Free Motion for Partial Summary Judgment - District Court of Colorado - Colorado

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 1 of 29

ANNEX F

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM10-QSB/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR E(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30,2001
OR

0 TRANSITION REPORT PURSUANT TO SECTION 13 OR lS(d)
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM Commission File Number 000-23174 TO

OF THE SECURJTIES

THE QUIZNO'S CORPORATION
(Exact name of registrant as specified in its charter)

(State of other jurisdiction of incorporation or organization)

Colorado

84-1169286
(I.R.S. Employer Identification No.)

14l5 Larimer Street Denver, Colorado 80202
(Address of principal executive offices)

(720) 359-3300
(Registrant3 telephone number, including area code)

Check whether issuer (1) has filed all reports required to be filed by Section 13 or 1S(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such a n g requirements for the past 90 days. Yes No 0 State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class Outstanding at August 10,2001

Common Stock, $0,001 par value

2,337,439 shares

TQC00322

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 2 of 29

THE QUIZNO'S CORPORATION
COMMISSION FILE NUMBER 000-23174
Quarter Ended June 30, 2001

FORM 10-QSB
Page -

Part I-Financial Infarmation Consolidated Statements of Operations . . . . .. .. .. . . .. . . . . . .. . .. . . . . . . . . .. . . . . . . . , .. . .. . . . .. . .. Consolidated Balance Sheets. ... . . . . . . . . . . . . . .. .. . . . .. .. ... . . . . . . . . . . . . . . . . .. . ... . . . . . . . . . . . . . Consolidated Statements of Cash Flows.. . ......... .. . .. ... .... .. ............. . .... . . . .. .... .. Consolidated Statement of Stockholders' Equity (Deficit) . . . . . .. . . , . . .. . . .. .. . .. . . . . . . . . , . ... . Notes to Consolidated Financial Statements. . . . . .. . .. . . .. . . . . . . . . .. . . . . .. .. . .. . . . . . .. .. . . . . . . . Management's Discussion and Analysis or Plan of Operation .. .... .... .. ... . ... . . . .. . . .... . . . Part II-Other Information ......... . .. .... ..... . .. ... .. ... ... . .. ... .. ... .. ... . ........ .. . . . . . Signatures . ..... .. . . . . . . . .. ... .. . , . . ... . ... , .. .. . . . . . . . . . .. . . . ... .. .. . . ... . . .. . . . . . . . .... . ..

3
4

5
7

8 14
26 27

.

.

2

TQC00323

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 3 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Nine Months Ended June 3 , 0 June 30, 2000 ZOO0 2001 2001 Restated Restated (Unaudited)

-

-

Franchise operations: Revenue Continuing fees (Note 9) ............. Initial franchise fees ................. Area director and master franchise fees ................................ Other.. .............................. Interest .............................. Total revenue.. .................. Expenses Sales and royalty commissions ' * ' ' General and administrative.. ....... Total expenses. .................. Net income from franchise operations .... Company Store Operations: (Note 5 ) Sales ..................................... Cost of sales ............................. Cost of labor ............................. Other store expenses ..................... Total expenses. .................. Net income from Company store operations Net income from partnership store operations (Note 5 ) .................................... Net income from Company and partnership store operations ............................ Other expense: New company start-up costs (Note 10) ... Impairment of long-lived assets (Note 5) Financing costs (Note 4) ................. Loss on sale of Company stores,. ........ Provision for bad debts. .................. Depreciation and amortization. ........... Amortization of deferred Snancing costs. Interest expense .......................... Other expense ............................ Total other expense ............. Net income (loss) before income taxes. ....... Income tax (provision) benefit ................ Net income (loss) ............................. Preferred stock dividends ..................... Net income (loss) applicable to common shareholders ................................ Basic net income (loss) per share of common stock .......................................... Diluted net income (loss) per share of common stock .............................. Weighted average common shares outstanding Basic ..................................... Diluted.. .................................

$ 8,010,904

$ 4,887,736

1,602,834 433,428 447,007 168,238 10,662,411

1,443,236 335,306 262,651 127,867 7,056,796

$20,571,522 $12,396,289 4,856,307 4,365,343 819,111 1,192,105 553,950 27,992,995 967,028 811,272 393,959 18,933,891

[$!:!$%]
(7,787,501) 2,874,910 2,317,240 (619,482) (1,992,819) 324,421 61,279
$

2,080,141 (7,451,502 5,720,677 [3,600,333] (13,742,9151 [9,254,7021 (5,680,474) (21,194,417) (14,975,379) 6,798,578 1,376,322 3,958,512 4.217.110 (1,240,320 (929,778 (1,812,898 (3,982,996) 234,114

I

..

10.672.945 10,835,043 3,170,042 3,041,720 2,304,102 2,630,648 14,441,Olj 4,300,823 (9,786,833) (10,101,513) 733,530 886,112 61,279

385,700

$

234,114

$

947,391 $ 733,530

.

(2,451,606) 809,004 (299,332) 509,672 (44,379)
$

(1,069,322) 541,114 (180,912) 360,202 (52,164)
$

(9,322,629) (3,253,614) (1,576,660) 1,438,428 583,365 (483,457) 993,295 954,971 1139,3891 (131,790) 823,181 0.27 0.24 2,997,634 3,566,898

465,293 0.20 0.15 2,344,240 3,129,462

308,038 $(1,132,684) $ 0.10 0.09 3,004,778 3,597,326
$ $

$
$

$
$

(0.45) $ (0.45) $ 2,521,729 2,521,729

3

TQC00324

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 4 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, September 30, 2001 2000 Restated (Unaudited)
_ .

ASSETS

Current assets: $ 8,726,320 $ 2,493,976 Cash and cash equivalents .......................................... Restricted cash (Note 8) ............................................ 1,054,340 Short term investments ............................................. 5,497,724 5,324,336 Accounts receivable, net of allowance for doubtful accounts of $348,420 at June 30, 2001 and $222,293 at September 30, 2000 ... 2,066,247 4,786,891 Current portion of notes receivable (Note 7) ....................... 462,432 1,545,844 221,182 221,182 Deferred tax asset .................................................. 1,408,826 481,854 Other current assets ................................................ 22,157,715 12,133,439 Total current assets.. ........................................... Property and equipment and assets held for resale at cost, net of accumulated depreciation and amortization of $3,464,301 at June 30, 2001 and $2,433,637 at September 30, 2000 (Note 5) .................. 10,177,369 11,863,819 Other assets: Intangible assets, net of accumulated amortization of $950,872 at June 30, 2001 and $1,104,646 at September 30, 2000 (Note 5) .... 4,114,246 4,497,528 Investments in area directorships, net of accumulated amortization of $452,185 at June 30, 2001 and $167,893 at September 30, 2000 (Note 6) .......................................................... 4,564,279 4,271,320 6,209,437 2,782,498 Other deferred assets (Note 4) ...................................... Deferred tax asset .................................................. 4,254,169 4,210,626 Deposits and other assets ........................................... 66,518 130,837 Notes receivable, net of allowance for doubtful accounts of $50,000 at June 30, 2001 and $50,000 at September 30, 2000 .............. 1,301,435 1,310,266 20,518,915 17,194,244 Total other assets.. ............................................. $52,853,999 $41,191,502 Total assets ................................................
.
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities: $ 6,393,779 $ 2,614,437 Accounts payable ................................................... Accrued habilities ................................................... 2,460,589 1,495,797 Current portion of long term obligations.. .......................... 1,843,460 1,550,501 51,774 Reserve for impairment (Note 5) ................................... 345,460 Income taxes payable ............................................... 10,749,602 6,006,195 Total current liabilities., ........................................ Line of credit (Note 3) .................................................. Long term obligations (Notes 4 and 8) .................................. 27,230,951 16,037,238 Deferred revenue. ....................................................... 20,208,495 16,402,957 Warrants subject to ut (Note 4) ........................................ 3,373,801 Commitments and ontingencies (Notes 2 and 7 ) Preferred stock, $.001 par value, 1,000,000 shares a;>horized: Series A issued and outstanding 146,000 at June 30, 2001 and 146 146 September 30, 2000 ($876,000 liquidation preference). ........ Series C issued and outstanding 57,000 at June 30, 2001 and 167,000 at September 30, 2000 ($285,000 liquidation preference) ................................................... 57 167 Series D issued and outstanding 3,000 at June 30, 2001 and 3 3 September 30, 2000 ($9,000 liquidation preference) ........... Series E issued and outstanding 59,480 at June 30, 2001 and September 30, 2000 ($512,718 liquidation preference). ........ 59 59 Common stock, $.001 par value; 9,000,000 shares authorized; issued and outstanding 2,337,439 at June 30, 2001 and 3,007,921 at September 30, 2000 (Note 4) ......................................................... 2,337 3,008 303,309 3,857,702 Capital in excess of par value ........................................... Accumulated deficit ..................................................... (9,014,761) (1,115,973) Total liabilities and stockholders' equity (deficit) ........... $52,853,999 $41,191,502

cp

4

TQC00325

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 5 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended June 30. 2001 ZOO0 . Restated (Unaudited)

954.971

Cash flows from operating activities: Net income (loss) ................................................... Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization ................................. Impairment of long-lived assets ................................ Provision for losses on accounts receivable ..................... Deferred income taxes ......................................... Promissory notes accepted for area director fees ............... Prior year financing costs ...................................... Amortization of prepaid interest expense ....................... Loss on disposal of Company store ............................ Amortization of deferred financing costs ....................... Amortization of deferred area director fee revenue ............ Interest expense accruals associated with benefit plans ......... Area director expenses recognized ............................. Other .......................................................... Changes in assets and liabilities: Accounts receivable ........................................ Other current assets ....................................... Accounts payable .......................................... Accrued liabilities .......................................... Income taxes payable ...................................... Deferred franchise costs ................................... Deferred initial franchise fees and other fees .............. Net cash provided by operations ........................................ Cash flows from investing activities: Purchase of property and equipment ............................... Issuance of other notes receivable .................................. Short term investments and restricted cash ......................... Proceeds from the sale of assets and stores ......................... Acquisition of Company owned stores .............................. Principal payments received on notes receivable .................... Intangible and deferred assets and deposits ......................... Investments in area director territories ............................. Net cash used in investing activities ..................................... Cash flows from financing activities: Proceeds from sale of stock ........................................ Proceeds from sale of Class D and Class E Preferred Stock ........ Repurchase of Class D Preferred Stock ............................ Principal payments on long term obligations ........................ Proceeds from issuance of notes payable ........................... Financing Costs ...................................................... Common Stock repurchased ........................................ Costs associated with tender of Common Stock and repurchase of stock options and warrants ....................................... Dividends paid ..................................................... Net cash (used in) provided by financing activities ...................... Net increase in cash .................................................... Cash. beginning of period ............................................... Cash. end of period ..................................................... Supplemental disclosures of cash flow information: Cash paid during the period for interest ............................ Cash paid during the period for income taxes ......................
5

$ (993.295) $

1.838. 847 1.269. 767 215.438 (43. 543 (293. 6931 104.896 1.025. 518 17.769 538. 841 (67. 618) 311. 036 22. 314 2. 177 (2.936. 082 (314. 9811 4.387. 630 964.792 3.873. 155 8.650. 045 1.689. 950 1.682. 054 1.227. 728 1.442. 261

1.380. 425

-

247.302 (296. 357

-

43. 595 56.611 (229. 628)

-

-

22.963

(115.351 720.139 721.299
1 ;949' ;205 2.529. 227

(5.513. 728 ,604. 7611 972.256 137.361 (5.779. 088) 386.047 82;214 (2.450. 396) (14.714. 607) 270.586 478.611 (3.809. 761 17.180. 000 (1.114. 032

-

3.050. 328 (1.268. 652)

.
.

.
(3.026. 473) 12.000. 000 (1.760 (6.232. 4401

(3.748. 987 (139.3891 790) (1.149. 049) 12.224. 104 6.232. 344 38.724 2.493. 976 626. 828 $ 8.726. 320 $ 665.552

(El.

$ 1.537. 522

$

370.173

$ 1.218. 317 $ 1.608.770

TQC00326

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 6 of 29

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVFIIES: During the nine months ended June 30, 2000, we accepted a promissory note in the amount of $19,446 for equipment previously held for resale. Note receivables in the amount of $311,028 were capitalized in exchange for an Area Director territory repurchased during the year. Also, we issued notes payable of $714,621 for partial payment of five area director territories repurchased during the quarter. Finally, a Company store held for resale was closed and the net assets of $35,633 were written-off.

6

TQC00327

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 7 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERSEQUITY (DEFICIT)
Convertible Preferred Stock Shares Amount Common Stock Shares - Amount (Unaudited) Additional Paid-in Capital

- Balances at September 30, 1999 313,000 Issuance of common stock for exercise of options and pursuant to the employee benefit plan ................... T x benefit from exercise of a options ........................ Issuance of Series D Convertible 4,000 Preferred Stock ............... Repurchase of Series D Convertible Preferred Stock ... Issuance of Series E Convertible Preferred Stock ............... 59,480 Common stock repurchased ..... Preferred stock dividends ........ Net income. ..................... 375,480 Balances at September 30, 2000 Payment in lieu of common stock contribution to the employee benefit plan ......... Issuance of common stock for exercise of options ............ Conversion of Series C Convertible Preferred Stock ... Common stock tendered (Note 4) ...................... Costs associated with tender offer (Note 4) ................. Preferred stock dividends ........ Net (loss) ....................... Balances at June 30, 2001 ....... 265,480

-

Accumulated Deficit Restated

$ 313

3,074,177

$3,074

$ 4,485,949

$ (2,375,478)

77,749

78

284,413 17,889

4
(144,005)

11,396 (2,999)

-

59

(144)

467,152 (1,219,641) (186,457) 3,857,702 (20,268)
(1)

375

3,007,921 (2,360) 933 110,000 (779,055)

3,008 (3)

1,259,505 (1,115,973)

-

1
110 (779)

(3,394,735)

(2,836,926) (4,068,567)

(139,389)

$ 265 - 2,337,439 $2,337 $

(993,295) 303,309 $(9,014,761)

-

-

7

TQC00328

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 8 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Summary of Significant Accounting Policies and Principles of Consolidation In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of (a) the results of consolidated operations for the three and nine month periods ended June 30,2001 and June 30,2000, (b) the consolidated financial position at June 30,2001 and September 30,2000, (c) the consolidated statements of cash flows for the nine month periods ended June 30,2001 and June 30,2000, and (d) the consolidated changes in stockholders' equity (deficit) for the twelve month and nine month periods ended September 30, 2000 and June 30, 2001, respectively, have been made.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for financial statements. For further information, refer to the audited consolidated financial statements and notes thereto for the twelve months ended September 30, 2000, included in our Annual Report on Form 10-KSB filed with the Securities and Exchange Commission filed on December 29, 2000. The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain reclassifications have been made to the balances for the three and nine months ended June 30, 2000 to make them comparable to those presented for the three and nine months ended June 30, 2001, none of which change the previously reported net income or total assets. In October 1999, we changed our fiscal year from December 31 to September 30. The results for the three and nine month periods ended June 30,2001 are not necessarily indicative of the results for the entire fiscal year of 2001. Effective January 1,1999, the Company changed its accounting policy related to the recognition of area director marketing agreement fees to one that recognizes such fees as revenue on a straight-line basis over the term of the agreement, which is ten years. Direct expenses attributable to the fees are classiiied as a prepaid and recognized as an expense over the same ten year term. The effect of the change in fiscal 1999 resulted in the deferral of $4,262,701 of net revenue previously recognized in prior years. Included in income for the three and nine months ended June 30, 2001 and 2000, was $129,036 and $387,108, respectively, of amortized deferred net revenue related to area director marketing agreement fees previously recognized prior to fiscal 1999.
¶ ,

r

2. Commitments and Contingencies

Other than the items discussed in our annual report on Form 10-KSB for the year ended September 30,2000, there are no other pending material legal proceedings to which we are a party or to which our property is subject. There are various claims and lawsuits pending by and against the Company. The settlement of some of these claims and lawsuits may result in the acquisition of certain area director territories. In the opinion of the management, and supported by advice from legal counsel, these claims and lawsuits will not result in any material adverse effect in excess of amounts accrued in the accompanying consolidated financial statements. The Company is obligated to pay an opening commission to the area director who sold the franchise at the time the franchise opens for business. These commissions are expensed at the time the related franchise opens for business and are not accrued as a liability of the Company until that t h e . At

8

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 9 of 29

. THE QUIZNO'S CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)

!

June 30, 2001, there were 842 domestic franchises sold but not yet open with related opening commissions totaling $2,730,650 ($2,295,875 at September 30, 2000).

In 1999, the Company commenced a program called Owner in Training under which it provides financial assistance to store managers interested in owning their own franchise. The Company provided financial guarantees to such persons for start-up capital loans. Under the program, the Company has guaranteed three such loans totaling $565,000. As of June 30, 2001, there were no new candidates enrolled in this program.

In April 2001, the Company was notilied that one such person, for which a financial guarantee of $185,000 had been made in January 2000, was past due on their March 2001 payment. The lender has not placed the note in default and is working with the franchisee and the Company to find a new franchisee. The Company has determined that the market value of the store is in excess of the outstanding loan amount and therefore, no loss contingency has been recorded.
In June 2001, the Quizno's National Marketing Fund Trust and the Quizno's'Regional Marketing Fund Trust (together the "marketing funds") entered into. a $4,000,000 line of credit with Wells Fargo Bank West, N.A. which matures on January 31,2002. The marketing funds collect a fee of 1% 3%, and respectively, of gross sales from our franchisees and deposit the funds into advertising funds that are used to develop advertising to attract customers to the restaurants and to create awareness of the Quizno's brand image. The Company has guaranteed this line of credit. As of August 3,2001, $2,800,000 had been drawn against this line of credit.
3. Line of Credit

On December 22,1999 the Company closed on a line of credit loan and was loaned $3,350,000 by Merrill Lynch Business Financial Services, Inc. The loan bears interest at the 30 day Dealer Commercial Paper Rate plus 2.5% (equal to 9.15% at November 30, 2000). The maximum amount of the line of credit loan is $3,350,000, which maximum is reduced monthly based on a seven-year amortization. The line of credit loan is secured by a first security interest in the Company's aircraft. All amounts previously borrowed under the line of credit had been repaid as of June 30, 2001.

4. Tender Offer and Note Payable On November 13,2000, the Company announced that it had commenced a tender offer to purchase all outstanding shares of its common stock, except for shares held by certain insiders, at a price of $8 per share, net in cash to the seller. The tender expired and the Company accepted the tendered shares as scheduled at midnight New York City time December 11, 2000.
Prior to the tender there were approximately three million shares of common stock outstanding, of which approximately 51.6 percent were owned by Richard E. Schaden, the President and CEO of The Quizno's Corporation; Richard E Schaden, Vice President, Secretary and a Director of The Quizno's Corporation; and Frederick H. Schaden, a Director of The Quizno's Corporation. The three Schadens did not tender their shares. As of March 31, 2001, 779,055 shares of Common Stock had been tendered for a total purchase price of $6,232,440. Direct costs related to the tender totaled $4,068,567, which included payment for the repurchase of 531,850 stock options and 415,056 warrants.

In conjunction with the tender offer, the Company closed on a loan of $13,862,260 with Levine Leichtman Capital Partners 11, L.P. ("LLCP''). The proceeds of the loan were used to prepay interest on the loan for one year in the amount of $1,862,260, to repurchase shares and pay costs associated with the tender offer and to increase working capital.
9

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 10 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINAiiCL4L STATEMENTS-(Continued)
(Unaudited)

.

.

The promissory note bears interest at 13.25%, interest only payable monthly, with the first twelve months prepaid, and is due in full in October 2005. LLCP received warrants for 14% of the equity ownership of the Company. The warrants will be adjusted to 14% of the equity ownership after completion of any merger transaction prior to September 12,2001. At December 31,2000, the warrants were valued at $3,373,801 and were recorded on the balance sheet as Warrants Subject to Put and as deferred financing costs under Other Deferred Assets. The deferred financing costs will be amortized n over the life of the note. The Company accounts for these warrants i accordance with Emerging Issues Task Force Issue No. 00-19. The value of the warrants will be adjusted quarterly based on the underlying value of the Company's Common Stock. Included in Amortization of Deferred Financing Costs for the three and nine months ended June 30, 2001 was $174,507 and $386,542, respectively, related to the amortization of this cost. The loan may be paid down to $7 million by September 12, 2001, with no penalty and with a corresponding reduction in the percent of warrants. The Company incurred and expensed $2,283,381 of hancing costs related to the LLCP loan. The warrant agreement between the Company and LLCP states that upon the earlier to occur of the maturity date of the note or the repayment in full of all principal of the note, LLCP shall have the right, exercisable at its sole option, to require the Company to purchase the warrant shares at fair market value, regardless of whether the warrants have been exercised. Therefore, the Company followed the guidance in Staff Accounting Bulletins, Topic 3C-Redeemable Preferred Stock. Although this guidance relates to preferred stock, the Company believes that any redeemable equity instrument, whose redemption is controlled by the holder, would fall under the intent of this guidance. As such, the Company determined the initial carrying value of $3,373,801 based upon the fair value at the date of issue and followed Rule 5-02.28 of Regulation S-X in not classifying the equity instrument as stockholders' equity. In June 2001, the Company entered into a definitive merger agreement with a corporation formed by Richard E. Schaden and Richard E Schaden, the Company's majority shareholders. Under the agreement, the new corporation will merge with the Company, and the shareholders of the Company (other than the Schadens and certain of their affiliates) will be entitled to receive $8.50 per share in cash. Completion of the merger is subject to approval by holders of a majority of the Company's outstanding common stock and receipt of a fairness opinion from the financia1 advisor retained by the Special Committee of the Board of Directors in connection with the proposed transaction. The acquirer may terminate the merger if there is a material change in the business of the Company or the transaction. The Schadens currently own approximately 67% of the Company's outstanding shares of common stock. The Company expects to fle definitive proxy materials for the sharehoIder meeting and to act on the merger proposal as soon as practical.
? r

5. Stores Held for Resale and Store Operations At September 30,2000, the Company had one store classified as a store held for resale. In October 2000, the Company reclassified 20 stores as held for resale. During the quarter ended December 31, 2000, two stores were sold resulting in a gain on sale of $24,419. Also, during the quarter ended December 31,2000, the Company incurred costs of $61,147 related to lease settlements of stores closed. During the quarter ended March 31, 2001, the Company sold twelve stores and recorded a loss of $63,440. During the quarter ended June 30,2001, the Company sold two stores and leased the assets of three stores to partnerships formed during the quarter, As of June 30, 2001, the Company had three stores classified as held for resale (including one partnership store), one of which was sold in August of 2001. The remaining stores held for resale are expected to be sold or closed i 2001. n Included on the consolidated balance sheets in property and equipment and assets held for resale and intangible assets were the following amounts related to stores held for resale:
10

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 11 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited) June 30, 2001 September 30, 2000

-

Property and equipment.. ......................................... Intangible assets. .................................................. Accumulated depreciation and amortization ....................... Reserve for impairment ........................................... Net assets of stores held for resale.. ..............................

$450,383 453,577 (40,469) (51,774) $361,334 -

$157,689 198,861 (4,282)

3,194 41,172 - -

$194,579 -

Included in the consolidated statement of operations under Company Store Operations were the following amounts related to stores held for resale and Company stores:

Stores Held for Resale
Three Months Ended June 30, 2001 . June 30, 2000 Nine .Months Ended June 30,2001 June 30,2000

$ 303,218 Sales ................................ Cost of sales ........................ (96,880) Costs of labor ....................... (89,831) (212,511) Other store expenses ................ Store expenses .................. (399,222) Net loss from stores held for resale $ (96,004)

$

(132)

$ 2,762,189

$ 103,153

(500) (57,399) (58,031) $(58,031)

(874,902) (756,808) (1,640,760) (3,272,470) $ (510,281)

(43,207) (41,075) (174,645) (258,927) $(155,774)

Company Stores"
Three Months Ended June 30,2001 June 30,2000
Nine Months Ended June 30, 2001 June 30, 2000

$ 2,014,022 Sales ................................ (522,602) Cost of sales ........................ (377,120) Costs of labor ....................... (693,875) Other store expenses ................ Store expenses .................. (1,593,597) Net income from Company stores.. . $ 420,425

$ 4,217,110 (1,240,188) (929,278) (1,755,499) (3,924,965) $ 292,145

$ 7,910,756

(2,166,818) (1,547,294) (2,800,251) (6,514,363) $ 1,396,393

$10,731,890 (3,126,835) (2,376,331) (4,339,420) (9,842,586) $ 889,304

*

Includes Quizno's stores and certain non-Quizno's operations located at Denver International Airport.

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the canying amount of the asset may not be recovered. At December 31, 2000, the Company-determined that an impairment related to its carrying value of its assets held for resale was required and expensed $934,106. During the nine months ended June, 2001, the Company incurred actual losses on the sale of these stores in the amounts of $882,332, which was charged to the impairment reserve.

Also, during the quarter ended December 31,2000, the Company determined that an impairment was required for certain equipment and inventory and expensed a total of $59,526. During the quarter ended June 30, 2001, the Company determined that an impairment was required, primarily for certain software assets, and expensed a total of $276,135.
During the quarter ended June 30, 2001, we provided certain Company store managers an opportunity to participate in the profits and losses of 18 company stores by forming partnerships in
1 1

TQC00332

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 12 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)

which those managers have a 51% interest. The Company entered into franchise agreements with each partnership and leased the underlying furniture, fixtures and equipment for each store to the partnerships (although the Company continues to own the furniture, fixtures and equipment, and assumes an active role, along with our partners, in the store operations). Along with distributions from the partnerships, the Company now receives lease rental fees on the Company store assets and royalty fees. Included in continuing fees for the quarter ended June 30, 2001, were royalties of $76,211 generated from these stores.

6. Investments in Area Directorships In the first three quarters of fiscal 2001, the Company reacquired four area director territories for $552,499, including related legal costs.
7. Related Party Transactions At September 30, 2000, the Company had a note receivable from the Advertising Fund of $1,030,000. During the nine months ended June 30, 2001, the Advertising Fund repaid the outstanding principal balance along with accrued interest.
8. AMRESCO Commercial Finance, Inc.

In 1999, the Company entered into loan agreements with AMRESCO Commercial Finance, Inc. ("AMRESCO"), in which AMRESCO loaned the Company $14 million. The loan agreements provide, among other things, that if the Company wishes to secure additional indebtedness, it may do so as long as, after giving effect to such new indebtedness, the Company meets a minimum financial ratio. AMRESCO took the position that the LLCP indebtedness (see Note 4) would result in the Company not achieving the required minimum ratio. The Company and its outside financial advisors had previously calculated the effect of the LLCP financing and concluded that the Company would exceed the required minimum ratio, and responded accordingly to AMRESCO. In February 2001, the Company and AMRESCO agreed to resolve the dispute in exchange for the Company's prepayment of principle of approximately $1,518,000 and payment of a non-refundable credit enhancement of approximately $169,000. AMRESCO agreed to release its collateral interest in the assets of eleven Company-owned stores. In addition, the Company agreed to deposit into an escrow account approximately $1.1million until the later of July 31, 2001 or the month the minimum ratio is met. The Company expects to achieve this by September 30, 2001 and have the escrowed funds released.
,& - ,

-

9. Distribution Operations
The Company's wholly owned distribution company subsidiary, American Food Distributors, Inc. ("AFDYy) commenced operations in January 2001 and is in the business of buying Quizno's proprietary products from the manufacturers and reselling those products to the unaffiliated company approved to distribute proprietary and other products to our franchisees. AFD has negotiated contracts with each manufacturer, and we will no longer receive licensing fees from those manufacturers. AFD will charge a mark-up on the products, which, in part, will replace the licensing fees, and, in part, will be paid to the marketing funds. 10. Recent Developments

In June 2001, the Company entered into an agreement with a Canadian company that is the Company's master franchisee in Canada and its principal owner to provide management services and
12

TQC00333

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 13 of 29

THE QUIZNO'S CORPORATION AND SUBSIDLARLES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)

other assistance to the master franchisee. At this time, the Canadian master franchise is financially distressed. In consideration for these services, the Company will be paid certain management fees and will be issued 20% of the outstanding capital stock of the master franchisee on a fully diluted basis. The Company will also be reimbursed for the costs of certain of our services. In August 2001, the principal Owner of the master franchisee granted the Company, subject to certain conditions, a series of options to purchase from it up to an additional 31% of the outstanding capital stock of the master franchisee on a fully diluted basis at a cost determined by various valuation methods that depend upon when the options are exercised. This last option in the series will expire on December 31, 2003. A of June 30, s 2001, there were 122 restaurants in Canada. During the quarter ended June 30,2001, the Company incurred $162,502 of expenses related to the start-up of this venture.

ll. Restatement
Net income has been restated to reflect the tax effected expensing of start-up costs originally expensed in the quarter ended December 2000 in September 30,2000, the reversal of an impairment in December 2000 and the accelerated depreciation of these costs over five quarters starting in December 2000 and the correction of the amortization of area director territories. These adjustments had the following effect:
Quarter Ended June 30, 2001 Net Income Basic Earnings Per Share

I

Fully Diluted Earnings Per Share -

As previously reported June 30, 2001 ............ $ 497,060 Restatement adjustment. ......................... (31,767) As restated June 30, 2001 ....................... $ 465,293
Nine Months Ended June 30, 2001

$ 0.21

$ 0.16

(0.01) $ 0.20

(0.01) 0.15

As previously reported June 30, 2001 ............ $(1,224,256) 91,572 Restatement adjustment.. ........................ $(1,132,684) As restated June 30, 2001 .......................

$(0.49) 0.04 $(0.45)

$(0.49) 0.04
S(0.45)

13

TQC00334

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 14 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Forward-Looking Statements
Certain of the information discussed in this quarterly report, and in particular in this section entitled "Management's Discussion and Analysis or Plan of Operation," are forward-looking statements that involve risks and uncertainties that might adversely affect our operating results in the future in a materia1 way. Such risks and uncertainties include, without limitation, the effect of national and regional economic and market conditions in the U.S. and the other countries in which we franchise restaurants, costs of fuel and energy, costs of labor and employee benefits, costs of marketing, the success or failure of marketing efforts, costs of food and non-food items used in the operation of the restaurants, intensity of competition for locations and franchisees as well as customers, perception of food safety, spending patterns and demographic trends, legal claims and litigation, the availability of financing for us and our franchisees at reasonable interest rates, the availability and cost of land and construction, legislation and governmental regulations, and accounting policies and practices. Many of these risks are beyond our control. In addition, sgecific reference is made to the "Risk Factors" section contained in our Prospectus, dated January 9, 1998, included in the Registration Statement on Form S-3 filed by our company (Registration No. 333-38691). The principal sources of our income are continuing fees, initial franchise fees, and, historically, area director marketing and master franchise fees. These sources are subject to a variety of factors that could adversely impact our profitability in the future, including those mentioned in the preceding paragraph. The continued strength of the U.S. economy is a key factor to the restaurant business because consumers tend to immediately reduce their discretionary purchases in economically difficult times. An economic downturn would adversely affect all three of the sources of income identified above, Because our franchises are still concentrated in certain regions of the U.S., regional economic factors could adversely affect our profitability. Weather, particularly severe winter weather, will adversely affect royalty income and could affect the other sources cited above. Culinary fashions among Americans and people in other countries in which we franchise the restaurants will also impact our profitability, As eating habits change and types of cuisine move in and out of fashion, our challenge will be to formulate a menu within the Quizno's distinctive culinary style that appeals to an increasing market share. Finally, the intense competition in the restaurant industry continues to challenge participants in all segments of this industry. As our revenues from foreign operations become more significant, our profitability could be adversely impacted by international business risks and political or economic instability in foreign markets. While international operations involve risks that do not exist in domestic operations, such as adverse fluctuation in foreign exchange rates, monetary exchange controls, foreign government regulation of business relationships, and uncertainty of intellectual property protection, we believe that the potential rewards of expanding the market for our- services to selected foreign countries far * outweighs such risks.
Overview

Our primary business is the franchising of Quizno's restaurants. As a franchisor, revenue is principally derived from: (1) continuing fees, (2) initial franchise fees, and (3) area director and master franchise fees. Continuing fees increase as the number of franchised restaurants open increase. Initial franchise fees are one-time fees paid upon the sale of a franchise and vary directly with the number of franchises we can sell and open. Area director and master franchise fees occur when a country or exclusive area is sold and are expected to decline as the number of remaining available markets declines. Effective January 1,1999, we changed our accounting policy related to the recognition of area director marketing agreement fees to one that recognizes such fees as revenue on a straight-line basis over the term of the agreement, which is ten years. Each of these sources of revenue contributes to our profitability, but the relative contribution of each source will vary as we mature. Over time initial fees
14

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 15 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION-(Continued)
and continuing fees will generate proportionately more revenue than area director and master franchise fees. For the nine months ended June 30, 2001, we incurred a loss before preferred dividends of $993,295, composed of income from franchise operations of $6,798,578, income from Company owned store and partnership store operations of $947,391 and less other income and expense and taxes totaling $(8,739,264). In the comparable period of fiscal 2000, we earned a profit before preferred dividends of $954,971, composed of income from franchise operations of $3,958,512, income from Company owned store operations of $733,530, and less other income and expense and taxes totaling $(3,737,071). The following chart reflects our revenue growth by source and number of restaurants for the three and nine month periods of fiscal 2001 compared to the comparable periods of fiscal 2000:
Three Months Ended June 30,

2001

2000

Change 2001 . ($ in t h o u s m G

", 70

Nine Months Ended June 30,
2OOO -

% Change

$ 8,011 $ 4,888 Continuing fees.. ....................... 1,603 Initial franchise fees .................... 1,443 434 335 Area director and master franchise fees 447 263 Other. .................................. Interest ................................. 168 128 Total franchise revenue ................. 10,663 7,057 Sales by Company owned stores ........ 2,014 4,217 Sales by Stores held for resale ......... 303 Total Revenue. ......................... $12,980 $11,274

64% 11% 29% 70% 32% 51% (52)% 100% 15%

$20,572 4,856 819 1,192 554 27,993 7,911 2,762 $38,666

$12,396 4,365 967 812 394 18,934 10,732 103 $29,769 -

66% 11% (15)% 47% 41% 48%

2378% -30% -

(6% 2)

Earnings before interest expense, income taxes, depreciation and amortization and preferred stock dividends (EBITDA) ................. $ 2,614

t $ 1542

69%

$ 3,316

$ 4,268 (22)% --

Three Months Ended June 30,

2001

2000 -

Nine Months Ended June 30, 2001 UMO _ .

-

1,159 792 972 634 Restaurants open, beginning.. ...... 92 94 303 282 New restaurants opened.. .......... 4 3 9 ' 4 Restaurants reopened .............. Restaurants closed, to reopen (19) (4) (9) (1) (5) (21) (31) Restaurants closed, QuiznoS(3). .... (5) 2) Restaurants closed, Bains ;...... -883 1,241 883 1,241 Restaurants open, end ............. Franchises sold, domestic. .......... 185 130 445 314 Franchises sold, international. ...... 13 12 21 49 Total sold ...................... 198 142 466 363 % $ 2.2 $ 8.2 m % l i $ 5.4 Initial franchise fees collected ...... $ 3.5 d Systemwide sales, domestic. ........ $106.9 million $72.0 million $280.3 million $190.3 million Avg. unit volume, domestic(1)...... $ 389,000 $ 365,000 Same store sales, domestic(2) Up 0.6% Up 9.2% u p 4.2% u p 7.7%

......

...

2) -

......

(footnotes on next page)
15

TQCOO336

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 16 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION-(Continued) (footnotes from previous page)
(1) Average unit volume is for the twelve months ended December 31, 2000 and 1999. Average unit volume excludes restaurants located in airports, convenience stores and gas stations and includes only restaurants open at least one year under the same ownership that are currently not in default. (2) Same store sales are based on 574 stores open since the beginning of January 2000. Stores that transferred ownership during this period or are in substantial default of the franchise agreement are excluded. Because we are and will continue to be in an aggressive growth mode over the next few years, it is anticipated that same store sales will fluctuate as units are included from more start up markets. Excludes non-traditional units located in convenience stores and gas stations. (3)Four of the five Quizno's closed in the quarter ended June 30, 2000 and two of the Eve Quizno's closed during the quarter ended June 30, 2001, were non-traditional locations. For the nine months ended June 30, 2000, 21 of the 31 Quizno's closed were non-traditional locations. For the nine months ended June 30, 2001, 6 of the 21 Quizno's closed were non-traditional locations. Nontraditional locations are convenience and gas units, hospitals, colleges, food courts, etc. We have changed our site criteria to approve such locations only when the demographics and unit economics for any such proposed unit are well above average.

Results of Operations
Comparison of the first three quarters of f i c a l 2 0 0 1 with the first three quarters of fiscal 2000 and the third quarter of fiscal 2001 with the third quarter of fiscal 2000 Franchise revenue increased 51% in the third quarter of 2001 to $10,662,411 from $7,056,796 in the comparable quarter last fiscal year. In the first three quarters of fiscal 2001, franchise revenue increased 48% to $27,992,995 from $18,933,891 last year. Total revenue increased 15% in the third quarter of 2001 to $12,979,651 from $11,273,906 in the comparable quarter last fiscal year. For the first three quarters of fiscal 2001, total revenue increased 30% to $38,665,940 from $29,768,934 last year.

Continuing fees increased 64% in the third quarter of 2001 to $8,010,904 from $4,887,736 in the third quarter of 2000. In the first three quarters of fiscal 2001, continuing fees increased 66% to $20,571,522 from $12,396,289 in fiscal 2000. Continuing fees are comprised of royalties, licensing fees and distribution fees.
Royalty fees are a percentage of each franchisee's sales paid to us and will increase as new franchises open, as the average royalty percentage increases, and as average unit sales increase. At June 30, 2001 there were 1,236 franchises open, as comparzd to 849 at June 30, 2000. The royalty was 5% for agreements entered into prior to February 11, 1995, 6% for agreements entered into from February 11,1995 to March 31, 1998, and 7% for al franchise agreements entered into after March 31, l 1998. The royalty for Quizno's Express units is 8%. The royalty paid to us by master franchisees on international units is generally 2.1%. We have no immediate plans to increase the royalty rate. Royalty fees were $6,808,033 for the third quarter of fiscal 2001 compared to $4,181,260 for the same period last year, an increase of 63%. For the first three quarters of fiscal 2001, royalty fees were $17,481,495 compared to $10,475,293 for the same period last fiscal year, an increase of 67%. Licensing fees are fees generated through the licensing of the Quizno's trademark for use by others, which includes fees received from product companies to sell proprietary products to our restaurant system. Licensing fees were $0 in the third quarter of fiscal 2001 and $706,476 in the comparable fiscal 2000 quarter. For the first three quarters of fiscal 2001, licensing fees were $1,051,130 and $1,920,996 in the comparable fiscal 2000 period. Included in the fiscal 2000 first quarter were $200,000 of nonrecurring licensing fees from Coca Cola Company related to a licensing agreement signed in April 1999. 16

TQC00337

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 17 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION-(Continued)
1

In fiscal 2001, we began negotiating terms and prices directly with the manufacturers of our food products. We formed a new subsidiary, American Food Distributors, Inc. ("AJ?D"), began purchasing such products and, i turn, selling these products to an unaffiliated national distribution company who n supplies our restaurants. We believe this will give us better control over our sources of proprietary products. As a result, licensing fee revenue has been replaced by distribution fees. Distribution fees were $1,202,871 in the third quarter of fiscal 2001 and $2,038,897 for the second and third quarters of fiscal 2001.

Initial franchise fees increased 11% in the third quarter of fiscal 2001 to $1,602,834 from $1,443,236

in the same fiscal quarter last year. For the first three quarters of fiscal 2001, initial franchise fees
increased 11% to $4,856,307 from $4,365,343 in the same period last fiscal year. Initial franchise fees are one-time fees paid by franchisees at the time the franchise is purchased. Initial franchise fees are not recognized as income until the period in which all of OUT obligations relating to the sale have been substantially performed, which generally occurs when the franchise opens. Our share of initial franchise fees sold by foreign master franchises is recognized when received. In the first three quarters of fiscal 2001, we opened 303 franchises, including 28 international restaurants, as compared to 282 franchises opened, including 37 international restaurants, in the same period last fiscal year. Ow domestic initial franchise fee has been $20,000 since 1994. Franchisees may purchase a second franchise for $15,000 and third and subsequent franchises for $10,000. The initial franchise fee for a Quizno's Express franchise is $10,000 for the first, $7,500 for the second, and $5,000 for the third and additional franchises purchased by the same franchisee. Our share of initial franchise fees for international restaurants is generally 30% of the franchise fee and will vary depending on the country and the currency exchange rate. Initial franchise fees for international restaurants are recognized as revenue on receipt. Domestic initial franchise fees collected by us are recorded as deferred initial franchise fees until the related franchise opens. Deferred initial franchise fees at June 30, 2001 were $13,979,606 and represent 842 domestic franchises sold but not yet in operation, compared to $8,930,151 at June 30,2000 representing 567 domestic franchises sold but not open. Direct costs related to the franchise sale, primarily sales commissions paid to area directors, are deferred on our books and recorded as an expense at the same time as the related initial franchise fee is recorded as income. Deferred costs paid with respect to initial franchise fees deferred at June 30, 2001 were $2,309,450. Approximately 50% of all initial franchisee fees received by us for franchise purchases in area director markets are paid to area directors for sales and opening commissions.

Area director and master franchise fees were $433,428 in the third quarter of fiscal 2001 and $335,306 in the same fiscal quarter last year. In the first three quarters of fiscal 2001, area director and master franchise fees were $819,111 and $967,028 in the same period last year. Revenue from domestic area director marketing agreement fees is recognized on a straight-line basis over the term of the agreement, which is ten years. Commissions paid to the area director upon the inception of the agreement are classified as a prepaid and recognized as an expense over the same ten year term.
Deferred domestic area fees are one-time fees paid to us for the right to sell franchises on our behalf in a designated, non-exclusive area. Domestic area director fees recognized were $183,428 in the third quarter of fiscal 2001 and $175,306 in the comparable fiscal 2000 quarter. In the first three quarters of fiscal 2001, domestic area director fees recognized were $539,111 and $497,028 in the comparable fiscal 2000 period. The fee for U.S. areas was $.03 per person in the designated area through June 1996, $.035 from .6 July 1996 through December 1996, $.05 from January 1997 through December 1997, $ 0 from January since March 1,1998, In addition, each area director is required to 1998 through February 1998, and $.W pay a training fee of $10,000. In the first three quarters of fiscal 2001, we sold four area directorships for $501,493 compared to 6 sold in the first three quarters of fiscal 2000 for $292,400. At June 30,2001, we 17

TQC00338

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 18 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION A M ) ANALYSIS OR PLAN OF OPERATION-(Continued)
had a total of 61 area directors who owned areas encompassing approximately 65% of the population of the United States. International master franchise fees are one-time fees paid to us for the right to sell franchises in a designated, exclusive, international market. The master franchisee assumes all of our obligations and duties under the agreement. We recognize these fees when the agreement is signed. International master franchise fees were $250,000 in the third quarter of fiscal 2001 and $160,000 in the third quarter of fiscal 2000. For the first three quarters of fiscal 2001, international master franchise fees recognized were $280,000 and $470,000 in the comparable fiscal 2000 period. In the first quarter of fiscal 2000, we sold the master franchise rights to Switzerland for $300,000. A total of $20,000 of the fee was deferred until OUT training obligation is completed. We also recognized $30,000 of previously deferred international master franchise fees in the second quarter as we substantially completed our training obligations under the agreements. In the third quarter of fiscal 2000, we sold the master franchise rights to Iceland and Mexico, Venezuela, Peru, Dominican Republic and certain other Caribbean islands for a total of $180,000, of which $20,000 of these fees was deferred. In the third quarter of fiscal 2001, we sold the master franchise rights for South Korea for $250,000. Also, during the three quarters ended June 30, 2001, we recognized $30,000 of international master franchise fees related to previously deferred international master franchise fees for Iceland and the United Kingdom as we substantially completed our training obligations under the agreement. We offer domestic area director and master franchise applicants financing for the area fee. The amount iinanced is required to be paid to us in installments over five years at interest rates between 6% and 15%. The promissory notes are personally signed by the area director and, depending on the personal financial strength of the area director, secured by collateral unrelated to the area directorship. We also periodically offer payment plans to international master franchisee applicants. The five domestic and international areas sold in the first three quarters of fiscal 2001 used this financing for $293,693, representing 39% of the total domestic area director fees and international master franchise fees received or financed in fiscal 2001. Of the nine domestic and international areas sold in the first three quarters of fiscal 2000, three used this iinancing for $296,357, representing 38% of the total domestic area director fees and international master franchise fees received or financed in fiscal 2000. The area director and master franchise agreements set increasing minimum performance levels that require the area director or master franchisee to sell and open a speczed number of franchised restaurants in each year during the term of the area agreement. Our experience with the program to date indicates that while some area directors and master franchisees will exceed their development schedules, others will fail to meet their schedules. In our planning, we have allowed for a certain percentage of area directors and master franchisees that wiU not meet their development schedule. Delays in the sale and opening of restaurants can occur fG many reasons. The most common are delays in the selection or acquisition of an appropriate location for the restaurant, delays i negotiating the n terms of the lease and delays in franchisee financing. We may terminate an area or master agreement if the area director or master franchisee fails to meet the development schedule, and we then have the right to resell the territory to a new area director or master franchisee or we can operate it.

- Since 1999, we have repurchased 21 area directorships for a total of $4,991,712, of which four were purchased in fiscal 2001 for $552,499. As a result of such repurchases, we no longer have to pay the area director sales, opening and royalty commissions. The purchase price is recorded as a prepaid commission and then expensed over the remaining term of the underlying franchise agreements. If the franchise closes, or the royalty from any location is impaired, the remaining prepaid royalty commission related to the specific unit is expensed. At September 30, 2000, there were 146 franchises open and 88 franchises sold not open, in repurchased area director territories. During fiscal 2000, we expensed $134,912 for amortization of prepaid commissions related these franchises and expensed another $6,749 representing the unamortized balance related to one such franchise closed. At June 30,2001, there were
18

TQC00339

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 19 of 29

THE QUIZNO'S CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION-(Continued)
212 franchises open and 19 franchises sold not open, in repurchased area director territories. During the nine months ended December 31,2000, we expensed $243,072 for amortization of prepaid commissions related these franchises and expensed another $41,220 representing the unamortized balance related to four such franchises closed.
Other revenue increased by 70% in the third quarter of fiscal 2001 to $447,007 from $262,651 in the third quarter of fiscal 2000. For the first three quarters of fiscal 2001, other revenue increased by 47% to $1,192,105 from $811,272 in the comparable fiscal 2000 period. Other revenue is primarily amounts paid by equipment suppliers for design and construction, franchise transfer fees and net bookkeeping fees charged franchisees that utilize our designated bookkeeping services provider. Amounts paid by equipment suppliers were $189,513 in the third quarter of fiscal 2001 compared to $127,500 in the third quarter of fiscal 2000. For the first three quarters of fiscal 2001, amounts paid by equipment suppliers were $520,013 compared to $475,658 in the first three quarters of fiscal 2000. This amount will vary based on new store openings. Franchise transfer fees increased in the third quarter of fiscal 2001 to $150,000 from $80,000 in the third quarter of fiscal 2000. For the first three quarters of fiscal 2001, franchise transfer fees were $331,000 compared to $172,500 in the first three quarters of fiscal 2000. Since 1995, our franchise agreement requires all new franchisees to utilize our bookkeeping services, or a firm designated by us to provide bookkeeping services, for their first 12 months of operations. Net bookkeeping fees were $26,266 in the third quarter of fiscal 2001 compared to $32,394 in the third quarter of fiscal 2000. For the first three quarters of fiscal 2001, net bookkeeping fees were $104,558 compared to $86,764 in the first three quarters of fiscal 2000. Bookkeeping fees are paid by the franchisee to the Company and then remitted on to the bookkeeping service designated by the Company. These fees represent the amounts retained by the Company to administer the bookkeeping function. Included in the first three quarters of fiscal 2001 was $75,036 of fees received from a vendor related to our inventorying of equipment packages received at new stores.

Sales and royalty commissions expense increased 29% in the third quarter of fiscal 2001 to $2,686,002 (32% of royalty and initial franchise fee revenue) from $2,080,141 (37% of royalty and initial franchise fee revenue) in the comparable quarter last fiscal year. For the first three quarters of fiscal 2001 sales and royalty commissions expense increased 30% to $7,451,502 (33% of royalty and initial franchise fee revenue) from $5,720,677 (39% of royalty and initial franchise fee revenue) in the comparable period last fiscal year. Sales and royalty commissions are amounts paid to our domestic area directors, commissions paid to other sales agents and employees, and costs related to sales promotions and incentives. Sales and royalty commission expense declined in 2001 as a percentage of royalty and initial franchise fee revenue due to the repurchase and reacquisition of certain area directorships. Our domestic area directors receive commissions equal to 50% of the initial franchise fees and 40% of royalties received by us from franchises sold, opened, and operating in the area director's territory. In exchange for these payments, the area director is required to market and sell franchises, provide location selection assistance, provide opening assistance to new franchisees, and perform monthly quality control reviews at each franchise open in the area director's territory.
The area director is entitled to receive commissions during the term of the area director marketing agreement and in some cases, upon expiration of the area director agreement, the commission paid is reduced to 1% of sales for 5 years or longer depending on the area director agreement. Our foreign master franchisees retain 70% of initial fees, area director fees and royalties paid from franchises sold, open and operating in the master franchisee's territory, except the Canadian master franchisee who retained 100% of initial franchise fees in 1998 only, the United Kingdom master franchisee who will retain 85% of the initial franchise fees through December 31, 2001 and the Costa Rican master franchisee who will retain 100% of all initial franchise fees. Under the master franchise agreement, we have no obligation to provide services that will result in any incremental cost to us, other than an initial training trip to the country by an employee of ours.
19

Case 1:04-cv-00725-RPM

Document 41-20

Filed 07/01/2005

Page 20 of 29

THE QUIZNO'S CORPORATION AND SUBSIDLchRIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION-(Continued) General and administrative expenses increased 42% to $5,101,499 in the third quarter of fiscal 2001 from $3,600,333 in the comparable quarter last fiscal year. For the first three quarters of fiscal 2001, general and administrative expenses increased 48% to $13,742,915 from $9,254,702 in the first three quarters of fiscal 2000. As a percent of franchise revenue, general and admini