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| SPKL > SEC Filings for SPKL > Form 10QSB on 14-May-2007 | All Recent SEC Filings |
14-May-2007
Quarterly Report
GENERAL
The following discussion and analysis should be read in conjunction with our consolidated financial statements and related footnotes for the year ended December 31, 2006 included in our report on Form 10-KSB. The discussion of results, causes and trends should not be construed to imply any conclusion that such results or trends will necessarily continue in the future.
OVERVIEW
Our sole business is the franchise and operation of Spicy Pickle restaurants. Spicy Pickle is a fast casual restaurant where made-to-order panini, submarine style sandwiches, pizzetti (neapolitan thin crust pizza), and salads created by our founders are served using fresh baked breads and high quality ingredients. Although prices are set by franchisees at the store level and vary from location to location, sandwiches typically cost approximately $6.50, with small and large soups and salads ranging from $3.25 to $6.00 respectively. Individual size pizzetti is usually $7.50. Our goal is to deliver a delicious flavor profile, an exceptional customer experience, and an enjoyable atmosphere in its locations; we cannot assure you that we will succeed. We believe our menu items appeal to diners of all ages and preferences and will soon accommodate breakfast, lunch and dinner segments.
We market our menu primarily through targeted local store marketing efforts, mail drops, and print campaigns, as well as through other grass roots efforts. The "Spicy Pickle" brand name has existed for seven years. We are headquartered in Denver, Colorado.
The first Spicy Pickle restaurant was launched in 1999 by founders Kevin Morrison and Anthony Walker under the name Spicy Pickle, LLC. In late 2001, there were three restaurants, two in Denver and one in Lakewood, a Denver suburb. By January 2003, we organized Spicy Pickle Franchising, LLC and launched the Spicy Pickle brand as a national franchise and recruited Marc Geman, former founder and president of the PretzelMaker franchise, as our chief executive.
As of May 1, 2007, we currently have 23 franchise restaurants opened. Until recently we had one company restaurant. We recently closed our company restaurant which was in Lakewood, Colorado. We are building a replacement company restaurant more centrally located in Denver, Colorado, which will open during the second quarter of 2007 and which will include a bakery.
Our prior company restaurant, which we used as a training restaurant, operated at a loss. This loss is primarily due to higher labor costs at a restaurant which is used for training purposes. The number of employees per shift is higher than a normal restaurant and the employees are less productive during the training period. We anticipate that our new training restaurant will also operate at a loss for the foreseeable future.
Our franchise agreements include build out schedules for franchisee restaurants. Based on current franchise agreements and construction schedules, we believe there will be at least 30 Spicy Pickle, franchisee owned and operated restaurants and at least 1 company operated restaurant open by the end of 2007.
As of May 1, 2007, we have sold 83 franchises. Of the franchises sold, 23 restaurants are opened and operating, 6 restaurants are under construction, 3 sites are under lease but the site has not been turned over to the franchisee, 9 sites are under lease negation (we have either received an actual lease which is being reviewed or a letter of intent), and 42 sites are under area development agreements. An area development is where a franchisee has purchased the rights to a geographic area with a set number of stores in that area.
We are building a bakery at our new Denver company store to supply the Spicy Pickle restaurants in the Denver, Boulder, and Ft. Collins area with daily fresh baked bread. This bakery will replace the current supplier of our artisan breads and is expected to result in a food cost savings for the franchisees in that market. Spicy Pickle restaurants outside this market are equipped for bread baking at the store location.
Our locations and marketing efforts are directed principally to white collar administrative, managerial, professional, and sales personnel which are generally found in and near downtown districts, technological centers, universities, hospitals and government complexes.
We derive our revenue from the sale of food and beverages at our company store, from the sale of franchises and from royalties paid by franchisees. Our business is currently centralized in the Rocky Mountain region, but we have sold several franchises elsewhere in the United States that we expect to open within the next eighteen months. Our restaurant locations as of May 1, 2007 are:
Denver, Colorado - 4 restaurants open, 1 corporate site under construction, 1
site under negotiation
Boulder, Colorado - 1 restaurant open, 1 site under negotiation
Ft. Collins, Colorado - 1 restaurant open, 1 site under negotiation
Aurora, Colorado - 1 restaurant open
Littleton, Colorado - 1 restaurant open, 1 site being developed
Centennial, Colorado - 1 restaurant open
Lone Tree, Colorado - 1 restaurant open
Greenwood Village, Colorado - 1 restaurant open
Federal Heights, Colorado - 1 restaurant open
Loveland, Colorado - 1 site under construction
Colorado Springs, Colorado - 2 restaurant under construction, 1 site being
developed
Englewood, Colorado - 1 restaurant open
Ashburn, Virginia - 1 restaurant open
Sioux Falls, South Dakota - 1 restaurant open, 1 site being developed
Portland, Oregon - 1 restaurant open, 1 site under negotiation, 2 sites being
developed
Poway, California - 1 restaurant open, 1 site being developed
Sacramento, California - 1 restaurant open
Henderson, Nevada - 1 restaurant under construction, 3 sites being developed
Reno, Nevada - 1 restaurant open, 1 site under negotiation, 1 site being
developed
Chicago, Illinois - 1 restaurant open, 4 sites being developed
Cincinnati, Ohio - 1 restaurant open, 2 sites being developed
Austin, Texas - 2 restaurant open, 6 sites being developed
San Diego, California - 1 site under negotiation, 11 sites being developed
Indianapolis, Indiana - 2 sites under negotiation, 8 sites being developed
Chandler, Arizona - 1 site under negotiation
Washington, DC - 1 site under negotiation
New York, New York - 1 site under negotiation
Hattiesburg, Mississippi - 1 restaurant under construction, 2 sites being
developed
We intend to increase our revenues by adding new company-owned stores, selling new franchises and by expanding consumption of our food products at all stores. General economic and industry conditions may affect our ability to do so and our revenue performance.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods. Actual results could differ from those estimates. A summary of accounting policies that have been applied to the historical financial statements presented in this quarterly report can found in the footnotes thereto and in the footnotes included with the financial statements filed in the our annual report on From 10-KSB for the year ended December 31, 2006. We consider certain of these accounting policies to be critical as they are both important to the portrayal of our financial condition and results of operations and may require judgments on the part of management about matters that are uncertain. We have identified the following accounting policies that are important to the presentation of financial information in this registration statement.
REVENUE RECOGNITION
Initial Franchise Fees - We enter into franchise agreements which grant franchisees the exclusive right to develop and operate businesses at certain locations. Initial franchise fees are recognized as revenue when all material services and conditions required to be performed by us have been substantially completed, which is generally when the restaurant opens.
Royalty Fees - Pursuant to the franchise agreements, franchisees are required to pay royalties to us at the rate of 5% of weekly gross sales as reported to us through the franchisees' point of sales systems. Royalties are recognized as revenue in the period corresponding to the reported period. Royalty fees were $111,611 and $62,315 for the three months ended March 31, 2007 and 2006, respectively.
In regards to royalty fees, our franchisees grant us the right to extract data from their point of sale systems in each restaurant they operate. We receive weekly reports on sales at each franchise location and calculate our revenue directly from those reports. This allows for extremely accurate accounting of our revenue stream from royalty fees. We do not anticipate any future change in the method of reporting.
Rebates - We received rebates from purveyors that supply products to our franchisees. Rebates related to franchisees are included in Franchise Fees and Royalties. The rebates are recorded when earned. Rebates which relate to the company owned restaurant are offset against restaurant cost of sales. Rebates related to franchisees were $25,031 and $11,075 for the three months ended March 31, 2007 and 2006, respectively.
Product Sales - We sell logo products to our franchisees. Sales are recognized when products are shipped to the franchisee. Since we are selling to our franchisees, we do not anticipate any problems with collectibility of product sales.
Restaurant Sales - We record revenue from company owned restaurant sales upon delivery of the related food and other products to customers. Our restaurant sales are either cash or credit cards (which are pre-approved) and therefore no estimate for collectibility is necessary.
ADVERTISING COSTS
Franchisees must contribute to an advertising fund established by us at a rate of up to 2% of total franchisee gross sales. In our discretion, we may spend more or less than our actual advertising receipts from the franchisees. Advertising fees collected were $43,035 and $23,552 for the three months ended March 31, 2007 and 2006, respectively. These fees are offset against actual advertising expenses, which are recognized when incurred. We incurred advertising expenses of $60,837 and $44,748 in 2007 and 2006, respectively. We paid those expenses from the advertising fund and from our own funds. The net amounts reflected as advertising costs in the financial statements are $17,802 and $21,196 in 2007 and 2006, respectively.
RENT EXPENSE
We recognize rent expense on a straight-line basis over the reasonably assured lease term as defined in the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 98, "Accounting for Leases." In addition, certain of our lease agreements provide for scheduled rent increases during the lease term or for rental payments commencing at a date other than the date of initial occupancy. We include any rent escalations and construction period and other rent holidays in our determination of straight-line rent expense. Therefore, rent expense for new locations is charged to expense beginning with the start of the construction period.
EQUITY BASED COMPENSATION
On January 1, 2006, we adopted Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values. SFAS 123(R) supersedes our
previous accounting under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS 123(R). We has applied the provisions of SAB 107 in our adoption of SFAS 123(R).
SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Statement of Operations. Prior to the adoption of SFAS 123(R), we had no stock based compensation awarded to employees and directors.
RECENT PRONOUNCEMENTS
We have reviewed all recently issued, but not yet effective, accounting pronouncements and do not believe the future adoption of any such pronouncements may be expected to cause a material impact on our financial condition or the results of our operations.
On February 15, 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities -- Including an Amendment of FASB Statement No. 115" ("FASB 159"). This standard permits an entity to measure financial instruments and certain other items at estimated fair value. Most of the provisions of SFAS No. 159 are elective; however, the amendment to FASB No. 115, "Accounting for Certain Investments in Debt and Equity Securities," applies to all entities that own trading and available-for-sale securities. The fair value option created by SFAS 159 permits an entity to measure eligible items at fair value as of specified election dates. The fair value option (a) may generally be applied instrument by instrument, (b) is irrevocable unless a new election date occurs, and (c) must be applied to the entire instrument and not to only a portion of the instrument. SFAS 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity (i) makes that choice in the first 120 days of that year, (ii) has not yet issued financial statements for any interim period of such year, and (iii) elects to apply the provisions of FASB 157. Management is currently evaluating the impact of SFAS 159, if any, on our financial statements.
We believe that any estimates or assumptions we have made in the past have been accurate. We do not anticipate that any estimate or assumption is likely to change in the future. We also believe that due to the nature of our business there should not be any change to our accounting policies in the future.
RESULTS OF OPERATIONS
The following analysis shows operating statistics for the three months ended March 31, 2007 and 2006:
Operating Statistics
2007 2006
-------------------------------- --------------------------------
As a Percentage As a Percentage
Amount of Total Revenue Amount of Total Revenue
------------ ----------------- ------------ -----------------
Revenues:
Restaurant sales $ - 0.00% $ 116,561 61.36%
Franchise fees and royalties 221,643 100.00% 73,390 38.64%
------------ ----------------- ------------ ---------------
Total revenue 221,643 100.00% 189,951 100.00%
------------ ----------------- ------------ ---------------
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Operating costs and expenses:
As a As a
Percentage Percentage
of Restaurant of Restaurant
Restaurant: Sales Sales
--------------- ---------------
Cost of sales - - 44,417 38.11%
Labor - - 42,754 36.68%
Occupancy - - 21,634 18.56%
Other operating cost - - 17,597 15.10%
--------------- --------------- --------------- ---------------
Total restaurant operating expenses - - 126,402 108.45%
--------------- --------------- --------------- ---------------
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As a As a
Percentage of Percentage of
Franchise Franchise
Fees amd Fees and
Franchise and general: Royalties Royalties
--------------- ---------------
Cost of sales 4,200 1.89% 6,708 9.14%
General and administrative 759,264 342.56% 212,983 290.21%
Depreciation 4,832 2.18% 4,858 6.62%
--------------- --------------- --------------- ---------------
Total franchise and general expenses 768,296 346.63% 224,549 305.97%
--------------- --------------- --------------- ---------------
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As a As a
Percentage Percentage
of Total of Total
Revenue Revenue
--------------- ---------------
Total operating costs and expenses 768,296 346.64% 350,951 184.76%
--------------- --------------- --------------- ---------------
(Loss) from operations (546,653) -246.64% (161,000) -84.76%
Other income and (expense):
Other income 93 0.04%
Interest income (expense) 8,331 3.76% (525) -0.28%
--------------- --------------- --------------- ---------------
Total other income and (expense) 8,424 3.80% (525) -0.28%
--------------- --------------- --------------- ---------------
Net (loss) $ (538,229) -242.84% $ (161,525) -85.04%
=============== =============== =============== ===============
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The components of revenue are restaurant sales for company owned restaurants and royalties and franchise fees for our franchise operations. In November of 2006 we closed our company owned restaurant as the lease had expired. Accordingly there were no restaurant operations for the three months ended March 31, 2007. We will open a new store located within 10 miles of the original location in the second quarter of 2007.
During the three months ended March 31, 2007, franchise fees and royalties increased $148,253 (202%) to $221,643 from $73,390 in 2006. This increase is due to the larger number of franchises sold and the number of opened franchised restaurants in 2007. Initial franchise fees are recognized as revenue when all material services and conditions required to be performed by us have been substantially completed, which is generally when the restaurant
opens. For the three months ended March 31, 2007, we recognized franchise fees of $85,000. This represented three locations opened during this period. No new restaurants opened during the three months ended March 31, 2006 and accordingly no franchise fees were recognized.
Deferred franchise revenue, which is not included in the statement of operations, increased $255,000 (37.2%), from $685,000 at December 31, 2006 to $940,000 at March 31, 2007. Deferred franchise revenue represents franchise fees paid to us for restaurants which have not yet opened. Until the restaurant is opened, no revenue is recognized, but cash is available to us for start-up costs. Royalty fees increased by $49,296 (79.1%) from $62,315, in 2006 to $111,611 in 2007 primarily as a result of more franchise locations open during the period ended March 31, 2007 as compared to the same period in 2006. For the three-month period ended March 31, 2007, we had 19 franchise locations. Two of those locations opened towards the end of the period and did not have a significant effect on royalty income. For the three-month period ended March 31, 2006 we collected revenue from 11 locations.
There are two main components of operating expenses, restaurant operating expenses and franchising and general expenses. There was no restaurant operations in the three-month period ended March 31, 2007.
The following table sets forth details of the costs which make up general and administrative expenses and the differences for the three months ended March 31, 2007 as compared to the three months ended March 31, 2006:
2007 2006 Difference
----------- ----------- ------------
Personnel cost $ 469,817 $ 81,733 $ 388,084
Professional fees 51,147 26,822 24,325
Travel and entertainment 76,059 22,239 53,820
Marketing, advertising, promotion 17,802 21,196 (3,394)
Rent 29,171 13,918 15,253
Office supplies and expenses 16,992 9,032 7,960
Communication 31,809 7,883 23,926
Other general and administrative expenses 66,467 30,160 36,307
----------- ----------- ------------
Total general and administrative expenses $ 759,264 $ 212,983 $ 546,281
----------- ----------- ------------
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General and administrative expense increased $546,281 (256%) from $212,983 for the three months ended March 31, 2006 to $759,264 for the three months ended March 31, 2007. The increase relates to the increased number of franchises and our increased activity in seeking out new franchisees. We increased the number of employees from 8 to 20 and had an increased personnel cost of $388,084 (475%) from $81,733 in 2006 to $469,817 in 2007. Professional fees, which are comprised of legal, accounting and consulting fees, increased $24,325 (90.7%) from $26,822 in 2006 to $51,147 in 2007. The $24,325 increase included a $19,167 increase in accounting fees, a $1,477 increase in legal fees and a $764 increase in consulting fees. Accounting fees increased as a result of our being a public company. Travel and entertainment costs increased $53,820 (242%) from $22,239 in 2006 to $76,059 in 2007. The increase is due to the increase in the number of new stores opened during the three months ended March 31, 2007 as compared to the same period in 2006. We believe that these costs will increase in future periods as we and our franchisees continue to open more restaurants. Our franchisees pay an advertising fee equal to 2% of the gross revenue of the franchised restaurants they operate. Our accounting policy is to offset the amounts collected from the franchisees against actual advertising expenses. The amount collected for the three months ended March 31, 2007 was $43,035 as compared to $23,552 in the 2006 period. Actual expenses for the three-month period ended March 31, 2007 were $60,837 as compared to $44,748 for the three-month period ended March 31, 2006. This increase was primarily due to increased marketing efforts to attract new franchisees as well as increased local advertising for a greater number of restaurants. We anticipate marketing, advertising and promotion expenses to increase in proportion to the increase in the total number of restaurants. Other general and administrative expenses increased across the board as our business grew and were anticipated.
The net loss for the three months ended March 31, 2007 was $538,229 compared to a loss of $161,525 for the same period in 2006 for an increased loss of $376,704. The loss from operations was $546,653 for the three months ended March 31, 2007 compared to loss from operations of $161,000 for the three months ended March 31, 2006, the increase in the loss from operations was primarily due to increased payroll expenses and increases in other operating expenses as discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2007, we had a working capital deficit of $373,698, as compared to working capital of $433,756 at December 31, 2006. This decrease in working capital during the three months ended March 31, 2007 was primarily due to our net loss. During the three months ended March 31, 2007, we used cash in operating activities of $868,668 as compared to cash provided from operations of $16,393 for the same period in 2006. We also used cash for the acquisition of . . .
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