ITEM 2.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Certain statements contained in Management's Discussion and Analysis of Financial Condition and Results of Operations, including statements regarding the development of the Company's business, the markets for the Company's products, anticipated capital expenditures, and the effects of completed and proposed acquisitions, and other statements contained herein regarding matters that are not historical facts, are forward-looking statements as is within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Because such statements include risks and uncertainties, actual results could differ materially from those expressed or implied by such forward-looking statements as set forth in this report, the Company's Annual Report on Form 10-K and other reports that the Company files with the Securities and Exchange Commission. Certain risks and uncertainties are wholly or partially outside the control of the Company and its management, including its ability to attract new franchisees; the continued success of current franchisees; the effects of competition on franchisees and consumer acceptance of the Company's products in new and existing markets; fluctuation in development and operating costs; brand awareness; availability and terms of capital; adverse publicity; acceptance of new product offerings; availability of locations and terms of sites for store development; food, labor and employee benefit costs; changes in government regulation (including increases in the minimum wage); regional economic and weather conditions; the hiring, training, and retention of skilled corporate and restaurant management; and the integration and assimilation of acquired concepts. Accordingly, readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revision to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
General
There are 73 franchised and 6 licensed units at May 31, 2019 compared to 80 franchised and 3 licensed units at May 31, 2018. System-wide revenues for the six months ended May 31, 2019 were $16.1 million as compared to May 31, 2018 which were $16.5 million.
The Company's revenues are derived primarily from the ongoing royalties paid to the Company by its franchisees and receipt of initial franchise fees. Additionally, the Company derives revenue from the sale of licensed products (My Favorite Muffin mix, Big Apple Bagels cream cheese and Brewster's coffee), and through nontraditional channels of distribution through a licensing agreement with Green Beans Coffee.
Royalty fees represent a 5% fee on net retail and wholesale sales of franchised units. Royalty revenues are recognized on an accrual basis using actual franchise receipts. Generally, franchisees report and remit royalties on a weekly basis. The majority of month-end receipts are recorded on an accrual basis based on actual numbers from reports received from franchisees shortly after the month-end. Estimates are utilized in certain instances where actual numbers have not been received and such estimates are based on the average of the last 10 weeks’ actual reported sales.
There are two items involving revenue recognition of contracts that require us to make subjective judgments: the determination of which performance obligations are distinct within the context of the overall contract and the estimated stand alone selling price of each obligation. In instances where our contract includes significant customization or modification services, the customization and modification services are generally combined and recorded as one distinct performance obligation.
The Company earns licensing fees from the sale of BAB branded products, which includes coffee, cream cheese, muffin mix and frozen bagels from a third-party commercial bakery, to the franchised and licensed units.
As of May 31, 2019, the Company employed 13 full-time employees at the Corporate office. The employees are responsible for corporate management and oversight, accounting, advertising and franchising. None of the Company's employees are subject to any collective bargaining agreements and management considers its relations with its employees to be good.
Results of Operations
Three Months Ended
May 31
, 2019
versus
Three Months Ended
May 31
, 2018
For the three months ended May 31, 2019 and 2018, the Company reported net income of $128,000 and $178,000, respectively. Total revenue of $774,000 increased $214,000, or 38.2%, for the three months ended May 31, 2019, as compared to total revenue of $560,000 for the three months ended May 31, 2018. Marketing revenue of $256,000 were included per adoption of ASC 606 and franchise fees increased $1,000, offset by a decrease of $5,000 in royalty revenue and a $38,000 decrease in licensing fees and other income. Adoption of ASC606 increased net income for May 31, 2019 by $8,000, from $120,000 to $128,000. Adoption of ASC606 includes $256,000 in revenue for Marketing revenue and rebates, offset by expenses of $256,000, an increase of $3,000 in franchise fees, an increase of $4,000 for license fee revenue and an increase of $1,000 for gift card revenue.
Royalty fee revenue of $420,000, for the quarter ended May 31, 2019, decreased $5,000, or 1.2%, from the $425,000 for quarter ended May 31, 2018.
Franchise fee revenues of $3,000, for the quarter ended May 31, 2019, increased $1,000, or 50.0%, from the $2,000 for the quarter ended May 31, 2018. There were no transfers in 2019 and one in 2018. In addition, there was a $3,000 franchise fee revenue increase for adoption of ASC606 in fiscal 2019.
Licensing fee and other income of $95,000, for the quarter ended May 31, 2019, decreased $38,000, or 28.6% from $133,000 for the quarter ended May 31, 2018. License fees and settlement income decreased $43,000, offset by gift card breakage revenue increased of $1,000 and Dubai license fee revenue of $4,000 compared to 2018. The increase in gift card breakage revenue was due to adoption of ASC 606 in fiscal 2019. The gift card breakage revenue would have been zero in the second quarter of 2019 without the adoption.
Total operating expenses of $641,000, for the quarter ended May 31, 2019 increased $258,000, or 67.4% from $383,000 for the quarter ended May 31, 2018. The increase was primarily due to 2019 adoption of ASC 606 which includes marketing expenses of $256,000. Marketing revenue and marketing expenses offset each other. There was an increase of $5,000 in payroll and payroll tax expense, an increase of $6,000 in professional fees, an increase in advertising expense of $10,000, an increase in employee benefit expense of $3,000 and an increase in travel of $2,000, offset by a decrease in occupancy of $12,000, a decrease in franchise expenses of $3,000, a decrease in reserve for uncollectible accounts of $2,000, a decrease in Sign Shop cost of goods sold of $3,000 and a decrease in general expenses of $4,000 for the 3 months ended May 31, 2019 compared to 2018.
There was an income tax expense of $5,000 in 2019 and none in 2018.
Earnings per share, as reported for basic and diluted outstanding shares for the quarters ended May 31, 2019 and 2018 was $0.02.
Six Months Ended May 31, 201
9
versus Six Months Ended May 31, 201
8
For the six months ended May 31, 2019 and 2018, the Company reported net income of $225,000 and $278,000, respectively. Total revenue of $1,487,000 increased $426,000, or 40.2%, for the six months ended May 31, 2018, as compared to total revenue of $1,061,000 for the six months ended May 31, 2018. Marketing revenues of $485,000 are included in revenue for 2019 per adoption of ASC 606. Franchise fees increased $15,000, offset by a decrease of $17,000 for royalty revenue and a $57,000 decrease in licensing fees and other income. Adoption of ASC606 decreased net income for May 31, 2019 by $32,000, from $257,000 to $225,000. Adoption of ASC606 includes $485,000 in revenue for Marketing revenue and rebates offset by a $485,000 marketing expense, an increase of $7,000 in franchise fees, offset by a decrease of $30,000 for gift card revenue and a decrease of $9,000 in license fees.
Royalty fee revenue of $793,000, for the six months ended May 31, 2019, decreased $17,000, or 2.1%, from the $810,000 for the six months ended May 31, 2018. Royalty revenues decreased primarily because of fewer locations in 2019 compared to prior year same period 2018.
Franchise fee revenues of $17,000, for the six months ended May 31, 2019, increased $15,000 from $2,000 for the period ended May 31, 2018. There were two transfers for the six months ended May 31, 2019 versus one transfer in the six months ended May 31, 2018. In addition, there was a $7,000 franchise fee revenue increase for adoption of ASC606 in fiscal 2019.
Licensing fee and other income of $192,000, for the six months ended May 31, 2019 decreased $57,000, or 22.9%, from $249,000 for the six months ended May 31, 2018. The decrease was primarily due to a decrease in settlement income of $49,000, a decrease of $23,000 for non-redeemed gift card revenue and a decrease in Sign Shop revenue of $2,000, offset by an increase in license fee revenue of $6,000 and an increase in nontraditional of $11,000 for the six months ended 2019 versus same period 2018. The adoption of ASC 606 resulted in decreased gift card revenue of $30,000 and a decrease in license fee revenue of $9,000 for the six months ended May 31, 2019 compared to same period 2018.
Total operating expenses of $1,252,000 increased $484,000, or 63.0%, for the six months ended May 31, 2019, from $768,000 for the same period 2018. The increase was primarily due to 2019 adoption of ASC 606 including marketing expenses of $485,000. Marketing revenue and marketing expenses offset each other. There was an increase of $13,000 in payroll and payroll tax expense, an increase in advertising expense of $21,000, an increase in employee benefit expense of $16,000 and an increase in travel of $1,000, an increase of $4,000 in legal fees and an increase of $1,000 in depreciation and amortization, offset by a decrease in occupancy expense of $33,000, a decrease in uncollectible accounts of $12,000, a decrease in Sign Shop cost of goods sold of $9,000 and a decrease in franchise development and general expenses of $1,000 each for the 3 months ended May 31, 2019 compared to 2018.
There was an income tax expense of $10,000 and $15,000, respectively for May 2019 and 2018.
Earnings per share, as reported for basic and diluted outstanding shares for the six months ended May 31, 2019 and 2018 were $0.03 and $0.04 per share, respectively.
Liquidity and Capital Resources
At May 31, 2019, the Company had working capital of $721,000 and unrestricted cash of 1,032,000. At November 30, 2018 the Company had working capital of $756,000 and unrestricted cash of $1,065,000.
During the six months ended May 31, 2019, the Company had net income of $225,000 and operating activities provided cash of $214,000. The principal adjustments to reconcile net income to cash provided in operating activities for the six months ending May 31, 2019 was noncash lease expense of $51,000, depreciation and amortization of $1,000 and a decrease in the provision for uncollectible accounts of $14,000. In addition, changes in operating assets and liabilities decreased cash by $49,000. During the six months ended May 31, 2018, the Company had net income of $278,000 and operating activities provided cash of $200,000. The principal adjustments to reconcile the net income to cash provided in operating activities for the six months ending May 31, 2018 was a decrease in the provision for uncollectible accounts of $2,000. In addition, changes in operating assets and liabilities decreased cash by $12,000.
The Company’s investing activities were $5,000 and $4,000, respectively for the six months ended May 31, 2019 and 2018.
The Company used $291,000 and $218,000 for cash distribution/dividend payments during the six month periods ended May 31, 2019 and 2018.
On June 5, 2019, the Board of Directors declared a $0.01 per share quarterly cash distribution/dividend to shareholders of record as of June 21, 2019, to be paid July 10, 2019. Although there can be no assurances that the Company will be able to pay cash distributions/dividends in the future, it is the Company’s intent that future cash distributions/dividends will be considered based on profitability expectations and financing needs and will be declared at the discretion of the Board of Directors. It is the Company’s intent going forward to declare and pay cash distributions/dividends on a quarterly basis if warranted.
Cash Distribution and Dividend Policy
It is the Company’s intent that future cash distributions/dividends will be considered after reviewing profitability expectations and financing needs and will be declared at the discretion of the Board of Directors. There can be no assurance that the Company will generate sufficient earnings to pay out cash distributions/dividends. The Company will continue to analyze its ability to pay cash distributions/dividends on a quarterly basis.
Determination of whether distributions are considered a cash distribution, cash dividend or combination of the two will not be made until after December 31, 2019, as the classification or combination is dependent upon the Company’s earnings and profits for tax purposes for its fiscal year ending November 30, 2019.
The Company believes execution of this policy will not have any material adverse effect on its ability to fund current operations or future capital investments.
R
ecent and Adopted Accounting Pronouncements
Revenue from Contracts with Customers, ASU 2014-09 (Topic 606) establishes a comprehensive revenue recognition standard for virtually all industries in U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. The standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, (v) recognize revenue when (or as) the entity satisfies a performance obligation. Entities will generally be required to make more estimates and use more judgment than under current guidance, which will be highlighted for users through increased disclosure requirements.
The standard requires that the transaction price received from customers be allocated to each separate and distinct performance obligation. The transaction price attributable to each separate and distinct performance obligation is then recognized as the performance obligations are satisfied. We have evaluated franchise fees and have determined that under the new standard the franchise fee is not separate and distinct from the overall franchise right. Franchise fees received will be recorded as deferred revenue and recognized as revenue over the term of each respective franchise agreement, typically 10 years. The Company has adopted this standard effective December 1, 2019. See note 3 for the impact of adoption on the Company’s financial position, cash flows or results of operations.
We have evaluated the impact of our franchise contributions to and subsequent expenditures from our marketing fund. We have determined we are the principal in these arrangements and under the new standard we have included them as revenue and expense items. The Company has adopted this standard effective December 1, 2019. See note 3 for the impact of adoption on the Company’s financial position, cash flows and results of operations.
In March 2016, the FASB issued ASU 2016-04,
Recognition of Breakage for Certain Prepaid Stored-Value Products
. The new guidance creates an exception under ASC 405-20,
Liabilities-Extinguishments of Liabilities
, to derecognize financial liabilities related to certain prepaid stored-value products using a revenue-like breakage model. In general, these liabilities may be extinguished proportionately in earnings as redemptions occur, or when redemption is remote if issuers are not entitled to the unredeemed stored value. The Company adopted this guidance effective December 1, 2018 in connection with its adoption of Topic 606, utilizing the modified retrospective method. Refer to Note 3 for further disclosure of the impact of the new guidance.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force), (“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted this new guidance on December 1, 2018 using a retrospective transition method, and restated the cash flow statement for the prior period presented.
Management does not believe that there are any other recently issued and effective or not yet effective pronouncements that would have or are expected to have any significant effect on the Company’s financial position, cash flows or results of operations.
Critical Accounting Policies
The Company has identified other significant accounting policies that, as a result of the judgments, uncertainties, uniqueness and complexities of the underlying accounting standards and operations involved could result in material changes to its financial condition or results of operations under different conditions or using different assumptions. The Company's most critical accounting policies are related to revenue recognition, valuation of long-lived and intangible assets, deferred tax assets and the related valuation allowance. Details regarding the Company's use of these policies and the related estimates are described in the Company's Annual Report on Form 10-K for the fiscal year ended November 30, 2018, filed with the Securities and Exchange Commission on February 25, 2019.