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( 208 .)


The provision for income taxes for the ¬scal
8. Area Developer Financing
year ended December 25, 1994, consists of
$4,277,000 of deferred income taxes, which is net
The Company currently offers partial ¬nancing to
of an income tax bene¬t of $3,102,000 pertaining
certain area developers for use in expansion of their
to the exercise of stock options.
operations. Only developers which are developing a
The difference between the Company™s 1993
signi¬cant portion of an area of dominant in¬‚uence
and 1994 actual tax provision and the tax provision
(“ADI”) or metropolitan area of a major city and
by applying the statutory Federal income tax rate is
which meet all of the Company™s requirements are
attributable to the following:
eligible for such ¬nancing. Certain of these ¬nanc-
ing arrangements permit the Company to obtain an
Fiscal Years Ended
equity interest in the developer at a predetermined
Dec. 25, Dec. 26,
price after a moratorium (generally two years) on
(In thousands of dollars) 1994 1993
conversion of the loan into equity. The maximum
Income tax expense at statutory rate $6,953 $ 560
loan amount is generally established to give the
State taxes, net of Federal bene¬t 818 66
Company majority ownership of the developer upon
Other 26 ”
Change in valuation allowance (3,520) (626) conversion (or option exercise, as described further
Provision for income taxes $4,277 $”
below) provided the Company exercises its right
164 Asset Analysis

Asset Analysis

to participate in any intervening ¬nancing of the (b) Commitment to Extend Area Developer
developer. Financing
The following table summarizes credit commitments
Area developer ¬nancing generally requires the
for area developer ¬nancing, certain of which are
developer to expend at least 75% of its equity capital
conditional upon additional equity contributions
toward developing stores prior to drawing on the
being made by area developers:
revolving loan account, with draws permitted during
a two- or three-year draw period in a pre-deter-
mined amount, generally equal to two to four times (In thousands of dollars, except Dec. 25, Dec. 26,
number of area developers) 1994 1993
the amount of the developer™s equity capital. Upon
expiration of the draw period, the loan converts to Number of area developers receiving
¬nancing 13 5
an amortizing term loan payable over four to ¬ve
Loan commitments $332,531 $ 51,041
years in periodic installments, sometimes with a ¬nal Unused loans (131,265) (7,243)

Boston Chicken
balloon payment. Interest is generally set at 1% over Loans outstanding (included in Notes
the applicable “reference rate” of Bank of America Receivable) $201,266 $ 43,798
Allowance for loan losses $ ” $ ”
Illinois from time to time and is payable each
period. The loan is secured by a pledge of substan-
tially all of the assets of the area developer and any The principal maturities on the aforementioned
franchisees under its area development agreement notes receivable are as follows:
and generally by a pledge of equity of the owners of
(In thousands of dollars)
the developer.
1995 $16,288
1996 4,456
(a) Loan Conversion Option
1997 13,132
For loans with a conversion option, all or any por- 1998 12,132
1999 15,417
tion of the loan amount may be converted at the
Thereafter 139,841
Company™s election (at any time after default of the
loan or generally after the second anniversary of the
loan and generally up to the later of full repayment
(c) Credit Risk and Allowance for Loan Losses
of the loan or a speci¬ed date in the agreement)
into equity in the developer at the conversion price The allowance for credit losses is maintained at a
set forth in such loan agreement, generally at a 12% level that in management™s judgment is adequate to
to 15% premium over the per equity unit price paid provide for estimated possible loan losses. The
by the developer for the equity investment made amount of the allowance is based on manage-
concurrently with the execution of the loan agree- ment™s review of each area developer™s ¬nancial
ment or subsequent amendments thereto. To the condition, store performance, store opening sched-
extent such loan is not fully drawn or has been ules, and other factors, as well as prevailing eco-
drawn and repaid, the Company has a correspond- nomic conditions. Based upon this review and
ing option to acquire at the loan conversion price analysis, no allowance was required as of Decem-
the amount of additional equity it could have ber 26, 1993 and December 25, 1994.
acquired by conversion of the loan, had it been fully
11. Relocation
There can be no assurance the Company will or
will not convert any loan amount or exercise its In September 1994, the Company consolidated its
option at such time as it may be permitted to do so four Chicago-based support center facilities into a
and, if it does convert, that such conversion will con- single facility and relocated to Golden, Colorado.
stitute a majority interest in the area developer. The cost of the relocation, including moving person-
Absent a default under any such agreement, the nel and facilities, severance payments, and the
Company currently cannot exercise these conversion write-off of vacated leasehold improvements was
or option rights. $5.1 million.
Asset Analysis

4-39 Part 2 Business Analysis and Valuation Tools

12. Subsequent Events
In March 1995, the Company entered into a con- $19.5 million of common stock. The number of
vertible secured loan agreement providing $20 mil- shares to be issued will be based upon the market
lion of ¬nancing to Progressive Bagel Concepts, Inc. value of the stock two days prior to the closing date.
(“PBCI”). The Company has agreed to provide PBCI The Company has granted PBCI registration rights
additional convertible secured loans subject to and has provided a price guarantee equal to the per
PBCI™s ability to meet certain conditions. share purchase price on any shares sold within a
speci¬ed number of days of the registration becom-
In March 1995, PBCI entered into stock pur-
ing effective.
chase agreements with the Company to purchase
Boston Chicken


To the Board of Directors and Stockholders of Boston Chicken, Inc.:

We have audited the accompanying consolidated balance sheets of Boston Chicken,
Inc. (a Delaware corporation) and Subsidiary as of December 25, 1994 and December
26, 1993, and the related consolidated statements of operations, stockholders™ equity,
and cash ¬‚ows for the ¬scal years ended December 25, 1994, December 26, 1993, and
December 27, 1992. These ¬nancial statements are the responsibility of the Company™s
management. Our responsibility is to express an opinion on these ¬nancial statements
based on our audits.
We conducted our audits in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable assur-
ance about whether the ¬nancial statements are free of material misstatements. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in
the ¬nancial statements. An audit also includes assessing the accounting principles used
and signi¬cant estimates made by management, as well as evaluating the overall ¬nan-
cial statement presentation. We believe that our audits provide a reasonable basis for our
In our opinion, the ¬nancial statements referred to above present fairly, in all mate-
rial respects, the ¬nancial position of Boston Chicken, Inc. and Subsidiary as of December
25, 1994 and December 26, 1993, and the results of their operations and their cash
¬‚ows for the ¬scal years ended December 25, 1994, December 26, 1993, and Decem-
ber 27, 1992, in conformity with generally accepted accounting principles.

(Arthur Andersen LLP)
Denver, Colorado
January 31, 1995 (except with respect to the matters discussed in Note 12, as to
which the date is March 24, 1995)
166 Asset Analysis

Asset Analysis

Boston Chicken Inc., Summary of 1994“1995 Quarterly Results

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Revenue ($000) $40,107 $34,800 $38,671
Net Income ($000) 7,116 7,420 8,814
EPS $0.15 $0.15 $0.17


Boston Chicken
Revenue ($000) $23,449 $20,360 $25,186 $27,165
2,561a 3,383a 4,679a
Net Income ($000) 5,550
EPS $0.06 $0.08 $0.11 $0.12

a. Pre-tax provisions for relocation were $4,708,000 in the second quarter of 1994, and $389,000 in the third quarter of
5 Li ab il it y a n d E q u it y A na l ys i s

F irms have two broad classes of ¬nancial claims on their assets: liabil-
ities and equity. The key distinction between these claims is the extent to which their
payoffs can be speci¬ed contractually. The ¬rm™s obligations under liabilities are speci-
¬ed relatively clearly, whereas equity claims tend to be dif¬cult to specify.
Business Analysis and
The economic differences between liabilities and equity are re¬‚ected in their ac-
Valuation Tools
counting de¬nitions. Liabilities are de¬ned as economic obligations that arise from ben-
e¬ts received in the past, and for which the amount and timing is known with reasonable
certainty. Liabilities include obligations to customers that have paid in advance for prod-
ucts or services; commitments to public and private providers of debt ¬nancing; obliga-
tions to federal and local governments for taxes; commitments to employees for unpaid
wages, pensions, and other retirement bene¬ts; and obligations from court or govern-
ment ¬nes or environmental cleanup orders.
For accounting purposes, equity ¬nancing is de¬ned as the claim on the gap between
assets and liabilities. It can therefore be thought of as a residual claim. Equity funds can
come from issues of common and preferred stock, from pro¬ts that are reinvested, and
from any reserves set aside from pro¬ts.
It is important for users of ¬nancial statements to analyze the nature of the ¬rm™s li-
abilities and its equity in order to assess the ¬nancial risks faced by both debt and equity
investors. Managers are likely to have the best information about the extent of the ¬rm™s
future commitments. However, they also have incentives to understate the value of these
commitments and the ¬rm™s ¬nancial risks. Analysis of liabilities involves assessing the
extent, nature, and measurability of any obligations the ¬rm has incurred. Equity values
are a primary input for the valuation approach discussed in Chapters 10, 11, and 12. It
is therefore important that equity values be reliable estimates of stockholders™ claims on
the ¬rm™s assets. However, since equity is de¬ned as a residual, analysis of equity is in-
direct, through analysis of assets, liabilities, revenues, and expenses. Additional ques-
tions about equity focus on classi¬cation of items within equity and hybrid securities.
In this chapter we discuss the key principles underlying the recording of liabilities
and equity. We also show the challenges in reporting these types of claims and the op-
portunities for analysis of each.

Under accrual accounting, liabilities can arise in three ways. First, they can arise when
a ¬rm has received cash from a customer but has yet to ful¬ll any of its contractual

168 Liability and Equity Analysis

Liability and Equity Analysis

obligations required for recognizing revenue (see Chapter 6). These types of liabilities
are termed deferred or unearned revenues. Second, a liability can arise if a ¬rm has used
goods and/or services in the course of its operating cycle or during the current period,
but has yet to pay the suppliers of these inputs. These are called payables and accrued
liabilities. Finally, a ¬rm incurs a liability when it raises debt capital from banks, ¬nan-
cial institutions, and the public. Under this form of ¬nancing arrangement, the ¬rm bor-


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