<PAGE>
================================================================================
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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-27008
----------------------
SCHLOTZSKY'S, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-2654208
(State or other Jurisdiction of (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 14, 2000 was approximately $40,827,000 based upon
the last sales price on March 14, 2000 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 7,430,027 shares of Common Stock outstanding on
March 14, 2000.
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.
================================================================================
<PAGE>
SCHLOTZSKY'S, INC.
INDEX TO FORM 10-K
YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C> <C>
PART I
Item 1. Business........................................................................................... 1
Item 2. Properties......................................................................................... 18
Item 3. Legal Proceedings.................................................................................. 18
Item 4. Submission of Matters to a Vote of Security Holders................................................ 19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................. 20
Item 6. Selected Consolidated Financial Data............................................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation........................................................................... 22
Item 7A. Quantitative and Qualitative Disclosures about Market Risk......................................... 32
Item 8. Financial Statements and Supplementary Data........................................................ 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................................................... 32
PART III
Item 10. Directors and Executive Officers of the Registrant................................................. 33
Item 11. Executive Compensation............................................................................. 33
Item 12. Security Ownership of Certain Beneficial Owners and Management..................................... 33
Item 13. Certain Relationships and Related Transactions..................................................... 33
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................... 36
</TABLE>
<PAGE>
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., RAD Acquisition Corp. 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. Effective January 1, 2000, the Company formed
Schlotzsky's Brands I, L.L.C., a Delaware Limited Liability Company, and
Schlotzsky's Brand Product, L.P., a Texas Limited Partnership, both of which
are directly or indirectly wholly-owned by the Company.
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, 1999,
the Schlotzsky's-Registered Trademark- Deli system included 23 Company-owned
stores and 736 franchised stores located in 37 states, the District of
Columbia and 13 foreign countries. Of the Company-owned stores, there are
thirteen stores which the Company intends to own and operate on a long term
basis. The other ten stores are being operated as held for sale until they
are re-franchised. The Company's revenues were $41.8 million for 1998 and
$47.9 million for 1999 while system-wide sales of the franchise system for
all stores were approximately $348.5 million for 1998 and $400.3 million for
1999. System-wide sales are based on reported sales of franchised stores, as
well as Company-owned stores, and are a principal driver of Company revenue
because royalty revenue is based on system-wide sales. Weighted average
annual unit volumes for all stores were $503,000 for 1998 and $550,000 for
1999.
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
acquiring and developing a limited number of Company-owned stores,
principally for concept development, and focusing the attention of many of
its area developers on franchisee support, rather than recruiting. The
Company initiated national network television advertising in the Spring of
1999.
MENU OF DISTINCTIVE, HIGH QUALITY PRODUCTS. Schlotzsky's-Registered
Trademark- 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
1
<PAGE>
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-Registered Trademark- Deli restaurants now offer an expanded
menu with 15 sandwiches on four types of bread, 10 sourdough crust pizzas,
five salads, soups, chips and other side items, fresh baked cookies and other
desserts, and beverages. At most locations, sandwiches 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 and franchisees in identify and acquire 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 to help them by the Company
because of its experience building prototype stores and its purchasing power
with suppliers and contractors.
AREA DEVELOPERS. The Company has 28 area developers trained to assist
the Company in achieving its expansion goals in the United States. 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, store opening schedules for these area
developers were eliminated and certain service requirements, such as
franchisee recruiting, were reduced. Depending on whether their agreements
were revised, area developers may provide a range of services: recruit and
qualify franchisees; assist franchisees in site selection, training,
financing, building and opening stores; provide ongoing operational support;
monitor product and service quality; and help coordinate local advertising.
Prior to 1991, these functions were performed exclusively 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 help develop their markets and monitor operating performance.
Generally, area developers whose agreements were not revised have been
required to recruit franchisee candidates and meet specific store opening
schedules with the Company in order to maintain their development rights.
MOTIVATED OWNER-OPERATOR FRANCHISEES. The Company is developing a strong
network of owner-operator franchisees. The Company believes that a motivated
owner-operator is an essential key to the success of a store. The
Schlotzsky's system consists almost exclusively of franchised stores, owned
and managed by entrepreneurial franchisees. The Company seeks franchisees who
are committed to providing on-site supervision of store operations and
prefers to limit franchisees to three or four locations in relatively close
proximity. As of December 31, 1999, out of 450 franchisees with stores,
thirteen franchisees have more than five stores each and, in the aggregate,
account for approximately 11% 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. In 1999, the Company started
advertising on national network television, using a portion of the marketing
contributions required from franchisees under their franchise contracts. 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 many of them 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. In addition, a
new line of Schlotzsky's-Registered Trademark- Deli meats, cheeses and
condiments were test marketed in an East Texas based grocery chain and
selected markets during 1999. The Company expects to continue to explore
alternative channels for retail distribution of some of its private label
products.
COMPANY-OWNED STORES. The Company opened its flagship store in Austin,
Texas in 1995 and it has continued to expand its portfolio of Company owned and
operated locations over the past few years. During 1998 and 1999,
2
<PAGE>
the Company added primarily prototype units to its group of stores in and
around its home market. At the end of 1999, the Company owned and operated 13
units, primarily in Texas and Georgia, and one location in New York City.
Over the last three years, the Company has also acquired ten other locations
which it does not consider part of its permanent portfolio of Company units.
The Company intends to re-market these locations once sales and operating
results are improved. These stores are classified as "Restaurants Held for
Sale". The operating results of the units held for sale are considered an
operating cost of the Turnkey Program and are reported in Turnkey Development
cost. Results from the restaurants the Company intends to own and operate on
a long term basis, are reflected in restaurant operations figures. The
Company anticipates opening or acquiring additional stores in Texas during
2000. 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.
EXPANSION
At December 31, 1999, the Schlotzsky's system consisted of 759 stores in
37 states, the District of Columbia, and 13 foreign countries. At December
31, 1997 and 1998, the system included 673 and 750 stores, respectively.
STORE LOCATIONS AS OF DECEMBER 31, 1999
<TABLE>
<CAPTION>
NUMBER OF
LOCATION STORES
-------- ------
<S> <C>
UNITED STATES:
Texas.............................................. 224
Tennessee.......................................... 38
Arizona............................................ 37
Georgia............................................ 35
Florida............................................ 32
Illinois........................................... 32
North Carolina..................................... 26
Michigan........................................... 23
Indiana............................................ 22
Colorado........................................... 21
Wisconsin.......................................... 21
Alabama............................................ 20
California......................................... 18
Oklahoma........................................... 17
South Carolina..................................... 17
Missouri........................................... 14
Ohio............................................... 13
Kansas............................................. 12
New Mexico......................................... 11
Louisiana.......................................... 10
Minnesota.......................................... 10
Nebraska........................................... 10
Arkansas........................................... 9
Utah............................................... 9
Oregon............................................. 8
Nevada............................................. 7
Kentucky........................................... 6
Virginia........................................... 6
Washington......................................... 6
Mississippi........................................ 5
Idaho.............................................. 4
West Virginia...................................... 4
North Dakota....................................... 3
Hawaii............................................. 2
Pennsylvania....................................... 2
South Dakota....................................... 2
District of Columbia............................... 1
3
<PAGE>
New York........................................... 1
-----
TOTAL DOMESTIC..................................... 738
4
<PAGE>
INTERNATIONAL:
Argentina.......................................... 4
Malaysia........................................... 4
Turkey............................................. 3
Australia.......................................... 1
Bahrain............................................ 1
Canada............................................. 1
China.............................................. 1
Germany............................................ 1
Guatemala.......................................... 1
Lebanon............................................ 1
Morocco............................................ 1
Saudi Arabia....................................... 1
Venezuela.......................................... 1
-----
TOTAL INTERNATIONAL:............................... 21
-----
TOTAL DOMESTIC & INTERNATIONAL:.................... 759
=====
</TABLE>
TURNKEY PROGRAM
The Company instituted the Turnkey Program to further assist franchisees
in obtaining superior sites and to achieve more rapid development of new
stores, especially in selected major markets where the Company believes there
is strong demand by franchisees for good locations. The Company also 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. 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, an area
developer, or a third-party investor, who then assumes responsibility for
developing the store. The Company may also purchase or lease a selected site,
construct a Schlotzsky's-Registered Trademark- Deli restaurant on the site
and sell, lease or sublease the completed store to a franchisee, or sell the
store to an investor who leases the store to the franchisee.
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 to an investor, the Company 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 expires, the Company recognizes
the revenue and allocable costs related to the site. Generally, if no credit
enhancement was provided in connection with such transactions, the Company
recognized the revenue and allocable expenses in the periods in which the
transactions occurred.
In 1998, the Company began encouraging ownership of the real estate by
its franchisees through a new mortgage loan program. Under the mortgage
program, the Company provided interim financing to the franchisee, to
purchase a store built under the Turnkey Program or to purchase land and
construct the building for a new store. The interim loan was either sold to,
or refinanced by, an institutional lender. The Company provided credit
enhancement for the franchisee in the form of a limited guaranty in favor of
the lender. These guarantees were usually limited to the first two to five
years and to 15% to 25% of the principal amount of the loan. Generally, the
Company recognized the revenue and allocable expenses in the period in which
the transaction occurred. The Company still provides interim financing for
stores in development or recently opened in anticipation of long-term
financing by a financial institution, although the Company recently
instituted efforts to reduce the level of interim financing it provides by
referring franchisees to certain institutional lenders to provide such
interim financing.
5
<PAGE>
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 services are
performed. The Company anticipates that the total investment in each
developed free-standing location will be approximately $1,300,000 to
$2,400,000 (less for leased locations).
MENU
The Schlotzsky's-Registered Trademark- 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. In 20 territories where 17 of the Company's area
developers have retained their original service obligations, the 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. Each such 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 who retained their original service obligations 50% of
all franchise fees paid by franchisees in their territories, although some
area developers received up to 100% of certain franchise fees as an
inducement to develop their territories more quickly. In addition, the
Company also pays these area developers 2.5% constituting 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.
The percentage of franchise fees and royalties payable to the other 11
area developers has been reduced to approximately 33% and 21%, respectively,
as a result of several transactions completed during 1999 and at the end of
1998. During the third quarter of 1999, the Company assumed territory
management responsibility for its largest area developer in conjunction with
an option to buy its territories. Net service costs associated with this
arrangement were reduced to 1% effective October 31st and escalate to 2% by
August 16, 2004, compared to the former 2.5% rate. A limited number of
additional transactions are contemplated, but 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 development
rights for a market. The Company has typically received 10% to 50% of the
area developer fee when the area development agreement is signed with the
balance payable with interest over an 18 to 60-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 has
eliminated the schedules
6
<PAGE>
for those whose royalties were reduced. 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
- -Registered Trademark- 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 certain area developers identify and recruit
potential franchisees, all franchisees must be approved by the Company.
FRANCHISE AGREEMENTS. The Company enters into an agreement with each
franchisee granting the franchisee the right to develop a store 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, 1999, 92 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-Registered Trademark- Deli restaurants
in various locations. In November 1995, the Company opened its new flagship
Schlotzsky's-Registered Trademark- 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 and pizzas. 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-Registered Trademark- 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 2000. Although the Company has the right to audit
franchisees, it relies primarily on voluntary compliance by franchisees to
accurately report sales and remit royalties. However, the Company began
auditing some franchise locations during 1999 and expects to continue
periodically auditing franchise locations during 2000.
7
<PAGE>
INTERNATIONAL MASTER LICENSEES. In addition to the Company's expansion
in the United States, the Company has granted nonassignable rights to develop
stores in international markets to master licensees. A master licensee is
typically licensed for 50 years to use the Schlotzsky's trademarks in
designated foreign territories and may grant area development rights and
franchises in those territories. Unlike area developers, master licensees
contract directly with franchisees, and the Company delegates the selection
of franchisees and approval of sites to the master licensees. When a master
license is granted, the master licensee pays the Company a negotiated,
nonrefundable license fee. In some instances, the Company will negotiate a
territorial agreement pursuant to which a foreign territory is reserved and
the principal economic terms of the master license agreement are agreed upon
in return for a nonrefundable fee to be applied toward the master license
fee. The Company normally receives 15% to 35% of the master license fee in
cash when the master license or territorial agreement is signed, with the
balance payable with interest over a term of up to 48 months under a
promissory note from the master licensee. Typically, the Company also
receives one-third to one-half of any sublicense and franchise fees and
one-third of any royalties received by the master licensee. All amounts
payable to the Company by the master licensees must be paid in U.S. dollars.
As of December 31, 1999, 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 STORES OPENED STORES OPENED BETWEEN
AS OF AS OF JANUARY 1, 1992 AND
STORE SITE DECEMBER 31, 1991 DECEMBER 31, 1999 DECEMBER 31, 1999
---------- ----------------- ----------------- ---------------------
<S> <C> <C> <C>
Free-Standing................ 24% 56% 60%
End-Cap...................... 31 25 22
In-Line...................... 28 9 6
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-Registered Trademark- Deli
restaurant concept offers attractive unit economics. The cost to a franchisee
of developing and opening a prototype Schlotzsky's-Registered Trademark-
Deli restaurant (excluding restaurants like the Company's flagship store) in
leased space has recently ranged from approximately $400,000 to $700,000,
including leasehold improvements, equipment, fixtures and initial working
capital. The initial cost of owning a free-standing, prototype restaurant
ranges from $1,300,000 to $2,400,000. During the twelve months ended December
31, 1999, the weighted average store sales for Schlotzsky's-Registered
Trademark- Deli restaurants was approximately $550,000, 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-Registered Trademark- Deli menu items are relatively low as a
percentage of gross store sales as compared to many quick service restaurant
concepts.
8
<PAGE>
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.
The Company has identified certain financial institutions who provide
mortgage loans to qualified franchisees with stores developed through the
Turnkey Program. These loans typically 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.
The Company has recently instituted efforts to reduce the level of interim
financing it provides. Interim loans the Company has provided have been in
the form of construction draw notes or mortgages. The Company had loaned an
aggregate of approximately $8.9 million to various franchisees through this
program, which had not been assigned to a financial institution as of
December 31, 1999. 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 during which the Company may be required to perform on its guaranty.
As of December 31, 1999, the Company had guaranteed an aggregate of
approximately $34.2 million of franchisee obligations, 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
9
<PAGE>
EVERY DAY. NAMF'S field marketing representatives coordinate advertising
campaigns and promotions for area developers and franchisees.
In addition, 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. Network advertising was initiated during the Spring
of 1999. The Company 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
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 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
10
<PAGE>
termination and give the franchisee an opportunity to cure any default, and
by requiring the franchisor to repurchase the franchisee's inventory or
provide other compensation. To date, those laws have not precluded the
Company from seeking franchisees in any given area and have not had a
material adverse effect on the Company's operations.
Each Schlotzsky's store must comply with regulations adopted by federal
agencies and with licensing and other regulations enforced by state and local
health, sanitation, safety, fire and other departments. Difficulties or
failures in obtaining the required licenses or approvals can delay and
sometimes prevent the opening of a new store.
Schlotzsky's stores must comply with federal and state environmental
regulations, such as those promulgated under the Federal Water Pollution Act,
Federal Clean Water Act of 1977 and the Federal Resource and Conservation
Recovery Act of 1976, but the Company believes that those regulations have
not had a material effect on their operations. More stringent and varied
requirements of local governmental bodies with respect to zoning, land use,
and environmental factors can delay and sometimes prevent development of new
stores in particular locations.
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, 1999, the Company employed 240 persons at its
corporate headquarters and 805 persons at Company-owned restaurants. 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 to
reduce the level of interim financing provided during the purchasing and
construction phase of Turnkey Program store development; (iv) plans
concerning the Company's relationship with its area developers; and (v) 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 1999, 66 new Schlotzsky's stores were
opened. During 1997 and 1998, the Company and its franchisees opened 120 and
107 stores, respectively. This level of store openings is greater than that
experienced by the Company prior to 1995. The Company relied primarily upon
its franchisees, area
10
<PAGE>
developers, the Turnkey Program, and new geographic markets to accomplish
this level of expansion. During 1999, the Company implemented more stringent
criteria in its restaurant site selection process in an effort to increase
sales potential at new locations. It is contemplated that this will result in
fewer openings than were experienced from 1995 to 1998. 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 financially and operationally 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 its growth or that the
Company will be able to manage its expanding operations effectively. See
"Business -- Strategy."
TURNKEY PROGRAM. As of December 31, 1999, the Company had developed 149
stores under the Turnkey Program, twenty-one of which were developed during
1999. The Company expects that the Turnkey Program will continue to produce
approximately 30% to 40% of new store development. 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 Turnkey Program. During 1999, the Company terminated certain real estate
purchase contracts and wrote off a significantly higher level of
pre-development costs associated with those contracts than had been
experienced in previous years. Most of the sites associated with the
contracts written off no longer met current standards for Turnkey development
sites. There can be no assurance that the Company's more stringent criteria
for site selection will prevent this from recurring. 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 along with its own licensing efforts 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. In 1999, the Company eliminated 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. 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, 1997 and December 31, 1999, 103 of the 293 new stores
opened were within territories controlled by only two area developers. As of
December 31, 1999, these two area developers controlled 15 territories having
a total of 310 stores. As these territories mature, system-wide growth will
depend upon more activity in other territories. The Company believes that the
concentration of store openings among a relatively few area developers is due
primarily to the longer tenure of these area developers with the Company and
the size and maturity of the territories covered by their agreements. As the
Company has reacquired or reduced the percentages of franchise fees and
royalties payable to certain area developers, it has assumed an increasing
level of responsibility for recruiting franchisees and received less
assistance with openings from many of its area developers. In 1999, the
Company assumed responsibility for all service requirements in the
territories controlled by its largest area developer, as well as all or part
of the services performed by several other area developers. Accordingly, its
success in several markets will depend on its ability to perform functions it
had previously relied on area developers to perform.
12
<PAGE>
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 costs to franchisees of opening
Schlotzsky's-Registered Trademark- Deli restaurants, particularly those
incurred under its more stringent site selection criteria, are 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. 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,
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. In addition, in 1999, a new line of
Schlotzsky's-Registered Trademark- Deli meats, cheese and condiments were
test marketed in an East Texas-based grocery chain and selected other
markets. The Company will continue to explore other alternative retail
channels of distribution for some of its private label products, and
anticipates renegotiating the terms of its contracts with some of its
suppliers, but there can be no assurance that the Company will achieve any
significant or consistent revenue from such sources.
The Company believes its purchasing programs provide franchisees with
significant cost savings and other advantages. There can be no assurance that
the Company's suppliers will not increase prices to franchisees or that
franchisees will not negotiate more favorable terms from other approved
suppliers. Some franchisees may also object to these fees as a source of
revenue to the Company. Any of these developments could result in reduced
purchases by franchisees of private label products and declining private
label licensing revenue to the Company. This could have a material adverse
effect on the financial condition and results of operations of the Company.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Results of Operations."
CREDIT RISK AND CONTINGENCIES. The Company guarantees certain real
estate obligations and equipment leases and other obligations of its
franchisees. The Company entered into guarantees with respect to most of the
leases between its franchisees and the buyers of the sites developed under
the Turnkey Program prior to 1999. These guarantees typically cover lease
payments and 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 guarantees a limited portion of most of the loans sold to
institutional lenders or made directly by such lenders for franchisees who
purchased Turnkey Program sites pursuant to the loan financing program which
the Company began implementing during 1998 and continued in 1999.
Under the loan financing program, the Company has made interim mortgage
loans and long-term subordinated loans to certain franchisees. See "Business
- --Turnkey Program" and "Business - Financing." At December 31, 1999, the
Company was contingently liable for approximately $34.2 million which is
principally comprised of guarantees on real estate leases and mortgages,
equipment leases and loans, and other obligations of its franchisees. The
principal amount of the loans outstanding under the loan financing program as
of December 31, 1999 was approximately $8.9 million.
13
<PAGE>
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, 1999, the Company held
notes receivable from area developers and master licensees in an aggregate
principal amount of approximately $9.2 million. At December 31, 1999, the
principal balance of these notes had been reserved on the financial
statements of the Company by approximately $407,000. In addition, at December
31, 1999 there was $7.7 million of deferred revenue related to these
transactions. 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, 1999, the outstanding principal amount of
these notes was approximately $17.4 million. While the Company considers it
unlikely that there will be defaults on a significant amount of the loans and
notes described above, 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 has guaranteed the repayment of a loan for this project in
the principal amount of $2.05 million due in October 2009. The Company does
not exercise control over the partnership and does not consider its
investment in the retail shopping center to represent a separate line of
business. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
LIMITED OPERATING HISTORY OF PROTOTYPES. Over the past several years,
the Company has refined its store prototypes and currently encourages
franchisees to develop larger, free-standing stores with higher visibility on
superior sites. 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 759 stores in the system at December
31, 1999, 224 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
14
<PAGE>
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, 1999, John C.
Wooley and Jeffrey J. Wooley beneficially owned an aggregate of approximately
15.4% 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. As a result,
these shareholders, if they were to act in concert, would have the ability to
influence the outcome of any issue submitted to a vote of the shareholders.
There are no agreements or understandings among these shareholders regarding
the voting of their shares, but to date they have voted consistently on
matters submitted to a vote of the shareholders.
DEPENDENCE ON MANAGEMENT AND KEY PERSONNEL. The Company's success is
highly dependent upon the efforts of its management and key personnel,
including its Chairman of the Board and President, John C. Wooley. The
Company has employment agreements with John C. Wooley and Jeffrey J. Wooley
each of which includes certain noncompetition provisions that survive the
termination of employment. The employment agreements 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, 1999, the Company
had 7,417,714 shares of Common Stock outstanding. A substantial number of
shares will become available for sale in the public market at various
15
<PAGE>
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.
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.
In 1999, the Company entered into an Option Agreement with its largest
area developer pursuant to which it agreed that if there is a change in
control of the Company (defined to include the acquisition of at least 20% of
the outstanding common stock by someone other than John C. Wooley or Jeffrey
J. Wooley), the Company is obligated to pay between $2.8 million and $3.8
million to prevent the option to reacquire the area developer agreement from
lapsing. Such payment is applicable to the exercise price, if and when paid.
16
<PAGE>
In December 1999, the Company entered into a Credit Agreement with Wells
Fargo Bank, (Texas), N.A., as agent for a group of lenders, pursuant to which
the Company obtained a new credit facility for up to $40,000,000, in the
aggregate. Under the Credit Agreement, the acquisition of beneficial
ownership of more than 33% of the outstanding stock of the Company by a
person or group of related persons constitutes a default, resulting in the
possible acceleration of outstanding indebtedness.
17
<PAGE>
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. In addition, this
limited liability company has provided the Company with storage space over
the last ten years rent free. During that period the Company was using up to
approximately 20,000 square feet of storage. Subsequent to December 31, 1999,
the location of the space was sold and the Company had to lease another
storage location. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations."
The Company operates 23 restaurants in eight states. Thirteen of these
stores are considered to be in the Company's portfolio of restaurants to be
held for the long term, and their operating results are reflected in the
Restaurant Operations figures. Of these units, eleven are in Texas, one is in
Georgia, and one is in New York. The remaining ten stores are considered held
for sale, and their results are included in the Turnkey Development segment.
These locations include three in Georgia, two in Texas, one in Alabama, one
in Utah, one in Mississippi, one in Arizona, and one in Illinois. The
properties consist of land, building, leasehold improvements, and restaurant
equipment. The equipment is typically owned, and the land and building is
either owned or leased.
As of December 31, 1999, the Company had 59 store sites in various
stages of development under the Turnkey Program. Development was completed on
3 sites and these sites are operating and under lease or mortgage. Nine of
the sites in development are in various stages of construction and 47 sites
remain in the pre-development stage. The Company also owns an additional five
sites, which it contemplates remarketing. It is contemplated that sites
acquired under the 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 1% general partner of a limited partnership which owns a
17,600 square foot shopping center in suburban Austin. 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 assessed the
Company $131,000 for gross receipts taxes, penalties and interest for the
years 1987 through 1993. The assessment imposed 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 violated the Commerce Clause of the United States Constitution
because the Company does not have any physical presence in or substantial
nexus with New Mexico. In November 1999, the Company accepted an amnesty
offer from the state of New Mexico, withdrew its protest and paid $121,000 in
full satisfaction of all claims by the state through 1998. The Company had
reserved a liability for taxes and attorneys' fees in respect of this
assessment in excess of the amount paid. 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. On
August 5, 1999, the Defendants' Motion to dismiss the consolidated complaint
was granted, with prejudice. Plaintiffs filed a notice of appeal on September
28, 1999, and filed their appellate brief on or about December 12, 1999.
Defendants filed their brief in response on February 25,
18
<PAGE>
2000. The Company believes that the allegations are without merit and intends
to vigorously defend against the appeal.
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.
19
<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
14, 2000, 7,430,027 shares of outstanding Common Stock were owned by
approximately 5,700 beneficial owners constituting 270 shareholders of record.
The high and low bid prices as reported by NASDAQ for the period from
January 1, 1998 to December 31, 1999 are set forth below:
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
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
FISCAL 1999
First Quarter................. 13 5/16 10
Second Quarter................ 12 1/2 10 1/8
Third Quarter................. 12 1/4 7 5/8
Fourth Quarter................ 8 1/4 6
</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.
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, 1997,
1998 and 1999 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, 1995 and 1996 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.
20
<PAGE>
<TABLE>
<CAPTION>
FISCAL YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Royalties......................................... $ 7,425 $10,747 $14,561 $18,885 $21,547
Franchise fees.................................... 1,494 1,775 1,555 1,365 843
Developer fees (1)................................ 2,666 1,993 325 270 1,057
Restaurant sales.................................. 505 3,610 6,364 7,720 14,816
Brand contribution................................ 397 1,295 2,915 4,003 6,173
Turnkey development............................... 41 726 1,139 8,314 1,687
Other fees and revenue............................ 324 568 1,110 1,291 1,815
---------- ---------- ---------- ---------- ----------
Total revenue................................. 12,852 20,714 27,969 41,848 47,938
Costs and expenses:
Service costs:
Royalties....................................... 2,405 3,791 5,373 7,225 6,601
Franchise fees.................................. 767 959 813 697 389
Restaurant operations:
Cost of sales................................... 189 1,183 2,014 2,513 4,404
Labor costs..................................... 408 1,424 2,493 3,205 5,482
Operating expenses.............................. 251 1,040 1,952 2,168 3,358
Turnkey development costs......................... 332 519 368 4,806 5,164
General and administrative........................ 5,419 6,509 7,686 11,472 13,677
Depreciation and amortization..................... 458 779 1,155 1,885 2,855
---------- ---------- ---------- ---------- ----------
Total costs and expenses...................... 10,229 16,204 21,854 33,971 41,930
---------- ---------- ---------- ---------- ----------
Income from operations.......................... 2,623 4,510 6,115 7,877 6,008
Other:
Interest income ................................ 286 786 1,050 2,296 3,142
Interest expense................................ (435) (331) (297) (238) (2,279)
Other income.................................... 138 132 195 -- --
---------- ---------- ---------- ---------- ----------
Total other income (expense).................. (11) 587 948 2,058 863
---------- ---------- ---------- ---------- ----------
Income before continuing operations before
income taxes.................................... 2,612 5,097 7,063 9,935 6,871
Income taxes.................................... (1,017) (1,902) (2,614) (3,729) (2,525)
Income from continuing operations.................... 1,595 3,195 4,449 6,206 4,346
Cumulative effect of change in accounting
principle..................................... -- -- -- -- (3,820)
Extraordinary Gain.............................. 38 -- -- -- --
---------- ---------- ---------- ---------- ----------
Net income........................................... $ 1,633 $ 3,195 $ 4,449 $ 6,206 $ 526
========== ========== ========== ========== ==========
Income from continuing operations - basic .47 .58 .74 .84 .59
Income from continuing operations - diluted .42 .57 .71 .82 .58
Net income per share - basic......................... $0.47 $ 0.58 $ 0.74 $ 0.84 $ 0.07
Net income per share - diluted....................... $0.42 $ 0.57 $ 0.71 $ 0.82 $ 0.07
Working capital...................................... $18,750 $13,515 $42,563 $26,842 $16,606
Total assets......................................... 36,708 40,979 79,521 104,822 132,759
Long-term debt, less current maturities.............. 3,029 3,129 1,936 9,219 21,275
Stockholders' equity................................. 28,974 32,312 66,991 73,963 74,735
</TABLE>
(1) Effective January 1, 1999, The Company implemented a change in accounting
principle regarding revenue recognition of developer fees. See discussion
in Item 7.
21
<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, 1999, 92
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 2000). 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-Registered Trademark- 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. As of December 31, 1999,
thirteen Company stores were being operated primarily for product
development, concept refinement, brand leadership and training franchisees.
Management does not believe that the operating costs for Company-owned stores
are necessarily 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." Prior to 1999, when the Company had
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, it recognized
as revenue the cash portion of the fee and the value of the promissory note,
as determined by an independent third party valuation. As a result of recent
positions taken by the Securities and Exchange Commission, the Company made a
change in its accounting policy for revenue recognition of developer fees
22
<PAGE>
effective January 1, 1999. With the change in accounting principle, revenue
generated from developer transactions will be recognized over the term of the
development schedule within the developer contracts generally about a ten
year period. Developer fees recognized in 1997 and 1998 under the previous
accounting policy were less than in previous years as most of the remaining
domestic territories had been sold and fees from the licensing of
international territories, which are not aggressively marketed by management,
were sporadic. Fees recognized in 1999 primarily represent amortization of
prior years' fees pursuant to the change in accounting principle.
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 $2,915,000 for 1997,
$4,003,000 for 1998 and $6,173,000 for 1999. 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,
terms with various suppliers are renegotiated and alternative channels of
distribution are exploited. 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-Registered Trademark- 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 $1,300,000 to $2,400,000 (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.
23
<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,
---------------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Royalties......................................... 52.1% 45.1% 44.9%
Franchise fees.................................... 5.6 3.3 1.8
Developer fees.................................... 1.2 0.6 2.2
Restaurant sales.................................. 22.7 18.4 30.9
Brand contribution................................ 10.4 9.6 12.9
Turnkey development............................... 4.1 19.9 3.5
Other fees and revenue............................ 3.9 3.1 3.8
------------ ------------- ------------
Total revenue................................. 100.0 100.0 100.0
Costs and expenses:
Service costs:
Royalties(1).................................... 36.9 38.3 30.6
Franchise fees(2)............................... 52.3 51.1 46.1
Restaurant operations:
Cost of sales(3)................................ 31.6 32.6 29.7
Labor costs(3).................................. 39.2 41.5 37.0
Operating expenses(3)........................... 30.7 28.1 22.7
Turnkey development costs (4) .................... 32.3 57.8 306.1
General and administrative........................ 27.5 27.4 28.5
Depreciation and amortization..................... 4.1 4.5 6.0
Total costs and expenses...................... 78.1 81.2 87.5
------------ ------------- ------------
Income from operations.......................... 21.9 18.8 12.5
Other:
Interest income................................. 3.8 5.5 6.6
Interest expense................................ (1.1) (0.6) (4.8)
Other income (expense).......................... 0.7 0.0 0.0
------------ ------------- ------------
Total other income............................ 3.4 4.9 1.8
------------ ------------- ------------
Income before income taxes and cumulative effect of
change in accounting principle.................. 25.3 23.7 14.3
Provision for income taxes...................... 9.3 8.9 5.3
------------ ------------- ------------
Income before cumulative effect of change
in accounting principle......................... 15.9% 14.8% 9.1%
============ ============= ============
Cumulative effect of change in accounting principle,
net of tax..................................... -- -- (8.0%)
------------ ------------- ------------
Net income.......................................... 15.9% 14.8% 1.1%
============ ============= ============
STORE DATA:
System-wide sales(5)........................... $270,400 $348,500 $400,300
Change in same store sales(6).................. 3.4% 3.1% 2.8%
Weighted average annual store sales(7)......... $455,000 $503,000 $550,000
Weighted average weekly store sales(7)......... $ 8,753 $ 9,671 $ 10,579
Change in average weighted weekly
store sales(8) .............................. 11.3% 10.5% 9.4%
Number of stores opened during period.......... 120 107 66
Number of stores closed during period.......... 20 30 57
Number of stores in operation at end
of period.................................... 673 750 759
- --------------------------------------------
</TABLE>
(1) Expressed as a percentage of royalties.
(2) Expressed as a percentage of franchise fees.
(3) Expressed as a percentage of restaurant sales.
24
<PAGE>
(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 eighteen months as of the end of the
corresponding prior period, including stores which were temporarily closed
and reopened within six 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.
RESULTS OF OPERATIONS
FISCAL YEAR 1999 COMPARED TO 1998
REVENUE. Total revenue increased 14.6% from $41,848,000 to $47,938,000.
Royalties increased 14.1% from $18,885,000 to $21,546,000. This increase
was due to the full year impact of stores opened in 1998 and the addition of
66 restaurants opened during the period from January 1, 1999 to December 31,
1999. Also contributing to the increase was the growing influence of larger
freestanding stores with higher visibility, a 9.4% increase in average weekly
sales and a 2.8% increase in same store sales. In addition, this increase is
directly related to the 14.9% increase in system sales. Royalties increased
at a lower rate during 1999 than 1998, primarily due to 57 closings which
occurred during 1999. However, the majority of closings tended to be
underperforming stores and stores that had been temporarily closed and the
franchisee had not made any significant effort to reopen or relocate within
the time required by the franchise agreement. In addition, the Company's
first national, network television advertising campaign was completed in 1999
impacting sales for the system.
Franchise fees decreased 38.2% from $1,365,000 to $843,000. This
decrease was a result of 41 fewer openings during 1999, as compared to 1998.
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 increased 291.5% from $270,000 to $1,057,000. While the
level of developer transactions increased, developer fees reported for the
year are primarily attributable to recognition of deferred revenue from
transactions which occurred prior years due to the change in accounting
principle. As a result of the change, developer fees are now being recognized
over the term of the development schedules. Because of the change in the
accounting principle, the Company anticipates that revenue recognized from
developer fees will be a more consistent amount from period to period during
the next several years.
Restaurant sales increased 91.9% from $7,720,000 to $14,816,000. This
increase was attributable to Company-owned stores added during 1998 and the
addition of five stores to the Company portfolio during 1999. 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, but that the
total number of Company units will remain at a small percentage of the
franchise system.
Private label licensing fees (brand contributions) increased 54.2% from
$4,003,000 to $6,173,000. 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. In addition, sales of
private label products through alternative channels of distribution was
greater than it had been in previous years, but still constituted less than
2.4% of the fees recognized in 1999.
Turnkey development revenue decreased 79.7% from $8,314,000 to
$1,687,000. In 1999, the Company placed less emphasis on generating a
material margin on the transactions it completed, but rather focused on
bringing the best value in terms of project cost to its franchisees, while
recovering some portion of its overhead cost. In addition, in 1998,
$2,102,000 of the revenue was related to transactions completed in 1997
involving the Company's lease guaranties, which were terminated in 1998. The
1999 revenue includes approximately $363,000 of rental revenue from sites
completed and under lease. The Company anticipates that Turnkey development
may remain at this lower level in the future as a greater emphasis is placed
on superior sites and controlling the cost to franchisees of each project.
25
<PAGE>
Other fees and revenues increased 40.8% from $1,289,000 to $1,815,000.
This change was primarily due to the increased level of supplier
contributions to the Company's annual convention held in June 1999, and a
one-time gain on the sale of the Company's limited partnership interest in an
entity that owns a small shopping center in suburban Austin, Texas.
COSTS AND EXPENSES. Royalty service costs decreased 8.6% from $7,225,000
to $6,601,000, and as a percentage of royalties declined from 38.3% to 30.6%.
This decrease reflects the impact of the reacquisition and reduction of
certain area developers interests in royalties during 1999. Area developers
generally receive approximately 42% or 21% of the royalties from stores in
their territories (depending on whether their share of royalties is 2.5% or
1.25%). The Company expects royalty service costs as a percentage of royalty
revenue to continue to decrease because the Company recently assumed
territory management responsibility for its largest area developer in
conjunction with an option to buy its territories (exercisable until 2012).
Under this option agreement, net service costs associated with this territory
management are 1% of royalties effective October 31, 1999 and escalate to 2%
by August 16, 2004, versus the current 2.5% rate. The Company may buy-down
the rights and obligations of certain area developers and may re-acquire the
full development rights to a limited number of territories over the next few
years.
Restaurant cost of sales, which consists of food, beverage and paper
costs, increased 75.2% from $2,513,000 to $4,404,000, but as a percentage of
restaurant sales decreased from 32.6% to 29.7%. Restaurant labor costs
increased 71.0% from $3,205,000 to $5,482,000, but as a percentage of
restaurant sales decreased from 41.5% to 37.0%. Restaurant operating expenses
increased 54.9% from $2,168,000 to $3,358,000, but, again, as a percentage of
restaurant sales decreased from 28.1% to 22.7% for 1999, as compared to 1998.
These percentage decreases were primarily due to operational efficiencies
experienced and cost controls implemented in the management of the
Company-owned stores. The decreases are also due to the increasing sales
outpacing the increased costs associated with operating the units.
Turnkey development costs increased 7.4% from $4,806,000 to $5,164,000
and as a percentage of Turnkey development revenue increased from 57.8% to
306.1%. These increases are primarily the result of fewer revenue
transactions in 1999 compared to 1998. In addition the Company experienced
approximately $900,000 in write-offs of Turnkey development costs associated
with sites under contract which were removed from consideration during the
period. Most of the sites written off either demonstrated higher than
expected development costs or no longer met current, more stringent standards
for Turnkey development sites.
General and administrative expenses increased 19.2% from $11,471,000 to
$13,678,000, and as a percentage of total revenue remained relatively stable
at 28.5%. The Company previously announced its goal of maintaining year 2000
general and administrative expenses at about the 1999 level.
Depreciation and amortization increased 51.5% from $1,885,000 to
$2,856,000, and as a percentage of revenue increased from 4.5% to 6.0%. The
dollar and percentage increases were principally due to amortization of
goodwill and other intangibles acquired in 1998 and 1999, such as area
developer territories and certain franchise rights, and depreciation related
to the additional stores the Company was operating during the year.
Interest income increased 36.9% from $2,296,000 to $3,142,000. This
increase was a result of a greater level of funds outstanding in the form of
Turnkey Mortgages and interim construction financing under the Turnkey
Program and an increase in the notes receivable related to the sale of
limited development rights. The Company plans to reduce the level of interim
construction financing by referring franchisees to third party financing
sources.
Interest expense increased 858% from $238,000 to $2,279,000. This
increase was the result of a greater level of debt outstanding during the
current period. The Company expects interest expense will trend slightly
upward as a result of the 1999 debt financing used to fund the re-acquisition
of certain area developer rights.
INCOME TAX EXPENSE. Income tax expense reflects a combined federal and
state effective tax rate of 36.8% for 1999, which is slightly lower than the
effective combined tax rate for the comparable period in 1998. Based on
projections of taxable income, the Company anticipates that its effective
combined rate for federal and state taxes will remain fairly stable.
26
<PAGE>
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
change in accounting principle did not affect revenue recognition of
developer fees.
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.
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.
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.
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 received approximately 42% of the royalties from the
stores in their 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
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.
27
<PAGE>
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.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $4,297,000 for 1999. Accounts
payable and accrued liabilities decreased $6,671,000, primarily because of
development territory purchases that were accrued in 1998 and funded in 1999.
The Company used only a net $2,791,000 of cash primarily in continuing its
construction and mortgage program for the Turnkey Program. Net cash of
$32,547,000 was used in investing activities primarily consisting of the
reacquisition of certain area developer rights and the royalty stream
associated with them. Also, the Company completed three Company owned stores
and used net cash of $5,629,000 to loan to the franchise system for national
advertising.
At December 31, 1999, the Company had approximately $40,730,000 of debt
outstanding. During 1999, the Company borrowed approximately $26,134,000 in
connection with the re-acquisition of certain domestic development rights and
drew on its line of credit to fund Turnkey development activities. During
1998, the Company had borrowed $5,000,000 primarily in connection with the
re-acquisition of certain domestic development rights. As of December 31,
1999, the Company had drawn substantially all of the $15,000,000 available
under the Company's line of credit from a financial institution to finance
Turkey Program capital requirements. In December 1999, the Company announced
it had obtained a new credit facility for up to $40,000,000, consisting of
$35,000,000 to refinance (i) repurchases of certain area developers'
interests in royalties into a long term facility, and (ii) renewal of a
revolving line of credit used to develop Company restaurants and restaurants
being developed through the Turnkey Program. The remaining $5,000,000
supports a letter of credit benefiting the Schlotzsky's National Advertising
Association, Inc. in its purchase of national television advertising. The
credit facility imposes a number of covenants on the Company, including
limitations on additional borrowings, capital expenditures, contingent
liabilities, and requirements to maintain certain financial ratios, working
capital and net worth. While the Company is currently in compliance with
these covenants, failure to do so would have material adverse consequences to
the Company. 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, 1999, these contingent
liabilities totaled approximately $34,249,000. 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 10% interest in
capital and profits. The loan, for which the Company is liable for the full
amount, had a balance of approximately $2,048,000 at December 31, 1999, bears
interest at prime plus 1.25% and matures January 2016. 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. The Company anticipates funding these
developments through long-term financing or available working capital.
28
<PAGE>
The Company continues to refine its Turnkey Program and expects that it
will have 30 to 80 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 to date. Even with a lower level of
anticipated activity in the Turnkey Program, the capital required to finance
the Turnkey Program will be significant. The tables below provide a summary
of Turnkey Program activity since its inception and a summary of the status
of the Turnkey Program at December 31, 1999.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
Turnkey Program revenue consists of the following: ----------------------------------------------
1997 1998 1999
------------ ------------ -----------
<S> <C> <C> <C>
Sales to investors and franchisees............................ $ 31,361,869 $ 29,596,310 $ 5,520,693
Development and construction management fees.................. 190,000 176,562 --
------------ ------------ -----------
Gross Turnkey Program revenue............................ 31,551,869 29,772,872 5,520,693
Turnkey Program development costs............................. (28,829,065) (23,382,340) (4,228,655)
------------ ------------ -----------
Net revenue from Turnkey Program projects................ 2,722,804 6,390,532 1,292,038
Rental income................................................. 303,091 258,187 363,386
Interim construction interest................................. 1,270 238,888 31,731
Deferred revenue recognized................................... -- 1,426,819 --
Revenue deferred.............................................. (1,888,555) -- --
------------ ------------ -----------
Total Turnkey Program revenue............................ $ 1,138,610 $ 8,314,426 $ 1,687,155
============ ============ ===========
</TABLE>
The following table reflects system performance of the Turnkey Program
for the years ended December 31, 1998 and 1999.
<TABLE>
<CAPTION>
NUMBER OF UNITS
---------------
1998 1999
---- ----
<S> <C> <C> <C>
Sites in process at beginning of year........................... 78 86
Sites beginning development during the year..................... 122 55
Sites removed from consideration during the period.............. (41) (68)
Sites inventoried as Company-owned stores....................... (1) (2)
Sites inventoried as real estate or restaurants held for sale... (2) --
Sites sold - revenue recognized................................. (69) (9)
Sites sold - revenue deferred................................... -- --
Other........................................................... (1) (3)
---- ----
Sites in process at end of year................................. 86 59
==== ====
INVESTED AT
DECEMBER 31,
1999
------------
Sites under development or to be sold........................... 4 9 $ 8,325,000
Predevelopment Site (prequalification).......................... 82 50 1,895,000
---- ---- ------------
Total....................................................... 86 59 $ 10,130,000
==== ==== ============
</TABLE>
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.
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.
29
<PAGE>
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
received 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 have
experienced or that they anticipate material internal risks. The Company is
continuing an in-depth inquiry concerning the readiness of its major
suppliers and those of the restaurant system. The Company has assessed and,
where practicable, attempted to mitigate its risks with respect to the
failure of these entities to be Year 2000 compliant. The Company attempted to
educate its franchise system during 1999 to prepare them to anticipate Year
2000 issues which could affect them locally. The Company believes that its
costs associated with monitoring readiness and mitigating risks concerning
the Year 2000 issue have not been material. There can be no assurance that
third parties will continue to be Year 2000 compliant. The impact on the
Company's operations, if any, from the inability of any of its suppliers and
franchisees to 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-Registered Trademark- 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, 107 in 1998 and 66 in 1999. 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.
Effective January 1, 1999, the Company changed its accounting policy
related to revenue recognition of developer fees. Prior to 1999, the Company
recognized developer fee revenue at the time the agreement was executed, its
obligations substantially completed, and the fee paid. This was typically in
the period in which the transaction occurred. However, based on a recent
change of its position related to these types of fees by the Securities and
Exchange Commission, the Company made a change in accounting principle
whereby revenue generated from developer transactions will be recognized over
the term of the development schedule specific to each contract. The change in
accounting principle will result in these fees being recognized over an
average of an approximately ten years. This change was made effective January
1, 1999. The quarterly results for 1999 reflect the application of this new
accounting principle. In addition, the first quarter of 1999 reflects the
cumulative effect of the change in accounting principle of $3,820,000 (net of
tax) for the impact of the change for developer transactions that occurred
prior to 1999. It is anticipated that as a result of the change in accounting
principle, and the growth of the royalty base, revenue from developer fees
will be fairly stable in actual dollars for the next several years but will
decline as a percentage of total revenue. Moreover, the Company anticipates
that other revenue will also continue to increase contributing to a further
decline in revenue recognized from developer fees will decline as a
percentage of total revenue, resulting in more normalized margins. The
Company also 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. Turnkey Program
revenue in 1999 was a result of transactions that involved the sale of the
site or land contract to a franchisee. Revenue for 1999 also included
approximately $363,000 of rental revenue.
30
<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 1997, 1998 and 1999 fiscal years.
<TABLE>
<CAPTION>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
PRESENTATION OF QUARTERLY FIGURES
1997 1998 1999
------------------------------ --------------------------------- ----------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Royalties $3,278 $3,606 $3,820 $3,858 $4,259 $ 4,720 $ 4,875 $ 5,032 $ 5,014 $ 5,560 $ 5,631 $ 5,341
Franchise fees 353 240 411 551 340 380 340 305 245 193 205 200
Developer fees (1) -- 125 -- 200 -- -- -- 270 228 243 282 305
Restaurant sales 1,324 1,439 1,636 1,965 1,616 1,885 1,745 2,475 2,543 3,839 4,233 4,201
Brands contribution 535 807 791 783 860 1,006 1,052 1,085 1,201 1,602 1,712 1,659
Turnkey development 685 762 1,374 (1,683) 1,125 1,732 2,845 2,612 670 160 420 437
Other fees and revenue 160 361 312 276 254 590 207 238 296 318 441 759
------------------------------- --------------------------------- ---------------------------------
Total revenues 6,335 7,340 8,344 5,950 8,454 10,313 11,064 12,017 10,197 11,915 12,924 12,902
COSTS AND EXPENSES 4,969 5,575 6,405 4,906 6,812 8,216 9,052 9,890 8,778 10,603 11,342 11,208
------------------------------- --------------------------------- ---------------------------------
OPERATING INCOME 1,366 1,765 1,939 1,044 1,642 2,097 2,012 2,127 1,419 1,312 1,582 1,694
NET INCOME BEFORE
CUMULATIVE EFFECT OF
CHANGE
IN ACCOUNTING PRINCIPLE 889 1,162 1,234 1,164 1,342 1,571 1,582 1,712 1,187 924 1,109 1,126
CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE
(NET OF TAX) -- -- -- -- -- -- -- -- (3,820) -- -- --
------------------------------ --------------------------------- ----------------------------------
NET INCOME/(LOSS) $ 889 $1,162 $1,234 $1,164 $1,342 $ 1,571 $ 1,582 $ 1,712 $(2,633) $ 924 $1,109 $1,126
============================== ================================= ==================================
INCOME PER COMMON SHARE
-BASIC
INCOME BEFORE CUMULATIVE
EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE $ 0.16 $ 0.21 $ 0.22 $ 0.16 $ 0.18 $ 0.21 $0.21 $ 0.23 $0.16 $0.12 $0.15 $0.15
CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING
PRINCIPLE -- -- -- -- -- -- -- -- (0.52) -- -- --
------------------------------ --------------------------------- ----------------------------------
NET INCOME/(LOSS) $ 0.16 $ 0.21 $ 0.22 $ 0.16 $ 0.18 $ 0.21 $0.21 $0.23 $(0.36) $0.12 $0.15 $0.15
============================== ================================= ==================================
INCOME PER COMMON SHARE -
DILUTED
INCOME BEFORE CUMULATIVE
EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE $ 0.16 $ 0.21 $ 0.21 $ 0.15 $ 0.18 $ 0.21 $0.21 $0.23 $0.16 $0.12 $0.15 $0.15
CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING
PRINCIPLE -- -- -- -- -- -- -- -- (0.51) -- -- --
------------------------------ --------------------------------- ----------------------------------
NET INCOME/(LOSS) $ 0.16 $ 0.21 $ 0.21 $ 0.15 $ 0.18 $ 0.21 $0.21 $0.23 $(0.35) $0.12 $0.15 $0.15
============================== ================================= ==================================
STORE OPENINGS 29 21 28 42 30 31 24 22 17 18 17 14
</TABLE>
- ----------
(1) The quarterly amounts shown for 1999 differ from those reported in the
Forms 10-Q for the first three quarters. The amounts originally reported
have been revised to reflect the impact of the change in accounting
principle implemented January 1, 1999 as discussed by Note 1 to the
financial statements.
31
<PAGE>
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, 1999 a hypothetical 100 basis point increase in interest
rates would result in a reduction of approximately $350,000 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, 1999. The fair values of the Company's bank loans are
not significantly affected by changes in market interest rates.
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, 2000.
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 guaranteed 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.
32
<PAGE>
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.
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 26, 2000, 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 26, 2000, 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 26, 2000,
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 26, 2000, and is incorporated herein
by reference.
33
<PAGE>
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.
<TABLE>
<CAPTION>
(a)(3) EXHIBITS
--------
<S> <C>
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)
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 10.10 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)
36
<PAGE>
10.17 -- Commitment Letter, dated July 7, 1995, by and between AT&T Commercial Finance Corporation and
the Registrant in an amount not to exceed $1,100,000.(1)
10.18 -- Term Sheet, dated July 19, 1995 by and between BeneVent-Noro and the Registrant.(1)
10.19 -- Promissory Note, dated December 1, 1994, by and between Bee Cave/Westbank, Ltd. and Liberty
National Bank in the original principal amount of $1,150,000.(1)
10.20 -- Loan Commitment, dated July 18, 1995, by and between Manns Capital Corporation and Bee
Cave/Westbank, Ltd., and Letter Amendment to Permanent Loan Commitment, dated July 28, 1995.(1)
10.21 -- Promissory Note, dated August 18, 1995, by and between the Registrant and First State Bank in
the original principal amount of $850,000.(1)
10.22 -- Operating Lease for 218 South Lamar, dated May 27, 1994, by and between William C. Pfluger, et
al. and Schlotzsky's Restaurants, Inc.(1)
10.23 -- Lease Agreement, September 8, 1995, by and between the Registrant and Austin CBD 29, Inc.(1)
10.24 -- Deed of Trust and Real Estate Lien Note, dated December 31, 1993, by and between Schlotzsky's
Real Estate, Inc. and Austin CBD Block 29, Ltd.(1)
10.25(a) -- Franchise Financing Program Procedures for Qualified Franchisees, dated April 15, 1994, by and
between Captec Financial Group, Inc. and the Registrant.(1)
10.25(b) -- Ultimate Net Loss Agreement, dated April 15, 1994, by and between the Registrant and Captec
Financial Group, Inc.(1)
10.25(c) -- Amendment to Ultimate Net Loss Agreement, dated March 30, 1995.(1)
10.26(a) -- Franchise finance letter of understanding, dated February 21, 1994, by and between Stephens
Franchisee Finance and the Registrant.(1)
10.26(b) -- Franchisee Financing Agreement, dated September 1, 1994, between the Registrant and Stephens
Diversified Leasing, Inc.(1)
10.27 -- Agreement, dated July 1, 1994, by and among Thomas Development Corporation, Micardo, Inc. and
the Registrant.(1)
10.28 -- Earnest Money Contract, dated May 20, 1994, among Schlotzsky's Real Estate, Inc., William C.
Pfluger, et al., Schlotzsky's Restaurants, Inc., the Registrant and John C. Wooley.(1)
10.29 -- Unsecured Promissory Note, dated June 29, 1993, from John C. Wooley payable to the Registrant
in the original principal amount of $280,000.(1)
10.30 -- Unsecured Promissory Note, dated June 29, 1993, from Jeffrey J. Wooley payable to the
Registrant in the original principal amount of $150,000.(1)
10.31 -- Unsecured Promissory Note, dated January 1, 1993, from John C. Wooley payable to the Registrant
in the original principal amount of $319,712.45.(1)
10.32 -- Unsecured Promissory Note, dated January 1, 1993, from Jeffrey J. Wooley payable to the
Registrant in the original principal amount of $76,540.93.(1)
10.33 -- Unsecured Promissory Note, dated February 6, 1995, from John C. Wooley payable to the
Registrant in the original principal amount of $131,000.(1)
10.34 -- Unsecured Promissory Note, dated February 6, 1995, from Jeffrey J. Wooley payable to the
Registrant in the original principal amount of $6,000.(1)
10.35(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
38
<PAGE>
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.(8)
10.50 -- Form of Loan Agreement between franchisee/borrower and Schlotzsky's Real Estate, Inc.(8)
10.51 -- Form of Assignment of Note and Lien from Schlotzsky's Real Estate, Inc. to mortgage lender.(8)
10.52 -- Form of Limited Guaranty between Schlotzsky's, Inc. and mortgage lender with respect to Turnkey
restaurants.(8)
10.53 -- Credit Agreement, as amended, with Wells Fargo.(8)
10.54 -- Credit Agreement with Texas Capital Bank, N.A. (9)
10.55 -- Option Agreement between DFW Restaurant Transfer Corp. and NS Associates I, Ltd. (10)
10.56 -- Management Agreement between DFW Restaurant Transfer Corp. and NS Associates I, Ltd. (10)
10.57* -- Credit Agreement with Wells Fargo Bank (Texas), National Association, as agent.
18 -- Letter regarding change in accounting principle
21.1* -- List of subsidiaries of the Registrant.
23.1* -- Consent of Grant Thornton LLP.
27.1* -- Financial Data Schedule - fiscal year ending 1999.
</TABLE>
- ----------
* Filed herewith.
(1) Previously filed as an Exhibit to the Registrant's Registration Statement
on Form S-1 (File No. 33-98004) filed with the Securities and Exchange
Commission on October 12, 1995, as amended, and incorporated herein by
reference.
(2) Previously filed as 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.
(8) Previously filed as an Exhibit to the Registrant's Annual Report on Form
10-K filed with the Securities and Exchange Commission on March 31, 1999
and incorporated herein by reference.
(9) Previously filed as an Exhibit to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on August 16, 1999.
(10) Previously filed as an Exhibit to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on November 12,
1999.
38
<PAGE>
(b) REPORTS ON FORM 8-K
None
39
<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,
Chairman of the Board and
Chief Executive Officer
Date: March 30, 2000
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.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<S> <C> <C>
/s/
- -------------------------------------------------------
John C. Wooley Chairman of the Board and March 30, 2000
Chief Executive Officer
(Principal Executive Officer)
/s/
- -------------------------------------------------------
Monica L. Gill Chief Financial Officer, Treasurer March 30, 2000
and Executive Vice President
(Principal Financial Officer and
Principal Accounting Officer)
/s/
- -------------------------------------------------------
Jeffrey J. Wooley Director, Senior Vice President March 30, 2000
and Secretary
/s/
- -------------------------------------------------------
John M. Hester Controller March 30, 2000
/s/
- -------------------------------------------------------
John L. Hill, Jr. Director March 30, 2000
/s/
- -------------------------------------------------------
Azie Taylor Morton Director March 30, 2000
/s/
- -------------------------------------------------------
Raymond A. Rodriguez Director March 30, 2000
/s/
- -------------------------------------------------------
Floor Mouthaan Director March 30, 2000
</TABLE>
40
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Financial Statements:
Report of Independent Certified Public Accountants.................................................... F-2
Consolidated Balance Sheets at December 31, 1998 and 1999 ............................................ F-3
Consolidated Statements of Income for the years ended
December 31, 1997, 1998 and 1999................................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1998 and 1999................................................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999................................................................... 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 CERTIFIED PUBLIC 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,
1999 and 1998, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the 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, 1999 and 1998, and the
consolidated results of their operations and their consolidated cash flows
for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
As discussed in Note 1 to the financial statements, the Company changed
its method of revenue recognition for Developer fees.
GRANT THORNTON LLP
Dallas, Texas
March 2, 2000
F-2
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31,
---------------------------
1998 1999
----------- ----------
<S> <C> <C>
Cash and cash equivalents......................................................... $15,384,991 $4,895,302
Temporary cash investments........................................................ 1,439,077 18,000
Receivables from Turnkey Program Development...................................... 1,229,468 51,603
Royalties receivable.............................................................. 762,141 1,306,465
Notes receivable, current portion................................................. 4,246,574 5,737,363
Real estate and restaurants held for sale, current portion........................ -- 7,909,870
Turnkey notes and other receivables, current portion.............................. 13,326,956 8,908,286
Other receivables................................................................. 3,086,065 4,480,022
Prepaid expenses and other assets................................................. 572,996 1,326,405
Turnkey Program development....................................................... 5,924,562 10,130,175
Deferred Federal income tax asset................................................. 617,499 1,021,828
------------ ------------
Total current assets.................................................... 46,590,329 45,785,319
Property, equipment and leasehold improvements, net............................... 18,529,746 19,861,420
Real estate and restaurants held for sale, less current portion................... 9,215,485 5,985,937
Notes receivable, less current portion............................................ 6,875,915 13,239,897
Turnkey notes and other receivables, less current portion......................... 2,185,429 --
Notes receivable from related parties, less current portion....................... 2,609,775 8,257,528
Investments and advances.......................................................... 1,530,947 564,446
Deferred Federal income tax asset................................................. -- 1,615,959
Intangible assets, net............................................................ 16,815,059 36,541,153
Other noncurrent assets........................................................... 469,069 907,722
------------ ------------
Total assets............................................................ $104,821,754 $132,759,381
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable - trade.......................................................... $4,752,369 $5,527,504
Current maturities of long-term debt.............................................. 5,382,585 19,455,430
Deferred revenue, current portion................................................. -- 1,206,206
Accrued liabilities............................................................... 9,613,593 2,990,522
------------ ------------
Total current liabilities............................................... 19,748,547 29,179,662
Deferred revenue, less current portion............................................ 1,298,486 7,570,095
Deferred Federal income tax liability............................................. 593,614 --
Long-term debt, less current maturities........................................... 9,218,515 21,275,043
------------ ------------
Total liabilities....................................................... 30,859,162 58,024,800
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, 7,401,942
and 7,427,714 issued at December 31, 1998 and 1999, respectively............ 62,877 63,135
Additional paid-in capital...................................................... 57,533,997 57,779,291
Retained earnings............................................................... 16,470,718 16,997,155
Treasury stock (10,000 shares), at cost......................................... (105,000) (105,000)
------------ ------------
Total stockholders' equity.............................................. 73,962,592 74,734,581
------------ ------------
Total liabilities and stockholders' equity.............................. $104,821,754 $132,759,381
------------ ------------
------------ ------------
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-3
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
Royalties........................................................ $14,561,377 $18,885,390 $21,546,495
Franchise fees................................................... 1,554,585 1,365,000 843,333
Developer fees................................................... 325,000 270,380 1,057,499
Restaurant sales................................................. 6,364,042 7,720,432 14,815,504
Brand contribution............................................... 2,915,233 4,003,247 6,173,389
Turnkey program development...................................... 1,138,610 8,314,426 1,687,155
Other fees and revenue........................................... 1,110,289 1,289,037 1,815,041
----------- ------------ ------------
Total revenues........................................... 27,969,136 41,847,912 47,938,416
Expenses:
Service costs:
Royalties..................................................... 5,373,151 7,225,320 6,600,899
Franchise fees................................................ 812,625 697,250 388,500
Restaurant operations:
Cost of sales................................................. 2,014,096 2,513,156 4,403,842
Labor costs................................................... 2,493,478 3,205,225 5,482,218
Operating expenses............................................ 1,951,618 2,167,784 3,358,236
Turnkey development costs........................................ 367,656 4,806,099 5,163,896
General and administrative....................................... 7,685,858 11,471,412 13,677,516
Depreciation and amortization.................................... 1,155,600 1,884,854 2,855,647
----------- ------------ ------------
Total expenses........................................... 21,854,082 33,971,100 41,930,754
----------- ------------ ------------
Income from operations................................... 6,115,054 7,876,812 6,007,662
Other:
Interest income.................................................. 1,049,938 2,296,023 3,142,647
Interest expense................................................. (296,978) (237,761) (2,279,116)
Other income..................................................... 195,661 -- --
----------- ------------ ------------
Income before income taxes and cumulative effect of
change in accounting principle......................... 7,063,675 9,935,074 6,871,193
Provision for income taxes......................................... 2,614,260 3,728,609 2,525,164
----------- ------------ ------------
Income before cumulative effect of change in
accounting principle................................... 4,449,415 6,206,465 4,346,029
Cumulative effect of change in accounting principle, net of tax.... -- -- (3,819,592)
----------- ------------ ------------
Net Income............................................... $ 4,449,415 $ 6,206,465 $ 526,437
----------- ------------ ------------
----------- ------------ ------------
Income per common share - basic:
Income before cumulative effect of change in accounting principle.. $ 0.74 $ 0.84 $ 0.59
Cumulative effect of change in accounting principle................ -- -- (0.52)
----------- ------------ ------------
Net Income................................................ 0.74 0.84 0.07
----------- ------------ ------------
----------- ------------ ------------
Income per common share - diluted:
Income before cumulative effect of change in accounting principle.. $ 0.71 $ 0.82 $ 0.58
Cumulative effect of change in accounting principle................ -- -- (0.51)
----------- ------------ ------------
Net Income................................................ $ 0.71 $ 0.82 $ 0.07
----------- ------------ ------------
----------- ------------ ------------
Proforma amounts assuming the change in accounting principle is
applied retroactively (1997 and 1998 amounts are unaudited) ......
Net Income................................................ $ 4,931,511 $ 6,999,226 $ 4,346,029
Basic income per share.................................... $ 0.82 $ 0.95 $ 0.59
Diluted income per share.................................. $ 0.79 $ 0.92 $ 0.58
Weighted average shares outstanding - basic...................... 5,994,403 7,382,983 7,409,496
Weighted average shares outstanding - diluted.................... 6,229,369 7,577,407 7,476,199
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
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, 1997................. 5,539,922 $ 44,257 $26,493,165 $ 5,774,599 $ -- $32,312,021
Public sale of stock..................... 1,731,825 17,318 29,615,201 -- -- 29,632,519
Options exercised........................ 57,201 572 485,802 40,239 -- 526,613
Warrants exercised....................... 5,468 55 69,936 -- -- 69,991
Net income............................... -- -- -- 4,449,415 -- 4,449,415
--------- ------------- ----------- ----------- ----------- -----------
Balance, December 31, 1997............... 7,334,416 62,202 56,664,104 10,264,253 -- 66,990,559
Options exercised........................ 44,089 441 399,175 -- -- 399,616
Warrants exercised....................... 23,437 234 224,761 -- -- 224,995
Treasury stock purchase (10,000 shares) . -- -- -- -- (105,000) (105,000)
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
Options exercised........................ 5,825 58 52,887 -- -- 52,945
Tax benefit from employee stock
transactions........................... -- -- 25,072 -- -- 25,072
Issuance of common stock in connection
with employee stock purchase plan...... 19,947 200 167,335 -- -- 167,535
Net income............................... -- -- -- 526,437 -- 526,437
--------- ------------- ----------- ----------- ----------- -----------
Balance, December 31, 1999............... 7,427,714 $ 63,135 $57,779,291 $16,997,155 $ (105,000) $74,734,581
========= ============= =========== =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
F-5
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1997 1998 1999
------------ ---------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Income before cumulative effect of change in accounting
principle........................................................ $ 4,449,415 $6,206,465 $ 4,346,029
Adjustments to reconcile income before cumulative effect adjustment
to net cash provided by operating activities:
Depreciation and amortization.................................... 1,155,600 1,884,854 2,855,647
Bad debt expense................................................. 100,000 972,724 1,246,401
Financed fees.................................................... (272,003) (2,250,000) (5,016,250)
Payments received on financed fees............................... 743,534 409,150 515,643
Other............................................................ (308,632) (175,553) 95,000
Changes in assets and liabilities:
Royalties and other receivables................................ (6,995,423) 218,880 (760,416)
Prepaid expenses and other assets.............................. (336,748) 11,514 (276,105)
Turnkey program development.................................... 1,621,773 (19,918,229) (2,790,694)
Other noncurrent assets........................................ (188,915) -- (503,653)
Deferred revenue............................................... 1,191,615 (1,556,894) 2,662,105
Deferred federal income tax asset.............................. 26,988 556,575 --
Accounts payable and accrued liabilities....................... 4,420,923 7,124,284 (6,670,818)
------------ ---------- --------------
Net cash provided by (used in) operating activities.......... 5,608,127 (6,516,230) (4,297,111)
------------ ---------- --------------
Cash flows from investing activities:
Expenditures for property and equipment............................ (7,436,003) (17,245,185) (7,668,434)
Sale of property and equipment..................................... 1,655,123 146,861 1,553,498
Acquisition of investments and intangible assets................... (2,721,814) (8,712,762) (21,072,889)
Sale of investments and intangible assets.......................... -- -- 2,699,913
Advances on notes receivable....................................... (693,100) (5,838,021) (44,689,244)
Collections on notes receivable.................................... 627,032 12,313,822 40,837,126
Sale of/(acquisitions) of investments.............................. (190,928) (1,421,077) 1,421,077
Advances to limited partnership, stockholders, and affiliates...... (37,940) (188,431) (10,855,191)
Distributions and collections from limited partnership,
stockholders and affiliates...................................... -- -- 5,226,659
------------ ---------- --------------
Net cash used in investing activities........................ (8,797,630) (20,944,793) (32,547,485)
------------ ---------- --------------
Cash flows from financing activities:
Sale of stock...................................................... 30,073,141 -- --
Repurchase of stock................................................ -- (105,000) --
Stock issue costs.................................................. (440,622) -- --
Options and warrants exercised..................................... 596,604 624,611 220,480
Proceeds from issuance of notes payable and long-term debt......... 1,112,709 16,060,000 48,475,524
Principal payments on notes payable and long-term debt............. (2,537,239) (4,987,645) (22,341,097)
------------ ---------- --------------
Net cash provided by (used in) financing activities.......... 28,804,593 11,591,966 26,354,907
------------ ---------- --------------
Net increase (decrease) in cash and cash equivalents................. 25,615,090 (15,869,057) (10,489,689)
Cash and cash equivalents at beginning of year....................... 5,638,958 31,254,048 15,384,991
------------ ---------- --------------
Cash and cash equivalents at end of year............................. $31,254,048 $15,384,991 $ 4,895,302
============ =========== ==============
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
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-Registered Trademark-Deli") that
feature made-to-order sandwiches, which has 759 Company-owned and franchised
stores located in 37 states, the District of Columbia, Argentina, Australia,
Bahrain, Canada, China, Germany, Guatemala, Lebanon, Malaysia, Morocco, Saudi
Arabia, Turkey and Venezuela. Approximately 30% of franchised stores are
located in Texas. In addition, the Company had granted territorial rights to
Area Developers located in all 50 states and to Master Licensees in 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.
REVENUE RECOGNITION AND CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1999, the Company changed its accounting policy
related to revenue recognition of developer fees. Prior to 1999, the Company
recognized developer fee revenue at the time the agreement was executed, its
obligations substantially completed, and the fee paid. This was typically in
the period in which the transaction occurred. However, as a result of recent
positions taken by the Securities and Exchange Commission, the Company made a
change in accounting principle whereby revenue generated from developer
transactions will be recognized over the term of the development schedule
specific to each contract. The change in accounting principle will result in
these fees being recognized over an average of ten years. The Company
considers the new revenue recognition method to result in a better matching
of revenues and obligations related to such revenues. The effect of the
change in 1999 resulted in the deferral of $6,062,845 of net revenue
previously recognized in prior years. 1999 income before the cumulative
effect adjustment included $1,057,499 of amortized deferred net revenue
related to developer fees. This change was reported as a cumulative effect of
change in accounting principle for $3,819,592 (net of $2,243,253 in income
tax benefits) and is included in 1999 net income.
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, 1998 and 1999, cash equivalents totaling approximately $11,232,000 and
$4,755,000, respectively, consisted primarily of money market accounts and
overnight repurchase agreements.
TEMPORARY CASH INVESTMENTS
F-7
<PAGE>
Temporary cash investments include amounts invested in certificates of
deposit with an original maturity date of greater than three months.
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)
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.
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.
NOTES RECEIVABLE
Notes receivable consist of Area Developer, Master Licensee, and
Franchisee promissory notes. As of December 31, 1998 and 1999, the Company
has recorded a valuation allowance of approximately $593,000 and $407,000,
respectively.
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. A number
of these properties which the Company intends to remarket or liquidate
within the next twelve months have been classified as current. Generally,
these properties have been acquired over the last twenty-four months. Each
property is reviewed individually in terms of its carrying value and the
expected net realizable value. The Company believes that no impairment of
these assets has occurred and that no reductions to the carrying amounts is
warranted.
INVESTMENTS
Investments are stated at the lower of cost or market. Limited
partnership investments are accounted for under the equity method, and
accordingly, the Company's investment is adjusted for allocated profits,
losses and distributions.
TURNKEY PROGRAM
Under the Turnkey Program, the Company works independently or with an
area developer to identify superior store sites within a territory. The
Company typically performs 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.
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)
TURNKEY PROGRAM, CONTINUED
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-Registered Trademark-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 as
"Turnkey Program development costs". 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 has often interim financed 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,
----------------------------------------
1997 1998 1999
----------- ----------- ----------
<S> <C> <C> <C>
Sales to investors and franchisees................................. $31,361,869 $29,596,310 $5,520,693
Development and construction management fees....................... 190,000 176,562 --
----------- ----------- ----------
Gross Turnkey Program revenue............................ 31,551,869 29,772,872 5,520,693
Capitalized Turnkey Program development costs...................... (28,829,065) (23,382,340) (4,228,655)
----------- ----------- ----------
Net revenue from Turnkey Program projects................ 2,722,804 6,390,532 1,292,038
Rental income...................................................... 303,091 258,187 363,386
Interim construction interest...................................... 1,270 238,888 31,731
Deferred revenue recognized........................................ -- 1,426,819 --
Revenue deferred................................................... (1,888,555) -- --
----------- ----------- ----------
Total Turnkey Program revenue............................ $1,138,610 $8,314,426 $1,687,155
=========== =========== ==========
</TABLE>
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)
The following table reflects system performance of the Turnkey Program for
the years ended December 31, 1998 and 1999.
<TABLE>
<CAPTION>
NUMBER OF UNITS
-------------------------
1998 1999
------------ ----------
<S> <C> <C>
Sites in process at beginning of year............................. 78 86
Sites beginning development during the year....................... 122 55
Sites removed from consideration during the period................ (41) (68)
Sites inventoried as Company-owned stores......................... (1) (2)
Sites inventoried as real estate or restaurants held for sale..... (2) --
Sites sold........................................................ (69) (9)
Other............................................................. (1) (3)
------------ ----------
Sites in process at end of year................................... 86 59
============ ==========
</TABLE>
<TABLE>
<CAPTION>
INVESTED AT
DECEMBER 31,
1999
--------------
<S> <C> <C> <C>
Sites under development or to be sold............................. 4 9 $ 8,235,000
Predevelopment sites (prequalification)........................... 82 50 1,895,000
------------ ---------- --------------
Total....................................................... 86 59 $ 10,130,000
============ ========== ==============
</TABLE>
Turnkey Program sites in process at end of year and certain sites
inventoried as real estate or restaurants held for sale are classified as
current assets as management expects to complete and sell such sites within
the next year.
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 reacquisition 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.
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)
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 has conveyed 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 during and
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-Registered
Trademark- 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-Registered Trademark- Deli restaurants in the
foreign territory are granted pursuant to the terms and conditions under an
agreement with a Master Licensee ("Master License Agreement").
The Company has also entered into Master Development Agreements or
Territorial Agreements (collectively the "Territorial Agreements") which, for
a nonrefundable reservation fee, grants the right to negotiate exclusive
territorial rights to develop Schlotzsky's-Registered Trademark- 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-Registered
Trademark- 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 not exceeding four years,
depending on the creditworthiness of the maker and guarantor of the note.
Area Developers and Master Licensees are generally 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. During 1999, the Company eliminated
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. Otherwise, failure to meet these
requirements could result in the Company terminating their agreements.
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)
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-third to
one-half of franchise fee paid by franchisees to the Company depending on the
level of services required by their agreements. 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 1.25% or 2.5% out of the 6% ongoing royalties depending on
the level of services required by their agreements, and Master Licensees
typically retain two-thirds of ongoing royalties, remitting one-third to the
Company.
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 services, the Company has incurred
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 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, 1998 and 1999.
ADVERTISING EXPENSE
The Company expenses advertising costs as incurred. Total advertising
expense amounted to approximately $315,000, $393,000, and $893,000 for the
years ended December 31, 1997, 1998, and 1999, respectively.
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)
INCOME PER SHARE
The Company computes income per share based on the weighted average
number of common shares outstanding. Diluted income per share is computed
based on the weighted average number of shares outstanding, plus the
additional common shares that would have been outstanding, if dilutive
potential common shares consisting of stock options had been issued.
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 1997
and 1999 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 or
to the corresponding quarters in the preceding or subsequent fiscal years,
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
<TABLE>
<CAPTION>
Notes receivable consist of the following:
DECEMBER 31,
---------------------------
1998 1999
------------ -------------
<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 $593,000 and $407,000, respectively, bearing interest
ranging from 6% to 9%
due through in installments through December 2003................... $ 2,828,977 $ 5,271,112
Notes receivable from franchisees, Area Developers, and Master Licensees
bearing interest at 8% to 10%, some notes collateralized by their
restaurants, others uncollateralized, net of valuation allowance of
$100,000 and $179,196 respectively, due in
installments through January 2023.................................. 821,245 2,048,592
Notes receivable from franchisees bearing interest ranging from 7.5% to
10.5%, collateralized by franchisees' property and equipment due in
installments through June 2019, net of
valuation allowance of $57,442 at December 31, 1999................. 7,270,096 11,415,975
Other................................................................. 202,171 241,581
------------ -------------
11,122,489 18,977,260
Current portion....................................................... (4,246,574) (5,737,363)
------------ -------------
Notes receivable, less current portion................................ $ 6,875,915 $ 13,239,897
============ =============
</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,
-------------------------
1998 1999
------------- ----------
<S> <C> <C>
Note receivable from National Advertising Association, a non-profit
corporation, bearing interest at a varying rate equal to the prime $
rate, due on demand at any time on or before December 31, 2010. ........ -- $5,168,315
Note receivable from Master Licensee, an organization of which a former
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...................... 292,619 386,469
Notes receivable from related entities controlled by stockholders of the
Company, bearing interest at 9%, collateralized by real estate, due in
installments through 2001............................................... 530,688 563,208
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...................................... 1,098,316 1,512,012
------------- ----------
2,651,623 8,360,004
Current portion........................................................... (41,848) (102,476)
------------- ----------
Notes from related parties receivable, less current portion............... $ 2,609,775 $8,257,528
============= ==========
</TABLE>
From time to time, the Company makes advances to certain stockholders,
related partnerships and affiliates (see notes 6 and 15).
4. TURNKEY NOTES AND OTHER RECEIVABLES
Notes and other receivables related to Turnkey projects consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1999
------------- ----------
<S> <C> <C>
Construction draw notes and other receivables from franchisees,
bearing interest ranging from 8.5% to 10% collateratized by real
estate, due through August 2000......................................... $ 6,539,353 $ 5,806,567
Mortgage notes receivable from franchisees, bearing interest ranging from
7.6% to 10.0% collateralized by real estate, due in installments
through October 2000.................................................... 7,336,345 3,101,719
Other receivables from franchisees........................................ 1,636,687 --
------------- ----------
15,512,385 8,908,286
Current portion........................................................... (13,326,956) (8,908,286)
------------- ----------
Turnkey notes and other receivables, less current portion ................ $ 2,185,429 --
============= ==========
</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) 1998 1999
------------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Building................................ Straight Line 32 $6,417,164 $7,718,096
Furniture, fixtures and
Equipment............................. Straight Line 3 to 7 6,223,498 7,846,491
Leasehold improvements.................. Straight Line 13 to 32 5,733,128 6,207,170
----------- -----------
18,373,790 21,771,757
Accumulated depreciation and amortization............................ (2,158,523) (3,832,588)
----------- -----------
16,215,267 17,939,169
Land................................................................. 2,314,479 1,922,251
----------- -----------
Property, equipment and leasehold improvements, net.................. $18,529,746 $19,861,420
=========== ===========
</TABLE>
During 1999, the Company purchased buildings, leasehold improvements and
furniture, fixtures and equipment in connection with their expansion of the
Company-owned restaurants in the amounts of $2,530,582, $1,866,289, and
$474,042, respectively.
Depreciation and amortization of property, equipment and leasehold
improvements totaled approximately $566,000, $1,060,000 and $1,918,000 for
the years ended December 31, 1997, 1998 and 1999, respectively.
6. INVESTMENTS AND ADVANCES
Investments and advances consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
------------ ----------
<S> <C> <C>
Limited partnership:
Investment................................................ $ 96,538 $ 1,375
Advances.................................................. 774,463 --
------------ ----------
871,001 1,375
Building art................................................ 263,071 263,071
Investments in Master Licensees............................. 396,875 300,000
------------ ----------
Investments and advances.................................... $ 1,530,947 $ 564,446
============ ==========
</TABLE>
LIMITED PARTNERSHIP
The Company owns a 10% general 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,
-----------------------
1998 1999
---------- ----------
<S> <C> <C>
Assets.................................................... $2,239,960 $2,410,294
Liabilities............................................... 1,933,276 2,199,214
Partners' capital......................................... 306,684 211,080
</TABLE>
F-17
<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
1% to the Company.
The Company was the guarantor of all partnership indebtedness which
consisted of borrowings under a $1,150,000 bank line of credit with
approximately $1,093,000 outstanding at December 31, 1998. In September 1999,
the partnership refinanced the debt under the bank line of credit and debt
owed to Schlotzsky's, Inc. in the aggregate amount of $2,048,000. The terms
of this loan with the new financial institution require a guarantee from
Schlotzsky's, Inc. for the entire loan amount, which is also collateralized
by real estate, and related leases and rents.
INVESTMENTS IN MASTER LICENSEES
The Company had a minority interest in two Master Licensees and was
guarantor of debt of one in the amount of $400,000 at December 31, 1998.
During 1999, the lender assigned this note back to the Company who is now in
the lender position to the Master Licensee.
7. INTANGIBLE ASSETS
Intangible assets consist of the following:
<TABLE>
<CAPTION>
AMORTIZATION DECEMBER 31,
PERIOD ------------------------------
(YEARS) 1998 1999
------------ -------------- ------------
<S> <C> <C>
Original franchise rights........................... 40 $ 5,688,892 $ 5,688,892
Royalty value and goodwill.......................... 20 3,122,117 3,916,116
Developer and franchise rights acquired............. 20 to 40 9,789,263 29,168,608
Debt issue costs.................................... 5 to 25 65,136 233,224
Other intangible assets............................. 5 318,449 948,204
-------------- ------------
18,983,857 39,955,044
Less accumulated amortization....................... (2,168,798) (3,413,891)
-------------- ------------
Intangible assets, net.............................. $ 16,815,059 $36,541,153
============== ============
</TABLE>
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 reacquired certain developer and franchise rights
in Georgia, Michigan, and certain portions of Ohio, Texas and various western
territories. In addition, the Company reacquired the international licensing
rights to Belgium, Luxemburg, and The Netherlands.
F-18
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. INTANGIBLE ASSETS - (CONTINUED)
In 1999, the Company acquired 100% of the area developers' interest in
territories in North Carolina, Florida, Southern California, Austin, Texas
and Canada. The Company also acquired 50% of several area developers'
interests in parts of Arizona, Illinois, Indiana, Michigan, Kentucky,
Tennessee, Virginia, South Carolina, North Carolina, Kansas, and Missouri. In
addition, in exchange for a $2.3 million note receivable, a cash payment of
$250,000, and a note payable of $500,000, the Company acquired an option to
purchase the development rights of its largest area developer during an
option period from August 16, 2004 to February 16, 2012 at prices ranging
from $28 million to $38.3 million. If a change in control, as defined, of the
Company occurs, the Company is obligated to pay between $2.8 million and $3.8
million to prevent the purchase option from lapsing. Such payment is
applicable to the exercise price, if and when paid.
The developer rights acquired under these transactions are being
amortized on a straight-line basis over 40 years. Amortization of intangible
assets totaled approximately $502,000, $747,000, and $938,000 for the years
ended December 31, 1997, 1998 and 1999, respectively.
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
----------- -----------
<S> <C> <C>
Accrued legal and professional.................................... $ 392,277 $ 154,827
Developer service costs........................................... 910,848 568,884
Repurchase of development territories............................. 6,550,000 --
Accrued liability-option cost..................................... -- 500,000
Other accrued liabilities......................................... 1,760,468 1,766,811
---------- ----------
$9,613,593 $2,990,522
========== ==========
</TABLE>
9. DEFERRED REVENUE
Franchise fees, developer fees and revenue from the Turnkey Program,
collected but not yet recognized in 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,
-------------------------
1998 1999
----------- -----------
<S> <C> <C>
Deferred developer fees........................................... $ -- $ 7,736,711
Deferred franchise fees........................................... 1,687,500 1,342,500
Deferred direct incremental costs:
Deferred franchise fee development service costs............... (838,750) (632,500)
Other ......................................................... (12,000) (3,500)
Deferred revenue, net -- Turnkey Program.......................... 461,736 333,090
---------- ----------
$1,298,486 $8,776,301
Current portion .................................................. -- (1,206,206)
---------- ----------
Deferred revenue, long term....................................... $1,298,486 $7,570,095
========== ==========
</TABLE>
F-19
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1999
----------- ------------
<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.................................... $ 1,225,298 $ 1,203,718
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................................. 534,937 527,656
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................................. 513,359 511,297
Various unsecured notes payable to individuals and corporations,
bearing interest at 7.00%, due in periodic principal and interest
installments through 2003............................................... -- 2,885,846
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 --
Syndicated notes payable to various financial institutions bearing
interest at the lesser of the maximum rate or the base rate. The base
rate is the greater of the prime rate of Wells Fargo Bank or the
Federal Funds rate plus 0.5%. The maximum rate is the maximum rate of
interest under applicable law that the lender may charge the
borrower. $15,000,000 matures September 30, 2000. The remaining
$20,000,000 has monthly principal and interest payments
of $333,333 through December, 2004. ................................... -- 35,000,000
Various notes payable to individuals and corporations, bearing interest
at 6.0% to 9.0% per annum, due in periodic principal and interest
installments through 2004, and collateralized by equipment
and assignment of royalties from certain franchisees................... 545,439 201,618
Other..................................................................... 422,067 400,338
----------- ------------
14,601,100 40,730,473
Current maturities...................................................... (5,382,585) (19,455,430)
----------- ------------
Long-term debt, less current maturities............................... $ 9,218,515 $ 21,275,043
=========== ============
</TABLE>
In December 1999, the Company secured financing from a bank syndicate which
provided an aggregate of $40,000,000 in three credit facilities. The first
facility was a $20,000,000 loan refinancing of $15,000,000 of outstanding debt
plus an additional $5,000,000 for additional area developer buy backs. This
facility has a five year term. The second facility is a $15,000,000 revolving
line of credit for working capital purposes which matures September 30, 2000.
The third facility is a $5,000,000 letter of credit in favor of the media buyer
for Schlotzsky's National Advertising Association, Inc. of which Schlotzsky's,
Inc. is a guarantor. This facility expires September 30, 2000. The credit
facility contains certain financial ratio and leverage covenants. Under the
credit facility, the acquisition of beneficial ownership of more than 33% of
the outstanding stock of the Company by a person or group of related persons
constitutes a default, resulting in the possible acceleration of outstanding
indebtedness.
F-20
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. LONG-TERM DEBT - (CONTINUED)
The aggregate annual maturities of long-term debt at December 31, 1999 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------
<S> <C>
2000......................................... $ 19,455,430
2001......................................... 4,713,012
2002......................................... 4,252,395
2003......................................... 4,254,452
2004......................................... 4,254,104
Thereafter................................... 3,801,080
------------
$ 40,730,473
============
</TABLE>
The net book value of assets held under capital leases were approximately
$2,432,000 and $2,321,000 at December 31, 1998 and 1999, respectively.
11. INCOME TAXES
The provision for federal and state income taxes consists of the
following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Federal:
Current ....................................... $2,416,124 $2,813,396 $2,658,905
Deferred ...................................... 26,988 556,575 (370,649)
---------- ---------- ----------
Total federal.......................... 2,443,112 3,369,971 2,288,256
State ........................................... 171,148 358,638 236,908
---------- ---------- ----------
Total provision for income taxes................. $2,614,260 $3,728,609 $2,525,164
========== ========== ==========
</TABLE>
The differences between the income tax expense and the amount that would
result if the Federal statutory rate was applied to the pretax financial income
were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Expense at Federal statutory rate of 34%......... $2,401,650 $3,377,925 $2,336,206
Nondeductible items, including amortization...... 99,653 69,922 77,716
State income taxes, net of Federal benefit....... 112,957 236,701 197,408
Other............................................ -- 44,061 (86,166)
---------- ---------- ----------
$2,614,260 $3,728,609 $2,525,164
========== ========== ==========
</TABLE>
F-21
<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,
-------------------------
1998 1999
---------- -----------
<S> <C> <C>
Deferred Tax Assets:
Receivables..................................... $ 265,167 $ 493,238
Deferred revenue................................ 307,004 3,261,210
Accrued liabilities............................. 117,753 12,460
Other........................................... 36,563 42,442
---------- -----------
Gross deferred tax assets....................... 726,487 3,809,350
---------- -----------
Deferred Tax Liabilities:
Property, equipment and intangibles............. 593,614 1,161,695
Installment sale................................ 99,202 --
Other........................................... 9,786 9,868
---------- -----------
Gross deferred tax liabilities.................... 702,602 1,171,563
---------- -----------
Net deferred tax asset.......................... $ 23,885 $ 2,637,787
========== ===========
</TABLE>
12. STOCKHOLDERS' EQUITY
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-22
<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 "Option 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 Option 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 Option 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 Company also has an employee stock purchase plan that
it adopted in 1998.
THE STOCK OPTION PLAN
Under the Option 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 Option 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 Option 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 and 1999 generally vest ratably over three years.
Options granted before 1998 generally vest ratably over five years.
F-23
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. STOCK-BASED COMPENSATION PLANS - (CONTINUED)
A summary of the status of the Company's stock options as of December 31,
1997, 1998 and 1999 and the changes during the years ended on those dates is
presented below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------
WEIGHTED AVERAGE
EXERCISE PRICES
SHARES PER SHARE
--------- ----------------
<S> <C> <C>
BALANCE, January 1, 1997........................................... 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
Granted (weighted average fair value of $4.77 per share) ........ 88,000 10.32
Exercised........................................................ (5,825) 9.09
Forfeited........................................................ (63,205) 10.66
---------
BALANCE, December 31, 1999......................................... 1,083,379 15.52
=========
Exercisable at December 31, 1997................................... 362,178 9.19
Exercisable at December 31, 1998................................... 491,972 9.54
Exercisable at December 31, 1999................................... 894,826 15.16
</TABLE>
The fair value of each stock option granted in 1997, 1998 and 1999 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 6.17% for 1997, 5.28% for 1998, and 5.14% for 1999; expected
lives of the options of six years; and volatility of 32.50% for 1997, 48.97%
for 1998, and 38.95% for 1999.
The following table summarizes information about stock options
outstanding at December 31, 1999:
<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 1999 CONTRACT LIFE PRICE 1999 PRICE
------------------------------- -------------- ------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$5.60 to $11.00................ 444,081 6.10 $ 8.46 330,414 $ 8.19
$11.09 to $14.97............... 226,798 7.48 $ 12.40 151,912 $ 12.34
$17.69 to $23.94............... 412,500 8.12 $ 21.79 412,500 $ 21.79
-------------- ------------- -------- -------------- --------
Total.......................... 1,083,379 7.29 $ 14.36 894,826 $ 15.16
</TABLE>
F-24
<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. During 1999, 62 participants
purchased 10,551 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 (the shares are purchased with after tax dollars). Therefore,
no compensation expense has been recognized for shares sold under this plan.
The fair value of stock purchase rights granted in 1998 and 1999 were
$6.55 and $3.39 per share respectively, or a total of $61,543 or $35,726
respectively. The fair value of each stock purchase right was determined
using an expected term of 6 months in 1998 and 1999, a volatility of 48.97%
and 38.95%, respectively, and a risk-free interest rate of 5.30% and 6.03%
respectively.
PRO FORMA NET INCOME AND NET INCOME PER COMMON SHARE
During 1997, 1998 and 1999, the Company did not incur any compensation
costs for the Option 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 1997, 1998 and 1999 would
approximate the pro forma amounts below:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999
---------------------- ---------------------- -----------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Income before cumulative effect of
change in accounting principle......... $ 4,449,415 $4,201,878 $6,206,465 $4,673,829 $4,346,029 $2,992,156
Net income per common share - basic.... $ 0.74 $ 0.70 $ 0.84 $ 0.63 $ 0.59 $ 0.40
Net income per common share - diluted.. $ 0.71 $ 0.67 $ 0.82 $ 0.62 $ 0.58 $ 0.40
</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-25
<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, 1997, 1998
and 1999 was approximately $297,000, $248,000 and $2,086,000, respectively.
Cash paid for income taxes during the years ended December 31, 1997,
1998 and 1999 was approximately $2,404,000, $2,515,000 and $3,250,000,
respectively.
Noncash investing and financing activities:
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 totaling approximately $2,250,000 were received as payment for
nonrefundable Area Developer, Master Licensee, Territorial and other
fees.
Notes totaling approximately $21,334,000 were received as payment
for investment in Turnkey Projects.
1999
Notes totaling approximately $5,016,000 were received as payment of
nonrefundable Area Developer fees.
Notes totaling approximately $42,749,000 were received as payment
for sale of, or investment in, Turnkey projects.
Notes totaling approximately $4,311,000 were issued for acquisition
of developer rights.
15. RELATED PARTY TRANSACTIONS
Franchisees contribute 1% of gross sales to Schlotzsky's N.A.M.F., Inc.
("NAMF") to be used solely for the production of programs and materials for
marketing and advertising. The Company charges NAMF an amount equal to
certain cost allocations and salaries for administering NAMF. Advances to
/(from) NAMF totaled approximately $11,000 and $(189,000) at December 31,
1998 and 1999, respectively, and are included in other receivables in the
accompanying consolidated balance sheets.
Franchises contribute 1.75% of gross sales to Schlotzsky's NAA to be
used solely for media placement. At December 31, 1999, Schlotzsky's Inc.
advanced approximately $5.2 million to NAA for the purchase of network
television advertising.
One or more principal stockholders of the Company is guarantor of debt
of the Company, totaling approximately $1,383,000 and $1,185,000 at December
31, 1998 and 1999, respectively.
F-26
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. RELATED PARTY TRANSACTIONS - (CONTINUED)
At December 31, 1998 and 1999 the Company holds combined notes in the
amount of $455,000 from Sino Carribbean development for the right to obtain a
master license for certain territories in the Pacific Rim and the assumption
of a promissory note in the amount of $275,000. 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%.
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 took assignment of the note from the bank in favor of Bonner
Carrington European Market ("BCCE") and has stepped into the lender position
for the $400,000.
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 and certain land, buildings and
equipment. Rent expense for the years ended December 31, 1997, 1998 and 1999,
was approximately $814,000, $1,195,000 and $2,078,000, 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, 1999 are
as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
2000.......................................................... $ 1,611,802
2001.......................................................... 1,636,541
2002.......................................................... 1,629,165
2003.......................................................... 1,598,228
2004.......................................................... 1,576,361
Thereafter.................................................... 18,470,750
-----------
$26,522,847
===========
</TABLE>
F-27
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
GUARANTIES ON FRANCHISE OPERATING LEASES AND OTHER OBLIGATIONS
The Company, and in some cases certain stockholders, guaranty certain real
estate and equipment leases and other obligations of its franchisees. Under
the Turnkey Program, the Company 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, 1999, the Company was contingently liable for approximately $6.2 million
under these guaranties. Additionally, at December 31, 1999, the Company was
contingently liable for approximately $28 million under guaranties of other
franchisee real estate and equipment leases and various obligations.
LITIGATION
The Company is a defendant in various lawsuits arising in the ordinary
course of business. Management is of the opinion that all such matters are
without merit or are of such kind, or involve such amounts, as would not have
a significant effect on the consolidated financial position, results of
operations or cash flows of the Company if disposed unfavorably.
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 with
unique sourdough buns and pizzas. At December 31, 1999 the Schlotzsky's
system included Company owned and franchised stores in 37 states, the
District of Columbia and 13 foreign countries.
F-28
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. SEGMENTS - (CONTINUED)
The Company identifies segments based on management responsibility within
the corporate structure. The Turnkey Development segment includes the
development of freestanding stores with high visibility and easy access. 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. The accounting policies of the Segments are the same as
those described in the summary of significant accounting policies (Note 1).
Segment information and a reconciliation to income, before interest and income
taxes are as follows:
<TABLE>
<CAPTION>
TURNKEY RESTAURANT FRANCHISE
YEAR ENDED DECEMBER 31, 1999 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenue from external customers........... $ 1,687,155 $ 14,815,504 $ 31,435,757 $ 47,938,416
Depreciation and amortization............. 336,608 941,007 1,578,032 2,855,647
Operating income (loss) .................. (3,813,349) 630,200 9,190,811 6,007,662
Significant noncash items-fees financed... -- -- 5,016,250 5,016,250
Capital expenditures...................... 3,254,150 3,768,921 645,363 7,668,434
Total assets.............................. $ 40,575,066 $ 25,851,163 $ 66,333,152 $132,759,381
TURNKEY RESTAURANT FRANCHISE
YEAR ENDED DECEMBER 31, 1998 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- ------------- ------------- ------------- --------------
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 $ 41,137,611 $ 104,821,754
TURNKEY RESTAURANT FRANCHISE
YEAR ENDED DECEMBER 31, 1997 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- ------------- ------------- ------------- --------------
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>
F-29
<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, 1997,
1998 and 1999 are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------------------
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
BASIC EPS
Net income before cumulative effect of change in
accounting principle............................. $ 4,449,415 $ 6,206,465 $4,346,029
Cumulative effect of change in accounting principle,
net of tax....................................... -- -- (3,819,592)
----------- ----------- -----------
Net income......................................... 4,449,415 6,026,465 526,437
=========== =========== ===========
Weighted average common shares outstanding......... 5,994,403 7,382,983 7,409,496
=========== =========== ===========
Basic EPS before cumulative effect of change in
accounting principle............................. $ 0.74 $ 0.84 $ 0.59
Cumulative effect of change in accounting principle -- -- (0.52)
----------- ----------- -----------
Basic EPS.......................................... $ 0.74 $ 0.84 $ 0.07
=========== =========== ===========
DILUTED EPS
Net income before cumulative effect of change in
accounting principle............................. $ 4,449,415 $ 6,206,465 $4,346,029
Cumulative effect of change in accounting principle,
net of tax...................................... -- -- (3,819,592)
----------- ----------- -----------
Net income........................................ 4,449,415 6,026,465 526,437
=========== =========== ===========
Weighted average common shares outstanding......... 5,994,403 7,382,983 7,409,496
Assumed conversion of common shares issuable
under stock option plan and exercise of warrants.. 234,966 194,424 66,703
----------- ----------- -----------
Weighted average common shares outstanding -
assuming dilution................................. 6,229,369 7,577,407 7,476,199
=========== =========== ===========
Diluted EPS before cumulative effect of change in
accounting principle............................. $ 0.71 $ 0.82 $ 0.58
Cumulative effect of change in accounting principle -- -- (0.51)
----------- ----------- -----------
Diluted EPS.......................................... $ 0.71 $ 0.82 0.07
=========== =========== ===========
</TABLE>
Outstanding options that were not included in the diluted calculation
because their effect would be anti-dilutive totaled 123,500, 571,000 and 748,000
in 1997, 1998 and 1999, respectively.
F-30
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC 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 March 2,
2000, 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,
1999. In our opinion, this schedule presents fairly, in all material
respects, the information required to be set forth therein.
GRANT THORNTON LLP
Dallas, Texas
March 2, 2000
S-1
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
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,
interest receivable, and other receivable:
Year ended December 31, 1999.............. $ (1,415,498) $ (1,246,401) $ -- $ 823,497 $ (1,838,402)
============= =============== ================ ============ ===============
Year ended December 31, 1998 ............. (442,774) (972,724) -- -- (1,415,498)
============= =============== ================ ============ ===============
Year ended December 31, 1997.............. (342,774) (100,000) -- -- (442,774)
============= =============== ================ ============ ===============
</TABLE>
S-2
<PAGE>
******************************************************************************
SCHLOTZSKY'S, INC.
CREDIT AGREEMENT
DATED AS OF DECEMBER 7, 1999
WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION,
AS AGENT
******************************************************************************
<PAGE>
TABLE OF CONTENTS
Page
----
ARTICLE I
Definitions..........................................................1
Section 1.1 Definitions........................................1
Section 1.2 Other Definitional Provisions.....................14
ARTICLE II
Revolving Credit Loan...............................................14
Section 2.1 Commitments.......................................14
Section 2.2 Revolving Credit Notes............................15
Section 2.3 Repayment of Revolving Credit Loan................15
Section 2.4 Interest..........................................15
Section 2.5 Revolving Credit Loan Borrowing Procedure.........15
Section 2.6 Use of Proceeds...................................16
Section 2.7 Commitment Fees...................................16
Section 2.8 Determination of Base Rate Margin.................16
Section 2.9 Reduction or Termination of Revolving Credit
Commitments.......................................17
ARTICLE III
Term Loan...........................................................18
Section 3.1 Term Commitments..................................18
Section 3.2 Notes.............................................19
Section 3.3 Repayment of Term Loan............................19
Section 3.4 Interest..........................................19
Section 3.5 Term Loan Borrowing Procedure.....................19
Section 3.6 Term Loan Fee.....................................20
Section 3.7 Use of Proceeds...................................20
ARTICLE IV
Letter of Credit....................................................20
Section 4.1 Letter of Credit..................................20
Section 4.2 Presentment and Reimbursement.....................21
Section 4.3 Payment...........................................21
Section 4.4 Letter of Credit Fee..............................22
Section 4.5 Obligations Absolute..............................22
Section 4.6 Limitation of Liability...........................23
-i-
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
ARTICLE V
Payments............................................................24
Section 5.1 Method of Payment.................................24
Section 5.2 Voluntary Prepayment..............................24
Section 5.3 Mandatory Prepayments.............................25
Section 5.4 Pro Rata Treatment................................25
Section 5.5 Non-Receipt of Funds by the Agent.................25
Section 5.6 Withholding Taxes.................................26
Section 5.7 Withholding Tax Exemption.........................26
Section 5.8 Computation of Interest...........................26
Section 5.9 Additional Costs in Respect of Letter of Credit...27
Section 5.10 Capital Adequacy..................................27
ARTICLE VI
Conditions Precedent................................................28
Section 6.1 Initial Extension of Credit.......................28
Section 6.2 All Extensions of Credit..........................29
ARTICLE VII
Representations and Warranties......................................30
Section 7.1 Existence.........................................30
Section 7.2 Financial Statements..............................30
Section 7.3 Action; No Breach.................................31
Section 7.4 Operation of Business.............................31
Section 7.5 Litigation and Judgments..........................31
Section 7.6 Rights in Properties; Liens.......................31
Section 7.7 Enforceability....................................31
Section 7.8 Approvals.........................................32
Section 7.9 Debt..............................................32
Section 7.10 Taxes.............................................32
Section 7.11 Use of Proceeds; Margin Securities................32
Section 7.12 ERISA.............................................32
Section 7.13 Disclosure........................................33
Section 7.14 Subsidiaries......................................33
Section 7.15 Agreements........................................33
-ii-
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
Section 7.16 Compliance with Laws..............................33
Section 7.17 Investment Company Act............................33
Section 7.18 Public Utility Holding Company Act................34
Section 7.19 Environmental Matters.............................34
ARTICLE VIII
Positive Covenants..................................................35
Section 8.1 Reporting Requirements............................35
Section 8.2 Maintenance of Existence; Conduct of Business.....37
Section 8.3 Maintenance of Properties.........................37
Section 8.4 Taxes and Claims..................................37
Section 8.5 Insurance.........................................37
Section 8.6 Inspection Rights.................................38
Section 8.7 Keeping Books and Records.........................38
Section 8.8 Compliance with Laws..............................38
Section 8.9 Compliance with Agreements........................38
Section 8.10 Further Assurances; Subsidiary Guaranty,
Subsidiary Pledge Agreement,Subsidiary Security
Agreement and Contribution and Indemnification
Agreement.........................................38
Section 8.11 ERISA.............................................39
Section 8.12 Year 2000 Compliance..............................39
ARTICLE IX
Negative Covenants..................................................39
Section 9.1 Debt..............................................40
Section 9.2 Limitation on Liens...............................40
Section 9.3 Mergers, Etc......................................41
Section 9.4 Restricted Payments...............................41
Section 9.5 Investments.......................................42
Section 9.6 Limitation on Issuance of Capital Stock...........42
Section 9.7 Transactions With Affiliates......................43
Section 9.8 Disposition of Assets.............................43
Section 9.9 Sale and Leaseback................................43
Section 9.10 Nature of Business................................43
Section 9.11 Environmental Protection..........................43
Section 9.12 Accounting........................................43
Section 9.13 Prepayment of Debt................................44
-iii-
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
ARTICLE X
Financial Covenants.................................................44
Section 10.1 Consolidated Working Capital......................44
Section 10.2 Leverage Ratio....................................44
Section 10.3 Consolidated Net Worth............................44
Section 10.4 Fixed Charge Coverage Ratio.......................45
Section 10.5 Capital Expenditures..............................45
Section 10.6 Contingent Liabilities............................45
ARTICLE XI
Default.............................................................45
Section 11.1 Events of Default.................................45
Section 11.2 Remedies..........................................47
Section 11.3 Cash Collateral...................................48
Section 11.4 Performance by the Agent..........................48
ARTICLE XII
The Agent...........................................................49
Section 12.1 Appointment, Powers and Immunities................49
Section 12.2 Rights of Agent as a Lender.......................51
Section 12.3 Sharing of Payments, Etc..........................51
Section 12.4 Indemnification...................................52
Section 12.5 Independent Credit Decisions......................52
Section 12.6 Several Commitments...............................53
Section 12.7 Successor Agent...................................53
ARTICLE XIII
Miscellaneous.......................................................54
Section 13.1 Expenses..........................................54
Section 13.2 INDEMNIFICATION...................................54
Section 13.3 Limitation of Liability...........................55
Section 13.4 No Duty...........................................55
Section 13.5 No Fiduciary Relationship.........................55
Section 13.6 Equitable Relief..................................55
Section 13.7 No Waiver; Cumulative Remedies....................55
-iv-
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
Section 13.8 Successors and Assigns............................56
Section 13.9 Survival..........................................58
Section 13.10 Amendments, Etc...................................58
Section 13.11 Maximum Interest Rate.............................59
Section 13.12 Notices...........................................59
Section 13.13 Governing Law; Venue; Service of Process..........60
Section 13.14 Binding Arbitration...............................60
Section 13.15 Counterparts......................................62
Section 13.16 Severability......................................62
Section 13.17 Headings..........................................62
Section 13.18 Non-Application of Chapter 346 of Texas
Credit Finance Code...............................62
Section 13.19 Construction......................................62
Section 13.20 Independence of Covenants.........................63
Section 13.21 Confidentiality...................................63
Section 13.22 WAIVER OF JURY TRIAL..............................63
Section 13.23 ENTIRE AGREEMENT..................................63
-v-
<PAGE>
CREDIT AGREEMENT
THIS CREDIT AGREEMENT (the "Agreement"), dated as of December 7, 1999, is
among SCHLOTZSKY'S, INC., a Texas corporation ("Borrower"), each of the banks or
other lending institutions which is or which may from time to time become a
signatory hereto or any successor or assignee thereof (individually, a "Lender"
and, collectively, the "Lenders"), and WELLS FARGO BANK (TEXAS), NATIONAL
ASSOCIATION, a national banking association, as agent for itself and the other
Lenders (in such capacity, together with its successors in such capacity, the
"Agent") and as the Issuing Bank (hereinafter defined).
R E C I T A L S
The Borrower has requested that the (i) Lenders extend credit to the
Borrower in the form of revolving credit advances and a term loan and (ii) the
Issuing Bank keep outstanding a standby letter of credit, all not to exceed an
aggregate principal amount of Forty Million Dollars ($40,000,000) at any time
outstanding. The Issuing Bank and the Lenders are willing to make such
extensions of credit to the Borrower upon the terms and conditions hereinafter
set forth.
NOW THEREFORE, in consideration of the premises and the mutual covenants
herein contained, the parties hereto agree as follows:
ARTICLE I
Definitions
Section 1.1 Definitions. As used in this Agreement, the following terms
have the following meanings:
"AAA" has the meaning set forth in Section 13.14(b).
"Adjustment Date" has the meaning set forth in Section 2.8.
"Advance" means an advance of funds by the Lenders or any of them to
the Borrower pursuant to Article II or Article III.
"Advance Request Form" means a certificate, in substantially the form
of Exhibit B hereto, properly completed and signed by the Borrower
requesting the Term Loan Advance (one time only on the date hereof) or a
Revolving Credit Loan Advance.
-1-
<PAGE>
"Affiliate" means, as to any Person, any other Person (a) that
directly or indirectly, through one or more intermediaries, controls or is
controlled by, or is under common control with, such Person; (b) that
directly or indirectly beneficially owns or holds five percent (5%) or more
of any class of voting stock of such Person; or (c) five percent (5%) or
more of the voting stock of which is directly or indirectly beneficially
owned or held by the Person in question. The term "control" means the
possession, directly or indirectly, of the power to direct or cause
direction of the management and policies of a Person, whether through the
ownership of voting securities, by contract, or otherwise; provided,
however, in no event shall the Agent, the Issuing Bank or any Lender be
deemed an Affiliate of the Borrower or any of its Subsidiaries.
"Agent" has the meaning set forth in the introductory paragraph of
this Agreement.
"Agreement" has the meaning set forth in the introductory paragraph of
this Agreement.
"Applicable Lending Office" means for each Lender, the Lending Office
of such Lender (or of an Affiliate of such Lender) designated below its
name on the signature pages hereof or such other office of such Lender (or
of an Affiliate of such Lender) as such Lender may from time to time
specify to the Borrower and the Agent as the office by which its Advances
are to be made and maintained.
"Applicable Rate" means the Base Rate plus the Base Rate Margin.
"Assignee" has the meaning set forth in Section 13.8(b).
"Assigning Lender" has the meaning set forth in Section 13.8(b).
"Assignment and Acceptance" means an assignment and acceptance entered
into by a Lender and its assignee and accepted by the Agent pursuant to
Section 13.8, in substantially the form of Exhibit D hereto.
"Base Rate" means as of any date of determination, a rate per annum
equal to the greater of (a) the Prime Rate in effect on such day, or (b)
the sum of the Federal Funds Rate in effect on such day plus one-half of
one percent (0.5%). Any change in the Base Rate due to a change in the
Prime Rate or the Federal Funds Rate shall be effective on the effective
date of such change in the Prime Rate or the Federal Funds Rate,
respectively, without notice to Borrower.
"Base Rate Margin" shall have the meaning set forth in Section 2.8.
"Basle Accord" means the proposals for risk-based capital framework
described by the Basle Committee on Banking Regulations and Supervisory
Practices in its paper entitled "International Convergence of Capital
Measurement and Capital Standards" dated July 1988, as amended,
supplemented and otherwise modified and in effect from time to time, or any
replacement thereof.
-2-
<PAGE>
"Benefit Arrangement" shall mean any employment, consulting, severance
or other similar contract, arrangement or policy and each plan, arrangement
(written or oral), program, agreement or commitment providing for insurance
coverage (including without limitation any self-insured arrangements),
workers' compensation, disability benefits, supplemental unemployment
benefits, vacation benefits, retirement benefits, life, health, disability
or accident benefits (including without limitation any "voluntary
employees' beneficiary association" as defined in Section 501(c)(9) of the
Code providing for the same or other benefits) or for deferred
compensation, profit-sharing bonuses, stock options, restricted stock,
phantom stock, stock appreciation rights, stock purchases or other forms of
incentive compensation or post-retirement insurance, compensation or
benefits which (i) is not a Plan, (ii) is (or was within the last six
years) entered into, maintained, contributed to or required to be
contributed to, as the case may be, by Borrower or any ERISA Affiliate, and
(iii) covers any current or former employee, director, or consultant of
Borrower or any ERISA Affiliate (with respect to their relationship with
such entities).
"Borrower" has the meaning set forth in the introductory paragraph of
this Agreement.
"Borrower Pledge Agreement" means that certain pledge agreement
executed by the Borrower and the Agent in favor of the Agent for the
benefit of the Agent, the Issuing Bank and the Lenders, in substantially
the form of Exhibit F, as the same may be amended, restated or modified
from time to time.
"Borrower Security Agreement" means that certain security agreement
executed by the Borrower and the Agent in favor of the Agent for the
benefit of the Agent, the Issuing Bank and the Lenders, in substantially
the form of Exhibit G, as the same may be amended, restated or modified
from time to time.
"Business Day" means any day on which commercial banks are not
authorized or required to close in San Francisco, California.
"Calculation Period" has the meaning set forth in Section 2.8.
"Capital Expenditures" means, for any period, all expenditures of the
Borrower and its Subsidiaries which are classified as additions to
property, plant and equipment on the consolidated statement of cash flows
of the Borrower in accordance with GAAP, including all such expenditures so
classified as "recurring capital expenditures" and all such expenditures
associated with Capital Lease Obligations.
-3-
<PAGE>
"Capital Lease Obligation" means, as to any Person, the obligations of
such Person to pay rent or other amounts under a lease of (or other
agreement conveying the right to use) real and/or personal property, which
obligations are required to be classified and accounted for as a capital
lease on a balance sheet of such Person under GAAP. For purposes of this
Agreement, the amount of such Capital Lease Obligations shall be the
capitalized amount thereof, determined in accordance with GAAP.
"Code" means the Internal Revenue Code of 1986, as amended, and the
regulations promulgated and rulings issued thereunder.
"Collateral" means the property in which liens have been granted
pursuant to the Borrower Pledge Agreement and the Borrower Security
Agreement or pursuant to any Subsidiary Security Agreement or Subsidiary
Pledge Agreement executed by a Subsidiary (including in accordance with
Section 8.10), whether such Liens are now existing or hereafter arise.
"Commitment Fee" has the meaning set forth in Section 2.7.
"Commitment Fee Rate" means one quarter of one percent (0.25%) per
annum.
"Commitments" means, as to each Lender, such Lender's Revolving Credit
Commitment, Term Commitment and LC Commitment.
"Consolidated Net Income" means, at any time, the aggregate net income
or loss of the Borrower and its Subsidiaries determined on a consolidated
basis and in accordance with GAAP.
"Consolidated Net Worth" means, at any particular time, all amounts
which, in conformity with GAAP, would be included as stockholders' equity
on a consolidated balance sheet of the Borrower and the Subsidiaries.
"Consolidated Working Capital" means, at any time, the current assets
of the Borrower and its Subsidiaries determined on a consolidated basis
less the current liabilities of the Borrower and its Subsidiaries
determined on a consolidated basis, all as determined in accordance with
GAAP.
"Contingent Liabilities" means, at any particular time, the contingent
liabilities of the Borrower and its Subsidiaries determined on a
consolidated basis in accordance with GAAP.
"Contribution and Indemnification Agreement" means the Contribution
and Indemnification Agreement executed by the Borrower and the Guarantors,
in substantially the form of Exhibit E hereto, as the same may be amended,
restated or modified from time to time.
-4-
<PAGE>
"Debt" means as to any Person at any time (without duplication): (a)
all obligations of such Person for borrowed money, (b) all obligations of
such Person evidenced by bonds, notes, debentures, or other similar
instruments whether secured or unsecured, (c) all Capital Lease Obligations
of such Person, (d) all Debt or other obligations of others Guaranteed by
such Person, (e) all obligations secured by a Lien existing on property
owned by such Person, whether or not the obligations secured thereby have
been assumed by such Person or are non-recourse to the credit of such
Person, but excluding those obligations secured by landlord's liens or
liens for taxes not yet due and payable, (f) all reimbursement obligations
of such Person (whether contingent or otherwise) in respect of letters of
credit (whether drawn or undrawn), bankers' acceptances, surety or other
bonds and similar instruments, and (g) all liabilities of such Person in
respect of unfunded vested benefits under any Plan; provided however, the
term "Debt" shall not include, except for clauses (d) and (f) above, any
items which are not required to be reflected as debt on the Borrower's
balance sheet in accordance with GAAP.
"Debt to EBITDA Ratio" means, for each Fiscal Quarter, the quotient
determined by dividing (i) those items described in clauses (a), (b), (c),
(d) and (e) of the definition of "Debt" of the Borrower and its
consolidated Subsidiaries, by (ii) the sum of (a) EBITDA for such Fiscal
Quarter plus (b) beginning with the Fiscal Quarter ending December 31, 1999
through and including the Fiscal Quarter ending September 30, 2000, the
annualized royalty payments made to area developers involved in the Royalty
Buy-Backs for the most recent Fiscal Quarter prior to such Royalty
Buy-Backs, less (c) any savings received by the Borrower since the closing
of the Royalty Buy-Backs as a result of such Royalty Buy-Backs (for
purposes of this calculation, in an amount equal to $100,000 for each
Fiscal Quarter).
"Default" means an Event of Default or the occurrence of an event or
condition which with notice or lapse of time or both would become an Event
of Default.
"Default Rate" means the lesser of (a) the Maximum Rate or, (b) the
sum of the Base Rate in effect from day to day plus five percent (5%).
"Deposit and Cash Management Services Obligations" means all the
obligations of the Borrower to a Lender to pay the fees charged for the
deposit and/or cash management products and services provided by any Lender
in connection with any deposit or other accounts maintained at such Lender.
"Dispute" has the meaning set forth in Section 13.14.
"Dollars" and "$" mean lawful money of the United States of America.
"EBITDA" means Consolidated Net Income, plus, to the extent that any
of the following were deducted in calculating such Consolidated Net Income,
interest expense, tax expenses, and depreciation and amortization, but
excluding all extraordinary items of income and loss.
-5-
<PAGE>
"Eligible Assignee" means (i) a Lender, (ii) an Affiliate of a Lender,
and (iii) any other Person approved by the Agent, and, unless a Default has
occurred and is continuing at the time any assignment is effected, in
accordance with Section 13.8, the Borrower, such approval not to be
unreasonably withheld or delayed by the Borrower; provided, however, that
neither the Borrower nor an Affiliate of the Borrower shall qualify as an
Eligible Assignee.
"Environmental Laws" means any and all federal, state, and local laws,
regulations, and requirements pertaining to health, safety, or the
environment, as such laws, regulations, and requirements may be amended or
supplemented from time to time.
"Environmental Liabilities" means, as to any Person, all liabilities,
obligations, responsibilities, Remedial Actions, losses, damages, punitive
damages, consequential damages, treble damages, costs, and expenses,
(including, without limitation, all reasonable fees, disbursements and
expenses of counsel, expert and consulting fees and costs of investigation
and feasibility studies), fines, penalties, sanctions, and interest
incurred as a result of any claim or demand, by any Person, whether based
in contract, tort, implied or express warranty, strict liability, criminal
or civil statute, including any Environmental Law, permit, order or
agreement with any Governmental Authority or other Person, arising from
environmental, health or safety conditions or the Release or threatened
Release of a Hazardous Material into the environment.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time, and the regulations and published
interpretations thereunder.
"ERISA Affiliate" means any corporation or trade or business which is
a member of the same controlled group of corporations (within the meaning
of Section 414(b) of the Code) as the Borrower, which is under common
control (within the meaning of Section 414(c) of the Code) with the
Borrower, or which is otherwise affiliated with the Borrower (within the
meaning of Section 414(m) or Section 414(o) of the Code).
"Event of Default" has the meaning set forth in Section 11.1.
"Exchange Act" means the Securities and Exchange Act of 1934, as
amended, and the rules and regulations promulgated thereunder.
"Existing Credit Agreements" has the meaning set forth in Section
6.1(m).
"Existing Debt" means the Debt listed on Schedule 9.1.
-6-
<PAGE>
"Existing LC Guaranty" means that certain Amended and Restated
Continuing Guaranty executed by the Borrower in favor of the Issuing Bank,
in substantially the form of Exhibit J hereto, as the same may be amended,
restated or modified from time to time, pursuant to which the Borrower
guaranteed the obligations of the LC Account Party under the Letter of
Credit.
"Existing TC Credit Agreement" has the meaning set forth in Section
6.1(m).
"Existing Wells Fargo Credit Agreement" has the meaning set forth in
Section 6.1(m).
"Federal Funds Rate" means, for any day, the rate per annum (rounded
upwards, if necessary, to the nearest 1/16 of 1%) equal to the weighted
average of the rates on overnight Federal funds transactions with members
of the Federal Reserve System arranged by Federal funds brokers on such
day, as published by the Federal Reserve Bank of New York on the Business
Day next succeeding such day, provided that (a) if the day for which such
rate is to be determined is not a Business Day, the Federal Funds Rate for
such day shall be such rate on such transactions on the next preceding
Business Day as so published on the next succeeding Business Day, and (b)
if such rate is not so published on such next succeeding Business Day, the
Federal Funds Rate for any day shall be the average rate charged to Wells
Fargo Bank (Texas), National Association on such day on such transactions
as determined by the Agent.
"Fiscal Quarter" means any three (3)-month period ending December 31,
March 31, June 30 or September 30.
"Fiscal Year" means each twelve (12)-month period ending December 31
of each year.
"Fixed Charge Coverage Ratio" means, for each Fiscal Quarter, the
quotient determined by dividing (i) the sum of EBITDA plus rent expense in
each case for such Fiscal Quarter and the prior three (3) Fiscal Quarters
by (ii) the sum of (a) the aggregate interest expense and rent expense of
the Borrower and its consolidated Subsidiaries, plus (b) that portion of
Long-Term Debt of the Borrower and its consolidated Subsidiaries that
should be classified as current in accordance with GAAP, in each case for
such Fiscal Quarter and the prior three (3) Fiscal Quarters.
"Funded Debt" means, at any particular time, calculated on a
consolidated basis for the Borrower and the Subsidiaries in accordance with
GAAP, all obligations for borrowed money and Capital Lease Obligations, but
excluding all Debt subordinated to the Obligations.
-7-
<PAGE>
"GAAP" means generally accepted accounting principles, applied on a
consistent basis, as set forth in Opinions of the Accounting Principles
Board of the American Institute of Certified Public Accountants and/or in
statements of the Financial Accounting Standards Board and/or their
respective successors and which are applicable in the circumstances as of
the date in question. Accounting principles are applied on a "consistent
basis" when the accounting principles applied in a current period are
comparable in all material respects to those accounting principles applied
in a preceding period.
"Governmental Authority" means any nation or government, any state or
political subdivision thereof and any entity exercising executive,
legislative, judicial, regulatory, or administrative functions of or
pertaining to government.
"Guarantee" by any Person means any obligation, contingent or
otherwise, of such Person directly or indirectly guaranteeing any Debt or
other obligation of any other Person and, without limiting the generality
of the foregoing, any obligation, direct or indirect, contingent or
otherwise, of such Person (a) to purchase or pay (or advance or supply
funds for the purchase or payment of) such Debt or other obligation
(whether arising by virtue of partnership arrangements, by agreement to
keep-well, to purchase assets, goods, securities or services, to
take-or-pay, or to maintain financial statement conditions or otherwise) or
(b) entered into for the purpose of assuring in any other manner the
obligee of such Debt or other obligation of the payment thereof or to
protect the obligee against loss in respect thereof (in whole or in part),
provided that the term Guarantee shall not include endorsements for
collection or deposit in the ordinary course of business. The term
"Guarantee" used as a verb has a corresponding meaning.
"Guarantor" means each and every Subsidiary of Borrower whether now in
existence or hereafter created which include but are not limited to those
Subsidiaries listed on Schedule 7.14.
"Guaranty" means the joint and several guaranty of each Guarantor in
favor of the Agent, the Issuing Bank and the Lenders, in substantially the
form of Exhibit C hereto, as the same may be amended, restated,
supplemented or modified from time to time.
"Hazardous Material" means any substance, product, waste, pollutant,
material, chemical, contaminant, constituent, or other material which is or
becomes listed, regulated, or addressed under any Environmental Law.
"Issuing Bank" means, with respect to the Letter of Credit, Wells
Fargo Bank (Texas), National Association.
"LC Account Party" means Schlotzsky's National Advertising
Association, Inc., a Texas corporation.
-8-
<PAGE>
"LC Commitment" means, as to each Lender, the obligation of such
Lender to fund draws under the Letter of Credit in an aggregate amount up
to but not exceeding the amount set forth opposite the name of such Lender
in Schedule 1.1(a) hereto under the heading "LC Commitment."
"LC Participation" means, with respect to any Lender, at any time, the
amount of participating interest held by such Lender (or in the case of the
Issuing Bank, other interests) in respect of the Letter of Credit.
"Lender" has the meaning set forth in the introductory paragraph of
this Agreement.
"Letter of Credit" has the meaning set forth in Section 4.1(a).
"Letter of Credit Disbursement" means a disbursement by the Issuing
Bank to the beneficiary of the Letter of Credit in connection with a
drawing thereunder.
"Letter of Credit Liabilities" means, at any time, the sum of (i) the
face amount of the Letter of Credit and (ii) the aggregate amount of all
Letter of Credit Disbursements for which the Issuing Bank has not been
reimbursed by the Borrower.
"Leverage Ratio" means, as of any Fiscal Quarter end the ratio of
Funded Debt to the sum of (i) EBITDA plus (ii) the amount of the reduction
of the royalty payments and franchise fee expense as a result of the
Royalty Buy-Back, less (iii) any savings received by the Borrower since the
closing of the Royalty Buy-Backs as a result of such Royalty Buy-Backs (for
purposes of this calculation, in an amount equal to $100,000 for each
Fiscal Quarter), in each case for such Fiscal Quarter and the prior three
(3) Fiscal Quarters.
"Lien" means any lien, mortgage, security interest, tax lien,
financing statement, pledge, charge, hypothecation, assignment, preference,
priority, or other encumbrance of any kind or nature whatsoever (including,
without limitation, any conditional sale or title retention agreement),
whether arising by contract, operation of law, or otherwise.
"Loan Documents" means this Agreement, the Notes, the Guaranties, the
Borrower Security Agreement, the Borrower Pledge Agreement, the Subsidiary
Security Agreement, the Subsidiary Pledge Agreement, the Contribution and
Indemnification Agreement, the Existing LC Guaranty, and all other
promissory notes, guaranties, and other instruments, documents, and
agreements now or hereafter executed and delivered pursuant to or in
connection with this Agreement, as such instruments, documents, and
agreements may be amended, modified, renewed, extended, or supplemented
from time to time.
"Long-Term Debt" means, at any particular time, all Debt of the
Borrower and its consolidated Subsidiaries which should be classified as
"funded indebtedness" or "long-term indebtedness" in accordance with GAAP.
-9-
<PAGE>
"Material Adverse Effect" means a material adverse effect on (a) the
business, condition (financial or otherwise), operations, prospects, or
properties of the Borrower and the Subsidiaries taken as a whole, or (b)
the validity or enforceability of this Agreement or any of the other Loan
Documents or the rights or remedies of the Agent, the Issuing Bank or the
Lenders hereunder or thereunder. In determining whether any individual
event could reasonably be expected to result in a Material Adverse Effect,
notwithstanding that such event does not itself have such effect, a
Material Adverse Effect shall be deemed to have occurred if the cumulative
effect of such event and all other then existing events could reasonably be
expected to result in a Material Adverse Effect.
"Material Debt" has the meaning set forth in Section 11.1(h).
"Maximum Rate" means, at any time and with respect to any Lender, the
maximum rate of interest under applicable law that such Lender may charge
the Borrower. The Maximum Rate shall be calculated in a manner that takes
into account any and all fees, payments, and other charges in respect of
the Loan Documents that constitute interest under applicable law. Each
change in any interest rate provided for herein based upon the Maximum Rate
resulting from a change in the Maximum Rate shall take effect without
notice to the Borrower at the time of such change in the Maximum Rate. For
purposes of determining the Maximum Rate under Texas law, the applicable
rate ceiling shall be the applicable weekly ceiling described in, and
computed in accordance with, Chapter 303 of the Texas Finance Code.
"Monthly Payment Date" means the first day of each calendar month of
each year, the first of which shall be January 1, 2000.
"Multiemployer Plan" means a multiemployer plan defined as such in
Section 3(37) of ERISA to which contributions have been made by the
Borrower or any ERISA Affiliate and which is covered by Title IV of ERISA.
"Net Proceeds" from any disposition of assets means the amount equal
to (a) the aggregate gross proceeds of such disposition, less (b) the
following: (i) sales or other similar taxes paid or payable by the seller
in connection with such disposition, (ii) reasonable broker fees in
connection with such disposition, (iii) reasonable legal fees and other
reasonable expenses payable by the seller in connection with such
disposition and (iv) the amount of any Debt secured by the assets that must
be repaid in connection with such disposition so long as it is a Debt
permitted under this Agreement.
"Notes" means, collectively, the Revolving Credit Notes and the Term
Notes.
"Obligated Party" means each Guarantor and any other Person who is or
becomes party to any written agreement that guarantees or secures payment
and performance of the Obligations or any part thereof.
-10-
<PAGE>
"Obligations" means all obligations, indebtedness, and liabilities of
the Borrower to the Agent, the Issuing Bank, and the Lenders, or any of
them, arising pursuant to any of the Loan Documents and all Deposit and
Cash Management Services Obligations, now existing or hereafter arising,
whether direct, indirect, related, unrelated, fixed, contingent,
liquidated, unliquidated, joint, several, or joint and several, including,
without limitation, the obligations, indebtedness, and liabilities of the
Borrower under this Agreement, the Notes and the other Loan Documents
(including without limitation, all of the Borrower's contingent
reimbursement obligations in respect of the Letter of Credit), and all
interest accruing thereon and all attorneys' fees and other expenses
incurred in the enforcement or collection thereof.
"PBGC" means the Pension Benefit Guaranty Corporation or any entity
succeeding to all or any of its functions under ERISA.
"Permitted Debt" means (a) the Obligations, (b) Existing Debt and (c)
Debt permitted by Section 9.1 of this Agreement.
"Permitted Liens" means Liens permitted by Section 9.2 of this
Agreement.
"Person" means any individual, corporation, business trust,
association, company, partnership, limited liability company, joint
venture, Governmental Authority, or other entity.
"Plan" means any employee benefit plan (within the meaning of Section
3(3) of ERISA) established or maintained by the Borrower or any ERISA
Affiliate within the last six (6) years, or to which the Borrower or any
ERISA Affiliate made contributions or was required to make contributions
during such six (6) year period, which plan is subject to the provisions of
ERISA.
"Prime Rate" means, at any time, the rate of interest per annum then
most recently announced by Wells Fargo Bank, National Association at its
principal office in San Francisco as its prime rate, which rate may not be
the lowest rate of interest charged by Wells Fargo Bank, National
Association to its borrowers. Each change in any interest rate provided for
herein based upon the Prime Rate resulting from a change in the Prime Rate
shall take effect on the date the change is announced by Wells Fargo Bank,
National Association without notice to the Borrower at the time of such
change in the Prime Rate.
"Principal Office" means the principal office of the Agent in Austin,
Texas, presently located at 111 Congress Avenue, Suite 300, Austin, Texas
78701.
"Prohibited Transaction" means any transaction set forth in Section
406 or 407 of ERISA or Section 4975(c)(1) of the Code for which there does
not exist a statutory or administrative exemption.
-11-
<PAGE>
"Quarterly Certificate" has the meaning set forth in Section 8.1(c).
"Quarterly Payment Date" means the first day of each January, April,
July and October of each year, the first of which shall be January 1, 2000.
"Register" has the meaning set forth in Section 13.8(d).
"Regulation D" means Regulation D of the Board of Governors of the
Federal Reserve System as the same may be amended or supplemented from time
to time.
"Regulatory Change" means, with respect to any Lender, any change
after the date of this Agreement in United States federal, state, or
foreign laws or regulations (including Regulation D) or the adoption or
making after such date of any interpretations, directives, or requests
applying to a class of lenders including such Lender of or under any United
States federal or state, or any foreign, laws or regulations (whether or
not having the force of law) by any court or governmental or monetary
authority charged with the interpretation or administration thereof.
"Release" means, as to any Person, any release, spill, emission,
leaking, pumping, injection, deposit, disposal, disbursement, leaching, or
migration of Hazardous Materials into the indoor or outdoor environment or
into or out of property owned by such Person, including, without
limitation, the movement of Hazardous Materials through or in the air,
soil, surface water, ground water, or property in violation of
Environmental Laws.
"Remedial Action" means all actions required to (a) clean up, remove,
treat, or otherwise address Hazardous Materials in the indoor or outdoor
environment, (b) prevent the Release or threat of Release or minimize the
further Release of Hazardous Materials so that they do not migrate or
endanger or threaten to endanger public health or welfare or the indoor or
outdoor environment, or (c) perform pre-remedial studies and investigations
and post-remedial monitoring and care.
"Reportable Event" means any of the events set forth in Section 4043
of ERISA.
"Required Lenders" means (i) at any time while no Advances or Letter
of Credit Liabilities are outstanding, two or more Lenders having at least
sixty-six and two-thirds percent (66-2/3%) of the aggregate amount of the
Commitments, and (ii) at any time while Advances or Letter of Credit
Liabilities are outstanding, two or more Lenders holding at least sixty-six
and two-thirds percent (66-2/3%) of the outstanding aggregate principal
amount of the Advances and LC Participations.
"Revolving Credit Commitment" means, as to each Lender, the obligation
of such Lender to make Revolving Credit Loan Advances as described in
Article II hereunder in an aggregate principal amount at any one time
outstanding up to but not exceeding the amount set forth opposite the name
of such Lender on Schedule 1.1(a) hereto under the heading "Revolving
Credit Commitment", as the same may be reduced pursuant to Section 2.11 or
terminated pursuant to Section 2.11 or 11.2.
-12-
<PAGE>
"Revolving Credit Loan" means the revolving credit loan made or to be
made hereunder to Borrower pursuant to Section 2.1.
"Revolving Credit Loan Advance" means an Advance under the Revolving
Credit Loan.
"Revolving Credit Loan Termination Date" means 8:00 A.M. San
Francisco, California time on September 30, 2000, or such earlier date and
time on which the Revolving Credit Commitments terminate as provided in
this Agreement.
"Revolving Credit Notes" means, collectively, the promissory notes of
the Borrower payable to the order of the Lenders in the aggregate principal
amount of the Revolving Credit Loan, in substantially the form of Exhibit
A-1 hereto, and all extensions, renewals, amendments, increases,
restatements and modifications thereof.
"RICO" means the Racketeer Influenced and Corrupt Organization Act of
1970, as amended from time to time.
"Royalty Buy-Backs" means the purchase from an area developer by the
Borrower or any Subsidiary of rights to royalty payments made by the
Borrower to such area developer, including, but not limited to, a reduction
of an area developer's rights to royalty payments in conjunction with the
reduction of all or part of the area developer's service obligations.
"Subsidiary"means any corporation (or other entity) of which at least
a majority of the outstanding shares of stock (or other ownership
interests) having by the terms thereof ordinary voting power to elect a
majority of the board of directors (or similar governing body) of such
corporation (or other entity) (irrespective of whether or not at the time
stock (or other ownership interests) of any other class or classes of such
corporation (or other entity) shall have or might have voting power by
reason of the happening of any contingency) is at the time directly or
indirectly owned or controlled by the Borrower or one or more of the
Subsidiaries or by the Borrower and one or more of the Subsidiaries.
"Subsidiary Pledge Agreement" means that certain pledge agreement
executed by each Subsidiary and the Agent in favor of the Agent for the
benefit of the Agent, the Issuing Bank and the Lenders, in substantially
the form of Exhibit H, as the same may be amended, restated, supplemented
or modified from time to time.
-13-
<PAGE>
"Subsidiary Security Agreement" means that certain security agreement
executed by each Subsidiary and the Agent in favor of the Agent for the
benefit of the Agent, the Issuing Bank and the Lenders, in substantially
the form of Exhibit I, as the same may be amended, restated, supplemented
or modified from time to time.
"Term Commitment" means, as to each Lender, the obligation of such
Lender to make an advance of funds under Section 3.1 in an aggregate
principal amount up to but not exceeding the amount set forth opposite the
name of such Lender in Schedule 1.1(a) hereto under the heading "Term
Commitment", as the same may be terminated pursuant to Section 11.2. The
aggregate amount of the Term Commitments of all Lenders equals Twenty
Million Dollars ($20,000,000).
"Term Loan" means, as to any Lender, the Advance made by such Lender
pursuant to Section 3.1.
"Term Notes" means, collectively, the promissory notes of the Borrower
payable to the order of the Lenders in the aggregate principal amount of
the Term Loan, in substantially the form of Exhibit A-2 hereto, and all
extensions, renewals, amendments, increases, restatements and modifications
thereto.
"Termination Date" means 8:00 A.M. San Francisco, California time on
December 1, 2004, or such earlier date and time on which the Term
Commitments terminate as provided in this Agreement.
"UCC" means the Uniform Commercial Code as in effect in the State of
Texas.
Section 1.2 Other Definitional Provisions. All definitions contained in
this Agreement are equally applicable to the singular and plural forms of the
terms defined. The words "hereof", "herein", and "hereunder" and words of
similar import referring to this Agreement refer to this Agreement as a whole
and not to any particular provision of this Agreement. Unless otherwise
specified, all Article and Section references pertain to this Agreement. All
accounting terms not specifically defined herein shall be construed in
accordance with GAAP. Terms used herein that are defined in the UCC, unless
otherwise defined herein, shall have the meanings specified in the UCC.
ARTICLE II
Revolving Credit Loan
Section 2.1 Commitments. Subject to the terms and conditions of this
Agreement, each Lender severally agrees to make one or more Revolving Credit
Loan Advances to the Borrower from time to time from the date hereof to but
excluding the Revolving Credit Loan Termination Date in an aggregate principal
amount at any time outstanding up to but not exceeding the amount of such
Lender's Revolving Credit Commitment as then in effect, provided that the
aggregate amount of all Revolving Credit Loan Advances at any time outstanding
shall not exceed the Revolving Credit Commitments. Subject to the foregoing
limitations, and the other terms and provisions of this Agreement, the Borrower
may borrow, repay, and reborrow hereunder the amount of the Revolving Credit
Commitments by means of Revolving Credit Loan Advances. Revolving Credit Loan
Advances made by each Lender shall be made and maintained at such Lender's
Applicable Lending Office.
-14-
<PAGE>
Section 2.2 Revolving Credit Notes. The obligation of the Borrower to repay
each Lender for Revolving Credit Loan Advances made by such Lender and interest
thereon shall be evidenced by a Revolving Credit Note executed by the Borrower,
payable to the order of such Lender, in the principal amount of such Lender's
Revolving Credit Commitment and dated the date hereof.
Section 2.3 Repayment of Revolving Credit Loan. The Borrower shall repay
the outstanding principal amount of the Revolving Credit Loan on the Revolving
Credit Loan Termination Date.
Section 2.4 Interest. The unpaid principal amount of the Revolving Credit
Loan shall bear interest at a varying rate per annum equal from day to day to
the lesser of (a) the Maximum Rate, or (b) the Applicable Rate. If at any time
the Applicable Rate for any Revolving Credit Loan Advance shall exceed the
Maximum Rate, thereby causing the interest accruing on such Revolving Credit
Loan Advance to be limited to the Maximum Rate, then any subsequent reduction in
the Applicable Rate for such Revolving Credit Loan Advance shall not reduce the
rate of interest on such Revolving Credit Loan Advance below the Maximum Rate
until the aggregate amount of interest accrued on such Revolving Credit Loan
Advance equals the aggregate amount of interest which would have accrued on such
Revolving Credit Loan Advance if the Applicable Rate had at all times been in
effect. Accrued and unpaid interest on the Revolving Credit Loan Advances shall
be due and payable on each Monthly Payment Date and on the Revolving Credit Loan
Termination Date. Notwithstanding the foregoing, upon the occurrence and during
the continuance of a Default, the outstanding principal amounts of all Revolving
Credit Loan Advances and (to the fullest extent permitted by law) any other
amounts payable by the Borrower under any Loan Document shall bear interest at
the Default Rate at the Required Lenders' option beginning upon the occurrence
of such Default or such later date as selected by the Required Lenders. Interest
payable at the Default Rate shall be payable from time to time on demand.
Section 2.5 Revolving Credit Loan Borrowing Procedure. The Borrower shall
provide to the Agent a telephone request of each requested Revolving Credit Loan
Advance not later than 11:00 A.M. San Francisco, California time on the Business
Day that is at least one (1) Business Day before the requested date of each
Revolving Credit Loan Advance, which telephone request shall be promptly
confirmed by delivery of a written Advance Request Form via facsimile to the
Agent not later than 1:00 P.M. on the same date of such telephone request, which
Advance Request Form shall specify: (a) the requested date of such Revolving
Credit Loan Advance (which shall be a Business Day) and (b) the amount of such
Revolving Credit Loan Advance; provided, however, with respect to the initial
requested Revolving Credit Loan Advance which will be the date of this
Agreement, Borrower shall give the Agent such Advance Request Form on the
requested date of such initial Revolving Credit Loan Advance. Each Revolving
Credit Loan Advance shall be in a minimum principal amount of Five Hundred
Thousand Dollars ($500,000) or in greater increments of One Hundred Thousand
Dollars ($100,000). The Borrower shall not request, and the Lenders shall not be
obligated to make, more than four (4) Revolving Credit Loan Advances each
calendar month. The Agent shall notify each Lender of the contents of each such
notice promptly. Not later than 11:00 A.M. San Francisco, California time on the
date specified for each Revolving Credit Loan Advance hereunder, each Lender
will make available to the Agent at the Principal Office in immediately
available funds, for the account of the Borrower, its pro rata share of each
Revolving Credit Loan Advance. After the Agent's receipt of such funds and
subject to the other terms and conditions of this Agreement, the Agent will make
each Revolving Credit Loan Advance available to the Borrower by depositing the
same, in immediately available funds, in an account of the Borrower (designated
by the Borrower) maintained with the Agent at the Principal Office. All notices
by the Borrower under this Section shall be irrevocable and shall be given not
later than 9:00 A.M. San Francisco, California time on the day which is not less
than the number of Business Days specified above for such notice.
-15-
<PAGE>
Section 2.6 Use of Proceeds. The proceeds of Revolving Credit Loan Advances
shall be used by the Borrower to refinance the indebtedness of the Borrower
pursuant to the Existing Wells Fargo Credit Agreement, for working capital in
the ordinary course of business and other general corporate purposes.
Section 2.7 Commitment Fees. The Borrower agrees to pay to the Agent for
the account of the Lenders a Commitment Fee (herein so called) on the average
daily unused amount of each Lender's Revolving Credit Commitment for the period
from and including the date of this Agreement to and including the Revolving
Credit Loan Termination Date, at the Commitment Fee Rate, based on a 360 day
year and the actual number of days elapsed. The accrued Commitment Fee shall be
payable in arrears on each Quarterly Payment Date and on the Revolving Credit
Loan Termination Date.
Section 2.8 Determination of Base Rate Margin. The Base Rate Margin shall
be defined and determined as follows:
"Base Rate Margin" shall mean (i) during the period commencing on the
date hereof and ending on but not including the first Adjustment Date, zero
percent (0%) per annum, and (ii) during each period, from and including one
Adjustment Date to but excluding the next Adjustment Date (herein a
"Calculation Period"), the percent per annum set forth in the table below
in this Section 2.8 under the heading "Base Rate Margin" opposite the Debt
to EBITDA Ratio calculated for the completed four (4) Fiscal Quarters which
immediately preceded the beginning of the applicable Calculation Period.
-16-
<PAGE>
===========================================================
Debt to EBITDA Ratio Base Rate Margin
-------------------- ----------------
Greater than or equal to 4.0 to 1.0 0%
-----------------------------------------------------------
Greater than 3.0 to 1.0 but less
than 4.0 to 1.0 -0.25%
-----------------------------------------------------------
Greater than 2.0 to 1.0 but less
than or equal to 3.0 to 1.0 -0.50%
-----------------------------------------------------------
Less than or equal to 2.0 to 1.0 -0.75%
===========================================================
Upon delivery of the Quarterly Certificate pursuant to Section 8.1(c)
commencing with such Quarterly Certificate delivered at the end of the
Fiscal Quarter ending on December 31, 1999, the Base Rate Margin shall
automatically be adjusted as set forth in the table above, such automatic
adjustment to take effect as of the first Business Day after the receipt by
the Agent of the related Quarterly Certificate (each such Business Day when
the Base Rate Margin is adjusted pursuant to this sentence or below, herein
an "Adjustment Date"). If the Borrower fails to deliver such Quarterly
Certificate which so sets forth the Debt to EBITDA Ratio within the period
of time required by Section 8.1(c), the Base Rate Margin shall
automatically be adjusted to the highest applicable percentage set forth in
the grid above, such automatic adjustment to take effect as of the first
Business Day after the last day on which the Borrower was required to
deliver the applicable Quarterly Certificate in accordance with Section
8.1(c) and to remain in effect until subsequently adjusted in accordance
herewith upon the delivery of a Quarterly Certificate.
Section 2.9 Reduction or Termination of Revolving Credit Commitments.
(a) Optional. The Borrower shall have the right to terminate
in whole or reduce in part the unused portion of the Revolving Credit
Commitments upon at least five (5) Business Days prior notice (which
notice shall be irrevocable) to the Agent and each Lender specifying
the effective date thereof, whether a termination or reduction is being
made, and the amount of any partial reduction, provided that each
partial reduction shall be in the amount of Five Million Dollars
($5,000,000) or an integral multiple thereof, and the Borrower shall
simultaneously prepay the amount by which the unpaid principal amount
of the Revolving Credit Loan Advances exceeds the Revolving Credit
Commitments (after giving effect to such notice) plus accrued and
unpaid interest on the principal amount so prepaid. The Revolving
Credit Commitments may not be reinstated after they have been
terminated or reduced.
-17-
<PAGE>
(b) Mandatory.
(i) On the date the Borrower or any Subsidiary receives funds
from mortgages on restaurants owned by the Borrower or any of its
Subsidiaries, the Revolving Credit Commitments shall automatically be
reduced by the amount of such funds received, and the Borrower shall
simultaneously prepay the amount by which the unpaid principal amount
of the Revolving Credit Loan Advances exceeds the Revolving Credit
Commitments (after giving effect to such reduction) plus accrued and
unpaid interest on the principal amount so prepaid.
(ii) Upon receipt of the Net Proceeds from the sale of any
restaurants or stores owned by the Borrower or any Subsidiary, the
Revolving Credit Commitments shall automatically be reduced by the
amount of the Net Proceeds, and the Borrower shall simultaneously
prepay the amount by which the unpaid principal amount of the
Revolving Credit Loan Advances exceeds the Revolving Credit
Commitments (after giving effect to such reduction) plus accrued and
unpaid interest on the principal amount so prepaid.
(iii) Upon receipt by the Agent of the report in accordance with
Section 8.1(l), the Revolving Credit Commitments shall automatically
be reduced by an amount equal to the difference between $5,000,000 and
the money actually used to finance the Royalty Buy-Backs as reflected
on such report, and the Borrower shall simultaneously prepay the
amount by which the unpaid principal amount of the Revolving Credit
Loan Advances exceeds the Revolving Credit Commitments (after giving
effect to such reduction) plus accrued and unpaid interest on the
principal amount so prepaid.
(iv) On March 31, 2000, the Revolving Credit Commitments shall
automatically be reduced by the amount equal to Five Million Dollars
($5,000,000) less the amount of any reductions in the Revolving Credit
Commitments as of such date pursuant to clauses (i), (ii) and (iii)
above, and the Borrower shall simultaneously prepay the amount by
which the unpaid principal amount of the Revolving Credit Loan
Advances exceeds the Revolving Credit Commitments (after giving effect
to such reduction) plus accrued and unpaid interest on the principal
amount so prepaid.
ARTICLE III
Term Loan
Section 3.1 Term Commitments. Subject to the terms and conditions of this
Agreement, each Lender severally agrees to make an Advance to the Borrower in
the amount of its Term Commitment on the Closing Date.
-18-
<PAGE>
Section 3.2 Notes. The Term Loan made by a Lender shall be evidenced by a
single promissory note of the Borrower in substantially the form of Exhibit A-2
hereto, payable to the order of such Lender in a principal amount equal to its
Term Commitment as originally in effect and otherwise duly completed.
Section 3.3 Repayment of Term Loan. The Borrower shall pay to the Agent for
the account of the Lenders the outstanding principal amount of the Term Loan as
follows:
(a) Fifty-nine (59) consecutive monthly installments shall be due and
payable on each Monthly Payment Date commencing January 1, 2000 and
continuing until and including November 1, 2004, each installment to be in
an amount equal to Three Hundred Thirty-Three Thousand Three Hundred
Thirty-Three and 33/100 Dollars ($333,333.33); and
(b) One (1) final installment in the amount of all outstanding
principal of the Term Loan due and payable on the Termination Date.
Section 3.4 Interest. The unpaid principal amount of the Term Loan shall
bear interest at a varying rate per annum equal from day to day to the lesser of
(a) the Maximum Rate, or (b) the Applicable Rate. If at any time the Applicable
Rate for the Term Loan shall exceed the Maximum Rate, thereby causing the
interest accruing on the Term Loan to be limited to the Maximum Rate, then any
subsequent reduction in the Applicable Rate for the Term Loan shall not reduce
the rate of interest on the Term Loan below the Maximum Rate until the aggregate
amount of interest accrued on the Term Loan equals the aggregate amount of
interest which would have accrued on the Term Loan if the Applicable Rate had at
all times been in effect. Accrued and unpaid interest on the Term Loan shall be
due and payable on each Monthly Payment Date and on the Termination Date.
Notwithstanding the foregoing, upon the occurrence and during the continuance of
a Default, the outstanding principal amounts of the Term Loan (and to the
fullest extent permitted by law) any other amounts payable by the Borrower under
any Loan Document shall bear interest at the Default Rate at the Required
Lenders' option beginning upon the occurrence of such Default or such later date
as selected by the Required Lenders. Interest payable at the Default Rate shall
be payable from time to time on demand.
Section 3.5 Term Loan Borrowing Procedure. The Borrower shall give the
Agent notice by means of an Advance Request Form of the requested Term Loan on
the requested date of the Term Loan which will be the date of this Agreement.
The Agent shall notify each Lender of the contents of such notice promptly. Not
later than 11:00 A.M., San Francisco, California time on the date specified for
the Term Loan, each Lender will make available to the Agent at the Principal
Office in immediately available funds, for the account of the Borrower, its pro
rata share of the Term Loan. After the Agent's receipt of such funds and subject
to the other terms and conditions of this Agreement, the Agent will make the
Term Loan available to the Borrower by depositing the same, in immediately
available funds, in an account of the Borrower (designated by the Borrower)
maintained with the Agent at the Principal Office. The notice by the Borrower
under this Section shall be irrevocable and shall be given not later than 9:00
A.M., San Francisco, California time on the requested date of the Term Loan.
-19-
<PAGE>
Section 3.6 Term Loan Fee. The Borrower shall pay to the Agent for the
account of the Lenders a term loan fee in an amount equal to Fifty Thousand
Dollars ($50,000), which term loan fee shall be due and payable as of the date
hereof.
Section 3.7 Use of Proceeds. The proceeds of the Term Loan shall be used by
the Borrower to refinance the indebtedness of the Borrower pursuant to the
Existing TC Credit Agreement and to provide financing for Royalty Buy-Backs.
ARTICLE IV
Letter of Credit
Section 4.1 Letter of Credit.
(a) Subject to the terms and conditions of this Agreement, the Issuing
Bank agrees to keep outstanding on the date hereof the standby letter of
credit for the account of the LC Account Party which was issued by the
Issuing Bank and which is further described on Schedule 1.1(b) (the "Letter
of Credit"). The Borrower has guaranteed the full and prompt payment and
performance of the obligations of the LC Account Party under the Letter of
Credit pursuant to the Existing LC Guaranty. Notwithstanding anything to
the contrary contained in this Agreement, the Issuing Bank shall not extend
the expiration date of the Letter of Credit without the prior written
consent of all of the Lenders.
(b) Without any further action on the part of the Issuing Bank or any
of the Lenders in respect thereof, the Issuing Bank hereby grants to each
Lender and each Lender hereby acquires from the Issuing Bank a
participation in the Letter of Credit and the related Letter of Credit
Liabilities, effective upon the date hereof without recourse or warranty,
equal to such Lender's pro rata share (based on the Revolving Credit
Commitments) of the Letter of Credit and Letter of Credit Liabilities. In
furtherance of the foregoing, each Lender hereby absolutely and
unconditionally agrees to pay to the Issuing Bank, as and when required by
Section 4.3, such Lender's pro rata share of each Letter of Credit
Disbursement. Each Lender acknowledges and agrees that its obligation to
acquire participations pursuant to this Section 4.1(b) in respect of the
Letter of Credit is absolute and unconditional and shall not be affected by
any circumstance whatsoever, including without limitation the occurrence
and continuance of any Default, and that each such payment shall be made
without any offset, abatement, withholding, or reduction whatsoever. This
agreement to grant and acquire participations is an agreement between the
Issuing Bank and the Lenders, and neither Borrower, the LC Account Party
nor the beneficiary of the Letter of Credit shall be entitled to rely
thereon. Borrower agrees that each Lender purchasing a participation from
the Issuing Bank pursuant to this Section 4.1(b) may exercise all its
rights to payment against Borrower pursuant to the Existing LC Guaranty
including the right of setoff, with respect to such participation as fully
as if such Lender were the direct creditor of Borrower in the amount of
such participation.
-20-
<PAGE>
(c) The Issuing Bank agrees with each Lender that it shall transfer to
such Lender, without any offset, abatement, withholding, or reduction
whatsoever, such Lender's proportionate share of any payment of a
reimbursement obligation of Borrower with respect to a Letter of Credit
Disbursement, including interest payments made to the Issuing Bank on such
Letter of Credit Disbursement, based on the proportion that the payment
made by such Lender to the Issuing Bank in respect of the principal amount
of such Letter of Credit Disbursement bears to the outstanding principal
amount of such Letter of Credit Disbursement.
Section 4.2 Presentment and Reimbursement. (a) Promptly upon receipt of any
documents purporting to represent a demand for payment under the Letter of
Credit, the Issuing Bank shall give notice to Borrower of the receipt thereof,
which notice may be telephonic. If the Issuing Bank shall have determined that a
demand for payment under the Letter of Credit appears on its face to be in
conformity with the terms and conditions of the Letter of Credit, the Issuing
Bank shall give notice to Borrower, which notice may be telephonic, of the
receipt and amount of such drawing and the date on which payment thereon will be
made. If Borrower shall not have discharged in full by 8:00 A.M., San Francisco,
California time on the date of such payment, its obligation to reimburse the
Issuing Bank pursuant to the Existing LC Guaranty in the amount of such drawing
under the Letter of Credit, then the amount of such drawing for which the
Issuing Bank shall not have been reimbursed by Borrower or the LC Account Party
shall be paid by Borrower to the Issuing Bank or, to the extent the Issuing Bank
shall have received payments with respect to such drawing from the Lenders, to
the Issuing Bank for the account of the Lenders, within three (3) Business Days
after the date of such drawing, together with interest on such amount at the
Default Rate from the date of payment by the Issuing Bank to the beneficiary
under the Letter of Credit (each such payment made after 8:00 A.M., San
Francisco, California time on such due date to be deemed to be made on the next
succeeding Business Day). The obligations of Borrower under this Section 4.2 and
the Existing LC Guaranty shall be unconditional, absolute, and irrevocable in
all respects.
Section 4.3 Payment. If the Issuing Bank shall pay any draft presented
under the Letter of Credit and if neither the Borrower nor the LC Account Party
shall have discharged in full its respective reimbursement obligation by 8:00
A.M., San Francisco, California time on the date of such Letter of Credit
Disbursement, then the Issuing Bank shall as promptly as practicable give
telephonic (which shall be promptly confirmed in writing) or facsimile notice to
each Lender of the date of such payment and the amount of such payment and each
Lender shall pay to the Issuing Bank, in immediately available funds, not later
than 1:00 P.M., San Francisco, California time on the date of such payment (or,
if Issuing Bank shall notify the Lenders of such payment after 9:00 A.M., San
Francisco, California time, then not later than 10:00 A.M., San Francisco,
California time on the next succeeding Business Day), an amount equal to such
Lender's pro rata share of such drawing; provided that, if any Lender shall for
any reason fail to pay the Issuing Bank its pro rata share of the drawing on the
date of such payment, the Issuing Bank shall itself fund such Lender's pro rata
share while retaining the right to proceed against such Lender for reimbursement
therefor. In the event that the Issuing Bank shall fund a Lender's pro rata
share of a drawing, the amount so funded shall bear interest at a rate per annum
equal to the Federal Funds Rate and shall be payable by such Lender when it
reimburses the Issuing Bank for funding its pro rata part (with interest to
accrue from and including the date of such funding to and excluding the date of
reimbursement). In the event that a Lender, after notice, pays its pro rata
share of a drawing hereunder and such payment is not required to fund a Letter
of Credit Disbursement, the Issuing Bank shall return such payment to the Lender
with interest calculated at a rate per annum equal to the Federal Funds Rate
(with interest to accrue from and including the date of such funding to and
excluding the date of return). The obligation of each Lender to pay to the
Issuing Bank such Lender's pro rata part of any drawing under the Letter of
Credit shall be absolute and unconditional under any and all circumstances, and
such obligations shall be several and not joint.
-21-
<PAGE>
Section 4.4 Letter of Credit Fee. The Agent has received (i) for the
account of the Issuing Bank, a nonrefundable issuing fee of $325, and (ii) a
nonrefundable letter of credit fee of $49,675, which letter of credit fee shall
be paid by the Agent to each Lender other than the Issuing Bank in an amount
equal to (a) the quotient of such Lender's LC Commitment divided by the face
amount of the Letter of Credit, multiplied by (b) the quotient of the number of
days beginning as of the date hereof through and including the expiration date
of the Letter of Credit, divided by the number of days beginning as of the
actual issuance date of the Letter of Credit through and including the
expiration date of the Letter of Credit with the remainder of such letter of
credit fee to be paid to the Issuing Bank. In addition, the Borrower shall pay,
or shall cause to be paid, to the Issuing Bank, solely for its own account as
issuer of the Letter of Credit, nonrefundable fronting, amendment, transfer,
negotiation and other fees as determined in accordance with the Issuing Bank's
current fee policy, a copy of which has been provided to the Borrower.
Section 4.5 Obligations Absolute. The obligations of Borrower under this
Agreement and the other Loan Documents (including without limitation the
obligation of Borrower to reimburse the Issuing Bank for draws under the Letter
of Credit) shall be absolute, unconditional, and irrevocable, and shall be
performed strictly in accordance with the terms of this Agreement and the other
Loan Documents under all circumstances whatsoever, including without limitation
the following circumstances:
(a) Any lack of validity or enforceability of the Letter of Credit or
any other Loan Document;
(b) Any amendment or waiver of or any consent to departure from any
Loan Document;
(c) The existence of any claim, set-off, counterclaim, defense or
other rights which Borrower, any Obligated Party, the LC Account Party or
any other Person may have at any time against any beneficiary of the Letter
of Credit, the Issuing Bank, any Lender, the Agent, or any other Person,
whether in connection with this Agreement or any other Loan Document or any
unrelated transaction;
-22-
<PAGE>
(d) Any statement, draft, or other document presented under the Letter
of Credit proving to be forged, fraudulent, invalid, or insufficient in any
respect or any statement therein being untrue or inaccurate in any respect
whatsoever;
(e) Payment by the Issuing Bank under the Letter of Credit against
presentation of a draft or other document which does not comply with the
terms of the Letter of Credit; or
(f) Any other circumstance or happening whatsoever, whether or not
similar to any of the foregoing.
Section 4.6 Limitation of Liability. Borrower assumes all risks of the acts
or omissions of the beneficiary of the Letter of Credit with respect to its use
of the Letter of Credit. Neither the Issuing Bank, the Lenders, the Agent, nor
any of their officers or directors shall have any responsibility or liability to
Borrower, the LC Account Party or any other Person for: (a) the failure of any
draft to bear any reference or adequate reference to the Letter of Credit, or
the failure of any documents to accompany any draft at negotiation, or the
failure of any Person to surrender or to take up the Letter of Credit or to send
documents apart from drafts as required by the terms of the Letter of Credit, or
the failure of any Person to note the amount of any instrument on the Letter of
Credit, each of which requirements, if contained in the Letter of Credit itself,
it is agreed may be waived by the Issuing Bank, (b) errors, omissions,
interruptions, or delays in transmission or delivery of any messages, (c) the
validity or genuineness of any draft or other document, or any endorsement(s)
thereon, even if any such draft, document or endorsement should in fact prove to
be in any and all respects invalid, fraudulent, or forged or any statement
therein is untrue or inaccurate in any respect, (d) the payment by the Issuing
Bank to the beneficiary of the Letter of Credit against presentation of any
draft or other document that does not comply with the terms of the Letter of
Credit, or (e) any other circumstance whatsoever in making or failing to make
any payment under the Letter of Credit in good faith. Borrower shall have a
claim against the Issuing Bank, and the Issuing Bank shall be liable to
Borrower, to the extent of any direct, but not consequential, damages suffered
by Borrower which Borrower proves in a final nonappealable judgment were caused
by (i) the Issuing Bank's willful misconduct or gross negligence in determining
whether documents presented under the Letter of Credit complied with the terms
thereof or (ii) the Issuing Bank's willful or grossly negligent failure to pay
under the Letter of Credit after presentation to it of documents strictly
complying with the terms and conditions of the Letter of Credit. The Issuing
Bank may accept documents that appear on their face to be in order, without
responsibility for further investigation, regardless of any notice or
information to the contrary.
-23-
<PAGE>
ARTICLE V
Payments
Section 5.1 Method of Payment. Except as provided in Article IV, all
payments of principal, interest, and other amounts to be made by the Borrower
under this Agreement and the other Loan Documents shall be made to the Agent at
the Principal Office for the account of each Lender's Applicable Lending Office
in Dollars and in immediately available funds, without setoff, deduction, or
counterclaim, not later than 11:00 A.M., San Francisco, California time on the
date on which such payment shall become due (each such payment made after such
time on such due date to be deemed to have been made on the next succeeding
Business Day). The Borrower shall, at the time of making each such payment,
specify to the Agent the sums payable by the Borrower under this Agreement and
the other Loan Documents to which such payment is to be applied (and in the
event that the Borrower fails to so specify, or if an Event of Default has
occurred and is continuing, the Agent may apply such payment to the Obligations
in such order and manner as it may elect in its sole discretion, subject to
Section 5.4 hereof). Each payment received by the Agent under this Agreement or
any other Loan Document for the account of a Lender shall be paid by the Agent
to such Lender, in immediately available funds, for the account of such Lender's
Applicable Lending Office within one (1) Business Day following receipt thereof.
Whenever any payment under this Agreement or any other Loan Document shall be
stated to be due on a day that is not a Business Day, such payment may be made
on the next succeeding Business Day, and such extension of time shall in such
case be included in the computation of the payment of interest and the
Commitment Fee, as the case may be.
Section 5.2 Voluntary Prepayment. The Borrower may, upon at least one (1)
Business Days prior notice to the Agent, voluntarily prepay the Revolving Credit
Loan Advances in whole at any time or from time to time in part without premium
or penalty but with accrued interest to the date of prepayment on the amount so
prepaid, provided that (a) each partial prepayment shall be in the principal
amount of Five Hundred Thousand Dollars ($500,000) or greater increments of One
Hundred Thousand Dollars ($100,000) and (b) Borrower may not voluntarily prepay
the Revolving Credit Loan Advances more than three (3) times each calendar
month. The Borrower may, upon at least one (1) Business Day's prior notice to
the Agent, voluntarily prepay the Term Loan in whole at any time or from time to
time in part without premium or penalty but with accrued interest to the date of
prepayment on the amount so prepaid, provided that (a) each partial prepayment
shall be in the principal amount of Five Hundred Thousand Dollars ($500,000) or
greater increments of One Hundred Thousand Dollars ($100,000), (b) each partial
prepayment shall be applied in inverse order of maturity to the last maturing
installments of principal, and (c) Borrower may not voluntarily prepay the Term
Loan more than one (1) time each calendar month; All notices under this Section
shall be irrevocable and shall be given not later than 9:00 A.M. San Francisco,
California, time on the day which is not less than the number of Business Days
specified above for such notice.
-24-
<PAGE>
Section 5.3 Mandatory Prepayments.
(a) If at any time the amount equal to the outstanding principal
amount of all Revolving Credit Loan Advances exceeds the aggregate amount
of the Revolving Credit Commitments, the Borrower shall promptly prepay the
outstanding Revolving Credit Loan Advances by the amount of the excess.
(b) After any reduction in the Revolving Credit Commitments pursuant
to Section 2.9, the Borrower shall promptly prepay the outstanding
Revolving Credit Loan Advances by the amount by which the outstanding
principal amount of the Revolving Credit Loan Advances exceeds the
aggregate amount of the Revolving Credit Commitments, as reduced.
Section 5.4 Pro Rata Treatment. Except to the extent otherwise provided
herein: (a) each Revolving Credit Loan Advance shall be made by the Lenders
under Section 2.1, each payment of the Commitment Fee under Section 2.7, the
Term Loan shall be made by the Lenders under Section 3.1 and each payment of the
Letter of Credit fee under Section 4.4 (except as provided therein) shall be
made for the account of the Lenders, and each termination or reduction of the
Revolving Credit Commitments under Section 2.9 shall be applied to the Revolving
Credit Commitments of the Lenders, pro rata according to the respective
Revolving Credit Commitments; (b) any and all other monies received by the Agent
from any source other than pursuant to any of clause (a) hereinabove (including,
without limitation, from the Borrower, any Guarantor or the LC Account Party) to
be applied against the Obligations shall be for the pro rata benefit and account
of the Lenders based upon each Lender's aggregate outstanding Revolving Credit
Loan Advances, Term Loan and LC Participations to the aggregate outstanding
Revolving Credit Loan Advances, Term Loan and LC Participations of all Lenders;
provided however, if no Advances are outstanding and so long as the Letter of
Credit is outstanding, any remaining amounts shall be retained as Collateral in
an amount equal to one hundred and ten percent (110%) of the available amount to
be drawn under the Letter of Credit; and (c) the Lenders shall purchase from the
Issuing Bank pursuant to Section 4.1 participations in the Letter of Credit and
the related Letter of Credit Liabilities, pro rata in accordance with their LC
Commitments.
Section 5.5 Non-Receipt of Funds by the Agent. Unless the Agent shall have
been notified by a Lender or the Borrower (the "Payor") prior to the date on
which such Lender is to make payment to the Agent hereunder or the Borrower is
to make a payment to the Agent for the account of one or more of the Lenders, as
the case may be (such payment being herein called the "Required Payment"), which
notice shall be effective upon receipt, that the Payor does not intend to make
the Required Payment to the Agent, the Agent may assume that the Required
Payment has been made and may, in reliance upon such assumption (but shall not
be required to), make the amount thereof available to the intended recipient on
such date and, if the Payor has not in fact made the Required Payment to the
Agent, (a) the recipient of such payment shall, on demand, pay to the Agent the
amount made available to it together with interest thereon in respect of the
period commencing on the date such amount was so made available by the Agent
until the date the Agent recovers such amount at a rate per annum equal to (i)
if recovered from a Lender, at the Federal Funds Rate for such period and (ii)
if recovered from the Borrower, the rate of interest applicable to the
respective Advance, as determined pursuant to Sections 2.4, 3.4 and 4.2 and (b)
Agent shall be entitled to offset against any and all sums to be paid to such
recipient, the amount calculated in accordance with the foregoing clause (a).
-25-
<PAGE>
Section 5.6 Withholding Taxes. All payments by the Borrower of principal of
and interest on the Advances and in reimbursement of draws under the Letter of
Credit and of all fees and other amounts payable under any Loan Document are
payable without deduction for or on account of any present or future taxes,
duties or other charges levied or imposed by the United States of America or by
the government of any jurisdiction outside the United States of America or by
any political subdivision or taxing authority of or in any of the foregoing
through withholding or deduction with respect to any such payments. If any such
taxes, duties or other charges are so levied or imposed, the Borrower will pay
additional interest or will make additional payments in such amounts so that
every net payment of principal of and interest on the Advances and of all other
amounts payable by it under any Loan Document, after withholding or deduction
for or on account of any such present or future taxes, duties or other charges,
will not be less than the amount provided for herein or therein, provided that
the Borrower shall have no obligation to pay such additional amounts to any
Lender to the extent that such taxes, duties, or other charges are levied or
imposed by reason of the failure of such Lender to comply with the provisions of
Section 5.7. The Borrower shall furnish promptly to the Agent for distribution
to each affected Lender, as the case may be, official receipts evidencing any
such withholding or reduction.
Section 5.7 Withholding Tax Exemption. Each Lender that is not incorporated
under the laws of the United States of America or a state thereof agrees that it
will deliver to the Borrower and the Agent two (2) duly completed copies of
United States Internal Revenue Service Form 1001 or 4224, certifying in either
case that such Lender is entitled to receive payments from the Borrower under
any Loan Document without deduction or withholding of any United States federal
income taxes. Each Lender which so delivers a Form 1001 or 4224 further
undertakes to deliver to Borrower and the Agent two (2) additional copies of
such form (or a successor form) on or before the date such form expires or
becomes obsolete or after the occurrence of any event requiring a change in the
most recent form so delivered by it, and such amendments thereto or extensions
or renewals thereof as may be reasonably requested by the Borrower or the Agent,
in each case certifying that such Lender is entitled to receive payments from
the Borrower under any Loan Document without deduction or withholding of any
United States federal income taxes, unless an event (including without
limitation any change in treaty, law or regulation) has occurred prior to the
date on which any such delivery would otherwise be required which renders all
such forms inapplicable or which would prevent such Lender from duly completing
and delivering any such form with respect to it and such Lender advises the
Borrower and the Agent that it is not capable of receiving such payments without
any deduction or withholding of United States federal income tax.
Section 5.8 Computation of Interest. Interest on the Advances and all other
amounts payable by the Borrower hereunder shall be computed on the basis of a
year of 360 days and the actual number of days elapsed (including the first day
but excluding the last day) unless such calculation would result in a usurious
rate, in which case interest shall be calculated on the basis of a year of 365
or 366 days, as the case may be.
-26-
<PAGE>
Section 5.9 Additional Costs in Respect of Letter of Credit. If as a result
of any Regulatory Change there shall be imposed, modified, or deemed applicable
any tax, reserve, special deposit, or similar requirement against or with
respect to or measured by reference to the Letter of Credit issued, and the
result shall be to increase the cost to the Issuing Bank of issuing or
maintaining the Letter of Credit or reduce any amount receivable by the Issuing
Bank hereunder in respect of the Letter of Credit (which increase in cost, or
reduction in amount receivable, shall be the result of the Issuing Bank's
reasonable allocation of the aggregate of such increases or reductions resulting
from such event), then, upon demand by the Issuing Bank, the Borrower agrees to
pay, or shall cause to be paid, to the Issuing Bank, from time to time as
specified by the Issuing Bank, such additional amounts as shall be sufficient to
compensate the Issuing Bank for such increased costs or reductions in amount. A
statement as to such increased costs or reductions in amount incurred by the
Issuing Bank, submitted by the Issuing Bank to the Borrower, shall be conclusive
as to the amount thereof, provided that the determination thereof is made on a
reasonable basis.
Section 5.10 Capital Adequacy. If after the date hereof, any Lender shall
have determined that the adoption or implementation after the date hereof of any
applicable law, rule, or regulation regarding capital adequacy (including,
without limitation, any law, rule, or regulation implementing the Basle Accord),
or any change therein, or any change in the interpretation or administration
thereof by any central bank or other Governmental Authority charged with the
interpretation or administration thereof, or compliance by such Lender (or its
parent) with any guideline, request, or directive regarding capital adequacy
(whether or not having the force of law) of any central bank or other
Governmental Authority (including, without limitation, any guideline or other
requirement implementing the Basle Accord), has or would have the effect of
reducing the rate of return on such Lender's (or its parent's) capital as a
consequence of its obligations hereunder or the transactions contemplated hereby
to a level below that which such Lender (or its parent) could have achieved but
for such adoption, implementation, change or compliance (taking into
consideration such Lender's policies with respect to capital adequacy) by an
amount deemed by such Lender to be material, then from time to time, within ten
(10) Business Days after demand by such Lender (with a copy to the Agent), the
Borrower shall pay to such Lender such additional amount or amounts as will
compensate such Lender (or its parent) for such reduction. A certificate of such
Lender claiming compensation under this Section in reasonable detail and setting
forth the additional amount or amounts to be paid to it hereunder shall be
conclusive, provided that the determination thereof is made on a reasonable
basis. In determining such amount or amounts, such Lender may use any reasonable
averaging and attribution methods. With respect to each demand by a Lender under
this Section 5.10, no Lender shall have the right to demand compensation for
amounts attributable to any reduction in such Lender's rate of return occurring
at any time before the date which is three (3) months prior to the date such
Lender gives such demand for compensation to the Borrower.
-27-
<PAGE>
ARTICLE VI
Conditions Precedent
Section 6.1 Initial Extension of Credit. The obligation of each Lender to
make its initial Advance is subject to the condition precedent that the Agent
shall have received on or before the day of such Advance all of the following,
each dated (unless otherwise indicated) the date hereof, in form and substance
satisfactory to the Agent:
(a) Resolutions. Resolutions of the Board of Directors of the Borrower
and each Guarantor certified by its Secretary or an Assistant Secretary
which authorize the execution, delivery, and performance of the Loan
Documents to which it is or is to be a party.
(b) Incumbency Certificate. A certificate of incumbency certified by
the Secretary or an Assistant Secretary of the Borrower and each Guarantor
certifying the names of each of its officers (i) who are authorized to sign
the Loan Documents to which such Person is or is to be a party (including
the certificates contemplated herein) together with specimen signatures of
such officers and (ii) who will, until replaced by other officers duly
authorized for that purpose, act as the representative of such Person for
the purposes of signing documentation and giving notices and other
communications in connection with this Agreement and the transactions
contemplated hereby.
(c) Articles of Incorporation. The articles or certificate of
incorporation of the Borrower and each Guarantor certified by the Secretary
of State of the state of its incorporation and dated a current date.
(d) Bylaws. The bylaws of the Borrower and each Guarantor certified by
the Secretary or an Assistant Secretary.
(e) Governmental Certificates. Certificates of the appropriate
government officials of the state of incorporation of the Borrower and each
Guarantor as to its existence and good standing and certificates of
appropriate government officials of each state in which the Borrower and
the Guarantor is required to qualify to do business, as to the Borrower's
and each such Guarantor's qualification to do business and good standing in
such state, all dated a current date.
(f) Notes. The Notes executed by the Borrower.
(g) Guaranty. A Guaranty executed by each Guarantor.
(h) Collateral Documents and Collateral. The Borrower Pledge Agreement
and the Borrower Security Agreement executed by the Borrower; the
Subsidiary Pledge Agreement and the Subsidiary Security Agreement executed
by each Guarantor; certificates representing the capital stock of the
Subsidiaries pledged pursuant to the Borrower Pledge Agreement together
with undated stock powers duly executed in blank; certificates representing
the capital stock of the Subsidiaries pledged pursuant to the Subsidiary
Pledge Agreement together with undated stock powers duly executed in blank;
UCC, tax and judgment Lien search reports listing all documentation on file
against Borrower and each Guarantor in the office of the Secretary of State
of Texas and Secretary of State of Georgia and executed documentation as
Agent may deem necessary to perfect or protect its Liens, including,
without limitation, financing statements under the UCC.
-28-
<PAGE>
(i) Termination of Liens. Duly executed UCC-3 termination statements
and such other documentation as shall be necessary to terminate or release
all Liens on the property of the Borrower and the Guarantors other than
those permitted by Section 9.2.
(j) Contribution and Indemnification Agreement. A Contribution and
Indemnification Agreement executed by the Borrower and the Guarantors.
(k) Opinion of Counsel. A favorable opinion of legal counsel to the
Borrower and each Guarantor satisfactory to the Agent, as to such matters
as the Agent or the Required Lenders may reasonably request.
(l) Attorneys' Fees and Expenses. Evidence that the costs and expenses
(including attorneys' fees) referred to in Section 13.1, to the extent
incurred, shall have been paid in full by the Borrower.
(m) Termination Agreements. Termination agreements confirming the
prior credit facilities provided pursuant to (i) that certain Credit
Agreement dated as of June 27,1997, by and between the Borrower and Wells
Fargo Bank (Texas), National Association, as the same has been amended,
restated or modified from time to time (the "Existing Wells Fargo Credit
Agreement"), and (ii) that certain Credit Agreement (the "Existing TC
Credit Agreement") dated April 9, 1999, by and between the Borrower and
Texas Capital Bank, National Association, as the same has been amended,
restated or modified from time to time (collectively, the Existing Wells
Fargo Credit Agreement and the Existing TC Credit Agreement are referred to
as the "Existing Credit Agreements"), shall be terminated and paid in full
effective as of the date hereof.
(n) Existing LC Guaranty. The Existing LC Guaranty executed by the
Borrower.
Section 6.2 All Extensions of Credit. The obligation of each Lender to make
any Advance (including the initial Advance) is subject to the following
additional conditions precedent:
(a) Advance Request Form. The Agent shall have received, in accordance
with Section 2.5 and 3.5, an Advance Request Form executed by an authorized
officer of the Borrower;
-29-
<PAGE>
(b) No Default or Event of Default. No Default or Event of Default
shall have occurred and be continuing, or would result from such Advance.
(c) Representations and Warranties. All of the representations and
warranties contained in Article VII hereof and in the other Loan Documents
shall be true and correct in all material respects on and as of the date of
such Advance with the same force and effect as if such representations and
warranties had been made on and as of such date except to the extent such
representations and warranties speak to a specific date;
(d) No Material Adverse Effect. Neither any Material Adverse Effect or
any material adverse change in the financial or capital markets shall have
occurred since the date of the most recent financial statements delivered
to the Agent and the Lenders pursuant to Section 8.1 hereof; and
(e) Additional Documentation. The Agent shall have received such
additional approvals, opinions, or documents as the Agent or its legal
counsel, Winstead Sechrest & Minick P.C., may request.
Each request for an Advance by the Borrower hereunder shall constitute a
representation and warranty by the Borrower that the conditions precedent set
forth in Sections 7.2(b), 7.2(c) and 7.2(d) have been satisfied (both as of the
date of such request and, unless the Borrower otherwise notifies the Agent prior
to the date of such Advance, as of the date of such Advance).
ARTICLE VII
Representations and Warranties
To induce the Agent, the Issuing Bank, and the Lenders to enter into this
Agreement, the Borrower represents and warrants to the Agent, the Issuing Bank,
and the Lenders that:
Section 7.1 Existence. The Borrower and each Subsidiary (a) is a
corporation (or other entity as set forth on Schedule 7.14) duly organized,
validly existing, and in good standing under the laws of the jurisdiction of its
incorporation or organization; (b) has all requisite power and authority to own
its assets and carry on its business as now being or as proposed to be
conducted; and (c) is qualified to do business in all jurisdictions in which the
nature of its business makes such qualification necessary. Each of the Borrower
and each Guarantor have the power and authority to execute, deliver, and perform
its obligations under the Loan Documents to which it is or may become a party.
Section 7.2 Financial Statements. The Borrower has delivered to the Agent
audited consolidated financial statements of the Borrower and its Subsidiaries
as at and for the fiscal year ended December 31, 1998, and unaudited
consolidated financial statements of the Borrower and its Subsidiaries for the
nine-month period ended September 30, 1999. Such financial statements are true
and correct, have been prepared in accordance with GAAP, and fairly and
accurately present, on a consolidated basis, the financial condition of the
Borrower and its Subsidiaries as of the respective dates indicated therein and
the results of operations for the respective periods indicated therein. As of
the date hereof, neither the Borrower nor any of its Subsidiaries has any
material contingent liabilities, liabilities for taxes, unusual forward or
long-term commitments, or unrealized or anticipated losses from any unfavorable
commitments except as referred to or reflected in such financial statements, and
there has been no Material Adverse Effect since the effective date of the most
recent financial statements referred to in this Section.
-30-
<PAGE>
Section 7.3 Action; No Breach. The execution, delivery, and performance by
the Borrower and each Guarantor of the Loan Documents to which it is or may
become a party, and compliance with the terms and provisions hereof and thereof
have been duly authorized by all requisite action on the part of the Borrower
and each Guarantor and do not and will not (a) violate or conflict with, or
result in a breach of, or require any consent, other than such consents which
have been obtained and copies of which have been provided to the Agent, under
(i) the articles of incorporation or bylaws or the applicable organizational
documents of the Borrower or any Guarantor, (ii) any applicable law, rule, or
regulation or any order, writ, injunction, or decree of any Governmental
Authority or arbitrator, or (iii) any agreement or instrument to which the
Borrower or any of the Guarantors is a party or by which any of them or any of
their property is bound or subject, or (b) constitute a default under any such
agreement or instrument, or result in the creation or imposition of any Lien
upon any of the revenues or assets of the Borrower or any Guarantor.
Section 7.4 Operation of Business. The Borrower and each of its
Subsidiaries possess all licenses, permits, franchises, patents, copyrights,
trademarks, and tradenames, or rights thereto, necessary to conduct their
respective businesses substantially as now conducted and as presently proposed
to be conducted except where such failure would not have a Material Adverse
Effect, and the Borrower and each of its Subsidiaries are not in violation of
any valid rights of others with respect to any of the foregoing except where
such failure would not have a Material Adverse Effect.
Section 7.5 Litigation and Judgments. There is no action, suit,
investigation, or proceeding before or by any Governmental Authority or
arbitrator pending, or to the knowledge of the Borrower, threatened against or
affecting the Borrower or any Subsidiary, that is reasonably expected to have a
Material Adverse Effect. As of the date hereof, there are no outstanding
judgments against the Borrower or any Subsidiary.
Section 7.6 Rights in Properties; Liens. The Borrower and each Subsidiary
have good and indefeasible title to or valid leasehold interests in their
respective properties and assets, real and personal, including the properties,
assets, and leasehold interests reflected in the financial statements described
in Section 7.2, and none of the properties, assets, or leasehold interests of
the Borrower or any Subsidiary is subject to any Lien, except as permitted by
Section 9.2.
Section 7.7 Enforceability. The Loan Documents to which the Borrower or a
Guarantor is a party, when delivered, shall constitute the legal, valid, and
binding obligations of the Borrower or such Guarantor, as applicable,
enforceable against the Borrower or such Guarantor, as applicable, in accordance
with their respective terms, except as limited by bankruptcy, insolvency, or
other laws of general application relating to the enforcement of creditors'
rights and general principles of equity.
-31-
<PAGE>
Section 7.8 Approvals. No authorization, approval, or consent of, and no
filing or registration with, any Governmental Authority or third party is or
will be necessary for the execution, delivery, or performance by the Borrower of
this Agreement and by the Borrower or any Guarantor of the other Loan Documents
to which the Borrower or such Guarantor, as applicable, is or may become a party
or for the validity or enforceability thereof.
Section 7.9 Debt. The Borrower and the Subsidiaries have no Debt, except as
permitted by Section 9.1.
Section 7.10 Taxes. The Borrower and each Subsidiary have filed all tax
returns (federal, state, and local) required to be filed, including all income,
franchise, employment, property, and sales tax returns, and have paid all of
their respective liabilities for taxes, assessments, governmental charges, and
other levies that are due and payable other than those being contested in good
faith by appropriate proceedings diligently pursued for which adequate reserves
have been established. The Borrower knows of no pending investigation of the
Borrower or any Subsidiary by any taxing authority or of any pending but
unassessed tax liability of the Borrower or any Subsidiary.
Section 7.11 Use of Proceeds; Margin Securities. Neither the Borrower nor
any Subsidiary is engaged principally, or as one of its important activities, in
the business of extending credit for the purpose of purchasing or carrying
margin stock (within the meaning of Regulations T, U, or X of the Board of
Governors of the Federal Reserve System), and no part of the proceeds of any
Advance will be used to purchase or carry any margin stock or to extend credit
to others for the purpose of purchasing or carrying margin stock.
Section 7.12 ERISA. The Borrower, each Subsidiary, ERISA Affiliate, and
each Plan are in compliance with all applicable provisions of ERISA and the Code
except for events of noncompliance that will not have a Material Adverse Effect.
Each Benefit Arrangement is in compliance with all applicable laws, including,
without limitation, the Code, except for events of noncompliance that will not
have a Material Adverse Effect. Neither a Reportable Event nor a Prohibited
Transaction has occurred or is continuing with respect to any Plan. No notice of
intent to terminate a Plan has been filed, nor has any Plan been terminated. No
circumstances exist which constitute grounds entitling the PBGC to institute
proceedings to terminate, or appoint a trustee to administer, a Plan, nor has
the PBGC instituted any such proceedings. Neither the Borrower nor any ERISA
Affiliate has completely or partially withdrawn from a Multiemployer Plan. The
Borrower and each ERISA Affiliate have met their minimum funding requirements
under ERISA with respect to all of their Plans, and no "accumulated funding
deficiency" (for which an excise tax is due or would be due in the absence of a
waiver) as defined in Section 412 of the Code or Section 302(a)(2) of ERISA,
whichever may apply, has been incurred with respect to any Plan, whether or not
waived. The present value of all benefits under each Plan do not exceed the fair
market value of all Plan assets allocable to such benefits, determined on a
termination basis as of the most recent valuation date of the Plan and in
accordance with ERISA. Neither the Borrower nor any ERISA Affiliate has incurred
any liability to the PBGC under ERISA. Neither the Borrower nor any ERISA
Affiliate is subject to any lien imposed under Section 412(n) of the Code or
Section 302(f) or 4068 of ERISA, whichever may apply, with respect to any Plan.
Neither the Borrower nor any ERISA Affiliate is required to provide security to
a Plan under Section 401(a)(29) of the Code. Neither the Borrower nor any ERISA
Affiliate has engaged in a transaction described in Section 4069 of ERISA.
-32-
<PAGE>
Section 7.13 Disclosure. All factual information (taken as a whole)
furnished by or on behalf of the Borrower in writing to the Agent, the Issuing
Bank or any Lender (including, without limitation, all information contained in
the Loan Documents) for purposes of or in connection with this Agreement, the
other Loan Documents or any transaction contemplated herein or therein is, and
all other such factual information (taken as a whole) hereafter furnished by or
on behalf of the Borrower to the Agent, the Issuing Bank or any Lender, will be
true and accurate in all material respects on the date as of which such
information is dated or certified and not incomplete by omitting to state any
fact necessary to make such information (taken as a whole) not misleading in any
material respect at such time in light of the circumstances under which such
information was provided.
Section 7.14 Subsidiaries. As of the date hereof, the Borrower has no
Subsidiaries other than those listed on Schedule 7.14 hereto, and Schedule 7.14
(a) sets forth the type of each Subsidiary listed thereon, (b) sets forth the
jurisdiction of incorporation or organization of each Subsidiary, and the
percentage of the Borrower's ownership of the outstanding voting stock or other
ownership interests of each Subsidiary, and with respect to each Subsidiary that
is a corporation, the authorized, issued and outstanding capital stock of such
Subsidiary. All of the outstanding capital stock of each corporate Subsidiary
has been validly issued, is fully paid, and is nonassessable. There are no
outstanding subscriptions, options, warrants, calls, or rights to acquire, and
no outstanding securities or instruments convertible into, capital stock of any
Subsidiary except as listed on Schedule 7.14.
Section 7.15 Agreements. Except as disclosed in the financial statements
provided to the Agent, the Issuing Bank, and each Lender prior to the date of
this Agreement, neither the Borrower nor any Subsidiary is a party to any
indenture, loan, or credit agreement, or to any lease or other agreement or
instrument, or subject to any charter or corporate restriction. Neither the
Borrower nor any Subsidiary is in default in the performance, observance, or
fulfillment of any of the obligations, covenants, or conditions contained in any
agreement or instrument material to its business to which it is a party.
Section 7.16 Compliance with Laws. Neither the Borrower nor any Subsidiary
is in violation of any law, rule, regulation, order, or decree of any
Governmental Authority or arbitrator.
Section 7.17 Investment Company Act. Neither the Borrower nor any
Subsidiary is an "investment company" within the meaning of the Investment
Company Act of 1940, as amended.
-33-
<PAGE>
Section 7.18 Public Utility Holding Company Act. Neither the Borrower nor
any Subsidiary is a "holding company"' or a "subsidiary company" of a "holding
company" or an "affiliate" of a "holding company" or a "public utility" within
the meaning of the Public Utility Holding Company Act of 1935, as amended.
Section 7.19 Environmental Matters. Except for those matters which will not
have a Material Adverse Effect:
(a) The Borrower, each Subsidiary, and all of their respective
properties, assets, and operations are in full compliance with all
Environmental Laws. The Borrower is not aware of, nor has the Borrower
received notice of, any past, present, or future conditions, events,
activities, practices, or incidents which may interfere with or prevent the
compliance or continued compliance of the Borrower and the Subsidiaries
with all Environmental Laws;
(b) The Borrower and each Subsidiary have obtained all permits,
licenses, and authorizations that are required under applicable
Environmental Laws, and all such permits are in good standing and the
Borrower and the Subsidiaries are in compliance with all of the terms and
conditions of such permits;
(c) No Hazardous Materials exist on, about, or within or have been
used, generated, stored, transported, disposed of on, or Released from any
of the properties or assets of the Borrower or any Subsidiary. The use
which the Borrower and the Subsidiaries make and intend to make of their
respective properties and assets will not result in the use, generation,
storage, transportation, accumulation, disposal, or Release of any
Hazardous Material on, in, or from any of their properties or assets except
in compliance with Environmental Laws;
(d) Neither the Borrower nor any of the Subsidiaries nor any of their
respective currently or previously owned or leased properties or operations
is subject to any outstanding or threatened order from or agreement with
any Governmental Authority or other Person or subject to any judicial or
docketed administrative proceeding with respect to (i) failure to comply
with Environmental Laws, (ii) Remedial Action, or (iii) any Environmental
Liabilities arising from a Release or threatened Release;
(e) There are no conditions or circumstances associated with the
currently or previously owned or leased properties or operations of the
Borrower or any of the Subsidiaries that could reasonably be expected to
give rise to any Environmental Liabilities;
(f) Neither the Borrower nor any of the Subsidiaries is a treatment,
storage, or disposal facility requiring a permit under the Resource
Conservation and Recovery Act, 42 U.S.C. ss. 6901 et seq., regulations
thereunder or any comparable provision of state law. The Borrower and the
Subsidiaries are in compliance with all applicable financial responsibility
requirements of all Environmental Laws;
-34-
<PAGE>
(g) Neither the Borrower nor any of the Subsidiaries has filed or
failed to file any notice required under applicable Environmental Law
reporting a Release; and
(h) No Lien arising under any Environmental Law has attached to any
property or revenues of the Borrower or the Subsidiaries.
ARTICLE VIII
Positive Covenants
The Borrower covenants and agrees that, as long as the Obligations or any
part thereof are outstanding or any Lender has any Commitment hereunder, the
Borrower will perform and observe the following positive covenants:
Section 8.1 Reporting Requirements. The Borrower will furnish to the Agent,
the Issuing Bank, and each Lender:
(a) Annual Financial Statements. As soon as available, and in any
event within one hundred twenty (120) days after the end of each Fiscal
Year of the Borrower and the Subsidiaries, beginning with the Fiscal Year
ending December 31, 1999, a copy of the annual audited financial statements
of the Borrower and the Subsidiaries for such fiscal year containing, on a
consolidated and consolidating basis, balance sheets and statements of
income, retained earnings, and cash flow as at the end of such Fiscal Year
and for the 12-month period then ended, in each case setting forth in
comparative form the figures for the preceding Fiscal Year, all in
reasonable detail and audited and certified by independent certified public
accountants of recognized standing acceptable to the Agent, to the effect
that such report has been prepared in accordance with GAAP;
(b) Prepared Form 10-K Report. As soon as available, and in any event
within one hundred twenty (120) days after the end of each Fiscal Year of
the Borrower and the Subsidiaries, beginning with the Fiscal Year ending
December 31, 1999, a copy of the annual report on the Form 10-K as filed
with the Securities and Exchange Commission, all as prepared by independent
certified public accountants of recognized standing acceptable to the
Agent, together with all exhibits, schedules, and annexes attached thereto;
(c) Quarterly Certificate. As soon as available, and in any event
within forty-five (45) days, after the end of each Fiscal Quarter of the
Borrower and the Subsidiaries, beginning with the Fiscal Quarter ending
December 31, 1999, a certificate (the "Quarterly Certificate") of the chief
financial officer of the Borrower (i) stating that to the best of such
officer's knowledge, no Default has occurred and is continuing, or if a
Default has occurred and is continuing, a statement as to the nature
thereof and the action that is proposed to be taken with respect thereto,
and (ii) showing in reasonable detail the most recent Fiscal Quarter
calculations demonstrating compliance with Article X;
-35-
<PAGE>
(d) Form 10-Q Report. As soon as available, and in any event within
forty-five (45) days after the end of each Fiscal Quarter (except for the
Fiscal Quarter ending as of the end of a Fiscal Year) of the Borrower and
the Subsidiaries, beginning with the Fiscal Quarter ending March 31, 2000,
a copy of the quarterly report on Form 10-Q as filed with the Securities
and Exchange Commission, together with all exhibits, schedules and annexes
attached thereto;
(e) Projections. As soon as available, and in any event not later than
the first day of each December of each year, beginning December 1, 2000,
projections of consolidated financial statements of the Borrower and its
Subsidiaries for the upcoming Fiscal Year;
(f) Management Letters. Promptly upon receipt thereof, a copy of any
management letter or written report provided in lieu of a management letter
submitted to the Borrower or any Subsidiary by independent certified public
accountants with respect to the business, condition (financial or
otherwise), operations, prospects, or properties of the Borrower or any
Subsidiary;
(g) Notice of Litigation. Promptly after the commencement thereof,
notice of all actions, suits, and proceedings before any Governmental
Authority or arbitrator affecting the Borrower or any Subsidiary which, if
determined adversely to the Borrower or such Subsidiary, could reasonably
be expected to have a Material Adverse Effect;
(h) Notice of Default. As soon as possible and in any event within ten
(10) days after the Borrower knows of the occurrence of each Default, a
written notice setting forth the details of such Default and the action
that the Borrower has taken and proposes to take with respect thereto;
(i) ERISA Reports. Promptly after the filing or receipt thereof,
copies of all reports, including annual reports, and notices which the
Borrower or any ERISA Affiliate files with or receives from the PBGC or the
U.S. Department of Labor under ERISA; and as soon as possible and in any
event within five (5) days after the Borrower or any ERISA Affiliate knows
or has reason to know that any Reportable Event or Prohibited Transaction
has occurred with respect to any Plan or that the PBGC or the Borrower or
any Subsidiary or any ERISA Affiliate has instituted or will institute
proceedings under Title IV of ERISA to terminate any Plan, a certificate of
the chief financial officer of the Borrower setting forth the details as to
such Reportable Event or Prohibited Transaction or Plan termination and the
action that the Borrower proposes to take with respect thereto;
(j) Notice of Material Adverse Effect. As soon as possible and in any
event within ten (10) days after the Borrower knows of the occurrence
thereof, written notice of any matter that could reasonably be expected to
have a Material Adverse Effect;
-36-
<PAGE>
(k) Proxy Statements, Etc. As soon as available, one copy of each
financial statement, report, notice or proxy statement sent by the Borrower
or any Subsidiary to its stockholders generally and one copy of each
regular, periodic or special report, registration statement, or prospectus
filed by the Borrower or any Subsidiary with any securities exchange or the
Securities and Exchange Commission or any successor agency;
(l) Buy-Back Report. As soon as available, and in any event on or
before January 15, 2000, a report detailing (i) the prices and terms of all
Royalty Buy-Backs which have been completed and closed as of such date,
(ii) the amount of cash payments paid by the Borrower and the Subsidiaries
in connection with such Royalty Buy-Backs, and (iii) the amount of seller
financing received by the Borrower and the Subsidiaries in connection with
such Royalty Buy-Backs; and
(m) General Information. Promptly, such other information concerning
the Borrower or any Subsidiary as the Agent or any Lender may from time to
time reasonably request.
Section 8.2 Maintenance of Existence; Conduct of Business. The Borrower
will preserve and maintain, and will cause each Subsidiary to preserve and
maintain, its corporate (or partnership) existence and all of its leases,
privileges, licenses, permits, franchises, qualifications, and rights that are
necessary or desirable in the ordinary conduct of its business, except where the
failure to do so does not and will not have a Material Adverse Effect. The
Borrower will conduct, and will cause each Subsidiary to conduct, its business
in an orderly and efficient manner in accordance with good business practices
customary in the industry in which the Borrower and the Subsidiaries are
engaged.
Section 8.3 Maintenance of Properties. The Borrower will maintain, keep,
and preserve, and cause each Subsidiary to maintain, keep, and preserve, all of
its properties (tangible and intangible) necessary or useful in the proper
conduct of its business in good working order and condition (ordinary wear and
tear excepted), except where the failure to do so does not and will not have a
Material Adverse Effect.
Section 8.4 Taxes and Claims. The Borrower will pay or discharge, and will
cause each Subsidiary to pay or discharge, at or before maturity or before
becoming delinquent (a) all taxes, levies, assessments, and governmental charges
imposed on it or its income or profits or any of its property, and (b) all
lawful claims for labor, material, and supplies, which, if unpaid, might become
a Lien upon any of its property; provided, however, that neither the Borrower
nor any Subsidiary shall be required to pay or discharge any tax, levy,
assessment, or governmental charge which is being contested in good faith by
appropriate proceedings diligently pursued, and for which adequate reserves have
been established.
Section 8.5 Insurance. The Borrower will maintain, and will cause each of
the Subsidiaries to maintain, insurance with financially sound and reputable
insurance companies in such amounts and covering such risks as is usually
carried by corporations engaged in similar businesses and owning similar
properties in the same general areas in which the Borrower and the Subsidiaries
operate, provided that in any event the Borrower will maintain and cause each
Subsidiary to maintain workmen's compensation insurance, property insurance,
comprehensive general liability insurance and products liability insurance,
satisfactory to the Agent.
-37-
<PAGE>
Section 8.6 Inspection Rights. At any time and from time to time, the
Borrower will permit, and will cause each Subsidiary to permit, representatives
of the Agent and each Lender to examine, copy, and make extracts from its books
and records, and, upon reasonable notice so long as no Default has occurred and
is continuing, to visit and inspect its properties, and to discuss its business,
operations, and financial condition with its officers, employees, and
independent certified public accountants.
Section 8.7 Keeping Books and Records. The Borrower will maintain, and will
cause each Subsidiary to maintain, proper books of record and account in which
full, true, and correct entries in conformity with GAAP shall be made of all
dealings and transactions in relation to its business and activities.
Section 8.8 Compliance with Laws. The Borrower will comply, and will cause
each Subsidiary to comply, in all material respects with all applicable laws,
rules, regulations, orders, and decrees of any Governmental Authority or
arbitrator.
Section 8.9 Compliance with Agreements. The Borrower will comply, and will
cause each Subsidiary to comply, in all material respects with all agreements,
contracts, and instruments binding on it or affecting its properties or
business.
Section 8.10 Further Assurances; Subsidiary Guaranty, Subsidiary Pledge
Agreement, Subsidiary Security Agreement and Contribution and Indemnification
Agreement. The Borrower will, and will cause each Subsidiary to, execute and
deliver such further agreements and instruments and take such further action as
may be reasonably requested by the Agent to carry out the provisions and
purposes of this Agreement and the other Loan Documents. Without limiting the
foregoing, upon the creation or acquisition of any Subsidiary, the Borrower
shall (a) provide written notice of such event to the Agent within five (5)
Business Days following the date the Borrower has knowledge thereof and (b)
cause each such wholly-owned, Domestic Subsidiary (hereinafter defined) to
execute and deliver supplements to the Guaranty, the Subsidiary Pledge
Agreement, the Subsidiary Security Agreement, the Contribution and
Indemnification Agreement, and such other documentation as the Agent may request
to cause such wholly-owned, Domestic Subsidiary to evidence or otherwise
implement the pledge of Collateral for, and the guaranty of, the Obligations
contemplated by the Guaranty, the Subsidiary Pledge Agreement, the Subsidiary
Security Agreement, or the Contribution and Indemnification Agreement within
thirty (30) calendar days following the date the Borrower has knowledge thereof.
If any Subsidiary is created or acquired after the date hereof, the Borrower
shall execute and deliver to the Agent (a) an amendment to Schedule 7.14 to this
Agreement (which only needs the signature of the Agent to be effective if the
only change is the addition of the new Subsidiary), (b) the Borrower shall
execute and deliver to the Agent an amendment to the Borrower Pledge Agreement
pledging as Collateral thereunder (1) all the stock of or other ownership
interests in the new Subsidiary owned by Borrower if the Subsidiary is directly
owned by the Borrower and is domestically organized ("Domestic Subsidiary") and
(2) all, but not more than sixty-six percent (66%) of the total outstanding
stock of or other ownership interests in the new Subsidiary owned by Borrower if
the Subsidiary is directly owned by the Borrower and is not domestically
organized ("Foreign Subsidiary"), (c) the then existing Subsidiaries shall
execute and deliver to the Agent an amendment to the Subsidiary Pledge Agreement
pledging as Collateral thereunder (1) all the stock of or other ownership
interests in the new Subsidiary owned by the then existing Subsidiaries if such
new Subsidiary is directly owned by any other Subsidiary and is a Domestic
Subsidiary and (2) all, but not more than sixty-six percent (66%) of the total
outstanding stock of or other ownership interests in the new Subsidiary owned by
the then existing Subsidiaries if such new Subsidiary is a Foreign Subsidiary,
(d) the Borrower and the then existing Subsidiaries shall deliver the
certificates representing such stock or other ownership interests in the new
Subsidiary to the Agent together with undated stock or other powers duly
executed in blank, and (e) any other documents which would have otherwise been
required to be delivered to the Agent, the Issuing Bank and the Lenders if such
Subsidiary had been a Subsidiary as of the date hereof.
-38-
<PAGE>
Section 8.11 ERISA. The Borrower will comply, and will cause each
Subsidiary and each ERISA Affiliate to comply, with all minimum funding
requirements, and all other material requirements of ERISA, if applicable, so as
not to give rise to any liability thereunder which could reasonably be expected
to have a Material Adverse Effect.
Section 8.12 Year 2000 Compliance. Borrower shall and shall cause each
Subsidiary to, perform all acts reasonably necessary to ensure that (i) Borrower
and each Subsidiary and any business in which Borrower or a Subsidiary holds a
substantial interest, and (ii) all customers, suppliers and vendors that are
material to Borrower's and each Subsidiary's business, become Year 2000
Compliant in a timely manner. Such acts shall include, without limitation,
performing a comprehensive review and assessment of all of Borrower's and each
Subsidiary's systems and adopting a detailed plan, for the remediation,
monitoring and testing of such systems. As used in this paragraph, "Year 2000
Compliant" shall mean, in regard to any entity, that all software, hardware,
firmware, equipment, goods or systems utilized by or material to the business
operations or financial condition of such entity, will properly perform date
sensitive functions before, during and after the year 2000. Borrower shall,
immediately upon request, provide to the Agent such certifications or other
evidence of Borrower's and each Subsidiary's compliance with the terms of this
paragraph as the Agent may from time to time require.
ARTICLE IX
Negative Covenants
The Borrower covenants and agrees that, as long as the Obligations or any
part thereof are outstanding or any Lender has any Commitment hereunder, the
Borrower will perform and observe the following negative covenants:
-39-
<PAGE>
Section 9.1 Debt. The Borrower will not incur, create, assume, or permit to
exist, and will not permit any Subsidiary to incur, create, assume, or permit to
exist, any Debt, except:
(a) Debt to the Lenders and the Issuing Bank pursuant to the Loan
Documents;
(b) Debt listed on Schedule 9.1;
(c) Debt not to exceed $1,000,000 in the aggregate at any time
outstanding secured by purchase money Liens permitted by Section 9.2; and
(d) Intercompany Debt among the Borrower and the wholly-owned domestic
Subsidiaries; provided that the obligations of each obligor of such Debt
shall be subordinated in right of payment to the Obligations from and after
such time as any portion of the Obligations shall become due and payable
(whether at stated maturity, by acceleration or otherwise) and shall have
such other terms and provisions as the Agent may reasonably require.
Section 9.2 Limitation on Liens. The Borrower will not incur, create,
assume, or permit to exist, and will not permit any Subsidiary to incur, create,
assume, or permit to exist, any Lien upon any of its property, assets, or
revenues, whether now owned or hereafter acquired, except:
(a) Liens disclosed on Schedule 9.2 hereto and Liens in favor of the
Agent for the benefit of the Agent, the Issuing Bank and the Lenders
pursuant to the Loan Documents;
(b) Liens for taxes, assessments, or other governmental charges which
are not delinquent or which are being contested in good faith and for which
adequate reserves have been established;
(c) Liens of mechanics, materialmen, warehousemen, carriers, landlords
or other similar statutory Liens securing obligations that are not yet due
and are incurred in the ordinary course of business;
(d) Liens resulting from good faith deposits to secure payments of
workmen's compensation or other social security programs or to secure the
performance of tenders, statutory obligations, surety and appeal bonds,
bids, contracts (other than for payment of Debt), or leases made in the
ordinary course of business;
(e) Purchase money Liens securing Permitted Debt described in Section
9.1; provided that, the Debt secured by any such Lien encumbers only the
asset so purchased;
(f) Encumbrances consisting of minor easements or other restrictions
on the use of real property that do not (individually or in the aggregate)
materially affect the value of the assets encumbered thereby or materially
impair the ability of the Borrower or the Subsidiaries to use such assets
in their respective businesses, and none of which is violated in any
material respect by existing or proposed structures or land use;
-40-
<PAGE>
(g) Liens arising from filing UCC financing statements regarding
leases not prohibited by this Agreement; and
(h) Encumbrances consisting of zoning restrictions on the use of real
property that would not have a Material Adverse Effect.
Neither Borrower nor any Subsidiary shall enter into or assume any agreement
(other than the Loan Documents) prohibiting the creation or assumption of any
Lien upon its properties or assets whether now owned or hereafter acquired;
provided that in connection with the creation of purchase money Liens permitted
hereby, the Borrower or the Subsidiary may agree that it will not permit any
other Liens to encumber the assets subject to such purchase money Lien. Further,
Borrower will not and will not permit any Subsidiaries directly or indirectly to
create or otherwise cause or suffer to exist to become effective any consensual
encumbrance or restriction of any kind on the ability of any Subsidiary to: (i)
pay dividends or make any other distribution on any of such Subsidiaries'
capital stock owned by Borrower or any Subsidiary of Borrower; (ii) subject to
subordination provisions pay any Debt owed to Borrower or any other Subsidiary;
(iii) make loans or advances to Borrower or any other Subsidiary; or (iv)
transfer any of its properties or assets to Borrower or any other Subsidiary not
restricted hereby.
Section 9.3 Mergers, Etc. The Borrower will not, and will not permit any
Subsidiary to become a party to a merger or consolidation, or to purchase or
otherwise acquire all or a substantial part of the business or assets of any
Person or any shares or other equity interest of any Person other than the new
Subsidiaries to be formed as more specifically described on Schedule 9.3
(whether or not certificated), or wind-up, dissolve, or liquidate itself;
provided that, (i) a Subsidiary may wind-up, dissolve or liquidate if no Default
exists or would result therefrom and its assets are transferred to Borrower or
another Subsidiary; (ii) any Subsidiary may merge with and into Borrower if
Borrower is the surviving entity and no Default exists or would result
therefrom; (iii) any Subsidiary may merge with and into any such Subsidiary if
such Subsidiary is the surviving entity, no Default exists or would result
therefrom and Section 8.10 is complied with; and (iv) the Borrower or a
Subsidiary may make investments permitted under Section 9.5 hereof.
Section 9.4 Restricted Payments. The Borrower will not, and will not permit
any Subsidiary, to directly or indirectly declare, order, pay, make or set apart
any sum for (a) any dividend or other distribution, direct or indirect, on
account of any shares of any class of stock or other equity interest of the
Borrower or any Subsidiary now or hereafter outstanding; (b) any redemption,
conversion, exchange, retirement, sinking fund or similar payment, purchase or
other acquisition for value, direct or indirect, of any shares of any class of
stock or other equity interest of Borrower or any Subsidiary now or hereafter
outstanding; provided however, Borrower or any Subsidiary may purchase any
shares or other equity interest of the Borrower or such Subsidiary,
respectively, in an aggregate amount not to exceed $1,000,000, so long as no
Default has occurred and is continuing or would result from such purchase; or
(c) any payment made to retire, or to obtain the surrender of, any outstanding
warrants, options or other rights to acquire shares of any class of stock or
other equity interest of the Borrower or any of the Subsidiaries now or
hereafter outstanding except that the Subsidiaries of the Borrower may make,
declare and pay dividends and make other distributions with respect to their
common stock.
-41-
<PAGE>
Section 9.5 Investments. The Borrower will not make, and will not permit
any Subsidiary to make or permit to remain outstanding, any advance, loan,
extension of credit, or capital contribution to or investment in any Person, or
purchase or own any stock, bonds, notes, debentures, or other securities of any
Person, or be or become a joint venturer with or partner of any Person, except:
(a) readily marketable direct obligations of the United States of
America or any agency thereof with maturities of one year or less from the
date of acquisition;
(b) fully insured certificates of deposit with maturities of one year
or less from the date of acquisition issued by any commercial bank
operating in the United States of America having capital and surplus in
excess of Fifty Million Dollars ($50,000,000);
(c) commercial paper of a domestic issuer if at the time of purchase
such paper is rated in one of the two highest rating categories of Standard
and Poor's Corporation or Moody's Investors Service, Inc.;
(d) investments in Subsidiaries existing on the date of this Agreement
and investments in the new Subsidiaries to be formed as more specifically
described on Schedule 9.3;
(e) loans to Schlotzsky's National Advertising Association, Inc. not
to exceed $7,000,000 in the aggregate at any time outstanding and loans to
Schlotzsky's N.A.M.F., Inc. not to exceed $500,000 in the aggregate at any
time outstanding; provided that such loans are evidenced by promissory
notes, which original promissory notes shall be endorsed and delivered to
the Agent in accordance with the Loan Documents;
(f) loans and advances to employees as more specifically described on
Schedule 9.5(f) and any additional loans to employees so long as (i) such
loans to any one employee shall not exceed $50,000 in the aggregate at any
time outstanding and (ii) the aggregate outstanding amount of all such
additional loans shall not exceed $150,000 at any time; and
(g) investments as described on Schedule 9.5(g).
Section 9.6 Limitation on Issuance of Capital Stock. The Borrower will not
permit any of its Subsidiaries to, at any time issue, sell, assign, or otherwise
dispose of (a) any of its capital stock (or any equivalent interest therein),
(b) any securities exchangeable for or convertible into or carrying any rights
to acquire any of its capital stock (or any equivalent interest therein), or (c)
any option, warrant, or other right to acquire any of its capital stock (or any
equivalent interest therein).
-42-
<PAGE>
Section 9.7 Transactions With Affiliates. The Borrower will not enter into,
and will not permit any Subsidiary to enter into, any transaction, including,
without limitation, the purchase, sale, or exchange of property or the rendering
of any service, with any Affiliate of the Borrower or such Subsidiary, except in
the ordinary course of and pursuant to the reasonable requirements of the
Borrower's or such Subsidiary's business and upon fair and reasonable terms no
less favorable to the Borrower or such Subsidiary than would be obtained in a
comparable arm's-length transaction with a Person not an Affiliate of the
Borrower or such Subsidiary, it being expressly provided that (a) compensation
granted to officers of the Borrower or such Subsidiary by the Board of Directors
or a committee thereof will not be considered a violation of this provision and
(b) the granting of a long-term license of foreign Trademarks by the Borrower or
any Subsidiary to any new Subsidiary described on Schedule 9.3 at less than an
arm's-length negotiated price will not be considered a violation of this
provision.
Section 9.8 Disposition of Assets. The Borrower will not sell, lease,
assign, transfer, or otherwise dispose (collectively "Dispositions") of any of
its assets, or permit any Subsidiary to do so with any of its assets, except for
Dispositions in the ordinary course of business, and except as described on
Schedule 9.8.
Section 9.9 Sale and Leaseback. The Borrower will not, and will not permit
any Subsidiary to, enter into any arrangement with any Person pursuant to which
it leases from such Person real or personal property that has been or is to be
sold or transferred, directly or indirectly, by it to such Person.
Section 9.10 Nature of Business. The Borrower will not, and will not permit
any Subsidiary to, engage in any business other than the businesses in which
they are engaged on the date hereof and businesses related or incidental
thereto.
Section 9.11 Environmental Protection. The Borrower will not, and will not
permit any of its Subsidiaries to, (a) use any of their respective properties or
assets for the handling, processing, storage, transportation, or disposal of any
Hazardous Material, (b) generate any Hazardous Material, (c) conduct any
activity that is likely to cause a Release or threatened Release of any
Hazardous Material, or (d) otherwise conduct any activity or use any of their
respective properties or assets, in each case described in clauses (a) through
(d) above in any manner that is likely to violate any Environmental Law or
create any Environmental Liabilities for which the Borrower or any of its
Subsidiaries would be responsible.
Section 9.12 Accounting. The Borrower will not, and will not permit any of
its Subsidiaries to, change its Fiscal Year or make any change in accounting
treatment or reporting practices, except as permitted by GAAP and disclosed to
the Agent.
-43-
<PAGE>
Section 9.13 Prepayment of Debt. Except for refinancings of any Debt
existing as of the date hereof under like or better terms, the Borrower will
not, and will not permit any Subsidiary to, prepay any Debt except the
Obligations.
ARTICLE X
Financial Covenants
The Borrower covenants and agrees that, as long as the Obligations or any
part thereof are outstanding or any Lender has any Commitment hereunder, the
Borrower will perform and observe the following financial covenants:
Section 10.1 Consolidated Working Capital. As of the last day of any Fiscal
Quarter, the Borrower will for the applicable Fiscal Quarter end indicated in
the table below maintain a Consolidated Working Capital of not less than the
amount set forth in the table below:
===================================================================
Period Minimum Consolidated
Working Capital
-------------------------------------------------------------------
Fiscal Quarter ending September 30, 1999 $12,000,000
-------------------------------------------------------------------
Fiscal Quarter ending December 31, 1999 $15,000,000
-------------------------------------------------------------------
Fiscal Quarter ending March 31, 2000 $15,000,000
-------------------------------------------------------------------
Fiscal Quarter ending June 30, 2000 $20,000,000
-------------------------------------------------------------------
Fiscal Quarter ending September 30, 2000 $25,000,000
and thereafter
===================================================================
Section 10.2 Leverage Ratio. As of the last day of any Fiscal Quarter, the
Borrower will during the periods indicated maintain a Leverage Ratio of not
greater than (a) 3.50 to 1.00 from the date hereof through and including
December 31, 1999, (b) 3.00 to 1.00 from January 1, 2000 through and including
September 30, 2000, (c) 2.75 to 1.00 from October 1, 2000 through and including
September 30, 2001, (d) 2.50 to 1.00 thereafter.
Section 10.3 Consolidated Net Worth. As of the last day of any Fiscal
Quarter, beginning with the Fiscal Quarter ending December 31, 1999, the
Borrower will maintain Consolidated Net Worth in an amount not less than (a)
Seventy-Seven Million Dollars ($77,000,000) plus (b) an amount equal to
seventy-five percent (75%) of Consolidated Net Income (not less than zero (0)
dollars [$0.00]) for the immediately preceding Fiscal Quarter.
-44-
<PAGE>
Section 10.4 Fixed Charge Coverage Ratio. As of the last day of any Fiscal
Quarter, the Borrower will during the periods indicated maintain a Fixed Charge
Coverage Ratio for the preceding four (4) Fiscal Quarters then ended of not less
than (a) 1.50 to 1.00 from the date hereof through and including September 30,
2000 and (b) thereafter 1.75 to 1.00.
Section 10.5 Capital Expenditures. Beginning January 1, 2000, Borrower will
not permit the aggregate amount of Capital Expenditures of Borrower and the
Subsidiaries to exceed Six Million Dollars ($6,000,000) during any Fiscal Year.
Section 10.6 Contingent Liabilities. Borrower will not permit at any time
the aggregate amount of Contingent Liabilities to exceed Forty-Five Million
Dollars ($45,000,000).
ARTICLE XI
Default
Section 11.1 Events of Default. Each of the following shall be deemed an
"Event of Default":
(a) The Borrower shall fail to pay (i) when due any principal payable
under any Loan Document or any part thereof, and (ii) within three (3)
Business Days of the due date any interest, fees payable or any other
Obligation under the Loan Documents or any part thereof.
(b) Any representation or warranty made or deemed made by the Borrower
or any Obligated Party (or any of their respective officers) in any Loan
Document or in any certificate, report, notice, or financial statement
furnished at any time in connection with this Agreement shall be false,
misleading, or erroneous in any material respect when made or deemed to
have been made.
(c) The Borrower shall fail to perform, observe, or comply with any
covenant, agreement, or term contained in Section 8.1, Article IX or
Article X of this Agreement; or the Borrower or any Obligated Party shall
fail to perform, observe, or comply with any other covenant, agreement or
term contained in this Agreement or any other Loan Document (other than
covenants to pay the Obligations), and such failure shall continue for a
period of fifteen (15) days.
(d) The Borrower, any Subsidiary, or any Obligated Party shall
commence a voluntary proceeding seeking liquidation, reorganization, or
other relief with respect to itself or its debts under any bankruptcy,
insolvency, or other similar law now or hereafter in effect or seeking the
appointment of a trustee, receiver, liquidator, custodian, or other similar
official of it or a substantial part of its property or shall consent to
any such relief or to the appointment of or taking possession by any such
official in an involuntary case or other proceeding commenced against it or
shall make a general assignment for the benefit of creditors or shall
generally fail to pay its debts as they become due or shall take any
corporate action to authorize any of the foregoing.
-45-
<PAGE>
(e) An involuntary proceeding shall be commenced against the Borrower,
any Subsidiary, or any Obligated Party seeking liquidation, reorganization,
or other relief with respect to it or its debts under any bankruptcy,
insolvency, or other similar law now or hereafter in effect or seeking the
appointment of a trustee, receiver, liquidator, custodian or other similar
official for it or a substantial part of its property, and such involuntary
proceeding shall remain undismissed and unstayed for a period of sixty (60)
days.
(f) The Borrower, any Subsidiary, or any Obligated Party shall fail to
discharge within a period of thirty (30) days after the commencement
thereof any attachment, sequestration, or similar proceeding or proceedings
involving an aggregate amount in excess of Two Hundred Fifty Thousand
Dollars ($250,000) against any of its assets or properties.
(g) A final judgment or judgments for the payment of money in excess
of Two Hundred Fifty Thousand Dollars ($250,000) in the aggregate shall be
rendered by a court or courts against the Borrower, any of its
Subsidiaries, or any Obligated Party and the same shall not be discharged
(or provision shall not be made for such discharge), or a stay of execution
thereof shall not be procured, within thirty (30) days from the date of
entry thereof and the Borrower or the relevant Subsidiary or Obligated
Party shall not, within said period of thirty (30) days, or such longer
period during which execution of the same shall have been stayed, appeal
therefrom and cause the execution thereof to be stayed during such appeal.
(h) The Borrower, any Subsidiary, or any Obligated Party shall fail to
pay when due any principal of or interest on any Material Debt (other than
the Obligations), or the maturity of any such Debt shall have been
accelerated, or any such Debt shall have been required to be prepaid prior
to the stated maturity thereof, or any event shall have occurred that
permits any holder or holders of such Debt or any Person acting on behalf
of such holder or holders to accelerate the maturity thereof or require any
such prepayment. For purposes of this clause (h) the term "Material Debt"
means Debt owed by the Borrower or any Subsidiary the principal amount of
which exceeds Two Hundred Fifty Thousand Dollars ($250,000).
(i) This Agreement or any other Loan Document shall cease to be in
full force and effect or shall be declared null and void or the validity or
enforceability thereof shall be contested or challenged by the Borrower,
any Subsidiary, any Obligated Party or any of their respective shareholders
(other than shareholders of the Borrower), or the Borrower or any Obligated
Party shall deny that it has any further liability or obligation under any
of the Loan Documents.
-46-
<PAGE>
(j) Any of the following events shall occur or exist with respect to
the Borrower or any ERISA Affiliate: (i) any Prohibited Transaction
involving any Plan; (ii) any Reportable Event with respect to any Plan;
(iii) the filing under Section 4041 of ERISA of a notice of intent to
terminate any Plan or the termination of any Plan; (iv) any event or
circumstance that might constitute grounds entitling the PBGC to institute
proceedings under Section 4042 of ERISA for the termination of, or for the
appointment of a trustee to administer, any Plan, or the institution by the
PBGC of any such proceedings; or (v) complete or partial withdrawal under
Section 4203, 4204 or 4205 of ERISA from a Multiemployer Plan or the
reorganization, insolvency, or termination of any Multiemployer Plan; and
in each case above, such event or condition, together with all other events
or conditions, if any, have subjected or could in the reasonable opinion of
Required Banks subject the Borrower to any tax, penalty, or other liability
to a Plan, a Multiemployer Plan, the PBGC, or otherwise (or any combination
thereof) which in the aggregate exceed or could reasonably be expected to
exceed Two Hundred Fifty Thousand Dollars ($250,000).
(k) Any Person or group of related Persons for purposes of Section
13(d) of the Exchange Act acquires after the date hereof "beneficial
ownership" (within the meaning of Section 13(d) of the Exchange Act) in
excess of thirty-three percent (33%) of the total voting power of all
classes of capital stock then outstanding of Borrower entitled (without
regard to the occurrence of any contingency) to vote in elections of
directors of Borrower.
(l) The Borrower or any of its Subsidiaries, or any of their
properties, revenues, or assets, shall become the subject of an order of
forfeiture, seizure, or divestiture (whether under RICO or otherwise) and
the same shall not have been discharged (or provisions shall not be made
for such discharge) within thirty (30) days from the date of entry thereof.
(m) Any Material Adverse Effect shall occur.
Section 11.2 Remedies.
(a) If any Event of Default shall occur and be continuing, the Agent
may (and if directed by Required Lenders, shall) do any one or more of the
following:
(i) Acceleration. Declare all outstanding principal of and
accrued and unpaid interest on the Notes, all outstanding Letter of
Credit Disbursements, and all other obligations of the Borrower under
the Loan Documents immediately due and payable, and the same shall
thereupon become immediately due and payable, without notice, demand,
presentment, notice of dishonor, notice of acceleration, notice of
intent to accelerate, protest, or other formalities of any kind, all
of which are hereby expressly waived by the Borrower.
(ii) Termination of Commitments. Terminate the Revolving Credit
Commitments and Term Loan Commitments without notice to the Borrower.
-47-
<PAGE>
(iii) Judgment. Reduce any claim to judgment.
(iv) Foreclosure. Foreclose or otherwise enforce any Lien granted
to the Agent for the benefit of itself, the Issuing Bank and the
Lenders to secure payment and performance of the Obligations in
accordance with the terms of the Loan Documents.
(v) Rights. Exercise any and all rights and remedies afforded by
the laws of the State of Texas or any other jurisdiction, by any of
the Loan Documents, by equity, or otherwise.
Provided, however, that upon the occurrence of an Event of Default
under Subsection (d) or (e) of Section 11.1, the Revolving Loan
Commitments and Term Loan Commitments of all of the Lenders shall
automatically terminate, and the outstanding principal of and accrued
and unpaid interest on the Notes and all other obligations of the
Borrower under the Loan Documents shall thereupon become immediately
due and payable without notice, demand, presentment, notice of
dishonor, notice of acceleration, notice of intent to accelerate,
protest, or other formalities of any kind, all of which are hereby
expressly waived by the Borrower.
(b) If an Event of Default shall have occurred and be continuing, each
Lender is hereby authorized at any time and from time to time, without
notice to the Borrower (any such notice being hereby expressly waived by
the Borrower), to set off and apply any and all deposits (general or
special, time or demand, provisional or final) at any time held and other
indebtedness at any time owing by such Lender to or for the credit or the
account of the Borrower against any and all of the obligations of the
Borrower now or hereafter existing under this Agreement, such Lender's
Note, or any other Loan Document, irrespective of whether or not the Agent
or such Lender shall have made any demand under this Agreement or such
Lender's Note or such other Loan Document and although such obligations may
be unmatured. Each Lender agrees promptly to notify the Borrower (with a
copy to the Agent and to each Lender) after any such setoff and
application, provided that the failure to give such notice shall not affect
the validity of such setoff and application. The rights and remedies of
each Lender hereunder are in addition to other rights and remedies
(including, without limitation, other rights of setoff) which such Lender
may have.
Section 11.3 Cash Collateral. If an Event of Default shall have occurred
and be continuing the Borrower shall, if requested by the Agent or Required
Lenders, pledge to the Agent as security for the Obligations an amount in
immediately available funds equal to the then outstanding Letter of Credit
Liabilities, such funds to be held in a cash collateral account at the Agent
without any right of withdrawal by the Borrower.
Section 11.4 Performance by the Agent. If the Borrower shall fail to
perform any covenant or agreement in accordance with the terms of the Loan
Documents, the Agent may, at the direction of Required Lenders, perform or
attempt to perform such covenant or agreement on behalf of the Borrower. In such
event, the Borrower shall, at the request of the Agent, promptly pay any amount
reasonably expended by the Agent or the Lenders in connection with such
performance or attempted performance to the Agent at the Principal Office,
together with interest thereon at the Default Rate from and including the date
of such expenditure to but excluding the date such expenditure is paid in full.
Notwithstanding the foregoing, it is expressly agreed that neither the Agent nor
any Lender shall have any liability or responsibility for the performance of any
obligation of the Borrower under this Agreement or any of the other Loan
Documents.
-48-
<PAGE>
ARTICLE XII
The Agent
Section 12.1 Appointment, Powers and Immunities. In order to expedite the
various transactions contemplated by this agreement, the Lenders and the Issuing
Bank hereby irrevocably appoint and authorize Wells Fargo Bank (Texas), National
Association to act as their Agent hereunder and under each of the other Loan
Documents. Wells Fargo Bank (Texas), National Association consents to such
appointment and agrees to perform the duties of the Agent as specified herein.
The Lenders and the Issuing Bank authorize and direct the Agent to take such
action in their name and on their behalf under the terms and provisions of the
Loan Documents and to exercise such rights and powers thereunder as are
specifically delegated to or required of the Agent for the Lenders and/or the
Issuing Bank, together with such rights and powers as are reasonably incidental
thereto. The Agent is hereby expressly authorized to act as the Agent on behalf
of itself, the other Lenders and the Issuing Bank:
(a) To receive on behalf of each of the Lenders and the Issuing Bank
any payment of principal, interest, fees or other amounts paid pursuant to
this Agreement and the Notes and to distribute to each Lender and/or the
Issuing Bank its share of all payments so received as provided in this
Agreement;
(b) To receive all documents and items to be furnished under the Loan
Documents;
(c) To act as nominee for and on behalf of the Lenders and the Issuing
Bank in and under the Loan Documents;
(d) To arrange for the means whereby the Advances are to be made
available to the Borrower;
(e) To distribute to the Lenders and the Issuing Bank information,
requests, notices, payments, prepayments, documents and other items
received from the Borrower, the other Obligated Parties, and other Persons;
-49-
<PAGE>
(f) To execute and deliver to the Borrower, the other Obligated
Parties, and other Persons, all requests, demands, approvals, notices, and
consents received from the Lenders and the Issuing Bank;
(g) To the extent permitted by the Loan Documents, to exercise on
behalf of each Lender and the Issuing Bank all rights and remedies of
Lenders and the Issuing Bank upon the occurrence of any Event of Default;
(h) To serve as liaison between the Lenders, the Issuing Bank and the
Borrower with respect to future negotiations, amendments and waivers of the
terms of this Agreement and transmittal of copies of such amendments and
waivers for signature to each Lender and the Issuing Bank;
(i) To receive signed copies of this Agreement, future amendments
hereto, waivers of any terms hereof, and related documents comprising the
Loan Documents, and provide appropriate signed or reproduction copies
thereof to each Lender, the Issuing Bank and the Borrower;
(j) To forward to each Lender and the Issuing Bank copies of all Loan
Documents and opinions furnished to Agent under this Agreement or any of
the other Loan Documents;
(k) To receive notices of Defaults, copies of which shall be forwarded
to all Lenders and the Issuing Bank, and any waivers of Defaults under this
Agreement and forward copies thereof to all Lenders and the Issuing Bank;
(l) To advise each Lender and the Issuing Bank of all notices received
or furnished by Agent hereunder;
(m) To take such other actions as may be requested by Required
Lenders; and
(n) To accept, execute, and deliver any and all security documents as
the secured party.
Neither the Agent nor any of its Affiliates, officers, directors,
employees, attorneys, or agents shall be liable to the Lenders for any action
taken or omitted to be taken by any of them hereunder or otherwise in connection
with this Agreement or any of the other Loan Documents except for its or their
own gross negligence or willful misconduct. Without limiting the generality of
the preceding sentence, the Agent (i) may treat the payee of any Note as the
holder thereof until the Agent receives written notice of the assignment or
transfer thereof signed by such payee and in form satisfactory to the Agent;
(ii) shall have no duties or responsibilities except those expressly set forth
in this Agreement and the other Loan Documents, and shall not by reason of this
Agreement or any other Loan Document be a trustee or fiduciary for any Lender or
the Issuing Bank; (iii) shall not be required to initiate any litigation or
collection proceedings hereunder or under any other Loan Document except to the
extent requested by Required Lenders; (iv) shall not be responsible to the
Lenders or the Issuing Bank for any recitals, statements, representations or
warranties contained in this Agreement or any other Loan Document, or any
certificate or other document referred to or provided for in, or received by any
of them under, this Agreement or any other Loan Document, or for the value,
validity, effectiveness, enforceability, or sufficiency of this Agreement or any
other Loan Document or any other document referred to or provided for herein or
therein or for any failure by any Person to perform any of its obligations
hereunder or thereunder; (v) may consult with legal counsel (including counsel
for the Borrower), independent public accountants, and other experts selected by
it and shall not be liable for any action taken or omitted to be taken in good
faith by it in accordance with the advice of such counsel, accountants, or
experts; and (vi) shall incur no liability under or in respect of any Loan
Document by acting upon any notice, consent, certificate, or other instrument or
writing believed by it to be genuine and signed or sent by the proper party or
parties. As to any matters not expressly provided for by this Agreement, the
Agent shall in all cases be fully protected in acting, or in refraining from
acting, hereunder in accordance with instructions signed by Required Lenders,
and such instructions of Required Lenders and any action taken or failure to act
pursuant thereto shall be binding on all of the Lenders; provided, however, that
the Agent shall not be required to take any action which exposes the Agent to
personal liability or which is contrary to this Agreement or any other Loan
Document or applicable law.
-50-
<PAGE>
Section 12.2 Rights of Agent as a Lender. With respect to its Commitments,
the Advances made by it and the Notes issued to it, Wells Fargo Bank (Texas),
National Association in its capacity as a Lender hereunder shall have the same
rights and powers hereunder as any other Lender and may exercise the same as
though it were not acting as the Agent, and the term "Lender" or "Lenders"
shall, unless the context otherwise indicates, include the Agent in its
individual capacity. The Agent and its Affiliates may (without having to account
therefor to any Lender) accept deposits from, lend money to, act as trustee
under indentures of, provide merchant banking services to, and generally engage
in any kind of business with the Borrower, any of its Subsidiaries, any other
Obligated Party, and any other Person who may do business with or own securities
of the Borrower, any Subsidiary, or any other Obligated Party, all as if it were
not acting as the Agent and without any duty to account therefor to the Lenders.
Section 12.3 Sharing of Payments, Etc. If any Lender shall obtain any
payment of any principal of or interest on any Advance made by it under this
Agreement or payment of any other obligation under the Loan Documents then owed
by the Borrower, any other Obligated Party or the LC Account Party to such
Lender, whether voluntary, involuntary, through the exercise of any right of
set-off, banker's lien, counterclaim or similar right, or otherwise, in excess
of its pro rata share (calculated (i) pursuant to Section 4.4 in respect of
letter of credit fees, and (ii) for all other of the Obligations on the basis of
the unpaid principal of and interest on the Revolving Credit Loan, the Term Loan
and LC Participations held by it), such Lender shall promptly purchase from the
other Lenders participations in the Obligations owed to them hereunder in such
amounts, and make such other adjustments from time to time as shall be necessary
to cause such purchasing Lender to share the excess payment ratably with each of
the other Lenders in accordance with its pro rata portion thereof. To such end,
all of the Lenders shall make appropriate adjustments among themselves (by the
resale of participations sold or otherwise) if all or any portion of such excess
payment is thereafter rescinded or must otherwise be restored. The Borrower
agrees, to the fullest extent it may effectively do so under applicable law,
that any Lender so purchasing a participation in the Advances and LC
Participations made by the other Lenders may exercise all rights of set-off,
banker's lien, counterclaim, or similar rights with respect to such
participation as fully as if such Lender were a direct holder of Advances to, or
Letter of Credit Disbursements for the account of, the Borrower in the amount of
such participation. Nothing contained herein shall require any Lender to
exercise any such right or shall affect the right of any Lender to exercise, and
retain the benefits of exercising, any such right with respect to any other
indebtedness or obligation of the Borrower.
-51-
<PAGE>
Section 12.4 Indemnification. THE LENDERS HEREBY AGREE TO INDEMNIFY THE
AGENT AND THE ISSUING BANK FROM AND HOLD THE AGENT AND THE ISSUING BANK HARMLESS
AGAINST (TO THE EXTENT NOT REIMBURSED UNDER SECTIONS 13.1 AND 13.2, BUT WITHOUT
LIMITING THE OBLIGATIONS OF THE BORROWER UNDER SECTIONS 13.1 AND 13.2), RATABLY
IN ACCORDANCE WITH THEIR RESPECTIVE COMMITMENTS, ANY AND ALL LIABILITIES,
OBLIGATIONS, LOSSES, DAMAGES, PENALTIES, ACTIONS, JUDGMENTS, DEFICIENCIES,
SUITS, COSTS, EXPENSES (INCLUDING REASONABLE ATTORNEYS' FEES), AND DISBURSEMENTS
OF ANY KIND OR NATURE WHATSOEVER WHICH MAY BE IMPOSED ON, INCURRED BY, OR
ASSERTED AGAINST THE AGENT AND THE ISSUING BANK IN ANY WAY RELATING TO OR
ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY ACTION TAKEN OR OMITTED TO BE
TAKEN BY THE AGENT AND THE ISSUING BANK UNDER OR IN RESPECT OF ANY OF THE LOAN
DOCUMENTS; PROVIDED, FURTHER, THAT NO LENDER SHALL BE LIABLE FOR ANY PORTION OF
THE FOREGOING TO THE EXTENT CAUSED BY THE AGENT'S OR THE ISSUING BANK'S GROSS
NEGLIGENCE OR WILLFUL MISCONDUCT. WITHOUT LIMITING ANY OTHER PROVISION OF THIS
SECTION, EACH LENDER AGREES TO REIMBURSE THE AGENT AND THE ISSUING BANK PROMPTLY
UPON DEMAND FOR ITS PRO RATA SHARE (CALCULATED ON THE BASIS OF THE COMMITMENTS)
OF ANY AND ALL OUT-OF-POCKET EXPENSES (INCLUDING REASONABLE ATTORNEYS' FEES)
INCURRED BY THE AGENT AND THE ISSUING BANK IN CONNECTION WITH THE PREPARATION,
EXECUTION, DELIVERY, ADMINISTRATION, MODIFICATION, AMENDMENT OR ENFORCEMENT
(WHETHER THROUGH NEGOTIATIONS, LEGAL PROCEEDINGS, OR OTHERWISE) OF, OR LEGAL
ADVICE IN RESPECT OF RIGHTS OR RESPONSIBILITIES UNDER, THE LOAN DOCUMENTS, TO
THE EXTENT THAT THE AGENT OR THE ISSUING BANK IS NOT REIMBURSED FOR SUCH
EXPENSES BY THE BORROWER.
Section 12.5 Independent Credit Decisions. Each Lender agrees that it has
independently and without reliance on the Agent, the Issuing Bank or any other
Lender, and based on such documents and information as it has deemed
appropriate, made its own credit analysis of the Borrower and decision to enter
into this Agreement and that it will, independently and without reliance upon
the Agent, the Issuing Bank or any other Lender, and based upon such documents
and information as it shall deem appropriate at the time, continue to make its
own analysis and decisions in taking or not taking action under this Agreement
or any of the other Loan Documents. The Agent shall not be required to keep
itself informed as to the performance or observance by the Borrower or any
Obligated Party of this Agreement or any other Loan Document or to inspect the
properties or books of the Borrower, any Obligated Party or the LC Account
Party. Except for notices, reports and other documents and information expressly
required to be furnished to the Lenders and the Issuing Bank by the Agent
hereunder or under the other Loan Documents, neither the Agent nor the Issuing
Bank shall have any duty or responsibility to provide any Lender with any credit
or other financial information concerning the affairs, financial condition or
business of the Borrower, any Obligated Party or the LC Account Party (or any of
their Affiliates) which may come into the possession of the Agent, the Issuing
Bank or any of their Affiliates.
-52-
<PAGE>
Section 12.6 Several Commitments. The Commitments and other obligations of
the Lenders under this Agreement are several. The default by any Lender in
making an Advance in accordance with its Commitment shall not relieve the other
Lenders of their obligations under this Agreement. In the event of any default
by any Lender in making any Advance, each nondefaulting Lender shall be
obligated to make its Advance but shall not be obligated to advance the amount
which the defaulting Lender was required to advance hereunder. In no event shall
any Lender be required to advance an amount or amounts which shall in the
aggregate exceed such Lender's Commitment. No Lender shall be responsible for
any act or omission of any other Lender.
Section 12.7 Successor Agent. Subject to the appointment and acceptance of
a successor Agent as provided below, the Agent may resign at any time by giving
notice thereof to the Lenders, the Issuing Bank and the Borrower and the Agent
may be removed at any time with or without cause by Required Lenders. Upon any
such resignation or removal, Required Lenders will have the right to appoint a
successor Agent. If no successor Agent shall have been so appointed by Required
Lenders and shall have accepted such appointment within thirty (30) days after
the retiring Agent's giving of notice of resignation or the Required Lenders'
removal of the retiring Agent, then the retiring Agent may, on behalf of the
Lenders and the Issuing Bank, appoint a successor Agent, which shall be a
commercial bank organized under the laws of the United States of America or any
State thereof and having combined capital and surplus of at least One Hundred
Million Dollars ($100,000,000). Upon the acceptance of its appointment as
successor Agent, such successor Agent shall thereupon succeed to and become
vested with all rights, powers, privileges, immunities, and duties of the
resigning or removed Agent, and the resigning or removed Agent shall be
discharged from its duties and obligations under this Agreement and the other
Loan Documents. After any Agent's resignation or removal as Agent, the
provisions of this Article XII shall continue in effect for its benefit in
respect of any actions taken or omitted to be taken by it while it was the
Agent. After the retiring Agent's resignation or removal hereunder as Agent,
each reference herein to a place of giving of notice or delivery to Agent shall
be deemed to refer to the principal office of the successor Agent as it may
specify to each party hereto.
-53-
<PAGE>
ARTICLE XIII
Miscellaneous
Section 13.1 Expenses. The Borrower hereby agrees to pay on demand: (a) all
reasonable costs and expenses of the Agent and the Issuing Bank in connection
with the preparation, negotiation, execution, and delivery of this Agreement and
the other Loan Documents and any and all amendments, modifications, renewals,
extensions, and supplements thereof and thereto, including, without limitation,
the reasonable fees and expenses of legal counsel for the Agent and the Issuing
Bank, (b) all costs and expenses of the Agent, the Issuing Bank and the Lenders
in connection with any Default and the enforcement of this Agreement or any
other Loan Document, including, without limitation, the fees and expenses of
legal counsel for the Agent, the Issuing Bank and the Lenders, (c) all transfer,
stamp, documentary, or other similar taxes, assessments, or charges levied by
any Governmental Authority in respect of this Agreement or any of the other Loan
Documents, (d) all costs, expenses, assessments, and other charges incurred in
connection with any filing, registration, recording, or perfection of any
security interest or Lien, if any, contemplated by this Agreement or any other
Loan Document, and (e) all other costs and expenses incurred by the Agent and
the Issuing Bank in connection with this Agreement or any other Loan Document.
Section 13.2 INDEMNIFICATION. THE BORROWER HEREBY AGREES TO INDEMNIFY THE
AGENT, THE ISSUING BANK AND EACH LENDER AND EACH AFFILIATE THEREOF AND THEIR
RESPECTIVE OFFICERS, DIRECTORS, EMPLOYEES, ATTORNEYS, AND AGENTS FROM, AND HOLD
EACH OF THEM HARMLESS AGAINST, ANY AND ALL LOSSES, LIABILITIES, CLAIMS, DAMAGES,
PENALTIES, JUDGMENTS, DISBURSEMENTS, COSTS, AND EXPENSES (INCLUDING REASONABLE
ATTORNEYS' FEES) TO WHICH ANY OF THEM MAY BECOME SUBJECT WHICH DIRECTLY OR
INDIRECTLY ARISE FROM OR RELATE TO (a) THE NEGOTIATION, EXECUTION, DELIVERY,
PERFORMANCE, ADMINISTRATION, OR ENFORCEMENT OF ANY OF THE LOAN DOCUMENTS, (b)
ANY OF THE TRANSACTIONS CONTEMPLATED BY THE LOAN DOCUMENTS, (c) ANY BREACH BY
THE BORROWER OF ANY REPRESENTATION, WARRANTY, COVENANT, OR OTHER AGREEMENT
CONTAINED IN ANY OF THE LOAN DOCUMENTS, (d) THE PRESENCE, RELEASE, THREATENED
RELEASE, DISPOSAL, REMOVAL, OR CLEANUP OF ANY HAZARDOUS MATERIAL LOCATED ON,
ABOUT, WITHIN, OR AFFECTING ANY OF THE PROPERTIES OR ASSETS OF THE BORROWER OR
ANY SUBSIDIARY, (e) THE USE OR PROPOSED USE OF THE LETTER OF CREDIT, (f) ANY AND
ALL TAXES, LEVIES, DEDUCTIONS, AND CHARGES IMPOSED ON THE ISSUING BANK OR ANY OF
THE ISSUING BANK'S CORRESPONDENTS IN RESPECT OF THE LETTER OF CREDIT, OR (g) ANY
INVESTIGATION, LITIGATION, OR OTHER PROCEEDING, INCLUDING, WITHOUT LIMITATION,
ANY THREATENED INVESTIGATION, LITIGATION, OR OTHER PROCEEDING RELATING TO ANY OF
THE FOREGOING AND ANY LEGAL PROCEEDING RELATING TO ANY COURT ORDER, INJUNCTION
OR OTHER PROCESS OR DECREE RESTRAINING OR SEEKING TO RESTRAIN THE ISSUING BANK
FROM PAYING ANY AMOUNT UNDER THE LETTER OF CREDIT. WITHOUT LIMITING ANY
PROVISION OF THIS AGREEMENT OR OF ANY OTHER LOAN DOCUMENT, IT IS THE EXPRESS
INTENTION OF THE PARTIES HERETO THAT EACH PERSON TO BE INDEMNIFIED UNDER THIS
SECTION SHALL BE INDEMNIFIED FROM AND HELD HARMLESS AGAINST ANY AND ALL LOSSES,
LIABILITIES, CLAIMS, DAMAGES, PENALTIES, JUDGMENTS, DISBURSEMENTS, COSTS, AND
EXPENSES (INCLUDING REASONABLE ATTORNEYS' FEES) ARISING OUT OF OR RESULTING FROM
THE SOLE OR CONTRIBUTORY NEGLIGENCE OF SUCH PERSON; PROVIDED HOWEVER, NO PERSON
SHALL BE INDEMNIFIED HEREUNDER FOR ITS OWN GROSS NEGLIGENCE OR WILLFUL
MISCONDUCT.
-54-
<PAGE>
Section 13.3 Limitation of Liability. None of the Agent, the Issuing Bank,
any Lender, or any Affiliate, officer, director, employee, attorney, or agent
thereof shall have any liability with respect to, and the Borrower hereby
waives, releases, and agrees not to sue any of them upon, any claim for any
special, indirect, incidental, or consequential damages suffered or incurred by
the Borrower in connection with, arising out of, or in any way related to, this
Agreement or any of the other Loan Documents, or any of the transactions
contemplated by this Agreement or any of the other Loan Documents.
Section 13.4 No Duty. All attorneys, accountants, appraisers, and other
professional Persons and consultants retained by the Agent, the Issuing Bank and
the Lenders shall have the right to act exclusively in the interest of the
Agent, the Issuing Bank and the Lenders and shall have no duty of disclosure,
duty of loyalty, duty of care, or other duty or obligation of any type or nature
whatsoever to the Borrower or any of the Borrower's shareholders or any other
Person.
Section 13.5 No Fiduciary Relationship. The relationship between the
Borrower and each of the Issuing Bank and the Lenders is solely that of debtor
and creditor, and neither the Agent, the Issuing Bank nor any Lender has any
fiduciary or other special relationship with the Borrower, and no term or
condition of any of the Loan Documents shall be construed so as to deem the
relationship between the Borrower and any of the Issuing Bank and the Lenders to
be other than that of debtor and creditor.
Section 13.6 Equitable Relief. The Borrower recognizes that in the event
the Borrower fails to pay, perform, observe, or discharge any or all of the
Obligations, any remedy at law may prove to be inadequate relief to the Agent,
the Issuing Bank and the Lenders. The Borrower therefore agrees that the Agent,
the Issuing Bank and the Lenders, if the Agent, the Issuing Bank or the Lenders
so request, shall be entitled to temporary and permanent injunctive relief in
any such case without the necessity of proving actual damages.
Section 13.7 No Waiver; Cumulative Remedies. No failure on the part of the
Agent, the Issuing Bank or any Lender to exercise and no delay in exercising,
and no course of dealing with respect to, any right, power, or privilege under
this Agreement shall operate as a waiver thereof, nor shall any single or
partial exercise of any right, power, or privilege under this Agreement preclude
any other or further exercise thereof or the exercise of any other right, power,
or privilege. The rights and remedies provided for in this Agreement and the
other Loan Documents are cumulative and not exclusive of any rights and remedies
provided by law.
-55-
<PAGE>
Section 13.8 Successors and Assigns.
(a) This Agreement shall be binding upon and inure to the benefit of
the parties hereto and their respective successors and assigns. The
Borrower may not assign or transfer any of its rights or obligations
hereunder without the prior written consent of the Agent, the Issuing Bank
and all of the Lenders. Any Lender may sell participations to one or more
banks or other institutions in or to all or a portion of its rights and
obligations under this Agreement and the other Loan Documents (including,
without limitation, all or a portion of its Commitments and the Advances
owing to it and the LC Participations held by it); provided, however, that
(i) such Lender's obligations under this Agreement and the other Loan
Documents (including, without limitation, its Commitments) shall remain
unchanged, (ii) such Lender shall remain solely responsible to the Borrower
for the performance of such obligations, (iii) such Lender shall remain the
holder of its Notes and LC Participations for all purposes of this
Agreement, (iv) the Borrower shall continue to deal solely and directly
with such Lender in connection with such Lender's rights and obligations
under this Agreement and the other Loan Documents, and (v) such Lender
shall not sell a participation that conveys to the participant the right to
vote or give or withhold consents under this Agreement or any other Loan
Document, other than the right to vote upon or consent to (A) any increase
of such Lender's Commitments, (B) any reduction of the principal amount of,
or interest to be paid on, the Advances and LC Participations of such
Lender, (C) any reduction of any commitment fee or other amount payable to
such Lender under any Loan Document, or (D) any postponement of any date
for the payment of any amount payable in respect of the Advances or LC
Participations of such Lender.
(b) The Borrower and each of the Issuing Bank and the Lenders agree
that any Lender (the "Assigning Lender") may at any time assign to one or
more Eligible Assignees all, or a proportionate part of all, of its rights
and obligations under this Agreement and the other Loan Documents
(including, without limitation, its Commitments and Advances and LC
Participations) (each an "Assignee"); provided, however, that (i) each such
assignment shall be of a consistent, and not a varying, percentage of all
of the Assigning Lender's rights and obligations under this Agreement and
the other Loan Documents, (ii) except in the case of an assignment of all
of a Lender's rights and obligations under this Agreement and the other
Loan Documents, the amount of the Commitments of the Assigning Lender being
assigned pursuant to each assignment (determined as of the date of the
Assignment and Acceptance with respect to such assignment) shall in no
event be less than Three Million Dollars ($3,000,000), and (iii) the
parties to each such assignment shall execute and deliver to the Agent for
its acceptance and recording in the Register, an Assignment and Acceptance,
together with the Note subject to such assignment, and a processing and
recordation fee of Three Thousand Dollars ($3,000). Upon such execution,
delivery, acceptance, and recording, from and after the effective date
specified in each Assignment and Acceptance, which effective date shall be
at least five (5) Business Days after the execution thereof, or, if so
specified in such Assignment and Acceptance, the date of acceptance thereof
by the Agent, (x) the assignee thereunder shall be a party hereto as a
"Lender" and, to the extent that rights and obligations hereunder have been
assigned to it pursuant to such Assignment and Acceptance, have the rights
and obligations of a Lender hereunder and under the Loan Documents and (y)
the Assigning Lender shall, to the extent that rights and obligations
hereunder have been assigned by it pursuant to such Assignment and
Acceptance, relinquish its rights and be released from its obligations
under this Agreement and the other Loan Documents (and, in the case of an
Assignment and Acceptance covering all or the remaining portion of an
Assigning Lender's rights and obligations under the Loan Documents, such
Assigning Lender shall cease to be a party thereto).
-56-
<PAGE>
(c) By executing and delivering an Assignment and Acceptance, the
Assigning Lender and the Assignee thereunder confirm to and agree with each
other and the other parties hereto as follows: (i) other than as provided
in such Assignment and Acceptance, such Assigning Lender makes no
representation or warranty and assumes no responsibility with respect to
any statements, warranties, or representations made in or in connection
with the Loan Documents or the execution, legality, validity, and
enforceability, genuineness, sufficiency, or value of the Loan Documents or
any other instrument or document furnished pursuant thereto; (ii) such
Assigning Lender makes no representation or warranty and assures no
responsibility with respect to the financial condition of the Borrower, any
Obligated Party or the LC Account Party or the performance or observance by
the Borrower or any Obligated Party of its obligations under the Loan
Documents; (iii) such assignee confirms that it has received a copy of the
other Loan Documents, together with copies of the financial statements
referred to in Section 7.2 and such other documents and information as it
has deemed appropriate to make its own credit analysis and decision to
enter into such Assignment and Acceptance; (iv) such assignee will,
independently and without reliance upon the Agent, the Issuing Bank or any
Lender and based on such documents and information as it shall deem
appropriate at the time, continue to make its own credit decisions in
taking or not taking action under this Agreement and the other Loan
Documents; (v) such assignee confirms that it is an Eligible Assignee; (vi)
such assignee appoints and authorizes the Agent to take such action as
agent on its behalf and exercise such powers under the Loan Documents are
as delegated to the Agent by the terms thereof, together with such powers
as are reasonably incidental thereto; and (vii) such assignee agrees that
it will perform in accordance with their terms all of the obligations which
by the terms of the Loan Documents are required to be performed by it as a
Lender.
(d) The Agent shall maintain at its Principal Office a copy of each
Assignment and Acceptance delivered to and accepted by it and a register
for the recordation of the names and addresses of the Lenders and the
Commitments of, and principal amount of the Advances owing to, and LC
Participations held by, each Lender from time to time (the "Register"). The
entries in the Register shall be conclusive and binding for all purposes,
absent manifest error, and the Borrower, the Agent, the Issuing Bank and
the Lenders may treat each Person whose name is recorded in the Register as
a Lender hereunder for all purposes under the Loan Documents. The Register
shall be available for inspection by the Borrower, any Lender or the
Issuing Bank at any reasonable time and from time to time upon reasonable
prior notice.
-57-
<PAGE>
(e) Upon its receipt of an Assignment and Acceptance executed by an
assigning Lender and assignee representing that it is an Eligible Assignee,
together with any Notes subject to such assignment, the Agent shall, if
such Assignment and Acceptance has been completed and is in substantially
the form of Exhibit E hereto, (i) accept such Assignment and Acceptance,
(ii) record the information contained therein in the Register, and (iii)
give prompt written notice thereof to the Borrower. Within five (5)
Business Days after its receipt of such notice, the Borrower, at its
expense, shall execute and deliver to the Agent in exchange for the
surrendered Notes, new Notes to the order of such Eligible Assignee in an
amount equal to the Commitments assumed by it pursuant to such Assignment
and Acceptance and, if the assigning Lender has retained a Commitment, a
new Note (or Notes) to the order of the assigning Lender in an amount equal
to the Commitments retained by it hereunder (each such promissory note
shall constitute a "Note" for purposes of the Loan Documents). Such new
Notes shall be in an aggregate principal amount of the surrendered Notes,
shall be dated the effective date of such Assignment and Acceptance, and
shall otherwise be in substantially the form of Exhibits A-1 and A-2
hereto.
(f) Any Lender may, in connection with any assignment or participation
or proposed assignment or participation pursuant to this Section, disclose
to the assignee or participant or proposed assignee or participant, any
information relating to the Borrower, its Subsidiaries or the LC Account
Party furnished to such Lender by or on behalf of the Borrower, its
Subsidiaries or the LC Account Party.
Section 13.9 Survival. All representations and warranties made in this
Agreement or any other Loan Document or in any document, statement, or
certificate furnished in connection with this Agreement shall survive the
execution and delivery of this Agreement and the other Loan Documents, and no
investigation by the Agent, the Issuing Bank or any Lender or any closing shall
affect the representations and warranties or the right of the Agent, the Issuing
Bank or any Lender to rely upon them. Without prejudice to the survival of any
other obligation of the Borrower hereunder, the obligations of the Borrower
under Article V and Sections 13.1 and 13.2 shall survive repayment of the Notes
and termination of the Commitments and the Letter of Credit.
Section 13.10 Amendments, Etc. No amendment or waiver of any provision of
this Agreement, the Notes, or any other Loan Document to which the Borrower or
any Obligated Party is a party, nor any consent to any departure by the Borrower
or Obligated Party therefrom, shall in any event be effective unless the same
shall be agreed or consented to by Required Lenders and the Borrower or the
Obligated Party, as applicable, and each such waiver or consent shall be
effective only in the specific instance and for the specific purpose for which
given; provided, that no amendment, waiver, or consent shall, unless in writing
and signed by all of the Lenders and the Borrower, do any of the following: (a)
increase Commitments of the Lenders or subject the Lenders to any additional
obligations; (b) reduce the principal of, or interest on, the Notes or any fees
or other amounts payable hereunder; (c) postpone any date fixed for any payment
of principal of, or interest on, the Notes or Letter of Credit Disbursements or
any fees or other amounts payable hereunder; (d) waive any of the conditions
specified in Article VI; (e) change the percentage of the Commitments or of the
aggregate unpaid principal amount of the Notes or Letter of Credit Liabilities
or the number of Lenders which shall be required for the Lenders or any of them
to take any action under this Agreement; (f) change any provision contained in
this Section 13.10; (g) release the Borrower from any of its obligations under
this Agreement or the other Loan Documents or release any Guarantor from its
obligations under its Guaranty and (h) release any Collateral. Notwithstanding
anything to the contrary contained in this Section, no amendment, waiver, or
consent shall be made (a) with respect to Article XII hereof without the prior
written consent of the Agent, or (b) with respect to Article IV hereof without
the prior written consent of the Issuing Bank.
-58-
<PAGE>
Section 13.11 Maximum Interest Rate. No provision of this Agreement or of
any other Loan Document shall require the payment or the collection of interest
in excess of the maximum amount permitted by applicable law. If any excess of
interest in such respect is hereby provided for, or shall be adjudicated to be
so provided, in any Loan Document or otherwise in connection with this loan
transaction, the provisions of this Section shall govern and prevail and neither
the Borrower nor the sureties, guarantors, successors, or assigns of the
Borrower shall be obligated to pay the excess amount of such interest or any
other excess sum paid for the use, forbearance, or detention of sums loaned
pursuant hereto. In the event any Lender ever receives, collects, or applies as
interest any such sum, such amount which would be in excess of the maximum
amount permitted by applicable law shall be applied as a payment and reduction
of the principal of the indebtedness evidenced by the Notes and the LC
Participations; and, if the principal of the Notes and the LC Participations has
been paid in full, any remaining excess shall forthwith be paid to the Borrower.
In determining whether or not the interest paid or payable exceeds the Maximum
Rate, the Borrower and each Lender shall, to the extent permitted by applicable
law, (a) characterize any non-principal payment as an expense, fee, or premium
rather than as interest, (b) exclude voluntary prepayments and the effects
thereof, and (c) amortize, prorate, allocate, and spread in equal or unequal
parts the total amount of interest throughout the entire contemplated term of
the indebtedness evidenced by the Notes and LC Participations so that interest
for the entire term does not exceed the Maximum Rate.
Section 13.12 Notices. All notices and other communications provided for in
this Agreement and the other Loan Documents to which the Borrower is a party
shall be given or made by telex, telegraph, telecopy, cable, or in writing and
telexed, telecopied, telegraphed, cabled, mailed by certified mail return
receipt requested, or delivered to the intended recipient at the "Address for
Notices" specified below its name on the signature pages hereof, or, as to any
party at such other address as shall be designated by such party in a notice to
each other party given in accordance with this Section. Except as otherwise
provided in this Agreement, all such communications shall be deemed to have been
duly given when transmitted by telex or telecopy, subject to telephone
confirmation of receipt, or delivered to the telegraph or cable office, subject
to telephone confirmation of receipt, or when personally delivered or, in the
case of a mailed notice, when duly deposited in the mails, in each case given or
addressed as aforesaid; provided, however, notices to the Agent pursuant to
Article II and to the Issuing Bank pursuant to Article IV shall not be effective
until received by the Agent or the Issuing Bank, as applicable.
-59-
<PAGE>
Section 13.13 Governing Law; Venue; Service of Process. This Agreement
shall be governed by and construed in accordance with the laws of the State of
Texas and the applicable laws of the United States of America. This Agreement
has been entered into in Travis County, Texas, and it shall be performable for
all purposes in Travis County, Texas. Subject to Section 13.14, any action or
proceeding against the Borrower under or in connection with any of the Loan
Documents may be brought in any state or federal court in Travis County, Texas.
The Borrower hereby irrevocably (a) submits to the nonexclusive jurisdiction of
such courts, and (b) waives any objection it may now or hereafter have as to the
venue of any such action or proceeding brought in any such court or that any
such court is an inconvenient forum. The Borrower agrees that service of process
upon it may be made by certified or registered mail, return receipt requested,
at its address specified or determined in accordance with the provisions of
Section 13.12. Nothing herein or in any of the other Loan Documents shall affect
the right of the Agent, the Issuing Bank or any Lender to serve process in any
other manner permitted by law or shall limit the right of the Agent, the Issuing
Bank or any Lender to bring any action or proceeding against the Borrower or
with respect to any of its property in courts in other jurisdictions. Subject to
Section 13.14, any action or proceeding by the Borrower against the Agent, the
Issuing Bank or any Lender shall be brought only in a court located in Travis
County, Texas.
Section 13.14 Binding 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 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.
ss.91 or any similar applicable state law.
-60-
<PAGE>
(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 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.
-61-
<PAGE>
(f) Miscellaneous. To the maximum extent practicable, the AAA, the
arbitrators and the parties shall take all action required to conclude any
arbitration proceedings 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 regulations, 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 provisions 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.
Section 13.15 Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
Section 13.16 Severability. Any provision of this Agreement held by a court
of competent jurisdiction to be invalid or unenforceable shall not impair or
invalidate the remainder of this Agreement and the effect thereof shall be
confined to the provision held to be invalid or illegal.
Section 13.17 Headings. The headings, captions, and arrangements used in
this Agreement are for convenience only and shall not affect the interpretation
of this Agreement.
Section 13.18 Non-Application of Chapter 346 of Texas Credit Finance Code.
The provisions of Chapter 346 of the Texas Finance Code (Vernon's Texas Civil
Statutes) are specifically declared by the parties hereto not to be applicable
to this Agreement or any of the other Loan Documents or to the transactions
contemplated hereby.
Section 13.19 Construction. The Borrower, the Agent, the Issuing Bank and
each Lender acknowledges that each of them has had the benefit of legal counsel
of its own choice and has been afforded an opportunity to review this Agreement
and the other Loan Documents with its legal counsel and that this Agreement and
the other Loan Documents shall be construed as if jointly drafted by the parties
hereto.
-62-
<PAGE>
Section 13.20 Independence of Covenants. All covenants hereunder shall be
given independent effect so that if a particular action or condition is not
permitted by any of such covenants, the fact that it would be permitted by an
exception to, or be otherwise within the limitations of, another covenant shall
not avoid the occurrence of a Default if such action is taken or such condition
exists.
Section 13.21 Confidentiality. The Agent and each Lender (each, a "Lending
Party") agrees to keep confidential any information furnished or made available
to it by the Borrower pursuant to this Agreement that is marked confidential;
provided that nothing herein shall prevent any Lending Party from disclosing
such information (a) to any other Lending Party or any affiliate of any Lending
Party, or any officer, director, employee, agent, or advisor of any Lending
Party or affiliate of any Lending Party, (b) to any other Person if reasonably
incidental to the administration of the credit facility provided herein, (c) as
required by any law, rule, or regulation, (d) upon the order of any court or
administrative agency, (e) upon the request or demand of any regulatory agency
or authority, (f) that is or becomes available to the public or that is or
becomes available to any Lending Party other than as a result of a disclosure by
any Lending Party prohibited by this Agreement, (g) in connection with any
litigation to which such Lending Party or any of its affiliates may be a party,
(h) to the extent necessary in connection with the exercise of any remedy under
this Agreement or any other Loan Document, and (i) subject to provisions
substantially similar to those contained in this Section, to any actual or
proposed participant or assignee.
Section 13.22 WAIVER OF JURY TRIAL. TO THE FULLEST EXTENT PERMITTED BY
APPLICABLE LAW, EACH OF THE PARTIES HERETO HEREBY IRREVOCABLY AND EXPRESSLY
WAIVES ALL RIGHT TO A TRIAL BY JURY IN ANY ACTION, PROCEEDING, OR COUNTERCLAIM
(WHETHER BASED UPON CONTRACT, TORT, OR OTHERWISE) ARISING OUT OF OR RELATING TO
ANY OF THE LOAN DOCUMENTS OR THE TRANSACTIONS CONTEMPLATED THEREBY OR THE
ACTIONS OF THE AGENT, THE ISSUING BANK, OR ANY LENDER IN THE NEGOTIATION,
ADMINISTRATION, OR ENFORCEMENT THEREOF.
Section 13.23 ENTIRE AGREEMENT. THIS AGREEMENT, THE NOTES, AND THE OTHER
LOAN DOCUMENTS REFERRED TO HEREIN REPRESENT THE FINAL AGREEMENT AMONG THE
PARTIES HERETO AND MAY NOT BE CONTRADICTED OR VARIED BY EVIDENCE OF PRIOR,
CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OR DISCUSSIONS OF THE PARTIES
HERETO. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES HERETO.
[Remainder of Page Intentionally Left Blank]
-63-
<PAGE>
IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as
of the day and year first above written.
BORROWER:
SCHLOTZSKY'S, INC.
By: __________________________________
Name: ____________________________
Title: ___________________________
Address for Notices:
203 Colorado Street
Austin, Texas 78701
Fax No.: (512) 236-3740
Telephone No.: (512) 236-3600
Attention: Chief Financial Officer
AGENT, ISSUING BANK AND LENDER:
WELLS FARGO BANK (TEXAS), NATIONAL
ASSOCIATION
By: __________________________________
Keith Smith
Vice President
Address for Notices:
111 Congress Avenue, Suite 300
Austin, TX 78701
Fax No.: (512) 344-7318
Telephone No.: (512) 344-7011
Attention: Keith Smith
-64-
<PAGE>
with a copy to:
Winstead, Sechrest & Minick, P.C.
5400 Renaissance Tower
1201 Elm Street
Dallas, Texas 75270
Fax No.: (214) 745-5390
Telephone No.: (214) 745-5265
Attention: T. Randall Matthews, Esq.
OTHER LENDERS:
FROST NATIONAL BANK
By: __________________________________
Name: ____________________________
Title: ___________________________
Address for Notices:
2728 North Harwood, Suite 100
Dallas, Texas 75201
Fax No.: (214) 515-4955
Telephone No.: (214) 515-4907
Attention: Shannon Bettis
-65-
<PAGE>
TEXAS CAPITAL BANK,
NATIONAL ASSOCIATION
By: __________________________________
Name: ____________________________
Title: ___________________________
Address for Notices:
2100 McKinney Avenue, Suite 900
Dallas, Texas 75201
Fax No.: (214) 932-6604
Telephone No.: (214) 932-6675
Attention: Tim Monter
-66-
<PAGE>
INDEX TO EXHIBITS
-----------------
Exhibits: Description of Exhibit:
- --------- -----------------------
A-1 Form of Revolving Credit Note
A-2 Form of Term Note
B Advance Request Form
C Form of Guaranty
D Form of Assignment and Acceptance
E Form of Contribution and Indemnification Agreement
F Form of Borrower Pledge Agreement
G Form of Borrower Security Agreement
H Form of Subsidiary Pledge Agreement
I Form of Subsidiary Security Agreement
J Form of Existing LC Guaranty
INDEX TO SCHEDULES
------------------
Schedules: Description of Schedule:
- ---------- ------------------------
1.1(a) Commitments
1.1(b) Letter of Credit
7.14 List of Subsidiaries
9.1 Existing Debt
9.2 Existing Liens
9.3 New Subsidiaries
9.5(f) Employee Loans
9.5(g) Investments
9.8 Disposition of Assets
<PAGE>
SCHEDULE 1.1(a)
Commitments
- --------------------------------------------------------------------------------
Lender Term Commitment Revolving Credit LC
Commitment Commitment
- --------------------------------------------------------------------------------
Wells Fargo Bank (Texas), $10,000,000 $7,500,000 $2,500,000
National Association
- --------------------------------------------------------------------------------
Frost National Bank $ 6,500,000 $4,875,000 $1,625,000
- --------------------------------------------------------------------------------
Texas Capital Bank, $3,500,000 $2,625,000 $ 875,000
National Association
- --------------------------------------------------------------------------------
<PAGE>
SCHEDULE 1.1(b)
Letter of Credit
Irrevocable Letter of Credit No. NZS317942, dated February 11, 1999, as amended
on September 30, 1999, in the amount of Five Million Dollars (US $5,000,000),
issued by Wells Fargo Bank (Texas), National Association for the account of
Schlotzsky's National Advertising Association, Inc. for the benefit of Western
International Media Corporation and expiring September 30, 2000.
<PAGE>
SCHEDULE 7.14
List of Subsidiaries
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Percentage of Ownership (and,
if corporation, amount of Outstanding
Type and State of authorized, issued and Options, Warrants,
Subsidiary Organization outstanding stock) etc.
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Borrower - 100% common stock N/A
RAD Acquisition Corp. Texas corporation 1,000 authorized, issued and
outstanding shares of common
stock
- ---------------------------------------------------------------------------------------------------------------------
Borrower - 100% common stock N/A
Schlotzsky's Real Estate, Texas corporation 1,000 authorized, issued and
Inc. outstanding shares of common
stock
- ---------------------------------------------------------------------------------------------------------------------
Borrower - 100% common stock N/A
Schlotzsky's Restaurants, Texas corporation 1,000 authorized, issued and
Inc. outstanding shares of common
stock
- ---------------------------------------------------------------------------------------------------------------------
Borrower - 100% common stock N/A
DFW Restaurant Transfer Texas corporation 100,000 authorized shares of
Corp. common stock
1,000 issued and outstanding
shares of common stock
- ---------------------------------------------------------------------------------------------------------------------
Borrower - 100% common stock N/A
Schlotzsky's Brand, Inc. Texas corporation 1,000,000 authorized shares of
common stock
1,000 issued and outstanding
shares of common stock
- ---------------------------------------------------------------------------------------------------------------------
Borrower - 100% common stock N/A
Schlotzsky's Equipment Texas corporation 1,000,000 authorized shares of
Corporation common stock
1,000 issued and outstanding
shares of common stock
- ---------------------------------------------------------------------------------------------------------------------
Schlotzsky's Real Estate, Inc. - N/A
SREI Turnkey Texas limited liability 100% membership interest
Development, L.L.C. company
- ---------------------------------------------------------------------------------------------------------------------
Schlotzsky's Restaurants, Inc. - N/A
56th & 6th, Inc. Texas corporation 100% common stock
1,000 authorized, issued and
outstanding shares of common
stock
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
SCHEDULE 9.1
Existing Debt
<PAGE>
SCHEDULE 9.2
Existing Liens
<PAGE>
SCHEDULE 9.3
New Subsidiaries
<PAGE>
SCHEDULE 9.5(f)
Employee Promissory Notes
<PAGE>
SCHEDULE 9.5(g)
Investments
<PAGE>
SCHEDULE 9.8
Dispositions
<PAGE>
March 27, 2000
Board of Directors
Schlotzsky's, Inc.
As stated in Note 1 to the consolidated financial statements of Schlotzsky's,
Inc. and Subsidiaries (the "Company") for the year ended December 31, 1999,
the company changed its accounting policy for recognition of developer fees
from recognizing such fees at inception of the contract to recognizing fees
on a straight-line basis over the term of the actual or expected development
schedule within developer contracts. Management believes the newly adopted
accounting principle is preferable in the circumstances because the new
revenue recognition policy results in a better matching of revenues and
obligations related to such revenues. At your request, we have reviewed and
discussed with management the circumstances, business judgment, and planning
that formed the basis for making this change in accounting principle.
It should be recognized that professional standards have not been established
for selecting among alternative principles that exist in this area or for
evaluating the preferability of alternative accounting principles.
Accordingly, we are furnishing this letter solely for purposes of the
Company's compliance with the requirements of the Securities and Exchange
commission, and it should not be used or relied on for any other purpose.
Based on our review and discussion, we concur with management's judgement
that the newly adopted accounting principle is preferable in the
circumstances. In formulating this position, we are relying on management's
business planning and judgment, which we do not find unreasonable.
Very truly yours,
Grant Thornton, LLP
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE 21.1
SUBSIDIARIES OF THE COMPANY
State of
Name of Subsidiary Incorporation
---------------------------------------- -----------------
<S> <C> <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
8 Schlotzsky's Brands I, L.L.C. Delaware
9 Schlotzsky's Brands Products, L.P. Texas
10 RAD Acquisition Corporation Texas
</TABLE>
S-3
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our reports dated March 2, 2000, accompanying the consolidated
financial statements and schedule included in the Annual Report of
Schlotzsky's, Inc. and Subsidiaries on Form 10-K for the year ended December 31,
1999. We hereby consent to the incorporation by reference of said reports in
the Registration Statements of Schlotzsky's, Inc. on Forms S-8 (File
No. 333-57077, effective June 17, 1998 and File No. 333-37785, effective
October 14, 1997 and file No. 333-03809, effective May 15, 1996).
GRANT THORNTON LLP
Dallas, Texas
March 2, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS ON PAGES TWO AND THREE
OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 4,913,302
<SECURITIES> 0
<RECEIVABLES> 22,322,141
<ALLOWANCES> (1,838,402)
<INVENTORY> 0
<CURRENT-ASSETS> 45,785,319
<PP&E> 23,694,008
<DEPRECIATION> (3,832,588)
<TOTAL-ASSETS> 132,759,381
<CURRENT-LIABILITIES> 29,179,662
<BONDS> 0
0
0
<COMMON> 63,135
<OTHER-SE> 74,671,446
<TOTAL-LIABILITY-AND-EQUITY> 132,759,381
<SALES> 14,815,504
<TOTAL-REVENUES> 47,938,416
<CGS> 4,403,842
<TOTAL-COSTS> 41,930,754
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,246,398
<INTEREST-EXPENSE> 2,279,116
<INCOME-PRETAX> 6,871,193
<INCOME-TAX> 2,525,164
<INCOME-CONTINUING> 4,346,029
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 3,819,592
<NET-INCOME> 526,437
<EPS-BASIC> .07
<EPS-DILUTED> .07
</TABLE>
