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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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, 1998
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:
PREFERRED STOCK PURCHASE RIGHTS
------------------
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 19, 1999 was approximately $60,849,000 based upon the
last sales price on March 19, 1999 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 7,401,338 shares of Common Stock outstanding on
March 19, 1999.
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, 1998
<TABLE>
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PAGE NO.
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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 . . . 17
Item 6. Selected Consolidated Financial Data. . . . . . . . . . . . . . . . . . . . 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation . . . . . . . . . . . . . . . . . . . . . . . . . 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . 28
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . 29
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . 29
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . 30
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . 30
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. . . . . . 30
</TABLE>
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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 Corp., 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, 1998, the
Schlotzsky's system included eight Company-owned stores and 742 franchised
stores located in 38 states, the District of Columbia and 13 foreign countries.
System-wide sales were approximately $270.4 million for 1997 and $348.5 million
for 1998. Weighted average annual unit volumes were $455,000 in 1997 and
$503,000 for 1998.
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; use the
Turnkey Program to develop new stores in high visibility, free-standing
locations; utilize area developers to decentralize certain labor intensive
aspects of 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.
The Company anticipates that it will initiate national network television
advertising in the Spring of 1999.
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 for every 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
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beverages. At most locations, sandwiches range in price from $3.00 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 32 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. Generally, area developers have been required to meet
specific store opening schedules under their agreements with the Company in
order to maintain their development rights. The Company recently contracted
with several area developers to buy down their portion of franchise fees and
royalties in return for cash or the combination of cash and a note. As a result
of these contracts, it is contemplated that store opening schedules for these
area developers will be eliminated.
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, 1998, out of 458 franchisees with stores, 9 franchisees have more
than five stores each and, in the aggregate, account for approximately 8.8% 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. In 1999, Schlotzsky's brand chips became
available for retail purchase outside of the restaurant system for the first
time in the domestic superstores of one of the world's largest retailers. The
Company expects to continue to explore alternative channels for retail
distribution of some of its private label products.
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, acquired two
stores in College Station, Texas and opened a store in Cedar Park, Texas. Also
during 1998, the stores in Houston, Illinois and Mississippi were reclassified
as "held for sale" and so were not considered to be part of the portfolio of
Company-owned units at the end of the year. The operating results of the units
held for sale are considered an operating cost of the Turnkey Program and are
reported in Turnkey Program cost. Results from restaurants the Company intends
to own and operate on a longer term basis are reflected in restaurant operations
figures. The Company anticipates opening or acquiring additional stores in Texas
during 1999. The Company operates these stores primarily for product
development, concept refinement, 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, 1998, the Schlotzsky's system consisted of 750 stores in 38
states, the District of Columbia, and 13 foreign countries. At December 31, 1996
and 1997, the system included 573 and 673 stores, respectively.
STORE LOCATIONS AS OF DECEMBER 31, 1998
<TABLE>
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NUMBER
LOCATION OF STORES
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UNITED STATES:
Texas. . . . . . . . . . 219
Arizona. . . . . . . . . 40
Georgia. . . . . . . . . 36
Tennessee. . . . . . . . 35
Florida. . . . . . . . . 31
Illinois . . . . . . . . 29
Indiana. . . . . . . . . 25
Michigan . . . . . . . . 23
California . . . . . . . 22
North Carolina . . . . . 21
Wisconsin. . . . . . . . 20
Colorado . . . . . . . . 20
Oklahoma . . . . . . . . 18
Alabama. . . . . . . . . 18
South Carolina . . . . . 17
Ohio . . . . . . . . . . 16
New Mexico . . . . . . . 15
Missouri . . . . . . . . 12
Kansas . . . . . . . . . 12
Nebraska . . . . . . . . 11
Louisiana. . . . . . . . 10
Utah . . . . . . . . . . 10
Minnesota. . . . . . . . 9
Arkansas . . . . . . . . 7
Nevada . . . . . . . . . 7
Virginia . . . . . . . . 6
Oregon . . . . . . . . . 6
Mississippi. . . . . . . 5
Idaho. . . . . . . . . . 5
Washington . . . . . . . 4
Iowa . . . . . . . . . . 3
West Virginia. . . . . . 3
North Dakota . . . . . . 3
Kentucky . . . . . . . . 3
South Dakota . . . . . . 2
Hawaii . . . . . . . . . 2
Pennsylvania . . . . . . 2
New York . . . . . . . . 2
District of Columbia . . 1
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TOTAL U.S. . . . . . . . 730
</TABLE>
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INTERNATIONAL:
Argentina. . . . . . . . 3
Japan. . . . . . . . . . 3
Turkey . . . . . . . . . 3
Malaysia . . . . . . . . 2
Canada . . . . . . . . . 1
China. . . . . . . . . . 1
Germany. . . . . . . . . 1
Guatemala. . . . . . . . 1
Lebanon. . . . . . . . . 1
Mexico . . . . . . . . . 1
Morocco. . . . . . . . . 1
Saudi Arabia . . . . . . 1
United Kingdom . . . . . 1
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TOTAL INTERNATIONAL: . . 20
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TOTAL STORES:. . . . . . 750
---
---
</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. 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. 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 perform various services including, but
not limited to, site selection, feasibility analysis, environmental studies,
site work, permitting and construction management, receiving a fee and
recognizing revenue upon the completion of these services. The Company may
assign its earnest money contract on a site to a franchisee, or a third-party
investor, who then assumes responsibility for developing the store. The Company
may also 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 inception of the Turnkey Program through 1997, the Company
typically provided credit enhancement in the form of limited guaranties on
the franchisees' leases for leased locations sold to investors. The Company
obtained agreements from the franchisees to indemnify the Company in case the
guaranties are called upon. Upon sale of the leased site or assignment of
its earnest money contract, the Company has deferred revenue generated (even
though proceeds were received in cash) and allocable costs incurred in
connection with the property. When a lease guaranty is terminated, or the
Company's exposure to loss under the guaranty has passed, the Company
recognizes the revenue and allocable costs related to the site. Generally,
if no credit enhancement is provided in connection with such transactions,
the Company recognizes the revenue and allocable expenses in the periods in
which the transactions occur. During 1998, the Company began emphasizing
ownership of the real estate by franchisees through a program which entails
acquiring the rights to a superior site and reselling the property, or its
rights (with any improvements), to a franchisee whose permanent mortgage loan
will be financed by a third party financial institution. The Company
provides credit enhancement for the franchisee in the form of a limited
guaranty in favor of the lender. These guarantees are usually for loan
payments required to be made during the first two to five years and are
limited to 15% to 25% of the principal amount of the loan. Generally, in
those cases, the Company recognizes the revenue and allocable expenses in the
period in which the transaction occurs. The Company will often interim
finance land and building costs in anticipation of permanent financing by a
financial institution. 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 completed. The Company anticipates that the total investment in each
developed free-standing location will be approximately $1,200,000 to
$2,000,000 (less for leased locations).
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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 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 support to franchised stores.
AREA DEVELOPERS. The Company's 32 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 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.
It is contemplated that the percentage of franchise fees and royalties
payable to certain area developers could be reduced to approximately 33% and
21%, respectively, if proposed transactions are consummated. There can be no
assurance that such transactions will be completed. 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.
The Company has agreed to extend or waive store opening schedules for certain
area developers under certain conditions, and may eliminate the schedules for
those whose royalties are bought down. If an area developer fails to meet its
obligations, the Company can terminate or repurchase its territory.
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.
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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 $30,000 for the franchisee's first store and $20,000 for any additional
store. The franchise fee is payable at the time of signing the agreement. The
current 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, 1998, 98 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. The Company's field service representatives and area developers
monitor compliance with the Company's standards and specifications as set forth
in the franchise agreement and the Company's manuals.
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 software for use by franchisees to record and report sales and
other operating information and anticipates that franchisees may be able to
license this software beginning at some point in 1999. Although the Company has
the right to audit franchisees, it relies primarily on voluntary compliance by
franchisees to accurately report sales and remit royalties. The Company expects
to begin auditing some franchise locations during 1999.
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
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the master licensee. All amounts payable to the Company by the master
licensees must be paid in U.S. dollars. As of December 31, 1998, the Company
had executed master licenses or territorial agreements covering 49 foreign
countries. As with area developers, if master licensees fail to meet their
obligations, the Company can terminate their rights or repurchase their
territories. 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 and its area developers often 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 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.
<TABLE>
<CAPTION>
STORES OPENED BETWEEN
AS OF AS OF JANUARY 1, 1992 AND
STORE SITE DECEMBER 31, 1991 DECEMBER 31, 1998 DECEMBER 31, 1998
---------- ----------------- ----------------- ---------------------
<S> <C> <C> <C>
Free-Standing . . . . . . . 24% 52% 57%
End-Cap . . . . . . . . . . 31 27 24
In-Line . . . . . . . . . . 28 11 7
Other . . . . . . . . . . . 17 10 12
--- --- ---
Total . . . . . . . . . . . 100% 100% 100%
--- --- ---
--- --- ---
</TABLE>
The Company has developed a series of prototype store designs and
specifications for free-standing and end-cap stores which it makes 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. While the initial cost of owning a free-standing, prototype
restaurant ranges from $1,200,000 to $2,000,000, the monthly payments at
interest rates in effect at December 31, 1998 were favorable compared to monthly
rent at comparable leased locations. During the twelve months ended December 31,
1998, the weighted average store sales for Schlotzsky's Deli restaurants was
approximately $503,000, 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
With respect to non-Turnkey Program stores, the Company usually 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.
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The Company has negotiated with certain financial institutions to provide
mortgage loans to qualified franchisees with stores developed through the
Turnkey Program. These loans typically would involve a limited guaranty by the
Company. In certain cases, the Company acquires the right to the land and, in
connection with the sale of the land to a franchisee (or another buyer who plans
to subsequently sell the property to a franchisee), provides interim financing
in anticipation of permanent financing by a financial institution. These loans
may be in the form of construction draw notes or mortgages. The Company had
loaned an aggregate of approximately $7.3 million to various franchisees through
this program, which had not been assigned to a financial institution as of
December 31, 1998. There can be no assurance that financial institutions will
agree to accept assignments of these or future loans made by the Company on
acceptable terms, if at all.
The Company from time to time agrees to guaranty 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 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, 1998, the Company had guarantied an aggregate of
approximately $26.4 million which is principally comprised of real estate leases
and mortgages, as well as equipment leases and other obligations of its
franchisees.
PURCHASING; PRIVATE LABELING
Franchisees are required to purchase equipment, furniture, smallwares,
merchandising displays and food from suppliers approved by the Company.
Approximately 80-85% 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. 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. NAMF'S field marketing representatives
coordinate advertising campaigns and promotions for area developers and
franchisees.
Franchisees are required by the terms of their franchise agreements to
spend at least 3% of gross sales on advertising. Effective January 1, 1999, the
Company began collecting 1.75% of the 3% for network television advertising. The
Company anticipates that network advertising will be initiated during the Spring
of 1999. The Company has requested franchisees to form local advertising groups
to pool the remainder of the 3% in order to maximize the benefits of local
advertising for members.
COMPETITION
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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.
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 and its 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
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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.
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, 1998, the Company employed 159 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," "contemplate," "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, including strategies
related to the Company's Turnkey Program and plans concerning the Company's
relationship with its area developers; and (iv) the declaration and payment of
dividends. Shareholders and prospective investors are cautioned that any such
forward-looking statements are not guaranties 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 1998, 107 new Schlotzsky's stores were
opened. During 1996 and 1997, the Company and its franchisees opened 135 and
120 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 franchisees, area developers, 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 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 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."
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TURNKEY PROGRAM. As of December 31, 1998, the Company had developed 128
stores under the Turnkey Program, 39 of which were developed during 1998. The
Company expects that the Turnkey Program will continue to produce approximately
30% to 40% of new store development. The Company has limited experience in
implementing this program, which has evolved significantly since its
inception. There can be no assurance that results experienced to date are
indicative of future performance under the program. 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. The Company may also be unable to obtain permanent third
party financing for interim loans made to the Company's franchisees, which
would further diminish capital available for the Turkey 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 certain area developers
to find qualified franchisees in their areas. Area developers are independent
contractors, and are not employees of the Company. Through 1998, most area
developer agreements specified a schedule for opening stores in the territory
covered by the agreement. It is contemplated that in 1999, the Company will
eliminate the development schedule for several area developers in connection
with the buy down of their rights to receive future franchise fees and
royalties. In addition, the Company has agreed in the past to extend or waive
development schedules for certain area developers. There can be no assurance
that area developers will be able to meet their contractual development
schedules. These schedules are a significant factor in 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 certain 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, 1996 and December 31, 1998, 123 of the 362 new stores
opened were within territories controlled by only two area developers. As of
December 31, 1998, these two area developers controlled 14 territories having a
total of 308 stores. As these territories mature, system-wide growth will depend
upon more activity in other territories. Because of its plans to buy down the
percentages of franchise fees and royalties payable to certain area developers,
the Company will be primarily responsible for recruiting franchisees and will
receive limited assistance with openings from many of its area developers. 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 and maturity 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 to use in evaluating
prospective franchisees, but there can be no assurance that it, or its area
developers, will recruit franchisees who have the level of 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.
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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."
IMPORTANCE OF LICENSING FEES. During the past three years, the Company's
revenue from private label licensing fees (brand contribution) has increased
significantly as the volume of system sales has increased, terms with certain
major suppliers have been renegotiated, and franchisees have increased their
participation in the Company's purchasing programs. This revenue is largely
dependent upon the voluntary participation of the franchisees. In 1999, the
Company anticipates renegotiating the terms of the contracts with some of its
suppliers and will explore other alternative retail channels of distribution for
some of its private label products.
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 guaranties certain real estate
obligations and equipment leases and other obligations of its franchisees. The
Company has entered into guaranties with respect to most of the leases 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. The Company guaranties 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 began implementing during 1998. See "Business -- Turnkey Program" and
"Business - Financing." At December 31, 1998, the Company was contingently
liable for approximately $26.4 million which is principally comprised of
guaranties on real estate leases and mortgages, equipment leases and other
obligations of its franchisees.
During 1998, the mortgage financing program substantially replaced the
lease transactions completed in the Turnkey Program during prior years. While
the Company provided financing for several mortgages which were sold or held for
sale to financial institutions, there can be no assurance that the financial
institutions will accept all or most of the mortgages that the Company expects
to assign. The principal amount of the loans outstanding under the mortgage
financing program as of December 31, 1998 was approximately $7.3 million. 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, 1998, the Company held notes receivable from area developers and
master licensees in an aggregate principal amount of approximately $5.2 million.
At December 31, 1998, the principal balance of these notes had been reserved on
the financial statements of the Company by approximately $593,000, reflecting
the fair market value of such notes based upon valuations from a third party
valuation service. 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, 1998, the outstanding principal amount of these
notes was approximately $8,092,000. 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
guarantied 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 guarantied 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
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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 prototype 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 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 750 stores in the system at December 31,
1998, 219 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 and its 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, 1998, John C. Wooley
and Jeffrey J. Wooley beneficially owned an aggregate of approximately 13.9% 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., an entity of which John M.
Rosillo, a director of the Company, is the managing director, beneficially owned
1.7% of the outstanding Common Stock at December 31, 1998. 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.
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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 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 and its area
developers and franchisees. 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, 1998, the Company had
7,391,942 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. The
Bylaws were amended in 1998 to provide that a director may only be removed for
cause by vote of the holders of at least two-thirds of the shares present in
person or by proxy at a meeting of shareholders called expressly for that
purpose. 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.
In December 1998, the Company announced that the Board of Directors had
adopted a Shareholder's Rights Plan and approved a dividend of one Right for
each share of Company Common Stock outstanding. Under the plan, each shareholder
of record receives one Right for each share of Common Stock held. Initially, the
Rights are not exercisable and automatically trade with the Common Stock. There
are no separate Rights certificates at this time. Each Right entitles the holder
to purchase one one-hundredth of a share of Company Class C Series A Junior
Participating Preferred Stock for $75.00 (the "Exercise Price").
The Rights separate and become exercisable upon the occurrence of certain
events, such as an announcement that an "acquiring person" (which may be a group
of affiliated persons) beneficially owns, or has acquired the rights to own,
20% or more of the outstanding Common Stock, or upon the commencement of a
tender offer or exchange offer that would result in an acquiring person
obtaining 20% or more of the outstanding shares of Common Stock.
Upon becoming exercisable, the Rights entitle the holder to purchase
Common Stock with a value of $150 for $75. Accordingly, assuming the Common
Stock had a per share value of $75 at the time, the holder of a right could
purchase two shares for $75. Alternatively, the Company may permit a holder to
surrender a Right in exchange for stock or cash equivalent to one share of
Common Stock (with a value of $75) without the payment of any additional
consideration. In certain circumstances, the holders have the right to acquire
common stock of an acquiring company having a value equal to two times the
Exercise Price of the Rights.
The Rights have certain anti-takeover effects. The Rights will cause
substantial dilution to an acquiring person. Accordingly, the existence of the
Rights may deter certain acquirers from making takeover proposals or tender
offers.
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 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
Discussion 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, and owns the real estate for a 3,200 square
foot store opened in Austin in December 1998. The Company leases approximately
3,000 square feet each for two stores which it operates in Houston. The Company
leases two stores in College Station, Texas with an aggregate of 5,400 square
feet of space. The Company also owns the sites of two stores in North Lake,
Illinois and Pearl, Mississippi and leases approximately 1,800 square feet for
its store in New York City. It is contemplated that the Houston stores, the
Pearl, Mississippi store and the North Lake, Illinois store will be sold.
As of December 31, 1998, the Company had 86 store sites in various stages
of development under the Turnkey Program. Development was completed on 71 sites
and these sites are operating and under lease or mortgage. Four of the sites in
development are in various stages of construction and 82 sites remain in the
pre-development stage. The Company also owns five sites, which it contemplates
remarketing. It is contemplated that sites acquired under the
15
<PAGE>
Turnkey Program will be sold to franchisees and investors at various stages
of development or after completion. 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. 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.
On February 8, 1999, the Lone Star Ladies Investment Club, et al., filed a
consolidated amended class action lawsuit in 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, director;
Jeffrey J. Wooley, Senior Vice President and director; and John C. Wooley,
President and Chairman of the Board of Directors). The complaint, alleges
securities fraud arising from a change in the timing of recognition of revenue
from the sale of real estate properties in connection with which the Company
provided limited guaranties on franchisees leases of the properties. In April
1998, Registrant announced that 1997 earnings would be lower than previously
announced because it would defer revenue received in the fourth quarter from
such real estate transactions rather than recognizing it during the period in
which the transaction occurred, as previously contemplated. Plaintiffs seek
monetary damages in an unspecified amount. The Company believes that the
allegations are without merit and intends to vigorously defend against the suit.
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.
16
<PAGE>
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 19, 1999, 7,401,338 shares
of outstanding Common Stock were owned by approximately 6,000 beneficial owners
constituting 283 shareholders of record.
The high and low bid prices as reported by NASDAQ for the period from
January 1, 1997 to December 31, 1998 are set forth below:
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
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
FISCAL 1998
First Quarter . . . . . . . . . . . 23 3/8 14 3/4
Second Quarter . . . . . . . . . . . 22 5/8 13 3/16
Third Quarter . . . . . . . . . . . 18 1/2 9 1/8
Fourth Quarter . . . . . . . . . . . 11 1/4 9 1/4
</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.
On December 18, 1998, the Board of Directors adopted resolutions regarding
the designation, preferences, and rights of Class C Series A Junior
Participating Preferred Stock in connection with the adoption of a Shareholders'
Rights Plan. See "Risk Factors - Anti Takeover Provisions."
The Transfer Agent and Registrar for the Company's Common Stock is Harris
Trust and Savings Bank of Chicago, Illinois.
17
<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, 1996, 1997 and
1998 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, 1994, and 1995 has 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,
----------------------------------------------------------
1994 1995 1996 1997 1998
------ ------ ------ ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF Operations Data:
Revenue:
Royalties . . . . . . . . . . . . . . . . . . . . . . . . $4,657 $7,425 $10,747 $14,561 $18,885
Franchise fees. . . . . . . . . . . . . . . . . . . . . . 1,019 1,494 1,775 1,555 1,365
Developer fees. . . . . . . . . . . . . . . . . . . . . . 2,793 2,666 1,993 325 270
Restaurant sales. . . . . . . . . . . . . . . . . . . . . 428 505 3,610 6,364 7,720
Brand contribution. . . . . . . . . . . . . . . . . . . . 150 397 1,295 2,915 4,003
Turnkey development . . . . . . . . . . . . . . . . . . . -- 41 726 1,139 8,314
Other fees and revenue. . . . . . . . . . . . . . . . . . 256 324 568 1,110 1,291
------- ------- ------- ------- -------
Total revenue. . . . . . . . . . . . . . . . . . . . 9,303 12,852 20,714 27,969 41,848
Costs and expenses:
Service costs:
Royalties. . . . . . . . . . . . . . . . . . . . . . . 1,122 2,405 3,791 5,373 7,225
Franchise fees . . . . . . . . . . . . . . . . . . . . 661 767 959 813 697
Restaurant operations:
Cost of sales. . . . . . . . . . . . . . . . . . . . . 188 189 1,183 2,014 2,513
Labor costs. . . . . . . . . . . . . . . . . . . . . . 154 408 1,424 2,493 3,205
Operating expenses . . . . . . . . . . . . . . . . . . 260 251 1,040 1,952 2,168
Turnkey development costs . . . . . . . . . . . . . . . . 16 332 519 368 4,806
General and administrative. . . . . . . . . . . . . . . . 4,183 5,419 6,509 7,686 11,472
Depreciation and amortization . . . . . . . . . . . . . . 372 458 779 1,155 1,885
------- ------- ------- ------- -------
Total costs and expenses . . . . . . . . . . . . . . 6,956 10,229 16,204 21,854 33,971
------- ------- ------- ------- -------
Income from operations . . . . . . . . . . . . . . . . 2,347 2,623 4,510 6,115 7,877
Other:
Interest income (expense) . . . . . . . . . . . . . . . . (201) (149) 455 753 2,058
Other income. . . . . . . . . . . . . . . . . . . . . . . 226 138 132 195 --
------- ------- ------- ------- -------
Total other income (expense) . . . . . . . . . . . . 25 (11) 587 948 2,058
------- ------- ------- ------- -------
Income before income taxes and
Extraordinary gain . . . . . . . . . . . . . . . . . . 2,372 2,612 5,097 7,063 9,935
Provision for income taxes. . . . . . . . . . . . . . . . 927 1,017 1,902 2,614 3,729
Gain on extinguishment of debt, net of tax. . . . . . . . 40 38 -- -- --
------- ------- ------- ------- -------
Net income. . . . . . . . . . . . . . . . . . . . . . . . $1,485 $1,633 $3,195 $4,449 $6,206
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Net income per share - basic(1) . . . . . . . . . . . . . $0.47 $0.47 $0.58 $0.74 $0.84
Net income per share - diluted(1) . . . . . . . . . . . . $0.44 $0.42 $0.57 $0.71 $0.82
Working capital . . . . . . . . . . . . . . . . . . . . . $1,909 $18,750 $13,515 $42,563 $26,224
Total assets. . . . . . . . . . . . . . . . . . . . . . . 16,481 36,708 40,979 79,521 104,228
Long-term debt, less current maturities(2). . . . . . . . 10,452 3,029 3,129 1,936 9,219
Stockholders' equity. . . . . . . . . . . . . . . . . . . 1,614 28,974 32,312 66,991 73,963
</TABLE>
- - ------------
(1) Earnings per share reflects retroactive application of statement of
financial accounting standards ("SFAS") no. 128, "Earning Per Share."
(2) For 1994, long-term debt includes $8,000,000 for redeemable preferred
stock.
18
<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 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 following 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
typically brand contributions, 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 1991 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, 1998, 98
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 1999). 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.
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 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 $30,000. The franchise fee for each
additional store committed to and opened by a franchisee is $20,000. 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. As the Company
reacquires a limited number of territories and buys down the percentage of
participation by certain area developers, the Company expects that franchise
fee service costs will decrease as a percentage of franchise fees to less
than 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
continues to acquire or open a limited number of additional Company-owned
stores. See "Business -- Strategy -- Company-Owned Stores."
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 three
years as most of the remaining domestic territories have
19
<PAGE>
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,
$2,915,000 for 1997 and $4,003,000 for 1998. The Company believes that
private label licensing fees will increase as a greater portion of the
systems' menu ingredients are covered by the program, system-wide sales grow
and terms with various suppliers are renegotiated. See "Business --
Purchasing; Private Labeling" and "Risk Factors -- Importance of Licensing
Fees."
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 perform various consulting
services including, but not limited to, site selection, feasibility analysis,
environmental studies, site work, permitting and construction management,
receiving a fee and recognizing revenue upon the completion of these
services. The Company may assign its earnest money contract on a site to a
franchisee, or a third-party investor, who then assumes responsibility for
developing the store. The Company may also 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.
The Company anticipates that the total investment in each developed
free-standing location will be approximately $1,200,000 to $2,000,000 (less for
leased locations). From inception of the Turnkey Program through 1997, the
Company typically provided a credit enhancement in the form of a limited
guaranty on the franchisee's lease for leased locations. Upon sale of the
leased site or assignment of its earnest money contract, the Company has
deferred revenue generated (even though proceeds were received in cash) and
allocable costs incurred in connection with the property. When a lease guaranty
is terminated, or the Company's exposure to loss under the guaranty has passed,
the Company recognizes 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. During 1998, the Company began
emphasizing ownership of the real estate by franchisees through a program which
entails acquiring the rights to a superior site and reselling the property, or
its rights (with any improvements), to a franchisee whose mortgage loan is
financed by a third party financial institution. The Company provides credit
enhancement for the franchisee in the form of a limited guaranty in favor of the
lender. Generally, in those cases, the Company recognizes the revenue and
allocable expenses in the period in which the transaction occurs. In some
cases, the Company may interim finance land and building costs in anticipation
of permanent financing by a financial institution. 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 completed.
20
<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,
---------------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Royalties. . . . . . . . . . . . . . . . . . . . . . . . . 51.9% 52.1% 45.1%
Franchise fees . . . . . . . . . . . . . . . . . . . . . . 8.6 5.6 3.3
Developer fees . . . . . . . . . . . . . . . . . . . . . . 9.6 1.2 0.6
Restaurant sales . . . . . . . . . . . . . . . . . . . . . 17.4 22.7 18.4
Brand contribution . . . . . . . . . . . . . . . . . . . . 6.3 10.4 9.6
Turnkey development. . . . . . . . . . . . . . . . . . . . 3.5 4.1 19.9
Other fees and revenue . . . . . . . . . . . . . . . . . . 2.7 3.9 3.1
--------- --------- ---------
Total revenue. . . . . . . . . . . . . . . . . . . . . 100.0 100.0 100.0
Costs and expenses:
Service costs:
Royalties(1). . . . . . . . . . . . . . . . . . . . . . . 35.3 36.9 38.3
Franchise fees(2) . . . . . . . . . . . . . . . . . . . . 54.0 52.3 51.1
Restaurant operations:
Cost of sales(3). . . . . . . . . . . . . . . . . . . . . 32.8 31.6 32.6
Labor costs(3). . . . . . . . . . . . . . . . . . . . . . 39.5 39.2 41.5
Operating expenses(3) . . . . . . . . . . . . . . . . . . 28.8 30.7 28.1
Turnkey development costs (4) . . . . . . . . . . . . . . 71.5 32.3 57.8
General and administrative . . . . . . . . . . . . . . . . 31.4 27.5 27.4
Depreciation and amortization. . . . . . . . . . . . . . . 3.8 4.1 4.5
Total costs and expenses . . . . . . . . . . . . . . . 78.2 78.1 81.2
--------- --------- ---------
Income from operations. . . . . . . . . . . . . . . . . . 21.8 21.9 18.8
Other:
Interest income . . . . . . . . . . . . . . . . . . . . . 2.2 2.7 4.9
Other income. . . . . . . . . . . . . . . . . . . . . . . 0.6 0.7 0.0
--------- --------- ---------
Total other income . . . . . . . . . . . . . . . . . . 2.8 3.4 4.9
--------- --------- ---------
Income before income taxes. . . . . . . . . . . . . . . . 24.6 25.3 23.7
Provision for income taxes. . . . . . . . . . . . . . . . 9.2 9.3 8.9
--------- --------- ---------
Net income. . . . . . . . . . . . . . . . . . . . . . . . 15.4% 15.9% 14.8%
--------- --------- ---------
--------- --------- ---------
STORE DATA:
System-wide sales(5). . . . . . . . . . . . . . . . . . . $202,400 $270,400 $348,500
Change in same store sales(6) . . . . . . . . . . . . . . 3.3% 3.4% 3.1%
Weighted average annual store sales(7). . . . . . . . . . $410,000 $455,000 $503,000
Weighted average weekly store sales(7). . . . . . . . . . $ 7,867 $ 8,753 $ 9,671
Change in average weighted weekly store sales(8) . . . . 11.0% 11.3% 10.5%
Number of stores opened during period . . . . . . . . . . 135 120 107
Number of stores closed during period . . . . . . . . . . 25 20 30
Number of stores in operation at end of period. . . . . . 573 673 750
</TABLE>
- - ---------------------------------
(1) Expressed as a percentage of royalties.
(2) Expressed as a percentage of franchise fees.
(3) Expressed as a percentage of restaurant sales.
(4) Expressed as a percentage of Turnkey development.
(5) In thousands. Includes sales for all stores, as reported by
franchisees or derived by the Company from other data reported by
franchisees.
(6) 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, including stores which were temporarily
closed and reopened within 6 months.
(7) In actual dollars (rounded in the case of average annual store sales).
(8) Percentage change in weighted average weekly store sales from previous
fiscal year.
21
<PAGE>
RESULTS OF OPERATIONS
FISCAL YEAR 1998 COMPARED TO 1997
REVENUE. Total revenue increased 49.6% from $27,969,000 to $41,848,000.
Royalties increased 29.7% from $14,561,000 to $18,885,000. This increase
was due to the full year impact of stores opened in 1997 and the addition of 107
restaurants opened during the period from January 1, 1998 to December 31, 1998.
Also contributing to the increase was the growing influence of larger
freestanding stores with higher visibility, a 10.5% increase in average weekly
sales and a 3.1% increase in same store sales.
Franchise fees decreased 12.2% from $1,555,000 to $1,365,000. This decrease
was a result of 13 fewer openings during 1998, as compared to 1997. 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 16.9% from $325,000 to $270,000. 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 has acquired.
Restaurant sales increased 21.3% from $6,364,000 to $7,720,000. This
increase was attributable to a 6.2% increase in sales volume at the Company's
flagship store and the relocation and reopening of two Company-owned stores
during 1998. In the future, it is contemplated that several more Company-owned
stores will be developed, operated and maintained by the Company in certain key
markets.
Private label licensing fees (brand contributions) increased 37.3% from
$2,915,000 to $4,003,000. 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. During 1999, the Company expects
additional products will be added to its private label program and alternative
retail channels of distribution of its products may become available, resulting
in the potential for further increases in licensing fees.
Turnkey development revenue increased from $1,139,000 to $8,314,000. In
contrast with 1997 when 33 of 40 Turnkey Program transactions involved the
Company's credit enhancement on franchisee leases, only five of the 69 Turnkey
Program transactions involved such lease guaranties in 1998. Of the $8,314,000,
$2,102,000 was related to transactions completed during 1997 involving the
Company's lease guaranties, which were terminated during 1998. The remainder of
the transactions in 1998 involved sales of rights to real estate to franchisees
or investors (who acquired with the objective of selling developed properties to
franchisees). Revenue in 1998 also included approximately $258,000 of rental
revenue from sites completed and under lease. The Company anticipates that
Turnkey development revenue may be reduced in the future as a greater emphasis
is placed on lowering the cost to franchisees of each project.
Other fees and revenues increased 16.1% from $1,110,000 to $1,289,000. This
change was primarily due to the increased level of supplier contributions to the
Company's annual convention held in July 1998.
COSTS AND EXPENSES. Royalty service costs increased 34.5% from $5,373,000
to $7,225,000. This increase was a direct result of the increase in royalty
revenue for 1998, as compared to 1997. Royalty service costs as a percentage of
royalties grew from 36.9% to 38.3%. 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 the stores in their
territories. During 1999, the Company expects developer service costs as a
percentage of royalty revenue to decrease as the Company intends to buy-down the
rights and obligations of several of its area developers and to re-acquire the
rights to a limited number of territories.
Restaurant cost of sales, which consists of food, beverage and paper costs,
increased 24.8% from $2,014,000 to $2,513,000, and as a percentage of restaurant
sales increased from 31.6% to 32.6%. Also, restaurant labor costs
22
<PAGE>
increased 28.6% from $2,493,000 to $3,205,000, and as a percentage of
restaurant sales increased from 39.2% to 41.5% for the same period in 1997.
These percentage increases were primarily due to operational inefficiencies
experienced in re-opening two Company-owned stores. Restaurant operating
expenses have increased 11.1% from $1,952,000 to $2,168,000, but as a
percentage of restaurant sales decreased from 30.7% to 28.1% for 1998, as
compared to 1997. This decrease is due to the increasing sales outpacing the
increased costs associated with operating the new stores.
Turnkey development costs increased from $368,000 to $4,806,000 and as a
percentage of Turnkey development revenue increased from 32.3% to 57.8%. These
increases are primarily the result of $1,063,000 of costs deferred in 1997 being
recognized in 1998, the addition of staff to the Turnkey Program in late 1997
and during 1998 and certain costs being recognized for sites no longer being
pursued.
General and administrative expenses increased 49.3% from $7,686,000 to
$11,471,000, and as a percentage of total revenue remained relatively stable at
27.4%.
Depreciation and amortization increased 63.1% from $1,156,000 to
$1,885,000, and as a percentage of revenue increased from 4.1 to 4.5%. This
dollar increase was principally due to amortization of goodwill and other
intangibles acquired in 1997 and 1998, and depreciation related to the
additional stores the Company was operating during the year.
OTHER. Net interest income increased 173.3% from $753,000 to $2,058,000.
This increase was a result of funds being loaned for Turnkey mortgages and
interim construction financing under the Turnkey Development Program.
INCOME TAX EXPENSE. Income tax expense reflects a combined federal and
state effective tax rate of 37.5% for 1998, which is slightly higher than the
effective combined tax rate for the comparable period in 1997. Based on
projections of taxable income, the Company anticipates that its effective
combined rate for federal and state taxes will remain fairly stable.
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 was 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.
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.
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.
23
<PAGE>
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 1997 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 comprise the
balance of Turnkey development revenue generated during 1997.
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 reflected the growing
percentage of restaurants serviced by the area developer system and whose area
developers receive approximately 42% of the royalties from the stores in their
territories.
Restaurant cost of sales, which consists of food, beverage and paper costs,
increased 70.3% 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 39.5% 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 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.
Turnkey development costs decreased 29.1% from $519,000 to $368,000, and as
a percentage of Turnkey development revenue decreases from 71.5% to 32.3%.
These increases were primarily attributable to the deferral of costs associated
with stores developed, or developed and sold with a lease guaranty, during 1997.
General and administrative expenses increased 18.1% from $6,508,000 to
$7,686,000, but as a percentage of total revenue decreased from 31.4% to 27.5%.
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.
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 dollar 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.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $6,516,000 for 1998. Accounts
payable and accrued liabilities increased $7,124,000, primarily because of
construction costs incurred during the fourth quarter that were due subsequent
to the end of the year. Net cash of $20,945,000 was used in investing activities
primarily consisting of expenditures of $17,245,000 on the completion of two
Company-owned stores, the acquisition of two additional Company-owned stores and
three future sites for additional Company-ownedstores. The Company used
$19,918,000 of cash primarily for establishing its construction and mortgage
program for the Turnkey Program. The Company used $8,713,000 to re-acquire the
development rights to several domestic
24
<PAGE>
territories and re-acquire franchise rights in some selected markets. During
1998, financing activities provided cash of approximately $11,592,000 due
primarily to the issuance of debt.
Net cash provided by operating activities was $5,608,000 for 1997. Also
during 1997, 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-acquired 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.
At December 31, 1998, the Company had approximately $14,601,000 of debt
outstanding. During 1998, the Company borrowed approximately $5,000,000 in
connection with the re-acquisition of certain domestic development rights and
drew on its line of credit to fund Turnkey development activities. During 1997,
the Company borrowed $1,113,000 primarily in connection with the re-acquisition
of certain domestic development rights. 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. The Company guaranties certain real estate leases, equipment leases and
other obligations of franchisees. At December 31, 1998, these contingent
liabilities totaled approximately $26,438,000. 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 $1,093,000 at December 31, 1998, 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 $10,000,000 are estimated to be required for the development of
these Company-owned stores. Two stores 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 sold and contracts assigned to
finance the activity of the Turnkey Program. With the anticipated activity in
the Turnkey Program, the capital required to finance the Turnkey Program will
be significant. The tables below provide a summary of Turnkey Program
activity since its inception and a summary of the status of the Turnkey
Program at December 31, 1998.
Turnkey Program revenue consists of the following:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Sales to investors and franchisees . . . . . . . . . . $6,638,150 $31,361,869 $29,596,310
Development and construction management fees . . . . . 174,979 190,000 176,562
------------ ------------ ------------
Gross Turnkey Program revenue . . . . . . . . . . . 6,813,129 31,551,869 29,772,872
Turnkey Program development costs. . . . . . . . . . . (6,455,618) (28,829,065) (23,382,340)
------------ ------------ ------------
Net revenue from Turnkey Program projects . . . . . 357,511 2,722,804 6,390,532
Rental income. . . . . . . . . . . . . . . . . . . . . 368,402 303,091 258,187
Interim construction interest. . . . . . . . . . . . . -- 1,270 238,888
Deferred revenue recognized. . . . . . . . . . . . . . -- -- 1,426,819
Revenue deferred . . . . . . . . . . . . . . . . . . . -- (1,888,555) --
------------ ------------ ------------
Total Turnkey Program revenue . . . . . . . . . . . $ 725,913 $ 1,138,610 $ 8,314,426
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
25
<PAGE>
The following table reflects system performance of the Turnkey Program
for the years ended December 31, 1997 and 1998.
<TABLE>
<CAPTION>
NUMBER OF UNITS
--------------------
1997 1998
------ ------
<S> <C> <C>
Sites in process at beginning of year. . . . . . . . . . . . . . . . . 30 78
Sites beginning development during the year. . . . . . . . . . . . . . 90 83
Sites inventoried as Company-owned stores. . . . . . . . . . . . . . . (1) (3)
Sites inventoried as real estate or restaurants held for sale. . . . . -- (2)
Sites sold - revenue recognized. . . . . . . . . . . . . . . . . . . . (7) (69)
Sites sold - revenue deferred. . . . . . . . . . . . . . . . . . . . . (33) --
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) (1)
------ ------
Sites in process at end of year. . . . . . . . . . . . . . . . . . . . 78 86
------ ------
------ ------
<CAPTION>
INVESTED AT
DECEMBER 31,
1998
-----------
<S> <C> <C> <C>
Sites under development or to be sold. . . . . . . . . . . . . . . . . 5 4 4,431,000
Predevelopment Site (prequalification) . . . . . . . . . . . . . . . . 73 82 1,494,000
------ ------ -----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 86 $ 5,925,000
------ ------ -----------
------ ------ -----------
</TABLE>
The Company currently has a line of credit available from a financial
institution 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,
and bears interest at the bank's prime lending rate and expires December 2001.
As of December 31, 1998, the Company had drawn approximately $6,360,000 on this
line of credit and had allowed certain Area Developers and Franchisees to borrow
$7,147,000 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. If net proceeds from the Turnkey Program, credit facilities, and cash
flow from operations are insufficient to finance the Company's future expansion
plans, including continuing investment in Turnkey Program properties and the
buydowns of percentages of participation by 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.
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 preliminary responses from many of its major restaurant equipment
suppliers indicating that they and the products they sell to the Company's
restaurant system also have no material internal risk from the Year 2000
issue. To date, none of the Company's major suppliers have indicated that
they anticipate material internal risks. The Company is 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.
26
<PAGE>
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.)
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 number of 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 135 store openings in 1996, 120 in 1997 and 107 in 1998.
At July 1, 1995, the initial franchise fee was increased from $17,500 to $20,000
and was further increased to $30,000 effective August 1, 1998. 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 were a significant portion of revenue in past
years , 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 believes
restaurant sales and private label licensing fees (brand contributions) will
continue to increase as a percentage of revenue.
In 1997, 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 of the property occurs.
The Company 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. During 1998, only five of the 69 Turnkey Program
transactions involved the Company's guaranty on franchisees' leases with third
party investors who acquired properties from the Company. Accordingly, most
of the revenue from Turnkey Program transactions during 1998 was recognized
in the period in which the transactions occurred.
27
<PAGE>
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 1996, 1997 and 1998 fiscal years.
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
PRESENTATION OF QUARTERLY FIGURES
<TABLE>
<CAPTION>
1996 1997
---------------------------------- ----------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES: (Dollars in thousands, except per share data)
Royalties $2,245 $2,675 $2,875 $2,953 $3,278 $3,606 $3,820 $3,858
Franchise fees 348 475 400 553 353 240 411 551
Developer fees 595 416 325 657 -- 125 -- 200
Restaurant sales 566 810 1,061 1,173 1,324 1,439 1,636 1,965
Brands contribution 121 238 511 424 535 807 791 783
Turnkey development 39 80 143 463 685 762 1,374 (1,683)
Other fees and revenue 168 214 123 63 160 361 312 276
---------------------------------- ----------------------------------
Total revenues 4,082 4,908 5,438 6,286 6,335 7,340 8,344 5,950
COSTS & EXPENSES 3,261 3,945 4,240 4,758 4,969 5,575 6,405 4,906
---------------------------------- ----------------------------------
OPERATING INCOME 821 963 1,198 1,528 1,366 1,765 1,939 1,044
NET INCOME $ 629 $ 714 $ 798 $1,053 $ 889 $1,162 $1,234 $1,164
---------------------------------- ----------------------------------
---------------------------------- ----------------------------------
Earnings per share - basic(1) $0.11 $0.13 $0.14 $0.20 $0.16 $0.21 $0.22 $0.16
Earnings per share - diluted(1) $0.11 $0.13 $0.14 $0.19 $0.16 $0.20 $0.21 $0.15
Store Openings 28 33 31 43 29 21 28 42
<CAPTION>
1998
----------------------------------
1ST 2ND 3RD 4TH
<S> <C> <C> <C> <C>
REVENUES:
Royalties $4,259 $4,720 $4,875 $5,032
Franchise fees 340 380 340 305
Developer fees -- -- -- 270
Restaurant sales 1,616 1,885 1,745 2,475
Brands contribution 860 1,006 1,052 1,085
Turnkey development 1,125 1,732 2,845 2,612
Other fees and revenue 254 590 207 238
----------------------------------
Total revenues 8,454 10,313 11,064 12,017
COSTS & EXPENSES 6,812 8,216 9,052 9,890
----------------------------------
OPERATING INCOME 1,642 2,097 2,012 2,127
NET INCOME $1,342 $1,571 $1,582 $1,712
----------------------------------
----------------------------------
Earnings per share - basic(1) $0.18 $0.21 $0.21 $0.23
Earnings per share - diluted(1) $0.18 $0.21 $0.21 $0.23
Store Openings 30 31 24 22
</TABLE>
- - -------------
(1) Earnings per share reflects retroactive application of Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share."
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.
ITEM 7A. 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 December 31, 1998 a hypothetical 100 basis point increase in interest
rates would result in a reduction of approximately $114,000 in annual 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 December 31, 1998. The fair values of the Company's
bank loans are not significantly affected by changes in market interest rates.
28
<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 Grant
Thornton LLP dated February 26, 1999.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On May 8, 1998, the Company reported on Form 8-K that Coopers & Lybrand
L.L.P., the Company's auditors for fiscal years 1994 through 1997, resigned
effective May 4, 1998. Their reports on the financial statements never
contained an adverse opinion, disclaimer of opinion, and were never qualified or
modified as to uncertainty, audit scope or accounting principles.
The Company has never been advised by Coopers & Lybrand that (1) internal
controls necessary for the Company to develop reliable financial statements did
not exist; (2) Coopers & Lybrand would no longer be able to rely on management's
representations or that it was unwilling to be associated with the financial
statements prepared by management; (3) Coopers & Lybrand needed to expand
significantly the scope of its audit; (4) Coopers & Lybrand had received
information which did or which might, if further investigated, impact the
fairness or reliability of a report or financial statement previously issued or
to be issued or which did or might cause Coopers & Lybrand to be unwilling to
rely on management's representations or be associated with the Company's
financial statements; or (5) Coopers & Lybrand did not conduct such further
investigation or expanded audit, or was not able to resolve its concerns about
the Company, because of its pending resignation as the Company's accountant or
any other reason.
On April 28, 1998, Coopers & Lybrand informed the Company that there was a
disagreement with management concerning the timing of the recognition of revenue
from certain of the Company's Turnkey Program transactions. The transactions at
issue were fiscal year 1997 sales of real estate with leases to franchisees
guarantied by the Company. The issue was resolved to Coopers & Lybrand's
satisfaction before the filing of the Company's Annual Report on Form 10-K. The
issue was discussed with the Audit Committee of the Board of Directors, and the
Company authorized Coopers & Lybrand to discuss the issue with the Company's
successor accountants. A letter from Coopers & Lybrand L.L.P. expressing
agreement with the Company's statements in such report on Form 8-K was included
as an exhibit to such report.
On June 19, 1998, the Company reported on Form 8-K that on June 18, 1998,
Grant Thornton LLP was engaged by the Company's Board of Directors as the new
independent accountant of the Company to replace Coopers & Lybrand L.L.P.
During the two fiscal years, and any interim period, preceding June 18, 1998,
neither the Company nor anyone on its behalf consulted Grant Thornton LLP on
accounting principles, audit opinions or financial reporting matters.
The Company requested Grant Thornton LLP to review the disclosures
required in the report on Form 8-K before it was filed with the Commission and
provided them with the opportunity to furnish the Company with a letter
addressed to the Commission containing any new information, or any clarification
of the Company's views or statements by Grant Thornton LLP that it did not agree
with the statements made in the report. Grant Thornton LLP informed the Company
that it reviewed the disclosures and did not intend to furnish the Company with
such a letter.
29
<PAGE>
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 28, 1999, 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 28, 1999, 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 28, 1999,
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 28, 1999, 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
3.1 -- Articles of Incorporation of the Registrant, as amended. (1)
3.2 -- Statement of Resolutions Regarding the Designation,
Preferences and Rights of Class C Series A Junior Participating
Preferred Stock of the Registrant. (2)
3.3 -- Bylaws of the Registrant, as amended.(3)
4.1 -- Specimen stock certificate evidencing the Common Stock. (1)
4.2 -- Schlotzsky's, Inc. Employee Stock Purchase Plan. (4)
4.3 -- Rights Agreement by and between Schlotzsky's, Inc. and
Harris Trust and Savings Bank dated December 18, 1998. (2)
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 master licensees.(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)
30
<PAGE>
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
Guaranty, 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)
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)
31
<PAGE>
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(a) -- Schlotzsky's, Inc. 1993 Third Amended and Restated Stock Option
Plan of the Registrant. (5)
10.35(b) -- Amendments to 1993 Third Amended and Restated Stock Option
Plan. (4)
10.36(a) -- Employment Agreement, dated as of March 1, 1998, by and between
the Registrant and John C. Wooley. (6)
10.36(b) -- Employment Agreement, dated as of March 1, 1998, by and between
the Registrant and Jeffrey J. Wooley. (6)
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. (7)
10.48 -- Form of Tenant Acknowledgment with Indemnification between
Schlotzsky's Real Estate, Inc. and Franchisee concerning Turnkey
restaurants. (7)
10.49* -- Form of Promissory Note from franchisee/borrower to Schlotzsky's
Real Estate, Inc.
10.50* -- Form of Loan Agreement between franchisee/borrower and
Schlotzsky's Real Estate, Inc.
10.51* -- Form of Assignment of Note and Lien from Schlotzsky's Real Estate,
Inc. to mortgage lender.
10.52* -- Form of Limited Guaranty between Schlotzsky's, Inc. and mortgage
lender with respect to Turnkey restaurants.
32
<PAGE>
10.53* -- Credit Agreement, as amended, with Wells Fargo.
22.1* -- List of subsidiaries of the Registrant.
24.1* -- Consent of Grant Thornton LLP.
27.1* -- Financial Data Schedule - fiscal year ending 1998.
- - -------------
* 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 a Exhibit to the Registrant's Registration of certain
Classes of Securities on Form 8-A filed with the Securities and Exchange
Commission on December 18, 1998 and incorporated herein by reference.
(3) Previously filed as an Exhibit to the Registrant's Report on Form 8-K filed
December 18, 1998 and incorporated herein by reference.
(4) Previously filed as an Exhibit to the Registrant's Registration Statement
on Form S-8 (File No. 333-57077) filed with the Securities and Exchange
Commission on June 17, 1998, as amended, and incorporated herein by
reference.
(5) 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.
(6) Previously filed as an Exhibit to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on November 16, 1998
and incorporated herein by reference.
(7) Previously filed as an Exhibit to the Registrant's Annual Report on Form
10-K filed with the Securities and Exchange Commission on April 14, 1998,
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 1998: On December
18, 1998 the Registrant issued a press release announcing the adoption of the
Shareholder's Rights Plan.
33
<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.
SCHLOTZSKY'S, INC.
By: /s/ John C. Wooley
-------------------------------------------------
John C. Wooley,
Chairman of the Board and Chief Executive Officer
Date: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report 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
--------- -------- ----
/s/ John C. Wooley
- - ------------------------
John C. Wooley Chairman of the Board and March 29, 1999
Chief Executive Officer
(Principal Executive Officer)
/s/
- - ------------------------
Monica L. Gill Chief Financial Officer, Treasurer March 29, 1999
Executive Vice President
(Principal Financial Officer and
Principal Accounting Officer)
/s/
- - ------------------------
Jeffrey J. Wooley Senior Vice President and March 29, 1999
Secretary
/s/
- - ------------------------
Joseph K. Pruett Controller of Financial Reporting March 29, 1999
/s/
- - ------------------------
John L. Hill, Jr. Director March 29, 1999
/s/
- - ------------------------
Azie Taylor Morton Director March 29, 1999
- - ------------------------
John M. Rosillo Director
/s/
- - ------------------------
Raymond A. Rodriguez Director March 29, 1999
/s/
- - ------------------------
Floor Mouthaan Director March 29, 1999
34
<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, 1997 and 1998. . . . . . F-3
Consolidated Statements of Income for the years ended
December 31, 1996, 1997 and 1998. . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1996, 1997 and 1998. . . . . . . . . . . F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998. . . . . . . . . . . . . . . . . F-6
Notes to Consolidated Financial Statements . . . . . . . . . . . . . F-7
Financial Statement Schedule:
Report of Independent Accountants. . . . . . . . . . . . . . . . . . S-1
Schedule II -- Valuation and Qualifying Accounts . . . . . . . . . . S-2
</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 accompanying consolidated balance sheets of
Scholotzsky's, Inc. (a Texas corporation) and Subsidiaries as of December 31,
1998 and 1997, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 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, 1998 and 1997, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
Grant Thornton LLP
February 26, 1999
F-2
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31,
---------------------------
1997 1998
------------ ------------
<S> <C> <C>
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . $31,254,048 $15,384,991
Temporary cash investments . . . . . . . . . . . . . . . . . . . . . . 18,000 1,439,077
Receivables from Turnkey Program development . . . . . . . . . . . . . 6,054,337 1,229,468
Royalties receivable . . . . . . . . . . . . . . . . . . . . . . . . . 809,125 762,141
Turnkey notes and other receivables, current portion . . . . . . . . . -- 13,326,956
Other receivables. . . . . . . . . . . . . . . . . . . . . . . . . . . 2,055,760 3,086,065
Prepaid expenses and other assets. . . . . . . . . . . . . . . . . . . 584,510 572,996
Turnkey Program development. . . . . . . . . . . . . . . . . . . . . . 6,950,595 5,924,562
Notes receivable, current portion. . . . . . . . . . . . . . . . . . . 2,574,588 4,246,574
------------ ------------
Total current assets . . . . . . . . . . . . . . . . . . . . 50,300,963 45,972,830
Property, equipment and leasehold improvements, net. . . . . . . . . . 9,998,630 18,529,746
Real estate and restaurants held for sale. . . . . . . . . . . . . . . 1,063,592 9,215,485
Notes receivable, less current portion . . . . . . . . . . . . . . . . 1,972,470 6,875,915
Notes receivable from related parties, less current portion. . . . . . 2,565,399 2,609,775
Turnkey notes and other receivables, less current portion. . . . . . . -- 2,185,429
Investments and advances . . . . . . . . . . . . . . . . . . . . . . . 1,456,790 1,530,947
Deferred federal income tax asset. . . . . . . . . . . . . . . . . . . 580,460 23,885
Intangible assets, net . . . . . . . . . . . . . . . . . . . . . . . . 11,113,213 16,815,059
Other noncurrent assets. . . . . . . . . . . . . . . . . . . . . . . . 469,069 469,069
------------ ------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . $79,520,586 $104,228,140
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable -- trade. . . . . . . . . . . . . . . . . . . . . . . $6,002,920 $4,752,369
Current maturities of long-term debt . . . . . . . . . . . . . . . . . 250,625 5,382,585
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . 1,484,715 9,613,593
------------ ------------
Total current liabilities. . . . . . . . . . . . . . . . . . 7,738,260 19,748,547
Deferred revenue, net. . . . . . . . . . . . . . . . . . . . . . . . . 2,855,380 1,298,486
Long-term debt, less current maturities. . . . . . . . . . . . . . . . 1,936,387 9,218,515
------------ ------------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . 12,530,027 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, 7,334,416
and 7,401,942 issued at December 31, 1997 and 1998,
respectively. . . . . . . . . . . . . . . . . . . . . . . . . . . 62,202 62,877
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . 56,664,104 57,533,997
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . . . 10,264,253 16,470,718
Treasury stock (10,000 shares) . . . . . . . . . . . . . . . . . . . -- (105,000)
------------ ------------
Total stockholders' equity . . . . . . . . . . . . . . . . . 66,990,559 73,962,592
------------ ------------
Total liabilities and stockholders' equity . . . . . . . . . $79,520,586 $104,228,140
------------ ------------
------------ ------------
</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,
------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Revenue:
Royalties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,747,238 $14,561,377 $18,885,390
Franchise fees . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,775,000 1,554,585 1,365,000
Developer fees . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,992,750 325,000 270,380
Restaurant sales . . . . . . . . . . . . . . . . . . . . . . . . . . 3,610,199 6,364,042 7,720,432
Brand contribution . . . . . . . . . . . . . . . . . . . . . . . . . 1,294,982 2,915,233 4,003,247
Turnkey Program development. . . . . . . . . . . . . . . . . . . . . 725,913 1,138,610 8,314,426
Other fees and revenue . . . . . . . . . . . . . . . . . . . . . . . 568,250 1,110,289 1,289,037
------------ ------------ ------------
Total revenues . . . . . . . . . . . . . . . . . . . . . . . 20,714,332 27,969,136 41,847,912
Expenses:
Service costs:
Royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,791,384 5,373,151 7,225,320
Franchise fees. . . . . . . . . . . . . . . . . . . . . . . . . . 958,500 812,625 697,250
Restaurant operations:
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . 1,183,361 2,014,096 2,513,156
Labor costs . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,424,434 2,493,478 3,205,225
Operating expenses. . . . . . . . . . . . . . . . . . . . . . . . 1,039,591 1,951,618 2,167,784
Turnkey development costs. . . . . . . . . . . . . . . . . . . . . . 519,328 367,656 4,806,099
General and administrative . . . . . . . . . . . . . . . . . . . . . 6,507,930 7,685,858 11,471,412
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . 779,284 1,155,600 1,884,854
------------ ------------ ------------
Total expenses . . . . . . . . . . . . . . . . . . . . . . . 16,203,812 21,854,082 33,971,100
------------ ------------ ------------
Income from operations . . . . . . . . . . . . . . . . . . . 4,510,520 6,115,054 7,876,812
Other:
Interest income, net . . . . . . . . . . . . . . . . . . . . . . . . 454,670 752,960 2,058,262
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132,075 195,661 --
------------ ------------ ------------
Income before income taxes . . . . . . . . . . . . . . . . . 5,097,265 7,063,675 9,935,074
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . 1,902,290 2,614,260 3,728,609
------------ ------------ ------------
Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,194,975 $ 4,449,415 $ 6,206,465
------------ ------------ ------------
------------ ------------ ------------
Income per common share - basic:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.58 $ 0.74 $ 0.84
------------ ------------ ------------
------------ ------------ ------------
Weighted average shares outstanding. . . . . . . . . . . . . . . . . 5,525,902 5,994,403 7,382,983
------------ ------------ ------------
------------ ------------ ------------
Income per common share - diluted:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.57 $ 0.71 $ 0.82
------------ ------------ ------------
------------ ------------ ------------
Weighted average shares outstanding. . . . . . . . . . . . . . . . . 5,639,225 6,229,369 7,577,407
------------ ------------ ------------
------------ ------------ ------------
</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
NUMBER OF STATED CAPITAL PAID-IN RETAINED TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS STOCK EQUITY
-------------- -------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 . . . . . 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
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
transactions . . . . . . . . . . -- -- 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
-------------- -------------- -------------- -------------- -------------- --------------
-------------- -------------- -------------- -------------- -------------- --------------
</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,
-----------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 3,194,975 $ 4,449,415 $ 6,206,465
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization. . . . . . . . . . . . . . 779,284 1,155,600 1,884,854
Bad debt expense . . . . . . . . . . . . . . . . . . . . 187,774 100,000 972,724
Gain on sale of assets . . . . . . . . . . . . . . . . . -- (308,632) (268,813)
Equity in losses of investment in partnership. . . . . . -- -- 93,260
Financed fees. . . . . . . . . . . . . . . . . . . . . . (1,860,796) (272,003) (2,250,000)
Payments received on financed fees . . . . . . . . . . . 829,590 743,534 409,150
Non-recurring expense relating to the
issuance of stock to a non-employee. . . . . . . . . . 103,791 -- --
Changes in assets and liabilities:
Royalties and other receivables. . . . . . . . . . . . (971,614) (6,995,423) 218,880
Prepaid expenses and other assets. . . . . . . . . . . 45,118 (336,748) 11,514
Turnkey program development. . . . . . . . . . . . . . (5,384,025) 1,621,773 (19,918,229)
Other noncurrent assets. . . . . . . . . . . . . . . . (280,154) (188,915) --
Deferred revenue . . . . . . . . . . . . . . . . . . . 91,440 1,191,615 (1,556,894)
Deferred federal income tax asset. . . . . . . . . . . (75,578) 26,988 556,575
Accounts payable and accrued liabilities . . . . . . . 1,172,539 4,420,923 7,124,284
----------- ----------- -----------
Net cash provided by (used in) operating activities. (2,167,656) 5,608,127 (6,516,230)
----------- ----------- -----------
Cash flows from investing activities:
Expenditures for property and equipment. . . . . . . . . . (1,664,363) (7,436,003) (17,245,185)
Sale of property and equipment . . . . . . . . . . . . . . -- 1,655,123 146,861
Acquisition of investments and intangible assets . . . . . (2,227,297) (2,721,814) (8,712,762)
Redemption of restricted certificates of deposit . . . . . 60,983 -- --
Advances on notes receivable . . . . . . . . . . . . . . . (603,121) (693,100) (5,838,021)
Collections on notes receivable. . . . . . . . . . . . . . 235,933 627,032 12,313,822
Acquisition of investments . . . . . . . . . . . . . . . . (83,147) (190,928) (1,421,077)
Advances to limited partnership, stockholders
and affiliates . . . . . . . . . . . . . . . . . . . . . (45,014) (37,940) (188,431)
Distributions and collections from limited
partnership, stockholders and affiliates . . . . . . . . 79,958 -- --
----------- ----------- -----------
Net cash used in investing activities. . . . . . . . (4,246,068) (8,797,630) (20,944,793)
----------- ----------- -----------
Cash flows from financing activities:
Sale of stock. . . . . . . . . . . . . . . . . . . . . . . -- 30,073,141 --
Repurchase of stock. . . . . . . . . . . . . . . . . . . . -- -- (105,000)
Stock issue costs. . . . . . . . . . . . . . . . . . . . . (51,180) (440,622) --
Options and warrants exercised . . . . . . . . . . . . . . 90,070 596,604 624,611
Proceeds from issuance of notes payable and
long-term debt . . . . . . . . . . . . . . . . . . . . . 583,774 1,112,709 16,060,000
Principal payments on notes payable and
long-term debt . . . . . . . . . . . . . . . . . . . . . (914,664) (2,537,239) (4,987,645)
----------- ----------- -----------
Net cash provided by (used in) financing activities. (292,000) 28,804,593 11,591,966
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents . . . . (6,705,724) 25,615,090 (15,869,057)
Cash and cash equivalents at beginning of year . . . . . . . 12,344,682 5,638,958 31,254,048
----------- ----------- -----------
Cash and cash equivalents at end of year . . . . . . . . . . $ 5,638,958 $31,254,048 $15,384,991
----------- ----------- -----------
----------- ----------- -----------
</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 Deli") that feature made-to-order
sandwiches, which has 750 stores located in 38 states, the District of Columbia,
Argentina, Canada, China, Germany, Guatemala, Japan, Lebanon, Malaysia,
Mexico, Morocco, Saudi Arabia, Turkey and the United Kingdom. Approximately 29%
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 49 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.
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, 1997 and
1998, cash equivalents totaling approximately $27,053,000 and $11,232,000,
respectively, consisted primarily of money market accounts and overnight
repurchase agreements.
TEMPORARY CASH INVESTMENTS
Temporary cash investments include amounts invested in certificates of
deposit with an original maturity date of greater than three months.
RECEIVABLES FROM TURNKEY PROGRAM DEVELOPMENT
Receivables from Turnkey Program development are comprised of amounts held
in escrow on behalf of the Company at title companies or institutional investors
at year end.
TURNKEY NOTES AND OTHER RECEIVABLES
Turnkey notes receivable consist of mortgage, draw notes and construction
receivables relating to the sale of Turnkey sites and funding of construction of
Turnkey units, respectively.
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)
NOTES RECEIVABLE
Notes receivable consist of Area Developer and Master Licensee promissory
notes. As of December 31, 1997 and 1998, the Company has recorded a valuation
allowance of approximately $443,000 and $593,000, respectively, based upon a
third party valuation.
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 over the estimated useful lives of the
assets, or lease term for leasehold improvements, if less.
REAL ESTATE AND RESTAURANTS HELD FOR SALE
Real estate and restaurants held for sale consist of properties owned by
the Company which it intends to remarket. The operating results of these
restaurants are considered a part of the Turnkey Program and are included in
Turnkey development costs in the consolidated income statement. These
properties are stated at the lower of cost or net realizable value.
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
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 perform various services including, but not limited to, site
selection, feasibility analysis, environmental studies, site work, permitting
and construction management, receiving a fee and recognizing revenue upon the
completion of these services. The Company may assign its earnest money contract
on a site to a franchisee, or a third-party investor, who then assumes the
responsibility for developing the store. The Company also may purchase or lease
a selected site, design and construct a Schlotzsky's Deli restaurant on the site
and sell, lease or sublease the completed store to a franchisee. Where the
Company does not sell the property to a franchisee, the Company sells the
improved property, or, in the case of a leased property, assigns the lease and
any sublease, to an investor. From inception of the Turnkey Program through
1997, the Company typically provided credit enhancement in the form of limited
guaranties on the franchisees' leases for leased locations sold to investors.
The Company obtained agreements from the franchisees to indemnify the Company in
case the guaranties are called upon. Upon sale of the leased site or assignment
of its earnest money contract, the Company has deferred revenue generated (even
though proceeds were received in cash) and allocable costs incurred in
connection with the property. When a lease guaranty is terminated, or the
Company's exposure to loss under the guaranty has passed, the Company recognizes
the revenue and allocable costs related to the site. Generally, if no credit
enhancement is provided in connection with such transactions, the Company
recognizes the revenue and allocable expenses in the periods in which the
transactions occur.
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)
TURNKEY PROGRAM, CONTINUED
During 1998, the Company began emphasizing ownership of the real estate
by franchisees through a program which entails acquiring the rights to a
superior site and reselling the property, or its rights (with any
improvements), to a franchisee whose permanent mortgage loan will be financed
by a third party financial institution. The Company provides credit
enhancement for the franchisee in the form of a limited guaranty in favor of
the lender. These guarantees are usually for loan payments required to be
made during the first two to five years and are limited to 15% to 25% of the
principal amount of the loan. Generally, in those cases, the Company
recognizes the revenue and allocable expenses in the period in which the
transaction occurs. The Company will often interim finance land and building
costs in anticipation of permanent financing by a financial institution. 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 completed.
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 until the property is ready for sale), are accumulated and accounted for
on a site specific basis.
Turnkey Program revenue consists of the following:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Sales to investors and franchisees . . . . . . . . . . . . . $ 6,638,150 $31,361,869 $29,596,310
Development and construction management fees . . . . . . . . 174,979 190,000 176,562
----------- ----------- -----------
Gross Turnkey Program revenue. . . . . . . . . . . . . . 6,813,129 31,551,869 29,772,872
Turnkey Program development costs. . . . . . . . . . . . . . (6,455,618) (28,829,065) (23,382,340)
----------- ----------- -----------
Net revenue from Turnkey Program projects. . . . . . . . 357,511 2,722,804 6,390,532
Rental income. . . . . . . . . . . . . . . . . . . . . . . . 368,402 303,091 258,187
Interim construction interest. . . . . . . . . . . . . . . . -- 1,270 238,888
Deferred revenue recognized. . . . . . . . . . . . . . . . . -- -- 1,426,819
Revenue deferred . . . . . . . . . . . . . . . . . . . . . . -- (1,888,555) --
----------- ----------- -----------
Total Turnkey Program revenue. . . . . . . . . . . . . . $ 725,913 $ 1,138,610 $ 8,314,426
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
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 for
the years ended December 31, 1997 and 1998.
<TABLE>
<CAPTION>
NUMBER OF UNITS
----------------------------
1997 1998
------------ ------------
<S> <C> <C>
Sites in process at beginning of year. . . . . . . . . . . . . . . . 30 78
Sites beginning development during the year. . . . . . . . . . . . . 90 83
Sites inventoried as Company-owned stores. . . . . . . . . . . . . . (1) (3)
Sites inventoried as real estate or restaurants held for sale. . . . -- (2)
Sites sold - revenue recognized. . . . . . . . . . . . . . . . . . . (7) (69)
Sites sold - revenue deferred. . . . . . . . . . . . . . . . . . . . (33) --
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) (1)
------------ ------------
Sites in process at end of year. . . . . . . . . . . . . . . . . . . 78 86
------------ ------------
------------ ------------
<CAPTION>
INVESTED AT
DECEMBER 31,
1998
------------
<S> <C> <C> <C>
Sites under development or to be sold. . . . . . . . . . . . . . . . 5 4 4,431,000
Predevelopment sites (prequalification). . . . . . . . . . . . . . . 73 82 1,494,000
------------ ------------ ------------
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 86 $ 5,925,000
------------ ------------ ------------
------------ ------------ ------------
</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.
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)
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 cash flows 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:
Royalties are paid to the Company by franchisees at 4% to 6% of gross
franchise sales. Royalties are recognized in the period of the related gross
franchise sales are earned.
Franchise Fees:
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 provide services to 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.
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 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").
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)
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 the 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 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 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. The Area Developers
portion of the fee, in general, is 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.
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)
EXPENSE RECOGNITION
Royalty Service Costs:
Royalty service costs include the portion of the royalty stream paid to
Area Developers.
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 related franchisee fee is recognized. Franchise fee
development costs paid, but not yet recognized, are recorded as a reduction of
gross deferred revenue in the accompanying consolidated financial statements.
Turnkey Development Costs:
In providing the Turnkey program, the Company has certain personnel and
overhead costs that are a direct result of Turnkey activities. Certain costs are
allocated to specific Turnkey projects and deferred until the site is sold, or
no longer pursued, and its related gain or loss is recognized.
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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents,
certificates of deposit, receivables, notes receivable, accounts payable,
accrued liabilities and debt. The carrying value of financial instruments
approximates fair value at December 31, 1997 and 1998.
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)
FISCAL YEAR
The Company utilizes a "4-4-5 week" quarterly reporting schedule for
royalties, restaurant operations and royalty service costs. As a result of this
reporting schedule, the fiscal year will include 53 weeks of activity for these
line items once every 5-6 years. The financial statements for 1996 and 1997
reflect 52 weeks of operations for these items, while 1998 includes 53 weeks.
Further, the fourth quarter of 1998 contained 14 weeks. In years having a 14
week fourth quarter, royalty revenue, restaurant sales, royalty service costs,
restaurant operating expenses and net income in the fourth quarter are not
comparable to results in each of the first three quarters, and can be expected
to decline in the following quarter. For all other areas of the financial
statements, the Company reports all fiscal quarters as ending on March 31, June
30, September 30 and December 31.
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.
2. NOTES RECEIVABLE
Notes receivable consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
<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 $443,000 and $593,000,
respectively, bearing interest ranging from 6% to 9%
due through in installments December 2003 . . . . . . . . . . . . . . . . . . $1,386,252 $2,828,977
Notes receivable from franchisees, Area Developers, and Master
Licensees bearing interest at 8% to 8.9%, some notes collateralized
by their restaurants, others uncollateralized, net of valuation
allowance of $100,000 in 1998, due in installments through
January 2023 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,814,981 821,245
Notes receivable from franchisees bearing interest ranging from
8.5% to 10%, collateralized by franchisees' property
and equipment due in installments through October 2003. . . . . . . . . . . . 324,405 7,270,096
Notes receivable bearing interest at 8%, collateralized by real estate,
principal and interest due October 1998 . . . . . . . . . . . . . . . . . . . 846,000 --
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175,420 202,171
---------- ----------
4,547,058 11,122,489
Current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,574,588) (4,246,574)
---------- ----------
Notes receivable, less current portion. . . . . . . . . . . . . . . . . . . . . $1,972,470 $6,875,915
---------- ----------
---------- ----------
</TABLE>
F-14
<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,
-------------------------
1997 1998
---------- ----------
<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%, due in installments through December 1999 . . . . . . $275,000 $275,000
Notes receivable from certain stockholders of the Company, bearing
interest at 7.5%, due in installments through 2001. . . . . . . . . . . . . . 237,618 292,619
Notes receivable from related entities controlled by stockholders
of the Company, bearing interest at 9%, collateralized by real
estate, due in installments through 2001. . . . . . . . . . . . . . . . . . . 579,466 530,688
Note receivable from Master Licensee, an organization of which
a member of the Company's management is a shareholder, bearing
interest at 8%, due in installments through December 2006. . . . . . . . . . . 455,000 455,000
Notes receivable from Master Licensee, an organization of which
the Company is a preferred shareholder, bearing interest at 9%,
due in installments through December 2007.. . . . . . . . . . . . . . . . . . 1,068,315 1,098,316
---------- ----------
2,615,399 2,651,623
Current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (50,000) (41,848)
---------- ----------
Notes from related parties receivable, less current portion . . . . . . . . . . $2,565,399 $2,609,775
---------- ----------
---------- ----------
</TABLE>
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").
4. TURNKEY NOTES AND OTHER RECEIVABLES
Notes and other receivables related to Turnkey projects consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
<S> <C> <C>
Draw notes and other receivables from franchisees, bearing interest
ranging from 8.5% to 10.0% collateratized by real estate, due in
December 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ -- $6,539,353
Mortgage notes receivable from franchisees, bearing interest ranging
from 7.6% to 10.0% collateralized by real estate, due in installments
through October 2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 7,336,345
Other receivables from franchisees, due by December 1999. . . . . . . . . . . . -- 1,636,687
---------- ----------
-- 15,512,385
Current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (13,326,956)
---------- ----------
Turnkey notes and other receivables, less current portion . . . . . . . . . . . $ -- $2,185,428
---------- ----------
---------- ----------
</TABLE>
F-15
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
DEPRECIABLE DECEMBER 31,
DEPRECIATION LIFE ---------------------------
METHOD (Years) 1997 1998
------------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Building . . . . . . . . . . . . . . . . . . Straight Line 32 $ -- $6,417,164
Furniture, fixtures and
Equipment. . . . . . . . . . . . . . . . . Straight Line 3 to 7 3,520,805 6,223,498
Leasehold improvements . . . . . . . . . . . Straight Line 13 to 32 7,229,286 5,733,128
----------- -----------
10,750,091 18,373,790
Accumulated depreciation and amortization. . . . . . . . . . . . . . . . . . . . . (1,163,265) (2,158,523)
----------- -----------
9,586,826 16,215,267
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411,804 2,314,479
----------- -----------
Property, equipment and leasehold improvements, net. . . . . . . . . . . . . . . . $9,998,630 $18,529,746
----------- -----------
----------- -----------
</TABLE>
During 1998, the Company purchased land, buildings, leasehold improvements
and furniture, fixtures and equipment in connection with their expansion of the
Company-owned restaurants in the amounts of $2,314,000, $2,014,000, $3,304,000,
and $1,470,000, respectively.
Depreciation and amortization of property, equipment and leasehold
improvements totaled approximately $363,000, $566,000 and $1,060,000 for the
years ended December 31, 1996, 1997 and 1998, respectively.
6. INVESTMENTS AND ADVANCES
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
<S> <C> <C>
Limited partnership:
Investment . . . . . . . . . . . . . . . . . . . . . . . . . . $ 189,798 $ 96,538
Advances . . . . . . . . . . . . . . . . . . . . . . . . . . . 507,046 774,463
---------- ----------
696,844 871,001
Building art . . . . . . . . . . . . . . . . . . . . . . . . . . 263,071 263,071
Investments in Master Licensees (net of $100,000 reserve). . . . 496,875 396,875
---------- ----------
Investments and advances . . . . . . . . . . . . . . . . . . . . $1,456,790 $1,530,947
---------- ----------
---------- ----------
</TABLE>
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,
-------------------------
1997 1998
---------- ----------
<S> <C> <C>
Assets . . . . . . . . . . . . . . $2,289,572 $2,239,960
Liabilities. . . . . . . . . . . . 1,634,384 1,933,276
Partners' Capital. . . . . . . . . 655,188 306,684
</TABLE>
F-16
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. INVESTMENTS AND ADVANCES - (CONTINUED)
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 approximately
$1,117,000 and $1,093,000 outstanding at December 31, 1997 and 1998,
respectively. The indebtedness is collateralized by project real estate, and
related leases and rents.
INVESTMENTS IN MASTER LICENSEES
In November 1996, the Company paid $300,000 to acquire a 7.5% interest in a
Master Licensee and also agreed to serve as guarantor of additional financing
not to exceed $400,000. At December 31, 1997 and 1998, the outstanding balance
on the additional financing guarantied by the Company was $400,000. See note on
"Related Party Transactions." During 1997, the Company made an investment of
approximately $197,000 in a Master Licensee.
7. INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
AMORTIZATION DECEMBER 31,
PERIOD --------------------------
(YEARS) 1997 1998
------------ ----------- -----------
<S> <C> <C> <C>
Original franchise rights. . . . . . . . . . . . 40 $ 5,688,892 $ 5,688,892
Royalty value and goodwill . . . . . . . . . . . 20 2,222,938 3,122,117
Developer and franchise rights acquired. . . . . 20 to 40 4,668,200 9,789,263
Debt issue costs . . . . . . . . . . . . . . . . 5 to 25 98,964 65,136
Organization costs . . . . . . . . . . . . . . . 4 to 10 29,021 --
Other intangible assets. . . . . . . . . . . . . 5 345,037 318,449
----------- -----------
13,053,052 18,983,857
Less accumulated amortization. . . . . . . . . . (1,939,839) (2,168,798)
----------- -----------
Intangible assets, net . . . . . . . . . . . . . $11,113,213 $16,815,059
----------- -----------
----------- -----------
</TABLE>
F-17
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. INTANGIBLE ASSETS - (CONTINUED)
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.
In 1998, the Company re-acquired certain developer and franchise rights in
Georgia, Michigan, and certain portions of Ohio, Texas and various western
territories. In addition, the Company re-acquired the international licensing
rights to Belgium, Luxemburg, and The Netherlands.
The developer rights acquired under these transactions are being
amortized on a straight-line basis over 40 years. Amortization of intangible
assets totaled approximately $340,000, $502,000 and $747,000 for the years
ended December 31, 1996, 1997 and 1998, respectively.
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
<S> <C> <C>
Accrued taxes . . . . . . . . . . . . . . . . $ 252,116 $1,216,954
Accrued legal and professional. . . . . . . . 212,012 392,277
Developer service costs . . . . . . . . . . . 742,541 910,848
Repurchase of development territories . . . . -- 6,550,000
Other accrued liabilities . . . . . . . . . . 278,046 543,514
---------- ----------
$1,484,715 $9,613,593
---------- ----------
---------- ----------
</TABLE>
9. 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:
Deferred revenue consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
<S> <C> <C>
Deferred franchise and developer fees. . . . . . . . . . . . . . $2,037,500 $1,687,500
Deferred direct incremental costs:
Deferred franchise fee development service costs. . . . . . . (1,034,375) (838,750)
Deferred commissions. . . . . . . . . . . . . . . . . . . . . (13,750) (6,500)
Other deferred costs. . . . . . . . . . . . . . . . . . . . . (22,550) (5,500)
Deferred revenue, net -- Turnkey Program . . . . . . . . . . . . 1,888,555 461,736
---------- ----------
$2,855,380 $1,298,486
---------- ----------
---------- ----------
</TABLE>
F-18
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. LONG-TERM DEBT
In June 1997, the Company secured an additional line of credit of up to
$15,000,000 from a financial institution. This line of credit bears interest at
the bank's prime lending rate and expires December 2001, with approximately
$6,360,000 outstanding at December 31, 1998 and approximately $7,147,000 which
had been loaned to various franchisees and area developers for which the Company
has provided a guaranty.
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
<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 . . . . . . . . . . . . . . . . . . . . . $1,238,170 $1,225,298
Various notes payable to individuals and corporations, bearing
interest at 6% to 9% per annum, due in periodic principal and
interest installments through 2004, and collateralized by
equipment and assignment of royalties from certain franchisees . . . . . . . . 791,607 545,439
Capitalized lease bearing an effective interest rate of 13.67%,
collateralized by real property; monthly principal and interest
installments of $6,312 due through 2017. . . . . . . . . . . . . . . . . . . . -- 534,937
Capitalized lease bearing an effective interest rate of 12.85%,
collateralized by real property; monthly principal and interest
installments of $5,361 due through 2027. . . . . . . . . . . . . . . . . . . . -- 513,359
Note payable to a financial institution bearing interest at the
lesser of LIBOR + 1.75% or the bank's prime lending rate,
collateralized by the Company's receivables and intangibles,
with the principal due March, 1999. . . . . . . . . . . . . . . . . . . . . . -- 5,000,000
Note payable to a financial institution bearing interest at the
lesser of LIBOR + 1.75% or the bank's prime lending rate,
collateralized by the Company's receivables and intangibles,
with the principal due December, 2001. . . . . . . . . . . . . . . . . . . . . -- 6,360,000
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157,235 422,067
---------- ----------
2,187,012 14,601,100
Current maturities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (250,625) (5,382,585)
---------- ----------
Long-term debt, less current maturities . . . . . . . . . . . . . . . . . . . . $1,936,387 $9,218,515
---------- ----------
---------- ----------
</TABLE>
F-19
<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, 1998 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------
<S> <C>
1999. . . . . . . . . . . . . . . . . . . . . . . . . $5,382,585
2000. . . . . . . . . . . . . . . . . . . . . . . . . 258,439
2001. . . . . . . . . . . . . . . . . . . . . . . . . 6,415,949
2002. . . . . . . . . . . . . . . . . . . . . . . . . 62,481
2003. . . . . . . . . . . . . . . . . . . . . . . . . 69,798
Thereafter. . . . . . . . . . . . . . . . . . . . . . 2,411,848
------------
$14,601,100
------------
------------
</TABLE>
Interest expense, totaled approximately $331,000, $297,000 and $248,000 for
the years ended December 31, 1996, 1997 and 1998, respectively. All of the
interest in 1997 and 1998 was capitalized.
11. INCOME TAXES
The provision for federal and state income taxes consists of the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Federal:
Current . . . . . . . . . . . . . . . . . . . . . . 1,886,719 $2,416,124 $2,813,396
Deferred . . . . . . . . . . . . . . . . . . . . . (75,578) 26,988 556,575
---------- ---------- ----------
Total federal . . . . . . . . . . . . . . . . . . 1,811,141 2,443,112 3,369,971
State . . . . . . . . . . . . . . . . . . . . . . . . 91,149 171,148 358,638
---------- ---------- ----------
Total provision for income taxes. . . . . . . . . . . 1,902,290 $2,614,260 $3,728,609
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The differences between the income tax expense 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,
-------------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Expense at statutory rate of 34% . . . . . . . . . . . . . $1,733,070 $2,401,650 $3,377,925
Nondeductible items, including
amortization . . . . . . . . . . . . . . . . . . . . . . 86,915 99,653 69,922
State income taxes, net. . . . . . . . . . . . . . . . . . 60,158 112,957 236,701
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . 22,147 -- 44,061
------------ ------------ ------------
1,902,290 $2,614,260 $3,728,609
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
F-20
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. INCOME TAXES - (CONTINUED)
Deferred taxes are provided for the temporary differences between the
financial reporting bases and the tax bases of the Company's assets and
liabilities. The temporary differences that give rise to the deferred tax
assets or liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1998
------------ ------------
<S> <C> <C>
Deferred Tax Assets:
Receivables. . . . . . . . . . . . . . . . . . . $ -- $ 265,167
Deferred revenue . . . . . . . . . . . . . . . . 666,842 307,004
Accrued liabilities. . . . . . . . . . . . . . . 21,809 117,753
Other. . . . . . . . . . . . . . . . . . . . . . 35,028 36,563
------------ ------------
Gross deferred tax assets. . . . . . . . . . . . 723,679 726,487
------------ ------------
------------ ------------
Deferred Tax Liabilities:
Property, equipment and intangibles. . . . . . . 143,219 593,614
Installment sale . . . . . . . . . . . . . . . -- 99,202
Other. . . . . . . . . . . . . . . . . . . . . . -- 9,786
------------ ------------
Gross deferred tax liabilities. . . . . . . . . . . 143,219 702,602
------------ ------------
Net deferred tax asset. . . . . . . . . . . $ 580,460 $ 23,885
------------ ------------
------------ ------------
</TABLE>
12. STOCKHOLDERS' EQUITY
WARRANTS
During 1994, the Company issued a warrant to purchase 23,437 shares of
common stock at an initial exercise price of $9.60 per share. The warrant was
exercised in March 1998.
SHAREHOLDERS' RIGHTS PLAN
In December 1998, the Company announced that the Board of Directors had
adopted a Shareholder's Rights Plan and approved a dividend of one Right for
each share of Company Common Stock outstanding. Under the plan, each shareholder
of record receives one Right for each share of Common Stock held. Initially, the
Rights are not exercisable and automatically trade with the Common Stock. There
are no separate Rights certificates at this time. Each Right entitles the holder
to purchase one one-hundredth of a share of Company Class C Series A Junior
Participating Preferred Stock for $75.00 (the "Exercise Price").
The Rights separate and become exercisable upon the occurrence of certain
events, such as an announcement that an "acquiring person" (which may be a group
of affiliated persons) beneficially owns, or has acquired the rights to own,
20% or more of the outstanding Common Stock, or upon the commencement of a
tender offer or exchange offer that would result in an acquiring person
obtaining 20% or more of the outstanding shares of Common Stock.
Upon becoming exercisable, the Rights entitle the holder to purchase
Common Stock with a value of $150 for $75. Accordingly, assuming the Common
Stock had a per share value of $75 at the time, the holder of a right could
purchase two shares for $75. Alternatively, the Company may permit a holder to
surrender a Right in exchange for stock or cash equivalent to one share of
Common Stock (with a value of $75) without the payment of any additional
consideration. In certain circumstances, the holders have the right to acquire
common stock of an acquiring company having a value equal to two times the
Exercise Price of the Rights.
F-21
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 was originally 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, and in May 1998, the shareholders approved amendments to
the Plan, including an additional 500,000 shares of common stock to be
authorized for issuance as either incentive stock options or non-qualified stock
options.
Options granted in 1998 generally vest ratably over three years. Options
granted before 1998 generally vest ratably over five years.
F-22
<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,
1996, 1997 and 1998 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, 1996. . . . . . . . . . . . . . . . . . . . . . . 621,790 $ 8.70
Granted (weighted average fair value of $4.96 per share). . . . . . 82,850 10.50
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (29,924) 6.75
Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (79,752) 8.05
Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- --
---------
BALANCE, December 31, 1996. . . . . . . . . . . . . . . . . . . . . . 594,964 9.13
Granted (weighted average fair value of $6.81 per share). . . . . . 200,500 15.08
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (57,201) 8.50
Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (85,799) 9.88
Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- --
---------
BALANCE, December 31, 1997. . . . . . . . . . . . . . . . . . . . . . 652,464 11.19
Granted (weighted average fair value of $8.30 per share). . . . . . 628,700 18.66
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (44,239) 8.88
Forfeited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (147,216) 17.10
Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,300) 15.50
---------
BALANCE, December 31, 1998. . . . . . . . . . . . . . . . . . . . . . 1,064,409 14.56
---------
---------
Exercisable at December 31, 1996. . . . . . . . . . . . . . . . . . . 339,981 8.75
Exercisable at December 31, 1997. . . . . . . . . . . . . . . . . . . 362,178 9.19
Exercisable at December 31, 1998. . . . . . . . . . . . . . . . . . . 491,972 9.54
</TABLE>
The fair value of each stock option granted in 1996, 1997 and 1998 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 1996, 6.17% for 1997, and 5.28% for 1998; expected
lives of the options of six years; and volatility of 37.01% for 1996, 32.50% for
1997, and 48.97% for 1998.
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ -----------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT AVERAGE AVERAGE EXERCISABLE AT AVERAGE
RANGE OF DECEMBER 31, REMAINING EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 1998 CONTRACT LIFE PRICE 1998 PRICE
- - ------------------------ -------------- -------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$5.60 to $11.00. . . . . 413,930 6.56 $ 8.59 363,930 $ 8.35
$11.09 to $14.97 . . . . 237,079 8.53 $12.40 115,142 $12.27
$17.69 to $23.94 . . . . 413,400 9.12 $21.78 12,900 $18.73
-------------- --------------
Total. . . . . . . . . . 1,064,409 7.99 $14.56 491,972 $ 9.54
</TABLE>
F-23
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. STOCK-BASED COMPENSATION PLANS - (CONTINUED)
EMPLOYEE STOCK PURCHASE PLAN
During 1998 the Company adopted the Schlotzsky's, Inc. Employee Stock
Purchase Plan (the "Stock Purchase Plan") and authorized 250,000 shares of stock
to be sold to employees through the Stock Purchase Plan. Under the terms of the
Stock Purchase Plan, employees may elect to contribute up to 15% of compensation
through payroll deductions for the purchase of Company stock at 85% of the
lesser of the market price at the beginning or the end of the offering period.
An offering period begins on January 1st and July 1st of each year and expires
in six months.
During 1998, 49 participants purchased 9,396 shares of stock through the
Stock Purchase Plan for $8.39 per share. Under APB Opinion No. 25, the Stock
Purchase Plan is considered noncompensatory. Therefore, no compensation expense
has been recognized for shares sold under this plan.
The fair value of stock purchase rights granted in 1998 were $6.55 per
share or a total of $61,543. The fair value of each stock purchase right was
determined using an expected term of six months, a volatility of 48.97%, and a
risk-free interest rate of 5.30%.
PRO FORMA NET INCOME AND NET INCOME PER COMMON SHARE
During 1996, 1997 and 1998, 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 1996, 1997 and 1998 would approximate the pro
forma amounts below:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997 DECEMBER 31, 1998
-------------------------- -------------------------- -------------------------
AS PRO AS PRO AS PRO
REPORTED FORMA REPORTED FORMA REPORTED FORMA
------------ ------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Net income . . . . . . . . . . . . . . . . $ 3,194,975 $ 3,085,016 $ 4,449,415 $ 4,201,878 $ 6,206,465 4,673,829
Net income per common share -- basic. . . . $ 0.58 $ 0.56 $ 0.74 $ 0.70 $ 0.84 $ 0.63
Net income per common share -- diluted . . $ 0.57 $ 0.55 $ 0.71 $ 0.67 $ 0.82 $ 0.62
</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 three to five years, the full impact
of the pro forma disclosure requirements will not be reflected until 2000.
F-24
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest during the years ended December 31, 1996, 1997 and
1998 was approximately $313,000, $297,000 and $248,000, respectively.
Cash paid for taxes during the years ended December 31, 1996, 1997 and 1998
was approximately $2,614,000, $2,404,000 and $2,515,000, respectively.
Noncash investing and financing activities:
1996
Notes totaling approximately $1,861,000 were received as payment for
nonrefundable Area Developer, Master Licensee, Territorial and other fees.
1997
Notes totaling approximately $272,000 were received as payment for
nonrefundable Area Developer, Master Licensee, Territorial and other fees.
Notes totaling approximately $1,400,000 were received as proceeds of for
sales of Turnkey Program properties.
Notes totaling approximately $525,000 were issued for acquisition of
developer rights.
1998
Notes receivable totaling approximately $2,250,000 were received as
payment for nonrefundable Area Developer, Master Licensee, Territorial and
other fees.
Notes receivable totaling approximately $21,334,000 were received as
payment for investment in Turnkey Projects.
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 $40,000 and $11,000 at December 31, 1997 and 1998, respectively,
and are included in other receivables in the accompanying consolidated balance
sheets.
One or more principal stockholders of the Company is guarantor of debt of
the Company's, totaling approximately $1,460,000 and $1,383,000 at December 31,
1997 and 1998, respectively.
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 $455,000 at December 31, 1997 and 1998. An officer of the Company
held 60% of Sino's outstanding common stock at December 31, 1996. In 1997, Sino
issued shares of common stock to third parties which reduced the officer's
interest to less than 30%.
F-25
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 February 1999, the Company
acted on the guarantee of the $400,000. 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. BCCE is a wholly
owned subsidiary of Bonner Carrington Corporation.
During 1998, the Company paid $100,000 earnest money toward the
reacquisition of a master license territory from Java Rim, a wholly-owned
subsidiary of Bonner Carrington Corporation ("BCC").
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.
During 1997, an organization whose managing director is also a member
of the Company's Board of Directors became the successor to the Company's
International development licensing rights for Belgium, Luxemburg and The
Netherlands held by Euro American Development B.V. During 1998, the Company
re-acquired these rights from the related entity for $290,000 (in the form of
$125,000 cash and the remainder through cancellation of indebtedness).
16. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office facilities, land, buildings and equipment for its
Company-owned stores. Rent expense for the years ended December 31, 1996, 1997
and 1998, was approximately $118,000, $814,000 and $1,195,000, 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,
1998 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
-------------
<S> <C>
1999 . . . . . . . . . . . . $ 1,353,839
2000 . . . . . . . . . . . . 1,374,725
2001 . . . . . . . . . . . . 1,387,205
2002 . . . . . . . . . . . . 1,378,732
2003 . . . . . . . . . . . . 1,414,603
Thereafter . . . . . . . . . 18,465,497
-----------
$25,374,601
-----------
-----------
</TABLE>
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 has typically provided 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 term of the 20 year lease. At December 31, 1998, the
Company was contingently liable for approximately $6.2 million under these
guaranties. Additionally, at December 31, 1998, the Company was contingently
liable for approximately $20.2 million under guaranties of other franchisee real
estate and equipment leases and various obligations.
F-26
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES B (CONTINUED)
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.
On February 8, 1999, the Lone Star Ladies Investment Club, et al., filed a
consolidated amended class action lawsuit in 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, director;
Jeffrey J. Wooley, Senior Vice President and director; and John C. Wooley,
President and Chairman of the Board of Directors). The complaint, alleges
securities fraud arising from a change in the timing of recognition of revenue
from the sale of real estate properties in connection with which the Company
provided limited guaranties on franchisees leases of the properties. In April
1998, Registrant announced that 1997 earnings would be lower than previously
announced because it would defer revenue received in the fourth quarter from
such real estate transactions rather than recognizing it during the period in
which the transaction occurred, as previously contemplated. Plaintiffs seek
monetary damages in an unspecified amount. The Company believes that the
allegations are without merit and intends to vigorously defend against the suit.
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, mortgage notes
receivable from franchisees, 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 the terms maturities
of certain of the notes, it has not experienced significant credit losses to
date.
18. SEGMENTS
The Company and its subsidiaries are principally engaged in franchising
quick service restaurants that feature salads, made-to-order sandwiches and
pizzas with unique sourdough buns. At December 31, 1998 the Schlotzsky's system
included Company owned and franchised stores in 38 states, the District of
Columbia and 13 foreign countries.
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which the Company has adopted in the current year.
F-27
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. SEGMENTS -- (CONTINUED)
The Company identifies such segments based on management responsibility
within the corporate structure. The Turnkey Development segment includes
the development of free-standing stores with high visibility and easy access.
The Restaurant Operations includes the operation of a limited number of
Company-owned restaurants for the purpose of product development, concept
refinement, prototype testing and training and to build brand awareness. The
Franchise Operations segment encompasses the franchising of stores in order
to achieve optimal success with owner-operated stores. 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 are as follows:
<TABLE>
<CAPTION>
TURNKEY RESTAURANT FRANCHISE
YEAR ENDED DECEMBER 31, 1998 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
- - -------------------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue from external customers. . . . . . . . . . $ 8,314,426 $ 7,720,432 $ 25,813,054 $ 41,847,912
Depreciation and amortization. . . . . . . . . . . 446,962 609,265 828,627 1,884,854
Operating income (loss) . . . . . . . . . . . . . 3,061,365 (774,999) 5,590,446 7,876,812
Significant noncash items - fees financed. . . . . -- -- 2,250,000 2,250,000
Capital expenditures . . . . . . . . . . . . . . . 5,150,880 9,102,579 2,991,726 17,245,185
Total assets . . . . . . . . . . . . . . . . . . . $ 42,902,095 $ 20,782,048 $ 40,543,997 $104,228,140
</TABLE>
<TABLE>
<CAPTION>
TURNKEY RESTAURANT FRANCHISE
YEAR ENDED DECEMBER 31, 1997 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
- - -------------------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue from external customers. . . . . . . . . . $ 1,138,610 $ 6,364,042 $ 20,466,484 $ 27,969,136
Depreciation and amortization. . . . . . . . . . . 178,953 434,698 541,949 1,155,600
Operating income (loss) . . . . . . . . . . . . . 592,001 (193,371) 5,716,424 6,115,054
Significant noncash items - fees financed. . . . . -- -- 272,003 272,003
Capital expenditures . . . . . . . . . . . . . . . 168,160 4,169,162 3,098,681 7,436,003
Total assets . . . . . . . . . . . . . . . . . . . $ 18,740,459 $ 8,992,965 $ 51,787,162 $ 79,520,586
</TABLE>
<TABLE>
<CAPTION>
TURNKEY RESTAURANT FRANCHISE
YEAR ENDED DECEMBER 31, 1996 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
- - -------------------------------------------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue from external customers. . . . . . . . . . $ 725,913 $ 3,610,199 $ 16,378,220 $ 20,714,332
Depreciation and amortization. . . . . . . . . . . 86,674 273,689 418,921 779,284
Operating income (loss) . . . . . . . . . . . . . 119,911 (310,876) 4,701,485 4,510,520
Significant noncash items - fees financed. . . . . -- -- 1,860,796 1,860,796
Capital expenditures . . . . . . . . . . . . . . . 21,424 1,234,537 408,402 1,664,363
Total assets . . . . . . . . . . . . . . . . . . . $ 15,533,211 $ 5,839,137 $ 19,606,764 $ 40,979,112
</TABLE>
F-28
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. EARNINGS PER SHARE
Basic and diluted EPS computation for the years ended December 31, 1996,
1997 and 1998 are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Basic EPS
- - ---------
Net income . . . . . . . . . . . . . . . . . . . . $3,194,975 $4,449,415 $6,206,465
---------- ---------- ----------
---------- ---------- ----------
Weighted average common shares outstanding . . . . 5,525,902 5,994,403 7,382,983
---------- ---------- ----------
---------- ---------- ----------
Basic EPS. . . . . . . . . . . . . . . . . . . . . $ 0.58 $ 0.74 $ 0.84
---------- ---------- ----------
---------- ---------- ----------
Diluted EPS
- - -----------
Net income . . . . . . . . . . . . . . . . . . . . $3,194,975 $4,449,415 $6,206,465
---------- ---------- ----------
---------- ---------- ----------
Weighted average common shares outstanding . . . . 5,525,902 5,994,403 7,382,983
Assumed conversion of common shares issuable
Under stock option plan and exercise of warrants 113,323 234,966 194,424
---------- ---------- ----------
Weighted average common shares outstanding --
assuming dilution. . . . . . . . . . . . . . . . . 5,639,225 6,229,369 7,577,407
---------- ---------- ----------
---------- ---------- ----------
Diluted EPS. . . . . . . . . . . . . . . . . . . . . $ 0.57 $ 0.71 $ 0.82
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Outstanding options that were not included in the diluted calculation
because their effect would be anti-dilutive totaled 199,361, 123,500 and
571,000 in 1996, 1997 and 1998, respectively.
F-29
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Schlotzsky's, Inc. and Subsidiaries
In connection with our audit of the consolidated financial statements of
Schlotzsky's, Inc. and Subsidiaries referred to in our report dated February 26,
1999, which is included in Part IV of this Form 10-K, we have also audited
Schedule II for each of the three years in the period ended December 31,
1998. In our opinion, this schedule presents fairly, in all material
respects, the information required to be set forth therein.
GRANT THORNTON LLP
Dallas, Texas
February 26, 1999
S-1
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
COL. A COL. B COL. C COL. D COL. E.
- - --------------------------------------------------- ------------- ----------------------------- ------------- -------------
ADDITIONS
BALANCE -----------------------------
AT CHARGE TO CHARGE TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTION PERIOD
- - --------------------------------------------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Valuation allowance for
Notes Receivable:
December 31, 1998
Valuation Allowance . . . . . . . . . . . . . $(442,774) $(972,724) $ -- $ -- $(1,415,498)
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
December 31, 1997
Valuation Allowance. . . . . . . . . . . . . . (342,774) (100,000) -- -- (442,774)
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
December 31, 1996
Valuation Allowance. . . . . . . . . . . . . . (155,000) (187,774) -- -- (342,774)
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
</TABLE>
S-2
<PAGE>
[PROMISSORY NOTE B]
PROMISSORY NOTE
"EFFECTIVE DATE:" ___________ __, 1999
"BORROWER:" ____________________
"PRINCIPAL AMOUNT:" _____________ DOLLARS ($____________)
"INITIAL RATE:" THE RATE OF _______ PERCENT ( %) PER ANNUM [9% TO 14%]
"STATED RATE:" ________________ PERCENT ( %) PER ANNUM [EQUAL TO THE
INDEX RATE DESIGNATED BY LENDER FOR THE SUBJECT LOAN, PLUS
THREE TO SEVEN PERCENT (3.00-7.00%)]
"TERMS OF PAYMENT:" PAYMENTS OF ALL ACCRUED INTEREST ON THE OUTSTANDING
PRINCIPAL BALANCE OF THIS NOTE SHALL BE DUE AND PAYABLE ON
THE FIRST DAY OF EACH MONTH COMMENCING ON _____ 1, 199__ ,
[THE FIRST DAY OF THE SECOND MONTH FOLLOWING THE EFFECTIVE
DATE] AND CONTINUING UNTIL AND INCLUDING THE FIRST DAY OF
THE MONTH IMMEDIATELY FOLLOWING THE CONVERSION DATE;
____ (__) CONSECUTIVE INSTALLMENTS OF PRINCIPAL AND INTEREST
IN THE PAYMENT AMOUNT (DEFINED BELOW) SHALL BE DUE AND
PAYABLE COMMENCING ON THE FIRST DAY OF THE SECOND MONTH
FOLLOWING THE CONVERSION DATE, AND CONTINUING ON THE FIRST
DAY OF EACH AND EVERY SUCCEEDING MONTH UNTIL AND INCLUDING
______ 1, _____ [THE FIRST DAY OF THE _____(___) MONTH
FOLLOWING THE CONVERSION DATE]; A FINAL PAYMENT OF PRINCIPAL
AND INTEREST IN THE AMOUNT OF________ DOLLARS ($________),
PLUS ANY OTHER UNPAID PRINCIPAL AND INTEREST, SHALL BE DUE
AND PAYABLE IN FULL ON THE FIRST DAY OF THE ______ (____)
MONTH FOLLOWING THE CONVERSION DATE. AS USED HEREIN, THE
TERM "PAYMENT AMOUNT" SHALL MEAN THE AMOUNT OF MONEY
NECESSARY TO BE PAID TO PAY THE ENTIRE AMOUNT OF PRINCIPAL
OUTSTANDING UNDER THIS NOTE ON THE CONVERSION DATE (AFTER
GIVING EFFECT TO ANY ADVANCE MADE ON SUCH DATE), TOGETHER
WITH INTEREST ON THE OUTSTANDING PORTION THEREOF AT THE
APPLICABLE RATE, IN ________ (___) EQUAL MONTHLY
INSTALLMENTS OF PRINCIPAL AND INTEREST. THE PAYMENT AMOUNT
SHALL BE CALCULATED BY LENDER AND SHALL BE DEEMED CORRECT
ABSENT MANIFEST ERROR.
"INDEX RATE:" [THE CURRENT WEEKLY AVERAGE YIELD OF TEN (10)-YEAR U.S.
TREASURY CONSTANT MATURITIES (AS PUBLISHED IN FEDERAL
RESERVE STATISTICAL RELEASE H.15 [519]) ON THE FRIDAY
IMMEDIATELY PRECEDING THE CONVERSION DATE ("T-BILL RATE"),
OR SUCH OTHER INDEX RATE DESIGNATED BY LENDER FOR THE
SUBJECT LOAN]
"COMPLETION DATE:" __________ 1, ______ [SAME AS IN LOAN AGREEMENT]
"NO PREPAYMENT
DATE:" THE FIRST DAY OF THE _____ [1ST - 60TH) MONTH FOLLOWING
THE EFFECTIVE DATE.
"PREMIUM FACTOR:" THE AMOUNT SHOWN ON THE FOLLOWING CHART [BASED ON THE
INDEX RATE BEING THE T-BILL RATE] FOR THE MONTH IN WHICH A
PREPAYMENT OCCURS:
1
<PAGE>
<TABLE>
<CAPTION>
---------------------------------
NUMBER OF MONTHS PREMIUM
REMAINING IN LOAN TERM FACTOR
---------------------------------
<S> <C>
120-109 0.070
---------------------------------
108-97 0.065
---------------------------------
96-85 0.060
---------------------------------
84-73 0.054
---------------------------------
72-61 0.048
---------------------------------
60-49 0.042
---------------------------------
48-37 0.036
---------------------------------
36-25 0.029
---------------------------------
24-13 0.022
---------------------------------
12 OR LESS 0.013
---------------------------------
</TABLE>
"MORTGAGE:" THAT CERTAIN COMMERCIAL _____________ [MORTGAGE OR DEED
OF TRUST], SECURITY AGREEMENT, ASSIGNMENT OF LEASES AND
RENTS AND FIXTURE FILING, DATED THE EFFECTIVE DATE AND
EXECUTED BY BORROWER IN FAVOR OF LENDER, COVERING THE REAL
PROPERTY AND OTHER ASSETS (THE "PROPERTY") DESCRIBED
THEREIN.
"APPLICABLE STATE:" _____________ [THE STATE WHERE THE PROPERTY IS LOCATED]
(1) FOR VALUE RECEIVED, Borrower, promises to pay to the order of
Schlotzsky's Real Estate, Inc., a Texas corporation (sometimes herein
referred to as "Schlotzsky's" or "Lender") at Lender's office at 203 Colorado
Street, Austin, Texas 78701 Attention: Accounting Department, or at such
other address as the holder hereof may from time to time designate in
writing, the Principal Amount or so much thereof as may be advanced
hereunder, together with interest from the date the proceeds of the loan (the
"Loan") evidenced by this Promissory Note (this "Note") are initially
disbursed until maturity on the principal balance from time to time remaining
unpaid hereon at the interest rates herein provided. This Note is made and
accepted pursuant to the provisions of that certain Loan Agreement ("Loan
Agreement") of even date herewith between Borrower and Lender. Advances made
hereunder shall be made in reliance upon, and subject to, the terms,
conditions, representations and warranties set forth in the Loan Agreement.
(2) From the Effective Date until the date (the "Conversion Date") which is
the earlier to occur of the Initial Conversion Date (as hereinafter defined)
and the Completion Date, this Note shall bear interest at Initial Rate.
Commencing on the Conversion Date and continuing until maturity (whether by
acceleration or otherwise), this Note shall bear interest at a rate (the
"Applicable Rate") equal to the lesser of (a) the Stated Rate or (b) the
maximum rate of interest allowed by applicable law; provided, however, if the
Initial Conversion Date does not occur on or before the Completion Date, the
Applicable Rate shall not be less than the Initial Rate. Each rate of
interest which this Note bears shall be computed on the basis of a 365 or 366
day year, as applicable, and shall be compounded monthly. In no event shall
any rate of interest which this Note bears ever exceed the highest rate
permitted by applicable law. The term "Initial Conversion Date", as used
herein, shall mean the latest date upon which both (i) all conditions
precedent for the Final Advance (as defined in the Loan Agreement), as set
forth in Section 2.8 of the Loan Agreement, have been satisfied and (ii) the
Final Advance has been made.
(3) This Note shall be payable as stated in the Terms of Payment above.
(4) The initial advance of the Loan from Lender to Borrower shall be made on or
about the Effective Date. Borrower shall have the right to receive subsequent
advances from Lender pursuant to
2
<PAGE>
the terms of the Loan Agreement and subject to Borrower's satisfaction of all
conditions precedent set forth therein. Each advance shall bear interest at
the interest rate described above from and after the date on which Lender
disburses such advance. In no event shall Lender have any obligation to make
any advance after the Conversion Date or the Completion Date.
(5) If any payment shall not be paid when due and shall remain unpaid for
ten business (10) days, Borrower shall pay an additional charge equal to five
percent (5.00%) of the delinquent payment or the highest additional charge
permitted by law, whichever is less, for the purpose of defraying the
expenses incident to handling such delinquent payment.
(6) Upon not less than thirty (30) days advance written notice to Lender at
any time after the No Prepayment Date, and upon payment of the Prepayment
Premium, Borrower shall have the right to prepay all, but not less than all,
of the outstanding balance of this Note on any regularly scheduled principal
and interest payment date. The Prepayment Premium shall be determined by (i)
calculating the decrease (expressed in basis points) in the Index Rate from
the Conversion Date, to the date on which the prepayment is made, (ii)
dividing the decrease by 100, (iii) multiplying the result by the following
described applicable premium factor (the "Premium Factor"), and (iv)
multiplying the product by the principal balance to be prepaid. If the Index
Rate is unchanged or has increased from the Conversion Date to the
prepayment date, no Prepayment Premium shall be due. If the Index Rate
identified herein ceases to be published, then the decrease in the Index Rate
will be determined from another source designated by Lender. Anything
contained herein to the contrary notwithstanding, prepayment prior to the
first day of the sixtieth (60th) month following the Conversion Date will not
be permitted.
(7) If Lender at any time accelerates this Note after an Event of Default
(defined below), then Borrower shall be obligated to pay the Prepayment
Premium in accordance with the foregoing schedule to the maximum extent
permitted by applicable law. The Prepayment Premium shall not be payable
with respect to condemnation awards or insurance proceeds from fire or other
casualty which Lender applies to prepayment, nor with respect to Borrower's
prepayment of the Note in full during the last three (3) months of the term
of this Note unless an Event of Default has occurred. Borrower expressly
acknowledges that the Prepayment Premium is not a penalty but is intended
solely to compensate Lender for the loss of its bargain and the reimbursement
of internal expenses and administrative fees and expenses incurred by Lender.
(8) The Loan is secured, in part, by the Mortgage covering the Property, and
by certain other documents executed and delivered in connection herewith
(this Note, the Loan Agreement, the Mortgage and such other documents are
collectively called the "Loan Documents").
(9) Each of the following shall constitute an Event of Default ("Event of
Default") hereunder and under the Mortgage, the Loan Agreement and the other
Loan Documents:
(a) Any failure of or refusal by Borrower to make any payment of principal,
interest, or any Prepayment Premium due under this Note when due, and such
failure or refusal shall continue for a period of ten (10) days after written
notice is given to Borrower by Lender specifying such failure; or
(b) The occurrence of any event of default under, or the failure to perform or
comply with any other provision of, any of the Loan Documents and the
continuance of such event of default beyond any applicable cure period provided
in the Loan Documents with respect to such event of default.
(10) Upon the occurrence of any Event of Default, Lender shall have the
option to declare the entire amount of unpaid principal and interest under
this Note immediately due and payable without notice or demand, and Lender
may exercise any of its rights under this Note, under the Mortgage, under the
Loan Agreement and under the other Loan Documents. After acceleration or
maturity, Borrower shall
3
<PAGE>
pay interest on the outstanding principal balance of this Note at the rate
which is the lower of (i) sixteen percent (16%) per annum or (ii) the maximum
interest rate permitted by law.
(11) All payments of the principal and interest on this Note shall be made in
coin or currency of the United States of America which at the time shall be
the legal tender for the payment of public and private debts.
(12) If this Note is placed in the hands of an attorney for collection,
Borrower agrees to pay reasonable attorneys' fees and costs incurred by
Lender in connection therewith, and in the event suit or action is instituted
to enforce or interpret this Note (including without limitation efforts to
modify or vacate any automatic stay or injunction), Lender shall be entitled
to recover all expenses reasonably incurred at, before or after trial and on
appeal, whether or not taxable as costs, or in any bankruptcy proceeding, or
in connection with post-judgment collection efforts, including, without
limitation, attorneys' fees, witness fees (expert and otherwise), deposition
costs, copying charges and other expenses.
(13) This Note shall be governed and construed in accordance with the laws of
the Applicable State applicable to contracts made and to be performed therein
(excluding choice-of-law principles). Borrower hereby irrevocably submits to
the jurisdiction of any state or federal court sitting in the Applicable
State in any action or proceeding brought to enforce or otherwise arising out
of or relating to this Note, and hereby waives any objection to venue in any
such court and any claim that such forum is an inconvenient forum.
(14) This Note is given in a commercial transaction for business purposes.
Lender's obligation to make any loan or advance hereunder shall be deemed to
be pursuant to a contract to make a loan or extend debt financing or
financial accommodations to Borrower within the meaning of Subsections
365(c)(2) and 365(e)(2)(B) of the Bankruptcy Code of the United States of
America.
(15) This Note may be declared due prior to its expressed maturity date in
the events, on the terms, and in the manner provided for in the Mortgage.
(16) Borrower and all sureties, endorsers, guarantors and other parties now
or hereafter liable for the payment of this Note, in whole or in part, hereby
severally (i) waive demand, notice of demand, presentment for payment, notice
of nonpayment, notice of default (except as specifically provided in Section
9(a) hereof), protest, notice of protest, notice of intent to accelerate,
notice of acceleration and all other notices, and further waive diligence in
collecting this Note or in enforcing any of the security for this Note; (ii)
agree to any substitution, subordination, exchange or release of any security
for this Note or the release of any party primarily or secondarily liable for
the payment of this Note; (iii) agree that Lender shall not be required to
first institute suit or exhaust its remedies hereon against Borrower or
others liable or to become liable for the payment of this Note or to enforce
its rights against any security for the payment of this Note; (iv) consent to
any extension of time for the payment of this Note, or any installment
hereof, made by agreement by Lender with any person now or hereafter liable
for the payment of this Note, even if Borrower is not a party to such
agreement; and (v) agree that Schlotzsky's may transfer, assign, or endorse
this Note, the Mortgage and the other Loan Documents to another person or
entity (a "Subsequent Payee") and, in any such event, Borrower agrees (a) to
look only to Schlotzsky's with respect to any claims, demands or liabilities
existing or alleged to be existing against Schlotzsky's then or thereafter;
and (b) not to assert any claims, demands, defenses, offsets or liabilities
against this Note or against any Subsequent Payee which Borrower may then or
thereafter have against Schlotzsky's, or as a result of any action or failure
to take action by Schlotzsky's.
(17) All agreements between Borrower and Lender, whether now existing or
hereafter arising and whether written or oral, are hereby limited so that in
no contingency, whether by reason of demand or acceleration of the final
maturity of this Note or otherwise, shall the interest contracted for,
charged, received, paid or agreed to be paid to Lender exceed the maximum
amount permissible under the
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applicable law. If, from any circumstance whatsoever, interest would
otherwise be payable to Lender in excess of the maximum amount permissible
under applicable law, the interest payable to Lender shall be reduced to the
maximum amount permissible under applicable law; and if from any circumstance
Lender shall ever receive anything of value deemed interest by applicable law
in excess of the maximum amount permissible under applicable law, an amount
equal to the excessive interest shall be applied to the reduction of the
principal hereof and not to the payment of interest, or if such excessive
amount of interest exceeds the unpaid balance of principal hereof, such
excess shall be refunded to Borrower. All interest paid or agreed to be paid
to Lender shall, to the extent permitted by applicable law, be amortized,
prorated, allocated, and spread throughout the full period (including any
renewal or extension) until payment in full of the principal so that the
interest hereon for such full period shall not exceed the maximum amount
permissible under applicable law. Lender expressly disavows any intent to
contract for, charge or receive interest in an amount which exceeds the
maximum amount permissible under applicable law. This paragraph shall
control all agreements between Borrower and Lender.
(18) If Borrower (as identified on the first page hereof) includes more than
one individual or entity, the obligations of Borrower hereunder shall be
joint and several, and each of such individuals and entities constituting
Borrower agrees that Lender, in its discretion, may (a) bring suit against
all of them jointly and severally or against any of them, (b) compromise or
settle with any of them for such consideration as Lender may deem proper, and
(c) release any of them from liability hereunder, and that no such actions
shall impair the rights of Lender against the individuals or entities not so
sued, settled with or released.
(19) As used herein, the term "Lender" shall include the successors and
assigns of Lender and any subsequent owner and holder of this Note.
(20) THIS NOTE AND THE OTHER LOAN DOCUMENTS WHICH ARE IN EXISTENCE ON THE
DATE HEREOF REFLECT THE ENTIRE UNDERSTANDINGS AND AGREEMENTS OF BORROWER AND
LENDER WITH RESPECT TO THE SUBJECT MATTER OF THE LOAN DOCUMENTS. ANY AND ALL
PRIOR UNDERSTANDINGS AND AGREEMENTS AND ANY AND ALL CONTEMPORANEOUS
UNDERSTANDINGS AND AGREEMENTS ARE INCORPORATED IN THE TRANSACTION DOCUMENTS.
EXCEPT AS SPECIFICALLY SET FORTH IN THE LOAN DOCUMENTS, THERE ARE NO
UNDERSTANDINGS OR AGREEMENTS, EXPRESS OR IMPLIED, WITH RESPECT TO THE SUBJECT
MATTER OF THE LOAN DOCUMENTS. BORROWER UNDERSTANDS THAT LENDER HAS MADE NO
COMMITMENT TO RENEW, REFINANCE, EXTEND OR REARRANGE THE LOAN, NOR TO ADVANCE
ADDITIONAL FUNDS TO OR ON BEHALF OF BORROWER, EXCEPT (IF AT ALL) AS
SPECIFICALLY PROVIDED IN THE LOAN AGREEMENT. BORROWER REPRESENTS AND WARRANTS
TO LENDER THAT NO OFFICER, EMPLOYEE, REPRESENTATIVE OF, OR ATTORNEY FOR,
LENDER HAS MADE ANY ORAL COMMITMENTS OR REPRESENTATIONS WHICH ARE NOT
INCORPORATED IN THE LOAN DOCUMENTS.
IMPORTANT: READ BEFORE SIGNING. THE TERMS OF THE LOAN DOCUMENTS
SHOULD BE READ CAREFULLY BECAUSE ONLY THOSE TERMS IN WRITING ARE
ENFORCEABLE. NO OTHER TERMS OR ORAL PROMISES NOT CONTAINED IN THE
LOAN DOCUMENTS MAY BE LEGALLY ENFORCED. BORROWER MAY CHANGE THE TERMS
OF THE LOAN DOCUMENTS ONLY BY ANOTHER WRITTEN AGREEMENT SIGNED BY BOTH
BORROWER AND LENDER.
BORROWER:
- - ----------------------------------
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LOAN AGREEMENT
"EFFECTIVE DATE:" ___________ __, 1999
"BORROWER:" ____________________
BORROWER'S ADDRESS: ____________________
"GUARANTOR:" ____________________
"PRINCIPAL AMOUNT:" $___________________
"COMPLETION DATE:" _________ __, 1999
"PURPOSE OF INITIAL ADVANCE:" _____________________
"MORTGAGE:" THAT CERTAIN COMMERCIAL _____________, SECURITY
AGREEMENT, ASSIGNMENT OF LEASES AND RENTS AND
FIXTURE FILING, DATED THE EFFECTIVE DATE AND
EXECUTED BY BORROWER IN FAVOR OF LENDER, SECURING
THE PAYMENT OF THE NOTE AND THE PAYMENT AND
PERFORMANCE OF ALL OBLIGATIONS SPECIFIED IN SAID
MORTGAGE AND THIS AGREEMENT, AND EVIDENCING A
VALID AND ENFORCEABLE LIEN ON THE PROPERTY SUBJECT
ONLY TO THE MATTERS APPROVED IN WRITING BY LENDER.
THIS LOAN AGREEMENT (this "Agreement") dated as of the Effective Date
is made by and between SCHLOTZSKY'S REAL ESTATE, INC., a Texas corporation
("Lender"), whose address is 203 Colorado Street, Austin, Texas 78701,
Attention: Accounting Department, and Borrower with respect to a loan up
to the Principal Amount.
ARTICLE I
DEFINITIONS
For purposes of this Agreement, in addition the terms defined opn the
first page hereof, the following terms shall have the respective meanings
assigned to them.
1.1. ADVANCE. The term "Advance" shall mean a disbursement by Lender of
any of the proceeds of the Loan.
1.2. AFFIDAVIT OF BORROWER. The term "Affidavit of Borrower" shall mean
a sworn affidavit of Borrower (and such other parties as Lender may require)
to the effect that all statements, invoices, bills, and other expenses
incident to the acquisition of the Land and the construction of the
Improvements incurred to a specified date, whether or not specified in the
Approved Budget, have been paid in full, except for (a) amounts retained
pursuant to the Construction Contract, and (b) items to be paid from the
proceeds of the Advance then being requested or in another manner
satisfactory to Lender.
1.3. APPLICATION FOR ADVANCE. The term "Application for Advance" shall
mean a written
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application (on AIA Document G702 or such other form acceptable to Lender) by
Borrower (and such other parties as Lender may require) to Lender specifying
by name, current address, and amount all parties to whom Borrower is
obligated for labor, materials, or services supplied for the construction of
the Improvements and all other expenses incident to the construction of the
Improvements, requesting an Advance for the payment of such items,
accompanied by such schedules, affidavits, releases, waivers, statements,
invoices, bills, and other documents as Lender may reasonably request, and
certifying that all materials purchased with the proceeds of any previous
Advance have been incorporated into the Improvements.
1.4. APPROVED BUDGET. The term "Approved Budget" shall mean the budget,
approved by Lender in writing in Lender's sole discretion, for the costs and
expenses to be incurred by Borrower in connection with the purchase of the
Land and the construction of the Improvements.
1.5. ARCHITECT. The term "Architect" shall mean the architect approved
by Lender in writing in Lender's sole discretion.
1.6. BORROWER. The term "Borrower" shall mean all parties identified as
Borrower on the first page of this Agreement and any and all subsequent
record or equitable owners of the Property.
1.7. COMPLETION DATE. The term "Completion Date" shall mean
the date set forth on the first page hereof.
1.8. CONSTRUCTION CONTRACT. The term "Construction Contract" shall mean
the construction contract executed by Borrower and Contractor for the
construction of the Improvements.
1.9. CONTRACTOR. The term "Contractor" shall mean mean the contactor
approved by Lender in writing in Lender's sole discretion.
1.10. EVENT OF DEFAULT. The term "Event of Default" shall mean:
(a) A failure by Borrower to comply with any of the covenants, terms or
conditions specified in this Agreement for a period of thirty (30) days after
delivery by Lender of written notice to Borrower of such failure, provided
that in no event shall Lender have any obligation to deliver, nor shall
Borrower have any right to receive, more than one (1) such notice in any
calendar year concerning a failure by Borrower to comply with the same
covenant, term or condition;
(b) An inability of Borrower to satisfy any condition specified herein
as precedent to the obligation of Lender to make an Advance after an
Application for Advance has been submitted by Borrower to Lender;
(c) Any breach by Borrower of its obligations under the Construction
Contract, or the termination of the Construction Contract;
(d) The failure by Borrower to complete construction of the
Improvements and satisfy all of the conditions precedent to the Final Advance
on or before the Completion Date; or
(e) The occurrence of any event of default, as defined or described in
the Note or any of the other Loan Documents.
1.11. FINAL ADVANCE. The term "Final Advance" shall mean the last
disbursement of the proceeds of the Loan.
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1.12. GOVERNMENTAL AUTHORITY. The term "Governmental Authority" shall
mean the United States, the state, the county, the city, or any other
political subdivision in which the
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Property is located, and any other political subdivision, agency, or
instrumentality exercising jurisdiction over the Property or over Borrower or
any Guarantor.
1.13. GOVERNMENTAL REQUIREMENTS. The term "Governmental
Requirements" shall mean all laws, ordinances, rules, and regulations of any
Governmental Authority applicable to Borrower, Guarantor, or the Property.
1.14. GUARANTOR. The term "Guarantor" shall mean all parties
identified as "Guarantor" on the first page of this Agreement.
1.15. GUARANTY. The term "Guaranty" shall mean a continuing
unconditional guaranty of the Loan executed by each Guarantor.
1.16. IMPROVEMENTS. The term "Improvements" shall mean the
Schlotzsky's Deli restaurant to be constructed on the Land, together with all
related facilities and amenities to be developed and constructed by the
Borrower on the Land.
1.17. INITIAL ADVANCE. The term "Initial Advance" shall mean the
advance of the Loan being made by Lender on or about the Effective Date.
1.18. INCIPIENT DEFAULT. The term "Incipient Default" shall mean
the existence of any condition or state of facts which with the giving of
notice by Lender, the passage of time, or both, would constitute an Event of
Default.
1.19. INTERIM ADVANCE. The term "Interim Advance" shall mean each
Advance of the proceeds of the Loan other than the Initial Advance and the
Final Advance.
1.20. LAND. The term "Land" shall mean the real property described
on EXHIBIT A attached hereto and incorporated herein by reference.
1.21. LENDER. The term "Lender" shall mean the Lender named on the
first page of this Agreement.
1.22. LOAN. The term "Loan" shall mean the Loan by Lender to
Borrower, in an amount not to exceed the Principal Amount, for the payment of
the costs of labor, materials, and services supplied for the construction of
the Improvements and all other expenses incident to the acquisition of the
Land and the construction of the Improvements, as set forth in the Approved
Budget or as otherwise approved by Lender in writing.
1.23. LOAN DOCUMENTS. The term "Loan Documents" shall mean this
Agreement, the Mortgage, the Note, the Guaranty, and such other instruments
evidencing, securing, or pertaining to the Loan as shall, from time to time,
be executed and delivered by Borrower, Guarantor, or any other party to
Lender pursuant to this Agreement or otherwise, including, without
limitation, each Affidavit of Borrower and each Application for Advance.
1.24. MORTGAGE. The term "Mortgage" shall mean the Mortgage
identified on the first page of this Agreement.
1.25. NOTE. The term "Note" shall mean that certain Promissory Note
dated the Effective Date, in the Principal Amount, executed by Borrower and
payable to the order of Lender.
1.26. PLANS. The term "Plans" shall mean the final working drawings
and specifications for
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the construction of the Improvements, as approved by Lender in its sole
discretion.
1.27. PROPERTY. The term "Property" shall mean the Land and
Improvements and all other property constituting the "Property", as described
in the Mortgage.
1.28. RETAINAGE. The term "Retainage" shall mean a sum of money
equal to ten percent (10%) of the cost of all work and materials with respect
to which each Interim Advance is requested (calculated prior to any deduction
for Retainage applicable to prior Interim Advances).
1.29. SURVEY. The term "Survey" shall mean a current, certified
as-built survey of the Property prepared in accordance with Lender's survey
requirements as determined by Lender in its sole discretion.
1.30. TITLE COMPANY. The term "Title Company" shall mean the title
company determined by Lender in its sole discretion.
1.31. TITLE POLICY. The term "Title Policy" shall mean a mortgagee
title insurance policy in form satisfactory to Lender, in the amount of the
Loan, insuring that the Mortgage constitutes a valid first and prior lien
covering the Property and is subject only to those exceptions and
encumbrances which Lender may approve (the "Permitted Exceptions"), issued by
the Title Company; such title insurance policy shall include an adjustable
mortgage loan endorsement and such other endorsements as Lender shall require.
ARTICLE II
AGREEMENTS OF LENDER
2.1. COMMITMENT OF LENDER. Subject to the conditions hereof, and
provided that neither an Event of Default nor an Incipient Default has
occurred, Lender will make Advances for the benefit of Borrower in accordance
with this Agreement. Advances are to be used by Borrower for the payment of
only those costs and expenses as set forth in the Approved Budget, and for no
other purposes whatsoever without the express prior written approval of
Lender.
2.2. INTEREST ON THE LOAN. Interest on the Loan, at the rate specified
in the Note, shall be computed on the outstanding balance of Advances and
shall be computed with respect to each Advance from the date such Advance is
wire transferred or otherwise sentby Lender to or for the benefit of Borrower.
2.3. LIMITATION ON ADVANCES. In no event shall Lender be required to
make (a) more than three (3) Interim Advances, (b) any Advance to the extent
it would cause the outstanding l amount of all of the Advances to be in
excess ofthe Principal Amount, (c) more than one (1) Advance in any thirty
(30) day period, (d) any Advance in an amount less than $100,000.00 (except
for the Final Advance), or (e) any Advance after the Completion Date.
2.4. INITIAL ADVANCE. Borrower acknowledges that, on or about the
Effective Date, Lender has made the Initial Advance to Borrower. Borrower
shall use the proceeds of the Initial Advance solely for the f Purpose of
Initial Advance set forth on the first page hereof.
2.5. CONDITIONS TO THE SECOND ADVANCE. As conditions precedent to the
second Advance hereunder, in addition to all other requirements herein,
Borrower must satisfy each of the following conditions (all of which must be
acceptable to Lender in its sole and absolute discretion):
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(a) No Event of Default shall have occurred.
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(b) No Incipient Default shall have occurred which shall not have been
cured to Lender's satisfaction.
(c) Borrower shall have delivered to Title Company such lien releases
and waivers and other items as may be required by Title Company to issue the
endorsement described in Section 2.5(e) below.
(d) Borrower shall have submitted to Lender an Application for Advance
and an Affidavit of Borrower in the form required by Lender.
(e) The Title Policy shall be endorsed to cover the second Advance with
no additional title exceptions objectionable to Lender and with mechanic's
lien coverage.
(f) Borrower and Contractor shall have submitted to Lender an
accounting of all costs expended to date in connection with the construction
of the Improvements and a detailed comparison of such costs to the Approved
Budget.
(g) Architect shall have certified to Lender that at least thirty
percent (30%) of the construction of the Improvements has been completed as
of the date of the Application for Advance.
(h) The maximum amount of the second Advance shall be equal to the
difference between (i) thirty percent (30%) of the costs set forth in the
Approved Budget for Improvements, and (ii) the Retainage applicable to the
second Advance.
2.6. CONDITIONS TO THE THIRD ADVANCE. As conditions precedent to the
third Advance hereunder, in addition to all other requirements herein,
Borrower must satisfy each of the following conditions (all of which must be
acceptable to Lender in its sole and absolute discretion):
(a) No Event of Default shall have occurred.
(b) No Incipient Default shall have occurred which shall not have been
cured to Lender's satisfaction.
(c) Borrower shall have delivered to Title Company such lien releases
and waivers and other items as may be required by Title Company to issue the
endorsement described in Section 2.6(e) below.
(d) Borrower shall have submitted to Lender an Application for Advance
and an Affidavit of Borrower in the form required by Lender.
(e) The Title Policy shall be endorsed to cover the third Advance with
no additional title exceptions objectionable to Lender and with mechanic's
lien coverage.
(f) Borrower and Contractor shall have submitted to Lender an
accounting of all costs expended to date in connection with the construction
of the Improvements and a detailed comparison of such costs to the Approved
Budget.
(g) Architect shall have certified to Lender that at least sixty
percent (60%) of the construction of the Improvements has been completed as
of the date of the Application for Advance.
(h) The maximum amount of the third Advance shall be equal to the
difference between (i) up to sixty percent (60%) of the costs set forth in
the Approved Budget for Improvements, and (ii) the
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sum of (A) the amount of the second Advance, and (B) the Retainage applicable
to the second Advance and to the third Advance.
2.7. CONDITIONS TO THE FOURTH ADVANCE. As conditions precedent to the
fourth Advance hereunder, in addition to all other requirements herein,
Borrower must satisfy each of the following conditions (all of which must be
acceptable to Lender in its sole and absolute discretion):
(a) No Event of Default shall have occurred.
(b) No Incipient Default shall have occurred which shall not have been
cured to Lender's satisfaction.
(c) Borrower shall have delivered to Title Company such lien releases
and waivers and other items as may be required by Title Company to issue the
endorsement described in Section 2.7(e) below.
(d) Borrower shall have submitted to Lender an Application for Advance
and an Affidavit of Borrower in the form required by Lender.
(e) The Title Policy shall be endorsed to cover the fourth Advance with
no additional title exceptions objectionable to Lender and with mechanic's
lien coverage.
(f) Borrower and Contractor shall have submitted to Lender an
accounting of all costs expended to date in connection with the construction
of the Improvements and a detailed comparison of such costs to the Approved
Budget.
(g) Architect shall have certified to Lender that at least ninety
percent (90%) of the construction of the Improvements has been completed as
of the date of the Application for Advance.
(h) The maximum amount of the fourth Advance shall be equal to the
difference between (i) up to ninety percent (90%) of the costs set forth in
the Approved Budget for Improvements, and (ii) the sum of (A) the amount of
the second Advance, (B) the amount of the third Advance and (C) the Retainage
applicable to the second Advance, the third Advance and the fourth Advance.
2.8. CONDITIONS TO FINAL ADVANCE. As conditions precedent to the Final
Advance, hereunder, in addition to all other requirements herein, Borrower
must satisfy each of the following conditions (all of which must be
acceptable to Lender in its sole and absolute discretion):
(a) Borrower shall have completed the construction of the Improvements.
(b) Architect shall have delivered a certification to Lender stating
that the Improvements have been completed in accordance with the Plans and
all Governmental Requirements and provided evidence of such completion to
Lender.
(c) Borrower shall have submitted to Lender an Application for Advance
and an Affidavit of Borrower in the form required by Lender.
(d) Borrower shall have delivered to Lender or Title Company final,
unconditional releases or waivers of mechanics' and materialmen's liens and
receipted bills showing payment to all parties who have furnished materials
or services or performed labor of any kind in
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connection with the construction of any of the Improvements including,
without limitation, Contractor.
(e) The Title Policy shall be endorsed to cover the Final Advance with
no additional title exceptions objectionable to Lender and with mechanic's
lien coverage.
(f) Borrower and Contractor shall have submitted to Lender an
accounting of all costs expended in connection with the construction of the
Improvements and a detailed comparison of such costs to the Approved Budget.
(g) Lender shall have received and approved the Survey.
(h) Borrower shall have delivered to Lender an unconditional final
certificate of occupancy with respect to the Property and copies of any other
licenses or permits required for the operation of the Property.
(i) In no event shall the amount of the Final Advance exceed the
difference between (i) the Principal Amount and (ii) the sum of the first
four (4) Advances. The Retainage shall be disbursed with the Final Advance.
2.9. REALLOCATION OF APPROVED BUDGET. Lender reserves the right to make
Advances which are allocated to any of the designated items in the Approved
Budget for such other purposes or in such different proportions as Lender
may, in its sole reasonable discretion, deem necessary or advisable. Borrower
may not reallocate items of cost or change the Approved Budget without the
prior written consent of Lender.
2.10. NO WAIVER. No Advance shall constitute a waiver of any
condition precedent to the obligation of Lender to make any further Advance
or preclude Lender from thereafter declaring the failure of Borrower to
satisfy such condition precedent to be an Event of Default. The making of an
Advance shall not be deemed an approval or acceptance by Lender of any work
or material theretofore completed, installed or delivered on the Property. In
the event Borrower's interest in any of the Property is transferred, Lender
may continue to make Advances to Borrower's successor in interest and all
sums so advanced shall be deemed Advances hereunder which are evidenced and
secured by the Loan Documents.
2.11. CONDITIONS PRECEDENT FOR THE BENEFIT OF LENDER. All
conditions precedent to the obligation of Lender to make any Advance are
imposed hereby solely for the benefit of Lender, and no other party may
require satisfaction of any such condition precedent or be entitled to assume
that Lender will refuse to make any Advance in the absence of strict
compliance with such conditions precedent. All requirements of this Agreement
may be waived by Lender, in whole or in part, at any time. Any requirement
herein of submission of evidence of the existence or non-existence of a fact
shall be deemed, also, to be a requirement that the fact shall exist or not
exist, as the case may be, and without waiving any condition or obligation of
Borrower, Lender may at all times independently establish to its satisfaction
such existence or non-existence.
2.12. NO OBLIGATION TO MAKE ADVANCE. Lender shall not be obligated
to make any Advance if Lender determines that such Advance will not be
secured by the Mortgage.
2.13. METHOD OF DISBURSEMENTS. Lender shall have the right to
disburse Advances in any manner deemed acceptable to Lender including,
without limitation, pursuant to two party checks naming Borrower and any
third party entitled to receive payment of any Advance.
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ARTICLE III
AGREEMENTS OF BORROWER
Borrower hereby, warrants, represents, covenants and agrees as follows:
3.1. COMPLIANCE WITH GOVERNMENTAL REQUIREMENTS. Borrower shall timely
comply with all Governmental Requirements and deliver to Lender evidence
thereof. Borrower assumes full responsibility for the compliance of the Plans
and the Property with all Governmental Requirements and with sound building
and engineering practices and, notwithstanding any approvals by Lender,
Lender shall have no obligation or responsibility whatsoever for the Plans or
any other matter incident to the Property or the construction of the
Improvements.
3.2. CONSTRUCTION OF THE IMPROVEMENTS. The construction shall be
prosecuted with diligence and continuity, in a good and workmanlike manner,
and in accordance with sound building and engineering practices, all
applicable Governmental Requirements, the Plans, the requirements herein
contained, and the requirements of any lessee, if applicable. Borrower shall
complete construction of the Improvements on or before the Completion Date,
free and clear of all liens. In the event the cost for completion of the
Improvements exceeds the amount set forth in the Approved Budget, Borrower
shall pay any such excess.
3.3. CORRECTION OF DEFECTS. Borrower shall correct or cause to be
corrected: (a) any material defect in the Improvements, (b) any material
departure in the construction of the Improvements from the Plans, the
requirements hereof, any Governmental Requirements or the requirements of any
lessee, if applicable, or (c) any encroachment by any part of the
Improvements or any other structure located on the Property on any building
line, easement, property line, or restricted area.
3.4. STORAGE OF MATERIALS. Borrower shall cause all materials supplied
for, or intended to be utilized in, the construction of the Improvements, but
not affixed to or incorporated into the Improvements or the Property, to be
stored on the Property or at such other location as may be approved by Lender
in writing, with adequate safeguards to prevent loss, theft, damage, or
commingling with other materials or projects.
3.5. INSPECTION OF THE PROPERTY. Borrower shall permit Lender, any
Governmental Authority, and their agents and representatives, to enter upon
the Property and any location where materials intended to be utilized in the
construction of the Improvements are stored for the purpose of inspection of
the Property and such materials at all reasonable times.
3.6. REQUIRED NOTICES. Borrower shall timely comply with and promptly
furnish to Lender true and complete copies of any official notice or claim by
any Governmental Authority pertaining to the Property. Borrower shall
promptly notify Lender of any fire or other casualty or any notice of taking
or eminent domain action or proceeding affecting the Property.
3.7. APPLICATION OF ADVANCES. Borrower shall disburse all Advances for
payment of costs and expenses specified in the Approved Budget, and for no
other purpose.
3.8. DIRECT DISBURSEMENT AND APPLICATION BY LENDER. Lender shall have
the right, but not the obligation, to disburse and directly apply the
proceeds of any Advance to the satisfaction of any of Borrower's obligations
hereunder. Any Advance by Lender for such purpose shall be part of the Loan
and shall be secured by the Loan Documents. Lender may advance and incur such
expenses as Lender reasonably deems necessary for the completion of
construction of the Improvements and to preserve the
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<PAGE>
Property, and any other security for the Loan, and such expenses, even though
in excess of the amount of the Loan, shall be secured by the Security
Instruments, and payable to Lender upon demand. Lender may disburse any
portion of any Advance at any time, and from time to time, to persons other
than Borrower for the purposes specified in this SECTION 3.8 and the amount
of Advances to which Borrower shall thereafter be entitled shall be
correspondingly reduced.
3.9. EXPENSES. Whether or not the transactions contemplated under this
Agreement and the other Loan Documents shall be consummated, Borrower shall
pay all reasonable expenses, including, without limitation, all attorney's
fees, in connection with such transactions, including, without limitation,
(a) the costs and expenses of preparation of this Agreement and of any other
document or instrument Lender reasonably considers necessary or appropriate
with respect to the Loan, (b) the costs and expenses of or incident to the
enforcement or performance of or compliance with any of the provisions of
this Agreement or any agreement or condition contained in any other document
or instrument required by Lender, (c) the costs and expenses of any persons
utilized by Lender in connection with the inspection, from time to time, of
the construction of the Improvements, and (d) and any other reasonable costs
and expenses related to the transactions contemplated under this Agreement.
3.10. ADDITIONAL ACTS. In addition to the acts recited herein and
contemplated to be performed, executed or delivered by Borrower, Borrower
hereby agrees, at any time, and from time to time, to perform, execute and
deliver to Lender any and all such further acts, additional instruments, or
further assurances as may be necessary or proper to (i) implement the intent
of the parties under this Agreement; (ii) correct any errors in this
Agreement or any other instrument relating thereto; (iii) assure Lender a
valid and direct first lien and prior first perfected security interest under
the Loan Documents or any of them on the Property; (iv) create, perfect,
preserve, maintain and protect the liens and security interests created or
intended to be created by the Loan Documents; and (v) provide the rights and
remedies to Lender granted or provided for by the Loan Documents.
3.11. INSPECTION OF BOOKS AND RECORDS. Borrower shall permit Lender, at
all reasonable times, to examine and copy the books and records of Borrower
pertaining to the Loan and the Property, and all contracts, statements,
invoices, bills, and claims for labor, materials, and services supplied for
the construction of the Improvements.
3.12. NO LIABILITY OF LENDER. Lender shall have no liability,
obligation, or responsibility whatsoever with respect to the construction of
the Improvements except to advance the Loan pursuant to this Agreement.
Lender shall not be obligated to inspect the Property or the construction of
the Improvements, nor be liable for the performance or default of Borrower,
Contractor, or any other party, or for any failure to construct, complete,
protect, or insure the Improvements, or for the payment of costs of labor,
materials, or services supplied for the construction of the Improvements, or
for the performance of any obligation of Borrower whatsoever. Nothing,
including, without limitation, any Advance or acceptance of any document or
instrument, shall be construed as a representation or warranty, express or
implied, to any party by Lender.
3.13. NO CONDITIONAL SALE CONTRACTS, ETC. No materials, equipment, or
fixtures shall be supplied, purchased, or installed for the construction or
operation of the Improvements pursuant to security agreements, conditional
sale contracts, lease agreements, or other arrangements or understandings
whereby a security interest or title is retained by any party or the right is
reserved or accrues to any party to remove or repossess any materials,
equipment, or fixtures intended to be utilized in the construction or
operation of the Improvements.
3.14. DEFENSE OF ACTIONS. Lender may (but shall not be obligated to)
commence, appear in,
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or defend any action or proceeding purporting to affect the Loan, the
Property, or the respective rights and obligations of Lender and Borrower
pursuant to this Agreement. Lender may (but shall not be obligated to) pay
all reasonable expenses, including reasonable attorneys' fees and expenses
incurred in connection with such proceedings or actions, which Borrower
agrees to repay to Lender upon demand.
3.15. PAYMENT OF CLAIMS. Borrower shall promptly pay or cause to be
paid when due all costs and expenses incurred in connection with the Property
and the construction of the Improvements, and Borrower shall keep the
Property free and clear of any liens, charges, or claims other than the lien
of the Mortgage and other liens approved in writing by Lender.
3.16 COMPLETION DEPOSIT. If, in the good faith judgment of Lender, it
appears at any time or from time that the unadvanced loan proceeds will be
insufficient to pay all costs to be incurred in connection with the
completion of the construction of the Improvements, then Borrower shall
immediately deposit, or shall make arrangements satisfactory to Lender to
deposit with Lender an amount equal to such deficiency (the "Completion
Deposit"). The Completion Deposit may be retained by Lender in a non-interest
bearing account, need not be segregated from any of Lender's other funds and
may be disbursed in accordance with the provisions of the Loan Documents by
Lender before making any further advances on the Loan.
3.17 AUTOMATIC CASH HANDLING ARRANGEMENT. Borrower shall execute and
deliver to Lender, from time to time at Lender's request, forms to authorize
Lender to withdraw monies from Borrower's bank account under an electronic
funds transfer, automatic cash handling, or similar arrangement, as such
monies are due and payable under the Note or the other Loan Documents.
Borrower shall cause sufficient funds to be available in such bank account to
allow Lender to withdraw amounts on and after the due date therefor.
ARTICLE IV
RIGHTS AND REMEDIES OF LENDER
4.1. RIGHTS OF LENDER. Upon the occurrence of an Event of Default,
Lender shall have the right, in addition to any other right or remedy of
Lender, but not the obligation, in its own name or in the name of Borrower,
to (a) enter into possession of the Property, (b) perform all work necessary
to complete the construction of the Improvements substantially in accordance
with the Plans (as they may be changed by Lender if it deems a change in the
Plans to be beneficial), Governmental Requirements, and the requirements of
any lessee, if applicable, (c) employ watchmen and other safeguards to
protect the Property, and (d) disburse funds for the payment of costs and
expenses incurred by Lender in connection with the foregoing. Without
limitation of the foregoing, and without any liability to Borrower
whatsoever, Lender shall have the right to disburse such sums to contractors,
engineers, architects, suppliers and other third parties (including Architect
and Contractor) as Lender may deem necessary to complete the construction of
the Improvements. Borrower hereby irrevocably appoints Lender as the
attorney-in-fact of Borrower, with full power of substitution, and in the
name of the Borrower, if Lender elects to do so, upon the occurrence of an
Event of Default, to (i) use such sums as are necessary, including any
proceeds of the Loan, make such changes or corrections in the Plans, and
employ such architects, engineers, and contractors as may be required for the
purpose of completing the construction of the Improvements substantially in
accordance with the Plans (as they may be changed by Lender if it deems a
change in the Plans to be beneficial) and Governmental Requirements, (ii)
execute all applications and certificates in the name of Borrower which may
be required for completion of construction of the Improvements, (iii) endorse
the name of Borrower on any checks or drafts representing proceeds of the
insurance policies or other checks or instruments
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<PAGE>
payable to Borrower with respect to the Property, (iv) do every act with
respect to the construction of the Improvements which Borrower may do, and
(v) prosecute or defend any action or proceeding incident to the Property.
Lender shall have no obligation to undertake any of the foregoing actions,
and if Lender should do so, it shall have no liability to Borrower for the
sufficiency or adequacy of any such actions taken by Lender. Borrower's
appointment of Lender as Borrower's attorney-in-fact is coupled with an
interest and will survive any disability of Borrower.
4.2. CESSATION OF ADVANCES. During the existence of an Incipient
Default, Lender may suspend any futher Advances. Upon the occurrence of an
Event of Default, the obligation of Lender to disburse the Loan and all other
obligations of Lender hereunder shall, at Lender's option, immediately
terminate.
4.3. FUNDS OF LENDER. Any funds of Lender used for any purpose referred
to in this Article IV shall constitute Advances secured by the Loan Documents
and shall bear interest at the rate specified in the Note to be applicable
after default or maturity thereunder.
4.4. NO WAIVER OR EXHAUSTION. No waiver by Lender of any of its rights
or remedies hereunder, in the other Loan Documents, or otherwise, shall be
considered a waiver of any other or subsequent right or remedy of Lender; no
delay or omission in the exercise or enforcement by Lender of any rights or
remedies shall ever be construed as a waiver of any right or remedy of
Lender; and no exercise or enforcement of any such rights or remedies shall
ever be held to exhaust any right or remedy of Lender.
4.5. OTHER REMEDIES. After the occurrence of an Event of Default, in
addition to the rights and remedies described in this Agreement, Lender shall
have the right to exercise any and all rights and remedies provided in the
Loan Documents or otherwise available at law or in equity.
ARTICLE V
DISCLAIMERS AND INDEMNITIES
5.1 EXCULPATION.
(a) Lender has no liability or obligation whatsoever or howsoever in
connection with the construction or completion of the Improvements or work
performed thereon, and has no obligation except to advance the Loan proceeds
as herein agreed, and Lender is not obligated to inspect the Improvements;
nor is Lender liable and under no circumstances whatsoever shall Lender be or
become liable for the performance or default of any contractor or
subcontractor, or for any failure to construct, complete, protect or insure
the Improvements, or any part thereof, or for the payment of any cost or
expense incurred in connection therewith, or for the performance or
non-performance of any obligation of Borrower or Guarantor to Lender or to
any other person, firm or entity without limitation; and nothing, including
without limitation, any disbursement of Loan proceeds or acceptance of any
document or instrument, shall be construed as a representation or warranty,
express or implied, on Lender's part. Further, Borrower shall be solely
responsible for all aspects of Borrower's business and conduct in connection
with the construction, completion and rearrangement of the Improvements,
including, but not limited to:
(i) Supervision of the work of construction;
(ii) The qualifications, financial condition and performance of all
architects, engineers, contractors, subcontractors and material suppliers and
consultants;
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<PAGE>
(iii) Conformance of the work of construction and the Improvements to
the requirements of all applicable public and private restrictions and
requirements and to the requirements of this Agreement;
(iv) The quality and suitability of all materials and workmanship; and
(v) The accuracy of all requests for the disbursement of Loan proceeds
and the proper application of disbursed Loan proceeds.
(b) Lender shall have no obligation to supervise, inspect or inform
Borrower or any third party of any aspect of the work or construction of the
Improvements or any other matter referred to above. Any inspection or review
made by Lender shall be made for the purpose of determining whether or not
the obligations of Borrower under this Agreement are being properly
discharged, and neither Borrower nor any third party shall be entitled to
rely upon any such inspection or review.
(c) Lender owes no duty of care to Borrower or any third person to
protect against or inform Borrower or any third person of the existence of
negligent, faulty, inadequate or defective design or construction of the
Improvements.
5.2 ROLE OF LENDER. Any term or condition hereof or of any of the
other Loan Documents to the contrary notwithstanding, Lender shall not have,
and by its execution and acceptance of this Agreement hereby expressly
disclaims, any obligation or responsibility for the management, conduct or
operation of the Improvements or business and affairs of Borrower or of
Guarantor, and any term or condition hereof or of any of the Loan Documents,
permitting Lender to disburse funds, whether from the proceeds of the Loan or
otherwise, or to take or refrain from taking any action with respect to
Borrower, the Guarantor, the Improvements or any other collateral, shall be
deemed to be solely to permit Lender to audit and review the management,
operation and conduct of the business and affairs of Borrower and of
Guarantor, and to maintain and preserve the security given by Borrower to
Lender, and may not be relied upon by any other person. Further, Lender shall
not have, has not assumed, and by its execution and acceptance of this
Agreement hereby expressly disclaims any liability or responsibility for the
payment or performance of any indebtedness or obligation of Borrower or of
Guarantor and no term or condition hereof or of any of the other Loan
Documents, shall be construed otherwise.
5.3 INDEMNITY.
(a) BORROWER AGREES TO DEFEND, PROTECT, INDEMNIFY AND HOLD HARMLESS
LENDER, ITS AFFILIATES, AND EACH OF THEIR RESPECTIVE (INCLUDING SUCH
AFFILIATES') OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, ATTORNEYS, SHAREHOLDERS
AND CONSULTANTS (INCLUDING, WITHOUT LIMITATION, THOSE RETAINED IN CONNECTION
WITH THE SATISFACTION OR ATTEMPTED SATISFACTION OF ANY OF THE CONDITIONS SET
FORTH HEREIN) OF EACH OF THE FOREGOING (COLLECTIVELY, "INDEMNITEES") FROM AND
AGAINST ANY AND ALL LIABILITIES, OBLIGATIONS, LOSSES, DAMAGES, PENALTIES,
ACTIONS, JUDGMENTS, SUITS, CLAIMS, COSTS, EXPENSES AND DISBURSEMENTS OF ANY
KIND OR NATURE WHATSOEVER (INCLUDING, WITHOUT LIMITATION, THE REASONABLE FEES
AND DISBURSEMENTS OF COUNSEL FOR SUCH INDEMNITEES IN CONNECTION WITH ANY
INVESTIGATIVE, ADMINISTRATIVE OR JUDICIAL PROCEEDING, WHETHER OR NOT SUCH
INDEMNITEES SHALL BE DESIGNATED A PARTY THERETO OR SUCH PROCEEDING SHALL HAVE
ACTUALLY BEEN INSTITUTED), IMPOSED ON, INCURRED BY, OR ASSERTED AGAINST SUCH
INDEMNITEES (WHETHER DIRECT, INDIRECT OR CONSEQUENTIAL AND WHETHER BASED ON
ANY FEDERAL, STATE, OR LOCAL LAWS AND REGULATIONS, UNDER COMMON LAW OR AT
EQUITABLE CAUSE, OR ON CONTRACT, TORT OR OTHERWISE), ARISING FROM OR
CONNECTED (i) WITH THE FAILURE OF BORROWER TO FULLY AND TIMELY PAY THE LOAN
AND EACH PORTION THEREOF (WHETHER SUCH LIABILITIES, OBLIGATIONS, LOSSES,
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DAMAGES, PENALTIES, ACTIONS, JUDGMENTS, SUITS, CLAIMS, COSTS, EXPENSES OR
DISBURSEMENTS ARISE BY REASON OF ANY PAST, PRESENT OR FUTURE GUARANTY OF ALL
OR ANY PORTION OF THE LOAN WHICH MAY AT ANY TIME BE EXECUTED AND DELIVERED BY
ANY INDEMNITEE, OR OTHERWISE), (ii) WITH THE PAST, PRESENT, OR FUTURE
OPERATIONS OF BORROWER, ANY AFFILIATE OR ANY PREDECESSORS IN INTEREST, (iii)
WITH THE PAST, PRESENT OR FUTURE ENVIRONMENTAL CONDITION OF THE LAND, OR (iv)
IN ANY WAY RELATING TO OR ARISING OUT OF THIS AGREEMENT, THE OTHER LOAN
DOCUMENTS, OR ANY ACT, EVENT OR TRANSACTION OR ALLEGED ACT, EVENT OR
TRANSACTION RELATING OR ATTENDANT THERETO, INCLUDING IN CONNECTION WITH, OR
AS A RESULT, IN WHOLE OR IN PART, OF NY NEGLIGENCE OF LENDER, OR THE USE OR
INTENDED USE OF THE PROCEEDS OF THE LOAN HEREUNDER, OR IN CONNECTION WITH ANY
INVESTIGATION OF ANY POTENTIAL MATTER COVERED HEREBY, OR ARISING FROM THE
VIOLATION OR ALLEGED VIOLATION OF ANY GOVERNMENTAL REQUIREMENTS BUT EXCLUDING
ANY CLAIM OR LIABILITY THAT ARISES AS THE RESULT OF (A) THE GROSS NEGLIGENCE
OR WILLFUL MISCONDUCT OF ANY INDEMNITEE, AS FINALLY JUDICIALLY DETERMINED BY
A COURT OF COMPETENT JURISDICTION, AND (B) THE ACT, OMISSION, EVENT OR
CIRCUMSTANCES (INCLUDING, WITHOUT LIMITATION, A VIOLATION OF ANY GOVERNMENTAL
REQUIREMENTS) TAKEN, OR CAUSED, SOLELY BY LENDER AT ANY TIME AFTER LENDER
TAKES POSSESSION OF, OR OTHERWISE FORECLOSES UPON, THE LAND, AND EXCLUDING
MATTERS RAISED BY ANY SHAREHOLDERS OF LENDER AGAINST LENDER OR ITS MANAGEMENT
(COLLECTIVELY, "INDEMNIFIED MATTERS"). EACH INDEMNITEE SHALL BE A THIRD PARTY
BENEFICIARY OF THE PROVISIONS OF THIS SECTION 5.3 AND SHALL BE ENTITLED TO
ENFORCE THE PROVISIONS HEREOF, WHICH PROVISIONS MAY NOT BE AMENDED TO AFFECT
THE RIGHTS OF ANY INDEMNITEE WITHOUT THE JOINDER OF SUCH INDEMNITEE.
(b) IN ADDITION, BORROWER SHALL PERIODICALLY, UPON REQUEST, REIMBURSE
EACH INDEMNITEE FOR ITS REASONABLE LEGAL AND OTHER ACTUAL EXPENSES (INCLUDING
THE COST OF ANY INVESTIGATION AND PREPARATION) INCURRED IN CONNECTION WITH
ANY INDEMNIFIED MATTER. THE REIMBURSEMENT, INDEMNITY AND CONTRIBUTION
OBLIGATIONS UNDER THIS SECTION SHALL BE IN ADDITION TO ANY LIABILITY WHICH
BORROWER MAY OTHERWISE HAVE, SHALL EXTEND UPON THE SAME TERMS AND CONDITIONS
TO EACH INDEMNITEE, AND SHALL BE BINDING UPON AND INURE TO THE BENEFIT OF ANY
SUCCESSORS, ASSIGNS, HEIRS AND PERSONAL REPRESENTATIVES OF BORROWER, LENDER,
AND ALL OTHER INDEMNITEES. THE OBLIGATIONS OF THE BORROWER UNDER THIS SECTION
5.3 SHALL SURVIVE (i) THE EXECUTION OF THIS AGREEMENT AND (ii) ANY
TERMINATION OF THIS AGREEMENT AND PAYMENT OF THE LOAN.
ARTICLE VI
GENERAL TERMS AND CONDITIONS
6.1 NOTICES. All notices, demands, requests, and other communications
required or permitted hereunder shall be in writing and shall be deemed to
have been given and received when presented personally or forty-eight (48)
hours after being deposited in a regularly maintained receptacle for the
United States Postal Service, postage prepaid, registered or certified,
return receipt requested, addressed to Borrower or Lender, as the case may
be, at the respective addresses set forth on the first page of this
Agreement, or such other address as Borrower or Lender may from time to time
designate by written notice to the other as herein required.
6.2 MODIFICATIONS. No provision of this Agreement or the other Loan
Documents may be modified, waived, or terminated except by instrument in
writing executed by the party against whom a modification, waiver, or
termination is sought to be enforced.
6.3 SEVERABILITY. In case any of the provisions of this Agreement
shall for any reason be held to be invalid, illegal, or unenforceable, such
invalidity, illegality, or unenforceability shall not affect any other
provision hereof, and this Agreement shall be construed as if such invalid,
illegal, or unenforceable provision had never been contained herein.
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<PAGE>
6.4 ELECTION OF REMEDIES. Lender shall have all of the rights and
remedies granted in the Loan Documents and available at law or in equity, and
these same rights and remedies shall be cumulative and may be pursued
separately, successively, or concurrently against Borrower, any Guarantor, or
any property covered by the Loan Documents at the sole discretion of
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<PAGE>
Lender. The exercise of, or failure to exercise, any of the same shall not
constitute a waiver or release thereof or of any other right or remedy, and
the same shall be nonexclusive.
6.5 FORM AND SUBSTANCE. All documents, certificates, insurance
policies, and other items required under this Agreement to be executed or
delivered to Lender shall be in form and substance satisfactory to Lender.
6.6 CONTROLLING AGREEMENT. All agreements between Borrower and Lender,
whether now existing or hereafter arising and whether written or oral, are
hereby limited so that in no contingency, whether by reason of demand or
acceleration of the maturity of the Note or otherwise, shall the interest
contracted for, charged, received, paid or agreed to be paid to Lender exceed
the maximum amount permissible under applicable law. If, from any
circumstance whatsoever, interest would otherwise be payable to Lender in
excess of the maximum lawful amount, the interest payable to Lender shall be
reduced to the maximum amount permitted under applicable law; and if, from
any circumstance whatsoever, Lender shall ever receive anything of value
deemed interest by applicable law in excess of the maximum lawful amount, an
amount equal to any excessive interest shall be applied to the reduction of
the principal of the Loan and not to the payment of interest, or if such
excessive interest exceeds the unpaid balance of principal of the Loan, such
excess shall be refunded to Borrower. All interest paid or agreed to be paid
to Lender shall, to the extent permitted by applicable law, be amortized,
prorated, allocated and spread throughout the full period until payment in
full of the principal so that the interest on the Loan for such full period
shall not exceed the maximum amount permitted by applicable law. This section
shall control all agreements between Borrower and Lender.
6.7 NO THIRD PARTY BENEFICIARY. This Agreement is for the sole benefit
of Lender, its successors and assigns, and Borrower, its permitted successors
and assigns, and is not for the benefit of any third party, except as
specifically provided in Section 5.3 hereof.
6.8 NUMBER AND GENDER. Whenever used herein the singular number shall
include the plural and the singular, and the use of any gender shall be
applicable to all genders. The duties, covenants, obligations, and warranties
of Borrower in this Agreement shall be joint and several obligations of
Borrower, and of each Borrower (if more than one person or entity is
identified as Borrower on the first page hereof).
6.9 CAPTIONS. The captions, headings, and arrangements used in this
Agreement are for convenience only and do not in any way affect, limit,
amplify, or modify the terms and provisions hereof.
6.10 APPLICABLE LAW. This Agreement and the Loan Documents shall be
governed by and construed in accordance with the laws of the Applicable State
and the laws of the United States applicable to transactions within such
state.
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6.11 SUCCESSORS AND ASSIGNS. The covenants and agreements herein
contained shall bind, and the rights hereunder shall inure to, the respective
heirs, successors and permitted assigns of Lender and Borrower.
EXECUTED AND DELIVERED as of the Effective Date.
LENDER:
SCHLOTZSKY'S REAL ESTATE, INC.
a Texas corporation
By:
--------------------------------
Name:
------------------------------
Title:
-----------------------------
BORROWER:
- - -----------------------------------
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EXHIBIT A
DESCRIPTION OF LAND
19
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ASSIGNMENT OF NOTE AND LIEN
"EFFECTIVE DATE:" _____________ __, 1999
"INVESTOR:" __________________________,
a __________ _____________
"INVESTOR'S ADDRESS:" __________________________
__________________________
"BORROWER:" __________________________
"GUARANTORS:" __________________________
"PRINCIPAL AMOUNT:" $_________________________
"LOAN DATE:" ____________ __, 1999
Schlotzsky's Real Estate, Inc., a Texas corporation (the "Lender"), the
present legal and equitable owner and holder of that one certain Promissory
Note (the "Note") in the Principal Amount dated the Loan Date executed by the
Borrower payable to the order of the Lender, for a good and valuable
consideration paid to the undersigned, the receipt and sufficiency of which
is hereby acknowledged, has TRANSFERRED and ASSIGNED, GRANTED and CONVEYED
and by these presents TRANSFERS, ASSIGNS, GRANTS and CONVEYS unto the
Investor, at Investor's Address, all of Lender's right, title, and interest
in the following documents (collectively the "Transaction Documents"):
A. The Note;
B. That certain mortgage or deed of trust (the "Mortgage") of even date
with the Note, executed by the Borrower, covering the property described on
Exhibit A attached and being duly recorded;
C. Guaranty by Guarantors in favor of Lender of even date with the Note.
D. Loan Agreement between Borrower and Lender of even date with the Note.
This Assignment of Note and Lien is made and accepted without recourse or
warranties, express or implied, by or upon the undersigned, except as
specifically set forth herein. Lender hereby represents and warrants to
Investor as follows:
1. Each of the Transaction Documents to which Lender is a party has been duly
and validly authorized, executed and delivered by Lender; is in full force
and effect; and constitutes the legal, valid and binding obligation of
Lender, enforceable in accordance with its respective terms, except as
limited by applicable bankruptcy, insolvency, reorganization, moratorium or
similar laws affecting the enforcement of creditors rights generally and
general principles of equity.
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<PAGE>
2. No default or event which, with the giving of notice or lapse of time or
both, would become a default has occurred under the Transaction Documents.
3. The Transaction Documents delivered to Investor by Lender constitute the
entire agreement of the parties with respect to the subject matter thereof.
4. Lender has not heretofore assigned or pledged its interest in the Note or
Mortgage, and the Mortgage on subject premises is a first lien free and
clear of any and all encumbrances.
5. All required payments under the Note have been made in a timely manner.
6. There have been no prepayments under the Note.
7. Lender has delivered to Investor the sole original copy of the Note and
Mortgage.
8. The Note and Mortgage comply with all applicable laws and regulations.
9. Lender has made all disclosures to the Borrower required by law, and all
sales, use and personal property taxes related to the Note and Mortgage
have been paid in full as required by law.
10. All parties to the Note and Mortgage had full capacity to contract and all
signatures of such parties are genuine.
11. Lender has fully performed all terms, covenants and conditions required on
its part under the Note and Mortgage.
12. Upon request, Lender will execute such documents as Investor may reasonably
request in furtherance of the foregoing.
13. The execution by Lender of the Transaction Documents and its participation
in the subject transaction is in its ordinary course of business and within
the scope of its existing corporate authority.
14. There is no action, suit or proceeding pending against Lender before or by
any court, administrative agency or other governmental authority which
brings into question the validity of, or might in any way, impair the
execution, delivery or performance by Lender of this Assignment of Note
and Lien or the Transaction Documents.
15. No approval of, or consent from, any governmental authorities is required
for the execution, delivery or performance by Lender of any of Transaction
Documents.
16. The execution, delivery and performance by Lender of this Assignment of
Note and Lien and the Transaction Documents and the transactions
contemplated hereby and thereby do not contravene any provisions of law
applicable to Lender and do not conflict and are not inconsistent with,
and will not result (with or without the giving of notice or passage of
time, or both) in the breach of or constitute a default or require any
consent under, or result in the creation of any lien, charge or encumbrance
upon the
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Note or Mortgage under any credit agreement, indenture, mortgage,
purchase agreement, deed of trust, security agreement, lease, guaranty or
other instrument to which Lender is a party or by which Lender may be
bound, or to which Lender or its property may be subject, or under
Lender's by-laws.
Investor shall have full recourse to Lender for breach of any of the
foregoing representations, covenants, and warranties and such recourse shall
survive the execution of this Assignment of Note and Lien.
EXECUTED as of the Effective Date.
SCHLOTZSKY'S REAL ESTATE, INC.
By:
---------------------------------
Name:
-------------------------------
Title:
------------------------------
STATE OF TEXAS )
)
COUNTY OF TRAVIS )
This instrument was acknowledged before me on this the ___ day of _________,
____, by _______________ , __________________ of Schlotzsky's Real Estate,
Inc., a Texas corporation, on behalf of said corporation.
------------------------------------
Notary Public, State of Texas
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<PAGE>
EXHIBIT A
LEGAL DESCRIPTION
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<PAGE>
LIMITED GUARANTY
(SECONDARY FRANCHISEE)
"EFFECTIVE DATE:" ______________ __, 1999
"INVESTOR:" _____________________,
a _________ __________
"BORROWER:" _____________________
"OTHER GUARANTORS:" _____________________
"PRINCIPAL AMOUNT:" $ _____________________
"LOAN DATE:" ______________ __, ____
"APPLICABLE STATE:" _____________________
THIS LIMITED GUARANTY ("Limited Guaranty") is made as of the Effective Date
by SCHLOTZSKY'S, INC., a Texas corporation (hereinafter "Guarantor") in favor of
Investor.
R E C I T A L S:
A. Investor has agreed to purchase from Schlotzsky's Real Estate, Inc., a
Texas corporation (hereinafter "SREI") a loan made by SREI to Borrower in the
Principal Amount (the "Loan"), evidenced by a promissory note dated the Loan
Date (the "Note"), secured by a mortgage or deed of trust (the "Mortgage") and
other security instruments of even date therewith, and guaranteed by the Other
Guarantors by a Guaranty (the "Guaranty") of even date therewith (the Note, the
Mortgage, the Guaranty and all other documents executed by Borrower in
connection with the Loan including, without limitation, a certain Certificate
and Indemnity Agreement Regarding Hazardous Substances, are collectively called
the "Loan Documents").
B. As a condition precedent to purchasing the Loan, Investor requires the
execution of this Limited Guaranty by Guarantor and Investor will be relying on
this Limited Guaranty in purchasing the Loan.
In consideration of Investor's purchasing the Loan, and as an inducement to
Investor to do so, Guarantor hereby agrees, warrants and covenants as follows:
1. Guarantor hereby unconditionally, irrevocably and absolutely
guarantees without demand by Investor the full and prompt payment when due,
whether by acceleration or otherwise, of the entire amount of principal and
accrued interest on the Note (other than any prepayment premium or penalty);
provided, however, that (a) Guarantor's liability hereunder shall not exceed the
amount of the Guaranty Limit (as defined in Section 16 hereof), and (b)
Guarantor shall have no further obligations hereunder and this Limited Guaranty
shall terminate as provided in Section 16 hereof. It is expressly understood
that this Limited Guaranty covers (without limitation, but subject to the
Guaranty Limit) all interest and default interest that would
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have accrued under the Note but for the commencement of a case under the
Federal Bankruptcy Code or any other similar federal or state law. All of
the indebtedness, obligations and liabilities described in this paragraph are
referred to herein, subject to the Guaranty Limit, as the "Guaranteed
Obligations." This Limited Guaranty is a guaranty of payment and not merely
of collection, and Guarantor hereby waives all rights which Guarantor may
have, if any, to require that any action be brought against Borrower (or any
other person or entity) or to require that resort be first made against any
security provided under the Loan Documents prior to demanding and/or
enforcing payment or performance hereunder.
2. This Limited Guaranty shall take effect when received by Investor
without the necessity of any acceptance by Investor or of any notice to
Guarantor or to Borrower, shall be continuing and irrevocable, and shall remain
in full force and effect (unless earlier terminated as provided in Section 1
above) until the Guaranteed Obligations are fully and finally paid. If payment
is made by Borrower, whether voluntarily or otherwise, or by any third party, on
the Guaranteed Obligations and thereafter Investor is forced to remit, rescind
or restore the amount of that payment under any federal or state bankruptcy law
or law for the relief of debtors, or for any other reason, (a) the amount of
such payment shall be considered to have been unpaid at all times for the
purposes of enforcement of this Limited Guaranty, (b) the obligations of
Borrower guarantied herein shall be automatically reinstated to the extent of
such payment, and (c) Guarantor will, on demand, indemnify Investor and hold
Investor harmless from all losses and all reasonable costs and expenses,
including legal fees, incurred by Investor in connection with such remission,
rescission or restoration up to (but not exceeding) an amount equal to the
difference between the Guaranty Limit and all amounts paid under this Limited
Guaranty by Guarantor.
3. The obligations of Guarantor hereunder are separate and independent of
the obligations of Borrower. This Limited Guaranty shall be fully enforceable
against Guarantor notwithstanding any determination that the Loan Documents, or
any part thereof, are not enforceable against Borrower for any reason.
Guarantor expressly agrees that a separate action may be brought against
Guarantor on this Limited Guaranty whether or not Borrower is joined in such
action.
4. Guarantor represents, warrants, and covenants to Investor
that Guarantor has derived or expects to derive financial and other advantages
and benefits, directly or indirectly, from the making of this Limited Guaranty;
(b) Investor shall have no obligation to disclose to Guarantor any information
or documents (financial or otherwise) heretofore or hereafter acquired by
Investor in the course of its relationship with Borrower; and (c) this Limited
Guaranty constitutes the entire agreement between Investor and Guarantor
regarding the Guaranteed Obligations.
5. Guarantor hereby agrees that Investor may without further consent or
disclosure and without affecting or releasing the obligations of Guarantor
hereunder: (a) surrender, exchange, release, assign, or sell any collateral or
waive, release, assign, sell, or subordinate any security interest, in whole or
in part; (b) waive, delay the exercise of, release, compromise, or grant
indulgences in respect of any rights or remedies of Investor against Borrower or
any surety or guarantor (including, without limitation, rights or remedies of
Investor against Guarantor under this Limited Guaranty); (c) waive or delay the
exercise of any rights or remedies of Investor in respect of any collateral or
security interest now or hereafter held; (d) renew, extend, waive, extend,
accelerate, or modify the terms of any Guaranteed Obligation or the obligations
of any surety or guarantor, including, without limitation, changes
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to the rate of interest, or any instrument or agreement (including, without
limitation, the Loan Documents) evidencing or relating to the same; (e)
realize on any security interest, judicially or nonjudicially, with or
without preservation of a deficiency judgment; or (f) adjust, compromise or
receive less than the amount due upon any collateral or the Guaranteed
Obligations, and enter into any accord and satisfaction or novation agreement
with respect to the same as Investor shall deem advisable.
6. Guarantor waives notice of (a) Investor's acceptance of this Limited
Guaranty and its intention to act or its actions in reliance hereon; (b) the
present existence or future incurring of any Guaranteed Obligations or any terms
or amounts thereof or any change therein; (c) any default by Borrower or any
surety or guarantor; (d) the obtaining of any guaranty or surety agreement (in
addition to this Limited Guaranty); (e) the obtaining of any pledge, assignment
or other security for any Guaranteed Obligations; (f) the release of Borrower or
any surety or guarantor; (g) the release of any collateral; (h) any change in
Borrower's business or financial condition; (i) any renewal, extension or
modification of the term of any Guaranteed Obligation or of the obligations or
liabilities of any surety or guarantor or of any instruments or agreements
evidencing the same; (j) any acts or omissions of Investor consented to in
Section 5 hereof; and (k) any other demands or notices whatsoever with respect
to the Guaranteed Obligations or this Limited Guaranty. Guarantor further
waives notice of presentment, demand, protest, notice of nonpayment, notice of
intent to accelerate, and notice of protest in relation to any instrument or
agreement evidencing any Guaranteed Obligation.
7. Guarantor expressly waives any and all rights and defenses arising by
reason of (a) any "one-action" or "anti-deficiency" law or any other law which
may prevent Investor from bringing any action, including a claim for deficiency
against Guarantor, before or after Investor's commencement or completion of any
foreclosure action, either judicially or by exercise of a power of sale; (b) any
election of remedies by Investor which destroys or otherwise adversely affects
the subrogation rights of Guarantor or the rights of Guarantor to proceed
against Borrower for reimbursement, including without limitation any loss of
rights Guarantor may suffer by reason of any law limiting, qualifying, or
discharging the Guaranteed Obligations; (c) any disability or defense of
Borrower, of any other guarantor, or of any other person, or by reason of the
cessation of Borrower's liability from any cause whatsoever, other than full and
final payment in legal tender of the Guaranteed Obligations; or (d) any right to
claim discharge of the Guaranteed Obligations on the basis of unjustified
impairment of any collateral for the Guaranteed Obligations. Guarantor further
waives (x) any right to cause a marshalling of Borrower's assets, (y) all rights
of set-off and counterclaims. Guarantor agrees that Investor may proceed
against any collateral securing the Guaranteed Obligations by way of either
judicial or nonjudicial foreclosure. Guarantor understands that a nonjudicial
foreclosure of any deed of trust securing the Guaranteed Obligations could
impair or eliminate any subrogation or reimbursement rights Guarantor may have
against Borrower, nevertheless Guarantor hereby waives and relinquishes any
defense based upon the loss of any such reimbursement or subrogation rights or
any other defense which may otherwise arise therefrom and any defense that may
arise out of election of remedies, discharge or satisfaction of the Guaranteed
Obligations. In the event any such deed of trust is foreclosed judicially or
nonjudicially, the liability of Guarantor under this Limited Guaranty shall be
that portion of the Guaranteed Obligations (not to exceed the Guaranty Limit)
representing a deficiency resulting from a judicial or nonjudicial sale, i.e.,
the difference between the amount due and owing on the Guaranteed Obligations on
the day of the foreclosure sale and the amount of the successful bid at any such
judicial or nonjudicial foreclosure sale. Guarantor hereby waives the right to
object to the amount which may be bid by Investor at such foreclosure sale.
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8. No act or omission of any kind or at any time on the part of Investor
with respect to any matter whatsoever shall in any way affect or impair this
Limited Guaranty, it being the intention hereof that Guarantor shall remain
liable as principal on the Guaranteed Obligations (not to exceed the Guaranty
Limit) notwithstanding any act, omission or event which might, but for the
provisions hereof, otherwise operate as a legal or equitable discharge of
Guarantor. Guarantor hereby waives all defenses of a surety to which they may
be entitled by statute or otherwise.
9. Guarantor acknowledges that Investor may obtain other guaranties and
collateral to secure the repayment of the Guaranteed Obligations. Guarantor
represents and warrants to Investor, however, that in making this Limited
Guaranty it is not relying upon Investor's obtaining any guaranty agreements
(other than the Guaranty) or any collateral pledged or assigned to secure
repayment of the Guaranteed Obligations. Guarantor specifically acknowledges
that Investor's obtaining any such guaranty agreements (other than the Guaranty)
or collateral is not a condition to the enforcement of this Limited Guaranty.
If Investor should simultaneously or hereafter elect to attempt to take
additional guaranty agreements or collateral to secure repayment of the
Guaranteed Obligations and if its efforts to do so should fail in any respect
including, without limitation, a determination that the agreement purporting to
provide such additional guaranty or security interest is invalid or
unenforceable for any reason, this Limited Guaranty shall, nonetheless, remain
in full force and effect.
10. This Limited Guaranty shall inure to the benefit of Investor, and
Investor's successors and assigns, and shall be binding upon Guarantor and its
successors and assigns. Investor may, with written notice to Guarantor, sell,
assign or transfer the Note, with or without any security therefor, and in that
event each and every immediate and successive assignee, transferee or holder of
all or any part of the Loan and the Note shall have the right to enforce this
Limited Guaranty, by suit or otherwise, for the benefit of such assignee,
transferee or holder as though such parties were herein by name specifically
given those rights, powers and benefits.
11. Guarantor agrees to pay all costs and expenses which may be incurred
by Investor in the enforcement of this Limited Guaranty, including reasonable
attorneys' fees and including all costs and reasonable attorneys' fees incurred
in any bankruptcy or insolvency proceeding involving Guarantor or on appeal to
one or more appellate courts.
12. This Limited Guaranty shall be governed by and construed and enforced
under the laws of the Applicable State.
13. No delay on the part of Investor in exercising any right, power or
privilege under this Limited Guaranty shall operate as a waiver of any such
right, power or privilege, nor shall any exercise or waiver of any privilege or
right preclude any other or further exercise of such privilege or right or the
exercise of any other right, power or privilege. All of Investor's rights and
remedies shall be cumulative. In the event Investor in its sole discretion
elects to give notice of any action with respect to the sale of collateral, if
any, securing the Guaranteed Obligations or any part thereof, Guarantor agrees
that ten (10) days prior written notice shall be deemed reasonable notice of any
matters contained in such notice.
14. If any provision of this Limited Guaranty or any portion of any
provision of this Limited Guaranty shall be deemed to be invalid, illegal or
unenforceable, such invalidity,
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illegality or unenforceability shall not alter the remaining portion of such
provision, or any other provision hereof, as each provision of this Limited
Guaranty shall be deemed severable from all other provisions hereof.
15. All agreements between Guarantor and Investor, whether now existing or
hereafter arising and whether written or oral, are hereby limited so that in no
contingency, whether by reason of demand or acceleration of the final maturity
of the Loan or otherwise, shall the interest contracted for, charged, received,
paid or agreed to be paid to Investor under or in connection with the Loan
exceed the maximum amount permissible under applicable law. All interest paid
or agreed to be paid to Investor shall, to the extent permitted by applicable
law, be amortized, prorated, allocated, and spread throughout the full period
(including any renewal or extension) until payment in full of the principal
balance of the Loan so that the interest hereon for such full period shall not
exceed the maximum amount permissible under applicable law. Investor expressly
disavows any intent to contract for, charge or receive interest in an amount
which exceeds the maximum amount permissible under applicable law. This
paragraph shall control all agreements between Guarantor and Investor.
16. The term "Guaranty Limit," as used herein, shall mean an amount
determined in accordance with the following provisions. The obligations of
Guarantor hereunder shall not exceed an amount equal to twenty-five percent
(25%) of the Principal Amount. At the end of three (3) years from the Effective
Date, a Debt Service Coverage test shall be performed by Investor with respect
to Borrower. If the Borrower's Debt Service Coverage for the twelve (12) month
period immediately preceding the expiration of such three (3) year period is 1.2
or greater, then this Limited Guaranty shall thereupon automatically terminate
and Guarantor shall have no further obligations hereunder. If, however, the
Borrower's Debt Service Coverage for such period is less than 1.2, then this
Limited Guaranty shall continue for an additional twelve (12) month period;
provided further however, that the Guaranty Limit for such additional period
shall not exceed an amount equal to fifteen percent (15%) of the Principal
Amount. At the end of such twelve month period, the Borrower's Debt Service
Coverage will again be tested as described above. If the result is 1.2 or
greater, this Limited Guaranty shall thereupon automatically terminate and
Guarantor shall have no further obligations hereunder; otherwise this Limited
Guaranty shall continue for a fifth (5th) year and the Guaranty Limit shall
continue to be an amount no greater than fifteen percent (15%) of the Principal
Amount. At the end of the fifth (5th) year, this Limited Guaranty shall
automatically terminate and Guarantor shall have no further obligations
hereunder regardless of the then Debt Service Coverage, hereof, unless an Event
of Default (as defined in the Note) exists on the date which is the end of such
fifth (5th) year and is not cured is not waived by Investor. For purposes of
the above, "Debt Service Coverage" shall be defined as "Cash Flow" divided by
"Debt Service." "Cash Flow" shall be defined as net income plus depreciation
plus interest expense plus or minus extraordinary non-cash expenses or income
minus the salary for Borrower's owner minus such owner's draws or distributions.
"Debt Service" shall be defined as regularly scheduled debt payments of the
Borrower, including principal and interest. The provisions of this Section 16
shall govern any contrary or inconsistent provisions of this Limited Guaranty.
IN WITNESS WHEREOF, Guarantor has executed this Guaranty as of the
Effective Date.
GUARANTOR:
SCHLOTZSKY'S, INC.
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By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
ADDRESS:
203 Colorado Street
Austin, Texas 78701
6
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CREDIT AGREEMENT
THIS AGREEMENT is entered into as of June 27, 1997, by and between
SCHLOTZSKY'S, INC., a Texas corporation ("Borrower"), and WELLS FARGO BANK
(TEXAS), NATIONAL ASSOCIATION ("Bank").
RECITAL
Borrower has requested from Bank the credit accommodations described
below (each, a "Credit" and collectively, the "Credits"), and Bank has agreed
to provide the Credits to Borrower on the terms and conditions contained
herein.
NOW, THEREFORE, for valuable consideration, the receipt and sufficiency
of which are hereby acknowledged, Bank and Borrower hereby agree as follows:
ARTICLE I
THE CREDITS
SECTION 1.1. LINE OF CREDIT.
(a) LINE OF CREDIT. Subject to the terms and conditions of this
Agreement, Bank hereby agrees to make advances to Borrower from time to time
up to and including April 30, 2000, not to exceed at any time the aggregate
principal amount of Twelve Million Dollars ($12,000,000.00) ("Line of
Credit"), the proceeds of which shall be used to finance working capital
purposes. Borrower's obligation to repay advances under the Line of Credit
shall be evidenced by a promissory note substantially in the form of Exhibit
A attached hereto ("Line of Credit Note"), all terms of which are
incorporated herein by this reference.
(b) BORROWING AND REPAYMENT. Borrower may from time to time during the
term of the Line of Credit borrow, partially or wholly repay its outstanding
borrowings, and reborrow, subject to all of the limitations, terms and
conditions contained herein or in the Line of Credit Note; provided however,
that the total outstanding borrowings under the Line of Credit shall not at
any time exceed the maximum principal amount available thereunder, as set
forth above.
SECTION 1.2. TERM COMMITMENT.
(a) TERM COMMITMENT. Subject to the terms and conditions of this
Agreement, Bank hereby agrees to make advances to Borrower from time to time
up to and including December 30, 1997, not to exceed the aggregate principal
amount of Three Million
<PAGE>
Dollars ($3,000,000.00) ("Term Commitment"), the proceeds of which shall be
used to (a) finance capital expenditures and (b) refinance existing debt, and
which shall be converted on December 30, 1997, to a term loan, as described
more fully below. Borrower's obligation to repay advances under the Term
Commitment shall be evidenced by a promissory note substantially in the form
of Exhibit B attached hereto ("Term Commitment Note"), all terms of which are
incorporated herein by this reference.
(b) BORROWING AND REPAYMENT. Borrower may from time to time during the
period in which Bank will make advances under the Term Commitment borrow and
partially or wholly repay its outstanding borrowings, provided that amounts
repaid may not be reborrowed, subject to all the limitations, terms and
conditions contained herein; provided however, that the total outstanding
borrowings under the Term Commitment shall not at any time exceed the maximum
principal amount available thereunder, as set forth above. The outstanding
principal balance of the Term Commitment shall be due and payable in full on
December 30, 1997; provided however, that so long as Borrower is in
compliance on said date with all terms and conditions contained herein and in
any other documents evidencing the Credits, Bank agrees to restructure
repayment of said outstanding principal balance so that principal and
interest shall be amortized over five years and shall be repaid in monthly
installments, as set forth in the promissory note executed by Borrower on
said date to evidence the new repayment schedule.
(c) PREPAYMENT. Borrower may prepay principal on the Term Commitment
solely in accordance with the provisions of the Term Commitment Note.
SECTION 1.3. INTEREST/FEES.
(a) INTEREST. The outstanding principal balance of the Line of Credit
and Term Commitment shall bear interest at the rate of interest set forth in
the Line of Credit Note and Term Commitment Note.
(b) COMPUTATION AND PAYMENT. Interest shall be computed on the basis
of a 360-day year, actual days elapsed, unless such calculation would result
in a usurious rate, in which case interest shall be computed on the basis of
a 365/366-day year, as the case may be, actual days elapsed. Interest shall
be payable at the times and place set forth in the Line of Credit Note and
Term Commitment Note (collectively, the "Notes").
(c) UNUSED COMMITMENT FEE. Borrower shall pay to Bank a fee equal to
one-quarter of one percent (.25%) per annum (computed on the basis of a
360-day year, actual days elapsed) on the average daily unused amount of the
Line Of Credit, which fee
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shall be calculated on a quarterly basis by Bank and shall be due and payable
by Borrower in arrears within ten (10) days after each billing is sent by
Bank.
SECTION 1.4. COLLECTION OF PAYMENTS. Borrower authorizes Bank to
collect all principal, interest and fees due under each Credit by charging
Borrower's demand deposit account number ___________ with Bank, or any other
demand deposit account maintained by Borrower with Bank, for the full amount
thereof. Should there be insufficient funds in any such demand deposit
account to pay all such sums when due, the full amount of such deficiency
shall be immediately due and payable by Borrower.
ARTICLE II
REPRESENTATIONS AND WARRANTIES
Borrower makes the following representations and warranties to Bank,
which representations and warranties shall survive the execution of this
Agreement and shall continue in full force and effect until the full and
final payment, and satisfaction and discharge, of all obligations of Borrower
to Bank subject to this Agreement.
SECTION 2.1. LEGAL STATUS. Borrower is a corporation, duly organized
and existing and in good standing under the laws of the state of Texas, and
is qualified or licensed to do business (and is in good standing as a foreign
corporation, if applicable) in all jurisdictions in which such qualification
or licensing is required or in which the failure to so qualify or to be so
licensed could have a material adverse effect on Borrower.
SECTION 2.2. AUTHORIZATION AND VALIDITY. This Agreement, the Notes,
and each other document, contract and instrument required hereby or at any
time hereafter delivered to Bank in connection herewith (collectively, the
"Loan Documents") have been duly authorized, and upon their execution and
delivery in accordance with the provisions hereof will constitute legal,
valid and binding agreements and obligations of Borrower or the party which
executes the same, enforceable in accordance with their respective terms.
SECTION 2.3. NO VIOLATION. The execution, delivery and performance by
Borrower of each of the Loan Documents do not violate any provision of any
law or regulation, or contravene any provision of the Articles of
Incorporation or By-Laws of Borrower, or result in any breach of or default
under any contract, obligation, indenture or other instrument to which
Borrower is a party or by which Borrower may be bound.
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SECTION 2.4. LITIGATION. There are no pending, or to the best of
Borrower's knowledge threatened, actions, claims, investigations, suits or
proceedings by or before any governmental authority, arbitrator, court or
administrative agency which could have a material adverse effect on the
financial condition or operation of Borrower other than those disclosed by
Borrower to Bank in writing prior to the date hereof.
SECTION 2.5. CORRECTNESS OF FINANCIAL STATEMENT. The consolidated
financial statement of Borrower and Scholtzsky's Real Estate, Inc. dated
March 31, 1997, a true copy of which has been delivered by Borrower to Bank
prior to the date hereof, (a) is complete and correct and presents fairly the
financial condition of Borrower, (b) discloses all liabilities of Borrower
that are required to be reflected or reserved against under generally
accepted accounting principles, whether liquidated or unliquidated, fixed or
contingent, and (c) has been prepared in accordance with generally accepted
accounting principles consistently applied. Since the date of such financial
statement there has been no material adverse change in the financial
condition of Borrower, nor has Borrower mortgaged, pledged, granted a
security interest in or otherwise encumbered any of its assets or properties
except in favor of Bank or as otherwise permitted by Bank in writing.
SECTION 2.6. INCOME TAX RETURNS. Borrower has no knowledge of any
pending assessments or adjustments of its income tax payable with respect to
any year.
SECTION 2.7. NO SUBORDINATION. There is no agreement, indenture,
contract or instrument to which Borrower is a party or by which Borrower may
be bound that requires the subordination in right of payment of any of
Borrower's obligations subject to this Agreement to any other obligation of
Borrower.
SECTION 2.8. PERMITS, FRANCHISES. Borrower possesses, and will
hereafter possess, all permits, consents, approvals, franchises and licenses
required and rights to all trademarks, trade names, patents, and fictitious
names, if any, necessary to enable it to conduct the business in which it is
now engaged in compliance with applicable law.
SECTION 2.9. ERISA. Borrower is in compliance in all material
respects with all applicable provisions of the Employee Retirement Income
Security Act of 1974, as amended or recodified from time to time ("ERISA");
Borrower has not violated any provision of any defined employee pension
benefit plan (as defined in ERISA) maintained or contributed to by Borrower
(each, a "Plan"); no Reportable Event as defined in ERISA has occurred and is
continuing with respect to any Plan initiated by Borrower; Borrower has met
its minimum funding requirements under ERISA
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with respect to each Plan; and each Plan will be able to fulfill its benefit
obligations as they come due in accordance with the Plan documents and under
generally accepted accounting principles.
SECTION 2.10. OTHER OBLIGATIONS. Borrower is not in default on any
obligation for borrowed money, any purchase money obligation or any other
material lease, commitment, contract, instrument or obligation.
SECTION 2.11. ENVIRONMENTAL MATTERS. Except as disclosed by Borrower
to Bank in writing prior to the date hereof, Borrower is in compliance in all
material respects with all applicable federal or state environmental,
hazardous waste, health and safety statutes, and any rules or regulations
adopted pursuant thereto, which govern or affect any of Borrower's operations
and/or properties, including without limitation, the Comprehensive
Environmental Response, Compensation and Liability Act of 1980, the Superfund
Amendments and Reauthorization Act of 1986, the Federal Resource Conservation
and Recovery Act of 1976, and the Federal Toxic Substances Control Act, as
any of the same may be amended, modified or supplemented from time to time.
None of the operations of Borrower is the subject of any federal or state
investigation evaluating whether any remedial action involving a material
expenditure is needed to respond to a release of any toxic or hazardous waste
or substance into the environment. Borrower has no material contingent
liability in connection with any release of any toxic or hazardous waste or
substance into the environment.
ARTICLE III
CONDITIONS
SECTION 3.1. CONDITIONS OF INITIAL EXTENSION OF CREDIT. The
obligation of Bank to grant any of the Credits is subject to the fulfillment
to Bank's satisfaction of all of the following conditions:
(a) APPROVAL OF BANK COUNSEL. All legal matters incidental to the
granting of each of the Credits shall be satisfactory to Bank's counsel.
(b) DOCUMENTATION. Bank shall have received, in form and substance
satisfactory to Bank, each of the following, duly executed:
(i) This Agreement and the Notes.
(ii) Corporate Resolution: Borrowing.
(iii) Certificate of Incumbency.
(iv) Such other documents as Bank may require under any other Section of
this Agreement.
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(c) FINANCIAL CONDITION. There shall have been no material adverse
change, as determined by Bank, in the financial condition or business of
Borrower, nor any material decline, as determined by Bank, in the market
value of any collateral required hereunder or a substantial or material
portion of the assets of Borrower.
(d) INSURANCE. Borrower shall have delivered to Bank evidence of
insurance coverage on all Borrower's property, in form, substance, amounts,
covering risks and issued by companies satisfactory to Bank, and where
required by Bank, with loss payable endorsements in favor of Bank.
SECTION 3.2. CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation
of Bank to make each extension of credit requested by Borrower hereunder
shall be subject to the fulfillment to Bank's satisfaction of each of the
following conditions:
(a) COMPLIANCE. The representations and warranties contained herein
and in each of the other Loan Documents shall be true on and as of the date
of the signing of this Agreement and on the date of each extension of credit
by Bank pursuant hereto, with the same effect as though such representations
and warranties had been made on and as of each such date, and on each such
date, no Event of Default as defined herein, and no condition, event or act
which with the giving of notice or the passage of time or both would
constitute such an Event of Default, shall have occurred and be continuing or
shall exist.
(b) DOCUMENTATION. Bank shall have received all additional documents
which may be required in connection with such extension of credit.
ARTICLE IV
AFFIRMATIVE COVENANTS
Borrower covenants that so long as Bank remains committed to extend
credit to Borrower pursuant hereto, or any liabilities (whether direct or
contingent, liquidated or unliquidated) of Borrower to Bank under any of the
Loan Documents remain outstanding, and until payment in full of all
obligations of Borrower subject hereto, Borrower shall, unless Bank otherwise
consents in writing:
SECTION 4.1. PUNCTUAL PAYMENTS. Punctually pay all principal,
interest, fees or other liabilities due under any of the Loan Documents at
the times and place and in the manner specified therein.
SECTION 4.2. ACCOUNTING RECORDS. Maintain adequate books and records
in accordance with generally accepted accounting
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principles consistently applied, and permit any representative of Bank, at
any reasonable time, to inspect, audit and examine such books and records, to
make copies of the same, and to inspect the properties of Borrower.
SECTION 4.3. FINANCIAL STATEMENTS. Provide to Bank all of the
following, in form and detail satisfactory to Bank:
(a) not later than 120 days after and as of the end of each fiscal
year, an audited consolidated financial statement of Borrower and
Schlotzsky's Real Estate, Inc., prepared by certified public accountant, to
include balance sheet, income statement, statement of cash flows and 10-K
reports;
(b) not later than 45 days after and as of the end of each quarter, a
consolidated financial statement of Borrower and Schlotzsky's Real Estate,
Inc., prepared by Borrower, to include balance sheet, income statement and
10-K reports;
(c) contemporaneously with each quarter financial statement of Borrower
required hereby, a certificate of the president or chief financial officer of
Borrower stating (a) that said financial statements are accurate and that
there exists no Event of Default nor any condition, act or event which with
the giving of notice or the passage of time or both would constitute an Event
of Default and (b) showing the calculations for the covenants set forth in
Section 4.9 below;
(d) from time to time such other information as Bank may reasonably
request.
SECTION 4.4. COMPLIANCE. Preserve and maintain all licenses, permits,
governmental approvals, rights, privileges and franchises necessary for the
conduct of its business; and comply with the provisions of all documents
pursuant to which Borrower is organized and/or which govern Borrower's
continued existence and with the requirements of all laws, rules, regulations
and orders of any governmental authority applicable to Borrower and/or its
business.
SECTION 4.5. INSURANCE. Maintain and keep in force insurance of the
types and in amounts customarily carried in lines of business similar to that
of Borrower, including but not limited to fire, extended coverage, public
liability, flood, property damage and workers' compensation, with all such
insurance carried with companies and in amounts satisfactory to Bank, and
deliver to Bank from time to time at Bank's request schedules setting forth
all insurance then in effect.
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SECTION 4.6. FACILITIES. Keep all properties useful or necessary to
Borrower's business in good repair and condition, and from time to time make
necessary repairs, renewals and replacements thereto so that such properties
shall be fully and efficiently preserved and maintained.
SECTION 4.7. TAXES AND OTHER LIABILITIES. Pay and discharge when due
any and all indebtedness, obligations, assessments and taxes, both real or
personal, including without limitation federal and state income taxes and
state and local property taxes and assessments, except such (a) as Borrower
may in good faith contest or as to which a bona fide dispute may arise, and
(b) for which Borrower has made provision, to Bank's satisfaction, for
eventual payment thereof in the event Borrower is obligated to make such
payment.
SECTION 4.8. LITIGATION. Promptly give notice in writing to Bank of
any litigation pending or threatened against Borrower with a claim in excess
of $100,000.00.
SECTION 4.9. FINANCIAL CONDITION. Maintain Borrower's financial
condition as follows using generally accepted accounting principles
consistently applied and used consistently with prior practices (except to
the extent modified by the definitions herein):
(a) Working Capital not at any time less than $12,000,000.00, with
"Working Capital" defined as total current assets minus total current
liabilities.
(b) Total Liabilities divided by Tangible Net Worth not at any time
greater than .90 to 1.0, with "Total Liabilities" defined as the aggregate of
current liabilities and non-current liabilities less subordinated debt, and
with "Tangible Net Worth" defined as the aggregate of total stockholders'
equity plus subordinated debt less any intangible assets.
(c) EBITDA Coverage Ratio not less than 2.0 to 1.0 as of each fiscal
year end, with "EBITDA" defined as net profit before tax plus interest
expense (net of capitalized interest expense), depreciation expense and
amortization expense, and with "EBITDA Coverage Ratio" defined as EBITDA
divided by the aggregate of total interest expense plus the prior period
current maturity of long-term debt and the prior period current maturity of
subordinated debt.
(d) EBITDA Borrowing Ratio not less than 2.0 to 1.0 as of the end of
each fiscal quarter, with "EBITDA" as defined above and calculated as of the
end of the preceding four fiscal quarters, and with "EBITDA Borrowing Ratio"
defined as the outstanding principal balance of the Revolving Line of Credit
divided by EBITDA.
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SECTION 4.10. NOTICE TO BANK. Promptly (but in no event more than five
(5) days after the occurrence of each such event or matter) give written
notice to Bank in reasonable detail of: (a) the occurrence of any Event of
Default, or any condition, event or act which with the giving of notice or
the passage of time or both would constitute an Event of Default; (b) any
change in the name or the organizational structure of Borrower; (c) the
occurrence and nature of any Reportable Event or Prohibited Transaction, each
as defined in ERISA, or any funding deficiency with respect to any Plan; or
(d) any termination or cancellation of any insurance policy which Borrower is
required to maintain, or any uninsured or partially uninsured loss through
liability or property damage, or through fire, theft or any other cause
affecting Borrower's property in excess of an aggregate of $500,000.00.
ARTICLE V
NEGATIVE COVENANTS
Borrower further covenants that so long as Bank remains committed to
extend credit to Borrower pursuant hereto, or any liabilities (whether direct
or contingent, liquidated or unliquidated) of Borrower to Bank under any of
the Loan Documents remain outstanding, and until payment in full of all
obligations of Borrower subject hereto, Borrower will not without Bank's
prior written consent:
SECTION 5.1. USE OF FUNDS. Use any of the proceeds of any of the
Credits except for the purposes stated in Article I hereof.
SECTION 5.2. OTHER INDEBTEDNESS. Create, incur, assume or permit to
exist any indebtedness or liabilities resulting from borrowings, loans or
advances, whether secured or unsecured, matured or unmatured, liquidated or
unliquidated, joint or several, except (a) the liabilities of Borrower to
Bank, and (b) the liabilities of Borrower existing as of the date hereof and
listed on Exhibit C to this Agreement, and (c) other liabilities not to
exceed an aggregate principal amount of $3,000,000.00.
SECTION 5.3. MERGER, CONSOLIDATION, TRANSFER OF ASSETS. Merge into or
consolidate with any other entity; make any substantial change in the nature
of Borrower's business as conducted as of the date hereof; acquire all or
substantially all of the assets of any other entity; nor sell, lease,
transfer or otherwise dispose of all or a substantial or material portion of
Borrower's assets except in the ordinary course of its business.
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SECTION 5.4. PLEDGE OF ASSETS. Mortgage, pledge, grant or permit to
exist a security interest in, or lien upon, all or any portion of Borrower's
assets now owned or hereafter acquired, except (a) any of the foregoing in
favor of Bank, (b) any of the foregoing existing as of the date hereof and
listed on Exhibit C to this Agreement, (c) purchase money security interests
granted in the ordinary course of business, and (d) liens granted on the
Borrower's real property.
ARTICLE VI
EVENTS OF DEFAULT
SECTION 6.1. The occurrence of any of the following shall constitute
an "Event of Default" under this Agreement:
(a) Borrower shall fail to pay when due any principal, interest, fees
or other amounts payable under any of the Loan Documents.
(b) Any financial statement or certificate furnished to Bank in
connection with, or any representation or warranty made by Borrower or any
other party under this Agreement or any other Loan Document shall prove to be
incorrect, false or misleading in any material respect when furnished or made.
(c) Any default in the performance of or compliance with any
obligation, agreement or other provision contained herein or in any other
Loan Document (other than those referred to in subsections (a) and (b)
above), and with respect to any such default which by its nature can be
cured, such default shall continue for a period of twenty (20) days from its
occurrence.
(d) Any default in the payment or performance of any obligation, or any
defined event of default, under the terms of any contract or instrument
(other than any of the Loan Documents) pursuant to which Borrower has
incurred any debt or other liability to any person or entity, including Bank.
(e) The filing of a notice of judgment lien against Borrower; or the
recording of any abstract of judgment against Borrower in any county in which
Borrower has an interest in real property; or the service of a notice of levy
and/or of a writ of attachment or execution, or other like process, against
the assets of Borrower; or the entry of a judgment against Borrower.
(f) Borrower shall become insolvent, or shall suffer or consent to or
apply for the appointment of a receiver, trustee, custodian or liquidator of
itself or any of its property, or shall generally fail to pay its debts as
they become due, or
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shall make a general assignment for the benefit of creditors; Borrower shall
file a voluntary petition in bankruptcy, or seeking reorganization, in order
to effect a plan or other arrangement with creditors or any other relief
under the Bankruptcy Reform Act, Title 11 of the United States Code, as
amended or recodified from time to time ("Bankruptcy Code"), or under any
state or federal law granting relief to debtors, whether now or hereafter in
effect; or any involuntary petition or proceeding pursuant to the Bankruptcy
Code or any other applicable state or federal law relating to bankruptcy,
reorganization or other relief for debtors is filed or commenced against
Borrower, or Borrower shall file an answer admitting the jurisdiction of the
court and the material allegations of any involuntary petition; or Borrower
shall be adjudicated a bankrupt, or an order for relief shall be entered
against Borrower by any court of competent jurisdiction under the Bankruptcy
Code or any other applicable state or federal law relating to bankruptcy,
reorganization or other relief for debtors.
(g) There shall exist or occur any event or condition which Bank in
good faith believes impairs, or is substantially likely to impair, the
prospect of payment or performance by Borrower of its obligations under any
of the Loan Documents.
(h) The death or incapacity of Borrower. The dissolution or
liquidation of Borrower; or Borrower, or any of its directors, stockholders
or members, shall take action seeking to effect the dissolution or
liquidation of Borrower.
(i) Any change in ownership during the term of this Agreement of an
aggregate of twenty-five percent (25%) or more of the common stock of
Borrower.
SECTION 6.2. REMEDIES. Upon the occurrence of any Event of Default:
(a) all principal and accrued and unpaid interest outstanding under each of
the Loan Documents, any term thereof to the contrary notwithstanding, shall
at Bank's option and without notice become immediately due and payable
without presentment, demand, or any notices of any kind, including without
limitation notice of nonperformance, notice of protest, protest, notice of
dishonor, notice of intention to accelerate or notice of acceleration, all of
which are hereby expressly waived by each Borrower; (b) the obligation, if
any, of Bank to extend any further credit under any of the Loan Documents
shall immediately cease and terminate; and (c) Bank shall have all rights,
powers and remedies available under each of the Loan Documents, or accorded
by law, including without limitation the right to resort to any or all
security for any of the Credits and to exercise any or all of the rights of a
beneficiary or secured party pursuant to applicable law. All rights, powers
and remedies of Bank may be exercised at any time by Bank and from time to
time after the
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occurrence of an Event of Default, are cumulative and not exclusive, and
shall be in addition to any other rights, powers or remedies provided by law
or equity.
ARTICLE VII
MISCELLANEOUS
SECTION 7.1. NO WAIVER. No delay, failure or discontinuance of Bank
in exercising any right, power or remedy under any of the Loan Documents
shall affect or operate as a waiver of such right, power or remedy; nor shall
any single or partial exercise of any such right, power or remedy preclude,
waive or otherwise affect any other or further exercise thereof or the
exercise of any other right, power or remedy. Any waiver, permit, consent or
approval of any kind by Bank of any breach of or default under any of the
Loan Documents must be in writing and shall be effective only to the extent
set forth in such writing.
SECTION 7.2. NOTICES. All notices, requests and demands which any
party is required or may desire to give to any other party under any
provision of this Agreement must be in writing delivered to each party at the
following address:
BORROWER: SCHLOTZSKY'S, INC.
200 West Fourth Street
Austin, TX 78701
BANK: WELLS FARGO BANK (TEXAS),
NATIONAL ASSOCIATION
Central Texas RCBO - Austin
100 Congress, Suite 150
Austin, TX 78701
or to such other address as any party may designate by written notice to all
other parties. Each such notice, request and demand shall be deemed given or
made as follows: (a) if sent by hand delivery, upon delivery; (b) if sent by
mail, upon the earlier of the date of receipt or three (3) days after deposit
in the U.S. mail, first class and postage prepaid; and (c) if sent by
telecopy, upon receipt.
SECTION 7.3. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay
to Bank immediately upon demand the full amount of all payments, advances,
charges, costs and expenses, including reasonable attorneys' fees (to include
outside counsel fees and all allocated costs of Bank's in-house counsel to
the extent permissible), expended or incurred by Bank in connection with (a)
the negotiation and preparation of this Agreement and the other Loan
Documents, Bank's continued administration hereof
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and thereof, and the preparation of any amendments and waivers hereto and
thereto, (b) the enforcement of Bank's rights and/or the collection of any
amounts which become due to Bank under any of the Loan Documents, and (c) the
prosecution or defense of any action in any way related to any of the Loan
Documents, including without limitation, any action for declaratory relief,
whether incurred at the trial or appellate level, in an arbitration
proceeding or otherwise, and including any of the foregoing incurred in
connection with any bankruptcy proceeding (including without limitation, any
adversary proceeding, contested matter or motion brought by Bank or any other
person) relating to any Borrower or any other person or entity.
SECTION 7.4. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding
upon and inure to the benefit of the heirs, executors, administrators, legal
representatives, successors and assigns of the parties; provided however,
that Borrower may not assign or transfer its interest hereunder without
Bank's prior written consent. Bank reserves the right to sell, assign,
transfer, negotiate or grant participations in all or any part of, or any
interest in, Bank's rights and benefits under each of the Loan Documents. In
connection therewith, Bank may disclose all documents and information which
Bank now has or may hereafter acquire relating to any of the Credits,
Borrower or its business, [any guarantor hereunder or the business of such
guarantor,] or any collateral required hereunder.
SECTION 7.5. AMENDMENT. This Agreement may be amended or modified
only in writing signed by each party hereto.
SECTION 7.6. NO THIRD PARTY BENEFICIARIES. This Agreement is made and
entered into for the sole protection and benefit of the parties hereto and
their respective permitted successors and assigns, and no other person or
entity shall be a third party beneficiary of, or have any direct or indirect
cause of action or claim in connection with, this Agreement or any other of
the Loan Documents to which it is not a party.
SECTION 7.7. TIME. Time is of the essence of each and every provision
of this Agreement and each other of the Loan Documents.
SECTION 7.8. SEVERABILITY OF PROVISIONS. If any provision of this
Agreement shall be prohibited by or invalid under applicable law, such
provision shall be ineffective only to the extent of such prohibition or
invalidity without invalidating the remainder of such provision or any
remaining provisions of this Agreement.
SECTION 7.9. COUNTERPARTS. This Agreement may be executed in any number
of counterparts, each of which when executed and
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delivered shall be deemed to be an original, and all of which when taken
together shall constitute one and the same Agreement.
SECTION 7.10. GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of Texas.
SECTION 7.11. SAVINGS CLAUSE. It is the intention of the parties to
comply strictly with applicable usury laws. Accordingly, notwithstanding any
provision to the contrary in the Loan Documents, in no event shall any Loan
Documents require the payment or permit the payment, taking, reserving,
receiving, collection or charging of any sums constituting interest under
applicable laws that exceed the maximum amount permitted by such laws, as the
same may be amended or modified from time to time (the "Maximum Rate"). If
any such excess interest is called for, contracted for, charged, taken,
reserved or received in connection with any Loan Documents, or in any
communication by or any other person to Borrower or any other person, or in
the event that all or part of the principal or interest hereof or thereof
shall be prepaid or accelerated, so that under any of such circumstances or
under any other circumstance whatsoever the amount of interest contracted
for, charged, taken, reserved or received on the amount of principal actually
outstanding from time to time under the Loan Documents shall exceed the
Maximum Rate, then in such event it is agreed that: (i) the provisions of
this paragraph shall govern and control; (ii) neither Borrower nor any other
person or entity now or hereafter liable for the payment of any Loan
Documents shall be obligated to pay the amount of such interest to the extent
it is in excess of the Maximum Rate; (iii) any such excess interest which is
or has been received by Bank, notwithstanding this paragraph, shall be
credited against the then unpaid principal balance hereof or thereof, or if
any of the Loan Documents has been or would be paid in full by such credit,
refunded to Borrower; and (iv) the provisions of each of the Loan Documents,
and any other communication to Borrower, shall immediately be deemed reformed
and such excess interest reduced, without the necessity of executing any
other document, to the Maximum Rate. The right to accelerate the maturity of
the Loan Documents does not include the right to accelerate, collect or
charge unearned interest, but only such interest that has otherwise accrued
as of the date of acceleration. Without limiting the foregoing, all
calculations of the rate of interest contracted for, charged, taken, reserved
or received in connection with any of the Loan Documents which are made for
the purpose of determining whether such rate exceeds the Maximum Rate shall
be made to the extent permitted by applicable laws by amortizing, prorating,
allocating and spreaing during the period of the full term of such Loan
Documents, including all prior and subsequent renewals and extensions hereof
or thereof, all interest at any time contracted for, charged, taken, reserved
or received by Bank. The terms of
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this paragraph shall be deemed to be incorporated into each of the other Loan
Documents.
To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes
is relevant to Bank for the purpose of determining the Maximum Rate, Bank
hereby elects to determine the applicable rate ceiling under such Article by
the indicated (weekly) rate ceiling from time to time in effect, subject to
Bank's right subsequently to change such method in accordance with applicable
law, as the same may be amended or modified from time to time.
SECTION 7.12. RIGHT OF SETOFF; DEPOSIT ACCOUNTS. Upon and after the
occurrence of an Event of Default, (a) Borrower hereby authorizes Bank, at
any time and from time to time, without notice, which is hereby expressly
waived by each Borrower, and whether or not Bank shall have declared the
Credits to be due and payable in accordance with the terms hereof, to set off
against, and to appropriate and apply to the payment of, Borrower's
obligations and liabilities under the Loan Documents (whether matured or
unmatured, fixed or contingent, liquidated or unliquidated), any and all
amounts owing by Bank to Borrower (whether payable in U.S. dollars or any
other currency, whether matured or unmatured, and in the case of deposits,
whether general or special (except trust and escrow accounts), time or demand
and however evidenced), and (b) pending any such action, to the extent
necessary, to hold such amounts as collateral to secure such obligations and
liabilities and to return as unpaid for insufficient funds any and all checks
and other items drawn against any deposits so held as Bank, in its sole
discretion, may elect. Borrower hereby grants to Bank a security interest in
all deposits and accounts maintained with Bank and with any other financial
institution to secure the payment of all obligations and liabilities of
Borrower to Bank under the Loan Documents.
SECTION 7.13. BUSINESS PURPOSE. Borrower represents and warrants that
the Credits are for a business, commercial, investment, agricultural or other
similar purpose and not primarily for a personal, family or household use.
SECTION 7.14. ARBITRATION.
(a) ARBITRATION. Upon the demand of any party, any Dispute shall be
resolved by binding arbitration (except as set forth in (e) below) in
accordance with the terms of this Agreement. A "Dispute" shall mean any
action, dispute, claim or controversy of any kind, whether in contract or
tort, statutory or common law, legal or equitable, now existing or hereafter
arising under or in connection with, or in any way pertaining to, any of the
Loan Documents, or any past, present or future extensions of credit and other
activities, transactions or obligations of any kind related directly or
indirectly to any of the Loan Documents, including without limitation, any of
the foregoing arising in
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connection with the exercise of any self-help, ancillary or other remedies
pursuant to any of the Loan Documents. Any party may by summary proceedings
bring an action in court to compel arbitration of a Dispute. Any party who
fails or refuses to submit to arbitration following a lawful demand by any
other party shall bear all costs and expenses incurred by such other party in
compelling arbitration of any Dispute.
(b) GOVERNING RULES. Arbitration proceedings shall be administered by
the American Arbitration Association ("AAA") or such other administrator as
the parties shall mutually agree upon in accordance with the AAA Commercial
Arbitration Rules. All Disputes submitted to arbitration shall be resolved
in accordance with the Federal Arbitration Act (Title 9 of the United States
Code), notwithstanding any conflicting choice of law provision in any of the
Loan Documents. The arbitration shall be conducted at a location in Texas
selected by the AAA or other administrator. If there is any inconsistency
between the terms hereof and any such rules, the terms and procedures set
forth herein shall control. All statutes of limitation applicable to any
Dispute shall apply to any arbitration proceeding. All discovery activities
shall be expressly limited to matters directly relevant to the Dispute being
arbitrated. Judgment upon any award rendered in an arbitration may be
entered in any court having jurisdiction; provided however, that nothing
contained herein shall be deemed to be a waiver by any party that is a bank
of the protections afforded to it under 12 U.S.C. Section 91 or any similar
applicable state law.
(c) NO WAIVER; PROVISIONAL REMEDIES, SELF-HELP AND FORECLOSURE. No
provision hereof shall limit the right of any party to exercise self-help
remedies such as setoff, foreclosure against or sale of any real or personal
property collateral or security, or to obtain provisional or ancillary
remedies, including without limitation injunctive relief, sequestration,
attachment, garnishment or the appointment of a receiver, from a court of
competent jurisdiction before, after or during the pendency of any
arbitration or other proceeding. The exercise of any such remedy shall not
waive the right of any party to compel arbitration hereunder.
(d) ARBITRATOR QUALIFICATIONS AND POWERS; AWARDS. Arbitrators must be
active members of the Texas State Bar with expertise in the substantive laws
applicable to the subject matter of the Dispute. Arbitrators are empowered
to resolve Disputes by summary rulings in response to motions filed prior to
the final arbitration hearing. Arbitrators (i) shall resolve all Disputes in
accordance with the substantive law of the state of Texas, (ii) may grant any
remedy or relief that a court of the state of Texas could order or grant
within the scope hereof and such ancillary relief as is necessary to make
effective any award, and (iii) shall have the power to award recovery of all
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costs and fees, to impose sanctions and to take such other actions as they
deem necessary to the same extent a judge could pursuant to the Federal Rules
of Civil Procedure, the Texas Rules of Civil Procedure or other applicable
law. Any Dispute in which the amount in controversy is $5,000,000 or less
shall be decided by a single arbitrator who shall not render an award of
greater than $5,000,000 (including damages, costs, fees and expenses). By
submission to a single arbitrator, each party expressly waives any right or
claim to recover more than $5,000,000. Any Dispute in which the amount in
controversy exceeds $5,000,000 shall be decided by majority vote of a panel
of three arbitrators; provided however, that all three arbitrators must
actively participate in all hearings and deliberations.
(e) JUDICIAL REVIEW. Notwithstanding anything herein to the contrary,
in any arbitration in which the amount in controversy exceeds $25,000,000,
the arbitrators shall be required to make specific, written findings of fact
and conclusions of law. In such arbitrations (i) the arbitrators shall not
have the power to make any award which is not supported by substantial
evidence or which is based on legal error, (ii) an award shall not be binding
upon the parties unless the findings of fact are supported by substantial
evidence and the conclusions of law are not erroneous under the substantive
law of the state of Texas, and (iii) the parties shall have in addition to
the grounds referred to in the Federal Arbitration Act for vacating,
modifying or correcting an award the right to judicial review of (A) whether
the findings of fact rendered by the arbitrators are supported by substantial
evidence, and (B) whether the conclusions of law are erroneous under the
substantive law of the state of Texas. Judgment confirming an award in such
a proceeding may be entered only if a court determines the award is supported
by substantial evidence and not based on legal error under the substantive
law of the state of Texas.
(f) MISCELLANEOUS. To the maximum extent practicable, the AAA, the
arbitrators and the parties shall take all action required to conclude any
arbitration proceeding within 180 days of the filing of the Dispute with the
AAA. No arbitrator or other party to an arbitration proceeding may disclose
the existence, content or results thereof, except for disclosures of
information by a party required in the ordinary course of its business, by
applicable law or regulation, or to the extent necessary to exercise any
judicial review rights set forth herein. If more than one agreement for
arbitration by or between the parties potentially applies to a Dispute, the
arbitration provision most directly related to the Loan Documents or the
subject matter of the Dispute shall control. This arbitration provision
shall survive termination, amendment or expiration of any of the Loan
Documents or any relationship between the parties.
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NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS
CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT
BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO
UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THE INDEBTEDNESS.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the day and year first written above.
WELLS FARGO BANK (TEXAS),
SCHLOTZSKY'S, INC. NATIONAL ASSOCIATION
By: By:
------------------------- --------------------------
John C. Wooley Keith Smith
Chief Executive Officer Vice President
<PAGE>
FIRST AMENDMENT TO CREDIT AGREEMENT
THIS FIRST AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is entered
into as of September 26, 1997, by and between SCHLOTZSKY'S, INC., a Texas
corporation ("Borrower"), and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION
("Bank").
RECITALS
WHEREAS, Borrower is currently indebted to Bank pursuant to the terms
and conditions of that certain Credit Agreement between Borrower and Bank
dated as of June 27, 1997, as amended from time to time ("Credit Agreement").
WHEREAS, Bank and Borrower have agreed to certain changes in the terms
and conditions set forth in the Credit Agreement and have agreed to amend the
Credit Agreement to reflect said changes.
NOW, THEREFORE, for valuable consideration, the receipt and sufficiency
of which are hereby acknowledged, the parties hereto agree that the Credit
Agreement shall be amended as follows:
1. The following is hereby added to the Credit Agreement as Section
1.1(c):
(c) FRANCHISEE NOTE SUBFEATURE. (i) As a subfeature under the Line
of Credit, Bank agrees from time to time during the term thereof to
make loans (each a "Franchisee Loan" and collectively, the "Franchisee
Loans") to certain franchisees or area distributors (each a
"Franchisee") of Borrower to finance the payment of leasehold
improvements to Borrower. Such loans will be evidenced by promissory
notes (each a "Franchisee Note" and collectively, "Franchisee Notes")
in the form attached hereto as Exhibit "C"; provided however, that the
aggregate amount of all outstanding Franchisee Notes shall not at any
time exceed Four Million Dollars ($4,000,000.00). Each Franchisee
Loan shall be in a minimum amount of Two Hundred Thousand Dollars
($200,000.00). The aggregate principal amount of all Franchisee Notes
shall be reserved under the Line of Credit and shall not be available
for borrowings thereunder.
(ii) Each Franchisee Note shall be issued for a term of one hundred
eighty (180) days, and may be renewed one (1) time for another one
hundred eighty days upon payment of the fee required by Section 1.3(d)
of this
<PAGE>
Agreement; provided however, that no Franchisee Note, or renewal thereof,
shall have an expiration date subsequent to the maturity date of the Line
of Credit. Each Franchisee Note shall be subject to the additional terms
and conditions of this agreement or other document, if any, required by
Borrower in connection with the issuance thereof (each a "Franchisee Note
Agreement" and collectively, "Franchisee Note Agreements").
(iii) Borrower acknowledges and agrees that the agreements and other
provisions of this Agreement and the guaranty of all Franchisee Loans
by Borrower are material inducements to Bank's decision whether to
make any Franchisee Loan. Borrower agrees to guarantee and does
hereby unconditionally guarantee the payment of all Franchisee Loan
amounts, including future Franchisee Loans, until all such
indebtedness is fully and finally paid. Borrower agrees that all of
the terms and provisions of the Guaranty of Franchise Note form
(attached hereto as Exhibit "D" and incorporated herein for all
purposes) shall be and are hereby incorporated by reference as the
terms and provisions of this guarantee by Borrower of the Franchisee
Loan amounts.
(iv) Borrower represents and warrants that the persons whose names
are signed as borrowers with respect to Franchisee Loans shall be
franchisees or area distributors of Borrower, their signatures shall
be genuine, and their authority and competence to execute all
Franchisee Loan documents shall be genuine and legally sufficient.
Borrower agrees to assure that all provisions of the Franchisee Note
and funding conditions are adequately explained to each Franchisee
borrower, agrees to not make any misrepresentations in connection with
the execution of any note or loan documents, and agrees not to make or
purport to make any representations on behalf of Bank or enter into
any oral agreements with any borrower that might be construed as
having been made by or on behalf of Bank. Bank may, from time to
time and in its sole discretion, revise the form of the note and other
documents used for Franchisee Loans. Borrower agrees to maintain a
deposit account with Bank which shall be used for the funding of
Franchisee Loans; all advances may be funded by Bank into said deposit
account, with Borrower being responsible for promptly making such
funds available to the Franchisee borrowers. Borrower shall maintain
reliable records of all Franchisee Loans and the balances of such
loans. Borrower agrees that when a Franchisee Loan is to be paid off,
Borrower
-20-
<PAGE>
shall be responsible for identifying each specific Franchisee Loan to be
paid off, obtaining the correct payoff quote for each such loan, and
delivering the correct sum to Bank to accomplish the full payment of such
Franchisee Loans.
(v) The obligation of the Bank to make any Franchisee Loan shall be
conditioned upon Bank's receipt of (A) an executed Franchisee Note,
with all blanks filled in, (B) an executed Guaranty of Franchisee
Note in the form attached hereto as Exhibit "D" with all blanks filled
in, and (C) a completed and executed corporate resolution of Borrower
authorizing the Guaranty of the applicable Franchise Note. Borrower
will review and approve all executed Franchisee Loan documents before
submitting them to Bank. Borrower will not change the form of such
documents without Bank's prior written consent.
(vi) Borrower agrees to promptly pay the outstanding indebtedness of
any Franchisee Loan under any circumstance by which the amount of any
Franchisee Loan becomes due and payable, including without limitation,
upon maturity if not renewed, or by acceleration after default. In
addition, Borrower agrees to purchase all Franchisee Loans or pay to
Bank all Franchisee Loan amounts within 10 days of Bank's request for
same upon the occurrence of an Event of Default under this Agreement.
Upon the occurrence of an Event of Default, any and all
obligations of Bank relating to the Franchisee Loans shall immediately
terminate and, at Bank's option, Bank may demand that within ten (10)
days all Franchisee Notes be paid in full by Borrower or that all
Franchisee Loans be purchased from Bank by Borrower without recourse
for the full outstanding balance of all indebtedness under such
Franchisee Loans, except that in the case of an Event of Default of a
type involving insolvency, such demand shall be understood as
occurring automatically, without the necessity of any action by Bank.
If, after default and demand as specified above, Borrower fails
to timely pay or purchase all Franchisee Loans, including all matured
and unmatured Franchisee Notes, then Bank may advance under the Line
of Credit the full amount of the Franchisee Loans to effect the
payment or purchase of such Franchisee Loans by Borrower, and such
sums (plus interest thereon as it accrues) shall be deemed to be an
advance under the
-21-
<PAGE>
Line of Credit and due and payable as provided therefor.
(vii) Borrower agrees to keep Franchisee Loan documentation,
guaranties and other forms safe and secure. Borrower agrees that
Borrower nor any employee of Borrower, are agents of Bank, and that
they are not authorized or empowered to act for or on behalf of Bank
in any respect. Their actions with respect to the loan application,
documentation and funding process are performed for or on behalf of
themselves and/or Franchisee borrowers.
(viii) INDEMNIFICATION. BORROWER AGREES TO INDEMNIFY BANK AND HOLD
BANK HARMLESS OF AND FROM ANY AND ALL CLAIMS, CAUSES OF ACTION,
LIABILITIES AND DAMAGES, INCLUDING ATTORNEY'S FEES, WHICH MAY BE
ASSERTED AGAINST BANK OR BANK'S OFFICERS, DIRECTORS, EMPLOYEES,
AGENTS, ATTORNEYS, PARENT CORPORATION OR AFFILIATES BY ANY FRANCHISEE
IN CONNECTION WITH ANY FRANCHISEE LOAN, EXCEPTING ONLY CLAIMS DUE
SOLELY TO GROSS NEGLIGENCE OR INTENTIONAL MISCONDUCT OF BANK.
2. The following is hereby added to the Credit Agreement as
Section 1.3(d):
(d) FRANCHISEE LOAN FEES. (i) Borrower shall pay to Bank a fee upon
the making of each Franchisee Loan equal to one percent (1.00%) of the
face amount thereof. Such fee shall be due and payable immediately
upon the making of each Franchisee Loan. (ii) Borrower shall pay to
Bank fees upon the renewal of each Franchisee Loan equal to one-half
of one percent (0.50%) of the face amount thereof. Such fee shall be
due and payable immediately upon the renewal of each Franchisee Loan.
3. The following is hereby added to the Credit Agreement as
Section 6.1(j):
(j) The nonpayment of any Franchisee Loan within five (5) days of its
maturity. A Franchisee Loan may be paid by renewal only once and then
only upon compliance with the conditions of any such renewals set
forth herein.
4. Annexes "I", and "II" hereto are hereby added to the Credit Agreement
as Exhibits "C", and "D" respectively.
-22-
<PAGE>
5. Except as specifically provided herein, all terms and conditions of
the Credit Agreement remain in full force and effect, without waiver or
modification. All terms defined in the Credit Agreement shall have the same
meaning when used in this Amendment. This Amendment and the Credit Agreement
shall be read together, as one document.
6. Borrower hereby remakes all representations and warranties contained
in the Credit Agreement and reaffirms all covenants set forth therein.
Borrower further certifies that as of the date of this Amendment there exists
no Event of Default as defined in the Credit Agreement, nor any condition,
act or event which with the giving of notice or the passage of time or both
would constitute any such Event of Default.
NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS
CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT
BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO
UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THE INDEBTEDNESS.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed as of the day and year first written above.
WELLS FARGO BANK (TEXAS),
SCHLOTSZKY'S, INC. NATIONAL ASSOCIATION
By: By:
--------------------------- ------------------------------
John C. Wooley Keith Smith
Chief Executive Officer Vice President
<PAGE>
SECOND AMENDMENT TO CREDIT AGREEMENT
THIS SECOND AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is entered
into as of April 7, 1998, by and between SCHLOTZKY'S, INC., a Texas
corporation ("Borrower"), and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION
("Bank").
RECITALS
WHEREAS, Borrower is currently indebted to Bank pursuant to the terms
and conditions of that certain Credit Agreement between Borrower and Bank
dated as of June 27, 1997, as amended by that certain First Amendment to
Credit Agreement between Borrower and Bank dated as of September 26, 1997
(collectively, the "Credit Agreement").
WHEREAS, Bank and Borrower have agreed to certain changes in the terms
and conditions set forth in the Credit Agreement and have agreed to amend the
Credit Agreement to reflect said changes.
NOW, THEREFORE, for valuable consideration, the receipt and sufficiency
of which are hereby acknowledged, the parties hereto agree that the Credit
Agreement shall be amended as follows:
1. Section 1.1(c) of the Credit Agreement is deleted in its entirety
and the following is substituted therefor:
(c) FRANCHISEE NOTE SUBFEATURE. (i) As a subfeature under the Line
of Credit, Bank agrees from time to time during the term thereof to
make loans to certain franchisees or area distributors (each a
"Franchisee") of Borrower. Such loans shall be for the purpose of
financing (A) the payment to Borrower by a franchisee or an area
distributor for leasehold improvements (the "Leasehold Loans"), or (B)
construction of new restaurants and the purchase of furniture,
fixtures and equipment related thereto by a franchisee (the
"Construction Loans"). Each Leasehold Loan will be evidenced by a
promissory note (each a "Leasehold Note" and collectively, "Leasehold
Notes") in the form attached hereto as Exhibit "C-1". Each
Construction Loan will be evidenced by a promissory note (each a
"Construction Note" and collectively, "Construction Notes") in the
form attached hereto as Exhibit "C-2" (the Leasehold Notes and the
Construction Notes, each a "Franchisee Note" and collectively, the
"Franchisee Notes"); provided however, that the aggregate amount of
<PAGE>
all outstanding Franchisee Notes shall not at any time exceed Twelve
Million Dollars ($12,000,000.00).
Each Franchisee Loan shall be in a minimum amount of Two Hundred
Thousand Dollars ($200,000.00). The aggregate principal amount of all
Franchisee Notes shall be reserved under the Line of Credit and shall
not be available for borrowings thereunder.
2. Section 1.1(c) of the Credit Agreement is deleted in its entirety
and the following is substituted therefor:
Borrower specifically acknowledges and agrees that Bank has made no
investigation as to the creditworthiness of any Franchisee and that
Bank would make no Franchisee Loan without the guarantee of such loans
by Borrower. Borrower represents and warrants that Borrower has
established adequate means of obtaining from each Franchisee on a
continuing basis financial and other information pertaining to such
Franchisee's financial condition. Borrower agrees to keep adequately
informed from such means of any facts, events or circumstances which
might in any way affect Borrower's risks hereunder or under any
related Guaranty of Franchisee Note, and Borrower further agrees that
Bank shall have no obligation to disclose to Borrower any information
or material about any Franchisee that is acquired by Bank in any
manner.
3. Section 4.9(d) of the Credit Agreement is deleted in its entirety
and the following is substituted therefor:
(d) EBITDA Borrowing Ratio not less than 2.0 to 1.0 as of the
end of each fiscal quarter, with "EBITDA" as defined above and
calculated as of the end of the preceding four fiscal quarters, and
with "EBITDA Borrowing Ratio" defined as the outstanding principal
balance of the Revolving Line of Credit plus the aggregate principal
amount of funded and unfunded portions of Franchisee Loans divided by
EBITDA.
4. Exhibit "C" is hereby deleted in its entirety, and Annexes "I" and
"II" hereto are substituted therefor as Exhibits C-1 and C-2, respectively.
5. Except as specifically provided herein, all terms and conditions of
the Credit Agreement remain in full force and effect, without waiver or
modification. All terms defined in the Credit Agreement shall have the same
meaning when used in this Amendment. This Amendment and the Credit Agreement
shall be read together, as one document.
-25-
<PAGE>
6. Borrower hereby remakes all representations and warranties contained
in the Credit Agreement and reaffirms all covenants set forth therein.
Borrower further certifies that as of the date of this Amendment there exists
no Event of Default as defined in the Credit Agreement, nor any condition,
act or event which with the giving of notice or the passage of time or both
would constitute any such Event of Default.
NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS
CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT
BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO
UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THE INDEBTEDNESS.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed as of the day and year first written above.
WELLS FARGO BANK (TEXAS),
SCHLOTZKY'S, INC. NATIONAL ASSOCIATION
By: By:
----------------------------- ---------------------------
John C. Wooley Keith Smith
Chief Executive Officer Vice President
<PAGE>
THIRD AMENDMENT TO CREDIT AGREEMENT
THIS THIRD AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is entered
into as of December 28, 1998, by and between Schlotzsky's, Inc., a Texas
corporation ("Borrower"), and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION
("Bank").
RECITALS
WHEREAS, Borrower is currently indebted to Bank pursuant to the terms
and conditions of that certain Credit Agreement between Borrower and Bank
dated as of June 27, 1997, as amended from time to time ("Credit Agreement").
WHEREAS, Bank and Borrower have agreed to certain changes in the terms
and conditions set forth in the Credit Agreement and have agreed to amend the
Credit Agreement to reflect said changes.
NOW, THEREFORE, for valuable consideration, the receipt and sufficiency
of which are hereby acknowledged, the parties hereto agree that the Credit
Agreement shall be amended as follows:
1. Section 1.1(a) is hereby amended (a) by deleting "April 30, 2000" as
the last day on which Bank will make advances under the Line of Credit, and
by substituting for said date "December 15, 2001," and (b) by deleting
"Twelve Million Dollars ($12,000,000.00)" as the maximum principal amount
available under the Line of Credit, and by substituting for said amount
"Fifteen Million Dollars ($15,000,000.00)," with such changes to be effective
upon the execution and delivery to Bank of a promissory note substantially in
the form of Exhibit A attached hereto (which promissory note shall replace
and be deemed the Line of Credit Note defined in and made pursuant to the
Credit Agreement) and all other contracts, instruments and documents required
by Bank to evidence such change.
1. Section 1.1(c) is hereby amended by deleting "Twelve Million Dollars
($12,000,000.00)" as the maximum amount available for Franchisee loans under
the subfeature therefor under the Line of Credit, and by substituting for
said amount "Ten Million Dollar ($10,000,000.00)," with such change to be
effective upon the execution and delivery to Bank of this Amendment and all
other contracts, instruments and documents required by Bank to evidence such
change.
<PAGE>
2. Section 1.3 is hereby deleted in its entirety, and the following
substituted therefor:
"SECTION 1.2. LOAN.
(a) LOAN. Subject to the terms and conditions of this
Agreement, Bank hereby agrees to make a loan to Borrower in
the principal amount of Five Million Dollars ($5,000,000.00)
("Loan"), the proceeds of which shall be used for capital
expenditures. Borrower's obligation to repay the Loan shall
be evidenced by a promissory note substantially in the form
of Exhibit B attached hereto ("Loan Note"), all terms of
which are incorporated herein by this reference. Bank's
commitment to grant the Loan shall terminate on January 22,
1999.
(b) REPAYMENT. The outstanding principal balance of
the Loan shall be due and payable in full on March 31, 1999.
(c) PREPAYMENT. Borrower may prepay principal on the
Loan solely in accordance with the provisions of the Loan
Note."
3. Sections 1.3(a) and (b) are hereby deleted in their entirety, and
the following substituted therefor:
"(a) INTEREST. The outstanding principal balances of
the Line of Credit, the Leasehold Loans, the Construction
Loans and the Loan shall bear interest at the rates of
interest set forth in the Line of Credit Note, the
Franchisee Notes and the Loan Note.
(b) COMPUTATION AND PAYMENT. Interest shall be
computed on the basis of a 360-day year, actual days
elapsed, unless such calculation would result in a usurious
rate, in which case interest shall be computed on the basis
of a 365/366-day year, as the case may be, actual days
elapsed. Interest shall be payable at the times and place
set forth in the Line of Credit Note, the Franchisee
-28-
<PAGE>
Notes and the Loan Note (collectively, the "Notes").
4. The following is hereby added to the Credit Agreement as Section 1.4:
"SECTION 1.4. COLLATERAL.
As security for all indebtedness of Borrower to Bank
subject hereto, Borrower hereby grants to Bank security
interests of first priority in all Borrower's accounts
receivables, other right to payment and general intangibles.
All of the foregoing shall be evidenced by and subject
to the terms of such security agreements, financing
statements, deeds of trust and other documents as Bank shall
reasonably require, all in form and substance satisfactory
to Bank. Borrower shall reimburse Bank immediately upon
demand for all costs and expenses incurred by Bank in
connection with any of the foregoing security, including
without limitation, filing and recording fees and costs of
appraisals, audits and title insurance."
5. Except as specifically provided herein, all terms and conditions of
the Credit Agreement remain in full force and effect, without waiver or
modification. All terms defined in the Credit Agreement shall have the same
meaning when used in this Amendment. This Amendment and the Credit Agreement
shall be read together, as one document.
6. Borrower hereby remakes all representations and warranties contained
in the Credit Agreement and reaffirms all covenants set forth therein.
Borrower further certifies that as of the date of this Amendment there exists
no Event of Default as defined in the Credit Agreement, nor any condition,
act or event which with the giving of notice or the passage of time or both
would constitute any such Event of Default.
NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS
CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT
BETWEEN THE PARTIES AND MAY NOT BE
-29-
<PAGE>
CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN
THE PARTIES RELATING TO THE INDEBTEDNESS.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed as of the day and year first written above.
WELLS FARGO BANK (TEXAS),
SCHLOTZSKY'S, INC. NATIONAL ASSOCIATION
By: By:
----------------------------- -------------------------------
John C. Wooley Keith Smith
Chief Executive Officer Vice President
-30-
<PAGE>
SUBSIDIARIES OF THE COMPANY
<TABLE>
<CAPTION>
NAME OF SUBSIDIARY STATE OF INCORPORATION
- - -------------------------------------------------------------------------------------
<S> <C>
1. Schlotzsky's Real Estate, Inc. Texas
2. Schlotzsky's Restaurants, 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
</TABLE>
<PAGE>
[GRANT THORNTON LETTERHEAD]
The US Member Firm of
Grant Thornton International
ACKNOWLEDGMENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Schlotzsky's, Inc.
We have issued our report dated February 29, 1999, accompanying the consolidated
financial statements of Schlotzsky's, Inc. as of December 31, 1998 and 1997, and
for each of the three years in the period ended December 31, 1998, included in
the Franchise Offering Circular. We agree to the inclusion of the
aforementioned report in the Franchise Offering Circular. This acknowledgment
should not be regarded as in any way updating the aforementioned report or
representing that we have performed any procedures subsequent to the date of
such report.
/s/ Grant Thornton LLP
- - -------------------------------
GRANT THORNTON LLP
Dallas, Texas
March 29, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF
INCOME ON PAGES TWO AND THREE OF THE COMPANY'S FORM 10-K FOR THE YEAR-TO-DATE
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0001002178
<NAME> SCHLOTZSKY'S INC.
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 16,824,068
<SECURITIES> 0
<RECEIVABLES> 24,066,702
<ALLOWANCES> (1,415,498)
<INVENTORY> 0
<CURRENT-ASSETS> 40,981,517
<PP&E> 20,830,592
<DEPRECIATION> (2,300,846)
<TOTAL-ASSETS> 104,228,140
<CURRENT-LIABILITIES> 19,748,547
<BONDS> 0
0
0
<COMMON> 62,877
<OTHER-SE> 73,899,715
<TOTAL-LIABILITY-AND-EQUITY> 104,228,140
<SALES> 7,720,432
<TOTAL-REVENUES> 41,847,912
<CGS> 2,513,156
<TOTAL-COSTS> 33,971,100
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 972,724
<INTEREST-EXPENSE> (2,058,262)
<INCOME-PRETAX> 9,935,074
<INCOME-TAX> 3,728,609
<INCOME-CONTINUING> 6,206,465
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,206,465
<EPS-PRIMARY> .84
<EPS-DILUTED> .82
</TABLE>
