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| SPKL.OB > SEC Filings for SPKL.OB > Form 10QSB on 13-Nov-2007 | All Recent SEC Filings |
13-Nov-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 our locations; we cannot assure you that we will succeed. We believe our menu items appeal to diners of all ages and preferences, and we expect to accommodate breakfast, lunch and dinner segments soon.
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 eight 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 president of the PretzelMaker franchise, as our chief executive.
As of November 1, 2007, we currently have 30 franchise restaurants opened. Until October 2006, we had one company restaurant. We closed our company restaurant, which was in Lakewood, Colorado. We are building a replacement company restaurant more centrally located in Denver, Colorado, which we expect to open during the fourth 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 its first year of operations.
Our franchise agreements include build out schedules for franchisee restaurants. Based on current franchise agreements and construction schedules, we believe there will be approximately 39 Spicy Pickle, franchisee-owned and operated restaurants and at least 1 company-operated restaurant open by the end of 2007.
As of November 1, 2007, we have sold 91 franchises. Of the franchises sold, 30 restaurants are opened and operating, 8 restaurants are under construction, 12 sites are under lease negation (we have either received an actual lease which is being reviewed or a letter of intent), and 41 sites are subject to area development agreements. An area development agreement is entered into when 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, Colorado Springs, and Ft. Collins areas 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, who are generally found in and near downtown districts, technological centers, universities, hospitals and government complexes.
We currently derive our revenue from the sale of franchises and from royalties paid by franchisees. We expect to resume deriving revenue from the sale of food and beverages when the company store we plan to open in the fourth quarter of 2007 begins operations. Our business is headquartered in Colorado, and we have a high concentration of restaurants in the Rocky Mountain region. Additionally, we have franchises opened and planned in a number of other regions in the United States. Our restaurant locations (including both company-owned and franchisee-owned), including those under construction and lease negotiation as of November 1, 2007, are:
Restaurants Under In Lease
Location Operating Construction Negotiation
Denver, Colorado 4 1 2
Boulder, Colorado 2
Ft. Collins, Colorado 1 1
Aurora, Colorado 1
Littleton, Colorado 1
Centennial, Colorado 1
Lone Tree, Colorado 1
Greenwood Village, Colorado 1
Federal Heights, Colorado 1
Johnstown, Colorado 1
Colorado Springs, Colorado 1 1
Louisville, Colorado 1
Englewood, Colorado 1
Ashburn, Virginia 1
Sioux Falls, South Dakota 1
Portland, Oregon 2
Poway, California 1
Sacramento, California 1
Henderson, Nevada 1
Reno, Nevada 1 1
Chicago, Illinois 1
Cincinnati, Ohio 1 1
Austin, Texas 2 1
San Diego, California 1 2
Indianapolis, Indiana 1 1 1
Chandler, Arizona 1
Brooklyn, New York 1
Hattiesburg, Mississippi 1
Edmond, Oklahoma 1
Pender, Virginia 1
Ocala, Florida 1
Cedar Park, Texas 1
30 8 12
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We intend to increase our revenues by adding new company-owned stores, selling new franchises and 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 be found in the footnotes thereto and in the footnotes included with the financial statements filed in our annual report on Form 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 periodic report.
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. Initial franchise fees were $60,000 and $60,000 for the three months ended September 30, 2007 and 2006, respectively, and $295,000 and $105,000 for the nine months ended September 30, 2007 and 2006, respectively.
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 sale systems. Royalties are recognized as revenue in the period corresponding to the reported period. Royalty fees were $150,670 and $77,320 for the three months ended September 30, 2007 and 2006, respectively, and $389,254 and $212,681 for the nine months ended September 30, 2007 and 2006, respectively.
With regard 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 receive 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 $49,430 and $26,873 for the three months ended September 30, 2007 and 2006, respectively, and $101,605 and $54,219 for the nine months ended September 30, 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. We are phasing out of these types of sales, which will be handled by a third-party supplier who will sell directly to our franchisees.
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 card (which are pre-approved) sales 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 $59,962 and $30,928 for the three months ended September 30, 2007 and 2006, respectively, and $155,687 and $93,039 for the nine months ended September 30, 2007 and 2006, respectively. These fees are offset against actual advertising expenses, which are recognized when incurred. We incurred advertising expenses of $164,409 and $76,662 for the three months ended September 30, 2007 and 2006, respectively, and $302,199 and $111,482 for the nine months ended September 30, 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 $104,447 and $45,734 for the three months ended September 30, 2007 and 2006, respectively, and $146,512 and $18,444 for the nine months ended September 30, 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 on 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 FASB 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." In March 2005, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS 123(R). We have 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 FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115" ("SFAS 159"). This standard permits an entity to measure many financial instruments and certain other items at estimated fair value. Most of the provisions of SFAS 159 are elective; however, the amendment to FASB Statement 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) generally may 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 Statement No. 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
September 30, 2007 and 2006:
Operating Statistics
2007 2006
As a As a
Percentage of Percentage of
Amount Total Revenue Amount Total Revenue
Revenues:
Restaurant sales $ - - $ 123,761 32.09 %
Franchise fees and royalties 260,849 100.00 % 261,915 67.91 %
Total revenue 260,849 100.00 % 385,676 100.00 %
Operating costs and expenses:
As a As a
Percentage of Percentage of
Restaurant Restaurant
Sales Sales
Restaurant:
Cost of sales - - 46,858 37.86 %
Labor - - 49,041 39.63 %
Occupancy - - 13,471 10.88 %
Other operating cost - - 15,397 12.44 %
Total restaurant operating expenses - - 124,767 100.81 %
As a As a
Percentage of Percentage of
Franchise Fees Franchise Fees
and Royalties and Royalties
Franchise and general:
Cost of sales 3,567 1.37 % 40,086 15.30 %
General and administrative 1,598,137 612.67 % 778,056 297.06 %
Depreciation 8,360 3.20 % 7,385 2.82 %
Total franchise and general expenses 1,610,064 617.24 % 825,527 315.18 %
As a
Percentage As a
of Total Percentage of
Revenue Total Revenue
Total operating costs and expenses 1,610,064 617.24 % 950,294 246.40 %
(Loss) from operations (1,349,215 ) (517.24 %) (564,618 ) (146.40 %)
Other income and (expense):
Other income (expense) 12 - (743 ) (0.19 %)
Interest income (expense) 16,730 6.41 % 12,775 3.31 %
Total other income and (expense) 16,742 6.42 % 12,032 3.12 %
Net income (loss) $ (1,332,473 ) (510.82 %) $ (552,586 ) (143.28 %)
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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 September 30, 2007. We plan to open a new store located within 10 miles of the original location in the fourth quarter of 2007.
During the three months ended September 30, 2007, franchise fees and royalties decreased $1,066 (0.4%) to $260,849 from $261,915 in 2006. 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-month period ended September 30, 2007, we recognized franchise fees of $60,000 which represented three restaurants opened. For the three-month period ended September 30, 2006, we recognized franchise fees of $60,000 which represented two restaurants opened.
Deferred franchise revenue, which is not included in the statement of operations, increased $185,000 (27.0%), from $685,000 at December 31, 2006 to $870,000 at September 30, 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 $73,350 (94.9%) from $77,320 in 2006 to $150,670 in 2007 primarily as a result of more franchise locations being open during the period ended September 30, 2007 as compared to the same period in 2006. For the three-month period ended September 30, 2007, we had 27 operating franchise locations. For the three-month period ended September 30, 2006, we collected revenue from 15 locations.
There are two main components of operating expenses, restaurant operating expenses and franchising and general expenses. There were no restaurant operations in the three-month period ended September 30, 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 September 30, 2007 as compared to the three months ended September 30, 2006:
2007 2006 Difference
Personnel cost $ 479,691 $ 348,097 $ 131,594
Stock option (fair value) 260,793 - 260,793
Professional fees 80,213 293,182 (212,969 )
Travel and entertainment 85,958 17,931 68,027
Marketing, advertising, promotion 104,447 45,734 58,713
Investor relations 346,032 - 346,032
Rent 47,658 14,566 33,092
Office supplies and expenses 16,553 13,852 2,701
Communication 35,812 12,152 23,660
MIS/IT 31,151 14,297 16,854
Other general and administrative expenses 109,829 18,245 91,584
Total general and administrative expenses $ 1,598,137 $ 778,056 $ 820,081
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General and administrative expense increased $820,081 (105.4%) from $778,056 for the three months ended September 30, 2006 to $1,598,137 for the three months ended September 30, 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 16 to 20 and had an increase in personnel cost of $131,594 (37.8%) from $348,097 in 2006 to $479,691 in 2007. During the three months ended September 30, 2006, we granted no stock options. During the three months ended September 30, 2007, we granted 1,500,000 options. The fair value of the options granted and expensed was $260,793. Professional fees, which are comprised of legal, accounting and consulting fees, decreased $212,969 (72.6%) from $293,182 in 2006 to $80,213 in 2007. The decrease was due to the cost associated with the registration statement filed in 2006. We expect that professional fees will increase in future periods as we incur costs associated with being a public company and increased legal costs for leasing activities. Travel and entertainment costs increased $68,027 (379.4%) from $17,931 in 2006 to $85,958 in 2007. The increase is due to the timing of new store openings. More travel was concentrated in the period ended September 30, 2007. 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 September 30, 2007 was $59,962 as compared to $30,928 in the 2006 period. Actual expenses for the three-month period ended September 30, 2007 were $164,407 as compared to $76,662 for the three-month period ended September 30, 2006. The overall increase in advertising costs 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 will 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 September 30, 2007 was $1,332,473 compared to a loss of $552,586 for the same period in 2006 for an increased loss of $779,887. The loss from operations was $1,349,215 for the three months ended September 30, 2007 compared to loss from operations of $564,618 for the three months ended September 30, 2006. The increase in the loss from operations was primarily due to increased personnel expenses, the cost of stock options, investor relations costs and increases in other operating expenses as discussed above.
The following analysis shows operating statistics for the nine months ended
September 30, 2007 and 2006:
Operating Statistics
2007 2006
As a
Percentage As a
of Total Percentage of
Amount Revenue Amount Total Revenue
Revenues:
Restaurant sales $ - - $ 360,947 44.94 %
Franchise fees and royalties 803,226 100.00 % 442,277 55.06 %
Total revenue 803,226 100.00 % 803,224 100.00 %
Operating costs and expenses:
As a As a
Percentage Percentage of
of Restaurant Restaurant
Sales Sales
Restaurant:
Cost of sales - - 142,005 39.34 %
Labor - - 138,523 38.38 %
Occupancy - - 58,787 16.29 %
Other operating cost - - 50,351 13.95 %
Total restaurant operating expenses - - 389,666 107.96 %
As a
Percentage As a
of Franchise Percentage of
Fees and Franchise Fees
Royalties and Royalties
. . .
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