Rave Restaurant Group, Inc. — Form 10-K Summary
Reporting period: Fiscal year ended June 24, 2018, comprising 52 weeks; comparable fiscal year ended June 25, 2017. The request references “2017 Q4,” but the supplied filing is the fiscal 2018 annual Form 10-K.
Business Context
Rave franchises Pizza Inn buffet, delivery/carry-out and express restaurants, licenses Pizza Inn Express kiosks, and operates and franchises Pie Five fast-casual pizza restaurants. At June 24, 2018, the system included one company-owned Pie Five restaurant, 72 franchised Pie Five units, 208 franchised Pizza Inn restaurants, three Pizza Inn Express kiosks and 58 international Pizza Inn restaurants.
During fiscal 2018, the Company transferred 12 company-owned Pie Five restaurants to franchisees and continued shifting toward a predominantly franchised model. It also discontinued the Norco food and supply distribution division during the second quarter, changing the presentation and composition of revenue and cost of sales.
Financial Performance and Key Metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Total revenue | $15.1 million | $26.1 million | Down 42.0% |
| Net income (loss) | $1.9 million | $(12.5) million | Improved $14.4 million |
| Basic EPS | $0.14 | $(1.18) | Improved $1.32 |
| Diluted EPS | $0.13 | $(1.18) | Improved $1.31 |
| Continuing operations before tax | $(1.0) million | $(11.2) million | Improved $10.1 million |
| Adjusted EBITDA | $0.6 million | $(1.7) million | Improved $2.4 million |
| Cash used in operating activities | $(3.9) million | $(5.5) million | Improved $1.6 million |
| Cash provided by investing activities | $0.7 million | $0.4 million | Improved $0.3 million |
| Cash provided by financing activities | $4.1 million | $4.7 million | Down $0.6 million |
| Cash and cash equivalents | $1.4 million | $0.5 million | Up $0.9 million |
Net margin was approximately 12.6% in fiscal 2018 versus a negative margin in fiscal 2017. However, continuing operations generated a pretax loss, and the reported profit was materially supported by a $3.4 million tax benefit from reversing part of the deferred tax valuation allowance. Adjusted EBITDA margin was approximately 4.1% of revenue.
Domestic comparable retail sales declined 2.1% to $108.4 million. Pizza Inn comparable sales increased 1.8%, while Pie Five comparable sales declined 12.9%. Total Pie Five system-wide retail sales decreased 16.7% to $47.6 million, primarily because average units open declined from 93 to 81 and underperforming units were closed or transferred.
Material Changes Versus the Prior Period
- Revenue declined primarily because company-owned restaurant sales fell 72.1% to $4.3 million after transferring 12 Pie Five restaurants to franchisees, and because Norco distribution sales were no longer reported as revenue.
- Pizza Inn franchise revenue decreased 5.7% to $6.9 million, while Pie Five franchise revenue increased 12.8% to $4.0 million, aided by an international setup fee, defaulted franchise fees and transferred stores.
- General and administrative expense declined $3.2 million to $7.6 million, including a $1.0 million reduction in corporate expenses.
- Impairment and other lease charges declined to $0.9 million from $5.9 million, and the Company recorded a $0.1 million gain on asset sales versus a $0.9 million loss.
- Domestic Pizza Inn units decreased from 161 to 153, while domestic Pie Five units decreased from 84 to 73, including a reduction in company-owned Pie Five units from 13 to one.
- Shareholders’ equity improved from a deficit of $2.1 million to positive equity of $6.3 million, primarily reflecting net income, equity issuance and note conversions.
Debt, Liquidity and Capital Resources
- Convertible notes had $1.7 million of principal outstanding at year-end, presented net of $0.1 million of unamortized issuance costs and discounts. The notes bear 4% interest, mature February 15, 2022, and are convertible at $2.00 per share. Approximately $1.3 million of principal was converted into common shares during fiscal 2018.
- The $1.0 million short-term loan from Newcastle Partners, an affiliate of the Chairman, was repaid during fiscal 2018.
- The Company raised $5.0 million of gross proceeds through a September 2017 rights offering and approximately $0.2 million through its ATM offering through June 24, 2018.
- Current assets were $4.7 million versus current liabilities of $2.0 million at year-end. The Company stated that cash on hand, operating cash flow and securities sales were expected to provide sufficient liquidity for fiscal 2019.
- Operating cash flow remained negative at $3.9 million, making the Company dependent on financing, asset sales and improved operating performance to support liquidity.
- Future minimum payments under active non-cancelable operating leases totaled $14.3 million, partially offset by expected sublease income of $1.0 million.
Outlook, Commentary, Risks and Unusual Items
Management planned to continue expanding franchised Pizza Inn and Pie Five units, pursue international development opportunities, including a planned first international Pie Five unit in Pakistan, and develop additional Pizza Inn Express kiosks. The Company did not anticipate opening additional company-owned restaurants in fiscal 2019 and intended to allocate more internal resources to Pie Five franchising.
- Management expected the recent trend of Pie Five closures to moderate and reverse, but comparable sales performance remained weak and the strategy depended on qualified, well-capitalized franchisees and suitable sites.
- The reported fiscal 2018 profit included significant non-operating and accounting-related benefits, particularly the deferred tax valuation allowance reversal. The Company continued to report a pretax loss from continuing operations and negative operating cash flow.
- The Norco discontinuation reduced credit, overhead and delivery responsibilities but also materially changed reported revenue and cost-of-sales comparability.
- Restaurant operations face intense competition, pricing pressure, labor and real estate constraints, regulatory requirements, food-cost volatility and risks associated with franchisee financial condition.
- Franchisee and notes-receivable credit risk remained relevant. One short-term franchisee note included a $0.6 million balloon payment due in the second quarter of fiscal 2019.
- The Company had $23.5 million of net operating loss carryforwards, with expirations beginning in 2032, but realization of related tax assets depends on future taxable income.
- The Company expected to adopt the new revenue recognition standard in the first quarter of fiscal 2019. License and development fee timing may change, and advertising fund contributions and expenditures may be presented gross, materially increasing reported revenue and expenses without a comparable effect on net income.
- Management reported effective disclosure controls and effective internal control over financial reporting as of June 24, 2018. The independent auditors issued an unqualified opinion on the financial statements but did not express an opinion on internal control because the Company was not required to obtain such an audit.
Investor Verification Checklist
- Verify the sustainability of positive net income excluding the $3.4 million deferred tax valuation allowance benefit and other nonrecurring items.
- Track operating cash flow, cash balances and financing needs given $3.9 million of operating cash use in fiscal 2018.
- Assess whether Pie Five comparable sales and unit closures stabilize, and whether franchise transfers improve economics without creating additional franchisee credit risk.
- Reconcile fiscal 2018 revenue with fiscal 2017 after the Norco distribution discontinuation and evaluate normalized revenue trends.
- Review the remaining convertible-note obligations, potential dilution, conversion terms and February 2022 maturity.
- Monitor the $0.6 million franchisee note balloon payment and the collectability of other notes receivable.
- Evaluate lease commitments, non-operating locations and the Company’s ability to sublease or terminate remaining obligations.
- Confirm the actual fiscal 2019 effect of the new revenue recognition and lease accounting standards.