Boston Chicken Case

Boston Chicken implemented a franchising strategy that differed from most other franchising companies at the time. Boston Chicken focused its expansion through franchising the company through large regional developers rather than selling store franchises to a large number of small franchisees. In that, an established network of 22 regional franchises that targeted their operations in the 60 largest U.S. metropolitan markets and in order to do so, the franchisee would have been an independent experienced businessman with vast financial resources and would be responsible for opening 50 – 100 stored in the region. Boston Chicken focused on widespread continuous expansion of its operations to become to developed across the board food chain. Scouting for real estate assured the highest standards for developing properties and was critical to the company’s future success. To assist in future growth of the franchises, Boston Chicken implemented a communications infrastructure, which provided a supporting link for communication between its networks of stores. In addition in efforts to improve operating efficiency, the company locked in low rates from its suppliers and developed flagship stores, which did most of the initial food preparation which inadvertently reduced employee training costs. Many of these regional developers were given a revolving credit line to help support expansion. This type of financing came with credit risk while the franchises average revenue from operations were not sufficient enough to cover the expenses which raises doubt for the repayment of such loans. 2. The accounting policy of reporting the franchise fees from Boston Chicken’s area developers as revenue seemed most controversial. These franchise fees, which accounted for more than 50% of total revenue, did not represent revenues from operations. Also, the source of most of the ranchise fees came from the financing provided by Boston Chicken, the franchiser, where the money coming in was the same money that was going out. This overstated earnings of the company. Since the debentures can be converted into shares of common stock, most of the revenue from franchise fees should have been deferred. Reporting revenues that included these franchise fees his the fact the most of the franchised stores were operating at a loss, which provided a false impression to investors. While Boston Chicken, the franchiser reported a net income from operations of $24,611 in 1994, if they excluded the income provided by franchise fees, they company-operated stores would have been operating at a loss, which would have been a more accurate picture for the company’s operations and its question of having a profitable future. 3. Boston Chicken, the franchiser, reports revenue based on franchise fees (includes royalties, initial franchise development costs, interest income from area developer financing, lease income, software fees, and other related franchise fees), and company operated stores. The revenue reported on the income statement does not reflect the operating income or losses generated by the area developers, with most of these area developers operating at a loss. Since the franchiser provides financing to the area developers, it seems that consolidation of the financial statements would provide vital information to the users of the financial statements especially since the repayment of loans relies heavily on the profitability of the franchisees. Basically, Boston Chicken was not reporting the results of operations from its area developers because Boston Chicken did not have an equity position in these firms; rather their stake in these franchises was reported as debt financing. In doing so, Boston Chicken did not have to report the losses that were incurred in these operations. By manipulating the financial statements, the company gave a false impression on its future prospects of the company, allowing them to more freely raise capital through the issuance of common stock, and inadvertently inflating tock prices. 4. The balance of notes receivable from area developers as of December 25, 1994 was at $201,266. Of this amount there was no allowance for loan loss and as a result, revenues would be overstated. With the high probability of uncollectibility on notes receivable due to the majority of operating losses of the area developers, creating an allowance for loan losses would more accurately reflect the financial position of Boston Chicken. Even with just a 25% allowance for uncollectibility the company would be operating at a loss of $25,714. 5 7. In the financial information provided in the case for 1994, Boston Chicken’s Operating profit for the year was $24,611, and net earnings $0. 38 per share. In 1995 Operating Profit for the year increased to $67,238 and net earnings to $0. 66 per share. Boston chicken continued to recognize profits in 1996, but was forced to amend its reported profits in May of 1997 due to improperly stating revenues. In 1998 the company files for Chapter 11 Bankruptcy and was subsequently purchased by McDonalds Corporation in 2000. As seen in Table 1 on the following page, it seems that since around the 2nd Quarter in 1997 to mid 2004 the stock price of the plummeted from around $50 per share to under $1 per share. At the time the stock price dropped drastically to $0. 00010 per share. In 2007, the company was sold to Sun Capital and went private. 6. After the company filed for bankruptcy, the stock price took a huge hit. In 1999 the company searched for a buyer as its stock price continued to steadily decline. As you can see in Table 1, trading volume drastically fell during the 1999 – 2000 period, and showed an increase in 2000 when McDonalds Corp purchased the company.