Summary of EACO CORP - Yahoo! Finance

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

Critical Accounting Policies

Revenue Recognition

The Company leases its properties to tenants under operating leases with terms of over one year. Some of these leases contain scheduled rent increases. We record rent revenue for leases which contain scheduled rent increases on a straight-line basis over the term of the lease, in accordance with Statement of Financial Accounting Standards ("SFAS") SFAS No. 13, "Accounting for Leases."

Receivables are carried net of an allowance for uncollectible receivables. An allowance is maintained for estimated losses resulting from the inability of any tenants to meet their contractual obligations under their lease agreements. We determine the adequacy of this allowance by continually evaluating each tenant's receivables considering the tenant's financial condition and security deposits, and current economic conditions. An allowance for uncollectible accounts of approximately $27,400 was determined to be necessary with regards to the outstanding rent amount due the Company from the tenant of one of its stores that has declared bankruptcy. It is unclear whether any of these funds will be collected during the bankruptcy proceedings.

Long Lived Assets

The Company's accounting policy for the recognition of impairment losses on long-lived assets is 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 the future net undiscounted cash flows expected to be generated by such asset. If such assets are considered impaired, the impairment recognized is measured by the amount by which the carrying value of the assets exceeds the fair value.

Workers' Compensation Liability

The Company's policy for estimating its workers' compensation liability is considered critical. The Company previously self-insured workers' compensation claims losses up to certain limits. The liability for workers' compensation represents an estimate of the present value of the ultimate cost of uninsured losses which are unpaid as of the balance sheet dates. The estimate is continually reviewed and adjustments to the Company's estimated claim liability, if any, are reflected in current operations. On an annual basis, the Company obtains an actuarial report which estimates its overall exposure based on historical claims and an evaluation of future claims. The Company pursues recovery of certain claims from an insurance carrier. Recoveries, if any, are recognized when realization is reasonably assured.

Deferred Tax Assets

The Company's policy for recording a valuation allowance against deferred tax assets is considered critical. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefit, or that future deductibility is uncertain. In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company records net deferred tax assets to the extent the Company believes these assets will more likely than not be realized. In making such determination, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. SFAS No. 109 further states that forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence, such as significant decreases in operations. As a result of the Company's recent disposal of significant business operations, the Company concluded that a valuation allowance should be recorded against federal and state net operating losses and certain federal and state tax credits. The utilization of these items requires sufficient taxable income.

Loss on Sublease Contracts

The Company's policy for recording a loss on sublease contracts is to evaluate the costs expected to be incurred under an operating sublease in relation to the anticipated revenue in accordance with FASB Technical Bulletin No. 79-15, "Accounting for Loss on a Sublease not Involving the Disposal of a Segment"; if such costs exceed anticipated revenue on the operating sublease, the Company recognizes a loss equal to the value of the shortfall over the term of the sublease.

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New Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations." SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141, "Business Combinations", that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. SFAS No. 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in SFAS No. 141(R). In addition, SFAS No. 141(R) requires acquisition costs and restructuring costs that the acquirer expected but was not obligated to incur to be recognized separately from the business combination, therefore, expensed instead of part of the purchase price allocation. SFAS No. 141(R) will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. The Company expects to adopt SFAS No. 141(R) to any business combinations with an acquisition date on or after January 1, 2009.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51." SFAS No. 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. The Company is currently evaluating the impact SFAS No. 160 may have on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after December 15, 2007. The Company plans to adopt SFAS No. 157 beginning in the first quarter of fiscal 2008. The adoption of SFAS No. 157 did not have a significant impact on the Company's financial statements.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." SFAS No. 159 expands the scope of specific types of assets and liabilities that an entity may carry at fair value on its statement of financial position, and offers an irrevocable option to record the vast majority of financial assets and liabilities at fair value, with changes in fair value recorded in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 159 did not have a significant impact on the Company's financial statements.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force, or "EITF"), the American Institute of Certified Public Accountants, and the SEC did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.

Use of Estimates

The preparation of the condensed financial statements of the Company requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. These estimates include the Company's workers' compensation liability, the depreciable lives of assets, estimated loss on or impairment of long-lived assets and the valuation allowance against deferred tax assets. Actual results could differ from those estimates. For a full description of the Company's critical accounting policies, see Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended January 2, 2008.

Results of Operations

Comparison of Quarters Ended July 2, 2008 and June 27, 2007

At July 2, 2008, the Company owns two real estate properties for restaurant use, one located in Orange Park, Florida (the "Orange Park Property") and one in Brooksville, Florida (the "Brooksville Property"). Both of these properties were vacant at the fiscal year end January 2, 2008. A tenant was found for the Brooksville Property with the lease period commencing on January 9, 2008 and expiring in January 2013. The Orange Park Property remains vacant at July 2, 2008. The Company is obligated for capital leases of two restaurant locations, one located in Tampa, Florida (the "Fowler Property") and another located in Deland, Florida (the "Deland Property"). The Deland Property is subleased to a restaurant operator whose sublease will expire in February 2017 while the Fowler Property is leased to a subtenant, which lease commenced on April 9, 2008. In addition, the Company owns an income producing real estate property held for investment in Sylmar, California (the "Sylmar Property") with two industrial tenants.

The Company experienced an increase of $155,400 or 80% in rental revenue during the second quarter of 2008 compared to the second quarter of 2007, due to having tenants in the Company's Brooksville, Deland and Fowler Properties for all or most of the second quarter of 2008, while these properties were vacant for all or most of the second quarter of 2007. The additional rent income was offset by the loss of the tenant in the Company's Orange Park Property, due to that tenant filing for bankruptcy at the end of 2007.

Depreciation and amortization expenses increased $30,700 or 25% in the second quarter of 2008 compared to the second quarter of 2007, primarily due to the return of two properties, the Fowler Property and the Deland Property, following the Banner bankruptcy. The Fowler Property was returned to the Company in December 2007 and was not depreciated during the second quarter of 2007. The Deland Property was held for sale in the second quarter of 2007 and was not depreciated.

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General and administrative expenses consist mainly of rent and related property insurance expense, legal and other professional fees. General and administrative expenses decreased $59,100 or 11% during the second quarter of 2008 as compared to the second quarter of 2007, due mainly to a decrease in legal fees. The Company concluded a major litigation case at the end of fiscal 2007 with a vast amount of the legal work on that case occurring in the second quarter of 2007. There was no similar case in progress in the second quarter of 2008.

In the quarter ended April 2, 2008, the Company liquidated all of its investment holdings. This resulted in no gain or loss from investments in the second quarter of 2008 versus a loss of $98,600 in the second quarter of 2007.

Interest and other income increased $69,300 or 425% in the second quarter of 2008 versus the second quarter of 2007. During the quarter ended July 2, 2008, the Company received a reimbursement of $53,000 from the Florida Disability Trust Fund (the "Trust Fund") related to a worker's compensation claim against the Company. No further reimbursements are due relating to any other worker's compensation cases from the Trust Fund.

Interest expense increased by $148,300 or 137% in the quarter ended July 2, 2008 versus the quarter ended June 27, 2007, mainly due to the refinancing of the Sylmar Property that occurred in the fourth quarter of 2007. The resulting interest on the higher loan amount was more than the interest paid on the mortgage in the second quarter of 2007.

Net loss was $434,800 in the second quarter of 2008 compared to net loss of $1,017,300 in the second quarter of 2007. Loss per share for the quarter was $0.11 in 2008 compared to $0.26 in 2007. The 2008 second quarter loss was due primarily to legal and professional fees and interest expense due to the refinancing of the Sylmar Property and new mortgage on the Brooksville Property. The loss in the second quarter of 2007 was principally due to investment losses, legal fees and the loss on the purchase commitment from the anticipated sale of the Deland Property.

Comparison of Six Months Ended July 2, 2008 and June 27, 2007

The Company experienced an increase of $220,300 or 51% in rental revenue during the first six months of 2008 compared to the first six months of 2007, due to the subleasing of both the Deland Property and Fowler Property during the first and second quarter of 2008, respectively, exceeding the loss of income from the vacancy of the Orange Park Property.

Depreciation and amortization expenses increased $144,600 or 68% during the first six months of 2008 compared to the first six months of 2007 mainly due to two reasons: first, the Fowler Property reverted back to the Company in December 2007 as a result of the Banner bankruptcy; and second, the Deland Property was classified as held for sale in the second quarter of 2007 and not depreciated. Both of those properties were depreciated throughout the first six months of 2008.

The results for the first six months of 2008 included realized gains from the sale of marketable securities of $104,400 and unrealized losses of $8,700. During the first six months of 2007, the Company had unrealized gains from the sale of marketable securities of $142,000 and realized losses of $345,300.

Interest and other income increased $102,500 or 223% due to the reimbursement received by the Company from the Florida Disability Trust Fund related to a worker's compensation claim against the Company and the receipt of interest in the first quarter of 2008 from the amount held in escrow related to the Lurie broker litigation.

Interest expense increased by $282,100 or 148% during the six months ended July 2, 2008 versus the six months ended June 27, 2007, mainly due to the refinancing of the Sylmar Property that occurred in the fourth quarter of 2007. The resulting interest on the higher loan amount was more than the interest paid on the mortgage in 2007 prior to the refinancing.

Net loss was $1,493,100 in the first six months of 2008, compared to net loss of $1,625,700 in the first six months of 2007. Loss per share for the six months was $0.37 cents in 2008 compared to $0.43 in 2007.

Liquidity and Capital Resources

The accompanying condensed financial statements of the Company have been prepared assuming that the Company will continue as a going concern. The Company incurred significant losses and had negative cash flow from operations for the year ended January 2, 2008, and had a working capital deficit of approximately $1,571,600 at that date. During the six months ended July 2, 2008, the Company incurred further losses and had a working capital deficit of approximately $1,792,500. The cash balance at April 2, 2008 is $7,200.

The cash outflows through June 2009 are estimated to total approximately $1,104,400, which will generate an estimated negative cash balance of $1,148,800 in the next twelve months.

The Company currently has estimated equity of $4 to $7 million in its three owned properties, of which $2 million is encumbered by a standby letter of credit to the Florida Self Insurers Guaranty Association ("FSIGA") as collateral for its workers compensation liability. The Company has the ability to sell any or all of these properties to fund operations; however, there can be no assurance that improvement in operating results will occur or that the Company will successfully implement its plans.

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The Company will require additional funds in order to maintain its current operations. In the past, short term funds have been provided by Bisco Industries, Inc. ("Bisco") and the option to continue borrowing from Bisco is available. The Company's Chief Executive Officer and Chairman of the Board of Directors, Glen F. Ceiley, is the President and sole shareholder of Bisco. In the long term, the Company expects any capital requirements to be provided through the sale or refinancing of property currently owned. Additional sources of financing may include public or private offerings of equity or debt securities. While management believes it will have access to these financing sources, no assurance can be given that such additional sources of financing will be available on acceptable terms, on a timely basis or at all.

The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

In the first six months of 2008, the Company received bridge loans from Bisco in the amount of approximately $2,475,000, of which $1,575,000 has been repaid. Bisco's sole shareholder and President is Glen F. Ceiley, the Company's Chief Executive Officer and Chairman of the Board. The note agreements do not provide for regularly scheduled payments; however, any remaining outstanding principal balance plus accrued interest is due six months from the date of the note, although the Company has the ability to extend the loans through March 2009.

Subsequent to year end, the Company financed the Brooksville Property, which was purchased in December 2007 with cash proceeds from the refinance of the Sylmar Property. The cash paid for the Brooksville Property was approximately $2,027,000, and the Company financed approximately $1,200,000 during the quarter ended April 2, 2008. Proceeds from the financing were used to pay down the Bisco loan by approximately $1,150,000.

On May 13, 2008, the Company borrowed an additional $550,000 from Bisco to pay the Horn settlement amount. The loan accrues interest at 7.5% per annum and principal and interest is due no later than November 13, 2008.

On June 11, 2008, the Company borrowed an additional $100,000 from Bisco to cover operating cash flow requirements through July 2008. The loan accrued interest at 7.5% per annum and principal and interest is due no later than December 11, 2008.

Substantially all of the Company's revenues are derived from rental income. Therefore, the Company has not carried significant receivables or inventories and the primary working capital requirements are the repayment of debt, legal expenses and payment on the workers' compensation liability.

As stated above, at July 2, 2008, the Company had a working capital deficit of $1,792,500 compared to a working capital deficit of $1,571,600 at January 2, 2008. The decrease was due to the payment of the Lurie and Horn litigation settlements and cash outlays for operating expenses, such as legal costs and rents. Cash used in operating activities was $4,206,600 in the six months ended July 2, 2008, compared to cash used in operating activities of $154,000 in the six months ended June 27, 2007. The increase in cash used in operating activities was primarily due to the payment of the Lurie and Horn litigation settlements.

Cash provided by investing activities was $1,186,500 for the first six months of 2008 versus cash used of $80,100 in the first six months of 2007. During the first quarter of 2008, the Company received $400,000 of previously restricted cash in escrow related to the Lurie litigation. Also, during the first quarter of 2008, the Company liquidated all of its equity holdings, including securities sold, not yet purchased resulting in a further reduction of restricted cash of $786,500. Cash related to these securities sold, not yet purchased was considered restricted as it was required to repurchase the stock. During the first six months of 2007, the Company increased its securities sold, not yet purchased approximately $80,000 from the year ended 2006.

Net cash provided by financing activities was $1,996,800 in the first six months of 2008 due to the proceeds received from the related party loan from Bisco of $2,475,000, offset by the repayment during the six months of $1,575,000. The Company also received proceeds from the financing of the Brooksville Property of $1,179,700 during the quarter ended July 2, 2008.

In connection with the Convertible Preferred Stock owned by the Company's Chief Executive Officer and Chairman of the Board, Glen Ceiley, dividends are paid quarterly when declared by the Company's Board of Directors. The Company paid one quarterly dividend in the six months ended July 2, 2008. There were $19,100 of accrued undeclared dividends as of July 2, 2008.

The Company is required to pledge collateral for its Workers' Compensation Self-Insurance Liability with FSIGA. The Company has a total of $1.37 million pledged collateral. Bisco provides $1 million of this collateral. As previously mentioned, the Company's Chief Executive Officer and Chairman of the Board of Directors, Glen F. Ceiley, is the President and sole shareholder of Bisco. During 2007, the Company received a demand from the Florida Division of Workers' Compensation (the "Division") to post further collateral in the amount of $2,781,500. The Company pledged the amount by posting a standby letter of credit. The letter of credit is collateralized by a certificate of deposit of $769,500 and the equity the Company holds in the Sylmar Property. The Company may be required to increase this collateral pledge from time to time in the future, based on its workers' compensation claim experience and various FSIGA requirements for self-insured companies. Despite the sale of the Company's restaurants, the workers' compensation will remain an ongoing liability for the Company until all claims are paid, which will likely take many years.

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The Company entered into a loan agreement with GE Capital for the Orange Park Property in 1996. As of July 2, 2008, the outstanding balance due under the Company's loan with GE Capital was $781,700. In December 2007, the Company refinanced the Sylmar Property with Community Bank. The cash proceeds were used
i) to fund the collateral required by the Division for the projected outstanding worker's compensation liability, ii) for payment on the purchase of the Brooksville Property, and iii) for payment of the Lurie litigation settlement in January 2008. As of July 2, 2008, the outstanding balance due on the Community Bank loan was $5,772,300. In April 2008, the Company completed financing of the Brooksville Property with Zions Bank. Proceeds of the loan were used to partially repay the related party loan received from Bisco. The weighted average interest rate on the Company's loans is 6.24%.

The preceding discussion of liquidity and capital resources contains certain forward-looking statements. Forward-looking statements involve a number of risks and uncertainties. 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, Community 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 reports filed by the Company with the Securities and Exchange Commission (the "SEC"), registration statements and public announcements. The Company assumes no duty to update forward-looking statements to reflect events or circumstances after the date of such statements.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements that are reasonably likely to have a current or future effect on the financial position, revenues, results of operations, liquidity or capital expenditures, except for the land leases on the restaurant properties treated as operating leases.

Contractual Financial Obligations

In addition to using cash flow from operations, the Company finances its operations through the issuance of debt, and previously by entering into leases. These financial obligations are recorded in accordance with accounting rules applicable to the underlying transactions, with the result that some are recorded as liabilities in the balance sheet while others are required to be disclosed in the Notes to the consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended January 2, 2008.