,601
<ALLOWANCES> (155,000) (342,774) (155,000) (155,000)
(155,000)
<INVENTORY> 0 0 0 0
0
<CURRENT-ASSETS> 21,883,416 17,669,306 21,109,603 20,683,550
20,649,927
<PP&E> 4,585,208 6,249,494 4,688,490 5,003,417
5,099,409
<DEPRECIATION> (445,589) (808,612) (642,475) (682,790)
(771,145)
<TOTAL-ASSETS> 36,708,367 40,979,112 36,369,507 37,142,445
38,109,303
<CURRENT-LIABILITIES> 3,133,160 3,873,989 2,237,448 2,070,228
2,209,339
<BONDS> 0 0 0 0
0
0 0 0 0
0
0 0 0 0
0
<COMMON> 43,958 44,257 43,958 44,220
44,232
<OTHER-SE> 28,930,407 32,267,764 29,559,509 30,436,755
31,193,934
<TOTAL-LIABILITY-AND-EQUITY> 36,708,367 40,979,112 36,369,507 37,142,445
38,109,303
<SALES> 505,765 3,610,199 566,268 1,375,945
2,437,391
<TOTAL-REVENUES> 12,851,665 20,714,332 4,116,870 9,087,513
14,524,415
<CGS> 188,751 1,183,361 210,007 461,606
792,798
<TOTAL-COSTS> 10,229,304 16,203,812 3,261,456 7,206,061
11,446,063
<OTHER-EXPENSES> 0 0 0 0
0
<LOSS-PROVISION> 0 187,774 0 0
0
<INTEREST-EXPENSE> 149,151 (454,670) (153,977) (270,888)
(388,580)
<INCOME-PRETAX> 2,611,186 5,097,265 1,009,391 2,152,340
3,466,932
<INCOME-TAX> 1,016,596 1,902,290 380,291 808,897
1,325,119
<INCOME-CONTINUING> 1,594,590 3,194,975 629,100 1,343,443
2,141,813
<DISCONTINUED> 0 0 0 0
0
<EXTRAORDINARY> 38,307 0 0 0
0
<CHANGES> 0 0 0 0
0
<NET-INCOME> 1,632,897 3,194,975 629,100 1,343,443
2,141,813
<EPS-PRIMARY> .47 .58 .11 .24
.39
<EPS-DILUTED> .42 .57 .11 .24
.38
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<CASH> 6,659,889 7,619,588 32,741,636
<SECURITIES> 0 0 0
<RECEIVABLES> 4,211,385 4,693,756 10,248,360
<ALLOWANCES> (342,774) (342,774) (392,774)
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 16,796,986 14,859,705 42,878,151
<PP&E> 6,869,820 8,584,898 9,130,697
<DEPRECIATION> (960,655) (1,121,894) (1,199,898)
<TOTAL-ASSETS> 41,028,144 42,251,344 69,703,731
<CURRENT-LIABILITIES> 3,118,525 2,946,960 4,453,490
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 44,307 44,345 59,637
<OTHER-SE> 33,196,289 34,428,305 61,793,526
<TOTAL-LIABILITY-AND-EQUITY> 41,028,144 42,251,344 69,703,731
<SALES> 1,323,650 2,762,290 4,398,625
<TOTAL-REVENUES> 6,334,551 13,675,067 22,019,230
<CGS> 397,729 840,875 1,379,416
<TOTAL-COSTS> 4,968,691 10,543,548 16,948,665
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 50,000
<INTEREST-EXPENSE> (58,399) (195,517) (284,148)
<INCOME-PRETAX> 1,424,259 3,327,036 5,354,713
<INCOME-TAX> 535,684 1,276,646 2,069,656
<INCOME-CONTINUING> 888,575 2,050,390 3,285,057
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 888,575 2,050,390 3,285,057
<EPS-PRIMARY> .16 .37 .59
<EPS-DILUTED> .16 .36 .57
</TABLE>
