UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 000-23174
THE QUIZNO'S CORPORATION
(Exact name of registrant as specified in its charter)
Colorado 84-1169286
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1099 18th Street, Suite 2850
Denver, Colorado 80202
(Address of principal executive offices)
(303) 291-0999
(Registrant's telephone number, including area code)
Check whether issuer (1) has filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
State the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
Outstanding at
Class November 2, 1998
------------------------ ----------------
Common stock, $.001 par value 3,051,389 shares
THE QUIZNO'S CORPORATION
Commission File Number: 000-23174
Quarter Ended September 30, 1998
FORM 10-QSB
Part I FINANCIAL INFORMATION
Consolidated Statements of Operations.............................Page 1
Consolidated Balance Sheets.......................................Page 3
Consolidated Statements of Cash Flows.............................Page 5
Consolidated Statement of Stockholders' Equity....................Page 7
Notes to Consolidated Financial Statements........................Page 8
Management's Discussion and Analysis of Financial
Condition or Plan of Operation..................................Page 9
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ----------- ---------- ----------
FRANCHISE OPERATIONS:
Continuing fees .................. $1,532,411 $ 728,758 $4,107,191 $1,735,243
Initial franchise fees ........... 788,500 743,000 1,996,567 1,590,001
Area fees ........................ 613,932 553,031 1,666,917 1,448,781
Other ............................ 89,301 146,261 466,306 400,814
Interest ......................... 68,845 23,187 142,375 107,433
---------- ---------- ---------- ----------
Total revenue .................... 3,092,989 2,194,237 8,379,356 5,282,272
---------- ---------- ---------- ----------
Expenses
Sales and royalty commissions .... 1,191,535 711,393 2,841,259 1,580,549
Advertising and promotion ........ 49,100 51,609 149,265 181,518
General and administrative ....... 1,388,486 1,216,974 4,150,377 3,195,042
---------- ---------- ---------- ----------
Total expenses ................... 2,629,121 1,979,976 7,140,901 4,957,109
---------- ---------- ---------- ----------
Net income from franchise operations 463,868 214,261 1,238,455 325,163
---------- ---------- ---------- ----------
COMPANY STORE OPERATIONS:
Sales by Company owned stores ...... 1,778,625 1,185,744 4,992,932 2,685,219
---------- ---------- ---------- ----------
Expenses
Cost of sales at Company stores .. 529,523 373,332 1,500,439 880,333
Cost of labor at Company stores .. 440,681 297,915 1,207,399 694,988
Other Company store expenses ..... 604,865 396,150 1,807,768 920,306
---------- ---------- ---------- ----------
Total expenses ................... 1,575,069 1,067,397 4,515,606 2,495,627
---------- ---------- ---------- ----------
Net income from Company stores ..... 203,556 118,347 477,326 189,592
---------- ---------- ---------- ----------
(continued on next page)
(Unaudited)
1
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
STATEMENTS OF OPERATIONS (continued)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ----------- ---------- ----------
OTHER INCOME (EXPENSE):
Sales by stores held for
resale ....................... $ 435,778 $ 29,680 $ 851,162 $ 140,966
Expenses related to stores held
for resale ................... (548,363) (45,484) (1,059,022) (196,265)
Provision for bad debts ....... (66,427) (7,000) (151,017) (85,416)
Other ......................... 1,411 (33,829) (5,880) (54,163)
Depreciation and amortization . (132,673) (98,328) (422,441) (264,119)
Interest expense .............. (78,643) (73,589) (259,723) (218,963)
----------- ----------- ----------- -----------
Total other expense ........... (388,917) (228,550) (1,046,921) (677,960)
----------- ----------- ----------- -----------
Net income (loss) ............. 278,507 104,058 668,860 (163,205)
Preferred stock dividends ..... (55,524) (14,235) (165,969) (42,705)
----------- ----------- ----------- -----------
Net income (loss) applicable to
common shareholders ........... $ 222,983 $ 89,823 $ 502,891 $ (205,910)
=========== =========== =========== ===========
Diluted net income (loss)
per share of common stock .... $ 0.06 $ 0.03 $ 0.15 $ (0.07)
=========== =========== =========== ===========
Diluted weighted average
common shares outstanding .... 4,349,781 3,427,408 4,360,577 2,867,868
=========== =========== =========== ===========
Basic net income (loss)
per share .................... $ 0.07 $ 0.03 $ 0.17 $ (0.07)
=========== =========== =========== ===========
Basic weighted average
common share outstanding ..... 3,047,611 2,904,567 3,038,496 2,867,868
=========== =========== =========== ===========
(Unaudited)
2
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, December 31,
1998 1997
----------- ------------
CURRENT ASSETS:
Cash and cash equivalents ................... $ 1,058,109 $ 561,287
Short term investments ...................... 1,203,189 538,188
Accounts receivable, net of allowance
for doubtful accounts of $116,021
in 1998 and $38,231 in 1997 ................ 663,766 545,109
Current portion of notes receivable ......... 1,527,044 598,486
Other current assets ........................ 423,046 375,902
Assets of stores held for resale ............ 995,447 --
Stores under development .................... -- 593,675
----------- -----------
Total current assets .................... 5,870,601 3,212,647
----------- -----------
Property and equipment at cost, net of
accumulated depreciation and amortization
of $516,361 in 1998 and $426,242 in 1997 .... 2,642,490 2,164,898
----------- -----------
OTHER ASSETS:
Intangible assets, net of accumulated
amortization of $822,656 in 1998 and
$662,087 in 1997 ........................... 1,511,150 1,727,400
Deferred assets ............................. 1,462,804 914,762
Deposits .................................... 81,048 76,294
Other ....................................... 66,429 --
Notes receivable, net of allowance
for doubtful accounts of $140,000
in 1998 and 1997 ........................... 405,001 734,495
----------- -----------
Total other assets ..................... 3,526,432 3,452,951
----------- -----------
Total assets ................................. $12,039,523 $ 8,830,496
=========== ===========
(Unaudited)
3
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
1998 1997
----------- ------------
CURRENT LIABILITIES:
Accounts payable .......................... $ 1,122,307 $ 1,065,374
Accrued liabilities ....................... 156,241 489,848
Current portion of subordinated debt ...... 300,000 110,912
Current portion of long term obligations .. 200,004 303,084
------------ ------------
Total current liabilities ............. 1,778,552 1,969,218
Long term obligations ...................... 968,507 741,570
Convertible subordinated debt .............. 1,150,000 1,389,088
Deferred initial franchise fees ............ 4,279,868 2,148,662
Minority interest in consolidated
subsidiary ................................ 150,000 --
------------ ------------
Total liabilities .................... 8,326,927 6,248,538
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value,
1,000,000 shares authorized:
Series A issued and outstanding 146,000
in 1998 and 1997 ($876,000 liquidation
preference) .............................. 146 146
Series B issued and outstanding 100,000
in 1998 and 1997 ($500,000 liquidation
preference) .............................. 100 100
Series C issued and outstanding 167,000
in 1998 and 1997 ($835,000 liquidation
preference) .............................. 167 167
Common stock, $.001 par value; 9,000,000
shares authorized; issued and outstanding
3,049,951 in 1998, 2,923,294 in 1997 ..... 3,050 2,923
Capital in excess of par value ............. 5,125,395 4,663,744
Accumulated deficit ........................ (1,416,262) (2,085,122)
------------ ------------
Total stockholders' equity ........... 3,712,596 2,581,958
------------ ------------
Total liabilities and stockholders'
equity ................................... $ 12,039,523 $ 8,830,496
============ ============
(Unaudited)
4
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
-----------------------------
1998 1997
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (loss) ........................... $ 668,860 $ (163,205)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization ............ 422,441 264,119
Provision for losses on accounts
receivable .............................. 77,790 10,500
Issuance of stock for services ........... -- 13,689
Issuance of stock options for
services ................................ -- 33,950
Promissory notes accepted for
area director fees ...................... (876,019) (553,824)
Changes in assets and liabilities:
Restricted cash ......................... -- 16,748
Accounts receivable ..................... (196,446) (188,832)
Other current assets .................... (76,901) (102,536)
Accounts payable ........................ 56,928 403,837
Accrued liabilities ..................... (333,607) 60,438
Deferred franchise costs ................ (410,772) (325,542)
Deferred tax asset ...................... (65,515) --
Deferred initial franchise fees ......... 2,131,206 694,285
----------- -----------
Net cash provided by operations ..... 1,397,965 163,627
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in short term investments .......... (665,001) --
Purchase of property and equipment .......... (272,004) (184,403)
Stores held for resale development costs .... (401,772) (759,820)
Proceeds from sale of turnkey units ........ -- 431,315
Development of Company owned stores ......... (351,367) (287,040)
Acquisition of Company owned stores ......... (371,789) --
Disposal of property and equipment .......... -- 9,249
Acceptance of notes receivable .............. (448,119) (271,354)
Principal payments received on notes
receivable ................................. 755,488 495,551
Intangible assets ........................... (76,135) (122,781)
Other assets ................................ (90,533) (7,933)
----------- -----------
Net cash used in investing
activities ........................ (1,921,232) (697,216)
----------- -----------
(continued on next page)
(Unaudited)
5
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Nine Months Ended
September 30,
-----------------------------
1998 1997
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes
payable .................................. 973,623 172,370
Proceeds from sale of stock ............... 627,449 75,808
Principal payments on long term
obligations .............................. (372,218) (342,412)
Principal payments on lines of credit ..... -- (220,239)
Financing and offering costs .............. (43,097) (17,606)
Dividends paid ............................ (165,668) (42,705)
----------- -----------
Net cash provied by (used in)
financing activities .................. 1,020,089 (374,784)
----------- -----------
Net increase in cash ....................... 496,822 (908,373)
Cash, beginning of period .................. 561,287 2,127,330
----------- -----------
Cash, end of period ........................ $ 1,058,109 $ 1,218,957
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 259,723 $ 218,963
=========== ===========
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
During the first quarter of 1998, the Company sold the area directorship
rights for Canada for $704,000. The Company received $176,000 in cash and
$528,000 in the form of a note receivable bearing 6% interest and due in
five quarterly principal installments of $105,600 plus accrued interest.
The last installment is due June 20, 1999.
Beginning in 1998 the Company offers its area directors a performance
incentive of short and long term common stock purchase options. The short
term options allow the area director to purchase a fixed number of shares
for seven days at a discount of the lesser of 20% or $1.20 from the market
price of the shares on the grant date. The long term options allow the
area director to purchase a fixed number of shares for six months at
market price on the grant date. In the first three quarters of 1998 the
Company granted 27,402 short term options and 27,423 long term options, of
which 23,768 and 17,158 respectively, were exercised as of September 30,
1998. In connection with this program, the Company has recorded an expense
in the first three quarters of 1998 of $13,590 representing the discounts.
(Unaudited)
6
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Convertible
Preferred Stock Common Stock Additional
------------------------- ------------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit
--------- ----------- --------- ----------- ----------- -----------
Balances at January 1, 1997 .... 146,000 $ 146 2,864,757 $ 2,865 $ 3,233,415 $(1,995,504)
Issuance of Series C preferred
stock for cash, net of
offering costs of $36,454 ..... 167,000 167 -- -- 798,379 --
Issuance of Series B preferred
stock for debt, net of
offering costs of $44,277 ..... 100,000 100 -- -- 455,623 --
Inherent value of stock warrants
granted to lender in connection
with conversion of debt to
Series B preferred stock ...... -- -- -- -- 44,277 --
Issuance of common stock for
acquisition ................... -- -- 18,182 18 99,982 --
Issuance of common stock for
exercise of options ........... -- -- 40,355 40 92,116 --
Inherent value of options
granted to area directors ..... -- -- -- -- 33,950 --
Preferred stock dividends ...... -- -- -- -- (93,998) --
Net loss
-- -- -- -- -- (89,618)
----------- ----------- ----------- ----------- ----------- -----------
Balances at December 31, 1997 .. 413,000 413 2,923,294 2,923 4,663,774 (2,085,122)
Issuance of common stock
pursuant to employee benefit
plan .......................... -- -- 1,348 2 8,135 --
Issuance of common stock for
exercise of options by
underwriter ................... -- -- 80,000 80 399,920 --
Issuance of common stock for
exercise of options by
area directors ................ -- -- 40,926 41 218,894 --
Issuance of common stock for
exercise of options pursuant
to the employee benefit
plan .......................... -- -- 4,383 4 371 --
Preferred stock dividends ...... -- -- -- -- (165,669) --
Net income ..................... -- -- -- -- -- 668,860
----------- ----------- ----------- ----------- ----------- -----------
Balances at September 30, 1998 . 413,000 $ 413 $ 3,049,951 $ 3,050 $ 5,125,395 $(1,416,262)
=========== =========== =========== =========== =========== ===========
(Unaudited)
7
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. In the opinion of management, all adjustments, consisting only of normal
recurring adjustments necessary for a fair statement of (a) the results of
consolidated operations for the three and nine month periods ended
September 30, 1998 and September 30, 1997, (b) the consolidated financial
position at September 30, 1998, (c) the consolidated statements of cash
flows for the nine month periods ended September 30, 1998 and September 30,
1997, and (d) the consolidated changes in stockholders' equity for the nine
month period ended September 30,1998 have been made.
2. The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information. Accordingly, they do not include all the
information and footnotes required by generally accepted accounting
principles for financial statements. For further information, refer to the
audited consolidated financial statements and notes thereto for the year
ended December 31, 1997, included in the Company's Annual Report on Form
10-KSB to the Securities and Exchange Commission filed on March 26, 1998.
3. The results for the three and nine month periods ended September 30, 1998
are not necessarily indicative of the results for the entire fiscal year of
1998.
4. The Company is obligated to pay an opening commission to the area director
who sold the franchise at the time the franchise opens for business. These
commissions are expensed at the time the related franchise opens for
business and are not accrued as a liability of the Company until that time.
At September 30, 1998, there were 324 franchises sold but not yet open with
related opening commissions totaling $1,105,875 ($510,437 at December 31,
1997).
5. In the second Quarter of 1998 the Company has reclassified royalty fee
revenue to a new statement of operations account called continuing fees.
Continuing fees will be comprised of royalty fee revenue plus other fees
generated from the licensing of the Quizno's trade mark to vendors and
suppliers of the Quizno's franchise system. See Managements Discussion and
Analysis of Financial Condition or Plan of Operation for details.
(Unaudited)
8
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION
Overview
The Company earned a profit in the third quarter of 1998 of $278,507,
composed of income from franchise operations of $463,868, income from Company
owned store operations of $203,556, and less other charges totaling $388,917.
The Company's primary business is the franchising of Quizno's Restaurants. As
a franchisor, revenue is principally derived from: (1) area fees, (2) initial
franchise fees, and (3) continuing fees. Area fees occur when a country or
exclusive area is sold, and are expected to decline as the number of
remaining available markets declines. Initial franchise fees are one time
fees paid upon the sale of a franchise and vary directly with the number of
franchises the Company can sell and open. Continuing fees, on the other hand,
increase as the number of franchised restaurants open increase. Each of these
sources of revenue contribute to the profitability of the Company, but the
relative contribution of each source will vary as the Company matures. Over
time initial fees and continuing fees will generate proportionately more
revenue than area fees.
The following chart reflects the Company's revenue growth by source and
number of restaurants for the third quarter and first three quarters of 1998
compared the third quarter and first three quarters of 1997:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ----------- ---------- ----------
Continuing fees ........ $ 1,532,411 $ 728,758 $ 4,107,191 $ 1,735,243
Initial franchise fees . 788,500 743,000 1,996,567 1,590,001
Area fees .............. 613,932 553,031 1,666,917 1,448,781
Other .................. 89,301 146,261 466,306 400,814
Interest 68,845 23,187 142,375 107,433
----------- ----------- ----------- -----------
Total franchise revenue 3,092,989 2,194,237 8,379,356 5,282,272
Sales by Company owned
stores ................ 1,778,625 1,185,744 4,992,932 2,685,219
Sales by Stores held for
resale ................ 435,778 29,680 851,162 140,966
----------- ----------- ----------- -----------
Total Revenue ........ $ 5,307,392 $ 3,409,661 $14,223,450 $ 8,108,457
=========== =========== =========== ===========
9
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
Restaurants open,
beginning (1) ...... 391 203 327 156
New restaurants
opened ............. 48 42 126 99
Restaurants acquired . 8 -- 8 --
Restaurants closed,
Quizno's ............ (5) (4) (15) (14)
Restaurants closed,
Bains ............... (4) -- (8) --
---------- ---------- ---------- ----------
Restaurants open,
end ................. 438 241 438 241
========== ========== ========== ==========
New franchises sold .. 75 58 306 136
Initial franchise fees
collected ........... $ 1,003,000 $ 1,027,762 $ 4,187,500 $ 2,323,000
Systemwide sales $28.0 million $15.6 million $71.4 million $37.0 million
Average unit volume for
1997 (2) -- -- -- $316,259
Same store sales (2) Up 8.8% Up 3.5% Up 11.3% Up 2.3%
(1) Includes 52 Bain's Deli units open at the beginning of 1998, 8 of which
have since closed. The Company acquired the Bain's Deli franchise system on
November 12, 1997.
(2) Same store sales is based on 112 stores open since the beginning of 1997.
Stores which transferred ownership during this period or are in substantial
default of the franchise agreement are excluded. Because the Company is and
will continue to be in an aggressive growth mode over the next few years,
it is anticipated that same store sales will fluctuate as units are
included from more start up markets. Excludes non-traditional units located
in convenience stores and gas stations, and includes only units open all of
1997.
Results of Operations
Comparison of the first three quarters of 1998 with the first three
quarters of 1997 and the third quarter of 1998 with the third quarter of
1997
Franchise revenue increased 41% in the third quarter of 1998 to $3,092,989
from $2,194,237 in the same quarter last year. For the first three quarters
of 1998, franchise revenue increased by 59% to $8,379,356 from $5,282,272
last year. Total revenue increased 56% in the third quarter of 1998 to
$5,307,392 from $3,409,661 in the same quarter last year, and 75% in the
first three quarters of 1998 to $14,223,450 from $8,108,457.
Continuing fees increased 110% in the third quarter of 1998 to $1,532,411
from $728,758 in the third quarter of 1997. For the first three quarters of
1998, continuing fees increased 137% compared to the first three quarters
of 1997. Continuing fees are comprised of royalties and licensing fees.
Royalty fees are a percentage of each franchisee's sales paid to the
Company and will increase as new franchises open, as the average royalty
percentage increases, and as average unit sales increase. At September 30,
1998 there were 408 franchises, 24 Company owned stores and 6 stores held
for resale open (including Bain's) as compared to 241 at September 30,
1997. The royalty was 5% for agreements entered into prior to February 11,
1995, 6% for agreements entered into from February 11, 1995 to March 31,
1998, and 7% for all franchise agreements entered into after March 31,
1998. The royalty for Quizno's Express units is 8%.
10
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
Royalty fees were $1,469,522 for the third quarter of 1998 compared to $728,758
for the same period last year, an increase of 102%. For the nine month period
ended September 30, royalty fees increased 120% to $3,819,302 from $1,735,243 in
1997.
Included are 44 Bain's franchises acquired in November 1997, which pay royalties
at various rates up to 5%, and account for $200,390 in royalty revenue for the
first three quarters of 1998, approximately 8% of the increase. The Company
records royalty revenue from Bain's franchisees when the funds are collected.
Licensing fees are fees generated through the licensing of the Quizno's
trademark for use by others. Licensing fees are expected to continue and to
increase as systemwide sales and the awareness and value of the Quizno's brand
increases. Licensing fees were $287,889 in the first three quarters of 1998 and
$0 in 1997. For the third quarter of 1998, licensing fees were $62,889.
Initial franchise fees increased 6% in the third quarter of 1998 to $788,500
from $743,000 in the same quarter last year. For the first three quarters of
1998, initial franchise fees increased 26% to $1,996,567 compared to $1,590,001
for the first three quarters of 1997. Initial franchise fees are one time fees
paid by franchisees at the time the franchise is purchased. Initial franchise
fees are not recognized as income until the period in which all of the Company's
obligations relating to the sale have been substantially performed, which
generally occurs when the franchise opens. In the first three quarters of 1998,
the Company opened 122 franchises and 4 Company owned units as compared to 98
franchises and one Company owned unit opened in the same period last year.
Initial franchise fees collected by the Company are recorded as deferred initial
franchise fees until the related franchise opens. Deferred initial franchise
fees at September 30, 1998 were $4,279,868 and represent 324 franchises sold but
not yet in operation, compared to $2,269,756 at September 30, 1997 representing
170 franchises sold but not open. The Company sold 306 new franchises for
$4,187,500 in the first three quarters of 1998, of which 145 were sold in the
first quarter, 86 in the second quarter, and 75 in the third quarter. The record
sales in the first quarter were due, in part, to a royalty increase from 6% to
7% effective for franchises purchased after March 31, 1998. Direct costs related
to the franchise sale, primarily sales commissions paid to area directors, are
deferred on the books of the Company and recorded as an expense at the same time
as the related initial franchise fee is recorded as income. Deferred costs paid
with respect to initial franchise fees deferred at September 30, 1998 were
$1,049,388. Approximately 50% of all initial franchisee fees received by the
Company are paid to area directors for sales and opening commissions. The
Company has not sold or opened any Bain's franchises, nor does it expect to in
the future.
Area fees increased 11% in the third quarter of 1998 to $613,932 from $553,031
in same quarter last year. For the first three quarters of 1998, area fees
increased 15% compared to the first three quarters of 1997. Area fees are one
time fees paid to the Company for the right to sell franchises in a designated,
non-exclusive area, including international markets.
11
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
Domestic area fees were $588,932 in the third quarter of 1998 compared to
$553,031 in the same quarter last year. For the nine months ended September 30,
1998 domestic area fees were $927,917 versus $1,448,781 in 1997. The fee for
U.S. areas was $.05 per person from January 1997 through December 1997, $.06
from January 1998 through February 1998, and $.07 since March 1, 1998. In
addition, each area director is required to pay a training fee of $10,000. The
population based portion of the fee is deemed fully earned by the Company when
the area agreement is signed and is recognized as income in that period.
International master franchise fees were $225,000 in the third quarter of 1998
and$739,000 for the nine months ended September 30, 1998. There were no
international master franchise fees in the first three quarters of 1997.
In the third quarter of 1998 the Company sold the master franchise rights for
Japan for a total of $1,682,848. The Company recorded as revenue in the third
quarter of 1998 $225,000, which represents the amount paid during the quarter.
(The remainder of the fee will be recorded as revenue when the amounts are paid
and any obligations of the Company related to such payments have been
substantially performed.) The agreement calls for the Company to receive
payments of $125,000 in the fourth quarter of 1998 and, subject to certain
contingencies, $1,332,848 in 1999.
Although the Company plans to continue to enter into master franchise agreements
internationally, it does not expect such transactions to be the magnitude of the
Japanese transaction.
In the first quarter of 1998 the Company sold all of the area directorship
rights for Canada to its Canadian master franchisee for $704,000. As part of the
agreement, the Canadian master franchisee is allowed to retain 100% of the
initial franchise fees from franchises sold in Canada in 1998 only.
In addition to the Japanese and Canadian master franchise, the Company sold 12
area directorships, including five existing area directors who purchased
additional territory, in the first three quarters of 1998, compared to 19,
including eight existing area directors who purchased additional territory, sold
in the first three quarters of 1997. At September 30, 1998, the Company had a
total of 80 area directors who owned areas encompassing approximately 74% of the
population of the United States.
The Company offers United States area director applicants financing for up to
50% of the area director marketing fee. The Canadian master franchisee used the
financing for the purchase of the Canadian area directorships in the amount of
$528,000. This was a negotiated transaction in which the promissory note will be
repaid over two years. Of the additional area directorships sold in the first
three quarters of 1998, area directors financed a total of $437,009. In the
first three quarters of 1997, a total of $553,824 was financed.
12
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
The area agreements set increasing minimum performance levels that require the
area director to sell and open a specified number of franchised restaurants in
each year during the term of the area agreement. The Company's experience with
the area director program to date indicates that while some area directors will
exceed their development schedules, others will fail to meet their schedules. In
its planning, the Company has allowed for a certain percentage of area directors
who will not meet their development schedule. Delays in the sale and opening of
restaurants can occur for many reasons. The most common are delays in the
selection or acquisition of an appropriate location for the restaurant, delays
in negotiating the terms of the lease and delays in franchisee financing. The
Company may terminate an area agreement if the area director fails to meet the
development schedule, and the Company would then have the right to resell the
territory to a new area director.
Thereare no area directors in the Bain's system and the Company does not intend
to sell any Bain's area directorships in the future.
Other revenue decreased by 39% in the third quarter of 1998 to $89,301 from
$146,261 in the third quarter of 1997. For the first three quarters of 1998,
other revenue increased 16% compared to the first three quarters of 1997. Other
revenue is primarily bookkeeping fees charged franchisees for whom the Company
provided bookkeeping services and amounts paid by equipment suppliers for design
and construction. Since 1995, the Company's franchise agreement requires all new
franchisees to utilize the Company's bookkeeping services, or a firm designated
by the Company to provide bookkeeping services, for their first 12 months of
operations. Bookkeeping fees were $172,120 in the first three quarters of 1998
compared to $212,914 in the first three quarters of 1997. The Company
out-sourced the bookkeeping to an unaffiliated party beginning in the second
quarter of 1998, after which it will earn only a small administrative fee
relative to the bookkeeping function. This party will perform all of the
functions and incur all of the costs previously paid by the Company to perform
the bookeeping functions.
Sales and royalty commissions expense increased to $1,191,535 in the third
quarter of 1998 from $711,393 in the same quarter last year. For the first three
quarters of 1998, sales and royalty commissions expense increased 80% compared
to the first three quarters of 1998. Sales and royalty commissions are amounts
paid to the area directors of the Company. As a percent of royalty fees and
initial franchisee fees, sales and royalty commissions were 49% for the first
three quarters of 1998 compared to 48% for the first three quarters of 1997.
The Company's U.S. area directors receive commissions equal to 50% of the
initial franchise fees and 40% of royalties received by the Company from
franchises sold, opened, and operating in the area director's territory. (In
exchange for these payments and retentions, the area director is required to
market and sell franchises, provide location selection assistance, provide
opening assistance to new owners, and perform monthly quality control reviews at
each franchise open in the area director's or master franchisee's territory.)
13
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
The Company's foreign master franchisees retain 70% of both all initial fees and
royalties paid by from franchises sold, open and operating in the master
franchisee's territory, except Canadian master franchisee who will retain 100%
of initial franchise fees in 1998 only, as discussed above. Under the master
franchise agreement, the Company has no obligation to provide services that will
result in any incremental cost to the Company, other than an initial training
trip to the country by an employee of the Company.
The area director is entitled to receive commissions during the term of the ten
year area director agreement or until early termination of the agreement,
although the area director may be entitled to a commission of 1% of sales for
the remainder of each franchised restaurant's franchise agreement, or five years
(whichever is less) if the area director agreement is terminated solely because
of failure to meet the development schedule. Agreements signed prior to December
30, 1997 provided for ongoing payment of a 1% commission in such circumstances
for the remaining life of each franchise agreement in the territory.
General and administrative expenses increased 14% to $1,388,486 in the third
quarter of 1998 from $1,216,974 in the same quarter last year. For the first
three quarters of 1998, general and administrative expenses increased 30%
compared to the first three quarters of 1997. As a percent of franchise revenue,
general and administrative expenses have fallen from 80% in 1995, 74% in 1996,
58% in 1997, to 50% for the first three quarters of 1998. General administrative
expenses include all operating costs of the Company. The increase is primarily
due to the addition of employees to service the growing network of Quizno's
franchisees and area directors.
The Company believes its general and administrative expenses are adequate and
are not excessive in relation to the size and growth of the Company.
Company stores earned $203,556 on sales of $1,778,625 in the third quarter of
1998 compared to $118,347 on sales of $1,185,744 in the same quarter last year.
For the first three quarters of 1998, Company stores earned $477,326 on revenue
of $4,992,932, compared to $189,592 on revenue of $2,685,219 in the first three
quarters of 1997. During the first three quarters of 1998 the Company operated
stores for a total of 155 store operating months, compared to 84 store operating
months in the first three quarters of 1997. Sales per store month increased 1%
in the first three quarters of 1998 to $32,212 from $31,967. At September 30,
1998 the Company had 24 (13 at June 30, 1997) operating Company stores including
one Bain's Deli and seven Subs and Stuff units. The Company acquired 8 Subs and
Stuff units in Wichita, KS in August of 1998. One unit was converted to a
Quizno's in September 1998 and the remaining seven are planned to be converted
to Quizno's in the fourth quarter of 1998.
14
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
Stores held for resale lost $207,860 on sales of $851,162 for the first three
quarters of 1998, compared to losses of $55,299 on sales of $140,966, for the
first three quarters of 1997. For the third quarter stores held for resale lost
$112,585 on sales of $435,778, compared to a loss of $15,804 on sales of $29,680
in the same quarter last year. In the third quarter of 1998 the Company operated
six stores held for resale, all of which were offered for sale by the Company at
the beginning of the second quarter of 1998, at which time they were
reclassified to stores held for resale from Company stores.
Depreciation and amortization was $132,673 in the third quarter of 1998 and
$98,328 in the same quarter last year. For the first three quarters of 1998
depreciation and amortization was $422,441 compared to $264,119 for the first
three quarters of 1997. The increase is primarily due to the acquisition and
development of eight new Company stores in 1998, five new company stores in the
first three quarters of 1998, and the acquisition of the Bain's chain in 1997.
Interest expense was $78,643 in the third quarter of 1998 and $73,589 in the
same quarter last year. For the first three quarters of 1998, interest was
$259,723 compared to $218,963 for the same period last year. The increase is
primarily attributable to the interest on debt related to financing new company
owned stores and stores held for resale.
Liquidity and Capital Resources
Net cash provided by operating activities was $1,397,965 in the first three
quarters of 1998 compared to cash provided by operating activities of $163,627
in the first three quarters of 1997. The primary reasons for the improvement are
net cash from franchise sales and the net income improvement.
Net cash used in investing activities was $1,921,232 in the first three quarters
of 1998 compared to cash used by investing activities of $697,216 in the first
three quarters of 1997. Cash used in investing activities in the first half of
1998 was primarily related to the acquisition and development of Company owned
stores and the investment of excess cash in short term investments.
Net cash provided by financing activities was $1,020,089 in the first three
quarters of 1998 compared to cash used by financing activities of $374,784 in
the first three quarters of 1997. The amount provided in 1998 was primarily from
the sale of stock and the proceeds of long term borrowing.
At September 30, 1998 the Company had $995,447 invested in six stores held for
resale. One such restaurant was sold for $213,000 in the fourth quarter of 1998,
of which the Company financed $193,000 of the price over ten years. The other
five restaurants are expected to be sold in 1999.
15
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
In the first quarter of 1998 the Company began a program under which its area
directors have a right to elect to have franchisee leases in the area director's
territory signed by The Quizno's Realty Company ("TQRC"), a wholly owned
subsidiary of the Company. As a condition of the lease, the landlord agrees not
to look beyond TQRC for payments. These locations are then subleased by TQRC to
the franchisee whose personal liability is limited to one year. The franchisee
will pay TQRC an indemnification fee of $38 per week, pay a one time lease
processing fee to TQRC of $2,200, and pay a security deposit to TQRC equal to
two months rent. Effective March 1, 1998, the Company transferred cash and other
assets having a book value of approximately $500,000 to TQRC in exchange for
stock and a promissory note. Through September 30, 1998 seven such leases have
been executed.
As it has in the past, the Company will continue to consider acquisitions of
other chains, the purchase of Quizno's restaurants from its franchisees, and the
purchase of Quizno's area directorships from its area directors. From time to
time the Company will make offers and enter into letters of intent for such
transactions subject to the completion of due diligence. In all such cases, the
Company will establish the sources of cash required to complete such
transactions prior to entering into a binding agreement.
Other than as described herein, the Company does not have any material
commitments or contracts which will require a significant amount of working
capital or capital resources.
The Company's restaurant sales, and therefore royalties, during the months of
November through February are generally lower due to the locations of most of
its restaurants.
Year 2000 Disclosure
The Company uses current versions of widely used, publicly available software
for its accounting and other data processing requirements. The providers of the
software utilized by the Company have stated that there will be no failures in
the programs used by the Company resulting from the year 2000. The Company has
no customized software. The Company has not yet determined the impact, if any,
that year 2000 issues may have on its vendors. However, the Company believes
there are adequate alternative vendors that can supply products and services to
the Company if necessary. Finally, the Company's business, quick service
restaurants, is not highly dependent upon electronic data processing. Therefore,
the Company does not believe it is at a material risk from year 2000 issues.
16
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION OR PLAN OF OPERATION (continued)
Forward-Looking Statements
Certain of the information discussed in this Form 10-QSB, and in particular in
the section entitled "Management's Discussion and Analysis of Financial
Condition or Plan of Operation," are forward-looking statements that involve
risks and uncertainties that might adversely affect the Company's operating
results in the future in a material way. Such risks and uncertainties include,
without limitation, the effect of national and regional economic and market
conditions in the United States and in other countries in which franchises are
sold, costs of labor and employee benefits, costs of marketing, costs of food
and non-food items used in the operation of the Restaurants, intensity of
competition of location and franchisees, as well as customers, perception of
food safety, legal claims, and the availability of financing for the Company and
its franchisees. Many of these risks are beyond the control of the Company. In
addition, specific reference is made to the "Risk Factors" contained in the
Company's Prospectus, dated January 9, 1998, related to the Registration
Statement on Form S-3 filed by the Company (Registration No. 333-38691) and to
the Company's annual report filed on Form 10-KSB for year ended December 31,
1997.
As described earlier, the Company's principal sources of income are royalty
fees, initial franchise fees, and area fees. These sources are subject to a
variety of factors that could adversely impact the profitability of the Company
in the future, including those mentioned in the preceding paragraph. The
continued strength of the U.S. economy is a key factor to the restaurant
business because consumers tend to immediately reduce their discretionary
purchases in economically difficult times. An economic downturn would adversely
affect all three of the above identified sources of income. Because the
Company's franchises are still concentrated in a few regions of the U.S.,
regional economic factors could adversely affect the Company's profitability.
Weather, particularly sever winter weather, will adversely affect royalty income
and could affect the other sources cited above. Culinary fashions among
Americans and people in other countries in which franchises are sold will also
impact the Company's profitability. As eating habits change and types of cuisine
move in and out of fashion, the Company's challenge will be to formulate a menu
with the Company's distinctive culinary style that appeals to an increasing
market share. Finally, the intense competition in the restaurant industry
continues to challenge participants in all segments of this industry.
17
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
Commission File Number: 000-23174
Quarter Ended September 30, 1998
Form 10-QSB
PART II OTHER INFORMATION
Item 1. Legal Proceedings
S2D Subs, LLC v. The Quizno's Corporation, Case No. 54 114 00027 97;
American Arbitration Association (Southfield, Michigan).On September 23,
1998, the arbitrator found in favor of the Company and against the
franchisee/claimants on all claimants' demands.
The Quizno's Corporation v. Robert W. Mitelhaus, No. 77 114 00187 98;
American Arbitration Association (Denver, Colorado). On August 1,
1998, the Company terminated the area director agreement with Robert
W. Mitelhaus, a California area director. On the same day, the Company
instituted an arbitration action against Mitelhaus in Denver,
Colorado, alleging that Mitelhaus had breached various provisions of
the area director agreement. On September 1, 1998, Miltelhaus denied
that he breached the area director agreeement. Mitelhaus alleged
fraudulent termination of the area director agreement. In addition,
Mitelhaus alleged that the Company failed to refund or pay certain
amounts he claims are due to him, and that the Company violated
various state and federal franchise and securities laws by misstating
revenues in publicly filed documents. Mitelhaus seeks unspecified
damages in excess of $350,000. The Company denied each of Mitelhaus'
claims and defenses. The action is currently pending.
Item 2. Changes in Securities and Use of Proceeds Sales of Unregistered
Securities
Securities Amount of
Sold Date Shares Consideration Purchasers Exemption
- ------------ ------ ------- ------------- -------------- ------------
Common Stock 7/21/98 372 $ 4,273 Quizno's 401(k) Section 4(2)
Plan
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - None
(b) Reports on Form 8-K: Form 8-K of the Company, dated July 24, 1998,
reporting in Item 5 preliminary 2nd Quarter 1998 operating results
Form 8-K of the Company, dated August 18, 1998, reporting in Item 5
the acceptance of a bid to acquire certain assets of the Subs
and Stuff chain. Form 8-K of the Company, dated September 1, 1998,
reporting in Item 2 the acquisition of certain assets of the Subs
and Stuff chain. Form 8-K of the Company, dated September 3, 1998,
reporting in Item 5 the hiring of a chief operating officer. Form
8-K of the Company, dated October 1, 1998, reporting in Item 5
the sale of master franchise rights to Japan.
18
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
Commission File Number: 000-23174
Quarter Ended September 30, 1998
Form 10-QSB
PART II OTHER INFORMATION (continued)
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE QUIZNO'S CORPORATION
By: Original signed by John L. Gallivan
John L. Gallivan
Chief Financial Officer
(Principal Financial and Accounting Officer)
Denver, Colorado
November 5, 1998
19