FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2004
Commission File Number: 0-27008
Schlotzsky’s, Inc.
| Texas | 74-2654208 | |
| (State or other jurisdiction of | (IRS Employer | |
| incorporation or organization) | Identification No.) |
203 Colorado Street, Suite 600, Austin, Texas 78701
(Address of principal executive offices)
(512) 236-3800
(Registrant’s telephone number)
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 þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
| Class | Shares Outstanding at November 5, 2004 | |
| Common Stock, no par value | 7,341,079 |
SCHLOTZSKY’S, INC.
Index to Form 10-Q
Quarter Ended June 30, 2004
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
| June 30, | December 31, | |||||||
| 2004 |
2003 |
|||||||
| (Unaudited) | ||||||||
ASSETS |
||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | 514,193 | $ | 1,058,300 | ||||
Accounts receivable, net: |
||||||||
Royalties |
827,569 | 884,098 | ||||||
Brands |
742,244 | 905,085 | ||||||
Other |
350,842 | 1,494,513 | ||||||
Refundable income taxes |
— | 9,350 | ||||||
Prepaids, inventories and other assets |
1,023,879 | 1,250,193 | ||||||
Real estate held for sale |
3,050,000 | 3,208,533 | ||||||
Current Portion of: |
||||||||
Notes receivable |
11,349 | 50,570 | ||||||
Notes receivable — related party |
— | 3,500 | ||||||
Total current assets |
6,520,076 | 8,864,142 | ||||||
Property, equipment and leasehold improvements, net |
23,712,634 | 42,396,145 | ||||||
Notes receivable, net, less current portion |
3,144,990 | 4,121,951 | ||||||
Notes receivable — related party, net, less current portion |
1,230,275 | 2,613,170 | ||||||
Investments |
267,850 | 567,850 | ||||||
Intangible assets, net |
6,153,543 | 62,523,367 | ||||||
Goodwill, net |
— | 3,519,242 | ||||||
Other noncurrent assets |
1,056,642 | 1,179,687 | ||||||
Total assets |
$ | 42,086,010 | $ | 125,785,554 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
Current Liabilities: |
||||||||
Short-term debt |
$ | 1,681,971 | $ | 1,133,701 | ||||
Current maturities of long-term debt |
45,441,286 | 6,564,646 | ||||||
Accounts payable |
4,160,576 | 5,768,117 | ||||||
Accrued liabilities |
9,931,731 | 5,243,563 | ||||||
Deferred revenue, current portion |
523,420 | 376,633 | ||||||
Total current liabilities |
61,738,984 | 19,086,660 | ||||||
Long-term debt, less current portion |
4,160,062 | 42,586,141 | ||||||
Deferred revenue, less current portion |
964,439 | 1,450,300 | ||||||
Deferred tax liability |
— | — | ||||||
Total liabilities |
66,863,485 | 63,123,101 | ||||||
Commitments and contingencies |
||||||||
Stockholders’ Equity: |
||||||||
Preferred stock, Class C, no par value, 1,000,000 shares
authorized, none issued |
— | — | ||||||
Common stock, no par value, 30,000,000 shares authorized,
7,528,186 shares and 7,521,524 shares issued at June 30,
2004 and December 31, 2003, respectively |
64,140 | 64,073 | ||||||
Additional paid-in capital |
58,243,854 | 58,213,945 | ||||||
Retained earnings |
(82,242,313 | ) | 5,227,591 | |||||
Treasury stock (189,525 shares at June 30, 2004 and
December 31, 2003, respectively), at cost |
(843,156 | ) | (843,156 | ) | ||||
Total stockholders’ equity |
(24,777,475 | ) | 62,662,453 | |||||
Total liabilities and stockholders’ equity |
$ | 42,086,010 | $ | 125,785,554 | ||||
The accompanying notes are an integral part of the condensed consolidated financial statements.
1
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
| Three months ended |
Six months ended |
|||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
Revenue: |
||||||||||||||||
Royalties |
$ | 3,617,959 | $ | 4,285,230 | $ | 7,210,727 | $ | 8,589,118 | ||||||||
Franchise fees |
— | 3,333 | — | 3,333 | ||||||||||||
Developer fees |
35,935 | 44,228 | 72,242 | 94,387 | ||||||||||||
Restaurant sales |
7,668,137 | 8,000,609 | 15,449,922 | 15,612,838 | ||||||||||||
Brand contribution |
1,167,860 | 1,708,957 | 2,584,457 | 3,360,062 | ||||||||||||
Other fees and revenue |
207,443 | 219,390 | 427,438 | 432,039 | ||||||||||||
Total revenue |
12,697,334 | 14,261,747 | 25,744,786 | 28,091,777 | ||||||||||||
Expenses: |
||||||||||||||||
Service costs: |
||||||||||||||||
Royalties |
533,660 | 667,118 | 1,062,543 | 1,330,910 | ||||||||||||
Franchise fees |
— | — | — | — | ||||||||||||
| 533,660 | 667,118 | 1,062,543 | 1,330,910 | |||||||||||||
Restaurant operations: |
||||||||||||||||
Cost of sales |
2,135,821 | 2,348,501 | 4,245,824 | 4,520,121 | ||||||||||||
Personnel and benefits |
2,901,252 | 3,445,067 | 5,851,749 | 6,810,228 | ||||||||||||
Operating expenses |
1,975,162 | 2,202,095 | 3,846,581 | 4,104,342 | ||||||||||||
| 7,012,235 | 7,995,663 | 13,944,154 | 15,434,691 | |||||||||||||
Equity loss on investments |
300,000 | 83,693 | 300,000 | 150,843 | ||||||||||||
Impairment of franchising assets |
59,938,180 | — | 59,938,180 | — | ||||||||||||
Restaurant impairment |
17,376,156 | — | 17,376,156 | — | ||||||||||||
General and administrative |
12,134,279 | 6,712,589 | 16,077,154 | 11,783,304 | ||||||||||||
Depreciation and amortization |
1,311,916 | 1,282,595 | 2,717,924 | 2,532,001 | ||||||||||||
Total expenses |
98,606,426 | 16,741,658 | 111,416,111 | 31,231,749 | ||||||||||||
Income (loss) from operations |
(85,909,092 | ) | (2,479,911 | ) | (85,671,325 | ) | (3,139,972 | ) | ||||||||
Other: |
||||||||||||||||
Interest income |
62,638 | 103,609 | 125,031 | 207,257 | ||||||||||||
Interest expense |
(932,140 | ) | (1,009,968 | ) | (1,863,610 | ) | (2,025,873 | ) | ||||||||
Income (loss) before provision
(credit) for income
taxes |
(86,778,594 | ) | (3,386,270 | ) | (87,409,904 | ) | (4,958,588 | ) | ||||||||
Provision (credit) for income taxes |
20,000 | (1,119,000 | ) | 60,000 | (1,625,000 | ) | ||||||||||
Net income (loss) |
$ | (86,798,594 | ) | $ | (2,267,270 | ) | $ | (87,469,904 | ) | $ | (3,333,588 | ) | ||||
Earnings per share-basic |
$ | (11.83 | ) | $ | (0.31 | ) | $ | (11.92 | ) | $ | (0.46 | ) | ||||
Earnings per share-diluted |
$ | (11.83 | ) | $ | (0.31 | ) | $ | (11.92 | ) | $ | (0.46 | ) | ||||
The accompanying notes are an integral part of the condensed consolidated financial statements
2
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
| Common Stock |
Additional | Total | ||||||||||||||||||||||
| Number of | Stated Capital | Paid-in | Retained | Treasury | Stockholders’ | |||||||||||||||||||
| Shares |
Amount |
Capital |
Earnings |
Stock |
Equity |
|||||||||||||||||||
Balance, January 1, 2003 |
7,496,778 | $ | 63,826 | $ | 58,122,469 | $ | 16,976,186 | $ | (843,156 | ) | $ | 74,319,325 | ||||||||||||
Issuance of common stock in
connection with employee stock
purchase plan |
24,746 | 247 | 76,766 | — | — | 77,013 | ||||||||||||||||||
Issuance of employee stock options |
— | — | 14,710 | — | — | 14,710 | ||||||||||||||||||
Net loss |
— | — | — | (11,748,595 | ) | — | (11,748,595 | ) | ||||||||||||||||
Balance, December 31, 2003 |
7,521,524 | 64,073 | 58,213,945 | 5,227,591 | (843,156 | ) | 62,662,453 | |||||||||||||||||
Issuance of common stock in
connection with employee stock
purchase plan |
6,662 | 67 | 11,485 | — | — | 11,552 | ||||||||||||||||||
Issuance of employee stock options |
— | — | 18,424 | — | — | 18,424 | ||||||||||||||||||
Net loss |
— | — | — | (87,469,904 | ) | — | (87,469,904 | ) | ||||||||||||||||
Balance, June 30, 2004 |
7,528,186 | $ | 64,140 | $ | 58,243,854 | (82,242,313 | ) | $ | (843,156 | ) | $ | (24,777,475 | ) | |||||||||||
The accompanying notes are an integral part of the condensed consolidated financial statements.
3
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
| For the six months ended |
||||||||
| June 30, | June 30, | |||||||
| 2004 |
2003 |
|||||||
Cash flows from operating activities: |
||||||||
Net income (loss) |
$ | (87,469,904 | ) | $ | (3,333,588 | ) | ||
Adjustments to reconcile net income (loss) to cash provided by
operating activities: |
||||||||
Depreciation and amortization |
2,717,924 | 2,532,001 | ||||||
Provision for deferred taxes |
— | (1,683,020 | ) | |||||
Provision for stock option compensation |
18,424 | 12,192 | ||||||
Provision for uncollectible accounts |
3,434,752 | 1,539,563 | ||||||
Provision for impairment of assets |
77,314,336 | — | ||||||
Amortization of deferred revenue |
97,758 | (91,064 | ) | |||||
Equity loss on investments |
300,000 | 150,844 | ||||||
Changes in: |
||||||||
Accounts receivable |
(652,966 | ) | 1,058,418 | |||||
Prepaid expenses and other assets |
349,359 | 341,617 | ||||||
Accounts payable and accrued liabilities |
3,844,045 | 3,728,710 | ||||||
Net cash provided by operating activities |
(46,272 | ) | 4,255,673 | |||||
Cash flows from investing activities: |
||||||||
Purchase of property, equipment and real estate held for sale |
(171,576 | ) | (3,025,961 | ) | ||||
Sale of property, equipment and real estate held for sale |
2,536 | 1,195,824 | ||||||
Acquisition of investments and intangible assets |
(43,426 | ) | (236,692 | ) | ||||
Issuance of notes receivable |
(25,107 | ) | (198,740 | ) | ||||
Repayments on notes receivable |
43,124 | 2,378,643 | ||||||
Net cash provided by (used in) investing activities |
(194,449 | ) | 113,074 | |||||
Cash flows from financing activities: |
||||||||
Sale of stock |
11,552 | 36,082 | ||||||
Acquisition of treasury stock |
— | — | ||||||
Proceeds from issuance of debt |
2,607,500 | 710,000 | ||||||
Debt issuance costs |
(247,103 | ) | (858,745 | ) | ||||
Repayment of debt |
(2,675,335 | ) | (4,154,752 | ) | ||||
Net cash used in financing activities |
(303,386 | ) | (4,267,415 | ) | ||||
Net increase (decrease) in cash and cash equivalents |
(544,107 | ) | 101,332 | |||||
Cash and cash equivalents at beginning of period |
1,058,300 | 678,895 | ||||||
Cash and cash equivalents at end of period |
$ | 514,193 | $ | 780,227 | ||||
The accompanying notes are an integral part of the condensed consolidated financial statements.
4
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
Note 1. — Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three months and six months ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. This information should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Schlotzsky’s, Inc. Annual Report on Form 10-K for the year ended December 31, 2003.
On August 3, 2004 (the “Petition Date”), Schlotzsky’s, Inc. (the “Company”) and its subsidiaries filed a voluntary petition for relief (the “Filing”) under Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the Western District of Texas (the “Bankruptcy Court”), San Antonio division. The cases have been assigned No. 04-54504. The Company is operating its business and managing its property as a debtor in possession of its assets and the Company’s existing directors and officers continue to oversee operation of the Company’s business as a debtor-in-possession.
Financial Statement Presentation
The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue to operate as a going concern, which contemplates continuity of operations, timely payment by franchisees and licensees, control of operating expenses and the professional fees associated with reorganizing the Company, and the realization of asset sales and liquidation of liabilities and commitments. The Filing and related circumstances raise substantial doubts about the Company’s ability to continue as a going concern and accordingly such realization of assets and liquidation of liabilities are subject to uncertainty. In connection with its plan of reorganization, the Company may liquidate or settle liabilities for amounts other than those reflected in the Condensed Consolidated Financial Statements. In addition, a plan of reorganization could materially change the amounts and classifications reported in the consolidated historical financial statements, which do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of a plan of reorganization.
Pursuant to the Bankruptcy Code, schedules have been and will continue to be filed by the Company with the Bankruptcy Court setting forth the assets and liabilities of the Company. Differences between amounts recorded by the Company and claims filed by creditors will be investigated and resolved as part of the Chapter 11 Cases.
The Company has received approval from the Bankruptcy Court to pay or otherwise honor certain of its pre-petition obligations, including employee wages, salaries, benefits and other employee obligations and certain other pre-petition claims.
Reclassifications and Required Accounting Issues Discussion
Certain reclassifications have been made to the condensed consolidated financial statements for the periods ended June 30, 2003, to correspond with the presentation used at June 30, 2004, and for the periods then ended.
Quarterly Financials Not Reviewed by Independent Accountants
Due to the constraints of operating as a debtor-in-possession and the need to negotiate cash collateral orders with its secured creditors the Company is unable to control the timing and amount of payments to its professionals. Due to the uncertainty of the payment of professional fees, the Company has been unable to secure a review of this Form 10-Q by its independent accountants, thus it was unreviewed by independent accountants at the time of filing.
Note 2. — Review of Accounting for Reacquired Area Developer Rights
The Company has received from the Securities and Exchange Commission (the “Commission”) comments to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. This action has led to discussions between the Company, the Commission, and the Company’s auditors concerning the appropriateness of capitalizing as intangible assets those payments made over the past eight years to area developers to modify or cancel their area developer contracts. Although the Company continues to believe the classification as intangible assets is proper, the Company has not resolved this issue with the Commission at the time of filing this Form 10-Q. Were the Company to restate its financials to reflect expensing the payments to area developers at the time the transactions were executed, approximately $60.1 million in repurchase expense would be recognized between 1996 and 2004, and $4.7 million in amortization expense would be reversed off the income statement during that same period. Additionally, see Note 14 for information regarding the Company’s treatment of these intangible assets during the second quarter of 2004.
5
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 3. — Stock-Based Compensation
Effective January 1, 2003, the Company adopted the cost recognition provisions for stock-based compensation of Statement of Financial Accounting Standards (“SFAS”) No. 123 under the prospective method of adoption authorized by SFAS No. 148. The amount charged to expense during the three and six-month periods ended June 30, 2004 were approximately $9,000 and $18,000, respectively. Had the Company adopted the cost recognition provisions of SFAS No. 123 in 1995, the Company’s net income and earnings per share would have been reduced to the pro forma amounts shown (in thousands, except per share amounts):
| For the three months ended |
For the six months ended |
|||||||||||||||
| June 30, 2004 |
June 30, 2003 |
June 30, 2004 |
June 30, 2003 |
|||||||||||||
Net income (loss), as reported |
$ | (86,799 | ) | $ | (2,267 | ) | $ | (87,470 | ) | $ | (3,334 | ) | ||||
Add: Stock-based employee
compensation expense included
in net income, net of related
tax effects |
9 | 4 | 18 | 8 | ||||||||||||
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effects |
(24 | ) | (45 | ) | (44 | ) | (114 | ) | ||||||||
Pro forma net income (loss) |
$ | (86,814 | ) | $ | (2,308 | ) | $ | (87,496 | ) | $ | (3,440 | ) | ||||
Earnings per share: |
||||||||||||||||
Basic-as reported |
$ | (11.83 | ) | $ | (0.31 | ) | $ | (11.92 | ) | $ | (0.46 | ) | ||||
Basic-pro forma |
$ | (11.83 | ) | $ | (0.32 | ) | $ | (11.92 | ) | $ | (0.47 | ) | ||||
Diluted-as reported |
$ | (11.83 | ) | $ | (0.31 | ) | $ | (11.92 | ) | $ | (0.46 | ) | ||||
Diluted-pro forma |
$ | (11.83 | ) | $ | (0.32 | ) | $ | (11.92 | ) | $ | (0.47 | ) | ||||
6
SCHLOTZSKY’S, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (CONTINUED)
(Unaudited)
Note 4. — Restaurant Operations
A summary of certain operating information for Company-operated restaurants is presented below for the three and six month periods ended June 30, 2004 and 2003 (dollars in thousands). The Company reviewed its 36 Company-operated restaurant units and determined it would close 18 underperforming units during the third and fourth quarters of 2004. Closure of these units was completed in October 2004. The results shown below do not reflect the impairment of certain intangible or real estate assets or recognition of liabilities related to the 18 closed restaurants.
| Retained |
Closed |
Total |
||||||||||
Three months ended June 30, 2004 |
||||||||||||
Restaurant sales |
$ | 5,324 | $ | 2,344 | $ | 7,668 | ||||||
Restaurant operations: |
||||||||||||
Cost of sales |
1,478 | 658 | 2,136 | |||||||||
Personnel and benefits |
1,836 | 1,065 | 2,901 | |||||||||
Operating expenses |
1,030 | 945 | 1,975 | |||||||||
| 4,344 | 2,668 | 7,012 | ||||||||||
Operating income (loss) before depreciation
and amortization |
$ | 980 | $ | (324 | ) | $ | 656 | |||||
Three months ended June 30, 2003 |
||||||||||||
Restaurant sales |
$ | 5,375 | $ | 2,626 | $ | 8,001 | ||||||
Restaurant operations: |
||||||||||||
Cost of sales |
1,590 | 759 | 2,349 | |||||||||
Personnel and benefits |
2,156 | 1,289 | 3,445 | |||||||||
Operating expenses |
1,036 | 1,166 | 2,202 | |||||||||
| 4,782 | 3,214 | 7,996 | ||||||||||
Operating income (loss) before depreciation
and amortization |
$ | 593 | $ | (588 | ) | $ | 5 | |||||
| Retained |
Closed |
Total |
||||||||||
Six months ended June 30, 2004 |
||||||||||||
Restaurant sales |
$ | 10,715 | $ | 4,735 | $ | 15,450 | ||||||
Restaurant operations: |
||||||||||||
Cost of sales |
2,931 | 1,315 | 4,246 | |||||||||
Personnel and benefits |
3,731 | 2,121 | 5,852 | |||||||||
Operating expenses |
2,009 | 1,837 | 3,846 | |||||||||
| 8,671 | 5,273 | 13,944 | ||||||||||
Operating income (loss) before depreciation
and amortization |
$ | 2,044 | $ | (538 | ) | $ | 1,506 | |||||
Six months ended June 30, 2003 |
||||||||||||
Restaurant sales |
$ | 10,504 | ||||||||||