<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2000
Commission File Number: 0-27008
SCHLOTZSKY'S, INC.
(Exact name of registrant as specified in its charter)
Texas 74-2654208
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
203 Colorado Street
Austin, Texas 78701
(address of principal executive offices)
(512) 236-3600
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
YES /X/ NO / /
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Shares Outstanding at August 1, 2000
Common Stock, no par value 7,443,342
================================================================================
<PAGE>
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets --
June 30, 2000 and December 31, 1999 2
Condensed Consolidated Statements of Operations --
Three and Six Months Ended
June 30, 2000 and June 30, 1999 3
Condensed Consolidated Statement of
Stockholders' Equity -- Six Months Ended
June 30, 2000 and Year Ended December 31, 1999 4
Condensed Consolidated Statements of
Cash Flows -- Six Months Ended
June 30, 2000 and June 30, 1999 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---------------- -----------------
(UNAUDITED)
<S> <C> <C>
Assets
Cash and cash equivalents.............................................. $ 3,588,954 $ 4,895,302
Temporary cash investments............................................. 18,000 18,000
Receivables from Turnkey Program Development........................... 80,000 51,603
Royalties receivable................................................... 1,195,609 1,306,465
Notes receivable, current portion...................................... 2,415,816 5,737,363
Real estate and restaurants held for sale, current portion............. 4,319,482 7,909,870
Turnkey notes and other receivables, current portion................... 3,027,786 8,908,286
Other receivables...................................................... 8,463,305 4,480,022
Prepaid expenses and other assets...................................... 1,479,346 1,326,405
Turnkey Program Development............................................ 4,450,030 10,130,175
Deferred Federal income tax asset, current portion..................... 2,360,022 1,021,828
---------------- -----------------
Total current assets............................................... 31,398,350 45,785,319
Property, equipment and leasehold improvements, net.................... 22,947,712 19,861,420
Real estate and restaurants held for sale, less current portion........ 7,623,254 5,985,937
Notes receivable, less current portion................................. 11,867,693 13,239,897
Notes receivable from related parties, less current portion............ 8,860,857 8,257,528
Investments and advances............................................... 1,563,948 564,446
Deferred Federal income tax asset, less current portion................ 2,246,948 1,615,959
Intangible assets, net................................................. 37,049,224 36,541,153
Other noncurrent assets................................................ 203,341 907,722
---------------- -----------------
Total assets....................................................... $ 123,761,327 $ 132,759,381
================ =================
Liabilities and Stockholders' Equity
Accounts payable-trade................................................. $ 2,010,310 $ 5,527,504
Current maturities of long-term debt................................... 32,171,246 19,455,430
Deferred revenue, current portion...................................... 598,572 1,206,206
Accrued liabilities.................................................... 3,363,756 2,990,522
---------------- -----------------
Total current liabilities.......................................... 38,143,884 29,179,662
Deferred revenue, less current portion................................. 7,536,757 7,570,095
Long-term debt, less current maturities................................ 6,093,043 21,275,043
---------------- -----------------
Total liabilities.................................................. 51,773,684 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 7,440,072 and
7,427,714 issued at June 30, 2000 and December 31, 1999, respectively 63,258 63,135
Additional paid-in capital............................................. 57,848,242 57,779,291
Retained earnings...................................................... 14,181,143 16,997,155
Treasury stock (10,000 shares) ........................................ (105,000) (105,000)
---------------- -----------------
Total stockholders' equity......................................... 71,987,643 74,734,581
---------------- -----------------
Total liabilities and stockholders' equity......................... $ 123,761,327 $ 132,759,381
================ =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
2
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------ -------------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
--------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues
Royalties.................................. $ 5,902,376 $ 5,559,690 $11,424,194 $10,573,957
Franchise fees............................. 115,000 193,333 270,850 438,333
Developer fees............................. 197,947 243,349 501,842 470,967
Restaurant sales........................... 4,688,718 3,838,564 9,090,079 6,381,611
Brand contribution......................... 1,844,993 1,601,513 3,448,451 2,802,580
Turnkey Program Development................ 38,564 159,997 658,160 830,045
Other fees and revenue..................... 312,140 318,314 782,388 614,741
--------------- -------------- --------------- ---------------
Total revenues....................... 13,099,738 11,914,760 26,175,964 22,112,234
Expenses
Service costs:
Royalties................................ 1,378,969 1,738,842 2,664,244 3,530,363
Franchise fees........................... 54,167 92,500 129,167 220,500
Restaurant operations:
Cost of sales............................ 1,363,341 1,126,487 2,630,645 1,895,057
Labor cost............................... 1,801,401 1,453,553 3,395,278 2,447,827
Operating expenses....................... 940,136 844,442 1,898,395 1,470,643
Turnkey Development costs.................. 5,421,970 975,421 6,651,616 2,011,990
General and administrative................. 6,954,334 3,676,296 10,863,115 6,532,596
Depreciation and amortization.............. 834,102 694,775 1,660,582 1,272,065
--------------- -------------- --------------- ---------------
Total expenses....................... 18,748,420 10,602,316 29,893,042 19,381,041
--------------- -------------- --------------- ---------------
Income (loss) from operations........ (5,648,682) 1,312,444 (3,717,078) 2,731,193
Other
Interest income............................ 681,229 719,024 1,444,095 1,438,047
Interest expense........................... (749,182) (570,686) (1,572,573) (831,395)
--------------- -------------- --------------- ---------------
Income (loss) before income taxes.... (5,716,635) 1,460,782 (3,845,556) 3,337,845
Provision (credit) for income taxes.......... (1,712,488) 536,837 (1,029,544) 1,226,658
Income (loss) before cumulative effect
of change in accounting principle.... (4,004,147) 923,945 (2,816,012) 2,111,187
Cumulative effect of change in
accounting principle, net of tax..... -- -- -- (3,819,592)
--------------- -------------- --------------- ---------------
Net income (loss).................... ($4,004,147) $ 923,945 ($2,816,012) ($1,708,405)
=============== ============== =============== ===============
Income (loss) per common share - basic:
Income (loss) before cumulative effect
of change in accounting principle..... ($0.54) $0.12 ($0.38) $0.29
Cumulative effect of change in
accounting principle, net of tax...... -- -- -- ($0.52)
--------------- -------------- --------------- ---------------
Net income (loss).................... ($0.54) $0.12 ($0.38) ($0.23)
=============== ============== =============== ===============
Weighted average shares outstanding........ 7,430,072 7,402,147 7,430,072 7,401,749
=============== ============== =============== ===============
Income (loss) per common share - diluted:
Income (loss) before cumulative effect
of change in accounting principle.... ($0.54) $0.12 ($0.38) $0.28
Cumulative effect of change in
accounting principle, net of tax..... -- -- -- ($0.51)
--------------- -------------- --------------- ---------------
Net income (loss).................... ($0.54) $0.12 ($0.38) ($0.23)
=============== ============== =============== ===============
Weighted average shares outstanding........ 7,430,072 7,500,782 7,430,072 7,507,653
=============== ============== =============== ===============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
3
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock
-----------------------------
Stated Additional Total
Number of Capital Paid-In Retained Treasury Stockholders
Shares Amount Capital Earnings Stock Equity
-------------- -------------- -------------- ------------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999............... 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 (loss)...................... -- -- -- 526,437 -- 526,437
-------------- -------------- -------------- ------------- ------------ ---------------
Balance, December 31, 1999............. 7,427,714 63,135 57,779,291 16,997,155 (105,000) 74,734,581
Options exercised...................... -- -- -- -- -- --
Issuance of common stock in connection
with employee stock purchase plan...... 12,358 123 68,951 -- -- 69,074
Net income (loss)...................... -- -- -- (2,816,012) -- (2,816,012)
-------------- -------------- -------------- ------------- ------------ ---------------
Balance, June 30, 2000 (unaudited)... 7,440,072 $ 63,258 $57,848,242 $14,181,143 ($105,000) $ 71,987,643
============== ============== ============== ============= ============ ===============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
4
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------------
JUNE 30, JUNE 30,
2000 1999
---------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ............................................................ ($2,816,012) ($1,708,405)
Non-cash adjustments to net income (loss):
Depreciation and amortization.............................................. 1,660,582 1,272,065
Cumulative effect of change in accounting principle, net of tax............ -- 3,819,592
Provisions for bad debt and impairment of assets........................... 5,834,462 663,934
Recognition of deferred revenue............................................ (764,281) (909,299)
Change in components of working capital.................................... (6,856,929) (14,956,874)
---------------- -----------------
Net cash provided by (used in) operating activities........................... (2,942,178) (11,818,987)
Cash flows from investing activities:
Net repayment (advances) on notes receivable ................................. 6,503,467 (3,501,622)
Acquisition of intangibles.................................................... (1,085,045) (17,553,149)
Purchase of property, equipment and leasehold improvements.................... (1,503,410) (2,730,742)
Sale (purchase) of property, equipment and leasehold improvements............. 470,332 --
Sale of temporary investments................................................. -- 1,421,077
Other......................................................................... (55,048) 900,953
---------------- -----------------
Net cash provided by (used in) investing activities........................... 4,330,296 (21,463,483)
Cash flows from financing activities:
Proceeds from issuance of long term debt...................................... 8,449,299 26,241,654
Principal payments on long term debt.......................................... (11,212,839) (5,390,028)
Proceeds from exercises of options............................................ 69,074 90,643
---------------- -----------------
Net cash provided by (used in) financing activities........................... (2,694,466) 20,942,269
---------------- -----------------
Net decrease in cash and cash equivalents..................................... (1,306,348) (12,340,202)
Cash and cash equivalents at beginning of period.............................. 4,895,302 15,384,991
---------------- -----------------
Cash and cash equivalents at end of period.................................... $3,588,954 $ 3,044,789
================ =================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
5
<PAGE>
SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the six months ended June 30, 2000, are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2000. This information should be read in connection with the
consolidated financial statements and footnotes thereto incorporated by
reference in the Schlotzsky's, Inc. Annual Report on Form 10-K for the year
ended December 31, 1999.
6
<PAGE>
NOTE 2. - EARNINGS PER SHARE
Basic and diluted EPS computations for the three months and the six
months ended June 30, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------- ----------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
-------------- ------------ --------------- ------------
<S> <C> <C> <C> <C>
BASIC EPS
Net income (loss) before cumulative effect of change
in accounting principle............................. ($4,004,147) $923,945 ($2,816,012) $2,111,187
Cumulative effect of change in accounting principle,
net of tax.......................................... -- -- -- (3,819,592)
-------------- ------------ --------------- ------------
Net income (loss)................................... ($4,004,147) $923,945 ($2,816,012) ($1,708,405)
============== ============ =============== ============
Weighted average common shares outstanding.......... 7,430,072 7,402,147 7,430,072 7,401,749
============== ============ =============== ============
Basic EPS before cumulative effect of change in
accounting principle................................ ($0.54) $0.12 ($0.38) $0.29
Cumulative effect of change in accounting principle
net of tax.......................................... -- -- -- ($0.52)
-------------- ------------ --------------- ------------
Basic EPS........................................... ($0.54) $0.12 ($0.38) ($0.23)
============== ============ =============== ============
DILUTED EPS
Net income (loss) before cumulative effect of change
in accounting principle............................. ($4,004,147) $923,945 ($2,816,012) $2,111,187
Cumulative effect of change in accounting principle,
net of tax.......................................... -- -- -- (3,819,592)
-------------- ------------ --------------- ------------
Net income (loss)................................... ($4,004,147) $923,945 ($2,816,012) ($1,708,405)
============== ============ =============== ============
Weighted average common shares outstanding.......... 7,430,072 7,402,147 7,430,072 7,401,749
Assumed conversion of common shares issuable
under stock option plan and exercise of warrants.. -- 98,635 -- 105,904
-------------- ------------ --------------- ------------
Weighted average common shares outstanding
-assuming dilution................................ 7,430,072 7,500,782 7,430,072 7,507,653
============== ============ =============== ============
Diluted EPS before cumulative effect of change in
accounting principle................................ ($0.54) $0.12 ($0.38) $0.28
Cumulative effect of change in accounting principle
net of tax.......................................... -- -- -- ($0.51)
-------------- ------------ --------------- ------------
Diluted EPS......................................... ($0.54) $0.12 ($0.38) ($0.23)
============== ============ =============== ============
</TABLE>
Outstanding options that were not included in the diluted calculation because
their effect would be anti-dilutive total 897,654 and 612,125 for the three
months ended June 30, 2000 and June 30, 1999, respectively, and 897,654 and
613,125 for the six months ended June 30, 2000 and June 30, 1999, respectively.
7
<PAGE>
NOTE 3. - SEGMENTS
The Company and its subsidiaries are principally engaged in franchising
quick service restaurants that feature made-to-order sandwiches with unique
sourdough buns, pizzas and salads. At June 30, 2000 the Schlotzsky's system
included Company owned and franchised stores in thirty-eight states, the
District of Columbia and twelve foreign countries.
The Company identifies segments based on management responsibility within
the corporate structure. The Turnkey Development segment includes the
development of freestanding stores with high visibility and easy access. The
Restaurant Operations segment includes the operation of a limited number of
Company-owned restaurants for the purposes of product development, concept
refinement, prototype testing, training and building brand awareness. The
Franchise Operations segment encompasses the franchising of stores in order to
achieve optimal success with owner-operated stores. The Company measures segment
profit as operating profit, which is defined as income before interest and
income taxes. Segment information and reconciliation to income, before interest
and income taxes, is as follows:
<TABLE>
<CAPTION>
TURNKEY RESTAURANT FRANCHISE
THREE MONTHS ENDED JUNE 30, 2000 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- --------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenue from external customers $ 38,564 $ 4,688,718 $ 8,372,456 $ 13,099,738
Operating income (loss) (5,479,294) 290,956 (460,344) (5,648,682)
Total assets $25,264,312 $30,461,665 $68,035,350 $123,761,327
TURNKEY RESTAURANT FRANCHISE
THREE MONTHS ENDED JUNE 30, 1999 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- --------------- ---------------- --------------- ---------------
Revenue from external customers $ 159,997 $ 3,838,564 $ 7,916,199 $ 11,914,760
Operating income (loss) (901,074) 187,014 2,026,504 1,312,444
Total assets $41,396,281 $ 26,544,299 $ 53,896,728 $121,837,308
TURNKEY RESTAURANT FRANCHISE
SIX MONTHS ENDED JUNE 30, 2000 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- --------------- ---------------- --------------- ---------------
Revenue from external customers $ 658,160 $ 9,090,079 $16,427,725 $ 26,175,964
Operating income (loss) (6,195,372) 592,665 1,885,629 (3,717,078)
Total assets $25,264,312 $30,461,665 $68,035,350 $ 123,761,327
TURNKEY RESTAURANT FRANCHISE
SIX MONTHS ENDED JUNE 30, 1999 DEVELOPMENT OPERATIONS OPERATIONS CONSOLIDATED
--------------------------------------------- --------------- ---------------- --------------- ---------------
Revenue from external customers $ 830,045 $ 6,381,611 $14,900,578 $ 22,112,234
Operating income (loss) (1,379,564) 172,154 3,938,603 2,731,193
Total assets $41,396,281 $26,544,299 $53,896,728 $121,837,308
</TABLE>
NOTE 4. - CHANGE IN ACCOUNTING PRINCIPLE
As discussed in the Company's Form 10-K for the year ended December 31,
1999, the Company changed its accounting policy related to revenue recognition
of developer fees. As such, the second quarter 1999 and six months ended June
30, 1999 results have been retroactively adjusted to reflect the change in
accounting principle effective January 1, 1999.
8
<PAGE>
NOTE 5. - DEBT
The Company had $38,264,289 of debt outstanding as of June 30, 2000 and
$40,730,473 as of December 31, 1999. Composition of debt at those dates is as
follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
---------------- -----------------
(UNAUDITED)
<S> <C> <C>
Type of Debt:
Term note............................................................. $ 18,000,000 $ 20,000,000
Mortgages on Company owned restaurants and equipment.................. 6,427,974 --
Credit facility....................................................... 6,205,424 15,000,000
Other obligations..................................................... 3,096,206 2,643,009
Capital leases........................................................ 2,616,685 3,087,464
Interim financing for real estate development......................... 1,918,000 --
---------------- -----------------
Total debt............................................................ 38,264,289 40,730,473
Less current maturities of long term debt............................. 32,171,246 19,455,430
---------------- -----------------
Long term debt........................................................ $ 6,093,043 $ 21,275,043
================ =================
</TABLE>
As of June 30, 2000, the Company would not have been in compliance with
certain financial covenants under its Credit Agreement, largely because of
the non-cash charge taken in the second quarter of 2000, as discussed below
in Part I. Item 2 of this form 10-Q under the heading of "Results of
Operations - Three Months Ended June 30, 2000 Compared to Three Months Ended
June 30, 1999 - Expenses." The Company has received from its lenders under
the Credit Agreement a written waiver of such covenant compliance effective
as of June 30, 2000.
The Company is currently in discussion with its lenders to amend the
covenants under the Credit Agreement to levels the Company believes it will be
able to meet in the future. The Company will use its best efforts to negotiate,
on terms acceptable to the Company, an amendment to the Credit Agreement or to
obtain replacement financing, or to obtain a further waiver of the applicable
covenants. However, there can be no assurance at this time that such amendment,
refinancing or further waiver will be obtained.
If the Company does not obtain such amendment, refinancing or further
waiver by September 30, 2000, the Company would then be in default of the Credit
Agreement and the lenders thereunder would be entitled to demand immediate
repayment of all amounts outstanding under the Credit Agreement. In addition,
through the operation of cross-default provisions, the Company would also be in
default of various other financial and contractual obligations.
As a result of the events discussed above, the entire outstanding balance of
approximately $24,205,000 under the Credit Agreement and approximately
$6,284,000 under certain mortgages has been classified on the Company's
Condensed Consolidated Balance Sheets as "current maturities of long-term
debt."
NOTE 6. - RELATED PARTY TRANSACTIONS
In addition to the related party transactions set forth in the Company's
10-K for the fiscal year ended December 31, 1999, the Company has become a
50% owner in a limited liability company that operates a
Schlotzsky's-Registered Trademark- Deli restaurant. The Company invested
approximately $1,000,000 in this company as of June 30, 2000 and has a
receivable from the company in the amount of approximately $2,174,000.
9
<PAGE>
NOTE 7. - TERMINATION OF TURNKEY PROGRAM
During the second quarter of 2000, the Company conducted a strategic
review of its business, particularly its approach to new restaurant
development. Since 1995, the Company has been focusing on the development of
larger, freestanding restaurants. This strategy has been effective in
producing growth for the Schlotzsky's-Registered Trademark- Deli system, with
an approximate 195% increase in system-wide sales and an approximate 63%
increase in average weekly sales for the 12 months ended June 30, 2000 as
compared to the year ended December 31, 1995.
The Company had implemented its Turnkey program to support this growth. The
Turnkey program identified and developed sites and constructed restaurants to be
sold to prospective franchisees. Because qualified franchisees were sometimes
not licensed or financed for these sites before construction was completed, the
Company opened and operated certain completed restaurants until they could be
financed and sold to qualified franchisees. As a result, the Company has
incurred significant investments in sites under development, real estate and
restaurants held for sale, and notes receivable for construction and permanent
mortgage financing related to these Turnkey projects. This has exposed the
Company to significant real estate development risks. In addition, the impact of
the sporadic nature of the completion of the sale and financing of the projects
contributed to volatility of the Company's earnings.
Based on this strategic review, the Company has terminated the Turnkey
program, although certain projects in process will be completed. In the
future, the Company intends to develop sites only if either the Company wants
to operate a Company-owned restaurant on the site or a qualified franchisee
has obtained third-party financing to acquire, build and open the site as a
Schlotzsky's-Registered Trademark- Deli restaurant.
Based on this significant change in restaurant development strategy, the
Company conducted a review of all Turnkey related assets to identify those which
do not qualify under the revised restaurant development strategy. The Company
decided to abandon certain pre-development sites, to reduce certain asset
valuations to the proceeds expected to be realized upon their orderly sale or
liquidation over the next twelve months, and to establish reserves for
collectibility of certain notes and accounts receivable. As a result of these
actions, a non-cash, pre-tax charge of approximately $5,340,000 has been
recorded under Turnkey Development Costs in the second quarter of 2000. This
non-cash charge consisted of the following:
- Reserves of approximately $2,468,000 were established for collectibility of
certain notes and accounts receivable primarily from highly leveraged
franchisees related to restaurants and sites that were developed by the
Company under the former Turnkey program.
- Impairment reserves of approximately $1,700,000 were recorded to reduce to
estimated fair market value the carrying value of certain restaurants and
sites which were developed under the Turnkey program and are now held for
resale by the Company.
- A charge of approximately $1,172,000 was recorded on the abandonment of
predevelopment costs incurred for certain sites in the Turnkey program
pipeline, which the Company has determined will not be developed as
Schlotzsky's-Registered Trademark- Deli restaurants.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
During the second quarter of 2000, the Company conducted a strategic
review of its business, particularly its approach to new restaurant
development. Since 1995, the Company has been focusing on the development of
larger, freestanding restaurants. This strategy has been effective in
producing growth for the Schlotzsky's-Registered Trademark- Deli system, with
an approximate 195% increase in system-wide sales and an approximate 63%
increase in average weekly sales for the 12 months ended June 30, 2000 as
compared to the year ended December 31, 1995.
The Company had implemented its Turnkey program to support this growth. The
Turnkey program identified and developed sites and constructed restaurants to be
sold to prospective franchisees. Because qualified franchisees were sometimes
not licensed or financed for these sites before construction was completed, the
Company opened and operated certain completed restaurants until they could be
financed and sold to qualified franchisees. As a result, the Company has
incurred significant investments in sites under development, real estate and
restaurants held for sale, and notes receivable for construction and permanent
mortgage financing related to these Turnkey projects. This has exposed the
Company to significant real estate development risks. In addition, the impact of
the sporadic nature of the completion of the sale and financing of the projects
contributed to volatility of the Company's earnings.
Based on this strategic review, the Company has terminated the Turnkey
program, although certain projects in process will be completed. In the
future, the Company intends to develop sites only if either the Company wants
to operate a Company-owned restaurant on the site or a qualified franchisee
has obtained third-party financing to acquire, build and open the site as a
Schlotzsky's-Registered Trademark-Deli restaurant.
Based on this significant change in restaurant development strategy, the
Company conducted a review of all Turnkey related assets to identify those which
do not qualify under the revised restaurant development strategy. The Company
decided to abandon certain pre-development sites, to reduce certain asset
valuations to the proceeds expected to be realized upon their orderly sale or
liquidation over the next twelve months, and to establish reserves for
collectibility of certain notes and accounts receivable. As a result of these
actions, a non-cash, pre-tax charge of approximately $5,340,000 has been
recorded under Turnkey Development Costs in the second quarter of 2000. Further
details of this charge are provided below under the heading "Results of
Operations--Three months ended June 30, 2000 compared to the three months
ended June 30, 1999--Expenses."
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999
REVENUES. Total revenues increased 9.9% from $11,915,000 to $13,100,000.
ROYALTIES increased 6.2% from $5,560,000 to $5,902,000. The increase was
due to an increase of 8.2% in average weekly sales, reflecting both a continued
shift to the larger restaurant format and an increase of 4.1% in same store
sales during the second quarter, partially offset by a net decrease of 14
franchised restaurants operating at the end of the quarter. The Company believes
its average weekly sales and same store sales have been positively impacted by
the national network television advertising campaign conducted during the past
twelve months.
FRANCHISE FEES decreased 40.4% from $193,000 to $115,000. The decrease was
principally a result of eleven fewer openings of franchised restaurants during
the three month period ended June 30, 2000 as compared to the same period in the
prior year. The fewer number of openings was principally the result of the
Company's increased emphasis on superior site selection for larger freestanding
restaurants with higher visibility and on more highly qualified franchisees.
DEVELOPER FEES decreased 18.5% from $243,000 to $198,000. The decrease is
largely due to the deferral of the amortization into income of deferred
developer fee revenue for certain underperforming international master
licensees.
RESTAURANT SALES increased 22.1% from $3,839,000 to $4,689,000. This
increase was principally attributable to the opening of a new restaurant in
the second quarter of 2000 and the full-period effect of three restaurants
opened or acquired during the second quarter of 1999, as well as increases of
11.7% in average weekly sales and 8.2% in same store sales for Company-owned
restaurants. As of June 30, 2000, 14 Company-owned restaurants were included
in restaurant sales.
11
<PAGE>
PRIVATE LABEL LICENSING FEES (BRAND CONTRIBUTION) increased 15.2% from
$1,602,000 to $1,845,000. This increase was principally the result of the
increasing volume of system-wide sales and growth of the licensing program in
the retail channels of distribution. The Company expects additional products may
be added to its private label program and alternative retail channels of
distribution of its products may be pursued, resulting in the potential for
further increases in licensing fees.
TURNKEY PROGRAM DEVELOPMENT revenue decreased 75.6% from $160,000 to
$39,000. This decrease was primarily attributable to a slow down of the Turnkey
program during the second quarter of 2000 while it was under review.
OTHER FEES AND REVENUE decreased 1.9% from $318,000 to $312,000.
SYSTEM PERFORMANCE. The following table reflects the changes in the
Schlotzsky's-Registered Trademark- Deli system for the three months ended
June 30, 2000 and 1999. The growth of system-wide sales (which include sales
of both franchised restaurants and Company-owned restaurants) during 1999 and
through June 30, 2000, along with the increase in the number of Company-owned
restaurants, were principally responsible for the increased Company revenues
as discussed above. Restaurant closings in the system occurred principally as
a result of franchisees deciding to close older underperforming restaurants
in strip center locations, and the Company's greater emphasis on quality,
service, cleanliness and compliance reviews.
12
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------
JUNE 30, JUNE 30,
2000 1999
----------------- ------------------
<S> <C> <C>
Units Opened
Domestic
Freestanding 6 11
Other 0 5
----------------- ------------------
Total Domestic Openings 6 16
International 1 2
----------------- ------------------
Total Openings 7 18
Units Closed (12) (15)
----------------- ------------------
Net Unit Growth (5) 3
================= ==================
System-wide Sales (in thousands) $ 110,110 $ 102,451
Increase in System-wide Sales 7.5% 18.1%
Average Weekly Sales $ 11,699 $ 10,814
Increase in Average Weekly Sales 8.2% 9.2%
Stores in Operation 745 758
Increase in Same Store Sales 4.1% 2.8%
</TABLE>
EXPENSES. ROYALTIES SERVICE COSTS decreased 20.7% from $1,739,000 to
$1,379,000 and, as a percentage of royalties, decreased from 31.3% to 23.4%.
These decreases were partly the result of the Company's assumption of 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 these territories were equivalent
to a 1% royalty rate effective October 31, 1999 and escalate to 2% by August 16,
2004, versus the previous 2.5% rate. The decreases also reflect the Company's
reacquisition and buy-down of rights to a limited number of additional area
developer territories during 1999. Area developers generally receive royalties
at the rate of 2.5% or 1.25% of the gross revenues of the restaurants in their
territories.
FRANCHISE FEES SERVICE COSTS decreased 41.9% from $93,000 to $54,000,
principally as a result of fewer franchised restaurant openings during the
three-month period ended June 30, 2000.
RESTAURANT COST OF SALES, which consists of food, beverage and paper costs,
increased 21.0% from $1,126,000 to $1,363,000, but as a percentage of restaurant
sales decreased from 29.3% to 29.1%. RESTAURANT LABOR COSTS increased 23.9% from
$1,454,000 to $1,801,000, and as a percentage of restaurant sales increased from
37.9% to 38.4% compared to the same quarter in 1999. RESTAURANT OPERATING
EXPENSES increased 11.4% from $844,000 to $940,000, but as a percentage of
restaurant sales decreased from 22.0% to 20.0% for the three months ended June
30, 2000, as compared to the corresponding period in 1999. The decreases in
restaurant cost of sales and restaurant operating expenses, as a percentage of
restaurant sales, were primarily attributable to operational efficiencies
experienced due to cost controls implemented in the management of Company-owned
restaurants. The increase in restaurant labor cost as a percentage of restaurant
sales was primarily attributable to the implementation of the Company's new
health insurance and other benefits to hourly employees in Company-owned
restaurants.
TURNKEY DEVELOPMENT COSTS increased 456.1% from $975,000 to $5,422,000.
This increase is primarily the result of the non-cash charge of $5,340,000
discussed under the heading "General" above, partially offset by a lower level
of Turnkey development activity in the quarter. This non-cash charge consisted
of the following:
- Reserves of approximately $2,468,000 were established for collectibility of
certain notes and accounts receivable primarily from highly leveraged
franchisees related to restaurants and sites that were developed by the
Company under the former Turnkey program.
- Impairment reserves of approximately $1,700,000 were recorded to reduce to
estimated fair market value the carrying value of certain restaurants and
sites which were developed under the Turnkey program and are now held for
resale by the Company.
13
<PAGE>
- A charge of approximately $1,172,000 was recorded on the abandonment of
predevelopment costs incurred for certain sites in the Turnkey program
pipeline, which the Company has determined will not be developed as
Schlotzsky's-Registered Trademark- Deli restaurants.
GENERAL AND ADMINISTRATIVE EXPENSES increased 89.2% from $3,676,000 to
$6,954,000. The increase is primarily the result of increases in reserves for
uncollectible accounts of approximately $955,000, primarily for receivables
and current and deferred royalties from financially troubled franchisees,
$542,000 for certain notes receivable from underperforming international
master licensees, $554,000 for increased salary and benefits primarily
attributable to headcount additions, and increases in other general and
administrative expenses including marketing, travel, legal and professional
expenses.
DEPRECIATION AND AMORTIZATION increased 20.0% from $695,000 to $834,000,
and as a percentage of total revenues increased from 5.8% to 6.4%. The increases
were principally due to the amortization of area developer territories and other
intangibles acquired during 1999 and the increase in the number of Company-owned
restaurants.
OTHER. INTEREST INCOME decreased 5.3% from $719,000 to $681,000. This
decrease was primarily the result of a lower level of funds outstanding in the
form of Turnkey mortgages and interim construction financing under the Turnkey
program.
INTEREST EXPENSE increased 31.2% from $571,000 to $749,000. This increase
was a result of a greater level of debt outstanding during the current period
and increases in applicable interest rates during the past year.
PROVISION (CREDIT) FOR INCOME TAXES. THE CREDIT FOR INCOME TAXES reflected
a combined federal and state effective tax rate of 30.0% for the three months
ended June 30, 2000, which was lower than the effective combined tax rate of
36.9% for the comparable period in 1999 due to certain state taxes being based
in part on factors other than income.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
REVENUES. Total revenues increased 18.4% from $22,112,000 to $26,176,000.
ROYALTIES increased 8.0% from $10,574,000 to $11,424,000. The increase was
due to an increase of 9.2% in average weekly sales, reflecting both a continued
shift to the larger restaurant format and an increase of 4.8% in same store
sales during the period, partially offset by a net decrease of 14 franchised
restaurants operating at the end of the six month period. The Company believes
its average weekly sales and same store sales have been positively impacted by
the national network television advertising campaign conducted during the past
12 months.
FRANCHISE FEES decreased 38.1% from $438,000 to $271,000. The decrease was
principally a result of 22 fewer openings of franchised restaurants during the
six month period ended June 30, 2000, as compared to the same period in the
prior year. The fewer number of openings was principally the result of the
Company's increased emphasis on superior site selection for larger freestanding
restaurants with higher visibility and on more highly qualified franchisees.
DEVELOPER FEES increased 6.6% from $471,000 to $502,000. The increase was
attributable to the sale of several developer territories in 1999, the effect of
which was largely offset by the deferral of amortization into income of deferred
developer fee revenue for certain underperforming international master
licensees. These revenues are normally amortized to income over a ten year
period.
RESTAURANT SALES increased 42.4% from $6,382,000 to $9,090,000. This
increase was principally attributable to the opening of a new restaurant in the
second quarter of 2000 and the full-period effect of 3 restaurants opened or
acquired in the first six months of 1999, as well as increases of 8.8% in
average weekly sales and 4.9% in same store sales for Company-owned restaurants.
PRIVATE LABEL LICENSING FEES (BRAND CONTRIBUTION) increased 23.0% from
$2,803,000 to $3,448,000. This increase was principally the result of the
increasing volume of system-wide sales, the growth of the licensing program in
the retail channels of distribution, and more favorable terms with certain major
suppliers.
14
<PAGE>
TURNKEY PROGRAM DEVELOPMENT revenue decreased 20.7% from $830,000 to
$658,000. This decrease was primarily attributable to a slow down of the Turnkey
program during the second quarter of 2000 while it was under review.
OTHER FEES AND REVENUE increased 27.2% from $615,000 to $782,000. The
increase is primarily a result of supplier contributions to the Company's
franchise Internet communications project.
SYSTEM PERFORMANCE. The following table reflects the changes in the
Schlotzsky's-Registered Trademark- Deli system for the six months ended June
30, 2000 and 1999. The growth of system-wide sales (which include sales of
both franchised restaurants and Company-owned restaurants) during 1999 and
through June 30, 2000, along with the increase in the number of Company-owned
restaurants, were principally responsible for the increased Company revenues
as discussed above. Restaurant closings in the system occurred principally as
a result of franchisees deciding to close older underperforming restaurants
in strip center locations and the Company's greater emphasis on quality,
service, cleanliness and compliance reviews.
15
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------------------------
JUNE 30, JUNE 30,
2000 1999
----------------- ------------------
<S> <C> <C>
Units Opened
Domestic
Freestanding 12 26
Other 1 7
----------------- ------------------
Total Domestic Openings 13 33
International 1 2
----------------- ------------------
Total Openings 14 35
Units Closed (28) (27)
----------------- ------------------
Net Unit Growth (14) 8
================= ==================
System-wide Sales (in thousands) $ 214,340 $ 194,679
194,6798
Increase in System-wide Sales 10.1% 18.1%
Average Weekly Sales $ 11,329 $ 10,371
Increase in Average Weekly Sales 9.2% 8.4%
Stores in Operation 745 758
Increase in Same Store Sales 4.8% 1.7%
</TABLE>
EXPENSES. ROYALTIES SERVICE COSTS decreased 24.5% from $3,530,000 to
$2,664,000 and, as a percentage of royalties, decreased from 33.4% to 23.3%.
These decreases were partly caused by the Company's assumption of 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 these territories were equivalent
to a 1% royalty rate effective October 31, 1999 and escalate to 2% by August 16,
2004, versus the previous 2.5% rate. The decreases also reflected the Company's
reacquisition and buy-down of rights to a limited number of area developer
territories during 1999. Area developers generally receive royalties at the rate
of 2.5% or 1.25% of the gross revenues of the restaurants in their territories.
FRANCHISE FEES COSTS decreased 41.6% from $221,000 to $129,000, principally
as a result of fewer franchised restaurant openings during the six-month period
ended June 30, 2000.
RESTAURANT COST OF SALES, which consists of food, beverage, and paper
costs, increased 38.8%, from $1,895,000 to $2,631,000, but as a percentage of
restaurant sales decreased from 29.7% to 28.9%. RESTAURANT LABOR COSTS increased
38.7% from $2,448,000 to $3,395,000, but as a percentage of restaurant sales
decreased from 38.4% to 37.3% compared to the same period in 1999. RESTAURANT
OPERATING EXPENSES increased 29.0% from $1,471,000 to $1,898,000, but as a
percentage of restaurant sales decreased from 23.0% to 20.9% for the six months
ended June 30, 2000, as compared to the corresponding period in 1999. The
decreases in restaurant cost of sales, restaurant labor cost and restaurant
operating expenses as a percentage of restaurant sales were primarily
attributable to operational efficiencies experienced due to cost controls
implemented in the management of Company-owned restaurants.
TURNKEY DEVELOPMENT COSTS increased 230.6% from $2,012,000 to $6,652,000.
This increase was primarily the result of the non-cash charge in the second
quarter of 2000 in the amount of $5,340,000. The charge is described above in
this Item 2, under the heading of "Results of Operations - Three Months Ended
June 30, 2000 Compared to Three Months Ended June 30, 1999 - Expenses."
GENERAL AND ADMINISTRATIVE EXPENSES grew 66.3% from $6,533,000 to
$10,863,000. The increase was the result of various charges and adjustments
incurred in the second quarter of 2000 (described above in this Item 2, under
the heading of "Results of Operations - Three Months Ended June 30, 2000
Compared to Three Months Ended June 30, 1999 - Expenses") and an increase in the
number of Company personnel as compared to the same period last year.
DEPRECIATION AND AMORTIZATION increased 30.6% from $1,272,000 to
$1,661,000, and as a percentage of total revenues increased from 5.8% to 6.3%.
The increases were principally due to the amortization of area developer
territories, and other intangibles acquired during 1999 and the increase in the
number of Company-owned restaurants.
16
<PAGE>
OTHER. INTEREST INCOME increased 0.4% from $1,438,000 to $1,444,000.
INTEREST EXPENSE increased 89.3% from $831,000 to $1,573,000. This
increase was a result of a greater level of debt outstanding during the
current period, primarily under the Credit Agreement executed in December
1999, and increases in applicable interest rates during the past year.
PROVISION (CREDIT) FOR INCOME TAXES. THE CREDIT FOR INCOME TAXES reflected
a combined federal and state effective tax rate of 26.8% for the six months
ended June 30, 2000, which was lower than the effective combined tax rate of
36.9% for the comparable period in 1999 due to certain state taxes being based
in part on factors other than income.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was approximately $2,942,000 for
the first six months of 2000. Accounts payable and accrued liabilities
decreased $3,144,000 primarily due to the payment of amounts outstanding at
December 31, 1999.
Net cash of $4,330,000 was provided by investing activities, primarily
consisting of payments received on interim financing loans provided by the
Company to facilitate the development of Turnkey program restaurants. Investing
outflows primarily consisted of investment in Company owned restaurants,
including the completion of a store in Austin, Texas, and loans made to the NAA
advertising entity.
Net cash of $2,694,000 was used in financing activities. This outflow
consisted of an $11,213,000 repayment of the Company's term and credit
facility obligations net of $8,449,000 in new mortgages on Company owned
restaurant facilities and equipment.
At June 30, 2000, the Company had $38,264,000 of debt outstanding.
During the six months ended June 30, 2000 the Company repaid approximately
$10,750,000 on the Credit Agreement established in December 1999. This Credit
Agreement consists of a $20 million term loan facility, which requires
payment ratably through December 2005, a revolving credit facility, in the
maximum amount of $15 million originally with scheduled reduction to the
approximate $6.2 million outstanding as of June 30, 2000, which expires on
September 30, 2000, and a $5 million stand by letter of credit facility. The
Company intends to fund repayment of the revolving credit facility largely
through long-term mortgages taken against wholly owned Company restaurants.
During the six months ended June 30, 2000 the company had repaid $8,749,000
on the revolving credit facility through financing of Company-owned
restaurants. Additionally, $463,000 was paid against mortgages and various
other notes owed by the Company.
As of June 30, 2000, the Company would not have been in compliance with
certain financial covenants under its Credit Agreement, largely because of the
non-cash charge taken in the second quarter of 2000, as discussed above in this
Item 2 under the heading of "Results of Operations - Three Months Ended June 30,
2000 Compared to Three Months Ended June 30, 1999 - Expenses." The Company has
received from its lenders under the Credit Agreement a written waiver of such
covenant compliance effective as of June 30, 2000.
The Company is currently in discussion with its lenders to amend the
covenants under the Credit Agreement to levels the Company believes it will be
able to meet in the future. The Company will use its best efforts to negotiate,
on terms acceptable to the Company, an amendment to the Credit Agreement or to
obtain replacement financing, or to obtain a further waiver of the applicable
covenants. However, there can be no assurance at this time that such amendment,
refinancing or further waiver will be obtained.
If the Company does not obtain such amendment, refinancing or further
waiver by September 30, 2000, the Company would then be in default of the Credit
Agreement and the lenders thereunder would be entitled to demand immediate
repayment of all amounts outstanding under the Credit Agreement. In addition,
through the operation of cross-default provisions, the Company would also be in
default of various other financial and contractual obligations.
As a result of the events discussed above, the entire outstanding balance
of approximately $24,205,000 under the Credit Agreement and approximately
$6,284,000 under certain mortgages and capitalized leases has been classified on
the Company's Condensed Consolidated Balance Sheets as "current maturities of
long-term debt."
The Company believes that cash flow from operations, together with the
proceeds of the liquidation of the assets of the former Turnkey program and
collections from notes receivable will be sufficient to meet the
17
<PAGE>
Company's anticipated operating and debt service cash needs for the foreseeable
future. However, in view of the status of the Credit Agreement as described
above, no assurances can be given regarding the amount of debt repayment that
may become due on September 30, 2000.
18
<PAGE>
YEAR 2000 COMPLIANCE
The Year 2000 issue is a result of many computer programs being written
using two digits, such as "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 and could result in system failure causing
disruptions in business activities and transactions.
The Company's computer software programs utilize four digits to define the
applicable calendar year and therefore the Company believes that it has no
material internal risk concerning the Year 2000 issue. To date, neither the
Company nor any of its major suppliers have experienced material internal
disruptions. The total costs to the Company of Year 2000 compliance activities
were not material to its financial condition or results of operations.
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 and Section 21E of the Securities Exchange Act of 1934, as amended. 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 negotiation of
an amendment, refinancing or further waiver under its bank credit agreement;
(iii) the Company's business and growth strategies, including strategies related
to new restaurant development; (iv) the expected impact of national television
advertising; and (v) development of the Company's private label licensing
program. 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
"Liquidity and Capital Resources," 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.
19
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Changes in short-term interest rates on loans from financial institutions
could materially affect the Company's earnings because the underlying
obligations are either variable, or fixed for such a short period of time as to
effectively become variable.
At June 30, 2000, a hypothetical 100 basis point increase in interest
rates would result in a decrease of approximately $242,000 in annual pre-tax
earnings. The estimated decrease is based upon the increased interest expense
of the Company's variable rate debt and assumes no change in the volume or
composition of debt at June 30, 2000. Since the Company's loans are at
variable rates, the fair values of the Company's bank loans are not affected
by changes in market interest rates.
20
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As disclosed in prior Company filings with the Securities and Exchange
Commission, on August 26, 1998, the Lone Star Ladies Investment Club filed a
class action lawsuit in federal court in the Western District of Texas against
the Company and six of its officers and directors (Monica Gill, former Chief
Financial Officer; Azie Taylor Morton, director; Raymond A. Rodriguez, director;
John M. Rosillo, former 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 in connection with a change in the timing
of recognition of revenue from the sale of real estate properties pursuant to
which the Company provided a limited guaranty on lease payments from franchisees
who had leased the properties. In April 1998, the Company 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 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. On September 28, 1999, the
Plaintiffs filed a notice of appeal with the United States Court of Appeals for
the Fifth Circuit, and both parties subsequently filed written briefs in
connection with such appeal. The appeals court has scheduled a hearing for
September 8, 2000. The Company believes that the allegations in this lawsuit 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, including references to administration of the
advertising funds, default or termination of franchisees or area developers,
requirements or payments relating to products used in the restaurants (such as
private label licensing), and the Turnkey program. 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Shareholders of the Company was held on May 26, 2000.
At the meeting, the following items were voted on:
Election of directors, whose terms expired at the meeting.
<TABLE>
<CAPTION>
For Withheld
--- --------
<S> <C> <C>
John L. Hill, Jr. 6,280,041 77,950
Floor Mouthaan 6,288,031 69,960
</TABLE>
The following directors' terms of office were not expired and continued after
the meeting:
Azie Taylor Morton
John C. Wooley
Raymond A. Rodriguez
Jeffrey J. Wooley
21
<PAGE>
Proposal to ratify and approve the Board's selection of Grant Thornton, L.L.P.
to serve as the Company's auditors for the 2000 fiscal year.
<TABLE>
<CAPTION>
FOR AGAINST WITHHELD
--- ------- --------
<S> <C> <C>
6,306,577 27,730 23,684
</TABLE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No.
-----------
<S> <C>
10.35(c) Form of Incentive Stock Option Agreement, as
amended.
10.36(e) Form of Employment Agreement between
Registrant and each of certain employees,
including Darrell Kolinek, Kelly R. Arnold,
and Karl D. Martin.
10.59 Amendment to Schlotzsky's 1995 Nonemployee
Directors Stock Option Plan
27 Financial Data Schedule.
</TABLE>
(b) Current Reports on Form 8-K:
None.
22
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. John C. Wooley has signed as the
principal financial officer and as a duly authorized officer of the Registrant.
SCHLOTZSKY'S, INC.
By: /s/ John C. Wooley
---------------------------------------
John C. Wooley
President and Chief Executive Officer
Austin, Texas
August 14, 2000
23
