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 March 31, 1999
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 (I.R.S. Employer
of 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 March 31, 1999
------------------------------ ---------------
Common Stock, $0.001 par value 3,059,952 shares
THE QUIZNO'S CORPORATION
Commission File Number: 000-23174
Quarter Ended March 31, 1999
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 or Plan of Operation.......Page 10
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
Three Months Ended
March 31,
----------------------------
1999 1998
---------- ----------
FRANCHISE OPERATIONS:
Continuing fees ....................... $ 2,505,498 $ 1,117,313
Initial franchise fees ................ 768,754 562,000
Area director and master franchise fees 472,146 573,000
Other ................................. 99,991 178,817
Interest .............................. 65,107 28,682
----------- -----------
Total revenue ........................ 3,911,496 2,459,812
----------- -----------
Expenses
Sales and royalty commissions ......... (1,173,440) (753,270)
Advertising and promotion ............. (30,045) (44,052)
General and administrative ............ (1,932,621) (1,370,602)
----------- -----------
Total expenses ....................... (3,136,106) (2,167,924)
----------- -----------
Net income from franchise operations .... 775,390 291,888
----------- -----------
COMPANY STORE OPERATIONS:
Sales ................................. 2,018,585 1,741,408
----------- -----------
Cost of sales ......................... (609,084) (544,287)
Cost of labor ......................... (547,535) (437,751)
Other store expenses .................. (651,986)
----------- -----------
(678,402)
Total expenses ....................... (1,835,021) (1,634,024)
----------- -----------
Net income from Company stores operations 183,564 107,384
----------- -----------
(continued on next page)
(Unaudited)
- 1 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
STATEMENTS OF OPERATIONS (continued)
Three Months Ended
March 31,
-----------------------------
1999 1998
----------- ------------
OTHER INCOME (EXPENSE):
Sales by stores held for resale .......... $ 223,994 $ --
Expenses related to stores held for resale (317,421) --
Sale of Japan master franchise ........... 860,867 --
Loss on sale of Company stores ........... (72,928) --
Provision for bad debts .................. (153,214) (33,677)
Other .................................... 5,716 (1,299)
Depreciation and amortization ............ (270,992) (144,610)
Interest expense ......................... (87,684) (78,007)
----------- -----------
Total other income (expense) ............... 188,338 (257,593)
----------- -----------
Net income before provision for income taxes 1,147,292 141,679
Provision for income taxes ................. 365,096 --
Net income ................................. 782,196 141,679
Preferred stock dividends .................. (45,660) (55,223)
----------- -----------
Net income before cumulative effect of
a change in accounting principle .......... 736,536 86,456
Cumulative effect of a change in accounting
principle (net of taxes) (Note 8) ......... (84,090) --
----------- -----------
Net income applicable to common shareholders $ 652,446 $ 86,456
=========== ===========
Net income per share-diluted
Net income before cumulative effect of
a change in accounting principle ........ $ 0.19 $ 0.03
Cumulative effect of a change in
accounting principle ..................... (0.02) --
----------- -----------
Diluted net income per share of common stock $ 0.17 $ 0.03
=========== ===========
Net income per share-basic
Net income before cumulative effect of a
change in accounting principle ........... $ 0.24 $ 0.03
Cumulative effect of a change in
accounting principle ..................... (0.03) --
----------- -----------
Diluted net income per share of common stock $ 0.21 $ 0.03
=========== ===========
Weighted average common shares outstanding
Diluted .................................. 3,756,414 3,053,191
=========== ===========
Basic .................................... 3,054,535 2,930,866
=========== ===========
(Unaudited)
- 2 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
March 31, December 31,
1999 1998
----------- ----------
CURRENT ASSETS:
Cash and cash equivalents ................. $ 2,990,837 $ 702,258
Short term investments .................... 1,661,174 1,541,423
Accounts receivable, net of allowance for
doubtful accounts of $140,530 in 1999 and
$20,000 in 1998 .......................... 1,273,054 857,280
Current portion of notes receivable ....... 880,180 1,212,522
Deferred tax asset ........................ 81,260 81,260
Other current assets ...................... 331,398 266,100
Assets of stores held for resale and
investment in area directorship ........... 883,121 690,030
----------- -----------
Total current assets ........................ 8,101,024 5,350,873
----------- -----------
Property and equipment at cost, net of
accumulated depreciation and amortization of
$1,088,111 in 1999 and $780,004 in 1998 .... 3,791,653 3,535,222
----------- -----------
OTHER ASSETS:
Intangible assets, net of accumulated
amortization of $1,006,005 in 1999 and
$867,343 in 1998 ......................... 891,638 1,553,522
Deferred assets ........................... 2,174,581 1,854,179
Deposits and other assets ................. 196,902 119,883
Notes receivable, net of allowance for
doubtful accounts of $0 in 1999 and 1998 .. 2,062,830 1,375,872
----------- -----------
Total other assets .......................... 5,325,951 4,903,456
----------- -----------
Total assets ................................ $17,218,628 $13,789,551
=========== ===========
(Unaudited)
- 3 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, December 31,
1999 1998
------------ ------------
CURRENT LIABILITIES:
Accounts payable ............................ $ 1,591,864 $ 1,317,085
Accrued liabilities ......................... 741,417 532,324
Current portion of subordinated debt ........ 210,265 244,084
Current portion of long term obligations .... 425,270 370,404
Income taxes payable ........................ 321,354 200,000
------------ ------------
Total current liabilities ..................... 3,290,170 2,663,897
Long term obligations ......................... 1,326,438 964,984
Subordinated debt (Note 6) .................... 1,610,174 1,130,916
Deferred revenue .............................. 6,572,694 4,781,946
------------ ------------
Total liabilities ............................. 12,799,476 9,541,743
------------ ------------
Minority interest in consolidated subsidiary .. 143,503 151,601
COMMITMENTS AND CONTINGENCIES (Note 7)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 1,000,000
shares authorized:
Series A issued and outstanding 146,000 in
1999 and 1998 ($876,000 liquidation
preference) ................................ 146 146
Series B issued and outstanding 0 in 1999
and 100,000 in 1998 ($500,000 liquidation
preference) ................................ -- 100
Series C issued and outstanding 167,000 in
1999 and 1998 ($835,000 liquidation
preference) ................................ 167 167
Common stock, $.001 par value; 9,000,000 shares
authorized; issued and outstanding 3,059,952
in 1999, 3,054,459 in 1998 ................... 3,060 3,054
Capital in excess of par value ................ 4,546,677 5,065,247
Accumulated deficit ........................... (274,401) (972,507)
------------ ------------
Total stockholders' equity .................... 4,275,649 4,096,207
------------ ------------
Total liabilities and stockholders' equity .... $ 17,218,628 $ 13,789,551
============ ============
(Unaudited)
- 4 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
-----------------------------
1999 1998
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................. $ 698,106 $ 141,679
Adjustments to reconcile net income to net
cash provided by operating activities:
Cumulative effect of a change in
accounting principle .................... 125,507 --
Depreciation and amortization ............. 270,992 144,610
Provision for losses on accounts receivable 36,323 27,885
Issuance of stock for services ............ -- 2,647
Deferred income taxes ..................... (19,107) --
Promissory notes accepted for area
director fees ............................ (74,835) (508,958)
Loss on disposal of Company store ......... 72,928 --
Changes in assets and liabilities:
Accounts receivable ...................... (481,221) (277,544)
Other current assets ..................... (67,157) (8,120)
Accounts payable ......................... 274,779 226,731
Accrued liabilities ...................... 209,093 (20,283)
Income taxes payable ..................... 121,354 --
Deferred franchise costs ................. (250,923) (233,099)
Deferred initial franchise fees .......... 1,515,098 1,530,391
----------- -----------
Net cash provided by operations .............. 2,430,937 1,025,939
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ......... (457,535) (39,314)
Investment in turnkey stores ............... (568) (245,238)
Short term investments ..................... (119,751) 274,472
Purchase of Company owned stores ........... -- (36,614)
Principal payments received on notes
receivable ................................ 570,219 482,380
Investment by minority interest owners ..... (8,098) --
Intangible and deferred assets and deposits (117,149) (84,438)
Other investments .......................... (352,571) --
----------- -----------
Net cash (used in) provided by
investing activities ........................ (485,453) 351,248
----------- -----------
(continued on next page)
(Unaudited)
- 5 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Three Months Ended
March 31,
------------------------------
1999 1998
----------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of stock ............... 28,305 114,732
Principal payments on long term obligations (1,476,409) (55,873)
Redemption of Class B Preferred Stock ..... (500,000) --
Financing costs ........................... (1,309) (29,100)
Dividends paid ............................ (45,660) (55,223)
Proceeds from issuance of notes payable ... 2,338,168 --
----------- -----------
Net cash (used in) provided by
financing activities ....................... 343,095 (25,464)
----------- -----------
Net increase in cash ........................ 2,288,579 1,351,723
Cash, beginning of period ................... 702,258 561,287
----------- -----------
Cash, end of period ......................... $ 2,990,837 $ 1,913,010
=========== ===========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid during the period for interest $ 81,825 $ 78,007
=========== ===========
Cash paid during the period for income taxes $ 202,325 $ -
=========== ===========
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 note was replaced
in the fourth quarter of 1998 when the same group purchased the master franchise
rights for the United Kingdom for $510,000. The Company received $200,000 in
cash and the remaining balance of $310,000 was added to the balance due on the
original note of $322,156. A new note for $632,156 was executed. The new note
bears interest at 6% and requires four quarterly payments of $164,010 beginning
March 20, 1999.
During the first quarter of 1999, the Company sold the franchising rights and
obligations for all but 15 of its Bain's Deli's franchise agreements to Bain's
Deli Corporation for $850,000, $800,000 of which was in the form of a promissory
note.
(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, 1998 . 413,000 $ 413 2,923,294 $ 2,923 $ 4,663,744 $(2,085,122)
Issuance of
common stock
for exercise of
options and
pursuant to the
employee
benefit plan .... -- -- 51,165 51 222,473 --
Issuance of
common stock
for exercise of
options by
underwriter ..... -- -- 80,000 80 399,920 --
Preferred stock
dividends ....... -- -- -- -- (220,890) --
Net income ....... -- -- -- -- -- 1,112,615
----------- ----------- ----------- ----------- ----------- -----------
Balances at
December 31, 1998 413,000 413 3,054,459 3,054 5,065,247 (972,507)
Issuance of
common stock
for exercise of
options and
pursuant to the
employee
benefit plan .... -- -- 5,493 6 26,990 --
Redemption of
Series B
Preferred Stock . (100,000) (100) -- -- (499,900) --
Preferred stock
dividends ....... -- -- -- -- (45,660) --
Net income ....... -- -- -- -- -- 698,106
----------- ----------- ----------- ----------- ----------- -----------
Balances at
March 31, 1999 .. 313,000 $ 313 3,059,952 $ 3,060 $ 4,546,677 $ (274,401)
=========== =========== =========== =========== =========== ===========
(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 month periods ended March 31, 1999
and March 31, 1998, (b) the consolidated financial position at March 31,
1999, (c) the consolidated statements of cash flows for the three month
periods ended March 31, 1999 and March 31, 1998, and (d) the consolidated
changes in stockholders' equity for the three month period ended March 31,
1999 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, 1998, included in the Company's Annual Report on Form
10-KSB to the Securities and Exchange Commission filed on March 31, 1999.
3. The results for the three month period ended March 31, 1999 are not
necessarily indicative of the results for the entire fiscal year of 1999.
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 March 31, 1999, there were 401 franchises sold but not yet open with
related opening commissions totaling $1,951,174 ($1,443,997 at December 31,
1998).
5. Beginning 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 trademark to
vendors and suppliers of the Quizno's franchise system. See Management's
Discussion and Analysis or Plan of Operation for details.
6. On January 6, 1999, the Company paid $500,000 to redeem all of its
outstanding Class B Preferred Stock and paid off the remaining principal of
its 12.75% convertible subordinated debt. As required by the loan
agreement, the Company issued a warrant to the bondholder to purchase
372,847 shares of its common stock at an exercise price of $3.10. The funds
used for this payoff were obtained through the borrowing of $1,853,931 from
an unrelated noteholder. This note accrues interest at the rate of 7.75%
per annum and requires 84 monthly payments of $28,665.40 per month starting
February 15, 1999. The note is collateralized by all of the restaurant
equipment and furniture and fixtures existing at six of the Company's
stores. The Company is required to maintain certain annual cash flow
covenants under the agreement.
(Unaudited)
- 8 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. There are various claims and lawsuits pending by and against the Company,
which, in the opinion of the management, and supported by advice from legal
counsel, will not result in any material adverse effect in excess of
amounts accrued in the accompanying consolidated financial statements.
On August 10, 1998, the Company terminated an area director agreement and
instituted an arbitration action alleging that the area director had
breached various provisions of the area director agreement. On September 1,
1998, the area director denied that he breached the area director
agreement, alleged fraudulent termination of the area director agreement,
alleged that the Company failed to refund or pay certain amounts due him
and alleged that the Company violated various state and federal franchise
and securities laws by misstating revenues in publicly filed documents.
Hearings in this matter were held before the American Arbitration
Association from March 8-16, 1999. The Company denied each of the area
director's claims and defenses.
On April 13, 1999, the arbitration panel issued its ruling. It found that
the area director had materially breached the area director agreement and
that the Company had properly terminated that agreement. The panel
therefore denied all of the area director's claims for breach of contract
and refuted his allegations of franchise and securities law violations.
While the panel did award the area director approximately $230,000 in
pre-termination commissions and costs, those related primarily to referral
commissions that the Company owed the area director, before the Company
terminated him in August 1998, for previous master franchise and area
directorship sales made. The Company had no liability for its lawful
termination of the area director's area director agreement. The panel also
ordered the area director to abide by all of the post-termination covenants
in the area director agreement.
8. During April 1998, Statement of Position 98-5, "Reporting in the Costs of
Start-Up Activities" was issued. SOP 98-5 requires costs of start-up
activities and organization costs to be expensed as incurred. SOP 98-5 was
required to be adopted by the first quarter of 1999. Upon adoption, the
Company was required to write-off $125,507 ($84,090 net of applicable
taxes) in preopening related costs that were deferred on the balance sheet
as of December 31, 1998. This write-off was reported as a cumulative effect
of a change in accounting principle.
(Unaudited)
- 9 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Overview
The Company earned a profit before taxes in the first quarter of 1999 of
$1,147,292, composed of income from franchise operations of $775,390, income
from Company owned store operations of $183,564, and plus other income and
expense totaling $188,338.
The Company's primary business is the franchising of Quizno's Restaurants. As a
franchisor, revenue is principally derived from: (1) area director and master
franchise fees, (2) initial franchise fees, and (3) continuing fees. Area
director and master franchise 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
contributes 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 director
and master franchise fees.
The following chart reflects the Company's revenue growth by source and number
of restaurants for the first quarter of 1999 compared to the first quarter of
1998:
Three Months Ended
March 31,
-------------------------
1999 1998
----------- ----------
Continuing fees ....................... $2,505,498 $1,117,313
Initial franchise fees ................ 768,754 562,000
Area director and master franchise fees 472,146 573,000
Other ................................. 99,991 178,817
Interest .............................. 65,107 28,682
---------- ----------
Total franchise revenue ............... 3,911,496 2,459,812
Sales by Company owned stores ......... 2,018,585 1,741,408
Sales by Stores held for resale ....... 223,994 --
---------- ----------
Total Revenue ......................... $6,154,075 $4,201,220
========== ==========
- 10 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Three Months Ended
March 31,
-----------------------
1999 1998
----------- ----------
Restaurants open, beginning .. 494 329
New restaurants opened ....... 52 39
Restaurants closed, to reopen (2) --
Restaurants closed, Quizno's . (5) (5)
Restaurants sold, Bains (1) .. (30) --
---- ----
Restaurants open, end ........ 509 363
==== ====
Franchises sold, domestic .... 135 145
Franchises sold, International 13 --
---- ----
Total ........................ 148 145
==== ====
Initial franchise fees collected $2.3 million $2.0 million
Systemwide sales $36.5 million $19.7 million
Average unit volume for 1998 (2) - $ 339,000
Same store sales (2) Up 7.6% Up 9.4%
(1) During the first quarter of 1999, the Company sold the franchising rights
for all but 15 of its Bain's Deli franchise agreements to Bain's Deli
Corporation.
(2) Same store sales are based on 242 stores open since the beginning of 1997.
Stores that 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 quarter of 1999 with the first quarter of
1998
Franchise revenue increased 59% in the first quarter of 1999 to $3,911,496 from
$2,459,812 in the same quarter last year. Total revenue increased 46% in the
first quarter of 1999 to $6,154,075 from $4,201,220 in the same quarter last
year.
- 11 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Continuing fees increased 124% in the first quarter of 1999 to $2,505,498 from
$1,117,313 in the first quarter of 1998. 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 March 31, 1999 there were 485
franchises open, as compared to 341 at March 31, 1998. 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%. The Company has no immediate plans to increase the royalty rate.
Royalty fees were $1,855,920 for the first quarter of 1999 compared to
$1,117,313 for the same period last year, an increase of 66%.
Included are 15 and 49 Bain's franchises at March 31, 1999 and 1998,
respectively, acquired in November 1997, which pay royalties at various rates up
to 5%, and account for $39,344 and $98,748 in royalty revenue for the first
quarter of 1999 and 1998, respectively. 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, which includes fees received from product companies
to sell proprietary products to the Company's restaurant system. 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 $649,578 in the
first quarter of 1999 and $0 in the comparable 1998 quarter.
Initial franchise fees increased 37% in the first quarter of 1999 to $768,754
from $562,000 in the same quarter last year. 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. The Company's share of initial
franchise fees sold by foreign master franchises is recognized when received. In
the first quarter of 1999, the Company opened 52 franchises as compared to 39
franchises 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 March 31, 1999 were $6,572,694 and represent 401 franchises sold but not
yet in operation, compared to $3,678,993 at March 31, 1998 representing 234
franchises sold but not open. 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 March 31, 1999 were $1,177,149. 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.
- 12 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Area director and master franchise fees decreased 18% in the first quarter of
1999 to $472,146 from $573,000 in the same quarter last year. Area fees are
one-time fees paid to the Company for the right to sell franchises on behalf of
the Company in a designated, non-exclusive area, including international
markets. Master franchise fees are one-time fees paid to the Company for the
exclusive rights to sell franchises and area directorships directly in a defined
international market. The Company is then paid a portion, typically 30%, of
franchise fees, royalties, and area director fees for sales by the master
franchisee.
Domestic area fees were $281,077 in the first quarter of 1999 compared to
$19,000 in the same quarter last year. 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 director marketing
agreement is signed and is recognized as income in that period. In the first
quarter of 1999, the Company sold 2 area directorships, including one existing
area director who purchased additional territory, compared to 0 sold in the
first quarter of 1998. At March 31, 1999, the Company had a total of 81 area
directors who owned areas encompassing approximately 75% of the population of
the United States.
International master franchise fees were $191,069 in the first quarter of 1999
and $554,000 for the quarter ended March 31, 1998.
In the first quarter of 1999, the Company sold the master franchise rights to
part of Australia for $191,069. 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, recognizing $554,000 as income in that quarter. As part of the
agreement, the Canadian master franchisee was allowed to retain 100% of the
initial franchise fees from franchises sold in Canada in 1998 only.
The Company offers domestic area applicants financing for up to 50% of the area
fee. The amount financed is required to be paid to the Company in installments
over five years at interest rates between 6% and 15%. The promissory notes are
personally signed by the Area Director and, depending on the personal financial
strength of the Area Director, secured by collateral unrelated to the area
directorship, usually a second mortgage on the Area Director's home. Of the
three domestic and international areas sold in 1999, one used this financing for
$74,835, representing 27% of the domestic area director fees recognized in 1999.
In the first quarter of 1998, the Canadian master franchisee used the financing
for the purchase of the Canadian area directorships in the amount of $528,000.
- 13 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
The area director and master franchise agreements set increasing minimum
performance levels that require the area director or master franchisee 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 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 and master
franchisees that 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 or master franchisee fails to meet the development schedule, and the
Company would then have the right to resell the territory to a new area
director.
There are 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 44% in the first quarter of 1999 to $99,991 from
$178,817 in the first quarter of 1998. Other revenue is primarily bookkeeping
fees charged franchisees for which 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 $11,169 in the first quarter of 1999 compared to $112,453 in the first
quarter of 1998. The Company out-sourced the bookkeeping to an unaffiliated
party beginning in the second quarter of 1998 and will now 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 bookkeeping functions.
Sales and royalty commissions expense increased to $1,173,440 in the first
quarter of 1999 from $753,270 in the same quarter last year. For the first
quarter of 1999, sales and royalty commissions expense increased 56% compared to
the first quarter of 1998. Sales and royalty commissions are amounts paid to the
domestic Area Directors of the Company, commissions paid to other sales agents
and employees, and costs related to sales promotions and incentives.
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, 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 territory.
The Area Director is entitled to receive commissions during the term of the Area
Director Agreement and in some cases, upon expiration of the Area Director
Agreement, in which case the commission paid is reduced to 1% of sales for 5
years.
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THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
The Company's foreign master franchisees retain 70% of both all initial fees and
royalties paid from franchises sold, open and operating in the master
franchisee's territory, except the Canadian master franchisee who retained 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.
General and administrative expenses increased 41% to $1,932,621 in the first
quarter of 1999 from $1,370,602 in the same quarter last year. As a percent of
franchise revenue, general and administrative expenses have fallen from 80% in
1995, 74% in 1996, 58% in 1997 and 49% in 1998 and the first quarter of 1999.
General administrative expenses include all operating costs of the Company. The
increase is primarily due to the addition of employees to service the rapidly
growing network of Quizno's Franchisees and Area Directors. Although general and
administrative expenses will likely continue to increase as the Company grows,
management expects the rate of increase to continue to decline.
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 $183,564 on sales of $2,018,585 in the first quarter of
1999 compared to $107,384 on sales of $1,741,408 in the same quarter last year.
During the first quarter of 1999 the Company operated stores for a total of 69.6
store operating months, compared to 57 store operating months in the first
quarter of 1998. At March 31, 1999 the Company had 24 (21 at March 31, 1998)
operating Company stores. The Company acquired 8 Subs and Stuff units in
Wichita, KS in August of 1998, all of which were converted to Quizno's in 1998.
Stores held for resale lost $93,427 on sales of $223,994 for the first quarter
of 1999. In the first quarter of 1998 the Company operated 0 stores held for
resale. At the beginning of the second quarter of 1998, the Company reclassified
six stores to stores held for resale from Company stores. At March 31, 1999, the
Company operated four stores held for resale. The four stores held for resale
are expected to be sold in 1999.
Japan master franchise represents payments received in the first quarter of 1999
of $1,081,924 for the master franchise rights and $22,000 for the Company's
shares of an area director marketing agreement in Japan. The Company incurred
direct costs related to the revenue totaling $243,057, resulting in net revenue
of $860,867. The Company received $350,000 in 1998 and a final payment of
$341,424 is due in the second quarter of 1999. The payments are recognized as
revenue when received. Although the Company plans to continue to enter into
master franchise agreements internationally, it does not expect such
transactions to be of the magnitude of the Japanese transaction.
Loss on sale of Company stores was $72,928 in the first quarter of 1999
primarily resulting from the January 1999 closure of one store held for resale.
- 15 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Provision for bad debts was $153,214 in the first quarter of 1999 and $33,677 in
the same quarter last year.
Depreciation and amortization was $270,992 in the first quarter of 1999 and
$144,610 in the same quarter last year. The increase is due to the acquisition
and development of eight new Company owned Restaurants, the acquisition of the
Bain's chain in late 1997, and certain other tangible and intangible assets with
short lives expensed beginning in late 1997 and 1998.
Interest expense was $87,684 in the first quarter of 1999 and $78,007 in the
same quarter last year. The increase is primarily attributable to the interest
on debt related to financing new company owned stores and stores held for resale
partially offset by a decrease in the Company's effective interest rate. On
January 6, 1999, the Company paid $500,000 to redeem all of its outstanding
Class B Preferred Stock and paid off the remaining principal of its 12.75%
convertible subordinated debt. The funds used for this payoff were obtained
through the borrowing of $1,853,931 from an unrelated noteholder. This note
accrues interest at the rate of 7.75% per annum.
Provision for income taxes was $365,096 in the first quarter of 1999. There was
no income tax provision or benefit or recorded in the first quarter of 1998. The
Company's taxable income has historically exceeded its book income primarily
because initial franchise fees the Company receives are taxable income in the
year received and are book income in the year the franchise opens. Consequently,
the Company will not pay income taxes on this income when it is recognized for
financial reporting purposes. In the fourth quarter of 1998, the Company used
all of its tax net operating loss carryforwards and incurred a tax liability.
Accordingly, the Company reduced the amount by which it had recorded an
impairment of its deferred tax asset in prior years and recorded the tax benefit
of prior years net operating losses.
Cumulative effect of a change in accounting principle was $84,090 (net of
applicable taxes of $41,417). During April 1998, Statement of Position 98-5,
"Reporting in the Costs of Start-Up Activities" was issued. SOP 98-5 requires
costs of start-up activities and organization costs to be expensed as incurred.
SOP 98-5 was required to be adopted in the first quarter of 1999. Upon adoption,
the Company was required to write-off $125,507 in preopening related costs that
were deferred on the balance sheet as of December 31, 1998.
Liquidity and Capital Resources
Net cash provided by operating activities was $2,430,937 in the first quarter of
1999 compared to cash provided by operating activities of $1,025,939 in the
first quarter of 1998. The primary reasons for the improvement are a decrease in
promissory notes accepted for area director fees and the net income improvement.
- 16 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Net cash used in investing activities was $485,453 in the first quarter of 1999
compared to cash provided by investing activities of $351,248 in the first
quarter of 1998. The primary reasons for the change were an increase in
purchases of property and equipment related to the conversion and development of
Company owned stores and an increase in other investments.
Net cash provided by financing activities was $343,095 in the first quarter of
1999 compared to cash used by financing activities of $25,464 in the first
quarter of 1998. The amount provided in 1999 was primarily from the net proceeds
of long-term borrowing and repayments.
In the first quarter of 1998, the Company tested a program under which its Area
Directors had the right to elect to have all future Franchisee leases in the
Area Director's territory signed by The Quizno's Realty Company ("QRC"), a
wholly owned subsidiary of the Company. As a condition of the lease, the
landlord agrees not to look beyond QRC for payments. These locations would then
be subleased by QRC to the Franchisee, whose personal liability is limited to
one year. The Franchisee pays QRC an indemnification fee of $165 per month, pays
a one-time lease-processing fee to QRC of $2,200, and pays a security deposit to
QRC 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 QRC in
exchange for stock and a promissory note. As of March 31, 1999, 10 leases had
been executed under this program, and the Company is evaluating whether to
continue the program in the future.
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 identify the sources of cash required to complete such transactions
prior to entering into a binding agreement.
On December 31, 1996, the Company completed a debt financing for $2 million of
which $500,000 was converted to preferred stock in December 1997. The $1,500,000
loan was payable interest only at 12.75%, $15,937.50 per month, through June
1998, interest and principal payments of $34,141 from July 1998 through November
2001, and a final balloon payment of $587,295 on December 31, 2001. In
connection with the loan, the lender had the right to convert a portion of the
loan into 372,847 shares of the Company's common stock at $3.10 per share. On
January 6, 1999 the Company paid off the loan and redeemed the preferred stock
at a cost of $1,854,000. These funds were borrowed from a financial institution
and is repayable over 7 years at an interest rate of 7.75%. As required by the
loan agreement, the Company issued a warrant to the bondholder to purchase
372,847 shares of its common stock at an exercise price of $3.10.
- 17 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
As discussed in the Company's 1998 Form 10-KSB, on December 29, 1998, the
Company received a proposal from the majority shareholders of the Company to
merge the Company into a new company owned by them, pursuant to which all of the
Company's shareholders other than themselves, would receive cash for their
Company shares. Such proposal is subject to a number of conditions, which are
listed in the Company's 1998 Form 10-KSB. None of such conditions have yet been
satisfied. If the proposed transaction is in fact completed, the Company or its
successors will incur substantial debt in order to fund the cash payments to the
minority shareholders. The amount of such debt cannot be determined at this
time. It is expected that some or all of the Company's assets will secure such
debt.
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 uses
a small amount of customized software, all of which has been developed by the
Company in the last twelve months, and has been written to be functional in the
year 2000. 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. In conclusion, the Company
does not believe it has material risk from year 2000 issues.
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 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 locations 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, 1998.
- 18 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
As described earlier, the Company's principal sources of income are royalty
fees, initial franchise fees, and area director marketing 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 many of 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.
- 19 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
Commission File Number: 000-23174
Quarter Ended March 31, 1999
Form 10-QSB
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
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 the area director in Denver, Colorado, alleging that the area director
had breached various provisions of the area director agreement. On September 1,
1998, the area director denied that he breached the area director agreement. The
area director alleged fraudulent termination of the area director agreement. In
addition, the area director 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. Hearings in this matter were held before the American
Arbitration Association from March 8-16, 1999. During the hearings, the
respondent demanded damages in excess of $4 million.
On April 13, 1999, the arbitration panel issued its ruling. It found that the
area director had materially breached the area director agreement and that the
Company had properly terminated that agreement. The panel therefore denied all
of the area director's claims for breach of contract and refuted his allegations
of franchise and securities law violations. While the panel did award the area
director approximately $230,000 in pre-termination commissions and costs, those
related primarily to referral commissions that the Company owed the area
director, before the Company terminated him in August 1998, for previous master
franchise and area directorship sales made. The Company had no liability for its
lawful termination of the area director's area director agreement. The panel
also ordered the area director to abide by all of the post-termination covenants
in the area director agreement.
There are various other claims and lawsuits pending by and against the Company,
which, in the opinion of the management, and supported by advice from legal
counsel, will not result in any material adverse effect in excess of amounts
accrued in the accompanying consolidated financial statements.
Item 2. Changes in Securities and Use of Proceeds
Sales of Unregistered Securities
Securities Amount of
Sold Date Consideration Purchasers Exemption
- ------------- ----------- ------------- -------------- -------------
Common stock 2/4/99 $ 3,149 Quizno's 401(k) Plan Section 4 (2)
413
- 20 -
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 January 11, 1999, reporting in Item 5 the
repayment of the Company's 12.75% convertible subordinated debt. Form 8-K of
the Company, dated February 12, 1999, reporting in Item 5 the opening of the
Company's first franchise in Japan. Form 8-K of the Company, dated March 2,
1999, reporting in Item 5 the Company's awarding of master franchises for the
United Kingdom and Australia.
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: /s/ John L. Gallivan
John L. Gallivan
Chief Financial Officer
(Principal Financial and Accounting Officer)
Denver, Colorado
May 14, 1999
- 21 -