Rave Restaurant Group - 10-Q quarterly report FY

 

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. Yes þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of November 11, 2008, 8,727,003 shares of the issuer’s common stock were outstanding.

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion should be read in conjunction with the consolidated financial statements, accompanying notes and selected financial data appearing elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended June 29, 2008 and may contain certain forward-looking statements that are based on current management expectations. Generally, verbs in the future tense and the words “believe,” “expect,” “anticipate,” “estimate,” “intends,” “opinion,” “potential” and similar expressions identify forward-looking statements. Forward-looking statements in this report include, without limitation, statements relating to our business objectives, our customers and our franchisees, our liquidity and capital resources, the impact of our historical and potential business strategies on our business, financial condition, and operating results and the expected effects of potentially adverse litigation outcomes. Our actual results could differ materially from our expectations. Further information concerning our business, including additional factors that could cause actual results to differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q, are set forth in our Annual Report on Form 10-K for the year ended June 29, 2008. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The forward-looking statements contained herein speak only as of the date of this Quarterly Report on Form 10-Q and, except as may be required by applicable law, we do not undertake, and specifically disclaim any obligation to, publicly update or revise such statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

     The Company is a franchisor and food and supply distributor to a system of restaurants operating under the trade name “Pizza Inn.” Our distribution division is Norco Restaurant Services Company (“Norco”). At September 28, 2008, there were 319 domestic and international Pizza Inn restaurants, consisting of one Company-owned domestic restaurant, 250 franchised domestic restaurants, and 68 franchised international restaurants. The 251 domestic restaurants consisted of: (i) 155 restaurants that offer dine-in, carry-out, and in many cases, delivery services (“Buffet Units”); (ii) 41 restaurants that offer delivery and carry-out services only (“Delco Units”); and (iii) 55 restaurants that are typically located within a convenience store, college campus building, airport terminal, or other commercial facility and offer quick carry-out service from a limited menu (“Express Units”). The 251 domestic restaurants were located in 17 states predominately situated in the southern half of the United States. The 68 international restaurants were located in nine foreign countries.

     Diluted income per common share remained $0.03 for the three month period ended September 28, 2008 compared to $0.03 for the comparable period ended September 23, 2007.  Net income for the three month period ended September 28, 2008 decreased $52,000 to $293,000 from $345,000 for the comparable period in the prior fiscal year, on revenues of $11,388,000 for the three month period ended September 23, 2007 and $12,078,000 for the comparable period in the prior fiscal year. 

     The decrease in net income during the three month period ended September 28, 2008, was primarily due to a non recurring inventory adjustment and increased income tax expense offset by lower severance costs, legal expenses and other operating expenses.

     Management believes that key performance indicators in evaluating financial results include domestic chain-wide retail sales and the number and type of operating restaurants. The following table summarizes these key performance indicators.

     Our revenues are primarily derived from sales of food, paper products, and equipment and supplies by Norco to franchisees, franchise royalties and franchise fees. Our financial results are dependent in large part upon the pricing and cost of these products and supplies to franchisees, and the level of chain-wide retail sales, which are driven by changes in same store sales and restaurant count.

     Food and supply sales by Norco include food and paper products, equipment and other distribution revenues.  Food and supply sales for the three month period ended September 28, 2008 decreased 6%, or $645,000, to $10,134,000 from $10,779,000 in the comparable period for the prior fiscal year.  During the three month period ended September 28, 2008, international sales and equipment sales decreased by $308,000. For the three month period ended September 28, 2008, total domestic chain-wide retail sales decreased 3%, or $1,105,000, over the comparable period for the prior fiscal year due to a lower store count. As a result of this decrease in retail sales, domestic food and paper sales decreased 3%, or $284,000, compared to the same period for the prior fiscal year.

     Franchise revenue, which includes income from royalties, license fees and area development and foreign master license sales, decreased 5%, or $52,000 to $1,064,000 for the three month period ended September 28, 2008 compared to $1,116,000 for the comparable period for the prior fiscal year. This decrease is primarily attributable to lower domestic royalties and franchise fees due to lower retail sales and fewer store openings compared to the comparable period in the prior fiscal year. The following chart summarizes the major components of franchise revenue (in thousands):

     Restaurant sales, which consist of revenue generated by the Company-owned restaurant, increased 4%, or $7,000, to $190,000 for the three month period ended September 28, 2008 compared to $183,000 for the comparable period for the prior fiscal year.

     Cost of sales decreased 4%, or $417,000, for the three month period ended September 28, 2008 compared to the comparable period for the prior fiscal year. Cost of sales for the current period includes a $154,000 adjustment increasing cost of sales due to a miscalculation of inventory as of the fiscal year ended June 29, 2008. The impact of this error is immaterial to prior public filings of financial statements of the Company and, accordingly, have been fully charged to the first quarter. Exclusive of this adjustment, cost of sales decreased 6%, or $571,000, for the three month period ended September 28, 2008 compared to the comparable period for the prior fiscal year. This decrease is primarily the result of lower food and supply sales, distribution fees, payroll costs, as well as increased purchase discounts.

     Franchise expenses include selling, general and administrative expenses directly related to the sale and continuing service of domestic and international franchises. These expenses decreased 23%, or $141,000 for the three month period ended September 28, 2008 compared to the comparable period for the prior fiscal year. These savings were primarily the result of lower payroll and travel expenses compared to the same period in the prior fiscal year. The following chart summarizes the major components of franchise expenses (in thousands):

     General and administrative expenses increased 11%, or $66,000, to $687,000 for the three month period ended September 28, 2008 compared to $621,000 for the comparable period for the prior fiscal year. The following chart summarizes the major components of general and administrative expenses (in thousands):

     The increase in general and administrative expenses during the three month period ended September 28, 2008 was primarily due to higher allocated overhead and stock compensation offset by lower payroll and legal fees.

     Provision for bad debt expense decreased to $15,000 for the three month period ended September 28, 2008 compared to $23,000 for the comparable period for the prior fiscal year due to improved collection results.

     Interest expense decreased to $12,000 for the three month period ended September 28, 2008 compared to $14,000 for the comparable period for the prior fiscal year.

     For the three month period ended September 28, 2008, income tax expense of $161,000 is calculated on an effective income tax rate that is consistent with the statutory U.S. federal income tax rate of 34%. Management believes that future operations will generate sufficient taxable income, along with the reversal of temporary differences, to fully realize the net deferred tax asset of $792,000. Income tax expense was $0 for the three month period ended September 23, 2007 due to a full valuation allowance of the deferred tax asset.

     Discontinued operations includes losses from the two Company-owned stores closed in Houston, Texas during the quarter ended September 23, 2007. Below is a summary of discontinued operations (in thousands):

     During the three month period ended September 28, 2008, one new Express unit was opened by a Pizza Inn franchise. Five domestic restaurants were closed by franchisees (three Buffet Units, two Express Units), typically because of unsatisfactory standards of operation or poor performance. We do not believe that these closings had any material impact on the collectibility of our outstanding receivables and royalties due to us because (i) these amounts have been reserved for or are otherwise collectable and (ii) these closed restaurants were generally lower volume restaurants whose financial impact on our business as a whole was not significant. For those restaurants that are anticipated to close or are exhibiting signs of financial distress, credit terms are typically restricted, weekly food orders are required to be paid for on delivery and/or with certified funds and royalty and advertising fees are collected as add-ons to the delivered price of weekly food orders.

     The following charts summarize restaurant activity for the three month periods ended September 28, 2008 and September 23, 2007:

Three months ended September 28, 2008

Three months ended September 23, 2007

     Our primary sources of liquidity are cash flows from operating activities, investing activities, and use of our credit facilities from time to time.

     Cash flows from operating activities generally reflect net income or loss adjusted for depreciation and amortization, changes in working capital and accrued expenses. In the three month period ended September 28, 2008 cash used by operations was $666,000 as compared to cash used by operating activities of $484,000 in the comparable period for the prior year. This increase in cash used for operating activities was primarily due a decrease in the Company’s trade payables balance.

     Cash flows from investing activities generally reflect capital expenditures for the purchase of Company assets. The Company used cash of $407,000 for the three month period ended September 28, 2008, primarily for a new Company store to be opened in Denton, Texas and for computer upgrades. This compares to cash used by investing activities of $40,000 for computer and related equipment for the same period in the prior fiscal year.

     Cash flows from financing activities generally reflect changes in the Company’s borrowings during the period, repurchases of outstanding shares of our common stock and the exercise of stock options. Net cash provided by financing activities was $69,000 in the three month period ended September 28, 2008 compared to cash used of $35,000 for the comparable period in the prior fiscal year. This change in the use of cash from financing activities was due to the repurchase of outstanding stock less a cash overdraft of $582,000 and increased bank debt of $301,000 used primarily to fund the new store in Denton, Texas.

     Management believes that future operations will generate sufficient taxable income, along with the reversal of temporary differences, to fully realize the net deferred tax asset of $792,000 without reliance on material non-routine income.

     On January 23, 2007, the Company and The CIT Group / Commercial Services, Inc. (“CIT”) entered into an agreement for a revolving credit facility of up to $3.5 million (the “CIT Credit Facility”). The actual availability on the CIT Credit Facility is determined by advance rates on eligible inventory and accounts receivable. Interest on borrowings outstanding on the CIT Credit Facility is at a rate equal to the prime rate plus an interest rate margin of 0.0% to 0.5% or, at the Company’s option, at the LIBOR rate plus an interest rate margin of 2.0% to 3.0%. The specific interest rate margin is based on the Company’s performance under certain financial ratio tests. An annual commitment fee is payable on any unused portion of the CIT Credit Facility at a rate of 0.375%. All of the Company’s (and its subsidiaries’) personal property assets (including, but not limited to, accounts receivable, inventory, equipment, and intellectual property) have been pledged to secure payment and performance of the CIT Credit Facility, which is subject to customary covenants for asset-based loans.

     On June 27, 2007, the Company and CIT entered into an agreement to amend the CIT Credit Facility to (i) allow the Company to repurchase Company stock in an amount up to $3,000,000, (ii) allow the Company to make permitted cash distributions or cash dividend payments to the Company’s shareholders in the ordinary course of business and (iii) increase the aggregate capital expenditure limit from $750,000 to $3,000,000 per fiscal year. On May 30, 2008, the Company again amended the CIT Credit Facility to permit the Company to repurchase up to $7,000,000 of the Company’s common stock. As of September 28, 2008, $301,000 was outstanding on the CIT Credit Facility and one letter of credit for approximately $230,000 was outstanding to reinsurers to secure loss reserves.

     The Company has cash available to fund operations through fiscal year 2009.

     On August 15, 2007, the Company’s then President and CEO, Tim Taft, submitted to the Company’s Board of Directors, his written notice of resignation as a director and officer of the Company, effective immediately. In connection with Mr. Taft’s separation from the Company, the Company agreed to pay severance of $300,000 (representing one year of salary), payable in twelve equal monthly installments. This amount was recorded as severance expense in the quarter ended September 23, 2007.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company’s management to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent liabilities. The Company bases its estimates on historical experience and various other assumptions that it believes are reasonable under the circumstances. Estimates and assumptions are reviewed periodically. Actual results could differ materially from estimates.

     The Company believes the following critical accounting policies require estimates about the effect of

matters that are inherently uncertain, are susceptible to change, and therefore require subjective judgments. Changes in the estimates and judgments could significantly impact the Company’s results of operations and financial condition in future periods.

     Accounts receivable consist primarily of receivables generated from food and supply sales to franchisees and franchise royalties. The Company records an allowance for doubtful receivables to allow for any amounts which may be uncollectible based upon an analysis of the Company’s prior collection experience, general customer creditworthiness and the franchisee’s ability to pay, as reflected by the franchisee’s sales and operating results and other general and local economic trends. Actual realization of amounts receivable could differ materially from the Company’s estimates.

     Inventory, which consists primarily of food, paper products, supplies and equipment primarily warehoused by the Company’s two third-party distributors, is stated at lower of cost or market, with cost determined according to the weighted average cost method. The valuation of inventory requires us to estimate the amount of obsolete and excess inventory. The determination of obsolete and excess inventory requires us to estimate the future demand for the Company’s products within specific time horizons, generally six months or less. If the Company’s demand forecast for specific products is greater than actual demand and the Company fails to reduce purchasing accordingly, the Company could be required to write down additional inventory, which would have a negative impact on the Company’s gross margin.

     As of June 24, 2007 we had recorded a valuation allowance based on our assessment that the realization of a portion of our net deferred tax assets did not meet the “more likely than not” criterion under SFAS No. 109, “Accounting for Income Taxes.” The entire valuation allowance was released in fiscal 2008. As a result of this determination the effective tax rate for fiscal 2009 is estimated to be 35%.

     The Company assesses its exposures to loss contingencies, including legal matters, based upon factors such as the current status of the cases and consultations with external counsel and accrues a reserve if a loss is judged to be probable and can be reasonably estimated. If the actual loss from a contingency differs from management’s estimate, operating results could be impacted.

     In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure many financial instruments, including employee stock option plans and operating leases accounted for in accordance with SFAS No. 13, Accounting for Leases, at their fair value. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. The Company has not completed its evaluation of the impact of adoption of SFAS No. 159 on

the Company’s financial statements but currently believes the impact of the adoption of SFAS No. 159 will not require material modification of the Company’s consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 141 (Revised), Business Combinations. SFAS No. 141(R) improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this Statement is not expected to have a material impact on the Company’s financial position or results of operations.

     In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary and clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This statement is effective for fiscal years beginning on or after December 15, 2008. The adoption of this Statement is not expected to have a material impact on the Company’s financial position or results of operations.

     In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133. SFAS No. 161 amends SFAS No. 133 and requires entities to enhance their disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for fiscal years beginning on or after November 15, 2008. The adoption of this Statement is not expected to have a material impact on the Company’s financial position or results of operations.

     In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (the GAAP hierarchy). SFAS No. 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AICPA Professional Standards AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The adoption of SFAS No. 162 is not expected to have a material impact on the Company’s financial statements.

Not applicable to smaller reporting company.

     The Company maintains disclosure controls and procedures designed to ensure that information it is required to disclose in the reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. The Company’s disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

     The Company’s management, including the Company’s principal executive officer and principal financial officer, or persons performing similar functions, have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on such evaluation, the Company’s principal executive and principal financial officers, or person performing similar functions, have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report. During the most recent fiscal quarter, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     As a result of the discovery of an immaterial inventory miscalculation in prior periods, the Company has strengthened controls surrounding the inventory reconciliation process. During the most recent fiscal quarter, there have been no other changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     On August 31, 2006, the Company was served with notice of a lawsuit filed against it in federal court by a former franchisee and its guarantors who operated one restaurant in the Harlingen, Texas market in 2003.  The former franchisee and guarantor alleged generally that the Company intentionally and negligently misrepresented costs associated with development and operation of the Company’s franchise, and that as a result they sustained business losses that ultimately led to the closing of the restaurant.  They seek damages of approximately $768,000, representing amounts the former franchisees claim to have lost in connection with their development and operation of the restaurant.  In addition, they seek unspecified punitive damages, and recovery of attorneys’ fees and court costs.  Pursuant to an Agreed Stipulation of Dismissal and Order, the plaintiff has dismissed the claim in federal court, with prejudice, and has re-filed the case in the state district courts of Dallas County, Texas.  Pizza Inn has answered, denying all claims, and filed a counterclaim against Plaintiffs for (i) breach of the franchise agreement, (ii) breach of guaranty and (iii) recovery of attorney fees.   The Company is waiting on a trial date to be set.  The Company believes that the plaintiff’s allegations are without merit and intends to vigorously defend against such allegations.  An adverse outcome to the proceeding could materially affect the Company’s financial position and results of operation.  Due to the preliminary nature of this matter and the general uncertainty surrounding the outcome, the Company has not made any accrual for such amounts as of September 28, 2008.

     Except as reported herein, there have been no material developments in the three month period ended September 28, 2008 in any material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is subject.

Not applicable to smaller reporting company.

     On May 23, 2007, the board of directors of the Company approved a stock purchase plan (the “2007 Stock Purchase Plan”) authorizing the purchase, on our behalf, of up to 1,016,000 shares of our common stock in the open market or in privately negotiated transactions. On June 2, 2008, the Company’s board of directors amended the 2007 Stock Purchase Plan to increase the number of shares of common stock the Company may repurchase by 1,000,000 shares to a total of 2,016,000 shares. The 2007 Stock Purchase Plan does not have an expiration date.

The following table furnishes information for purchases made pursuant to the 2007 Stock Purchase Plan during the first quarter of fiscal 2009:

     The Company’s ability to purchase shares of its common stock is subject to various laws, regulations and policies as well as the rules and regulations of the Securities and Exchange Commission. Subsequent to September 28, 2008, the Company has purchased 61,259 shares at an average price of $2.60 per share, and intends to make further purchases under the 2007 Stock Purchase Plan. The Company may also purchase shares of its common stock other than pursuant to any publicly announced plan or program.

     Not applicable.

     Not applicable.

     Not applicable.

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 12, 2008