BT Brands, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion of financial condition, results of operations, liquidity and capital resources of BT Brands, Inc. and its wholly-owned subsidiaries (together, the “Company”) should be read in conjunction with the Company’s condensed consolidated financial statements and accompanying notes included under Part I, Item 1 of this quarterly report on Form 10-Q, as well as with the audited consolidated financial statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s annual report on Form 10-K for the year ended January 3, 2021. Introduction We own and operate ten fast food restaurants, including nine Burger Time restaurants and one Dairy Queen restaurant, all of which are in the North Central region of the United States. Our Burger Time restaurants feature a wide variety of burgers and other affordably priced foods such as chicken sandwiches, pulled pork sandwiches, sides and soft drinks. Our Dairy Queen restaurant offers the established Dairy Queen menu consisting of burgers, chicken, sides, ice cream and other desserts, and a wide array of beverages. Our revenues are derived from the sale of food and beverages at our restaurants. Our Burger Time operating principles include: (i) offering bigger burgers and more value for the money; (ii) offering a limited menu to permit attention to quality and speed of preparation; (iii) providing fast service by way of single and double drive-thru designs and a point-of-sale system that expedites the ordering and preparation process; and (iv) great tasting quality food made fresh to order at a fair price. Our primary strategy is to serve the drive-thru and take-out segment of the quick-service restaurant industry. Operationally, we take several steps to maintain efficiency, including maintaining inventory of no more than approximately $5,000 to $10,000 per store at any given time (which also has the advantage of allowing for frequent deliveries of fresh food). Our Burger Time investment model targets an average total cash investment of between $325,000 and $535,000. Real estate and finance costs may vary materially by location but, assuming the average investment figure applies, the amount allocated to the purchase of real estate would be approximately $225,000. These costs can fluctuate significantly, based on the number and timing of restaurant openings and the specific expenses incurred for each restaurant. Our average customer transaction increased by approximately 4% in the fiscal 2020 compared to 2019 principally because of the price increase implemented in the middle of 2020. Our sales trends are influenced by many factors and the environment remains challenging for smaller restaurant chains as competition from the major fast-food hamburger-focused business is intense. Material Trends and Uncertainties There are industry trends which may have a significant adverse effect on our business. These trends principally relate to the rapidly changing area of technology and food delivery. The major companies in the restaurant industry have rapidly adopted and developed applications for the smart phone and mobile delivery, have aggressively expanded drive-through operations and have developed loyalty programs and data base marketing supported by a robust technology platform. We expect these trends to continue as restaurants aggressively complete for customers. Further, the major QSR’s have been increasingly willing to strategically discount prices through promotions such as a “dollar menu”. We expect these significant trends will continue. 14 Table of Contents The cost of food has increased over the last two years; however, we expect to see some inflationary pressure in 2021. Beef costs were stable in 2020 following an increase of approximately 5% in 2019. Given the competitive nature of the fast-food burger restaurant industry, it may be difficult to raise menu prices to fully cover future cost increases. During 2020, a significant increase in business volume contributed to improved profit margins. Additional margin improvements may have to be made through operational improvements, equipment advances and increased volumes to help offset any food cost increases, due to the competitive state of the restaurant industry. Labor will continue to be a critical factor in the foreseeable future. In most areas where we operate our restaurants, there historically has been a shortage of suitable labor. This has resulted in higher wages as the competition for employees intensifies, not only in the restaurant industry, but in practically all retail and service industries. It is crucial for the Company to develop and maintain programs to attract and retain quality employees. Increases in the federally and state mandated minimum wage may also impact our operations. While details have not been determined the initial proposal by the Biden Administration includes a proposal to increase the minimum wage to $15 per hour. In North Dakota, the minimum wage is set at the federally mandated minimum wage of $7.25 per hour and the rates are annually adjusted to reflect any increase in cost of living. South Dakota has established a minimum wage of $9.10 per hour which is annually adjusted to increase with the cost of living. Minnesota’s minimum-wage rate for small employers, such as us, is $8.04 per hour. Our hourly employees earn a wage of on average of approximately $12 to $13 per hour. An increase in the minimum wage to $15 per hour would adversely impact our profit margins. In March 2020, the World Health Organization declared coronavirus COVID-19 a global pandemic. A health pandemic is a disease outbreak that spreads rapidly and widely by infection and affects many individuals in an area or population at the same time. This contagious disease outbreak, which increases and decreases in intensity, and any related adverse public health developments, has adversely affected workforces, customers, economies, and financial markets globally, potentially leading to an economic downturn. Our stores have remained open for drive-through business. The response to COVID-19 has disrupted the normal operations of many businesses, including ours. More recently, food service businesses, including ours, have faced challenges in attracting and hiring workers and it is possible the labor shortages may become more acute in the busier summer months. Most states, including Minnesota and North Dakota, have limited or banned public gatherings to halt or delay the spread of disease. Under these emergency orders, essential services have remained open, including, but not limited to gas stations, pharmacies, grocery stores, food banks, convenience stores, take-out and delivery restaurants, banks, hospitals, and laundromats. Under the directions limiting public gatherings, regulators have generally allowed drive-through restaurant services to remain open. To date, our restaurants have remained open although we have curtailed hours at some stores and have experienced temporary restaurant closures while locations have been cleaned and employees tested. Thus far, we have been able to reopen after two or three days. Local, regional or national governments may, at any time, implement directives that further limit or order our business to close or take other measures intended to mitigate the spread of disease. Further, customers may choose to remain in self-imposed isolation and avoid public gathering places. While a program to vaccinate a majority of Americans is currently in progress, it is not possible for us to predict the duration or magnitude of the effects of the outbreak and its impact on our business or results of operations at this time. The conditions may influence restaurant customer traffic and our ability to adequately staff our restaurants, receive deliveries on a timely basis or perform functions at the corporate level. Further, such conditions could impact the availability of the menu items we offer and the ability of suppliers to deliver such products. We also may be adversely affected if jurisdictions in which we have restaurants impose mandatory closures, seek voluntary closures or impose restrictions on operations. Even if such measures are not implemented, the perceived risk of infection or significant health risk may adversely affect our business. 15 Table of Contents Growth Strategy and Outlook We are focused on growing our business and building value for our shareholders. We are seeking to increase value for our shareholders in the foodservice industry. We expect to pursue the acquisition of multi-unit restaurant concepts and individual restaurant properties at attractive multiples of earnings. Once acquired, we will operate the business or businesses with a shared central management organization. Assuming we are successful in acquiring an operating business, following the acquisition, we expect to pursue growth strategies to both expand the number of locations and to increase comparable store sales and profits. Our business plan is to grow through acquisitions in the foodservice industry. In addition, we may develop additional Burger Time locations through the acquisition and conversion of existing properties. We also expect to identify and complete acquisitions of existing restaurant units and multi-unit chains which could be operated and expanded through the addition of new locations. Our growth strategy is predicated upon (i) building or acquiring new restaurants, (ii) growing comparable restaurant sales and profits, and (iii) quickly and cost-effectively scaling our growth while leveraging our corporate services. We believe that we will have opportunities to acquire new restaurant businesses. We intend to follow a disciplined strategy of evaluating acquisition opportunities to determine the operations are in markets meeting our demographic, real estate and investment criteria. Our ability to successfully evaluate an acquisition opportunity and to understand the competitive landscape of a new market will be critical in making a successful acquisition. Additionally, our ability to identify, recruit and hire both salaried and hourly staff will impact our ability to expand as will changes in the legal environment, including increases to the minimum wage, which could impact our ability to expand into certain areas. Further, we believe that there has been an oversaturation of restaurants in certain areas which could decrease the number of markets that we believe will be attractive to expand into. Even if we can acquire restaurants, the new restaurants, and our Company, will be subject to various risks, some of which, including factors impacting our customers, such as declining economic conditions, are entirely out of our control. We will seek to quickly and cost-effectively scale our growth by leveraging our general and administrative costs. Our ability to acquire or open new restaurants is predicated on the availability of capital for such purposes. We cannot be certain that capital will be available to us on acceptable terms if at all. 16 Table of Contents Results of Operations for the Thirteen Weeks Ended April 4, 2021 and the Thirteen Weeks Ended March 29, 2020 The following table sets forth, for the fiscal periods indicated, our Condensed Statements of Operations expressed as percentage of total revenues. Percentages below may not reconcile because of rounding. 13 Weeks Ended, April 4, 2021 March 29, 2020 SALES 100.0 % 100.0 % COSTS AND EXPENSES Food and paper costs 37.7 41.4 Labor costs 29.1 37.1 Occupancy costs 7.0 12.5 Other operating expenses 6.4 6.6 Depreciation and amortization 2.8 3.4 General and administrative 5.5 5.1 Total costs and expenses 88.5 106.1 Income (loss) from operations 11.5 (6.1 ) INTEREST EXPENSE (2.0 ) (2.8 ) INCOME (LOSS) BEFORE TAXES 9.5 (8.9 ) PROVISION FOR INCOME TAXES (2.6 ) NET INCOME (LOSS) 6.9 % (8.9 )% Net Revenues: Net sales for Fiscal first quarter of 2021 increased $637,442 or 48.9% to $1,940,872 from $1,303,430 in the first quarter of Fiscal 2020. The sales increase was attributable principally to the favorable impact on our drive-through locations because of the COVID-19 related government restrictions on restaurants resulting in an increase in consumers choosing Burger Time as a dining alternative. In addition, the Company implemented a price increase in the second half of 2020 which increased sales an estimated 5% to 10%. Restaurant unit sales for the period ranged from a low of $126,000 to a high of $274,000 and average sales for each Burger Time unit during the period was approximately $201,300 in 2021 an increase from approximately $141,000 in 2020. Costs of Sales - food and paper: Cost of sales - food and paper for first quarter of fiscal 2021 decreased as a percentage of sales to 37.7% of restaurant sales from 41.4% of restaurant sales in the first quarter of fiscal 2020. This decrease was the result of a favorable six-month price on the price of ground beef patties which remained unchanged at $2.51 per pound. 17 Table of Contents Restaurant Operating Costs: Restaurant operating costs (which refer to all the costs associated with the operation of our restaurants, but do not include general and administrative costs, and depreciation and amortization) as a percent of restaurant sales decreased significantly to 80.2% of sales in the first fiscal quarter of 2021 from 97.6% in the same period of fiscal 2020. This decrease was due primarily to a significant increase in sales which favorably impacted both fixed and semi-fixed costs and the matters discussed in the “Cost of Sales,” “Labor Costs,” “Occupancy and Other Operating Cost” sections below. Labor Costs: For the first quarter of fiscal 2021, labor and benefits costs increased by $82,183 to $565,492, however, labor costs as a percentage of sales declined to 29.1% of restaurant sales from 37.1% of restaurant sales in fiscal 2020 first quarter. The decrease in the percentage was the result of the leveraging of existing staffing levels as sales increased significantly from the year earlier. The Company continued to benefit from minimal turnover in its unit restaurant management which tends to cause unfavorable variations in labor costs. Payroll costs are semi-variable in nature, meaning that they do not change proportionally to changes in revenue. Occupancy and Other Operating Expenses For the first fiscal quarter of 2021, occupancy and other expenses increased $10,995, however, as a result of the increased sales volume, these costs as a percentage of sales declined to 13.4% of sales from 19.1% of sales in the similar period in 2020. Depreciation and Amortization Expense: For first fiscal quarter of 2021, depreciation and amortization increased $10,016 to $54,836 (2.8 % of sales) from $44, 822 (3.4% of sales) in the same period in fiscal of 2020. The company continues to reinvest in its properties to maintain and upgrade items such as point-of-sale equipment and HVAC equipment. General and Administrative Costs General and administrative costs increased 59.1% or $39,122 from $66,216 (5.1% of sales) in the first fiscal quarter of 2020 to $105,338 (5.5% of sales) in the first quarter of 2021. The increase in general and administrative costs is primarily an increase in CEO compensation over the year earlier level. Income from Operations Income from operations for the 13-week period was $223,495 in fiscal 2021 compared to a loss from operations of $116,244 in the similar period in 2020. The change in income from operations in fiscal 2021 compared to fiscal 2020 was due to the significant increase in profitability of the Company’s stores resulting from an increase in sales, partially offset by an increase in General and Administrative Expense and the matters discussed in the “Net Revenues” and “Restaurant Operating Costs” sections above. 18 Table of Contents Restaurant-level EBITDA : To supplement the condensed consolidated financial statements, which are prepared and presented in accordance with GAAP, the Company uses restaurant-level EBITDA, which is not a measure defined by GAAP. This non-GAAP operating measure is useful to both management and, we believe, to investors because it represents one means of gauging the overall profitability of our recurring and controllable core restaurant operations. This measure is not, however, indicative of our overall results, nor does restaurant-level profit accrue directly to the benefit of stockholders, primarily due to the exclusion of corporate-level expenses. Restaurant-level EBITDA should not be considered a substitute for, or superior to, operating income, which is calculated in accordance with GAAP, and the reconciliations to operating income set forth below should be carefully evaluated. We define restaurant-level EBITDA as operating income before pre-opening costs, if any, general and administrative costs, and depreciation and amortization. General and administrative costs are excluded as they are generally not specifically identifiable to restaurant specific costs. Depreciation and amortization are excluded because they are not ongoing controllable cash expenses, and they are not related to the health of ongoing operations. 13-Week Period April 4, 2021 March 29, 2020 Revenues $ 1,940,872 $ 1,303,430 Reconciliation: Income (loss) from operations 223,495 (79,777 ) Depreciation and amortization 54,836 44,820 General and administrative, corporate level expenses 105,338 66,216 Restaurant-level EBITDA 383,670 31,159 Restaurant-level EBITDA margin 19.8 % 2.4 % Liquidity and Capital Resources Since March of 2020, the COVID-19 pandemic has had a positive impact of the Company’s sales and liquidity. For the 53 weeks ended January 3, 2021, the Company earned an after-tax profit of $791,992. On April 4, 2021 the Company had $1,460,098 in cash and working capital of $296,321, a decrease of $21,628 from January 3, 2021. The decrease is the result of including $182,000 in current maturities of long-term debt from the Company’s early payoff of the mortgage on its West St. Paul location at the beginning of the second fiscal quarter. In the 13-week period ending April 4, 2021, the Company continued to see strong results and positive operating cash flow. COVID-19 likely will to continue to have a significant impact on the United States economy. It is difficult to predict either the ultimate impact of the COVID-19 pandemic or the impact of governmental responses on the United States economy in general, and specifically the impact on the quick service drive-through segment of the food service industry and on Company’s operating results and financial condition as the situation is evolving. 19 Table of Contents In May 2020, the Company received pandemic-related loans totaling $487,900. Included in that amount was $460,400 borrowed under the Small Business Administration’s Paycheck Protection Program (“PPP”) under the terms of the program, the Company applied for forgiveness of the loans in 2020, anticipating its application qualified the loans for forgiveness. Following application by the Company, the loans were forgiven in 2021. In anticipation of forgiveness of the PPP advances, the loan forgiveness was reflected as “Other Income” in the third quarter of 2020. Also, in May 2020, the Company borrowed $27,500 at no interest under the Minnesota Small Business Emergency Loan Program. Our primary requirements for liquidity are to fund our working capital needs, capital expenditures, and general corporate needs, as well as to invest in or acquire companies that are synergistic with or complimentary to our business. Our operations do not require significant working capital, and, like many restaurant companies, we generally operate with negative working capital. We anticipate that working capital deficits may be incurred in the future and possibly increase. Our primary sources of liquidity and cash flows are operating cash flows and cash on hand. We use this to service debt and to maintain our stores to operate in an efficient manner, and to increase our working capital. Our working capital position benefits from the fact that we collect cash from sales from our customers at the point of sale, or within a few days from our credit card processor, and in general, payments to our vendors are not due for thirty days. Summary of Cash Flows Cash Flows Provided by Operating Activities As a result of the strong sales increase over the prior year, we generated significant positive cash flow in the 13-week period ending April 4, 2021. The winter months have historically been seasonally the slowest part of the Company’s business. Cash Flows Used in Investing Activities In 2020 through the first quarter of 2021 the Company has focused on its primary business and building its working capital reserves. Cash Flows Used in Financing Activities A significant portion of the Company’s cash flow is allocated to service the Company’s debt. Contractual Obligations As of April 4, 2021, we had $3.2 million in contractual obligations relating principally to amounts due under mortgages on the real property on which are stores are situated. Our monthly required payment is approximately $32,000. Following the end of the first quarter, the Company concluded to repay the Note payable to Bremer Bank in the amount of approximately $182,000 using on-hand cash reserves to make the payment. 20 Table of Contents Qualitative and Quantitative Disclosure about Market Risk Commodity Price Risk We are subject to volatility in food costs as a result of market risk associated with commodity prices. Our ability to recover increased costs through higher pricing is, at times, limited by the competitive environment in which we operate. We do not enter into pricing agreements with any of our suppliers to manage these risks. Beef is our largest single food purchase and the price we pay for beef fluctuates weekly based on beef commodity prices. We do not currently manage this risk with commodity future and option contracts. A ten percent increase in the cost of beef would result in approximately $175,000 of additional food costs for the Company annually. Seasonality and Inflation Seasonal factors and the timing of holidays cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically slightly lower in the first and fourth quarters due to holiday closures and the impact of cold weather at all our locations. Adverse weather conditions may also affect customer traffic, especially in the first and fourth quarters, when customers do not use our outdoor seating areas, which impacts the use of these areas and may adversely affect our revenue. Management does not believe that inflation has had a material effect on income during the recent years. Increases in food, labor or other operating costs could adversely affect the Company’s operations. In the past, however, the Company generally has been able to increase menu prices or modify its operating procedures to substantially offset increases in its operating costs. The cost of construction has also increased in recent history. We expect that costs to construct new restaurants in our existing and contiguous markets will be more expensive than several years ago, but we expect to achieve higher restaurant sales volumes and/or margin improvements to offset these or addition construction cost increases. Construction cost increases could have an adverse effect on our business and operations, particularly for new restaurant development. Our business is subject to a wide range of federal, state and local regulations, which are subject to change in ways we cannot now anticipate. We are uncertain as to the effect, if any, that changes in the regulatory environment may have on our Company. Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the Securities and Exchange Commission. Recent Accounting Pronouncements There has been no impact to our financial statements and our results of operations and financial condition as the result of the adoption of Recent Accounting Pronouncements, see “Part I, Item 1, Note 1. Summary of Significant Accounting Policies” of the Notes to Condensed Consolidated Financial Statements included in this quarterly report. 21 Table of Contents Critical Accounting Policies and Estimates Our discussion and analysis of operating results and financial condition are based upon our financial statements. The preparation of our financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses and related disclosures of contingent assets and liabilities. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. Our critical accounting policies are those that materially affect our financial statements and involve subjective or complex judgments by management. Although these estimates are based on management’s best knowledge of current events and actions that may impact us in the future, actual results may be materially different from the estimates. Jumpstart Our Business Startups Act of 2012 We qualify as an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act, as modified by the JOBS Act. Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies. Subject to certain conditions set forth in the JOBS Act, we are also eligible for and intend to take advantage of certain exemptions from various reporting requirements applicable to other public companies that are not emerging growth companies, including (i) the exemption from the auditor attestation requirements with respect to internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act, (ii) the exemptions from say-on-pay, say-on-frequency and say-on-golden parachute voting requirements and (iii) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We may take advantage of these exemptions until we are no longer an emerging growth company. We will continue to be an emerging growth company until the earliest to occur of (i) the last day of the fiscal year in which the market value of our common stock that is held by non-affiliates exceeds $700 million as of June 30 of that fiscal year, (ii) the last day of the fiscal year in which we had total annual gross revenue of $1 billion or more during such fiscal year (as indexed for inflation), (iii) the date on which we have issued more than $1 billion in non-convertible debt in the prior three-year period or (iv) the last day of the fiscal year following the fifth anniversary of the date of the completion of our initial public offering. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item. 22