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 June 30, 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 of (I.R.S. Employer
incorporation or organization) Identification No.)
1415 Larimer Street
Denver, Colorado 80202
(Address of principal executive offices)
(720) 359-3300
(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 August 2, 1999
------------------------------ ----------------
Common Stock, $0.001 par value 3,062,115 shares
THE QUIZNO'S CORPORATION
Commission File Number: 000-23174
Quarter Ended June 30, 1999
FORM 10-QSB
Part I - FINANCIAL INFORMATION
Consolidated Statements of Income................................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
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
FRANCHISE OPERATIONS:
Revenue
Continuing fees ....................... $2,847,698 $1,457,467 $5,353,196 $2,574,780
Initial franchise fees ................ 849,603 646,067 1,618,357 1,208,067
Area director and master franchise fees 442,444 479,985 914,590 1,052,985
Other ................................. 96,860 198,188 196,851 377,005
Interest .............................. 78,633 44,848 143,740 73,530
---------- ---------- ---------- ----------
Total revenue ........................ 4,315,238 2,826,555 8,226,734 5,286,367
---------- ---------- ---------- ----------
Expenses
Sales and royalty commissions ......... 1,302,214 896,454 2,475,654 1,649,724
Advertising and promotion ............. 12,593 56,113 42,638 100,165
General and administrative ............ 2,178,465 1,391,289 4,111,086 2,761,891
---------- ---------- ---------- ----------
Total expenses ....................... 3,493,272 2,343,856 6,629,378 4,511,780
---------- ---------- ---------- ----------
Net income from franchise operations ... 821,966 482,699 1,597,356 774,587
---------- ---------- ---------- ----------
COMPANY STORE OPERATIONS:
Sales .................................. 2,111,782 1,472,898 4,130,367 3,214,307
---------- ---------- ---------- ----------
Expenses
Cost of sales ......................... 635,599 426,629 1,244,683 970,916
Cost of labor ......................... 559,811 328,967 1,107,346 766,718
Other store expenses .................. 718,603 550,916 1,397,005 1,202,903
---------- ---------- ---------- ----------
Total expenses ....................... 1,914,013 1,306,512 3,749,034 2,940,537
---------- ---------- ---------- ----------
Net income from Company store
operations ............................ 197,769 166,386 381,333 273,770
---------- ---------- ---------- ----------
(continued on next page)
(Unaudited)
- 1 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (continued)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Sales by stores held for resale ...... $ 208,845 $ 415,384 $ 432,839 $ 415,384
Expenses related to stores held
for resale .......................... (300,329) (510,658) (617,750) (510,658)
Sale of Japan master franchise ....... 307,934 -- 1,168,801 --
Gain (loss) on sale of Company stores 4,685 -- (68,243) --
Provision for bad debts .............. (95,767) (50,913) (248,981) (84,590)
Other ................................ (120,342) (5,993) (116,951) (7,292)
Depreciation and amortization ........ (224,291) (145,158) (495,283) (289,768)
Interest expense ..................... (77,381) (103,073) (165,065) (181,080)
----------- ----------- ----------- -----------
Total other expense ................ (296,646) (400,411) (110,633) (658,004)
Net income before provision for
income taxes ........................ 723,089 248,674 1,868,056 390,353
Provision for income taxes ........... (242,231) -- (605,002) --
----------- ----------- ----------- -----------
Net income ........................... 480,858 248,674 1,263,054 390,353
Preferred stock dividends ............ (39,285) (55,222) (84,945) (110,445)
----------- ----------- ----------- -----------
Net income before cumulative effect
of a change in accounting principle . 441,573 193,452 1,178,109 279,908
Cumulative effect of a change in
accounting principle (net of taxes)
(Note 8) ............................ -- -- (84,090) --
----------- ----------- ----------- -----------
Net income applicable to common
shareholders ........................ $ 441,573 $ 193,452 $ 1,094,019 $ 279,908
=========== =========== =========== ===========
Net income per share-diluted
Net income before cumulative effect
of a change in accounting principle . $ 0.13 $ 0.08 $ 0.33 $ 0.12
Cumulative effect of a change in
accounting principle ................ -- -- (0.02) --
----------- ----------- ----------- -----------
Diluted net income per share of common
stock ............................... $ 0.13 $ 0.08 $ 0.31 $ 0.12
=========== =========== =========== ===========
Net income per share-basic
Net income before cumulative effect of
a change in accounting principle .... $ 0.14 $ 0.06 $ 0.39 $ 0.09
Cumulative effect of a change in
accounting principle ................ -- -- (0.03) --
----------- ----------- ----------- -----------
Basic net income per share of
common stock ........................ $ 0.14 $ 0.06 $ 0.36 $ 0.09
=========== =========== =========== ===========
Weighted average common shares
outstanding
Diluted ............................ 3,770,275 3,166,858 3,773,306 3,162,141
=========== =========== =========== ===========
Basic .............................. 3,058,288 3,022,745 3,058,005 3,018,242
=========== =========== =========== ===========
(Unaudited)
- 2 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
June 30, December 31,
1999 1998
----------- -----------
CURRENT ASSETS:
Cash and cash equivalents ................. $ 1,004,097 $ 702,258
Short term investments .................... 4,213,360 1,541,423
Accounts receivable, net of allowance
for doubtful accounts of $80,000 in
1999 and $20,000 in 1998 ................. 1,185,497 857,280
Current portion of notes receivable ....... 883,944 1,212,522
Deferred tax asset ........................ 81,260 81,260
Other current assets ...................... 343,903 266,100
Assets of stores held for resale and
investment in area directorship ........... 1,127,679 690,030
----------- -----------
Total current assets ........................ 8,839,740 5,350,873
----------- -----------
Property and equipment at cost, net of
accumulated depreciation and amortization of
$1,262,583 in 1999 and $780,004 in 1998 .... 4,021,541 3,535,222
----------- -----------
OTHER ASSETS:
Intangible assets, net of accumulated
amortization of $925,505 in 1999 and
$867,343 in 1998 ......................... 833,545 1,553,522
Deferred assets ........................... 2,560,216 1,854,179
Deposits and other assets ................. 188,802 119,883
Notes receivable, net of allowance for
doubtful accounts of $140,177 in 1999
and 1998 ................................. 1,934,393 1,375,872
----------- -----------
Total other assets .......................... 5,516,956 4,903,456
----------- -----------
Total assets ................................ $18,378,237 $13,789,551
=========== ===========
(Unaudited)
- 3 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
1999 1998
------------ ------------
CURRENT LIABILITIES:
Accounts payable .......................... $ 1,466,183 $ 1,317,085
Accrued liabilities ....................... 584,857 532,324
Current portion of subordinated debt ...... 214,366 244,084
Current portion of long term obligations .. 428,066 370,404
Income taxes payable ...................... -- 200,000
------------ ------------
Total current liabilities ................... 2,693,472 2,663,897
Long term obligations ....................... 1,251,650 964,984
Subordinated debt (Note 6) .................. 1,555,020 1,130,916
Deferred revenue ............................ 8,000,017 4,781,946
------------ ------------
Total liabilities ........................... 13,500,159 9,541,743
------------ ------------
Minority interest in consolidated subsidiary 150,177 151,601
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
3,062,115 in 1999, 3,054,459 in 1998 ..... 3,062 3,054
Capital in excess of par value ............ 4,518,069 5,065,247
Retained earnings (accumulated deficit) ... 206,457 (972,507)
------------ ------------
Total stockholders' equity .................. 4,727,901 4,096,207
------------ ------------
Total liabilities and stockholders' equity .. $ 18,378,237 $ 13,789,551
============ ============
(Unaudited)
- 4 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
----------------------------
1999 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................. $ 1,178,964 $ 390,353
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 .............. 495,283 289,768
Provision for bad debts .................... 248,981 42,147
Issuance of stock for services ............. -- 5,083
Deferred income taxes ...................... (25,062) --
Promissory notes accepted for area
director fees ............................. (307,279) (644,226)
Loss on disposal of Company store .......... 72,928 --
Changes in assets and liabilities:
Accounts receivable ....................... (466,145) (69,501)
Other current assets ...................... (52,162) 29,757
Accounts payable .......................... 320,610 (151,496)
Accrued liabilities ....................... 52,533 (345,603)
Income taxes payable ...................... (371,512) --
Deferred franchise costs .................. (444,897) (394,898)
Deferred initial franchise fees and other
deferred fees ............................ 2,942,421 1,981,251
----------- -----------
Net cash provided by operations ......... 3,770,170 1,132,635
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment .......... (760,205) (7,546)
Investment in turnkey stores ................ (568) (315,513)
Issuance of other notes receivable .......... (6,513) (445,116)
Short term investments ...................... (2,671,937) (757,186)
Purchase of Company owned stores ............ -- (508,875)
Principal payments received on notes
receivable ................................. 793,672 603,423
Investment by minority interest owners ...... (1,424) --
Intangible and deferred assets and deposits . (309,558) (67,536)
Other investments ........................... (703,242) (21,626)
----------- -----------
Net cash (used in) provided by investing
activities ............................. (3,659,775) (1,519,975)
----------- -----------
(continued on next page)
(Unaudited)
- 5 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
Six Months Ended
June 30,
----------------------------
1999 1998
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of stock ................. 40,322 533,814
Principal payments on long term obligations . (1,599,454) (166,081)
Redemption of Class B Preferred Stock ....... (500,000) --
Financing costs ............................. (2,647) (31,972)
Dividends paid .............................. (84,945) (110,445)
Proceeds from issuance of notes payable ..... 2,338,168 921,355
----------- -----------
Net cash provided by financing activities 191,444 1,146,671
----------- -----------
Net increase in cash ......................... 301,839 759,331
Cash, beginning of period .................... 702,258 561,287
----------- -----------
Cash, end of period .......................... $ 1,004,097 $ 1,320,618
=========== ===========
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid during the period for interest ... $ 165,065 $ 103,073
=========== ===========
Cash paid during the period for income taxes $ 937,275 $ --
=========== ===========
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 14 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 Retained
Preferred Stock Common Stock Additional Earnings
---------------------------- --------------------------- 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 -- -- 7,656 8 37,667 --
Redemption of Series B
Preferred Stock ..... (100,000) (100) -- -- (499,900) --
Preferred stock
dividends ........... -- -- -- -- (84,945) --
Net income ........... -- -- -- -- -- 1,178,964
----------- ----------- ----------- ----------- ----------- -----------
Balances at
June 30, 1999 ....... 313,000 $ 313 3,062,115 $ 3,062 $ 4,518,069 $ 206,457
=========== =========== =========== =========== =========== ===========
(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 six month periods ended June 30,
1999 and June 30, 1998, (b) the consolidated financial position at June 30,
1999, (c) the consolidated statements of cash flows for the six month periods
ended June 30, 1999 and June 30, 1998, and (d) the consolidated changes in
stockholders' equity for the six month period ended June 30, 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 and six month periods ended June 30, 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 June
30, 1999, there were 458 franchises sold but not yet open with related
opening commissions totaling $1,899,700 ($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 are comprised of royalty fee revenue plus other fees
generated from the licensing of the Quizno's trademarks 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 lender 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
(continued)
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.
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 net income applicable to common shareholders of $441,573, or
$0.13 per diluted share, in the second quarter of 1999 compared to $193,452, or
$0.08 per diluted share, in the second quarter of 1998. Net income for the
second quarter of 1999 was composed of income from franchise operations of
$821,966, income from Company owned store operations of $197,769, other income
and expense totaling ($296,646), income taxes of ($242,231) and preferred
dividends of ($39,285). For the six months ended June 30, 1999, the Company
earned net income applicable to common shareholders of $1,094,019, or $0.31 per
diluted share compared to $279,908, or $0.12 per diluted share, in the six
months ended June 30, 1998. Net income for the six months ended June 30, 1999,
was composed of income from franchise operations of $1,597,356, income from
Company owned store operations of $381,333, other income and expense totaling
($110,633), income taxes of ($605,002), preferred dividends of ($84,945) and a
cumulative effect of a change in accounting of ($84,090).
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 tables reflects the Company's revenue growth by source and number
of restaurants for the second quarter and first six months of 1999 compared to
the comparable periods in 1998:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Continuing fees ............... $ 2,847,698 $ 1,457,467 $ 5,353,196 $ 2,574,780
Initial franchise fees ........ 849,603 646,067 1,618,357 1,208,067
Area director and master
franchise fees ............... 442,444 479,985 914,590 1,052,985
Other ......................... 96,860 198,188 196,851 377,005
Interest ...................... 78,633 44,848 143,740 73,530
----------- ----------- ----------- -----------
Total franchise revenue ....... 4,315,238 2,826,555 8,226,734 5,286,367
Sales by Company owned stores . 2,111,782 1,472,898 4,130,367 3,214,307
Sales by Stores held for resale 208,845 415,384 432,839 415,384
----------- ----------- ----------- -----------
Total Revenue ................. $ 6,635,865 $ 4,714,837 $12,789,940 $ 8,916,058
=========== =========== =========== ===========
- 10 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------- ------------- ------------- -------------
Restaurants open, beginning .. 509 361 494 327
New restaurants opened ....... 68 39 120 78
Restaurants reopened ......... 1 -- 1 --
Restaurants closed, to reopen (2) -- (4) --
Restaurants closed, Quizno's . (6) (5) (11) (10)
Restaurants closed, Bains .... (2) (4) (2) (4)
Restaurants sold, Bains (1) .. -- -- (30) --
------------- ------------- ------------- -------------
Restaurants open, end ........ 568 391 568 391
============= ============= ============= =============
Franchises sold, domestic .... 112 77 247 200
Franchises sold, international 14 9 27 31
------------- ------------- ------------- -------------
Total ........................ 126 86 274 231
============= ============= ============= =============
Initial franchise fees collected $1.8 million $1.2 million $4.1 million $3.2 million
Systemwide sales $40.2 million $23.2 million $74.5 million $42.7 million
Avg. unit volume for 1998 (2) - - - $339,000
Same store sales (2) Up 3.4% Up 9.6% Up 6.4% Up 9.4%
(1) During the first quarter of 1999, the Company sold the franchising rights
for all but 14 of its Bain's Deli franchise agreements to Bain's Deli
Corporation.
(2) Same store sales are based on 229 stores open since the beginning of 1998.
Stores that transferred ownership during this period or are in substantial
default of the franchise agreement are excluded along with non-traditional
units located in convenience stores and gas stations. 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.
Results of Operations
Comparison of the first half of 1999 with the first half of 1998 and the second
quarter of 1999 with the second quarter of 1998
Franchise revenue increased 53% in the second quarter of 1999 to $4,315,238 from
$2,826,555 in the same quarter last year. For the first half of 1999, franchise
revenue increased 56% to $8,226,734 from $5,286,367 last year. Total revenue
increased 41% in the second quarter of 1999 to $6,635,865 from $4,714,837 in the
same quarter last year. For the first half of 1999, total revenue increased 43%
to $12,789,940 from $8,916,058 last year.
- 11 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(continued)
Continuing fees increased 95% in the second quarter of 1999 to $2,847,698 from
$1,457,467 in the second quarter of 1998. For the first half of 1999, continuing
fees increased 108% to $5,353,196 from $2,574,780 in 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 June 30, 1999 there were 540
franchises open, as compared to 369 at June 30, 1998. The royalty is 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 $2,279,985 for the second quarter of 1999 compared to
$1,232,467 for the same period last year, an increase of 85%. For the first half
of 1999, royalty fees were $4,135,905 for 1999 compared to $2,349,780 for the
same period last year, an increase of 76%.
Included are 13 and 48 Bain's franchises at June 30, 1999 and 1998,
respectively, acquired in November 1997, which pay royalties at various rates up
to 5%, and account for $15,579 and $45,333 in royalty revenue for the second
quarter of 1999 and 1998, respectively, and $54,379 and $144,081 in royalty
revenue for the first half 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
trademarks for use by others and 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 $567,713 in the
second quarter of 1999 and $225,000 in the comparable 1998 quarter. For the
first half of 1999, licensing fees were $1,217,291 in 1999 and $225,000 in the
comparable 1998 period.
Initial franchise fees increased 32% in the second quarter of 1999 to $849,603
from $646,067 in the same quarter last year. For the first half of 1999, initial
franchise fees increased 34% to $1,618,357 from $1,208,067 in the same period
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 half of 1999, the
Company opened 120 franchises as compared to 75 franchises and three Company
stores opened in the same period last year. The average initial franchise fee
per unit has declined as more international units are included, for which the
Company's share of the initial franchise fee is approximately 30%.
- 12 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(continued)
Initial franchise fees collected by the Company are recorded as deferred initial
franchise fees until the related franchise opens. Deferred initial franchise
fees at June 30, 1999 were $7,043,947 and represent 458 franchises sold but not
yet in operation, compared to $4,129,913 at June 30, 1998 representing 306
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 June 30, 1999 were $1,371,123. 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 director and master franchise fees decreased 8% in the second quarter of
1999 to $442,444 from $479,985 in the same quarter last year. For the first half
of 1999, area director and master franchise fees decreased 13% to $914,590 from
$1,052,985 in the same period 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 paid a portion, typically 30%, of franchise fees,
royalties, and area director fees for sales by the master franchisee.
Domestic area fees were $347,444 in the second quarter of 1999 compared to
$479,985 in the same quarter last year. For the first half of 1999, domestic
area fees were $628,521 compared to $498,985 in the same period 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 half of 1999, the Company sold 4 area directorships,
including two existing area directors who purchased additional territory,
compared to the sale of seven sales of area directorships, including eight
existing area directors who purchased additional territory, in the first half of
1998. At June 30, 1999, the Company had a total of 81 area directors who owned
areas encompassing approximately 74% of the population of the United States.
International master franchise fees were $95,000 in the second quarter of 1999
and $0 for the quarter ended June 30, 1998. For the first half of 1999,
international master franchise fees were $286,069 compared to $554,000 in the
same period last year.
In the first half of 1999, the Company sold the master franchise rights to part
of Australia for $221,069 and the rights to part of Central America for
$115,000. The Company has deferred $50,000 of these fees in that period until
the Company's obligations are completed. In the first half 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 period. 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.
- 13 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
(continued)
The Company offers area and master applicants financing for up to 50% of the
area fee. The amount financed is required to be paid to the Company in
installments over not more than five years at interest rates between 6% and 15%.
The promissory notes are personally signed and, depending on the personal
financial strength of the Area Director or master franchisee, secured by
collateral unrelated to the area directorship, usually a second mortgage. Of the
six domestic and international areas sold in 1999, four used this financing for
$307,279, representing 34% of the area director fees recognized in 1999. In the
first half of 1998, the Canadian master franchisee used the financing for the
purchase of the Canadian area directorships in the amount of $528,000. Of the
additional area directorships sold in the first half of 1998, two area directors
financed a total of $150,643.
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
or master franchisee.
Other revenue decreased by 51% in the second quarter of 1999 to $96,860 from
$198,188 in the second quarter of 1998. For the six months ended June 30,1999,
other revenue decreased by 48% to $196,851 from $377,005 in the comparable
period of 1998. Other revenue is primarily amounts paid by equipment suppliers
for design and construction and bookkeeping fees charged franchisees for which
the Company provided bookkeeping services. 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 $7,010 in the
first quarter of 1999 compared to $66,153 in the first quarter of 1998. For the
six months ended June 30, 1999, bookkeeping fees were $18,179 compared to
$178,606 in the comparable period of 1998. The Company out-sourced the
bookkeeping to an unaffiliated party beginning in the second quarter of 1998 and
now earns 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 $1,302,214 in the second
quarter of 1999 from $896,454 in the same quarter last year. For the six months
ended June 30, 1999, sales and royalty commissions expense increased to
$2,475,654 from $1,649,724 in the same period last year. For the second quarter
and first half of 1999, sales and royalty commissions expense increased 45% and
50%, respectively, when compared to the same periods in 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.
- 14 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
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.
The Company's foreign master franchisees retain 70% of 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 for franchises sold 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 57% to $2,178,465 in the second
quarter of 1999 from $1,391,289 in the same quarter last year. For the six
months ended June 30, 1999, general and administrative expenses increased 49% to
$4,111,086 from $2,761,891 in the same period last year. As a percent of
franchise revenue, general and administrative expenses have fallen from 80% in
1995, 74% in 1996, 58% in 1997, 49% in 1998 and 50% in the first half 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 $197,769 on sales of $2,111,782 in the second quarter of
1999 compared to $166,386 on sales of $1,472,898 in the same quarter last year.
For the six months ended June 30, 1999, Company stores earned $381,333 on sales
of $4,130,367 compared to $273,770 on sales of $3,214,307 in the same period
last year. During the first half of 1999 the Company operated stores for a total
of 140.9 store operating months, compared to 100 store operating months in the
first half of 1998. At June 30, 1999 the Company had 24 (16 at June 30, 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.
- 15 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Stores held for resale lost $91,484 on sales of $208,845 for the second quarter
of 1999 compared to a loss of $95,274 on sales of $415,384 in the second quarter
of 1998. For the six months ended June 30, 1999, stores held for resale lost
$184,911 on sales of $432,839 compared to a loss of $95,274 on sales of $415,384
in the comparable period of 1998. At the beginning of the second quarter of
1998, the Company reclassified six stores to stores held for resale from Company
stores. At June 30, 1999, the Company operated four stores held for resale.
Three stores held for resale are expected to be sold in 1999. The fourth store
was closed in early July 1999.
Japan master franchise represents payments received in the second quarter and
first half of 1999 of $341,424 and $1,423,348, respectively, for the master
franchise rights. In the first quarter of 1999, the Company also received
$22,000 for the Company's share of an area director marketing agreement sold in
Japan. In the second quarter and first half of 1999, the Company incurred direct
costs related to the revenue totaling $33,490 and $276,547, respectively,
resulting in net revenue of $307,934 and $1,168,801, respectively. The Company
received $350,000 in 1998. 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 $68,243 in the first half of 1999 primarily
resulting from the January 1999 closure of one store held for resale. The store
was a Bain's unit.
Provision for bad debts was $95,767 in the second quarter of 1999 and $50,913 in
the same quarter last year. For the six months ended June 30, provision for bad
debts was $248,981in 1999 and $84,590 in 1998. The 1999 provision provides a
reserve of approximately 5% of the Company's accounts and notes receivable
balances at June 30, 1999.
Depreciation and amortization was $224,291 in the second quarter of 1999 and
$145,158 in the same quarter last year. For the six months ended June 30,
depreciation and amortization was $495,283 in 1999 and $289,768 in 1998. The
increase is due to the acquisition and development of eight new Company-owned
restaurants and certain other tangible and intangible assets with short lives
expensed beginning in late 1998 and 1999.
Interest expense was $77,381 in the second quarter of 1999 and $103,073 in the
same quarter last year. For the six months ended June 30, interest expense was
$165,065 in 1999 and $181,080 in 1998. The decrease is primarily attributable to
the interest on debt related to financing new Company owned stores and stores
held for resale at the end of the first quarter of 1998 and 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.
- 16 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
Provision for income taxes was $242,231 and $605,002 in the second quarter and
first half of 1999, respectively. There was no income tax provision or benefit
recorded in the first half 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.
Cumulative effect of a change in accounting principle was $84,090 (net of
applicable taxes of $41,417) in the first quarter of 1999. 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 $3,770,170 in the first half of
1999 compared to cash provided by operating activities of $1,132,635 in the
first half of 1998. The primary reasons for the improvement are an increase in
deferred initial franchise fees resulting from franchise sales in excess of
franchise openings and the net income improvement.
Net cash used in investing activities was $3,659,775 in the first half of 1999
compared to cash provided by investing activities of $1,519,975 in the first
half 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, an increase in other investments and the short-term investment of
$2,671,937 of excess cash.
Net cash provided by financing activities was $191,444 in the first half of 1999
compared to cash provided by financing activities of $1,146,671 in the first
half 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 June 30, 1999, 10 leases had
been executed under this program, and the Company is evaluating whether to
continue the program in the future.
- 17 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (continued)
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 lender to purchase 372,847
shares of its common stock at an exercise price of $3.10. 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.
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. On August 10, 1999, the Company announced that the proposal had
been withdrawn. An agreement regarding all the terms of the transaction could
not be reached with the Special Committee of the Board of Directors evaluating
the offer.
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.
- 18 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS 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 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.
As described earlier, the Company's principal sources of income are royalty
fees, initial franchise fees, and area director marketing and master franchise
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 concentrated in a few
regions of the U.S., regional economic factors could adversely affect the
Company's profitability. Weather, particularly severe 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 June 30, 1999
Form 10-QSB
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
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.
Item 2. Changes in Securities and Use of Proceeds
Sales of Unregistered Securities
Securities Amount of
Sold Date Consideration Purchasers Exemption
------------ --------- ------------- ------------- --------------
465 shares of 5/6/99 $3,192 Quizno's 401(k) Section 4 (2)
common stock Plan
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 of Regulations S-B
EXHIBIT NO. DESCRIPTION
----------- -----------
3.4 Bylaws of the Company, amended through May 6, 1999
(b) Reports on Form 8-K:
Form 8-K of the Company, dated April 1, 1999, related to a press release
reported in Item 5 announcing the 1998 financial results.
Form 8-K of the Company, dated June 28, 1999, reported in Item 5 an update to
the previously announced going private proposal.
- 20 -
THE QUIZNO'S CORPORATION AND SUBSIDIARIES
Commission File Number: 000-23174
Quarter Ended June 30, 1999
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: /s/ John L. Gallivan
John L. Gallivan
Chief Financial Officer
(Principal Financial and Accounting Officer)
Denver, Colorado
August 16, 1999
- 21 -