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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 26, 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 ...........
AFC ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
Minnesota 58-2016606
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
Six Concourse Parkway, Suite 1700
Atlanta, Georgia 30328-5352
(Address of principal executive offices) (Zip Code)
(770) 391-9500
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Exchange Act: None
Securities registered pursuant to Section 12 (g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Not applicable.
The aggregate market value of the common stock of AFC Enterprises, Inc. held by
non-affiliates of AFC Enterprises, Inc. is not applicable as the common stock of
AFC Enterprises, Inc. is privately held.
As of March 27, 2000, there were 39,443,398 shares of the registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The exhibit index is contained in Part IV herein on page 55.
AFC Enterprises, Inc.
INDEX TO FORM 10-K
PART I
Item 1. Business................................................ 1
Item 2. Properties.............................................. 19
Item 3. Legal Proceedings....................................... 22
Item 4. Submission of Matters to a Vote of Security Holders..... 22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholders Matters.................................. 23
Item 6. Selected Consolidated Financial Data.................... 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 27
Item 8. Consolidated Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................... 39
PART III
Item 10. Directors and Executive Officers of the Registrant...... 40
Item 11. Executive Compensation.................................. 44
Item 12. Security Ownership of Certain Beneficial Owners
and Management........................................ 52
Item 13. Certain Relationships and Related Transactions.......... 53
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K................................................ 55
Part I.
Item 1. BUSINESS.
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities and Exchange Act of 1934, as amended. Such forward-
looking statements relate to our plans, objectives and expectations for future
operations. In light of the risks and uncertainties inherent in any discussion
of our expected future performance or operations, the inclusion of forward-
looking statements in this report should not be regarded as a representation by
us or any other person that these will be realized. Such performance could be
materially affected by a number of potential risks and uncertainties, including
without limitation, changes in consumer and demographic trends, increases in
food and labor costs, our ability to franchise new units, the level of
competition in the industry, currency, political and economic factors affecting
our international operations and increased government regulations requiring
substantial capital expenditures.
General
We (sometimes referred to as the "Company") are a Minnesota corporation and
together with our 100% owned subsidiaries are principally engaged in the
operation, development and franchising of quick-service restaurants, bakeries
and cafes ("QSRs") under the primary trade names of Popeyes Chicken & Biscuits
("Popeyes"), Churchs Chicken ("Churchs"), Cinnabon Bakeries ("Cinnabon") and
Seattle's Best Coffee and Torrefazione Italia ("Seattle Coffee"). We operate
and franchise others to operate 3,374 restaurants, bakeries and cafes in 46
states, the District of Columbia and 24 foreign countries. Our system-wide
sales in fiscal year 1999 totaled approximately $2.1 billion. Our total
restaurants, bakeries and cafes by brand as of December 26, 1999 were as
follows:
Domestic International
--------------------- ---------------------
Company- Company-
Operated Franchised Operated Franchised Total
-------- ---------- -------- ---------- -----
Popeyes............ 175 990 - 231 1,396
Churchs............ 494 684 - 314 1,492
Cinnabon........... 195 166 - 27 388
Seattle Coffee..... 73 17 3 5 98
--- ----- - --- -----
Total......... 937 1,857 3 577 3,374
=== ===== = === =====
We are also engaged in the business of selling premium brand coffees
through wholesale and retail distribution channels. In addition, we have a
small manufacturing plant that produces gas fryers and other custom-fabricated
restaurant equipment for sale to our Company-operated and franchised restaurants
and bakeries and to other foodservice operators.
Our principal executive offices are located at Six Concourse Parkway, Suite
1700, Atlanta, Georgia 30328-5352 and our telephone number is (770) 391-9500.
1
Brand Profiles
We franchise and operate restaurants, bakeries and cafes catering to
different segments of the QSR industry. We also operate a wholesale coffee
business within Seattle Coffee in which we roast and blend specialty coffees
sold to various retailers.
Popeyes Chicken & Biscuits(R). Our Popeyes brand was founded in New
Orleans, Louisiana in 1972 and is the market leader in the Cajun segment of the
QSR industry. With 1,396 restaurants worldwide, Popeyes was the second largest
quick-service chicken restaurant chain in 1999, measured by system-wide sales
which were approximately $1.1 billion. Popeyes specialty menu item is fresh,
hand-battered, bone-in fried chicken sold in two flavors--New Orleans Spicy(R)
and Louisiana Mild(R). Popeyes chicken is complemented with a wide assortment
of signature Cajun cuisine side dishes, including red beans and rice, Cajun
rice, Cajun fries and fresh buttermilk biscuits. Popeyes is positioned as a
premium fried chicken for customers who seek its full flavor and specialty blend
of seasonings and spices. Popeyes is also known for its unique items that
complement its core menu, including its Louisiana Legends menu of jambalaya,
crawfish etoufee' and chicken and seafood gumbo. Popeyes spicy fried chicken
and other Cajun menu offerings have also proven to be popular in Far East
countries. Popeyes restaurants are generally found in urban areas in
traditional stand-alone and in-line locations, as well as in non-traditional
formats such as convenience stores, airports and other travel centers.
In 1999, Popeyes put into test two new Cajun cuisine restaurant concepts.
The first was Cajun Kitchen, a quick casual dining concept, and the second was
Cajun cafe, a mall food court concept.
Churchs Chicken(R). Our Churchs brand, founded in San Antonio, Texas in
1952, is one of the United States oldest QSR chains and as of December 26, 1999
had 1,492 restaurants worldwide, making Churchs the second largest quick-service
chicken restaurant chain, measured by number of outlets. System-wide sales for
fiscal year 1999 were approximately $811 million. Churchs restaurants focus on
serving traditional Southern fried chicken in a simple, no frills restaurant
setting. Churchs menu items also include other Southern specialties including
fried okra, coleslaw, mashed potatoes and gravy, corn on the cob, jalapeno
peppers and honey butter biscuits. Churchs is positioned as a value-oriented
brand, providing simple, traditional meals to price conscious consumers.
Churchs restaurants are traditionally found in urban areas where their
reputation as a "neighborhood" restaurant has been established. With its small
footprint and a simple operating system, Churchs is rapidly expanding into non-
traditional formats such as convenience stores, grocery stores and co-branded
locations. Internationally, Churchs has been very popular in the Far East and
Puerto Rico, operating under the brand name Texas Chicken(R) in the Far East.
Cinnabon(R). Founded in Seattle, Washington in 1985, our Cinnabon brand is
the leading cinnamon roll bakery retailer in North America. As of December 26,
1999,
2
Cinnabon had 388 bakeries. System-wide sales for fiscal year 1999 were
approximately $152.4 million. Located in high traffic shopping malls, airports,
train stations, travel plazas and supermarkets, Cinnabon bakeries serve fresh
cinnamon rolls made with Indonesian cinnamon and topped with a sweet, rich cream
cheese-based frosting. Cinnabon has built a reputation for offering fresh,
aromatic, oven-hot cinnamon rolls at affordable prices. The Classic Cinnabon
Roll laid the foundation for Cinnabon's high standards and commitment to quality
and freshness. Some of our new product offerings include the Caramel
Pecanbon(R), the Berrybon(R) and the Caramel Frosted Applebon(TM). In addition
to the cinnamon roll related products, we offer a variety of proprietary
beverages including the Mochalatta Chill(R) and Vareva(R) Orange Juice and we
serve Seattle's Best Coffee(R) in 195 bakeries.
Seattle Coffee. Our Seattle Coffee Company subsidiary was created as a
result of combining Seattle's Best Coffee, Inc. and Torrefazione Italia, Inc. in
May 1994. Currently, we have more than 5,000 wholesale accounts, and we have 98
cafes in the Seattle Coffee system.
Seattle's Best Coffee ("SBC") is one of the oldest brands in the specialty
coffee business in the United States. Founded in 1969, the first retail cafe
was opened in 1983 in Bellevue Square, a regional mall, and management adopted a
strategy of using retail stores to promote the brand name and drive wholesale
sales. This strategy has remained basically unchanged to the present. SBC
markets several "coffee house blends" under names such as Seattle's Best
Blend(R), Post Alley Blend(R), Saturday's Blend, Grand Central Blend and Henry's
Blend. Each blend has a unique flavor profile, allowing SBC to meet a full
range of taste preferences.
In late 1999, we franchised three Seattle Coffee cafes in Hartsfield
Airport, Atlanta, Georgia, which are currently in operation. In March 2000, we
executed an agreement to franchise two cafes in the Greater Pittsburgh
International Airport, Pittsburgh, Pennsylvania, and we are currently in
negotiations with prospective franchisees for several other major airport
locations, but franchise agreements have not yet been executed. We plan to
pursue these types of franchise relationships within major airports in the
future when and if opportunities arise. We believe major airport venues provide
our Seattle Coffee brand with both wholesale and retail opportunities and
increase brand awareness due to the heavy consumer traffic in such facilities.
Our Torrefazione Italia ("TI") brand was founded in 1986. Like SBC, TI has
opened retail locations to support and build brand awareness for its primary
business of wholesaling premium brand coffees. TI presents a classic Italian
coffee experience. TI coffees are positioned at the highest end of the quality
and price range and are marketed with an Italian image, with blend names such as
Venezia, Milano, Perugia and Napoli. The Italian heritage is enhanced by
serving TI coffees in hand-painted ceramics imported from Deruta, Italy. The TI
cafes project the brand's European flavor and are designed to accommodate those
who are on-the-go as well as those who wish to relax and sip their coffee while
listening to classic music.
3
Wholesale Operations
Seattle Coffee. We roast and blend specialty coffees in our 30,000 square
foot automated roasting facility on Vashon Island, near Seattle. We believe
that our roasting and packaging facility may be one of the most technically
advanced in the U.S., for its capacity. We select our coffee beans from the
best quality Arabica beans, which come from the finest growing regions of the
world.
Our wholesale coffee sales are made primarily to other food service
retailers and supermarkets. Food service wholesale sales are targeted to food
service providers, such as hotel chains, fine restaurants, specialty coffee
retailers, espresso carts, delis, and theaters, among others. Some of our major
wholesale accounts include multi-market retailers such as Books-A-Million, Eddie
Bauer, Mrs. Fields Cookies, Dave and Busters, Aramark and Alaska Airlines.
Our SBC coffee is distributed to supermarkets throughout the Pacific
Northwest and other parts of the country. The brand has achieved a high degree
of penetration in the Pacific Northwest with settings in most major
supermarkets, including QFC, Safeway and others. We initiated the entry of TI
coffee into supermarkets in late 1995 and our brand is now carried in selected
high-end chains and independents in Western Washington and Oregon. The
prospects for growth in the supermarket channel appear to be significant. We
believe that the increasing presence of our brands in retail cafes and key food
service accounts around the country will, in turn, stimulate opportunities for
long-term growth of bean sales through supermarkets. We operate 14 regional
wholesale offices throughout the U.S. and one in Canada.
Manufacturing Operations
Ultrafryer Systems. Our manufacturing division, called Ultrafryer, is a
manufacturer of restaurant equipment and is located in San Antonio, Texas.
Ultrafryer's focus is to provide equipment for our Company-operated and
franchised restaurants and bakeries domestically and internationally, as well as
other QSR customers. Our main product is the Ultrafryer(TM) gas fryer.
Restaurant Locations
As of December 26, 1999, our 3,374 system-wide restaurants, bakeries and
cafes were located in 46 states, the District of Columbia and 24 foreign
countries.
Popeyes. Popeyes restaurants are located in 41 states, the District of
Columbia and 16 foreign countries. Our 175 Company-operated Popeyes restaurants
are located in the states of Texas, Louisiana, Georgia, North Carolina and South
Carolina. Over 70% of our 990 domestic franchised Popeyes restaurants are
located in the states of Texas, Louisiana, Florida, California, Illinois,
Maryland, Mississippi, Virginia and Georgia. Over 65% of our 231 international
franchised Popeyes restaurants are located in Korea.
4
Churchs. Churchs restaurants are located in 30 states and nine foreign
countries. Our 494 Company-operated Churchs restaurants are concentrated
primarily in the states of Texas, Louisiana, Georgia, Oklahoma, Alabama,
Florida, Mississippi and Arizona. Almost 65% of our 684 domestic franchised
Churchs restaurants are located in Texas, California, Louisiana, Georgia,
Florida, Michigan, New York and Illinois. Over 95% of our 314 international
franchised Churchs restaurants are in Canada, Puerto Rico, Indonesia, Taiwan,
Mexico and the Philippines.
Cinnabon. Cinnabon bakeries are located in 41 states and eight foreign
countries. Our 195 Company-operated Cinnabon bakeries are concentrated
primarily in the states of California, Washington, Florida, Illinois, Ohio,
Texas, Massachusetts, Michigan, Wisconsin and Pennsylvania. Our 166 domestic
franchised Cinnabon bakeries are concentrated primarily in the states of
Minnesota, Massachusetts, Illinois, Arizona, California, Nevada, New Jersey,
Ohio and New York. Our 27 international franchised Cinnabon restaurants are
located in Canada, Mexico, United Kingdom, Philippines, Japan, Thailand,
Venezuela and Saudi Arabia.
Seattle Coffee. Our coffee cafes are located in thirteen states and three
foreign countries. Our domestic 73 Company-operated cafes are located primarily
in the states of Washington, Oregon, California and Illinois. There are three
Company-operated cafes in Canada. Our 17 domestic franchised cafes are located
primarily in Washington, Georgia and Oregon. We have five international
franchised cafes in Saudi Arabia and Japan.
Strategy
Global Strategy. In order to grow revenues and profits, our global
strategy is to (i) increase franchise ownership and development of restaurants,
bakeries and cafes, (ii) increase the multiple-channel distribution of our
specialty coffee products, penetrating both at-home and away-from-home
consumption, (iii) deliver world class service and support to our franchisees by
capitalizing on our size, state-of-the-art technology and leadership position,
(iv) promote franchise development of traditional and non-traditional formats in
new and existing markets, (v) provide new and existing franchisees with
investment opportunities in high value/high growth branded concepts, (vi)
expand wholesale and retail channels of distribution for our specialty coffees
and (vii) consolidating our collective purchasing power with our franchisees to
negotiate favorable terms and reduce operating costs.
Franchisor of Choice(R). We have adopted the Franchisor of Choice(R) global
strategy, which we will implement by (i) promoting our distinctly positioned
brands, (ii) developing multi-unit development territories, (iii) providing high
quality service and support to our franchisees, (iv) providing our franchisees
with alternative formats in innovative market settings, (v) eliminating barriers
to growth for existing and new franchisees through new financial and real estate
support mechanisms and (vi) providing on-site support including site selection,
construction expertise, multi-national supply and distribution, marketing,
operations and training.
Increase Domestic Franchised Restaurants, Bakeries and Cafes. We believe
that significant opportunities exist to increase the number of domestic
franchised
5
restaurants, bakeries and cafes operated by new and existing franchisees and
that growth through franchising can provide us with significantly increased
revenue with relatively low levels of capital expenditures by us. We intend to
target unit growth in markets where we have or can achieve sufficient
penetration to justify television advertising because sales at restaurants,
bakeries and cafes in our media efficient markets are generally 5% to 10% higher
than sales in non-media efficient markets. We already have franchise commitments
to develop domestic units totaling 934 at December 26, 1999 versus 211 at the
beginning of 1993. Over the same period, our domestic franchised restaurants,
bakeries and cafes have increased from approximately 990 to 1,857. Our domestic
franchised unit openings during fiscal year 1999 were:
Fiscal Year
1999
-----------
Popeyes......... 100
Churchs......... 72
Cinnabon........ 30
Seattle Coffee.. 6
---
Total.......... 208
===
Increase International Franchised Restaurants, Bakeries and Cafes. We
believe that international expansion is an attractive growth opportunity due to
(i) advantageous per unit economics, resulting largely from higher average unit
volumes, lower food and/or labor costs and less QSR competition abroad, (ii)
foreign economies with an expanding group of QSR consumers and (iii) well
established markets for quick-service restaurants, bakeries and cafes in a
substantial number of countries around the world. Our international operations
have increased from 172 franchised restaurants in 14 foreign countries at the
beginning of 1993, to 577 franchised units in 24 foreign countries at December
26, 1999. Additionally, commitments to develop international franchised units
have risen from 161 at the beginning of 1993, to 1,049 at December 26, 1999.
Our international franchised unit openings during fiscal year 1999 were:
Fiscal Year
1999
-----------
Popeyes......... 41
Churchs......... 39
Cinnabon........ 11
Seattle Coffee.. 4
--
Total.......... 95
==
Increase Specialty Coffee Wholesale Business. Our goal is to develop
Seattle's Best Coffee and Torrefazione Italia into nationally recognized brand
names in the premium segment of the specialty coffee industry. Quality
restaurants, hotels, offices, specialty retailers, clubs, universities and other
places where people consume food and beverages are potential outlets for
specialty coffee. Supermarkets will remain the dominant source of coffee for
home consumption and specialty coffee's share of this
6
market is expanding rapidly. We anticipate significant growth in specialty
coffee distribution through retail, wholesale food service and grocery over the
next few years.
Capitalize on Additional Growth Opportunities. We intend to aggressively
pursue selected growth opportunities by (i) expanding our existing brands to new
domestic and international markets, (ii) continuing the development of new
points of distribution, (iii) expanding the channels of distribution for our
specialty coffees and (iv) acquiring additional branded concepts to provide
franchisees with a broad range of investment opportunities, thereby generating a
larger and more diversified stream of franchise revenues to us. These
initiatives include the following:
. Non-Traditional Formats. In response to new marketing opportunities
and consumer demand, we intend to continue the expansion of the number
and type of non-traditional formats from which we sell products. In
addition to the traditional stand-alone models, we have franchised and
opened restaurants, bakeries and cafes within community shopping
plazas, convenience stores, mall food courts, airports and other
transportation centers and grocery stores.
. Co-Branding Initiatives. We intend to selectively enter into co-
branding arrangements in which our brands share facilities with other
QSRs. We believe that co-branding represents a revenue growth
opportunity that provides brand awareness in new markets and faster
opening times (because our units are constructed within existing QSR
facilities), together with reduced costs of entry and lower ongoing
capital expenditures. We have entered into several such arrangements
including franchising Churchs restaurants in 83 Harvey's hamburger
restaurants in Canada and in 93 White Castle hamburger restaurants
throughout the Midwest, Southeast and Northeast United States.
. New Distribution Channels. We intend to aggressively pursue new and
expanded distribution channels for our premium coffee products. Our
marketing efforts will be aimed at developing key accounts with such
food service providers as airports, espresso carts, quality
restaurants, hotels, independent coffee cafes, delis, theaters,
colleges, corporate offices and general merchandise retailers. Our
marketing efforts will also be aimed at securing wholesale accounts
with larger hotel chains, quality restaurant chains and specialty
retailers doing business in multiple regions or on a national basis.
We believe that significant opportunities exist to expand our
distribution channels into regional and national supermarkets.
. New Branded Concepts. Since 1998, we have identified and acquired
additional high value/high growth brands which we believe will benefit
from our operating efficiency, management experience, state-of-the-art
technology, service commitment to franchisees and shared
administrative
7
infrastructure. We plan to continue to seek out additional high
value/high growth brands to acquire, operate and franchise in the
future.
Increase Operational Efficiencies and Leverage Information Technology. Our
customized management information systems, typically not affordable by smaller
QSR chains, provide both us and our franchisees with the ability to quickly
capitalize on restaurant sales enhancement and profit opportunities. We utilize
our management information systems to (i) minimize waste and control labor
costs, (ii) effectively manage inventory and (iii) analyze product mix and
various promotional programs using point-of-sale information. In 1998, we
launched AFC Online, an intranet for franchisees that provides operational
support, a restaurant development roadmap, a business planning template,
marketing information and certain other relevant information on a 24 hours a
day, seven days a week basis.
Maintain High Quality Products, Superior Customer Service and Strong
Community Relations. We seek to ensure overall customer satisfaction through
consistency in food quality, service and restaurant appearance. We maintain
rigorous and ongoing quality control procedures over suppliers and distributors
to ensure that our product specifications are maintained. In addition, we have
taken an important leadership role in the neighborhoods and communities we
serve. Through our involvement in Habitat for Humanity, the United Negro
College Fund and the Hispanic Association of Colleges and Universities, among
others, we have established a meaningful presence in the local communities we
serve, while building customer loyalty and brand awareness.
Site Selection
We have an extensive domestic site selection process for the establishment
of new restaurants, bakeries and cafes, commencing with an overall market plan
for each intended area of development, which we compile together with the area
developer, if any. Our Churchs and Popeyes brands emphasize free-standing pad
sites and end-cap locations with ample parking and easy dinner-time access from
high traffic roads. Our Cinnabon and Seattle Coffee brands emphasize mall food
courts, in-line shopping centers, transportation facilities, airports and office
buildings.
International sites are often located in highly concentrated urban areas
and are built with a multi-floor layout to accommodate the scarcity of real
estate and higher percentage of dine-in customers.
Franchise Development
Our global strategy includes the opening of substantially all of our new
restaurants, bakeries and cafes through our franchise programs with new and
existing franchisees. We enjoy strong relationships with our franchisees as a
result of our ongoing efforts to (i) re-invent and refresh our restaurants,
bakeries and cafes by investing capital to re-image and renovate our Company-
operated units in each of our systems, (ii) provide strong operational,
marketing and technological support to our
8
franchisees, (iii) deliver operating efficiencies and economies of scale to our
franchisees and (iv) promote the expansion of our points of distribution to non-
traditional formats and new markets for our existing brands.
Domestic Development Agreements. Our domestic franchise development
agreements provide for the development of a specified number of restaurants,
bakeries and cafes within a defined geographic territory in accordance with a
schedule of unit opening dates. These development schedules generally cover
three to five years and typically have benchmarks for the number of restaurants,
bakeries and cafes to be opened and in operation at six-month and twelve-month
intervals. Our Popeyes and Churchs franchisee developers currently pay a
development fee of $10,000 for the first unit to be developed and then a reduced
fee ranging from $2,500 to $7,500 for each additional unit to be developed under
the same development agreement depending upon the type of development. Our
Cinnabon developers currently pay a development fee of $5,000 per unit. Our
Seattle Coffee developers currently pay $10,000 for the first unit to be
developed and $5,000 for each additional unit under the same development
agreement. Such development fees are non-refundable and are typically paid when
the development agreement is executed.
International Development Agreements. We also enter into franchise
development agreements with qualified parties to develop restaurants, bakeries
and cafes in locations outside of the United States. We may grant international
development rights in one or more countries or in limited geographic areas
within a particular country. The terms of our international development
agreements are, in most respects, similar to our domestic development
agreements. International development agreements also require a pre-payment of
a portion of the franchise fee for each unit to be developed under the
agreement. International development agreements include additional provisions
necessary to address the multi-national nature of the transaction (including
foreign currency exchange, taxation matters and international dispute resolution
provisions) and are also subject to modifications necessary to comply with
applicable local laws, such as laws relating to technology transfers,
export/import matters and franchising.
Franchise Agreements. Once a site has been approved by us and the property
has been secured by our franchisee, we and our franchisee enter into a franchise
agreement under which our franchisee has the right to operate the specific unit
to be developed at the site. Our current franchise agreements provide for
payment of franchise fees of the following: Churchs franchisees pay $15,000 per
location for free-standing units and $5,000 per location for units opened in
convenience stores or travel plazas; Popeyes franchisees pay $20,000 per
location; Cinnabon franchisees pay $35,000 for the first unit, and $25,000 per
location for any second and third units, and $20,000 for the fourth and more
units developed under a single development agreement; Seattle Coffee franchisees
pay $30,000 per location for the first cafe unit, and $20,000 per location for
additional cafe units developed under the same development agreement, $20,000
per location for the first kiosk unit, and $15,000 for each additional kiosk
unit developed under the same development agreement, and $5,000 for each mobile
cart unit. In addition, our Popeyes and Churchs franchise agreements require
franchisees to pay a
9
5% royalty on net restaurant sales and a 3% (with respect to Popeyes) and 4%
(with respect to Churchs) national advertising fund contribution (reduced to a
maximum of 1% if a local advertising co-operative is formed). Our Cinnabon
franchise agreements require franchisees to pay a 5% royalty on net restaurant
sales and a 1.5% national advertising fund contribution. Seattle Coffee
franchise agreements currently require the payment to us of a 3% royalty on net
restaurant sales and a 2% national advertising fund contribution. In addition,
our Seattle Coffee franchisees are required to purchase coffee exclusively from
us. Certain of our older franchise and area development agreements provide for
lower royalties and reduced franchise and area development fees. Such older
forms of agreements constitute a decreasing percentage of all franchise
agreements.
All of our franchise agreements require that each restaurant, bakery and
cafe operate in accordance with our operating procedures, adhere to the menu
established by us and meet applicable quality, service and cleanliness
standards. We may terminate the franchise rights of any franchisee who does not
comply with such standards. We are specifically authorized to take accelerated
action if any franchised location presents a health risk. We believe that
maintaining superior food quality, a clean and pleasant environment and
excellent customer service are critical to the reputation and success of our
Popeyes, Churchs, Cinnabon and Seattle Coffee systems and we intend to
aggressively enforce these contractual requirements. Our franchisees may
contest such enforcement, and when necessary, contest our termination of
franchise rights.
The terms of our international franchise agreements are substantially
similar to our domestic franchise agreements, except that these agreements may
be modified to reflect the multi-national nature of the transaction and to
comply with the requirements of applicable local laws. In addition, royalty
rates may differ from domestic franchise agreements due to the number of units
required to be developed by our international franchisees. Our international
franchisees are required to partially pre-pay a franchise fee of up to $45,000
at the time our franchise development agreement is signed, along with a
development fee of up to $10,000 for each unit to be developed.
Turnkey Development. In order to expedite development of our domestic
franchised restaurants, bakeries and cafes, we may build units in certain
markets for the purpose of subsequent sales to qualified franchisees. We have
entered into relationships with several lenders to provide financing to our
qualified franchisees who purchase these turnkey units. In fiscal year 1999, we
sold seven turnkey units.
AFC Loan Guarantee Program. In March 2000, we implemented a program offered
to current franchisees, new franchisees and our restaurant management employees
to open and operate new franchised units, provided they meet certain financial
and operational criteria. We have an agreement with one national lender to
participate in the program and we anticipate entering into agreements with
several other national lenders. Under the AFC Loan Guarantee Program, we will
guarantee up to 20% of each qualified franchisee's loan amount, typically for a
three-year period. Currently, the total amount of funding to franchisees under
this program will not exceed $10.0 million in
10
total and our overall guarantee will not exceed 10% of the $10.0 million. This
program is available for Popeyes, Churchs and Cinnabon franchisees and the
qualifications vary depending upon the type of franchise development. This
program is intended to accelerate franchise development by assisting franchisees
in obtaining development financing at competitive rates and provide
entrepreneurial opportunities for our restaurant management employees.
Marketing and Community Activity
Our Popeyes, Churchs, Cinnabon and Seattle Coffee products are marketed to
their respective customer bases using a predominantly three-tiered marketing
strategy consisting of electronic media, print media and signage and point-of-
purchase materials at our restaurants, bakeries and cafes. Each of our brands
offers consumers at least one new program each month to maintain consumer
product interest. New product introductions and "limited time only" promotional
items also play major sales building roles and create regular repeat customers.
We and our franchisees contribute to a national advertising fund to pay for
the development of marketing materials. We and our franchisees also contribute
to local advertising funds to support programs in our local markets. For the
fiscal year ended December 26, 1999, we contributed approximately $25.2 million
to these various advertising funds.
We are also heavily involved in community activities and support programs
that often have an educational theme. Through the AFC Foundation, Inc., a non-
profit foundation, we have sponsored and helped construct 200 homes worldwide
through Habitat for Humanity, a non-profit sponsor of housing construction for
the poor. In addition, we support the United Negro College Fund and the
Hispanic Association of Colleges and Universities with promotional fund-raisers.
We also sponsor Adopt-A-School programs.
Competition
Our industry, and particularly the quick service restaurant segment, is
intensely competitive with respect to price, quality, name recognition, service
and location. Other QSR competitors include chicken, hamburger, pizza, Mexican,
sandwich, Chinese food QSRs, other purveyors of carryout food and convenience
dining establishments, including national restaurant chains. Numerous well-
established QSR competitors possess substantially greater financial, marketing,
personnel and other resources than we do. In addition, the QSR industry is
characterized by the frequent introduction of new products, accompanied by
substantial promotional campaigns. We must respond to various factors affecting
the restaurant industry, including changes in consumer preferences, tastes and
eating habits, demographic trends and traffic patterns, increases in food and
labor costs, competitive pricing and national, regional and local economic
conditions. In recent years, a number of companies in the QSR industry have
introduced products, including non-fried chicken products, which were developed
to capitalize on a
11
growing consumer preference for food products which are, or are perceived to be,
healthful, nutritious, low in calories and low in fat content. It can be
expected that we will be subject to increasing competition from companies whose
products or marketing strategies address these consumer preferences. There can
be no assurance that consumers will continue to regard our products favorably,
as compared to such competitive products, or that we will be able to continue to
compete successfully in the QSR marketplace. In addition, our chief competitors
in the chicken segment of the QSR industry, KFC(R), and in the specialty coffee
business, Starbucks(R), are larger, better capitalized and have greater access
to financing at favorable rates, all of which may affect our competitive
abilities.
Our Cinnabon bakeries compete with other QSR's, bagel bakeries and
traditional bakeries in the bagel and cinnamon roll business. While national
chains such as Einstein/Noah Bagels, New World Coffee-Manhattan Bagel and others
compete directly with us for the sale of bakery products, there are few direct
competitors in cinnamon rolls. Cinnabon is the leader in the cinnamon roll
segment of the QSR business and is the only national cinnamon roll retailer in
North America.
Our whole bean coffees compete directly with specialty coffees sold at
retail through supermarkets, specialty retailers, and a growing number of
specialty coffee stores. Our coffee beverages compete directly with all
restaurant and beverage outlets that serve coffee and a growing number of
espresso kiosks, carts, and coffee cafes. Both our whole bean coffees and our
coffee beverages compete indirectly with all other coffees on the market,
including specialty retail companies such as Starbucks, and conventional coffee
companies such as Kraft Foods, Procter & Gamble, and Nestle.
Suppliers
Our franchisees are generally required to purchase all ingredients,
products, materials, supplies, and other items necessary in the operation of
their businesses solely from suppliers who (i) demonstrate, to our continuing
satisfaction, the ability to meet our standards and specifications for such
items, (ii) possess adequate quality controls and capacity to supply our
franchisees' needs promptly and reliably and (iii) have been approved in writing
by us.
Supply Contracts. In addition, our Company-operated restaurants and
bakeries are obligated to serve certain Coca-Cola(R) and Dr Pepper(R) beverages
exclusively. We also have a long-term agreement with Diversified Foods and
Seasonings, Inc. ("Diversified") under which we are required to purchase for our
Popeyes restaurants certain proprietary products made exclusively by
Diversified. We have designated Diversified as the sole supplier of certain
proprietary products for the Popeyes system. Diversified sells these products
to our approved distributors who in turn sell them to our franchised and
Company-operated Popeyes restaurants. In our fiscal year ended December 26,
1999, the Popeyes system purchased approximately $37.8 million of proprietary
products made by Diversified. Our Popeyes and Churchs systems also purchase
fresh chicken from 14 suppliers who service us from 33 plant locations.
12
With respect to our wholesale coffee operations, our principal raw material
is green coffee beans. We typically enter into supply contracts to purchase a
pre-determined quantity of green coffee beans at a fixed price per pound. These
contracts usually cover periods up to a year as negotiated with the individual
supplier. At March 27, 2000, we had commitments to purchase green coffee beans
at a total cost of approximately $12.5 million. The contract terms cover a
period from January 2000 to December 2000. We purchase 50% of our green coffee
beans from two suppliers and purchase the remaining 50% from 15 other suppliers.
To the extent the two major suppliers cannot meet our coffee orders, we have the
option of ordering our coffee from the other fifteen suppliers.
Purchasing Cooperative. Supplies are generally provided to our franchised
and Company-operated restaurants, bakeries, and to a lesser degree cafes
pursuant to supply agreements, which until recently were negotiated by Popeyes
Operators Purchasing Cooperative Association, Inc. and Churchs Operators
Purchasing Association, Inc. respectively, each a not-for-profit corporation.
These corporations were created for the purpose of consolidating our collective
purchasing power with our franchisees and as a result being able to negotiate
more favorable terms. In January 2000, our purchasing cooperatives were
combined into one purchasing and logistical service cooperative, Supply
Management Services, Inc., for our members. Our purchasing cooperative is not
obligated to purchase, and cannot bind its members to commitments to purchase
any supplies. Membership in the cooperative is open to all of our franchisees.
Since 1995, our Popeyes and Churchs franchise agreements have required that each
franchisee join the purchasing cooperative as a member. Substantially all of
our domestic franchisees participate in our purchasing cooperative.
SCC Cafes. Our Company-operated and franchised cafes purchase all of their
coffee from our wholesale distribution centers and their non-coffee food and
supply items from Unisource Worldwide, Inc., a large food service supply
distributor.
Trademarks and Licenses
We own a number of trademarks and service marks that have been registered
with the United States Patent and Trademark Office, including the marks
"Popeyes", "Popeyes Chicken & Biscuits", "Churchs", "Cinnabon World Famous
Cinnamon Roll", "Seattle's Best Coffee", "Torrefazione Italia", "Ultrafryer" and
each brand's logo utilized by us and our franchisees in virtually all
restaurants, bakeries and cafes domestically. We have trademark registrations
for a number of additional marks, including "Gotta Love It"(R), "Day of
Dreams"(R), "Love That Chicken From Popeyes"(R), "New Age of Opportunity"(R) and
"Franchisor of Choice"(R). In addition, we have registered or made application
to register the marks (or, in certain cases, the marks in connection with
additional words or graphics) in approximately 150 foreign countries, although
there can be no assurance that any mark is registrable in every country
registration is sought. We consider our intellectual property rights to be
important to our business and actively defend and enforce them.
13
Formula Agreement. In connection with our Popeyes brand, we have a
perpetual formula licensing agreement with Alvin C. Copeland, the founder of
Popeyes, the former owner of the Popeyes and Churchs restaurant systems, and the
owner of Diversified Foods and Seasonings, Inc., under which we have the
worldwide exclusive rights to the Popeyes spicy fried chicken recipe and certain
other ingredients used in Popeyes products. The agreement provides that we pay
Mr. Copeland monthly royalty payments of $254,166 until March 2029.
King Features Agreements. We have several agreements with The Hearst
Corporation, King Features Syndicate Division under which we have the exclusive
right to use the image and likeness of the cartoon character "Popeye" (and
certain companion characters such as "Olive Oyl") in connection with Popeyes
restaurants worldwide. Under these agreements, we are obligated to pay to King
Features a royalty of one-tenth of one percent on the first $1 billion of
Popeyes cumulative, annual system-wide sales and one twentieth of one percent on
the next $2 billion of such annual sales. The annual royalties are capped at
$2.0 million for the year under the agreement. The King Features agreements
automatically renew annually.
Year 2000 Issues
In the process of customizing our management information systems, we
established procedures to ensure that our new systems were year 2000 compliant.
In addition, we formalized a plan to analyze all of our financial and operating
computer systems to ensure that any problems would be eliminated before the
beginning of the year 2000. This plan included analysis of our supplier
systems, and to the extent possible the systems used by our vendors and others
that are needed for the proper functioning of our business. We completed the
analysis and corrective phases of the plan in 1999. We did not encounter any
significant issues related to the Year 2000 rollover. As such, we believe that
we have resolved substantially all of the potential year 2000 issues. See
"Item 7. Management's Discussion and Analysis - Year 2000".
14
Expansion; Dependence on Franchisees and Developers
Our global strategy will depend heavily on our ability to grow our
franchise base of operations. At December 26, 1999, we franchised 1,857
restaurants, bakeries and cafes domestically and 577 restaurants, bakeries and
cafes internationally. Our success is dependent upon our franchisees and the
manner in which they develop and operate restaurants, bakeries and cafes. As
we expand we will also need to find new franchisees who are capable of
successfully developing and operating these units. The opening and success of
franchised restaurants, bakeries and cafes will depend on various other factors,
including the availability of suitable sites, the negotiation of acceptable
lease or purchase terms for new locations, permitting and regulatory compliance,
the ability to meet construction schedules, the financial and other capabilities
of our franchisees and developers, our ability to manage this anticipated
expansion and hire and train personnel, and general economic and business
conditions. Not all of the foregoing factors are within our control or the
control of our franchisees or developers.
International Operations
As of December 26, 1999, we franchised 577 restaurants, bakeries and cafes
to franchisees in 24 foreign countries and plan to expand our foreign
franchising program significantly in the future. We currently operate three
coffee cafes and a wholesale coffee distribution center located in Canada. We
do not currently operate any other units outside of the U.S. Included in our
revenues are foreign franchise royalties and other fees that are based, in part,
on sales generated by our foreign franchised restaurants, bakeries and cafes,
including a significant number of franchised restaurants in Asia. Currently, we
have limited exposure to changes in international economic conditions and
currency fluctuations. We have not historically maintained any hedges against
foreign currency fluctuations, although we did enter into a foreign currency
hedging agreement in 1999 with respect to the Korean Won. Our losses during the
past three years related to foreign currency fluctuations have not been material
to our results of operations. For fiscal years 1999, 1998 and 1997, royalties
and other revenues from foreign franchisees represented 1.7%, 1.9% and 2.4%,
respectively, of our total revenues.
Food Service Industry
Food service businesses are often affected by changes in consumer tastes,
national, regional and local economic conditions, demographic trends, traffic
patterns and the type, number and location of competing restaurants, bakeries
and cafes. Multi-unit food service chains such as Popeyes, Churchs, Cinnabon
and Seattle Coffee can also be adversely affected by publicity resulting from
food quality, illness, injury or other health concerns or operating issues
stemming from just one restaurant or a limited number of restaurants.
Dependence on frequent deliveries of fresh food products also subjects food
service businesses such as ours to the risk that shortages or interruptions in
supply caused by adverse weather or other conditions could adversely affect the
15
availability, quality and cost of ingredients. In addition, material changes
in, or the failure by us or our franchisees to comply with, applicable federal,
state and local government regulations, and such factors as inflation, increased
food, labor and employee benefits costs, such as federally-mandated increases in
the minimum wage, regional weather conditions and the unavailability of
experienced management and hourly employees may also adversely affect the food
service industry in general and our results of operations and financial
condition in particular.
Fluctuations in Cost of Chicken
The principal raw material for our Popeyes and Churchs systems is fresh
chicken. For fiscal years ended December 26, 1999 and December 27, 1998,
approximately 47% and 50%, respectively of Popeyes' and Churchs' restaurant
cost of sales was attributable to the purchase of fresh chicken. As a result, we
are significantly affected by increases in the cost of chicken, which can be
affected by, among other factors, the cost of grain, the price for other
alternative domestic meats and overseas demand for chicken products. Due to
extremely competitive conditions in the QSR industry, with respect to increases
in raw material costs such as chicken, we have generally not been able to raise
retail prices sufficiently to pass all such increased costs to the consumer.
In order (i) to ensure favorable pricing for our chicken purchases in the
future, (ii) to reduce volatility in chicken prices and (iii) to maintain an
adequate supply of fresh chicken, the Popeyes and Churchs purchasing
cooperatives entered into two types of chicken purchasing contracts with chicken
suppliers in 1999. The first is a grain-based "cost-plus" pricing contract that
provides chicken prices based upon the cost of feed grains, such as corn and
soybean meal, plus certain agreed upon non-feed and processing costs. The other
is a market-priced formula contract based on the "Georgia whole bird market
value". Under this contract, we pay market price plus a premium for the cut
specifications for our restaurants. The market-priced formula contracts are
subject to a "ceiling", or highest price, and a "floor", or lowest price, that
we will pay over the contract term. Both contracts have terms ranging from three
to five years with provisions for certain annual price adjustments as defined in
the contracts. In 2000, we intend to increase our purchase volume in the "cost-
plus" pricing contract, thereby reducing purchases under the market based
contract in order to further reduce our exposure to rising chicken prices should
they occur.
Availability and Cost of Green Coffee Beans
The supply and prices of green coffee beans are volatile. Although most
coffee beans trade in the commodity market, coffee beans of the quality sought
by us generally trade on a negotiated basis at a premium above the commodity
market coffee pricing,
16
depending upon the supply and demand at the time of purchase. Availability and
price can be affected by many factors in producing countries, including weather
and political and economic conditions.
Insurance
We carry property, liability, business interruption, crime, and workers'
compensation insurance policies, which we believe are customary for businesses
of our size and type. Our franchisees are also required to maintain certain
minimum standards of insurance with insurance companies satisfactory to us
pursuant to their franchise agreements, including commercial general liability
insurance, workers' compensation insurance, all risk property and casualty
insurance and automobile insurance.
Seasonality
We have historically experienced the strongest operating results at our
Popeyes and Churchs restaurants during the summer months while operating results
have been somewhat lower during the winter season. Our Cinnabon bakeries and
Seattle Coffee cafes have traditionally experienced the strongest operating
results during the Christmas holiday shopping season between Thanksgiving and
Christmas. Certain holidays and inclement weather reduce the volume of consumer
traffic at quick-service restaurants and may impair the ability of certain
restaurants to conduct regular operations for short periods of time.
Regulation
We are subject to various federal, state and local laws affecting our
business, including various health, sanitation, fire and safety standards.
Newly constructed or remodeled restaurants, bakeries and cafes are subject to
state and local building code and zoning requirements. In connection with the
remodeling and alteration of our restaurants, bakeries and cafes, we may be
required to expend funds to meet certain federal, state and local regulations,
including regulations requiring that remodeled or altered restaurants, bakeries
and cafes be accessible to persons with disabilities. Difficulties or failures
in obtaining the required licenses or approvals could delay or prevent the
opening of new restaurants, bakeries and cafes in particular areas.
We are also subject to the Fair Labor Standards Act and various state laws
governing such matters as minimum wage requirements, overtime and other working
conditions and citizenship requirements. A significant number of our food
service personnel are paid at rates related to the federal minimum wage and
increases in the minimum wage, including those recently enacted by the federal
government, have increased our labor costs.
Certain states and the Federal Trade Commission require franchisors such as
us to transmit specified disclosure statements to potential franchisees before
granting a
17
franchise. Additionally, some states require us to register our franchise
offering documents with the state before we may offer a franchise. We believe
that our Uniform Franchise Offering Circulars (together with any applicable
state versions or supplements) comply with both the Federal Trade Commission
guidelines and all applicable state laws regulating franchising in those states
in which we have offered franchises. We are also subject to various federal,
state and local laws regulating the discharge of pollutants into the
environment. We believe that we conduct our operations in substantial compliance
with applicable environmental laws and regulations as well as other applicable
laws and regulations governing our operations.
Environmental Matters
Approximately 150 of our owned and leased properties are known or suspected
to have been used by prior owners or operators as retail gas stations, and a few
of these properties may have been used for other environmentally sensitive
purposes. Many of these properties previously contained underground storage
tanks ("USTs") and some of these properties may currently contain abandoned
USTs. As a result of the use of oils and solvents typically associated with
automobile repair facilities and gas stations, it is possible that petroleum
products and other contaminants may have been released at these properties into
the soil or groundwater. Under applicable federal and state environmental laws,
we, as the current owner or operator of these sites, may be jointly and
severally liable for the costs of investigation and remediation of any such
contamination if it exists. As a result, after an analysis of our property
portfolio, including testing of soil and groundwater at a representative sample
of our facilities, we believe we have accrued adequate reserves and have
obtained adequate insurance coverage for any environmental remediation
liabilities. We are currently not subject to any administrative or court order
requiring remediation at any of our properties.
Employees and Personnel
As of December 26, 1999, we employed 2,499 full-time salaried employees and
14,511 full-time and part-time hourly employees. Of our full-time salaried
employees, 125 are involved in overseeing restaurant, bakery and cafe
operations, 1,794 are involved in the management of individual restaurants,
bakeries and cafes and all remaining salaried employees are responsible for
corporate administration, franchise administration and business development.
None of our employees are covered by a collective bargaining agreement. We
believe that the dedication of our employees is critical to our success, and
that our relationship with our employees is good.
18
Item 2. PROPERTIES
We either own or lease the land and buildings for our Company-operated
restaurants, bakeries and cafes. In addition, we own or lease land and
buildings, which we lease or sublease to our franchisees and third parties.
While we expect to continue to lease many of our sites in the future, we also
may purchase the land and/or buildings for restaurants, bakeries and cafes to
the extent acceptable terms are available. The majority of our units are
located in retail community shopping centers and freestanding, heavily traveled
locations.
Restaurants, bakeries and cafes leased to us are typically leased under
"triple net" leases that require us to pay real estate taxes, maintenance costs
and insurance premiums and, in some cases, to pay percentage rent based on sales
in excess of specified amounts. Generally, our leases have initial terms ranging
from 5 to 20 years with options to renew for one or more additional periods. Our
typical leases or subleases to franchisees are triple net to the franchisee,
provide for a minimum rent, based upon prevailing market rental rates, and have
a term that usually coincides with the term of the franchise agreement for the
location, often being 20 years with renewal options. Such leases are typically
cross-defaulted with the corresponding franchise agreement for that site.
The following table sets forth the locations by state of our Company-
operated Popeyes restaurants as of December 26, 1999:
Land
Land and and/or
Building Building
Owned Leased Total
-------- -------- -----
Texas............ 23 40 63
Georgia.......... 3 45 48
Louisiana........ 6 37 43
North Carolina... - 13 13
South Carolina... - 7 7
Illinois......... 1 - 1
-- --- ---
Total Popeyes.. 34 141 175
== === ===
19
The following table sets forth the locations by state of our Company-
operated Churchs restaurants as of December 26, 1999:
Land
Land and and/or
Building Building
Owned Leased Total
-------- -------- -----
Texas............ 151 98 249
Georgia.......... 35 17 52
Alabama.......... 27 12 39
Louisiana........ 19 18 37
Arizona.......... 19 8 27
Florida.......... 20 2 22
Oklahoma......... 14 2 16
Mississippi...... 10 4 14
Tennessee........ 12 1 13
New Mexico....... 5 2 7
Missouri......... 6 - 6
Arkansas......... 5 1 6
Nevada........... 2 2 4
Kansas........... 2 - 2
--- --- ---
Total Churchs.. 330 164 494
=== === ===
The following table sets forth the locations by state of our Company-
operated Seattle Coffee cafes as of December 26, 1999:
Land
Land and and/or
Building Building
Owned Leased Total
-------- -------- -----
Washington...... - 29 29
California...... - 13 13
Illinois........ - 10 10
Oregon.......... - 6 6
Massachusetts... - 5 5
Georgia......... - 3 3
Maryland........ - 2 2
Texas........... - 2 2
Colorado........ - 1 1
Indiana......... - 1 1
Virginia........ - 1 1
-- -- --
Total SCC.... - 73 73
== == ==
20
The following table sets forth the locations by state of our Company-
operated Cinnabon bakeries as of December 26, 1999:
Land
Land and and/or
Building Building
Owned Leased Total
-------- -------- -----
California........... - 46 46
Washington........... - 22 22
Illinois............. - 15 15
Florida.............. - 14 14
Ohio................. - 12 12
Texas................ - 10 10
Michigan............. - 9 9
Pennsylvania......... - 7 7
Indiana.............. - 6 6
Massachusetts........ - 6 6
Wisconsin............ - 6 6
New Jersey........... - 5 5
Hawaii............... - 4 4
Maryland............. - 4 4
Nevada............... - 4 4
Oregon............... - 3 3
Virginia............. - 3 3
Georgia.............. - 2 2
Iowa................. - 2 2
Kentucky............. - 2 2
Tennessee............ - 2 2
Alabama.............. - 1 1
Colorado............. - 1 1
Connecticut.......... - 1 1
Delaware............. - 1 1
Kansas............... - 1 1
Missouri............. - 1 1
Montana.............. - 1 1
Nebraska............. - 1 1
New Hampshire........ - 1 1
New York............. - 1 1
South Dakota......... - 1 1
--- --- ---
Total Cinnabon.. - 195 195
=== === ===
Our headquarters are located in approximately 75,000 square feet of leased
office space in Atlanta, Georgia. This lease is subject to extensions through
2013. Popeyes leases another facility in Atlanta, Georgia. This lease is subject
to extensions through 2010. Churchs leases office space in a separate facility
also in Atlanta, Georgia. This lease is subject to extensions through 2011.
Currently, Cinnabon is located in our headquarters location. Seattle Coffee
leases office space in Seattle, Washington and has four distribution facilities
that service our coffee wholesale operations. Two of the distribution centers
are located in the Seattle, Washington area. The other two facilities are
located in Portland, Oregon and Chicago, Illinois. Our accounting and computer
facilities and our Ultrafryer manufacturing
21
facilities are located in San Antonio, Texas and are housed in three buildings
that are located on approximately 16 acres of land that we own. We believe that
our existing headquarters and other leased facilities provide sufficient space
to support our corporate and coffee wholesale operational needs.
Substantially all of our properties and assets are pledged as collateral
against our bank credit facility (See Note 8 to our Consolidated Financial
Statements).
Item 3. LEGAL PROCEEDINGS
While we are a party to a number of pending legal proceedings that have
arisen in the ordinary course of our business, we do not believe that the we are
a party to any pending legal proceeding, the resolution of which would have a
material adverse effect on our financial condition or results of operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
22
Part II.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for our common stock. As of
March 27, 2000, the number of record holders of our common stock was 94.
We have not declared or paid cash dividends to our shareholders. We
anticipate that all of our earnings in the near future will be retained for the
development and expansion of our business and, therefore, do not anticipate
paying dividends on our common stock in the foreseeable future. Declaration of
dividends on our common stock will depend upon, among other things, levels of
indebtedness, future earnings, our operating and financial condition, our
capital requirements and general business conditions. The agreements governing
our indebtedness contain provisions, which restrict our ability to pay dividends
on our common stock.
In connection with the acquisition of SCC on March 18, 1998, we issued
70,141 shares of AFC Common Stock to former SCC shareholders on March 18, 1999
pursuant to a contingent earn-out provision defined in the acquisition
agreement. We issued all of these unregistered securities under the limited
offering exemption under Rule 506 of Regulation D.
23
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth our selected historical consolidated
financial information for the periods and the dates indicated. The balance
sheet data and statement of operations data for the years ended December 31,
1995, December 29, 1996, December 28, 1997 December 27, 1998 and December 26,
1999 set forth below have been derived from our financial statements of, which
have been audited by Arthur Andersen LLP, independent public accountants. This
selected historical consolidated financial information should be read in
conjunction with, and is qualified in its entirety by (i) "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
(ii) our audited Consolidated Financial Statements and the notes thereto, each
of which is included elsewhere in this report.
Year Ended(1)
------------------------------------------------------------------------
December 26, December 27, December 28, December 29, December 31,
1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------
Revenues:
Restaurant sales............. $559,512 $487,441 $403,182 $430,280 $426,707
Franchise revenues........... 77,463 64,211 61,716 51,336 47,916
Wholesale revenues........... 51,643 36,411 - - -
Manufacturing revenues....... 9,076 7,561 7,647 8,222 9,969
Other revenues............... 9,448 9,935 8,766 8,005 8,320
-------- -------- -------- -------- --------
Total revenues............ 707,142 605,559 481,311 497,843 492,912
Costs and expenses:
Restaurant cost of sales..... 167,659 155,165 131,332 142,199 139,286
Restaurant operating
expenses.................... 287,519 244,651 197,232 211,275 214,703
Wholesale cost of sales...... 24,693 19,064 - - -
Wholesale operating
expenses.................... 13,104 8,070 - - -
Manufacturing cost of sales.. 8,048 5,802 6,381 7,201 9,180
General and administrative... 96,475 86,784 77,492 76,071 78,095
Executive compensation
award (2)................... - - - - 10,647
Depreciation and
amortization................ 42,352 45,478 33,532 30,904 28,665
Charges for restaurant
closings.................... 4,435 8,858 479 1,304 688
Provision for software
write-offs.................. 3,830 5,000 - - -
Gain on sale of fixed assets
from AFDC transaction....... - - (5,319) - -
-------- -------- -------- -------- --------
Total costs and expenses.. 648,115 578,872 441,129 468,954 481,264
-------- -------- -------- -------- --------
Income from operations.......... 59,027 26,687 40,182 28,889 11,648
Other expenses:.................
Interest, net................ 34,219 30,786 20,645 15,875 23,444
-------- -------- -------- -------- --------
Income (loss) from continuing
operations before income
taxes......................... 24,808 (4,099) 19,537 13,014 (11,796)
Income tax expense
(benefit).................. 10,293 (1,346) 8,530 5,163 (2,969)
-------- -------- -------- -------- --------
Net income (loss) from
continuing operations......... 14,515 (2,753) 11,007 7,851 (8,827)
Discontinued segment:
Loss from operations of
Chesapeake Bagel Bakery
(net of income tax)......... 688 5,893 7 - -
Loss on sale of Chesapeake
Bagel Bakery (net of income
tax)........................ 1,742 - - - -
-------- -------- -------- -------- --------
Net loss from discontinued
segment....................... 2,430 5,893 7 - -
Extraordinary loss, net of
taxes (3).................. - - - (4,456) -
-------- -------- -------- -------- --------
Net income (loss).............. 12,085 (8,646) 11,000 3,395 (8,827)
8% Preferred Stock dividends... - - - 1,316 4,555
10% Preferred Stock dividends
payable in kind............... - - 2,240 3,956 -
Accelerated accretion of 8%
Preferred Stock discount upon
retirement.................... - - - 8,719 -
Accretion of 8% Preferred
Stock discount................ - - - 813 2,571
-------- -------- -------- -------- --------
Net income (loss) attributable
to common stock............... $ 12,085 $ (8,646) $ 8,760 $(11,409) $(15,953)
======== ======== ======== ======== ========
24
Year Ended(1)
------------------------------------------------------------------------
December 26, December 27, December 28, December 29, December 31,
1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------
Other Financial Data:
EBITDA, as defined (4)......... $ 113,009 $ 87,037 $ 74,017 $ 64,866 $ 55,342
EBITDA margin (5).............. 15.9 % 14.3 % 15.3 % 13.0 % 11.2 %
Cash flows provided by
(used in):
Operating activities........ 55,227 45,537 52,515 47,801 28,031
Investing activities........ (47,846) (188,287) (35,782) (29,388) (20,114)
Financing activities........ (1,951) 126,852 (2,985) (12,806) (10,721)
Cash capital
expenditures(6)
Maintenance capital
expenditures............. $ 7,903 $ 6,059 $ 7,756 $ 6,010 $ 5,483
Re-images and renovation.. 7,766 2,679 13,356 15,342 15,502
New restaurant
development............. 24,771 13,749 4,588 3,215 2,272
Wholesale operations...... 2,154 1,400 - - -
Other..................... 12,376 13,965 16,436 9,384 1,739
---------- ---------- ---------- ----------- ----------
Total cash capital
expenditures........... $ 54,970 $ 37,852 $ 42,136 $ 33,951 $ 24,996
========== ========== ========== =========== ==========
Ratio of earnings to fixed
charges (7).................. 1.48 % - 1.64 % 1.29 % -
Balance Sheet Data:
Total assets................. $ 561,889 $ 556,465 $ 380,002 $ 339,668 $ 328,645
Total debt and capital lease
obligations................. 348,091 360,711 243,882 151,793 204,025
Mandatorily redeemable
preferred stock............. - - - 59,956 46,468
Total shareholders equity
(deficit)................... 100,799 87,917 48,459 37,902 (21,665)
Restaurant, Bakery and
Cafe Data (unaudited) (8):
System-wide sales
(in thousands):
Popeyes................... $1,068,574 $ 954,305 $ 853,078 $ 762,108 $ 710,840
Churchs................... 810,471 755,074 723,988 675,996 647,746
Cinnabon.................. 152,421 41,738 - - -
Seattle Coffee............ 31,660 24,887 - - -
---------- ---------- ---------- ---------- ----------
Total.................. $2,063,126 $1,776,004 $1,577,066 $1,438,104 $1,358,586
========== ========== ========== ========== ==========
System-wide units:
Popeyes................... 1,396 1,292 1,131 1,021 964
Churchs................... 1,492 1,399 1,356 1,257 1,219
Cinnabon.................. 388 369 - - -
Seattle Coffee............ 98 71 - - -
---------- ---------- ---------- ---------- ----------
Total.................. 3,374 3,131 2,487 2,278 2,183
========== ========== ========== ========== ==========
System-wide percentage change
in comparable restaurant
sales:
Popeyes domestic.......... 4.4 % 5.2 % 3.6 % 0.5 % 1.2 %
Churchs domestic.......... 1.1 % 4.6 % 4.0 % 4.6 % 4.6 %
Cinnabon domestic (9)..... 2.4 % - - - -
Seattle Coffee
domestic (9)............. 3.3 % - - - -
Popeyes international..... (4.8)% (13.3)% 1.3 % 4.3 % 11.6 %
Churchs international..... (2.7)% (1.5)% 2.6 % (2.1)% 0.9 %
Cinnabon
international (9)........ 11.5 % - - - -
Total commitments outstanding,
end of period (10)............. 1,983 1,602 1,550 1,319 1,083
(1) The company has a 52/53-week fiscal year ending on the last Sunday in
December, which normally consists of 13 four-week periods. The fiscal year
ended December 31, 1995 included 53 weeks of operations.
(2) During 1995, the Board of Directors granted a special award of $10.0
million to the CEO of the Company and his designees contingent upon the
happening of certain events related to a recapitalization of the Company.
See "Item 11. Executive Compensation -- Note (2)." The award became payable
at the time of the Recapitalization. This award was paid in 1996 in
approximately 3.0 million shares of the Company's common stock valued at
$3.317 per share, the market value of the Company's common stock at the
date of issuance. As a result of the Recapitalization, certain
25
senior executive officers became fully vested in certain stock options
pursuant to the terms of the 1992 Stock Option Plan resulting in
recognition of $647,000 of compensation expense in 1995.
(3) The extraordinary loss recorded in fiscal 1996 represents the loss
associated with the prepayment of certain debt obligations of the Company,
net of related income tax effects.
(4) EBITDA is defined as income from operations plus depreciation and
amortization; adjusted for non-cash items related to gains/losses on asset
dispositions and write-downs, compensation expense related to stock option
activity, the executive compensation award (see Note 2 above) and non-cash
officer notes receivable items related to the executive compensation award.
EBITDA, as defined, should not be construed as a substitute for income from
operations or as a better indicator of liquidity than cash flow from
operating activities, which is determined in accordance with generally
accepted accounting principles. EBITDA, as defined, is included herein to
provide additional information with respect to the ability of the Company
to meet its future debt service, capital expenditure and working capital
requirements. In addition, management believes that certain investors find
EBITDA, as defined, to be a useful tool for measuring the ability of the
Company to service its debt. EBITDA, as defined, is not necessarily a
measure of the Company's ability to fund its cash needs. See the
Consolidated Statements of Cash Flows of the Company and the related Notes
to the Consolidated Financial Statements thereto attached.
(5) EBITDA margin represents EBITDA, as defined, divided by total revenues.
(6) Capital expenditures (excluding expenditures funded through capital leases,
and fixed assets in connection with the acquisitions of Seattle Coffee,
Cinnabon and Pinetree and not reduced by the cash proceeds received from
the sale of fixed assets) have been segregated into the following
categories to provide additional information:
. Maintenance capital expenditures-represents day to day expenditures
related to restaurant equipment replacements and general restaurant
capital improvements.
. Re-images and renovation-represents significant restaurant renovations
and upgrades pursuant to the Company's re-imaging and renovation
activities.
. New restaurant development-represents new Company-operated restaurant
construction and development.
. Wholesale operations-represents capital expenditures related to our
Seattle Coffee wholesale operations.
. Other-represents capital expenditures at various corporate offices and
new restaurant equipment such as fryers and security systems.
(7) The Company had a deficiency of earnings to fixed charges for the fiscal
years December 31, 1995 and December 27, 1998 of approximately $12,284,000
and $13,139,000, respectively. Earnings consist of income (loss) before
taxes, plus fixed charges (excluding capitalized interest). Fixed charges
consist of interest expense, amortization of debt issuance cost and debt
discount, preferred stock dividend requirements and accretion (including
related tax effects), and one-third of rent expense on operating leases
considered representative of the interest factor attributable to rent
expense.
(8) Represents sales for all franchised and Company-operated restaurants,
bakeries and cafes. Sales information for franchised restaurants is as
reported by franchisees or, in some instances, estimated by the Company
based on other data, and is unaudited.
(9) Prior year sales figures used to calculate comparable sales include sales
from Cinnabon and Seattle Coffee prior to our acquisition of these two
brands in 1998.
(10) Commitments represent commitments to open franchised restaurants, bakeries
and cafes, as set forth in development agreements. On a historical basis,
a number of such commitments have not resulted in unit openings. There can
be no assurance that parties to development agreements will open their
respective number of units.
26
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities and Exchange Act of 1934, as amended. Such
forward-looking statements relate to our plans, objectives and expectations for
future operations. In light of the risks and uncertainties inherent in any
discussion of our expected future performance or operations, the inclusion of
forward-looking statements in this report should not be regarded as a
representation by us or any other person that these will be realized. Such
performance could be materially affected by a number of factors, including
without limitation those factors set forth in the "Item 1. Business" section in
this filing.
Chesapeake Bagel Divestiture
On July 26, 1999, we entered into a definitive agreement to sell our
Chesapeake Bagel franchise rights and system to New World Coffee-Manhattan
Bagel, Inc. for $3.8 million. The sale closed on August 30, 1999. As a result,
restaurant sales, franchise revenues, restaurant cost of sales, restaurant
operating expenses, general and administrative expenses and depreciation and
amortization related to Chesapeake's operations have been classified as
discontinued operations in our financial statements. Chesapeake's operations
were included in our bakery segment prior to the sale. Accordingly, the
discussions that follow have been restated to reflect the continuing operations
of our existing brands.
Consolidated Results of Operations
The following table presents selected revenues and expenses as a percentage
of total revenues for our consolidated statements of operations for the fiscal
years ended December 26, 1999, December 27, 1998 and December 28, 1997.
27
Percentage Results of Operations
Year Ended
--------------------------------------
December 26, December 27, December 28,
1999 1998 1997
------------ ------------ ------------
Revenues:
Restaurant sales........................ 79.1% 80.5 % 83.8 %
Franchise revenues...................... 11.0 10.6 12.8
Wholesale revenues...................... 7.3 6.0 -
Manufacturing revenues.................. 1.3 1.3 1.6
Other revenues.......................... 1.3 1.6 1.8
----- ----- -----
Total revenues......................... 100.0% 100.0 % 100.0 %
----- ----- -----
Costs and expenses:
Restaurant cost of sales (1)............ 30.0% 31.8 % 32.6 %
Restaurant operating expenses (1)....... 51.4 50.2 48.9
Wholesale cost of sales (2)............. 47.9 52.2 -
Wholesale operating expenses (2)........ 25.4 22.0 -
Manufacturing cost of sales (3)......... 87.9 76.3 84.2
General and administrative.............. 13.6 14.3 16.1
Depreciation and amortization........... 6.0 7.5 7.0
Charges for restaurant closings......... 0.6 1.5 0.1
Provision for software write-offs....... 0.5 0.8 -
Gain on sale of fixed assets from
AFDC transaction....................... - - (1.1)
Total costs and expenses............... 91.7 95.6 91.6
Income from operations................... 8.3 4.4 8.4
Interest expense, net.................... 4.8 5.1 4.3
Income (loss) from continuing
operations before income taxes.......... 3.5 (0.7) 4.1
Income tax expense (benefit)............. 1.4 (0.2) 1.8
Net income (loss) from
continuing operations................... 2.1 (0.5) 2.3
Loss on discontinued operations, net of
taxes, (4).......................... 0.3 1.0 -
Net income (loss)........................ 1.8% (1.5)% 2.3 %
(1) Expressed as a percentage of restaurant sales by Company-operated
restaurants, bakeries and cafes.
(2) Expressed as a percentage of wholesale revenues.
(3) Expressed as a percentage of manufacturing revenues.
(4) Represents Chesapeake's operations.
28
Selected Consolidated Financial Data
The following table sets forth certain financial information and other
restaurant, bakery and cafe data relating to our Company-operated and franchised
restaurants, bakeries and cafes (as reported to us by our franchisees) for the
fiscal years ended December 26, 1999, December 27, 1998 and December 28, 1997:
Year Ended
-------------------------------------------------------------------------
December 26, December 27, % Change December 28, % Change
1999 1998 1998 - 1999 1997 1997 - 1998
------------ ------------ ----------- ------------ -----------
(dollars in millions)
EBITDA, as defined (1)......................... $ 113.0 $ 87.0 29.8 % $ 74.0 17.6 %
EBITDA margin.................................. 15.9 % 14.3 % 11.5 15.3 % (6.7)
Capital Expenditures........................... 55.2 (2) 41.5 (2) 33.0 62.9 (34.0)
Restaurant, bakery and cafe data (unaudited):
System-wide sales (3):
Popeyes..................................... $1,068.6 $ 954.3 12.0 % $ 853.0 11.9 %
Churchs..................................... 810.5 755.1 7.3 724.0 4.3
Cinnabon.................................... 152.4 41.7 N/A - N/A
Seattle Coffee.............................. 31.7 24.9 N/A - N/A
-------- -------- --------
Total.................................... $2,063.2 $1,776.0 16.2 % $1,577.1 12.6 %
======== ======== ========
System-wide unit openings (3):
Popeyes..................................... 151 198 (23.7)% 137 44.5 %
Churchs..................................... 133 87 52.9 132 (34.1)
Cinnabon.................................... 46 6 N/A - N/A
Seattle Coffee.............................. 27 18 N/A - N/A
-------- -------- --------
Total.................................... 357 309 15.5 % 269 14.9 %
======== ======== ========
System-wide units open, end of period:
Popeyes..................................... 1,396 1,292 8.1 1,131 14.2 %
Churchs..................................... 1,492 1,399 6.7 1,356 3.2
Cinnabon.................................... 388 369 5.1 - N/A
Seattle Coffee.............................. 98 71 36.6 - N/A
-------- -------- --------
Total.................................... 3,374 3,131 7.8 % 2,487 25.9 %
======== ======== ========
System-wide percentage change in comparable
restaurant sales:
Popeyes domestic............................ 4.4 % 5.2% 3.6 %
Churchs domestic............................ 1.1 4.6 4.0
Cinnabon domestic (4)....................... 2.4 - -
Seattle Coffee domestic (4)................. 3.3 - -
Popeyes international....................... (4.8) (13.3) 1.3
Churchs international....................... (2.7) (1.5) 2.6
Cinnabon international (4).................. 11.5 - -
(1) EBITDA is defined as income from operations plus depreciation and
amortization; adjusted for items related to gains/losses on asset
dispositions and write-downs and compensation expense related to stock
option activity.
(2) Excludes fixed assets added in connection with the Seattle Coffee, Cinnabon
and Pinetree acquisitions and capital expenditures made to convert the
Pinetree restaurants to Popeyes Company-operated restaurants and not
reduced for cash proceeds received from the sale of fixed assets.
(3) Prior year system-wide sales figures and unit openings for Cinnabon and
Seattle Coffee are not comparable since these acquisitions occurred during
1998.
(4) Prior year sales figures used to calculate comparable sales include sales
from Cinnabon and Seattle Coffee prior to our acquisition of these two
brands in 1998.
29
Certain items relating to prior periods have been reclassified to conform with
current presentation.
Sales
System-wide Sales. System-wide sales include sales from all restaurants,
bakeries and cafes, whether operated by us or our franchisees. System-wide
sales increases in 1999 ($287.2 million) and 1998 ($199.0 million) were
primarily due to our acquisitions of Seattle Coffee Company and Cinnabon
International in 1998, new unit growth within our chicken brands and positive
comparable sales growth in our domestic markets, offset by weaker foreign
currencies (measured on a constant currency basis) concentrated in Asia.
Domestically, we opened 208 restaurants, bakeries and cafes in 1999 and 138
restaurants, bakeries and cafes in 1998. We opened 95 restaurants, bakeries and
cafes in 1999 in international markets, however, international system-wide sales
did not experience growth in 1999 related to the new unit openings due to weaker
foreign currencies.
Restaurant Sales. Restaurant sales include sales from our Company-operated
restaurants, bakeries and cafes. The chicken segment includes both our Popeyes
and Churchs brands. The bakery segment includes our Cinnabon brand, and the
coffee segment is comprised of our Seattle Coffee brand's operations.
Chicken
1999 sales at our Company-operated chicken restaurants of $462.8 million
increased $18.5 million and 1998 sales of $444.3 million also grew by $41.1
million. The increased revenue growth in 1999 was due to new restaurant growth
(32 units) and comparable sales increases within our chicken brands. 1998 sales
grew at a higher rate mainly due to a higher number of restaurant openings (80
restaurants) and higher comparable sales increases. In 1998, we acquired all of
the restaurant properties operated by Pinetree Foods, Inc. and during the first
and second quarters of 1998 we converted these properties into 66 Popeyes
Company-operated restaurants. Sales generated by these restaurants alone during
1998 were $32.9 million.
Bakery
Sales at our Company-operated Cinnabon bakeries increased $49.8 million in
1999. Sales growth was primarily due to the full year recognition of revenues
from our acquisition of Cinnabon in October 1998. Sales generated by Cinnabon
bakeries from our acquisition date to our 1998 year end were $22.8 million.
Coffee
Sales from our Company-operated cafes increased $4.7 million in 1999. Our
1999 sales growth was mainly due to the full year recognition of revenues from
our
30
acquisition of Seattle Coffee Company in March 1998 and a 17 unit increase in
1999. Sales generated by our SCC cafes from the date of acquisition to our 1998
year end were $20.4 million.
Franchise Revenues. Franchise revenues include royalties and franchise fees
received from restaurants, bakeries and cafes operated by our franchisees.
Royalties are based on a percent of sales, while franchise fees represent
initial fixed fees depending on the type of franchise and location. Franchise
fees are recorded as revenue when the respective franchised restaurant, bakery
or cafe opens or the development agreement is terminated due to a franchisee
default. For segment purposes, we have segregated our franchised operations
between domestic and international operations.
Chicken
1999 domestic royalty revenue from our franchised chicken restaurants of
$60.8 million increased $6.6 million and 1998 royalty revenue of $51.4 million
increased as well by $6.1 million. Both the 1999 and 1998 growth in royalty
revenue was driven by positive comparable sales and new unit expansion within
our franchise community. We opened 172 domestic franchised restaurants in 1999
and 134 restaurants in 1998.
Domestic franchise fee revenue grew by $2.9 million in 1999, but decreased
in 1998 by $4.2 million. 1999 franchise fee revenue increased primarily due to
the opening of 172 domestic franchised chicken restaurants which exceeded 1998
openings by 38 restaurants and $1.3 million in franchise fees resulting from the
transfer of 100-units from one franchisee to another franchisee and the
termination of a development agreement. The revenue decrease in 1998 stemmed
from two large franchise transactions in 1997 that produced $3.7 million in
franchise fee revenue, which was not matched in 1998. Additionally, domestic
franchise restaurant openings during 1998 were 134 versus 170 in 1997.
Bakery
Royalty revenue from our franchised Cinnabon bakeries increased by $3.0
million in 1999. The 1999 royalty revenue hike was primarily due to our
acquisition of Cinnabon in October 1998 and 30 domestic franchised bakery
openings in 1999. Royalty revenues in 1998 were $1.0 million from the date of
acquisition to our 1998 year end.
International
Over 90% of our international operations are comprised of franchised
Popeyes and Churchs chicken restaurants. International franchise royalty
revenue increased $1.5 million in 1999 and decreased $1.4 million in 1998. Our
1999 increase in royalty revenue was attributable to an increase in restaurants
in international markets. In 1998, royalty revenues were down, despite an
increase in the number of international franchised restaurants, primarily due to
the depressed economies in Southeast Asia
31
causing a decrease in comparable sales as well as the impact from the
depreciating Southeast Asian currencies in converting foreign currency-based
royalties to US dollars.
In 1999, franchise fee revenue decreased $1.2 million resulting from a
decrease of $1.5 million in territorial fees that did not reoccur. The 1999
decrease was offset by a $0.3 million increase in franchise fee revenue due to
the opening of 95 units in 1999 versus 71 unit openings in 1998. 1998 franchise
fee revenue grew by $0.8 million primarily due to amounts recorded in connection
with the development of international Cinnabon bakeries and Seattle Coffee cafes
in the Middle East.
Wholesale Revenues. Our wholesale revenues consist of sales of premium
brand coffee from our Seattle Coffee roasting and distribution operations to
food service retailers and supermarkets. 1999 wholesale revenues increased by
$15.2 million mainly due to the full year recognition of revenues resulting from
our acquisition of Seattle Coffee in March 1998. Our 1998 wholesale revenues
were $36.4 million from the date of acquisition to our year ended 1998.
Operating Profit
Company-operated Operating Profit. Company-operated operating profit is equal
to Company-operated restaurant, bakery and cafe sales less related operating
costs of these restaurants, bakeries and cafes.
Chicken
Our chicken Company-operated operating profit increased $8.9 million or 11.1%
in 1999 and $3.4 million or 4.5% in 1998. Our 1999 operating profit growth
resulted from increased comparable sales and a 4.6% drop in average poultry
prices. In 1998, a 4.0% rise in comparable sales caused an increase in our
operating profit, which was offset by a 2.8% increase in poultry prices.
Company-operated chicken restaurant operating profit as a percent of
restaurant sales was 19.1% in 1999, 17.9% in 1998 and 18.9% in 1997.
Bakery
Our 1999 operating profit at our Company-operated Cinnabon bakeries grew by
$8.3 million. The increase was primarily due to the full year recognition of
operating profit resulting from our acquisition of Cinnabon International in
October 1998. Operating profit reported at our Cinnabon bakeries from our
acquisition date to our 1998 year end was $5.2 million.
32
Coffee
1999 operating profit at our Company-operated Seattle Coffee cafes slightly
increased by $0.8 million. The increase in operating profit resulted from the
full year recognition of operating profit after our acquisition of Seattle
Coffee Company in March 1998.
Wholesale Coffee Operating Profit. Wholesale coffee operating profit is the
differences between coffee sales generated from our Seattle Coffee brands to
wholesale accounts and the related operating costs of our wholesale operations,
which includes the cost of coffee beans and the direct overhead used to roast,
blend and distribute specialty coffee blends.
Coffee
Our wholesale coffee operating profit of $13.8 million in 1999 grew by $4.6
million or 49.3%. The increase was mainly due to the full year recognition of
operating profit after our acquisition of Seattle Coffee Company in March 1998.
Our 1998 wholesale coffee operating profit from the date of acquisition to our
1998 year end was $9.3 million.
Expenses
General and Administrative Expenses. General and administrative expenses
increased $9.7 million or 11.2% in 1999 and $9.3 million or 12.0% during 1998.
The increase in both 1999 and 1998 was primarily attributable to general and
administrative expenses incurred in our Seattle Coffee and Cinnabon operations,
both acquired in 1998. In 1999, Seattle Coffee and Cinnabon accounted for $7.0
million of the total increase in general and administrative expenses, and our
chicken brands added another $4.9 million to these expenses. Decreases in our
general liability insurance expense and reimbursement of 1999 marketing expenses
offset the increases in general and administrative expenses. In 1998, Seattle
Coffee and Cinnabon accounted for $8.9 million of the overall increase in
general and administrative expenses, due to our acquisitions of these brands in
1998, and our chicken brands contributed $5.3 million to the increase in general
and administrative expenses. A 12% decrease in corporate expenses offset the
1998 increase in general and administration expenses. As a percentage of total
revenues, general and administrative expenses were 13.6% in 1999, 14.3% in 1998
and 16.1% in 1997.
Depreciation and Amortization. Depreciation and amortization decreased by
$3.1 million in 1999 and increased by $12.0 million in 1998. In 1999, we re-
estimated the useful lives of certain buildings, equipment and leasehold
improvements increasing some and decreasing others. In some cases the lives
were not adjusted. The 1999 impact of our change in depreciable lives resulted
in a decrease of $7.5 million. The decrease was offset by added depreciation and
amortization from our Seattle Coffee, Cinnabon and Pinetree Foods acquisitions
in 1998. The $12.0 million increase in depreciation and amortization expense in
1998 was primarily attributable to our acquisitions of Seattle Coffee, Cinnabon
and Pinetree Foods. Depreciation and amortization as a percentage of total
revenues was 6.0% in 1999 7.5% in 1998 and 7.0% in 1997.
33
Charges for Restaurant Closings. Charges for restaurant closings include
write-downs of restaurant, bakery and cafe assets to net realizable value,
provisions related to future rent obligations for closed properties and write-
offs of intangible assets identified with the properties. Charges for
restaurant closings decreased by $4.5 million in 1999, but increased by $8.4
million in 1998 to $8.5 million. 1999 charges of $4.4 million resulted from the
closure of seven Churchs restaurants and five Popeyes restaurants. The increase
in 1998 charges primarily resulted from the closure of 14 Popeyes restaurants.
Software Write-offs. We wrote-off $3.8 million in 1999, and $5.0 million in
1998 that related to our "back office" automation system that was under
development, which essentially constituted the entire cost of the system.
Gain on Sale of Assets from AFDC Transaction. During the second quarter of
1997, we recorded a $5.3 million pre-tax gain associated with the sale of 100
Company-operated restaurants to AFDC, a Churchs franchisee.
Income from Operations. Excluding charges for restaurant closings,
software write-offs and the AFDC gain, income from operations increased $26.6
million or 65.5% in 1999 and $5.2 million or 14.7% in 1998. The 1999 growth in
income from operations was due to the full year recognition of revenues and
expenses resulting from our 1998 acquisitions of Seattle Coffee and Cinnabon,
positive comparable sales and lower depreciation expense. Our chicken brands
contributed $12.9 million or 20.0% to the increase in income from operations.
The 1998 growth rate was primarily due to our 1998 acquisitions and a 12%
decrease in corporate general and administrative expenses offset by a decrease
in income from operations from our chicken brands of 10% (driven by start-up
costs related to our Pinetree Foods, Inc. acquisition).
Net Interest Expense. Interest expense, net of capitalized interest,
increased $3.5 million in 1999 and $10.1 million in 1998. The 1999 increase in
interest expense was due to higher levels of average debt and higher interest
rates. In addition, we increased usage on our revolving line of credit in 1999.
The 1998 increase in interest expense was due to higher levels of average debt
outstanding and higher effective interest rates during 1998 as compared with
1997. The increase in average debt outstanding was primarily attributable to
the refinancing transaction completed during the second quarter of 1997,
borrowings made under our acquisition and revolving loan facilities during 1998
and borrowings made under our Tranche B term loan. The refinancing transaction
also led to higher effective interest rates during 1998.
Income Taxes. Our effective tax rate for 1999 was 40.7% compared with an
effective tax rate of 32.8% in 1998 and an effective tax rate of 43.6% in 1997.
Our effective tax rate for 1999 increased due to a full year recognition of non-
deductible amortization expense related to our 1998 acquisitions partially
offset by job tax credits.
Loss from Discontinued Operations. The loss from discontinued operations
reflects the operating results of Chesapeake Bagel's operations as well as the
loss on the
34
sale of Chesapeake. The loss from operations, net of income taxes, was $0.7
million in 1999 and $5.9 million in 1998. The 1998 loss from operations includes
a $4.6 million write-down (net of income taxes) of Chesapeake's intangible
asset. In 1999, we incurred a loss of $1.7 million on the sale of Chesapeake,
net of income taxes.
Liquidity and Capital Resources
Cash for Operations
We finance our business activities primarily with funds generated from
operating activities, proceeds from the sale of shares of common stock, proceeds
from long-term debt and a revolving line of credit.
Net cash provided by operating activities for the years ended December 26,
1999, December 27, 1998 and December 28, 1997 was $55.2 million, $45.5 million
and $52.5 million, respectively. Available cash and cash equivalents, net of
bank overdrafts, as of December 26, 1999 was $3.3 million, compared to $10.8
million at December 27, 1998 and $23.3 million at December 28, 1997. The
decrease in available cash and cash equivalents, net of bank overdrafts, in 1999
was primarily due to the timing of accounts payable payments made at year end
1999 versus year end 1998. The decrease in available cash and cash equivalents,
net of bank overdrafts in 1998 was primarily due to the acquisitions of Pinetree
Foods, Inc. and Seattle Coffee Company.
Additionally, we meet our short-term needs using our revolving line of
credit. Typically, we maintain a low current ratio, .66 at year end 1999 and
.63 at year end 1998.
Based upon our current level of operations and anticipated growth, we
believe that available cash flow, together with the available borrowings under
our Senior Secured Credit Facility and other sources of liquidity, will be
adequate to meet our anticipated future requirements for working capital,
capital expenditures and scheduled payments under our Senior Subordinated Notes
and our Senior Secured Credit Facility.
Capital Expenditures
During our fiscal year ended 1999, we invested $55.2 million in various
capital projects including $24.8 million in new restaurant, bakery and cafe
locations; $7.8 million in our re-imaging and renovation program; $2.1 million
in our Seattle Coffee wholesale operations; $3.6 million in new management
information systems; $7.9 million in other capital assets to update, replace and
extend the lives of restaurant, bakery and cafe equipment and facilities; and
$9.0 million to complete other corporate projects. Essentially all capital
expenditures were financed through cash flows provided from normal operating
activities and internal funds. Compared to 1998, our capital expenditures in
1999 increased $13.7 million.
35
In fiscal year 2000, we plan to invest approximately $40.0 million in
capital expenditures. We intend to fund these investments with cash from
operations. We estimate $14.3 million will be used for re-imaging and
rebuilding existing restaurants, bakeries and cafes; $12.1 million will be used
for updating, replacing and extending the lives of restaurant, bakery and cafe
equipment and facilities; $4.5 million will be used in our Seattle Coffee
wholesale operations; and the remaining $9.1 million will be used for corporate
and other matters.
Repurchase of Subordinated Notes
During the fourth quarter of 1999, we repurchased $8.0 million of our
Senior Subordinated Notes at a slight discount. From time to time, we may
repurchase more of the Senior Subordinated Notes on the open market.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from changes in interest rates on debt and
changes in commodity prices. In addition, a portion of our receivables are
denominated in foreign currency, which exposes us to exchange rate movements.
Historically, we have not utilized hedging contracts to manage our exposure to
foreign currency rate fluctuations since we determined the market risk
associated with international receivables was not significant. However, we
entered into hedging contracts to some extent in 1999 with respect to the Korean
Won to reduce our exposure to future foreign currency rate fluctuations.
Our net exposure to interest rate risk consists of our Senior Subordinated
Notes and borrowings under our 1997 Credit Facility. Our Senior Subordinated
Notes bear interest at a fixed rate of 10.25%. The aggregate balance
outstanding under our Senior Subordinated Notes as of December 26, 1999 was
$167.0 million. Should interest rates increase or decrease, the estimated fair
value of these notes would decrease or increase, respectively. As of December
26, 1999, the fair value of our Senior Subordinated Notes exceeded the carrying
amount by approximately $0.8 million. Our 1997 Credit Facility has borrowings
made pursuant to it that bear interest rates that are benchmarked to US and
European short-term floating-rate interest rates. The balances outstanding under
our 1997 Credit Facility as of December 26, 1999 totaled $171.2 million. The
impact on our annual results of operations of a hypothetical one-point interest
rate change on the outstanding balances under our 1997 Credit Facility would be
approximately $1.7 million. This assumes no change in the amount or composition
of the debt at December 26, 1999.
We entered into two types of chicken purchasing contracts with our
suppliers in 1999. One is a grain-based "cost-plus" pricing arrangement that is
based upon the cost of feed grains, such as corn and soybean meal, plus certain
agreed upon non-feed and processing costs. The other is a market-priced formula
contract based on the Georgia whole bird market value, under which we pay market
plus a premium for the cut specifications for our restaurants. The market-priced
formula contracts are subject to a "ceiling", or highest price, and a "floor",
or lowest price, that we will pay over the contract term. Both contracts have
terms ranging from three to five
36
years with provisions for certain annual price adjustments as defined in the
contracts. In 2000, we intend to increase our purchases under such cost-plus
contracts, and reduce purchases under the market-based contracts in order to
further reduce our exposure to rising chicken prices should they occur.
With respect to our wholesale coffee operations, our principal raw material
is green coffee beans. We typically enter into supply contracts to purchase a
pre-determined quantity of green coffee beans at a fixed price per pound. These
contracts usually cover periods up to a year as negotiated with the individual
supplier. At March 27, 2000, we had commitments to purchase green coffee beans
at a total cost of approxima