SCHLOTZSKYS INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2002

Commission File Number: 0-27008

Schlotzsky's, Inc.
(Exact name of registrant as specified in its charter)

Texas (State or other Jurisdiction of incorporation or organization)		74-2654208 (IRS Employer Identification No.)
203 Colorado Street, Austin, Texas 78701 (Address of principal executive offices)
(512) 236-3600 (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 ý No o

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class
Common Stock, no par value

Shares Outstanding at November 9, 2002
7,307,253

SCHLOTZSKY'S, INC.

Index to Form 10-Q
Quarter Ended September 30, 2002

			Page No.
Part I		FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets—September 30, 2002 and December 31, 2001	1
		Condensed Consolidated Statements of Income—Three and Nine Months Ended September 30, 2002 and September 30, 2001	2
		Condensed Consolidated Statements of Stockholders' Equity—Nine Months Ended September 30, 2002 and Year Ended December 31, 2001	3
		Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2002 and September 30, 2001	4
		Notes to Condensed Consolidated Financial Statements	5
	Item 2.	Management's Discussion and Analysis of Financial Condition And Results of Operations	14
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
	Item 4.	Controls and Procedures	23
Part II		OTHER INFORMATION
	Item 1.	Legal Proceedings	24
	Item 2.	Changes in Securities and Use of Proceeds	25
	Item 3.	Defaults Upon Senior Securities	25
	Item 4.	Submission of Matters to a Vote of Security Holders	25
	Item 5.	Other Information	25
	Item 6.	Exhibits and Reports on Form 8-K	25

PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

				September 30, 2002			December 31, 2001
				(Unaudited)
ASSETS
Current Assets:
	Cash and cash equivalents			$	290,570		$	2,567,904
	Accounts receivable, net:
		Royalties			750,914			579,503
		Brands			1,505,742			1,214,936
		Other			1,694,280			1,588,853
	Refundable income taxes				362,830			1,609,795
	Prepaids, inventories and other assets				1,236,569			1,349,444
	Real estate held for sale				5,168,163			6,347,726
	Deferred tax asset				2,029,777			1,888,074
	Current portion of notes receivable				226,115			533,077

			Total current assets		13,264,960			17,679,312
Property, equipment and leasehold improvements, net					40,168,960			39,348,025
Notes receivable, net, less current portion					12,127,418			11,863,393
Investments					1,556,721			1,693,639
Intangible assets, net					68,025,871			43,118,101
Other noncurrent assets					1,151,775			446,790

			Total assets	$	136,295,705		$	114,149,260

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
	Short-term debt			$	926,454		$	681,011
	Current maturities of long-term debt				7,153,479			5,799,003
	Accounts payable				1,018,446			1,429,762
	Accrued liabilities				3,371,494			3,546,551
	Deferred revenue, current portion				308,531			403,421

			Total current liabilities		12,778,404			11,859,748
Long-term debt, less current portion					46,330,404			25,896,769
Deferred revenue, less current portion					1,641,769			1,837,943
Deferred tax liability					152,764			152,764

			Total liabilities		60,903,341			39,747,224

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, 7,496,778 shares and 7,463,990 shares issued at September 30, 2002 and December 31, 2001, respectively					63,886			63,498
Additional paid-in capital					58,119,954			57,986,546
Retained earnings					18,051,680			17,175,234
Treasury stock (189,525 shares and 186,300 shares at September 30, 2002 and December 31, 2001, respectively), at cost					(843,156	)		(823,242	)

			Total stockholders' equity		75,392,364			74,402,036

			Total liabilities and stockholders' equity	$	136,295,705		$	114,149,260

The accompanying notes are an integral part of the condensed consolidated financial statements.

SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

				Three months ended						Nine months ended
				September 30, 2002			September 30, 2001			September 30, 2002			September 30, 2001
Revenue:
	Royalties			$	4,984,274		$	5,471,449		$	15,368,072		$	16,639,449
	Franchise fees				—			132,500			62,000			317,500
	Developer fees				59,369			208,901			179,435			378,950
	Restaurant sales				7,934,927			7,320,478			24,075,180			22,384,680
	Brand contribution				1,820,224			1,884,192			5,694,381			5,580,338
	Other fees and revenue				294,307			489,305			862,986			1,616,832

			Total revenue		15,093,101			15,506,825			46,242,054			46,917,749

Expenses:
	Service costs:
		Royalties			1,008,337			1,162,233			3,249,705			3,646,464
		Franchise fees			—			56,250			25,955			133,750

					1,008,337			1,218,483			3,275,660			3,780,214

Restaurant operations:
	Cost of sales				2,247,065			2,060,403			6,755,185			6,254,081
	Personnel and benefits				3,305,235			3,056,962			9,767,124			9,404,125
	Operating expenses				1,988,932			1,725,348			5,624,926			5,078,803

					7,541,232			6,842,713			22,147,235			20,737,009

Equity loss on investments					58,624			32,628			136,918			87,080

General and administrative					4,833,741			4,873,360			14,149,018			14,563,112

Depreciation and amortization					1,273,342			1,072,062			3,443,073			3,109,830

			Total expenses		14,715,276			14,039,246			43,151,904			42,277,245

			Income from operations		377,825			1,467,579			3,090,150			4,640,504
Other:
	Interest income				119,195			251,471			431,257			781,737
	Interest expense				(797,001	)		(665,512	)		(2,054,961	)		(2,158,246	)

			Income (loss) before income taxes		(299,981	)		1,053,538			1,466,446			3,263,995
Provision (credit) for income taxes					(60,000	)		395,000			590,000			1,263,000

Net income (loss)				$	(239,981	)	$	658,538		$	876,446		$	2,000,995

Earnings (loss) per share-basic				$	(0.03	)	$	0.09		$	0.12		$	0.27

Earnings (loss) per share-diluted				$	(0.03	)	$	0.09		$	0.12		$	0.27

The accompanying notes are an integral part of the condensed consolidated financial statements.

SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)

	Common Stock
	Number of Shares	Stated Capital Amount		Additional Paid-in Capital		Retained Earnings		Treasury Stock			Total Stockholders' Equity
Balance, January 1, 2001	7,443,342	$	63,291	$	57,877,642	$	14,686,095	$	(105,000	)	$	72,522,028
Issuance of common stock in connection with employee stock purchase plan	18,348		184		38,806		—		—			38,990
Issuance of warrants	—		—		57,000		—		—			57,000
Treasury stock purchases (176,300 shares)	—		—		—		—		(718,242	)		(718,242	)
Options exercised	2,300		23		6,877		—		—			6,900
Tax benefit from employee stock transactions	—		—		6,221		—		—			6,221
Net income	—		—		—		2,489,139		—			2,489,139

Balance, December 31, 2001	7,463,990		63,498		57,986,546		17,175,234		(823,242	)		74,402,036
Issuance of common stock in connection with employee stock purchase plan	16,467		165		66,726		—		—			66,891
Treasury stock purchases (3,225 shares)	—		—		—		—		(19,914	)		(19,914	)
Options exercised	16,321		223		61,829		—		—			62,052
Tax benefit from employee stock transactions	—		—		4,853		—		—			4,853
Net income	—		—		—		876,446		—			876,446

Balance, September 30, 2002	7,496,778	$	63,886	$	58,119,954	$	18,051,680	$	(843,156	)	$	75,392,364

PREFERRED STOCK

Authorized 1,000,000 Class C shares, no par value; no shares outstanding at September 30, 2002, December 31, 2001, or January 1, 2001.

COMMON STOCK

Authorized 30,000,000 shares, no par value; 7,496,778 shares issued at September 30, 2002, 7,463,990 shares issued at December 31, 2001, and 7,443,342 shares issued at January 1, 2001. Shares issued include 189,525, 186,300 and 10,000 shares in treasury at September 30, 2002, December 31, 2001, and January 1, 2001, respectively.

The accompanying notes are an integral part of the condensed consolidated financial statements.

SCHLOTZSKY'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

					For the nine months ended
					September 30, 2002			September 30, 2001
Cash flows from operating activities:
Net income					$	876,446		$	2,000,995
	Adjustments to reconcile net income to cash provided by operating activities:
		Depreciation and amortization				3,443,073			3,109,830
		Provisions for uncollectible accounts and impairment of assets				806,841			1,348,329
		Provision for deferred taxes				(141,703	)		—
		Amortization of deferred revenue				(220,086	)		(756,517	)
		Equity loss on investments				136,918			87,080
		Changes in:
			Accounts receivable			(114,497	)		(133,738	)
			Prepaid expenses and other assets			(404,504	)		(76,563	)
			Accounts payable and accrued liabilities			(538,346	)		433,786

				Net cash provided by operating activities		3,844,142			6,013,202

Cash flows from investing activities:
	Purchase of property, equipment and real estate held for sale					(1,659,571	)		(6,632,720	)
	Sale of property, equipment and real estate held for sale					1,182,913			2,138,744
	Acquisition of investments and intangible assets					(2,253,614	)		(1,941,749	)
	Issuance of notes receivable					(24,391	)		(1,022,917	)
	Repayments of notes receivable					66,704			5,335,930
	Sale of investments and intangible assets					—			70,748

				Net cash used in investing activities		(2,687,959	)		(2,051,964	)

Cash flows from financing activities:
	Sale of stock					133,796			38,990
	Issuance of warrants					—			57,000
	Acquisition of treasury stock					(19,914	)		(698,850	)
	Proceeds from issuance of debt					9,471,950			2,242,105
	Repayment of debt					(13,019,349	)		(5,561,674	)

				Net cash used in financing activities		(3,433,517	)		(3,922,429	)

Net increase (decrease) in cash and cash equivalents						(2,277,334	)		38,809
Cash and cash equivalents at beginning of period						2,567,904			1,163,839

Cash and cash equivalents at end of period					$	290,570		$	1,202,648

The accompanying notes are an integral part of the condensed consolidated financial statements.

SCHLOTZSKY'S, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 nine months ended September 30, 2002, are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. 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, 2001.

Reclassifications

Certain reclassifications have been made to the condensed consolidated financial statements for the periods ended September 30, 2001, to correspond with the presentation used at September 30, 2002, and for the periods then ended.

Note 2.—Restaurant Operations

A summary of certain operating information for Company-owned restaurants is presented below for the three and nine month periods ended September 30, 2002 and 2001 (dollars in thousands).

			Long-term Portfolio Restaurants					Available for Sale Restaurants
			Schlotzsky's® Delis					Available for Sale Restaurants
			Schlotzsky's® Delis		Marketplaces			Schlotzsky's® Delis
Three months ended September 30, 2002
	Restaurant sales		$	3,784	$	1,230		$	2,921

	Restaurant operations:
		Cost of sales		1,043		377			827
		Personnel and benefits		1,354		625			1,326
		Operating expenses		688		318			983

				3,085		1,320			3,136

	Operating income (loss) before depreciation and amortization		$	699	$	(90	)	$	(215	)

Three months ended September 30, 2001
	Restaurant sales		$	3,437	$	1,251		$	2,632

	Restaurant operations:
		Cost of sales		930		392			738
		Personnel and benefits		1,287		606			1,165
		Operating expenses		583		329			813

				2,800		1,327			2,716

	Operating income (loss) before depreciation and amortization