Securities and Exchange Commission
450 5th Street N. W.
Judiciary Plaza
Washington, D. C. 20549
Dear Sirs:
This Form 10-KSB/A is a first amendment to form 10-KSB filed on March 1, 1999
for the fiscal year ending November 30, 1998 and consists of the following
corrections to item 7. FINANCIAL STATEMENTS:
1. Consolidated Balance Sheet; subtotal Noncurrent Liabilities;
amount was $ 2,275,169; amount should be $ 2,275,669.
2. Note 4-Income Taxes; Deferred tax assets (liabilities); Net
operating loss carryforwards; was $1,647,245; amount should be
$1,672,245.
3. Consent was obtained from the predecessor auditors, however
their report was inadvertently omitted. As a result we are
including the financial statements in their entirety.
4. We have also corrected certain typographical errors within the
financial statements.
Very truly yours,
/s/ Joseph M. Merkin
Joseph M. Merkin, Chief
Financial Officer and
Treasurer (Principal
Financial and Accounting
Officer)
ITEM 7. FINANCIAL STATEMENTS
- ------------------------------
The Consolidated Financial Statements and Reports of Independent Auditors
are included immediately following.
BAB HOLDINGS, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
INDEPENDENT AUDITOR'S REPORTS
YEARS ENDED NOVEMBER 30, 1998 AND 1997
<PAGE>
BAB HOLDINGS, INC.
Years Ended November 30, 1998 and 1997
C O N T E N T S
---------------
Reference Page
Independent Auditor's Reports
Consolidated Balance Sheets Exhibit A
Consolidated Statements of Operations Exhibit B
Consolidated Statements of
Stockholders' Equity Exhibit C
Consolidated Statements of
Cash Flows Exhibit D
Notes to Consolidated Financial
Statements
<PAGE>
INDEPENDENT AUDITOR'S REPORT
----------------------------
Stockholders and Board of Directors
BAB Holdings, Inc.
We have audited the accompanying consolidated balance sheet of BAB HOLDINGS,
INC. as of November 30, 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for the year 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 audit. The consolidated financial statements of BAB HOLDINGS,
INC. as of and for the year ended November 30, 1997, were audited by other
auditors whose report dated February 27, 1998, expressed an unqualified
opinion on those statements.
We conducted our audit 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 audit provides 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. as of November 30, 1998, and the consolidated results of its operations
and its cash flows for the year then ended in conformity with generally
accepted accounting principles.
/s/ Blackman Kallick Bartelstein, LLP
Chicago, Illinois
February 6, 1999
<PAGE>
Report of Independent Auditors
The Shareholders and Board of Directors
BAB Holdings, Inc.
We have audited the accompanying consolidated balance sheet of BAB Holdings,
Inc. as of November 30, 1997, and the related consolidated statements of
operations, shareholders' equity, and cash flows for the year 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 audit.
We conducted our audit 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 audit provides 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 the consolidated results of its operations and
its cash flows for the year then ended, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Chicago, Illinois
February 27, 1998
<PAGE>
<TABLE>
<CAPTION>
BAB HOLDINGS, INC.
Consolidated Balance Sheets
November 30, 1998 and 1997
ASSETS
------
1998 1997
----------- -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents, including
restricted cash of $218,646 in 1998
and $285,442 in 1997 $ 700,162 $ 389,896
Receivables
Trade accounts receivable, net of
allowance for doubtful accounts of
$341,000 in 1998 and $217,000 in 1997 1,181,282 988,992
National Marketing Fund contributions
receivable 309,633 382,432
Notes receivable, net of allowance for
doubtful accounts of $20,000 in 1998
and 1997 444,560 203,230
Inventories 298,501 344,424
Deferred franchise costs 18,227 76,805
Assets held for sale - 170,500
Prepaid expenses and other current assets 206,952 422,913
Deferred income taxes 431,719 -
---------- ----------
Total Current Assets 3,591,036 2,979,192
Property and Equipment
Leasehold improvements 2,618,906 2,690,940
Furniture and fixtures 744,833 686,542
Equipment 2,513,715 2,513,289
Construction in progress 68,543 80,830
---------- ----------
5,945,997 5,971,601
Less accumulated depreciation (1,743,800) (882,693)
---------- ----------
Total Property and Equipment, Net 4,202,197 5,088,908
Notes Receivable 1,086,100 785,065
---------- ----------
Intangibles
Patents, trademarks and copyrights (Net of
accumulated amortization of $90,374 in 1998
and $56,025 in 1997) 568,683 527,140
Goodwill (Net of accumulated amortization
of $164,806 in 1998 and $101,629 in 1997) 2,591,515 2,599,393
Franchise contract rights (Net of accumulated
amortization of $152,375 in 1998 and
$60,442 in 1997) 1,919,909 2,011,842
Other assets (Net of accumulated amortization
of $235,056 in 1998 and $424,855 in 1997) 485,551 635,706
---------- ----------
Total Intangibles, Net 5,565,658 5,774,081
---------- ----------
$14,444,991 $14,627,246
========== ==========
</TABLE>
The accompanying notes are an intergral part of the consolidated financial
statements.
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Current Liabilities
Accounts payable $ 1,014,734 $ 1,603,661
Accrued liabilities 714,789 768,977
Reserve for closed store expenses 36,388 504,203
Accrued professional and other services 214,972 227,895
Unexpended National Marketing Fund
contributions 465,173 522,722
Long-term debt due within one year 134,814 26,143
Deferred franchise fee revenue 360,500 642,000
------------ ------------
Total Current Liabilites 2,941,370 4,295,601
------------ ------------
Noncurrent Liabilities
Deferred revenue 263,996 -
Deferred income taxes 251,719 -
Long-term debt (Net of portion included
in current liabilities) 1,759,954 1,676,895
------------ ------------
Total Noncurrent Liabilities 2,275,669 1,676,895
------------ ------------
Total Liabilities 5,217,039 5,972,496
------------ ------------
Stockholders' Equity:
Common stock - No par value; 20,000,000
shares authorized; 8,655,006 shares and
7,981,630 shares issued, respectively;
and 8,361,706 shares and 7,711,630 shares
outstanding, respectively 11,430,452 10,908,062
Preferred stock - $0.01 par value; 3,880,000
shares authorized; no shares issued
and outstanding - -
Series A Preferred stock - $25 par value;
120,000 shares authorized; 60,000 shares and
78,710 shares issued and outstanding,
respectively 1,548,731 1,862,035
Treasury stock at cost, 293,300 shares and
270,000 shares, respectively (36,067) (17,500)
Additional paid-in capital 1,252,402 1,368,619
Accumulated deficit (4,967,566) (5,466,466)
------------ ------------
Total Stockholders' Equity 9,227,952 8,654,750
------------ ------------
$ 14,444,991 $ 14,627,246
============ ============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
BAB HOLDINGS, INC.
Consolidated Statements of Operations
Years Ended November 30, 1998 and 1997
1998 1997
----------- -----------
<S> <C> <C>
Revenues
Net sales by Company-owned stores $ 8,929,664 $ 9,846,020
Royalty fees from franchised stores 3,178,262 2,367,220
Franchise and area development fees 1,104,000 1,005,545
Licensing fees and other income 1,337,314 947,658
----------- -----------
Total Revenues 14,549,240 14,166,443
Operating Costs and Expenses
Food, beverage, and paper costs 2,998,079 3,309,504
Store payroll and other operating expenses 5,213,359 5,859,322
Provision for impairments and store closures (107,699) 1,836,981
Selling, general and administrative expenses:
Payroll-related expenses 2,262,616 2,058,644
Advertising and promotion 532,678 603,373
Professional service fees 362,360 514,319
Franchise-related expenses 261,287 232,964
Depreciation and amortization 1,180,259 1,490,329
Other 1,331,146 1,666,659
----------- -----------
Total Selling, General and
Administrative Expenses 5,930,346 6,566,288
----------- -----------
Total Operating Costs
and Expenses 14,034,085 17,572,095
----------- -----------
Income (Loss) from Operations 515,155 (3,405,652)
Interest Income 119,244 74,513
Interest Expense (205,618) (74,651)
Other Income 54,022 3,701
----------- -----------
Income (Loss) Before Taxes 482,803 (3,402,089)
Provision (Benefit) for Income Taxes
Current 16,039 -
Deferred (180,000) -
----------- -----------
(163,961) -
----------- -----------
Net Income (Loss) 646,764 (3,402,089)
Preferred Stock Dividends Accumulated (147,864) (648,197)
----------- -----------
Net Income (Loss) Attributable to
Common Stockholders $ 498,900 $(4,050,286)
=========== ===========
Income (Loss) per Share - Basic and Diluted $ 0.06 $ (0.55)
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
<TABLE>
<CAPTION>
BAB HOLDINGS, INC.
Consolidated Statements of Shareholders' Equity
Years Ended November 30, 1998 and 1997
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, 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 Dividends
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)
Termination of
Options Issued in
Connection with
Acquisition -- -- -- -- -- --
Purchase Of Treasury
Stock -- -- -- --
(23,300)(18,567)
Preferred Dividends
Accumulated -- -- -- 147,864 -- -
- -
Preferred Dividends
Paid -- -- -- (19,995) -- -
- -
Conversion of Preferred
to Common Stock 673,376 522,390 (18,710) (441,173) -- -
- -
Net Income -- -- -- -- -- -
- -
---------- ----------- ------ ---------- -------- -----
- -
Balance as of
November 30, 1998 8,655,006 $11,430,452 60,000 $1,548,731
(293,300)$(36,067)
========== =========== ====== ========== ========
=======
</TABLE>
(WIDE TABLE CONTINUED FROM ABOVE)
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN ACCUMULATED
CAPITAL DEFICIT TOTAL
----------- ----------- -----------
<S> <C> <C> <C>
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
Termination of Options Issued
in Connection with Acquistions (35,000) -- (35,000)
Purchase of Treasury Stock -- -- (18,567)
Preferred Dividends Accumulated -- (147,864) --
Preferred Dividends Paid -- -- (19,995)
Conversion of Preferred to
Common Stock (81,217) -- --
Net Income 646,764 646,764
----------- ---------- -----------
Balance as of November 30, 1998 $ 1,252,402 $(4,967,566) $ 9,227,952
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
<TABLE>
<CAPTION>
BAB HOLDINGS, INC.
Consolidated Statements of Cash Flows
Years Ended November 30, 1998 and 1997
1998 1997
----------- ----------
<S> <C> <C>
Cash Flows from Operating Activities
Net income (loss) $ 646,764
$(3,402,089)
----------- ---------
- -
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities
Depreciation and amortization 1,180,259
1,490,329
Provision for impairment and closure -
1,836,981
Deferred preopening store cost -
(240,927)
Deferred revenue 350,000
- -
Benefit for deferred income taxes (180,000)
- -
Gain on sale of property and equipment (10,393)
- -
(Increase) decrease in
Trade accounts receivable (207,290)
(432,604)
National Marketing Fund contributions
receivable 72,799
(245,779)
Inventories 45,923
(211,614)
Deferred franchise costs 58,578
(21,319)
Notes receivable (491,003)
(138,632)
Prepaid expenses and other assets 386,461
(215,653)
Amounts due from affiliate -
(88,653)
Increase (decrease) in
Accounts payable (588,927)
176,318
Accrued professional and other services (12,923)
(178,331)
Reserve for closed store expenses (467,815)
- -
Accrued liabilities (140,192)
75,157
Unexpended National Marketing Fund
franchisee contributions (57,549) 358,840
Deferred franchise fee revenue (281,500) 17,600
---------- --------
- -
Total Adjustments (343,572)
2,181,713
---------- --------
- -
Net Cash Provided by (Used in)
Operating Activities 303,192
(1,220,376)
--------- --------
- -
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
<TABLE>
<CAPTION>
BAB HOLDINGS, INC.
Consolidated Statements of Cash Flows (continued)
Years Ended November 30, 1998 and 1997
1998 1997
------------ ----------
- --
<S> <C> <C>
Cash Flows from Investing Activities
Purchases of property and equipment $ (198,295)
$(3,679,705)
Sale of property and equipment 33,484
57,400
Purchase of MFM -
(115,551)
Purchase of trademarks (75,892)
(16,236)
Purchases of other assets -
(120,000)
Loan disbursements (13,263)
(74,201)
Loan repayments 138,900
77,748
Other (31,029)
56,440
----------- ----------
- -
Net Cash Used in Investing Activities (146,095)
(3,814,105)
----------- ----------
- -
Cash Flows from Financing Activities
Borrowing on line of credit 337,500
1,675,975
Debt repayments (145,769)
(364,037)
Proceeds from issuance of preferred stock -
2,192,750
Payment of preferred stock issuance costs -
(247,275)
Other (38,562)
3,671
----------- ----------
- -
Net Cash Provided by Financing Activities 153,169
3,261,084
----------- ----------
- -
Net Increase (Decrease) in Cash and Cash Equivalents 310,266
(1,773,397)
Cash and Cash Equivalents, Beginning of Year 389,896
2,163,293
----------- ---------
- -
Cash and Cash Equivalents, End of Year $ 700,162 $
389,896
===========
==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
BAB HOLDINGS, INC.
Notes to Consolidated Financial Statements
Years Ended November 30, 1998 and 1997
- ------------------------------------------------------------------------
NOTE 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. As of
November 1998, Investments was dissolved and merged into the parent company,
Systems. Operations was formed on August 30, 1995, primarily to operate
Company-owned stores, currently "Big Apple Bagels" 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.
NOTE 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.
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.
Depreciation and Amortization
- -----------------------------
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.
The Company's intangible assets consist primarily of patents,
trademarks, 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 is
being amortized over 40 years. Amortization expense recorded in the
accompanying consolidated statements of operations for the years ended
November 30, 1998 and 1997 was $326,089 and $549,640, 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
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.
Revenue Recognition
- -------------------
Royalty fees from franchised stores represent a fee of 5% of net retail
sales of franchised units. Royalty revenues are recognized on the
accrual basis.
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 those units located primarily in airport and travel plazas.
In fiscal 1998 and 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 at November 30, 1998 or 1997, or area
development fees collected are as follows (excluding six Company-owned
stores which were closed subsequent to year end [see Note 12]):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Stores opened:
Company-owned 22 28
Franchisee-owned 194 182
Licensed 77 47
---- ----
293 257
Unopened stores:
Franchise agreement 15 25
Area development agreement 19 28
---- ----
34 53
---- ----
327 310
==== ====
</TABLE>
Advertising Costs
- -----------------
The Company expenses advertising costs as incurred. Advertising expense
was $331,004 and $339,496 in 1998 and 1997, respectively. Included in
advertising expense was $53,593 and $55,733 in 1998 and 1997,
respectively, related to the Company's franchise operations.
Income (Loss) Per Share
- -----------------------
The Company adopted Statement of Financial Accounting Standards (SFAS)
No. 128, "Earnings Per Share" during the first quarter of 1998. This
standard prescribes the methods of calculating basic and diluted
earnings per share and requires dual presentation of these amounts on
the face of the income statement. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options,
warrants, and convertible securities. Diluted earnings per share is
very similar to the previously reported fully diluted earnings per
share of $.53 in 1997. All earnings per share amounts for all periods have
been presented, and where necessary, restated to conform to the SFAS No. 128
requirements.
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 as of November 30, 1998,
approximates their carrying value.
New Accounting Standards
- ------------------------
In June 1997, SFAS No. 130, "Reporting Comprehensive Income" and SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related
Information" were issued. SFAS No. 130 establishes standards for the
reporting of comprehensive income and its components in a financial
statement presentation. SFAS No. 130 separates comprehensive income into
net income and other comprehensive income, but does not change the
measurement and presentation of net income. Other comprehensive income
includes certain changes in the equity of the Company which are
currently recognized and presented separately in the Consolidated
Statements of Stockholders' Equity, such as the change in the Cumulative
Translation Adjustment account. SFAS No. 130 is effective for the
Company beginning in fiscal 1999.
SFAS No. 131 establishes new standards for the way companies report
information about operating segments and requires that those enterprises
report selected information about operating segments in the financial
reports issued to stockholders. SFAS No. 131 is effective for the
Company beginning in fiscal 1999.
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.
Reclassifications
- -----------------
Certain 1997 amounts have been reclassified to reflect the 1998
presentation.
NOTE 3 - RESTRICTED CASH
Systems established the National Marketing Fund (Fund) during 1994.
Franchisees 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. As of November 30, 1998 and 1997, the Fund's cash balance
was $184,804 and $256,678, 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. As of November 30, 1998 and 1997, the
MFM Fund's cash balance was $33,842 and $8,764, respectively.
Systems was required by certain states to maintain franchise and area
development fees in escrow accounts until the related franchise stores
commence operations. As of November 30, 1998 and 1997, these accounts
totaled $ 0 and $20,000, respectively.
NOTE 4 - INCOME TAXES
The reconciliation of the income tax provision (benefit) computed at the
federal statutory rate of 34% and the benefit for income taxes is as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
Income tax provision (benefit)
computed at federal statutory rate $ 164,153 $(1,156,710)
State income taxes (benefit), net
of federal tax benefit 23,261 (163,913)
Permanent differences on debt
financing obtained (1,748) (1,748)
Other adjustments 18,529 22,584
Valuation allowance without income
tax benefit (368,156) 1,299,787
---------- ---------
Benefit for Income Taxes $ (163,961) $ -
========== =========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting
purposes and the amounts used for income tax purposes.
Deferred tax assets (liabilities) are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- --------
<S> <C> <C>
Franchise fee revenue $ 20,638 $ 216,615
Franchise costs 52,745 32,102
National Marketing Fund net contributions 71,737 99,638
Allowance for uncollectible accounts 129,125 108,392
Net operating loss carryforwards 1,672,245 1,617,089
Valuation allowance (1,514,771) (1,882,927)
--------- ---------
Total Deferred Tax Assets 431,719 190,909
--------- ---------
Depreciation (249,263) (171,017)
Start-up costs - (17,807)
Other (2,456) (2,085)
--------- ---------
Total Deferred Tax Liabilities (251,719) (190,909)
--------- ---------
$ 180,000 $ -
========= =========
</TABLE>
As of November 30, 1998, the Company has cumulative net operating loss
carryforwards expiring between 2008 and 2013 for U.S. federal income tax
purposes of approximately $4,308,000. The net operating loss
carryforwards are subject to limitation in any given year as a result of
the Company's initial public offering and may be further limited if
certain other events occur. A valuation allowance has been established
for $1,514,771 of the deferred tax benefit related to those loss
carryforwards for which it is considered more likely than not that the
benefit will not be realized.
NOTE 5 - LONG-TERM OBLIGATIONS
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Secured line of credit payable to
bank, due December 31, 1998,
at an interest rate of prime
plus 1% $1,877,465 $1,657,975
Capital lease obligations,
various rates 17,303 31,220
Unsecured note payable, principal
payments due monthly at an
interest rate of 10% - 13,843
--------- ---------
1,894,768 1,703,038
Less: current portion 134,814 26,143
--------- ---------
Long-Term Debt, Net of Current Portion $1,759,954 $1,676,895
========= ==========
</TABLE>
The Company had a secured $2 million line-of-credit facility (Line) with
a bank which expired December 31, 1998. Maximum borrowing under the
Line was limited to 80% of accounts receivable under 90 days and 40% of
original cost of equipment, furniture and fixtures. Interest was
payable monthly at prime plus 1% (8.75% as of November 30, 1998), with
principal due upon maturity on December 31, 1998. As of November 30,
1998, the Company had borrowed $1,877,465 on the Line.
In December 1998, the Company repaid $127,465 and replaced the Line with a
$1.75 million line-of-credit facility with a bank which expires December
31, 1999. Maximum borrowing under the Line is limited to 75% of
accounts receivable under 90 days and 40% of the original cost of
equipment, furniture and fixtures. Interest is payable monthly at prime
plus 1% (8.75% as of January 1, 1999), with principal due upon maturity
on December 31, 1999. 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.
As of November 30, 1998, annual maturities on long-term obligations are
due as follows: $134,814 in 1999 and $1,759,954 in 2000. Interest
paid for the years ended November 30, 1998 and 1997 was $202,312 and
$55,188, 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, 1998, $1,040,458
has been advanced to franchises under this program.
NOTE 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, 1998 and 1997 was $936,895 and $955,693,
including contingent rental expense of $41,646 and $26,600, less
sublease income of $106,606 and $46,109, respectively. As of November
30, 1998, future minimum annual rental commitments under leases, net of
sublease income of $253,965 in 1999, $226,968 in 2000, $97,338 in 2001,
$36,000 in 2002 and $3,000 in 2003, are as follows:
Year Ending November 30:
1999 $ 665,773
2000 505,887
2001 477,122
2002 246,401
2003 241,801
Thereafter 535,089
------------
$ 2,672,073
============
NOTE 7 - NONCASH TRANSACTIONS
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-owned units
(see Note 11).
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 11).
In May 1997, the Company terminated an option to purchase 75,000 shares
of common stock which had been originally issued in a previous
acquisition and subsequently, in a separate transaction, assigned 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 five annual installments of principal and
interest beginning May 1999 and 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 11).
In January 1998, the Company sold the assets of one Company-owned store
to a franchisee in exchange for approximately $30,000 in cash and a note
receivable for $177,000. The note bears interest at a rate of 8.5% and
interest payments were made through August 1998. Thereafter, monthly
payments of principal and interest are due until March 1, 2003 when the
entire unpaid balance of principal and interest is due in full.
In November 1998, the Company acquired from a franchisee its option to
purchase the Company's 100,000 shares of common stock which had been
issued in a previous acquisition. In exchange, the Company canceled a
total of $35,000 of royalties and other receivables owed to its
subsidiaries by the franchisee.
NOTE 8 - STOCKHOLDERS' EQUITY
In April 1997, the Company completed the sale of 87,710 shares of $25
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, plus accrued dividends, out of assets of
the Company available for distribution to stockholders.
Commencing August 1, 1997 through July 31, 1999, subject to certain
extensions, the stockholders 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 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 in 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
through January 1998. During January 1999, the Company entered into a
Conversion Suspension Period.
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 stockholder to purchase two shares of
common stock for each share of Preferred Stock. Preferred dividends of
$147,864 accumulated during fiscal 1998.
During fiscal 1997, holders elected to convert 9,000 shares of Preferred
Stock plus dividends accrued thereon into 110,342 shares of common
stock. During fiscal 1998, holders elected to convert 18,710 shares of
Preferred Stock plus dividends accrued thereon into 673,376 shares of
common stock. The common shares issued upon conversion include shares
issued in payment of preferred dividends on 10,306 shares of Preferred
Stock. The Company elected to pay accrued dividends in cash of
approximately $20,000 upon conversion of the remaining 8,404 shares of
Preferred Stock.
NOTE 9 - EARNINGS PER SHARE
The computation of basic and diluted earnings (loss) per share is as
follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Numerator:
Net income (loss) $ 646,764 $(3,402,089)
Preferred stock dividend accumulated (147,864) (648,197)
----------- -----------
Numerator for basic earnings (loss)
per share - income (loss)
attributable to common stockholders 498,900 (4,050,286)
Effect of dilutive securities:
Preferred stock dividend accumulated 147,864 -
----------- -----------
Numerator for diluted earnings (loss)
per share - income (loss)
attributable to common stockholders $ 646,764 $(4,050,286)
=========== ===========
Denominator:
Denominator for basic earnings (loss)
per share - weighted average shares 8,101,080 7,420,811
Effect of dilutive securities:
Convertible preferred stock 2,407,159 -
---------- ----------
Denominator for diluted earnings (loss)
per share - weighted average shares 10,508,239 7,420,811
========== ==========
Basic and diluted earnings (loss)
per share $ 0.06 $ (0.55)
========== ==========
</TABLE>
The exercise of options and warrants outstanding during the years ended
November 30, 1998 and 1997 and the conversion of convertible securities
outstanding during the year ended November 30, 1997 is not assumed as
the result is antidilutive to the reported loss per share.
NOTE 10 - STOCK OPTIONS PLANS
On September 20, 1995, the Company adopted and received stockholder
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 nonqualified 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 are owned by a 10% or greater stockholder) 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 up to 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
stockholder approval of the 1995 Outside Directors Stock Option Plan
(the Directors Plan), which permits the issuance of nonqualified options
to nonemployee 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 ten 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, 1998, is as follows:
<TABLE>
<CAPTION>
Weighted-
Number of Average Option
Shares Price Per Share
---------- ---------------
<S> <C> <C>
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
Granted 151,545 $1.32
Exercised - -
Canceled (25,980) $2.12
-------
Outstanding as of November 30, 1998 432,565 $4.74
=======
</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 1998 and 1997 consistent with provisions of SFAS
No. 123, the Company's net income (loss) and net income (loss) per share
would have been as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Net income (loss) attributable to
common stockholders:
As reported $ 498,900 $(4,050,286)
Pro forma $ 89,973 $(4,388,032)
Basic income (loss) per share:
As reported $ 0.06 $ (0.55)
Pro forma $ 0.01 $ (0.59)
Diluted income (loss) per share:
As reported $ 0.06 $ (0.55)
Pro forma $ 0.01 $ (0.58)
</TABLE>
The fair value of each option grant is estimated using the Black-Scholes
Option-Pricing Model with the following weighted-average assumptions for
1998 and 1997, respectively: risk-free interest rates of 5.0% and 6.17%;
dividend yield of 0.0%; expected volatility of .89 and .69; and a
weighted-average expected life of the option of 5.20 years and 8.07
years.
Information on options outstanding under the Incentive Plan and the
Directors Plan as of November 30, 1998, 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>
$0.70 - $1.00 79,000 4.54 $0.72
$2.00 - $2.75 68,565 5.53 $2.15
$4.17 - $4.83 13,500 7.28 $4.39
$6.37 - $7.01 262,500 5.21 $6.65
</TABLE>
NOTE 11 - BUSINESS COMBINATIONS
During 1997, the Company completed several acquisitions which were
accounted for using the purchase method of accounting.
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 it
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 12).
In May 1997, the Company acquired MFM. At the time of acquisition,
MFM had five 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,
1996, revenue for the fiscal year ended November 30, 1997, would have
been $15,421,000. Net loss for fiscal 1997 would have been $3,500,000
or a net loss per share of $0.54.
NOTE 12 - IMPAIRMENT OF LONG-LIVED ASSETS AND STORE CLOSURES
The provision recorded as of November 30, 1997 consisted 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's 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 totaled approximately $171,000 was
recorded as other current assets as of November 30, 1997. During fiscal
1998, the assets were sold to third parties and no significant gains or
losses were incurred.
The seven stores identified as impaired incurred operating losses during
the fiscal year ended November 30, 1997, of approximately $555,000.
One store was closed by November 30, 1997, and the remaining six stores
were closed during the first quarter of fiscal 1998. The six stores
closed during fiscal 1998 incurred operating losses of approximately
$90,000 which are included in the results of Company-owned store
operations.
The reserve for closed-store expense, established on November 30, 1997,
includes an amount for the noncancelable operating lease payments after
the expected closure date, net of estimated sublease income. At
November 30, 1998, the Company has entered into agreements terminating
the contractual lease obligations associated with the stores closed.
The final payments to be made pursuant to these agreements will be
completed in February 1999. At November 30, 1998, the reserve for
closed store leases is approximately $36,000.
NOTE 13-SUBSEQUENT EVENTS
On February 1, 1999, the Company purchased certain assets of a related
group of entities doing business as Jacobs Bros. Bagels (Jacobs Bros.),
a chain operating retail bagel stores the Chicago, Illinois area. The
assets acquired include eight retail locations and a central commissary
facility in exchange for $950,000 in cash and warrants to acquire
500,000 shares of the Company's common stock. The warrants provide for
the purchase of 275,000 shares and 225,000 shares of common stock at an
exercise price of $1.25 and $1.50 per share, respectively. The warrants
are first exerciseable on February 1, 2000 and expire on January 31,
2006. Further, the Company entered into noncompetition agreements
with two principals of Jacobs Bros. totaling $210,000 to be paid over
varying periods. Finally, the Company issued 160,000 shares of the
Company's common stock to the investment bankers.
In January 1999, the Company received a commitment from a finance
company for various secured loans totaling $1,350,000 to be used for the
purpose of acquiring the assets identified above and for the
refurbishment and conversion of the units acquired to Big Apple Bagels
concept stores. Principal and interest are payable monthly over a
period of seven years and are secured by the assets acquired from
Jacobs Bros. and all improvements made thereon. In February 1999, the
Company borrowed $1,100,000 pursuant to this commitment.
