U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

ý               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 25, 2004

 

OR

 

o               TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from               to               

 

Commission File Number 1-14556

 

POORE BROTHERS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Indicate by check 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  ý     No  o

 

Indicate by check whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  o     No  ý

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:   18,831,954 as of September 25, 2004.

 

 

Table of Contents

 

Part I.  FINANCIAL INFORMATION
Item 1.  Financial Statements (unaudited)
Consolidated balance sheets as of September 25, 2004 and December 27, 2003
Consolidated statements of income for the quarter and nine months ended September 25, 2004 and September 27, 2003
Consolidated statements of cash flows for the nine months ended September 25, 2004 and September 27, 2003
Notes to consolidated financial statements
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
Item 4.  Controls and Procedures
Part II.  OTHER INFORMATION
Item 1.  Legal Proceedings
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.  Defaults Upon Senior Securities
Item 4.  Submission of Matters to a Vote of Security Holders
Item 5.  Other Information
Item 6.  Exhibits

 

2

 

PART I.         FINANCIAL INFORMATION

Item 1.    Financial Statements

POORE BROTHERS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

		September 25, 2004			December 27, 2003
ASSETS
Current assets:
Cash and cash equivalents		$	8,600,923		$	3,239,570
Accounts receivable, net of allowance of $167,334 in 2004 and $347,147 in 2003		5,030,812			5,714,106
Inventories		1,878,791			2,400,503
Deferred income tax asset		1,427,768			2,254,996
Other current assets		330,417			889,003
Total current assets		17,268,711			14,498,178
Property and equipment, net		11,117,542			11,755,096
Goodwill		5,986,252			5,986,252
Intangible assets		4,207,032			4,207,032
Other assets		110,057			133,762
Total assets		$	38,689,594		$	36,580,320
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	3,220,549		$	3,012,059
Accrued liabilities		2,842,731			2,703,040
Current portion of long-term debt		934,936			932,155
Current portion of accrued costs related to brand discontinuance		396,105			—
Total current liabilities		7,394,321			6,647,254
Long-term debt, less current portion		2,418,242			3,139,801
Non-current portion of accrued costs related to brand discontinuance		325,983			—
Deferred income tax liabilitiesDeferred income tax liabilities		1,731,625			1,731,625
Total liabilities		11,870,171			11,518,680
Commitments and contingencies (Note 5)
Shareholders’ equity:
Preferred stock, $100 par value; 50,000 shares authorized; no shares issued or outstanding at September 25, 2004 and December 27, 2003		—			—
Common stock, $.01 par value; 50,000,000 shares authorized; 18,831,954 and 18,581,788 shares issued and outstanding at September 25, 2004 and December 27, 2003, respectively		188,319			185,817
Additional paid-in capital		25,938,008			25,673,752
Accumulated earnings (deficit)		693,096			(797,929		)
Total shareholders’ equity		26,819,423			25,061,640
Total liabilities and shareholders’ equity		$	38,689,594		$	36,580,320

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 

POORE BROTHERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

		Quarter Ended						Nine Months Ended
		Sept. 25, 2004			Sept. 27, 2003			Sept. 25, 2004			Sept. 27, 2003
Net revenues		$	17,176,201		$	16,661,499		$	52,335,763		$	50,460,125
Cost of revenues		12,871,232			13,016,505			40,348,800			39,048,891
Write-down of equipment		—			35,882			—			1,046,602
Costs related to brand discontinuance		—			—			1,414,759			—
Gross profit		4,304,969			3,609,112			10,572,204			10,364,632
Selling, general and administrative expenses		2,695,000			3,093,271			7,993,475			7,996,941
Operating income		1,609,969			515,841			2,578,729			2,367,691
Insurance claim settlement income, net		—			—			—			1,918,784
Interest expense, net		(49,758		)	(55,542		)	(145,704		)	(191,570		)
Income before income tax provision		1,560,211			460,299			2,433,025			4,094,905
Income tax provision		(604,000		)	(172,000		)	(942,000		)	(1,533,000		)
Net income		$	956,211		$	288,299		$	1,491,025		$	2,561,905
Earnings per common share:
Basic		$	0.05		$	0.02		$	0.08		$	0.15
Diluted		$	0.05		$	0.01		$	0.08		$	0.14
Weighted average number of common shares:
Basic		18,831,954			17,997,911			18,685,191			17,237,799
Diluted		19,202,074			19,369,977			19,321,246			18,153,174

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

POORE BROTHERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Nine Months Ended
		Sept. 25, 2004			Sept. 27, 2003
Cash flows from operating activities:
Net income		$	1,491,025		$	2,561,905
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,030,631			911,147
Amortization		23,704			23,297
Provision for bad debts		(56,073		)	180,397
Other asset amortization		44,066			110,991
Deferred income taxes		827,228			536,873
Costs related to brand discontinuance		1,758,919			—
Loss on disposition of equipment		16,571			1,041,768
Tax benefit from exercise of stock options		—			492,107
Change in operating assets and liabilities:
Accounts receivable		739,367			(814,437		)
Inventories		265,561			(559,240		)
Other assets and liabilities		(21,088		)	(34,661		)
Accounts payable and accrued liabilities		140,988			538,269
Net cash provided by operating activities		6,260,899			4,988,416
Cash flows from investing activities:
Increase in restricted cash		—			(2,497,004		)
Purchase of equipment		(447,526		)	(782,951		)
Proceeds from disposition of fixed assets		—			41,000
Net cash used in investing activities		(447,526		)	(3,238,955		)
Cash flows from financing activities:
Proceeds from issuance of common stock		266,758			2,021,065
Payments made on long-term debt		(718,778		)	(835,445		)
Net cash (used in) provided by financing activities		(452,020		)	1,185,620
Net increase in cash		5,361,353			2,935,081
Cash and cash equivalents at beginning of period		3,239,570			1,395,187
Cash and cash equivalents at end of period		$	8,600,923		$	4,330,268
Supplemental disclosures of cash flow information:
Cash paid during the period for interest		$	168,562		$	184,800
Summary of non-cash investing and financing activities:
Common stock issued for acquisition earnout payment		—			420,565

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5

 

POORE BROTHERS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1.     Organization and Summary of Significant Accounting Policies:

 

General

 

The Company, a Delaware corporation, was formed in 1995 as a holding company to acquire a potato chip manufacturing and snack food distribution business which had been founded by Donald and James Poore in 1986.

 

In December 1996, the Company completed an initial public offering of its Common Stock.  In November 1998, the Company acquired the business and certain assets (including the Bob’s Texas Style® potato chip brand) of Tejas Snacks, L.P. (“Tejas”), a Texas-based potato chip manufacturer.  In October 1999, the Company acquired Wabash Foods, LLC (“Wabash”) including the Tato Skins®, O’Boisies®, and Pizzarias® trademarks, and assumed all of Wabash Foods’ liabilities.  In June 2000, the Company acquired Boulder Natural Foods, Inc. (“Boulder”) and the Boulder Potato Company® brand of totally natural potato chips.

 

As part of the Boulder acquisition, the Company agreed to a provision that it may be required to issue additional unregistered shares of common stock to the seller on each of the first, second and third anniversaries of the closing of the acquisition.  Any such issuances are dependent upon, and are calculated based upon, increases in sales of Boulder products as compared to previous periods.  In 2003, the Company was required to issue 93,728 shares pursuant to this provision, which were valued at $420,565 and increased the goodwill recorded from this acquisition.

 

In October 2000, the Company launched its T.G.I. Friday’s® brand salted snacks pursuant to a license agreement with TGI Friday’s Inc., which expires in 2014.  In June 2003, the Company launched its Crunch Toons® brand potato snacks, initially featuring characters pursuant to a multi-year license agreement with Warner Bros. Consumer Products.  The Company decided to discontinue the brand in June 2004 after testing of different consumer marketing variables did not significantly improve the consumer acceptance, and amended its license agreements with Warner Bros. Consumer Products to discontinue all manufacturing and marketing activities.  In September 2004 the Company signed a multi-year license agreement with Cinnabon®, Inc. pursuant to which the Company plans to develop and test a variety of snack products.

 

The Company is engaged in the development, production, marketing and distribution of innovative snack food products that are sold primarily through grocery retailers, mass merchandisers, club stores, convenience stores and vend distributors across the United States.  The Company currently manufactures and sells nationally T.G.I. Friday’s® brand salted snacks under license from TGI Friday’s Inc.  The Company also currently (i) manufactures and sells regionally its own brands of salted snack food products, including Poore Brothers®, Bob’s Texas Style®, and Boulder Potato Company® brand batch-fried potato chips and Tato Skins® brand potato snacks, (ii) manufactures private label potato chips for grocery retail chains in the southwest, and (iii) distributes in Arizona snack food products that are manufactured by others.  The Company sells its T.G.I. Friday’s® brand salted snack products to grocery retailers, mass merchandisers and club stores directly and to convenience stores and vend operators through independent distributors.  The Company’s other brands are also sold through independent distributors.

 

6

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Poore Brothers, Inc. and all of its wholly owned subsidiaries.  All significant intercompany amounts and transactions have been eliminated.  The financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all the information and footnotes required by accounting principles generally accepted in the United States of America.  In the opinion of management, the consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary in order to make the consolidated financial statements not misleading.  A description of the Company’s accounting policies and other financial information is included in the audited financial statements filed with the Form 10-K for the fiscal year ended December 27, 2003.  The results of operations for the nine months and quarter ended September 25, 2004 are not necessarily indicative of the results expected for the full year.

 

Earnings Per Common Share

 

Basic earnings per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period.  Exercises of outstanding stock options or warrants are assumed to occur for purposes of calculating diluted earnings per share for periods in which their effect would not be anti-dilutive.

 

		Quarter Ended						Nine Months Ended
		Sept. 25, 2004			Sept. 27, 2003			Sept. 25, 2004			Sept. 27, 2003
Basic Earnings Per Share:
Net income		$	956,211		$	288,299		$	1,491,025		$	2,561,905
Weighted average number of common shares		18,831,954			17,997,911			18,685,191			17,237,799
Earning per common share		$	0 .05		$	0.02		$	0.08		$	0.15
Diluted Earnings Per Share:
Net income		$	956,211		$	288,299		$	1,491,025		$	2,561,905
Weighted average number of common shares		18,831,954			17,997,911			18,685,191			17,237,799
Incremental shares from assumed conversions-
Warrants		143,707			237,402			163,495			207,721
Stock options		226,413			1,134,664			472,560			707,654
Adjusted weighted average number of common shares		19,202,074			19,369,977			19,321,246			18,153,174
Earnings per common share		$	0.05		$	0.01		$	0.08		$	0.14

 

7

 

The Company’s stock-based compensation plan is accounted for under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.  The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”.  Accordingly, no compensation cost has been recognized for stock option grants.  Awards under the plan vest over periods ranging from one to three years, depending on the type of award.  The following table illustrates the effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested awards in each period presented, using the Black-Scholes valuation model.

 

		Quarter Ended						Nine Months Ended
		Sept. 25, 2004			Sept. 27, 2003			Sept. 25, 2004			Sept. 27, 2003
Net income as reported		$	956,211		$	288,299		$	1,491,025		$	2,561,905
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects		141,655			135,073			497,032			324,715
Pro forma net income.		$	814,556		$	153,226		$	993,993		$	2,237,190
Net income per share – basic – as reported		$	0.05		$	0.02		$	0.08		$	0.15
Pro forma net income per share – basic		$	0.04		$	0.01		$	0.05		$	0.13
Net income per share – diluted – as reported		$	0.05		$	0.01		$	0.08		$	0.14
Pro forma net income per share – diluted.		$	0.04		$	0.01		$	0.05		$	0.12

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for options granted in 2003 and 2004, respectively:  dividend yield of 0%; expected volatility of 58.5% and 62%; risk-free interest rate of 2.1% and 2.74%; and expected lives of 3 years.  Under this method, the weighted-average fair value of the options granted was $3.66 in 2003 and $0.90 in 2004.

 

8

 

2.     Inventories

 

Inventories consisted of the following:

 

		Sept. 25, 2004			Dec. 27, 2003
Finished goods		$	1,183,283		$	1,610,776
Raw materials		695,508			789,727
		$	1,878,791		$	2,400,503

 

3.     Long-Term Debt

 

The Company’s Goodyear, Arizona manufacturing, distribution and headquarters facility is collateral for a $1.8 million mortgage loan from Morgan Guaranty Trust Company of New York, which bears interest at 9.03% per annum and is secured by the building and the land on which it is located.  The loan matures on July 1, 2012; however, monthly principal and interest installments of $16,825 are determined on a twenty-year amortization period.

 

The U.S. Bancorp Credit Agreement consists of a $5.0 million Line of Credit, a $0.5 million capital expenditure line of credit (“CapEx Term Loan”) and a $5.8 million term loan (“Term Loan A”).  At September 25, 2004, there were no balances on either the Line of Credit or the CapEx Term Loan, and $1.6 million outstanding on Term Loan A.  The U.S. Bancorp Line of Credit matures October 31, 2005.  The Company is evaluating its options to either payoff the Term Loan A and/or negotiate a new credit facility with a bank.  In July 2004, the U.S. Bancorp Credit Agreement was amended to modify certain financial covenants that allow the Company to exclude one-time extraordinary, non-operating gains/losses during the applicable period.

 

The U.S. Bancorp Credit Agreement is secured by accounts receivable, inventories, equipment and general intangibles.  Borrowings under the U.S. Bancorp Line of Credit are limited to 80% of eligible receivables, 60% of eligible finished goods inventories and 50% of eligible raw materials inventories.  At September 25, 2004, the Company had a borrowing base of approximately $3.9 million under the U.S. Bancorp Line of Credit.  The U.S. Bancorp Credit Agreement requires the Company to be in compliance with certain financial performance criteria, including minimum annual operating results, a minimum tangible capital base and a minimum fixed charge coverage ratio.  At September 25, 2004 the Company was in compliance with all of the financial covenants. Management believes that the fulfillment of the Company’s plans and objectives will enable the Company to attain a sufficient level of profitability to remain in compliance with these financial covenants.

 

4.     Special Items

 

On June 11, 2004, the Company discontinued its Crunch Toons® brand.  As a result of the discontinuance, the Company recorded expenses in the second quarter of approximately $1.8 million.  The charge covered approximately $1.1 million related to minimum royalties under the license agreements and $0.3 million in inventories and capital equipment, which are shown in “Costs related to brand discontinuance” on the accompanying Consolidated Statement of Income for 2004.  In addition, a charge of $0.3 million in estimated allowances given to our customers to sell-off remaining distributor

 

9

 

and retailer inventories were recorded and are included in “Net revenues” on the accompanying Consolidated Statement of Income for the nine months ended September 25, 2004.

 

In connection with the brand discontinuation, and included in the $1.1 million charge above, the Company negotiated amendments to its license agreements with Warner Bros. Consumer Products pursuant to which the Agreements will remain in effect but become non-exclusive.  Therefore in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, the Company estimated the fair value of the remaining guaranteed future minimum payments under the agreements by computing the present value of the future cash payments.

 

The following table summarizes the activity of the accrued costs related to brand discontinuance for the quarter ended September 25, 2004:

 

 

(1)           These amounts are reflected in the Consolidated Balance Sheets as “Current and Non-current portions of accrued costs related to brand discontinuance”.

(2)           In accordance with SFAS No. 146, interest accretion of $10,877 was recorded for the period and future royalty payments will be made in accordance with the amended agreements.

 

In June 2003, the Company received $2,000,000 from its insurance company as final settlement of outstanding claims related to a fire that occurred at the Company’s Arizona facility in October, 2000, which is shown in “Insurance claim settlement income, net” on the accompanying Consolidated Statements of Income for the nine months ended September 27, 2003.  This includes (i) $1,100,000 as reimbursement for the additional capital equipment costs, and (ii) $900,000 as reimbursement for business interruption.  Additionally, the Company incurred expenses as a result of the mediation in the amount of approximately $82,000 which were netted against the proceeds.

 

Also in June 2003, the Company concluded that some of its packaging equipment that had recently been replaced by more technologically advanced machinery was no longer likely to be reinstalled and used.  Therefore, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” the Company performed an assessment of the equipment’s fair value, which resulted in the need to write-down the equipment $1,046,602.

 

10

 

5.     Litigation

 

The Company is periodically a party to various lawsuits arising in the ordinary course of business.  Management believes, based on discussions with legal counsel, that the resolution of any such lawsuits will not have a material effect on the financial statements taken as a whole.

 

6.     Business Segments

 

The Company’s operations consist of two segments: Manufactured Products and Distributed Products.  The Manufactured Products segment produces potato chips, potato crisps, tortilla chips and extruded products.  These items are produced for (i) sale under brands owned or licensed by the Company, or (ii) sale under private label arrangements for third parties. The Distributed Products segment consists of snack food products manufactured by other companies which are re-sold to the Company’s Arizona snack food distributors.  The Company’s reportable segments offer different products and services.  All of the Company’s revenues are attributable to external customers in the United States and all of its assets are located in the United States.  The Company does not allocate assets based on its reportable segments.  The accounting policies of the segments are the same as those described in the Summary of Accounting Policies included in Note 1 to the audited financial statements filed with the Form 10-K for the fiscal year ended December 27, 2003.  The Company does not allocate selling, general and administrative expenses, income taxes or unusual items to segments and has no significant non-cash items other than depreciation and amortization.

 

		Manufactured Products			Distributed Products			Consolidated
Quarter ended September 25, 2004
Net revenues from external customers		$	16,667,270		$	508,931		$	17,176,201
Depreciation and amortization in segment gross profit		247,797			—			247,797
Segment gross profit		4,237,710			67,259			4,304,969
Quarter ended September 27, 2003
Net revenues from external customers		$	15,729,565		$	931,934		$	16,661,499
Depreciation and amortization in segment gross profit		228,013			—			228,013
Segment gross profit		3,459,195			149,917			3,609,112
Nine months ended September 25, 2004
Net revenues from external customers		$	50,722,411		$	1,613,352		$	52,335,763
Depreciation and amortization in segment gross profit		777,207			—			777,207
Segment gross profit		10,330,460			241,744			10,572,204
Nine months ended September 27, 2003
Net revenues from external customers		$	47,251,315		$	3,208,810		$	50,460,125
Depreciation and amortization in segment gross profit		654,769			—			654,769
Segment gross profit		9,857,613			507,019			10,364,632

 

11

 

The following table reconciles reportable segment gross profit to the Company’s consolidated income before income tax provision:

 

		Quarter Ended							Nine Months Ended
		Sept. 25, 2004			Sept. 27, 2003				Sept. 25, 2004			Sept. 27, 2003
Consolidated segment gross profit		$	4,304,969		$	3,609,112			$	10,572,204		$	10,364,632
Unallocated amounts:
Selling, general and administrative expenses		(2,695,000		)	(3,093,271			)	(7,993,475		)	(7,996,941			)
Insurance claim settlement income, net		—			—				—			1,918,784
Interest expense, net		(49,758		)	(55,542			)	(145,704		)	(191,570			)
Income before income tax provision		$	1,560,211		$		460,299		$	2,433,025		$		4,094,905

 

7.       Income Taxes

 

The Company accounts for income taxes using a balance sheet approach whereby deferred tax assets and liabilities are determined based on the differences in financial reporting and income tax basis of assets and liabilities.  The differences are measured using the income tax rate in effect at the balance sheet date.

 

The Company experienced significant net losses in prior fiscal years resulting in a net operating loss carryforward (“NOLC”) for federal income tax purposes of approximately $4.2 million at December 27, 2003.  The Company’s NOLC will begin to expire in varying amounts between 2010 and 2018.

 

Generally accepted accounting principles require that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized.  Changes in valuation allowances from period to period are included in the tax provision in the period of change.  In determining whether a valuation allowance is required, the Company takes into account all positive and negative evidence with regard to the utilization of a deferred tax asset including our past earnings history, expected future earnings, the character and jurisdiction of such earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of a deferred tax asset, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset.

 

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

 

THIS QUARTERLY REPORT ON FORM 10-Q, INCLUDING ALL DOCUMENTS INCORPORATED BY REFERENCE, INCLUDES “FORWARD-LOOKING” STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”) AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AND THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, AND POORE BROTHERS, INC. (THE “COMPANY”) DESIRES TO TAKE ADVANTAGE OF THE “SAFE HARBOR” PROVISIONS THEREOF.  THEREFORE, THE COMPANY IS INCLUDING THIS STATEMENT FOR THE EXPRESS PURPOSE OF AVAILING ITSELF OF THE PROTECTIONS OF THE SAFE HARBOR WITH RESPECT TO ALL OF SUCH FORWARD-LOOKING STATEMENTS. IN THIS QUARTERLY REPORT ON FORM 10-Q, THE WORDS “ANTICIPATES,” “BELIEVES,” “EXPECTS,” “INTENDS,” “ESTIMATES,” “PROJECTS,” “WILL LIKELY RESULT,” “WILL CONTINUE,” “FUTURE” AND SIMILAR TERMS AND EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. THE FORWARD-LOOKING STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-Q REFLECT THE COMPANY’S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING SPECIFICALLY THE COMPANY’S RELATIVELY BRIEF OPERATING HISTORY, HISTORICAL OPERATING LOSSES AND THE POSSIBILITY OF FUTURE OPERATING LOSSES, THE POSSIBILITY THAT THE COMPANY WILL NEED ADDITIONAL FINANCING DUE TO FUTURE OPERATING LOSSES OR IN ORDER TO IMPLEMENT THE COMPANY’S BUSINESS STRATEGY, THE POSSIBLE DIVERSION OF MANAGEMENT RESOURCES FROM THE DAY-TO-DAY OPERATIONS OF THE COMPANY AS A RESULT OF STRATEGIC ACQUISITIONS, POTENTIAL DIFFICULTIES RESULTING FROM THE INTEGRATION OF ACQUIRED BUSINESSES WITH THE COMPANY’S BUSINESS, OTHER ACQUISITION-RELATED RISKS, SIGNIFICANT COMPETITION, CUSTOMER ACCEPTANCE OF NEW PRODUCTS, DEPENDENCE UPON MAJOR CUSTOMERS AND KEY EMPLOYEES, DEPENDENCE UPON LICENSE AGREEMENTS WITH THIRD PARTIES, RISKS RELATED TO THE FOOD PRODUCTS INDUSTRY (INCLUDING CONSUMER NUTRITIONAL CONCERNS, DIET TRENDS AND FOOD LABELING REQUIREMENTS), VOLATILITY OF THE MARKET PRICE OF THE COMPANY’S COMMON STOCK, THE POSSIBLE DE-LISTING OF THE COMMON STOCK FROM THE NASDAQ SMALLCAP MARKET IF THE COMPANY FAILS TO SATISFY THE APPLICABLE LISTING CRITERIA (INCLUDING A MINIMUM SHARE PRICE) IN THE FUTURE AND THOSE OTHER RISKS AND UNCERTAINTIES DISCUSSED HEREIN AND IN THE COMPANY’S OTHER PERIODIC REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE ANTICIPATED.  IN LIGHT OF THESE RISKS AND UNCERTAINTIES, THERE CAN BE NO ASSURANCE THAT THE FORWARD-LOOKING INFORMATION CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q WILL IN FACT TRANSPIRE OR PROVE TO BE ACCURATE.  READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THE DATE HEREOF.  THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE HEREOF. ALL SUBSEQUENT WRITTEN OR ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THIS SECTION.

 

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Results of Operations

 

Quarter ended September 25, 2004 compared to the quarter ended September 27, 2003.

 

Net revenues increased 3% to $17.2 million compared to third-quarter 2003 net revenues of $16.7 million.  The Company’s revenue increase was driven by continued strong growth of T.G.I. Friday’s® brand salted snacks, principally in the convenience store and grocery channels.  Overall, T.G.I. Friday’s® brand salted snacks revenue was 15% higher than in the third quarter of 2003 and accounted for approximately 72% of the Company’s net revenue in the quarter.  The Company’s other brands rose modestly.  Last year’s results included approximately $1.2 million in revenues from Crunch Toons® and a distributed product line that have since been discontinued.

 

Net income for the third quarter was $1.0 million, or $0.05 per basic and diluted share, a 232% increase compared to third-quarter 2003 net income of $0.3 million, or $0.02 per basic and $0.01 per diluted share.  The improved profitability resulted from higher revenues, improved manufacturing efficiencies and strong spending management across the Company.

 

Gross profit in the third quarter increased 19% to $4.3 million, or 25% of net revenue, compared to $3.6 million, or 22% of net revenue, in the same quarter of 2003. The increase in gross profit percentage was attributable to improved manufacturing efficiencies and lower overall trade promotion spending.  Operating costs decreased to $2.7 million in the third quarter of 2004, down from $3.1 million in 2003, or 16% versus 19% of net revenue.  The higher level of spending in 2003 was driven principally by consumer marketing programs and other costs associated with the launch of Crunch Toons®.

 

Net interest expense was essentially flat in the third quarter of 2004 versus the comparable period in 2003.  Pre-tax income rose 239% to $1.6 million compared to $0.5 million in the same quarter of 2003.  The Company’s income tax rate in 2004 of approximately 38.7% is up slightly from last year’s rate of 37.4% reflecting higher state income taxes.

 

Nine months ended September 25, 2004 compared to the nine months ended September 27, 2003

 

For the nine months ended September 25, 2004, net revenue increased 4% to $52.3 million, compared with revenue of $50.5 million in the first nine months of the previous year.  Increased revenue was the result of the same factors affecting third-quarter results discussed above.  Net income for the nine months ended September 25, 2004 decreased 42% to $1.5 million, or $0.08 per basic and diluted share, compared with net income of $2.6 million, or $0.15 per basic and $0.14 per diluted share, in the prior-year period due to the impact of certain special items discussed below.

 

Net income for the nine-months ended September 27, 2003 included $1.2 million of after-tax income from an insurance claim settlement, partially offset by a $0.7 million in after-tax charges from the write-down of idle packaging equipment.  Net income for the nine-months ended September 25, 2004 included $1.1 million in after-tax charges for expenses associated with the discontinuance of the Crunch Toons® brand.  Excluding these special items, net revenues for the nine-months ended September 25, 2004 would have been $52.7 million and net income for the period would have been approximately $2.6 million, or $0.14 per basic and $0.13 per diluted share. Similarly, net income for the nine-months ended September 27, 2003 would have been approximately $2.0 million, or $0.12 per basic and $0.11 per diluted share.  Accordingly, net income would have reflected a 27% increase in 2004 over 2003 instead of the 42% decrease mentioned above.

 

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Gross profit for the nine months ended September 25, 2004 was $10.6 million, or 20% of net revenues, as a result of being negatively impacted by the $1.8 million expenses associated with the Crunch Toons® brand discontinuance, compared to $10.4 million, or 21% of net revenues for the nine months ended September 27, 2003.  Excluding the brand discontinuance costs in 2004 and the $1.0 million packaging write-down in 2003, gross profit margins would have been approximately 24% and 23%, respectively, for the nine months ended September 25, 2004 and September 27, 2003.

 

Selling, general and administrative expenses remained flat at $8.0 million, but decreased as a percentage of net revenues to 15% for the nine months ended September 25, 2004 and 16% of net revenues for the nine months ended September 27, 2003.  The percentage decrease relates principally to increased net revenues.

 

Net interest expense decreased by 24% from the comparable period in 2003 due to lower long-term debt and interest rate reductions during the past year.  The Company’s income tax rate in 2004 of approximately 38.7% reflects higher state income taxes than the 37.5% rate used in 2003.

 

Liquidity and Capital Resources

 

Net working capital was $9.9 million (a current ratio of 2.3:1) at September 25, 2004 and $7.9 million (a current ratio of 2.2:1) at December 27, 2003.  For the nine months ended September 25, 2004, the Company generated cash flow of $6.3 million from operating activities, principally from lower receivables; invested $0.4 million in new equipment; and made $0.7 million in payments on long-term debt.

 

The U.S. Bancorp Credit Agreement consists of a $5.0 million Line of Credit, a $0.5 million capital expenditure line of credit (“CapEx Term Loan”) and a $5.8 million term loan (“Term Loan A”).  At September 25, 2004, there were no balances on either the Line of Credit or the CapEx Term Loan, and $1.6 million outstanding on Term Loan A.  The U.S.Bancorp Line of Credit matures October 31, 2005. The Company is evaluating its options to either payoff the Term Loan A and/or negotiate a new credit facility with a bank.  In July 2004, the U.S. Bancorp Credit Agreement was amended to modify certain financial covenants that allow the Company to exclude one-time extraordinary, non-operating gains/losses during the applicable period.

 

The U.S. Bancorp Credit Agreement is secured by accounts receivable, inventories, equipment and general intangibles.  Borrowings under the U.S. Bancorp Line of Credit are limited to 80% of eligible receivables, 60% of eligible finished goods inventories and 50% of eligible raw materials inventories.  At September 25, 2004, the Company had a borrowing base of approximately $3.9 million under the U.S. Bancorp Line of Credit.  The U.S. Bancorp Credit Agreement requires the Company to be in compliance with certain financial performance criteria, including minimum annual operating results, a minimum tangible capital base and a minimum fixed charge coverage ratio.  At September 25, 2004 the Company was in compliance with all of the financial covenants. Management believes that the fulfillment of the Company’s plans and objectives will enable the Company to attain a sufficient level of profitability to remain in compliance with these financial covenants.

 

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Contractual Obligations

 

The Company’s future contractual obligations consist principally of long-term debt, operating leases, minimum commitments regarding third party warehouse operations services, and remaining minimum royalty payments due licensors pursuant to brand licensing agreements.  There have been no material changes to the Company’s contractual obligations since year end other than scheduled payments.  Under the amendments to the license agreements with Warner Bros. Consumer Products, the remaining minimum royalty payments will continue to be due throughout the remaining term of the agreements. The Company currently has no material marketing or capital expenditure commitments.

 

Management’s Plans

 

In connection with the implementation of the Company’s business strategy, the Company may incur operating losses in the future and may require future debt or equity financings (particularly in connection with future strategic acquisitions, new brand introductions or capital expenditures).  Expenditures relating to acquisition-related integration costs, market and territory expansion and new product development and introduction may adversely affect promotional and operating expenses and consequently may adversely affect operating and net income.  These types of expenditures are expensed for accounting purposes as incurred, while revenue generated from the result of such expansion or new products may benefit future periods.  Management believes that the Company will generate positive cash flow from operations during the next twelve months, which, along with its existing working capital and borrowing facilities, will enable the Company to meet its operating cash requirements for the next twelve months.  The belief is based on current operating plans and certain assumptions, including   those   relating to the Company’s   future revenue levels and expenditures, industry and general economic conditions and other conditions. If any of these factors change, the Company may require future debt or equity financings to meet its business requirements. There can be no assurance that any required financings will be available or, if available, on terms attractive to the Company.

 

Critical Accounting Policies and Estimates

 

In December 2001, the Securities and Exchange Commission issued an advisory requesting that all registrants describe their three to five most “critical accounting policies”.  The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.  The Company believes that the following accounting policies fit this definition:

 

Allowance for Doubtful Accounts.  The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments.  If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.  The allowance for doubtful accounts was $167,334 at September 25, 2004 and $347,147 at December 27, 2003, respectively.

 

Inventories.  The Company’s inventories are stated at the lower of cost (first-in, first-out) or market.  The Company identifies slow moving or obsolete inventories and estimates appropriate loss provisions related thereto.  Historically, these loss provisions have not been significant; however, if actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

 

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Goodwill and Trademarks.  Goodwill and trademarks are reviewed for impairment annually, or more frequently, if impairment indicators arise.  Goodwill is required to be tested for impairment between the annual tests if an event occurs or circumstances change that more-likely-than-not reduce the fair value of a reporting unit below its carrying value.  Intangible assets with indefinite lives are required to be tested for impairment between the annual tests if an event occurs or circumstances change indicating that the asset might be impaired.  The Company believes at this time that the carrying values continue to be appropriate.

 

Advertising and Promotional Expenses.  The Company expenses production costs of advertising the first time the advertising takes place, except for cooperative advertising costs, which are expensed when the related sales are recognized.  Costs associated with obtaining shelf space (i.e. “slotting fees”) are expensed in the period in which such costs are incurred by the Company.  Anytime the Company offers consideration (cash or credit) as trade advertising or promotional allowance to a purchaser of products at any point along the distribution chain, the amount is accrued and recorded as a reduction in revenue.  Any marketing programs that deal directly with the consumer are recorded in selling, general and administrative expenses.

 

Income Taxes.  The Company has been profitable since 1999; however, it experienced significant net losses in prior fiscal years resulting in a net operating loss carryforward (“NOLC”) for federal income tax purposes of approximately $4.2 million at December 27, 2003.  Generally accepted accounting principles require that the Company record a valuation allowance against the deferred tax asset associated with this NOLC if it is “more likely than not” that the Company will not be able to utilize it to offset future taxes.  Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the provision for income taxes to vary significantly from period to period, although the cash tax payments will remain unaffected until the benefit of the NOLC is utilized.

 

The above listing is not intended to be a comprehensive list of all of the Company’s accounting policies.  In many cases the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application.  See the Company’s audited financial statements for the fiscal year ended December 27, 2003 and the notes thereto included in the Company’s Annual Report on Form 10-K with respect to such period, which contain a description of the Company’s accounting policies and other disclosures required by accounting standards generally accepted in the United States of America.

 

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Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

The principal market risks to which the Company is exposed that may adversely impact the Company’s results of operations and financial position are changes in certain raw material prices and interest rates.  The Company has no market risk sensitive instruments held for trading purposes.

 

Raw materials used by the Company are exposed to the impact of changing commodity prices.  The Company’s most significant raw material requirements include potatoes, potato flakes, wheat flour, corn and oil.  The Company attempts to minimize the effect of future price fluctuations related to the purchase of raw materials primarily through forward purchasing to cover future manufacturing requirements, generally for periods from one to 12 months.  Futures contracts are not used in combination with the forward purchasing of these raw materials.  The Company’s procurement practices are intended to reduce the risk of future price increases, but also may potentially limit the ability to benefit from possible price decreases.  Inflation and changing prices have not had a material impact on the Company’s net revenues and net income.  Increased transportation costs, driven by higher fuel prices, could result in higher commodity costs in the future.

 

The Company also has interest rate risk with respect to interest expense on variable rate debt, with rates based upon changes in the prime rate.  Therefore, the Company has an exposure to changes in those rates.  At September 25, 2004 the Company had $1.6 million of variable rate debt outstanding.  A hypothetical 10% adverse change in weighted average interest rates during fiscal 2004 would have had an unfavorable impact of less than $0.01 million on both the Company’s net earnings and cash flows.

 

The Company’s primary concentration of credit risk is related to certain trade accounts receivable.  In the normal course of business, the Company extends unsecured credit to its customers.  Substantially all of the Company’s customers are distributors or retailers whose sales are concentrated in the grocery industry, throughout the United States.  The Company investigates a customer’s credit worthiness before extending credit.  Two customers accounted for approximately 27% of net revenues for the nine months ended September 25, 2004 and for approximately 19% of the Company’s accounts receivable balance at the end of the quarter.

 

Item 4.  Controls and Procedures

 

(a)           Evaluation of Disclosure Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms.

 

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(b)           Change in Internal Control over Financial Reporting

 

No change in the Company’s internal control over financial reporting occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially effect, the Company’s internal control over financial reporting.

 

Part II.   Other Information

 

Item 1.    Legal Proceedings

 

The Company is periodically a party to various lawsuits arising in the ordinary course of business.  Management believes, based on discussions with legal counsel, that the resolution of such lawsuits will not have a material effect on the Company’s financial position or results of operations.

 

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

 

On June 30, 2004, the Company issued 31,685 shares of unregistered common stock to a financial institution following the net exercise of a warrant previously issued to such institution in a private placement exempt from registration pursuant to Section 4(2) under the Securities Act of 1933 (as amended, the “Securities Act”), of which 18,315 shares were withheld by the issuer in payment of the exercise price of $1.00 per share.  In issuing the shares, the Company relied upon an exemption from registration pursuant to Section 4(2) on the basis that the transaction did not involve a public offering.

 

Item 3.    Defaults Upon Senior Securities

 

None.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

None.

 

Item 5.    Other Information

 

As of July 19, 2004 the Company entered into an employment agreement with David Greenberg, the Company’s Senior Vice President - Marketing.  A copy of the employment agreement is filed as an exhibit to this Form 10-Q.

 

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Item 6.    Exhibits

 

(a)           Exhibits:

 

10 —                    Executive Employment Agreement entered into as of July 19, 2004, by and between Poore Brothers, Inc. and David Greenberg. *

 

31 —                    Certification of Chief Executive Officer and Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) *

 

32 —                    Certification of Chief Executive Officer and Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *

 

*- Filed Herewith

 

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SIGNATURE

 

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

 

	POORE BROTHERS, INC.
	By:	/s/ Thomas W. Freeze
Dated: November 9, 2004		Thomas W. Freeze
		President and Chief Executive Officer,
		Chief Financial Officer,
		Treasurer and Secretary
		(principal financial and accounting officer)

 

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