UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
/ X / SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 28, 1997
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
/ / SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-26270
INTERNATIONAL FRANCHISE SYSTEMS, INC.
(Exact name of Small Business Issuer in its charter)
DELAWARE 52-1853204
(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) No.)
6701 Democracy Boulevard
Suite 300
Bethesda, MD 20817
(Address of principal executive offices) (Zip Code)
(301) 897-4870
(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
(Title of Class)
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Check whether the issuer (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
past 12 months (or for such shorter period that the issuer was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes X No
Check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
Yes X No
State issuer's revenues for its most recent fiscal year.
$28,360,981
As of April 1, 1998, the aggregate market value of the Issuer's
Common Stock held by non-affiliates of the Issuer was $5,380,731.
As of April 1, 1998, there were 7,034,324 shares outstanding of the
Issuer's Common Stock.
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TABLE OF CONTENTS
ITEM PAGE
PART I
1. Description of Business......................................... 4
2. Description of Properties.......................................13
3. Legal Proceedings...............................................13
4. Submission of Matters to a Vote of
Security Holders................................................14
PART II
5. Market for the Issuer's Common
Equity and Related Stockholder
Matters.........................................................15
6. Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................................................17
7. Financial Statements and Supplementary
Data............................................................21
8. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure......................................................21
PART III
9. Directors, Executive Officers, Promoters and Control Persons
compliance with Section 16a of the Exchange Act.................23
10. Executive Compensation..........................................24
11. Security Ownership of Certain Beneficial
Owners and Management...........................................26
12. Certain Relationships and Related
Transactions....................................................27
13. Exhibits and Reports on Form 8-K................................28
Signatures......................................................30
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PART I
Item 1. Description of Business
Introduction
International Franchise Systems, Inc. and its subsidiaries (collectively, the
"Company" or "IFS") have the exclusive right to own, operate and franchise
Domino's Pizza stores ("Domino's Stores") in the United Kingdom, and the
Republic of Ireland ("the Territory") pursuant to a master franchise agreement
(the "Master Agreement") with Domino's Pizza International, Inc. ("DPII), a
wholly owned subsidiary of Domino's Pizza, Inc. ("Domino's). The Company also
has the right to operate a fresh pizza dough production facility and wholesale
supply business (the "Commissary") for all Domino's Stores in the Territory
pursuant to an agreement with Domino's (the "Commissary Agreement").
IFS is a Delaware corporation, incorporated on October 22, 1993. As of December
28, 1997, IFS had 154 Domino's Stores opened as well as two distribution centers
and a commissary. At year end 1997, it was the largest Domino's franchisee in
Europe and the fourth largest Domino's franchisee outside the United States.
Business Objectives and Strategy
IFS's mission is to maintain its status as the leading pizza delivery brand in
the marketplace and to continue to build stockholder value. To accomplish this,
IFS has developed a strategy designed to achieve high levels of customer
satisfaction and repeat business, as well as to enhance recognition of the
Domino's name and concept in the Territory. The key elements of IFS's strategy
include:
New Store Locations
IFS believes that the location of a Domino's Store is an essential element of
success. IFS's development of the Territory is based on store locations that are
strategically located in areas that satisfy IFS's demographic criteria. The
stores are positioned in high visibility areas with prominent signage and
brightly lit interiors to attract attention.
Franchise System
IFS is committed to developing a strong franchise system by attracting
experienced operators and business people who adhere to IFS's high standards.
IFS devotes significant resources to providing its franchisees with assistance
in marketing, site selection, store design and employee training.
High Quality Menu
Domino's Stores offer a menu of high quality pizzas. Pizzas are prepared using
fresh dough, real mozzarella cheese, a propriety mix of tomato sauce and spices
and other high quality ingredients and toppings. Other menu items include garlic
bread, cole slaw, chicken wings, ice cream and soft drinks. IFS has expanded its
menu in limited ways to increase market penetration and average spend per order.
Efficient Operating System
IFS believes that its operating systems, store layout and designated delivery
areas result in lower in-store cost, improved food quality and higher customer
service. IFS's Commissary and distribution system provide consistency and
efficiencies of scale in dough production. This eliminates the need for each
store to order food from third party vendors and commit substantial labor and
other resources to dough
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production. To ensure consistent food quality, each franchisee must purchase all
food and supplies from IFS or its approved suppliers.
Training and Development
IFS operates a training program for store personnel and new franchisees to
improve store operations and the management of each franchisee's business. IFS
has revised the standard Domino's training program to make it more appropriate
and relevant to operations in the Territory.
Targeted Marketing
IFS's marketing programs target the delivery area of each store, making
extensive use of coupons, leaflets and direct mail promotions. IFS also uses
radio to advertise its product and name. The local marketing efforts include
more effective involvement with community oriented activities with sports teams,
schools and other organizations. IFS is implementing an in-store computer system
that enables better tracking of customer preferences and targets its marketing
based on these preferences. IFS works closely with franchisees on local
marketing efforts. IFS promoted both the brand and selected new pizza products
on television in 1997.
The Domino's Store System
Domino's opened its first store in 1960 and today is the world's leader in pizza
delivery, with over 5,952 company-owned and franchised stores as of December 31,
1997. It had system-wide revenues of approximately $3.2 billion for fiscal year
1997.
Domino's has developed a pizza store format and operating system which includes
a recognized design, decor and color scheme for store buildings; uniforms for
store personnel; signage; service format; quality and uniformity of products and
services offered; procedures for inventory and management control; a delivery
system; and Domino's trademarks (collectively, the "Domino's System"). All
Domino's Stores are required to be operated in accordance with the Domino's
System.
Domino's Stores feature carryout services and delivery services to customers
located within a prescribed service area. The service area for each Domino's
Store is established to enable the store to deliver a pizza within 30 minutes of
the customer's order. Domino's Stores offer a substantially similar core menu
including various types of pizza and soft drinks. In the Territory, other menu
items include cole slaw, garlic bread and ice cream. Pizza accounts for the most
significant amount of system-wide sales. Prices for Domino's menu items are
determined by the various operators of Domino's Stores and, accordingly, may
vary throughout the Territory.
Relationship With Domino's Pizza, Inc.
Master Franchise Agreement
IFS acquired the rights to the Territory from DPII in December 1993. Since that
time, the relationship between IFS and Domino's has been governed principally by
the Master Agreement. The initial term of the agreement runs from December 31,
1995 through December 31, 2006. According to the terms of the initial agreement,
IFS shall have opened and operating a minimum number of Domino's Stores in
accordance with the following yearly schedule:
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Year Minimum(1)
Ended Total
December 31 Stores
1998 168
1999 192
2000 217
2001 227
2002 252
2003 277
2004 297
2005 317
2006 337
(1) Does not include non-traditional Domino's Pizza stores.
If IFS does not meet the development schedule, within one hundred-eighty (180)
days after written notice of such failure is provided by DPII, DPII may
terminate IFS's exclusive right to operate and franchise additional Domino's
Stores in the Territory. To date, the Company has exceeded the required
schedule.
If IFS is in compliance with the Master Agreement at the expiration of the
Initial Term, IFS will have the option to extend its exclusive development
rights for an additional 10-year period, provided IFS and DPII agree to a
minimum development schedule for the renewal term. If after expiration of the
Initial Term (or any renewal term), IFS fails to exercise its option to renew
its exclusive development rights, or the parties are unable to agree to a
minimum development schedule for the renewal term, then IFS would continue to
have the right to operate its then-existing Company-owned Domino's Stores and to
maintain and continue its rights and obligations, and act as subfranchisor, with
respect to all then existing franchised Domino's Stores. In such event, IFS
would generally have no further right to operate or grant franchises for
additional Domino's Stores and DPII would have the right to proceed (or the
right to grant a third party the right to proceed) with further development of
the Territory, subject to territorial rights granted under then- existing
franchise agreements.
IFS is required to pay DPII a one-time store opening fee for each new Domino's
Store, whether Company-owned or franchised. IFS has passed and will continue to
pass the cost through to the franchisees in the case of franchised stores. In
addition, IFS must pay to DPII a monthly royalty fee equal to a certain
percentage of each Domino's Store's gross sales. This royalty fee is payable to
DPII irrespective of the profitability of IFS or the Domino's Store, and
irrespective of IFS's ability to collect royalties from franchisees. This
royalty fee as reduced in accordance with the Stock Purchase Agreement discussed
below, escalates each year until it reaches a maximum of 3% in 2003. IFS's
payments to DPII are to be made in U.S.
dollars.
DPII and IFS entered into a Stock Purchase Agreement as of May 26, 1997, ("SPA")
whereby IFS agreed to sell to DPII 300,000 shares of its common stock in
consideration for royalty concessions under the Master Agreement. The SPA
provides that DPII may not sell, transfer or otherwise dispose of its shares
before May 26, 2001 and any transferee receiving stock in violation of this
prohibition will have no rights with respect to the shares. The SPA further
provides for put and call options on the common shares at an agreed upon base
purchase price of $1,200,000 adjusted to reflect changes in the common stock,
such as, stock splits and dividends.
The Master Agreement cannot be assigned by IFS without DPII's consent. In
addition, the agreement prohibits Domino's Pizza Group Limited, a majority-owned
subsidiary of IFS, ("DP Group") and Colin and Gail Halpern (as indirect
controlling shareholders of DP Group) from transferring control of IFS without
DPII's prior written consent. For the term of the Master Franchise Agreement, DP
Group and Colin and
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Gail Halpern are restricted from having an interest in, being employed by,
advising or assisting another business in the pizza or pizza store business in
the Territory.
Under certain circumstances of default by IFS under the Master Agreement, DPII
has the right to terminate the Master Agreement. If the Master Agreement is
terminated, IFS would be subject to a one-year non-competition covenant in the
delivery or carryout pizza business. Should this occur, DPII would have the
right (but not the obligation) to purchase, at the then-current fair market
value, all of IFS's rights and interests as the subfranchisor of Domino's Stores
and all of the assets of each Domino's Store owned by IFS. The fair market value
would be determined by mutual agreement of IFS and DPII, or in the absence of
such agreement, by an appraiser. Under certain circumstances of default by
Domino's under the Master Agreement, IFS has the right to terminate the
agreement and continue as an independent pizza operation, including the
operation of the Commissary.
Commissary Agreement
Pursuant to the agreement with DPII relating to the Commissary ("Commissary
Agreement"), DPII has agreed to provide IFS, on an ongoing basis, all
information and materials necessary to make IFS familiar with the methods used
to operate and manage a Domino's Commissary. IFS must maintain the
confidentiality of such information and, subject to limited exceptions, cannot
use it in any other business. The Commissary Agreement has a term co-extensive
with the Master Agreement, with termination and default provisions and
restrictions on transfers substantially similar to those contained in the Master
Agreement.
Geographic Concentration/Expansion
As of December 31, 1997, IFS had 154 Domino's Stores in the Territory.
Thirty-five were located in greater London, two were in Northern Ireland, two
were in the Republic of Ireland, three were in Scotland, and one was in Wales,
with the remainder of the stores located throughout England.
The Company currently has two distribution centers. The original center, opened
in 1985, is located in the Company's Milton Keynes headquarters. In November
1996, the Company opened a second distribution center in the north of England to
service the franchisees in Ireland, Scotland and Wales. As of December 1997 this
second distribution center was servicing 25 stores.
In February 1998, the Company began construction on a new facility to replace
the Company's current administrative offices and Commissary in Milton Keynes.
The new facility, also in Milton Keynes, is scheduled for completion in August
1998. National Westminster Bank has agreed to finance 65% of the construction
costs with a loan of (pound)1.9 million bearing a base plus 1 3/4% rate and a
15-year term. The Company has a commitment to finance an additional
(pound)500,000 for a five year period as a capital lease and corresponds to the
cost of the equipment for the Commissary. The Company expects to finance the
remainder of the building costs out of cash flow from operations and from the
proceeds from the sale of 15% of the UK subsidiary, DP Group, to Nigel Wray in
June 1997.
In 1995, the Company signed an exclusive agreement with Total Oil Great Britain,
a subsidiary of the multinational Total Oil, to open non-traditional stores with
the opening of the first Domino's franchise within a gas station convenience
store. Currently there are six Domino's franchises operating in these service
stations. The Company has also entered into an arrangement with Alldays, a
British convenience store company, to establish Domino's delivery stores on the
premises of Alldays Stores. The Company currently has nine Domino's franchises
operating in Allday's Stores. The Company believes that these non-traditional
stores have generated additional product awareness by providing a
phone-in/pick-up service to customers in areas where delivery is not available.
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Expansion
IFS believes that the location of a Domino's Store is an essential element of
success. The site selection process involves an evaluation of a variety of
factors, including demographics (such as population density); specific site
characteristics (such as visibility, accessibility and traffic volume);
proximity to activity centers (such as office or retail shopping districts and
apartment, hotel and office complexes); competition in the area; construction or
renovation costs, and lease terms and conditions. IFS will inspect and approve
proposed sites for each Domino's Store prior to the execution of a franchise
agreement or lease. All sites are subject to the approval of Domino's and the
store must generally be approved by the local planning board. Planning board
approval can take approximately six months.
To promote restaurant growth and increase the presence of Domino's in the
Territory, the Company has established a very successful Dealer Development
Program whereby experienced and talented restaurant managers in the IFS system
who lack start-up capital can enter into the Domino's system with financial
support from the Company. Those who qualify make a good faith payment of $7,500
while the Company invests the remaining capital to build and equip the
restaurant. The individual then operates the restaurant with full responsibility
for operations, marketing and financial management. There are currently five
Dealer Development units in the system.
Store Operations
Menu
Domino's Stores offer a substantially similar core menu including high-quality
pizza, garlic bread and soft drinks. Other menu items include cole slaw and ice
cream. IFS also continuously test-markets pizzas with specialty toppings and
adds those items to the regular menu if they prove popular. Pizza accounts for
approximately 85% of Domino's Stores' sales in the Territory. Prices for
Domino's menu items are determined by franchisees and, accordingly, may vary
throughout the Territory.
Store Design
A typical Domino's Store in the Territory ranges from 800 to 1,200 square feet
and is designed to facilitate a smooth flow of food orders through the store.
The layout includes specific areas for order taking and pizza preparation. This
results in simplified operations, increased efficiency, and improved consistency
and quality of food products. The interior of each store has a red and blue
color scheme and includes a bright menu board and carryout customer area. The
exterior typically includes a Domino's sign with the Domino's logo. The design
for a Domino's Store must comply with specified Domino's standards and
specifications. However, these requirements are flexible enough to allow a store
to be configured to fit a wide variety of building shapes and sizes, thereby
increasing the number of suitable locations.
IFS currently estimates that once the site has the appropriate council planning
approval, approximately 30-60 days is required to open a Domino's Store. IFS
currently estimates the cost of opening a Domino's Store to be between
(pound)90,000 ($148,000) and (pound)120,000 ($198,000), including leasehold
improvements, furniture, fixtures, equipment and opening inventories, but
excluding lease payments and the franchise fee. Such estimates vary depending on
the size of the proposed store and the extent of required leasehold
improvements.
Delivery Service
Approximately 85% of the sales made by stores in the Territory are delivered. A
delivery area is designed for each store to deliver a pizza within approximately
30 minutes of the time an order is placed. In defining a delivery area, IFS
takes into consideration the least favorable driving conditions, strict
compliance with all laws, regulations and rules of the road, and due care and
caution in the operation of
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delivery vehicles. Deliveries throughout the Territory are generally made on
mopeds owned by the franchisee and driven by store employees. IFS provides
training to franchisees on safe driving and moped safety.
Store Personnel
A typical Domino's Store employs a store manager, an assistant manager and
approximately 14 hourly employees, most of whom work part-time. The manager is
responsible for the day-to-day operation of the store and for the maintenance of
operating standards. IFS and franchisees seek to hire experienced store managers
and staff and motivate and retain them by providing opportunities for
advancement and performance-based financial incentives.
Reporting and Oversight
Franchisees provide IFS with weekly reports containing certain information
including the amount of royalty sales, the number of pizzas of various sizes
sold and the number of pizzas that were late. Pizzas are considered to be late
if they are removed from the oven more than 21 minutes after an order is taken.
IFS maintains financial, accounting and management controls for its company
owned Domino's Stores through the use of centralized accounting systems,
detailed budgets and computerized management information systems. This includes
an accounting system that provides each Domino's Store's daily sales, expenses
and cash position.
IFS has selected and continues to install computer systems in Domino's Stores.
The system begins with the taking of orders and follows through to the
management of deliveries. The system generates all of the daily, weekly and
monthly reports and maintains a customer database that aids in the achievement
of significant sales through target marketing. The systems are installed,
maintained, and supported by Domino's Pizza Group Ltd. ("DP Group"). To date,
the Company has installed the system in 130 stores. The Company has a computer
staff that trains franchisees in the use of these in-store computers. The
Company has also formed a user group of franchisees to facilitate feedback and
to discuss new developments.
Franchise Program
General
IFS believes that the success of the Domino's System, together with the
relatively low initial capital investment per Domino's Store, allows IFS to
attract franchisees with significant business experience. IFS considers its
franchisees to be a vital part of its continued growth. There can be no
assurance that IFS will be able to attract a sufficient number of qualified
franchisees to meet the development schedule in the Master Agreement.
Approval
Franchisees are approved on the basis of the applicant's business background,
restaurant operating experience and financial resources.
Franchise Agreements
Each franchisee must comply strictly with the Domino's System and its standards,
specifications and procedures. The franchise agreement sets forth various
requirements regarding signage, equipment, menu, service, hygiene, hours of
operation and communications.
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Under IFS's current standard franchise agreement, the franchisee is required to
pay, at the time of signing the franchise agreement, a non-refundable fee of
either (pound)8,000 ($13,163) or (pound)18,000 ($29,172), depending upon whether
the franchisee is an existing franchisee or a new franchisee of Domino's Stores.
Generally, a franchise agreement is executed when a franchisee secures a
location. IFS's current standard franchise agreement provides for a term of 10
years (with one ten-year renewal option) and payment to IFS of a royalty fee of
5.5% of sales. The franchise agreement gives IFS the right to terminate a
franchisee for a variety of reasons, including a franchisee's failure to make
payments when due or failure to adhere to IFS's policies and standards.
Franchise Store Development
IFS furnishes each franchisee with assistance in selecting sites and developing
stores. IFS provides its franchisees with the physical specifications for
typical stores. IFS will generally present store locations to franchisees for
their approval and franchisees must obtain Company approval of their store
design. Each location is selected on the basis of accessibility and visibility
of the site and targeted demographic factors, including population, density,
income, age and traffic pattern. While IFS assists in the design and planning of
each store and assists the franchisee in acquiring the equipment needed for each
location at competitive prices, the franchisee is responsible for all costs
associated with the purchase of equipment.
Franchise Training and Support
Every franchisee is required to have a principal operator approved by IFS who
satisfactorily completes IFS's training program. Each manager of a franchised
store is required to complete IFS's training program. Multi-unit franchisees are
encouraged to hire a full-time training coordinator to train new employees for
their stores. IFS maintains constant communication with its franchisees,
relaying operating and marketing information through quarterly newsletters and
posters for products and recruitment. IFS also conducts a quarterly operations
advisory meeting. Every eight weeks, Company representatives visit all stores
and prepare a standards report detailing each store's operations.
Franchise Operations
All franchisees are required to operate their Domino's Stores in compliance with
IFS's policies, standards and specifications, including matters such as menu,
ingredients, materials, supplies, services, fixtures, furnishings, decor and
signs. Each franchisee has full discretion to determine the prices to be charged
to its customers.
Franchisee Advisory Group
IFS has instituted a Franchisee Advisory Group for the purpose of assisting IFS
with the development of new ideas. The Franchisee Advisory Group is composed of
up to eight members, all of whom are franchisees of IFS. The members serve at
the discretion of IFS and advise IFS on matters such as store design and menu,
operation, marketing, safety and competition in local markets.
Purchasing; Commissary and Distribution Operations
Domino's and IFS set quality standards for all products used in Domino's Stores
in the Territory. IFS provides fresh dough and substantially all of the other
food products and supplies to franchisees through its Commissary and
distribution facilities. In order to ensure product quality and consistency, all
stores are required to make all purchases through the Commissary or from
suppliers approved by Domino's and IFS.
IFS has begun construction on a new Commissary and distribution center in Milton
Keynes which is scheduled for completion in August 1998. This facility will
replace IFS's existing Commissary. IFS believes that the new facility will
provide adequate room for expansion. IFS operates the Commissary as a separate
profit center. The Commissary negotiates purchase contracts for virtually all of
the ingredients
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and supplies used in Domino's Stores. When possible, IFS enters into one-year,
fixed-price contracts for products purchased for the Commissary. Certain
products, such as mushrooms, are purchased at market prices due to the volatile
nature of the prices of those products. The Commissary produces pizza dough that
it delivers fresh to the stores.
Virtually every store orders products through the Commissary on a regular basis
and is billed by IFS for the purchases. The Commissary employs an individual who
is responsible for quality control and quality assurance and an employee who is
responsible for distribution. Products are delivered to stores on a daily basis
in refrigerated trucks that are owned or leased by IFS.
All of the equipment, counters and smallwares needed to open and operate a
Domino's Store can be purchased from IFS. IFS also provides layout and design
services and recommends contractors, signage installers and telephone systems to
its franchisees. Although not required to do so, substantially all of IFS's
franchisees purchase most of their equipment from IFS or specified suppliers.
Advertising and Promotion
The franchise agreement provides that each franchisee must contribute a monthly
advertising and promotion fee of 4% of its royalty sales to a fund administered
by IFS to be used for advertising, sales promotion and public relations. IFS is
responsible for using the proceeds of the advertising fund to develop and
implement advertising and promotional plans, materials and activities on behalf
of the Domino's Stores in the Territory. All advertising, promotional plans,
materials and activities are subject to Domino's approval.
IFS's principal method of promotion is through leaflets which are distributed to
the homes and places of business within each store's service area. These
leaflets generally announce promotional prices, new menu items or include
special coupons. The leaflets are generally designed by IFS and can be
customized by each store. The customizing is facilitated through the use of a
single print shop that provides printing services to IFS and the franchisees.
IFS also uses local radio advertising and cable television for advertising.
During 1997, the Company began advertising on national television throughout
Great Britain to further develop brand recognition. In 1998, IFS intends to
expand its marketing to include not only television advertising, but also
promotions with Hollywood video rentals and new movie releases.
IFS is installing an in-store computer system in many franchisee stores. This
system provides data that enables franchisees to better track information such
as location of customers, the frequency with which each customer orders and the
response to a particular coupon or other promotion. IFS believes the system will
enable IFS to do better target marketing, improve the effectiveness of its
marketing and reduce the cost of its marketing effort.
Trademarks
IFS is authorized to use such trademarks, service marks and such other marks as
Domino's may authorize from time to time for use in connection with Domino's
Stores (collectively, the "Domino's Trademarks"). Domino's has represented to
IFS that, to the best of its knowledge, Domino's owns all of the rights, title
and interests to the Domino's Trademarks used by IFS. Any events or conditions
that negatively affect the Domino's Trademarks could have a material adverse
effect on IFS.
Foreign Currency and Exchange
IFS converts United States dollars, as needed, into British pounds sterling for
use in the Territory. Revenues from operations in the Territory will be
maintained in pound-denominated accounts, although they may be freely converted
into foreign currencies, at then-current official exchange rates, for purposes
of paying for foreign goods, payment of royalties and for repatriation of
profits. IFS anticipates that it will continue to leave a substantial portion of
the profits of its operation, if any, in the Territory for use in its
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business. There are presently no limitations on IFS's ability to repatriate
profits. The exact amount of profits, if any, that IFS repatriates at a given
time will depend on, among other factors, IFS's financial condition, results of
operations and capital requirements. IFS will be subject to risks from exchange
rate fluctuations. IFS may seek to limit its exposure to the risk of currency
fluctuations by engaging in hedging or other transactions.
United States and United Kingdom Income Taxes
Pursuant to United States tax laws, if IFS's subsidiaries organized under the
laws of the United Kingdom are not engaged in business in the United States,
such subsidiaries will not be subject to United States taxation. Any earnings of
these United Kingdom subsidiaries, when paid to IFS (or, in certain cases,
deemed paid, even though not distributed, under certain technical provisions of
the Internal Revenue Code), would be included by IFS for United States Federal
income tax purposes. However, IFS would receive a credit against Federal income
tax liability that otherwise would result from any deemed or actual
distributions from its United Kingdom subsidiaries, for any United Kingdom
corporate taxes paid by such United Kingdom subsidiaries on these distributions,
as well as for any United Kingdom dividend and royalty withholding taxes imposed
directly on IFS. Because the United Kingdom corporation tax rate (presently 31
percent of taxable income) is lower than the United States corporate tax rate,
IFS does not anticipate being subject to significant United States Federal
income tax on either distributed or undistributed earnings of its United Kingdom
subsidiaries.
Under United Kingdom tax law, when a United Kingdom corporation pays a dividend
to a shareholder, it must also pay Advance Corporate Tax (referred to herein as
"ACT") with respect to that dividend. The ACT is presently set at 25% of the net
amount of the dividends paid (which is equivalent to 20% of the sum of the
dividend plus the ACT). The paying corporation can normally apply the ACT it
pays with respect to dividends paid by it in any accounting period as a credit
against its corporation tax liability for the accounting period. To the extent
that the ACT cannot be fully applied as such a credit, any unapplied amount may
be carried back six years or carried forward indefinitely.
Under the combined effect of current United Kingdom tax law and the current
United States-United Kingdom Tax Treaty relating to income and capital gains
taxes, if IFS's United Kingdom subsidiary pays it a dividend, IFS will receive
in addition to the dividend a tax credit equal to one-half of the ACT paid by
the subsidiary with respect to that dividend. Subject to a United Kingdom
withholding tax calculated as a percentage of the aggregate of the dividend
received and such tax credit, which the treaty limits, in the case of a dividend
paid to a United States corporation holding not less than 10% of the
subsidiary's voting stock, to no more than 5%. On November 25, 1997, the United
Kingdom government pronounced proposals which abolish the requirement to account
for ACT in respect of dividends paid on or after April 6, 1999.
Competition in the U.K. Pizza Business
Pizza has proven to be a particular success in the United Kingdom. Although
there are several large pizza operators in the U.K., the market is fragmented
with well over 2,000 small units. The Company believes that the two largest
operators in the Territory are Pizza Hut with approximately 104 stores and
Perfect Pizza with approximately 148 stores dedicated to home delivery.
IFS also competes for qualified franchisees with many other business concepts,
including international, national and regional restaurant chains such as
McDonalds, Kentucky Fried Chicken and Burger King. There can be no assurance
that IFS will be able to attract a sufficient number of qualified franchisees to
satisfy its obligations under the Master Agreement.
12
<PAGE>
Employees
As of December 31, 1997, IFS employed 212 persons of whom 117 were store
employees, 51 were corporate personnel and 44 were employed in IFS's Commissary
and distribution center. Most store employees work part-time and are paid on an
hourly basis. None of IFS's employees are covered by a collective bargaining
agreement.
Government Regulation
IFS is subject to various British, European and local laws affecting its
business. Each of IFS's stores is subject to licensing and regulation by a
number of governmental authorities, which include health, safety, sanitation,
building and fire agencies in the municipality in which the store is located.
Difficulties in obtaining or failure to obtain required licenses or approvals
could delay or prevent the opening of a new store in a particular area. The
Commissary and distribution facility are licensed and subject to regulation by
national and local health and fire codes, and the operation of its trucks is
subject to certain regulations. IFS is also subject to environmental
regulations, though these have not had a material effect on IFS's operations.
IFS is subject to British and European Union regulations over the
franchiser-franchisee relationship. These regulations limit, among other things,
the duration and scope of non-competition provisions, exclusive territories and
restrictions on sources of supply.
IFS's store operations are also subject to British, European Union and local
laws governing such matters as wages, working conditions, citizenship
requirements and overtime. IFS's hourly personnel are paid at rates ranging from
(pound)3 to (pound)8 and, accordingly, further increases could increase IFS's
labor costs. New European Community regulations could materially increase IFS's
and franchisees' cost of operations.
Item 2. Description of Properties
In the Territory, DP Group maintains its place of business at Unit 10, Maryland
Road, Tongwell, Milton Keynes, England. There are three leased spaces associated
with DP Group's administrative offices and the Commissary. The leases (for a
total of approximately 20,000 square feet) cover a period of two to five years,
with options that allow for early release from the commitments, at a rate of
$194,889 per year.
IFS is constructing a new site on which it is building a larger Commissary and
distribution center. The Company anticipates completion of the project in August
1998. DP Realty Limited, a wholly owned subsidiary of DP Group, has a total of
115 leases. DP Realty Limited enters the lease on new properties as a service to
franchisees, enabling them to secure longer rent obligations. The Company then
subleases the store space to each franchisee. This practice allows the Company
to ensure the franchisee maintains the image of the brand. DP Realty Limited
obtains a markup on the sublease to cover the administrative costs. The Company
currently subleases 108 of the 115 properties to franchisees. In 1997, the
margin generated from the subleases less the cost of the leased properties was
approximately $83,000.
The Company has a one year lease for its U.S. office that is renewable. The
total rent payable by the Company is approximately $1,000 per month.
Item 3. Legal Proceedings
The Company is not a party to any litigation or governmental proceedings that
management believes would result in judgments or fines that would have a
material adverse effect on IFS.
13
<PAGE>
Item 4. Submissions of Matters to a Vote of Security Holders
No matters were submitted to a vote of the holders of the Company's Common Stock
during the fourth quarter of the Company's fiscal year ended December 28, 1997.
14
<PAGE>
PART II
Item 5. Market for the Issuer's Common Equity and Related Stockholder Matters
Market Information
The Company's Common Stock is traded separately and as part of a unit (a "Unit")
which includes one share of Common Stock, and one warrant to purchase one share
of stock through December 9, 1999 at $10.00 per share (a "Class B Warrant"). The
Company's Units, Common Stock, and B Warrants are listed on the OTC Bulletin
Board, an inter-dealer, over-the-counter market, under the symbols DOMSU, DOMS,
and DOMSZ. Quotes for stock traded on the OTC Bulletin Board are not listed in
newspapers.
The high and low bid prices of the Units and Common Stock, as reported by
Nasdaq, were as follows:
1998
Common Units
High Low High Low
First Quarter $2.625 $2.00 $3.50 $1.75
1997
Common Units
High Low High Low
First Quarter $1.3125 $0.50 $1.25 $0.50
Second Quarter 2.25 1.125 2.125 1.1875
Third Quarter 2.375 1.125 2.3125 1.25
Fourth Quarter 2.875 1.75 2.375 1.5625
1996
Common Units
High Low High Low
First Quarter $1.87 $0.50 $2.00 $0.62
Second Quarter 1.50 0.62 1.50 0.62
Third Quarter 1.75 0.62 1.75 0.62
Fourth Quarter 1.25 0.50 1.25 0.50
1995
Common Units
High Low High Low
First Quarter $ --- $ --- $6.25 $5.75
(beginning January 11, 1995)
Second Quarter 5.00 5.00 6.375 5.50
(beginning June 23, 1995)
Third Quarter 6.125 5.00 7.00 5.125
Fourth Quarter 8.00 0.75 8.25 0.875
15
<PAGE>
These quotations reflect inter-dealer prices, without retail mark-up, mark-down
or commission and may not represent actual transactions. Quotations have been
obtained through Standard & Poor's Comstock.
Dividends
The Company has not paid any cash dividends on its Common Stock and does not
intend to pay cash dividends on its Common Stock for the foreseeable future. The
Company intends to retain future earnings to finance future developments.
Number of Stockholders
As of April 1, 1998, there were 87 record holders of the Company's Common Stock
and 38 record holders of Class B Warrants. The Company believes there are
approximately 4,320 beneficial owners of the Company's Common Stock.
16
<PAGE>
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Introduction
The Company's principal business consists of franchise and royalty fees, the
sale and support of Company owned Domino's Pizza stores, the sale of food,
non-food products and in-store computer systems to franchisees, and rental
income from the sublease of delivery stores. These sources of revenue represent
the total revenue earned by the Company.
The Company had 154 Domino's stores opened by December 28, 1997. New unit
openings of traditional delivery stores increased from 21 in 1996 to 27 in 1997.
The increase in store openings is the result of: (i) enhanced awareness of the
Domino's brand through trade exhibitions and industry publications; (ii)
additional store openings by existing franchisees; and (iii) partnership with
Allday's (a British convenience store chain). The Company continues to select
"high street" locations that provide enhanced visibility, adequate parking and
late night operating hours.
In June, 1997 the Company agreed to sell up to a 20% interest in its Domino's UK
operation for approximately $4.5 million to British businessman Nigel Wray. Mr.
Wray paid IFS approximately $3 million for 15% of its shares in the UK
subsidiary and holds an option to invest in DP Group for an additional 5% of new
shares for a price of $1.5 million. The Company plans to use the proceeds from
the sale to fund expansion of IFS and Domino's UK.
The Company purchased three Haagen Dazs ice cream parlors in 1995. The Company
decided in June 1996 that operating and accumulating more parlors was not
consistent with its primary mission. As a result, one store was sold back to the
master franchiser in September 1996. The Company disposed of the other two
stores in December 1997. The revenue and costs from these stores are reported in
discontinued operations.
The Company opened a sit down restaurant, Pizzazz, in December 1995 to increase
further awareness of the Domino's brand. The restaurant was closed in June 1996
after the Company determined that it wished to discontinue this line of business
as the success of the concept would require too much management attention to be
redirected from the Company's primary business. The Company subleased the
property commencing April 1997 and terminating at the expiration of the lease,
in December 2010.
Results of Operations
The Company realized income of $2,346,084 for the fifty-two week period ended
December 28, 1997 primarily due to the nonrecurring income from the sale of DP
Group shares to Nigel Wray ($2,163,038), increased systemwide sales of 35% which
resulted in higher royalty and commissary income, and the opening of 27 new
units. This compared to a net loss of $139,808 for the same period last year.
Gross margins increased from the prior year by $2,120,116. Income from
continuing operations, before tax, was $1,087,893 in 1997 as compared to
$514,029 in 1996 or an increase of 112%.
17
<PAGE>
The following tables set forth the percentage relationships to total revenue,
unless otherwise indicated, of certain income statement data and certain
restaurant data for the years 1997 and 1996.
December 28, 1997 December 29, 1996
INCOME STATEMENT DATA
Revenues:
Company Owned Stores 11.6% 15.6%
Franchise Royalties 14.0% 13.9%
Franchise Fees 1.8% 2.4%
Commissary Sales 59.7% 57.6%
Property Rentals 7.9% 6.4%
Other Income 5.0% 4.1%
----- -----
Total Revenues 100.0% 100.0%
Costs and Expenses:
Company Owned Stores(1) 94.6% 92.1%
Commissary Expenses(1) 86.5% 90.0%
Franchise Support, G&A(2) 18.2% 15.5%
Depreciation/Amortization(2) 2.7% 3.3%
----- -----
Total Costs and Expenses 97.1% 97.9%
Operating Income 2.9% 2.1%
Other Income(2) 5.9% 0.3%
----- -----
Income from Continuing Operations 8.8% 2.4%
===== =====
Notes:
(1) As a percentage of respective revenues
(2) As a percentage of total revenues
RESTAURANT DATA
Percentage Increase in Comparable
Restaurant Sales 11% 14%
Average Annual Sales for Company Owned
Stores Open for Full Year $820,000 $655,000
Number of Company Owned Stores:
Beginning of Year 11 10
Opened -- 2
Acquired 2 2
Sold (2) (3)
----- -----
End of Year 11 11
----- -----
Number of Franchised Stores:
Beginning of Year 116 93
Opened 27 22
Acquired from Company 2 3
Sold to Company (2) (2)
----- -----
End of Year 143 116
----- -----
Total Stores End of Year 154 127
===== =====
18
<PAGE>
Comparison of Fiscal 1997 to Fiscal 1996
Revenues
Total revenue for the fiscal year ended December 28, 1997 was $28.4 million
versus $21.2 million for the fiscal year 1996. This represents a 34% increase in
total revenue. System-wide sales increased from $55.0 million in 1996 to $72.1
million in 1997 or an increase of 31%.
Sales by company owned stores remained constant at $3.3 million. The consistency
in revenues was primarily the result of the timing of the acquisition and
disposal of units and different trading levels of the stores acquired/disposed.
Royalty fees increased 37.9% to $4.0 million in 1997 from $2.9 million in 1996.
The increase was primarily due to a same store comparable sales increase of 11%
versus 1996 and the opening of 27 new delivery stores.
Franchise and other fees decreased to $507,000 in 1997 or a decrease of 2% over
1996 when fee revenues were $517,000. The Company increased fees attributed to
new stores openings but experienced a decrease in fees because more new stores
were opened by existing franchisees which reduced franchise training fees and
support.
Commissary sales increased 38.5% net of intercompany sales to $16.9 million from
$12.2 million in 1996. This increase of 38.5% is primarily due to new stores in
the system and the increase in comparable store sales.
The increase in other sales to $1.4 million from $831,000 is related to the
Company's expansion of computer sales to franchisees.
Cost and Expense
For the fifty-two week period ended December 28, 1997, gross margins increased
from $5.5 million in 1996 to $7.6 million in 1997, or an increase from 25.8% to
26.8% of total revenues. This increase was principally related to consistent
margins throughout the year on the sale of commissary products and better gross
margins on computer sales and franchise and other fees.
The Company-operated pizza delivery stores are either staffed with Company
personnel or are operated under a Dealer Development Program. Under the Dealer
Development Program, the store is operated under a third party management
contract where the Company receives a fixed percentage of sales. In those cases,
the Company records revenue but does not record cost of food, labor, and
delivery expense associated with the store. In the Company operated stores, the
Company was able to maintain food costs as a percentage of sales at 25.5% for
both 1997 and 1996. In total, cost and expense at the Company-operated pizza
delivery stores increased as a percentage of revenue from 92.1% in 1996 to 94.6%
in 1997. The increase is attributed to new corporate owned store openings and
acquiring two under performing stores from franchisees.
The Commissary expenses include the cost of sales, warehousing and packaging,
and distribution expenses associated with food sales, non-food sales, and
equipment sales. These expenses decreased as a percentage of revenue from 90.0%
in 1996 to 86.5% in 1997. This decrease is primarily due to improved controls to
ensure that Commissary pricing was adjusted for raw material price fluctuations.
Franchise support, general and administrative expenses increased as a percentage
of revenues from 15.5% to 18.2% as the Company increased franchise support staff
to serve existing stores and to prepare for continuing new store growth and
expanding market share. The Company's market share has increased from 5% to 12%
in the last four years.
19
<PAGE>
Depreciation and amortization decreased as a percentage of revenues to 2.7% in
1997 from 3.3% in 1996. The expense decreased primarily as a result of increased
revenues and lower capital expenditures in 1997 versus 1996.
Net Other Income increased to $2,377,031 from $63,000 in 1996. This increase is
primarily related to the interest earned on the lending of funds to related
parties ($180,576) and the gain (2,163,038) on sale of a portion of the
investment in subsidiaries.
Liquidity and Capital Resource
The Company's net working capital at December 28, 1997 was $3.7 million, an
increase from $1.7 million on December 29, 1996. Total current assets were $9.6
million at December 28, 1997 versus $7.5 million on December 28, 1996. Current
liabilities increased by $0.1 million in 1997 to $5.9 on December 28, 1997 from
$5.8 million in 1996.
The primary increases in current assets related to cash which increased as a
result of the expanding business and the sale of shares to Nigel Wray. The
increase in current liabilities relates to decreases in accounts payable offset
by increases in value-added taxes payable, and accrued expenses.
The following table represents the net funds provided and/or used in operating,
financing, and investment activities for both periods:
<TABLE>
<CAPTION>
<S> <C> <C>
(Thousands)
December 30-December 28, January 1-December 29,
1997 1996
Net Cash Provided/(used) from
Continuing Operations $2,561 $1,193
Net Cash (used) for Discontinued Operations (224) (654)
Net Cash (used) from Investing (1047) (464)
Net Cash provided/(used) by Financing 820 (307)
</TABLE>
The Company generated approximately $2.6million in cash from continuing
operations and utilized cash of $224,000 in discontinued operations. The Company
had a net profit of approximately $2.3 million for the year ended December 28,
1997. Trade accounts receivable and franchisee loans and other receivables
increased from the prior year by $532,000, prepaid and accrued income decreased
by $599,745, and inventories increased $150,000. Accounts payables and accrued
and other payables decreased by $296,000, and value added taxes and income taxes
payable increased by $627,000. The Company anticipates that it will continue to
generate positive cash flow from operations in 1998 as a result of improving
profits of the Company, the opening of additional stores, and reduction of
administrative expenses as a percentage of sales.
The Company utilized $1 million and $464,000 in investing activities for fiscal
years 1997 and 1996, respectively. The Company requires capital to open or
acquire stores, the acquisition of new commissary equipment and delivery trucks,
or the enhancement of corporate systems and facilities. The Company spent $3.2
million in 1997 versus $1.3 million in 1996 in property and equipment and land
for the new Commissary. The Company anticipates that it will need $6.2 million
to open three new corporate stores and invest in Commissary equipment and the
new facility in 1998. The Company also believes it will collect approximately
$2.4 million of the receivable from its parent, Crescent Capital, in 1998. Cash
utilized for financing activities during the year ended December 28, 1997 was
$0.8 million. Proceeds of a loan to DP Group from National Westminster Bank
totaled $1.5 million. Repayments of debt totaled $550,860 and capital lease
payments totaled $97,000.
20
<PAGE>
The Company has a commitment on office space at its Corporate office until June,
1998. The Company's UK subsidiary has its principle office in Milton Keynes,
England, and leases 115 Domino's store properties. Estimated annual operating
lease payments for the next five years range each year between $2.52 million and
$2.86 million and approximately $21 million for all of the years combined
subsequent to 2002 for a total of $34.8 million. The Company collects rental
income from the sublease of the Domino store properties that total approximately
$32.1 million. The Company does not believe that the net exposure is $2.6
million because the total minimum future rental income as calculated assumes the
subleases are for the initial ten year period of the franchise agreement only.
The Company believes that the franchisees will exercise the renewal option of
the franchise agreement.
The Company has lease obligations under capital leases for commissary equipment
and motor vehicles. As of December 28, 1997, and the next two years, the Company
has decreasing annual obligations which range from $108,000 down to $25,000 per
year. The net present value of these obligations total approximately $188,000.
The Company's anticipated debt payment through December 27, 1998 will be
approximately $200,000. In the following three years, annual principal payments
are expected to be approximately $218,000, $200,000, and $138,000.
The Company believes it can meet its short-term liquidity needs from the
projected cash to be generated from operations and collection of its receivable
from the parent company of approximately $2.4 million. The Company's long-term
liquidity needs will also be met by cash generated from operations, and if
necessary, supplemented by debt financing or additional equity funding. The
Company currently has a commitment from National Westminster Bank to finance the
commissary. The loan commitment is approximately $4.0 million. The Company
anticipates it will spend $6.2 million to open additional corporate stores and
acquire commissary equipment in 1998. The Company is not obligated to open any
additional Company owned stores by December 1998 under the Master Franchise
Agreement. If the company's plans change, or its assumptions or estimates prove
to be inaccurate, the Company may require additional funds to achieve increased
sales. If such funds are unavailable, the Company will have to reduce its
operations to a level more consistent with its available funding.
Inflation
The primary inflationary factor affecting the Company's operations is
the cost of food. As the cost of food has increased, the Company has
historically been able to offset these increases through economies of scale and
improved operating procedures, although there is no assurance that such offsets
will continue. To date, inflation has not had a material effect on the Company's
operations.
Item 7. Financial Statements and Supplementary Data
See the Financial Statements and Supplementary Data listed in the
accompanying Index to Financial Statements and Schedules on Page F-1 herein.
Information required by other schedules called for under Regulation S-X is
either not applicable or is included in the financial statements or notes
thereto.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
Moore Stephens, P.C. was preciously the principal accountants for
International Franchise Systems, Inc. On December 10, 1997, that firms
appointment as principal accountants was terminated. The decision to terminate
was approved by the board of directors. In connection with the audits of the two
fiscal years ended December 29, 1996, and the subsequent interim period through
December 10, 1997, there were no disagreements with Moore Stephens, P.C. on any
matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements if not
21
<PAGE>
resolved to their satisfaction would have caused them to make reference in
connection with their opinion to the subject of the disagreement.
The audit reports of Moore Stephens, P.C. on the consolidated financial
statements of IFS and subsidiaries as of and for the years ended December 29,
1996 and December 31, 1995, did not contain any adverse opinion or disclaimer of
opinion, not were they qualified or modified as to uncertainty, audit scope, or
accounting principles.
On March 9, 1998, the Company appointed Ernst & Young to replace Moore Stephens,
P.C. as their independent auditors for the fiscal year ended December 28, 1997.
The decision to engage Ernst and Young as the Company's independent auditors was
approved by the Company's board of directors.
The Company has agreed to provide indemnification to Moore Stephens, P.C., for
the payment of any legal costs or expenses reasonably incurred in connection
with a successful defense of any action or claim relating to the reissuance of
the 1996 audit report.
22
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
The Directors and Executive Officers, their ages, their
principal occupations during the past five years or more, and directorships of
each in public companies in addition to the Company, are as follows:
Colin Halpern, age 60, has served as Chairman of the Board
since December 1993, and served as President of the Company from December 1993
until May 1996. He also currently serves as President, Secretary, Treasurer and
Director of Crescent Capital, Director of Celebrated Group Plc., and President,
Chief Executive Officer and Chairman of the Board of Directors of NPS
Technologies Group, Inc., all of which are public companies. He has held these
positions since July 1994, January 1998 and August 1983, respectively. Mr.
Halpern serves as Chairman of the Board for Red Hot Concepts, a public company
that operates Chili's restaurants in the United Kingdom, from June 1994 to
present. He also served as President from June 1994 to August 1996, and is
serving again as President since May 1997. Mr. Halpern also served as Executive
Vice President of Lafayette Industries from January 1992 to December 1996. From
1985 to the present, Mr. Colin Halpern has also served as the Chairman of
Universal Services Group, Inc. Mr. Colin Halpern was formerly the Chairman and
Chief Executive Officer of DRC Industries, Inc., a company which, from November
1975 through October 1985, had a Budget Rent-A-Car master license agreement for
the New York metropolitan area, including LaGuardia and John F. Kennedy
Airports.
In June 1991, the SEC sought and received, and NPS
Technologies Group, Inc. ("NPS") consented to the entering of, an order against
NPS and its officers and employees that required NPS to file certain periodic
reports with the SEC that had not been timely filed and permanently restrained
and enjoined NPS and such officers and employees from failing to file in proper
form with the SEC accurate and complete reports required to be filed by NPS
pursuant to the rules and regulations of the SEC. Mr. Colin Halpern is the
President and Director of NPS, which is currently inactive. Since June 1991,
certain of NPS' reports have not been timely filed by NPS and other reports have
not been filed in proper form. The SEC has taken no further action against NPS
or any of its officers and employees.
H. Michael Bush, age 43, has served as Chief Financial Officer
and Secretary since joining the Company in November 1995. Since May 1996, Mr.
Bush has also served as Acting President. From November 1995 to present, Mr.
Bush has also served as Chief Financial Officer/Secretary for Red Hot Concepts,
Inc., the UK licensee of Chili's Bar & Grill restaurant. In addition, Mr. Bush
is currently serving as Chief Executive Officer of the Celebrated Group Plc, the
company that merged with Red Hot Concepts, Inc. in December 1997. Prior to
joining the Company, Mr. Bush worked at Mobil Oil Corporation. He served at
Mobil in various financial capacities from 1980 through November 1995, including
Manager of Financial Analysis, Accounting Manager and Senior Tax Planning
Advisor. From 1976 through 1980, Mr. Bush worked at Unisys. Mr. Bush is a
certified public accountant.
Gerald Halpern, age 65, has served as Executive Vice President
and Director of the Company since December 1993. From April 1991 through
December 1993, he has served as Treasurer of Chinese Pompano, Inc., a fast food
restaurant and delivery company, and is responsible for financial planning and
development. He remains a director of Chinese Pompano, Inc. Mr. Gerald Halpern
served as Executive Vice President of Courter & Co., a mechanical contracting
firm from 1988 to 1990. Mr. Gerald Halpern also served for 11 years as President
of DRC Industries. Gerald Halpern and Colin Halpern are brothers. Mr. Gerald
Halpern is also a director of Live Bait.
David Coffer, age 50, has served as a Director of the Company
since February 9, 1998. From 1972 to present, Mr. Coffer has served as Chairman
of Davis Coffer Lyons, a company specializing in all property aspects relating
to restaurants, public houses, wine bars, music and dancing and leisure
23
<PAGE>
premises. Mr. Coffer is a Fellow of the Royal Institute of Chartered Surveyors,
an Associate of the Chartered Institute of Arbitrators, and President of the
Restaurant Property Advisors Society.
Bernard Goldman, age 77, has served as a Director of the
Company since February 9, 1998. From 1957 to 1979, Mr. Goldman was the Chief
Executive Officer of Goldman's Discount Department Stores, a 14-store chain
located throughout western Ohio. Presently, in addition to owning and operating
a variety of real estate investment properties, Mr. Goldman is involved with a
variety of philanthropic organizations.
Item 10. Executive and Director Compensation
Summary Compensation Table
The following table sets forth the aggregate cash compensation paid by the
Company for the fifty-two weeks ended December 28, 1997 to those executive
officers whose salary and bonus exceeded $100,000 and the Chief Executive
Officer.
<TABLE>
<CAPTION>
Long-Term Compensation
Annual Compensation Awards
Other Restricted Securities
Name and Salary Annual Stock Underlying All Other
Principal Compensation Bonus Compensation Award(s) Options Compensation
Position Year ($) ($)(1) ($)(2) ($) (#) ($)
<S> <C> <C> <C> <C> <C> <C> <C>
Colin Halpern 1997(3) 152,000 100,000 27,238 0 25,000 0
Chairman(4) 1996 96,000 0 23,283 0 10,000 0
1995 96,000 0 56,043 0 0 0
H. Michael Bush 1997 70,000 60,000 5,000 0 75,000 0
Acting President, 1996 50,000 10,000 --- 0 15,000 0
Chief Financial Officer,
Secretary
Gerald Halpern 1997 93,000 60,000 31,568 0 75,000 0
Executive Vice 1996 72,000 0 30,860 0 0 0
President 1995 72,000 0 34,814 0 0 0
<FN>
(1) Represents amounts paid under the Company bonus plan.
(2) For 1997, Colin Halpern's compensation includes $18,322 car allowance and
$8916 for insurance and for 1996 includes $15,840 car allowance and $7,443 for
insurance and for 1995 includes $15,840 car allowance, $7443 for insurance, and
$32,760 for housing allowance. For Gerald Halpern, the 1997 figure includes
$25,668 housing allowance and $5900 for insurance, the 1996 figure includes
$24,960 housing allowance and $5,900 for insurance and 1995 includes $28,914
housing allowance and $5,900 for insurance. Where no amount is given, the dollar
value of perquisites paid to the named executive officer does not exceed the
lesser of $50,000 or 10% of the total of annual salary and bonus reported for
the named executive officer.
(3) For 1997, Colin Halpern's compensation reflects $120,000 of compensation
paid to Englewood Consulting Group, Inc. ("Englewood") for consulting services.
Englewood is owned by Gail Halpern, Colin Halpern's spouse. Colin Halpern is the
sole employee of Englewood.
(4) Colin Halpern served as President from December 1993 through May 1996.
</FN>
</TABLE>
24
<PAGE>
The following tables set forth, as to the executive officers, certain
information relating to options for the purchase of Common Stock granted and
exercised during fiscal year 1997 and held at the end of fiscal year 1997.
<TABLE>
<CAPTION>
Option Grants in Last Fiscal Year
Individual Grants
Name Options % of Total Options Granted Exercise or Expiration Date
Granted to Employees in Fiscal Year Base Price
(#)
<S> <C> <C> <C> <C>
Colin Halpern 5,000(1) 4.14% $ 0.5625 1/2/07
5,000 4.14% $1.15625 4/1/07
5,000 4.14% $2.25 7/1/07
5,000 4.14% $2.00 10/1/07
H. Michael Bush 75,000(2) 27.6% $0.50 8/12/06
Gerald Halpern 75,000(2) 27.6% $0.50 8/12/06
</TABLE>
(1) Represents options granted under the Company's 1997 Non-Employee Director
Plan. Mr. Colin Halpern was not an executive officer of the Company at the time
of grant. Such options are exercisable after the first anniversary of the grant
until ten years from the date of grant.
(2) One-third of such options were exercisable on August 18, 1997, one-third are
exercisable on August 18, 1998, and the remaining one-third are exercisable on
August 18, 1999. No option is exercisable after August 18, 2006.
Aggregated Option Exercises in Last
Fiscal Year and FY-End Option Values
<TABLE>
<CAPTION>
# of securities # of securities Value of Value of
underlying underlying unexercised unexercised
unexercised unexercised in-the-money in-the-money
Shares Value options at options at option at option at
acquired on Realized FY-End FY-End FY-End (1) FY-End (1)
Name exercise (#) ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ --- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Colin Halpern 0 0 10,000 25,000 $22,500 $34,570
H. Michael 0 0 35,000 55,000 $78,750 $135,300
Bush 0 0 25,000 50,000 $59,500 $119,000
Gerald
Halpern
</TABLE>
(1) Represents the difference between the option exercise price and the closing
market price for the Company's Common Stock on December 31, 1997 ($2.875).
Director Compensation
Directors who are officers or employees of the Company receive no additional
compensation for service as members of the Board of Directors or committees
thereof. Directors who are not officers or employees of the Company receive such
compensation for their services as the Board of Directors may from time to time
determine. Non-employee directors receive an annual fee of $5,000 and a fee of
$1,000 for each board, committee, and shareholder meeting attended. During
fiscal year 1997, non-employee directors participated in
25
<PAGE>
the 1997 Non-Employee Directors Stock Option Plan (See Note 16A of Notes to
Financial Statements), which plan was adopted by the shareholders at the 1997
annual meeting of shareholders. During fiscal year 1997, Messrs. Abelman, Lazar,
Franklin and Halpern each were granted options to acquire 20,000 shares of
common stock at an exercise price of $.5625, $1.15625, $2.00 and $2.25 (5,000
shares at each price) under the plan. Mr. Flack was granted options to acquire
10,000 shares of common stock at an exercise price of $.5625 and $1.15625 (5,000
shares at each price). The exercise periods for the shares belonging to Messrs.
Abelman, Lazar, Flack and Franklin have expired.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The table below sets forth certain information as of April 1, 1998
regarding the beneficial ownership, as defined in regulations of the Securities
and Exchange Commission, of Common Stock of (i) each person who is known to the
Company to be the beneficial owner of more than 5% of the outstanding shares of
the Company's Common Stock, (ii) each director of the Company, and (iii) all
directors and executive officers as a group. On April 1, 1998, there were
7,034,324 shares of the Company's Common Stock and options outstanding. Unless
otherwise specified, the named beneficial owner has sole voting and investment
power. The information in the table below was furnished by the persons listed.
"Beneficial Ownership" as used herein has been determined in accordance with the
rules and regulations of the Securities and Exchange Commission and is not to be
construed as a representation that any of such shares are in fact beneficially
owned by any person.
<TABLE>
<CAPTION>
Names and Address of Amount and Nature of Percentage of
Beneficial Owner Beneficial Ownership Class
<S> <C> <C>
Crescent Capital, Inc.(1)(2) 4,700,000 67%
6701 Democracy Boulevard
Suite 300
Bethesda, MD 20817
Colin Halpern 10,000 *
H. Michael Bush 35,000(3) *
Gerald Halpern 25,000 *
Bernard Goldman 0 *
David Coffer 6,250(4) *
All directors and officers
as a group (4 persons) 76,250 *
</TABLE>
* Less than 1%
(1) From December 1993, Woodland Limited Partnership, a limited partnership of
which Woodland Group is the General Partner, owns approximately 92% of
Crescent's issued and outstanding shares of Common Stock. Woodland Group is
owned one-third by Mr. Jay Halpern, one-third by Ms. Nancy Gillon and one-third
by Mrs. Gail Halpern. Gail Halpern is the wife of Colin Halpern. Jay Halpern and
Nancy Gillon are the children of Gail and Colin Halpern. By reason of their
indirect ownership of approximately 92% of the outstanding stock of Crescent,
Mr. Jay Halpern, Ms. Gillon and Mrs. Halpern may be deemed to have a beneficial
interest in the shares owned by Crescent. Messrs. Halpern, Ms. Gillon and Mrs.
Halpern disclaim beneficial ownership of such securities.
26
<PAGE>
(2) On December 18, 1992, the SEC directed by Order that an investigation be
made into possible violations of certain of the federal securities laws,
including laws dealing with manipulation and false disclosure, by a number of
named individuals and entities, with respect to the securities of seven issuers,
including Crescent, and other unnamed issuers. The investigation of Crescent was
initiated prior to the time current management became affiliated with Crescent.
To date, no actions have been brought against Crescent and, insofar as Crescent
is aware, no actions have been brought against anyone involving the Company or
its securities.
(3) Represents options to purchase shares of Common Stock exercisable within 60
days of April 1, 1998.
(4) Represents options granted under the 1995 Consultants and Advisors Stock
Incentive Plan (See Note 15A in Notes to Financial Statements) prior to Mr.
Coffer becoming a director.
Item 12. Certain Relationships and Related Transactions
The Company has entered into several transactions with affiliates. The
Company believes that the terms of the transactions with affiliates are on terms
at least as favorable as could have been obtained from unaffiliated third
parties. The Company will require that in the future, transactions with
affiliates will continue to be made on terms the Company believes are at least
as favorable as those obtainable from unaffiliated third parties.
Englewood Consulting
In May 1997, the Company entered into a consulting agreement with Englewood
Consulting Group, Inc. Englewood is a Florida corporation owned by Gail Halpern,
Colin Halpern's spouse. Colin Halpern is an employee of Englewood. This
agreement continues until December 31, 1999 and is renewable for successive one
(1) year periods until terminated by either party by giving thirty (30) days
prior written notice. Colin Halpern is the sole employee of Englewood Consulting
Group, Inc. During fiscal year 1997, the Company paid $120,000 to Englewood (see
Executive Compensation).
Woodland Limited Partnership
Woodland Limited Partnership ("Woodland") is a partnership controlled
by members of Mr. Colin Halpern's family. Woodland owns approximately 92% of the
outstanding voting stock of Crescent Capital, Inc. ("Crescent"), the holder of
approximately 67% of the voting stock of the Company. Mr. Colin Halpern is the
President and sole director of Crescent. Through its ownership of the stock of
Crescent, Woodland is able to control the election of directors and any other
matter submitted for shareholder approval.
Crescent Capital, Inc.
The Company has advanced funds from time to time to Crescent. As of
December 28, 1997 the total amount due to the Company from Crescent for funds
advanced was $2,347,765. The funds were advanced on a short-term basis and are
not interest bearing. As of December 31, 1996, the amount due the Company from
Crescent was $1,839,325.
Advances to Colin Halpern
The Company has advanced funds from time to time to Mr. Colin Halpern.
At December 28, 1997, the total amount due to the Company from Mr. Colin Halpern
was $148,573 reflecting an increase of $23,557 from December 31, 1996.
27
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
3(A)(1)(2) Amended and Restated Certificate of Incorporation
of Issuer dated October 22, 1993, as amended
December 21, 1993 and July 25, 1994.
(B)(1) Bylaws of Issuer dated December 29, 1993 and
amended on June 30, 1994.
4(A)(2) Form of Common Stock Certificate
(B)(2) Class B Common Stock Purchase Warrant Specimens
(C)(2) Warrant Subscription Form
10(A)(1) Master Franchise Agreement dated December 29, 1993
between Domino's Pizza International, Inc. and
Domino's Pizza Group Limited
(B)(1) Know-How and Technical Knowledge, License and
Management Agreement dated December 29, 1993
between Domino's Pizza International, Inc. and
Domino's Pizza Group Limited
(E)(1) Loan and Exchange of Stock Agreement dated December
23, 1993 between the Company and Crescent Capital,
Inc.
(F)(1) Store Trust Agreement dated December 30, 1993
between Domino's Pizza International (UK) Limited
and DP Realty Limited
(H)(3) Stock Option and Incentive Plan
(I)(2) Unit Purchase Option
(L)(*)(**) International Franchise Systems, Inc. 1996
Consultant and Advisor Stock Incentive Plan
(M)(*)(**) International Franchise Systems, Inc. 1996
Non-Employee Director Stock Option Plan
22(1) Subsidiaries of the Issuer
- ---------------------
(1) Filed as an exhibit to the Company's Form SB-2 (File No. 33-78950) filed
with the Commission on May 13, 1994.
(2) Filed as an exhibit to Amendment No. 1 of the Company's Form SB-2 (File No.
33-78950) filed with the Commission on July 28, 1994.
28
<PAGE>
(3) Filed as an exhibit to Amendment No. 2 to the Company's Form SB-2 (File No.
33-78950) filed with the Commission on August 9, 1994.
(*) Denotes Compensatory Plans
(**) Filed herewith
(b) Reports on Form 8-K
December 10, 1997 Termination of Auditors
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the issuer has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
INTERNATIONAL FRANCHISE SYSTEMS, INC.
By:/s/H. Michael Bush
H. Michael Bush, Acting President
Date: May 7, 1998
In accordance with the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the issuer
and in the capacities and on the dates indicated.
/s/H. Michael Bush Acting President, May 7, 1998
H. Michael Bush Chief Financial Officer
and Secretary (Principal
Financial and Accounting
Officer)
/s/Colin Halpern Chairman of the Board May 7, 1998
Colin Halpern
/s/Gerald Halpern Executive Vice President May 7, 1998
Gerald Halpern and Director
/s/Bernard Goldman Director May 7, 1998
Bernard Goldman
/s/David Coffer Director May 7, 1998
David Coffer
30
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
Reports of Independent Auditors........................................... F-1
Consolidated Balance Sheets at December 28, 1997 and December 29,1996..... F-3
Consolidated Statements of Operations for the fifty-two weeks ended
December 28, 1997 and December 29, 1996................................... F-5
Consolidated Statements of Stockholders' Equity for the
period December 31, 1995 to December 28, 1997............................. F-6
Consolidated Statements of Cash Flows for the fifty-two weeks ended
December 28, 1997 and December 29, 1996................................... F-7
Notes to Consolidated Financial Statements................................ F-9
. . . . . . . . .
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Stockholders and Board of Directors of
International Franchise Systems, Inc.
We have audited the accompanying consolidated balance sheet of
International Franchise Systems, Inc. and its subsidiaries as of December 28,
1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for the fifty-two week period ended December 28, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with United States
generally accepted auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial
position of International Franchise Systems, Inc. and its subsidiaries as of
December 28, 1997, and the consolidated results of their operations and their
consolidated cash flows for the fifty-two week period ended December 28, 1997,
in conformity with United States generally accepted accounting principles.
ERNST & YOUNG
Chartered Accountants
Luton, England
May 7, 1998
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITOR'S
To the Stockholders and Board of Directors of
International Franchise Systems, Inc.
We have audited the accompanying consolidated balance sheet of
International Franchise Systems, Inc. and its subsidiaries as of December 29,
1996, and the related consolidated statements of operations, stockholders'
equity and cash flows for the fifty-two week period ended December 29, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the consolidated financial
position of International Franchise Systems, Inc. and its subsidiaries as of
December 29, 1996, and the consolidated results of their operations and their
consolidated cash flows for the fifty-two week period ended December 29, 1996,
in conformity with generally accepted accounting principles.
MOORE STEPHENS, P.C.
Certified Public Accountants
Cranford, New Jersey
March 3, 1997
F-2
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 28, 1997 AND DECEMBER 29, 1996.
<TABLE>
<CAPTION>
<S> <C> <C>
DECEMBER 28, DECEMBER 29,
1997 1996
Assets:
Current Assets:
Cash and Cash Equivalents $ 2,610,227 $ 664,123
Trade Accounts Receivable (Net of Allowances) 2,050,094 2,278,638
Franchisee Loans 707,009 1,008,990
Inventories 1,015,651 865,131
Prepaid Expenses and Other Current Assets 65,776 665,521
Due from Parent Company 2,347,765 1,839,325
Due from Officer 148,573 125,016
Other Receivables 611,690 51,475
---------------- ---------------
Total Current Assets 9,556,785 7,498,219
---------------- ---------------
Property and Equipment - At Cost 7,132,961 4,517,819
Less: Accumulated Depreciation 1,697,143 1,067,528
---------------- ---------------
Property and Equipment - Net 5,435,818 3,450,291
---------------- ---------------
Other Assets:
Deposits 308,318 637,562
Intangible Assets - Net 1,079,741 1,107,953
Investment in Marketable Securities of Parent Company 388,072 776,145
---------------- ---------------
Total Other Assets 1,776,131 2,521,660
Total Assets $ 16,768,734 $ 13,470,170
================ ===============
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
F-3
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 28, 1997 AND DECEMBER 29, 1996.
<TABLE>
<CAPTION>
DECEMBER 28, DECEMBER 29,
1997 1996
<S> <C> <C>
Liabilities and Stockholders' Equity:
Current Liabilities:
Trade Accounts Payable $ 2,691,247 $ 3,731,272
Accrued Expenses and Other Payables 1,858,441 1,114,416
Taxes Payable 1,042,354 415,771
Obligations Under Capital Leases 111,604 217,691
Current Portion of Long-Term Debt 200,629 321,621
Related Party Payable -- 29,785
----------------- ---------------
Total Liabilities 5,904,275 5,830,556
----------------- ---------------
Long-Term Liabilities:
Long-Term Debt 1,438,409 392,363
Obligations Under Capital Leases 76,843 67,877
----------------- ---------------
Total Long-Term Debt 1,515,252 460,240
----------------- ---------------
Minority Interest 751,087 --
Stockholders' Equity:
$.01 Par Value, Preferred Stock, 1,000,000 Shares Authorized,
No Shares Issued and Outstanding -- --
$.01 Par Value, Common Stock - 19,000,000 Shares
Authorized and 7,034,324 Shares Issued and Outstanding
in 1997 and 6,727,324 in 1996 70,343 67,273
Additional Paid-In Capital 6,493,041 6,489,611
Unrealized (Loss) on For-Sale Securities (388,073) --
Retained Earnings 2,148,616 372,090
Shares Held in Company Treasury (7,000) (14,000) --
Cumulative Foreign Currency Translation Adjustment 288,193 250,400
----------------- ---------------
Total Stockholders' Equity 8,598,120 7,179,374
----------------- ---------------
Total Liabilities and Stockholders' Equity $ 16,768,734 $13,470,170
================= ===============
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
F-4
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
<S> <C> <C>
Fifty-two weeks ended
December 28, December 29,
1 9 9 7 1 9 9 6
Revenue:
Sales by Company-Owned Stores $ 3,297,210 $ 3,319,001
Commissary Sales 16,943,678 12,241,320
Royalty Fees 3,960,780 2,941,971
Rental Income 2,227,129 1,364,434
Franchise Fees 506,974 516,780
Computer Sales and Other Income 1,375,494 831,328
Management Fees from Related Party 49,716 25,000
--------------- ---------------
Total Revenue 28,360,981 21,239,834
--------------- ---------------
Cost of Sales:
Company-Owned Stores 2,116,317 2,067,477
Food, Packaging and Distribution 14,649,036 10,796,422
Other Operating Expenses 4,000,654 2,901,077
--------------- ---------------
Total Cost of Sales 20,766,007 15,764,976
--------------- ---------------
Gross Margin 7,594,974 5,474,858
--------------- ---------------
General Administrative and Operating Expenses 5,898,080 4,330,783
Loss on Sale of Assets 67,078 --
Depreciation and Amortization 755,916 693,201
--------------- ---------------
Operating Income 873,900 450,874
--------------- ---------------
Other Income (Expense):
Interest Income from Parent Company 180,576 112,776
Interest Income 142,394 68,833
Interest Expense (108,977) (118,454)
Sale of Investment in Subsidiary 2,163,038 --
--------------- ---------------
Total Other Income 2,377,031 63,155
--------------- ---------------
Income Before Taxes 3,250,931 514,029
Income Taxes 656,362 --
Minority Interest 85,886 --
--------------- ---------------
Income from Continuing Operations 2,508,683 514,029
Discontinued Operations:
Loss from Operations and Closing Costs (Note 8) 162,599 653,837
--------------- ---------------
Net Income (Loss) $ 2,346,084 $ (139,808)
=============== ================
Earnings Per Share:
Income from Continuing Operations After Tax and Minority Interest .36 $ .08
Loss on Discontinued Operations (.02) (.10)
--------------- ---------------
Net Income (Loss) Per Share $ .34 $ (.02)
Weighted Average Number of Shares Outstanding 6,877,324 6,727,324
=============== ===============
Earning Per Share Assumed Dilution:
Fully Diluted Earnings Per Share .33 (.02)
Weighted Average Number of Shares Outstanding 7,056,449 6,727,324
=============== ===============
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
F-5
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Cumulative
Unrealized Foreign
Common Stock Additional (Loss) Currency Total
Number of Paid-in Retained on For Sale Translation Treasury Stockholders
Shares Amount Capital Earnings Securities Adjustments Stock Equity
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance - December 31, 1995 6,727,324 $67,273 6,489,611 $511,898 -- $31,622 -- $7,100,404
Foreign Currency Translation
Adjustment -- -- -- -- -- 218,778 -- 218,778
Net [Loss] for the fifty-two weeks
ended December 29, 1996 -- -- -- (139,808) -- -- -- (139,808)
--------- -------- ---------- ----------- --------- -------- ------- ----------
Balance - December 29, 1996 6,727,324 $67,273 6,489,611 $372,090 $250,400 -- $7,179,374
Issue of Shares to Domino's Pizza
International, Inc. 300,000 3,000 -- -- -- -- -- 3,000
Redeemed Employee Options 7,000 70 3430 -- -- -- -- 3,500
Unrealized gain/(loss)
On Available-for-Sale Securities -- -- -- -- (388,073) -- -- (388,073)
Foreign Currency Translation
Adjustment -- -- -- -- 37,793 -- 37,793
Minority Share of Reserves -- -- -- (569,558) -- -- -- (569,558)
Purchase Shares for Treasury -- -- -- -- -- -- (14,000) (14,000)
Net Income for the fifty-two weeks
ended December 28, 1997 -- -- -- 2,346,084 -- -- 2,346,084
--------- -------- ---------- ----------- --------- -------- ------- ----------
Balance - December 28, 1997 7,034,324 $ 70,343 $6,493,041 $ 2,148,616 $(388,073) $288,193 (14,000) $8,598,120
========= ======== ========== =========== ========= ======== ======= ==========
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
F-6
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Fifty-two weeks ended
December 28, December 29,
1 9 9 7 1 9 9 6
Operating Activities:
<S> <C> <C>
Net Income (Loss) Before Minority Interest After Tax $ 2,655,935 $ 514,029
--------------- ---------------
Adjustments to Reconcile Net Income (Loss) to Net Cash (Used for) Provided by
Operating Activities:
Depreciation and Amortization 921,342 917,546
Gain on Sale of Subsidiary Stock (2,163,038) --
Recovery of Bad Debts -- (46,230)
(Loss) on Disposal of Property and Equipment 67,078 (306,057)
Changes in Assets and Liabilities:
(Increase)/Decrease in:
Trade Accounts and Other Receivables 530,525 (61,787)
Inventories (150,520) (174,788)
Prepaid Expenses and Accrued Income 599,745 (327,587)
Other Assets (230,971) (206,176)
Increase (Decrease) in:
Trade Accounts Payable (1,040,025) 320,797
Accrued Expenses 744,025 355,198
Other Payables and Accrued Interest -- 129,026
Taxes Payable 626,583 79,244
--------------- ---------------
Net Cash Provided by Continuing Operations 2,560,679 1,193,215
--------------- ---------
Net Cash (Used) by Discontinued Operations (223,965) (653,837)
---------------- ---------
Net Cash - Operating Activities - Forward 2,336,714 539,378
--------------- ---------------
Investing Activities:
Proceeds from Sale of Subsidiary Stock 3,125,063 --
Purchase of Property and Equipment and Capitalized Costs (3,253,569) (1,294,141)
Cost of Disposal of Subsidiary Stock (664,873) --
Proceeds on Disposal of Property and Equipment 390,542 700,855
Advances to Officer (125,557) --
Payments by Officer 102,000 9,135
Advances to Parent Company (1,329,815) (1,025,040)
Payments by Parent Company 821,385 801,000
Payments/Advances to Related Parties (29,785) (20,000)
Payments by Related Parties -- 228,520
(Increase) Decrease in Restricted Cash -- 200,000
Purchase of Intangible Assets (82,708) (64,223)
---------------- ----------------
Net Cash - Investing Activities - Forward (1,047,317) (463,894)
---------------- ---------------
Financing Activities:
Proceeds from Sale of Common Stock 6,500 --
Purchase Shares for Treasury Stock (14,000) --
New Bank Loans 1,475,914 187,920
Repayment of Debt (550,860) (281,504)
Capital Lease Payments (97,121) (213,178)
---------------- ---------------
Net Cash - Financing Activities - Forward $ 820,433 $ (306,762)
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
F-7
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Fifty-two weeks ended
December 28, December 29,
1 9 9 7 1 9 9 6
<S> <C> <C>
Net Cash - Operating Activities - Forwarded $ 2,336,714 $ 539,378
Net Cash - Investing Activities - Forwarded (1,047,317) (463,894)
Net Cash - Financing Activities - Forwarded 820,433 (306,762)
Effect of Exchange Rate Changes on Cash (163,726) 55,486
---------------- ---------------
Net Increase (Decrease) in Cash and Cash Equivalents 1,946,104 (175,792)
Cash and Cash Equivalents - Beginning of Periods 664,123 839,915
--------------- ---------------
Cash and Cash Equivalents - End of Periods $ 2,610,227 $ 664,123
=============== ===============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the periods for:
Interest $ 108,977 $ 50,904
Income Taxes $ -- $ --
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
Acquisition of Equipment Under Capital Lease $ 84,696 $ 81,719
Receipt of Parent Company Stock in Payment of Related Party
Note for Assignment of Consulting Agreements $ -- $ 776,145
Write Down of Parent Company Stock to Market $ 388,073 $ --
</TABLE>
The Accompanying Notes are an Integral Part of These Consolidated Financial
Statements.
F-8
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Organization and Business
Corporate Structure - International Franchise Systems, Inc. ("IFS") was
incorporated in Delaware on October 22, 1993. IFS owns 85% of the stock of
Domino's Pizza Group Limited ("DP Group"), a United Kingdom ("UK") corporation
headquartered in Milton Keynes, England. DP Group owns 100% of the stock of DP
Realty Limited ("DP Realty"), DPGS Limited ("DPGS"), Livebait Limited
("Livebait"), and DP Group Developments Ltd., each a UK corporation with
headquarters at Milton Keynes, England.
Since December 1993, IFS has been a subsidiary of Crescent Capital, Inc.
("Crescent"), a Delaware corporation. Crescent trades publicly on the NASD
Electronic Bulletin Board under the symbol CRCI. At December 28, 1997, Crescent
owned 67% of the Company's common stock while the remaining 33% is publicly
traded.
Crescent was incorporated in January 1991 for the purpose of seeking business
ventures, either through the acquisition of existing businesses or the
acquisition of assets to establish subsidiary businesses. Since its acquisition
of IFS, Crescent's operations have consisted substantially of the Company's
operations.
Description and Nature of Business - The principal purpose of IFS and its
wholly-owned subsidiaries (collectively referred to as the "Company") is to be a
holding company for the exclusive right to own, operate and franchise Domino's
Pizza Stores in the U.K., and the Republic of Ireland (the "Territory") pursuant
to a Master Franchise Agreement ("MFA") (See Note 17A). The Company's
multi-national operations include the ownership and operation of Domino's Pizza
Stores, the sale of commissary food products, supplies and equipment to
franchisees and the development of new franchises. As of December 28, 1997,
there were 154 stores operating, 143 of which were franchised and 11 were
Company-owned. As of December 29, 1996, there were 127 stores operating, 116 of
which were franchised and 11 were Company-owned.
(2) Summary of Significant Accounting Policies
Cash and Cash Equivalents - Cash equivalents are comprised of certain highly
liquid investments with a maturity of three months or less when purchased.
Accounts Receivable - Substantially all accounts receivable are due from
franchisees for commissary and small wares equipment purchases and royalties.
Credit is extended based on an evaluation of the franchisee's financial
condition. The Company has a security interest in the franchise stores and their
assets as collateral. The Company considers its accounts receivable to be fully
secured.
Franchisee Loans - Franchisee loans consist of loans issued for in store
computer purchases, new loans for equipment purchases, or loans acquired from
Dominos Pizza International, Inc. which were issued to the original franchisees.
The Company has a security interest in the franchise stores and their assets as
collateral. The Company considers their franchisee loans to be fully secured.
Inventories - Inventories, which consist primarily of food products and
equipment for resale to franchises, are stated at the lower of cost, determined
by the first-in, first-out basis or market value.
Property and Equipment and Depreciation - Property and equipment are stated at
cost. Depreciation is computed primarily using the straight-line method over the
estimated useful lives of the assets, which range from 3 to 7 years. Leasehold
improvements are amortized using the straight-line method over the lesser of the
term of the related lease or the estimated useful lives of the improvements.
Master Franchise Agreement - The MFA is stated at cost that includes associated
professional costs. One-third of the cost of the MFA has been allocated to the
exclusive development rights under the MFA
F-9
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #2
(2) Summary of Significant Accounting Policies (Continued)
and is being amortized over a ten-year period and the expiring date of the
agreement is the year 2003. The remaining two-thirds of the cost of the MFA has
been allocated to the right to operate as sub-franchisor in the Territory and is
being amortized over a twenty-year period. Amortization expense for the
fifty-two weeks ended December 28, 1997 and December 29, 1996 was $79,559 and
$72,000, respectively (See Note 17A).
Consulting Agreements - The Company had entered into various consulting
agreements which were being amortized over the life of the agreements. The
Company assigned these assets to Woodland Limited Partnership ("Woodland"), a
related party, at their net book value on April 1, 1996 (See Note 17C).
Amortization expense for the fifty-two weeks ended December 28, 1997 and
December 29, 1996 was $-0- and $51,563, respectively.
Rights to Store Leases - The rights to store leases are stated at cost and are
being amortized over a ten-year period (the average length of the remaining term
under the leases) under the straight-line method. Amortization expense for the
fifty-two weeks ended December 28, 1997 and December 29, 1996 is $14,419 and
$13,439, respectively.
Store Franchise Agreement - The Store Franchise Agreement represents the cost of
the franchise fees paid for corporate-owned stores. The cost of the franchise
fees range from $4,650 to $12,400 per store. These costs are amortized over the
term of the franchise agreements, which is ten years. Amortization expense for
the fifty-two weeks ended December 28, 1997 and December 29, 1996 is $8,306 and
$7,210, respectively.
Store Development Costs - Store development costs, which represent expenses
incurred before a new store opens, including design and construction costs, are
amortized on a straight-line basis over three years. Amortization expense for
the fifty-two weeks ended December 28, 1997 and December 29, 1996 is $7,345 and
$30,075, respectively.
Goodwill - Goodwill represents the excess of the price paid for a corporate
store over the fair value attributed to the assets acquired, and is being
amortized using the straight-line method over ten years. Amortization expense
for the fifty-two weeks ended December 28, 1997 and December 29, 1996 is $1,293
and $1,253, respectively.
Marketable Securities - Statement of Financial Accounting Standards ("SFAS") No.
115 addresses the accounting and reporting for investments in equity securities
that have readily determinable fair values and for all investments in debt
securities. Those investments are classified into the following three
categories: held-to-maturity debt securities; trading securities; and
available-for-sale securities.
Management determines the appropriate classification of its investments in debt
and equity securities at the time of purchase and reevaluates such determination
at each balance sheet date. Debt securities for which the Company does not have
the intent or ability to hold to maturity are classified as available for sale,
along with the Company's investment in equity securities. Securities available
for sale are carried at fair value, with any unrealized holding gains and
losses, net of tax, reported in a separate component of shareholders' equity
until realized. Trading securities are securities bought and held principally
for the purpose of selling them in the near term and are reported at fair value,
with unrealized gains and losses included in operations for the current year.
Held-to-maturity debt securities are reported at amortized cost. The Company's
investments at December 28, 1997 consisted of equity securities in Crescent
which are classified as available for sale and were stated at estimated fair
value (See Note 11).
F-10
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #3
(2) Summary of Significant Accounting Policies (Continued)
Revenue Recognition - Revenue from commissary sales is recognized upon shipment
of products and company-owned store sales are recognized at point of sale.
Franchise fees consist of initial franchise fees which are recognized in income
when the Company has substantially completed its obligations under the franchise
agreement. This generally occurs upon the opening of a franchise location at
which time the Company has completed its obligation to assist with the location
and design of the new store and the training of staff. Royalty fees are earned
on sales by franchisees and is recognized as revenue when the related sales are
made. Rental income, which consists of rent paid under subleases (See Note 7) is
recognized ratably over the lease period. Other operating income consists
primarily of computer system sales which is recognized at point of installation.
Advertising Costs - Advertising costs are expensed as incurred and are offset by
a fee of 4% of royalty sales by franchisees, which amount must be spent on the
franchise's behalf for various advertising programs. If advertising costs exceed
the fees received at a given point, a receivable to the franchisor is recorded
from the franchisee on the Company books for the amounts still due. Similarly if
at a given point, more fees are received than have been expended, a payable to
the franchisee is recorded. This amount is included in other receivables or
other payables.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
Earnings (Loss) Per Share - Earnings (loss) per share of common stock is based
on the weighted average number of common shares outstanding for the period
presented. Common stock equivalents are included in the computation when their
effect is considered dilutive. Fully diluted earnings/(loss) per share is
calculated in accordance with FAS128, taking into account the impact of any
additional common stock that would have been outstanding if the dilutive
potential common stock had been issued.
Foreign Currency Translation - The functional currency for the Company's foreign
operations is the British pound sterling. The translation from British pound
sterling into U.S. dollars is performed for balance sheet accounts using current
exchange rates in effect at the balance sheet date and for revenue and expense
accounts using a weighted average exchange rate during the period. The gains or
losses resulting from such translation are included in stockholders' equity.
Equity transactions denominated in British pound sterling have been translated
into U.S. dollars using the effective rate of exchange at date of issuance.
Impairment - Certain long-term assets of the Company are reviewed at least
annually as to whether their carrying value has become impaired, pursuant to
guidance established in SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets." Management considers assets to be impaired if the carrying
value exceeds the future projected cash flows from related operations
(undiscounted and without interest charges). If impairment is deemed to exist,
the assets will be written down to fair value or projected discounted cash flows
from related operations. Management also re-evaluates the periods of
amortization to determine whether subsequent events and circumstances warrant
revised estimates of useful lives. As of December 28, 1997, management expects
these assets to be fully recoverable.
Stock Options Issued to Employees - The Company adopted SFAS No. 123 on January
1, 1996 for financial note disclosure purposes and will continue to apply the
intrinsic value method of Accounting Principles Board ("APB") Opinion No. 25 for
financial reporting purposes.
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
F-11
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #4
(2) Summary of Significant Accounting Policies (Continued)
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Reclassification - Certain items in the prior year's financial statements have
been reclassified to conform with the current year's presentation.
(3) Significant Risks and Uncertainties
(A) Concentrations of Credit Risk - Cash - The Company had approximately $1.9
million on deposit at National Westminster Bank, Plc, a U.K. bank at December
28, 1997. Neither the bank nor the UK government insures the deposits under a
program similar to the Federal Deposit Insurance Corporation. Thus, the $1.9
million is subject to loss due to credit risk. The Company does not require
collateral in relation to cash credit risk.
(B) Concentrations of Credit Risk - Receivables - The Company routinely assesses
the financial strength of its franchisees and, based upon factors surrounding
the credit risk of its franchisees, establishes an allowance for uncollectible
accounts and, as a consequence, believes that its accounts receivable credit
risk exposure beyond such allowances is limited. The Company has a security
interest in franchised stores and their assets are collateral for the
receivable.
(C) DPII Relationship - Due to the nature of franchising and the Company's
agreements with DPII, the success of the Company is in part dependent upon the
overall success of DPII, including DPII's financial condition, management and
marketing success, and the successful operation of stores opened by other
franchisees.
(D) Potential Loss of Exclusive Development Rights - The Company's business plan
is dependent on its exclusive development rights under the MFA. The MFA requires
that the Company have opened and operating a minimum number of Domino's stores
in accordance with a specified yearly schedule. The Company was obligated for
the year ended December 28, 1997 to have a total of 146 delivery stores opened.
As of that date, the Company had 154 stores opened, of which 148 were delivery
stores, including 11 of which were Company owned. There can be no assurance that
the Company will be successful in opening the number of Domino's Stores
required, or that new Domino's stores opened by the Company or its franchisees
will be operated profitably. Furthermore, there can be no assurance that the
Company will be able to renew the MFA beyond December 31, 2006. If the MFA is
not renewed, the Company would lose its exclusive development rights.
(E) Operations in a Foreign Country - The Company is subject to numerous factors
relating to conducting business in a foreign country (including, without
limitation, economic, political and currency risks), any of which could have a
significant impact on the Company's operation.
The Company's U.K. operating subsidiary, DP Group, is subject to U.K.
corporation tax on its profits. The Company has used and expects DP Group to be
able to continue to use the tax loss carryforwards previously held by its
predecessor and carried over to DP Group to offset some of its future tax
payments. However, there can be no guarantee that DP Group will be profitable to
be able to continue to use the carryforward tax losses.
Currently, DP Group's operations are subject to the laws and regulations of the
Territory and the European Union, including such laws and regulations relating
to antitrust and trade regulation. The failure by DP Group to comply with these
laws may cause the Company to be unable to enforce its franchise agreements with
franchisees. The Company and its franchisees are also subject to U.K. government
and local laws and regulations generally. Store operations are subject to
health, sanitation, employment and safety standards imposed by the European,
national and local authorities. These
F-12
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #5
regulations and any new laws and regulations could have a significant financial
impact on the operation of the Company owned and franchised stores.
(4) Property and Equipment
The following details the composition of property and equipment:
<TABLE>
<CAPTION>
Cost Depreciation Net
<S> <C> <C> <C>
Land and Buildings $ 2,079,183 $ 1,522 $ 2,077,661
Equipment, Fixtures and Furnishings 2,473,404 1,074,573 1,398,831
Capital Leases 710,479 298,520 411,959
Leasehold Improvements 1,745,603 265,793 1,479,810
Motor Vehicles 124,292 56,735 67,557
-------------- --------------- --------------
Totals $ 7,132,961 $ 1,697,143 $ 5,435,818
============== =============== ==============
</TABLE>
Depreciation expense for the fifty-two weeks ended December 28, 1997 and
December 29, 1996 was $810,422 and $533,195, respectively.
(5) Intangible Assets
Intangible assets, at December 28, 1997, consists of the following:
<TABLE>
<CAPTION>
Write-offs
Accumulated and
Cost Amortization Assignments Net
<S> <C> <C> <C> <C>
Master Franchise Agreement $ 1,200,698 $ 320,183 $ -- $ 880,515
Rights to Store Leases 144,188 41,509 -- 102,679
Store Franchise Agreement 49,362 6,754 -- 42,608
Store Development 79,675 31,871 3,535 44,269
Goodwill 13,163 3,493 -- 9,670
-------------- -------------- --------------- --------------
Totals $ 1,487,086 $ 403,810 $ 3,535 $ 1,079,741
============== ============== =============== ==============
</TABLE>
(6) Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 28,
1 9 9 7
<S> <C>
Note Payable to Domino's Pizza International, Inc. for the
Master Franchise Agreement $ --
Loans Payable to National Westminster Bank 1,639,038
---------------
Total 1,639,038
Less: Current Portion 200,629
Long-Term $ 1,438,409
===============
</TABLE>
F-13
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #6
(6) Long-Term Debt (Continued)
The note payable to Domino's Pizza International, Inc. for the MFA was
originally for $650,000 of which $300,000 was paid on January 17, 1995 and
$350,000 is payable in installments of approximately $29,000 for twelve
consecutive quarters beginning on January 1, 1995, with interest at the rate of
8% per annum payable on the installment dates. Total installment payments of
$116,667 were made as of December 28, 1997. The note has been completely paid
off.
The Company has various loans payable to National Westminster Bank ("NatWest")
of $1,639,038 at December 28, 1997. The loans are payable over terms of 3 to 15
years in aggregate monthly installments of approximately $25,950. Interest on
one loan is 9.75% per annum and the second loan carries interest at 9.875% per
annum while the other loans bear interest at the bank's base rate plus 3%. The
Company has secured a 15-year mortgage on the purchase of land for the new
commissary. This loan carries an interest rate of 8.75%. The bank's base rate at
December 28, 1997 was 5.5%. The obligations to NatWest are secured by all of the
assets of DP Group, DP Realty, DPGS, and DP Group Developments Ltd.
Additionally, the Chairman of the Company has personally guaranteed these
obligations to a maximum of approximately $42,000.
The following are maturities of long-term debt for the next fourteen years:
December
1998 $ 200,629
1999 218,183
2000 200,087
2001 138,214
2002 85,540
Over 2002 796,385
----------
Total $1,639,038
==========
(7) Leases
The Company is the lessee of motor vehicles and equipment under capital leases
expiring in various years through 1999. The assets and liabilities under capital
leases are recorded at the present value of the minimum lease payments. The
assets are depreciated over the shorter of their related lease terms or their
estimated productive lives.
Depreciation of assets held under capital leases is included in depreciation
expense.
Following is a summary of property held under capital leases at December 28,
1997:
Equipment and Motor Vehicles $ 710,479
Less: Accumulated Depreciation 298,520
----------------
Net $ 411,959
================
F-14
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #7
(7) Leases (Continued)
Minimum future lease payments under capital leases as of December 28, 1997 for
each of the next five years and in the aggregate are:
<TABLE>
<CAPTION>
Year Ended
December Amount
<S> <C>
1998 111,604
1999 79,692
2000 21,460
2001 --
2002 --
Subsequent to 2002 --
---------------
Total Minimum Lease Payments $ 212,756
Less: Amount Representing Interest 24,308
---------------
Present Value of Net Minimum Lease Payment $ 188,448
===============
</TABLE>
Interest rates on capitalized leases vary from 3% to 8% and are imputed based on
the lower of the Company's incremental borrowing rate at the inception of each
lease or the lessor's implicit rate of return.
The Company has a one-year operating lease for its U.S. office that expires on
June 30, 1998 and is renewable year-to-year.
The Company leases land and buildings, office equipment and motor vehicles under
operating leases expiring in various years through 2022.
The Company leases store properties directly, through a subsidiary, DP Realty,
and then subleases the properties to franchisees. At December 28, 1997, the
Company had operating leases for approximately 115 stores with periods ranging
from 10 to 25 years, of which 108 were also subject to subleases to the
franchisees and the balance are used for Company-owned stores. The subleases are
for an initial ten year period, consistent with the franchisee period, with a
subsequent ten year renewal period. Total minimum future rental income, as shown
below, from subleases to be received in the future under non-cancelable
subleases assumes the subleases are for the initial ten year period only,
although the Company believes that the franchisees will exercise the renewal
option on substantially all subleases. Also included below is the minimum future
rental payments and sublease rental income for the building where the Pizzazz
restaurant was located (See Notes 8 and 17D).
Minimum future rental payments and sublease rental income under non-cancelable
operating leases and subleases, respectively, having remaining terms in excess
of one year as of December 28, 1997 for each of the next five years and in the
aggregate are as follows:
<TABLE>
<CAPTION>
Operating
Year ending Leases Subleases
December
<S> <C> <C>
1998 2,857,008 2,518,138
1999 2,823,414 2,510,323
2000 2,781,389 2,481,186
2001 2,682,864 2,467,131
2002 2,654,706 2,467,131
Subsequent to 2002 21,056,121 19,657,529
--------------- ----------------
Total Minimum Future Rentals $ 34,855,502 $ 32,101,438
=============== ================
</TABLE>
F-15
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #8
(7) Leases (Continued)
Rent expense for the fifty-two weeks ended December 28, 1997 and December 29,
1996 was $2,354,765 and $1,889,624, respectively. The rental income received on
subleases for the fifty-two weeks ended December 28, 1997 and December 29, 1996
was $2,227,129 and $1,639,953, respectively.
(8) (A) Discontinued Operations - Pizzazz Concept
On May 31, 1996, the Company's Board of Directors approved the Company's
recommendation to discontinue the development of the Pizzazz concept and the
operation of the Pizzazz restaurant. The primary purpose for the closure of the
restaurant and the cessation of the concept development was to ensure that
management's time was not redirected from the primary focus of developing the
Domino's brand and delivery store franchise network. On June 3, 1996, the
Company closed the restaurant. The Company continues to have an obligation for
the property under the lease that expires in fifteen years. The Company has been
able to secure a subtenant for the property beginning in April 1997. The
sublease runs concurrent with the Company's lease. The income from the sublease
is approximately $130,000. The annual cost of the lease is approximately
$87,000.
The results of operations of Pizzazz were treated as discontinued operations in
the accompanying financial statements and are presented net of any related
income tax expense. The prior year results of operations and statement of cash
flows have been reclassified to conform to this method of presentation. The
discontinued Pizzazz concept had net property and equipment of $575,671 as of
December 28, 1997. These assets have been reclassified as rental assets from the
start of the sublease agreement. The loss from discontinued operations consists
of:
<TABLE>
<CAPTION>
1997 1996
------------------ -----------
<S> <C> <C>
Revenues $ 96,250 $ 103,874
Cost of Sales 80 170,583
Operating Expenses 248,919 429,362
Estimated Closing Costs -- 135,270
--------------- ----------------
Net Before Taxation Effects $ (152,749) $ (631,341)
The taxation benefit from the losses was: 41,853 --
--------------- ----------------
Total (110,896) (631,341)
================ =================
</TABLE>
The Company is obligated under a 15-year lease on the building where the
restaurant was located. However it is anticipated that a sublease will offset
these expenses (See Note 17D).
(8) (B) Discontinued Operations -Haagen Dazs
In August 1995, the Company entered into an agreement with an unrelated entity
to purchase all of the assets and operating rights of three Haagen Dazs ice
cream parlors for approximately $140,000. The Company, however, sold one Haagen
Dazs parlor back to the master franchisor in the UK because the Company feels,
at this time, that management's attention and resources must be focused on the
core business of delivery pizza stores. The Company sold the other two Haagen
Dazs units in December 1997. The results of operations for the Haagen Dazs units
have been treated as discontinued operations for the fifty-two weeks ended
December 28, 1997:
F-16
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #9
<TABLE>
<CAPTION>
1997 1996
--------------- ----------------
<S> <C> <C>
Revenues $ 816,158 $ 1,532,361
Cost of Sales 551,732 967,653
Operating Expenses 335,642 587,204
--------------- ----------------
Net Before Taxation Effects $ (71,216) $ (22,496)
- ---------------------------
The taxation benefit from the losses was: 19,513 --
--------------- ----------------
Total (51,703) (22,496)
================ =================
</TABLE>
The Statements of Operations and Cash Flows for the year ended December 29, 1996
has been reclassified to reflect the treatment of the Haagen Dazs income as
discontinued operations.
(9) Fair Value of Financial Instruments
Generally accepted accounting principles require disclosing the fair value of
financial instruments to the extent practicable for financial instruments which
are recognized or unrecognized in the balance sheet. The fair value of the
financial instruments disclosed herein is not necessarily representative of the
amount that could be realized or settled, nor does the fair value amount
consider the tax consequences of realization or settlement.
In assessing the fair value of these financial instruments, the Company used a
variety of methods and assumptions, which were based on estimates of market
conditions and risks existing at that time. For certain instruments, including
cash and cash equivalents, trade receivables and trade payables and officer
advances, it was estimated that the carrying amount approximated fair value for
the majority of these instruments because of their short maturities. For
long-term investment in marketable securities, fair value is estimated based on
current quoted market price.
Management estimates that the carrying value of its long-term debt, related
party debt and amounts due from parent approximate its fair value because the
applicable interest rates approximates the current market rates.
(10) Related Party Transactions
Woodland Limited Partnership ("Woodland") is a partnership controlled by members
of Mr. Colin Halpern's family. Mr. Halpern is the Chairman of the Board of the
Company.
As of December 28, 1997, Woodland owns 92% of the shares of Crescent.
As of December 28, 1997, Crescent owns 4,700,000 restricted shares, or
approximately 67%, of IFS's outstanding stock. As a result of the capital
structures of the Company and Crescent, Woodland has indirect voting control of
the Company and, consequently, can elect the Company's entire Board of
Directors, determine the vote on any matter submitted for shareholder approval
(including increasing the Company's authorized capital stock and authorizing any
merger, sale of assets or dissolution of the Company), and, generally, direct
the affairs of the Company.
The Company has advanced funds to Crescent. These funds are to be paid on a
short-term basis and are interest bearing at 8% per annum beginning January 1,
1996. At December 28, 1997, the total amount due to the Company from Crescent
was $2,347,765 including accrued interest of $352,590. At December 29, 1996, the
balance due from Crescent was $1,839,325 including accrued interest of $172,014.
Interest income was $180,576 for the fifty-two weeks ended December 28, 1997 and
$112,776 for December 31, 1996. In December 1997, the Company and Crescent
renegotiated the payment terms for the short-term advances. A promissory note
was executed and collateralized with the
F-17
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #10
(10) Related Party Transactions (Continued)
pledge of IFS shares to secure the monies due. For the fifty-two weeks ended
December 29, 1996, the Company charged Crescent a management fee of $5,000 for
administrative services which was included in Other Operating Income. There was
no management fee paid in 1997.
Mr. Halpern is the President and Chairman of the Board of Red Hot Concepts, Inc.
("Red Hot"). The Chief Financial Officer of International Franchise Systems is
also the Chief Financial Officer of Red Hot. The charge for his services is
allocated between the two companies.
The Company has advanced funds to Mr. Halpern. At December 28, 1997, the total
amount due to the Company is approximately $148,573. This amount is being offset
through reimbursements due to Mr. Halpern.
Mr. Halpern's son is an attorney with a law firm that provides legal services to
the Company. Legal expense incurred with this firm for the fifty-two weeks ended
December 28, 1997 was $135,108.
(11) Investment in Marketable Securities of Parent Company
In September 1996, the Company received from Woodland, 51,743 shares of Crescent
Class A Common Stock in payment of Woodland's interest bearing note for the
assignment of the three consulting agreements (See Note 17C). The Company
classifies its investment in Crescent as available for sale securities pursuant
to SFAS No. 115. The number of shares to be received in payment of the Woodland
loan of $776,145, was estimated using the market value of Crescent's shares on
the open market. The Company's intention is to hold these securities for a least
a twelve month period. The Company has written down the value of the Crescent
shares by $388,073 to the estimated market value as of December 28, 1997.
(12) Income Taxes and Provision for Income Taxes
<TABLE>
<CAPTION>
1997 1996
$ $
The current year taxation charge consists of the following:
<S> <C> <C>
Continuing Operations
- - United States 182,000 0
- - United Kingdom 474,362 0
--------------- ----------------
$656,362 $0
Discontinued Operations
- - United States 0 0
- - United Kingdom (61,366) 0
---------------- ----------------
$(61,366) $0
Total Income Tax Charge $594,996 $0
=============== ================
</TABLE>
Rate Reconciliation:
The following is an analysis of the differences between United States statutory
income tax rate and the Company's effective tax rates on continuing operations.
F-18
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #11
(12) Income Taxes and Provision for Income Taxes (Continued)
<TABLE>
<CAPTION>
%
<S> <C>
United States statutory income tax rate 35.0
Permanent differences 5.1
Utilization of net operating losses carried forward
of UK operations (4.3)
Net US operating losses utilized against extraordinary income 11.8
Other operating unprovided timing differences (1.9)
Difference in effective tax rate of UK operations 1.9
-----------------
Effective tax rate on continuing activities 20.2
=================
</TABLE>
Pursuant to United States tax laws, if the Company's subsidiaries organized
under the laws of the UK are not engaged in business in the United States,
profits of such subsidiaries will not be subject to United States taxation,
until distributed as dividends. The Company however, would receive a credit
against its UK federal income tax liability that would otherwise result from any
distributions from its subsidiaries for any UK corporate taxes paid by its UK
subsidiaries on these distributions, as well as for any UK dividend and royalty
withholding taxes imposed directly on the Company.
The Company through its UK subsidiary is a tax payer in the United Kingdom. The
Company's estimated tax liability for the 1997 tax year is $413,000. There are
tax losses available to carryforward indefinitely against future UK profits
amounting to $210,980.
(13) Gain on Sale of Portion of Investment in Subsidiary
<TABLE>
<CAPTION>
<S> <C> <C>
1997 1996
---------------- ----------------
Profit on Sale of 15% of the
investment in Domino's Pizza Group (UK) 2,163,038 0
Taxation Thereof (182,000) 0
---------------- ----------------
Gain After Taxation 1,981,038 0
=============== ================
</TABLE>
$1.1 million of net operating losses brought forward in the US were utilized
against this income for taxation purposes.
(14) Stock Transactions
On December 30, 1994, the Company completed the first phase of an initial public
offering (the "Offering") of its common stock. The Company sold 1,017,681 units,
each unit consisting of one share of common stock and two common stock purchase
warrants, at an initial public offering price of $5 per unit. Net proceeds from
the first phase of the Offering (after deducting the underwriting discounts of
$585,167 and expenses of $883,673) were $3,619,565. On January 17, 1995, the
Company completed the second phase of its initial public offering and sold an
additional 59,643 units. Net proceeds from these additional units (after
deducting the underwriting discounts of $76,210 and expenses of $44,855) were
$177,150. Additional costs for both the first and second phase relating to the
offering of $244,831 were paid during 1995 reducing paid-in capital.
On May 12, 1995, the Company issued 237,500 shares of common stock valued at
$350,000 in connection with entering into a four year consulting agreement.
On June 5, 1995, the Company issued 237,500 shares of common stock valued at
$475,000 in connection with entering into a five year consulting agreement.
F-19
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #12
(14) Stock Transactions (Continued)
During October 1995, the Company issued 475,000 shares of common stock valued at
$1,900,000 and received cash of $1,781,250 in connection with entering into a
five year consulting agreement (See Notes 11 and 17C).
During July 1997, the Company issued 300,000 shares of common stock valued at a
market price of $300,000 to DPII with put/call provisions that can be exercised
in May 2001 at a cost of $1.2 million. This was in connection to a modification
of the franchise agreement that altered the royalty rate, store opening costs
and development schedule. This was recorded on the Company's books and records
at a par value of $3,000 (See Note 17A).
In December 1997, three employees of the Company who were issued share options
under the 1997 Stock Plan, exercised their options. The Company purchased these
shares (7,000) as Treasury Stock.
(15) Stock Options and Warrants
(A) Stock Options - In order to attract, retain and motivate employees
(including officers), directors and consultants who perform substantial services
for or on behalf of the Company, the Company adopted the 1995 and 1996
Non-Employee Directors Stock Option Plans, the 1994 Stock Incentive Plan and the
1995 Consultants and Advisors Stock Incentive Plan (the "Director Plan", the
"Stock Plan" and the "Consultants Plan", respectively).
The 1994 Stock Plan was terminated effective December 31, 1996 and replaced by
the 1997 Stock Plan. Pursuant to the 1997 Stock Plan, officers and key employees
of the Company are eligible to receive awards of stock options (with or without
limited stock appreciation rights). Options granted under the Stock Plan may be
"incentive stock options" ("ISO"), or non-qualified stock options ("NQSO").
Limited Stock Appreciation Rights ("LSARs") may be granted simultaneously with
the grant of an option or (in the case of NQSOs) at any time during its term.
The Company's acting president and chief financial officer was granted an ISO
for 15,000 shares at $1.25 per share on March 8, 1996 and for 75,000 shares at
$.50 per share on January 28, 1997, which approximated the market value of the
shares on that date. Both option grants become exercisable at the rate of 33%
per year and are generally exercisable over a ten-year period.
The 1995 Director Plan was terminated effective December 31, 1996. At the same
time, the 1996 Director Plan was declared void and replaced by the 1997 Director
Plan (See Note 15A). Under the 1997 Directors Plan, only NQSOs can be granted.
The 1995 Consultants Plan was amended, effective April 29, 1997 to make
additional shares available for grant under that plan. Under this Plan, either
stock or NQSOs can be granted to eligible consultants and advisors.
The Company has reserved 800,000 shares of the Common Stock for issuance of
awards under the 1997 Stock Plan, 300,000 shares of Common Stock under the
Director Plan and 250,000 shares of Common Stock under the Consultants Plan
(subject to anti-dilution and similar adjustments).
The 1997 Stock Plan, 1997 Director Plan and the 1995 Consultants Plan (as
amended) are administered by a committee (the "Committee"), established by the
Company's Board of Directors. Subject to the provisions of the 1997 Stock Plan
and the 1995 Consultants Plan (as amended), the Committee determines the type of
award, when and to whom awards will be granted, and the number of shares covered
by each award, the terms, provisions and kind of consideration payable (if any),
with respect to awards. The Committee has sole discretionary authority to
interpret each of the Plans and to adopt rules and regulations related thereto.
Under the 1997 Director Plan, any nonemployee member of the
F-20
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #13
(15) Stock Options and Warrants (Continued)
the Board of Directors is automatically granted a NQSO for 5,000 shares on the
first business day of January, April, July and October of each year.
An option may be granted under the 1997 Stock Plan and the 1995 Consultants Plan
(as amended) on such terms and conditions as the Committee may approve, and
generally may be exercised for a period of up to 10 years from the date of
grant. Generally, options will be granted under the Stock Plan with an exercise
price equal to the "Fair Market Value" (as defined in the Plan) on the date of
grant. The exercise price for options granted under the Consultants Plan may not
be less than 60% "Fair Market Value" (as defined in the Plan) on the date of
grant. In the case of ISOs granted under the Stock Plan, certain limitations
will apply with respect to the aggregate value of option shares which can become
exercisable for the first time during any one calendar year, and certain
additional limitations will apply to "Ten Percent Stockholders" (as defined in
the Stock Plan). The Committee may provide for the payment resulting from the
exercise of the option in cash, by delivery of other common stock having fair
market value equal to such option price or by a combination thereof.
An option granted under the 1997 Stock Plan or the 1995 Consultants Plan (as
amended) shall be exercisable at such time or times as the Committee, in its
discretion, shall determine, except that no stock option shall be exercisable
after the expiration of ten years (five years in the case of an incentive stock
option granted to a "Ten Percent Employee", as defined in the Stock Plan) from
the date of the grant. The Stock Plan contains special rules governing the time
of exercise in the case of death, disability or other termination of employment
and also provides for acceleration of the exercisability of options upon certain
events involving a change in control of the Company. Options granted under the
1997 Director Plan are exercisable one year after the grant is made for a period
of nine years. The Director Plan also contains special exercise rules in the
event of death or other termination.
The Company's Board of Directors may at any time and from time to time suspend,
amend, modify or terminate the Plans. However, to the extent required by the
Securities Exchange Act of 1934 or other applicable law, no such amendment shall
be effective unless approved by the holders of a majority of the issued and
outstanding securities of the Company entitled to vote. In addition, no such
change may adversely affect any option previously granted, except with the
written consent of the optionee or be made to extent inconsistent with the
Securities laws or other applicable law.
Information pertaining to options as of December 28, 1997 and for the year then
ended is as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Remaining
Contractual
Exercisable Life
Common Exercise Prices Stock of Options
Shares Per Share Options Outstanding
Options Outstanding - January 1, 1996 40,000 $5.94 40,000 8.5 years
Options Granted 65,000 0.63-1.25 -- 9.25-9.5 years
----------- ---------- --------- -----------------
Options Outstanding - January 1, 1997 105,000 0.63-5.94 40,000 8.25-8.5 years
Options Granted 514,000 .50-2.25 96,333 9.5 years
Options Exercised (7,000) .50 -- --
Options Canceled (135,000) -- -- --
----------- ---------- --------- -----------------
Options Outstanding - December 31, 1997 477,000 $.50 -5.94 141,333 8.25 - 9.5 years
=========== ========== ========= =================
</TABLE>
At the 1997 grant dates, the weighted average fair value of the above options
was $.80. No compensation cost was recognized in income. The weighted average
exercise price for options outstanding at December 28, 1997 was $0.893 per
share.
F-21
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #14
(15) Stock Options and Warrants (Continued)
Had compensation cost been determined on the basis of fair value pursuant to
SFAS No. 123, net income and earnings per share would have been as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
For the Fifty-Two Weeks Ended
December 28, December 29,
1 9 9 7 1 9 9 6
------- -------
Net (Loss) Income:
As Reported $ 2,346,084 $ (139,808)
============== ================
Pro Forma $ 2,326,001 $ (183,008)
============== ================
(Loss) Earnings Per Share:
As Reported $ .34 $ (.02)
============== ================
Pro Forma $ .34 $ (.03)
============== ================
</TABLE>
The fair value used in the pro forma data was estimated by using an option
pricing model which took into account as of the grant date, the exercise price
and the expected life of the option, the current price of the underlying stock
and its expected volatility, expected dividends on the stock and the risk-free
interest rate for the expected term of the option. The following is the average
of the data used for the following items.
Risk-Free Expected Expected Expected
Interest Rate Life Volatility Dividends
1997 6.63% 5 Years 139.4% --
1996 6.63% 10 Years 81.99% --
(B) Common Stock Purchase Warrants - As of December 28, 1997, there were
1,077,324 Class B warrants outstanding, which were issued on December 30, 1994
as part of a public offering. Holders of each Class B warrant are entitled to
purchase one share of common stock at $10.00 per share until December 9, 1999.
No warrants were exercised during the fifty-two week periods ended December 28,
1997 or December 29, 1996.
In connection with the public offering, the Company granted 107,732 unit options
to Patterson Travis, Inc., the Company's Underwriter, as part of the
Underwriting Agreement dated September 9, 1994. The exercisable price of these
options is $8.25 per unit.
(16) Operations by Geographic Area
The summary of financial information for the Company's operations by geographic
area is as follows:
For the fifty-two weeks ended December 28, 1997:
<TABLE>
<CAPTION>
United
United States Kingdom Eliminations Consolidated
<S> <C> <C> <C> <C>
Revenue $ 441,804 $ 28,360,981 $ (441,804) $ 28,360,981
Operating Profit (Loss) $ 1,076,828 $ 1,732,299 $ 441,804 $ 3,250,931
Net Income $ 1,250,745 $ 1,095,339 $ -- $ 2,346,084
Assets $ 6,637,173 $ 11,179,130 $ (1,037,070) $ 16,779,233
Liabilities $ 345,620 $ 6,691,379 $ (1,132,724) $ 5,904,275
Company's Investment in
Foreign Subsidiaries $ 1,683,863 $ -- $ (1,683,863) $ --
</TABLE>
F-22
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #15
(16) Operations by Geographic Area (Continued)
For the fifty-two weeks ended December 29, 1996:
<TABLE>
<CAPTION>
United
United States Kingdom Eliminations Consolidated
<S> <C> <C> <C> <C>
Revenue $ 500,534 $ 21,263,864 $ (524,564) $ 21,239,834
Operating Profit (Loss) $ (669,428) $ 488,951 $ -- $ (180,477)
Net (Loss) Income $ (585,100) $ 445,292 $ -- $ (139,808)
Assets $ 5,501,197 $ 10,460,791 $ (2,491,818) $ 13,470,170
Liabilities $ 161,192 $ 6,841,905 $ (712,301) $ 6,290,796
Company's Investment in
Foreign Subsidiaries $ 1,981,016 $ -- $ (1,981,016) $ --
</TABLE>
(17) Commitments and Contingencies
(A) Master Franchise Agreement - The relationship between the Company and
Domino's Pizza International, Inc.("DPII") is governed principally by the MFA.
The MFA requires that during the 10-year period ending December 2006, the
Company shall open and operate a minimum number of Domino's pizza stores in
accordance with a yearly schedule. If the Company does not meet the development
schedule, Domino's may terminate the Company's exclusive right to operate and
franchise additional Domino's Stores in the Territory. The Company was obligated
for the year ended December 28, 1997 to have a total of 146 delivery stores
opened. As of that date, the Company had 154 stores opened of which 148 were
delivery stores, including 11 that were Company owned.
If the Company is in compliance with the MFA at the expiration of the initial
term, the Company will have the option to extend its exclusive development
rights for an additional 10-year period, provided the Company and DPII agree to
a minimum development schedule for the renewal term. There can be no assurance
that the Company will be successful in opening the number of Domino's Stores
required. If after expiration of the initial term (or any renewal term), the
Company fails to exercise its option to renew its exclusive development rights,
or the parties are unable to agree to a minimum development schedule for the
renewal term, then the Company would continue to have the right to operate its
then existing Company-owned Domino's Stores and to maintain and continue its
rights and obligations, and act as subfranchisor, with respect to all then
existing franchised Domino's Stores. The Company would generally have no further
right to operate or grant franchises for additional Domino's Stores and DPII
would have the right to proceed (or the right to grant a third party the right
to proceed) with further development of the Territory, subject to territorial
rights granted under then-existing franchise agreements.
The Company is required to pay DPII a one-time store opening fee for each new
Domino's Store, whether Company-owned or franchised. The Company expects to pass
this cost through to the franchisees in the case of franchised stores. In
addition, the Company must pay to Domino's a monthly royalty fee equal to a
certain percentage of each Domino's Store's gross sales. This royalty fee is
payable to Domino's irrespective of the profitability of the Company or the
Domino's Store, and irrespective of the Company's ability to collect royalties
from franchisees. The Company's payments to DPII are to be made in United States
dollars.
Under certain circumstances of default by the Company under the MFA, DPII has
the right to terminate the MFA. If the MFA is terminated, the Company would be
subject to a one-year non- competition covenant in the delivery, carryout or
sit-down pizza business and DPII would have the right (but not the obligation)
to purchase, at the then-current fair market value, all of the Company's rights
and interests as the subfranchisor of Domino's Stores and all of the assets of
each Domino's Store owned by the Company. The fair market value would be
determined by mutual agreement of the Company and DPII,
F-23
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #16
(17) Commitments and Contingencies (Continued)
or in the absence of such agreement by an appraiser. Under certain circumstances
of default by DPII under the MFA, the Company has the right to terminate the
agreement and continue as an independent pizza operation, including the
operation of the fresh pizza dough production facility and wholesale business
(the "Commissary").
DPII and IFS entered into a Stock Purchase Agreement as of May 26, 1997, ("SPA")
whereby IFS agreed to sell to DPII 300,000 shares of its common stock in
consideration for royalty concessions under the Master Agreement. The SPA
provides that DPII may not sell, transfer or otherwise dispose of its shares
before May 26, 2001 and any transferee receiving stock in violation of this
prohibition will have no rights with respect to the shares. The SPA further
provides for put and call options on the common shares at an agreed upon base
purchase price of $1,200,000 adjusted to reflect changes in the common stock,
such as, stock splits and dividends.
The Master Agreement cannot be assigned by IFS without DPII's consent. In
addition, the agreement prohibits Domino's Pizza Group Limited, a majority-owned
subsidiary of IFS, ("DP Group") and Colin and Gail Halpern (as indirect
controlling shareholders of DP Group) from transferring control of IFS without
DPII's prior written consent. For the term of the Master Franchise Agreement, DP
Group and Colin and Gail Halpern are restricted from having an interest in,
being employed by, advising or assisting another business in the pizza or pizza
store business in the Territory.
(B) Employment Agreement - In August 1994, the Company entered into an
employment agreement with its then President and now Chairman of the Board for a
salary of $96,000 per year. The initial term of the agreement expired on January
31, 1996. The salary was adjusted at the discretion of the Board of Director's
Compensation Committee to $180,000 per year.
(C) Consulting Agreements - In May, June and October 1995, the Company entered
into three consulting agreements with terms of 4, 5 and 5 years respectively,
issuing 950,000 shares of common stock as compensation for these agreements (See
Note 17C). Consulting expense of $943,750 was to be amortized over the terms of
these agreements. The Company was also responsible for out-of-pocket expenses
incurred and a monthly advisory fee. During the years ended December 28, 1997
and December 29, 1996, the Company recognized $0 and $51,563, respectively, of
consulting expense related to these agreements. These consulting agreements were
assigned to Woodland in the form of an interest bearing note at the net book
value of $776,145 on April 1, 1996 (See Note 11).
(D) Pizzazz Lease Commitment - In connection with the Pizzazz restaurant, the
Company had entered into a 15-year operating lease, expiring December 24, 2010
(See Note 7).
(18) New Authoritative Accounting Pronouncements
The FASB has issued SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities." SFAS No. 125 is effective
for transfers and servicing of financial assets and extinguishment of
liabilities occurring after December 31, 1997. Earlier application is not
allowed.
The provisions of SFAS No. 125 must be applied prospectively; retroactive
application is prohibited. Adoption on January 1, 1998 is not expected to have a
material impact on the Company. The FASB deferred some provisions of SFAS No.
125, which are not expected to be relevant to the Company.
The FASB issued Statement of Financial Accounting Standards ("SFAS") No. 129,
"Disclosure of Information about Capital Structure" in February 1997. SFAS No.
129 does not change any previous disclosure requirements, but rather
consolidates existing disclosure requirements for ease of retrieval.
F-24
<PAGE>
INTERNATIONAL FRANCHISE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #17
(18) New Authoritative Accounting Pronouncements (Continued)
SFAS No. 130 "Reporting Comprehensive Income" and SFAS No. 131 "Disclosure About
Segments of an Enterprise and Related Information" both clarify existing
reporting requirements and in certain cases expand the disclosure. Neither is
expected to have a material impact on the Company.
(19) Subsequent Events
On March 11, 1998, the Company received an offer from IFS Acquisition
Corporation, an affiliate of Crescent Capital, Inc., the Company's largest
shareholder, to participate in a merger which would result in all of the
shareholders other than Crescent Capital, Inc. receiving $2.80 per share for
each share of the Company's stock. The Board of Directors named a Special
Committee of directors, comprised of Bernard Goldman and David Coffer, to
consider the offer. The Special Committee hired legal and financial advisors and
is considering the offer. On April 17, 1998, the Special Committee announced
that an agreement had been reached on the financial terms of the merger and that
the public shareholders would receive $3.60 per share if the transaction is
completed. The proposed merger is subject to, among other things (i) execution
of a definitive merger agreement containing customary representations,
warranties, covenants and conditions (including a financial condition), and (ii)
compliance with all applicable regulatory and governmental requirements.
Accordingly, there can be no assurance that the proposed merger will be
consummated.
. . . . . . . . .
F-25
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-28-1997
<PERIOD-START> DEC-30-1996
<PERIOD-END> DEC-28-1997
<CASH> 2,610,227
<SECURITIES> 0
<RECEIVABLES> 2,050,094
<ALLOWANCES> 0
<INVENTORY> 1,015,651
<CURRENT-ASSETS> 9,556,785
<PP&E> 5,435,818
<DEPRECIATION> 1,697,143
<TOTAL-ASSETS> 16,768,734
<CURRENT-LIABILITIES> 5,904,275
<BONDS> 0
<COMMON> 70,343
0
0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 16,768,734
<SALES> 20,240,888
<TOTAL-REVENUES> 28,360,981
<CGS> 20,766,007
<TOTAL-COSTS> 20,766,007
<OTHER-EXPENSES> 5,898,080
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (108,977)
<INCOME-PRETAX> 3,250,931
<INCOME-TAX> 656,362
<INCOME-CONTINUING> 2,508,683
<DISCONTINUED> 162,599
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,346,084
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.33
</TABLE>
