Boston Chicken, Inc. - No Chicken About Aggressive Franchising

Boston Chicken, Inc.:
No Chicken About Aggressive Franchising

Boston Chicken, Inc. franchises and operates retail food service stores under the name “Boston Market” These stores specialize in fresh, convenient meals featuring home style entrees of chicken, turkey, ham, and meat loaf, as well as a variety of freshly prepared vegetables, salads, and other side dishes. It product line also includes sandwiches, soups, and holiday home replacement meals. The total number of stores in the Boston Market system increased from 83 on December 27, Year 12 to 829 on December 31, Year 15.  Gross system-wide store revenues increased from $42.7 million during the Year 12 fiscal year to $792.9 million during the Year 15 fiscal year.  Franchisees owned and operated all but three of the Boston Market stores open at the end of Year 15.  The company retains ownership of three stores to test market new entrees, assess new operating procedures, and train employees.

Area Developers

The company relies on area developers to achieve rapid penetration of targeted markets.  Area developers are independently owned companies to which Boston Market grants an exclusive franchise in a particular geographical area to develop and operate Boston Market stores.  An experienced retail food-service veteran with substantial invested equity capital heads each firm that is an area developer.  The company currently has 22 area developers.  There are 829 stores open at the end of Year 15.  The area developers have committed to opening an additional 934 stores within the next several years.  These area developers have incurred substantial net losses during the recent rapid expansion of stores ($51.3 million in Year 14 and $148.3 million in Year 15), and most have negative net worth. The company believes that the area developers will recover such losses as the rate of expansion moderates by reduction or elimination of development costs, increased operational efficiencies as a result of post-expansion operational focus, greater economies of scale, increased advertising efficiencies, and increased store revenue.  The company anticipates domestic expansion of the Boston Market concept.  The company does not, therefore, seek additional domestic area developers or franchisees.

Development Agreements

Development agreements provide for the development of a specified number of stores within a defined geographic territory in accordance with a schedule of dates.  The development schedule generally covers two to five years and typically has store operation benchmarks for the number of stores to be open and in operation at six-month intervals.  Area developers currently pay a nonrefundable development fee of $5,000 per store to be developed and make a deposit of $5,000 per store to be developed towards the store initial franchise fee (discussed below).  Failure to meet development schedules or other breaches of the area development agreement may lead to termination of the exclusivity provided by the agreement.

Franchise Agreements

Once the company and the area developer execute an acceptable lease for an approved store site, they enter into a franchise agreement under which the area developer becomes the franchisee for the specific store to be developed at the site. The company assists the area developer with site selection and construction coordination, for which it receives a real estate fee.  Current franchise agreements typically provide for payment of a $35,000 per store initial franchise fee (less the $5,000 deposit), a 5 percent royalty on gross store revenue, and a $10,000 minimum grand opening expenditure.  In addition, the franchise agreement provides that the company may from time to time specify computer software for use in the stores, for which the franchisee pays an upfront license fee plus an ongoing maintenance fee. Integrated hardware and software permit the company to closely monitor the operations of each store as well as communicate new developments. The company may own the equipment of a particular store, for which it receives periodic lease revenue from franchisees.  

Area Developer Financing

The company believes that the development and operation of stores in a targeted market is enhanced when the area developer not have to spend time raising capital.  Accordingly, the company extends secured debt financing to area developers to partially finance store development and working capital needs in maximum amounts equal to three to four times the area developer’s paid-in capital..  As of the end of Year 15, The company had agreements to provide secured financing to 17 of its areas developers.  Such commitments aggregated $621.5 million, of which $471.0 million was outstanding.  

The company’s loan agreement with its area developers generally requires the area developer to expend at least 75 percent of its contributed capital toward developing stores prior to drawing on its revolving loan.  The draw period is approximately two the three years.  On expiration of the draw period, the loan converts to an amortizing term loan payable over four to five years in periodic installments, generally with a final balloon payment.  (The term amortizing term loan means that the borrower makes payments each period for interest and for principal.  The principal payments are large enough in this case that the borrower pays off the entire loan in five years or less.  The fact that the loan involves a final balloon payment means that the last payment is larger, usually much larger, than the preceding payments.) The borrower pays interest each period at 1 percent over the applicable “reference rate” of the Bank of American Illinois as established from time to time.  A pledge of substantially all of the assets of the area developer secures the loan.  Some loans have a conversion feature in which the company may convert unpaid amounts of the loan into an equity interest in the area developer.  The company can exercise the conversion feature only after a moratorium period has elapsed (generally two years after execution of the loan) or the area developer defaults on the loan. The conversion price is set at a 12 percent to 15 percent premium over the per-unit equity price paid by the area developer for its equity interest in the area development entity.

Marketing

The company markets through television, radio, newspapers, and other print media, direct mail, and in-store point-of-purchase displays.  Franchisees pay a national advertising fee of 2 percent of gross store revenues and a local advertising fee of 4 percent of gross store revenues.  

Financial Statements and Notes

Exhibit 1 presents balance sheets, Exhibit 2 present income statements, and Exhibit 3 presents statements of cash flows for Boston Chicken, Inc. for the Year 13 through Year 15 fiscal years.  Selected notes to these financial