FORM 10-KSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: November 30, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number: 0-27068
BAB Holdings, Inc.
- ----------------------------------------------------------------
(Name of small business issuer in its charter)
- ----------------------------------------------------------------
Illinois 36-3857339
- ----------------------------------------------------------------
(State or other jurisdiction (IRS Employer
of incorporation or organiztion) Indentification No.)
8501 West Higgins Road, Suite 320, Chicago, Illinois 60631
- ----------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (773) 380-6100
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, no par value
Check whether the issuer: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
Check if there is no disclosure of delinquent filers in response
to Item 405 of Regulation S-B is not contained in this form, and
no disclosure will be contained, to the best of registrant's
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year:
$14,166,443
State the aggregate market value of the voting stock held by
nonaffiliates computed by reference to the price at which the
stock was sold, or the average bid and asked prices of such
stock, as of a specified date within the past 60 days: $4,073,994
based on 5,321,135 shares held by nonaffiliates as of February
17, 1998, and the average of the closing bid ($0.71875) and asked
($.8125) prices for said shares in the NASDAQ Small-Cap Market as
of such date.
State the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date:
7,744,302 shares of Common Stock, as of February 17, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's definitive proxy materials to be filed on or before
March 30, 1998 are incorporated by reference in Part III of Form
10-KSB. In addition, certain exhibits identified in Part III,
Item 13 are incorporated by reference to said exhibits as
previously filed with the Commission.
Transitional Small Business Disclosure Format (check one):
[ ] Yes [X] No
FORM 10-KSB INDEX
PART I
Item 1. Description of Business
Overview
Risk Factors
Recent Acquisitions
Locations
Store Operations
Franchising
Competition
Trademarks and Service Marks
Government Regulation
Employees
Year 2000 Issue
Item 2. Description of Property
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Common Equity and Related Stockholder Matters
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 7. Financial Statements
Item 8. Changes in and Disagreement with Accountants on Accounting
and Financial Disclosure
PART III
Item 9. Directors, Executive Officers, Promotors and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Item 10. Executive Compensation
Item 11. Security Ownership of Certain Beneficial Owners and Management
Item 12. Certain Relationships and Related Transactions
Item 13. Exhibits and Reports on Form 8-K
Reports on Form 8-K
Exhibits
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- --------------------------------
OVERVIEW
BAB Holdings, Inc. (the "Company") was incorporated under the
laws of the State of Illinois on November 25, 1992 and currently
operates, franchises and licenses bagel, muffin and coffee retail
units under the Big Apple Bagels, My Favorite Muffin and
Brewster's Coffee tradenames and at November 30, 1997 had 257
units in operation in 28 states and two Canadian provinces. The
Company additionally derives income from the sale of its
trademark bagels, muffins and coffees through nontraditional
channels of distribution including under licensing agreements
with Host Marriott Services Corporation, Mrs. Fields Cookies,
Choice Pick Food Courts, and through direct home delivery of
specialty muffin gift baskets and coffee.
The Big Apple Bagels brand franchise and Company-owned stores
feature daily baked "from scratch" bagels, flavored cream
cheeses, premium coffees, gourmet bagel sandwiches and other
related products. Licensed Big Apple Bagels units serve the
Company's par-baked frozen bagel products, freshly baked daily,
and related products. The My Favorite Muffin brand consists of
units operating as "My Favorite Muffin" featuring a large variety
of freshly baked muffins, coffees and related products, and units
operating as "My Favorite Muffin and Bagel Cafes" featuring these
products as well as a variety of specialty bagel sandwiches and
related products. The Company's Brewster's Coffee units are
specialty coffee shops featuring a variety of premium arabica
bean coffees--freshly brewed or in bulk--and related products.
Big Apple Bagels units are concentrated in the Midwest and
Western United States, while My Favorite Muffin units are
clustered in the Middle Atlantic States and Florida. Brewster's
Coffee Shops are currently located in two states--Illinois and
Ohio.
The Company has grown significantly since its initial public
offering in November 1995 through growth in franchise units,
Company-store development, acquisitions and the development of
alternative distribution channels for its branded products. The
Company intends on continuing its expansion through these means
in the future. With the acquisition of My Favorite Muffin Too,
Inc. (MFM) on May 13, 1997, the Company immediately added 60
franchise and five Company-operated units and expects to leverage
on the natural synergy of distributing muffin products in
existing Big Apple Bagels units and, alternatively, bagel
products and Brewster's Coffee in existing My Favorite Muffin
units. Additionally, the Company expects to realize efficiencies
in servicing the combined base of Big Apple Bagels, My Favorite
Muffin and Brewster's Coffee franchisees as a result of this
acquisition.
RISK FACTORS
Limited Operating History
The Company was formed in November 1992. As of November 30,
1997, the Company had 28 Company-owned stores, excluding 6
Company-owned stores closed during 1998 (see "Management's
Discussion and Analysis" and Note 11 to the audited financial
statements included herein), and 229 franchised and licensed
stores in operation. The Company has grown from only 2 Company-
owned and 59 franchise units at the time of its initial public
offering in November 1995 primarily through acquisitions.
Consequently, the Company's operating results achieved to date
may not be indicative of the results that may be achieved in the
future by the Company.
Operating Losses
The Company reported an operating loss of $3,406,000 and $621,000
for the years ended November 30, 1997 and 1996, respectively.
While the Company believes that the level of its franchising and
licensing operations and number of Company-owned stores will
generate revenues sufficient to exceed the expenses necessary to
support such operations, given its historical losses, there can
be no assurance that the Company will operate profitably in the
future.
Recent Acquisitions
The Company's strategic plan has included growth through business
acquisitions. Since the beginning of fiscal 1996, the Company
has completed the acquisitions of Brewster's Coffee ("Brewster's"),
Strathmore Bagels Franchise Corp. ("Strathmore"), Bagels Unlimited, Inc.
("BUI"), Danville Bagels, Inc. ("Danville"), Just Bagels, Inc. ("JBI")
and MFM. No assurance can be given that these or other acquisitions will
be profitable or that the Company will successfully integrate, convert,
or operate any acquired businesses.
As a result of acquisitions, the Company has grown significantly
in size, has expanded the geographic area in which it operates
and has added product lines and distribution channels. Any
acquisition involves inherent uncertainties, such as the effect
on the acquired businesses of integration into a larger
organization and the availability of management resources to
oversee the operations of the acquired business. The Company's
ability to integrate the operations of acquired businesses is
essential to its future success. There can be no assurance as to
the Company's ability to integrate new businesses nor as to its
success in managing the significantly larger operations resulting
therefrom. Additionally, amortization of intangible assets
recorded as a result of the acquisitions will have a significant
impact on future operating results. During 1997 and 1998, the
Company closed the stores acquired from JBI (see "Management's
Discussion and Analysis" and Note 11 to the audited financial
statements included herein.)
Recoverability of Intangible Assets
The Company has recorded significant intangible assets in
connection with certain acquisitions. Applicable accounting
standards require the Company to review long-lived assets (such
as goodwill and other identifiable intangible assets) to be held
and used by the Company for impairment whenever events or changes
in circumstances indicate that the carrying values of those
assets may not be recoverable. In the fourth quarter 1997, the
Company recorded a provision for impairment and store closures
totaling $1,837,000. Of this amount, approximately $323,000
related to goodwill and other intangible assets related to stores
acquired which have been closed (see "Management's Discussion
and Analysis" and Note 11 to the audited financial statements
included herein.) While management believes goodwill and other
identifiable intangible assets recorded as of November 30, 1997
to be fairly stated, there is no assurance that an additional
charge to write down assets will not be required in the future.
Any such charge could have a material effect on the Company's
financial results.
Rapid Growth
The Company has grown significantly during the past year, both
internally and through acquisitions, and expects to continue its
growth in franchising and licensed product distribution to
continue in the future. The opening and success of franchise Big
Apple Bagels, Brewster's Coffee and My Favorite Muffin stores
will depend on various factors, including customer acceptance of
these concepts in new markets, the availability of suitable
sites, the negotiation of acceptable lease or purchase terms for
new locations, permit and regulatory compliance, the ability to
meet construction schedules, the financial and other capabilities
of the Company and its franchisees, the ability of the Company
to successfully manage this anticipated expansion and to hire and
train personnel, and general economic and business conditions.
Not all of the foregoing factors are within the control of the
Company.
The Company will continue to require the implementation of
enhanced operational and financial systems and additional
management, operational, and financial resources. Failure to
implement these systems and add these resources could have a
material adverse effect on the Company's results of operations
and financial condition. There can be no assurance that the
Company will be able to manage its expanding operations
effectively or that it will be able to maintain or accelerate its
growth.
Terms of Credit Facility and Availability of Capital
In April 1997, the Company entered into a secured $2 million line
of credit facility with a bank which expires December 31, 1998.
The line is secured by substantially all of the assets of the
Company and requires, among other things, that the Company
maintain minimum net worth of $8 million and a compensating cash
balance of $250,000. In February 1998, the Company fell below
the compensating cash balance requirement and obtained a waiver
from the bank to lower the requirement to $150,000 for 60 days
expiring April 25, 1998. While the Company has a plan in place
to achieve and maintain the compensating cash balance
requirements, there can be no assurance that this will be
successful nor can there be assurance that, if required, the
Company will be able to obtain additional waivers from the bank.
See Management's Discussion and Analysis and Note 5 of the
audited financial statements included herein.
Although the Company believes that its cash flows from current
operations and current financing arrangements will provide
sufficient working capital to enable the Company to meet
operating requirements and compensating cash balance requirements
for the foreseeable future, there can be no assurance that no
additional financing will be required, that the Company will be
able to obtain any required additional financing that may be
required, or that such financing, if obtained, will be on terms
favorable or acceptable to the Company. Any future equity
financing may result in dilution to holders of the Common Stock
and any future debt financing may reduce earnings. If the
Company is unable to secure additional financing when needed, or
at all, it could be required to significantly reduce the scope of
its existing operations, or even to discontinue operations.
Dependence on Franchisees
The Company has historically received a significant portion of
its revenues from initial franchise fees and continuing royalty
payments from franchisees. Although the Company uses established
criteria to evaluate franchisees, there can be no assurance that
franchisees will have the business ability or access to financial
resources necessary to successfully develop or operate stores in
a manner consistent with the Company's concepts and standards.
Additionally, no assurance can be given that desirable locations
and acceptable leases can be obtained by franchisees. Should the
Company's franchisees encounter business or operational
difficulties, the Company's revenues will be adversely affected.
The poor performance of any franchisee may also negatively impact
the Company's ability to sell new franchises. Consequently, at
present, the Company's financial prospects are substantially
related to the success of the franchise stores, over which the
Company has limited control. There can be no assurance that the
Company will be able to successfully attract new franchisees or
that the Company's franchisees will be able to successfully
develop and operate stores.
Although the Company monitors franchisees' compliance with
ongoing obligations on the basis of weekly revenue, and the
Company's standard franchise agreement also grants the Company
the right to audit the books and records of franchisees at any
time, no assurance can be given that all franchisees will operate
their stores in accordance with the Company's operating
guidelines and in compliance with all material provisions of the
franchise agreement, and the failure of franchisees to so operate
their stores could have a material adverse impact on the
Company's business. The franchise agreement gives the Company
the choice of seeking legal remedies, which could be time-
consuming and expensive, and terminating the franchisee, which
would diminish the Company's revenue until such time, if ever, as
a new franchisee replaces the terminated franchisee.
Competition
The food service industry, in general, and the fast food/take-out
sector in particular, are highly competitive, and competition is
likely to increase. The Company believes that specialty bagel,
muffin and coffee retail businesses are growing rapidly and are
likely to become increasingly competitive. The Company competes
against well-established food service companies with greater
product and name recognition and with larger financial,
marketing, and distribution capabilities than those of the
Company, as well as innumerable local food service establishments
that offer products competitive with those offered by the
Company. The Company's principal competitors include Bruegger's
Bagel Bakery ("Bruegger's"), Chesapeake Bagel Bakery
("Chesapeake") and Einstein/Noah Bagel Corp. ("Einstein"). In
addition, other fast-food service providers, such as Dunkin'
Donuts, have recently added bagels to their product offerings.
Any increase in the number of food service establishments in
areas where the Company's or its franchisees' sites are located
could have a material adverse effect on the Company's sales and
revenues. The Company competes for qualified franchisees with a
wide variety of investment opportunities both in the food service
business and in other industries. Investment opportunities in
the bagel store business include competing franchises offered by
Bruegger's, Chesapeake and Einstein as well as operators of
individual stores and multi-store chains.
Food Service Industry
Food service businesses are often affected by changes in consumer
tastes, national, regional, and local economic conditions,
demographic trends, traffic patterns, and the type, number, and
location of competing restaurants. Multi-unit food service
chains, such as the Company's, can also be substantially
adversely affected by publicity resulting from problems with food
quality, illness, injury, or other health concerns or operating
issues stemming from one store or a limited number of stores.
Such businesses are also subject to the risk that shortages or
interruptions in supply caused by adverse weather or other
conditions could negatively affect the availability, quality, and
cost of ingredients and other food products. In addition,
factors such as inflation, increased food and labor costs,
regional weather conditions, availability and cost of suitable
sites and the availability of experienced management and hourly
employees may also adversely affect the food service industry in
general and the Company's results of operations and financial
condition in particular.
Government Regulation
The Company is subject to the Trade Regulation Rule of the
Federal Trade Commission (the "FTC") entitled ``Disclosure
Requirements and Prohibitions Concerning Franchising and Business
Opportunity Ventures'' (the "FTC Franchise Rule") and state and
local laws and regulations that govern the offer, sale and
termination of franchises and the refusal to renew franchises.
Continued compliance with this broad federal, state and local
regulatory network is essential and costly, and the failure to
comply with such regulations may have a material adverse effect
on the Company and its franchisees. Violations of franchising
laws and/or state laws and regulations regulating substantive
aspects of doing business in a particular state could limit the
Company's ability to sell franchises or subject the Company and
its affiliates to rescission offers, monetary damages, penalties,
imprisonment and/or injunctive proceedings. In addition, under
court decisions in certain states, absolute vicarious liability
may be imposed upon franchisors based upon claims made against
franchisees. Even if the Company is able to obtain insurance
coverage for such claims, there can be no assurance that such
insurance will be sufficient to cover potential claims against
the Company.
Dependence on Personnel
The Company's ability to develop and market its products and to
achieve and maintain a competitive market position depends, in
large part, on its ability to attract and retain qualified food
marketing personnel and franchisees. Competition for such
personnel is intense, and there can be no assurance that the
Company will be able to attract and retain such personnel. In
November 1997, the Chief Financial Officer resigned from the
Company. The Company is in the process of hiring a qualified
replacement.
Trademarks/Service Marks
The trademarks and service marks used by the Company contain
common descriptive English words and thus may be subject to
challenge by users of these words, alone or in combination with
other words, to describe other services or products. Some
persons or entities may have prior rights to those names or marks
in their respective localities. Accordingly, there is no
assurance that such marks are available in all locations. Any
challenge, if successful, in whole or in part, could restrict the
Company's use of the marks in areas in which the challenger is
found to have used the name prior to the Company's use. Any such
restriction could limit the expansion of the Company's use of the
marks into that region, and the Company and its franchisees may
be materially and adversely affected.
Potential Effects of Antitakeover Provisions
The Company is authorized to issue up to 4,000,000 shares of
preferred stock, 78,710 shares are issued and outstanding as of
November 30, 1997. The remaining authorized preferred stock may
be issued in one or more series, the terms of which may be
determined at the time of issuance by the Board of Directors,
without further action by shareholders. The issuance of any
preferred stock could adversely affect the rights of the holders
of Common Stock, and specific rights granted to holders of
preferred stock could restrict the Company's ability to merge
with or sell its assets to a third party, thereby preserving
control of the Company by its then owners.
Certain provisions of the Illinois Business Corporation Act (the
"Illinois Act") restrict a publicly-held corporation from
engaging in a "business combination" with an "interested
shareholder" or its affiliates, unless the business combination
is approved by the Board of Directors or by a supermajority vote
of the shareholders. These provisions of the Illinois Act could
delay and make more difficult a business combination even if the
business combination could be beneficial to the interests of the
Company's shareholders.
Possible Depressive Effect on Price of Common Stock from Future
Sales of Common Stock
As of February 27, 1998, 1,116,343 shares of Common Stock are
issuable from time to time pursuant to the terms of the Company's
outstanding Series A Convertible Preferred Stock and related
warrants issued to the holders of the Company's Series A
Convertible Preferred Stock and to the placement agent for such
stock. Upon issuance, the shares will be freely tradeable. In
addition, the Company intends to file a registration statement
covering the shares of Common Stock issuable under its Incentive
Plan and Directors Plan, pursuant to which such shares, when
issued, will be freely tradeable, except to the extent held by
officers and directors who are limited to resale by Rule 144.
The sale, or availability for sale, of substantial amounts of
Common Stock in the public market subsequent to this offering,
plus the offerings described above, could materially adversely
affect the market price of the Common Stock and could impair the
Company's ability to raise additional capital through the sale of
its equity securities or debt financing.
Effects of Delisting From Nasdaq SmallCap Market
If the Company fails to maintain the qualification for its Common
Stock to trade on the Nasdaq SmallCap Market, its Common Stock
could be delisted from Nasdaq. In such event, trading, if any,
in such securities would be thereafter be conducted in the over-
the-counter markets in the so-called "pink sheets" or the
National Association of Securities Dealer's "Electronic Bulletin
Board." Consequently, the liquidity of the Company's securities
would likely be impaired, not only in the number of shares which
could be bought and sold, but also through delays in the timing
of the transactions, reduction in security analysts' and the news
media coverage, if any, of the Company, and the lower prices for
the Company's securities than might otherwise prevail.
Penny Stock Regulation
In the event the Company's securities are delisted from the
Nasdaq SmallCap Market, as described above, the Company's
securities could become subject to the rules and regulations
under the Securities Exchange Act of 1934 relating to "penny
stocks" (the "Penny Stock Rule"), which impose additional sales
practice requirements on broker-dealers who sell such securities
to persons other than established customers and certain
institutional investors. Penny stocks generally are equity
securities with a price of less than $5.00 (other than securities
registered on certain national securities exchanges or authorized
for quotation on the Nasdaq system, provided that current price
and volume information with respect to transactions in that
security is provided by the exchange or system). For
transactions covered by the Penny Stock Rule, a broker-dealer
must, among other things, make a special suitability
determination for the purchaser and have received the purchaser's
written consent to the transaction prior to sale. Consequently,
the Penny Stock Rule may reduce the level of trading activity in
the secondary market for the Company's securities, may adversely
effect the ability of broker-dealers to sell the Company's
securities and may adversely affect the ability of purchasers in
this offering to sell any of the securities acquired hereby in
the secondary market.
RECENT BUSINESS ACQUISITIONS
In January 1997, the Company completed the acquisition of JBI,
and affiliate, franchisees of the Company, operating a total of
four stores in southern California. The total purchase price
paid was $770,000, including $120,000 related to a noncompetition
agreement with the former owners of JBI and was paid in part
through the forgiveness of notes receivable and other receivables
from JBI of approximately $486,000. The stores acquired were
closed in 1997 and 1998 (see "Management's Discussion and
Analysis" and Note 11 to the audited financial statements
included herein.)
On May 13, 1997 the Company acquired My Favorite Muffin Too,
Inc., a New Jersey corporation. MFM franchised and operated
muffin and bagel specialty retail stores concentrated primarily
in the Eastern United States and Florida, and had 60 franchise
and 5 company-operated units in operation. MFM was merged into
BAB Acquisition Corporation, a wholly-owned subsidiary of the
Company, with MFM being the surviving entity. The acquisition
through merger was completed by exchanging 150 shares of MFM
stock held equally by Owen Stern, Ruth Stern and Ilona Stern (the
"Sellers"), for 432,608 shares of the Company's common stock,
restricted as to transfer until January 1, 1999, and $259,000 in
cash to the Sellers. In addition to current liabilities, the
Company has assumed approximately $350,000 of MFM's existing bank
debt. The Company has retained two of the three Sellers as
employees of the Company pursuant to employment contracts,
through May 8, 2001 for Owen Stern, and through May 8, 2000 for
Ruth Stern. Total revenue of MFM was $2.7 million for the year
ended December 31, 1996. (See "Management's Discussion and
Analysis")
LOCATIONS
The following table sets forth the states and provinces in which
the Company's units were located as of November 30, 1997
(exclusive of 6 Company-owned units which were closed during the
first quarter of 1998):
<TABLE>
<CAPTION>
COMPANY
STATE/PROVINCE OWNED FRANCHISED LICENSED TOTAL
- --------------- ------- ---------- -------- -----
<S> <C> <C> <C> <C>
UNITED STATES:
California (i) 8 2 10
Colorado 8 8
Connecticut 5 5
Florida 9 6 15
Georgia 3 2 5
Illinois (ii) 3 44 47
Indiana 6 6
Iowa 7 7
Kansas 1 1
Kentucky (ii) 3 3
Massachusetts 1 1
Michigan 13 5 18
Minnesota 4 1 5
Nebraska (ii) 1 1 2
Nevada 3 5 8
New Jersey 2 15 10 27
New York 3 12 15
North Carolina 3 3
Ohio 2 12 14
Oregon 1 1
Pennsylvania 5 9 1 15
Rhode Island 2 2
South Carolina 1 1
Texas 5 5
Utah 2 2
Washington 2 2
West Virginia 1 1
Wisconsin 7 15 1 23
CANADA:
British Columbia 1 1 2
Ontario 3 3
----- ------ ----- -----
Total 28 182 47 257
===== ====== ===== =====
</TABLE>
(i) Does not include 3 Company-owned stores which were closed
during the first quarter of fiscal 1998.
(ii) Does not include 1 Company-owned store which was closed
during the first quarter of fiscal 1998.
STORE OPERATIONS
BIG APPLE BAGELS--Big Apple Bagels franchised and Company-owned
stores daily bake "from scratch" over 18 varieties of fresh
bagels and prepare up to 18 varieties of cream cheese spreads.
Licensed units under Host Marriott, and Choice Picks Food Courts,
serve the Company's par-baked frozen bagel products, freshly
baked daily. Stores also offer a variety of breakfast and lunch
bagel sandwiches, soups, various dessert items, and gourmet
coffees and other beverages. A typical Big Apple Bagels
franchise or Company-owned store is located within a three-mile
radius of at least 25,000 residents in an area with a mix of both
residential and commercial properties. The average Company-owned
or franchised store ranges from 1,500 to 2,000 square feet. The
Company's current store design is approximately 2,000 square
feet, with seating capacity for 30 to 40 persons and includes 750
square feet devoted to production and baking. A satellite store
is typically smaller than a production store, averaging 600 to
1,000 square feet. Although franchise stores may vary in size
from Company-owned stores, and from other franchise stores, store
layout is generally consistent. Licensed units are generally
located in airports, travel plazas, hotels, and universities.
MY FAVORITE MUFFIN--My Favorite Muffin franchised and Company-
owned stores bake 20-25 varieties of muffins daily, from over 400
recipes, plus a variety of bagels. They also serve gourmet
coffees, beverages and, at My Favorite Muffin and Bagel Caf,
locations, a variety of bagel sandwiches and related products.
While a number of MFM units are located in shopping mall
locations with minimal square footage of 400-800 square feet,
the typical strip mall prototype unit is approximately 2,000
square feet with seating for 30 to 40 persons. A typical MFM
franchise or Company-owned store is located within a three-mile
radius of at least 25,000 residents in an area with a mix of both
residential and commercial properties.
BREWSTER'S COFFEE--Brewster's Coffee franchised and Company-owned
units serve a variety of arabica bean coffees, both freshly
brewed and in bulk, and related products such as bagels, muffins
and other beverages. The typical Brewster's location is
approximately 1,500 square feet and offers seating for 20-30
persons and is generally located in high traffic urban or
suburban locations.
FRANCHISING
The Company requires payment of an initial franchise fee per
store, plus a 5% royalty on net sales. Additionally, Big Apple
Bagels ("BAB") franchisees are members of a national marketing
fund requiring a 2% contribution based on net sales. MFM
franchisees pay a 1% net sales contribution to a national
marketing fund. The Company currently requires a franchise fee of
$25,000 on a franchisee's first BAB or MFM store. The fee for
subsequent production stores is $20,000 and $15,000 for satellite
stores. The initial franchise fee for a franchisee's first
Brewster's store is $17,500, with a fee of $15,000 for the second
and third stores and $13,500 for the fourth store and any
additional stores.
The Company's franchise agreements provide a franchisee with the
right to develop one store at a specific location. Each franchise
agreement is for a term of ten years with the right to renew. A
franchisee is required to be in operation not later than ten
months following the signing of the franchise agreement.
Area development agreements, which may be granted to new or
existing franchisees, provide that a franchisee may open a
predetermined number of concept stores within a defined
geographic area (an "Area of Exclusivity"). The Area of
Exclusivity is negotiated prior to the signing of the area
development agreement and varies by agreement as to size of the
area, the number of BAB stores required, and the schedule for
store development and opening. The Company's current area
development fee is $5,000 per store to be developed. As
additional franchise agreements are executed, additional
franchise fees are collected. The area development fee is not
refundable if no franchise agreement is executed.
The Company is currently in the process of revising its Uniform
Franchise Offering Circular to provide for, among other things,
the opportunity for prospective franchisees to enter into a
preliminary agreement for their first production store. This
agreement enables a prospective franchisee a period of 60 days in
which to locate a site. The fee for this preliminary agreement
is $10,000. If a site is not located and approved by the
franchisor within the 60 days, the prospective franchisee will
receive a refund of $7,000. If a site is approved, the entire
$10,000 will be applied to toward the initial franchise fee. The
Company anticipates that this preliminary agreement will help to
increase the number of franchise agreements sold. See also
"Government Regulation."
The Company currently advertises its franchising opportunities at
franchise trade shows, directories, newspapers and business
opportunity magazines worldwide. In addition, a substantial
number of prospective franchisees contact the Company as a result
of patronizing an existing store.
In February 1997, the Company entered an agreement with Franchise
Mortgage Acceptance Company, LLC ("FMAC") of Greenwich,
Connecticut to provide financing to qualified existing
franchisees for the purpose of adding second or subsequent units.
FMAC has reserved a total of $25 million for the program, which
is expected to assist in increasing the number of units in the
Company's franchise system. Pursuant to the agreement, the
Company guarantees up to 10% of the amount funded by FMAC in each
12-month period commencing from the date the first financing is
funded. As of November 30, 1997, FMAC has advanced funds
totaling $438,000 to franchisees.
COMPETITION
The quick service restaurant industry is intensely competitive
with respect to product quality, concept, location, service and
price. There are a number of national, regional and local chains
operating both owned and franchised stores which may compete with
the Company on a national level or solely in a specific market or
region. The Company believes that because the industry is
extremely fragmented, there is a significant opportunity for
expansion in the bagel, muffin and coffee concept chains.
The Company believes that the most direct competitors of its
bagel concept units are Bruegger's, Chesapeake, and Einstein's,
all of which are also franchisors. There are several other
regional bagel chains with fewer than fifty stores, all of which
may be expected to compete with the Company. There is currently
not a major national competitor in the muffin business, but there
are a number of local and regional operators. Additionally, the
Company competes directly with a number of national, regional and
local coffee concept stores and brandnames.
The Company competes, and can be anticipated to compete, against
numerous small independently-owned bagel bakeries and fast food
restaurants, such as Dunkin' Donuts, that offer bagels and
muffins as part of their breakfast food offerings and supermarket
bakery sections. In particular, the Company's bagels compete
against Lenders Bagels and other brands of fresh and frozen
bagels offered in supermarkets. Certain of these competitors may
have greater product and name recognition and larger financial,
marketing and distribution capabilities than the Company. In
addition, the Company believes that the startup costs associated
with opening a retail food establishment offering similar
products on a stand-alone basis are competitive with the startup
costs associated with opening its concept stores and,
accordingly, such startup costs are not an impediment to entry
into the retail bagel, muffin or coffee businesses.
The Company believes that its stores compete favorably in terms
of taste, food quality, convenience, customer service, and value,
which the Company believes are important factors to its targeted
customers. Competition in the food service industry is often
affected by changes in consumer taste, national, regional, and
local economic and real estate conditions, demographic trends,
traffic patterns, the cost and availability of labor, consumer
purchasing power, availability of product, and local competitive
factors. The Company attempts to manage or adapt to these
factors, but not all such factors are within the Company's
control and such factors could cause the Company and some or all
of its area developers and franchisees to be adversely affected.
The Company competes for qualified franchisees with a wide
variety of investment opportunities in the restaurant business
and in other industries. The Company's continued success is
dependent to a substantial extent on its reputation for providing
high quality and value with respect to its service, products and
franchises, and this reputation may be affected not only by the
performance of Company-owned stores but also by the performance
of its franchise stores over which the Company has limited
control.
TRADEMARKS AND SERVICE MARKS
The trademarks and service marks "Big Apple Bagels," "Brewster's
Coffee" and "My Favorite Muffin" are registered under applicable
federal trademark law. These marks are licensed by the Company to
its franchisees pursuant to franchise agreements, and the Company
has licensed the "Big Apple Bagels" mark to Big Apple Bagels,
Inc., a corporation which is wholly-owned by Paul C. Stolzer, a
principal shareholder and a former director and president of the
Company. Mr. Stolzer currently serves as a consultant to the
Company.
The Company is aware of the use by other persons and entities in
certain geographic areas of names and marks which are the same as
or similar to the Company's marks. Some of these persons or
entities may have prior rights to those names or marks in their
respective localities. Therefore, there is no assurance that the
marks are available in all locations. It is the Company's policy
to pursue registration of its marks whenever possible and to
vigorously oppose any infringement of its marks.
GOVERNMENT REGULATION
The Company and its franchisees are required to comply with
federal, state and local government regulations applicable to
consumer food service businesses, including those relating to the
preparation and sale of food, minimum wage requirements,
overtime, working and safety conditions, and citizenship
requirements, as well as regulations relating to zoning,
construction, health, and business licensing. Each store is
subject to regulation by federal agencies and to licensing and
regulation by state and local health, sanitation, safety, fire
and other departments. Difficulties or failures in obtaining the
required licenses or approvals could delay or prevent the opening
of a new Company-owned or franchise store, and failure to remain
in compliance with applicable regulations could cause the
temporary or permanent closing of an existing store. The Company
believes that it is in material compliance with these provisions.
Continued compliance with these federal, state and local laws and
regulations is costly but essential, and failure to comply may
have an adverse effect on the Company and its franchisees.
The Company's franchising operations are subject to regulation by
the Federal Trade Commission (the "FTC") under the Uniform
Franchise Act which requires, among other things, that the
Company prepare and periodically update a comprehensive
disclosure document known as a Uniform Franchise Offering
Circular ("UFOC"), in connection with the sale and operation of
its franchises. In addition, some states require a franchisor to
register its franchise with the state before it may offer a
franchise to a prospective franchisee. The Company believes its
UFOCs, together with any applicable state versions or
supplements, complies with both the FTC guidelines and all
applicable state laws regulating franchising in those states in
which it has offered franchises.
The Company is also subject to a number of state laws, as well as
foreign laws (to the extent it offers franchises outside of the
United States), that regulate substantive aspects of the
franchisor-franchisee relationship, including, but not limited
to, those concerning termination and non-renewal of a franchise.
EMPLOYEES
As of November 30, 1997, the Company employed 537 persons. Of
these individuals, 483 work in the Company-owned stores and the
majority are part-time employees. The remaining employees are
responsible for oversight of franchising and Company-store
operations. In November 1997, the Chief Financial Officer
resigned from the Company. The Company is in the process of
hiring a qualified replacement. None of the Company's employees
is subject to any collective bargaining agreements and management
considers its relations with its employees to be good.
YEAR 2000 ISSUES
The year 2000 issue relates to the fact that computer software
often was written using two rather than four digits to represent
an applicable year; accordingly, software might recognize a date
using "00" as the year 1900 rather than as the year 2000. This
could result in a system failure or miscalculations causing
disruptions of operations.
The Company utilizes hardware and software systems which are
commercially available products and are year 2000 compliant. The
Company anticipates incurring certain costs related to the
upgrade and replacement of existing systems in the normal course
of business. These costs are not anticipated to be significant.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The Company's principal executive office, consisting of
approximately 7,300 square feet, is located in Chicago, Illinois
and is leased pursuant to two leases, expiring in March 2000 and
June 1999. The Company believes that these facilities will be
adequate to meet its needs for the remainder of the term of the
two leases. As a result of the My Favorite Muffin acquisition,
the Company assumed a lease on approximately 6,600 square feet of
office space used as the former MFM corporate headquarters,
expiring in September 2000. In October 1997, the Company entered
into 2 agreements to sublease the entire facility. These
sublease agreements expire in March 2000 and September 2000,
respectively. Additionally, the Company leases space for each
of its Company-owned stores. Lease terms for these stores are
generally for initial terms of five years and contain options for
renewal for one or more five-year terms. See Note 6 to the
Company's Consolidated Financial Statements contained herein for
further information.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
On April 16, 1996, the Company filed an arbitration action
against a franchisee alleging breach of its franchise agreement
for refusal to submit required sales reports and pay royalty fees
and contributions to the national marketing fund. The franchisee
filed suit in the Circuit Court of Cook County, Illinois against
the Company and its officers and directors on April 19, 1996. The
franchisee alleged that the Company misrepresented the initial
investment required to establish a store and made untrue and
unauthorized earnings claims in violation of the Illinois
Franchise Disclosure Act. Plaintiffs sought rescission of the
franchise agreement, damages of $600,000 and punitive damages in
the amount of $6,000,000. On May 28, 1996, management filed a
motion to stay litigation in order to compel the plaintiffs to
have their claims heard in arbitration as required by the
provisions of the franchise agreement. The hearing was held over
seven days and resulted in an award in favor of the Company. In
January 1998, the Company was awarded all past due royalty fees
and amounts owed to the national marketing fund plus accrued
interest thereon and the franchisees counterclaim was rejected.
The Company is in the process of enforcing the award in court.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
During the fourth quarter of the fiscal year ended November 30,
1997, no matter was submitted to a vote of security holders.
PART II
ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ---------------------------------------------------------------------
The following table sets forth the quarterly high and low sale
prices for the Company's Common Stock, as reported in The Nasdaq
Stock Market's Small-Cap Market for the two years ended November
30,1997. The Company's Common Stock is traded under the symbol
"BAGL." Prices reflect a three-for-two stock dividend paid on
April 26, 1996 to holders of record as of April 12, 1996.
<TABLE>
<CAPTION>
LOW HIGH
----- ----
<S> <C> <C>
YEAR ENDED NOVEMBER 30, 1996
First quarter.................... $3.17 $4.50
Second quarter................... 4.00 9.13
Third quarter.................... 6.25 11.75
Fourth quarter................... 6.75 9.00
YEAR ENDED NOVEMBER 30, 1997
First quarter.................... $3.13 $8.25
Second quarter................... 2.50 4.50
Third quarter.................... 2.50 3.63
Fourth quarter................... 1.06 3.63
</TABLE>
As of February 17, 1998, the Company's Common Stock was held of
record by 171 holders. Registered ownership includes nominees who
may hold securities on behalf of multiple beneficial owners. The
Company estimates that the number of beneficial owners of its
common stock at February 10, 1998 is 2,400, based upon information
provided by a proxy services firm.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its
Common Stock, and the Board of Directors currently intends to
retain all earnings, if any, for use in the Company's business
for the foreseeable future. Any future determination as to
declaration and payment of dividends will be made at the
discretion of the Board of Directors, subject to the existence of
any covenants restricting the payment of dividends.
RECENT SALES OF UNREGISTERED SECURITIES
On March 27, 1997, the Company authorized and issued a series of
convertible preferred stock which has liquidation and dividend
rights senior to that of common stock. See Notes 8 to the
Company's Consolidated Financial Statements included herein and
Exhibit 4.4 to the report on Form 10-QSB filed for the quarter
ended February 28, 1997 for further information.
On May 13, 1997, the Company issued a total of 432,608 shares of
Common Stock to acquire MFM. See Note 10 of the audited financial
statements included herein and Form 8-K filed with the
Commission on May 28, 1997 (as amended on July 23, 1997 and
December 15, 1997.)
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- ----------------------------------------------------------
The selected financial data contained herein have been derived
from the financial statements of the Company included elsewhere
in this Report on Form 10-KSB. The data should be read in
conjunction with the consolidated financial statements and notes
thereto.
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 such term is defined in the Private Securities
Litigation Reform Act of 1995). Because such statements include
risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking
statements, which reflect management's analysis only as of the
date hereof. Such statements should be read in light of the Risk
Factors enumerated herein as well as the other information
contained in this Report and other documents filed by the Company
with the Commission pursuant to the Securities Act of 1933 and
the Securities Exchange Act of 1934. 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
Since its inception in November 1992, the Company has grown to 28
Company-owned (excluding 6 units identified by management for
closing during the first quarter of 1998) and 229 franchised and
licensed units at the end of fiscal 1997 from 15 Company-owned
and 134 franchised and licensed units at the end of fiscal 1996.
System-wide revenues in fiscal 1997 exceeded $57 million compared
to $31.5 million in the year ago period. Further, the units
added in the acquisition of MFM, contributed approximately $12
million to system-wide sales in the last six months of fiscal
1997. This rapid expansion in operations significantly affects
the comparability of results of operations of the Company in
several ways, particularly in the significant increase in
Company-owned store revenues and related expenses.
The Company's revenues are derived primarily from the operation
of Company-owned stores, initial franchise fees and ongoing
royalties paid to the Company by its franchisees. Additionally,
the Company has significantly increased revenue derived from the
sale of licensed products as a result of purchasing trademarks
(My Favorite Muffin and Brewster's) and licensing contracts
(licenses with Host Marriott), and by directly entering into
licensing agreements (Choice Picks Food Courts, Oberweis Dairy
and Mrs. Fields Cookies). Additionally, the Company has generated
other revenue through the sale of store units to franchisees of
the Company. The significant increase in overall revenues (up
124% in fiscal 1997 over fiscal 1996 and up 597% over fiscal
1995) has reduced the dependence on the initial franchise fee as
a source of income.
On May 13, 1997, the Company completed the acquisition of MFM.
This acquisition added to the Company's existing product offering
a premium muffin product and additional points of distribution
for its branded bagel and coffee products. It is expected that
the introduction of MFM muffin products will enhance the revenue
potential of existing bagel stores and result in operating
leverage as corporate overhead is spread over additional units
(62 franchise and 7 Company-operated units at November 30, 1997.)
The Company has reduced the number of MFM employees, subleased
the office space which was formerly the MFM headquarters in New
Jersey, and has completed the integration of MFM operations into
its Chicago, Illinois headquarters. Since the process of
integration of MFM products into the Company's existing units
does not entail any significant increase in administrative
overhead (the Company already has sufficient infrastructure in
place to oversee franchisee and Company stores operations) it is
expected that the Company will experience improved profitability
in fiscal 1998 due to increased retail sales and royalty revenues
attributable to these products.
Rapid growth in Company-owned units occurred throughout fiscal
1996 and 1997 --- 13 units were added in fiscal 1996 and over 15
units were added in fiscal 1997 by both development and
acquisition. Management believes the Company did not realize the
full potential of expected margins from Company-owned store
operations during this period. New store operations suffer from
low revenues in the early start-up stages of operations and
inefficiencies due to continuing training activities of store-
level personnel. Similarly, as stores that are opened in the
early stages of entering into a specific geographic market, the
efficiencies of advertising, promotion and area management are
not reached and cause an additional drain on store-level
economics until a critical mass of stores is established in that
geographic market. Start-up costs related to expenditures
incurred prior to opening individual units, which are amortized
over the first year of operation of a store, also reduce
operating profitability during the early stages of store
operations. Stores added which were acquired and converted to
Company-owned units, while not generally affected by low early
stage revenues, also exhibit inefficiencies in early operations
due to initial staff and management turnover and related training
issues resulting in higher than normal costs.
During the fourth quarter of fiscal 1997, management identified
certain under-performing stores which were operating at a loss
and which, based on the estimated future cash flows, were
considered to be impaired. Four of the seven stores which were
considered to be impaired were located in the Southern California
market. In accordance with the Financial Accounting Standards
Board Standard No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of" and the
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
of Costs to Exit an Activity", management recorded a provision
for impairment of assets and store closures which totaled
approximately $1,837,000. Approximately $1,333,000 represents a
non-cash write-down of property, plant and equipment and goodwill
associated with these units and the remainder represents a
reserve for store closure costs. One store was closed during
fiscal 1997 and the remaining units were closed during the first
quarter of 1998. Management anticipates that the store closings
will not only improve cash flow from remaining Company-store
operations but will also improve the profitability of operations
overall. The 6 stores identified as impaired as of November 30,
1997, but which were not closed until fiscal 1998, are not included
as units in operation as the fair value of the assets has been
reclassified as "Assets Held for Resale" in the November 30, 1997
audited financial statements incorporated herein.
In September 1996, the Company signed an agreement to purchase
the operations of Chesapeake, an operator and franchisor of
approximately nine company-owned and 134 franchise Chesapeake
Bagel Bakery specialty bagel retail stores. This acquisition was
not completed due to the Company's inability to secure financing
on acceptable terms. As a result of the failure to complete this
acquisition, the Company recorded a write-off of approximately
$651,000 in the fourth quarter of fiscal 1996, consisting
primarily of accounting, legal, printing, placement agent
expenses and filing fees associated with the acquisition and a
placement of common stock which, if completed, would have
provided the required financing. Management believes that while
the uncompleted acquisition of Chesapeake diverted management and
operational attention during the second half of 1996, the
Company's existing operations and strategic acquisitions made in
1997, including the MFM acquisition noted above, have the
potential to replace the strategic advantage the Company believed
would have been obtained with Chesapeake acquisition.
With the increase in both franchise, licensed and Company-owned
operations and with the acquisition of MFM, the Company has
experienced increases in payroll, occupancy and overhead costs in
the corporate offices. At November 30, 1997, the Company had 54
employees at the corporate level who oversee operations of the
franchise, licensed and Company-owned store operations, up from
21 at the end of 1995, and 33 at the end of fiscal 1996. While
these costs have increased, they have decreased as a percentage
of total revenues, and management expects that these costs will
further decline as a percentage of revenue as additional
franchise and Company-owned units are added. Additionally, as
the Company approximately doubled the space at the corporate
headquarters in late 1996 through subletting an office suite
adjacent to the Company's existing offices, it is anticipated
that the Company will not require additional office facilities in
fiscal 1998. The Company believes it is in a position to leverage
selling, general and administrative expenses against increased
revenues anticipated in fiscal 1998.
RESULTS OF OPERATIONS
The following table sets forth, for the fiscal years 1997 and
1996, revenue by type and as a percentage of total revenue during
the year, along with the change from 1996 (in thousands):
<TABLE>
<CAPTION>
Year ended November 30,
-----------------------------------------
1997 1996 Inc.(Dec.)
-------------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Selected Revenue Data:
Company-owned stores..... $9,846 69.5% $3,484 55.1% $6,362
Royalty fees from
franchise stores....... 2,367 16.7% 1,403 22.2% 964
Franchise and area
development fees....... 1,005 7.1% 1,024 16.2% (19)
Licensing fees and
other income........... 948 6.7% 413 6.5% 535
------- ------ ------ ------ ------
Total $14,166 100.0% $6,324 100.0% $7,842
======= ====== ====== ====== ======
</TABLE>
FISCAL YEAR 1997 COMPARED TO FISCAL YEAR 1996
Total revenues increased 124% to $14,166,000 in 1997 from
$6,324,000 the prior year. This increase was driven primarily by
the increase in Company-owned store revenues which accounts for
69.5% of total revenue in 1997 up from 55.1% in the prior year.
The Company added 13 Company-owned units during the year bringing
the total to 28 in operation at November 30, 1997, exclusive of
those units identified as impaired. Royalty fees from franchise
stores increased to $2,367,000 in 1997 from $1,403,000
principally due to the addition of the 60 MFM franchised units in
May 1997. Franchise and area development fee revenue remained
relatively flat from the year-ago period and is attributed to
legal and geographical restrictions in selling franchise
agreements during the last half of fiscal 1996 while the Company
was involved in the acquisition of Chesapeake. For over six
months the Company was unable to complete franchise sales in
certain key markets while updating franchise offering circulars
and attempting to minimize territorial disputes with existing
Chesapeake area developers. Finally, licensing fees and other
income more than doubled in fiscal 1997 from the previous year as
the Company continued to develop various nontraditional channels
of distribution, including commissions received on the sale of
Brewster's Coffee to its franchisees and licensees, fees paid by
Host Marriott licensed units based on retail sales, and
commissions received from a third party commercial baker on sales
of par-baked Big Apple Bagels to all licensed units.
Food, beverage and paper costs incurred at the Company-owned
stores rose by 170.9% from the prior year compared to a 182.6%
increase in sales principally due to the greater number of units in
operation during the current fiscal year (34 units, including
those identified as impaired, at November 30, 1997 versus 15 at
November 30, 1996.) However, store payroll and other operating
expenses increased by over 234.2%. The Company is aggressively
working to improve store level profitability and accordingly, in
the fourth quarter, determined that it was necessary to close
stores that were generating negative cash flow and which, in
management's opinion, would not reach acceptable levels of
profitability within the foreseeable future. One such store was
closed in the fourth quarter of 1997 and the remaining six stores
were closed in fiscal 1998. Management is currently in the
process of selling equipment to franchisees and attempting to
sublease or otherwise eliminate its commitment under these
facility leases. Additionally, on November 30, 1997, the Company
sold two Company-owned units to an existing franchisee in the
Milwaukee, Wisconsin market. Subsequent to year end, the Company
sold one unit to a franchisee in the Lincoln, Nebraska market and
the other Company-owned store in that geographic market was
closed in 1998. Strategic decisions to close or sell certain
units have substantially been completed during the first quarter
of 1998; accordingly, management anticipates that Company-owned
store revenues should contribute more significantly to
profitability throughout fiscal 1998. Finally, as of February
28, 1998, over 75% of the remaining Company-owned units have now
been opened for greater than one year which is expected to lessen
certain expenses related to employee training and related start-
up inefficiencies.
As identified above, the decision to close under-performing
stores resulted in the recognition of a fourth quarter 1997
charge of approximately $1,837,000, or $0.24 per share for the
fourth quarter ($0.25 per share for the fiscal year).
Approximately 73% of this charge to net income, or $1,333,000,
represents a non-cash write-down of property, plant and equipment
and associated goodwill to fair market value. The remainder
represents a reserve established to accrue for future
noncancelable lease obligations plus the costs to close the
stores. See Note 11 to the audited financial statements included
herein.
Selling, general and administrative expenses increased by
$3,248,000 to $6,566,000 but continue to decrease as a percentage
of overall revenues. The increasing base of Company-owned and
franchised stores has resulted in a favorable trend with respect
to overhead costs --- fiscal year 1997 costs represented 46.4% of
revenues, fiscal year 1996 costs represented 52.5% of revenues
and fiscal year 1995 costs represented 97.4 of revenues.
Payroll-related expenses increased by $721,000. Depreciation and
amortization increased by 293% due to the significant increase in
Company-owned store depreciation and amortization and the
amortization of intangible assets acquired including goodwill,
franchise contract and other contract rights, non-competition
agreements, and trademarks acquired in the Company's various
acquisitions. Other selling, general and administrative expenses
increased 136.7% due to the increase in office space at the
corporate headquarters as well as insurance and other expenses
associated with the support of the increased corporate headcount.
Excluding depreciation and amortization, fiscal 1997 selling,
general and administrative expenses were less than 35.8% of total
revenues compared to 46.4% in the year ago period as the Company
continues to experience operating leverage from its increasing
revenue base.
Loss from operations was $3,406,000 in fiscal 1997 versus
$621,000 in fiscal 1996. Interest income decreased to $75,000 in
fiscal 1997 from $317,000 in the prior year due to the lower
average cash and cash equivalent balances on hand throughout the
current year. In 1996, the Company had just received the
proceeds from its initial public offering and invested the
proceeds in interest bearing securities generating significant
interest income. Interest expense was $75,000 during 1997 versus
$4,000 in 1996 as a result of the Company's borrowing on the
Company's credit facility.
The net loss totaled $3,402,000 in fiscal 1997 versus a net loss
of $321,000 for fiscal 1996. During fiscal 1997, the Company
issued 87,710 shares of convertible preferred stock (the
Preferred Stock) and recorded preferred dividends associated with
this security of over $648,000 resulting in a net loss
attributable to common shareholders of $4,050,000 for the fiscal
year. Approximately $387,000 of the preferred dividend is
attributable to the 15% discount available to holders of the
Preferred Stock in acquiring Common Stock upon ultimate
conversion. Such discounts result in dividends under
generally accepted accounting principles and no additional
preferred dividends will accumulate related to this conversion
discount. The Company was additionally obligated to issue
warrants to purchase two shares of Common Stock for each share of
Preferred Stock on August 1, 1997. The value of these two-year
warrants was additionally recorded as a preferred stock dividend
accumulated of $138,000. As fully recognized in August 1997, no
additional preferred dividends will accumulate related to either
the conversion discount or the warrants. See Note 9 of the
audited financial statements included herein.
Net loss per share for fiscal 1997 was $0.55 per share ($0.53
diluted loss per share) versus net loss per share for fiscal 1996
of $0.04 per share ($0.04 diluted loss per share.)
On a pro forma basis, had the acquisitions of MFM, JBI,
Strathmore, BUI and Danville occurred at the beginning of fiscal
1996, revenues for fiscal 1997 would have been $15,421,000
representing a 29% increase from $11,985,000 in fiscal 1996,
attributable primarily to the increase in franchised and Company-
owned units acquired in MFM. Net loss on a pro forma basis for
1997 and 1996 would have been $3,500,000 and $616,000,
respectively. This increase is related to the write-off of long-
lived assets recorded in fiscal 1997 and other factors noted
above, as well as inefficiencies in selling, general and
administrative expenses implicit in comparing on a pro forma
basis costs incurred by entities acquired prior to the
acquisitions by the Company. Pro forma net loss per share would
have been approximately $0.54 and $0.08 for the fiscal years
ended November 1997 and 1996, respectively.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended November 30, 1997, cash used for operating
activities was $1,220,000 compared to $69,000 provided from operating
activities in the prior fiscal year. Cash used in operating
activities in fiscal 1997 is attributable to an overall increase in
accounts receivables, inventories, and prepaids due to the increased
number of Company-owned and franchised stores in operation.
Additionally, notes receivable obtained in the sale of Company-owned
stores and in exchange for a master franchise agreement contributed
to the overall use of cash in operating activities.
Cash used for investing activities during 1997 totaled $3,814,000
which consisted primarily of $3,795,000 used for the purchase of
property, plant and equipment associated with the acquisition and
development of 20 Company-owned units. During fiscal 1996, cash
used for investing activities of $6,422,000 of which $2,512,000
was used in the purchase of property, plant and equipment
primarily for new Company-owned store construction during the
year. Business acquisitions during the year required $2,474,000
in cash, including $991,000 related to BUI, $880,000 related to
Strathmore and $603,000 related to Danville. The purchase of the
Brewster's trademark and other rights required $171,000 in fiscal
1996.
Financing activities provided a total of $3,261,000 during fiscal
1997. In April 1997, the Company completed the sale of 87,710
shares of $25.00 Preferred Stock in a private placement to
qualified investors, netting approximately $2 million after
placement agent commissions and fees. Additionally, in April
1997, the company entered into a $2 million secured line of
credit agreement (the "Credit Facility") with a bank expiring in
December 1998. Maximum borrowing under the credit facility is
limited to a borrowing base of 80% of accounts receivable under
90 days and 40% of equipment costs. Interest is payable monthly
at prime plus 1% (9.5% at November 30, 1997) with principal due
upon maturity at December 31, 1998. In July 1997, the Company
borrowed $356,000 on its Credit Facility to retire debt and other
borrowings assumed in connection with the MFM acquisition. At
November 30, 1997, the Company had $1,676,000 outstanding against
the Credit Facility.
The Credit Facility is secured by substantially all of the assets
of the Company and requires, among other things, that the Company
maintain minimum net worth of $8 million and a compensating cash
balance of $250,000. In February 1998, the Company fell below
the compensating cash balance requirement and obtained a waiver
from the bank to lower the requirement to $150,000 for 60 days
expiring April 25, 1998. Management has implemented a plan to
increase the cash balances and to remain within compliance of the
compensating cash provision of the Credit Facility. This plan
includes improvements in cash flow associated with store
closures, proceeds from the sale of stores or other assets,
reduction of general and administrative expenses, increased
collection efforts and potential debt or equity investments by
significant shareholders. Management believes these efforts will be
sufficient to ensure compliance with the compensating cash balance
covenants by April 25, 1998 and for the remainder of the fiscal year.
Financing activities provided a total of $837,000 in 1996, due
principally to the exercise in January of the underwriter's over-
allotment option from the Company's initial public offering which
provided the Company $882,000 after expenses. This amount was
reduced by the repayment of long-term obligations during the year
of $36,000.
The Company has implemented a strategy which includes closing
under-performing Company-owned units, the sale of equipment and
fixtures located at these units to its franchisees or to third
parties, and the sale of other Company-owned units located in
certain geographic markets to franchisees. This action is
anticipated to improve profitability and cash flow from the
remaining Company-owned units and to generate working capital.
The Company believes that improved cash flow from existing
operations, the remaining availability on its credit facility,
increased collection efforts and the sale of certain assets will
be sufficient to fulfill its working capital requirements for the
foreseeable future.
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
The Consolidated Financial Statements and Report of Independent
Auditors is included immediately following.
Consolidated Financial Statements
BAB Holdings, Inc.
Years ended November 30, 1997 and 1996
with Report of Independent Auditors
<PAGE>
BAB Holdings, Inc.
Consolidated Financial Statements
Years ended November 30, 1997 and 1996
Contents
Report of Independent Auditors
Consolidated Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
<PAGE>
Report of Independent Auditors
The Shareholders and Board of Directors
BAB Holdings, Inc.
We have audited the accompanying consolidated balance sheets of
BAB Holdings, Inc. as of November 30, 1997 and 1996, and the
related consolidated statements of operations, shareholders'
equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial
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 assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of BAB Holdings, Inc. at November 30, 1997 and
1996, and the consolidated results of its operations and its cash
flows for the years then ended, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
February 27, 1998
<PAGE>
<TABLE>
<CAPTION>
BAB Holdings, Inc.
Consolidated Balance Sheets
NOVEMBER 30
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents,
including restricted cash of
$276,678 and $149,232, respectively $ 389,896 $ 2,163,293
Trade accounts receivable, net of allowance
for doubtful accounts of $217,000
and $30,000, respectively 988,992 471,303
National Marketing Fund contributions
receivable 382,432 96,121
Inventories 344,424 103,314
Notes receivable 203,230 556,143
Amounts due from affiliate - 36,347
Deferred franchise costs 76,805 43,576
Assets held for sale 170,500 -
Prepaid expenses and other current assets 422,913 216,176
----------- -----------
Total current assets 2,979,192 3,686,273
Property, plant, and equipment:
Leasehold improvements 2,690,940 1,064,648
Furniture and fixtures 686,542 435,277
Equipment 2,513,289 1,335,719
Construction in progress 80,830 997,383
----------- -----------
5,971,601 3,833,027
Less: Accumulated depreciation 882,693 299,315
----------- -----------
5,088,908 3,533,712
Notes receivable 785,065 288,184
Patents, trademarks, and copyrights,
net of accumulated amortization
of $56,025 and $21,752, respectively 527,140 545,177
Goodwill, net of accumulated amortization
of $101,629 and $27,924, respectively 2,599,393 2,511,295
Franchise contract rights, net of
accumulated amortization of $60,442 2,011,842 -
Other assets, net of accumulated amortization
of $424,855 and $147,090, respectively 635,706 583,346
----------- -----------
$14,627,246 $11,147,987
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
<TABLE>
<CAPTION>
NOVEMBER 30
1997 1996
------------ ------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,603,661 $ 1,056,548
Accrued liabilities 768,977 228,947
Reserve for closed store expenses 504,203 -
Accrued professional and other services 227,895 289,567
Unexpended National Marketing Fund
contributions 522,722 145,383
Current portion of long-term debt 26,143 6,375
Deferred franchise fee revenue 642,000 624,400
------------ ------------
Total current liabilities 4,295,601 2,351,220
Long-term debt, less current portion 1,676,895 1,758
Shareholders' equity:
Common stock, no par value; 20,000,000
shares authorized,7,981,630 shares and
7,413,069 shares issued, respectively,
and 7,711,630 and 7,143,069
outstanding, respectively 10,908,062 9,218,522
Preferred stock, $0.01 par value; 3,880,000
shares and 4,000,000 shares authorized,
respectively, and no shares issued
and outstanding - -
Series A Preferred stock, $25.00 par value,
120,000 shares authorized, 78,710 shares
issued and outstanding 1,862,035 -
Treasury stock at cost, 270,000 shares (17,500) (17,500)
Additional paid-in capital 1,368,619 1,010,167
Accumulated deficit (5,466,466) (1,416,180)
------------ ------------
Total shareholders' equity 8,654,750 8,795,009
------------ ------------
$ 14,627,246 $ 11,147,987
============ ============
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
BAB Holdings, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED NOVEMBER 30
1997 1996
----------- -----------
<S> <C> <C>
REVENUES
Net sales by Company-owned stores $ 9,846,020 $ 3,484,319
Royalty fees from franchised stores 2,367,220 1,402,839
Franchise and area development fees 1,005,545 1,023,331
Licensing fees and other income 947,658 413,109
----------- -----------
14,166,443 6,323,598
OPERATING COSTS AND EXPENSES
Food, beverage, and paper costs 3,309,504 1,221,826
Store payroll and other operating expenses 5,859,322 1,753,397
Provision for impairments and store closures 1,836,981 -
Costs of uncompleted business acquisition - 650,922
Selling, general, and administrative expenses:
Payroll-related expenses 2,058,644 1,337,587
Advertising and promotion 603,373 365,387
Professional service fees 514,319 373,614
Franchise-related expenses 232,964 157,990
Depreciation and amortization 1,490,329 379,266
Other 1,666,659 704,228
----------- -----------
6,566,288 3,318,072
----------- -----------
17,572,095 6,944,217
----------- -----------
Loss from operations (3,405,652) (620,619)
Interest income 74,513 316,855
Interest expense (74,651) (4,530)
Other income (expense) 3,701 (12,550)
----------- -----------
Net loss (3,402,089) (320,844)
Preferred stock dividends accumulated (648,197) -
----------- -----------
Net loss attributable to common
shareholders $(4,050,286) $ (320,844)
=========== ===========
Loss per share $ (0.55) $ (0.04)
=========== ===========
Fully diluted loss per share $ (0.53) $ (0.04)
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
BAB Holdings, Inc.
Consolidated Statements of Shareholders' Equity
SERIES A
COMMON STOCK PREFERRED STOCK TREASURY STOCK
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------------- ---------------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Balance as of
November 30, 1995 6,772,038 $7,903,183 -- $ -- (270,000) $(17,500)
Bond payable
conversion 75,060 190,989 -- -- -- --
Issuance of common
stock 382,500 882,350 -- -- -- --
Cashless exercise of
investor warrant 133,471 -- -- -- -- --
Issuance of common
stock in
acquisitions 50,000 242,000 -- -- -- --
Issuance of
stock options
in acquisitions -- -- -- -- -- --
Net loss -- -- -- -- -- --
----------- ---------- ---- --------- -------- -------
Balance as of
November 30, 1996 7,413,069 9,218,522 -- -- (270,000) (17,500)
Issuance of common
stock in
acquisitions 458,219 1,441,355 -- -- -- --
Termination of options
issued in connection
with acquisition -- -- -- -- -- --
Issuance of
preferred stock -- -- 87,710 1,558,519 -- --
Issuance of warrants -- -- -- -- -- --
Preferred dividend
accumulated -- -- -- 510,668 -- --
Conversion of
preferred to
common stock 110,342 248,185 (9,000) (207,152) -- --
Net loss -- -- -- -- -- --
---------- ---------- ------ ---------- ------ ------
Balance as of
November 30, 1997 7,981,630 $10,908,062 78,710 $1,862,035 (270,000)$(17,500)
========== =========== ====== ========== ======== =======
</TABLE>
(WIDE TABLE CONTINUED FROM ABOVE)
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN ACCUMULATED
CAPITAL DEFICIT TOTAL
----------- ----------- -----------
<S> <C> <C> <C>
Balance as of November 30, 1995 $ -- $(1,095,336) $6,790,347
Bond payable conversion -- -- 190,989
Issuance of common stock -- -- 882,350
Cashless exercise of investor
warrant -- -- --
Issuance of common stock in
acquisitions -- -- 242,000
Issuance of stock options in
acquisitions 1,010,167 -- 1,010,167
Net loss -- (320,844) (320,844)
----------- ----------- -----------
Balance as of November 30, 1996 1,010,167 (1,416,180) 8,795,009
Issuance of common stock
in acquisitions -- -- 1,441,355
Termination of options issued
in connection with
acquisition (125,000) -- (125,000)
Issuance of preferred stock 386,956 -- 1,945,475
Issuance of warrants 137,529 (137,529) --
Preferred dividends accumulated -- (510,668) --
Conversion of preferred to
common stock (41,033) -- --
Net loss -- (3,402,089) (3,402,089)
----------- ----------- -----------
Balance as of November 30, 1997 $1,368,619 $(5,466,466) $ 8,654,750
=========== =========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
<TABLE>
<CAPTION>
BAB Holdings, Inc.
Consolidated Statements of Cash Flows
YEAR ENDED NOVEMBER 30
1997 1996
----------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(3,402,089) $(320,844)
Adjustments to reconcile net loss to net cash
(used for) provided by operating activities:
Depreciation and amortization 1,490,329 379,266
Provision for impairment and closure 1,836,981 -
Deferred preopening store cost (240,927) (142,867)
Other - 11,045
Changes in operating assets and liabilities:
Trade accounts receivable (432,604) (447,293)
National Marketing Fund contributions
receivable (245,779) (69,326)
Inventories (211,614) (7,926)
Deferred franchise costs (21,319) (18,338)
Notes receivable (138,632) (3,682)
Prepaid expenses and other assets (215,653) (180,623)
Amounts due from affiliate (88,653) (18,321)
Accounts payable 176,318 672,083
Accrued professional and other services (178,331) 184,567
Accrued liabilities 75,157 121,411
Unexpended National Marketing Fund
franchisee contributions 358,840 87,820
Deferred franchise fee revenue 17,600 (178,100)
---------- ---------
Net cash (used for) provided by
operating activities (1,220,376) 68,872
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
<PAGE>
<TABLE>
<CAPTION>
BAB Holdings, Inc.
Consolidated Statements of Cash Flows (continued)
YEAR ENDED NOVEMBER 30
1997 1996
------------ ------------
<S> <C> <C>
INVESTING ACTIVITIES
Purchases of property, plant and equipment $(3,679,705) $(2,512,472)
Sale of property, plant and equipment 57,400 -
Purchase of Bagels Unlimited - (990,874)
Purchase of Strathmore - (879,566)
Purchase of Danville - (602,988)
Purchase of MFM (115,551) -
Purchase of trademarks (16,236) (171,396)
Purchases of other assets (120,000) (143,765)
Loan disbursements (74,201) (1,254,196)
Loan repayments 77,748 183,578
Other 56,440 (50,171)
----------- -----------
Net cash used for investing activities (3,814,105) (6,421,850)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock 2,192,750 -
Payment of preferred stock issuance costs (247,275) -
Proceeds from issuance of common stock - 1,020,000
Payment of common stock issuance costs - (137,650)
Borrowing on line of credit 1,675,975 -
Debt repayments (364,037) (35,928)
Other 3,671 (9,160)
----------- -----------
Net cash provided by financing activities 3,261,084 837,262
----------- -----------
Net decrease in cash and cash equivalents (1,773,397) (5,515,716)
Cash and cash equivalents at beginning of year 2,163,293 7,679,009
----------- -----------
Cash and cash equivalents at end of year $ 389,896 $ 2,163,293
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<PAGE>
BAB Holdings, Inc.
Notes to Consolidated Financial Statements
1. Basis of Presentation
BAB Holdings, Inc. (the Company) is an Illinois Corporation
incorporated on November 25, 1992. The Company has four wholly
owned subsidiaries, BAB Operations, Inc. (Operations), BAB
Systems, Inc. (Systems), Brewster's Franchise Corporation (BFC),
and My Favorite Muffin Too, Inc. (MFM). Systems was incorporated
on December 2, 1992, and was primarily established to franchise
"Big Apple Bagels" specialty bagel retail stores. Systems has a
wholly owned subsidiary, Systems Investments, Inc. (Investments),
which was created to operate the first Company-owned Big Apple
Bagels store, which, until December 1995, also operated as the
franchise training facility. Investments also owned a 50%
interest in a joint venture which operated a franchise satellite
store. During fiscal 1997, the stores operated by Investments
and by the joint venture were sold and are currently operating as
franchised stores. Operations was formed on August 30, 1995,
primarily to operate Company-owned stores, currently, "Big Apple
Bagel" and "Brewster's Coffee" concept stores, including one
which currently serves as the franchise training facility. BFC
was established on February 15, 1996, to franchise "Brewster's
Coffee" concept coffee stores. MFM, a New Jersey Corporation,
was acquired on May 13, 1997. MFM franchises and operates
Company-owned "My Favorite Muffin" concept muffin stores.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its direct and indirect wholly owned subsidiaries.
All intercompany accounts and transactions have been eliminated
in consolidation. The joint venture was accounted for using the
equity method.
Cash Equivalents
The Company classifies as cash equivalents all highly liquid
investments, primarily composed of money market mutual funds,
certificates of deposit, and government agency notes, which are
convertible to a known amount of cash and carry an insignificant
risk of change in value.
Inventories
Inventories are valued at the lower of cost, determined on a
first in, first out (FIFO) basis, or market.
Leasehold Improvements and Equipment
Leasehold improvements and equipment are stated at cost, less
accumulated depreciation. Depreciation is calculated on the
straight-line method over the estimated useful lives of the
assets. Estimated useful lives for the purposes of depreciation
are: leasehold improvements - ten years or term of lease if
less; machinery, equipment and fixtures - five to seven years.
Intangible Assets
The Company's intangible assets consist primarily of patents,
trademarks, and copyrights, organization costs, contract rights,
noncompetition agreements, and goodwill. Organization costs are
primarily incorporation fees and legal fees associated with
initial Uniform Franchise Offering Circulars related to
operations and are being amortized over five years. Patents,
trademarks, and copyrights are being amortized over 17 years.
Franchise contract rights acquired in the MFM acquisition are
amortized over 20 years. Contract rights allocated to license
agreements assumed by the Company in the acquisition of
Strathmore Bagels Franchise Corporation are being amortized over
8.5 years, the remaining life of the contract. Noncompetition
agreements are amortized over the term of the agreements, which
is six years. Goodwill recorded as a result of acquisitions
described in Note 10 is being amortized over 40 years.
Amortization expense recorded in the accompanying consolidated
statements of operations for the years ended November 30, 1997
and 1996 was $549,640 and $164,956, respectively.
Stock Options
The Company uses the intrinsic method to account for stock
options granted for employees and directors. No compensation
expense is recognized for stock options because the exercise
price of the option is at least equal to the market price of the
underlying stock on the grant date. Stock options granted as
consideration in purchase acquisitions during 1996 have been
recorded as an addition to additional paid-in capital in the
accompanying balance sheet based on the fair value of such
options on the date of the acquisition.
Deferred Franchise Fee Revenues and Costs
The Company recognizes franchise fee revenue upon the opening of
a franchise store. Direct costs associated with the franchise
sales are deferred until the franchise fee revenue is recognized.
These costs include site approval, construction approval,
commissions, blueprints, purchase of cash registers, and training
costs.
Area development agreement revenue is recognized on a pro rata
basis as each store covered by the agreement opens. At the
termination of an agreement, any remaining deferred franchise and
area development agreement revenue is recognized as such amounts
are not refundable.
In addition to Company-operated and franchised stores, the
Company acts as licensor of "Big Apple Bagels" units owned and
operated primarily by Host Marriott Services (Host Marriott).
Included below in "licensed units" are these units located
primarily in airport and travel plazas. In fiscal 1997, the
Company opened additional units pursuant to other licensing
arrangements. The Company derives a licensing fee from certain
sales at these units as well as a sales commission from the sale
of par-baked bagels to these units by a third-party commercial
bakery.
Stores which have been opened and unopened stores for which an
agreement has been executed and franchise at November 30, 1997 or
area development fees collected are as follows (excludes 6
Company-owned stores at November 30, 1997 which were closed
subsequent to year end (see Note 11)):
<TABLE>
<CAPTION>
November 30
1997 1996
---- ----
<S> <C> <C>
Stores opened:
Company-owned 28 15
Franchisee-owned 182 99
Licensed 47 35
---- ----
257 149
Unopened stores:
Franchise agreement 25 26
Area development agreement 28 39
---- ----
53 65
---- ----
310 214
==== ====
</TABLE>
Advertising Costs
The Company expenses advertising costs as incurred. Advertising
expense was $339,496 and $179,659 in 1997 and 1996, respectively.
Included in advertising expense was $55,733 and $41,928 in 1997
and 1996, respectively, related to the Company's franchise
operations.
Net Loss Attributable to Common Share
All share information presented has been adjusted for the three-
for-two stock split effected in the form of a 50% dividend which
occurred in April 1996. The primary calculation of net loss
attributable to common share is based on the net loss
attributable to common shareholders and the weighted-average
number of common shares outstanding during the period. The
primary calculation of net loss attributable to common share does
not include the convertible preferred stock, because they are not
common stock equivalents. The fully diluted calculation of net
loss attributable to common share assumes conversion at the
beginning of the period of any convertible security converted
during the period. Accordingly, the net loss attributable to
common shareholders was adjusted for preferred dividends
accumulated on securities converted during the period.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Reclassification
Certain 1996 amounts have been reclassified to reflect 1997
presentation.
New Accounting Pronouncement
The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standard No. 128 "Earnings Per Share" (the
Standard), which is required to be adopted in both interim and
annual financial statements for periods ending December 15, 1997.
At that time, the Company will be required to change the method
presently used to compute earnings per share and to restate all
prior period amounts. The Standard replaced primary and fully
diluted earnings per share with basic and diluted earnings per
share. The impact of the Standard is not expected to be
material.
3. Restricted Cash
Systems is required by certain states to maintain franchise and
area development fees in escrow accounts until the related
franchise stores commence operations. At November 30, 1997 and
November 30, 1996, these accounts totaled $20,000 and $63,500,
respectively.
Systems established the National Marketing Fund (Fund) during
1994. Both franchised and Company-owned Big Apple Bagels stores
are required to contribute to the Fund based on their net sales
and in turn are reimbursed for a portion of media advertising
placed in their local markets up to a maximum equal to the amount
they contributed. At November 30, 1997 and 1996, the Fund's cash
balance was $256,678 and $85,732, respectively.
Both franchised and Company-owned MFM stores are required to
contribute to the MFM National Marketing Fund (MFM Fund) based on
their net sales. These monies are then used in the production
and creation of advertising materials and Media placement. At
November 30, 1997, the MFM Fund's cash balance was $8,764.
4. Income Taxes
There were no provisions for income taxes during the years ended
November 30, 1997 and 1996, due to net operating losses incurred
during those periods. The reconciliation of the income tax
benefit computed at the federal statutory rate of 34% and the
provision for income taxes is as follows:
<TABLE>
<CAPTION>
Year ended November 30
1997 1996
----------- ---------
<S> <C> <C>
Income tax benefit computed at
federal statutory rate $(1,156,710) $ (109,087)
State income tax benefit, net
of federal tax benefit (163,913) (15,458)
Permanent differences on debt
financing obtained (1,748) (1,748)
Other permanent differences 22,584 1,046
Valuation allowance against
net deferred tax asset 1,299,787 125,247
---------- ---------
Provision for income taxes $ - $ -
========== =========
</TABLE>
There was no current income tax expense for the years ended
November 30, 1997 and 1996, due to the Company incurring net
operating losses for tax purposes during each of those two years.
No deferred taxes have been reflected in the consolidated
statements of operations because the Company has fully reserved
the tax benefit of net deductible temporary differences and
operating loss carryforwards due to the fact that the likelihood
of realization of the tax benefits cannot be established. The
Company did not pay any income taxes during the years ended
November 30, 1997 and 1996.
Deferred tax assets (liabilities) are as follows:
<TABLE>
<CAPTION>
November 30
1997 1996
---------- --------
<S> <C> <C>
Franchise fee revenue $ 216,615 $ 249,760
Net operating loss carryforwards 1,617,089 350,464
Franchise costs 32,102 74,979
National Marketing Fund net contributions 99,638 19,664
Allowance for uncollectible accounts 108,392 4,000
Depreciation (171,017) (94,741)
Start-up costs (17,807) (21,092)
Other (2,085) 106
--------- --------
1,882,927 583,140
Valuation allowance (1,882,927) (583,140)
--------- -------
$ - $ -
========= =======
</TABLE>
At November 30, 1997, the Company has cumulative net operating
loss carryforwards expiring between 2008 and 2012 for U.S.
federal income tax purposes of approximately $4,166,000. The net
operating loss carryforwards are subject to limitation in any
given year as a result of the Company's initial public offering
(see Note 8) and may be further limited if certain other events
occur.
5. Long-Term Obligations
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
November 30
1997 1996
-------- --------
<S> <C> <C>
Secured line of credit payable to
bank, due December 31, 1998,
at an interest rate of prime
plus 1% $1,657,975 $ -
Capital lease obligations,
various rates 31,220 -
Unsecured note payable, principal
payments due monthly at an
interest rate of 10% 13,843 -
Other - 8,133
--------- ---------
1,703,038 8,133
Less: Current portion 26,143 6,375
--------- ---------
Long-term debt, net of current portion $1,676,895 $ 1,758
========= =========
</TABLE>
The Company has a secured $2 million line of credit facility with
a bank which expires December 31, 1998. Maximum borrowing under the line
is limited to 80% of accounts receivable under 90 days and 40% of
equipment and furniture and fixtures. Interest is payable monthly at
prime plus 1% (9.5% at November 30, 1997), with principal due upon
maturity at December 31, 1998. In July 1997, the Company borrowed
approximately $330,000 on the line of credit to repay debt plus accrued
interest acquired in the MFM acquisition (see Note 10). At November 30,
1997, the Company had borrowed $1,657,975 on the line of credit.
The line of credit is secured by substantially all of the assets of
the Company and requires, among other things, that the Company maintain
minimum net worth of $8 million and a compensating cash balance of
$250,000. In February 1998, the Company fell below the compensating cash
balance requirement and obtained a waiver from the bank to lower the
requirement to $150,000 for 60 days expiring April 25, 1998. Management
has implemented a plan to increase the cash balances and to remain within
compliance of the compensating cash provision of the line of credit.
This plan includes improvements in cash flow associated with the store
closures (see Note 11), proceeds from the sale of stores or other assets,
reduce general and administrative expenses, increase collection efforts
and potential debt or equity investments by significant shareholders.
Management believes that these efforts will be sufficient to ensure
compliance with the compensating cash balance covenant by April 25, 1998
and for the remainder of the fiscal year.
In fiscal 1996, the Company had outstanding 8% unsecured
convertible bonds due July 1, 2002. The bonds were convertible
into shares of common stock at the conversion ratio of one share
for every $2.67 of principal outstanding. Among other terms of
the issue, the Company had the option of calling outstanding
bonds at any time during the term, subject to certain redemption
notice requirements. On December 29, 1995, the Company notified
the remaining bondholders of its intent to redeem the outstanding
principal balance of the issue. Bondholders representing $200,160
of principal elected to convert their interests to common stock
pursuant to the terms of bonds, resulting in the issuance of 75,060
shares of common stock. The remaining outstanding principal was
retired by the payment by the Company of approximately $31,000 to
bondholders in February 1996.
As of November 30, 1997, annual maturities on long-term
obligations are due as follows: $26,143 in 1998, $1,666,941 in
1999 and $9,954 in 2000. Interest paid for the years ended
November 30, 1997 and 1996, was $55,188 and $4,530, respectively.
In February 1997, Systems entered into an agreement with a finance
company to provide financing to qualifying franchisees for the purpose
of adding second or subsequent units. The program is administered by
the finance company; however, Systems has the final right of approval
over individual applicants. Systems has provided a guarantee of
borrowings up to a maximum of 10% of the total amount financed in each
12-month period under the program. As of November 30, 1997, $438,000
has been advanced to franchisees under this program.
6. Lease Commitments
The Company rents its office and Company-owned store facilities
under leases which require it to pay real estate taxes,
insurance, and general repairs and maintenance on these leased
facilities. Rent expense for the years ended November 30, 1997
and 1996, was $955,693 including contingent rental expense of
$26,600 less sublease income of $46,109 and $230,480,
respectively. At November 30, 1997, future minimum annual rental
commitments under leases, net of sublease income of $126,554 in
1998, $138,059 in 1999, $119,817 in 2000 and $61,338 in 2001 are
as follows:
<TABLE>
<S> <C>
1998 $ 962,254
1999 977,248
2000 825,526
2001 676,609
2002 405,431
Thereafter 907,833
---------
$4,754,901
=========
7. Noncash Transactions
During 1996, the Company converted $190,989 of bonds, net of bond
issue costs, to shares of common stock (see Note 5).
On May 1, 1996, the Company issued 50,000 shares of common stock
and an option to purchase 100,000 additional shares of common
stock valued, in total, at approximately $392,000 and canceled
notes and other receivables totaling approximately $145,000 as a
portion of consideration of the purchase of several bagel stores
owned and operated by a franchisee (see Notes 8 and 10).
On May 22, 1996, the Company issued an option to purchase 625,000
shares of common stock valued at $860,000 in connection with the
purchase of various contract rights related to licensed units
owned and operated by Host Marriott (see Notes 8 and 10).
On October 18, 1996, the Company canceled notes and other
receivables totaling approximately $165,000 in connection with
the purchase of all contract rights and other assets of BrewCorp
(formerly known as Brewster's Coffee Company, Inc.) in
foreclosure proceedings.
In January 1997, the Company forgave notes and other receivables
totaling approximately $486,000 from a franchisee, Just Bagels,
Inc. ("JBI") and acquired three stores for conversion to Company-
owed units (see Note 10).
In April 1997, the Company issued 25,611 shares of Common Stock
valued at approximately $94,000, forgave royalties owed totaling
approximately $42,000, and assumed liabilities of approximately
$36,000 in connection with the purchase of one franchised store.
In August 1997, this store was sold to a franchisee for
approximately $235,000, consisting of two notes receivable from
the purchaser, approximately $46,000 which was paid in October
1997 and approximately $189,000, due in monthly payments through
August 2004, with interest at 8.5% (see Note 10).
In May 1997, the Company terminated an option to purchase 75,000
shares of Common Stock which had been originally issued in
connection with the Strathmore acquisition (Note 10). The former
owners of Strathmore had, in a separate transaction, assigned the
rights to acquire 75,000 shares of the 625,000 total shares of
Common Stock to Hawaiian Bagel Factory, Inc. ("HBF"). HBF
entered into an option to purchase the master franchise rights of
the State of Hawaii from Systems in exchange for the assignment
of the option to purchase the Company's Common Stock, valued at
$125,000, and a note receivable for $75,000 which is due and
payable in 5 annual installments of principal and interest
beginning May 1998 and which bears interest at 9% per annum.
In May 1997, Systems repurchased the franchise rights for the
western provinces of Canada from the master franchisor in
exchange for the discharge of a note receivable, plus interest
accrued thereon, totaling approximately $165,000.
In May 1997, the Company acquired MFM by exchanging 432,608
shares of Common Stock plus cash for 150 shares of MFM common
stock (see Note 10).
8. Shareholders' Equity
On March 28, 1996, the Board of Directors declared a three-for-
two stock split effected in the form of a 50% dividend payable to
shareholders of record on April 12, 1996 and distributed on
April 26, 1996. The terms of all outstanding options and
warrants to purchase shares of common stock were adjusted
accordingly. All share information has been adjusted to reflect
the stock split.
On January 2, 1996, in connection with the Company's initial
public offering of 2,500,000 shares of common stock which was
completed on November 30, 1995, the Company sold an additional
382,500 shares of Common Stock at the public offering price of
approximately $2.67 per share upon exercise in full of the
underwriter's over-allotment option, for an aggregate of
$1,020,000. Costs associated with the exercise of the over-
allotment option totaled approximately $138,000 which included an
underwriting discount of 9% of the offering amount, plus a
nonaccountable expense allowance of 3%, and other expenses. The
net proceeds to the Company were approximately $882,000.
Pursuant to the underwriting, the Company also sold to the
underwriter, for nominal consideration, warrants to purchase
255,000 shares of the Company's common stock. The warrants are
exerciseable between the first and fifth anniversary of the
effective date of the initial public offering at $3.20 per share.
On May 1, 1996, in connection with the acquisition of Bagels
Unlimited, Inc., the Company issued 50,000 shares of common stock
and an option to purchase an additional 100,000 shares of common
stock. The option is exercisable for 5 years commencing on
May 1, 1996, at a $4.00 per share price. The stock and option
were valued at approximately $242,000 and $150,000, respectively.
On May 22, 1996, in connection with the acquisition of Strathmore
Bagels Franchise Corp., the Company issued an option to purchase
625,000 shares of Holdings' common stock, no par value, at an
exercise price of $6.17 per share. The option is exercisable for
312,500 shares commencing on May 21, 1997, and for the remaining
312,500 shares commencing on May 21, 1998. The exercise period
for the option ends on May 21, 1999. The option was valued at
approximately $860,000. In fiscal 1997, the Company issued an option
to purchase 6,000 shares of Common Stock as additional consideration
at terms similar to the previously issued option.
On June 25, 1996, 133,471 shares of common stock were issued
pursuant to a cashless exercise of a warrant. The warrant was
originally issued on November 30, 1995 to an investor to purchase
up to 144,041 shares of common stock exerciseable through
September 1, 1996, at a price of $.67 per share. In connection
with this exercise, the investor forfeited the option to purchase
the remaining 10,570 shares covered by the warrant.
In April 1997, the Company completed the sale of 87,710 shares of
$25.00 Series A Convertible Preferred Stock (the "Preferred
Stock") in a private placement to institutional investors. The
Preferred Stock carries an 8% annual dividend payable in cash or,
at the option of the Company, in shares of common stock; provided
that during a Conversion Suspension Period (defined below),
dividends will accrue at a rate of 15% per annum. Dividends are
payable only when shares are converted to shares of common stock.
The holders have no voting rights and have a liquidation
preference of $25.00, plus accrued dividends, out of assets of
the Company available for distribution to shareholders.
Commencing August 1, 1997 through July 31, 1999, subject to
certain extensions, the shareholders may elect to convert each
preferred stock share into common shares as determined by
dividing the $25 purchase price by the lesser of $5.64 or 85% of
the average closing bid price of the common stock for the 30
trading days immediately preceding the conversion date. In
addition, if the Company engages in an underwritten public
offering, for any holder who has given notice of participation in
such offering, the conversion rate shall be 85% of the public
offering price, if less than the amount calculated in the
immediately preceding sentence.
A Conversion Suspension Period takes effect if the closing bid
price of the common stock is less than $2.325 for 30 consecutive
trading days. The Conversion Suspension Period continues until
the first trading day thereafter that the closing bid price for
the common stock has exceeded $2.325 for 30 consecutive trading
days; provided, however, that a Conversion Suspension Period
shall not continue for more than sixty (60) days in any period of
365 days. The Company is not required to recognize or accept any
conversion of Preferred Stock during a Conversion Suspension
Period. During any Conversion Suspension Period, the Company,
at its option, may redeem any or all of the Preferred Stock by
payment to the holders of $28.75 per share, plus all accrued and
unpaid dividends. The Company entered a Conversion Suspension Period
during November 1997.
Preferred dividends in the amount of $648,197 accumulated during
fiscal 1997, which includes $386,956 attributable to the 15%
discount available to holders of the Preferred Stock in acquiring
common stock upon ultimate conversion and $137,529 attributable
to the value of two-year warrants issued to each preferred
shareholder to purchase one share of common stock for each share
of Preferred Stock.
During fiscal 1997, holders elected to convert 9,000 shares of
Preferred Stock plus dividends accrued thereon were converted
into 110,342 shares of common stock. In January 1998, 1,000
shares of Preferred Stock plus dividends accrued thereon were
converted into 32,672 shares of common stock.
9. Stock Options Plans
On September 20, 1995, the Company adopted and received
shareholder approval of the 1995 Long-Term Incentive and Stock
Option Plan (the Incentive Plan), which permits the issuance of
options, stock appreciation rights, and restricted stock awards
to employees and nonemployee officers, directors, and agents of
the Company. The Incentive Plan reserves 570,000 shares of
common stock for grant and provides that the term of each award
be determined by the Board or a committee of the Board. Under
the terms of the Incentive Plan, options granted may be either
non-qualified or incentive stock options. Incentive stock
options must be exercisable at not less than the fair market
value of a share on the date of grant (110% of fair market value
if the options is a 10% or greater shareholder) and may be
granted only to employees. The Incentive Plan will terminate on
September 19, 2005, unless terminated sooner by action of the
Board.
Options are exercisable for a period of ten years from the
respective exercise date. Options issued terminate immediately
following an optionee's termination of employment or, in some
circumstances, one to three months after termination or up to 12
months in the case of the death of the employee.
Additionally, on September 20, 1995, the Company adopted and
received shareholder approval of the 1995 Outside Directors Stock
Option Plan (the Directors Plan), which permits the issuance of
non-qualified options to non-employee members of the Board. The
Directors Plan reserves 30,000 shares of common stock for grant.
The Directors Plan provides for a grant of options to purchase
2,000 shares upon initial election to the Board and for annual
grants thereafter, upon reelection, of options to purchase 1,000
shares.
Options granted are immediately exercisable for a period of 10
years from the date of grant at an exercise price per share equal
to the fair market value of a share on the date of grant. Upon
termination of the directorship, the options remain exercisable
for periods of varying lengths based on the nature of the option
and the reason for termination. The Directors Plan will
terminate on September 19, 2005, unless terminated sooner by
action of the Board.
Activity under the Incentive Plan and Directors Plan during the
two years ended November 30, 1997 is as follows:
</TABLE>
<TABLE>
<CAPTION>
Weighted
Number of Average Option
Shares Price Per Share
---------- ---------------
<S> <C> <C>
Outstanding as of December 1, 1995 30,000 $2.67
Granted 276,000 $6.54
Exercised - -
Canceled (9,000) $2.67
Outstanding as of November 30, 1996 297,000 $6.27
Granted 4,000 $2.53
Exercised - -
Canceled (3,000) $2.67
Outstanding as of November 30, 1997 298,000 $6.25
</TABLE>
The Company has adopted the disclosure-only provisions of
Financial Accounting Standards Board Statement No. 123
"Accounting and Disclosure of Stock-Based Compensation" ("SFAS
No. 123".) Accordingly, no employee compensation expense
has been recognized for the Incentive Plan or for the Directors
Plan. Had employee compensation expense for the Company's plan
been determined based on the fair value at the grant date for
awards in fiscal years 1996 and 1997 consist with provisions of
SFAS No. 123, the Company's net loss and net loss per share would
have been as follows:
<TABLE>
<CAPTION>
Years ended November 30
1997 1996
----------- ----------
<S> <C> <C>
Net loss attributable to
common shareholders:
As reported $(4,050,286) $(320,844)
Pro forma $(4,388,032) $(596,836)
Loss per share:
As reported $(0.55) $(0.04)
Pro forma $(0.59) $(0.08)
Diluted loss per share:
As reported $(0.53) $(0.04)
Pro forma $(0.58) $(0.08)
</TABLE>
The fair value of each option grant is estimated using the Black-
Scholes option-pricing model with the following weighted average
assumptions for 1997 and 1996: risk-free interest rates of 6.17%,
dividend yield of 0.0%, expected volatility of .69 and a weighted
average expected life of the option of 8.07 years.
Information on options outstanding under the Incentive Plan and
the Directors Plan at November 30, 1997 is as follows:
<TABLE>
<CAPTION>
Weighted
Weighted Average Average
Range of Number of Remaining Exercise
Exercise Price Options Contractual Life Price
-------------- ------- ----------------- --------
<C> <C> <C> <C>
$2.31 - $2.75 22,000 8.13 $2.64
$4.17 - $4.83 13,500 8.28 $4.39
$6.37 - $7.01 262,500 6.21 $6.65
</TABLE>
10. Business Combinations
During 1997 and 1996, the Company completed several acquisitions
which were all accounted for using the purchase method of
accounting. On May 1, 1996, the Company acquired certain assets
of Bagels Unlimited, Inc. (BUI), a franchisee of the Company
which operated five Big Apple Bagels stores in southeastern
Wisconsin, for a purchase price, including acquisition costs, of
approximately $1,428,000. Additionally, the Company paid
$100,000 to the former owners of BUI in exchange for
noncompetition agreements. The acquired stores are currently
operated as Company-owned Big Apple Bagels units.
On May 21, 1996, the Company acquired certain assets and contract
rights of Strathmore Bagels Franchise Corporation (Strathmore)
for a purchase price including acquisition costs of approximately
$1,740,000, plus additional consideration based on future
openings of units operated by Host Marriott Services Corporation
(Host Marriott). In this acquisition, the Company acquired
rights to a license agreement with Host Marriott which operated
34 units, contracts for each facility, and certain machinery and
equipment. Additionally, as part of the acquisition, the Company
entered into noncompetition agreements with the two former
principals of Strathmore.
On October 7, 1996, the Company acquired certain assets of
Danville Bagels, Inc. (Danville), a franchisee of the Company
operating two Big Apple Bagels stores in northern California, for
a purchase price of approximately $603,000. Additionally, as
part of the acquisition, the Company entered into noncompetition
agreements with the two former principals of Danville. The
acquired stores are currently operated as Company-owned Big Apple
Bagels units.
During 1997, the Company acquired and sold several stores.
Stores purchased are operated as Company-owned units for a period
of time prior to the ultimate resale as a franchised unit.
In January 1997, the Company completed the acquisition of JBI and
its affiliate, franchisees of the Company, operating a total of
four stores in southern California. The total purchase price
paid was $770,000, including $120,000 related to a noncompetition
agreement with the former JBI owner. In October 1997, management
closed one of the stores and closed the remaining three stores
in January 1998. All of the long-lived assets associated with
this purchase were considered impaired as of November 30, 1997.
See Notes 7 and 11.
In May 1997, the Company acquired MFM. At the time of
acquisition, MFM had 5 company-owned and 60 franchised units in
operation and its 1996 revenues exceeded $2.7 million. The
Company acquired MFM by exchanging 432,608 shares of the
Company's Common Stock, restricted as to transfer until January
1, 1999, and $259,000 in cash in exchange for 150 shares of MFM
stock. The Company assumed all assets, including approximately
$143,000 in cash, and liabilities of MFM. The Company borrowed
approximately $356,000 on its credit facility to repay MFM bank
debt and other borrowings assumed in the acquisition.
On a pro forma basis, had the above acquisitions occurred at
December 1, 1995, revenues for the fiscal years ended November
30, 1997 and 1996 would have been $15,421,000 and $11,985,000,
respectively. Net loss for fiscal 1997 and 1996 would have been
$3,500,000 and $616,000, respectively, or a net loss per share of
$0.54 and $0.08, respectively.
11. Impairment of Long-Lived Assets and Store Closures
The provision recorded of $1,836,981 consists of the following:
Impairment of long-lived assets $1,009,867
Closed store operating leases and
other store closing costs 504,203
Impairment of goodwill and other
intangible assets associated
with impaired long-lived assets 322,911
---------
$1,836,981
=========
For purposes of determining impairment, management, in certain
circumstances, groups long-lived assets on a geographic market or
store level as appropriate. Such review included, among other
criteria, management's estimate of future cash flows for the
geographic market or store. If the estimated future cash flow
(undiscounted and without interest charges) were not sufficient
to recover the carrying value of the long-lived assets, including
associated goodwill, of the market or store, such assets were
determined to be impaired and were written down to fair value.
Fair value was determined based on current market selling prices
of such assets. Management judgment is inherent in the estimated
fair value determinations and, accordingly, actual results could
vary significantly from such estimates. The estimated fair value
of impaired long-lived assets which total approximately $171,000
have been recorded as other current assets as of November 30,
1997.
The seven stores identified as impaired incurred operating losses
of approximately $555,000 during the fiscal year ended November
30, 1997. One store was closed by year end and the
remaining six stores were closed subsequent to year end.
The reserve for closed store expense includes an amount for the
noncancelable operating lease payments after the expected closure
date, net of estimated sublease income.
12. Costs of Uncompleted Acquisition
On September 4, 1996, the Company signed an agreement to acquire
certain assets and assume certain liabilities of the two
companies which represent the operations of The Chesapeake Bagel
Bakery (Chesapeake), a franchisor and operator of Chesapeake
Bagel Bakery concept specialty bagel stores. The agreement was
subject to certain closing conditions including the Company
obtaining funding for the acquisition by December 31, 1996. At
that date, the Company was unable to complete a public offering
of its common stock necessary to close the transaction on terms
agreeable to management. The Company's costs incurred in
acquisition-related and equity offering-related activities have
been expensed during fiscal 1996 in the accompanying consolidated
statement of operations under the caption "costs of uncompleted
business acquisition."
13. Disclosures About Fair Value of Financial Instruments
The Company evaluates its various financial instruments based on
current market interest, rates relative to stated interest rates,
length to maturity, and the existence of a readily determinable
market price. Based on the Company's analysis, the fair value of
financial instruments recorded on the consolidated balance sheet
at November 30, 1997, approximate their carrying value.
ITEM 8. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
- --------------------------------------------------------
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
- -------------------------------------------------------------------
Incorporated by reference to the Company's definitive proxy materials
to be filed with the Commission on or before March 30, 1998.
ITEM 10. EXECUTIVE COMPENSATION
- -------------------------------
Incorporated by reference to the Company's definitive proxy materials
to be filed with the Commission on or before March 30, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
- ------------------------------------------------------------
Incorporated by reference to the Company's definitive proxy materials
to be filed with the Commission on or before March 30, 1998.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------------------------------------------------------
Incorporated by reference to the Company's definitive proxy materials
to be filed with the Commission on or before March 30, 1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
REPORTS ON FORM 8-K
The following reports on Form 8-K were filed by the Company
during the last quarter of the fiscal year ended November 30,
1997:
None
EXHIBITS
The following exhibits are filed herewith.
Exhibit
No. Description of Exhibit
- -------- ------------------------------------------------------
[i] 2.1 Asset Purchase Agreement dated February 2, 1996
between the Company, Brewster's Coffee Company, Inc.
and Peter D. Grumhaus
[ii] 2.2a Asset Purchase Agreement by and among BAB Systems,
Inc., Bagels Unlimited, Inc.(''BUI''), and Donald Nelson
and Mary Ann Varichak dated May 1, 1996
[ii] 2.2b Non-Competition Agreement by and among the Company and
Donald Nelson and Mary Ann Varichak dated May 1, 1996
[ii] 2.2c Stock Option Agreement between the Company and BUI
dated May 1, 1996
[ii] 2.2d Registration Rights Agreement between the Company
and BUI dated May 1, 1996
[iii] 2.3a Asset Purchase Agreement by and between the Company
and Strathmore Bagels Franchise
Corp. (''Strathmore'') dated May 21, 1996
[iii] 2.3b Stock Option Agreement dated May 21, 1996 between
the Company and Strathmore
[iii] 2.3c Registration Rights Agreement dated May 21, 1996
between the Company and Strathmore
[iii] 2.3d Non-Competition Agreement dated May 21, 1996 among
the Company, Strathmore, Jack Freedman and Glen Steuerman
[iii] 2.3e Memorandum of Understanding Regarding Form of
License Agreement effective November 30, 1995,
between Strathmore and Host International, Inc.
[iii] 2.3f Consent to Assignment between Strathmore and Host
International, Inc., dated March 13, 1996,
as amended May 21, 1996
[iv] 2.4a Acquisition Agreement dated May 1, 1997 by and among
BAB Holdings, Inc., BAB Acquisition Corp., My
Favorite Muffin, Too, Inc., Muffin Holdings of
Pennsylvania, a limited partnership, Ruth Stern,
Owen Stern, and Ilona Stern
[iv] 2.4b Registration Rights Agreement dated as of May 1,
1997 between BAB Holdings, Inc., and
Owen Stern, Ruth Stern, Ilona Stern and Pierce W.
Hance.
[v] 3.1a Amended Articles of Incorporation of the Company
[vii] 3.1b Amended and Restated Statement of Designation,
Number, Voting Powers, Preferences and Rights of
Series A Convertible Preferred Stock as filed with
the Secretary of State of Illinois on March 26, 1997
[v] 3.2 Bylaws of the Company, as amended
[v] 4.1 Form of Stock Certificate evidencing Common Stock,
no par value
[v] 4.2 Subscription Agreement with the Aladdin
International, Inc. dated August 31, 1995
[v] 4.3 Amended Form of Warrant Issued to Aladdin
International, Inc.
[v] 10.1 Form of Franchise Agreement
[v] 10.2 Form of Franchise Agreement-Satellite
[v] 10.3 Form of Franchise Agreement-Wholesale
[v] 10.4 Form of Area Development Agreement
[v] 10.5 Confidentiality and Non-Competition Agreement with
Franchisees
[v] 10.6 Form of Confidentiality Agreement with Employees
[v] 10.7 Licensing Agreement dated November 20, 1992 between
the Company and Big Apple Bagels, Inc.
[v] 10.8 Assignment of Royalty Mark & Trademark to the
Company by Big Apple Bagels, Inc. dated November 20, 1992
[v] 10.9 Agreement dated September 14, 1995 among the
Company, Big Apple Bagels, Inc. and Paul C. Stolzer
[i] 10.10 Consulting agreement dated February 16, 1996 between
Paul C. Stolzer and BAB Holdings, Inc.
[v] 10.11 Leases dated November 2, 1994 and February 14, 1995
for principal executive office
[v] 10.12 1995 Long-Term Incentive and Stock Option Plan
[v] 10.13 1995 Outside Directors Stock Option Plan
[v] 10.14 Settlement Agreement with Timothy Williams d/b/a Big
Apple Deli and Stipulated Dismissal with Prejudice
[i] 10.15 Program Agreement dated February 10, 1997 between
BAB Systems, Inc. a wholly owned subsidiary of
the Company, and Franchise Mortgage Acceptance
Company LLC
[iv] 10.16 Employment agreement between the Company and Owen
Stern dated May 8, 1997
11.1 Calculation of Earnings Per Share
21.1 List of Subsidiaries of the Company
23.1 Consent of Ernst & Young LLP, independent auditors
___________________________________________
[i] Incorporated by reference to the Company's Report on Form
10-KSB for the fiscal year ended November 30, 1995
[ii] Incorporated by reference to the Company's Report on Form 8-K
dated May 1, 1996
[iii] Incorporated by reference to the Company's Report on
Form 8-K dated May 21, 1996
[iv] Incorporated by reference to the Company's Report on Form 8-K
dated May 13, 1997
[v] Incorporated by reference to the Company's Registration
Statement on Form SB-2, effective November 27, 1995
(Commission File No. 33-98060C)
[vi] Incorporated by reference to the Company's Report on Form
10-KSB for the fiscal year ended November 30, 1996
[vii] Incorporated by reference to the Company's Report on
Form 10-QSB for the quarter ended February 28, 1997
INDEX TO EXHIBITS
INDEX
NUMBER DESCRIPTION PAGE #
11.1 Calculation of Earnings Per Share
21.1 List of Subsidiaries of the Company
23.1 Consent of Ernst & Young LLP, independent auditors
SIGNATURES
In accordance with Section 13 of the Exchange Act, the Registrant
has duly caused this report on Form 10-KSB to be signed on its
behalf by the undersigned, thereunto duly authorized.
BAB HOLDINGS, INC.
Dated: March 2, 1998 By /s/ MICHAEL W. EVANS
--------------------------
Michael W. Evans, Chief Executive
Officer and President (Principal
Executive Officer)
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report Form 10-KSB has been signed below by the
following persons on behalf of the company and in the capacities
and on the dates indicated.
/s/ MICHAEL W. EVANS March 2, 1998
- -------------------------------------------
Michael W. Evans, Chief Executive Officer,
President and Director (Principal Executive
Officer)
/s/ MICHAEL K. MURTAUGH March 2, 1998
- ------------------------------------------
Michael K. Murtaugh, Director and Vice
President/General Counsel
/s/ TOM J. FLETCHER March 2, 1998
- ------------------------------------------
Tom J. Fletcher, Chief Operating Officer
(Principal Operating Officer and Principal
Financial and Accounting Officer)
/s/ DAVID L. EPSTEIN March 2, 1998
- ------------------------------------------
David L. Epstein, Director
- ------------------------------------------
Cynthia A. Vahlkamp, Director
/s/ ROBERT B. NAGEL March 2, 1998
- ------------------------------------------
Robert B. Nagel, Director
BAB HOLDINGS, INC.
CALCULATION OF EARNINGS PER SHARE
YEARS ENDED NOVEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
PRIMARY
Net loss $(3,402,089) $(320,844)
Less: Preferred dividend
accumulated (648,197) -
----------- --------
Net loss attributable to
common shareholders $(4,050,286) $(320,844)
=========== =========
Weighted average shares
outstanding 7,420,811 7,366,645
========= =========
Net loss per common share $ (0.55) $ (0.04)
========= =========
FULLY DILUTED
Net loss $(3,402,089) $(320,844)
Less: Preferred dividend
accumulated (648,197) -
Plus: Preferred dividend
on conversions 47,206 -
Plus: Bond interest exp.
on conversions - 566
--------- -------
Net loss attributable to
common shareholders $(4,003,080) $(320,278)
========== ========
Weighted average shares
outstanding 7,506,657 7,420,538
========== =========
Net loss per common share $ (0.53) $ (0.04)
========== ========
</TABLE>
SUBSIDIARIES OF BAB HOLDINGS, INC.
BAB Systems, Inc., an Illinois corporation
BAB Operations, Inc., an Illinois corporation
Brewster's Franchise Corporation, an Illinois corporation
Systems Investments, Inc., an Illinois corporation, (a wholly-
owned subsidiary of BAB Systems, Inc., which is a subsidiary of
BAB Holdings, Inc.)
My Favorite Muffin Too, Inc., a New Jersey corporation
We consent to the incorporation by reference in the Registration Statement
(Form S-3 No. 333-42253) of BAB Holdings, Inc. and in the related
Prospectus of our report dated February 27, 1998, with respect to the
consolidated financial statements of BAB Holdings, Inc. included in this
Annual Report (Form 10-KSB) for the year ended November 30, 1997.
ERNST & YOUNG LLP
Chicago, Illinois
February 27, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF BAB HOLDINGS, INC. FOR THE YEAR ENDED NOVEMBER 30,
1997 AND IS QUALIFIED IN THE ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> NOV-30-1997
<PERIOD-END> NOV-30-1997
<CASH> 389,896
<SECURITIES> 0
<RECEIVABLES> 2,576,719
<ALLOWANCES> 217,000
<INVENTORY> 344,424
<CURRENT-ASSETS> 2,979,192
<PP&E> 5,971,601
<DEPRECIATION> 882,693
<TOTAL-ASSETS> 14,627,246
<CURRENT-LIABILITIES> 4,295,601
<BONDS> 0
0
1,862,035
<COMMON> 10,908,062
<OTHER-SE> (4,115,347)
<TOTAL-LIABILITY-AND-EQUITY> 14,627,246
<SALES> 9,846,020
<TOTAL-REVENUES> 14,240,956
<CGS> 3,309,504
<TOTAL-COSTS> 17,572,095
<OTHER-EXPENSES> (3,701)
<LOSS-PROVISION> 244,232
<INTEREST-EXPENSE> 74,651
<INCOME-PRETAX> (3,402,089)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,402,089)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,050,286)
<EPS-PRIMARY> (0.55)
<EPS-DILUTED> (0.53)
</TABLE>
