Summary of EACO CORP - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policy and Use of Estimates

The Company has recorded a provision for a loss totaling $3,034,000 on the Note from Banner. The net balance of the Note represents the estimated liquidated value of the collateralized equipment still in Banner's possession. The Company believes the recorded net amount of the Note is collectible. The Company subsequently received $200,000 from Banner as payment for the collateralized equipment sold to a third party. See Notes 5 and 12.

The Company's accounting policy for the recognition of impairment losses on long- lived assets is also considered critical. The Company's policy is to review long- lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For the purpose of the impairment review, assets are tested on an individual basis. The recoverability of the assets is measured by a comparison of the carrying value of each asset to future net cash flows expected to be generated by such assets. If such assets are considered impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets.

Prior to and as of December 28, 2005, the Company classified its existing marketable equity securities as available for sale in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Subsequent to year-end, the Company changed its pattern to purchasing investments for the purpose of trading them often with the objective of generating profits on short-term differences in price. The change in the pattern indicated above triggered a change in the classification of Company's investments, from the "available-for-sale" category to "trading". Pursuant to SFAS No. 115, the transfer of investments between categories shall be accounted for at fair value at the date of the transfer and the unrealized holding gain or loss of $6,100 was recognized in earnings effective December 29, 2005.

The preparation of EACO Corporation's consolidated financial statements requires the Company to make estimates, assumptions and judgments that affect the Company's assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. The Company bases these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information it believes are reasonable. Actual results may differ from these estimates under different conditions. For a full description of the Company's critical accounting policy, see Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's 2005 Annual Report on Form 10-K.

Results of Operations

Quarter Ended September 27, 2006 versus September 28, 2005

The Company experienced an increase of 237% in rental revenue during the third quarter of 2006 compared to the third quarter of 2005, due to the acquisition of rental property in Sylmar, California during the fourth quarter of 2005.

Depreciation and amortization expenses increased 14% due to the acquisition of the Sylmar, California property. General and administrative expenses, such as payroll, payroll related costs and insurance, increased 44% due to increases in legal and other professional fees versus the third quarter of 2005.

Interest expense increased to $143,900 in the third quarter of 2006 from $34,900 in the same quarter of 2005, primarily due to borrowings related to the Sylmar, California property.

The Company recognized income tax benefits of $1,031,000 and $29,400 for the quarter ended September 27, 2006 and September 28, 2005, respectively. The increase is due to losses recognized in the third quarter of 2006.

The Company invests a portion of its available cash in marketable securities. The Company maintains an investment account to effect these transactions. Investments are made based on a combination of fundamental and technical analysis primarily using a value-based investment approach. The holding period for investments usually ranges from 30 days to 24 months. Management also purchases marketable securities using margin debt. In determining whether to engage in transactions on margin, the Company's Chairman evaluates the risk of the proposed transaction and the relative returns offered thereby and executes such transactions. If the market value of securities purchased on margin were to decline below certain levels, the Company would be required to use additional cash from its operating account to fund a margin call in its investment account. The Company's Chairman reviews the status of the investment account on a regular basis and analyzes such margin positions and adjusts purchase and sale transactions as necessary to ensure such margin calls are not likely. The results for the third quarter of 2006 included realized losses from the sale of marketable securities of $534,900 and unrealized gains of $672,600. During the third quarter of 2005 the Company had realized gains from the sale of marketable securities of $19,200 and no unrealized gains or losses.

As previously reported, all significant restaurant operations were sold on June 30, 2005. All income and expense items related to those restaurants were reclassified as income from discontinued operations beginning in the second quarter of 2005.

The net loss was $2,377,400 in the third quarter of 2006, compared to net income of $7,367,500 in the third quarter of 2005. The 2006 third quarter loss was due, primarily, to recording a provision for loss on the Note due from Banner totaling $3,034,100. The third quarter of 2005 recognized the gain on the sale of the restaurant properties to Banner. Loss per share for the quarter was 61 cents in 2006 compared to earnings per share of $1.89 in 2005.

Nine Months Ended September 27, 2006 versus September 28, 2005

The Company experienced an increase of 409% in rental revenue during the first nine months of 2006 compared to the first nine months of 2005, due to the acquisition of rental property in Sylmar, California during the fourth quarter of 2005.

Depreciation and amortization expenses increased 52% due to the acquisition of the Sylmar, California property. General and administrative expenses, such as payroll, payroll related costs and insurance, increased 52% due to increases in legal and other professional fees in the first nine months of 2006 versus the first nine months of 2005, as well as, expenses related to closing the corporate offices in Florida and moving them to Anaheim, California.

Interest and other income increased to $525,500 due to the interest received on the $4,000,000 note receivable from Banner and a settlement made with a tenant from one of the Company's properties that vacated the premises prior to the completion of their lease term.

Interest expense increased to $343,000 in the first nine months of 2006 from $104,500 in the first nine months of 2005, primarily due to borrowings on the Sylmar, California propety.

The Company recognized income tax benefits of $1,141,400 and $215,700 for the nine months ended September 27, 2006 and September 28, 2005, respectively.

The results for the nine months of 2006 included realized losses from the sale of marketable securities of $623,200 and unrealized gains of $642,400. During the first nine months of 2005, the Company had realized gains from the sale of marketable securities of $58,100 and no unrealized gains or losses.

The net loss was $2,711,100 in the first nine months of 2006, compared to net income of $10,168,600 in the first nine months of 2005. The 2006 net loss was due, primarily, to recording a provision for loss totaling $3,034,000 on the Note due from Banner. The income of 2005 recognized the gain on the sale of the restaurant properties to Banner. Loss per share for the nine months was 64 cents in 2006 compared to earnings per share of $2.62 in 2005.

Effective April 1, 2006, the Company's corporate office was moved from Neptune Beach, Florida to Anaheim, California. The Company is leasing space from Bisco Industries, Inc. ("Bisco"), the wholly owned company of the Company's Chairman of the Board of Directors and Chief Executive Officer, Glen Ceiley. The Company has also entered into an agreement with Bisco whereas Bisco will provide accounting and other administrative services to the Company in exchange for a fee. Through September 27, 2006, Bisco billed the Company $32,400.

Liquidity and Capital Resources

Substantially all of the Company's revenues are derived from rental income. Therefore, the Company does not carry significant receivables or inventories and, other than repayment of debt, working capital requirements for continuing operations are not significant.

On June 30, 2005, the Company completed the sale of all of its operating restaurants (the "Asset Sale"). The total purchase price was approximately $29,950,000, consisting of $25,950,000 in cash and a promissory note for $4,000,000. The note required monthly interest payments at a rate of 8.0% through June 30, 2007, when the first principal payment of $1.5 million is due. The Company received $187,000 of the $1.5 million dollar payment early on March 9, 2006 lowering the amount due on June 30, 2007 to $1,313,000. See Note 5 for further discussion. The Company paid off approximately $12,413,000 in loans due to GE Capital with the proceeds from the Asset Sale in 2005. In addition to the cash proceeds, the Buyer assumed $4,509,000 in capital lease obligations.

As of September 27, 2006, the Company had total cash and cash equivalents of $1,992,700 comprised of cash and cash equivalents of $1,064,700 and restricted cash of $928,000, invested in brokerage money market accounts. However, $928,000 of the brokerage accounts cash resulted from the sale of securities sold, not yet purchased ("short sales"), which is included as a liability on the Company's balance sheet at September 27, 2006. Accordingly, the Company will require this cash to cover the short sales liability, and therefore the $928,000 is not available for the Company's use and is classified as restricted. The balance of the cash in the brokerage accounts is available for use by the Company.

The Company purchased a property in November 2005 (the "California Property") for $8.3 million. The transaction was structured as a like-kind exchange transaction under Section 1031 of the Internal Revenue Code, which resulted in the deferral of an estimated $1 million in income taxes payable from the Asset Sale. The Company assumed a loan on the property for $1.8 million with a variable interest rate equal to prime. The property includes one industrial tenant with rental income of approximately $240,000 per year. As of April 30, 2006 one of the tenants vacated the premises at the expiration of their lease term, as anticipated before purchase of the property. The Company has since leased this property to a new tenant at a substantially higher monthly rental amount. Rent under a 10 year operating lease will commence on October 1, 2006.

At September 27, 2006, the Company had working capital of $537,500 compared to $2,475,600 at December 28, 2005. The decrease was due to cash outlays for workers compensation claims and other operating expenses, such as legal costs and costs associated with moving the corporate offices from Neptune Beach, FL to Anaheim, CA paid during the first nine months of 2006. Cash used in operating activities was $4,161,400 in the first nine months of 2006 compared to cash provided by operations of $6,156,200 in the first nine months of 2005, primarily due to the sale of the Company's restaurants to Banner in the third quarter of 2005 and the related gain.

The Company recorded a provision for loss on the Note due from Banner during the third quarter of 2006. See Note 5 for further discussion of the bankruptcy by Banner. The Company expects to receive approximately $573,000 of the remaining $3,813,000 due on the Note, from the disposition of the remaining collaterized restaurant equipment held by Banner. As of November 16, 2006, the Company had received $200,000 of the expected amount.

A further contingency of the Company continues to be the litigation with two brokers claiming commissions totaling approximately $4.25 million. See Item 1 of Part II, Legal Proceedings. While the Company continues to defend its position and management continues to believe in a favorable outcome, the Company has available borrowing capacity on the two California properties, if required, to cover any capital requirements associated with this case or those of any other normal operating expenditures.

The Company had capital expenditures in the third quarter of 2006 totaling $37,700 related to tenant improvements on the Sylmas property. The Company is not budgeting for any further capital expenditures for 2006.

In June 2004, the Company sold 145,833 shares of its Common Stock directly to Bisco Industries, Inc. Profit Sharing and Savings Plan for a total purchase price of $175,000 cash. In September 2004, the Company sold 36,000 shares of the Company's newly authorized Series A Cumulative Convertible Preferred Stock at a price of $25 per share, for a total purchase price of $900,000 cash. The Preferred Stock was sold to the Company's Chairman. Dividends are paid quarterly when declared by the Company's Board of Directors. The Company paid a declared dividend of $19,100 during the third quarter of 2006. Undeclared dividends as of September 27, 2006 were $19,100.

The Company is required to pledge collateral for its workers' compensation self-insurance liability with the Florida Self Insurers Guaranty Association. The Company increased this collateral by $69,500 during the first quarter of 2005, and now has a total of $1.37 million pledged collateral. Bisco Industries, Inc. ("Bisco") provides $1 million of this collateral. EACO Corporation's Chairman of the Board of Directors and Chief Executive Officer, Glen Ceiley, is the President of Bisco.

After the Asset Sale, the Company terminated its self-insurance program. No further claims were incurred after June 29, 2005. The Company's liability for Workers' Compensation is expected to decrease and the Company should be able to reduce its required collateral deposits accordingly.

The Company has entered into a loan agreement with GE Capital and assumed a loan with Citizen's Bank pertaining to the California Property. As of September 27, 2006, the outstanding balance due under the Company's loan with GE Capital was $875,000 and with Citizen's Bank was $1,773,700. The weighted average interest rate for these loans is 8.2% for the quarter ended September 27, 2006.

The GE Capital loan agreements contain various restrictions on fixed charge coverage ratios, determined both on aggregate and individual restaurant levels. As of December 28, 2005, the Company was not in compliance with one of the debt covenants. The Company obtained a waiver of the debt covenant from GE Capital.

The preceding discussion of liquidity and capital resources contains certain forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, and in addition to the factors discussed herein, among the other factors that could cause actual results to differ materially are the following: failure of facts to conform to necessary management estimates and assumptions; the willingness of GE Capital, Citizen's Bank or other lenders to extend financing commitments; repairs or similar expenditures required for existing properties due to weather or acts of God; the Company's success in selling properties listed for sale; the economic conditions in the new markets into which the Company expands, if any; business conditions, such as inflation or a recession, and growth in the general economy; and other risks identified from time to time in the Company's SEC reports, registration statements and public announcements.

Recent Developments

On September 15, 2006, Banner filed for bankruptcy protection under Chapter 11. Banner has failed to make interest payments on the Note due Eaco beginning August 1, 2006. Banner has also failed to make rental payments under the management agreement for the lease not assigned to Banner beginning August 1, 2006. See Note 5 for further discussion.