-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CHocTlxcS9I6rv5/te3hGtfMPIurycHfmoOkOo/cK4wLusAOVA2cGFtPC+EXXYf2 PRihESEt3J76Jt9+4dKUEA== 0001005477-98-002847.txt : 19980929 0001005477-98-002847.hdr.sgml : 19980929 ACCESSION NUMBER: 0001005477-98-002847 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980928 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: BLIMPIE INTERNATIONAL INC CENTRAL INDEX KEY: 0000895477 STANDARD INDUSTRIAL CLASSIFICATION: PATENT OWNERS & LESSORS [6794] IRS NUMBER: 132908793 STATE OF INCORPORATION: NJ FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-13945 FILM NUMBER: 98716326 BUSINESS ADDRESS: STREET 1: 1775 THE EXCHANGE STREET 2: SUITE 600 CITY: ATLANTA STATE: GA ZIP: 30339 BUSINESS PHONE: 7709842707 MAIL ADDRESS: STREET 1: 1775 THE EXCHANGE STREET 2: SUITE 600 CITY: ATLANTA STATE: GA ZIP: 30339 10-K/A 1 AMENDMENT NO. 1 TO FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Amendment No. 1 to FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended June 30, 1998 Commission File Number 0-21036 BLIMPIE INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) New Jersey 13-2908793 (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 740 Broadway, New York, NY 10003 (Address and Zip Code of Principal Executive Offices) (212) 673-5900 (Registrant's telephone number including area code) Securities Registered Under Section 12(b) of the Exchange Act: Common Stock, $.01 Par Value Securities Registered Under 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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| 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. [ ] The aggregate market value of the registrant's common stock held by non-affiliates of the registrant as of September 15, 1998 was approximately $9,020,000. Solely for purposes of the foregoing calculation all of the registrant's directors and officers are deemed to be affiliates. There were 9,573,726 shares of the registrant's common stock outstanding as of September 15, 1998. Documents incorporated by reference. Part III of this Form 10-K incorporates information by reference from the registrant's definitive proxy statement which will be filed no later than 120 days after June 30, 1998. 1 Table of Contents Item Number Page - ------ ---- PART I 3 1. Business 3 Forward-looking Statements 3 General 3 Financial Information About Business Segments 4 The Blimpie Outlet Franchise, Subfranchise and Master License 4 Services to Franchisees 7 Blimpie Outlet Properties 8 Blimpie Outlet Locations 9 Government Regulation 9 Trademarks, Trade Names, Service Marks and Logos; Know-How and Methods of Operation 10 Research and Development 13 Business Expansion 13 Competition 15 Employees 15 2. Properties 16 3. Legal Proceedings 16 3a. Executive Officers of the Company 18 4. Submission of Matters to a Vote of Security Holders 20 PART II 5. Market for Common Equity and Related Stockholder Matters 20 6. Selected Financial Data 21 Management's Discussion and Analysis of Financial 7. Condition and Results of Operations 21 8. Financial Statements 32 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure PART III 33 10. Directors, Executive Officers 33 11. Executive Compensation 33 12. Security Ownership of Certain Beneficial Owners and 33 Management 13. Certain Relationships and Related Transactions 33 PART IV 14. Exhibits, Financial Statements, Schedules and Reports of 33 Form 8-K 14(a)(1) Financial Statements 33 14(a)(2) Financial Statement Schedule 33 14(a)(3) Exhibits 33 14(b) Reports on Form 8-K 36 SIGNATURES 37 2 PART I ITEM 1. BUSINESS Forward-looking Statements Certain forward-looking statements are included in this report. They use such words as "may," "will," "expect," "believe," "plan" "anticipate" and other similar terminology. These statements reflect management's current expectations and involve a number of risks and uncertainties. Actual results could differ materially due to changes in: global and local business and economic conditions; legislation and governmental regulation; competition; success of operating initiatives and advertising and promotional efforts; food, labor and other operating costs; availability and cost of land and construction; adoption of new or changes in accounting policies and practices; consumer preferences, spending patterns and demographic trends; political or economic instability in local markets; and currency exchange rates. General The Company is a New Jersey corporation which was formerly known as Astor Restaurant Group, Inc. (from October, 1986 - April, 1992) and International Blimpie Corporation (from its formation in 1977 until October, 1986). The Company engages in franchising, subfranchising and master licensing of the Blimpie trademarks, trade names, service marks, logos (the "Blimpie Trademarks"), marketing concepts and marketing programs. The Company franchises BLIMPIE(R) Subs & Salads and Pasta Central(TM) and is the majority owner of Maui Tacos International, Inc., the franchisor of Maui Tacos(TM) and Smoothie Island(TM). BLIMPIE Subs & Salads offers a quick-service, healthy, sub sandwich in approximately 2,000 franchise stores operating throughout the United States and in 12 other countries. The main products sold in a Blimpie outlet are sub sandwiches and salads. Blimpie(R) is a registered trademark of the Company. Unless otherwise specified, the terms "Blimpie" and the "Company" include Blimpie(R). The Company currently is developing Pasta Central, Maui Tacos and Smoothie Island, and anticipates that the first location for each concept will open before December 31, 1998. Pasta Central's baked pasta meals address current eating trends for eat-in or take home replacement meals. Maui Tacos restaurants provide a healthy, affordable menu of "Maui-Mex" items, including traditional Mexican food marinated in Hawaiian spices. Smoothie Island is a selection of blended beverages of frozen yogurt, fruit and nutritional supplements sold through the Blimpie, Pasta Central, and Maui Tacos locations. The Company also provides professional store design service and equipment sales through its wholly-owned subsidiary, B I Concept Systems, Inc. Currently, the Company does not operate any of the restaurants, subfranchisor or master licensor areas within the Blimpie International system. The first Blimpie outlet commenced operations in 1964 in Hoboken, New Jersey. The Company's rights regarding the Blimpie Trademarks and the methodology and know-how which comprise the Blimpie outlet marketing concepts and programs (the "Blimpie Marketing System") are, pursuant to written licensing agreements between the Company and the owners of such rights, limited to specific geographic regions throughout the World. See "Business - Trademarks, Trade Names, Service Marks and Logos; Know-How and Methods of Operation." Since the incorporation of the Company in 1977, the chain of franchised Blimpie outlets has expanded to encompass 1,972 outlets located in 46 states, Argentina, Canada, Cyprus, Dominican Republic, Jordan, Panama, Peru, Poland, Saudi Arabia, South Africa, Spain and Great Britain (as of June 30, 1998). See "Business - Blimpie Outlet Locations." There are approximately 250 additional Blimpie outlets which are controlled by an entity unaffiliated with the Company that are located in areas of the country in which the Company does not possess rights to license the Blimpie trademarks or sell franchises or subfranchises. Commencing in 1977, the Company began selling individual outlet franchises and area subfranchises. The Company distributes the nationally registered Blimpie trademarks pursuant to a 99 year exclusive trademark grant (expiring in the year 2076) from the trademark owners. Commencing in 1995, the Company began selling master licenses for various territories located outside of the United States. The Company distributes the internationally registered Blimpie trademarks, as the owner of an 3 undivided 60% interest therein, and pursuant to an agreement with the holder of the remaining 40% undivided interest therein which provides for automatic annual renewals until July, 2090. See "Business - Trademarks, Service Marks, Trade Names and Logos; Know-How and Methods of Operation." The Company derives its revenue primarily from four sources: (1) store equipment sales, (2) continuing franchise fees based upon each franchisee's gross sales, (3) fees from the grant of individual outlet franchises and (4) fees from the grant of subfranchises to Subfranchisors and the grant of master licenses to Master Licensors worldwide. Individual outlet franchises are granted for both "traditional" locations, i.e., Blimpie outlets located in free-standing buildings, shopping malls, and in-line urban store clusters, and "new-concept" locations, i.e., convenience stores, institutional food service entities, colleges, schools, mass feeders (such as institutional food service providers and in-facility commissaries) and hospitals that sell or otherwise make all or part of the Blimpie line of food products available to their customers, clientele or attendees through facilities that may or may not contain all of the components normally associated with a traditional Blimpie outlet, such as kitchen, food preparation and customer dining areas. The Company also has commenced developing several new types of product distribution formats, some of which it has begun to introduce and some of which it anticipates introducing in the future. One such program involves the sale of a limited number of prepared Blimpie sandwiches and salads maintained in "Grab'n Go" refrigeration cases at Company-approved "distribution points" operated by franchisees and non-franchisees. There are approximately 200 Grab'n Go locations operating in the United States. The Company currently is developing new types of carts, kiosks, vending machines and other mobile Blimpie branded product delivery systems. The Company further anticipates the development of a format that would allow the sale of some Blimpie branded products at supermarkets and other retail locations. Financial Information About Business Segments See Note 13 to the Company's audited financial statements. The Blimpie Outlet Franchise, Subfranchise and Master License A Blimpie outlet is a non-cooking, sandwich outlet characterized by portion-controlled meat and cheese combinations generally sold on six inch or twelve inch French/Italian white or wheat bread garnished with special Blimpie spices and dressings along with salads and other food items. The sandwich products sold in these outlets are known as Blimpie sandwiches and the outlets themselves are known as Blimpie outlets. The Company requires each franchisee to offer food products from a list of products authorized by the Company. Such products include hot and cold sandwiches, including hot items such as Italian meatball sandwiches and chicken breast sandwiches, and cold items such as roast beef and club sandwiches. The Company's "signature" item is the "Blimpie Best" sandwich, which consists of ham, salami, cappacola, prosciuttini and provolone. In addition, all Blimpie sandwiches are dressed at no additional charge with tomatoes, lettuce, onions, oil and vinegar and oregano. The Company establishes recommended prices for food products which franchisees may or may not adopt. Accordingly, such prices differ depending upon geographic location. For example, in New York City a "Blimpie Best" may sell for $3.89, while in Atlanta, Georgia, the same sandwich may be purchased for $2.89. In addition to the authorized Blimpie sandwich line, Blimpie outlets also offer a variety of salads including chef, tuna, seafood and tossed green salads and a variety of baked products including bagels, rolls, muffins, cookies, cinnamon buns, donuts and a variety of other products produced mostly from raw frozen dough products and baked in the approved Blimpie deck oven installed in each Blimpie outlet. Prices for all authorized products vary depending upon geographic location. Each franchisee is obligated to purchase its raw materials, both food and non-food, from authorized and designated distributors who may only sell authorized and approved raw materials purchased from approved manufacturers and suppliers. The Company negotiates approved product relationships with manufacturers and suppliers on a national level with respect to all products except 4 produce, whether or not they bear the Blimpie logo. The Company negotiates and enters into recognition agreements authorizing approved distributors to deliver to Blimpie outlets the raw products purchased by such distributors from approved manufacturers and suppliers. All products purchased by franchisees on a local level must meet the Company's quality standards. Franchisees may request approval of additional manufacturers, suppliers or distributors subject to the Company's approval, which approval is based upon a number of conditions including price, quality, ability to service the system on a national basis and such other reasonable standards as may be promulgated by the Company from time to time. Currently, there are no other manufacturers, suppliers or distributors approved by the Company other than those designated by the Company. The Company believes that it could easily obtain alternate manufacturers, suppliers and distributors should any of its current manufacturers, suppliers or distributors become unwilling or unable to provide the Company's franchisees with the authorized required raw materials. A franchisee pays a non-refundable initial franchise fee (currently $18,000) in connection with his execution of a franchise agreement which grants to the franchisee the right to use the various Blimpie trademarks, trade names, service marks, logos, marketing concepts and marketing programs, and to operate a Blimpie outlet at a location to be agreed upon by the Company and the franchisee in accordance with the operations manual issued by the Company to its franchisees (the "Operations Manual"). The non-refundable initial franchise fee payable by the holder of a new-concept franchise can range between $1.00 and $18,000 depending on the number of new-concept transactions executed, the location of the new-concept franchisee, the marketing area in question and other subjective factors. After a location has been found and the lease or purchase thereof has been negotiated by the franchisee and approved by the Company, the franchisee then constructs and installs its Blimpie outlet in accordance with design and layout specifications provided by the Company. Franchisees are required, pursuant to the franchise agreement and the Operations Manual, to maintain specified standards as to food quality, menu items, uniforms, appearance, sanitation and all other aspects of outlet operations. In addition to the initial franchise fee, a Blimpie franchisee also pays all other costs and expenses related to the installation of his Blimpie outlet at an approved location. An equipment package, including but not limited to slicing machines, refrigeration cases, food preparation counters and signs bearing the registered "Blimpie" logos, costs approximately $25,000 to $40,000. Construction of a Blimpie outlet, which generally includes walls, floor, ceiling, plumbing and electrical work required to modify an existing premises to an approved Blimpie design costs between $10,000 to $80,000 to complete. These costs, plus the initial lease security payable to the owner of the leased premises and utility deposits to the various utility companies and recommended minimum opening inventory and working capital aggregating approximately $5,000 to $15,000, comprise the approximate cash investment of an average Blimpie franchise. Blimpie franchisees are required to pay continuing franchise fees of 6% of the franchisee's weekly gross sales. Franchisees are also required to pay mandatory advertising contributions of 4% of the franchisees' weekly gross sales except that persons or entities acquiring franchises before the Fall of 1994 are required to pay mandatory advertising contributions of 3%. Two percent of the advertising contributions made by franchisees in the same general marketing area are used for the payment of advertising which benefits all of such franchisees, while the remainder is used for national advertising. Canadian franchisees pay continuing franchise fees of 8% and advertising contributions of 2%. Each Subfranchisor pays a subfranchise fee that is based upon the population of the subfranchise. At present, the fee, which can typically range between $10,000 and $350,000, is based upon a charge of $.10 per person located within the area that is the subject of the subfranchise. In addition to the subfranchise fee, each Subfranchisor must join a Subfranchisor advertising cooperative association sponsored by the Company which purchases franchise advertisements in national periodicals for the benefit of all Subfranchisors. A Subfranchisor's annual contribution to the advertising cooperative typically ranges between $1,200 and $4,800. The Company makes voluntary contributions to the cooperative association that match the contributions made by the Subfranchisors. 5 Each subfranchise consists of a specifically defined territory within which the Subfranchisor has the exclusive right for a period of 50 to 60 years to solicit potential purchasers of Blimpie franchises who sublicense directly from the Company the right to use the Blimpie trademarks, trade names, service marks, logos, marketing concepts and marketing programs. The Company's standard form of subfranchise agreement grants to the Subfranchisor the exclusive license to purchase the territory for a one year period, followed by four to six renewal terms, all but the last of which are annual in duration. The license is subject to the Company's continuing right to market and sell the Blimpie trademarks, trade names, service marks, logos, marketing concepts and marketing programs within specified territories. If all terms and conditions of the subfranchise agreement have been met during the initial one year term and each of the subsequent one year renewal terms, a 50 to 60 year right is granted during the final renewal term upon payment of the fee set forth in the agreement. Each subfranchise agreement obligates the Subfranchisor to satisfy all of the operational obligations owed by the Company to each franchisee within the Subfranchisor's territory at the sole expense of the Subfranchisor; to use his best efforts to promote the sale of franchises within his territory; and to meet certain sales quotas. Each such agreement is terminable by the Company upon thirty days' notice in the event of the Subfranchisor's default under certain provisions of the agreement. The Subfranchisor may terminate the agreement upon certain defaults by the Company and where such defaults remain uncured, depending on the nature of the default, for more than 30 days to more than 75 days. Subfranchisors who are in full compliance with the obligations imposed upon them pursuant to the subfranchise agreement, including, among other things, the obligation to open defined quantities of franchised Blimpie outlets within specified periods of time, are entitled to receive one half of each initial franchise fee (after deductions for sales commissions, design, training and real estate fees) paid by new franchisees establishing Blimpie outlets within the Subfranchisor's territory, and one half of the 6% of gross sales continuing franchise fee paid by such franchisees pursuant to their respective franchise agreements with the Company. Each Master Licensor pays a master license fee that is based upon the population of the master license territory. The fee, which typically ranges between $10,000 and $1,000,000, is presently based upon a charge that ranges from $.01 per person to $.10 per person located within the area that is the subject of the master license. Each master license consists of a specifically defined territory within which the Master Licensor has the exclusive right for a period of 50 years to solicit potential purchasers of Blimpie franchises who sublicense either directly from the Master Licensor or from a wholly-owned subsidiary of the Company the right to use the Blimpie trademarks, trade names, service marks, logos, marketing concepts and marketing programs. The Company's standard form of master license agreement grants to the Master Licensor the exclusive license, subject to the Company's continuing right to market and sell the Blimpie trademarks, trade names, service marks, logos, marketing concepts and marketing programs, within specified territories for a term of 50 years. Each such agreement obligates the Master Licensor to satisfy all of the operational obligations to each franchisee within the Master Licensor's territory at the sole expense of the Master Licensor and to meet certain sales quotas. Each Master Licensor is required to organize a regional advertising program. Each such agreement is terminable by the Company upon notice in the event of the Master Licensor's default under certain provisions of the agreement. The Master Licensor may terminate the agreement upon certain defaults by the Company where such defaults remain uncured for periods ranging from 30 to 75 days, depending upon the nature of the default. Master Licensors who are in full compliance with the obligations imposed upon them pursuant to the master license agreement including, among other things, the obligation to open defined quantities of franchised Blimpie outlets within specified periods of time, are entitled to receive 5/8 of the initial franchise fees paid by new franchisees establishing Blimpie outlets within the Master Licensor's territory, and 5/8 of 6 the 8% of gross sales continuing franchise fees paid by such franchisees pursuant to their respective franchise agreements with the master licensor, the Company or the Company's subsidiary. The Company markets and sells franchises, subfranchises and master licenses through advertisements placed in local and national periodicals, through presentations at trade shows and franchise conventions, through referrals from existing franchisees, Subfranchisors and Master Licensors and through informational materials placed in Blimpie outlets. As of June 30, 1998 there were 105 existing domestic subfranchisors, at least one of which is located in each of the 46 states in which the 1,972 domestic Blimpie outlets are located; four Canadian subfranchisors, one of which is located in each of the Provinces of Alberta, British Columbia, Manitoba and Ontario in which 14 Blimpie outlets are located; and 13 Master Licensors for the countries of Argentina, Bahrain, Cyprus, Dominican Republic, Egypt, Great Britain, Greece, Jordan, Kuwait, Lebanon, Northern Ireland, Oman, Panama, Peru, Poland, Portugal, Puerto Rico, Qatar, The Republic of Ireland, Saudi Arabia, South Africa, Spain, United Arab Emirates, Uruguay and Venezuela in which collectively there are 23 outlets located. Such subfranchises and Master licenses range in size, depending upon the specific geographical area involved, from entire states to a specific county or counties. See "Business - Blimpie Outlet Locations"; "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations." Services to Franchisees On a continuing basis, franchisees in the U.S. and Canada are furnished with advisory assistance from the Company regarding outlet operations, new menu items and new marketing aids developed by the Company. No additional fees are charged to franchisees for these services or for the training program described below. The Company, in its sole discretion, also provides services to franchisees by visiting their outlets and inspecting them for quality, cleanliness and service. A written operation inspection analysis is provided after each inspection. Outside of the U.S. and Canada, Master Licensors provide all such services, with the assistance of the Company. The Company provides training for new franchisees in the U.S. and Canada consisting of (i) forty hours of pre-training classes at an existing Blimpie outlet approved by the Company, (ii) one week of classroom training at its Georgia training center, and (iii) an additional 80 hours of operational post-training at an existing Blimpie outlet approved by the Company. The Company provides training for new Subfranchisors and Master Licensors consisting of two weeks of classroom training at its Georgia training center, plus 80 hours of operational training at an existing Blimpie outlet approved by the Company. The training program addresses all phases of outlet operations from service training to financial management, including the various controls of the Blimpie marketing system specified in the Operations Manual. Inventories, ordering procedures, hiring and firing, equipment maintenance, product controls, bookkeeping and accounting are all covered by the training program. The training provided to Subfranchisors and Master Licensors also encompasses franchisor-related activities including, but not limited to, franchise sales, communication, analysis of franchisee construction needs and the fulfillment thereof. After a Blimpie outlet is constructed or renovated and the equipment installed, a Company representative, Subfranchisor or Master Licensor generally is on site for one week after an outlet opens for the purpose of providing additional operational assistance and supervisory functions. Each Subfranchisor or Master Licensor is responsible for providing each franchisee within his territory with operational assistance throughout the term of his subfranchise or master license agreement. Generally, a Company representative is only on site as described above with respect to the first three franchisees which open outlets within a territory. However, representatives of the Company remain available on a continuing basis to provide additional support to franchisees, Subfranchisors and Master Licensors. In connection therewith, the Company maintains a toll-free hotline by which franchisees and Subfranchisors may contact representatives of the Company for advice and assistance regarding operational matters. 7 Blimpie Outlet Properties Each traditional franchisee in the U.S. and Canada generally is required to lease the outlet premises from a designated leasing subsidiary of the Company. Each franchisee outside of the U.S. and Canada generally is required to lease the outlet premises from a corporation in which the Master Licensor owns 50% and the Company or its designee owns 50%, or such franchisee is required to provide a collateral assignment of the lease to the jointly owned corporation. In all such cases, it is the franchisee's sole obligation to find the premises to be leased and to obtain the Company's approval of such location as the situs of his franchised outlet. Once the location is approved, the Company (or its leasing subsidiary) will negotiate and enter into a lease of the premises, subject to the franchisee's approval, and will then enter into a sublease thereof with the franchisee for the entire term and renewal term, if any, of the lease of the premises less one day (generally 10 to 20 years). The percentage royalty and advertising payments due pursuant to the franchise agreement constitute additional rent under the sublease. Payment of the percentage royalties and advertising fees under the franchise agreement satisfies the above-mentioned corresponding additional rental payment obligation under the sublease. All rents specified pursuant to the lease of the premises are paid directly by the franchisee to the landlord specified in the lease pursuant to the cancelable authorization by the Blimpie subsidiary leasing corporation set forth in the sublease. Accordingly, except in a rare case in which the Company or one of its subsidiaries may be the owner and landlord of a franchisee's outlet, no funds which constitute the rent and additional rent due under the lease of the premises are ever commingled or otherwise used by the Company or any of its affiliates or subsidiaries. The Company has no payment or performance obligations with respect to any of the existing outlet location leases, except for less than one percent thereof. The leasing/subleasing mechanism described above enables the Company to maintain control of each Blimpie outlet premises and to enforce franchisee compliance with the Company's authorized product line and quality standards. In addition, since percentage royalties and advertising fees constitute additional rent under the subleases, the leasing/subleasing mechanism gives the Company an additional vehicle through which to enforce its rights regarding receipt of such payments and payments to the landlord of the Blimpie outlet premises. Typically, upon a franchisee's failure to timely make rental payments, the Company's leasing subsidiary will receive notice from the landlord of such fact. The franchisee is then notified of its default and is given the opportunity to cure the default. Upon failure to cure the default, eviction proceedings usually will be instituted by either the unaffiliated landlord or the Company's leasing subsidiary. Following eviction of the franchisee, the Company, if the landlord so permits, will attempt to sell the existing franchised outlet to a new franchisee who will take possession of the premises subject to the terms of the prior lease and sublease, or pursuant to a new lease negotiated by the Company with the landlord, and a new sublease. In cases where a lease has been terminated and/or a franchisee has been evicted, if a replacement franchisee cannot be obtained by the Company to cure all defaults and operate or re-open the Blimpie outlet in question, it is the general policy of the Company either to abandon the location and the leasing subsidiary, or to dispose of ownership of the leasing subsidiary to unaffiliated parties for nominal consideration. Substantially all leases executed by the Company's various leasing subsidiaries during the past five years have provided (and it is the Company's intention that all future leases for outlet premises shall provide) that the respective landlords thereunder will not directly or indirectly claim or institute legal proceedings against the Company. All of the 1,972 existing Blimpie outlets (as of June 30, 1998) are operating in premises located in free-standing buildings, shopping malls, shopping centers, in-line urban store clusters, convenience stores, institutional food service facilities, colleges, schools, mass feeders, hospitals, bowling alleys, golf courses and subway stations. The size of a Blimpie outlet varies from 400 square feet to approximately 3,500 square feet. Since the cost of renovating pre-existing premises into an approved Blimpie outlet is dependent upon the condition and prior use of the premises, an exact estimation is impossible. Historically, the cost of Blimpie outlet construction/renovation, which must be completed in accordance with design and layout specifications provided by the Company, and at the franchisee's sole expense, has ranged from as low as $10,000 to as high as $80,000. The franchisee must also equip the Blimpie outlet 8 at the franchisee's sole cost and expense. Such equipment costs, in the aggregate, approximately $25,000 to $40,000. Blimpie Outlet Locations The following table sets forth the number of Blimpie franchised outlets in operation as of June 30, 1998: Number Number of of Location Outlets Location Outlets United States outlets: United States outlets (cont'd): Alabama 22 Oklahoma 12 Alaska 11 Oregon 15 Arizona 75 Pennsylvania 56 Arkansas 19 Rhode Island 9 California 69 South Carolina 56 Colorado 36 South Dakota 3 Connecticut 31 Tennessee 74 Florida 174 Texas 140 Georgia 196 Utah 37 Hawaii 9 Washington 33 Idaho 14 West Virginia 19 Illinois 37 Wisconsin 27 Indiana 56 Wyoming 10 Iowa 58 --------- Kansas 15 United States total 1,935 Kentucky 25 Louisiana 42 International outlets: Maine 2 Argentina 5 Massachusetts 5 Canada 14 Michigan 80 Cyprus 3 Minnesota 28 Dominican Republic 1 Mississippi 15 Jordan 1 Missouri 59 Panama 1 Montana 7 Peru 1 Nebraska 22 Poland 1 Nevada 34 Saudi Arabia 1 New Hampshire 1 South Africa 1 New Jersey 53 Spain 3 New Mexico 13 Great Britain 5 New York 76 --------- North Carolina 65 International total 37 North Dakota 5 --------- Ohio 90 Total 1,972 ========= Government Regulation The Federal Trade Commission and various state governmental authorities have adopted laws regulating franchise operations and the franchisor-franchisee relationship. Such laws vary from merely requiring the filing of disclosure documents concerning the offer and sale of franchises to the application of statutory standards regulating established franchise relationships. The most common provisions of those laws regulate the substance of franchisor-franchisee relationships and establish restrictions on the ability of franchisors to terminate or to refuse to renew franchise agreements. Other states' laws contain 9 provisions designed to ensure the fairness of the franchise agreements to franchisees by, among other means, including limitations, prohibitions and/or restrictions pertaining to the assignability of the rights of franchisees; a franchisee's right to own or be involved in other businesses; franchisee membership in trade associations; and franchisor interference with franchisee employment practices. In addition to the foregoing state regulations, the Federal Trade Commission has adopted rules and guidelines which require franchisors to make certain disclosures to prospective franchisees prior to the offer or sale of franchises. In addition to requiring the disclosure of information necessary for a franchisee to make an informed decision on whether to enter into a franchise relationship, the guidelines delineate the circumstances in which franchisors may make predictions on future sales, income and profits. The Company does not furnish or authorize its salespersons to furnish any oral or written information on the actual or projected sales, costs, income or profits of a franchise. Failure to comply with such rules constitutes an unfair trade practice under Section 5 of the Federal Trade Commission Act. Several state and federal courts have revealed a tendency to be sympathetic to and desirous of protecting the rights and interests of franchisees in litigation with their franchisors. Although such tendency may result in some modification of the Company's licensing activities and some delays or failures in enforcing certain of its rights and remedies under certain franchising and lease agreements, the Company does not believe that such modifications, delays or failures will have a materially adverse effect on its operations or business. However, the law applicable to franchise operations and relationships is rapidly developing, and the Company is unable to predict the effect on its operations of additional requirements or restrictions which may be enacted or promulgated or of court decisions which may generally be adverse to the franchise industry. The Company believes that it has conducted and is conducting its business in substantial compliance with all applicable laws and regulations governing its operations. The franchisees' outlets are also subject to regulatory provisions relating to the wholesomeness of food, sanitation, health, safety, fire, land use and environmental standards. Suspension of certain licenses or approvals, due to failure to comply with applicable regulations or otherwise, could interrupt the operations of the affected outlet or otherwise adversely affect the outlet. The franchisees are also subject to federal and state laws establishing minimum wages and regulating overtime and working conditions. Changes in such laws could result in an increase in labor costs that could adversely affect the outlet. The Company believes that it is conducting its business in substantial compliance with all applicable laws and regulations governing its operations. Trademarks, Trade Names, Service Marks And Logos; Know-How And Methods Of Operation The Company regards the Blimpie Trademarks and the Blimpie Marketing System as having significant value and as being important to its marketing efforts. Each Blimpie franchisee and Subfranchisor is authorized pursuant to his franchise agreement to use the Blimpie Trademarks and Blimpie Marketing System, along with all other future trademark filings. The Blimpie Trademarks and Blimpie Marketing System may only be used by traditional and new-concept Blimpie outlets which sell Blimpie sandwiches and Blimpie-related products, and by Blimpie distribution points. There are specific product limitations as to each Blimpie outlet so that each Blimpie franchisee may sell only those products authorized by his particular franchise agreement and the Operations Manual or otherwise approved in writing by the Company. Any variation from the authorized product line is actionable by the trademark owners or the Company. Prior to 1976, all rights under the laws of the United States pertaining to the Blimpie Trademarks and the Blimpie Marketing System were owned by Anthony P. Conza and David L. Siegel, Esq. (who are the Company's founders and principal shareholders, directors and, respectively, the President and Chief Operating Officer, of the Company) and by Peter DeCarlo, an individual who is not affiliated with the Company. During that period of time, Messrs. Conza, Siegel and DeCarlo conferred the right to distribute the Blimpie Trademarks and to license the use of the Blimpie Marketing System upon a number of 10 corporations which they owned and controlled. In 1976, they ceased their joint association and divided, by written agreement, the right to issue Blimpie franchise and subfranchise agreements. In 1984, Mr. DeCarlo assigned his interests in the Blimpie Trademarks to Metropolitan Blimpie, Inc. ("MBI"), a corporation which is not affiliated with the Company. Prior to 1991, MBI, and Messrs. Conza and Siegel had reserved to themselves and jointly owned undivided 40%, 40% and 20% interests, respectively, in and with respect to all international, i.e. non-U.S., rights pertaining to the Blimpie Trademarks and the Blimpie Marketing System. The Company, pursuant to 99 year grants made to it by Messrs. Conza and Siegel in 1976, has the exclusive right to distribute the Blimpie Trademarks and license the use of the Blimpie Marketing System in the following territories located within the U.S.: Alabama, Arizona, Connecticut, Florida, Georgia, Idaho, Illinois, Indiana, Kentucky, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Montana, New Hampshire, the Counties of Morris, Warren, Sussex, Bergen, Passaic and Essex in New Jersey except for the Cities of Alpine, Belville, Cliffside Park, Cloister, Cresskill, Demarest, Dumont, East Rutherford, Edgewater, Englewood, Englewood Cliffs, Fairview, Fort Lee, Hackensack, Harrington Park, Haworth, Old Tappan, Northvale, Nutley, Norwood, Palisades Park, Paterson, Ridgefield, Ridgefield Park, Rock Leigh, Rutherford, South Hackensack and Tenafly; New York (except for the following counties: New York, Bronx, Kings and Queens, Westchester and Rockland), Ohio, Oregon, Rhode Island, North Carolina, South Carolina, Tennessee, Texas, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming. In 1993, the Company acquired from Messrs, Conza, Siegel and MBI the exclusive right to license the Blimpie Trademarks and the Blimpie Marketing System in New Mexico, in consideration for the transfer to MBI of the exclusive right to license the Blimpie Trademarks and Blimpie Marketing System in Richmond County, New York. MBI presently has the right to distribute the Blimpie Trademarks and license the Blimpie Marketing System in the following territories located within the U.S. (collectively, the "MBI Territories"): Arkansas, Colorado, Delaware, Iowa, Kansas, Maryland, Missouri, Nebraska, New Jersey (except for the counties and cities referred to above), Nevada, the counties of New York, Queens, Kings, Richmond, Rockland, Bronx and Westchester in New York, North Dakota, Oklahoma, Pennsylvania (from the eastern border westward to and including Harrisburg), South Dakota and Virginia. From time to time, the Company has been authorized by MBI to issue, and has issued, franchises or subfranchises in the MBI Territories. From each franchise sale, subfranchise sale or other sale, the net receipts after the deduction of the specific expenses have been divided unequally between the Company and MBI. The Company also is authorized to issue replacement or substitute franchise agreements for any franchised locations granted under MBI's authorization. The Company possesses the exclusive right to license the Blimpie Trademarks and Blimpie Marketing System in the area of Northern California between the southern border of Monterrey and the northern border of the state, including the counties of Monterrey, San Benito, Santa Cruz, Santa Clara, San Mateo, Alameda, Mariposa, San Francisco, Contra Costa, Marin Novato, Mono, Tudumne, Calaveras, Napa, Solano, Sonoma, Amedor, Alpine, Sacramento, Yolo, Sutter, El Dorado, Placer, Colusa, Nevada, Lake, Yuba, Mendocino, Glenn, Sierra, Butte, Tehama, Plumas, Humboldt, Trinity, Shasta, Lassen, Del Norte, Siskiyou and Modoc. Blimpie of California, Inc. ("BOC"), a corporation which is not affiliated with the Company, possesses the exclusive right to license the Blimpie Trademarks and Blimpie Marketing System throughout the balance of the state of California pursuant to a joint trademark distribution agreement which the Company and MBI entered into in 1984 with ISM, Inc. (a corporation which is not affiliated with the Company), which agreement was subsequently assigned to BOC, and thereafter amended. A number of franchised Blimpie outlets located in Southern California have been established pursuant to trademark licenses granted by BOC. The Company receives 2.5% of the gross sales by such franchisees, and shares half of such receipts with MBI. By agreement dated July 19, 1991 (the "1991 Agreement"), MBI granted to the Company the exclusive right to license the Blimpie Trademarks and Blimpie Marketing System throughout the MBI Territories, except for those portions thereof located in, or consisting of, Delaware, Maryland, New Jersey, New York, Pennsylvania, Virginia and Washington DC. The Company also acquired, pursuant to the 1991 11 Agreement, the exclusive right to license the Blimpie Trademarks and Blimpie Marketing System in Alaska, Hawaii, Puerto Rico and all other U.S. territories located outside of the continental U.S. In accordance with the 1991 Agreement, the Company acquired all rights which MBI possessed regarding the licensing of the Blimpie Trademarks and Blimpie Marketing System in all non-U.S. territories, subject to completion of appropriate trademark filings in each territory at the expense of the Company. In consideration for the grants made to the Company by the 1991 Agreement, the Company agreed to pay specified percentages of all revenues derived by the Company within the MBI Territories and outside of the U.S., subject to a minimum annual payment requirement of $100,000. The 1991 Agreement provided for an initial term of 42 months, and further provides for automatic annual renewals until July 2090, provided that the Company continues to pay said minimum annual payments. If the Company fails to satisfy its payment obligations under the 1991 Agreement, the Company would lose the right to license the Blimpie Trademarks and Blimpie Marketing System outside of the U.S. and throughout the MBI Territories. From July 1991 through June 30, 1998, the Company paid approximately $2,587,000 to MBI pursuant to the 1991 Agreement. Management has no reason to believe that MBI would ever seek to cancel or terminate the 1991 Agreement. Furthermore, management believes that the Company will continue to pay not less than $100,000 per year to MBI pursuant to the 1991 Agreement, and that such agreement shall remain in full force and effect throughout the entire period of permissible automatic renewals thereof. However, no assurance can be given that the 1991 Agreement will remain in full force and effect until July 2090. In accordance with a written agreement which the Company executed with Anthony P. Conza and David L. Siegel, the Company's Chairman and Chief Executive Officer and its Vice Chairman and Chief Operating Officer, respectively, on February 18, 1997, the Company acquired ownership of the undivided 60% interest in the international rights to the Blimpie trademarks and Blimpie marketing system owned by such individuals. In accordance with such agreement, the terms of which were negotiated by a Committee of the Board consisting solely of outside directors, the Company agreed to pay $4.5 million ($3 million to Mr. Conza and $1.5 million to Mr. Siegel), plus certain contingent fees which take effect after cumulative international revenues exceed $5 million, in consideration for their sale of such rights to the Company. Commencing on January 1, 2002, or such later year in which aggregate international revenues exceed $5 million, and continuing through the year 2052, the Company will be obligated to pay the first $150,000 of the revenues it derives from its international operations to Messrs. Conza ($100,000) and Siegel ($50,000). The agreement further provides that each of Messrs. Conza and Siegel may elect, at any time prior to January 1, 2001, to receive a lump sum distribution of $3 million ($2 million payable to Mr. Conza and the balance payable to Mr. Siegel) in lieu of such annual fee payments. If either or both of Messrs. Conza or Siegel do not exercise such option, the agreement grants to them a further option, exercisable at any time prior to January 1, 2006, to receive smaller lump sum payments based upon the foregoing amounts, but reduced pursuant to a formula to account for any annual contingent fee payments made to them prior to exercise of the second option. In determining the fairness of the consideration paid to Messrs. Conza and Siegel, the Committee of outside directors relied upon a report regarding the valuation of the international trademarks and the international rights to the Blimpie marketing system which had been prepared for the Committee by a firm of trademark valuation experts which had been retained for such purpose. The agreement supersedes a licensing agreement pertaining to such international trademark and marketing system rights which the Company had previously entered into with such individuals. Metropolitan Blimpie, Inc. (MBI), an unaffiliated company, continues to own the balance of such international trademark and marketing system rights. Previously executed international licensing agreements between MBI and the Company also remain in place. On October 1, 1995, the Company entered into an agreement to settle a trademark infringement proceeding which it commenced in Canada against an unaffiliated party (the "claimant") who had filed trademark registration documents seeking trademark protection for the word "Blimpie" prior to the time that the Company made such filings in Canada. Pursuant to the settlement agreement, the Company acquired all rights held by the claimant in such Canadian trademark registration in consideration for the payment of $40,000 and an agreement to issue 125,000 unregistered shares of the Company's Common 12 Stock at the rate of 25,000 shares per year. The issuance of each installment after the initial 25,000 shares (which were issued upon the closing of such settlement) is subject to the claimant's compliance with various conditions specified in the settlement agreement. To the knowledge of the Company, there are no infringing uses of the Blimpie Trademarks in any territory where any of the Company's franchisees has established or attempted to establish operations which would in any way materially affect the use of such trademarks by the Company or a franchisee. Research and Development The Company conducts ongoing development of new menu items and test markets such products, as well as new Company-developed food marketing aids, in selected Blimpie outlets. Although such research and development activities are important to the Company's business, its expenditures for these activities heretofore have not been material. Business Expansion Equipment Leasing. The Company provides financing to new and existing franchisees primarily through entering into participation arrangements with unaffiliated third party finance/leasing entities. During the year ended June 30, 1998, the Company participated in the financing of 39 of such equipment leases, and at June 30, 1998, the balance of those participations totaled $679,000. The Company believes that such programs will result in an increase in financing profits and an increase in franchise sales due to the greater availability of equipment to new and existing franchisees. However, no assurances can be given in that regard. Domestic Expansion. The Company plans to grow through continued development of traditional and new-concept Blimpie outlets throughout the U.S. The Company also plans to continue to hire and train additional staff to develop new types of Blimpie distribution points throughout the U.S. International Expansion. The Company continues to grow internationally through the sale of master license agreements. The agreements are analogous to subfranchise agreements, except that the master licensor or a wholly-owned subsidiary of the Company enters into franchise agreements directly with the franchisees in each international market. The master licensor, in effect, is the Company's representative in that specific country and is obligated to provide all of the support services and selling activities required to develop the franchised market. Initially, however, the Company will provide administrative support to assist the master licensors. The Company has entered into master license agreements for the following countries: Argentina, Bahrain, Canada (provinces of Alberta, British Columbia, Manitoba and Ontario), Cyprus, Dominican Republic, Egypt, Great Britain, Greece, Jordan, Kuwait, Lebanon, Northern Ireland, Oman, Panama, Peru, Poland, Portugal, Puerto Rico, Qatar, The Republic of Ireland, Saudi Arabia, South Africa, Spain, United Arab Emirates, Uruguay and Venezuela. In addition, the master licensor for Egypt, Lebanon and Jordan has purchased a two year option to buy the master license rights for Syria. In the United Kingdom, pursuant to an amendment of the master license agreement, the Company formed a 50% owned subsidiary, Blimpie International of Great Britain, Ltd., which will issue franchise agreements for use in the United Kingdom. The Company anticipates that it will execute master license agreements for various other countries in the near future. The Company also plans to develop joint venture agreements with various entities such as petroleum marketers or convenience store chains for the installation of Blimpie outlets in such entities' locations. The Company is in the midst of negotiations for several such arrangements in the United Kingdom and elsewhere. There can be no assurance, however, that the Company will consummate any such transactions. Development of Blimpie Branded Products. The Company's long term strategic plan includes developing products for sale at distribution points such as Blimpie restaurants, supermarkets and 13 convenience stores. The Company began selling Blimpie branded peppers, potato chips and potato sticks during the year ended June 30, 1998 in a limited number of Blimpie outlets. The Company intends to expand this initiative by increasing the number of Blimpie branded products and the number of locations in which they are sold. No assurances can be given, however, that the sale of Blimpie branded products will continue to generate increased revenue for the Company. Expansion of Equipment Sales Department. Due to the success achieved by the Company from the sale of equipment to Blimpie franchisees, the Company has expanded its equipment sales department in Houston, and began selling equipment to franchisees of other chains commencing in fiscal 1998. In connection with such expansion, the equipment sales department was reorganized as a wholly owned subsidiary known as BI Concept Systems, Inc. The Company believes that this expansion will increase revenue, and result in an increase in net income. However, no assurances can be given in such regard. Acquisition of Existing Franchise Concept. On October 29, 1997 an agreement was signed between the Company and Maui Tacos International, Inc. (MTII) which resulted in the Company acquiring a majority interest in MTII. See "Business - Business Expansion - Development of New Franchise Concepts" below. The Company believes that its mature infrastructure is capable of supporting additional franchise systems, and that additional acquisitions of this nature will open up additional market segments for development by the Company. However, no assurances can be given that additional acquisitions will be consummated, and if consummated, that the Company will generate increased revenues or net income therefrom. Development of New Franchise Concepts. The Company is actively engaged in the development of new franchised food concepts involving product offerings which will not be directly competitive with the products offered by the chain of Blimpie outlets. Maui Tacos(TM) - In October 1997 the Company acquired a majority interest in MTII, a concept featuring a health-oriented, affordable restaurant-quality menu of "Maui-Mex" items, including traditional Mexican foods marinated in Hawaiian spices. The Company has acquired the trademarks and development rights for Maui Tacos, and intends to convert the existing full service restaurant concept with six locations operating in Hawaii into a quick service restaurant concept. The strategy of Maui Tacos is to award development rights to subfranchisors and master licensors across the United States and internationally. The first company-owned restaurant is under construction in Atlanta and is expected to be operational prior to December 31, 1998. Pasta Central(TM) - This Company-created concept features baked pasta and pizza offerings in the HMR (Home Meal Replacement) category that address current eating trends for eat-in or take home meals. The Company's strategy for this concept is to co-brand Pasta Central with Blimpie outlets to create natural synergies and cost efficiencies. In the typical Blimpie location, the majority of sales take place at lunch time. The Company anticipates that Pasta Central will generate significant evening traffic, inasmuch as it includes meals for in-store dining, take-away, or for final preparation and consumption at home. The Company expects that the two concepts can co-exist in the same location and generate greater returns to the franchisee and the Company based on higher revenues and lower costs as a percentage of these revenues. The concept may eventually be developed as a stand-alone location. The first location is expected to be operational prior to December 31, 1998. Smoothie Island(TM) - This MTII-created concept features offerings of blended beverages of frozen yogurt, fruit and nutritional supplements. Smoothie Island will be co-branded with Blimpie and Maui Tacos locations, and may also stand alone in other venues such as airports, sporting arenas, and fitness centers. The first two locations opened within existing Blimpie locations in early September 1998 in Tallahassee, FL and Denver, CO. No assurances can be given that the Company will be able to successfully develop any or all of these new franchise food concepts. The Company has incurred substantial initial costs associated with the development of these new concepts and it will, in all likelihood, continue to incur substantial initial 14 costs which will exceed the initial revenues to be derived therefrom. Furthermore, no assurances can be given that the Company will be able to develop sufficient market acceptance and market penetration with respect to any of the new franchise concepts, or that it will be able to derive any revenues or net income from such undertakings. COMPETITION The Company and its franchisees compete in the quick-service outlet industry, which is highly competitive with respect to price, service, outlet location and food quality, and is often affected by changes in consumer tastes, local and national economic conditions affecting consumer spending habits, population trends and traffic patterns. The Company and its franchisees compete with an increasing number of national chains of quick-service outlets, a number of which have dominant market positions, and possess substantially greater financial resources and longer operating histories than the Company. The Company's most significant competitor is the Subway(R) chain of sandwich outlets, whose outlets offer food products substantially similar to those offered by Blimpie outlets, at comparable prices. The Company and its franchisees also compete with regional and local franchised and independently owned outlet operations, many of which are larger in terms of financial resources and sales volume, than the Company's chain of franchised outlets and its franchisees, respectively. Blimpie outlets compete principally on the basis of price, nature of product, food quality and quality of service. In selling franchises, the Company competes with a number of franchisors of outlets and other business concepts. In general, there is also active competition for management personnel, as well as for attractive commercial real estate sites suitable for outlets. The Company is also required to respond to various consumer preferences, tastes and eating habits; demographic trends and traffic patterns; increases in food and labor costs; and national, regional and local economic conditions. In the past, several quick-service restaurant companies have experienced flat growth rates and declines in average sales per outlet, in response to which certain of such companies have adopted "value pricing" strategies. Such strategies could have the effect of drawing customers away from companies that do not engage in discount pricing and could also negatively impact the operating margins of competitors that do attempt to match competitors' price reductions. Continuing or sustained price discounting in the fast food industry could have an adverse effect on the Company. The Company believes that it can differentiate itself from its competitors. Blimpie outlets offer freshly sliced-to-order sandwich products, freshly made salads, freshly baked bread and bakery products which are distinguished by use of high quality ingredients, as compared to pre-made or pre-sliced sandwich products made with lesser quality ingredients. EMPLOYEES As of June 30, 1998, the Company employed 109 full-time employees (including thirteen officers). Nineteen employees (including five officers) attend to the Company's franchisee operations support, executive management and legal staffing needs at the Company's New York City office; 16 employees (including one officer) provide construction and design and franchisee operations support services at the Company's Houston, Texas office; and 74 employees (including seven officers) are engaged in accounting, franchisee operations support and training, marketing and franchise development activities at the Company's Atlanta, Georgia office. In addition, five employees (including one officer) of MTII are engaged in franchisee operations support, executive management and franchise development activities in an office adjacent to the Company's Atlanta, Georgia office. None of the employees is covered by collective bargaining agreements. All of the Company's full-time employees, including executive officers, are covered by a health plan and the Company's 401(k) profit sharing plan. 15 The Company considers its employee relations to be good. The Company believes that it provides working conditions and pays salaries and bonuses that compare favorably with those of its competitors. The Company has adopted a stock incentive plan for its employees and officers. See "Executive Compensation - Omnibus Stock Incentive Plan." ITEM 2. PROPERTIES The Company has its principal offices at 740 Broadway, New York, New York, where it leases, through a wholly-owned subsidiary, 740 Broadway Top Floor Corp., approximately 6,000 square feet of office space from an unaffiliated landlord. The Company is guarantor with respect to the obligations of said subsidiary under such lease. Such subsidiary pays a monthly rent of $9,800 which is subject to escalations, plus certain utilities and other fees. The term of such lease expires in February, 2003. The Company also leases 18,710 square feet of office space in Atlanta, Georgia from an unaffiliated landlord, through its wholly owned subsidiary Blimpie Capital Corporation. The monthly payments under such lease currently approximate $20,706 and escalate to $23,777 per month during the last year of the lease term in 2003. The Company also subleases 3,585 square feet of office space in Houston, Texas, on a month-to-month basis pursuant to an oral agreement with Vet Con Management Company, Inc. ("Vet Con"), a company wholly owned by Joseph Conza. Vet Con holds the lease relating to such office space with a landlord unaffiliated with the Company. The Company makes monthly payments under such sublease directly to the landlord. The monthly payments under such sublease made by the Company are currently $3,200 and, if the Company continues to occupy the premises pursuant to its oral sublease, may escalate to include annual common area maintenance payments during the final three years of the lease term, which may require moderate increased payments to the landlord for expenses incurred by the landlord in maintaining common areas. The Company is also the owner of a building and is the lessee of a ground lease relating to property in Marietta, Georgia. Such building was purchased by the Company in 1984 for $80,855 and is currently subleased to a Blimpie franchisee for use as a Blimpie outlet. There is no mortgage on such building. Each franchisee is required to lease the outlet premises from a designated wholly owned leasing subsidiary of the Company. Each leasing subsidiary leases such premises from a landlord unaffiliated with the Company. See "Business - Blimpie Outlet Properties." ITEM 3. LEGAL PROCEEDINGS An action was commenced against the Company in the United States District Court for the Middle District of Florida entitled Mike Arodak v. Blimpie International, Inc. (Civil Action No. 95-143-Civ-T-24). The plaintiff was the holder of a license to own and operate a traditional Blimpie outlet within a 15 square mile protected area wherein no other Blimpie outlet may be located. In 1994, the Company authorized the installation of a new-concept Blimpie outlet in a convenience store located outside of said protected area. The plaintiff claimed that such new-concept outlet violated his protected area rights notwithstanding the fact that it was located more than one mile beyond the limits of such area at a point which is inside of the protected area of another Blimpie franchisee who has given his permission to the establishment of the new-concept outlet at such location. In December 1997, the plaintiff acknowledged that the Company did not violate his franchise agreement or any other rights, and withdrew all claims and causes of action in consideration for the Company's agreement to purchase the plaintiff's franchise agreement and 15 square mile exclusive market for $75,000. An arbitration proceeding was brought against the Company entitled Blimpie Food Services, Inc. v. Blimpie International, Inc. F/K/A Astor Restaurant Group (case no. 511140041495). The claimant filed the demand for arbitration with the Chicago, Illinois regional office of the American Arbitration Association 16 ("AAA") on November 30, 1995 and indicated that it was seeking unspecified relief. The claimant formerly was a subfranchisor whose subfranchise was terminated by the Company. On or about February 27, 1996, the Company sought leave to file a counterclaim against claimant and its principal shareholder alleging that claimant breached its subfranchise agreement and seeking a declaration that it properly terminated claimant's subfranchise agreement, and indemnification for any damages and attorneys' fees arising out of claimant's conduct in connection with the sale of Blimpie franchises to third parties. On April 9, 1996, claimant filed a motion for leave to amend the original arbitration demand to seek compensatory damages in excess of $100,000, treble and punitive damages, and attorneys' fees and costs, as well as cancellation of a promissory note executed by claimant in connection with the purchase of the subfranchise. The Claimant's application for leave to amend its claims, and the Company's application for leave to interpose its counterclaim were granted by the arbitrator. Thereafter, pre-hearing discovery and evidentiary hearings were completed. During such hearings, the claimant quantified its claims for damages as $710,000 for lost profits, approximately $165,000 in additional compensatory damages and approximately $100,000 in attorney's fees and expenses. In December 1997, the arbitrator in a written decision ruled in the Company's favor by denying all of the claims against the Company An arbitration proceeding was commenced against the Company in the New York City office of the AAA entitled Michael J. Moran, Randall M. Besch, and Alkeny, Inc. v. Blimpie International, Inc. (case no. 131140081696). The claimant's arbitration demand seeks damages in the amount of $290,000 for its alleged financial harm based upon a claim that the Company breached claimant's franchise agreement when it allowed another Blimpie outlet to open within two miles of the claimant's outlet. At the arbitration hearing which was held in May 1997, the Company adduced testimony that the allegedly infringing outlet is located at a truck stop on an interstate highway and caters almost exclusively to truckers who never venture into the town in which the claimant's Blimpie restaurant is located. The arbitrator awarded the claimant $25,000, ordered the Company to pay the claimant's share of the arbitrator's fee, and the administrative fees and expenses of the AAA. Ocean Shore Group, Inc. ("OSG") filed a demand for arbitration with the New York City regional office of the American Arbitration Association entitled Ocean Shore Group, Inc. v. Blimpie International, Inc., Foodservice, Inc. and Jane B. Davis, (case no. 131140030996) seeking specific performance of an alleged contract, or in lieu thereof, damages in excess of $2,000,000. In January, 1996, the Company and OSG entered into a letter of intent with respect to a proposed subfranchise program in which OSG sought to purchase subfranchise rights in five counties in the Daytona Beach area in the State of Florida. However, another subfranchisor owned the rights in one of the counties and refused to sell those rights to OSG. Prior to entering into an agreement with the Company, OSG filed its demand for arbitration. The Company initially objected to the arbitration demand because there was no arbitration agreement between the parties. However, on June 5, 1996, the Company and OSG entered into a written subfranchise agreement for four of the five counties. The subfranchise agreement specifically provided for all disputes to be submitted to arbitration. On June 17, 1996, OSG filed an action against the Company in Volusia County, Florida, raising the same claims it raised in the arbitration demand (Case No. 96-31335-CICI, Circuit Court, Seventh Judicial Circuit in and for Volusia County, Florida). The Court granted the Company's motion to stay the proceedings in state court pending arbitration. Upon completion of the arbitration hearing, the arbitrator awarded the claimant $50,000. Two arbitration proceedings were commenced in the Chicago, Illinois office of the AAA Jac J. Howard and Bonnie Howard v Blimpie International, Inc. (case no.) and Timothy J. Markham and Sophie Radlowski v Blimpie International, Inc. (case no. 51114004797 American Arbitration Association, Chicago, Illinois). Both proceedings involved claimants who were franchisees who formerly operated Blimpie franchises in Bloomington, Illinois and Carol Stream, Illinois, respectively. Both claims alleged that the Company violated (i) the Illinois Consumer Fraud and Deceptive Business Practices Act, (ii) the Illinois Franchise Disclosure Act and (iii) the Racketeer Influenced and Corrupt Organizations Act. Claims of common law fraud in connection with the purchase of the franchises, as well as claims for breach of written and oral contract based on the Company's alleged failure to provide operational and other support and assistance to the claimants were also alleged. Both arbitration demands sought compensatory damages in an unspecified amount and treble damages for alleged violations of the RICO statute. The Howard case was settled for $22,000. The claimants in the Markham and Radlowski proceeding have 17 disclosed that they have suffered damages of approximately $100,000. The Company has denied all liability, and is vigorously defending itself An arbitration proceeding was commenced in February 1998 in the San Francisco, California office of the AAA entitled Peacox Ventures LLC v Blimpie International, Inc. (case no. 74-114-0209-98). The claim alleges violations of the California Franchise Investment Law, the California Unfair Practices Act, fraud and negligent misrepresentation based on alleged misrepresentations and omissions in the sale of franchises by the Company's subfranchisor, who is alleged to be the Company's agent, as well as a claim for breach of contract based on the Company's alleged failure to provide operational support and assistance to the claimant. The demand seeks rescission of claimant's franchise agreements and restitution of monies spent by the claimant in an unspecified amount, as well as consequential damages in an unspecified amount and injunctive relief. The Company has denied all liability, and is vigorously defending itself. It anticipates that evidentiary hearings will be held in this proceeding during the quarter ending December 31, 1998. It is the opinion of management that the liability, if any, arising from all pending claims and lawsuits will not have a material adverse impact upon the Company's consolidated earnings, financial position or cash flows. Item 3a. Executive Officers of the Company The following table sets forth certain information concerning all executive officers of the Company. Executive officers are elected by the Board of Directors to serve at the pleasure of the Board. Name Age Position - ---- --- -------- Anthony P. Conza 58 President and Chief Executive Officer David L. Siegel 54 Chief Operating Officer and General Counsel Patrick J. Pompeo 59 Executive Vice President, Research and Development Charles G. Leaness 48 Executive Vice President - Senior Corporate Counsel and Secretary Joseph A. Conza 44 Senior Vice President, President - B I Concept Systems, Inc. Robert S. Sitkoff 45 Senior Vice President, President - Maui Tacos International, Inc. Joseph W. Morgan 36 Senior Vice President, President - Blimpie Subs & Salads Bruce A. Kolbinsky 37 Vice President - Franchise Development Arthur L. Mancino 49 Vice President - New Business Rebecca D. Killarney 41 Vice President - Marketing Brian D. Lane 36 Vice President, Chief Financial Officer Mr. Anthony P. Conza, together with two individuals who are not affiliated with the Company, originally created the Blimpie concept in 1964. He is one of the original founders of the Blimpie outlet chain, and is a co-founder of the Company. He has been Chairman of the Board of Directors, President and Chief Executive Officer of the Company since the Company commenced business operations in 1977. In 1992, "the Entrepreneur of the Year" for New York, an award sponsored by Ernst & Young, Merrill Lynch and Inc. Magazine, was presented to Mr. Conza. In the same year, he was also named Chain Operator of the Year by the New York State Restaurant Association. He is a member of the Board 18 of the Jose Limon Dance Company, a member of the Board of Governors of The Boys & Girls Clubs of America and he serves on the Dean's Council at Harvard University's JFK School of Government. Mr. Conza is the brother of Joseph A. Conza, the brother-in-law of Patrick Pompeo and the father-in-law of Joseph Morgan. Mr. Siegel, one of the co-founders of the Company, served as the Company's Executive Vice President and General Counsel and as a member of its Board of Directors since its formation in 1977. In September 1995, he was appointed as the Company's Vice Chairman of the Board, Chief Operating Officer and General Counsel. He also served as the Company's Treasurer from 1977 until January, 1991. He is also a practicing attorney in the City of New York. Mr. Siegel received a Bachelor of Arts degree in 1965 from Marietta College, a Juris Doctor Degree in 1968 from New York University School of Law and a Master of Laws Degree in 1970 from New York University School of Law. During the past five years, Mr. Siegel has also served as an officer of each of the Company's leasing subsidiaries. Mr. Pompeo has served as a director and Senior Vice President in charge of operations since the time of commencement of the Company's business operations in 1977. In September 1995, he became Executive Vice President of Research Development and Procurement. Mr. Pompeo was employed for 16 years as a floor supervisor by E.F. Hutton & Co., the former New York Stock Exchange member firm. Mr. Pompeo is also a principal shareholder, officer and director of Georgia Enterprises, Inc., the Company's Subfranchisor for the State of Georgia. Mr. Pompeo is the brother-in-law of Anthony Conza. Mr. Leaness has been a member of the Company's Board of Directors since the Company commenced business operations, and served as the Company's Senior Vice President-Corporate Counsel for more than the past five years. In September, 1995, he became an Executive Vice President. Mr. Leaness is also a principal shareholder, officer and director of Llewellyn Distributors, Inc., the Company's Subfranchisor for a part of New Jersey. Mr. Leaness received a Bachelor of Arts degree from Tulane University in 1972 and a Juris Doctor degree from New York Law School in 1982. Mr. Leaness is a practicing attorney in New York State. He currently serves as Director of the New York State Restaurant Association and is President of the New York City Chapter. Mr. Leaness also serves on the Board of Directors of the International Franchise Association (IFA). Mr. Joseph A. Conza held the position of Vice President - Construction and Design from February 1, 1991 through August 1995. In September 1995, he was appointed Senior Vice President - Equipment and Design Services. In November 1997, he was appointed President of B I Concept Systems, Inc., the Company's wholly-owned equipment and design subsidiary. From 1986 through his appointment as one of the Company's Vice Presidents, Mr. Conza was employed as President of Lone Star Blimpie, Inc. He has also served as President of International Southwest Blimpie, Inc. since 1990. Mr. Conza is also a principal shareholder, officer and director of International Southwest Blimpie, Inc., the Company's Subfranchisor for the Harris County (Houston), Texas market. Mr. Conza also owns 45% of Georgia Enterprises, Inc., the Company's Subfranchisor for the State of Georgia. Mr. Conza is the brother of Anthony P. Conza. Mr. Sitkoff served as a Vice President, Treasurer and Chief Financial Officer of the Company from January 1991 through August 1995. In September 1995, he was appointed Senior Vice President, Treasurer and Chief Financial Officer. In September 1997, he was appointed President of Maui Tacos International, Inc. Between 1980 and 1985, he was self-employed as a distributor for Pepperidge Farms' Biscuit Division. Between 1986 and 1988, he was a principal shareholder and President of Blimpie of Central Florida, Inc., the Company's Subfranchisor for the Orlando, Florida market. From 1989 through 1990 he was employed as Controller of the Company. Mr. Sitkoff received a B.S. degree in Industrial Management from Georgia Institute of Technology in 1974. Mr. Morgan joined the Company in 1992 in the capacity as a corporate counsel. From 1994 through August 1995, he served as the Company's director of strategic planning. In September 1995, he was appointed as Vice President of Strategic Planning and in December 1996 he was appointed to Senior Vice President of Strategic Planning. In September 1997 he was appointed President of the Blimpie Subs & Salads division of the Company. During the three year period prior to joining the 19 Company, Mr. Morgan attended the University of Miami School of Law, and received a J.D. degree from said institution in June 1992. Mr. Kolbinsky has been Vice President-Operations since July 1994. Since joining the Company in October, 1990, Mr. Kolbinsky has held the positions of National Training Director and National Director of Operations. After graduating from The University of North Carolina Chapel Hill in 1983 with a Bachelor of Arts in Business Administration, Mr. Kolbinsky became a supervisor for Domino's Pizza. Over the next six years he rose through the corporate ranks to the position of South Eastern Operations Director in 1988, a position he held until 1989. During 1989 and 1990, Mr. Kolbinsky operated several Subway(R) submarine sandwich franchise outlets. Mr. Mancino was elected Vice President of New Business in August 1995 after serving as Blimpie's Director of New Concepts since August 1993. In this capacity he oversees development of new business opportunities in the various new-concept areas such as petroleum, education, healthcare, and the like. Mr. Mancino joined Blimpie as a salesperson in April 1992. From April 1990 to March 1992, Mr. Mancino was the Director of Franchising for EBC Franchise Group, Inc. and from July 1988 to May 1990, Mr. Mancino was Vice President of Integrated Concepts Corporation, a Burger King Franchisee. Ms. Killarney was appointed Vice President of Marketing in December of 1995. Upon joining the Company in June of 1991 she served as Director of Marketing. Prior to joining Blimpie Ms. Killarney worked for Hardee's Food Systems, Inc. in a Field Marketing capacity. Ms. Killarney works with the Boys & Girls Clubs of America on their National Marketing Committee. Mr. Lane joined the Company in 1998 in the capacity of Vice President, Chief Financial Officer. After graduating from the University of Georgia in 1984 with a Bachelor of Business Administration in Accounting, Mr. Lane joined Ernst & Young LLP as a staff accountant. He progressed to the position of Audit Senior Manager before leaving the firm in 1995. Mr. Lane then joined Checkmate Electronics, Inc., an electronics manufacturer in Roswell, Georgia, as Director of Finance. He was promoted to Vice President of Finance before leaving the company to join Blimpie International, Inc. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders of the Company during the fourth quarter of its fiscal year ended June 30, 1998. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock traded on the Nasdaq National Stock Market through March 16, 1998. On March 17, 1998, the Common Stock was listed on the American Stock Exchange under the symbol BLM. The quarter by quarter ranges of the high, low and closing prices of the Company's Common Stock on these markets during the fiscal years ended June 30, 1997 and 1998 were as follows: Quarter-End High Low Close ------------------ --------- --------- --------- 9/96 $15.625 $10.625 $12.750 12/96 13.250 10.000 10.375 3/97 10.875 6.625 7.000 6/97 7.750 5.375 5.500 9/97 5.500 4.500 4.625 12/97 5.500 3.188 3.438 3/98 4.438 3.500 4.438 6/98 4.375 3.000 3.063 As of September 15, 1998, there were 524 holders of record of the Company's Common Stock. 20 The Company paid its first cash dividends on its Common Stock in the amount of $.025 per share during its fiscal year ended June 30, 1993 ($.017 per share as adjusted for a 3:2 stock split effected during the fiscal year ended June 30, 1994 (the "1994 Stock Split"). During the fiscal years ended June 30, 1994, 1995, 1996, 1997 and 1998 the Company paid cash dividends aggregating $.03 ($.02 as adjusted for the 1994 Stock Split), $.05, $.06, $.07 and $.07 per share, respectively. The Company presently intends to pay dividends in or about October and April of each year, subject to such factors as earnings levels, anticipated capital requirements, the operating and financial condition of the Company and other factors deemed relevant by the Board of Directors. During the fiscal years ended June 30, 1996, 1997 and 1998, the Company did not sell any securities which were not registered under the Securities Act of 1933. ITEM 6. SELECTED FINANCIAL DATA Fiscal Year Ended June 30, ------------------------------------------------ 1998 1997 1996 1995 1994 --------- -------- --------- -------- ---------- (Dollars in 000's, Except Per Share and Outlets Open Data) Revenues $37,875 $38,127 $34,991 $26,374 $16,090 Continuing Fees 17,343 15,391 12,465 8,734 6,017 Net Income 2,444 3,278 4,040 2,340 1,383 Basic Earnings Per Share $ 0.26 $ 0.34 $ 0.43 $ 0.27 $ 0.16 Diluted Earnings Per Share $ 0.26 $ 0.34 $ 0.41 $ 0.27 $ 0.16 Total Assets $28,323 $27,704 $21,823 $15,252 $11,170 Long Term Debt 0 0 5 13 19 Long Term Trademark Obligations 3,408 3,509 0 0 0 Total Shareholders' Equity 20,625 18,865 15,675 7,308 5,311 Cash Dividends Declared Per Common Share $ 0.07 $ 0.07 $ 0.06 $ 0.05 $ 0.02* Outlets Open 1,972 1,684 1,407 986 674 - ---------- * Adjusted to account for three for two stock split implemented in March 1994. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-looking Statements The following discussion contains certain forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements use such words as "may," "will," "expect," "believe," "plan" "anticipate" and other similar terminology. These statements reflect management's current expectations and involve a number of risks and uncertainties. Actual results could differ materially due to changes in: global and local business and economic conditions; legislation and governmental regulation; competition; success of operating initiatives and advertising and promotional efforts; food, labor and other operating costs; availability and cost of land and construction; adoption of new or changes in accounting policies and practices; consumer preferences, spending patterns and demographic trends; political or economic instability in local markets; and currency exchange rates. Overview The Company has centered its operations around the Blimpie Subs & Salads chain of quick service restaurants. The Company and its subfranchisors have doubled the number of operating restaurants over the past three years, increasing from 986 restaurants at June 30, 1995 to 1,972 21 restaurants at June 30, 1998. Continuing fees based upon each franchisee's gross sales have increased 98.6% in the same time period, increasing from $8.7 million in fiscal 1995 to $17.3 million in fiscal 1998. In fiscal 1996, the Company achieved record profitability by generating over $4 million in net income and $0.41 per diluted share. Despite the continued increases in the number of restaurants and in continuing fees, the Company's profitability declined in both fiscal 1997 and 1998 due, in each case, primarily to a decrease in revenues from the sale of subfranchise territories. Generally, the Company pays its subfranchisors approximately half of the continuing fees and franchise fees it receives, and has a high cost of equipment sales. Sales of subfranchises and master licenses are the most profitable sales for the Company, since only a portion of such sales must be paid in the form of a trademark license fee which is approximately 30% of the related revenues. During fiscal 1996, the Company recognized over $3.1 million in subfranchise and master license fees, but this amount declined to $2.3 million in fiscal 1997 and to just under $1.4 million in fiscal 1998. Since most of the available domestic subfranchise territories have been sold, the Company began focusing on the international market beginning in fiscal 1996. Sales of master license territories were strong in fiscal 1997, but decreased in fiscal 1998 as the Company focused on assisting its existing Master Licensors in developing their territories. While the Company believes that the international marketplace represents a vast potential for growth, there are many barriers to success in this arena, and no assurances can be given that the Company will be successful in its attempt to develop outside of the United States. Faced with declining profitability despite the consistent growth in the number of Blimpie outlets and continuing fees, the Company began to develop several new initiatives, the most notable of which was the introduction of three new brands. During fiscal 1998, the Company restructured its management personnel in order to provide better support to its subfranchisors and franchisees in the Blimpie Subs & Salads Group, as well as to allow others to focus on building new franchise opportunities. The Company believes that it can continue to improve its Blimpie Subs & Salads operations while using its franchising expertise to introduce new franchise concepts that complement the Blimpie brand. The development of new franchise concepts is an expensive endeavor, and the Company has incurred additional expenses in fiscal 1998 relating to these efforts, and will continue to incur similar costs in fiscal 1999 and beyond. The three new franchise concepts are Maui Tacos(TM), Pasta Central(TM), and Smoothie Island(TM). The first locations for Maui Tacos and Pasta Central are under construction as of September 15, 1998, and are expected to be operational prior to December 31, 1998. The first Maui Tacos subfranchise territory was sold in July 1998. The first two Smoothie Island locations opened in early September 1998 within existing Blimpie Subs & Salads locations in Tallahassee, FL and Denver, CO. The Company believes that these new concepts will be well received and that the Blimpie brand will continue to be successful. Looking forward, the Company anticipates that fiscal 1999 will include many changes in its operations. The Company will operate the first Maui Tacos store, and expects to generate store sales and store costs associated with the operation of this store. In addition, all three new concepts are expected to generate new revenues in fiscal 1999, and to continue to increase selling, general and administrative expenses through additional personnel, legal and advertising costs necessary to support these initiatives. No assurance can be given that the introduction of these concepts will result in increased revenues, or that such revenues, if received, will exceed the related costs. Results Of Operations Fiscal Year Ended June 30, 1998 Compared With Fiscal Year Ended June 30, 1997. The Company's net income decreased 25.4% to $2,444,000 in fiscal 1998 from $3,278,000 in fiscal 1997. The Company's basic and diluted earnings per share decreased 23.5% to $0.26 per share in fiscal 1998 from $0.34 per share in fiscal 1997. Such decreases are attributable primarily to decreases in subfranchise, master license and franchise fees, and an increase in selling, general and administrative expenses, all of which are discussed below. 22 The Company's continuing fees derived from franchises increased 12.7% to $17,343,000 in fiscal 1998 from $15,391,000 in fiscal 1997. This increase was due to the 17.1% increase in the number of open outlets from 1,684 at June 30, 1997 to 1,972 at June 30, 1998. Continuing fees increased at a slower rate than the rate of outlet openings primarily because a greater percentage of the new outlets were "new concept" outlets which have lower average unit volumes than traditional outlets. New concept outlets include those located in convenience stores, institutional food service facilities, colleges, schools, mass feeders, hospitals, bowling alleys, golf courses and subway stations. Subfranchisor fees, master license fees and fees from the sales and resales of franchises decreased 23.5% to $4,983,000 in fiscal 1998 from $6,516,000 in fiscal 1997. The following table summarizes the components of these fees for fiscal 1998 and 1997: Year Ended June 30, (amounts in 000's) 1998 1997 Change --------------------------------- Subfranchisor fees $ 791 $ 969 -18.4% Master license fees 575 1,368 -58.0% Franchise and resale fees 3,617 4,179 -13.4% --------------------------------- Total $4,983 $6,516 -23.5% ================================= Subfranchise fees decreased 18.4% due to fewer expansions of existing territories and lower deferred subfranchise fees recognized in fiscal 1998 compared to fiscal 1997. Master license fees decreased 58.0% from fiscal 1997 to fiscal 1998. In fiscal 1997, the Company granted development rights for 17 international territories, including 16 countries and the Canadian province of Ontario. In fiscal 1998, the Company granted development rights for four international territories, including Panama, Portugal, Puerto Rico and the Canadian province of Manitoba. This reduction in the number of master licenses sold was due to a shift in focus from selling new territories to helping existing Master Licensors to develop their respective territories. Revenues from sales of franchises and resale fees decreased 13.4% in fiscal 1998 due primarily to a greater percentage of the new outlets being "new concept" outlets, which generally have a lower franchise fee per outlet. The number of new outlets opened increased 6.6% to 454 new outlets in fiscal 1998 from 426 in fiscal 1997. As of June 30, 1998, the Company had Master Licensors operating in 26 countries, and 37 Blimpie outlets operating in 12 of these countries. The Company's focus in 1999 will be to continue to sell new international territories while assisting our Master Licensors with the aggressive development of the existing areas. Although the Company has strengthened its infrastructure and created an international department to support international expansion, the international market has not developed as rapidly as expected with regard to master license fees and outlet openings. No assurances can be given that the Company's investment in the international marketplace will increase either franchise grants, master license fees or outlet openings, or if such increases do occur, that they will result in material increments in revenue. Store equipment sales decreased 3.8% to $14,374,000 in fiscal 1998 from $14,935,000 in fiscal 1997. This slight decrease was due to a greater percentage of the new franchises being "new concept" franchises, which typically purchase less equipment than traditional locations. The decrease in sales to Blimpie franchises was partially offset by an increase in sales to non-affiliates. In fiscal 1998, the Company expanded its equipment sales department in Houston in order to sell equipment to franchisees of other chains. For that year, such activities accounted for 3.0% of total equipment sales. The Company believes this expansion will continue to increase revenue and in turn net income, however no assurances can be given that this expansion will generate any additional revenue or net income. Management fees and other income for the year ended June 30, 1998 decreased 8.6% to $1,175,000 from $1,285,000 in fiscal 1997. This decrease resulted from the January 1997 relocation of 23 one of the Company's subfranchisors who had previously been sharing office space in the Atlanta office, and paying fees to the Company in connection therewith. The Subfranchisors' shares of continuing and franchise fees increased 4.6% to $11,188,000 in fiscal 1998 from $10,692,000 in fiscal 1997. The most significant portion of this expense is the subfranchisor's share of continuing fees, which generally is 50% of the fees collected by the Company. The overall increase in this expense was due primarily to the 12.7% increase in continuing fees. Another component of this expense is the subfranchisor's share of franchise and resale fees. This share generally amounts to between 40% and 60% of the franchise fee for new franchises and between 30% and 50% of the resale fees collected. Due to the overall decrease in franchise and resale fees, this portion of the total expense decreased in fiscal 1998 from fiscal 1997. The final component of this expense is the trademark license fee paid to MBI. See "Business - Trademarks, Trade Names, Service Marks and Logos; Know-How and Methods of Operation." MBI receives a fee on revenues earned in all international markets and certain domestic markets, which consisted of all or a portion of 13 states in which the Company had open franchises as of June 30, 1998. Generally, the fee earned by MBI is 30% of the amount received by the Company, net of direct costs, including amounts paid to subfranchisors and master licensors and the cost of equipment. The trademark license fees earned by MBI decreased to $837,000 in fiscal 1998 from $968,000 in fiscal 1997 due primarily to the decrease in master license and subfranchise fees. In fiscal 1997, a trademark license fee totaling $134,000 also was paid to Anthony P. Conza, the Chairman and Chief Executive Officer of the Company, and David L. Siegel, the Vice Chairman and Chief Operating Officer of the Company, amounting to 30% of all international revenues, net of direct expenses. This trademark license fee was discontinued in February 1997, when the Company acquired the international trademark rights owned by these individuals. Store equipment cost of sales decreased 6.4% to $12,192,000 in fiscal 1998 from $13,024,000 in fiscal 1997. This decrease was due to the 3.8% decrease in store equipment sales, combined with an improvement in the profit margin on the sales. The gross margin on store equipment sales increased to 15.2% in fiscal 1998 from 12.8% in fiscal 1997 due to a small price increase in fiscal 1998 and a favorable product mix. Selling, general and administrative expense rose 14.1% to $11,417,000 in fiscal 1998 from $10,008,000 in fiscal 1997. This increase was due primarily to additional personnel and related costs associated with the 17.1% growth in number of Blimpie outlets, as well as personnel, legal and other costs incurred in the development of the Maui Tacos, Smoothie Island and Pasta Central brands. Management believes that the number of Blimpie outlets will continue to increase and the new brands will continue to require increased support as franchises and/or subfranchise territories are sold. Therefore, management expects selling, general and administrative expenses will continue to increase for at least the next year. Interest income in fiscal 1998 decreased by 4.9% to $846,000 from $890,000 in fiscal 1997. This decrease was the result of the selling of a portion of the U.S. Treasury notes owned by the Company to purchase a portion of the international trademarks and service marks in February 1997. See "Business - Trademarks, Trade Names, Service Marks and Logos; Know-How and Methods of Operation." The effective income tax rates (income taxes expressed as a percentage of pre-tax income) were 37.7% in fiscal 1998 and 38.1% in fiscal 1997. The slight decrease was due to a lower effective state tax rate. Fiscal Year Ended June 30, 1997 Compared With Fiscal Year Ended June 30, 1996. Results Of Operations The Company's net income decreased 19% to $3,277,994 for the twelve months ended June 30, 1997 from $4,040,275 for the twelve months ended June 30, 1996. The Company's primary earnings per share decreased 21% to $.34 per share for the twelve months ended June 30, 1997 from $.43 per share for the twelve months ended June 30, 1996, while during the same periods, the Company`s fully diluted earnings 24 per share decreased 17% to $.34 per share from $.41 per share. Such decreases are attributable to the decreases in subfranchise and franchise fees, and the increase in selling, general and administrative expenses, all of which are discussed below. The Company's continuing fees derived from domestic franchises increased 23% to $15,287,457 for the twelve months ended June 30, 1997 from $12,441,768 for the twelve months ended June 30, 1996. Continuing fees derived from international franchises increased during the twelve months ended June 30, 1997 to $103,342 from $22,734 during comparable period of fiscal 1996. These increases are directly attributable to the greater number of total open outlets as compared to the same periods ended in fiscal 1996. During the twelve month period ended June 30, 1997, the Company experienced decreases in revenue from total subfranchise fees and franchise fees recognized. The Company believes that such decreases are the result of the saturation of the domestic market with subfranchisors and the maturing of the convenience store segment of the new-concept marketplace. With that in mind the Company has refocused on traditional outlet development by increasing franchise advertising, and hiring more sales staff. The Company believes its refocusing on traditional outlet development will increase both franchise grants and outlet openings in the future. In addition, the Company will continue to place greater emphasis on developing the international market to mirror the success it has achieved in the United States. Although the Company has strengthened its infrastructure and created an international department to support international expansion, the international market has not developed as rapidly as expected with regard to master license fees and outlet openings. No assurances can be given that the above-mentioned refocusing by the Company will increase either franchise grants, master license fees or outlet openings, or if such increases do occur, that they will result in material increments in revenue. The Company and its franchisees compete in the quick-service restaurant (QSR) industry, which is highly competitive with respect to price, service, outlet location and food quality, and is often affected by changes in consumer tastes, local and national economic conditions influencing consumer spending habits, population trends and traffic patterns. In awarding franchises, the Company competes with a number of QSR franchisors and other business concepts, as well as for attractive commercial real estate sites suitable for outlets. The Company and its franchisees also compete with regional and local franchised and independently owned outlet operations, many of which are larger in terms of financial resources and sales volume, than the Company's chain of franchised outlets and its franchisees, respectively. In addition to these constant obstacles to growth, unforeseen problems could arise which would keep the Company from reaching its goals, e.g., a strike by an equipment vendor or a material increase in borrowing rates, could temporarily slow down projected openings. Revenue from subfranchise, master license and franchise fees for the twelve months ended June 30, 1997 decreased 14% to $6,515,699 from $7,604,787 for the same period ended 1996. The following table sets forth an analysis of the components of such fees. Twelve Months Ended June 30, 1997 1996 ---- ---- SUBFRANCHISE FEES - DOMESTIC: New Subfranchise Grants $ 0 $ 488,580 Existing Subfranchise Expansions 323,570 167,738 Principal Payments Recognized on Deferred Subfranchise Notes 76,070 220,664 Annual Renewal Term Payments Recognized 310,665 334,372 Deferred Subfranchise Fees Recognized 258,749 955,449 ------- ---------- TOTAL SUBFRANCHISE FEES $969,054 $2,166,803 ======== ========== 25 Twelve Months Ended June 30, 1997 1996 ---- ---- MASTER LICENSE FEES - INTERNATIONAL: New Master License Grants $ 864,093 $ 472,157 Lump Sum Payments Recognized in Current Fiscal Year 504,200 497,150 ---------- ---------- TOTAL MASTER LICENSE FEES $1,368,293 $ 969,307 ========== ========== FRANCHISE FEES RECOGNIZED: Domestic $4,135,544 $4,468,677 International 42,808 0 ---------- ---------- TOTAL FRANCHISE FEES $4,178,352 $4,468,677 ========== ========== TOTAL SUBFRANCHISE, MASTER LICENSE & FRANCHISE FEES $6,515,699 $7,604,787 ========== ========== Total revenue from subfranchise fees decreased 55% to $969,054 for the twelve months ended June 30, 1997 from $2,166,803 for the twelve months ended June 30, 1996. During the twelve month period ended June 30, 1997, the Company neither granted nor derived any revenue from any new domestic subfranchises, compared to the same period ended June 30, 1996 in which the Company granted nine domestic subfranchises and received $488,580 in initial subfranchise fees. Three of the nine domestic subfranchises provide for five or seven annual renewal term options, and if all of such options were to be exercised, the Company would receive additional subfranchise fee revenues aggregating $338,709. This decrease resulted from the substantial achievement of the Company's goal of saturating the domestic market with subfranchises. During the twelve months ended June 30, 1997, 16 domestic subfranchisors expanded and the Company received $323,570 in fees in connection therewith. If all renewal term options on these domestic expansions were to be exercised, the Company would receive additional subfranchise fee revenues aggregating $378,925. By comparison during the twelve months ended June 30, 1996, nine domestic subfranchisors expanded and the Company received $167,738 in fees. Such increases resulted from the Company's efforts to expand beyond the major population centers located in existing subfranchise territories by the expansion of existing subfranchisors. In addition, during the twelve months ended June 30, 1997, the Company recognized $76,070 in principal payments received on deferred subfranchise notes due from existing subfranchisors and recognized $310,665 in annual renewal term options exercised by 25 subfranchisors, as compared to $220,664 recognized in principal payments received on deferred subfranchise notes and $334,372 recognized in annual renewal term options exercised by 20 subfranchisors during the twelve months ended June 30, 1996. The above-described decreases in recognition of principal payments received on deferred subfranchise notes are directly related to the change, more fully discussed below, with respect to current accounts receivable, of issuing annual renewable subfranchise agreements as opposed to issuing 50 to 60 year subfranchise agreements. The new agreements have been executed in connection with all subfranchise sales since November 1994, and some subfranchisors operating under the prior agreement are replacing them with the new agreement, thereby eliminating principal and interest payments on the notes connected with the old agreements. During the twelve months ended June 30, 1997, the Company recognized $258,749 of deferred subfranchise fees with respect to four subfranchises operating under the prior agreements discussed above, that had sufficiently matured, while during the same period in 1996, the Company was able to recognize $955,449 in deferred subfranchise fees with respect to 21 subfranchises. As in the previous fiscal year, the Company is continuing to place substantial emphasis on its prospects in the international market. During the twelve months ended June 30, 1997, the Company granted development rights for Argentina, Uruguay, Saudi Arabia, United Arab Emirates, Bahrain, Oman, Qatar, 26 Kuwait, Greece, Cyprus, Venezuela, Peru, South Africa, Ontario, Poland, Northern Ireland and the Republic of Ireland, and received master license fees with respect to such agreements totaling $864,093. Three of these master license agreements provide for various lump sums totaling $603,106 due in fiscal 1997, 1998, 1999 and 2000. During the twelve month period ended June 30, 1996, the Company granted seven master licenses and received $472,157 in master license fees in connection therewith. During the twelve months ended June 30, 1997, $504,200 in lump sum payments due in fiscal 1997, was recognized in accordance with nine master license agreements, as compared to the twelve months ended June 30, 1996 in which $497,150 in lump sum payments due, was recognized in accordance with two master license agreements. As of June 30, 1997 there were five Blimpie outlets and 28 Grab 'n Go locations operating in Sweden, two outlets in Spain, four in the United Kingdom, two in Argentina and four in Canada. Total domestic franchise fees recognized decreased 7% to $4,135,544 for the twelve months ended June 30, 1997 from $4,468,677 for the twelve months ended June 30, 1996. This decrease is attributable to the decrease to 413 outlets (169 traditional and 244 new-concept) opened during the twelve months ended June 30, 1997, from 468 outlets (171 traditional and 297 new-concept) opened during the comparable period ended 1996. This decrease in franchise fees recognized is attributable to the fact that many of the new-concept outlet openings were the second, third, or fourth outlet opened in the same chain and these franchises were granted at a reduced rate, versus a traditional outlet, to entice the new-concept chain to open multiple outlets. The Company derived $42,808 in franchise fees from the opening of thirteen international outlets during the twelve month period ended June 30, 1997, while for the same period ended 1996, the Company did not derive any revenue from the opening of five international outlets. Store equipment sales to domestic franchises increased 7% to $14,425,107 during the twelve month period ended June 30, 1997 from $13,424,298 for same period ended 1996. During these same periods, store equipment sales to international franchises increased $509,737 from $78,824. These increases were attributable to the 32% increase in orders processed by the Company's equipment sales department to 2014 orders processed during the twelve month period ended June 30, 1997 from 1527 orders processed during the same period ended 1996. Due to the success and experience obtained from selling equipment to Blimpie franchisees, the Company has decided to expand the equipment sales department in Houston in order to sell equipment to franchisees of other chains. The Company believes this expansion will increase revenue and in turn the net income, however no assurances can be given that this expansion will generate increased revenue or net income. Management fees and other income for the twelve months ended June 30, 1997 decreased 9% to $1,285,657 from $1,418,971 for the same period ended 1996. This decrease resulted from the January 1997 relocation of one of the Company's subfranchisors who had previously been sharing office space in the Atlanta office, therefore the fees the Company was receiving for reimbursement of a portion of office expenses decreased. The Subfranchisors' shares of continuing and franchise fees increased 22% to $9,777,740 for the twelve months ended June 30, 1997 from $7,994,170 for the same period ended 1996. The following table sets forth an analysis of the components of such fees. Twelve Months Ended June 30, ---------------------------- 1997 1996 ---- ---- SUBFRANCHISORS / MASTER LICENSORS SHARE OF CONTINUING FEES: Domestic $7,497,208 $6,017,314 International 47,731 10,216 ---------- ---------- TOTAL SUBFRANCHISORS/MASTER LICENSORS SHARE OF CONTINUING FEES $7,544,939 $6,027,530 ========== ========== 27 Twelve Months Ended June 30, ---------------------------- 1997 1996 ---- ---- SUBFRANCHISORS/ MASTER LICENSORS SHARES OF FRANCHISE FEES: Domestic $1,120,586 $1,191,903 International 9,826 0 ---------- ---------- TOTAL SUBFRANCHISORS SHARE OF FRANCHISE FEES $1,130,412 $1,191,903 ========== ========== TRADEMARK LICENSE FEES ON CONTINUING, FRANCHISE, MASTER LICENSE & SUBFRANCHISE FEES: Domestic $ 630,683 $ 582,045 International 471,706 192,692 ---------- ---------- TOTAL TRADEMARK LICENSE FEES ONCONTINUING, FRANCHISE, MASTER LICENSE & SUBFRANCHISE FEES $1,102,389 $ 774,737 ========== ========== TOTAL SUBFRANCHISORS / MASTER LICENSORS SHARE OF CONTINUING & FRANCHISE FEES AND TRADEMARK LICENSE FEES ON CONTINUING, FRANCHISE, MASTER LICENSE & SUBFRANCHISE FEES $9,777,740 $7,994,170 ========== ========== The subfranchisors' total share of domestic continuing fees increased 25% to $7,497,208 for the twelve months ended June 30, 1997 from $6,017,314 for the same period ended 1996. The master licensors' share of international continuing fees increased to $47,731 during the twelve month period ended June 30, 1997 from $10,216 during the comparable period in 1996. This increase is directly related to the increase in the revenue derived from continuing fees. By reason of the above-mentioned decrease in domestic franchise fees for the twelve months ended June 30, 1997, the subfranchisors share thereof decreased 6% to $1,120,586 for the twelve months ended June 30, 1997 from $1,191,903 for the same period ended 1996. Trademark license fee obligations owed to Metropolitan Blimpie, Inc. (MBI), an unaffiliated corporation, on certain domestic continuing, franchise, and subfranchise fees increased 8% to $630,683 for the twelve months ended June 30, 1997 from $582,045 for the same period ended 1996. Such increase is directly related to the increase in domestic continuing fees as discussed above. Trademark license fee obligations owed to MBI, and Anthony P. Conza and David L. Siegel, the Chairman and Chief Executive, and Vice Chairman and Chief Operating Officer, respectively, of the Company, with respect to international continuing, franchise, subfranchise and master license fees increased to $471,706 during the twelve months ended June 30, 1997 from $192,692 during the comparable period of 1996 due to the overall increase in international revenue. Store equipment cost of sales to domestic franchisees increased 3% to $12,575,514 for the twelve month period ended June 30, 1997 from $12,200,024 for the same period ended 1996. During this same twelve month period, store equipment cost of sales to international franchisees increased to $448,569 from $70,841. These increases are directly attributable to the increase in store equipment sales to domestic and international franchisees. Selling, general and administrative expense rose 19% to $10,917,566 for the twelve month period ended June 30, 1997 from $9,203,507 for the same period ended 1996. This increase is directly related to the continuing expansion of the Company's workforce to strengthen its infrastructure, create an international department, expand the domestic franchise development department, and increases in office and travel expenses incurred in order to provide support services to the increasing number of franchisees and master licensors, and the increasing size of subfranchisors. In addition, the increase reflects a charge 28 taken by the Company during the first quarter of fiscal 1997 in the amount of $100,000 which represents the Company's share of an arbitrator's award. See Part II, Section I Litigation Proceedings. Interest income for the twelve months ended June 30, 1997 decreased by 12% to $889,535 from $1,015,112 for the comparable period ended 1996. This decrease was the result of the selling of a portion of the U.S. Treasury notes owned by the Company to purchase a portion of the international trademarks and service marks in February 1997. See "Business - Trademarks, Trade Names, Service Marks and Logos; Know-How and Methods of Operation." The effective income tax rates (income taxes expressed as a percentage of pre-tax income) were 38.1% and 38.2% for the twelve months ended June 30, 1997 and 1996, respectively. For the twelve months ended June 30, 1997, cash and cash equivalents decreased by 18% to $3,532,339 from $4,328,468 at June 30, 1996. Investments under current assets decreased 18% to $4,462,253 from $5,430,950 at June 30, 1996. Investments under other assets decreased 36% to $3,877,827 from $6,016,014 at June 30, 1996. Trademarks less accumulated amortization increased to $8,704,472 from $445,556 at June 30, 1996. These decreases and increases are the direct result of the purchase of a portion of international Blimpie trademarks and service marks. (See Footnotes to Financial Statements.) Current accounts receivable, less allowance for doubtful accounts, increased 43% to $2,084,825 at June 30, 1997 from $1,455,986 at June 30, 1996. Deferred revenue decreased 21% as at the same dates, respectively, to $1,325,146 from $1,678,918. Said increase and decrease were the direct result of a policy, implemented by the Company during fiscal 1995, of issuing annual renewable subfranchise agreements, instead of subfranchise agreements having terms of 50 to 60 years. Under the previous agreements, if the subfranchise fees were collectible over an extended period of time and no reasonable basis existed for estimating collectibility, the fees were deferred and not recognized until they were collected or the uncertainty regarding collectibility was resolved. Under the new agreements, the subfranchisor purchases a territory for a one year period, followed by four to six renewal terms, all but the last being annual in duration. If all terms and conditions of the agreement have been met during the initial one year term and each of the subsequent one year terms, a 50 to 60 year right is granted during the final renewal term upon payment of the fee set forth in the agreement. The first year annual fee is recognized when all material services and conditions related to the sale are satisfied by the Company. Subsequent years are recognized annually upon renewal. The Company still maintains numerous subfranchise agreements under the prior policy and continues to recognize revenue under these agreements consistent with prior years. However, the amount of such revenue will continue to decline in the future as some of the prior subfranchise agreements are replaced with the new agreement, upon the subfranchisors request. The new agreements have been used on all subfranchise sales since November 1994. Deferred income taxes in current assets and deferred income taxes payable in other liabilities decreased to $0 at June 30, 1997 from $189,000 and $343,000, respectively, at June 30, 1996. Deferred income taxes in other assets and deferred income taxes payable in current liabilities both increased to $76,000 and $115,000, respectively, from $0 at June 30, 1996. These decreases and increases resulted from the decreases in deferred revenue and the difference in amortization periods for financial accounting purposes, as opposed to tax purposes, applicable to the international trademark purchase consummated in February 1997. The Company's current portion of notes receivable increased 84% to $985,772 at June 30, 1997 from $535,163 at June 30, 1996. This was the result of the fact that several master licensors have lump sum payments due in fiscal 1998, therefore these amounts were moved from notes receivable under other assets to current portion of notes receivable. The Company's property, plant and equipment less accumulated depreciation, increased 29% to $1,253,003 at June 30, 1997 from $972,251 at June 30, 1996. This increase resulted from the Company's continued modernization and computerization of its offices. 29 Other non-current assets increased 82% to $507,633 at June 30, 1997 from $279,386 at June 30, 1996. This increase primarily resulted from the Company's purchase of a new accounting software package. The Company's accounts payable increased 30% to $3,518,657 at June 30, 1997 from $2,697,900 at June 30, 1996. This increase resulted from the greater number of deferred payment, as opposed to cash on delivery transactions, effected by the Company's equipment sales department, coupled with the longer periods that the Company takes to pay equipment vendors with respect to purchase transactions financed by the Company's franchisees. In such cases, the Company defers payment until (1) the franchisee has given notice to the lender that the equipment has been installed and accepted; and (2) the lender has delivered payment of the financed amount to the Company. Accounts payable also increased as a result of the fees payable to the increasing number of subfranchisors. Income taxes payable at June 30, 1997 decreased to $7,676 from $563,912 at June 30, 1996. This decrease was the result of the payment of income taxes on September 15, 1996 and October 15, 1996, for fiscal year ended June 30, 1996 income taxes that had been accrued, and the decrease in net income. The payment of fiscal year end 1996 bonuses to employees that had been accrued at June 30, 1996, resulted in the 58% decrease in other current liabilities to $358,951 at June 30, 1997 from $851,687 at June 30, 1996. Trademark obligations increased to $3,508,594 at June 30, 1997 from $0 at June 30, 1996. Such increase resulted from the recordation of the aggregate value of the remaining shares of Common Stock issuable by the Company in connection with its acquisition of the Canadian rights to the Blimpie trademarks in October 1995 from an unaffiliated party. Such increases also resulted from the recordation of the additional fees payable to Anthony P. Conza and David L. Siegel in connection with the February 1997 acquisition of the undivided 60% interest in the international rights to the Blimpie trademarks and Blimpie marketing system which they respectively owned. See "Business -- Trademarks, Trade Names, Service Marks and Logos; Know-How and Methods of Operation" and the Footnotes to the Company's audited financial statements appearing elsewhere herein. During the twelve months ended June 30, 1997, 413 domestic Blimpie franchise outlets opened (169 traditional outlets and 244 new-concept outlets) in the following states: Alabama (7); Alaska (2); Arizona (17); Arkansas (1); California (16); Colorado (5); Connecticut (2); Florida (41); Georgia (24); Hawaii (1); Idaho (2); Illinois (10); Indiana (13); Iowa (8); Kansas (3); Kentucky (7); Louisiana (12); Maine (2); Massachusetts (2); Michigan (11); Minnesota (13); Mississippi (2); Missouri (17); Montana (3); Nebraska (7); Nevada (9); New Hampshire (1); New Jersey (3); New Mexico (6); New York (20); North Carolina (19); North Dakota (2); Ohio (25); Oklahoma (2); Oregon (5); Pennsylvania (11); Rhode Island (2); South Carolina (12); South Dakota (2); Tennessee (15); Texas (21); Utah (3); Washington (5); West Virginia (7); Wisconsin (11); and Wyoming (4). During the same period, 13 international Blimpie franchise outlets opened (10 traditional outlets and 3 new-concept outlets) in the following areas: Argentina (2); Canada (4); Spain (2); Sweden (1); and United Kingdom (4). By comparison, during the twelve months ended June 30, 1996, 468 domestic and 5 international Blimpie franchise outlets opened (173 traditional outlets and 300 new-concept outlets). During the twelve months ended June 30, 1997, 151 domestic Blimpie franchise outlets closed (75 traditional outlets and 76 new-concept outlets) in the following states: Alabama (2); Arizona (2); California (3); Colorado (6); Connecticut (1); Florida (17); Georgia (6); Hawaii (4); Idaho (2); Illinois (5); Indiana (2); Iowa (6); Kansas (4); Kentucky (4); Massachusetts (4); Michigan (8); Minnesota (3); Missouri (4); Nebraska (1); Nevada (1); New Jersey (6); New York (6); North Carolina (8); North Dakota (1); Ohio (1); South Carolina (5); South Dakota (1); Tennessee (2); Texas (28); Utah (3); Washington (2); and West Virginia (3). By comparison, during the same period ended 1996, 62 domestic Blimpie franchise outlets closed (48 traditional outlets and 14 new-concept outlets). During the twelve months ended June 30, 1997, three closed domestic Blimpie franchise outlets reopened in: Idaho (1); Michigan (1); and Texas (1). By comparison, during the same period ended 1996, 10 closed domestic Blimpie franchise outlets reopened. 30 During the twelve months ended June 30, 1997, the Company received $3,193,006 from the granting of 602 domestic individual outlet franchises (239 traditional franchises and 363 new-concept franchises) in the following states: Alabama (11); Alaska (3); Arizona (21); Arkansas (1); California (30); Colorado (7); Connecticut (4); Florida (53); Georgia (51); Hawaii (2); Idaho (5); Illinois (8); Indiana (13); Iowa (14); Kansas (1); Kentucky (5); Louisiana (16); Maine (3); Massachusetts (5); Michigan (21); Minnesota (20); Mississippi (4); Missouri (22); Montana (4); Nebraska (5); Nevada (6); New Hampshire (1); New Jersey (3); New Mexico (1); New York (37); North Carolina (37); North Dakota (1); Ohio (39); Oklahoma (1); Oregon (7); Pennsylvania (31); Rhode Island (6); South Carolina (18); South Dakota (2); Tennessee (19); Texas (32); Utah (5); Washington (5); Wisconsin (20); and Wyoming (2). During the same period ended, the Company received $284,559 from the granting of 30 international individual outlet franchises (29 traditional franchises and 1 new-concept franchise) in the following territories: Argentina (2); Canada (12); Cyprus (1); Spain (3); Sweden (1); and United Kingdom (11). By comparison, during the twelve months ended June 30, 1996, the Company received $3,881,419 from the granting of 769 domestic individual outlet franchises (291 traditional franchises and 478 new-concept franchises), and did not derive any revenue from the granting of 5 international individual outlet franchises (2 traditional franchises and 3 new-concept franchises). The decrease in the funds received from the granting of domestic franchises, was the result of a decrease in the actual number of franchises granted, and the reduction of the franchise fee to $1,000, for a limited time only to current Blimpie franchisees only, to encourage multiple outlet ownership. Of the 602 domestic individual outlet franchises granted during the twelve months ended June 30, 1997, 41 were at this reduced price. Liquidity And Capital Resources During fiscal years 1998, 1997 and 1996 the Company did not incur any material capital commitments. As of June 30, 1998, the Company's working capital was $9,465,000 and total cash and investments were $12,202,000. The Company generated cash flows from operating activities of $2,090,000, $1,919,000 and $2,042,000 in the fiscal years ended June 30, 1998, 1997 and 1996, respectively. The increase in fiscal 1998 was primarily the result of collections on notes receivable and higher depreciation and amortization, and was partially offset by an increase in accounts receivable and decreases in accounts payable and deferred revenues. The decrease in fiscal 1997 as compared to fiscal 1996 was due to lower net income, an increase in notes receivable, and a decrease in income taxes payable, partially offset by an increase in accounts payable. Net cash used in investing activities during fiscal 1998, 1997 and 1996 totaled $688,000, $2,096,000 and $5,534,000, respectively. The greater use of cash in fiscal 1997 when compared to fiscal 1998 was due to the purchase of international trademark rights. The greater use of cash in fiscal 1996 when compared to fiscal 1997 was due to the net purchase of investments in that year. Net cash used in financing activities was $913,000 in fiscal 1998 and $619,000 in fiscal 1997. Net cash provided by financing activities was $3,898,000 in fiscal 1996. The increase in the use of cash from fiscal 1997 to fiscal 1998 was due to the implementation of a plan announced by the Company in fiscal 1998 to repurchase up to 250,000 shares of its Common Stock. As of June 30, 1998 the Company had repurchased 65,500 shares pursuant to this plan. The net cash provided in fiscal 1996 resulted from the stock offering which occurred in that year. The Company's primary liquidity needs arise from expansion, research and development, capital expenditures and trademark obligations. These needs are primarily met by the cash flows from operations and from the Company's cash and investments. The Company believes that the cash flows from operations and the Company's cash and investments will be sufficient to fund its future liquidity needs for the foreseeable future. 31 Impact of Year 2000 The Company's business and relationships with its business partners and customers depend significantly on a number of computer software programs, internal operating systems and connections to other networks, and the failure of any of these programs, systems or networks to successfully address the Year 2000 data rollover problem could have a material adverse effect on the Company's business, financial condition and results of operations. Many installed computer software and network processing systems currently accept only two-digit entries in the date code field and may need to be upgraded or replaced in order to accurately record and process information and transactions on and after January 1, 2000. The Company utilizes personal computers that are connected to a network for all of its employee workstations. These personal computers all utilize Microsoft Windows NT as their operating system. The Company believes that the Windows NT operating system is Year 2000 compliant. Additionally, the Company recently installed new software to operate all of its accounting operations. The Company believes this new software, and the computer hardware on which it runs, to be Year 2000 compliant. Management anticipates that all accounting operations will be performed using the Year 2000 compliant software by March 1999. The majority of the costs of installing and implementing the aforementioned software and hardware had been incurred prior to June 30, 1998. The Company anticipates that any additional expenditures to complete the implementation will be funded from cash flow generated by operations. The Company primarily does business with its subfranchisors and its franchisees who in turn deal with retail customers and food distribution companies. The Company has considered the transactions it conducts with its subfranchisors and franchisees in its analyses of the Year 2000 issue, and believes that it has completed substantially all modifications to the computer systems used in these transactions to ensure the systems are Year 2000 compliant. The Company is not certain as to whether the computer software and business systems of its franchisees' suppliers are Year 2000 compliant. The failure or delay of these distributors to successfully address the Year 2000 issue may result in delays in placing or receiving orders for goods and services at the store level. Such delays may result in lost revenues for the franchisees, and in turn, lower continuing fee revenue for the Company. The Company anticipates that such delays and lost revenues, if any, would be minimal. The Company intends to continue to monitor its Year 2000 compliance and to correct any noncompliance as it is discovered. Management anticipates funding such efforts out of operating cash flow. The Company believes that the effects of any noncompliance on its part, or by its customers and suppliers, will not have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. Item 8. FINANCIAL STATEMENTS The following financial statements of the Company and the report of independent accountants thereon are set forth following the Index of Financial Statements on page F-1 of this report: Report of independent accountants Consolidated balance sheets at June 30, 1998 and 1997 Consolidated statements of income for each of the three years in the period ended June 30, 1998 Consolidated statements of shareholders' equity for each of the three years in the period ended June 30, 1998 Consolidated statements of cash flows for each of the three years in the period ended June 30, 1998 32 Notes to consolidated financial statements Report of independent accountants on financial statement schedule Consolidated schedule of valuation and qualifying accounts Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Item 10. DIRECTORS, EXECUTIVE OFFICERS Information regarding directors is incorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after June 30, 1998. Information regarding all of the Company's executive officers is included in Part I at Item 3a. Item 11. EXECUTIVE COMPENSATION Incorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after June 30, 1998. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after June 30, 1998. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference from the Company's definitive proxy statement which will be filed no later than 120 days after June 30, 1998. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial statements: Consolidated financial statements filed as part of this report are listed under Part II, Item 8 of this Form 10-K. 2. Financial statement schedule: The financial statement schedule filed as part of this report is listed under Part II, Item 8 of this Form 10-K. 3. Exhibits: The exhibits listed in the accompanying index are filed as part of this report. 33 Exhibit Number Description - ------ ----------- 3.1 Certificate of Incorporation of the Company, as Amended* 3.2 By-laws of the Company* 4.1 Specimen stock certificate of the Company's common stock* 10.1 Trademark Agreement dated as of August 1, 1976 among Peter DeCarlo, Anthony P. Conza and David L. Siegel* 10.2 Modification Agreement dated as of November 15, 1977 by and among Peter DeCarlo, Anthony P. Conza and David L. Siegel* 10.3 Agreement dated as of June 15, 1981 by and between Peter DeCarlo, Anthony P. Conza and David L. Siegel* 10.4 Agreement dated as of June 1, 1977 by and between Anthony P. Conza and David L. Siegel and International Blimpie Corporation* 10.5 Agreement dated as of December 15, 1980 by and between International Blimpie of Illinois, Inc. and International Blimpie Corporation* 10.6 Trademark Distribution Agreement dated July 18, 1984 by and between International Blimpie Corporation and ISM, Inc. and Anthony P. Conza, Peter DeCarlo and David Siegel* 10.7 Agreement dated April 30, 1992 by and between Astor Restaurant Group, Inc. and Blimpie of California, Inc. and ISM, Inc.* 10.8 Replacement Subfranchise Agreement dated as of October 17, 1991 by and between Astor Restaurant Group, Inc. and Patrick J. Pompeo and Joseph Conza* 10.9 Agreement dated July 19, 1991 by and between Metropolitan Blimpie, Inc. and Astor Restaurant Group, Inc.* 10.10 Area Distributor's Agreement dated October 6, 1976 between International Blimpie Corporation and Jeffrey P. Wiener and Charles Leaness* 10.11 Subfranchise Agreement dated April 1, 1984 by and between International Blimpie Corporation and Joseph P. Conza* 10.12 Lease dated as of December 2, 1987 by and between First Capital Income Properties, Ltd. - Series IX and Blimpie Capital Corporation and Lease Modification Agreement dated November 1, 1989 and Second Lease Modification Agreement dated August 21, 1991 between the parties thereto* 10.13 Service Agreement dated as of August 1, 1992 between the Company and Mellon Securities Trust Company* 10.14 Option, Loan, and Pledge Agreements and Promissory note dated as of December 20, 1991 between Astor Restaurant Group, Inc. and Patrick J. Pompeo* 10.15 Option, Loan and Pledge Agreements and Promissory Note dated as of December 20, 1991 between Astor Restaurant Group, Inc. and David L. Siegel* 34 10.16 Option, Loan and Pledge Agreements and Promissory Note dated as of December 20, 1991 between Astor Restaurant Group, Inc. and Charles G. Leaness* 10.17 Option, Loan and Pledge Agreements and Promissory Note dated as of December 20, 1991 between Astor Restaurant Group, Inc. and Anthony P. Conza* 10.18 Agreement dated as of January 31, 1992 by and between Astor Restaurant Group, Inc. and Barber & Bronson, Inc.* 10.19 Blimpie Retirement Plan 401(k) Profit Sharing Plan* 10.20 Copy of the Company's Group Life, Accident and Health Insurance Policy* 10.21 Agreement dated December 18, 1991 between Astor Restaurant Group, Inc. and Llewellyn Distributors, Inc.* 10.22 Agreement dated March 1, 1992 between Blimpie International, Inc. and International Southwest Blimpie, Inc.* 10.23 Agreement dated March 1, 1992 between Blimpie International, Inc. and Blimpie of Atlanta, Inc.* 10.24 1993 Stock Incentive Plan* 10.25 Form of Option Issuable Under the 1993 Stock Incentive Plan* 10.26 Standard Form of Franchise Agreement* 10.27 Standard Form of Subfranchise Agreement* 10.28 Agreement dated June 13, 1991 by and between International Blimpie Co., an unincorporated division of Astor Restaurant Group, Inc. and Blimpie Fifty-Seven, Inc.* 10.29 Form of indemnity agreement between the Company and its directors and/or officers* 10.30 Standard Form of Sublease Agreement* 10.31 Lease dated February 18, 1993 between Lafayette Astor Associates and 740 Broadway Top Floor Corp. and Guaranty of Blimpie International, Inc. with respect thereto* 10.32 Fourth Lease Modification Agreement dated April 27, 1994 between First Capital Income Properties, Ltd., - Series IX and Blimpie Capital Corporation* 10.33 Agreement dated July 19, 1993 by and between Marc Haskell, Andrew Whitman, Riaz Baksh and The Border Cafe, Inc. and Blimpie International, Inc.* 10.34 Agreement dated May 24, 1993 by and between Metropolitan Blimpie, Inc., Anthony P. Conza, David L. Siegel and Blimpie International, Inc.* 10.35 Equipment Lease Agreement dated January 24, 1992 by and between Rapid Leasing International, Inc. and Consal Enterprises, Inc.* 10.36 License Agreement dated July 19, 1993 between The Border Cafe, Inc. and Blimpie International, Inc.* 35 10.37 Promissory Note, Note Addendum and Pledge Agreement dated March 24, 1995 between Joseph Conza and the Company* 10.38 Form of Warrant Issued to Non-Employee Directors* 10.39 Warrant dated February 12, 1993 Issued to Barber & Bronson Incorporated* 10.40 Option dated September 15, 1994 Issued to Kirschenbaum & Bond, Inc.* 10.41 Financial Consulting Agreement by and between Barber & Bronson Incorporated and Blimpie International, Inc. (a copy of which was filed with the Commission on July 19, 1995 as Exhibit 10.41 to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (Reg. No. 33-93738), and is hereby incorporated herein by this reference). 10.42 International Trademark Licensing Agreement among Anthony P. Conza, David L. Siegel and the Company* 10.43 Agreement made as of the 18th day of February, 1997 by and between Anthony P. Conza, David L. Siegel and Blimpie International, Inc.** The following document has been filed as an Exhibit solely with the Securities and Exchange Commission: 27 Financial Data Schedule - ---------- * (a copy of which was filed with the Commission on June 30, 1995 as an Exhibit of corresponding number to the Company's Registration Statement on Form SB-2 (Reg. No. 33-93738), and is hereby incorporated herein by this reference). ** (a copy of which was filed with the Commission on May 12, 1997 as an Exhibit of corresponding number to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997, and is hereby incorporated herein by this reference). (b) Reports on Form 8-K: The Company did not file any Current Reports on Form 8-K during the fourth quarter of its fiscal year ended June 30, 1998. 36 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BLIMPIE INTERNATIONAL, INC. Dated: September 25, 1998 By: /s/ Anthony P. Conza ----------------------------------------- Anthony P. Conza, Chairman In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Principal Executive Officer Date: September 25, 1998 /s/ Anthony P. Conza -------------------------------------------- Anthony P. Conza, Chairman and Chief Executive Officer Principal Financial And Accounting Officer Date: September 25, 1998 /s/ Brian D. Lane -------------------------------------------- Brian D. Lane, Vice President, Chief Financial Officer Date: September , 1998 -------------------------------------------- David L. Siegel, Vice Chairman, Chief Operating Officer and General Counsel Date: September 25, 1998 /s/ Patrick J. Pompeo -------------------------------------------- Patrick J. Pompeo, Executive Vice President and Director Date: September 25, 1998 /s/ Charles G. Leaness -------------------------------------------- Charles G. Leaness, Executive Vice President, Secretary and Director Date: September 25, 1998 /s/ Alvin Katz -------------------------------------------- Alvin Katz, Director Date: September 25, 1998 /s/ Harry G. Chernoff -------------------------------------------- Harry G. Chernoff, Director 37 INDEX TO FINANCIAL STATEMENTS Report of Independent Accountants F-1 Consolidated Balance Sheets at June 30, 1998 and 1997 F-2 Consolidated Statements of Operations for each of the three years in the period ended June 30, 1998 F-3 Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended June 30, 1998 F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 1998 F-5 Notes to Consolidated Financial Statements F-6 Report of Independent Accountants on Financial Statement Schedule F-21 Consolidated Schedule of Valuation and Qualifying Accounts for each of the three years in the period ended June 30, 1998 F-22 38 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders Blimpie International, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in shareholders' equity, and of cash flows present fairly, in all material respects, the financial position of Blimpie International, Inc. and Subsidiaries at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP Atlanta, Georgia August 17, 1998 F-1 Blimpie International, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS
(in thousands except for per share amounts) - --------------------------------------------------------------------------------- June 30 Assets 1998 1997 - --------------------------------------------------------------------------------- Current assets: Cash and cash equivalents $ 4,021 $ 3,532 Investments 4,495 4,462 Accounts receivable, less allowance of $107 in 1998 and $83 in 1997 3,007 2,085 Prepaid expenses and other current assets 498 702 Deferred income taxes 211 0 Current portion of notes receivable 569 986 -------- -------- Total current assets 12,801 11,767 -------- -------- Property and equipment - at cost less accumulated depreciation of $1,262 in 1998 and $868 in 1997 1,584 1,253 -------- -------- Other assets: Notes receivable, less allowance of $165 in 1998 and $60 in 1997 and less current portion 1,324 1,519 Investments 3,686 3,878 Deferred income taxes 0 76 Trademarks - at cost, less accumulated amortization of $437 in 1998 and $154 in 1997 8,568 8,704 Other 360 507 -------- -------- Total other assets 13,938 14,684 -------- -------- $ 28,323 $ 27,704 ======== ======== - --------------------------------------------------------------------------------- Liabilities and Shareholders' Equity - --------------------------------------------------------------------------------- Current liabilities: Accounts payable and other current liabilities $ 3,060 $ 3,877 Current portion of long-term debt 0 5 Income taxes payable 276 8 Deferred income taxes 0 115 -------- -------- Total current liabilities 3,336 4,005 Deferred revenue 736 1,325 Deferred income taxes 218 0 Trademark obligations 3,408 3,509 Shareholders' equity: Common stock, $.01 par value: Authorized shares - 20,000,000 Issued and outstanding shares - 9,574,000 in 1998 96 95 and 9,526,000 in 1997 Additional paid-in capital 8,420 8,210 Retained earnings 12,519 10,744 Net unrealized gain on marketable securities 51 26 -------- -------- 21,086 19,075 Treasury stock at cost - 66,000 shares in 1998 (251) 0 Subscriptions receivable (210) (210) -------- -------- Total shareholders' equity 20,625 18,865 -------- -------- $ 28,323 $ 27,704 ======== ========
See accompanying notes to consolidated financial statements F-2 Blimpie International, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except for per share amounts) - -------------------------------------------------------------------------------------------- Years Ended June 30 1998 1997 1996 --------- --------- --------- Revenues: Continuing fees $ 17,343 $ 15,391 $ 12,465 Subfranchisor fees, master license fees and sale of franchises 4,983 6,516 7,605 Store equipment sales 14,374 14,935 13,503 Management fees and other income 1,175 1,285 1,418 --------- --------- --------- 37,875 38,127 34,991 Expenses: Subfranchisors' share of franchise and continuing fees 11,188 10,692 9,032 Store equipment cost of sales 12,192 13,024 12,271 Selling, general and administrative expenses 11,417 10,008 8,168 --------- --------- --------- 34,797 33,724 29,471 --------- --------- --------- Operating income 3,078 4,403 5,520 Interest income 846 890 1,015 --------- --------- --------- Income before income taxes 3,924 5,293 6,535 Income taxes 1,480 2,015 2,495 --------- --------- --------- Net income $ 2,444 $ 3,278 $ 4,040 ========= ========= ========= Basic earnings per share $ 0.26 $ 0.34 $ 0.43 ========= ========= ========= Diluted earnings per share $ 0.26 $ 0.34 $ 0.41 ========= ========= ========= Weighted average basic shares outstanding 9,533 9,517 9,371 ========= ========= ========= Weighted average diluted shares outstanding 9,549 9,761 9,592 ========= ========= =========
See accompanying notes to consolidated financial statements. F-3 Blimpie International, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Years ended June 30, 1998, 1997, and 1996
(in thousands except for per share amounts) - --------------------------------------------------------------------------------------------------------------------------- Common Stock ---------------------- Additional Unrealized Shares Paid-In Retained holding Outstanding Amount Capital Earnings Gain (Loss) Total ----------- --------- ---------- --------- ----------- --------- Balance - July 1, 1995 8,576 $ 86 $ 2,838 $ 4,660 $ (18) $ 7,566 Stock incentive granted/stock options exercised 17 141 141 Stock issued under Canadian trademark agreement 25 272 272 Stock offering 863 9 4,453 4,462 Dividends paid (568) (568) Net income 4,040 4,040 Net unrealized gain on marketable securities 14 14 ----------- --------- ---------- --------- ----------- --------- Balance - June 30, 1996 9,481 95 7,704 8,132 (4) 15,927 Stock incentive granted/stock options exercised 20 267 267 Stock issued under Canadian trademark agreement 25 239 239 Dividends paid (666) (666) Net income 3,278 3,278 Net unrealized gain on marketable securities 30 30 ----------- --------- ---------- --------- ----------- --------- Balance - June 30, 1997 9,526 95 8,210 10,744 26 19,075 Stock incentive granted/stock options exercised 23 1 109 110 Stock issued under Canadian trademark agreement 25 101 101 Dividends paid (669) (669) Net income 2,444 2,444 Net unrealized gain on marketable securities 25 25 ----------- --------- ---------- --------- ----------- --------- Balance - June 30, 1998 9,574 $ 96 $ 8,420 $ 12,519 $ 51 $ 21,086 =========== ========= ========== ========= =========== =========
See accompanying notes to consolidated financial statements. F-4 Blimpie International, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands except for per share amounts) - ---------------------------------------------------------------------------------------------- Years Ended June 30 1998 1997 1996 - ---------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net income $ 2,444 $ 3,278 $ 4,040 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 706 441 238 Incentive stock granted 98 255 136 Decrease (increase) in: Accounts receivable (922) (629) (763) Prepaid expenses and other current assets 204 (27) (44) Other assets 118 (228) (211) Deferred income taxes (32) (115) 190 Notes receivable 612 (474) 536 Increase (decrease) in: Accounts payable and other current liabilities (817) 328 (853) Income taxes payable 268 (556) (268) Deferred revenue (589) (354) (959) --------- --------- --------- Net cash provided by operating activities 2,090 1,919 2,042 --------- --------- --------- Cash Flows from Investing Activities Purchase of available-for-sale securities (4,643) (5,322) (102) Proceeds from sales of available-for-sale securities 4,832 8,463 74 Reinvested dividends of available-for-sale securities (5) (5) (10) Purchase of held-to-maturity securities 0 0 (7,562) Proceeds from held-to-maturity securities 0 0 2,558 Purchase of international trademarks (147) (4,646) 0 Proceeds from sale of property and equipment 0 14 17 Acquisition of property, plant and equipment (725) (600) (509) --------- --------- --------- Net cash used in investing activities (688) (2,096) (5,534) --------- --------- --------- Cash Flows from Financing Activities Purchase of treasury stock (251) 0 0 Proceeds from stock warrants/options exercised 12 12 5 Proceeds from stock offering 0 0 4,462 Collections on officers notes receivable for stock purchase 0 42 5 Cash dividend paid (669) (666) (568) Repayment of long term debt (5) (7) (6) --------- --------- --------- Net cash provided by (used in) financing activities (913) (619) 3,898 --------- --------- --------- Net increase (decrease) in cash and cash equivalents 489 (796) 406 Cash and cash equivalents at beginning of year 3,532 4,328 3,922 --------- --------- --------- Cash and cash equivalents at end of year $ 4,021 $ 3,532 $ 4,328 ========= ========= =========
See accompanying notes to consolidated financial statements. F-5 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 1: Description of Company Blimpie International, Inc. (the "Company") engages in franchising, subfranchising and master licensing the Blimpie trademarks, trade names, service marks, logos, marketing concepts and marketing programs. The Company franchises BLIMPIE(R) Subs & Salads and Pasta Central(TM) and is the majority owner of Maui Tacos International, Inc., the franchisor of Maui Tacos(TM) and Smoothie Island(TM). BLIMPIE Subs & Salads offers a quick-service, healthy, sub sandwich in approximately 2,000 franchise stores operating throughout the United States and in 12 other countries. The Company currently is developing Pasta Central, Maui Tacos and Smoothie Island, and anticipates that the first location for each concept will open before December 31, 1998. Pasta Central's baked pasta meals address current eating trends for eat-in or take home replacement meals. Maui Tacos restaurants provide a health-oriented, affordable menu of "Maui-Mex" items, including traditional Mexican foods marinated in Hawaiian spices. Smoothie Island is a selection of blended beverages of frozen yogurt, fruit and nutritional supplements sold through the Blimpie, Pasta Central, and Maui Tacos locations. The Company also provides professional store design services and equipment sales through its wholly-owned subsidiary, B I Concept Systems, Inc. Currently, the Company does not operate any of the restaurants, subfranchisor or master licensor areas within the Blimpie International system. Note 2: Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. Revenue Recognition Fees relating to subfranchisor and master licensor sales are recognized when all material services or conditions relating to the sale are substantially performed or satisfied by the Company. If fees are collectible over an extended period and no reasonable basis exists for estimating collectibility, those fees are recognized as they are collected or when the uncertainty regarding collectibility of fees is resolved. Initial fees from the awarding of individual franchises are deferred and recorded as revenue when the franchisee's restaurant is opened. Expenses associated with site selection, real estate, training, commissions and design are deferred and charged to expense when the initial fees are recognized. Continuing fees from franchised restaurants are recorded as revenue when earned. Revenue from equipment sales is recognized when the equipment is shipped. Cash and Cash Equivalents For the purpose of the statement of cash flows, the company considers all short-term debt securities purchased with a maturity of three months or less to be cash equivalents. The Company has cash deposits with financial institutions which fluctuate in excess of federally insured limits. If these financial institutions were not to honor their contractual liability, the Company could incur losses. Management is of the opinion that there is no significant risk of loss because of the financial strength of the financial institutions. F-6 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 2: Summary of Significant Accounting Policies (continued) Investments Pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," debt securities that may be sold prior to maturity and all marketable equity securities are classified as available-for-sale and carried at fair value. Fair value is estimated based on quoted market prices for those or similar investments. Net unrealized gains and losses, determined on the specific identification method, on securities classified as available-for-sale are carried as a separate component of Shareholders' equity. Fair Market Value Disclosure Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" (SFAS 107), requires disclosure of the fair value of certain items, including receivables, payables, debt and investments. The Company believes that the amounts disclosed within the consolidated balance sheet do not differ significantly from fair value as defined in SFAS 107. The carrying value of cash and cash equivalents and accounts receivable approximates fair value because of the short maturity of those instruments. The carrying value of notes receivable was deemed appropriate since recognition was deferred until such time as collection can be assured. The carrying value of amounts due from related parties was deemed to approximate fair value based on current market conditions as well as the relationship of the parties. Accounts and Notes Receivable The Company provides an allowance for doubtful receivables equal to the estimated collection losses that will be incurred in the collection of all receivables. The estimated losses are based on historical collection experience coupled with a review of all existing receivables. Property, Equipment and Depreciation Property and equipment are carried at cost. Depreciation is computed over the estimated useful lives of the assets using both accelerated and straight-line methods. Significant expenditures for additions and improvements are capitalized and expenditures for routine repairs and maintenance are charged to operations as incurred. The costs of assets retired or otherwise disposed of and the related accumulated depreciation are eliminated from the accounts in the year of disposal. Gains or losses resulting from disposals are included in operations. Trademarks Trademarks are carried at cost less accumulated amortization which is calculated on a straight-line basis over the estimated useful lives of 15-40 years. Amortization expense was $295,000 in 1998, $135,000 in 1997 and $19,000 in 1996. Advertising The Company follows the policy of charging the costs of advertising to expense as incurred. Advertising expense was $429,000 in 1998, $477,000 in 1997 and $427,000 in 1996. F-7 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 2: Summary of Significant Accounting Policies (continued) Income Taxes The Company and its wholly-owned subsidiaries file a consolidated Federal income tax return. The provision for income taxes and corresponding balance sheet accounts are determined in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). Under SFAS 109, the deferred tax liabilities and assets are determined based on temporary differences between the basis of certain assets and liabilities for income tax and financial reporting purposes. These differences are primarily attributable to differences in the recognition of depreciation and amortization of property and revenues. Use of Estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Accordingly, actual results could differ from those estimates. Earnings per Share In February, 1997 the FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128), which establishes standards for computing and presenting earnings per share (EPS). SFAS 128 simplifies the standards for computing earnings per share and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS and requires dual presentation of basic and diluted EPS on the face of the income statement. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common share outstanding for the period. The Company adopted SFAS 128 in 1998. All EPS amounts for all periods have been presented and, where appropriate, restated to conform to the provisions of SFAS 128. Supplemental Disclosure of Cash Flow Information
Years Ended June 30 ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Cash paid during the year for: Interest $ 3,000 $ 3,000 $ 3,000 Income taxes 1,143,000 2,571,000 3,509,000 Noncash investing and financing activities: Stock issued under Canadian trademark agreement 101,000 239,000 272,000 Purchase of international trademarks 0 3,509,000 0 Net unrealized gain on marketable securities 25,000 30,000 14,000
Reclassifications Certain amounts have been reclassified to conform with current year presentation. F-8 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 3: Investments The following is a summary of available-for-sale securities included in investments as of June 30: Unrealized Fair 1998 Cost Gain (Loss) Value ----------- ----------- ----------- Available-for-Sale Securities: Current: Common stocks $ 61,000 $ 28,000 $ 89,000 Preferred stocks 258,000 3,000 261,000 Mutual funds 149,000 1,000 150,000 U. S. Government securities 3,966,000 29,000 3,995,000 ----------- ----------- ----------- 4,434,000 61,000 4,495,000 Long-Term U. S. Government securities 3,696,000 (10,000) 3,686,000 ----------- ----------- ----------- $ 8,130,000 $ 51,000 $ 8,181,000 =========== =========== =========== 1997 Available-for-Sale Securities: Current: Common stocks $ 61,000 $ 19,000 $ 80,000 Preferred stocks 178,000 5,000 183,000 Mutual funds 125,000 (1,000) 124,000 U. S. Government securities 4,071,000 4,000 4,075,000 ----------- ----------- ----------- 4,435,000 27,000 4,462,000 Long-Term U. S. Government securities 3,879,000 (1,000) 3,878,000 ----------- ----------- ----------- $ 8,314,000 $ 26,000 $ 8,340,000 =========== =========== =========== The contractual maturities of long-term debt securities at June 30, 1998 are as follows: $1,849,000 in 2000 and $1,837,000 in 2001. On February 19, 1997, the Company sold held-to-maturity securities with an aggregate cost of $2,646,000 and realized a gain of $28,000. The proceeds from the sale were $2,674,000. At June 30, 1997, United States Treasury notes previously categorized as being held-to-maturity were recategorized as available-for-sale. Accordingly, this group of securities has been marked to market with the resulting adjustment reported in shareholders' equity. F-9 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 4: Notes Receivable Notes receivable consisted of the following as of June 30:
1998 1997 --------------- --------------- Notes from subfranchisors, with interest ranging from 8% to 13% payable at various dates through June, 2006 $ 1,261,000 $ 2,066,000 Notes receivable from sale of discontinued segment due in weekly installments including interest of 10% per annum through March, 2000 67,000 80,000 Notes receivable from an officer due in semi-monthly installments including interest of 8% per annum through April, 2000 51,000 53,000 Receivable from a leasing company arising from participation in franchisee equipment leases with interest ranging from 7% to 17% payable at various dates through June, 2003 679,000 366,000 --------------- --------------- 2,058,000 2,565,000 Allowance for doubtful accounts 165,000 60,000 --------------- --------------- 1,893,000 2,505,000 Current maturities 569,000 986,000 --------------- --------------- $ 1,324,000 $ 1,519,000 =============== ===============
Note 5: Property and Equipment The major components of property and equipment and depreciation periods as of June 30 are:
Cost ---------------------------------- Depreciation Item 1998 1997 Period - ------------------------------------------- ---------------- ---------------- ----------------- Building and other $ 160,000 $ 81,000 7-14 years Office furniture and fixtures 2,169,000 1,855,000 5-10 years Automobiles 185,000 185,000 5 years Software 332,000 0 5 years ---------------- ---------------- 2,846,000 2,121,000 Less accumulated depreciation 1,262,000 868,000 ---------------- ---------------- $1,584,000 $1,253,000 ================ ================
Depreciation expense was $394,000 in 1998, $306,000 in 1997, and $212,000 in 1996. F-10 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 6: Trademark Obligations Trademark obligations consist of the following as of June 30:
1998 1997 --------------- --------------- Amount payable to related parties in connection with acquisition of international trademarks (see Note 9) $3,000,000 $3,000,000 Common shares issuable in connection with acquisition of Canadian trademark (see Note 9) 408,000 509,000 --------------- --------------- $3,408,000 $3,509,000 =============== ===============
Note 7: Income Taxes The provision for income taxes is comprised as follows for the years ended June 30: 1998 1997 1996 ------------ ------------ ------------ Federal Current $1,264,000 $1,810,000 $1,959,000 Deferred (28,000) (98,000) 161,000 ------------ ------------ ------------ 1,236,000 1,712,000 2,120,000 ------------ ------------ ------------ State Current 248,000 320,000 346,000 Deferred (4,000) (17,000) 29,000 ------------ ------------ ------------ 244,000 303,000 375,000 ------------ ------------ ------------ $1,480,000 $2,015,000 $2,495,000 ============ ============ ============ The following is a reconciliation of income taxes to normal expected Federal income tax computed by applying statutory rates for the years ended June 30: 1998 1997 1996 ------------ ------------ ------------ Federal statutory rate - 34% $1,334,000 $1,800,000 $2,222,000 State or local taxes, net of federal benefit 159,000 198,000 245,000 Non deductible expenses 48,000 23,000 27,000 Other (61,000) (6,000) 1,000 ------------ ------------ ------------ $1,480,000 $2,015,000 $2,495,000 ============ ============ ============ For the year ended June 30, 1995, the Internal Revenue Service granted a change in accounting method relating to the recognition, for tax purposes, of subfranchisor and franchise revenue and related expenses. The revenue and related expenses from these changes are recognized for tax purposes in equal amounts over a six year period from June 1995 to June, 2000. The components of F-11 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 7: Income Taxes (continued) temporary differences and their tax effects which comprise the Company's net deferred tax asset (liability) are as follows at June 30: 1998 1997 ----------- ----------- Deferred tax assets: Franchise revenue recognition $197,000 $146,000 Other 108,000 133,000 ----------- ----------- 305,000 279,000 ----------- ----------- Deferred tax liabilities: Subfranchisor revenue recognition (312,000) (318,000) ----------- ----------- $(7,000) $(39,000) =========== =========== Note 8: Commitments and Contingencies The Company leases its facilities under noncancelable operating leases, expiring in various years through the year 2012. The minimum future annual rentals under these noncancelable operating leases as of June 30, 1998 for each of the next five years and in the aggregate, are as follows: Year Amount -------------- ---------------- 1999 $ 414,000 2000 418,000 2001 383,000 2002 393,000 2003 278,000 Thereafter 214,000 ---------------- $2,100,000 ================ The Company is also obligated for increases in real estate taxes and operating costs. Rent expenses including real estate taxes and operating costs amounted to $425,000 in 1998, $383,000 in 1997 and $307,000 in 1996. The Company's leasing subsidiaries execute leases for the approved Blimpie restaurant locations. The subsidiaries have been organized for the purpose of negotiating and signing the primary lease and, after execution, sublease the premises to a franchisee. Under the terms of the agreement, the subsidiary's liability is limited to it's net assets and the landlord agrees to not commence any legal proceedings against Blimpie International, Inc. The franchisee assumes the payment of rent and agrees to perform all terms, convenants and conditions of the original lease. Since the franchisee is substituted under the original lease agreement and the subsidiary is secondarily liable only to the extent of it's net assets, accounting and reporting of the sublease is not included in the consolidated financial statements. As of June 30, 1998, there were 548 leasing subsidiaries with aggregate net assets of $540,000, which are included in cash and other assets on the consolidated balance sheet. The terms of these leases range from 5 to F-12 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 8: Commitments and Contingencies (continued) 20 years. The minimum annual lease payments for the fiscal years ending June 30 are as follows: Year Amount ----------------- ----------------- 1999 $15,064,000 2000 14,429,000 2001 12,878,000 2002 11,091,000 2003 9,583,000 Thereafter 23,022,000 ----------------- $86,067,000 ================= According to the terms of signed agreements between the Company and its franchisees, the Company is obligated, among other things, to supply to the franchisee logo types, dies, mats, etc., of its trademarks, along with sets of materials, manuals and forms at a price equivalent to the Company's cost for such materials, and certain training and continued support. The Company also assists in the selection and purchase of equipment and helps the franchisee to obtain financing of the initial cost of franchising. Area subfranchisors and master licensors responsible for providing day-to-day operational support for Blimpie franchise restaurants in their territory, while receiving compensation amounting to half of the fees from the individual Blimpie franchises, are under the Company's supervision. Various claims and lawsuits arise in the normal course of business. It is the Company's practice to vigorously defend all actions. Although the amount of liability as of June 30, 1998 with respect to all claims and lawsuits cannot be ascertained, in the opinion of management, the resulting liability, if any, will not materially affect the Company's results of operations or financial position. Note 9: Trademarks Messrs. Anthony P. Conza and David L. Siegel (both of whom are officers, directors and principal shareholders of the Company), and Metropolitan Blimpie, Inc. ("MBI"), an unrelated company, own respectively, undivided 40%, 20% and 40% interests in the Blimpie trademarks and the Blimpie marketing system. Pursuant to various agreements made by and among such parties, (1) Messrs. Conza and Siegel possess the exclusive right to exploit, directly or indirectly, the Blimpie trademarks and Blimpie marketing system in 35 entire states and various portions of other states throughout the USA (the "Conza-Siegel Territory"); (2) MBI possessed the exclusive right to exploit, directly or indirectly, the Blimpie trademarks and Blimpie marketing system in the balance of the USA outside of the Conza-Siegel Territory (the "MBI Territories"); and (3) Messrs. Conza and Siegel and MBI possess the exclusive right to exploit, directly or indirectly, the Blimpie trademarks and Blimpie marketing system throughout the world outside of the USA. The Company, pursuant to 99 year grants made to it in 1976 by Messrs. Conza and Siegel, has the exclusive right to distribute the Blimpie trademarks and license the use of the Blimpie marketing system throughout the Conza-Siegel Territory. By agreement dated July 19, 1991 (the "1991 Agreement"), MBI granted to the Company the right to license the Blimpie trademarks and Blimpie marketing system throughout the MBI Territories (with specific exceptions). Pursuant to the 1991 Agreement, the Company may also exploit the rights possessed by MBI outside of the USA with respect to the Blimpie trademarks and Blimpie marketing system. In consideration for the grants made to the Company by the 1991 Agreement, the Company agreed to pay specified percentages of all revenues derived by the Company from the sales of franchises within the MBI Territories and outside of the USA, subject to a minimum annual payment requirement of $100,000. The 1991 Agreement provided for an initial term of 42 months, and further provides for automatic annual renewals until July, 2090, provided that the Company continues F-13 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 9: Trademarks (continued) to pay said minimum annual payments. The payments made to MBI under this arrangement were $837,000 in 1998, $968,000 in 1997 and $785,000 in 1996. On February 18, 1997, the Company entered into an agreement with Anthony P. Conza and David L. Siegel to acquire the ownership of the undivided 60% interest in the international rights to the Blimpie trademarks and Blimpie marketing system owned by such individuals. The agreement supersedes a licensing agreement pertaining to such international trademark and marketing system rights which the Company had previously entered into with such individuals. Pursuant to the agreement, the Company acquired the rights for $4.5 million of cash paid at closing, plus certain contingent payments. The contingent payments would generally be required once cumulative international revenues exceed $5,000,000. The contingent payments of $150,000 per year would generally commence on January 1, 2002 and continue for 50 years. The agreement also provides Messrs. Conza and Siegel with an option to require, anytime prior to January 1, 2001, the Company to pay $3,000,000 of cash to Messrs. Conza and Siegel in exchange for a cancellation of their right to receive the contingent payments. As of June 30, 1998, the Company believes it is probable that Messrs. Conza and Siegel will elect to effect a cancellation of the contingent payments in exchange for the receipt of $3,000,000. Therefore, the Company has recorded, at June 30, 1998, the remaining international trademark rights and related trademark obligation of $3,000,000 on the balance sheet as trademark assets and trademark obligations, respectively. On October 1, 1995, the Company entered into an agreement to settle a trademark infringement proceeding which it commenced in Canada against an unaffiliated party ("claimant") who had filed trademark registration documents seeking Canadian trademark protection for the word "Blimpie" prior to the time the Company made such filings in Canada. Pursuant to the agreement, the Company acquired all rights held by the claimant in said Canadian trademark registration in consideration for the payment of $40,000 and an agreement to issue 125,000 unregistered shares of the Company's common stock at the rate of 25,000 shares per year. As of June 30, 1998, 75,000 shares of common stock had been issued to the claimant. The future installments of such shares are subject to the claimant's ongoing compliance with various conditions specified in the agreement. Note 10: Related Party Transactions The Company had numerous transactions which result from written agreements between the Company and subfranchisors who are related parties. The following is a summary of the types of transactions and revenue or expense recognized related to these transactions for the years ended June 30:
Revenue or Expense Related Party Recognized 1998 1997 1996 - -------------------------------- -------------------------- ---------- ---------- ---------- Georgia Enterprises, Inc., a Revenue derived from area $3,814,000 $3,122,000 $2,981,000 corporation partially owned by Management fees earned 4,000 168,000 245,000 two officers of the Company Fees paid to subfranchisor 990,000 984,000 894,000 Llewellyn Distributors, Inc., Revenue derived from area 649,000 716,000 874,000 a corporation partially owned Management fees earned 119,000 101,000 85,000 by an officer of the Company Fees paid to subfranchisor 254,000 289,000 339,000 International Southwest Blimpie, Revenue derived from area 544,000 532,000 742,000 Inc., a corporation principally Management fees earned 8,000 49,000 61,000 owned and controlled by an Fees paid to subfranchisor 143,000 150,000 165,000 officer of the Company
F-14 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- During fiscal year ended June 30, 1992, certain officers issued demand notes to the Company in the amount of $270,000 for the purchase of shares of the Company's common stock. The balance of these notes have been recorded as a reduction to equity as subscriptions receivable. In April, 1994, an officer was granted an additional loan of $20,000 against these shares. These notes bear interest at the rate of 5% per annum, payable quarterly. Interest income of $12,000, $12,000 and $14,000 was recognized by the Company for the years ended June 30, 1998, 1997 and 1996, respectively. The Company pays rent based on use of an apartment in New York City, which is owned by an officer/employee of the Company. Rental expense of $11,000, $8,000 and $7,000 was recognized for the years ended June 30, 1998, 1997 and 1996, respectively. (See Note 6 and Note 9 with regard to trademark transactions with related parties). Note 11: Stock Options and Warrants The Company has established an Omnibus Stock Incentive Plan ("the Plan") which permits the Company to award various forms of incentive compensation. Through June 30, 1998, the Company has issued incentive and nonstatutory stock options and stock grants under the Plan. The options are exercisable at the fair market value on the date of grant. The options and stock grants provide for vesting at the rate of 20% per annum. In connection with the issuance of the stock grants, the Company recognized compensation expense of $98,000 in 1998, $255,000 in 1997 and $136,000 in 1996. Option activity under the Plan is as follows: Weighted Average Number of Exercise Options Price ------------- --------- Outstanding at July 1, 1995 150,150 $ 5.76 Granted 8,000 9.81 Exercised (4,100) 7.78 Canceled (400) 7.25 ------------- Outstanding at June 30, 1996 153,650 5.92 Granted 267,000 6.39 Exercised (2,200 6.77 Canceled (5,800 11.00 ------------- Outstanding at June 30, 1997 412,650 6.15 Granted 15,500 4.86 Exercised (3,750) 3.25 Canceled (44,000) 6.28 ------------- Outstanding at June 30, 1998 380,400 $ 6.11 ============= Options exercisable: At June 30, 1996 72,990 $ 5.47 At June 30, 1997 153,820 5.82 At June 30, 1998 212,600 5.98 F-15 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 11: Stock Options and Warrants (continued) The following table summarizes information concerning options outstanding and exercisable at June 30, 1998: Options Outstanding Options Exercisable ------------------------------------ ---------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price - ---------------- ----------- ----------- -------- ----------- -------- $3.250 - $3.688 45,750 0.44 $3.29 42,150 $3.26 $5.500 - $6.063 239,750 3.72 6.05 96,850 6.05 $6.375 - $7.250 84,400 1.50 7.20 68,500 7.19 $9.125 - $14.750 10,500 2.88 11.07 5,100 10.81 ----------- ----------- 380,400 2.81 6.11 212,600 5.98 =========== =========== The Company has issued common stock purchase warrants and stock options to various individuals in consideration of services provided to the Company. None of these securities have been exercised as of June 30, 1998. The following table summarizes information concerning common stock purchase warrants and options held by non-employees as of June 30, 1998: Number of Exercise Expiration Security Holder Warrants Price Date - ------------------------------------- --------- --------- ---------- Outside members of Board of Directors 8,000 $ 8.88 Sept. 2000 Outside members of Board of Directors 15,000 6.00 Nov. 1998 Unaffiliated advertising agency 10,985 7.51 May 2000 Unaffiliated advertising agency 10,986 7.51 Sept. 2000 Underwriter of 1995 common stock offering 150,000 8.58 Aug. 2000 Minority shareholder of MTII 50,000 4.75 Oct. 2002 On July 1, 1996 the Company adopted Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation" (SFAS 123). As permitted by SFAS 123, the Company has chosen to apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its Plan. Under APB 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required by SFAS 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to June 30, 1995 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for fiscal 1998, 1997 and 1996: risk-free interest rates of approximately 6.0%; dividend yield of $0.07 per share; volatility factor of the expected market price of the Company's common stock of .50; and a weighted-average expected life of the options of 4.5 years. F-16 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 11: Stock Options and Warrants (continued) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information, assuming SFAS 123 had been adopted, is as follows: 1998 1997 1996 ----------- ------------ ------------ Net income as reported $2,444,000 $3,278,000 $4,040,000 Pro forma net income 2,281,000 3,224,000 4,036,000 Pro forma net income per share: Basic $0.24 $0.34 $0.43 Diluted $0.24 $0.33 $0.41 Note 12: Employee Benefit Plan The Company maintains a 401(k) Profit Sharing Plan available to substantially all employees. Under the plan the Company can elect to make matching contributions of up to 100% of the elective deferral contributions. During the year ended June 30, 1998, 1997 and 1996, contributions charged to earnings were $53,000, $48,000 and $24,000 respectively. Note 13: Business Segment Information In June, 1997 the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131), which the Company adopted in 1998. SFAS 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by management in deciding how to allocate resources and in assessing performance. During 1996 the Company began operations outside of the United States. As of June 30, 1998 the Company has sold master licenses in Argentina, Bahrain, Canada, Cyprus, Dominican Republic, Egypt, Greece, Jordan, Kuwait, Lebanon, Northern Ireland, Oman, Panama, Peru, Poland, Portugal, Puerto Rico, Qatar, The Republic of Ireland, Saudi Arabia, South Africa, Spain, United Arab Emirates, Great Britain, Uruguay, and Venezuela. Franchisees are operating in the following countries: Argentina, Canada, Cyprus, Dominican Republic, Jordan, Panama, Peru, Poland, Saudi Arabia, South Africa, Spain, and Great Britain. There were no capital expenditures outside of the United States in 1998, 1997 or 1996. F-17 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 13: Business Segment Information (continued) Financial information by geographic area is as follows for the years ended June 30:
Depreciation Operating Identifiable And 1998 Revenue income Assets Amortization ---------------- --------------- --------------- ---------------- Franchise operations: United States $ 22,836,000 $ 2,497,000 $ 17,413,000 $ 337,000 International 663,000 (502,000) 8,397,000 309,000 Equipment 14,376,000 1,083,000 2,513,000 60,000 ---------------- --------------- --------------- ---------------- $ 37,875,000 $ 3,078,000 $ 28,323,000 $ 706,000 ================ =============== =============== ================ 1997 Franchise operations: United States $ 21,066,000 $ 3,220,000 $ 16,867,000 $ 239,000 International 2,028,000 179,000 9,078,000 154,000 Equipment 15,033,000 1,004,000 1,759,000 48,000 ---------------- --------------- --------------- ---------------- $ 38,127,000 $ 4,403,000 $ 27,704,000 $ 441,000 ================ =============== =============== ================
Note 14: Subfranchisor Fees and Franchise Revenue Franchise Fees and Costs The initial non-refundable fee for franchisees that have never owned a Blimpie restaurant is $18,000, which is payable in cash at the time of execution of the franchise agreement. Additional franchises are awarded at lesser amounts based upon the number of units awarded. The initial non-refundable fee for new concept franchisees, such as convenience stores, institutional food service entities, colleges, schools, mass feeders, hospitals and others range from $1.00 to $18,000 (dependent upon the number of new concept transactions executed, the location of the new concept franchisee, the marketing area and other subjective concerns). The Company reserves the right to issue franchises to its subfranchisors or their designees for $1.00 to $5,000 each in order to accelerate the development of the area of the subfranchisor. The Company defers recognition of the revenues and costs related to these transactions until the restaurant is opened. The number of franchised restaurants open as of June 30, 1998, 1997, and 1996 were 1,972 (1,935 United States, 37 International), 1,684 (1,667 United States, 17 International), and 1,407 (1,402 United States, 5 International) respectively. The following is a summary of the deferred franchise revenues and costs. Number Revenue Costs of Units ----------- ----------- ----------- Balance June 30, 1995 $4,006,000 $2,982,000 709 Franchises awarded 3,881,000 3,020,000 774 Revenue recognized (3,991,000) (3,092,000) (605) ----------- ----------- ----------- Balance June 30, 1996 3,896,000 2,910,000 878 Franchises awarded 3,356,000 2,612,000 632 Revenue recognized (3,711,000) (2,834,000) (737) ----------- ----------- ----------- Balance June 30, 1997 3,541,000 2,688,000 773 Franchises awarded 2,672,000 2,092,000 439 Revenue recognized (3,308,000) (2,556,000) (697) ----------- ----------- ----------- Balance June 30, 1998 $2,905,000 $2,224,000 515 =========== =========== =========== F-18 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 14: Subfranchisor Fees and Franchise Revenue (continued) Subfranchisor and Master Licensor Fees The subfranchisor and master licensor fee ranges from $10,000 to $575,000. These fees are established by calculating the population of the area of the subfranchisor or master licensor and multiplying the population by $0.10 for the United States and $0.01 for International. Subfranchisors and master licensors in operation as of June 30, 1998, 1997, and 1996 were 105 (86 United States, 19 International), 121 (105 United States, 16 International), and 117 (109 United States, 8 International) respectively. During the year ended June 30, 1995, the Company implemented new subfranchisor agreements which provide for annual renewals. Pursuant to the new form of agreement, the Company sells a territory to a subfranchisor or master licensor for a one year period, followed by four to six renewal terms, all but the last of which are annual in duration. If the subfranchisor or master licensor has met all terms and conditions of the subfranchise or master license agreement during the initial one year term and each of the one year renewal terms, a 50 to 60 year right is granted during the final renewal term upon payment of the fee set forth in the agreement. Future annual renewals for existing agreements for the years ending June 30 are as follows: 1999 $ 532,000 2000 349,000 2001 163,000 2002 109,000 2003 56,000 Thereafter 96,000 ----------- $ 1,305,000 =========== The following is a summary of the remaining deferred subfranchisor fees: Balance June 30, 1995 $ 1,614,000 Revenue recognized (921,000) ----------- Balance June 30, 1996 693,000 Revenue recognized (221,000) ----------- Balance June 30, 1997 472,000 Subfranchisor fees 32,000 Contracts amended (180,000) Revenue recognized (269,000) ----------- Balance June 30, 1998 $ 55,000 =========== F-19 Blimpie International, Inc. and Subsidiaries Notes To Consolidated Financial Statements - -------------------------------------------------------------------------------- Note 15: Earnings Per Share Earnings per share on a basic and diluted basis as required by Statement No. 128 is calculated as follows:
1998 1997 1996 ------------ ------------ ------------ Net income $2,444,000 $3,278,000 $4,040,000 ============ ============ ============ Calculation of weighted average shares outstanding plus assumed conversions: Weighted average basic shares outstanding 9,533,000 9,517,000 9,371,000 Effect of dilutive employee stock options 16,000 244,000 534,000 ------------ ------------ ------------ Weighted average diluted shares outstanding 9,549,000 9,761,000 9,905,000 ============ ============ ============ Basic earnings per share $0.24 $0.34 $0.43 ============ ============ ============ Diluted earnings per share $0.24 $0.33 $0.41 ============ ============ ============
Note 15: Quarterly Information (Unaudited) The following table sets forth a summary of the unaudited quarterly results of operations for the twelve month periods ended June 30, 1998 and June 30, 1997.
Quarter -------------------------------------------------- 1998 First Second Third Fourth Total ----------- ---------- ---------- ---------- ----------- Total Revenues $10,033,000 $9,654,000 $8,309,000 $9,879,000 $37,875,000 Gross Profit 3,713,000 3,638,000 3,403,000 3,741,000 14,495,000 Net Income 803,000 761,000 436,000 444,000 2,444,000 Earnings Per Share: Basic $0.08 $0.08 $0.05 $0.05 $0.26 Diluted $0.08 $0.08 $0.05 $0.05 $0.26 1997 Total Revenues $10,017,000 $9,186,000 $8,929,000 $9,995,000 $38,127,000 Gross Profit 3,735,000 3,386,000 3,277,000 4,013,000 14,411,000 Net Income 941,000 850,000 756,000 731,000 3,278,000 Earnings Per Share: Basic $0.10 $0.08 $0.08 $0.08 $0.34 Diluted $0.10 $0.08 $0.08 $0.08 $0.34
F-20 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders Blimpie International, Inc. and Subsidiaries Our report on the consolidated financial statements of Blimpie International, Inc. is included on page F-2 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page F-1 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. /s/ PricewaterhouseCoopers LLP Atlanta, Georgia August 17, 1998 F-21 Blimpie International, Inc. and Subsidiaries SCHEDULE II CONSOLIDATED SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
(in thousands except for per share amounts) - ------------------------------------------------------------------------------------------------- Column A Column B Column C Column D Column E - ------------------------------------------------------------------------------------------------- Balance at Charged to Charged to Balance at Beginning of Cost and Other End of Description Period Expenses Account Deductions Period Year ended June 30, 1998 Accounts receivable 83 47 0 23 107 Notes receivable 60 105 0 0 165 Year ended June 30, 1997 Accounts receivable 47 78 0 42 83 Notes receivable 47 13 0 0 60 Year ended June 30, 1996 Accounts receivable 130 53 0 136 47 Notes receivable 88 0 0 41 47
F-22 EX-27 2 FDS
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheet at June 30, 1998 and the Consolidated Statement of Operations for the year ended June 30, 1998 and is qualified in its entirety by reference to such financial statements. 1000 YEAR JUN-30-1998 JUL-01-1997 JUN-30-1998 4,021 4,495 3,114 107 0 12,801 2,846 1,262 28,323 3,336 0 0 0 96 20,529 28,323 36,700 37,875 23,380 23,380 11,417 0 0 3,924 1,480 2,444 0 0 0 2,444 0.26 0.26
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