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 70 franchised and 3 licensed units at May 31, 2021 compared to 72 franchised and 7 licensed units at May 31, 2020. System-wide revenues for the three months ended May 31, 2021 were $15.6 million and May 31, 2020 was $12.7 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.
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, 2021, the Company employed 12 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, 2021 versus Three Months Ended May 31, 2020
For the three months ended May 31, 2021 and May 31, 2020, the Company reported net income of $87,000 and a net loss of $72,000, respectively. Total revenue of $749,000 increased $397,000, or 112.8%, for the three months ended May 31, 2021, as compared to total revenue of $352,000 for the three months ended May 31, 2020.
Royalty fee revenue of $421,000, for the quarter ended May 31, 2021, increased $182,000, or 76.2%, from the $239,000 for quarter ended May 31, 2020. In mid to late March of 2020 because of COVID-19 most restaurants closed temporarily with many state-imposed restrictions during the months to follow in 2020 and early 2021. The primary reason royalty revenue increased in 2021 was because stores had begun to reopen from the prior year. During the Pandemic, they had developed and incorporated on-line order, delivery and curb-side pickup systems, which continued to support sales into 2021. These systems were not yet fully utilized during the second quarter of 2020.
Franchise fee revenues of $9,000, for the quarter ended May 31, 2021, increased $5,000, or 125.0%, from the $4,000 for the quarter ended May 31, 2020. In 2021 there was one transfer for $5,000 in franchise fee revenue versus no transfers in same period 2020.
Licensing fee and other income of $68,000, for the quarter ended May 31, 2021, increased $6,000 or 9.7% from $62,000 for same quarter 2020. There was an $11,000 increase in nontraditional and a $3,000 increase in Sign Shop revenue, offset by a decrease of $8,000 in license fees and settlement revenue in 2021 versus 2020.
Marketing Fund revenues of $251,000, for the quarter ended May 31, 2021, increased $204,000, or 434.0%. The primary reason Marketing Fund revenue increased in 2021 is fees were assessed as usual in 2021, versus fees were waived to assist franchisees during COVID-19 from mid-March through the end of May 2020.
Total operating expenses of $627,000, for the quarter ended May 31, 2021, increased $204,000, or 48.0% from $423,000 for the quarter ended May 31, 2020. The increase was primarily related to an increase in Marketing Fund expenses of $204,000, payroll expenses increased $12,000 because salary cuts and furloughs occurred in April 2020 and salaries were at pre-COVID amounts in 2021, business insurance increased $3,000, Sign Shop cost of goods increased $3,000 and other general expenses of $7,000 increased in 2021 compared to 2020. These increases were offset by a decrease in professional fees of $12,000, a decrease in advertising of $6,000, employee benefits of $5,000 and travel of $2,000 in 2021 compared to 2020.
For the three months ended May 31, 2021 the provision for income tax was $35,000, compared to no income tax provision for the three months ending May 31, 2020. In 2021 the deferred tax liability increased, due to the utilization and expiration of Federal NOL’s, increasing the tax provision in the second quarter 2021.
Earnings per share, as reported for basic and diluted outstanding shares for the quarters ended May 31, 2021 and May 31, 2020 was $0.01 and negative $0.01 respectively.
Six Months Ended May 31, 2021 versus Six Months Ended May 31, 2020
For the six months ended May 31, 2021 and May 31, 2020, the Company reported net income of $420,000 and a net loss of $28,000, respectively. Total revenue of $1,472,000 increased $424,000, or 40.5%, for the six months ended May 31, 2021, as compared to total revenue of $1,048,000 for the six months ended May 31, 2020.
Royalty fee revenue of $767,000, for the six months ended May 31, 2021, increased $141,000, or 22.5%, from the $626,000 for six months ended May 31, 2020. The primary reason royalty revenue increased in 2021 was the effects of restaurants being closed and restricted services in mid-March through May 2020 due to COVID-19.
Franchise fee revenues of $26,000, for the six months ended May 31, 2021, increased $18,000, or 225.0%, from the $8,000 for the six months ended May 31, 2020. In 2021 a store closed that had not been fully amortized, resulting in $12,000 of franchise fees recognized. In 2021, there was one transfer for $5,000 compared to none in 2020 and $5,000 for 2021 and $4,000 for 2020 of franchise fee amortization.
Licensing fee and other income of $226,000, for the six months ended May 31, 2021, increased $86,000 or 61.4% from $140,000 for same period 2020. There was a $93,000 increase in settlement income and a $5,000 increase in Sign Shop revenue, offset by a $9,000 decrease in license fee and a $3,000 decrease in nontraditional revenue in 2021 compared to 2020.
Marketing Fund revenues of $452,000, for the six months ended May 31, 2021, increased $178,000, or 65.0% from $274,000. The primary reason Marketing Fund revenue increased was the six months of 2021 marketing fees were collected at their normal rate, while in 2020 marketing fees were waived to assist franchisees during COVID-19 from mid-March through the end of May 2020.
Total operating expenses of $1,213,000, for the six months ended May 31, 2021, increased $152,000, or 14.3% from $1,061,000 for the same period 2020. The increase was primarily related to an increase in Marketing Fund expenses of $178,000, a $6,000 increase in business insurance, a $6,000 increase in annual meeting expense and a $5,000 increase in Sign Shop cost of goods sold in 2021 compared to 2020. The increases were offset by decreases to payroll of $10,000 and a $5,000 decrease in employee benefits due to an employee retiring, a $19,000 decrease in advertising expense and a $9,000 decrease in travel expense, as a result of decreased travel during the Pandemic.
On May 1, 2020 the Company received loan proceeds of $228,000 through the CARES Act offered by the Treasury Department and Small Business Administration. On December 9, 2020 the Company was notified that the loan was forgiven in full, including any accrued interest. The cash received was used to pay employees, employee benefits, rent and utilities. On December 9, 2020, the SBA forgave the debt from the Payroll Protection Program loan and it is included in other income in 2021.
For the six months ended May 31, 2021 the provision for income tax was $67,000 compared to a $15,000 income tax provision for the six months ending May 31, 2020. The federal and state effective tax rate used to compute income tax expense is a federal rate of 21% and a state rate of 7.11%, which is net of the federal tax effect.
On December 9, 2020 the Payroll Protection Program loan was forgiven by the Small Business Administration (“SBA”). Among other provisions, the CARES Act eliminated federal tax on the forgiveness of the SBA loan. States were allowed to determine whether they would follow the federal government forgiveness. Illinois has adopted the federal government forgiveness program.
In fiscal 2021, the Company’s income included the $228,000 of forgiveness, but it is excluded from federal and state tax calculations as a permanent difference, thereby reducing the federal and state effective rate from the customary effective tax rate used to compute income tax expense at the federal rate of 21% and a state rate of 7.11%, which is net of the federal tax effect.
Earnings per share, as reported for basic and diluted outstanding shares for the six months ended May 31, 2021 and May 31, 2020 was $.06 and $0.00 respectively.
Liquidity and Capital Resources
At May 31, 2021, the Company had working capital of $1,050,000 and unrestricted cash of $1,360,000. At May 31, 2020 the Company had working capital of $733,000 and unrestricted cash of $1,007,000.
During the six months ended May 31, 2021, the Company had net income of $420,000 and operating activities provided cash of $334,000. The principal adjustments to reconcile the net income to cash provided by operating activities for the six months ending May 31, 2021 was depreciation and amortization of $2,000, deferred tax expense of $49,000 and noncash lease expense of $50,000, less PPP loan forgiveness of $228,000 and the recovery of uncollectible accounts of $1,000. In addition, changes in operating assets and liabilities increased cash by $42,000. During the six months ended May 31, 2020, the Company had a net loss of $28,000 and operating activities used cash of $155,000. The principal adjustments to reconcile net income to cash provided in operating activities for the six months ending May 31, 2020 was noncash lease expense of $50,000, depreciation and amortization of $2,000, less provision for uncollectible accounts of $4,000. In addition, changes in operating assets and liabilities decreased cash by $174,000.
The Company had no investing activities during the quarter ended May 31, 2021 and $3,000 of trademark capitalization for the same period 2020.
Cash distributions/dividends used $145,000 in financing activities in 2021 versus $291,000 of cash distributions/dividends for the same period 2020. On May 1, 2020 the Company received loan proceeds of $228,000 through the CARES act offered by the Treasury Department and Small Business Administration. The loan was forgiven in the first quarter of 2021. See Note 8 for additional information.
Cash Distribution and Dividend Policy
The Company will continue to monitor the impact of the Coronavirus Pandemic on its operations when determining the future cash distribution/dividend payments. Cash distributions/dividend payments will be considered after reviewing profitability expectations and financing needs and will be declared at the discretion of the Board of Directors. The Company will continue to analyze its ability to pay cash distributions/dividends on a quarterly basis. For fiscal 2021 $0.01 cash distribution have been declared for the first and second quarters.
Determination of whether distributions are considered a cash distribution, cash dividend or combination of the two will not be made until after December 31, 2021, as the classification or combination is dependent upon the Company’s earnings and profits for tax purposes for its fiscal year ending November 30, 2021.
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard’s main goal is to improve financial reporting by requiring earlier recognition of credit losses on financing receivables and other financial assets in scope, including trade receivables. The amendments in this update broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The guidance in ASU 2016-13 is effective for public companies for fiscal years and for interim periods with those fiscal years beginning after December 15, 2020. The Company will adopt ASU 2019-13 for fiscal year ending November 30, 2022 and the adoption of this guidance is not expected to have any material impact on the Company’s financial position, cash flows or results of operations.
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes,” which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. The amendments in ASU 2019-12 are effective for public business entities for fiscal years beginning after December 15, 2023, including interim periods therein. Early adoption of the standard is permitted, including adoption in interim or annual periods for which financial statements have yet been issued. The Company will adopt ASU 2019-12 for fiscal year ending November 30, 2024 and the adoption of this guidance is not expected to have any material impact on the Company’s financial position, cash flows or results of operations.
Management does not believe that there are any recently issued and effective or not yet effective accounting pronouncements as of May 31, 2021 that would have or are expected to have any significant effect on the Company’s financial position, cash flows or income statement.
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, 2020, filed with the Securities and Exchange Commission on February 26, 2021.