10QSB 1 a5248431.txt BAB, INC. 10-QSB FORM 10-QSB U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: August 31, 2006 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to _________________ Commission file number: 0-31555 BAB, Inc. (Name of small business issuer in its charter) Delaware 36-4389547 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 500 Lake Cook Road, Suite 475, Deerfield, Illinois 60015 (Address of principal executive offices) (Zip Code) Issuer's telephone number (847) 948-7520 Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 x No __ As of October 13, 2006, BAB, Inc. had : 7,222,932 shares of Common Stock outstanding. TABLE OF CONTENTS PART I Item 1. Financial Information Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operation Item 3 Controls and Procedures PART II Item 1. Legal Proceedings Item 2 Changes in Securities Item 3 Defaults Upon Senior Securities Item 4 Submission of Matters to a Vote of Security Holders Item 5 Other Information Item 6 Exhibits and Reports on Form 8-K SIGNATURE ITEM 1. FINANCIAL INFORMATION BAB, Inc. Condensed Consolidated Balance Sheet (Unaudited) August 31, 2006
ASSETS Current Assets Cash $ 1,821,229 Restricted cash 241,510 Receivables Trade accounts receivable (net of allowance for doubtful accounts of $32,787) 87,879 Marketing fund contributions receivable from franchisees and stores 22,269 Notes receivable (net of allowance for doubtful accounts of $8,616) 14,502 Inventories 44,628 Prepaid expenses and other current assets 120,595 ----------- Total Current Assets 2,352,612 ----------- Property, plant and equipment (net of accumulated depreciation of $358,608) 108,940 Notes receivable (net of current portion) 4,304 Trademarks 763,667 Goodwill 3,542,772 Other (net of accumulated amortization of $300,197) 5,185 ----------- Total Noncurrent Assets 4,424,868 ----------- Total Assets $ 6,777,480 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Current portion of long-term debt $ 254,454 Accounts payable 39,095 Accrued expenses and other current liabilities 475,749 Unexpended marketing fund contributions 189,160 Deferred franchise fee revenue 185,000 Deferred revenue 57,829 ----------- Total Current Liabilities 1,201,287 ----------- Long-term debt (net of current portion) 273,572 Deferred revenue (net of current portion) 59,233 ----------- Total Noncurrent Liabilities 332,805 ----------- Total Liabilities 1,534,092 ----------- Stockholders' Equity (Deficit) Common stock 13,508,216 Additional paid-in capital 876,999 Treasury stock (222,781) Accumulated deficit (8,919,046) ----------- Total Stockholders' Equity 5,243,388 ----------- Total Liabilities and Stockholders' Equity $ 6,777,480 ===========
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS BAB, Inc. Condensed Consolidated Statements of Operations (Unaudited)
3 months ended 9 months ended --------------------------------- --------------------------------- August 31, 2006 August 31, 2005 August 31, 2006 August 31, 2005 --------------- --------------- --------------- --------------- REVENUES Net sales by Company-owned stores $ 116,282 $ 370,594 $ 384,523 $ 1,115,622 Royalty fees from franchised stores 591,519 581,675 1,715,490 1,703,787 Franchise fees 20,000 40,000 225,500 147,500 Licensing fees and other income 217,158 273,368 644,153 946,969 --------------- --------------- --------------- --------------- Total Revenues 944,959 1,265,637 2,969,666 3,913,878 --------------- --------------- --------------- --------------- OPERATING EXPENSES Food, beverage and paper costs 35,893 136,030 123,779 388,332 Store payroll and other operating expenses 108,822 316,565 369,815 939,213 Selling, general and administrative expenses: Payroll-related expenses 314,869 336,407 1,030,477 1,013,460 Occupancy 34,903 33,398 106,564 97,075 Advertising and promotion 18,857 32,525 78,482 115,822 Professional service fees 52,999 54,506 157,728 162,890 Travel expenses 27,209 27,015 73,373 75,077 Depreciation and amortization 17,229 21,106 51,797 63,508 Other 111,056 152,054 353,315 500,423 --------------- --------------- --------------- --------------- Total Operating Expenses 721,837 1,109,606 2,345,330 3,355,800 --------------- --------------- --------------- --------------- Income from operations 223,122 156,031 624,336 558,078 Interest income 20,421 2,249 33,129 6,080 Interest expense (7,067) (10,696) (23,687) (34,363) Other income 0 -- 1,585 512 --------------- --------------- --------------- --------------- Income before provision for income taxes 236,476 147,584 635,363 530,307 --------------- --------------- --------------- --------------- Provision for income taxes Current -- -- -- -- Deferred -- -- -- -- --------------- --------------- --------------- --------------- --------------- --------------- --------------- --------------- Net Income $ 236,476 $ 147,584 $ 635,363 $ 530,307 =============== =============== =============== =============== Net Income per share - Basic $ 0.03 $ 0.02 $ 0.09 $ 0.07 --------------- --------------- --------------- --------------- Net Income per share - Diluted $ 0.03 $ 0.02 $ 0.09 $ 0.07 --------------- --------------- --------------- --------------- Weighted average number of shares outstanding - Basic 7,222,932 7,208,946 7,222,436 7,175,427 Weighted average number of shares 7,255,733 7,250,558 7,258,862 7,245,677 outstanding - Diluted Cash dividends per share $ 0.02 $ - $ 0.12 $ 0.02 =============== =============== =============== ===============
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS BAB, Inc. Condensed Consolidated Statements of Cash Flows (Unaudited)
9 Months Ended --------------------------------- August 31, 2006 August 31, 2005 --------------- --------------- Operating activities Net income $ 635,363 $ 530,307 Depreciation and amortization 51,797 65,795 Loss on sale of equipment 17,151 - Provision for uncollectible accounts, net of recoveries (7,951) 36,000 Changes in: Trade accounts receivable 31,291 66,530 Restricted cash (37,455) 111,565 Marketing fund contributions receivable 8,120 12,369 Notes receivable (3,634) (22,739) Inventories 20,627 (9,299) Prepaid expenses and other 14,893 (21,140) Accounts payable (54,333) (59,880) Accrued liabilities (31,530) (126,476) Unexpended marketing fund contributions 30,247 (123,888) Deferred franchise fee revenue (38,751) 184,475 Other deferred revenue (27,747) --------------- --------------- Net Cash Provided by Operating Activities 608,088 643,619 --------------- --------------- Investing activities Purchase of equipment (6,940) (17,429) Proceeds from sale of equipment 5,000 - Collection of notes receivable 52,269 49,073 --------------- --------------- Net Cash Provided by Investing Activities 50,329 31,644 --------------- --------------- Financing activities Repayment of borrowings (183,104) (173,225) Proceeds from exercise of stock options 6,077 23,552 Payment of dividend (866,685) (717,161) --------------- --------------- Net Cash Used In Financing Activities (1,043,712) (866,834) --------------- --------------- Net Decrease in Cash (385,295) (191,571) Cash, Beginning of Period 2,206,524 2,194,834 --------------- --------------- Cash, End of Period $ 1,821,229 $ 2,003,263 =============== =============== Supplemental disclosure of cash flow information: --------------- --------------- Interest paid $ 13,996 $ 23,875 --------------- ---------------
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS BAB, Inc. Notes to Unaudited Condensed Consolidated Financial Statements (Unaudited) Note 1 - Nature of Operations BAB, Inc. (the "Company") was incorporated under the laws of the State of Delaware on July 12, 2000. The Company currently operates, franchises and licenses bagel, muffin and coffee retail units under the Big Apple Bagels ("BAB"), My Favorite Muffin ("MFM") and Brewster's Coffee trade names. The Company additionally derives income from the sale of its trademark bagels, muffins and coffee through nontraditional channels of distribution, including license agreements and direct home delivery of specialty muffin gift baskets and coffee. The Company has four wholly owned subsidiaries: BAB Systems, Inc. (Systems); BAB Operations, Inc. (Operations); Brewster's Franchise Corporation (BFC); and My Favorite Muffin Too, Inc. (MFM). Systems was incorporated on December 2, 1992, and was primarily established to franchise BAB specialty bagel retail stores. Operations was formed on August 30, 1995, primarily to operate Company-owned stores. There is currently one Company-owned store which serves as the franchise training facility. BFC was established on February 15, 1996 to franchise "Brewster's Coffee" concept coffee stores. MFM, a New Jersey corporation, was acquired on May 13, 1997. MFM franchises "MFM" concept muffin stores. The accompanying condensed consolidated financial statements are unaudited. These financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted pursuant to such SEC rules and regulations: nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading. These financial statements and the notes hereto should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-KSB/A for the year ended November 30, 2005 which was filed April 14, 2006. In the opinion of the Company's management, the condensed consolidated financial statements for the unaudited interim periods presented include all adjustments, including normal recurring adjustments, necessary to fairly present the results of such interim periods and the financial position as of the end of said period. The results of operations for the interim period are not necessarily indicative of the results for the full year. 2. Stores Open and Under Development Stores which are open or under development at August 31, 2006 are as follows: Stores open: Company-owned 1 Franchisees 140 Licensed 4 Under development 7 ---- Total 152 3. Earnings per Share The following table sets forth the computation of basic and diluted earnings per share:
3 months ended 9 months ended ------------------------------------ ---------------------------------- August 31, 2006 August 31, 2005 August 31, 2006 August 31, 2005 ------------------------------------ ---------------------------------- Numerator: Net income available to common shareholders $ 236,476 $ 147,584 $ 635,363 $ 530,307 Denominator: Weighted average outstanding shares Basic 7,222,932 7,208,946 7,222,436 7,175,427 Earnings per Share - Basic $ 0.03 $ 0.02 $ 0.09 $ 0.07 Effect of dilutive common stock 32,801 41,612 36,426 70,250 Weighted average outstanding shares Diluted 7,255,733 7,250,558 7,258,862 7,245,677 Earnings per share - Diluted $ 0.03 $ 0.02 $ 0.09 $ 0.07
4. Long-Term Debt On June 25, 2004, the Company entered into a Business Loan and Security Agreement ("Bank Agreement") with Associated Bank which provides for a term loan in the original amount of $723,700. The term loan under the Bank Agreement is secured by substantially all of the assets of the Company and is being repaid in monthly installments of $21,900, including interest at a rate of 5.5 percent per annum, with final payment due July 1, 2007. 5. Stock Options In May 2001, the Company approved a Long-Term Incentive and Stock Option Plan (Plan). The Plan reserves 1,400,000 shares of common stock for grant. As of August 31, 2006, 1,185,000 stock options were granted to directors, officers and employees, leaving 215,000 options available for grant. As of August 31, 2006, there were 915,869 stock options exercised and 50,582 stock options forfeited or expired under the Plan. 9 months ended ------------------------------------------- August 31, 2006 August 31, 2005 ----------------- ----------------- Options Options ----------------- ----------------- Options Outstanding at 163,034 258,486 beginning of period Granted 75,000 95,000 Forfeited (5,499) (3,000) Exercised (13,986) (179,452) ----------------- ----------------- Options Outstanding at end of period 218,549 171,034 The Company uses the intrinsic method, as allowed by SFAS 123, "Accounting for Stock-Based Compensation," to account for stock options granted to employees and directors. No compensation expense is recognized for stock options because the exercise price of the options is at least equal to the market price of the underlying stock on the grant date. For those companies that do not elect to change their method of accounting for stock-based employee compensation, SFAS Statement No. 148 requires increased disclosure of the pro forma impact of applying the fair value method to the reported operating results. The increased disclosure requirements apply to the Company's interim and annual financial statements. Had employee compensation expense for the Company's Plan been recorded in the financial statements, consistent with provisions of SFAS 123, net income would have been reduced by approximately $8,000 for the 3 months ended August 31, 2006, $31,000 for the 9 months ended August 31, 2006, $9,000 for the 3 months ended August 31, 2005, and $22,000 for the 9 months ended August 31, 2005 based on the Black-Scholes option-pricing model. The following table illustrates the effect on net income and earnings per share:
3 months ended 9 months ended ---------------------------------- -------------------------------- August 31, 2006 August 31, 2005 August 31, 2006 August 31, 2005 ---------------------------------- -------------------------------- Pro forma impact of fair value method Reported net income $ 236,476 $ 147,584 $ 635,363 $ 530,307 Less: Fair value impact of employee stock compensation (8,403) (9,400) (30,594) (22,300) Pro forma net income $ 228,073 $ 138,184 $ 604,769 $ 508,007 Earnings per common share Basic - as reported $ 0.03 $ 0.02 $ 0.09 $ 0.07 Diluted - as reported $ 0.03 $ 0.02 $ 0.09 $ 0.07 Basic - pro forma $ 0.03 $ 0.02 $ 0.08 $ 0.07 Diluted - pro forma $ 0.03 $ 0.02 $ 0.08 $ 0.07 Weighted average Black Scholes fair value assumptions Risk free interest rate 4.39% 4.00% 4.39% 4.00% Expected life 10.0 yrs 5.3 yrs 10.0 yrs 5.3 yrs Expected volatility 1.23 2.53 1.23 2.53 Expected dividend yield 7.00% 4.60% 7.00% 4.60%
6. Goodwill and Other Intangible Assets In accordance with SFAS No. 142, goodwill and indefinite-lived intangible assets are tested for impairment upon adoption of the standard and annually thereafter. SFAS No. 142 requires that goodwill be tested for impairment using a two-step process. The first step is to identify a potential impairment and the second step measures the amount of the impairment loss, if any. Goodwill is deemed to be impaired if the carrying amount of a reporting unit's net assets exceeds its estimated fair value. SFAS No. 142 requires that indefinite-lived intangible assets be tested for impairment using a one-step process, which consists of a comparison of the fair value to the carrying value of the intangible asset. Intangible assets are deemed to be impaired if the net book value exceeds the estimated fair value. The Company completed its annual goodwill impairment assessment during the first quarter ended February 28, 2006, and it indicated no impairment of goodwill. Net intangible assets with definitive lives, representing master lease origination fees with an original cost of $95,000, totaled $5,000, net of accumulated amortization expense of $90,000, as of August 31, 2006. Amortization expense of intangible assets with definitive lives for the nine months ended August 31, 2006 was $7,000. The estimated amortization expense on these intangible assets is $9,200 in 2006 and $2,900 in 2007. 7. Commitments and Contingencies None 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-KSB 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 one Company-owned store and 140 franchised and 4 licensed units at August 31, 2006. Units in operation at August 31, 2005 included three Company-owned stores and 147 franchised and 4 licensed units. System-wide revenues in the nine months ended August 31, 2006 were $35 million as compared to August 31, 2005 which were $36 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 (Chartwell, Kohr Bros. and Mrs. Fields Famous Brands). At August 31, 2006, the Company had 18 employees, including 1 part-time employee, at the Corporate level to oversee operations of the franchise, licensed and Company-owned store operations, as compared to 20 employees at August 31, 2005. Results of Operations Three Months Ended August 31, 2006 versus Three Months Ended August 31, 2005 For the three months ended August 31, 2006, the Company reported net income of $236,000 versus net income of $148,000 for the same period in 2005. Total revenue decreased $321,000, for the three months ended August 31, 2006, as compared to the three months ended August 31, 2005, primarily due to a decrease in Company-owned store sales of $254,000. Other income decreased by $41,000 and franchise fee revenue decreased $20,000. Royalty fee revenue of $592,000, for the quarter ended August 31, 2006, increased $10,000 from the quarter ended August 31, 2005. The Company earned $15,000 income in 2006 due to the premature closing of a franchisee's store. Franchise fee revenue of $20,000, for the quarter ended August 31, 2006, decreased $20,000 from the quarter ended August 31, 2005. One store opened during the quarter ended August 31, 2005, versus none in the same quarter of 2006. Licensing fee and other income of $217,000, for the quarter ended August 31, 2006, decreased $56,000 from the quarter ended August 31, 2005. In 2005 the Company earned $34,000 for the sale of a Company-owned store. Sign Shop revenue decreased $19,000 in 2006. Company-owned store sales of $116,000, for the quarter ended August 31, 2006, decreased $254,000 from the quarter ended August 31, 2005. This decrease is due to the fact the Company had one Company-owned store, versus three Company-owned stores for the quarter ending August 31, 2005. Total operating expenses of $722,000, were 76% of total revenues, for the quarter ended August 31, 2006, versus $1,110,000, or 88%, in 2005. Expenses declined because there was only one Company-owned store operating in the quarter ended August 31, 2006, versus three in the quarter ended August 31, 2005, and because of continued tight cost controls. Interest income of $20,000 increased approximately $18,000 for the current quarter over the same period in 2005 as a result of the Company's decision to invest excess cash in higher yield investments. Interest expense of $7,000 decreased $4,000 due to a lower outstanding debt balance. Net Income per share, as reported for basic and diluted outstanding shares, for the three months ended August 31, 2006, was $0.03 versus $0.02 for the three months ended August 31, 2005. Nine Months Ended August 31, 2006 versus Nine Months Ended August 31, 2005 For the nine months ended August 31, 2006, the Company reported net income of $635,000 versus net income of $530,000 for the same period in 2005. Total revenue decreased $944,000, for the nine months ended August 31, 2006, as compared to the nine months ended August 31, 2005, primarily due to a decrease in Company-owned store sales of $731,000, and a decrease in licensing fees and other income of $303,000, offset by an increase in franchise fee revenue of $78,000. Royalty fee revenue of $1,715,000, for the nine months ended August 31, 2006, increased $12,000 from the nine months ended August 31, 2005. Included in the 2006 revenue is $15,000 of income from the premature closing of a franchisee's store. Franchise fee revenue of $226,000, for the nine months ended August 31, 2006, increased by $78,000 from the same period in 2005. There were seven new franchise store openings in 2006, as compared to only three new franchise store openings in 2005. Licensing fee and other income of $644,000, for the nine months ended August 31, 2006, decreased $303,000 from the same period in 2005 because the Company earned and received a $90,000 trademark infringement fee in May, 2005, and Sign Shop revenue decreased $116,000 in 2006. In 2005, the Sign Shop received considerable revenue from work received as a result of the Company's convention in late 2004. The nine month period in 2005 also includes $34,000 from the sale of assets at an operating store and $29,000 additional sublease rental income. Company-owned store sales of $385,000, for the nine months ended August 31, 2006, decreased $731,000 as a result of one Company-owned store in 2006, versus three Company-owned stores in 2005. Total operating expenses of $2,345,000, were 79% of total revenues for the nine months ended August 31, 2006 versus $3,356,000, or 86%, in 2005. Expenses declined because there was only one Company-owned store operating for a majority of the nine months ended August 31, 2006, versus three in the nine months ended August 31, 2005, and because of continued tight cost controls. Interest income of $33,000 increased $27,000 for the nine months ended August 31, 2006 over the same period in 2005 as a result of the Company's decision to invest excess cash in higher yield investments. Interest expense of $24,000 decreased $11,000 due to a lower outstanding debt balance. Net Income per share, for the nine months ended August 31, 2006, was $0.09 on a basic and fully diluted basis versus $0.07 on a basic and fully diluted basis for the nine months ended August 31, 2005. Liquidity and Capital Resources ------------------------------- The net cash provided by operating activities totaled $608,000 for the nine months ended August 31, 2006, versus cash provided from operating activities of $644,000 for the same period in 2005. Cash provided by operating activities principally represents net income of $635,000, plus depreciation and amortization of $52,000, a loss on disposal of equipment of $17,000, a reduction in bad debt of $8,000, a decrease to Marketing Fund contributions receivable of $8,000, a $31,000 decrease in accounts receivable, a reduction in inventories of $21,000, a reduction in prepaid assets of $15,000, and an increase in unexpended Marketing Fund contributions of $30,000. Uses of funds from operations were due to a $37,000 increase in restricted cash, a reduction in payables of $54,000, a reduction in accrued professional fees and other accrued liabilities of $32,000, a decrease in deferred franchise fee revenue of $39,000, a $28,000 decrease in other deferred revenue, and issuance of $4,000 in notes receivable. Cash provided from investing activities during the nine months ended August 31, 2006 totaled $50,000, and was provided by collection of notes receivable of $52,000 and proceeds from sale of equipment of $5,000, offset by purchases of equipment of $7,000. Cash provided from investing activities during 2005 totaled $32,000, and was provided from collection of notes receivable equal to $49,000, offset by purchases of equipment for $17,000. Financing activities used $1,044,000 during the nine months ended August 31, 2006, due to the repayment of notes payable of $183,000 and the payment of cash dividends of $867,000, offset by proceeds from the exercise of stock options in the amount of $6,000. In fiscal 2005 for this same period, financing activities used $867,000 due to repayment of notes payable of $173,000 and payment of cash dividends of $717,000, offset by proceeds from the exercise of stock options in the amount of $24,000. Dividend Policy It is the Company's intent that future dividends will be considered after reviewing returns to shareholders, profitability expectations and financing needs and will be declared at the discretion of the Board of Directors. It is the Company's intent going forward to declare and pay cash dividends on a quarterly basis. 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 December 2003, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." This Statement, which is effective for years ending after December 15, 2003 amends SFAS No. 123, "Accounting for Stock-Based Compensation," and provides alternative methods of transition for a voluntary change to the fair value-based methods of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 regardless of the accounting method used to account for stock-based compensation. The Company has chosen to continue to account for stock-based compensation of employees using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. The effects of the enhanced disclosure provisions as defined by SFAS 148 are included in Note 5 of this report. In December 2004, the FASB issues SFAS No. 123(R), "Share-Based Payment." SFAS No. 123(R) establishes accounting standards for transactions in which a company exchanges its equity instruments for goods or services. In particular, this Statement will require companies to record compensation expense for all share-based payments, such as employee stock options, at fair market value. This Statement is effective as of the beginning of the first annual reporting period that begins after December 15, 2005 (the Company's period beginning December 1, 2006). Adoption of SFAS No. 123(R) is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections, - a replacement of APB Opinion No. 20 and FASB Statement No. 3." This Statement replaces APB Opinion No. 20, "Accounting Changes," and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements," and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 (the Company's period beginning December 1, 2006). Early adoption is permitted for accounting changes and correction of errors made in fiscal years beginning after the date this Statement is issued. Adoption of SFAS No. 154 is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows. Management has considered all other recently issued accounting pronouncements and does not believe that the adoption of such pronouncements will have a material impact on the Company's financial statements. 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 assets, concentrations of credit risks, valuation allowance and deferred taxes. Details regarding the Company's use of these policies and the related estimates are described in the Company's Annual Report on Form 10-KSB/A for the fiscal year ended November 30, 2005, filed with the Securities and Exchange Commission on April 14, 2006. 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, 2006. ITEM 3. CONTROLS AND PROCEDURES Disclosure controls The Chief Executive Officer and the Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as amended) as of August 31, 2006. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Internal control over financial reporting The Chief Executive Officer and the Chief Financial Officer confirm that there was no change in the Company's internal control over financial reporting during the quarter ended August 31, 2006 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) See index to exhibits (b) REPORTS ON FORM 8-K None filed during this quarter. SIGNATURE In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BAB, Inc. Dated: October 13, 2006 /s/ Jeffrey M. Gorden --------------------- Jeffrey M. Gorden Chief Financial Officer INDEX TO EXHIBITS (a) EXHIBITS The following exhibits are filed herewith. INDEX NUMBER DESCRIPTION 21.1 List of Subsidiaries of the Company 31.1 Section 302 of the Sarbanes-Oxley Act of 2002 Certification of Chief Executive Officer 31.2 Section 302 of the Sarbanes-Oxley Act of 2002 Certification of Chief Financial Officer 32.1 Section 906 of the Sarbanes-Oxley Act of 2002 Certification of Chief Executive Officer 32.2 Section 906 of the Sarbanes-Oxley Act of 2002 Certification of Chief Financial Officer SUBSIDIARIES OF BAB, INC. Exhibit 21.1 BAB Systems, Inc., an Illinois corporation BAB Operations, Inc., an Illinois corporation Brewster's Franchise Corporation, an Illinois corporation My Favorite Muffin Too, Inc., a New Jersey corporation