TOFUTTI BRANDS INC - Quarter Report: 2012 September (Form 10-Q)

TOFUTTI BRANDS INC.

The following is management’s discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying financial statements.

The discussion and analysis which follows in this Quarterly Report and in other reports and documents and in oral statements made on our behalf by our management and others may contain trend analysis and other forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 which reflect our current views with respect to future events and financial results. These include statements regarding our earnings, projected growth and forecasts, and similar matters which are not historical facts. We remind stockholders that forward-looking statements are merely predictions and therefore are inherently subject to uncertainties and other factors which could cause the actual future events or results to differ materially from those described in the forward-looking statements. These uncertainties and other factors include, among other things, business conditions in the food industry and general economic conditions, both domestic and international; lower than expected customer orders; competitive factors; changes in product mix or distribution channels; and resource constraints encountered in developing new products. The forward-looking statements contained in this Quarterly Report and made elsewhere by or on our behalf should be considered in light of these factors.

Critical Accounting Policies

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The policies discussed below are considered by management to be critical to an understanding of our financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.

Revenue Recognition. We recognize revenue when goods are shipped from our production facilities or outside warehouses and the following four criteria have been met: (i) the product has been shipped and we have no significant remaining obligations; (ii) persuasive evidence of an arrangement exists; (iii) the price to the buyer is fixed or determinable; and (iv) collection is probable. We record as deductions against sales all trade discounts, returns and allowances that occur in the ordinary course of business, when the sale occurs. To the extent we charge our customers for freight expense, it is included in revenues. The amount of freight costs charged to customers has not been material to date.

Accounts Receivable. The majority of our accounts receivables are due from distributors (domestic and international) and retailers. Credit is extended based on evaluation of a customers’ financial condition and, generally, collateral is not required. Accounts receivable are most often due within 30 to 90 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered past due. We determine whether an allowance is necessary by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, the customer’s current ability to pay its obligation, and the condition of the general economy and the industry as a whole. We write off accounts receivable when

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they become uncollectible, and payments subsequently received on such receivables are credited to the bad debt expense account. We do not accrue interest on accounts receivable past due.

Inventory. Inventory is stated at lower of cost or market determined by first in first out (FIFO) method. Inventories in excess of future demand are written down and charged to the provision for inventories. At the point of which loss is recognized, a new, lower cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in the newly established cost basis.

Income Taxes. The carrying value of deferred tax assets assumes that we will be able to generate sufficient future taxable income to realize the deferred tax assets based on estimates and assumptions. If these estimates and assumptions change in the future, we may be required to record a valuation allowance against deferred tax assets which could result in additional income tax expense. We will recognize a tax benefit in the financial statements for an uncertain tax position only if management’s assessment is that the position is “more likely than not” (i.e., a likelihood greater than 50 percent) to be allowed by the tax jurisdiction based solely on the technical merits of the position. The term “tax position” refers to a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for financial reporting purposes. Our federal and state tax returns are open to examination for the years 2009 through 2011.

Deferred Revenue and Costs. Deferred revenue represents amounts from sales of our product that have been billed, but for which the transactions have not met our revenue recognition criteria. The cost of the related product has been recorded as deferred costs on our balance sheet.

Results of Operations

Thirteen Weeks Ended September 29, 2012 Compared with Thirteen Weeks Ended October 1, 2011

Net sales for the thirteen weeks ended September 29, 2012 were $3,498,000, a decrease of $119,000, or 3%, from $3,617,000 in net sales for the thirteen weeks ended October 1, 2011. Sales since mid-2011, when Trader Joe’s, formerly our largest customer, discontinued stocking branded goods continue to be impacted as we have not yet been able to entirely replace those sales. We are working to replace those sales with aggressive promotional sales activities.

Our gross profit in the thirteen week period ended September 29, 2012 was $882,000, a $239,000 decrease from gross profit of $1,121,000 in the thirteen week period ended October 1, 2011. Our gross profit percentage for the thirteen week period ended September 29, 2012 was 25% compared to 31% for the period ended October 1, 2011. The decrease in gross profit and gross profit percentage was due to the decrease in sales and the increase in sales promotions and allowances incurred to expand our future sales. Sales promotions and allowances, which are netted against gross sales, were $282,000 for the thirteen weeks ended September 29, 2012 compared to $239,000 for the thirteen weeks ended October 1, 2011.

Selling and warehouse expenses were $350,000, an increase of $19,000, or 6%, for the thirteen weeks ended September 29, 2012 compared with $331,000 for the thirteen weeks ended October 1, 2011. This increase was due primarily to a $24,000 increase in payroll expense and auto expense of $7,000, which were partially offset by decreases in commission expense of $6,000 and outside warehouse expense of $5,000. The increase in payroll expense is the result of additional sales personnel.

Marketing expenses were $184,000, an increase of $16,000, or 10%, for the thirteen weeks ended September 29, 2012 compared with $168,000 for the thirteen weeks ended October 1, 2011, due principally to a $28,000 increase in advertising expense, a $20,000 increase in public relations expense,

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and a $5,000 increase in point of sale material expense, which were partially offset by a decrease in promotion expense of $36,000.

Research and development costs, which consist principally of salary expenses and laboratory costs, were $144,000, an increase of $16,000, or 13%, for the thirteen weeks ended September 29, 2012 compared to $128,000 for the thirteen weeks ended October 1, 2011. This increase was primarily due to an increase in professional fees and outside services expense of $4,000, an increase in payroll expense of $13,000, and an increase in equipment repairs of $7,000, offset by a decrease in lab supplies expense of $6,000.

General and administrative expenses were $483,000, an increase of $59,000, or 14%, for the thirteen weeks ended September 29, 2012 compared with $424,000 for the thirteen weeks ended October 1, 2011, due primarily to increases in payroll expense of $24,000, public relations expense of $20,000, and IT expense of $17,000. The increase in payroll expense is due to the employment of an additional administrative person.

We recorded an income tax benefit of $62,000 in the thirteen weeks ended September 29, 2012 due to an operating loss in the 2012 period compared to income tax expense of $36,000 in the thirteen weeks ended October 1, 2011 due to an operating profit in the 2011 period. The imputed effective tax rate was 22% in the 2012 period compared to 51% in the 2011 period.

Thirty-Nine Weeks Ended September 29, 2012 Compared with Thirty-Nine Weeks Ended October 1, 2011

Net sales for the thirty-nine weeks ended September 29, 2012 were $10,486,000, a decrease of $1,586,000, or 13%, from $12,072,000 in net sales for the thirty-nine weeks ended October 1, 2011. Sales continue to be impacted by the decision of Trader Joe’s, formerly our largest customer, to discontinue stocking branded goods in mid-2011. During the first thirty-nine weeks of 2012, there were no sales to Trader Joe’s as compared to $1,420,000 in sales in the first thirty-nine weeks of 2011. We continue to work to replace those sales with aggressive promotional sales activities.

Our gross profit in the period ended September 29, 2012 was $2,828,000, a decrease of $608,000, or 18%, from $3,436,000 in the period ended October 1, 2011, due to the lower level of sales in the 2012 period. Our gross profit percentage for the thirty-nine week period ending September 29, 2012 was 27% compared to 28% for the period ending October 1, 2011. Sales promotions and allowances, which are netted against gross sales, were $726,000 for the thirty-nine weeks ended September 29, 2012 compared to $628,000 for the thirty-nine weeks ended October 1, 2011.

Selling and warehouse expenses were $1,157,000, an increase of $88,000, or 8%, for the thirty-nine week period ended September 29, 2012 compared to $1,069,000 for the comparable period in 2011. This increase is due primarily to increases in commission expense of $22,000, meetings and conventions expense of $27,000, outside warehouse rental expense of $59,000, messenger expense of $17,000 and travel expense of $8,000, partially offset by a decrease in payroll expense of $49,000. The increase in outside warehouse expense is the result of the increase in inventory due to the buildup of inventory of new products that are being introduced during the third and fourth quarters. The decrease in payroll expense is due to no provision being made for bonuses during 2012.

Marketing expenses were $509,000, an increase of $148,000, or 41%, in the thirty-nine week period ended September 29, 2012 from $361,000 in the thirty-nine weeks ended October 1, 2011, due principally to a $38,000 increase in advertising expenses, a $15,000 increase in artwork and plate expense, a $92,000 increase in public relations expenses, and a $14,000 increase in point of sales marketing expense. The increases in marketing expenses were the result of our introduction of new products.

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Research and development costs, which consist principally of salary expenses and laboratory costs, were $497,000, an increase of $86,000, or 21%, for the thirty-nine weeks ended September 29, 2012 compared to $411,000 for the thirty-nine weeks ended October 1, 2011, due principally to an increase in payroll expense of $40,000, lab costs and supplies of $20,000 and equipment repairs of $21,000. The increase in lab costs and supplies is due to the introduction of new products, while the increase in payroll expense is due to the addition of new personnel.

General and administrative expenses were $1,450,000, a decrease of $46,000, or 3%, for the thirty-nine week period ended September 29, 2012 compared with $1,496,000 for the thirty-nine week period ended October 1, 2011 due primarily to decreases in outside fees and professional fee expense of $21,000 and payroll expense of $153,000, which were partially offset by increases in IT expense of $67,000, insurance expense of $11,000, and public relations expense of $27,000. The reduction in payroll expense is due to no provision being made for bonuses.

There was no provision for bonuses in the thirty-nine weeks ended September 29, 2012 as compared to a provision of $250,000 in the thirty-nine weeks ended October 1, 2011, which resulted in the significant decrease in overall payroll expense during the thirty-nine weeks ended September 29, 2012.

We recorded an income tax benefit of $259,000 in the thirty-nine week period ended September 29, 2012 compared to income tax expense of $47,000 in the thirty-nine week period ended October 1, 2011 due to the operating loss in the 2012 period. The imputed effective tax rate was 33% in the 2012 period compared to 39% in 2011 period.

Liquidity and Capital Resources

As of September 29, 2012, we had approximately $213,000 in cash and cash equivalents and our working capital was approximately $3.9 million, compared with approximately $1.6 million in cash and cash equivalents and working capital of $4.4 million at December 31, 2011.

The following table summarizes our cash flows for the periods presented:

		Thirty-Nine Weeks ended September 29, 2011			Thirty-Nine Weeks ended October 1, 2011
Net cash (used in) by operating activities		$	(1,364,000	)	$	(904,000	)
Net cash (used in) financing activities			(17,000	)		—
Net change in cash and cash equivalents		$	(1,381,000	)	$	(904,000	)

The net cash used in operating activities was the result of a $526,000 net loss in the period, a $570,000 increase in inventory, an increase in refundable and deferred taxes of $168,000, an increase in prepaid expenses of $103,000, and an increase in accounts receivable of $27,000, which were partially offset by an increase in accounts payable and accrued expenses of $25,000. Net cash used in financing activities was used in connection with the repurchase of shares of our common stock under our share repurchase program. As a result of the foregoing our cash and cash equivalents for the thirty-nine weeks ended September 29, 2012 decreased by $1.4 million. We believe that we will be able to fund our operations during the next twelve months from our working capital and from cash generated from operations.

Our Board of Directors first instituted a share repurchase program in September 2000 which, after several amendments, has to date authorized the repurchase of 2,200,000 shares of our common stock at prevailing market prices. While we may purchase an additional 360,000 shares of common stock based on such

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authorization, we did not purchase any shares of our common stock from the first quarter of fiscal 2009 until December 2011. During December 2011, we repurchased 14,492 shares at a cost of $24,115. We repurchased an additional 8,480 shares in January and February 2012 at a cost of $14,000. Cumulatively, from the beginning of our share repurchase program, we have purchased 1,829,000 shares at a cost of $5,318,000.

Inflation and Seasonality

We do not believe that our operating results have been materially affected by inflation during the preceding two years. There can be no assurance, however, that our operating results will not be affected by inflation in the future. Our business is subject to minimal seasonal variations with slightly increased sales historically in the second and third quarters of the fiscal year. We expect to continue to experience slightly higher sales in the second and third quarters, and slightly lower sales in the fourth and first quarters, as a result of reduced sales of nondairy frozen desserts during those periods.

Off-balance Sheet Arrangements

None.

Contractual Obligations

As of September 29, 2012, we did not have any contractual obligations or commercial commitments, including obligations relating to discontinued operations.

Recent Accounting Pronouncements

See Note 3 to the unaudited condensed consolidated financial statements included in Part I, Item 1, Financial Statements, of this Quarterly Report on Form 10-Q.

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

We do not believe that our exposure to market risk related to the effect of changes in interest rates, foreign currency exchange rates, commodity prices and other market risks with regard to instruments entered into for trading or for other purposes is material.

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Item 4.	Controls and Procedures

Evaluation of Disclosure Controls and Procedures. As of September 29, 2012, our company’s chief executive officer and chief financial officer conducted an evaluation regarding the effectiveness of our company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act. Based upon the evaluation of these controls and procedures, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were not effective as September 29, 2012.

Disclosure Controls and Internal Controls. As provided in Rule 13a-14 of the General Rules and Regulations under the Securities and Exchange Act of 1934, as amended, Disclosure Controls are defined as meaning controls and procedures that are designed with the objective of insuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, designed and reported within the time periods specified by the SEC’s rules and forms. Disclosure Controls include, within the definition under the Exchange Act, and without limitation, controls and procedures to insure that information required to be disclosed by us in our reports is accumulated and communicated to our management, including our chief executive officer and principal financial officer, as appropriate to allow timely decisions regarding disclosure. Internal Controls are procedures which are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with generally accepted accounting principles.

Management’s Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of the Chief Executive Officer and Chief Financial Officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management’s evaluation of internal control over financial reporting includes using the COSO framework, an integrated framework for the evaluation of internal controls issued by the Committee of Sponsoring Organizations of the Treadway Commission, to identify the risks and control objectives related to the evaluation of our control environment.

Based on their evaluation under the frameworks described above, our chief executive officer and chief financial officer have concluded that our internal control over financial reporting was ineffective as of September 29, 2012 because of the following material weaknesses in internal controls over financial reporting:

	•	A lack of sufficient resources and an insufficient level of monitoring and oversight, which may restrict our ability to gather, analyze and report information relative to the financial statements and income tax assertions in a timely manner.
	•	The limited size of the accounting department makes it impracticable to achieve an optimum separation of duties.

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We are seeking ways to remediate these weaknesses, which stem from our small workforce, which consisted of twelve employees at September 29, 2012, that will not require us to hire additional personnel.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the period covered by this report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings
	We are not a party to any material litigation.

Item 1A.	Risk Factors

We may not be able to sustain profitability in the future. To the extent that we continue to incur operating losses, we may not have sufficient working capital to fund our operations in the future.

Since mid-2011, when Trader Joe’s, formerly our largest customer, discontinued stocking branded goods, our sales have continued to be impacted as we have been unable to replace those sales as of yet. The loss of revenues from Trader Joe’s has impacted our profitability. We had net income of $43,000 in the year ended December 31, 2011 and incurred operating losses in the three and nine months ended September 29, 2012. If we are unable to replace the Trader Joe’s revenues, we may not be able to achieve or sustain profitable operations in the future or generate positive cash flows from operations. As of September 29, 2012, we had $213,000 in cash and cash equivalents. To the extent that we incur operating losses in the future or are unable to generate free cash flows from our business, we may not have sufficient working capital to fund our operations and will be required to obtain additional financing. Such financing may not be available, or, if available, may not be on terms satisfactory to us. If adequate funds are not available to us, our business, and results of operations and financial condition will be adversely affected.

                    There have been no other material changes to our “Risk Factors” set forth in our Annual Report on Form 10-K for the year ended December 31, 2011.

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	None.
Item 3.	Default Upon Senior Securities
	None.
Item 4.	Removed and Reserved
Item 5.	Other Information
	None.

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Item 6.	Exhibits
31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1	Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	Instance Document*
101.SCH	Schema Document*
101.CAL	Calculation Linkbase Document*
101.DEF	Definition Linkbase Document*
101.LAB	Labels Linkbase Document*
101.PRE	Presentation Linkbase Document*

*	Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for the purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

	TOFUTTI BRANDS INC.
	(Registrant)
	/s/David Mintz
	David Mintz
	President
	/s/Steven Kass
	Steven Kass
	Chief Accounting and Financial Officer

Date: November 21, 2012

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