<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 1999
Commission File Number: 0-27008
SCHLOTZSKY'S, INC.
(Exact name of registrant as specified in its charter)
Texas 74-2654208
(State or other (IRS Employer
jurisdiction of Identification
incorporation or Number)
organization)
203 Colorado Street
Austin, Texas 78701
(address of principal executive offices)
(512) 236-3600
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
YES /X/ NO / /
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Shares Outstanding at November 1, 1999
Common Stock, no par value 7,417,714
<PAGE>
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets --
September 30, 1999 and December 31, 1998 2
Consolidated Statements of
Income - Three and Nine Months Ended
September 30, 1999 and September 30, 1998 3
Consolidated Statement of
Stockholders' Equity - Nine Months Ended
September 30, 1999 and the year ended
December 31, 1998 4
Condensed Consolidated Statements of
Cash Flows - Nine Months Ended
September 30, 1999 and September 30, 1998 5
Notes to Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Item 3 Quantitative and Qualitative Disclosures About
Market Risk 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 16
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
(UNAUDITED)
-------------- --------------
<S> <C> <C>
Assets
Cash and cash equivalents .......................................................... $ 2,054,705 $ 15,384,991
Temporary cash investments ......................................................... 18,000 1,439,077
Royalties receivable ............................................................... 1,317,978 762,141
Notes receivable, current portion .................................................. 7,857,199 4,246,574
Turnkey notes and other receivables, current portion ............................... 12,161,210 14,556,424
Other receivables .................................................................. 4,188,440 3,086,065
Prepaid expenses and other assets................................................... 866,110 572,996
Turnkey Program development ........................................................ 11,628,137 5,924,562
-------------- --------------
Total current assets ....................................................... 40,091,779 45,972,830
Property, equipment and leasehold improvements, net ................................ 19,861,841 18,529,746
Real estate and restaurants held for sale .......................................... 11,086,645 9,215,485
Notes receivable, less current portion ............................................. 11,188,351 9,061,344
Notes receivable from related parties, less current portion ........................ 2,357,284 2,609,775
Intangible assets, net ............................................................. 37,245,495 16,815,059
Other noncurrent assets ............................................................ 1,428,944 2,023,901
-------------- --------------
Total assets ............................................................... $ 123,260,339 $ 104,228,140
-------------- --------------
-------------- --------------
Liabilities and Stockholders' Equity
Accounts payable-trade ............................................................. $ 5,452,005 $ 4,752,369
Current maturities of long-term debt ............................................... 15,554,569 5,382,585
Accrued liabilities ................................................................ 2,635,024 9,613,593
-------------- --------------
Total current liabilities .................................................. 23,641,598 19,748,547
Deferred revenue, net .............................................................. 1,155,225 1,298,486
Long-term debt, less current maturities ............................................ 19,786,766 9,218,515
-------------- --------------
Total liabilities .......................................................... 44,583,589 30,265,548
Commitments and contingencies
Stockholders' equity:
Preferred stock:
Class C-no par value; authorized-1,000,000 shares; issued-none ............. -- --
Common stock, no par value, 30,000,000 shares authorized, 7,427,714
and 7,401,942 issued at September 30, 1999 and December 31, 1998, ...... 63,135 62,877
respectively
Additional paid-in capital ..................................................... 57,754,218 57,533,997
Retained earnings .............................................................. 20,964,397 16,470,718
Treasury stock (10,000 shares) ................................................. (105,000) (105,000)
-------------- --------------
Total stockholders' equity ................................................. 78,676,750 73,962,592
-------------- --------------
Total liabilities and stockholders' equity ................................. $ 123,260,339 $ 104,228,140
-------------- --------------
-------------- --------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
2
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------- -----------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---------------- -------------- --------------- ------------------
<S> <C> <C> <C> <C>
Revenues
Royalties ............................. $ 5,631,144 $ 4,874,853 $ 16,205,102 $ 13,853,409
Franchise fees ........................ 205,000 340,000 643,333 1,060,000
Developer fees ........................ 864,988 -- 2,818,758 --
Restaurant sales ...................... 4,233,349 1,744,790 10,614,960 5,245,698
Brand contribution .................... 1,711,879 1,052,341 4,514,460 2,918,227
Turnkey program development ........... 419,721 2,844,877 1,249,766 5,702,355
Other fees and revenue ................ 441,469 206,886 1,056,208 1,051,373
---------------- -------------- --------------- ------------------
Total revenues .................. 13,507,550 11,063,747 37,102,587 29,831,062
Expenses
Service costs:
Royalties ........................... 1,699,805 1,861,054 5,230,168 5,281,567
Franchise fees ...................... 102,500 167,500 323,000 542,000
Restaurant operations:
Cost of sales ....................... 1,287,090 581,908 3,182,147 1,717,234
Labor cost .......................... 1,525,714 728,128 3,973,541 2,244,545
Operating expenses .................. 998,302 484,068 2,468,945 1,526,853
Turnkey development costs ............. 1,445,938 1,710,241 3,457,928 3,039,229
General and administrative ............ 3,520,257 3,001,071 10,052,854 8,448,096
Depreciation and amortization ......... 770,255 517,935 2,058,274 1,281,324
---------------- -------------- --------------- ------------------
Total expenses .................. 11,349,861 9,051,905 30,746,857 24,080,848
---------------- -------------- --------------- ------------------
Income from operations .......... 2,157,689 2,011,842 6,355,730 5,750,214
Other
Interest income ....................... 835,582 569,309 2,319,016 1,597,183
Interest expense ...................... (665,140) (49,480) (1,541,922) (155,836)
---------------- -------------- --------------- ------------------
Income before income taxes ...... 2,328,131 2,531,671 7,132,824 7,191,561
Provision for income taxes .............. 861,409 949,579 2,639,145 2,696,835
---------------- -------------- --------------- ------------------
Net income ...................... $ 1,466,722 $ 1,582,092 $ 4,493,679 $ 4,494,726
---------------- -------------- --------------- ------------------
---------------- -------------- --------------- ------------------
Income per common share - basic:
Net income ...................... $ 0.20 $ 0.21 $ 0.61 $ 0.61
---------------- -------------- --------------- ------------------
---------------- -------------- --------------- ------------------
Weighted average shares outstanding ... 7,416,620 7,400,417 7,407,083 7,380,388
---------------- -------------- --------------- ------------------
---------------- -------------- --------------- ------------------
Income per common share - diluted:
Net income ...................... $ 0.20 $ 0.21 $ 0.60 $ 0.59
---------------- -------------- --------------- ------------------
---------------- -------------- --------------- ------------------
Weighted average shares outstanding ... 7,479,601 7,560,876 7,495,327 7,593,529
---------------- -------------- --------------- ------------------
---------------- -------------- --------------- ------------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
3
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock
------------------------
Stated Additional Total
Number of Capital Paid-In Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
--------- ------------ ------------ ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1998 ................ 7,334,416 $ 62,202 $ 56,664,104 $ 10,264,253 $ -- $ 66,990,559
Options exercised ....................... 44,089 441 399,175 -- -- 399,616
Warrants exercised ...................... 23,437 234 224,761 -- -- 224,995
Treasury stock purchase (10,000
shares) ................................ -- -- -- -- (105,000) (105,000)
Tax benefit from employee stock
transaction ............................. -- -- 245,957 -- -- 245,957
Net income .............................. -- -- -- 6,206,465 -- 6,206,465
--------- ------------ ------------ ------------ ---------- -------------
Balance, December 31, 1998 .............. 7,401,942 62,877 57,533,997 16,470,718 (105,000) 73,962,592
Options exercised ....................... 25,772 258 220,221 220,479
Net income .............................. 4,493,679 4,493,679
--------- ------------ ------------ ------------ ---------- -------------
Balance, September 30, 1999 ............. 7,427,714 $ 63,135 $ 57,754,218 $ 20,964,397 $ (105,000) $ 78,676,750
--------- ------------ ------------ ------------ ---------- -------------
--------- ------------ ------------ ------------ ---------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
4
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
-------------- --------------
<S> <C> <C>
Net cash used in operating activities ................................ $ (9,251,519) $(19,468,404)
Cash flows from investing activities:
Advances on notes receivable (less payments) ...................... (5,348,224) 2,016,966
Acquisition of intangibles ........................................ (18,784,735) (1,665,471)
Purchase of property, equipment and leasehold improvements ........ (3,279,847) (9,578,092)
Sale (purchase) of temporary investments .......................... 1,421,077 (1,421,077)
Other ............................................................. 950,567 (79,020)
-------------- --------------
Net cash used in investing activities ................................ (25,041,162) (10,726,694)
Cash flows from financing activities:
Net proceeds from issuance of debt ................................ 27,040,593 4,700,000
Principal payments on debt ........................................ (6,298,677) (244,132)
Proceeds from exercises of options and warrants ................... 220,479 624,610
-------------- --------------
Net cash provided by financing activities ............................ 20,962,395 5,080,478
-------------- --------------
Net decrease in cash and cash equivalents ............................ (13,330,286) (25,114,620)
Cash and cash equivalents at beginning of period ..................... 15,384,991 31,254,048
-------------- --------------
Cash and cash equivalents at end of period ........................... $ 2,054,705 $ 6,139,428
-------------- --------------
-------------- --------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
5
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1999
NOTE 1. -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the nine months ended September 30, 1999,
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1999. This information should be read in connection with the
consolidated financial statements and footnotes thereto incorporated by
reference in the Schlotzsky's, Inc. Annual Report on Form 10-K for the year
ended December 31, 1998, as amended.
NOTE 2. - EARNINGS PER SHARE
Basic and diluted EPS computations for the three and nine months ended
September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
BASIC EPS
Net income ................................................. $1,466,722 $1,582,092 $4,493,679 $4,494,726
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
Weighted average common shares outstanding ................. 7,416,620 7,400,417 7,407,083 7,380,388
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
Basic EPS .................................................. $ 0.20 $ 0.21 $ 0.61 $ 0.61
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
DILUTED EPS
Net income ................................................. $1,466,722 $1,582,092 $4,493,679 $4,494,726
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
Weighted average common shares outstanding ................. 7,416,620 7,400,417 7,407,083 7,380,388
Assumed conversion of common shares issuable
under stock option plan and exercise of warrants . ....... 62,981 160,459 88,244 213,141
------------ ------------ ------------ -------------
Weighted average common shares outstanding
-assuming dilution ........................................ 7,479,601 7,560,876 7,495,327 7,593,529
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
Diluted EPS ................................................ $ 0.20 $ 0.21 $ 0.60 $ 0.59
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
</TABLE>
Outstanding options that were not included in the diluted calculation because
their effect would be anti-dilutive total 852,701 and 535,000 for the three
months ended September 30, 1999 and September 30, 1998, respectively, and
767,651 and 560,500 for the nine months ended September 30, 1999 and September
30, 1998, respectively.
6
<PAGE>
NOTE 3. - SEGMENTS
The Company and its subsidiaries are principally engaged in franchising
quick service restaurants that feature made-to-order sandwiches with unique
sourdough buns, pizzas, and salads. At September 30, 1999 the Schlotzsky's
system included Company owned and franchised stores in 37 states, the District
of Columbia and 12 foreign countries.
The Company identifies segments based on management responsibility within
the corporate structure. The Turnkey Development segment includes the
development of freestanding stores with high visibility and easy access.
Restaurant Operations includes the operation of Company-owned restaurants not
only for profit but also for the purpose of product development and testing,
concept refinement, prototype testing, franchisee and employee training, and to
build brand awareness. The Franchise Operations segment encompasses the
Company's restaurant concept, royalty, and licensed private label products
business. The Company measures segment profit as operating profit, which is
defined as income before interest and income taxes. Segment information and a
reconciliation to income, before interest and income taxes is as follows:
<TABLE>
<CAPTION>
TURNKEY RESTAURANT FRANCHISE
THREE MONTHS ENDED SEPTEMBER 30, 1999 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
----------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue from external customers $ 419,721 $ 4,233,349 $ 8,854,480 $ 13,507,550
Operating income (loss) (1,091,601) 145,896 3,103,394 2,157,689
Total assets $ 42,813,534 $ 25,900,887 $ 54,545,918 $123,260,339
TURNKEY RESTAURANT FRANCHISE
THREE MONTHS ENDED SEPTEMBER 30, 1998 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
----------------------------------------- ------------ ------------ ------------ ------------
Revenue from external customers $ 2,844,876 $ 1,744,790 $ 6,474,081 $ 11,063,747
Operating income (loss) 980,902 (201,531) 1,232,471 2,011,842
Total assets $ 41,416,741 $ 14,219,880 $ 29,987,485 $ 85,624,106
TURNKEY RESTAURANT FRANCHISE
NINE MONTHS ENDED SEPTEMBER 30, 1999 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
----------------------------------------- ------------ ------------ ------------ ------------
Revenue from external customers $ 1,249,766 $ 10,614,960 $ 25,237,861 $ 37,102,587
Operating income (loss) (2,471,163) 318,051 8,508,842 6,355,730
Total assets $ 42,813,534 $ 25,900,887 $ 54,545,918 $123,260,339
TURNKEY RESTAURANT FRANCHISE
NINE MONTHS ENDED SEPTEMBER 30, 1999 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
----------------------------------------- ------------ ------------ ------------ ------------
Revenue from external customers $ 5,702,356 $ 5,245,698 $ 18,883,008 $ 29,831,062
Operating income (loss) 2,381,139 (668,464) 4,037,539 5,750,214
Total assets $ 41,416,741 $ 14,219,880 $ 29,987,485 $ 85,624,106
</TABLE>
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1998
REVENUES. Total revenues increased 22.1% from $11,064,000 to $13,508,000.
Royalties increased 15.5% from $4,875,000 to $5,631,000. This increase
was due to the opening of 74 restaurants during the period from October 1,
1998 to September 30, 1999, which was only partially offset by the closing of
50 stores. The growing influence of larger freestanding units, particularly
the prototype units, which are the focus of the new unit development, drove
the increase. Furthermore, average sales increased 10.3% and same store sales
increased 4.2% during the third quarter of 1999. The Company believes its
average weekly sales and same store sales were positively impacted by the
1999 launch of its first network television advertising campaign and the
introduction of "Deli Deals-TM-", in-store menu board offerings of a
sandwich or pizza, chips and a drink for one price.
Franchise fees decreased 39.7% from $340,000 to $205,000. This decrease was
principally the result of seven fewer store openings during the three-month
period ended September 30, 1999. The fewer number of openings is the result of
the Company's increasing emphasis on superior site selection for prototype
stores with higher visibility and on more highly qualified franchisees.
Developer fees increased from $0 to $865,000. This increase was
attributable to the sale of regional service rights to two domestic territories
during the three months ended September 30, 1999. The rights sold entitle these
representatives to receive 1.25% or 2.5%, respectively, out of the 6.0%
royalties payable to the Company on sales from restaurants in those territories.
In return, the representatives have certain franchisee support responsibilities
in the territories.
Restaurant sales increased from $1,745,000 to $4,233,000. The addition of
seven more Company-owned units being operated in this quarter than in the
corresponding quarter of the previous year and an increase of 4.7% in same store
sales at the units which were operated by the Company during both quarters
contributed to this increase.
Brand contribution increased 62.7% from $1,052,000 to $1,712,000. This
increase was principally the result of more favorable terms with certain
major suppliers than existed in the prior period, as well as the increasing
volume of system-wide sales, greater franchisee participation in the
Company's purchasing programs and limited retail sales of certain branded
products. The Company recently announced that a select line of Schlotzsky's
Deli Premium Provisions-TM- products were available in an East Texas based
grocery chain beginning in October and expects additional products and
alternative retail channels of distribution of its products may be pursued,
which could result in further increases in licensing fees, although no
assurance can be given in this regard.
Turnkey development revenue decreased 85.2% from $2,845,000 to $420,000.
This decrease from 1998 was primarily attributable to an significantly greater
number of real estate sales transactions recognized in 1998, many of which
consisted of converting franchisees' existing leases, on which the Company had
limited guarantees, to mortgages. In addition, the Company previously indicated
that it intended to transition away from an emphasis on Turnkey transactional
revenue.
Other fees and revenues increased 113.0% from $207,000 to $441,000,
primarily from the increased level of contributions made by certain suppliers to
partially offset the cost of the annual franchisee meetings. In addition, a
higher level of revenue from expired licensing contracts and fees for the
transfer of some franchise restaurants were recognized during the third quarter
of the current year compared to the prior year.
8
<PAGE>
The following table reflects the growth of the franchise system for the
three months ended September 30, 1999 and 1998. The growth of the system during
1998 and 1999 to date was principally responsible for the increased revenue as
discussed above. In 1999, restaurant closings in the system increased as a
result of the permanent removal of temporarily closed stores where the
franchisees had not recently been actively pursuing new locations, and greater
emphasis on quality, service, cleanliness and compliance audits instituted in
connection with the Company's initial network advertising campaign. The Company
recently announced that it expects to open fewer new stores during 2000 than
during 1999 and in each of the previous three years.
<TABLE>
<CAPTION>
SYSTEM PERFORMANCE THREE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
------------- -------------
<S> <C> <C>
Units Opened
Domestic
Freestanding 11 23
End Cap 1 1
Other 1 --
------------- -------------
Total Domestic Openings 13 24
International 4 --
------------- -------------
Total Openings 17 24
Units Closed (15) (10)
------------- -------------
Net Unit Growth 2 14
------------- -------------
------------- -------------
System-wide Sales (in thousands) $ 105,109 $ 90,023
Average Weekly Sales $ 11,041 $ 10,011
Increase in Average Weekly Sales 10.3% 11.8%
Stores in Operation 760 736
Increase in Same Store Sales 4.2% 3.0%
</TABLE>
COSTS AND EXPENSES. Royalty service costs decreased 8.7% from $1,861,000 to
$1,700,000. In addition, royalty service costs as a percentage of royalties
declined from 38.2% to 30.2%. These decreases reflected the Company's
reacquisition and buy-down of rights to a limited number of area developer
territories during 1999 and at the end of 1998. Area developers generally
receive approximately 42% or 21% of the royalties from stores in their
territories (depending on whether their share of royalties is 2.5% or 1.25%).
The Company expects royalty service costs as a percentage of royalty revenue to
continue to decrease because the Company recently assumed territory management
responsibility of its largest area developer in conjunction with an option to
buy its territories (exercisable until 2012). Net service costs associated with
this territory management agreement will be 1% of royalties beginning October 31
and escalating to 2% by August 16, 2004, versus the current 2.5% rate. In
addition, the Company plans to buy-down the rights and obligations of several
more of its area developers and may re-acquire the full development rights to a
limited number of territories.
Franchise fee costs decreased 38.7% from $168,000 to $103,000, principally
as a result of seven fewer store openings during the three-month period ended
September 30, 1999. The fewer number of openings is mainly the result of the
Company's increasing emphasis on superior site selection for larger freestanding
stores with higher visibility and on more highly qualified franchisees. In
addition, these costs should continue to decrease as a percentage of Franchise
fee revenue as restaurants open in territories which have been recently
reacquired or bought down.
Restaurant cost of sales, which consists of food, beverage and paper costs,
increased from $582,000 to $1,287,000, but as a percentage of restaurant sales
decreased from 33.4% to 30.4%. Likewise, restaurant labor costs increased from
$728,000 to $1,526,000, but as a percentage of restaurant sales decreased from
41.7% to 36.1% compared to the same quarter in 1998. Restaurant operating
expenses increased from $484,000 to $998,000, but as a percentage of restaurant
sales decreased from 27.7% to 23.6% for the three months ended September 30,
1999, as compared to the corresponding period in 1998. The percentage decreases
were primarily attributable to increased operating efficiencies and cost
controls implemented over the last twelve months.
9
<PAGE>
Turnkey development costs decreased 15.4% from $1,710,000 to $1,446,000 but
as a percentage of Turnkey development revenue increased from 60.1% to 344.3%.
This increase as a percentage of revenue was primarily the result of fewer
revenue transactions in the current period compared to the third quarter of
1998. In addition, the Company experienced $584,000 in write offs of Turnkey
development costs associated with sites under contract which were removed from
consideration during the period, which was significantly higher than normal.
Most of the sites written off either demonstrated higher than expected
development costs or no longer met current standards for Turnkey development
sites.
General and administrative expenses grew 17.3% from $3,001,000 to
$3,520,000, but as a percentage of total revenues decreased from 27.1% to 26.1%.
The percentage decrease was primarily the result of the lessening pace of
additions to the corporate staff since the prior period and the fact that
revenue was increasing at a faster pace than costs. The Company recently
announced its goal of maintaining the level general and administrative expenses
during 2000, compared to 1999.
Depreciation and amortization increased 48.6% from $518,000 to $770,000,
and as a percentage of total revenues increased from 4.7% to 5.7%. The increases
were principally due to the amortization of area development territories,
goodwill, and other intangibles acquired during 1998 and the nine months ended
September 30, 1999. In addition, depreciation increased as a result of seven
additional Company-owned stores operating in this period compared to the same
period in the prior year.
Interest income increased 46.9% from $569,000 to $836,000. This increase
was a result of a greater level of funds outstanding in the form of Turnkey
mortgages and interim construction financing under the Turnkey Program and an
increase in the notes receivable related to the sale of limited development
rights.
Interest expense increased from $49,000 to $665,000. This increase was a
result of a greater level of debt outstanding during the current period. The
Company expects interest expense will continue to trend upward as additional
debt financing may be used to fund construction of Company-owned stores, and
reacquire certain area developer rights.
INCOME TAX EXPENSE. Income tax expense reflected a combined federal and
state effective tax rate of 37.0% for the three months ended September 30, 1999,
which was slightly lower than the effective combined tax rate of 37.5% for the
comparable period in 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1998
REVENUES. Total revenues increased 24.4% from $29,831,000 to $37,103,000.
Royalties increased 17.0% from $13,853,000 to $16,205,000. This increase
was due to the opening of 74 stores during the period from October 1, 1998 to
September 30, 1999 which was partially offset by the closing of 50 stores. Also
driving the increase was the growing influence of larger freestanding units,
particularly the prototype units, which are the focus of the new unit
development. Furthermore, average weekly sales increased 9.4% and same store
sales increased 2.5% during the nine months ended September 30, 1999. Royalties
were only slightly impacted by 50 closings since the end of the prior period.
Many of those stores were underperforming or had been temporarily closed prior
to the Company's determination to treat them as permanently closed because of
the franchisees' failure to actively search for new sites.
Franchise fees decreased 39.3% from $1,060,000 to $643,000. This decrease
was principally a result of 33 fewer store openings during the nine-month period
ended September 30, 1999. The fewer number of openings is primarily the result
of the Company's increasing emphasis on superior site selection for larger
freestanding stores with higher visibility and on more highly qualified
franchisees. The Company anticipates that these costs, as a percentage of
revenue, will begin to gradually trend downward as restaurants open in
territories which have been acquired or bought down.
Developer fees increased from $0 to $2,819,000. The increase was
attributable to the sale of certain regional service rights to five domestic
territories during the nine months ended September 30, 1999. The rights sold,
depending upon the transaction, entitle the developers to either 1.25% or 2.5%
out of the Company's 6% royalties from restaurants in those territories. In
return, the developers have certain franchisee support responsibilities in those
territories.
10
<PAGE>
Restaurant sales increased from $5,246,000 to $10,615,000. This increase
was principally attributable to the acquisition of five stores from franchisees,
the opening of two new corporate stores, and a 7.2% increase in same store sales
for stores that were open the entirety of both nine month periods. The increase
in same store sales is mainly attributable to the rollout of national
advertising, the introduction of "Deli Deals-TM-", and an increased management
focus on the store level details in each of the company-owned restaurants.
Brand contribution increased 54.7% from $2,918,000 to $4,514,000. This
increase was principally the result of more favorable terms with certain major
suppliers than existed in the prior period, as well as the increasing volume of
system-wide sales, greater franchisee participation in the Company's purchasing
programs and limited retail sales of certain branded products.
Turnkey development revenue decreased 78.1% from $5,702,000 to $1,250,000.
This decrease from 1998 was primarily attributable to a significantly greater
number of real estate sales transactions recognized in 1998, many of which
consisted of converting franchisees' existing leases, on which the Company had
limited guarantees, to mortgages. In addition, the Company previously indicated
that it intends to transition away from an emphasis on Turnkey transactional
revenue during 1999.
The following table reflects the growth of the franchise system for the
nine months ended September 30, 1999 and 1998. The growth of the system during
1998 and 1999 to date was principally responsible for the increased revenue as
discussed above. In 1999, restaurant closings in the system increased
principally as a result of the permanent removal of temporarily closed stores
where the franchisee had not recently been actively pursuing new locations, and
greater emphasis on quality, service, cleanliness and compliance audits
instituted in connection with the Company's initial network advertising
campaign.
<TABLE>
<CAPTION>
SYSTEM PERFORMANCE NINE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
------------- -------------
<S> <C> <C>
Units Opened
Domestic
Freestanding 37 67
End Cap 6 11
Other 3 4
------------- -------------
Total Domestic Openings 46 82
International 6 3
------------- -------------
Total Openings 52 85
Units Closed (42) (22)
------------- -------------
Net Unit Growth 10 63
------------- -------------
------------- -------------
System-wide Sales (in thousands) $ 299,788 $ 254,804
Average Weekly Sales $ 10,603 $ 9,695
Increase in Average Weekly Sales 9.4% 12.0%
Stores in Operation 760 736
Increase in Same Store Sales 2.5% 3.8%
</TABLE>
COSTS AND EXPENSES. Royalty service costs decreased 1.0% from $5,282,000 to
$5,230,000 and, as a percentage of royalties, decreased from 38.1% to 32.3%.
This decrease resulted from the reacquisition and buy-down of rights to a
limited number of territories during the period and at the end of 1998. Area
developers typically receive approximately 42% of the royalties from stores in
their territories unless the Company has bought down a portion of their
development rights and obligations, in which case they receive approximately 21%
of the royalties.
Franchise fee costs decreased 40.4% from $542,000 to $323,000, principally
as a result of 33 fewer store openings during the nine-month period ended
September 30, 1999. The fewer number of openings is primarily the result of the
Company's increasing emphasis on superior site selection for prototype stores
with higher visibility and on more highly qualified franchisees.
11
<PAGE>
Restaurant cost of sales, which consists of food, beverage and paper costs,
increased 85.3% from $1,717,000 to $3,182,000, but as a percentage of restaurant
sales decreased from 32.7% to 30.0%. Likewise, restaurant labor costs increased
77.0% from $2,245,000 to $3,974,000, but as a percentage of restaurant sales
decreased from 42.8% to 37.4% compared to the same period in 1998. Restaurant
operating expenses increased 61.7% from $1,527,000 to $2,469,000, but as a
percentage of restaurant sales decreased from 29.1% to 23.3% for the nine months
ended September 30, 1999, as compared to the corresponding period in 1998. These
percentage decreases in restaurant operating expenses were primarily
attributable to improved operating efficiencies related to the Company-owned
restaurants operated during the nine months ended September 30, 1999. In
addition, during the nine month period ending September 30, 1998, two new stores
opened which results in higher than normal operating costs because of certain
nonrecurring preopening and opening expenses.
Turnkey development costs increased 13.8% from $3,039,000 to $3,458,000,
but as a percentage of Turnkey development revenue increased from 53.3% to
276.6%. The primary factor contributing to the increase as a percentage of sales
was due to a significantly lower level of real estate transactions revenue
versus last year.
General and administrative expenses grew 19.0% from $8,448,000 to
$10,053,000, but as a percentage of total revenues decreased from 28.3% to
27.1%. The percentage decrease was a result of revenues increasing at a faster
pace than expenses. In addition, the Company hired personnel at a slower pace in
the first nine months of 1999 than it did in 1998, resulting in reduced hiring
costs.
Depreciation and amortization increased 60.7% from $1,281,000 to
$2,058,000, and as a percentage of total revenues increased from 4.3% to 5.5%.
These increases were principally due to the amortization of area development
rights and goodwill acquired in 1999, and depreciation related to seven
additional Company-owned restaurants.
Interest income increased 45.2% from $1,597,000 to $2,319,000. This
increase was a result of a greater level of funds outstanding in the form of
Turnkey mortgages and interim construction financing under the Turnkey Program
and an increase in notes receivables related to the sale of limited development
rights.
Interest expense increased from $156,000 to $1,542,000 due to the greater
level of debt outstanding during the current period. The Company expects
interest expense will continue to trend upward as additional debt financing may
be used to fund construction of Company-owned stores and reacquisition of
certain area developer rights.
INCOME TAX EXPENSE. Income tax expense reflected a combined federal and
state effective tax rate of 37.0% for the nine months ended September 30, 1999,
which was slightly lower than the effective combined tax rate of 37.5% for the
comparable period in 1998.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $9,252,000 for the first nine
months of 1999. Accounts payable and accrued liabilities decreased
$6,279,000, primarily due to a higher than normal accrual for Turnkey
Activity at December 31, 1998. The majority of the amounts paid were related
to properties under development in the Turnkey Program. Net cash of
$25,041,000 was used in investing activities, primarily consisting of the
following: approximately $3,280,000 to purchase and develop seven
Company-owned restaurants, a net of approximately $2,076,000 primarily
consisting of notes receivable related to the sale of regional service
rights, and approximately $18,785,000 to buy-down the rights of several of
its area developers and to re-acquire the rights to a limited number of
territories, including the Austin, Texas territory.
During the first nine months of 1999, financing activities provided net
cash of $20,962,000. The financing activities consisted primarily of the
issuance of short-term debt used for the acquisition of certain development
rights and Company-owned stores.
At September 30, 1999, the Company had approximately $35.3 million of debt
outstanding. These notes bear interest at rates ranging from the lender's prime
interest rate to 10.6% and all mature by the end of 2001. During the first nine
months of 1999, the Company borrowed $15 million under a new line of credit to
fund the buy-down of the rights of several of its area developers and to
re-acquire the rights to a limited number of territories. In addition, the
Company guarantees certain real estate mortgages and leases, equipment leases
and other obligations of franchisees. At September 30, 1999, contingent
liabilities totaled approximately $35 million.
12
<PAGE>
The Company is subject to a number of covenants under its various debt
instruments including limitations on additional borrowings, capital
expenditures, contingent liabilities, and requirements to maintain certain
financial ratios, working capital, and net worth. The bank credit facilities are
secured by a first priority perfected security interest in certain assets of the
Company. While the Company is currently in compliance with all financial
covenants under these facilities, the term of one facility is scheduled to
expire on February 1, 2000, and the financial covenants of the other facility
become stricter effective December 30, 1999. The Company has signed a commitment
letter with one of its lenders to refinance the bulk of its outstanding debt
into a long-term facility. Failure to complete this refinancing or to
renegotiate the terms of the existing agreements could have material adverse
consequences to the Company.
The Company continues to refine its Turnkey Program and expects that it
will reduce the number of sites under contract or at various stages of
development at any given time to between 30 and 80 sites. The Company has used
the net proceeds from its public offerings and the proceeds from sites sold and
contracts assigned to finance the activity of the Turnkey Program to date. Even
with a lower level of anticipated activity in the Turnkey Program, the capital
required to finance the Turnkey Program will be significant. The tables below
provide a summary of the Turnkey Program activity for the nine months ended
September 30, 1999 and 1998.
Turnkey Program revenue consists of the following:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
------------ -------------
<S> <C> <C>
Sales to investors and franchisees ................... $ 2,530,748 $ 20,642,134
Development and construction management fees ......... -- 135,000
------------ -------------
Gross Turnkey Program revenue ................... 2,530,748 20,777,134
Turnkey Program project costs ........................ (1,567,740) (16,516,626)
------------ -------------
Net revenue from Turnkey Program projects ....... 963,008 4,260,508
Rental income ........................................ 286,758 96,933
Interim construction interest * ...................... -- 109,046
Deferred revenue recognized .......................... -- 1,815,868
Revenue deferred ..................................... -- (580,000)
------------ -------------
Total Turnkey Program revenue ................... $ 1,249,766 $ 5,702,355
============ =============
</TABLE>
*Interest earned through constructions loans and mortgages is reflected in
interest income.
The following table reflects activity of the Turnkey Program for the nine months
ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
NUMBER OF UNITS
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
------------ -------------
<S> <C> <C>
Sites in process at beginning of period .............. 86 78
Sites beginning development during the period ........ 50 72
Sites removed from consideration during the period ... (56) (25)
Sites inventoried as Company-owned stores ............ (2) (1)
Sites sold - revenue recognized ...................... (7) (39)
Sites sold - revenue deferred ........................ -- (5)
Other ................................................ 5 (1)
------------ -------------
Sites in process at end of period .................... 73 79
============ =============
</TABLE>
<TABLE>
<CAPTION>
INVESTED AT
SEPTEMBER 30,
1999
--------------
<S> <C> <C> <C>
Sites under development or to be sold .................. 12 8 9,754,000
Predevelopment Sites (prequalification) ................ 61 71 1,874,000
------------ ------------- --------------
73 79 $11,628,000
============ ============= ==============
</TABLE>
13
<PAGE>
The Company has a line of credit from a financial institution which may be
used to finance Turnkey Program capital requirements. In December 1998, the line
of credit was increased to allow the Company to draw up to $15,000,000, bears
interest at the bank's prime lending rate and expires December 2001. As of
September 30, 1999, the Company had drawn approximately $13,570,000 on this line
of credit and had allowed certain area developers and franchisees to borrow
$1,430,000 under this credit facility.
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, will be sufficient
to meet the Company's anticipated operating cash needs for the foreseeable
future. Since the net proceeds from the Turnkey Program, credit facilities, and
cash flow from operations may not be sufficient to finance both continuing
investment in Company-owned stores and Turnkey Program properties as well as the
buydowns of percentages of royalties of certain area developers, the Company
intends to seek additional funds for this purpose from 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. Inability to
obtain the funds necessary for these capital transactions could result in a
reduction in the number of openings, Turnkey transactions, area developer
buydowns, or a combination of each.
YEAR 2000 COMPLIANCE
The year 2000 issue is a result of many computer programs being written
using two digits, e.g. "99", 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. The Company has received
responses from many of its major restaurant product and equipment suppliers
indicating that they and the products they sell to the Company's restaurant
system also have no material internal risk from the Year 2000 issue. To date,
none of the Company's major suppliers have indicated that they anticipate
material internal risks. The Company is continuing a process of in-depth inquiry
concerning the readiness of its major suppliers and those of the restaurant
system. The Company will assess and, where practicable, attempt to mitigate its
risks with respect to the failure of these entities to be Year 2000 compliant.
The Company plans to continue to educate its franchise system during 1999 to
prepare them to anticipate Year 2000 issues which could affect them locally. The
Company does not anticipate that its costs associated with monitoring readiness
and mitigating risks concerning the Year 2000 issue will be material. However,
even if favorable responses are received, there can be no assurance that third
parties will be Year 2000 compliant. The impact on the Company's operations, if
any, from the inability of any of its suppliers and franchisees to become Year
2000 compliant is not reasonably estimable (except that if there is a national
or regional crisis in the financial, transportation or utility infrastructure,
it would likely adversely affect most commercial enterprises, including the
Company.)
FORWARD LOOKING STATEMENTS
This report contains forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, that are not historical facts. Such
statements may include, but are not limited to, projections of revenues, income,
expenses and capital expenditures, plans for future operations and openings of
new restaurants, financing needs or plans (including plans relating to Turnkey
Program real estate transactions, possible debt financings, retail sales of
Schlotzsky's Deli brand products and transactions with area developers), and
plans relating to products or services of the Company, as well as assumptions
relating to the foregoing. These statements involve management assumptions and
are subject to risks and uncertainties such as changes in interest rates,
availability of favorable financing for the Company or its franchisees,
satisfactory completion of transactions with franchisees and area developers,
intense competition, the timing of future restaurant openings and changes in
development plans, strategies and staffing based on less support from area
developers and fewer anticipated openings, as well as factors associated with
Year 2000 compliance by third parties. The Company refers you to the factors set
forth in the Company's Annual Report on Form 10-K/A in "Business," pages 1-15.
The Company undertakes no obligation to update forward looking statements that
may be contained in this report.
14
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Changes in short-term interest rates on loans from financial institutions
could materially affect the Company's earnings because the underlying
obligations are either variable, or fixed for such a short period of time as to
effectively become variable.
At September 30, 1999 a hypothetical 100 basis point increase in interest
rates would result in a reduction of approximately $72,000 in quarterly pre-tax
earnings. The estimated reduction is based upon the increased interest expense
of our variable rate debt and assumes no change in the volume or composition of
debt at September 30, 1999. The fair values of the Company's bank loans are not
significantly affected by changes in market interest rates.
15
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On September 29, 1999, the plaintiffs in the purported class action lawsuit
filed against the Company filed a notice of appeal to the district court's
decision to dismiss the case with prejudice. A consolidated amended complaint
had been filed on August 26, 1998 by the Lone Star Ladies Investment Club, et
al. in the Federal District Court for the Western District of Texas against the
Company and four of its officers and directors (Monica Gill, Executive Vice
President and Chief Financial Officer; John M. Rosillo, a former director;
Jeffrey J. Wooley, Senior Vice President; and John C. Wooley, President and
Chairman of the Board of Directors).
ITEM 2. CHANGES IN SECURITIES.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits:
Exhibit
No.
-----
10.55 Option Agreement between DFW Restaurant Transfer
Corp. and NS Associates I Ltd.
10.56 Management Agreement between DFW Restaurant Transfer
Corp. and NS Associates, I Ltd.
27 Financial Data Schedule.
b. Current Reports on Form 8-K:
None
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCHLOTZSKY'S, INC.
By: /s/ John C. Wooley
------------------------
John C. Wooley
President and
Chief Executive Officer
By: /s/ Monica Gill
-----------------------------
Monica Gill
Executive Vice President and
Chief Financial Officer
Austin, Texas
November 12, 1999
17
<PAGE>
OPTION AGREEMENT
This Option Agreement (the "Agreement") dated as of September 1, 1999, by
and between DFW RESTAURANT TRANSFER CORP., a Texas corporation ("Holder"), NS
ASSOCIATES I, LTD., a Texas limited partnership ("Grantor"), and SCHLOTZSKY'S,
INC., a Texas corporation ("Guarantor").
WITNESSETH:
WHEREAS, Holder desires to obtain an option to purchase Grantor's rights
under that certain Amended and Restated Schlotzsky's Area Developer Agreement
dated August 13, 1996 between Grantor and Guarantor, as amended (the "ADA"); and
WHEREAS, Grantor has agreed to grant Holder an option to acquire its right,
title and interest in the Area Developer Agreement pursuant to the terms and
conditions hereof;
NOW, THEREFORE, in consideration of the premises and the covenants and
agreements set forth herein, and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties agree as
follows:
1. GRANT OF OPTION. In consideration of the payment by Holder of the sum
of Three Million Dollars ($3,000,000) (the "Option Price") Two Million Five
Hundred Thousand Dollars ($2,500,000) of which shall be payable in cash to
Grantor contemporaneous with the execution hereof, and the remaining Five
Hundred Thousand Dollars ($500,000) of which shall be payable in cash on January
25, 2000, Grantor hereby grants to Holder the option (the "Option") to acquire
all of Grantor's right, title and interest in and to the ADA at any time during
the Option Period (as hereinafter defined) for the Exercise Price (as
hereinafter defined). Further, the Option shall terminate, at Grantor's
election, upon the failure by Holder to pay any of the sums described in the
preceding sentence or upon any default by Holder in the performance of any of
its obligations under that certain Consulting Agreement of even date herewith
between Holder and Grantor which is not cured within thirty (30) days after
written notice of such default is given to Holder by Grantor. Grantor agrees
that at the time that Grantor receives the Option Price from Holder, it will
discharge the indebtedness to Guarantor described in SCHEDULE 1 hereto and that
upon receipt of the Exercise Price or other amounts payable under this
Agreement, it will, at Holder's request, discharge any other indebtedness of
Grantor to Holder or Guarantor or any of their respective affiliates to the
extent of the funds received.
<PAGE>
2. OPTION. Holder shall be entitled to exercise the Option in accordance
with the provisions of paragraph 4 during the period commencing on the date of
this Agreement and continuing until 5:00 p.m., Dallas, Texas time on February
16, 2012 (such period being the "Option Period"). If the Option is not
exercised prior to the termination of the Option Period, the Option shall
automatically terminate and Grantor shall have the right to retain the Option
Price and any other amounts paid to Grantor hereunder.
3. EXERCISE PRICE. Upon the exercise of the Option, Holder shall be
entitled to purchase Grantor's rights under the ADA by delivering to Grantor, at
the Closing (as hereinafter defined), a cash payment in the amount set forth
below (the "Exercise Price"). The Exercise Price shall be determined as
follows:
- If the Closing occurs on or before August 16, 2004, the Exercise
Price shall equal the sum of Twenty-Eight Million Dollars ($28,000,000);
- If the Closing occurs at any time from August 17, 2004 and through
August 16, 2005, the Exercise Price shall equal the sum of Twenty-Nine Million
One Hundred Twenty Thousand Dollars ($29,120,000);
- If the Closing occurs at any time from August 17, 2005 through
August 16, 2006, the Exercise Price shall equal the sum of Thirty Million Two
Hundred Eighty-Four Thousand Dollars ($30,284,000);
- If the Closing occurs at any time from August 17, 2006 through
August 16, 2007, the Exercise Price shall equal the sum of Thirty-One Million
Four Hundred Ninety-Six Thousand One Hundred Ninety-Two Dollars ($31,496,192);
- If the Closing occurs at any time from August 17, 2007 through
August 16, 2008, the Exercise Price shall equal the sum of Thirty-Two Million
Seven Hundred Fifty-Six Thousand Thirty-Nine Dollars ($32,756,039)
- If the Closing occurs at any time from August 17, 2008 through
August 16, 2009, the Exercise Price shall equal the sum of Thirty-Four Million
Sixty-Six Thousand Two Hundred Eighty Dollars ($34,066,280);
- If the Closing occurs at any time from August 17, 2009 through
August 16, 2010, the Exercise Price shall equal the sum of Thirty-Five Million
Four Hundred Twenty-Eight Thousand Nine Hundred Thirty-One Dollars
($35,428,931);
- If the Closing occurs at any time from August 17, 2010 through
August 16, 2011, the Exercise Price shall equal the sum of Thirty-Six Million
Eight Hundred Forty-Six Thousand Eighty-Eight Dollars ($36,846,088); and
<PAGE>
- If the Closing occurs at any time from August 17, 2011 through the
expiration of the Option, the Exercise Price shall equal the sum of Thirty-Eight
Million Three Hundred Nineteen Thousand Nine Hundred Thirty-One Dollars
($38,319,931).
The Exercise Price shall be reduced at the Closing by the Option Price paid to
Grantor concurrently with the execution of this Agreement and any amounts paid
pursuant Section 9 of this Agreement.
4. EXERCISE OF THE OPTION. Holder shall be entitled to exercise the
Option during the Option Period by delivering to Grantor at the address set
forth in Section 12 hereof by courier or by certified mail, postage prepaid,
return receipt requested notice of Holder's exercise of the Option; and the
Closing shall be held ten (10) business days thereafter provided, however, that
in no event shall the Closing occur prior to January 1, 2000 or later than
ninety (90) days following February 16, 2012. The parties agree that the
confidentiality, non-compete and other post-termination provisions of the ADA
will continue to be binding on Grantor notwithstanding the execution of this
Agreement or the exercise of the Option.
5. CLOSING.
(a) At the closing (the "Closing) of the assignment of the ADA
contemplated hereby, Holder shall deliver to Grantor the following:
(i) The Exercise Price (reduced by the Option Price and, if
paid by Holder, the amount specified in paragraph 9) in immediately available
funds;
(ii) a mutual release of claims executed by Guarantor and
Grantor, through which each party releases the other party and its principals
from any obligations under the ADA (other than those specifically intended to
survive the termination of the ADA), the form of which release is attached as
EXHIBIT A hereto (the "Mutual Release of Claims");
(iii) a certificate executed by the President or a Vice President
of Holder and the President or a Vice President of Guarantor, respectively,
confirming that the representations and warranties of Grantor and Guarantor set
forth in this Agreement are true and correct at and as of the Closing;
-3-
<PAGE>
(b) At the Closing, Grantor shall deliver to Holder the following:
(i) an assignment of the ADA;
(ii) the Mutual Release of Claims; and
(iii) a certificate executed by the President or a Vice President
of Grantor's general partner confirming that the representations and warranties
set forth in this Agreement are true and correct at and as of the Closing.
6. REPRESENTATIONS AND WARRANTIES OF GRANTOR. Grantor hereby represents
and warrants to Holder as follows:
(a) Grantor is a limited partnership duly organized and validly
existing under the laws of the State of Texas. Grantor has full power and
authority to enter into this Agreement and to perform its obligations hereunder.
This Agreement has been duly authorized by all partnership action required on
the part of Grantor.
(b) Grantor is the owner and holder of the developer's rights under
the ADA free and clear of any liens, claims or encumbrances. Grantor has not
pledged, assigned or hypothecated any of its rights under the ADA. Grantor has
no knowledge of the occurrence of any defaults under the ADA or any events
which, with notice or the passage of time could constitute a default under the
ADA.
(c) There are no actions, suits, proceedings or investigations
pending, or to the best knowledge of Grantor, threatened before any court,
governmental agency or instrumentality against, by or affecting Grantor or any
of its properties or assets that would prevent the Closing or any of the
transactions contemplated hereby.
(d) The execution and delivery of this Agreement and the assignments
to be delivered by Grantor at the Closing, and the consummation of the
transactions contemplated hereby, will not violate any provision of, or result
in the breach of or permit the acceleration of, or give rise to any liability or
obligation under, any applicable law, rule or regulation of any governmental
body, the limited partnership agreement of Grantor or any contract, indenture or
agreement to which Grantor is a party.
-4-
<PAGE>
7. REPRESENTATIONS AND WARRANTIES OF HOLDER AND GUARANTOR. Holder and
Guarantor hereby jointly and severally represent and warrant to Grantor as
follows:
(a) Holder is a corporation duly organized, validly existing and
in good standing under the laws of the state of Texas. Holder has full power
and authority to enter into this Agreement and to perform its obligations
hereunder. This Agreement has been duly authorized by all corporate action
necessary on the part of Holder.
(b) There are no actions, suits, proceedings or investigations
pending, or to the best knowledge of Holder, threatened before any court,
governmental agency or instrumentality against, by or affecting Holder or any
of its properties or assets that would prevent the Closing or any of the
transactions contemplated hereby.
(c) The execution and delivery of this Agreement and the
performance by Holder of its obligations hereunder will not violate any
provision of, or result in the breach of or permit the acceleration of, or
give rise to any liability or obligation under any applicable law, rule or
regulation of any governmental body, the articles of incorporation or bylaws
of Holder or any contract, indenture or agreement to which Holder is a party.
(d) Guarantor is a corporation duly organized, validly existing
and in good standing under the laws of the State of Texas. Guarantor has
full power and authority to enter into this Agreement and to perform its
obligations hereunder. This Agreement has been duly authorized by all
corporate action required on the part of Guarantor.
(e) Other than litigation matters referred to in Guarantor's
Annual Report on Form 10-K filed with the Securities and Exchange Commission
for the year ended December 31, 1998, any one of which could have a material
adverse effect on the results of operations or financial condition of
Guarantor if a decision adverse to Guarantor is reached, there are no
actions, suits, proceedings or investigations pending, or to the best
knowledge of Guarantor, threatened before any court, governmental agency or
instrumentality against, by or affecting Guarantor or any of its property or
assets that would prevent the Closing or any of the transactions contemplated
hereby.
(f) The execution and delivery of this Agreement and the
performance by Guarantor of its obligations hereunder will not violate any
provision of, or result in the breach of or permit the acceleration of, or
give rise to any liability or obligation under any applicable law, rule or
regulation of any
-5-
<PAGE>
governmental body, or the articles of incorporation or bylaws of Guarantor or
any contract, indenture or agreement to which Guarantor is a party.
8. COVENANTS. The parties hereby covenant and agree as follows:
(a) Contemporaneous with the execution of this Agreement, Holder,
Grantor and Guarantor shall execute a Management Agreement in the form of the
Management Agreement attached hereto as EXHIBIT B (the "Management
Agreement"), pursuant to which Holder shall perform all of Grantor's duties
under the ADA. Guarantor agrees that the appointment of Holder to act on
behalf of Grantor shall not constitute a default under the ADA. Guarantor
further agrees to guarantee the performance by Holder of its obligations
under the Management Agreement.
(b) Guarantor and Grantor agree that contemporaneous with the
execution of this Agreement, they will execute the Amendment to Area
Developer Agreement, the form of which is attached hereto as EXHIBIT C (the
"Amended and ADA"). The Amended ADA shall become effective immediately.
(c) Guarantor agrees that during the term of the Management Agreement
it will not terminate the ADA, as amended.
9. CHANGE IN CONTROL. If there is a Change in Control of Guarantor or
Holder, as hereinafter defined, during the Option Period, unless such Change
in Control constitutes an Excluded Transaction, as hereinafter defined,
Holder shall notify Grantor within ten (10) business days following such
change and such notice shall include an election on the part of Holder to
either terminate the Option or to keep the Option in effect. If no notice is
given or if such notice does not include a statement of Holder's decision to
either terminate the Option or keep the Option in effect, then Holder shall
be deemed to have elected to keep the Option in effect. If Holder elects not
to terminate the Option pursuant to the foregoing provisions, then Holder
shall be obligated to pay to Grantor, within ninety (90) days after the
expiration of Holder's ten (10) business day election period, an amount equal
to ten percent (10%) of the then applicable Exercise Price (as specified in
paragraph 3 hereof). Said amount shall be applicable to the Exercise Price
at the Closing (if the Option is exercised) but shall otherwise be
non-refundable to Holder. If Holder fails to deposit the amount specified
above, the Option shall lapse.
As used herein, the term "Change in Control of Guarantor or Holder"
shall mean any of the following: (i) the sale of all or more than a majority
in book value of the assets of Guarantor or Holder, as applicable, (ii) the
merger of Guarantor or Holder, as applicable, with or into another entity so
that after such merger the
-6-
<PAGE>
shareholders of Guarantor or Holder, as applicable, own less than a majority
of the shares of the surviving entity or (iii) the acquisition of beneficial
ownership of more than twenty percent (20%) of Guarantor's or Holder's common
stock for more than sixty (60) days (with such period of sixty (60) days
commencing on the date that Guarantor receives notice that one or more
persons have acquired more than twenty percent (20%) of the common stock of
Guarantor or Holder) by a person or group of persons acting in concert who
did not hold such stock at the time of this Agreement; provided, that if such
person or group of persons reduces their ownership below 20% prior to the
expiration of said sixty (60) days it shall not be considered a change in
control.
Notwithstanding anything to the contrary set forth herein, the following
transactions (the "Excluded Transactions") shall be excluded from the
definition of "Change in Control of Guarantor or Holder", as set forth in the
preceding paragraph: (i) any transaction that falls within the definition of
a "Change in Control of Guarantor or Holder" that is caused by the
acquisition of more than twenty percent (20%) of Guarantor's stock by (A)
John C. Wooley, (B) Jeffrey J. Wooley, (C) Morris P. Newberger, (D) any
member of the immediate family of either John C. Wooley, Jeffrey J. Wooley or
Morris P. Newberger, (E) any entity a majority of whose equity interests are
owned by, or a trust formed for the benefit of, any of the persons named in
(A) through (D) above, or (F) a group including anyone identified in
(A) - (E) in a transaction in which Guarantor ceases to be a reporting company
under the Securities Exchange Act of 1934, as amended, (ii) any transaction
that falls within the definition of "Change in Control of Guarantor or
Holder" that is caused by the actions of Grantor or any of its affiliates or
(iii) a Change in Control that results from the issuance prior to August 31,
2000 of shares of Guarantor's common stock (or warrants or options to acquire
Guarantor's common stock, or the exercise thereof at any time before or after
August 31, 2000) in connection with Guarantor's acquisition of at least 100
stores or store sites, at least 20 of which are within the territory covered
by the ADA that are or were formerly part of another chain of fast food
stores.
10. ABSENCE OF CLAIMS.
(a) Guarantor hereby acknowledges that except for Grantor's future
obligations under the ADA, and Guarantor's right to seek indemnification from
Grantor pursuant to the terms of the ADA, neither Guarantor nor its
affiliates has any rights, claims or causes of action, whether absolute or
contingent, against Grantor or any of its principals or affiliates, under
the ADA or otherwise. Further, except for Guarantor's right to seek
indemnification from Grantor under the ADA to the extent set forth therein,
Guarantor hereby releases Grantor, its principals and affiliates from any
claims, demands, liabilities or causes of action, absolute or contingent,
known or unknown, that accrued prior to the date of this
-7-
<PAGE>
Agreement. Additionally, Guarantor agrees that contemporaneously with the
execution of this Agreement, it shall execute the Mutual Release of Claims in
favor of M. P. Newberger Corp., the form of which is attached hereto as
EXHIBIT D.
(b) Grantor hereby acknowledges that, except for accrued payments due
under the ADA, Guarantor's future obligations under the ADA, Holder's future
obligations under the Management Agreement, the Consulting Agreement and
Grantor's right to seek indemnification from Guarantor pursuant to the terms
of the ADA, Grantor has no rights, claims or causes of action, whether
absolute or contingent, against Guarantor under ADA or otherwise. Further
except for Grantor's right to receive accrued payments under the ADA,
Guarantor's future obligations under the ADA, the obligations of Holder and
Guarantor under the Management Agreement and the Consulting Agreement,
Guarantor's future obligations under this Agreement and Grantor's right to
seek indemnification from Guarantor under the ADA to the extent set forth
therein, Grantor hereby releases Guarantor and Holder and each of them form
any claims, demands, liabilities or causes of action, absolute or contingent
known or unknown.
11. NOTIFICATION OF TERMINATION. Holder agrees that if, at any time
prior to February 16, 2012 it determines that it does not wish to exercise
the Option, Holder will give Grantor written notice of that fact, and the
Option shall terminate ninety (90) days after the date of such notice.
Further, notwithstanding anything to the contrary contained elsewhere herein,
if Holder does not deliver written notice of its exercise of the Option on or
before November 17, 2011, then the Option shall automatically terminate at
the end of the Option Period.
12. NOTICES. Unless otherwise specifically provided herein, any notice
required or permitted to be given hereunder shall be in writing and shall be
deemed delivered when delivered by courier or upon deposit in the United
States mail, postage prepaid, certified mail, return receipt requested to the
following addresses or to such other address as may be specified by notice:
If to Grantor: NS Associates I, Ltd.
5580 LBJ Freeway, Suite 600
Dallas, Texas 75240
With a copy to: Lester V. Baum, Esq.
Powell, Sweet & Coleman, L.L.P.
8080 North Central Expressway, Suite 1380
Dallas, Texas 75206
If to Holder: DFW Restaurant Transfer Corp.
203 Colorado Street
-8-
<PAGE>
Austin, Texas 78701
If to Guarantor: Schlotzsky's, Inc.
203 Colorado Street
Austin, Texas 78701
13. ENTIRE AGREEMENT; AMENDMENT. This Agreement embodies the entire
agreement of the parties with regard to the subject matter hereof, supersedes
all other agreements and understandings, if any, relating to the subject
matter hereof and may be amended or supplemented only by an instrument in
writing executed all of the parties hereto.
14. SEVERABILITY. If any provision of this Agreement is held to be
illegal, invalid or unenforceable, such provision shall be fully severable
and this Agreement shall be construed and enforced as if such illegal,
invalid or unenforceable provision had never been a part hereof.
Furthermore, the remaining provisions of this agreement shall not be affected
by the illegal, invalid or unenforceable provision or by its severance from
this Agreement and there shall, in lieu of such provision, be added a
provision as similar in terms and intent to such illegal, invalid or
unenforceable provision as may be legal, valid or enforceable, as the case
may be.
15. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon and
inure to the benefit of the parties hereto and their respective successors
and assigns. Notwithstanding the foregoing, no party shall assign any of its
rights or delegate any of its duties or obligations hereunder without the
express written consent of the other parties, which consent may be withheld
for any or no reason. Any purported assignment of this Agreement contrary to
the terms hereof shall be void.
16. GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the laws of the State of Texas without regard to conflicts
of laws principles.
17. COUNTERPARTS. This Agreement may be executed in multiple
counterparts, each of which shall be deemed an original, provided that all of
which taken together shall constitute one and the same instrument.
-18-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
and year first above written.
GRANTOR:
NS ASSOCIATES I, LTD.
By: NS Associates, Inc.
Its: General Partner
By: /s/ Morris Newberger
-----------------------------------------------
Name: Morris Newberger
------------------------------------------
Title: President
-----------------------------------------
HOLDER:
DFW RESTAURANT TRANSFER CORP.
By: /s/ John C. Wooley
-----------------------------------------------
Name: John C. Wooley
------------------------------------------
Title: President
-----------------------------------------
-10-
<PAGE>
The undersigned, Schlotzsky's, Inc., the sole shareholder of Holder,
acknowledges that it will receive substantial direct and indirect benefits as a
result of Holder entering into this Agreement with Grantor. Therefore, in
consideration of the foregoing and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, and to induce Grantor
to enter into this Agreement, the undersigned, intending to be legally bound
hereby unconditionally irrevocably guaranties to Grantor the full and timely
performance of Holder's obligations under this Agreement.
GUARANTOR:
SCHLOTZSKY'S, INC.
By: /s/ John C. Wooley
-----------------------------------------------
Name: John C. Wooley
------------------------------------------
Title: President
-----------------------------------------
-11-
<PAGE>
MANAGEMENT AGREEMENT
This Management Agreement ("Agreement") dated as of September 1, 1999 by
and between NS ASSOCIATES I, LTD., a Texas limited partnership ("Developer"),
DFW RESTAURANT TRANSFER CORP., a Texas corporation ("Manager"), and
SCHLOTZSKY'S, INC., a Texas corporation ("Guarantor").
WITNESSETH:
WHEREAS, Developer, Manager and Guarantor are parties to that certain
Option Agreement of even date herewith (the "Option Agreement"), which agreement
granted Manager the right to acquire Developer's rights under that certain
Amended and Restated Schlotzsky's Area Developer Agreement dated August 13, 1996
between Developer and Guarantor, as amended (the "ADA");
WHEREAS, the Option Agreement provides that commencing with the date of the
Option Agreement, Manager shall assume and perform all of Developer's duties and
obligations under the ADA;
NOW, THEREFORE, in consideration of the mutual covenants set forth herein,
and for other good and valuable consideration, the sufficiency and receipt of
which are hereby acknowledged, the parties agree as follows:
1. DEFINED TERMS. This Agreement is being entered into in connection
with the Option Agreement and except as expressly set forth herein, all
capitalized terms used herein without definition shall have the meanings
assigned to them in the Option Agreement.
2. MANAGER'S DUTIES. Commencing on October 31, 1999 and continuing until
its earlier termination or expiration, Manager shall perform in a timely and
efficient manner all of Developer's duties under the ADA. In connection with
performing its services thereunder, Manager shall have the right, but except as
specified in Section 10 below not the obligation, to hire any of Developer's
employees, provided that any employees of Developer who are hired by Manager
shall not be prevented from returning to work for Developer if Manager does not
exercise the Option, notwithstanding anything to the contrary contained in the
ADA. In discharging its duties under this Agreement, Manager shall act
prudently with due regard for the interests of both Manager and Developer; it
being agreed that Manager shall have been deemed to have performed its duties
and performed its services under this Agreement in a timely and efficient manner
if it completes an average of at least two Quality Service Cleanliness
Compliance inspections (QSCCs) or Key Result Area evaluations (KRAs) (or any
combination
<PAGE>
of QSCCs or KRAs) per franchised restaurant per year prior to the occurrence
of Change in Control, as defined in the Option Agreement, and an average of
at least four QSCC inspections or KRA evaluations (or any combination
thereof) per franchised restaurant per year after a Change in Control. In
addition to the general obligations of Manager outlined above, during the
term of this Agreement Guarantor shall provide Developer with monthly written
reports, which reports shall be delivered not later than the 15th day of each
month, as follows: (i) a schedule of the royalties paid by franchisees
within territories covered by the ADA during the preceding month, in the same
format as heretofore provided by Guarantor under the ADA, a copy of which
format is attached hereto as Schedule 1, (ii) a schedule listing all new
franchise agreements executed during the preceding month for the territory
covered by the ADA, (iii) a schedule listing all franchise agreements
terminated during the preceding month, (iv) a schedule listing the stores
within the territories covered by the ADA for which construction was
commenced during the preceding month, (v) a schedule listing the stores
within the territories covered by the ADA which opened for business during
the preceding month (vi) a schedule listing all stores within the territory
covered by the ADA that closed during the preceding month..
3. MANAGER'S COMPENSATION. As compensation for its services hereunder,
Manager shall receive a management fee equal to 100% of the store transfer fees
payable under the ADA and the following:
- During the period commencing on October 31, 1999 and continuing
until August 16, 2001, Manager shall receive a fee equal to 60% of the royalties
and all of the Franchise Fees paid to Developer for such period under the ADA;
- During the period commencing August 17,2001 and continuing until
August 16, 2003, Manager shall receive a fee equal to 50% of the royalties paid
to Developer and all of the Franchise Fees paid to Developer for such period
under the ADA;
- During the period commencing on August 17, 2003 and continuing until
the August 16, 2004, Manager shall receive a fee equal to 25% of the royalties
paid to Developer; and
-During the period commencing on August 17, 2004 and continuing until
the expiration of the ADA, Manager shall receive a fee equal to 20% of the
royalties paid to Developer.
Provided that all such fees shall cease to accrue upon the earlier of the
Closing or the termination of this Agreement pursuant to Section 9 hereof.
Developer
-2-
<PAGE>
hereby authorizes Guarantor to pay directly to Manager, Manager's share of
such royalties. Manager shall be responsible for paying its own expenses.
4. LIMITATION ON MANAGER'S AUTHORITY. During the term of this
Agreement, Manager shall have no authority to take any of the following
actions without the prior written consent of Developer, which consent may be
withheld in Developer's sole discretion:
(a) to amend, modify or terminate the ADA;
(b) to compromise, release or settle any claim of or against
Developer arising under the ADA;
(c) to confess any judgments or otherwise admit to any liabilities
binding upon Developer; or
(d) to release any territories covered by the ADA.
5. ACCESS BY DEVELOPER. Developer and its agents or designees shall
have the right, during normal business hours following reasonable notice to
Manager, to examine all sales reports from franchisees, royalty reports from
Guarantor, QSCCs, or any reports issued as a replacement for QSCCs, KRAs or
any replacement for KRAs and any store transfer files for store transfers
occurring during the preceding twelve (12) months which are in the possession
of Manager or Guarantor.
6. INDEMNIFICATION BY MANAGER. Manager shall indemnify, hold harmless
and defend Developer, its partners, and the directors, officers and
shareholders of its corporate general partner, from and against any and all
losses, claims, damages, liabilities, judgments and expenses (including
reasonable attorneys' fees and other expenses incurred by any of them in
connection with defending, settling or investigating any action or claim),
directly or indirectly arising out of or relating to the acts or omissions of
Manager or any person employed, engaged or supervised by Manager in
connection with the performance of its duties under this Agreement. Further,
Guarantor shall name Developer as an additional named insured under its
general comprehensive liability insurance policies. The provisions contained
in this Section 6 shall survive the Closing under the Option Agreement or the
termination of this Agreement, for any reason, including the Closing under
the Option Agreement.
7. EXTENSION OF AGREEMENT. If Manager terminates the Option or the
Option expires without being exercised by Manager, Developer shall have the
right, but not the obligation, to extend this Agreement for the remaining
term of
-3-
<PAGE>
the ADA upon written notice to Manager. If this Agreement is extended by
Developer, all of the terms and conditions set forth herein shall remain
unchanged.
8. DEFAULT; REMEDIES FOLLOWING A DEFAULT.
(a) Each of the following shall constitute a default ("Default")
under this Agreement:
(i) Manager shall fail in any material respect to perform any
obligation under this Agreement (other than the payment of money), following
thirty (30) days' notice thereof to Manager and Guarantor and the opportunity to
cure such default; and
(ii) Either Manager or Guarantor shall seek, consent to or
acquiesce in the filing of any proceeding under any bankruptcy, insolvency,
reorganization or other law providing for the relief of debtors or an
involuntary proceeding shall be brought against Manager or Guarantor and such
proceeding shall not be dismissed within sixty (60) days.
(b) Following the occurrence of a Default, Developer shall have
the right, at its election, to pursue one or more of the following remedies:
(i) to require Guarantor's performance of the defaulted
obligation;
(ii) to recover damages for the Default; and/or
(iii) to terminate this Agreement.
9. TERMINATION. This Agreement shall terminate upon the first to occur
of the following:
(a) On the Closing of the assignment of the ADA to Guarantor under
the Option Agreement;
(b) On written notice from Developer (which may be tendered at
Developer's option) upon the expiration or termination of the Option Period, as
set forth in the Option Agreement, if the Option has not been exercised prior to
that time; or
(c) On written notice from Developer (given at Developer's election)
following the occurrence of a Default and the expiration of any applicable cure
periods.
-4-
<PAGE>
10. ASSIGNMENT. This Agreement shall be binding upon and inure to the
benefit of the parties hereto and their respective successors and assigns,
provided that Developer is relying on the unique skills and experience of
Manager and its personnel. Accordingly, this Agreement shall not be assignable
or delegable by Manager except to Guarantor without the prior written consent of
Developer. Any purported assignment or delegation of this Agreement by Manager
contrary to the terms hereof shall be void.
11. EMPLOYEES. Manager agrees that upon execution of this Agreement it
will hire the employees of Developer who are identified on Annex 1 attached
hereto at their present compensation and on the same terms and conditions as are
applicable to other non-executive employees of Manager; provided, however, that
the terms of employment of Justin Still and Keith Coleman will be modified to
provide that they will be employed pursuant to one (1) year employment contracts
with Manager.
12. NOTICES. Any notice or other communication to be given by any party
hereunder shall be in writing and shall be deemed sufficient if delivered by
courier or by certified mail, postage prepaid, addressed as set forth in Section
12 of the Option Agreement.
13. ENTIRE AGREEMENT; AMENDMENT. This Agreement embodies the entire
agreement of the parties with regard to the subject matter hereof, supersedes
all other agreements and understandings, if any, relating to the subject matter
hereof and may be amended or supplemented only by an instrument in writing
executed all of the parties hereto.
14. SEVERABILITY. If any provision of this Agreement is held to be
illegal, invalid or unenforceable, such provision shall be fully severable and
this Agreement shall be construed and enforced as if such illegal, invalid or
unenforceable provision had never been a part hereof. Furthermore, the
remaining provisions of this agreement shall not be affected by the illegal,
invalid or unenforceable provision or by its severance from this Agreement and
there shall, in lieu of such provision, be added a provision as similar in terms
and intent to such illegal, invalid or unenforceable provision as may be legal,
valid or enforceable, as the case may be.
15. GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of Texas without regard to conflicts of
laws principles.
-5-
<PAGE>
16. COUNTERPARTS. This Agreement may be executed in multiple
counterparts, each of which shall be deemed an original, provided that all of
which taken together shall constitute one and the same instrument.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
and year first above written.
MANAGER:
DFW RESTAURANT TRANSFER CORP.
By: /s/ John C. Wooley
--------------------------------
Name: John C. Wooley
------------------------------
Title: President
-----------------------------
DEVELOPER:
NS ASSOCIATES I, LTD.
By: NS Associates, Inc.,
Its: General Partner
By: /s/ Morris Newberger
--------------------------------
Name: Morris Newberger
------------------------------
Title: President
-----------------------------
The undersigned, Schlotzsky's, Inc., the sole shareholder of Manager,
acknowledges that it will receive substantial direct and indirect benefits as a
result of Manager entering into this Agreement with Developer. Therefore, in
consideration of the foregoing and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, and to induce
-6-
<PAGE>
Developer to enter into this Agreement, the undersigned, intending to be
legally bound hereby unconditionally and irrevocably guaranties to Developer
the full and timely performance of Manager's obligations under this
Agreement.
SCHLOTZSKY'S, INC.
By: /s/ John C. Wooley
-------------------------------------
Name: John C. Wooley
-----------------------------------
Title: President
----------------------------------
-7-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS ON PAGES TWO AND
THREE OF THE COMPANY'S FORM 10-Q FOR THE YEAR TO DATE.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 2,072,705
<SECURITIES> 0
<RECEIVABLES> 26,752,316
<ALLOWANCES> (1,227,489)
<INVENTORY> 0
<CURRENT-ASSETS> 40,091,779
<PP&E> 23,207,154
<DEPRECIATION> (3,345,313)
<TOTAL-ASSETS> 123,260,339
<CURRENT-LIABILITIES> 23,641,598
<BONDS> 0
0
0
<COMMON> 63,135
<OTHER-SE> 78,613,615
<TOTAL-LIABILITY-AND-EQUITY> 123,260,339
<SALES> 10,614,960
<TOTAL-REVENUES> 37,102,587
<CGS> 3,182,147
<TOTAL-COSTS> 30,746,857
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,429,814
<INTEREST-EXPENSE> 1,541,922
<INCOME-PRETAX> 7,132,824
<INCOME-TAX> 2,639,145
<INCOME-CONTINUING> 4,493,679
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,493,679
<EPS-BASIC> .61
<EPS-DILUTED> .60
</TABLE>
