BAB Inc (QB)【BABB】株式ニュース

BAB Inc: Get Paid To Wait While Market Realizes Potential Double

If one wants to have an edge in investing and achieve above average returns, they have to do things differently than the crowd. You have to go to places that other people aren’t and must have an edge. The areas that are off-limits to the smarter funds and just plainly go unnoticed by the investment community are micro-caps. Here anyone willing to do the digging can find mis-priced companies with niches trading at large discounts. It’s no surprise that Warren Buffett (Trades, Portfolio) said:

“If I had $10,000 to invest, I would focus on smaller companies because there would be a greater chance that something was overlooked in that arena. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money.I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that. But you can’t compound $100 million or $1 billion at anything remotely like that rate.”

So, we love to find micro-cap companies that have minimal capital requirements and high rates of return. A company that we have recently found that fits the bill is the franchisor BAB Inc, (BABB).

When you think of quick serve restaurants (QSR) many of the more famous names come to mind. What does not come high on that list is Big Apple Bagels since it has only roughly 100 franchises throughout the US. BABB owns Big Apple Bagels, My Favorite Muffins and and Sweet Duet. The franchisor has less revenue than 2005, however, royalty revenues have been quite steady the past couple of years. Management owns a majority of the company and smartly decided to cut salaries and expenses to manage the decline. Since the company has 0 analyst coverage and goes under the radar due to its $6 million market cap, the market has not fully priced in the impact of a recently signed master franchisor agreement. We believe that the company’s current franchise base is stable and royalty revenues should continue, while the master franchise agreement has minimum guarantees of store growth of 30% of current stores over the next 10 years. BABB has also enlisted the help of refreshing their brand and marketing which should help current stores gather more sales as well as gaining interest franchisee interest. BABB is trading at nearly half of their closest competitor’s multiple of royalty EBITDA indicating the market is not pricing in any franchise growth. Investors are paid 5% in dividends - that can be mostly taxed as capital distributions - while the market takes its time in seeing the true value of BABB.

It is no surprise that QSRs have been going the way of total franchise models ditching the company owned operations due to the capital light, high cash flow and ability to grow quickly. Operational risk is reduced and cash can be deployed in highly accretive ways or it can be handed directly back to investors. BAB’s owner operators figured this out in 2010 and has been operating a full franchise model since that period and gives a majority of their cash back to investors. The only problem is revenues are less than years past. What we have noticed is that franchise closings the last two years has been very low at 1-3 stores or 1-3% of total franchises and during 2009 7 stores were closed equaling a 6.7% closing rate. These numbers indicate that the current franchise lineup is unlikely to close or not renew their franchise agreement and royalty revenues should be stable. In other words there is limited downside.

Other bagel QSRs like Einstein Noah Restaurant (BA*L) have similar operations and can give us an idea of what a bagel QSR could be worth. BA*L is shifting to focus less on company owned operations, yet has significantly more debt than BABB with roughly 35% of it’s market cap in long-term debt. BABB, on the other hand, has 8% of its market cap in cash and virtually no long-term debt.

BA*L’s sum of the parts valuation indicates that the franchise businesses are worth roughly 8x royalty EBITDA. BABB on the other hand, is trading for ~4.5x royalty EBITDA. We acknowledge that BA*L is larger than BABB and has more liquidity, so we should expect a discount, however, a nearly 50% discount would only be warranted if BABB had no growth going forward. We feel the market is overlooking two important factors that will lead to growth of the franchise making the large discount unwarranted. We would say that BABB’s royalty revenues could be worth 6x EBITDA which includes an illiquidity discount. With a 6x multiple, BABB’s enterprise value would be $11 million instead of the current $5.15 million today. Indicating upside of >100%.

(Source: Our Calculations)

To achieve this higher multiple we will outline the two important drivers of the company’s franchise growth. First, BAB partnered with marketing agency Streng/MSI to help modernize their marketing program, which could help improve the profile of the BAB franchise brands. The websites of the franchises, as well as the social media pages, are a significant improvement. It will take time for the marketing to help promote the franchises and the franchise opportunity. BABB also recently announced at the beginning of May this year a new master franchise agreement with Mont Royal General Trading, LLC in Dubai to expand Big Apple Bagels and other franchises throughout the Middle East. The market clearly does not take this growth into perspective since there are guaranteed minimum number of stores that must be opened in the next three and tend years.

Let’s see what impact this master agreement would have on BABB. The new agreement stipulates that Mont Royal must open at least 9 BAB franchises in the next three years and at least 30 franchises in the next ten years. Currently, BAB franchises receive roughly $17,500 in royalty revenues per store, but that is at 5% of franchise sales. The agreement states that the international franchise royalty fees with Mont Royal will be at 3% of sales, so if we adjust gross sales slightly downward to adjust for currency differences, our estimate for royalty revenue per store is ~$10,000. So if we specifically look three years out and put a similar 6 times multiple on royalty EBITDA, excluding licensing fee, and discounting those cash flows 10% we estimate the current value of that stream of income at $570,000 or $0.08 a share.

Our total conservative estimate of intrinsic value would be:

$1.53 + $0.08 = $1.61

BAB Inc, currently trades for $0.82 a share, so there is a huge margin of safety. Investors have the benefit of receiving a 5% stream of cash while they wait for the market to realize the company’s true value. We say stream of cash since the income is not necessarily taxed as a dividend and is mostly earmarked as a capital distribution. Income given as a capital distribution is significantly beneficial to long-term shareholders since distributions defer taxes. What happens is instead of getting taxed for each distribution, the distributions lower the shareholder’s cost basis. So, when an investor sells the capital gains will be larger and thus a larger sum to tax on. Taxes are then deferred until the sale of shares. It makes sense that this decision was made since the CEO is the largest shareholder and the board/management team own a significant portion of BABB.

Management’s decision to take pay cuts and further reduce salaries is another indication that management is focused on the long-term value and is aligned with minority shareholders.

Risks

Royalty cash streams from franchisees could continue to decline. This could then impair the company’s ability to pay a capital distribution. We think that this risk is mitigated by the stickiness inherent in the franchise model. Also, the franchise closing and non-renewal rates have been in the 1-3% range over the last few years and only 7% in the worst recession in many years. We can take comfort in the fact that the CEO is majority owner and the capital distribution is roughly $60,000 or 30% of his salary and will take the appropriate steps to continue receiving this distribution as well as growing it.

BABB could have trouble growing in the US and the recent master franchising agreement could lead to unprofitable franchises. This could be possible but even if the minimum franchises from the master agreement are opened and not successful, the current valuation has this baked into the price.

BABB is a micro-cap company with very little trading volume, so one must use limit orders and be ready to hold onto the long-term. This risk is mitigated by the large capital distribution.

Catalysts

Positive results from the new opened franchises in the Middle East as well as positive performance from the marketing campaign would further reduce the value gap.

Conclusion

Investors with smaller capital to invest should heed Warren Buffett (Trades, Portfolio)’s advice and invest in small-cap and micro-caps where there are greater opportunities. BAB Inc, is a micro-cap with solid cash generation capacity that is trading at a very large discount. Investors get a dollar for fifty cents and have the optionality for larger growth. Illiquidity should not be a problem since BABB’s 5% capital distribution provides plenty of value while they wait for Mr. Market to understand the company’s true intrinsic value.

Source

Form 10-Q for $BABB INC.

12-Oct-2010

Quarterly Report

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements contained in Management's Discussion and Analysis of Financial Condition and Results of Operations, including statements regarding the development of the Company's business, the markets for the Company's products, anticipated capital expenditures, and the effects of completed and proposed acquisitions, and other statements contained herein regarding matters that are not historical facts, are forward-looking statements as is within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Because such statements include risks and uncertainties, actual results could differ materially from those expressed or implied by such forward-looking statements as set forth in this report, the Company's Annual Report on Form 10-K and other reports that the Company files with the Securities and Exchange Commission. Certain risks and uncertainties are wholly or partially outside the control of the Company and its management, including its ability to attract new franchisees; the continued success of current franchisees; the effects of competition on franchisees and Company-owned store results; consumer acceptance of the Company's products in new and existing markets; fluctuation in development and operating costs; brand awareness; availability and terms of capital; adverse publicity; acceptance of new product offerings; availability of locations and terms of sites for store development; food, labor and employee benefit costs; changes in government regulation (including increases in the minimum wage); regional economic and weather conditions; the hiring, training, and retention of skilled corporate and restaurant management; and the integration and assimilation of acquired concepts. Accordingly, readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revision to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

General

The Company has 1 Company-owned store, 97 franchised and 5 licensed units at August 31, 2010. Units in operation at August 31, 2009 included 1 Company-owned store, 106 franchised and 3 licensed units. System-wide revenues for the nine months ended August 31, 2010 were $26.7 million as compared to August 31, 2009 which were $28.8 million.

The Company's revenues are derived primarily from ongoing royalties paid to the Company by its franchisees, from the operation of Company-owned stores and receipt of franchise fees. Additionally, the Company derives revenue from the sale of licensed products (My Favorite Muffin mix, Big Apple Bagels cream cheese and Brewster's coffee), and through licensing agreements (Kohr Bros. and Mrs. Fields Famous Brands).

Royalty fees from franchised stores represent a fee of 5% on net retail and wholesale sales of franchised units. Royalty revenues are recognized on an accrual basis using actual franchise receipts. Generally, franchisees report and remit royalties on a weekly basis. The majority of month-end receipts are recorded on an accrual basis based on actual numbers from reports received from franchisees shortly after the month-end. Estimates are utilized in certain instances where actual numbers have not been received and such estimates are based on the last 10 weeks' average.

The Company recognizes franchise fee revenue upon the opening of a franchise store. Direct costs associated with the franchise sale are deferred until the franchise fee revenue is recognized. These costs include site approval, construction approval, commissions, blueprints and training costs.

In addition, the Company earns a licensing fee from the sale of BAB branded products, which includes coffee, cream cheese, muffin mix and par baked bagels from a third-party commercial bakery to the franchised and licensed units.

As of August 31, 2010, the Company employed 26 persons, consisting of 11 working in the Company-owned store, of which 10 are part-time employees, and 15 employees located at the Corporate offices are responsible for corporate management and oversight, accounting, advertising and franchising. None of the Company's employees are subject to any collective bargaining agreements and management considers its relations with its employees to be good.

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Results of Operations

Three Months Ended August 31, 2010 versus Three Months Ended August 31, 2009

For the three months ended August 31, 2010 and 2009, the Company reported net income of $128,000 and $115,000, respectively. Total revenue of $748,000 decreased $76,000, or 9.2%, for the three months ended August 31, 2010, as compared to total revenue of $824,000 for the three months ended August 31, 2009.

Royalty fee revenue of $435,000, for the quarter ended August 31, 2010, decreased $26,000, or 5.6%, from $461,000 for quarter ended August 31, 2009. The Company had 97 franchise locations at August 31, 2010 as compared to 106 locations at August 31, 2009. The decrease in the number of franchise units have negatively impacted our royalty revenue.

Franchise fee revenue of $40,000, for the quarter ended August 31, 2010, increased $15,000, or 60.0%, from $25,000 for the quarter ended August 31, 2009. One store opened in each of the quarters with 3 store transfers in 2010 versus 1 in 2009.

Licensing fee and other income of $159,000, for the quarter ended August 31, 2010, decreased $58,000, or 26.7%, from $217,000 for the quarter ended August 31, 2009. Rent revenue decreased $43,000 due to the termination of the Lincoln, NE sublease on December 31, 2009, Sign Shop revenues decreased $11,000 and license fee revenue decreased $12,000, offset by an increase of $8,000 in settlement/franchise audit adjustment fee revenue in 2010 compared to 2009.

Company-owned store sales of $114,000, for the quarter ended August 31, 2010, decreased $7,000, or 5.8%, from $121,000 for the quarter ended August 31, 2009.

Total operating expenses of $619,000 decreased $90,000, or 12.7%, for the quarter ended August 31, 2010, from $709,000 in 2009. The $90,000 decrease in total operating expenses was primarily due to a $41,000 decrease in rent expense for Lincoln, NE (the lease terminated December 31, 2009), a $23,000 decrease in legal expenses, a $5,000 decrease in payroll related expense for the Company-owned store, and a decrease in SG&A of $22,000 which included a $3,000 decrease in travel expense, a $4,000 decrease in payroll related benefits, a $9,000 decrease in Sign Shop expense, and a $5,000 decrease in franchise development expense which are all part of SG&A expense in 2010 compared to 2009.

Interest income of $2,000 decreased $1,000, or 33.3% for the quarter ended August 31, 2010, from $3,000 for the same period in 2009. Lower interest rates resulted in the lower interest income.

Interest expense of $2,000 decreased $1,000, or 33.3% for the quarter ended August 31, 2010, from $3,000 for the same period in 2009.

Net income per share, as reported for basic and diluted outstanding shares for three months ended August 31, 2010 and 2009 was $0.02 per share.

Nine Months Ended August 31, 2010 versus Nine Months Ended August 31, 2009

For the nine months ended August 31, 2010, the Company reported a net income of $259,000 versus a net loss of $2,168,000 for the same period in 2009. The prior year loss was due to an impairment charge for goodwill and other intangibles in the first quarter 2009 of $2,399,000. Total revenue of $2,105,000 decreased $294,000, or 12.3%, for the nine months ended August 31, 2010, as compared to total revenue of $2,399,000 for the nine months ended August 31, 2009.

Royalty fee revenue of $1,292,000, for the nine months ended August 31, 2010, decreased $96,000, or 6.9%, from the $1,388,000 for the nine months ended August 31, 2009. The Company had 97 franchise locations at August 31, 2010 as compared to 106 locations at August 31, 2009. The decrease in stores and the general economic downturn have negatively impacted our franchise network and resulting royalty revenue.

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Franchise fee revenue of $65,000, for the nine months ended August 31, 2010, decreased $10,000, or 13.3%, from $75,000 for the nine months ended August 31, 2009. Two stores opened during the nine months ended August 31, 2010, and 3 stores transferred versus 3 stores opening and 2 transfers in the same period of 2009.

Licensing fee and other income of $413,000, for the nine months ended August 31, 2010, decreased $176,000, or 29.9%, from $589,000 for the nine months ended August 31, 2009. Rent revenue decreased $123,000 due to the termination of the Lincoln, NE sublease on December 31, 2009, Sign Shop revenue decreased $37,000 and licensing fee revenue decreased $33,000 primarily due to less stores and the general economic downturn, offset by a $17,000 settlement/franchise audit adjustment fee revenue increase in 2010 compared to 2009.

Company-owned store sales of $335,000, for the nine months ended August 31, 2010, decreased $13,000, or 3.7%, from $348,000 for the same period of 2009.

Total operating expenses of $1,843,000 decreased $328,000 or 15.1%, for the nine months ended August 31, 2010 from $2,171,000, excluding the impairment charge of $2,399,000, in 2009. The $328,000 decrease in total operating expenses was primarily due to an $85,000 decrease in payroll expense, a $109,000 decrease in rent and utility expense for Lincoln, NE, (the lease terminated December 31, 2009), a $17,000 decrease in Company-owned store expense, a $7,000 decrease in professional fees, a $5,000 decrease in advertising and promotion, and a $104,000 decrease in SG&A which includes a $21,000 decrease in travel expense due to more in-house pre-visit analysis in 2010, a $33,000 decrease in Sign Shop expense, a $19,000 decrease in bad debt expense, primarily due to recovery of 2009 bad debt in 2010, a $14,000 decrease in franchise development expenses, a $10,000 decrease in general administrative expenses and a $6,000 decrease in employee benefit expenses.

Interest income of $5,000 decreased $6,000, or 54.5% for the nine months ended August 31, 2010, from $11,000 for the same period in 2009. Lower interest rates and a change in investment instruments in 2010 resulted in the lower interest income. As opposed to using an outside investment sweep account, funds are now held in the bank account and earnings on the balances are used to offset bank fees. Bank fees were approximately $1,000 less for the nine months ended August 31, 2010, versus the same period 2009.

Interest expense of $7,000 decreased $1,000, or 12.5% for the nine months ended August 31, 2010, from $8,000 in same period 2009.

Net income per share, as reported for basic and diluted outstanding shares for nine months ended August 31, 2010 was $0.04 compared to net loss per share of $0.30 for August 31, 2009.

Liquidity and Capital Resources

The net cash provided by operating activities totaled $327,000 for the nine months ended August 31, 2010, versus cash provided by operating activities of $154,000 for the same period in 2009. Cash provided by operating activities principally represents net income of $259,000, plus depreciation and amortization of $21,000, provision for uncollectible accounts of $14,000 and share-based compensation of $7,000 plus inventories of $5,000, accrued liabilities of $27,000, unexpended Marketing Fund contributions of $55,000 and deferred revenue of $51,000, less changes in trade accounts and notes receivable of $52,000, restricted cash of $34,000, Marketing Fund contributions receivable of $5,000, prepaid expenses and other assets of $7,000 and accounts payable of $13,000. Operating activities in 2009 provided cash of $154,000, represented by a net loss of $2,168,000, plus depreciation and amortization of $25,000, goodwill and intangible impairment of $2,399,000, provision for uncollectible accounts of $7,000 and share-based compensation of $8,000, plus changes in accounts and notes receivable of $1,000, restricted cash of $64,000, inventories of $12,000 and prepaid expenses and other assets of $14,000, less changes in Marketing Fund contributions receivable of $2,000, accounts payable of $14,000, accrued liabilities of $20,000, unexpended Marketing Fund contributions of $62,000 and deferred revenue of $110,000.

Cash used in investing activities during the nine months ended August 31, 2010 totaled $24,000. Equipment was purchased for $22,000 and trademark renewal expenditures were $2,000. Cash used during 2009 totaled $20,000. Equipment purchases were $1,000 and trademark renewal expenditures were $19,000.

Financing activities used $218,000 for the nine months ended August 31, 2010 for payment of cash distributions. Financing activities for 2009 used $291,000 for the payment of cash dividends.

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Cash Distribution and Dividend Policy

It is the Company's intent that future cash distributions/dividends will be considered after reviewing profitability expectations and financing needs and will be declared at the discretion of the Board of Directors. Due to the general economic downturn and its impact on the Company, there can be no assurance that the Company will generate sufficient earnings to pay out cash distributions/dividends. The Company will continue to analyze its ability to pay cash distributions/dividends on a quarterly basis.

The Company believes that for tax purposes the cash distribution declared in 2010 may be treated as a return of capital to shareholders depending on each shareholder's basis or it may be treated as a dividend or a combination of the two. Determination of whether it is a cash distribution, cash dividend or combination of the two will not be determined until after December 31, 2010, as the classification or combination is dependent upon the Company's earnings and profits for tax purposes for its fiscal year ending November 30, 2010.

The Company believes execution of this policy will not have any material adverse effects on its ability to fund current operations or future capital investments.

The Company has no financial covenants on any of its outstanding debt.

Recent Accounting Pronouncements

In August 2009, the FASB (Financial Accounting Standards Board) issued ASU (Accounting Standards Update) 2009-05 to provide guidance on measuring the fair value of liabilities under ASC 820, "Fair Value Measurements and Disclosures." ASU 2009-05 became effective for us during the quarter ended February 28, 2010. ASU 2009-05 provides guidance regarding valuation for liabilities which trade as an asset in an active market. The adoption of this guidance did not have an impact on our consolidated financial position, cash flows or results of operations.

In January 2010, the FASB issued ASU 2010-05, "Compensation-Stock Compensation" This update is a clarification of the treatment of escrowed share arrangements and provides guidance on the presumption of compensation under such arrangements. The Company has determined that the changes to the accounting standards required by this update do not have a material effect on our consolidated financial position, cash flows or results of operations.

In January 2010, the FASB issued ASU 2010-06, "Fair Value Measurements and Disclosure." This guidance requires new disclosures for fair value measurements and provides clarification for existing disclosure requirements. The guidance is effective for interim and annual periods beginning after December 15, 2009, except for gross presentation of activity in level 3 which is effective for annual periods beginning after December 15, 2010, and for interim periods in those years. The adoption of this guidance did not have an impact on our consolidated financial position, cash flows or results of operations.

Management does not believe that there are any other recently issued and effective or not yet effective pronouncements as of August 31, 2010 that would have or are expected to have any significant effect on the Company's consolidated financial position, cash flows or results of operations.

Critical Accounting Policies

The Company has identified significant accounting policies that, as a result of the judgments, uncertainties, uniqueness and complexities of the underlying accounting standards and operations involved, could result in material changes to its financial condition or results of operations under different conditions or using different assumptions. The Company's most critical accounting policies are related to the following areas: revenue recognition, long-lived and intangible assets, deferred tax assets and the related valuation allowance. Details regarding the Company's use of these policies and the related estimates are described in the Company's Annual Report on Form 10-K for the fiscal year ended November 30, 2009, filed with the Securities and Exchange Commission on February 23, 2010. There have been no material changes to the Company's critical accounting policies that impact the Company's financial condition, results of operations or cash flows for the nine months ended August 31, 2010.