| AFC ENTERPRISES INC Item 1A RISK FACTORS Certain statements we make in this filing, and other written or oral statements made by or on our behalf, may constitute “forward-looking statements” within the meaning of the federal securities laws |
| Words or phrases such as “should result,” “are expected to,” “we anticipate,” “we estimate,” “we project,” “we believe,” or similar expressions are intended to identify forward-looking statements |
| These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections |
| We believe that these forward-looking statements are reasonable; however, you should not place undue reliance on such statements |
| Such statements speak only as of the date they are made, and we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of future events, new information or otherwise |
| The following risk factors, and others that we may add from time to time, are some of the factors that could cause our actual results to differ materially from the expected results described in our forward-looking statements |
| If we are unable to compete successfully against other companies in the QSR industry or develop new products that appeal to consumer preferences, we could lose customers and our revenues may decline |
| The QSR industry is intensely competitive with respect to price, quality, brand recognition, service and location |
| If we are unable to compete successfully against other foodservice providers, we could lose customers and our revenues may decline |
| We compete against other QSRs, including chicken, hamburger, pizza, Mexican and sandwich restaurants, other purveyors of carry out food and convenience dining establishments, including national restaurant chains |
| Many of our competitors possess substantially greater financial, marketing, personnel and other resources than we do |
| There can be no assurance that consumers will continue to regard our products favorably, that we will be able to develop new products that appeal to consumer preferences, or that we will be able to continue to compete successfully in the QSR industry |
| Because our operating results are closely tied to the success of our franchisees, the failure or loss of one or more of these franchisees could adversely affect our operating results |
| Our operating results are dependent on our franchisees and, in some cases, on certain franchisees that operate a large number of restaurants |
| How well our franchisees operate their restaurants and their desire to maintain their franchise relationship with us is outside of our direct control |
| Any failure of these franchisees to operate their franchises successfully or loss of these franchisees could adversely affect our operating results |
| As of December 25, 2005 we had 333 franchisees operating restaurants within our Popeyes system and several preparing to become operators |
| The largest of our domestic franchisees operates 165 Popeyes restaurants; and the largest of our international franchisees operates 150 Popeyes restaurants |
| Typically, each of our international franchisees is responsible for the development of significantly more restaurants than our domestic franchisees |
| As a result, our international operations are more closely tied to the success of a smaller number of franchisees than our domestic operations |
| There can be no assurance that our domestic and international franchisees will operate their franchises successfully |
| If we face continuing labor shortages or increased labor costs, our growth and operating results could be adversely affected |
| Labor is a primary component in the cost of operating our restaurants |
| As of December 25, 2005, we employed 1cmam269 hourly employees in our company-operated restaurants |
| If we face labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates or increases in the federal minimum wage or other employee benefits costs (including costs associated with health insurance coverage), our operating expenses could increase and our growth could be adversely affected |
| Our success depends in part upon our and our franchisees’ ability to attract, motivate and retain a sufficient number of qualified employees, including restaurant managers, kitchen staff and servers, necessary to keep pace with our expansion schedule |
| The number of qualified individuals needed to fill these positions is in short supply in some areas |
| 8 _________________________________________________________________ [62]Table of Contents Since Hurricane Katrina, in our New Orleans company market, we have experienced labor shortages and increased labor costs |
| If this were to continue indefinitely, our future operating results could be adversely impacted |
| As it is, increased sales in those same restaurants since the hurricane have more than compensated for the increased costs |
| However, as sales normalize in future periods, we may have a cost structure out of line with our restaurant sales volume in that market |
| If the cost of chicken increases, our cost of sales will increase and our operating results could be adversely affected |
| The principal raw material for our Popeyes operations is fresh chicken |
| Any material increase in the costs of fresh chicken could adversely affect our operating results |
| Our company-operated and franchised restaurants purchase fresh chicken from various suppliers who service us from various plant locations |
| These costs are significantly affected by increases in the cost of chicken, which can result from a number of factors, including increases in the cost of grain, disease, declining market supply of fast-food sized chickens and other factors that affect availability |
| Because our purchasing agreements for fresh chicken allow the prices that we pay for chicken to fluctuate, a rise in the prices of chicken products could expose us to cost increases |
| If we fail to anticipate and react to increasing food costs by adjusting our purchasing practices or increasing our sales prices, our cost of sales may increase and our operating results could be adversely affected |
| Shortages or interruptions in the supply or delivery of fresh food products could adversely affect our operating results |
| We, and our franchisees, are dependent on frequent deliveries of fresh food products that meet our specifications |
| Shortages or interruptions in the supply of fresh food products caused by unanticipated demand, problems in production or distribution, declining number of distributors, inclement weather or other conditions could adversely affect the availability, quality and cost of ingredients, which would adversely affect our operating results |
| Changes in consumer preferences and demographic trends, as well as concerns about health or food quality, could result in a loss of customers and reduce our revenues |
| Foodservice businesses are often affected by changes in consumer tastes, national, regional and local economic conditions, discretionary spending priorities, demographic trends, traffic patterns and the type, number and location of competing restaurants |
| Our franchisees, and we, are from time to time, the subject of complaints or litigation from guests alleging illness, injury or other food quality, health or operational concerns |
| Adverse publicity resulting from these allegations may harm our reputation or our franchisees’ reputation, regardless of whether the allegations are valid or not, whether we are found liable or not, or those concerns relate only to a single restaurant or a limited number of restaurants or many restaurants |
| In addition, the restaurant industry is currently under heightened legal and legislative scrutiny resulting from the perception that the practices of restaurant companies have contributed to the obesity of their guests |
| Additionally, some animal rights organizations have engaged in confrontational demonstrations at certain restaurant companies across the country |
| As a multi-unit restaurant company, we can be adversely affected by the publicity surrounding allegations involving illness, injury, or other food quality, health or operational concerns |
| Complaints, litigation or adverse publicity experienced by one or more of our franchisees could also adversely affect our business as a whole |
| If we are unable to adapt to changes in consumer preferences and trends, or we have adverse publicity due to any of these concerns, we may lose customers and our revenues may decline |
| Instances of avian flu or other food-borne illnesses could adversely affect the price and availability of poultry and other foods and create negative publicity which could result in a decline in our sales |
| Instances of avian flu or other food-borne illnesses could adversely affect the price and availability of poultry and other foods |
| As a result, Popeyes restaurants could experience a significant increase in food costs if there are additional instances of avian flu or other food-borne illnesses |
| In addition to losses associated with higher prices and a lower supply of our food ingredients, instances of food-borne illnesses could result in 9 _________________________________________________________________ [63]Table of Contents negative publicity for us |
| This negative publicity, as well as any other negative publicity concerning food products we serve, may reduce demand for our food and could result in a decrease in guest traffic to our restaurants |
| A decrease in guest traffic to Popeyes restaurants as a result of these health concerns or negative publicity could result in a decline in our sales |
| If we are unable to maintain an adequate system of internal controls, our ability to report our financial results on a timely and accurate basis may continue to be adversely affected |
| In connection with their audits of our 2002, 2001 and 2000 financial statements, our independent auditors advised our Audit Committee that they identified certain deficiencies that constituted material control weaknesses |
| These weaknesses contributed to the restatement of our financial statements for the first three quarters of 2002 and for fiscal years 2001, 2000, 1999 and 1998 |
| Our Audit Committee, pursuant to an independent investigation into several accounting issues that arose in connection with the restatement, concluded that our accounting, financial reporting and internal control functions needed significant improvement |
| Additionally, in connection with our assessment of internal controls over financial reporting at the end of fiscal years 2004 and 2003, our management identified certain material weaknesses |
| Though we believe we have adequately addressed the material weaknesses previously disclosed, we can provide no assurance that weaknesses in these or other areas will not arise which would adversely impact our ability to report on a timely and accurate basis |
| The effect of Hurricane Katrina and any failure to properly address the issues caused by Hurricane Katrina could adversely affect our operating results |
| During the last week of August 2005, the Company’s business operations in Louisiana, Mississippi, and Alabama were adversely impacted by Hurricane Katrina |
| We describe the effect of Hurricane Katrina on our operations at Note 17 to our Consolidated Financial Statement |
| At December 25, 2005, 21 company-operated restaurants and 4 franchised restaurants remained closed |
| Collectively, the estimated annualized sales for the 21 company-operated restaurants that remained closed at December 25, 2005 is approximately dlra24dtta9 million |
| The impact of Hurricane Katrina on our results of operations and financial condition, generally, and more specifically on our New Orleans restaurants remains uncertain |
| Our ability to re-open restaurants impacted by Hurricane Katrina depends on a number of factors, including but not limited to: the restoration of local and regional infrastructure such as utilities, transportation and other public services; our ability to obtain services and materials for the repair of our restaurants; the displacement and return of the population in affected locations and the plans of governmental authorities for the rebuilding of affected areas; and the amounts and timing of payments under our insurance coverage |
| Our ability to collect our insurance coverage is subject to, among other things, our insurers not denying coverage of claims, timing matters related to the processing and payment of claims and the solvency of our insurance carriers |
| Factors which could limit our ability to recover total losses from insurance proceeds include: the percentage of losses ultimately attributable to wind versus flood perils, the business interruption recovery period deemed allowable under the term of our insurance policies, and our ability to limit ongoing costs such as facility rents, taxes, and utilities |
| Further, there can be no assurance that sales levels at certain company-operated and franchised restaurants that have remained open in the region will continue at the heightened levels experienced since the storm |
| If any member of our senior management left us, our operating results could be adversely affected, and we may not be able to attract and retain additional qualified management personnel |
| We are dependent on the experience and industry knowledge of Kenneth L Keymer, our Chief Executive Officer, and other members of our senior management team |
| If, for any reason, our senior executives do not continue to be active in management or if we are unable to retain qualified new members of senior management, our operating results could be adversely affected |
| We cannot guarantee that we will be able to attract and retain additional qualified senior executives as needed |
| We have employment agreements with 10 _________________________________________________________________ [64]Table of Contents Mr |
| Keymer and other executives; however, these agreements do not ensure their continued employment with us |
| Our 2005 Credit Facility may limit our ability to expand our business, and our ability to comply with the covenants, tests and restrictions contained in this agreement may be affected by events that are beyond our control |
| The 2005 Credit Facility contains financial and other covenants, including covenants requiring us to maintain various financial ratios, limiting our ability to incur additional indebtedness, restricting the amount of capital expenditures that may be incurred, restricting the payment of cash dividends and limiting the amount of debt which can be loaned to our franchisees or guaranteed on their behalf |
| This facility also limits our ability to engage in mergers or acquisitions, sell certain assets, repurchase our stock and enter into certain lease transactions |
| The 2005 Credit Facility includes customary events of default, including, but not limited to, the failure to pay any interest, principal or fees when due, the failure to perform certain covenant agreements, inaccurate or false representations or warranties, insolvency or bankruptcy, change of control, the occurrence of certain ERISA events and judgment defaults |
| The restrictive covenants in our 2005 Credit Facility may limit our ability to expand our business, and our ability to comply with these provisions may be affected by events beyond our control |
| A failure to comply with any of the financial and operating covenants included in the 2005 Credit Facility would result in an event of default, permitting the lenders to accelerate the maturity of outstanding indebtedness |
| This acceleration could also result in the acceleration of other indebtedness that we may have outstanding at that time |
| Were we to default on the terms and conditions of the 2005 Credit Facility and the debt were accelerated by the facility’s lenders, such developments would have a material adverse impact on our financial condition and our liquidity |
| If we are unable to franchise a sufficient number of restaurants, our growth strategy could be at risk |
| As of December 25, 2005, we franchised 1cmam451 restaurants domestically and 345 restaurants in Puerto Rico, Guam and 24 foreign countries |
| Our growth strategy is significantly dependent on increasing the number of our franchised restaurants |
| If we are unable to franchise a sufficient number of restaurants, our growth strategy could be significantly impaired |
| Our ability to successfully franchise additional restaurants will depend on various factors, including the availability of suitable sites, the negotiation of acceptable leases or purchase terms for new locations, permitting and regulatory compliance, the ability to meet construction schedules, the financial and other capabilities of our franchisees, our ability to manage this anticipated expansion, and general economic and business conditions |
| Many of the foregoing factors are beyond the control of our franchisees |
| Further, there can be no assurance that our franchisees will successfully develop or operate their restaurants in a manner consistent with our concepts and standards, or will have the business abilities or access to financial resources necessary to open the restaurants required by their agreements |
| Historically, there have been many instances in which Popeyes franchisees have not fulfilled their obligations under their development agreements to open new restaurants |
| Currency, economic, political and other risks associated with our international operations could adversely affect our operating results |
| As of December 25, 2005, we had 345 franchised restaurants in Puerto Rico, Guam and 24 foreign countries |
| Business at these operations is conducted in the respective local currency |
| The amount owed us is based on a conversion of the royalties and other fees to US dollars using the prevailing exchange rate |
| In particular, the royalties are based on a percentage of net sales generated by our foreign franchisees’ operations |
| Consequently, our revenues from international franchisees are exposed to the potentially adverse effects of our franchisees’ operations, currency exchange rates, local economic conditions, political instability and other risks associated with doing business in foreign countries |
| We expect that our franchise revenues generated from international operations will increase in the future, thus increasing our exposure to changes in foreign economic conditions and currency fluctuations |
| 11 _________________________________________________________________ [65]Table of Contents We have recently experienced a decline in the number of restaurants we have franchised in Korea |
| We had 154 franchised restaurants in Korea as of December 25, 2005 as compared to 186 at December 26, 2004 |
| The decline in the number of Korean restaurants was primarily due to weak financial and operating performance by a franchisee in that country (our largest international franchisee) |
| We agreed to abate the entire 3prca royalty due to be paid to us by that franchisee for the last two quarters of 2005 and to abate one-third of the royalties to be paid to us during the first two quarters of 2006 |
| We continue to work with that franchisee to address challenges facing its restaurants and those of sub-franchisees concerning sales growth and profitability, and to otherwise strengthen our franchise system in that country, however, there can be no assurance that these efforts will be successful |
| If we and our franchisees fail to purchase chicken at quantities specified in SMS’s poultry contracts, we may have to purchase the commitment short-fall and this could adversely affect our operating results |
| In order to ensure favorable pricing for fresh chicken purchases and to maintain an adequate supply of fresh chicken for us and our Popeyes franchisees, SMS, has entered into poultry supply contracts with various suppliers |
| These contracts establish pricing arrangements, as well as purchase commitments |
| AFC has agreed to indemnify SMS as it concerns any shortfall of annual purchase commitments entered into by SMS on behalf of the Popeyes restaurant system |
| If we and our Popeyes franchisees fail to purchase fresh chicken at the commitment levels, AFC may be required to purchase the commitment short-fall |
| This may result in losses as AFC would then need to find uses for the excess chicken purchases or to resell the excess purchases at spot market prices |
| This could adversely affect our operating results |
| Our expansion into new markets may present additional risks that could adversely affect the success of our new restaurants, and the failure of a significant number of these restaurants could adversely affect our operating results |
| We expect to enter into new geographic markets in which we have no prior operating or franchising experience |
| We face challenges in entering new markets, including consumers’ lack of awareness of our Popeyes brand, difficulties in hiring personnel, and problems due to our unfamiliarity with local real estate markets and demographics |
| New markets may also have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets |
| Any failure on our part to recognize or respond to these differences may adversely affect the success of our new restaurants |
| The failure of a significant number of the restaurants that we open in new markets could adversely affect our operating results |
| Our quarterly results and same-store sales may fluctuate significantly and could fall below the expectations of securities analysts and investors, which could cause the market price of our common stock to decline |
| Our quarterly operating results and same-store sales have fluctuated significantly in the past and may continue to fluctuate significantly in the future as a result of a variety of factors, many of which are outside of our control |
| If our quarterly results or same-store sales fluctuate or fall below the expectations of securities analysts and investors, the market price of our common stock could decline |
| Factors that may cause our quarterly results or same-store sales to fluctuate include the following: • the opening of new restaurants by us or our franchisees; • the re-opening of restaurants temporarily closed due to Hurricane Katrina; • the closing of restaurants by us or our franchisees; • rising gasoline prices; • increases in labor costs; • increases in the cost of food products; • the ability of our franchisees to meet their future commitments under development agreements; 12 _________________________________________________________________ [66]Table of Contents • consumer concerns about food quality; • the level of competition from existing or new competitors in the QSR industry; • inclement weather patterns, and • economic conditions generally, and in each of the markets in which we, or our franchisees, are located |
| Accordingly, results for any one-quarter are not indicative of the results to be expected for any other quarter or for the full year, and same-store sales for any future period may decrease |
| We are subject to extensive government regulation, and our failure to comply with existing regulations or increased regulations could adversely affect our business and operating results |
| We are subject to numerous federal, state, local and foreign government laws and regulations, including those relating to: • the preparation and sale of food; • building and zoning requirements; • environmental protection; • minimum wage, overtime and other labor requirements; • compliance with the Americans with Disabilities Act; and • working and safety conditions |
| If we fail to comply with existing or future regulations, we may be subject to governmental or judicial fines or sanctions, or we could suffer business interruption or loss |
| In addition, our capital expenses could increase due to remediation measures that may be required if we are found to be noncompliant with any of these laws or regulations |
| We are also subject to regulation by the Federal Trade Commission and to state and foreign laws that govern the offer, sale and termination of franchises and the refusal to renew franchises |
| The failure to comply with these regulations in any jurisdiction or to obtain required approvals could result in a ban or temporary suspension on future franchise sales or fines or require us to make a rescission offer to franchisees, any of which could adversely affect our business and operating results |
| The SEC investigation arising in connection with the restatement of our financial statements could adversely affect our financial condition |
| On April 30, 2003, we received an informal, nonpublic inquiry from the staff of the SEC requesting voluntary production of documents and other information |
| The requests, for documents and information, which are ongoing, relate primarily to our announcement on March 24, 2003 indicating we would restate our financial statements for fiscal year 2001 and the first three quarters of 2002 |
| The staff has informed our counsel that the SEC has issued an order authorizing a formal investigation with respect to these matters |
| We are cooperating with the SEC in these inquiries |
| We may not be able to adequately protect our intellectual property, which could harm the value of our Popeyes brand and branded products and adversely affect our business |
| We depend in large part on our Popeyes brand and branded products and believe that it is very important to the conduct of our business |
| We rely on a combination of trademarks, copyrights, service marks, trade secrets and similar intellectual property rights to protect our Popeyes brand and branded products |
| The success of our expansion strategy depends on our continued ability to use our existing trademarks and service marks in order to increase brand awareness and further develop our branded products in both domestic and international markets |
| We also use our trademarks and other intellectual property on the Internet |
| If our efforts to protect our intellectual property are not adequate, or if any third party misappropriates or infringes 13 _________________________________________________________________ [67]Table of Contents on our intellectual property, either in print or on the internet, the value of our Popeyes brand may be harmed, which could have a material adverse effect on our business, including the failure of our Popeyes brand and branded products to achieve and maintain market acceptance |
| We franchise our restaurants to various franchisees |
| While we try to ensure that the quality of our Popeyes brand and branded products is maintained by all of our franchisees, we cannot be certain that these franchisees will not take actions that adversely affect the value of our intellectual property or reputation |
| We have registered certain trademarks and have other trademark registrations pending in the US and foreign jurisdictions |
| The trademarks that we currently use have not been registered in all of the countries in which we do business and may never be registered in all of these countries |
| We cannot be certain that we will be able to adequately protect our trademarks or that our use of these trademarks will not result in liability for trademark infringement, trademark dilution or unfair competition |
| There can be no assurance that all of the steps we have taken to protect our intellectual property in the US and foreign countries will be adequate |
| In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the US Further, through acquisitions of third parties, we may acquire brands and related trademarks that are subject to the same risks as the brand and trademarks we currently own |
| Because many of our current or former properties were used as retail gas stations in the past, we may incur substantial liabilities for remediation of environmental contamination at our properties |
| Certain of our currently or formerly owned and/or leased properties (including certain Church’s locations) are known or suspected to have been used by prior owners or operators as retail gas stations, and a few of these properties may have been used for other environmentally sensitive purposes |
| Many of these properties previously contained underground storage tanks, and some of these properties may currently contain abandoned underground storage tanks |
| It is possible that petroleum products and other contaminants may have been released at these properties into the soil or groundwater |
| Under applicable federal and state environmental laws, we, as the current or former owner or operator of these sites, may be jointly and severally liable for the costs of investigation and remediation of any contamination, as well as any other environmental conditions at our properties that are unrelated to underground storage tanks |
| If we are found liable for the costs of remediation of contamination at any of these properties, our operating expenses would likely increase and our operating results would be materially adversely affected |
| We have obtained insurance coverage that we believe will be adequate to cover any potential environmental remediation liabilities |
| However, there can be no assurance that the actual costs of any potential remediation liabilities will not materially exceed the amount of our policy limits |