**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

# **Washington, D.C. 20549**

#  

**FORM 10-K**

 

**(Mark One)**

**ý****                                ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

## **For thefiscal year ended December 31, 2005**

## ** **

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from          to          **

 

**CommissionFile Number: 1-14556**

 

**POORE BROTHERS, INC.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                     | ** ** | **86-0786101**                        |
|----------------------------------|------------|---------------------------------------|
| (State or  other jurisdiction of |       | (I.R.S.  Employer Identification No.) |
| incorporation  or organization)  |       |                                  |

 

**3500 SouthLa Cometa DriveGoodyear, Arizona 85338**

(Address of principal executiveoffices)(Zip Code)

 

Registrant’s telephone number,including area code:  **(623) 932-6200**

 

Securities registered pursuantto Section 12(b) of the Act:

 

| **Title of Class** | ** ** | **Name of exchange on which registered** |
|------------------------------|------------|-------------------------------------------------------------------|
| Common Stock, $.01 par value |       | Nasdaq                                                            |

 

Securities registered pursuantto Section 12(g) of the Act:  **None**

 

Indicate bycheck mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.

Yes o  No ý

 

Indicate bycheck mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.

Yes o  No ý

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.                                                       Yes ý  No o

 

Indicateby check mark if disclosure of delinquent filers in response to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof Registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.                                                                                      o

 

Indicateby check mark whether the Registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 ofthe Act).

 
| Large  accelerated filer | o | Accelerated  filer | o | Non-accelerated  filer | ý |
|--------------------------|---|--------------------|---|------------------------|--------|

 

Indicate bycheck mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o  No ý

 

The aggregate market value of the voting stock (Common Stock, $.01 parvalue) held by non-affiliates of the Registrant was approximately $52.5 millionbased upon the closing market price on June 25, 2005, the last businessday of the Registrant’s most recently completed second fiscal quarter.

 

The number of issued and outstanding shares of Common Stock, $.01 parvalue, as of March 24, 2006 was 20,115,413.

 

DOCUMENTS INCORPORATED BYREFERENCE

 

Portions of the Proxy Statement for the Registrant’s Annual Meeting ofShareholders to be held on May 23, 2006 are incorporated by reference intoPart III of this Form 10-K.

 

EXCHANGE ACT REPORTS AVAILABLEON COMPANY WEBSITE

 

Under “SEC Filings” on the “Investors” page of the Company’swebsite located at www.poorebrothers.com, the following filings are madeavailable as soon as reasonably practicable after they are electronically filedwith or furnished to the Securities and Exchange Commission: the Company’sAnnual Report on Form 10-K, Quarterly Reports on Form 10-Q, CurrentReports on Form 8-K, Proxy Statement on Schedule 14A related to theCompany’s Annual Shareholders Meeting, and any amendments to those reports orstatements filed or furnished pursuant to Section 13(a) or 15(d) ofthe Securities Exchange Act of 1934.

 

 

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**TABLE OFCONTENTS**

 
| **PART I**   |
|-------------------|
|              |   |   |
| Item 1.           | Business |   |
| Item  1A.         | Risk  Factors |   |
| Item  2.          | Properties |   |
| Item  3.          | Legal  Proceedings |   |
| Item 4.           | Submission of Matters to a Vote of Security Holders |   |
|              |   |   |
| **PART II**  |
| ** **        |   |   |
| Item 5.           | Market for Registrant’s Common Equity, Related Stockholder Matters  and Issuer Purchases of Equity Securities |   |
| Item 6.           | Selected Financial Data |   |
| Item 7.           | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |   |
| Item 7A.          | Quantitative and Qualitative Disclosures  about Market Risk |   |
| Item 8.           | Financial Statements and Supplementary Data |   |
| Item 9.           | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure |   |
| Item 9A.          | Controls and Procedures |   |
| Item 9B.          | Other Information |   |
|              |   |   |
| **PART III** |
| ** **        |   |   |
| Item 10.          | Directors and Executive Officers of the  Registrant |   |
| Item 11.          | Executive Compensation |   |
| Item 12.          | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters |   |
| Item 13.          | Certain Relationships and Related  Transactions |   |
| Item 14.          | Principal Accounting Fees and Services |   |
|              |   |   |
| **PART IV**  |
| ** **        |   |   |
| Item 15.          | Exhibits and Financial Statement Schedules |   |

 

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**CAUTIONARY STATEMENT REGARDING****FORWARD-LOOKING STATEMENTS**

 

This Annual Report on Form 10-K,including all documents incorporated by reference, includes “forward-looking”statements within the meaning of Section 27A of the Securities Act of1933, as amended (the “Securities Act”), Section 21E of the SecuritiesExchange Act of 1934, as amended, and the Private Securities Litigation Reform Actof 1995, and Poore Brothers, Inc. (the “Company”) desires to takeadvantage of the “safe harbor” provisions thereof. Therefore, the Company isincluding this statement for the express purpose of availing itself of theprotections of the safe harbor with respect to all of such forward-lookingstatements. In this Annual Report on Form 10-K, the words “anticipates,” “believes,”“expects,” “intends,” “estimates,” “projects,” “will likely result,” “willcontinue,” “future” and similar terms and expressions identify forward-lookingstatements. The forward-looking statements in this Annual Report on Form 10-Kreflect the Company’s current views with respect to future events and financialperformance. These forward-looking statements are subject to certain risks anduncertainties, including specifically the possibility that the Company willneed additional financing due to future operating losses or in order toimplement the Company’s business strategy, the possible diversion of managementresources from the day-to-day operations of the Company as a result ofstrategic acquisitions, potential difficulties resulting from the integration ofacquired businesses with the Company’s business, other acquisition-relatedrisks, lack of consumer acceptance of existing and future products, dependenceupon key license agreements, dependence upon major customers, significantcompetition, risks related to the food products industry, volatility of themarket price of the Company’s common stock, par value $.01 per share (the “CommonStock”), the possible de-listing of the Common Stock from the Nasdaq SmallCapMarket if the Company fails to satisfy the applicable listing criteria(including a minimum share price) in the future and those other risks anduncertainties discussed herein, that could cause actual results to differmaterially from historical results or those anticipated. In light of theserisks and uncertainties, there can be no assurance that the forward-lookinginformation contained in this Annual Report on Form 10-K will in facttranspire or prove to be accurate. Readers are cautioned to consider thespecific risk factors described herein and in “Risk Factors,” and not to placeundue reliance on the forward-looking statements contained herein, which speakonly as of the date hereof. The Company undertakes no obligation to publiclyrevise these forward-looking statements to reflect events or circumstances thatmay arise after the date hereof. All subsequent written or oralforward-looking statements attributable to the Company or persons acting on itsbehalf are expressly qualified in their entirety by this section.

 

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**Item 1. Business**

 

**Description of Business**

 

Poore Brothers, Inc. (the “Company”) isengaged in the development, production, marketing and distribution ofinnovative consumer products that are sold primarily through grocery retailers,mass merchandisers, club stores, convenience stores and vend distributorsacross the United States. The Company currently manufactures and sellsnationally T.G.I. Friday’s® brand salted snacks under license from TGI Friday’sInc. and sells nationally Cinnabon® brand snacks under license from Cinnabon, Inc.The Company also currently (i) manufactures and sells regionally its ownbrands of salted snack food products, including Poore Brothers®, Bob’s TexasStyle®, and Boulder Canyon Natural FoodsTM brandbatch-fried potato chips and Tato Skins® brand potato snacks, (ii) manufacturesprivate label potato chips for grocery retail chains in the southwest, and (iii) distributesin Arizona snack food products that are manufactured by others. The Companysells its T.G.I. Friday’s® brand salted snack products to mass merchandisers,grocery, club and drug stores directly and to primarily convenience stores andvend operators through independent distributors. The Company’s other brands arealso sold through independent distributors. For the fiscal years 2005, 2004 and2003, net revenues totaled $75,332,541, $68,734,763 and $66,417,836,respectively, and T.G.I. Friday’s® brand salted snacks represented 65%, 72% and61%, respectively, of the Company’s total net revenues. See Note 11 “*Business Segments and Significant Customers*” to thefinancial statements included in Item 8.

 
| ** **                                    | ** ** | **Percent of Total Net Revenues** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Branded  products                             |       | 93                                                    | %          | 94 | % | 91 | % |
| Private  label products                       |       | 3                                                     | %          | 3 | % | 3 | % |
| Total  manufactured products segment revenues |       | 96                                                    | %          | 97 | % | 94 | % |
|                                          |       |                                                  |       |   |   |   |   |
| Distributed  products segment revenues        |       | 4                                                     | %          | 3 | % | 6 | % |
|                                          |       |                                                  |       |   |   |   |   |
| Total  revenues                               |       | 100                                                   | %          | 100 | % | 100 | % |

 

The Company produces T.G.I. Friday’s® brandsalted snacks and Tato Skins® brand potato snacks utilizing a sheeting andfrying process that includes patented technology. T.G.I. Friday’s® brand saltedsnacks and Tato Skins® brand potato snacks are offered in several differentflavors and formulations. All of these products are manufactured at the Company’sleased facility in Bluffton, Indiana, except for Mozzarella Snack Sticks, OnionRings and Hot Pepper Jack Cheese Fries products which are produced by contractmanufacturers on behalf of the Company and sold under the T.G.I. Friday’s®brand name. Cinnabon® brand snacks are also produced by contract manufacturerson behalf of the Company and sold under the Cinnabon® brand name. The Cinnabon®brand has not met consumer demand expectations in many channels during its 2005introduction and the Company is evaluating future prospects for the brand.

 

Poore Brothers®, Bob’s Texas Style® andBoulder Canyon Natural FoodsTM brandpotato chips are manufactured with a batch-frying process that the Companybelieves produces potato chips with enhanced crispness and flavor. Poore Brothers®,Bob’s Texas Style® and Boulder Canyon Natural FoodsTMpotato chips are each offered in a variety of flavors. The Company alsomanufactures potato chips for sale on a private label basis using a continuousfrying process. The Company’s potato chips are manufactured at a Company-ownedfacility in Goodyear, Arizona. See “*Products*” and “*Marketing and Distribution*”

 

The Company’s business objective is to builda diverse portfolio of national niche food brands that provide high qualityproducts at competitive prices that are superior in taste, texture, flavorvariety and brand personality to comparable products. A significant element ofthe Company’s growth strategy is to develop, acquire or license innovativeconsumer brands. We may broaden our focus for new opportunities beyondsnack foods, and perhaps even beyond food brands. TheCompany also plans to increase sales of its existing brands and continue toimprove profit margins through increased operating efficiencies andmanufacturing capacity utilization. See “*Business Strategy*.”

 

The Company’s executive offices arelocated at 3500 South La Cometa Drive, Goodyear, Arizona 85338, and itstelephone number is (623) 932-6200.

 

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**Company History**

 

The Company, a Delaware corporation, wasformed in 1995 as a holding company to acquire a potato chip manufacturing anddistribution business which had been founded by Donald and James Poore in 1986.

 

In December 1996, the Companycompleted an initial public offering of its Common Stock. In November 1998,the Company acquired the business and certain assets (including the Bob’s TexasStyle® potato chip brand) of Tejas Snacks, L.P. (“Tejas”), a Texas-based potatochip manufacturer. In October 1999, the Company acquired Wabash Foods, LLC(“Wabash”) including the Tato Skins®, O’Boisies®, and Pizzarias® trademarks andthe Bluffton, Indiana manufacturing operation and assumed all of Wabash Foods’liabilities. In June 2000, the Company acquired Boulder Natural Foods, Inc.(“Boulder”) and the Boulder Canyon Natural FoodsTM brand oftotally natural potato chips. As part of the Boulder acquisition, theCompany was required to issue additional unregistered shares of Common Stock tothe seller on each of the first three anniversaries of the closing of theacquisition. The issuance of such shares was dependent upon increases in salesof Boulder product as compared to previous periods. In 2003, 2002 and 2001, theCompany was required to issue 93,728 shares valued at $420,566, 88,864 sharesvalued at $210,786 and 57,898 shares valued at $185,274, respectively. Witheach issuance of shares the Company increased the goodwill recorded from thisacquisition.

 

In October 2000,the Company launched its T.G.I. Friday’s® brand salted snacks pursuant to alicense agreement with TGI Friday’s Inc., which expires in 2014.

 

In June 2003,the Company launched its Crunch Toons® brand potato snacks, initially featuringcharacters pursuant to a multi-year license agreement with Warner Bros.Consumer Products. The Company decided to discontinue the brand in June 2004and ceased using its license agreements with Warner Bros. Consumer Products. See*“Note 7. Brand Discontinuance.”*

 

In April 2005,the Company launched its Cinnabon® brand pursuant to a multi-year licenseagreement with Cinnabon, Inc, the initial term of which expires in 2011. Arenewal term for an additional five years exists at the end of the initialterm.

 

In September 2005,the Company signed a licensing agreement with Panda Restaurant Group, Inc.for the development, manufacture and sale of snack food products under thePanda Express® brand name. The Company is currently determining the viabilityof test marketing products under the Panda Express® brand name.

 

### **BusinessStrategy**

### ** **

The Company is engaged in the development,production, marketing and distribution of innovative snack food products thatare sold primarily through grocery retailers, mass merchandisers, club stores,convenience stores and vend distributors across the United States. The Companycurrently manufactures and sells nationally T.G.I. Friday’s® brand snacks underlicense from TGI Friday’s Inc. and sells nationally Cinnabon® brand snacksunder license from Cinnabon, Inc., however, the Company is currentlyevaluating the Cinnabon® licensed products to determine their future prospects.The Company also currently (i) manufactures and sells regionally its ownbrands of snack food products, including Poore Brothers®, Bob’s Texas Style®,and Boulder Canyon Natural FoodsTM brand batch-fried potato chipsand Tato Skins® brand potato snacks, (ii) manufactures private labelpotato chips for grocery retail chains in the southwest, and (iii) distributesin Arizona snack food products that are manufactured by others. The Companysells its T.G.I. Friday’s® brand snack products to mass merchandisers, grocery,club and drug stores directly and to convenience stores and vend operatorsthrough independent distributors. The Company’s other brands are also soldthrough independent distributors.

 

The Company has an aggressive strategic planto achieve its long-term vision of being a significant marketer of consumerbrands. The Company’s business strategy is to continue building a diverseportfolio of national niche brands with annualized revenues of $20 million to$50 million each through licensing, acquisition or development. This representsa broadening of the Company’s strategy beyond snack foods and may includeopportunities other than food brands. The goals of our strategy are to (i) capitalizeon national niche market opportunities, (ii) deliver incremental categorygrowth for retailers, (iii) provide product innovation targeted to adefined consumer segment, (iv) complement, rather than compete directlyagainst, large national competitors with leading national brands, and (v) buildrelationships with major retailers in all channels of distribution by providingthem higher margins, excellent customer service and constant innovation. Theprimary elements of the Company’s long-term business strategy are as follows:

 

*Develop,Acquire or License Innovative Consumer Brands.*Asignificant element of the Company’s business strategy is to develop, acquireor license new innovative consumer brands that provide strategic fit with ourexisting business and possess strong national brand equity in order to expand,complement or diversify the Company’s existing business. In October 2000the Company initiated this element of its strategy by launching its firstnational niche

 

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brand, T.G.I. Friday’s® brand salted snacks,under an exclusive license from TGI Friday’s Inc. In June 2003 the Companylaunched its second national niche brand, Crunch Toons®, featuring LooneyTunesTM characters, under a multi-year agreement with Warner Bros. ConsumerProducts. This brand launch was unsuccessful and the brand was discontinued in June 2004.The Company signed a license agreement in September 2004 to develop andsell Cinnabon® brand salted snacks, shelf-stable cookies and breakfast/snackbars under an exclusive license from Cinnabon, Inc., which commencedinitial shipments in the second quarter of 2005. However, the Cinnabon® brandhas not met consumer demand expectations in many channels during its 2005introduction and the Company is evaluating future prospects for the brand. TheCompany plans to continue developing, acquiring or licensing additionalnational niche brands, though it intends to mitigate the financial impact oflaunching new brands by introducing new licensed products in small-scale testmarkets rather than large scale regional or national introductions.

 

*BroadenDistribution of Existing Brands.*The Company plansto increase distribution and build the market share of its existing brandedproducts through selected trade activity in various existing or new markets andchannels. For example, the Company plans to expand sales to Canadian customersthat it commenced in 2004 and is exploring other international marketopportunities for its brands. Marketing efforts may include, among otherthings, trade advertising and promotional programs with distributors andretailers, in-store advertisements, in-store displays and limited consumeradvertising, public relations and coupon programs.

 

*Develop NewProducts for Existing Brands.*In addition, theCompany plans to continue its innovation activities to identify and develop (i) newline extensions for its brands, such as new flavors or products, and (ii) newfood segments in which to expand the brand’s presence. For example, in the secondquarter of 2005 the Company commenced initial shipments of a new line of tendermeat snacks under the T.G.I. Friday’s® brand. Similar projects would allow theCompany to identify potential additional food segments besides salted snacks inwhich to develop and launch new products.

 

*LeverageInfrastructure and Capacity.*The Company’s Indianaand Arizona facilities are currently operating at approximately 40% and 50% oftheir respective manufacturing capacities. The Company currently hasarrangements with several grocery chains for the manufacture and distributionby the Company of their respective private label potato chips and believes thatadditional contract manufacturing opportunities exist. While they are extremelyprice competitive and can be short in duration, the Company believes that they may providea profitable opportunity for the Company to improve the capacity utilization ofits facilities. The Company intends to seek additional private label andcontract manufacturing customers located near its facilities who demandsuperior product quality at a reasonable price.

 

The Companyalso utilizes contract manufacturers’ excess capacity to produce items that theCompany does not have the equipment or know-how to manufacture.

 

*ImproveProfit Margins.*The Company plans to increasegross profit margins through increased long-term revenue growth, improvedoperating efficiencies, and higher margin new products. It believes thatadditional improvements to its manufactured products’ gross profit margins arepossible with the achievement of the business strategies discussed above. Dependingon product mix, the Company believes that the existing manufacturing facilitiescould produce, in the aggregate, up to $150 million in annual revenue volumeand thereby further reduce manufacturing product costs as a percentage of netrevenue.

 

#### **Products**

#### ** **

*ManufacturedSnack Food Products*. The Company produces T.G.I.Friday’s® brand Potato Skins salted snacks and Tato Skins® brand potato crispsutilizing a sheeting and frying process. T.G.I. Friday’s® brand salted snacksand Tato Skins® brand potato crisps are offered in several different flavorsand formulations. All of these products are manufactured at the Company’sleased facility in Bluffton, Indiana, except for Mozzarella Snack Sticks, OnionRings and Hot Pepper Jack Cheese Fries products which are produced by contractmanufacturers on behalf of the Company and sold under the T.G.I. Friday’s®brand name. The licensed Cinnabon® brand packaged cookies are produced bycontract manufacturers and sold under the Cinnabon® name.

 

Poore Brothers®, Bob’s Texas Style®, andBoulder Canyon Natural FoodsTM brandpotato chips are produced utilizing a batch-frying process and are marketed bythe Company as premium products based on their distinctive combination ofcooking method and variety of distinctive flavors. Poore Brothers®, Bob’s TexasStyle® and Boulder Canyon Natural FoodsTM potato chipsare each offered in a variety of flavors. The Company currently has agreementswith several grocery

 

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chains pursuant to which the Company produces their respective privatelabel potato chips in the styles and flavors specified by each grocery chain.

 

*DistributedSnack Food Products*. The Company purchases andresells throughout Arizona snack food products manufactured by others. Suchproducts include pretzels, popcorn, dips and meat snacks.

 

**Manufacturing**

 

TheCompany’s manufacturing facility in Bluffton, Indiana includes three fryerlines that can produce an aggregate of up to approximately 9,000 pounds perhour of T.G.I. Friday’s® and Tato Skins® brand products. The Indiana facilityis currently operating at approximately 40% of capacity. Certain T.G.I. Friday’s®and Tato Skins® brand products are produced utilizing a sheeting and fryingprocess that includes some patented technology. Some T.G.I. Friday’s® brandsalted snack products are produced by contract manufacturers on behalf of theCompany. See “*Patents, Trademarks and Licenses*.”

 

TheCompany believes that a key element of the success to date of the PooreBrothers®, Bob’s Texas Style® and Boulder Canyon Natural FoodsTMbrand potato chips has been the Company’s use of certain cooking techniques andkey ingredients in the manufacturing process to produce potato chips withimproved flavor. These techniques currently involve two elements: the Company’suse of a batch-frying process, as opposed to the conventional continuous linecooking method, and the Company’s use of distinctive seasonings to producepotato chips in a variety of flavors. The Company believes that although thebatch- frying process produces less volume, it is superior to conventionalcontinuous line cooking methods because it enhances crispness and flavorthrough greater control over temperature and other cooking conditions.

 

The Arizona facility has the capacity toproduce up to approximately 3,500 pounds of potato chips per hour, including1,400 pounds of batch-fried branded potato chips per hour and 2,100 pounds ofcontinuous-fried private label potato chips per hour. The Company ownsadditional batch-frying equipment which, if needed, could be installed withoutsignificant time or cost, and which would result in increased capacity toproduce the batch-fried potato chips. The Arizona facility is currentlyoperating at approximately 50% of capacity.

 

There can be no assurance that the Companywill obtain sufficient business to recoup the Company’s investments in itsmanufacturing facilities or to increase the utilization rates of suchfacilities. See “*Item 2. Properties.*”

 

### **Marketingand Distribution**

### ** **

The Company’s T.G.I. Friday’s® brand snackfood products have achieved significant market presence across a number ofsales channels. The Company attributes the success of its products in thesemarkets to consumer loyalty. The Company believes this loyalty results from theproducts’ differentiated taste, texture and flavor variety which result fromits manufacturing processes. The Company has retained Acosta, Inc., aleading national sales and marketing agency with employees and officesnationwide to represent T.G.I. Friday’s® brand salted snacks on behalf of theCompany in the grocery and convenience store channels. T.G.I. Friday’s® brandsalted snacks are now sold in approximately 50% of U.S. grocery stores and inover 88% of the top 100 convenience store chains. The Company’s own salesorganization sells T.G.I. Friday’s® brand salted snacks in the mass, club anddrug channels. The Company also obtains significant sales on T.G.I. Friday’s® brandsalted snacks in the vending channel nationwide through an independent networkof brokers and distributors. The Company uses these same selling anddistribution methods to sell its line of Cinnabon® branded products.

 

The Company’s potato chip brands aredistributed to grocery and other retailers primarily by a select group ofindependent distributors. Poore Brothers® brand potato chip products haveachieved significant market presence in the southwest United States. TheCompany’s Bob’s Texas Style® brand potato chip products have achievedsignificant market presence in south/central Texas. The Company’s BoulderCanyon Natural FoodsTM brand potato chipproducts have achieved significant market presence in Colorado and in naturalfood stores nationwide. The Company selects brokers and distributors for itsbranded products primarily on the basis of quality of service, call frequencyon customers, financial capability and relationships they have withsupermarkets and vending distributors, including access to shelf space forsnack food.

 

The Company’s distribution throughout Arizonaincludes approximately 50 independently operated service routes. Each route isoperated by an independent distributor who purchases from the Company andmerchandises to major grocery store chains in Arizona, such as Albertson’s,Basha’s, Fry’s and Safeway stores. In addition to servicing major supermarketchains, the Company’s distributors service many independent grocery stores,club stores, and military facilities throughout Arizona. In addition to PooreBrothers® brand products, the Company distributes throughout Arizona a widevariety of snack food items manufactured by other companies, includingpretzels, popcorn, dips, and meat snacks.

 

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The Company commenced selling internationallyto Canadian customers during the fourth quarter of 2004 and is seekingopportunities to selectively expand its growth in other countries.

 

Successful marketing of the Company’sproducts depends, in part, upon obtaining adequate shelf space for suchproducts, particularly in supermarkets and vending machines. Frequently, theCompany incurs additional marketing costs in order to obtain additional shelfspace. Whether or not the Company will continue to incur such costs in thefuture will depend upon a number of factors including, demand for the Company’sproducts, relative availability of shelf space and general competitiveconditions. The Company may incur significant shelf space, consumermarketing or other promotional costs as a necessary condition of entering intocompetition or maintaining market share in particular markets or channels. Anysuch costs may materially affect the Company’s financial performance.

 

The Company’s marketing programs are designedto increase product trial and build brand awareness in core markets. Most ofthe Company’s marketing spending has traditionally been focused on tradeadvertising and trade promotions designed to attract new consumers to theproducts at a reduced retail price, except in 2003, when the Company conductednational television advertising and coupon programs in connection with thelaunch of the Crunch Toons® brand. The Company’s marketing programs alsoinclude selective event sponsorship designed to increase brand awareness and toprovide opportunities to mass sample branded products. Sponsorship of theArizona Diamondbacks typifies the Company’s efforts to reach targeted consumersand provide them with a sample of the Company’s products to encourage new andrepeat purchases.

 

**Suppliers**

 

The principal raw materials used by theCompany are potatoes, potato flakes, wheat flour, corn and oil. The Companybelieves that the raw materials it needs to produce its products are readilyavailable from numerous suppliers on commercially reasonable terms. Potatoes,potato flakes, wheat flour and corn are widely available year-round. TheCompany uses a variety of oils in the production of its products and theCompany believes that alternative sources for such oils, as well as alternativeoils, are readily abundant and available. The Company also uses seasonings andpackaging materials in its manufacturing process.

 

The Company chooses its suppliers basedprimarily on price, availability and quality. Although the Company believesthat its required products and ingredients are readily available, and that itsbusiness success is not dependent on any single supplier, the failure ofcertain suppliers to meet the Company’s performance specifications, qualitystandards or delivery schedules could have a material adverse effect on theCompany’s operations. In particular, a sudden scarcity, a substantial priceincrease, or an unavailability of product ingredients could materiallyadversely affect the Company’s operations. There can be no assurance thatalternative ingredients would be available when needed and on commerciallyattractive terms, if at all.

 

### **Customers**

### ** **

Two customers of the Company, Wal*Mart(including its SAM’s Clubs) and Vistar, formerly Vending Services of America, anational vending distributor accounted for 19% and 11%, respectively, of theCompany’s 2005 net revenues. The remainder of the Company’s revenues wasderived from sales to a limited number of additional customers, either grocerychains, club stores or regional distributors, none of which individuallyaccounted for more than 10% of the Company’s net revenues in 2005. A decisionby any of the Company’s major customers to cease or substantially reduce theirpurchases could have a material adverse effect on the Company’s business.

 

The majority of the Company’s revenues areattributable to external customers in the United States; however, the Companystarted selling product to Canadian customers in October, 2004. All of theCompany’s assets are located in the United States.

 

### **MarketOverview and Competition**

### ** **

According to the Snack Food Association (“SFA”),the U.S. market for salted snack foods reached $24.3 billion at retail in 2004(the latest year for which data is available) with potato chips, tortilla chipsand potato crisps, accounting for nearly 45% of the market, and corn snacks,popcorn, pretzels, nuts, meat snacks and other products accounting for thebalance. Total salted snack sales, in dollar terms, increased in each of thelast ten years, ranging from an increase of 8.5% (in 1997) to 0.3% (in 1995),with a 2004 increase of 3.5%. Potato chip, tortilla chips and potato crispscombined sales in 2004 were $10.8 billion, a 2.2% increase over 2003 sales of$10.6 billion.

 

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According to the SFA, the U.S. market forbakery foods reached $35.0 billion at retail in 2004 (the latest year for whichdata is available) with snack bars and cookies & crackers, accountingfor approximately 40% of the market, and bread, baked sweet goods, refrigerated &frozen baked goods and other products accounting for the balance.

 

The Company’s products compete generallyagainst other snack foods, including potato chips, tortilla chips, cookies, etc.The snack food industry is large and highly competitive and is dominated bylarge food companies, including Frito-Lay, Inc., a subsidiary of PepsiCo, Inc.,Nabisco, Keebler and Kraft. These Companies possess substantially greaterfinancial, production, marketing, distribution and other resources than theCompany and brands that are more widely recognized than the Company’s products.Numerous other companies that are actual or potential competitors of theCompany, many with greater financial and other resources (including moreemployees and more extensive facilities) than the Company, offer productssimilar to those of the Company. In addition, many of such competitors offer awider range of products than offered by the Company. Local or regional marketsoften have significant smaller competitors, many of whom offer products similarto those of the Company. Expansion of the Company’s operations into new marketshas and will continue to encounter significant competition from national,regional and local competitors that may be greater than that encounteredby the Company in its existing markets. In addition, such competitors may challengethe Company’s position in its existing markets. While the Company believes thatit has innovative products and methods of operation that will enable it tocompete successfully, there can be no assurance of its ability to do so.

 

The principal competitive factors affectingthe market of the Company’s products include product quality and taste, brandawareness among consumers, access to shelf space, price, advertising andpromotion, variety of snacks offered, nutritional content, product packagingand package design. The Company competes in the market principally on the basisof product quality and taste. While products produced at the Company’sBluffton, Indiana facility involve the use of certain licensed technology andunique manufacturing processes, the taste and quality of products produced atthe Company’s Goodyear, Arizona facility are largely due to two elements of theCompany’s manufacturing process: its use of batch-frying and its use ofdistinctive seasonings to produce a variety of flavors. The Company does nothave exclusive rights to the use of either element; consequently, competitors may incorporatesuch elements into their own processes.

 

**Government Regulation**

 

The manufacture, labeling and distribution ofthe Company’s products are subject to the rules and regulations of variousfederal, state and local health agencies, including the Food & DrugAdministration (“FDA”). In May 1994, regulations issued under theNutrition Labeling and Education Act of 1990 (“NLEA”), which requires specifiednutritional information to be disclosed on all packaged foods, concerninglabeling of food products, including permissible use of nutritional claims suchas “fat-free” and “low-fat,” became effective. The Company believes that it iscomplying in all material respects with the NLEA regulations and closelymonitors the fat content of its products through various testing and qualitycontrol procedures. The Company does not believe that compliance with the NLEAregulations materially increases the Company’s manufacturing costs.

 

As a direct result of the September 11,2001 terrorism attack, the FDA issued the Bioterrorism Act of 2002 (“the Act”)to protect the U.S. food supply. While there are four parts to the Act, onlytwo of the provisions impact the Company. One requirement for the Company wasregistration with the FDA as a U.S. Food Manufacturing Company, which theCompany completed prior to the required date of December 12, 2003. Thesecond of the Act’s provisions pertaining to the Company relates to recordretention. The Company is required to retain records pertaining to its rawmaterials’ immediate previous sources (“one back”) as well as its finishedgoods’ subsequent recipients (“one up”) for twelve months. The Act waseffective January 1, 2005, and the Company believes it is currentlycompliant with this provision.

 

On July 11, 2003, the FDA published itsfinal rule on Trans Fat Labeling requiring that food labels declare transfats on or before January 1, 2006. This rule requires that trans fatbe declared on a separate line in the standard Nutrition Facts below total fatand saturated fat and be calculated to the nearest 0.5 grams, unless it is lessthan 0.5 grams in which case it may be expressed as 0 grams.

 

There can be no assurance that new laws orregulations will not be passed that could require the Company to alter thetaste or composition of its products or impose other obligations on the Company.Such changes could affect sales of the Company’s products and have a materialadverse effect on the Company.

 

In addition to laws relating to foodproducts, the Company’s operations are governed by laws relating toenvironmental matters, workplace safety and worker health, principally theOccupational Safety and Health Act. The Company believes that it presentlycomplies in all material respects with such laws and regulations.

 

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### **Employees**

### ** **

As of December 31,2005, the Company had 270 full-time employees, including 215 in manufacturingand distribution, 35 in sales and marketing and 20 in administration andfinance. The Company’s employees are not represented by any collectivebargaining organization and the Company has never experienced a work stoppage. TheCompany believes that its relations with its employees are good.

 

**Patents, Trademarks and Licenses**

 

The Company produces T.G.I. Friday’s® brandsalted snacks and Tato Skins® brand potato crisps utilizing a sheeting andfrying process that includes patented technology that the Company licenses fromMiles Willard Technologies, LLC, an Idaho limited liability company (“MilesWillard”). Pursuant to the license agreement between the Company and MilesWillard, the Company has an exclusive right to use the patented technologywithin North America until the patents expire on December 26, 2006. Inconsideration for the use of these patents, the Company is required to makeroyalty payments to Miles Willard on sales of products manufactured utilizingthe patented technology until the expiration date. Once thesepatents expire, the Company will no longer have exclusive rights to thistechnology and may face additional competition.

 

The Companylicenses the T.G.I. Friday’s® brand salted snacks trademark from TGI Friday’sInc. under a license agreement with a term expiring in 2014. Pursuant to thelicense agreement, the Company is required to make royalty payments on sales ofT.G.I. Friday’s® brand salted snack products and is required to achieve certainminimum sales levels by certain dates during the contract term.

 

The Companylicenses the Cinnabon® brand for salted snacks, shelf-stable packagedcookies and breakfast/snack bars from Cinnabon Inc. under a license agreementwith terms and options extending through 2015. Pursuant to thelicense agreement, the Company is required to make royalty payments on sales ofCinnabon® brand products and is required to achieve certain minimum saleslevels by certain dates during the contract term.

 

TheCompany continues to evaluate new licensing opportunities tobroaden its product offering and to complement the growth of itsexisting T.G.I. Friday’s® and Cinnabon® product lines through the introductionof new products in salted snacks as well as other consumer product categories.

 

The Company ownsthe following trademarks in the United States: Poore Brothers®, An IntenselyDifferent Taste®, Texas Style®, Boulder Canyon®, Tato Skins®, O’Boisies®,Pizzarias®, Braids® and Knots®.

 

The Companyconsiders its trademarks to be of significant importance in the Company’sbusiness. The Company is not aware of any circumstances that would have amaterial adverse effect on the Company’s ability to use its trademarks. Anytermination of the Company’s license agreements, whether at the expiration ofits term or prior thereto, could have a material adverse effect on the Company’sfinancial condition and results of operations.

 

**Seasonality**

 

The food productsindustry is seasonal. Consumers tend to purchase our products at higher levelsduring the major summer holidays and also at times surrounding major sportingevents throughout the year. Additionally, we may face seasonal priceincreases for raw materials.

 

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**Item 1A. Risk Factors**

 

Any one of the following factors could affectoperating results. You should read and carefully consider these riskfactors, and the entirety of this report, before you invest in our securities.

 

**Risks Related to Our Business**

 

*We may incursignificant future expenses due to the implementation of our business strategy.*

 

The Company has an aggressive strategic planto achieve its long-term vision of being a significant marketer of consumerbrands. Such action is subject to the substantial risks, expenses anddifficulties frequently encountered in the implementation of a new businessstrategy. Even if the Company is successful in developing, acquiring and/orlicensing new brands, and increasing distribution and sales volume of theCompany’s existing products, it may require the Company to incursubstantial additional expenses, including advertising and promotional costs, “slotting”expenses (i.e., the cost of obtaining shelf space in certain grocery stores),and integration costs of any future acquisitions. Accordingly, the Company may incuradditional losses in the future as a result of the implementation of theCompany’s business strategy, even if revenues increase significantly. There canbe no assurance that the Company will be able to implement its new strategicplan, that its business strategy will prove successful or that it will be ableto maintain profitability during such implementation.

 

*We may notbe able to obtain the additional financing we need to implement our businessstrategy.*

 

A significant element of the Company’sbusiness strategy is the development, acquisition and/or licensing ofinnovative food brands, for the purpose of expanding, complementing and/ordiversifying the Company’s business. In connection with each of the Company’sprevious brand acquisitions, the Company borrowed funds or assumed additionalindebtedness in order to satisfy a substantial portion of the considerationrequired to be paid by the Company. The Company may, in the future, requireadditional third party financing (debt or equity) as a result of any futureoperating losses, in connection with the expansion of the Company’s businessthrough non-acquisition means, in connection with any additional acquisitionscompleted by the Company, or to provide working capital for general corporatepurposes. There can be no assurance that any such required financing will beavailable or, if available, be on terms attractive to the Company. Any thirdparty financing obtained by the Company may result in dilution of the equityinterests of the Company’s shareholders.

 

*We expectour future growth to be derived in significant part, from acquisitions, but ouracquisition strategy may not be successful or we may not besuccessful integrating acquisitions.*

 

A significant element of the Company’sbusiness strategy is the pursuit of selected strategic acquisitionopportunities for the purpose of expanding, complementing and/or diversifyingthe Company’s business. However, no assurance can be given that the Companywill be able to identify, finance and complete additional suitable acquisitionson acceptable terms, or that future acquisitions, if completed, will besuccessful. Any future acquisitions could divert management’s attention fromthe daily operations of the Company and otherwise require additionalmanagement, operational and financial resources. Moreover, there can be noassurance that the Company will be able to successfully integrate acquiredcompanies or their management teams into the Company’s operating structure, retainmanagement teams of acquired companies on a long-term basis, or operateacquired companies profitably. Acquisitions may also involve a number ofother risks, including adverse short-term effects on the Company’s operatingresults, dependence on retaining key personnel and customers, and risksassociated with unanticipated liabilities or contingencies.

 

*We aresubject to ongoing financial covenants under our main credit facility, and ifwe fail to meet those covenants or otherwise default on our credit facility,our lender may accelerate our borrowings.*

 

At December 31, 2005, the Company hadoutstanding indebtedness under a credit agreement with U.S. Bancorp (the “U.S.Bancorp Credit Agreement”) in the aggregate principal amount of $0.5 million. Theindebtedness under the U.S. Bancorp Credit Agreement is secured bysubstantially all of the Company’s assets. The Company is required to complywith certain financial covenants pursuant to the U.S. Bancorp Credit Agreementso long as borrowings from U.S. Bancorp remain outstanding. Should the Companybe in default under any of such covenants, U.S. Bancorp shall have the right,upon written notice and after the expiration of any applicable period duringwhich such default may be cured, to demand immediate payment of all of thethen unpaid principal and accrued but unpaid interest under the U.S. BancorpCredit Agreement. At December 31, 2005, the Company was in compliance withall financial covenants under the U.S. Bancorp Credit Agreement (including aminimum tangible net worth, a minimum fixed charge coverage ratio and a minimumcurrent ratio). As the Company implements its business strategy, there can beno assurance that the Company will remain in compliance with the financialcovenants in the future. Any acceleration of the borrowings under the U.S.Bancorp Credit Agreement prior to the applicable

 

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maturity dates could have a material adverse effect upon the Company.See “*Item 7. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Liquidity and Capital Resources*.”

 

*We may notbe able to successfully implement our strategy to expand our businessinternationally.*

 

The Company plans to expand sales to Canadiancustomers and is exploring other international market opportunities for itsbrands. Such expansion may require significant management attention andfinancial resources and may not produce desired levels of revenue. Internationalbusiness is subject to inherent risks, including longer accounts receivablecollection cycles, difficulties in managing operations across disparategeographical areas, difficulties enforcing agreements and intellectual propertyrights, fluctuations in local economic, market and political conditions, compliancerequirements with U.S. and foreign export regulations, potential adverse taxconsequences and currency exchange rate fluctuations.

 

*We may incurmaterial losses and costs as a result of product liability claims that may bebrought against us or any product recalls we have to make*.

 

As a manufacturer and marketer of foodproducts, the Company may be subjected to various product liability claims.There can be no assurance that the product liability insurance maintained bythe Company will be adequate to cover any loss or exposure for productliability, or that such insurance will continue to be available on termsacceptable to the Company. Any product liability claim not fully covered byinsurance, as well as any adverse publicity from a product liability claim,could have a material adverse effect on the financial condition or results ofoperations of the Company.

 

*We aresubject to numerous governmental regulations, and our failure to comply withthose regulations could result in fines or penalties being imposed on us.*

 

The packaged food industry is subject tonumerous federal, state and local governmental regulations, including thoserelating to the preparation, labeling and marketing of food products. TheCompany is particularly affected by the Nutrition Labeling and Education Act of1990 (“NLEA”), which requires specified nutritional information to be disclosedon all packaged foods.

 

Additionally, as a direct result of the September 11,2001 terrorism attack, the FDA issued the Bioterrorism Act of 2002 (“the Act”)to protect the U.S. food supply. While there are four parts to the Act, onlytwo of the provisions impact the Company. One requirement for the Company wasregistration with the FDA as a U.S. Food Manufacturing Company, which theCompany completed prior to the required date of December 12, 2003. Thesecond of the Act’s provisions pertaining to the Company relates to recordretention. The Company is required to retain records pertaining to its rawmaterials’ immediate previous sources (“one back”) as well as its finishedgoods’ subsequent recipients (“one up”) for twelve months. The Act waseffective January 1, 2005.

 

On July 11, 2003, the FDA published itsfinal rule on Trans Fat Labeling requiring that food labels declare transfats on or before January 1, 2006. This rule requires that trans fatbe declared on a separate line in the standard Nutrition Facts below total fatand saturated fat and be calculated to the nearest 0.5 grams, unless it is lessthan 0.5 grams in which case it may be expressed as 0 grams.

 

We cannot assure you that we will not facefines or penalties if our efforts to comply with these regulations aredetermined to be inadequate.

 

*Newlyadopted governmental regulations could increase our costs or liabilities orimpact the sale of our products.*

 

The food industry is highly regulated. Wecannot assure you that new laws or regulations will not be passed that couldrequire the Company to alter the taste or composition of its products or imposeother obligations on the Company. Such changes could affect sales of theCompany’s products and have a material adverse effect on the Company.

 

*Unavailabilityof our necessary supplies, at reasonable prices, could materially adverselyaffect our operations.*

 

The Company’s manufacturing costs are subjectto fluctuations in the prices of potatoes, potato flakes, wheat flour, corn andoil, as well as other ingredients of the Company’s products. Potatoes, potatoflakes, wheat flour and corn are widely available year-round, and the Companyuses a variety of oils in the production of its products. Nonetheless, theCompany is dependent on its suppliers to provide the Company with products andingredients in adequate supply and on a timely basis. The failure of certainsuppliers to meet the Company’s performance specifications, quality standardsor delivery schedules could have a material adverse effect on the Company’soperations. In particular, a sudden scarcity, a substantial price increase,

 

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or an unavailability of product ingredients could materially adverselyaffect the Company’s operations. There can be no assurance that alternativeingredients would be available when needed and on commercially attractiveterms, if at all.

 

*We do notown the patents for the technology we use to manufacture our T.G.I. Friday’s®and Tato Skins® brand products*.

 

The Company licenses patented technology froma third party in connection with the manufacture of its T.G.I. Friday’s® andTato Skins® brand products and has an exclusive right to use such technologywithin North America until the patents expire on December 26, 2006. Once thesepatents expire, we will no longer have exclusive rights to this technology and may faceadditional competition that could adversely affect our revenues. Moreover,competitors of the Company, certain of which may have significantlygreater resources than the Company, may utilize different technology inthe manufacture of products that are similar to those currently manufactured,or that may in the future be manufactured, by the Company. The entry ofany such products into the marketplace could have a material adverse effect onsales of T.G.I. Friday’s® and Tato Skins® brand products, as well as anysuch future products, by the Company.

 

The taste and quality of Poore Brothers®, Bob’sTexas Style® and Boulder Canyon Natural FoodsTMbrand potato chips is largely due to two elements of the Company’smanufacturing process: its use of batch-frying and its use of distinctiveseasonings to produce a variety of flavors. The Company does not have exclusiverights to the use of either element; consequently, competitors may incorporatesuch elements into their own processes.

 

*Themajority of revenues are derived from a limited number of snack food brands.*

 

The Companyderives a substantial portion of its revenue from a limited number of snackfood brands. For the year ended December 31, 2005, over 74% of the Company’snet revenues were attributable to the T.G.I. Friday’s® brandproducts and the Poore Brothers® brand products. A decrease in the popularityof a particular snack food brand during any year could have a material adverseeffect on the Company’s business, financial condition and results of operations.There can be no assurance that any of the Company’s snack food brands willretain their historical levels of popularity or increase in popularity. Anyimpact to a licensed brand’s reputation could also lead to an impact on theCompany’s other snack food products associated with that brand. Decreased salesfrom any one of our key snack food brands without a corresponding increase insales from other existing or newly introduced products would have a materialadverse effect on the Company’s financial condition and results of operations.

 

*We dependon a license agreement for the right to sell our T.G.I. Friday’s® brandproducts and other products, and we may rely on similar license agreementsin the future.*

 

The T.G.I. Friday’s® brand products aremanufactured and sold by the Company pursuant to a license agreement by andbetween the Company and TGI Friday’s Inc. which expires in 2014. Pursuant tothe license agreement, the Company is subject to various requirements andconditions (including, without limitation, minimum sales targets). The failure ofthe Company to comply with certain of such requirements and conditions couldresult in the early termination of the license agreement by TGI Friday’s Inc. Anytermination of the license agreement, whether at the expiration of its term orprior thereto, could have a material adverse effect on the Company’s financialcondition and results of operations.

 

The Company may introduce one or morenew product lines in the future that will be manufactured and sold pursuant toadditional license agreements by and between the Company and one or more thirdparties. Pursuant to any such license agreements, the Company will likely besubject to various requirements and conditions (including minimum sales targetsor royalty payments). The failure of the Company to comply with certain of suchrequirements and conditions could result in the early termination of suchadditional license agreements. Depending upon the success of any such newproduct lines, a termination of the applicable license agreements, whether atthe expiration of their respective terms or prior thereto, could have amaterial adverse effect on the Company’s financial condition and results ofoperations.

 

*The loss ofone of our major customers could have a material adverse effect on our business*.

 

Two customers of the Company, Wal*Mart(including its SAM’s Clubs), and Vistar, formerly Vending Services of America,a national vending distributor accounted for 19% and 11%, respectively, of theCompany’s 2005 net revenues, with the remainder of the Company’s net revenuesbeing derived from sales to a limited number of additional customers, eithergrocery chains or regional distributors, none of which individually accountedfor more than 10% of the Company’s revenues for 2005. A decision by any majorcustomer to cease or substantially reduce its purchases could have a materialadverse effect on the Company’s business.

 

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*The loss ofcertain key employees could adversely affect our business*.

 

The Company’s success is dependent in large part uponthe abilities of its executive officers, including Eric Kufel, President andChief Executive Officer, Steve Sklar, Senior Vice President of Marketing andThomas F. Tierney, Senior Vice President of Sales. The Company’s refocusedbusiness strategy will challenge its executive officers, and the inability ofsuch officers to perform their duties or the inability of the Company toattract and retain other highly qualified personnel could have a materialadverse effect upon the Company’s business and prospects.

 

**Risks Related to Our Industry**

 

*We may notbe able to compete successfully in our highly competitive industry.*

 

The market for snack foods, such as thosesold by the Company, including potato chips, cookies and meat snacks, is largeand intensely competitive. Competitive factors in the snack food industryinclude product quality and taste, brand awareness among consumers, access tosupermarket shelf space, price, advertising and promotion, variety of snacksoffered, nutritional content, product packaging and package design. The Companycompetes in that market principally on the basis of product taste and quality.

 

The snack food industry is dominated by largefood companies, including Frito-Lay, Inc., Nabisco and others which havesubstantially greater financial and other resources than the Company and sellsbrands that are more widely recognized than are the Company’s products.Numerous other companies that are actual or potential competitors of theCompany, many with greater financial and other resources (including moreemployees and more extensive facilities) than the Company, offer productssimilar to those of the Company. In addition, many of such competitors offer awider range of products than that offered by the Company. Local or regionalmarkets often have significant smaller competitors, many of whom offer productssimilar to those of the Company. With expansion of Company operations into newmarkets the Company has and will continue to encounter significant competition fromnational, regional and local competitors that may be greater than thatencountered by the Company in its existing markets. In addition, suchcompetitors may challenge the Company’s position in its existing markets.There can be no assurance of the Company’s ability to compete successfully.

 

*We may incursubstantial costs in order to market our products.*

 

Successful marketing of food productsgenerally depends upon obtaining adequate retail shelf space for productdisplay, particularly in supermarkets. Frequently, food manufacturers anddistributors, such as the Company, incur additional costs in order to obtainadditional shelf space. Whether or not the Company incurs such costs in aparticular market is dependent upon a number of factors, including demand forthe Company’s products, relative availability of shelf space and generalcompetitive conditions. The Company may incur significant shelf space orother promotional costs as a necessary condition of entering into competitionor maintaining market share in particular markets or stores. If incurred, suchcosts may materially affect the Company’s financial performance.

 

*Ourbusiness may be adversely affected by oversupply of food products at thewholesale and retail levels and seasonal fluctuations.*

 

Profitability in the food product industry issubject to oversupply of certain food products at the wholesale and retaillevels, which can result in our products going out of date before they are sold.The food products industry is also seasonal. Consumers tend to purchase ourproducts at higher levels during the major summer holidays and also at timessurrounding the major sporting events throughout the year.

 

*We may notbe able to respond successfully to shifting consumer tastes.*

 

Consumer preferences for snack foods arecontinually changing and are extremely difficult to predict. The ability of theCompany to generate revenues in new markets will depend upon customeracceptance of the Company’s products. The success of new products will be keyto the success of the Company’s business plan and there can be no assurancethat the Company will succeed in the development of any new products or thatany new products developed by the Company will achieve market acceptance orgenerate meaningful revenue for the Company.

 

*Diet trendsmay adversely affect our revenues.*

 

Increased consumer concerns about nutritionand healthy diets and the risk that sales of our food product may declinedue to perceived health concerns, changes in consumer tastes or other reasonsbeyond the control of the Company may adversely affect our revenues.

 

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**Risks Related to Our Securities**

 

*The marketprice of our Common Stock is volatile.*

 

The market price of the Common Stock hasexperienced a high level of volatility since the completion of the Company’sinitial public offering in December 1996. Commencing with an offeringprice of $3.50 per share in the initial public offering, the market price ofthe Common Stock experienced a substantial decline, reaching a low of $0.50 pershare (based on last reported sale price of the Common Stock on the NasdaqSmallCap Market) on December 22, 1998. During fiscal 2005, the marketprice of the Common Stock (based on last reported sale price of the Common Stockon the Nasdaq SmallCap Market) ranged from a high of $6.77 per share to a lowof $2.57 per share. The last reported sales price of the Common Stock on theNasdaq SmallCap Market on March 24, 2006 was $2.93 per share. There can beno assurance as to the future market price of the Common Stock. See *“Our Common Stock may not continue to trade at a market pricesufficient to prevent our de-listing from the NASDAQ SmallCap Market.”*

 

*Our CommonStock may not continue to trade at a market price sufficient to preventour de-listing from the NASDAQ SmallCap Market.*

 

In order for the Company’s Common Stock tocontinue to be listed on the Nasdaq SmallCap Market, the Company is required tobe in compliance with certain continued listing standards. One of such requirementsis that the bid price of listed securities be equal to or greater than $1.00. If,in the future, the Company’s Common Stock fails to be in compliance with theminimum closing bid price requirement for at least thirty consecutive tradingdays or the Company fails to be in compliance with any other Nasdaq continuedlisting requirements, then the Common Stock could be de-listed from the NasdaqSmallCap Market. Upon any such de-listing, trading, if any, in the Common Stockwould thereafter be conducted in the over-the-counter market on the so-called “pinksheets” or the “Electronic Bulletin Board” of the National Association ofSecurities Dealers, Inc. (“NASD”). As a consequence of any suchde-listing, an investor could find it more difficult to dispose of, or toobtain accurate quotations as to the price of, the Company’s Common Stock. See *“The market price of our Common Stock is volatile.”*

 

*Asignificant amount of our Common Stock is controlled by individuals, and theinterests of such individuals may conflict with those of othershareholders.*

 

As a result of the Wabash Foods acquisition,Capital Foods, LLC (“Capital Foods”) (an affiliate of the former owner ofWabash Foods) became the single largest shareholder of the Company, currentlyholding approximately 21% of the outstanding shares of Common Stock based onCapital Foods’ Schedule 13G filing. Accordingly, Capital Foods is in aposition to exercise substantial influence on the business and affairs of theCompany. In addition, Heartland Advisors, Inc. (“Heartland”), Eagle RockCapital Management, LLC (“Eagle Rock”) and Gruber and McBaine CapitalManagement, LLC (“Gruber”), which, based on their Schedule 13G filings,are currently the beneficial owners of approximately 10%, 9% and 7%,respectively, of the outstanding shares of Common Stock. Capital Foods,Heartland, Eagle Rock and Gruber are hereinafter referred to collectively asthe “Significant Shareholders.”  Therecan be no assurance that one or more of those Significant Shareholder will notadopt or support a plan to undertake a material change in the management orbusiness of the Company.

 

Apart fromtransfer restrictions arising under applicable provisions of the securitieslaws, there are no restrictions on the ability of the Significant Shareholdersto transfer any or all of their respective shares of Common Stock at any time. Oneor more of such transfers could have the effect of transferring effectivecontrol of the Company, including to one or more parties not currently known tothe Company.

 

*A significantamount of our Common Stock is subject to registration rights, and theregistration and sale of such shares could negatively affect the market priceof our Common Stock and impair our ability to obtain financing.*

 

Approximately 4.3 million shares ofoutstanding Common Stock issued by the Company are subject to “piggyback”registration rights granted by the Company, pursuant to which such shares ofCommon Stock may be registered under the Securities Act and, as a result,become freely tradable in the future. The Company will be required to pay allexpenses relating to any such registration, other than underwriting discounts,selling commissions and stock transfer taxes applicable to the shares, and anyother fees and expenses incurred by the holder(s) of the shares (including,without limitation, legal fees and expenses) in connection with theregistration. All or a portion of such shares may, at the election of theholders thereof, be included in a future registration statement of the Companyand, upon the effectiveness thereof, may be sold in the public markets.

 

Noprediction can be made as to the effect, if any, that future sales of shares ofCommon Stock will have on the market price of the Common Stock prevailing fromtime to time. Sales of substantial amounts of Common Stock, or the

 

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perception that these sales couldoccur, could adversely affect prevailing market prices for the Common Stock andcould impair the ability of the Company to raise additional capital through thesale of its equity securities or through debt financing.

 

*OurCertificate of Incorporation authorizes us to issue preferred stock, and therights of holders of Common Stock may be adversely affected by the rightsof holders of any such preferred stock*.

 

The Company’s Certificate of Incorporationauthorizes the issuance of up to 50,000 shares of “blank check” preferred stockwith such designations, rights and preferences as may be determined fromtime to time by the Board of Directors of the Company. The Company may issuesuch shares of preferred stock in the future without shareholder approval. Therights of the holders of Common Stock will be subject to, and may beadversely affected by, the rights of the holders of any preferred stock that may beissued in the future. The issuance of preferred stock, while providingdesirable flexibility in connection with possible acquisitions and othercorporate purposes, could have the effect of discouraging, delaying orpreventing a change of control of the Company, and preventing holders of CommonStock from realizing a premium on their shares. In addition, under Section 203of the Delaware General Corporation Law (the “DGCL”), the Company is prohibitedfrom engaging in any business combination (as defined in the DGCL) with anyinterested shareholder (as defined in the DGCL) unless certain conditions aremet. This statutory provision could also have an anti-takeover effect.

 

### **Item 2.**           Properties

### ** **

The Company leases a 140,000 square foot facilitylocated on 15 acres of land in Bluffton, Indiana, approximately 20 miles southof Ft. Wayne, Indiana. The Company has entered into a lease expiring in April 2018with respect to the facility and the lease has two five-year renewal options. The land andbuilding are leased from American Pacific Financial Corporation, an affiliateof Capital Foods LLC, a shareholder of the Company. See “Securities Ownershipof Certain Beneficial Owners and Management.” Current lease payments are approximately $23,000 permonth. The lease payments are subject to an annual CPI-based increase. TheCompany produces its T.G.I. Friday’s® brand snacks and Tato Skins® brand potatosnacks at the Bluffton, Indiana facility.

 

The Company also leases one-half of a 200,000square foot facility in Bluffton, Indiana which is used as a distributioncenter. The Company has entered into a lease expiring in November 2006with respect to the facility and the lease has two three-year renewal options. Currentlease payments are approximately $31,500 per month.

 

The Company owns a 60,000 square footfacility located on 7.7 acres of land in Goodyear, Arizona, approximately 15miles west of Phoenix, Arizona. The facility is financed by a mortgage withMorgan Guaranty Trust Company of New York that matures in June 2012. TheCompany produces its Poore Brothers®, Bob’s Texas Style® and Boulder CanyonNatural FoodsTM brand potato chips,as well as its private label potato chips, at the Goodyear, Arizona facility.

 

The Company is responsible for all insurancecosts, utilities and real estate taxes in connection with its facilities. TheCompany believes that its facilities are adequately covered by insurance.

 

### **Item 3.**           Legal Proceedings

### ** **

The Company is periodically a party tovarious lawsuits arising in the ordinary course of business. Managementbelieves, based on discussions with legal counsel, that the resolution of suchlawsuits, individually and in the aggregate, will not have a material adverseeffect on the Company’s financial position or results of operations.

 

### **Item 4.**           Submission of Matters to a Vote ofSecurity Holders

### ** **

None.

 

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#### **PART II**

#### ** **

#### **Item 5.**           Market for Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities

#### ** **

The Company’s Common Stock is traded on theNasdaq SmallCap Market tier of the Nasdaq Stock Market under the symbol “SNAK”.There were approximately 264 shareholders of record on March 24, 2006. TheCompany believes the number of beneficial owners is substantially greater thanthe number of record holders because a large portion of the Common Stock isheld of record in broker “street names.”

 

The Company has never declared or paid anydividends on the shares of Common Stock. Management intends to retain anyfuture earnings for the operation and expansion of the Company’s business anddoes not anticipate paying any dividends at any time in the foreseeable future.Additionally, certain debt agreements of the Company limit the Company’sability to declare and pay dividends.

 

The following table sets forth the range ofhigh and low sale prices of the Company’s Common Stock as reported on theNasdaq SmallCap Market for each quarter of the fiscal years ended December 31,2005 and December 25, 2004.

 
| ** **                        | ** ** | **Sales Prices** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| **Period of Quotation** | ** ** | **High**              | ** ** | **Low** | ** ** |
| Fiscal 2004:                      |       |                  |       |   |   |
| First  Quarter                    |       | $                     | 4.05       |   | $ | 2.83 |   |
| Second Quarter                    |       | $                     | 3.45       |   | $ | 2.38 |   |
| Third Quarter                     |       | $                     | 2.89       |   | $ | 2.07 |   |
| Fourth Quarter                    |       | $                     | 3.34       |   | $ | 2.53 |   |
|                              |       |                  |       |   |   |
| Fiscal 2005:                      |       |                  |       |   |   |
| First  Quarter                    |       | $                     | 3.49       |   | $ | 2.81 |   |
| Second  Quarter                   |       | $                     | 4.08       |   | $ | 2.91 |   |
| Third  Quarter                    |       | $                     | 6.77       |   | $ | 4.25 |   |
| Fourth  Quarter                   |       | $                     | 5.17       |   | $ | 2.57 |   |

 

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**Item 6. Selected Financial Data**

 

**FIVE YEARFINANCIAL SUMMARY**

**(Inmillions except share and per share data)**

 
| ** **                           | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **Statements  of Earnings Data**     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                         |       | $          | 75.3       |       | $          | 68.7       |       | $          | 66.4       |       | $          | 59.3 |   | $ | 53.9 |   |
| Gross profit                         |       | 14.1       |       | 14.3       |       | 13.3       |       | 11.3       |       | 10.9       |       |
| Operating  income                    |       | 0.5        |       | 3.7        |       | 0.0        |       | 2.7        |       | 2.1        |       |
| Net income                           |       | 0.3        |       | 2.1        |       | 1.1        |       | 2.6        |       | 1.0        |       |
|                                 |       |       |       |       |       |       |       |       |       |       |       |
| Net income  per share – diluted |       | $          | 0.01       |       | $          | 0.11       |       | $          | 0.06       |       | $          | 0.15 |   | $ | 0.06 |   |
| Weighted  average common shares      |       | 19,946,941 |       | 18,947,533 |       | 18,476,486 |       | 17,826,953 |       | 17,198,648 |       |
|                                 |       |       |       |       |       |       |       |       |       |       |       |
| **Balance  Sheet Data**              |       |       |       |       |       |       |       |       |       |       |       |
| Net working  capital                 |       | $          | 13.9       |       | $          | 11.7       |       | $          | 7.9        |       | $          | 2.0 |   | $ | 2.0 |   |
| Total assets                         |       | 41.8       |       | 40.1       |       | 36.6       |       | 31.8       |       | 31.7       |       |
| Long-term  debt                      |       | 1.7        |       | 1.7        |       | 3.1        |       | 4.1        |       | 8.7        |       |
| Shareholders’  equity           |       | 30.2       |       | 28.8       |       | 25.1       |       | 20.7       |       | 16.8       |       |

 

**Item 7.****           Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

Management’s Discussion and Analysis ofFinancial Condition and Results of Operations (“MD&A”) should be read inconjunction with the other sections of this Annual Report on Form 10-K,including “Item 1:  Business;” “Item6:  Selected Financial Data;” and “Item8:  Financial Statements andSupplementary Data.”  The varioussections of this MD&A contain a number of forward-looking statements, allof which are based on our current expectations and could be affected by theuncertainties and risk factors described throughout this filing andparticularly in “Item 1A. Risk Factors.” Accordingly, the Company’s actual future results may differmaterially from historical results or those currently anticipated.

 

**Overview**

 

Poore Brothers, Inc. (the “Company”) isengaged in the development, production, marketing and distribution ofinnovative snack food products that are sold primarily through groceryretailers, mass merchandisers, club stores, convenience stores and venddistributors across the United States. The Company currently manufactures andsells nationally T.G.I. Friday’s® brand salted snacks under license from TGIFriday’s Inc. The Company also currently (i) manufactures and sellsregionally its own brands of salted snack food products, including PooreBrothers®, Bob’s Texas Style®, and Boulder Canyon Natural FoodsTMbrand batch-fried potato chips and Tato Skins® brand potato snacks, (ii) manufacturesprivate label potato chips for grocery retail chains in the southwest, and (iii) distributesin Arizona snack food products that are manufactured by others. The licensedCinnabon® brand packaged cookies are produced by contract manufacturers andsold under the Cinnabon® name.

 

18

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The Company’s net revenue grew 10% in fiscal2005. T.G.I. Friday’s®, which comprised 65% of total net revenues, wasrelatively flat. Our batch-fried chips performed well in the year, up 13% as anaggregate, especially the *Boulder Canyon*TMbrand which grew 45% in net revenues in 2005. Tato Skins® brand declinedslightly, mostly because of the cannibalization by the T.G.I. Friday’s® brand. Ouroverall growth rate was 10%. The table below highlights the changes betweenyears:

 

**NetRevenues Comparison**

**($ inmillions)**

 
| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** | **% Change** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| T.G.I.  Friday’s® |       | $        | 49.1       |     | $          | 49.1              |       | (<1 | )% |
| Potato Chips  and Other     |       | 26.2     |       | 19.3     |       | 36                | %          |
| Subtotal                    |       | 75.3     |       | 68.4     |       | 10                | %          |
| Discontinued  Products      |       | —   |       | 0.3      |       | (100              | )%         |
| Total                       |       | $        | 75.3       |     | $          | 68.7              |       | 10 | % |

 

The market forsnack foods, such as potato chips, tortilla chips, meat snacks and cookies, islarge and intensely competitive. The industry is dominated by severalsignificant competitors and includes many other competitors with greaterfinancial and other resources than the Company. However, the Company’s growthhas exceeded the industry average over the last few years primarily due to itsgrowth from T.G.I. Friday’s® branded products. This growth has been due topenetration into new and existing accounts, primarily in vend, mass, groceryand convenience stores.

 

The Company has been profitable for sevenstraight years. This has been accomplished through sales growth, operatingefficiency gains and tight controls over spending. The Company generally haskept spending in line with revenue growth, except with respect to our nationaladvertising for Crunch Toons® in 2003 and the Cinnabon® brand launch in 2005,excess product write-off in 2004 and 2005, significant management severance costsin 2005, and professional fees associated with a financial restatement of the2005 second quarter results.

 

In late 2004 the Company developed a moreaggressive strategic plan to achieve a new vision of being a significantmarketer of *Intensely Different*TM (our trademark)food brands. Our plans include continuing to identify new licensingopportunities, such as Cinnabon®, to broaden our product offering and tocomplement the growth of our existing T.G.I. Friday’s® products through theintroduction of new products in snacks as well as other food categories. TheCompany commenced selling internationally to Canadian customers during thefourth quarter of fiscal 2004 and it will continue to seek opportunities toselectively expand its growth in other countries. In addition, we haveactivated an acquisition strategy to help us accelerate our growth in order toleverage our existing competencies or gain new ones.

 

In connection with the implementation of theCompany’s business strategy, the Company is likely to require future debt orequity financings (particularly in connection with future strategicacquisitions). Expenditures stemming from acquisition-related integrationcosts, trade and consumer marketing programs and new product development may adverselyaffect operating expenses and consequently may adversely affect operatingand net income.

 

**Key Trends**

 

*RetailerConsolidation*

 

The retail food environment continues to beinfluenced by consolidation as fewer large retailers, including Kroger, Safewayand Wal*Mart, are gaining a larger share of the grocery retail environment. Theseretailers are also consolidating their regional buying operations into singularnational operations to improve efficiency. This action creates opportunitiesfor the Company because brands like T.G.I. Friday’s® salted snacks are nichebrands that can be sold effectively on a national basis.

 

*ConsumerTrends*

 

The snack industry has been heavilyinfluenced in the past five years by a proliferation of new flavors and healthfocused snacks, with a rapid increase in the number of low-fat, low-carb andall-natural and organic products. Mainstream

 

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retailers such as Safeway have now created standalone natural andorganic sections in their stores. The Company believes this trend for healthiersnacks will continue.

 

*RawMaterial and Freight Price Increases and Subsequent Retail Price Increases*

 

The industry has experienced higher costs asa result of the increase in the price of oil. Both inbound transportation ofraw materials and outbound transportation of finished goods have experiencedhigher costs as a result of freight surcharges. Nearly all raw materials haveexperienced higher pricing both as a result of higher freight costs and certainproducts have oil based raw materials. As a result of these raw material priceincreases, many companies, including us, are contemplating price increasesduring 2006.

 

**Results of Operations**

 

The following discussion summarizes thesignificant factors affecting the consolidated operating results, financialcondition, liquidity and capital resources of the Company. This discussionshould be read in conjunction with Item 8: “Financial Statements andSupplementary Data” and the “Cautionary Statement on Forward-Looking Statements”on page 4.

 

*Year ended December 31,2005 compared to the year ended December 25, 2004*

 
| ** **                                                       | ** ** | **2005** | ** ** | **2004**               | ** ** | **Difference** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|------------------------|------------|----------------|------------|
| **(dollars in millions)**                              | ** ** | **$**    | ** ** | **% of Rev** | ** ** | **$**          | ** ** | **% of Rev** | ** ** | **$** | ** ** | **%** | ** ** |
| Net revenues                                                     |       | $        | 75.3       |                   | 100.0      | %              | $          | 68.7 |   | 100.0 | % | $ | 6.6 |   | 9.6 | % |
| Cost of revenues                                                 |       | 61.4     |       | 81.6                   |       | 52.7           |       | 76.7 |   | 8.7 |   | 16.5 |   |
| (Gain on  sale)/write-down of equipment and brand discontinuance |       | (0.2     | )          | (0.3                   | )          | 1.7            |       | 2.5 |   | (1.9 | ) | 111.3 |   |
| Gross profit                                                     |       | 14.1     |       | 18.7                   |       | 14.3           |       | 20.8 |   | (0.2 | ) | (1.2 | ) |
| Selling,  general and administrative expenses                    |       | 13.6     |       | 18.1                   |       | 10.6           |       | 15.4 |   | 3.1 |   | 29.2 |   |
| Operating  income                                                |       | 0.5      |       | 0.7                    |       | 3.7            |       | 5.4 |   | (3.3 | ) | (87.8 | ) |
| Interest  income (expense), net                                  |       | —   |       | 0.1                    |       | (0.2           | )          | (0.3 | ) | 0.2 |   | 129.9 |   |
| Income  before income taxes                                      |       | 0.5      |       | 0.7                    |       | 3.5            |       | 5.1 |   | (3.0 | ) | (85.8 | ) |
| Income tax benefit  (provision)                                  |       | (0.2     | )          | (0.3                   | )          | (1.4           | )          | (2.0 | ) | 1.2 |   | 84.3 |   |
| Net income                                                       |       | $        | 0.3        |                   | 0.4        | %              | $          | 2.1 |   | 3.1 | % | $ | (1.9 | ) | (86.9 | )% |

 

For the fiscal year ended December 31,2005, net revenues increased 9.6% to $75.3 million, compared with net revenuesof $68.7 million for the previous fiscal year. T.G.I. Friday’s® brand snacksnet revenues remained relatively flat as compared to fiscal 2004, accountingfor 65% of the Company’s total net revenues for fiscal 2005. The Company’sbatch-fried chips performed well in the year, up 13% as an aggregate,especially the Boulder Canyon Natural FoodsTM brand which grew 45%in net revenues in 2005 and the Tato Skin® brand declined slightly in fiscal2005. The Company’s distributed products segment revenues increased $1.2million compared to fiscal 2004.

 

Gross profit for 2005 was relatively flat at$14.1 million (or 18.7% of net revenues) compared with gross profit of $14.3million (or 20.8% of net revenues) in 2004. Cost of revenues increased from76.7% of net revenues last year to 81.6% this year. This increase was dueprimarily to greater than expected trade and promotional allowances, which arededucted from gross revenue, and increased freight expense due to higher fuelcosts. Included in cost of revenues were charges associated with slow-movingnew product, mainly attributable to the Cinnabon® branded product, in the thirdand fourth quarters, amounting to $1.2 million for 2005.

 

Selling, general and administrative expensesincreased to $13.6 million in fiscal 2005, up from $10.6 million in 2004, or18.1% versus 15.4% of net revenues. The increase was primarily due to severancefees, professional service fees and costs incurred to investigate anacquisition opportunity that did not materialize.

 

The Company’s effective income tax rate was44.1% in 2005 and 39.7% in 2004. This increase was the result of the impact ofpermanent differences between financial reporting and taxable income, primarilynon-deductible travel and meals expenses related to the above mentionedacquisition activity.

 

20

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Net income for 2005 decreased 86.9% to $0.3million, or $0.01 per basic and diluted share, compared with net income of $2.1million, or $0.11 per basic and diluted share, in 2004.

 

*Year ended December 25,2004 compared to the year ended December 27, 2003*

 
| ** **                                        | ** ** | **2004** | ** ** | **2003**               | ** ** | **Difference** | ** ** |
|---------------------------------------------------|------------|----------|------------|------------------------|------------|----------------|------------|
| ** **                                        | ** ** | **$**    | ** ** | **% of Rev** | ** ** | **$**          | ** ** | **% of Rev** | ** ** | **$** | ** ** | **%** | ** ** |
| Net revenues                                      |       | $        | 68.7       |                   | 100.0      | %              | $          | 66.4 |   | 100.0 | % | $ | 2.3 |   | 3.5 | % |
| Cost of  revenues                                 |       | 52.7     |       | 76.7                   |       | 52.1           |       | 78.4 |   | 0.6 |   | 1.3 |   |
| Write-down  of equipment and brand discontinuance |       | 1.7      |       | 2.5                    |       | 1.0            |       | 1.5 |   | 0.7 |   | 67.3 |   |
| Gross profit                                      |       | 14.3     |       | 20.8                   |       | 13.3           |       | 20.1 |   | 1.0 |   | 7.1 |   |
| Selling,  general and administrative expenses     |       | 10.6     |       | 15.4                   |       | 13.3           |       | 20.0 |   | (2.8 | ) | (20.6 | ) |
| Operating  income                                 |       | 3.7      |       | 5.4                    |       | —         |       | 0.0 |   | 3.7 |   | 3,700.0 |   |
| Insurance  claim settlement income, net           |       | —   |       | 0.0                    |       | 1.9            |       | 2.9 |   | (1.9 | ) | (100.0 | ) |
| Interest  income (expense), net                   |       | (0.2     | )          | (0.3                   | )          | (0.2           | )          | (0.4 | ) | — |   | 0.0 |   |
| Income  before income taxes                       |       | 3.5      |       | 5.1                    |       | 1.7            |       | 2.6 |   | 1.8 |   | 109.1 |   |
| Income tax  benefit (provision)                   |       | (1.4     | )          | (2.0                   | )          | (0.6           | )          | (1.0 | ) | 0.8 |   | 119.2 |   |
| Net income                                        |       | $        | 2.1        |                   | 3.1        | %              | $          | 1.1 |   | 1.6 | % | $ | 1.0 |   | 102.9 | % |

 

For the fiscal year ended December 25,2004, net revenues increased 3% to $68.7 million, compared with net revenues of$66.4 million for the previous fiscal year. T.G.I. Friday’s® brand snacks netrevenues increased 21% over fiscal 2003, accounting for 72% of the Company’stotal net revenues for fiscal 2004. The Company’s batch-fried kettle chipbrands were flat in comparison to fiscal 2003 and the Tato Skin® brand declinedin fiscal 2004. The Company’s discontinued Crunch Toons® brand snacks declined$3.1 million in net revenues versus last year and distributed products segmentrevenues declined $2.0 million due to the discontinuance of a product line.

 

Gross profit for 2004 increased to $14.3million, or 21% of net revenues, compared to $13.3 million, or 20% of netrevenues, in 2003. Cost of revenues decreased from 78.4% of net revenues lastyear to 76.7% this year. The improvement was due to efficiency gains inmanufacturing and supply chain partially offset by an increase in freight costs.Due to some idled packaging equipment, there were $0.3 million and $1.0 millionof equipment write-downs in 2004 and 2003, respectively. Also included in 2004cost of revenues was $1.4 million of Crunch Toons® brand discontinuance costs.

 

Selling, general and administrative expensesdecreased to $10.6 million in fiscal 2004, down from $13.3 million in 2003, or15% versus 20% of net revenues. The decrease was primarily due to $3.5 millionof consumer marketing costs associated with the Crunch Toons® brand launch in2003.

 

In fiscal 2003, other income and expenseincluded $1.9 million of pre-tax income from an insurance claim settlement.

 

The provision for income taxes increased to39.7% of income before income taxes in fiscal 2004 from 37.9% in fiscal 2003primarily due to an increase in state taxes.

 

Net income for 2004 increased 103% to $2.1million, or $0.11 per basic and diluted share, compared with net income of $1.1million, or $0.06 per basic and diluted share, in the prior year period.

 

**Liquidity and Capital Resources**

 

Net working capital was $13.9 million (acurrent ratio of 2.8:1) and $11.7 million (a current ratio of 2.6:1) at December 31,2005 and December 25, 2004, respectively. For the fiscal year ended December 31,2005, the Company generated cash flow of $0.5 million from operatingactivities, invested $0.6 million in new equipment, made $1.0 million inpayments on long-term debt and received $0.8 million in proceeds from theissuance of Common Stock pursuant to the exercise of stock options. For thefiscal year ended December 25, 2004, the Company generated cash flow of$6.5 million from operating activities, invested $0.5 million in new equipment,made $1.0 million in payments on long-term debt and received $1.3 million inproceeds from issuance of Common Stock primarily pursuant to the exercise ofstock options. For the fiscal year ended December 27, 2003, the Companygenerated cash flow of $2.0 million from operating activities, invested

 

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$1.1 million in new equipment, made $1.1 million in payments onlong-term debt and received $2.0 million in proceeds from issuance of CommonStock primarily pursuant to the exercise of stock options.

 

On August 19, 2005, the Companyrefinanced its U.S. Bancorp Credit Agreement into a new $5.0 million Line ofCredit and a $756,603 Term Loan (collectively, the “New Credit Agreement”) withthe same bank. The original credit facility consisted of: (i) a $5.0million line of credit with a borrowing limit calculated based on specifiedpercentages of eligible receivables and inventories; (ii) a $0.5 millioncapital expenditures line of credit; and (iii) a $5.8 million term loanwith a remaining balance of $756,603 at the time of the refinancing.

 

The Line of Credit bears interest at theprime rate less 0.5% (6.75% at December 31, 2005) and matures on June 30,2007. Interest is due monthly, with the outstanding principal balance due infull at the maturity date. The Term Loan bears interest at the prime rate(7.25% at December 31, 2005) and matures on July 1, 2006. Monthlyprincipal payments of $68,782 plus interest are due under the Term Loan. At December 31,2005, there was no outstanding balance on the Line of Credit and $0.5 millionoutstanding on the Term Loan.

 

The New Credit Agreement is secured bysubstantially all assets of the Company. The Company’s obligations under theNew Credit Agreement are guaranteed by each of its subsidiaries. The agreementrequires the Company to maintain compliance with certain financial covenants,including a minimum tangible net worth, a minimum fixed charge coverage ratioand a minimum current ratio. At December 31, 2005, the Company was incompliance with all covenants of the New Credit Agreement. Management believesthat the fulfillment of the Company’s plans and objectives will enable theCompany to attain a sufficient level of profitability to remain in compliancewith these financial covenants. There can be no assurance, however, that theCompany will attain any such profitability and remain in compliance.

 

The Company’s Goodyear, Arizonamanufacturing, distribution and headquarters facility is subject to a $1.7million mortgage loan from Morgan Guaranty Trust Company of New York, bearsinterest at 9.03% per annum and is secured by the building and the land onwhich it is located. The loan matures on July 1, 2012; however monthlyprincipal and interest installments of $16,825 are determined based on atwenty-year amortization period.

 

During 2005, 2004 and 2003, the Companyreceived $0.8 million, $1.3 million and $2.0 million of proceeds from theissuance of Common Stock. These proceeds were primarily due to the exercise ofstock options.

 

At December 31, 2005, the Company had anet operating loss carryforward available for federal income taxes ofapproximately $2.4 million. The Company’s accumulated net operating losscarryforward will begin to expire in varying amounts between 2010 and 2018.

 

**Off-Balance Sheet Arrangements**

 

Under SEC regulations, in certaincircumstances, the Company is required to make certain disclosures regardingthe following off-balance sheet arrangements, if material:

 

•                  Anyobligation under certain guarantee contracts;

•                  Anyretained or contingent interest in assets transferred to an unconsolidatedentity or similar arrangement that serves as credit, liquidity or market risksupport to that entity for such assets;

•                  Anyobligation under certain derivative instruments; and

•                  Anyobligation arising out of a material variable interest held by us in anunconsolidated entity that provides financing, liquidity, market risk or creditrisk support to us, or engages in leasing, hedging or research and developmentservices with us.

 

The Company does not have any off-balancesheet arrangements that are required to be disclosed pursuant to theseregulations, other than those described in the Notes to Consolidated FinancialStatements. The Company does not have, nor does it engage in, transactions withany special purpose entities. The Company is not engaged in hedging activitiesand had no forward exchange contracts or other derivatives outstanding at December 31,2005. In the ordinary course of business, the Company enters into operatinglease commitments, purchase commitments and other contractual obligations. Thesetransactions are recognized in our financial statements in accordance withgenerally accepted accounting principles in the United States, and are morefully discussed below.

 

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**Contractual Obligations**

 

The following table outlines the Company’sfuture contractual financial obligations as of December 31, 2005, due byperiod:

 
| ** **                                       | ** ** | **Total** | ** ** | **Less than 1  Year** | ** ** | **1 – 3 Years** | ** ** | **3 – 5 Years** | ** ** | **More than 5  Years** | ** ** |
|--------------------------------------------------|------------|-----------|------------|---------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|
| Long-term  debt (including interest)             |       | $         | 3,828,000  |                            | $          | 696,000                             |       | $                                   | 404,000    |                             | $          | 404,000 |   | $ | 2,324,000 |   |
| Operating  leases                                |       | 8,182,000 |       | 1,469,000                       |       | 2,397,000                           |       | 1,492,000                           |       | 2,824,000                        |       |
| Outside  Warehouse Minimum Monthly Usage Charges |       | 3,564,000 |       | 1,188,000                       |       | 2,376,000                           |       | —                              |       | —                           |       |
| Royalty  payments (i)                            |       | 375,000   |       | 178,000                         |       | 197,000                             |       | —                              |       | —                           |       |
| Severance  Charges to Executives                 |       | 491,000   |       | 491,000                         |       | —                              |       | —                              |       | —                           |       |
| Total  contractual cash obligations              |       | $         | 16,440,000 |                            | $          | 4,022,000                           |       | $                                   | 5,374,000  |                             | $          | 1,896,000 |   | $ | 5,148,000 |   |

 

For information regarding the Company’slong-term debt, please read “Liquidity and Capital Resources” above and Note 6inItem 8.

 

The Company has entered into a variety ofoperating leases for equipment and facilities. For information regarding theCompany’s facility leases, please read “Item 2: Properties” and Note 8 in Item 8.

 

(i) Remaining minimum royalty paymentsdue licensors pursuant to brand licensing agreements discussed in “Item 1:Business” under the “Patents, Trademarks and Licenses” section.

 

The Company currently has no materialmarketing or capital expenditure commitments.

 

**Management’s Plans**

 

In connection with the implementation of theCompany’s business strategy, the Company may incur operating losses in thefuture and may require future debt or equity financings (particularly inconnection with future strategic acquisitions, new brand introductions orcapital expenditures). Expenditures relating to acquisition-related integrationcosts, market and territory expansion and new product development andintroduction may adversely affect promotional and operating expenses andconsequently may adversely affect operating and net income. These types ofexpenditures are expensed for accounting purposes as incurred, while revenuegenerated from the result of such expansion or new products may benefitfuture periods. Management believes that the Company will generate positivecash flow from operations during the next twelve months, which, along with itsexisting working capital and borrowing facilities, will enable the Company tomeet its operating cash requirements for the next twelve months. The belief isbased on current operating plans and certain assumptions, including thoserelating to the Company’s future revenue levels and expenditures, industry andgeneral economic conditions and other conditions. If any of these factorschange, the Company may require future debt or equity financings to meetits business requirements. There can be no assurance that any required financingswill be available or, if available, will be on terms attractive to the Company.

 

On February 14, 2006, the Companyterminated its previously announced non-binding letter of intent to acquirecertain assets and liabilities of Shadewell Grove Foods, Inc., andShadewell Grove IP, LLC, including licenses to produce and sell Mrs. Field’s®brand products.

 

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**Inflation and Seasonality**

 

While inflation has not had a significanteffect on operations in the last year, management recognizes that inflationarypressures may have an adverse effect on the Company as a result of higherasset replacement costs and related depreciation and higher material and fuelcosts. Additionally, the Company may be subject to seasonal priceincreases for raw materials. The Company attempts to minimize the fluctuationin seasonal costs by entering into purchase commitments in advance, which havethe effect of smoothing out price volatility. The Company will attempt tominimize overall price inflation, if any, through increased sales prices andproductivity improvements.

 

**Critical Accounting Policies and Estimates**

 

In December 2001, the Securities andExchange Commission issued an advisory requesting that all registrants describetheir three to five most “critical accounting policies”. The Securities andExchange Commission indicated that a “critical accounting policy” is one whichis both important to the portrayal of the Company’s financial condition andresults and requires management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effect ofmatters that are inherently uncertain. The Company believes that the followingaccounting policies fit this definition:

 

*Allowance for Doubtful Accounts.*TheCompany maintains an allowance for doubtful accounts for estimated lossesresulting from the inability of its customers to make required payments. If thefinancial condition of the Company’s customers were to deteriorate, resulting inan impairment of their ability to make payments, additional allowances may berequired. The allowance for doubtful accounts was $187,000 and $89,000 at December 31,2005 and December 25, 2004, respectively.

 

*Inventories.*TheCompany’s inventories are stated at the lower of cost (first-in, first-out) ormarket. The Company identifies slow moving or obsolete inventories andestimates appropriate loss provisions related thereto. If actual marketconditions are less favorable than those projected by management, additionalinventory write-downs may be required.

 

*Goodwill and Trademarks.*Goodwilland trademarks are reviewed for impairment annually, or more frequently ifimpairment indicators arise. Goodwill is required to be tested for impairmentbetween the annual tests if an event occurs or circumstances change thatmore-likely-than-not reduce the fair value of a reporting unit below itscarrying value. Intangible assets with indefinite lives are required to betested for impairment between the annual tests if an event occurs orcircumstances change indicating that the asset might be impaired. The Companybelieves at this time that the carrying values continue to be appropriate.

 

*Advertising, Promotional Expenses and TradeSpending.*The Company expenses production costs ofadvertising the first time the advertising takes place, except for cooperativeadvertising costs which are expensed when the related sales are recognized. Costsassociated with obtaining shelf space (i.e. “slotting fees”) are expensed inthe period in which such costs are incurred by the Company. Anytime the Companyoffers consideration (cash or credit) as a trade advertising or promotionallowance to a purchaser of products at any point along the distribution chain,the amount is accrued and recorded as a reduction in revenue. Any marketingprograms that deal directly with the consumer are recorded in selling, generaland administrative expenses.

 

*Income Taxes.*TheCompany has been profitable since 1999; however, it experienced significant netlosses in prior fiscal years resulting in a net operating loss (“NOL”)carryforward for federal income tax purposes of approximately $2.4 million at December 31,2005. Generally accepted accounting principles require that the Company recorda valuation allowance against the deferred tax asset associated with this NOLif it is “more likely than not” that the Company will not be able to utilize itto offset future taxes.

 

The above listing is not intended to be acomprehensive list of all of the Company’s accounting policies. In many casesthe accounting treatment of a particular transaction is specifically dictatedby generally accepted accounting principles, with no need for management’sjudgment in their application. See the Company’s audited financial statementsand notes thereto included in this Annual Report on Form 10-K whichcontain accounting policies and other disclosures required by accountingprinciples generally accepted in the United States.

 

24

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**New Accounting Pronouncements**

 

On December 16, 2004, the FASB issuedSFAS No. 123R, “Share-Based Payment,” requiring all share-basedpayments to employees, including grants of employee stock options, to berecognized as compensation expense in the consolidated financial statementsbased on their fair values. Pro forma disclosure is no longer an alternative. Thisstandard is effective for periods beginning after December 15, 2005 andincludes two transition methods, the modified prospective and the modifiedretrospective transition method. Under the modified prospective method, awardsthat are granted, modified or settled after the date of adoption should bemeasured and accounted for in accordance with SFAS 123R. Unvestedequity-classified awards that were granted prior to the effective date shouldcontinue to be accounted for in accordance with SFAS 123 except thatamounts must be recognized in the income statement. Under the modifiedretrospective approach, the previously-reported amounts are restated (either tothe beginning of the year of adoption or for all periods presented) to reflectthe SFAS 123 amounts in the income statement. The Company will use themodified prospective method upon adoption of SFAS 123R effective January 1,2006. As permitted by SFAS 123R, we currently account for share-based paymentsto employees using APB Opinion 25’s intrinsic value method and, as such,generally recognize no compensation cost for employee stock options. As aresult of the adoption of SFAS 123R, the compensation expense that we wouldhave recognized in 2005 relating to employee stock options would haveapproximated the pro forma compensation expense described in Note 1 of theconsolidated financial statements appearing elsewhere in this Form 10-K.As of December 31, 2005, the amount of unrecognized compensation expenseto be recognized in future periods, in accordance with SFAS 123R, isapproximately $0.3 million. This expected compensation expense does not reflectany new awards, or modifications to existing awards, that could occur in thefuture.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs.”  This statementclarifies the accounting for abnormal amounts of idle facilities expense,freight, handling costs and wasted material. This statement requires that thoseitems be recognized as current-period expense. In addition, the statementrequires that allocation of fixed overhead to the cost of conversion be basedon the normal capacity of the production facilities. This statement iseffective for inventory costs incurred after December 31, 2005. TheCompany is currently evaluating the impact that SFAS No. 151 will have onits financial position and results of operations.

 

In March 2005, the FASB issuedInterpretation No. 47 “Accounting for Conditional Asset RetirementObligations” to clarify that the term “conditional asset retirement obligation”as used in SFAS No. 143 is a legal obligation to perform an assetretirement activity in which the timing and (or) method of settlement areconditional on a future event that the enterprise may or may not havecontrol over. This Interpretation requires recognition of a liability for thefair value of a conditional asset retirement obligation when incurred if theliability’s fair value can be reasonably determined. This Interpretation iseffective no later than fiscal years ending after December 15, 2005 (December 31,2005 for calendar year end enterprises). The implementation of thisInterpretation did not have a material impact on the Company’s consolidated financialstatements.

 

**Item 7A.****              Quantitative andQualitative Disclosures about Market Risk**

 

The principal market risks to which theCompany is exposed that may adversely impact the Company’s results ofoperations and financial position are changes in certain raw material pricesand interest rates. The Company has no market risk sensitive instruments heldfor trading purposes.

 

Raw materials used by the Company are exposedto the impact of changing commodity prices. The Company’s most significant rawmaterial requirements include potatoes, potato flakes, wheat flour, corn andoil. The Company attempts to minimize the effect of future price fluctuationsrelated to the purchase of raw materials primarily through forward purchasingto cover future manufacturing requirements, generally for periods from one to12 months. Futures contracts are not used in combination with the forwardpurchasing of these raw materials. The Company’s procurement practices areintended to reduce the risk of future price increases, but also may potentiallylimit the ability to benefit from possible price decreases. Inflation andchanging prices have not had a material impact on the Company’s net revenuesand net income. Increased transportation costs, driven by higher fuel prices,could result in higher commodity costs in the future.

 

The Company has interest rate risk withrespect to interest expense on variable rate debt, with rates based uponchanges in the prime rate. Therefore, the Company has an exposure to changes inthose rates. At December 31, 2005 and December 25, 2004, the Companyhad $0.5 million and $1.3 million of variable rate debt outstanding. Ahypothetical 10% adverse change in weighted average interest rates duringfiscal 2005 and 2004 would have had minimal impact on both the Company’s netearnings and cash flows.

 

The Company’sprimary concentration of credit risk is related to certain trade accountsreceivable. In the normal course of business, the Company extends unsecuredcredit to its customers. Substantially all of the Company’s customers are

 

25

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distributors or retailerswhose sales are concentrated in the grocery industry, throughout the UnitedStates. The Company investigates a customer’s credit worthiness beforeextending credit. Two customers (Wal*Mart and Vistar) accounted forapproximately 30% of net revenues during fiscal 2005 and for approximately 23%of the Company’s accounts receivable balance at December 31, 2005.

 

**Item 8.****                       FinancialStatements and Supplementary Data**

 
| Report of Independent Registered Public Accounting Firm                                                                                              |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated balance sheets as of December 31, 2005 and December 25,  2004                                                                 |   |
| Consolidated statements of income for the  years ended December 31, 2005, December 25, 2004 and December 27,  2003                    |   |
| Consolidated statements of shareholders’  equity for the years ended December 31, 2005, December 25, 2004 and  December 27, 2003 |   |
| Consolidated statements of cash flows for  the years ended December 31, 2005, December 25, 2004 and December 27,  2003                |   |
| Notes to consolidated financial statements                                                                                                           |   |

 

### **Item 9.**                       Changes in and Disagreements withAccountants on Accounting and Financial Disclosure

### ** **

None.

 

**Item 9A.****  Controlsand Procedures.**

 

**(a)****               Evaluation ofDisclosure Controls and Procedures**

 

The Company’s management, with theparticipation of the Company’s Chief Executive Officer (currently acting asboth our principal executive and principal financial officer), evaluated theeffectiveness of the Company’s disclosure controls and procedures as of the endof the period covered by this report. Based on that evaluation, the ChiefExecutive Officer concluded that the Company’s disclosure controls andprocedures as of the end of the period covered by this report have beendesigned and are functioning effectively to provide reasonable assurance thatthe information required to be disclosed by the Company in reports filed underthe Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time period specified in the SEC’s rules and forms.

 

**(b)****               Change in InternalControl over Financial Reporting**

 

During the third quarter, an evaluation was performed under the supervision and with the participation of the Company’s principal executive officer and principal financial officer of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of October 1, 2005. Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were not effective as of October 1, 2005. The conclusion that the Company’s disclosure controls and procedures were not effective as of October 1, 2005, was based on the identification of a material weakness in the Company’s internal controls over financial reporting as of June 25, 2005 that continued into the third quarter ended October 1, 2005. The material weakness related to deficiencies or inadequacies in the following specific areas: (1) execution of selected aspects of the Company’s processes and controls environment over trade spending programs to ensure prompt notification and recording of the transactions, and (2) inadequate monitoring of product inventory levels at a single large customer. This conclusion was made by management with the input of an independent consultant engaged by the Company’s audit committee.

 

The Company has taken steps to improve its internal control structure to remediate this material weakness by (1) hiring additional qualified and experienced people, (2) improving documentation and reporting of trade spending programs, (3) increasing reporting frequency and monitoring of trade spending and large customer inventory levels, and (4) enhancing its trade spending accrual preparation and review process.

 

These were the only changes in the Company’s internal control overfinancial reporting that occurred during the Company’s most recent fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

26

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The Company’s Chief Executive Officer(currently acting as both our principal executive and principal financialofficer) does not expect that the Company’s internal controls will prevent allerrors and all fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs. Because of theinherent limitations in all control systems, no evaluation of internal controlscan provide absolute assurance that all control issues and instances of fraud,if any, within the Company have been detected. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatinternal controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures may deteriorate.

 

**Item 9B.****  Other Information.**

 

None.

 

**PART III**

 

**Item 10.****                Directorsand Executive Officers of the Registrant**

 

**Code of Ethics**

 

Each of the Company’s directors, officers andemployees are required to comply with the Poore Brothers, Inc. Code ofBusiness Conduct and Ethics adopted by the Company. The Code of BusinessConduct and Ethics sets forth policies covering a broad range of subjects andrequires strict adherence to laws and regulations applicable to the Company’sbusiness. The Company has also adopted a Financial Code of Ethics for its ChiefExecutive Officer, Chief Financial Officer and all other finance managers. TheFinancial Code of Ethics supplements the Code of Business Conduct and Ethicsand is intended to emphasize the importance of honest and ethical conduct inconnection with the Company’s financial reporting obligations. The Code ofBusiness Conduct and Ethics and the Financial Code of Ethics are available onthe Company’s website at www.poorebrothers.com, under the “Investors-Governance”captions. Copies of these Codes may also be obtained, without charge, byany shareholder upon written request directed to the Secretary of the Companyat 3500 South La Cometa Drive, Goodyear, Arizona 85338. The Company will postto its website any amendments to these Codes, or waiver from the provisionsthereof, applicable to the Company’s directors or any principal executiveofficer, principal financial officer principal accounting officer orcontroller, or any person performing similar functions under the “Investors-Governance-Codeof Business Conduct-Waivers” caption.

 

The information regarding Directors andExecutive Officers appearing under the headings “Proposal 1: Election ofDirectors,” “Executive Officers” and “Section 16(a) BeneficialOwnership Reporting Compliance” of the Company’s 2006 Proxy Statement isincorporated by reference in this section.

 

**Item 11.****                ExecutiveCompensation**

 

The information appearing under the headings “Compensationof Directors,” “Employment Agreements,” “Compensation Committee Report onExecutive Compensation” and “Executive Compensation” of the Company’s 2006Proxy Statement is incorporated by reference in this section.

 

**Item 12.****                Security Ownershipof Beneficial Owners and Management and Related Stockholder Matters**

 

The information appearing under the headings “SecurityOwnership of Certain Beneficial Owners and Management” and “SecuritiesAuthorized for Issuance Under Equity Compensation Plans” of the Company’s 2006Proxy Statement is incorporated by reference in this section.

 

**Item 13.****                CertainRelationships and Related Transactions**

 

The information appearing under the heading “CertainRelationships and Related Transactions” of the Company’s 2006 Proxy Statementis incorporated by reference in this section.

 

**Item 14.****                PrincipalAccountant Fees and Services**

 

Information appearing under the heading “IndependentAuditors” of the Company’s 2006 Proxy Statement is incorporated by reference inthis section.

 

27

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**PART IV**

 

**Item 15.****                Exhibits and Financial StatementSchedules:**

 

The following documents are filed as part ofthis Annual Report on Form 10-K

 

**1.****              Financial Statements**

 
| Report of Independent Registered Public Accounting Firm                                                                                              |
|------------------------------------------------------------------------------------------------------------------------------------------------------|
| Consolidated balance sheets as of December 31, 2005 and December 25,  2004                                                                 |
| Consolidated statements of income for the  years ended December 31, 2005, December 25, 2004 and  December 27, 2003                    |
| Consolidated statements of shareholders’  equity for the years ended December 31, 2005, December 25, 2004 and  December 27, 2003 |
| Consolidated statements of cash flows for  the years ended December 31, 2005, December 25, 2004 and  December 27, 2003                |
| Notes to consolidated financial statements                                                                                                           |

 

**2.****              Financial Schedules**

 

Schedules have been omitted because of theabsence of conditions under which they are required or because the informationrequired is included in the Company’s consolidated financial statements ornotes thereto.

 

**3.****              Exhibits required byItem 601 of Regulation S-K:**

 
| **Exhibit**  | ** ** | ** **                                                                                                                                                                                     |
|--------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**   | ** ** | **Description**                                                                                                                                                                                |
| 3.1 —   |       | Certificate of Incorporation of the Company  filed with the Secretary of State of the State of Delaware on February 23,  1995. (14)                                                       |
| 3.2 —   |       | Certificate of Amendment to the Certificate  of Incorporation of the Company filed with the Secretary of State of the  State of Delaware on March 3, 1995. (14)                           |
| 3.3 —   |       | Certificate of Amendment to the Certificate  of Incorporation of the Company filed with the Secretary of State of the  State of Delaware on October 7, 1999. (14)                         |
| 3.4 —   |       | By-Laws of the Company (As amended and  restated on January 11, 2005). (17)                                                                                                               |
| 4.1 —   |       | Specimen Certificate for shares of Common  Stock. (1)                                                                                                                                          |
| 4.4 —   |       | Warrant to purchase 400,000 shares of  Common Stock, issued by the Company to Wabash Foods on October 7,  1999. (2)                                                                       |
| 4.5 —   |       | Form of Revolving Note, Term Note A  and Term Note B issued by the Company to U.S. Bancorp Republic Commercial  Finance, Inc. on October 7, 1999. (4)                           |
| 10.1* — |       | Non-Qualified Stock Option Agreements dated  August 1, 1995, August 31, 1995 and February 29, 1996, by and  between the Company and Mark S. Howells. (1)                        |
| 10.5* — |       | Non-Qualified Stock Option Agreement dated  as of October 22, 1996, by and between the Company and Mark S. Howells.  (1)                                                                  |
| 10.6* — |       | Letter Agreement dated as of November 5,  1996, by and between the Company and Jeffrey J. Puglisi. (1)                                                                                    |
| 10.7* — |       | Letter Agreement dated November 1,  1996, by and among the Company, Mark S. Howells, Jeffrey J. Puglisi, David J.  Brennan and Parris H. Holmes, Jr. (1)                             |
| 10.8* — |       | Letter Agreement dated December 4,  1996, by and between the Company and Jeffrey J. Puglisi, relating to stock  options. (1)                                                              |
| 10.9* — |       | Letter Agreement dated December 4,  1996, by and between the Company and Mark S. Howells, relating to stock  options. (1)                                                                 |
| 10.10 — |       | Fixed Rate Note dated June 4, 1997, by  and between La Cometa Properties, Inc. and Morgan Guaranty Trust Company  of New York. (3)                                                   |
| 10.11 — |       | Deed of Trust and Security Agreement dated June 4,  1997, by and between La Cometa Properties, Inc. and Morgan Guaranty  Trust Company of New York. (3)                              |
| 10.12 — |       | Guaranty Agreement dated June 4, 1997,  by and between the Company and Morgan Guaranty Trust Company of New York. (3)                                                                     |
| 10.13 — |       | Agreement for Purchase and Sale of Limited  Liability Company Membership Interests dated as of August 16, 1999, by  and between Pate Foods Corporation, Wabash Foods and the Company. (2) |
| 10.14 — |       | Letter Agreement dated July 30, 1999  by and between the Company and Stifel, Nicolaus & Company,  Incorporated. (5)                                                              |

 

28

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| 10.15* — |   | Poore Brothers, Inc. 1995 Stock Option  Plan, as amended. (4)                                                                                                                                                                                                                                                                                     |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16 —  |   | Credit Agreement, dated as of October 3,  1999, by and between the Company and U.S. Bancorp Republic Commercial Finance, Inc.  (4)                                                                                                                                                                                                           |
| 10.17 —  |   | Security Agreement, dated as of October 3,  1999, by and between the Company and U.S. Bancorp Republic Commercial Finance, Inc.  (4)                                                                                                                                                                                                         |
| 10.18 —  |   | Commercial Lease, dated May 1, 1998,  by and between Wabash Foods, LLC and American Pacific Financial Corporation.  (4)                                                                                                                                                                                                                           |
| 10.19 —  |   | Agreement for the Purchase and Sale of  Assets of Boulder Potato Company dated as of June 8, 2000, by and among  the Company, the shareholders of Boulder Potato Company, and Boulder Potato  Company. (6)                                                                                                                                        |
| 10.20 —  |   | Registration Rights Agreement dated as of June 8,  2000, by and between Boulder Potato Company and the Company. (6)                                                                                                                                                                                                                               |
| 10.21 —  |   | First Amendment, dated as of June 30,  2000, to Credit Agreement, dated as of October 3, 1999, by and between  the Company and U.S. Bancorp. (6)                                                                                                                                                                                             |
| 10.22 —  |   | Second Amendment to Credit Agreement (dated  March 2, 2001), by and between the Company and U.S. Bank National  Association. (7)                                                                                                                                                                                                                  |
| 10.23 —  |   | License Agreement, dated April 3,  2000, by and between the Company and TGI Friday’s Inc. (Certain portions of  this exhibit have been omitted pursuant to a confidential treatment  request filed with the Securities and Exchange Commission.) (7)                                                                                    |
| 10.24 —  |   | Third Amendment to Credit Agreement (dated March 30,  2001), by and between the Company and U.S. Bank National Association. (8)                                                                                                                                                                                                                   |
| 10.25 —  |   | First Amendment to License Agreement, dated  as of July 11, 2001, by and between the Company and TGI Friday’s Inc.  (certain portions of this exhibit have been omitted pursuant to a  confidentiality treatment request filed with the Securities and Exchange  Commission.) (9)                                                       |
| 10.27 —  |   | Fourth Amendment to Credit Agreement (dated  as of June 29, 2002), by and between the Company and U.S. Bank National  Association. (10)                                                                                                                                                                                                           |
| 10.28 —  |   | License Agreement, dated November 20,  2002, by and between the Company and Warner Bros., a division of Time Warner  Entertainment Company, L.P. (Certain portions of this exhibit have been  omitted pursuant to a confidential treatment request filed with the  Securities and Exchange Commission.) (11)                                 |
| 10.29 —  |   | License Agreement, dated November 20,  2002, by and between the Company and Warner Bros., a division of Time Warner  Entertainment Company, L.P. (Certain portions of this exhibit have been  omitted pursuant to a confidential treatment request filed with the  Securities and Exchange Commission.) (11)                                 |
| 10.30 —  |   | License Agreement, dated July 19,  2000, by and between the Company and M.J. Quinlan & Associates Pty.  Limited (Certain portions of this exhibit have been omitted pursuant to  a confidential treatment request filed with the Securities and Exchange  Commission.). (11)                                                        |
| 10.32* — |   | Executive Employment Agreement entered into  as of August 15, 2004 by and between Poore Brothers, Inc. and  Thomas W. Freeze. (16)                                                                                                                                                                                                           |
| 10.33* — |   | Executive Employment Agreement entered into  as of January 5, 2003, by and between Poore Brothers, Inc. and Glen  E. Flook. (12)                                                                                                                                                                                                             |
| 10.34 —  |   | Fifth Amendment to Credit Agreement (dated  as of September 27, 2003) by and between the Company and U.S. Bank  National Association. (13)                                                                                                                                                                                                        |
| 10.35 —  |   | License Agreement, dated November 10,  2003, by and between the Company and Warner Bros. Consumer Products Inc.  (Certain portions of this exhibit have been omitted pursuant to a  confidential treatment request filed with the Securities and Exchange  Commission.). (14)                                                                |
| 10.36 —  |   | Commercial Lease Agreement, dated May 22,  2003, by and between the Company and Westland Park LLC (14)                                                                                                                                                                                                                                            |
| 10.37 —  |   | Warehouse Services Agreement, dated June 30,  2003, by and between the Company and Customized Distribution Services, Inc.  (14)                                                                                                                                                                                                              |
| 10.38 —  |   | License Agreement - #13770-WBLT-Amendment  1, dated June 14, 2004, by and between the Company and Warner Bros.  Consumer Products, Inc. (15)                                                                                                                                                                                                 |
| 10.39 —  |   | License Agreement - #14559-SCOO-Amendment  1, dated June 14, 2004, by and between the Company and Warner Bros.  Consumer Products, Inc. (15)                                                                                                                                                                                                 |
| 10.40* — |   | Executive Employment Agreement entered into  as of July 19, 2004 by and between Poore Brothers, Inc. and David  Greenberg. (16)                                                                                                                                                                                                              |
| 10.41* — |   | Executive Employment Agreement entered into  as of December 6, 2004 by and between Poore Brothers, Inc. and  Richard M. Finkbeiner. (18)                                                                                                                                                                                                     |
| 10.42* — |   | Form of Officer Nonstatutory Stock  Option Agreement. (19)                                                                                                                                                                                                                                                                                        |
| 10.43* — |   | Summary of Director Compensation. (20)                                                                                                                                                                                                                                                                                                                 |
| 10.44 —  |   | Agreement between Poore Brothers, Inc.  and Cinnabon, Inc. entered into as of September 10, 2004, but  becoming material in the reporting period of June 25, 2005 (certain  portions of this exhibit have been omitted pursuant to a confidential  treatment request filed with the Securities and Exchange Commission). (21) |

 

29

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| 10.45 —  |   | Loan Agreement (Revolving Line of Credit  Loan and Term Loan) dated August 19, 2005 between the Company and U.S.  Bank National Association. (22)                                                                        |
|---------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.46 —  |   | Security Agreement relating to the Loan  Agreement dated August 19, 2005 between the Company and U.S. Bank  National Association. (22)                                                                                   |
| 10.47 —  |   | $5 Million Promissory Note (Facility 1 -  Revolving Line of Credit Loan) dated August 19, 2005 between the Company  and U.S. Bank National Association. (22)                                                             |
| 10.48 —  |   | $756,603 Promissory Note (Facility 2 – Term  Loan) dated August 19, 2005 between the Company and U.S. Bank National  Association. (22)                                                                              |
| 10.49* — |   | Executive Employment Agreement dated August 1,  2005 between the Company and Steven Sklar. (22)                                                                                                                          |
| 10.50* — |   | Restricted Stock Agreement dated August 1,  2005 between the Company and Steven Sklar. (22)                                                                                                                              |
| 10.51* — |   | Letter Agreement dated as of December 14,  2005, by and between the Company and Eric J. Kufel. (23)                                                                                                                      |
| 10.52* — |   | Letter Agreement dated as of December 16,  2005, by and between the Company and Thomas W. Freeze. (23)                                                                                                                   |
| 10.53* — |   | Letter Agreement dated as of December 16,  2005, by and between the Company and Richard M. Finkbeiner. (23)                                                                                                              |
| 10.54* — |   | Poore Brothers, Inc. 2005 Equity  Incentive Plan. (24)                                                                                                                                                                   |
| 10.55* — |   | Form of Director Nonstatutory Stock  Option Agreement – 2005 Equity Incentive Plan. (26)                                                                                                                            |
| 10.56* — |   | Form of Employee Incentive Stock  Option Agreement – 2005 Equity Incentive Plan. (26)                                                                                                                               |
| 10.57* — |   | Executive  Employment Agreement by and between Poore Brothers, Inc. and Eric J.  Kufel, dated as of February 14, 2006. (25)                                                                                         |
| 21.1 —   |   | List of Subsidiaries of the Company. (26)                                                                                                                                                                                     |
| 23.1 —   |   | Consent of Deloitte & Touche, LLP.  (26)                                                                                                                                                                             |
| 31 —     |   | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15(d)-14(a).  (26)                                                                                    |
| 32 —     |   | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to Rule 13a-14(b) and 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. (26) |

 

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|   * |   | Management compensatory plan or  arrangement.                                                                                                                                   |
|---------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1)           |   | Incorporated by reference to the Company’s  Registration Statement on Form SB-2, Registration No. 333-5594-LA.                                                   |
| (2)           |   | Incorporated  by reference to the Company’s definitive Proxy Statement on Schedule 14A  filed with the Securities and Exchange Commission on September 15, 1999. |
| (3)           |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended June 30,  1997.                                                |
| (4)           |   | Incorporated by reference to the Company’s  Annual Report on Form 10-KSB for the fiscal year ended December 31,  1999.                                           |
| (5)           |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended September 30,  1999.                                           |
| (6)           |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended June 30,  2000.                                                |
| (7)           |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended March 31,  2001.                                               |
| (8)           |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended June 30,  2001.                                                |
| (9)           |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-QSB for the quarter ended September 30,  2001.                                           |
| (10)          |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended September 28,  2002.                                             |
| (11)          |   | Incorporated by reference to the Company’s  Annual Report on Form 10-K for the fiscal year ended December 28,  2002.                                             |
| (12)          |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 28, 2003.                                                   |
| (13)          |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended September 27,  2003.                                             |
| (14)          |   | Incorporated by reference to the Company’s  Annual Report on Form 10-K for the fiscal year ended December 27,  2003.                                             |
| (15)          |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 26, 2004.                                                   |
| (16)          |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended September 25,  2004.                                             |
| (17)          |   | Incorporated by reference to the Company’s  Current Report on Form 8-K filed on January 12, 2005.                                                                |
| (18)          |   | Incorporated by reference to the Company’s  Current Report on Form 8-K filed on December 23, 2004.                                                               |
| (19)          |   | Incorporated by reference to the Company’s  Annual Report on Form 10-K for the fiscal year ended December 25,  2004.                                             |
| (20)          |   | Incorporated by reference to the Company’s  Current Report on Form 8-K filed on August 4, 2005.                                                                  |
| (21)          |   | Incorporated by reference to the Company’s  Quarterly Report on 10-Q for the quarter ended June 25, 2005.                                                             |
| (22)          |   | Incorporated by reference to the Company’s  Quarterly Report on 10-Q for the quarter ended October 1, 2005                                                            |
| (23)          |   | Incorporated by reference to the Company’s  Current Report on Form 8-K filed on December 19, 2005.                                                               |
| (24)          |   | Incorporated  by reference to the Company’s definitive Proxy Statement on Schedule 14A  filed with the Securities and Exchange Commission on April 28, 2005.     |
| (25)          |   | Incorporated by reference to the Company’s  Current Report on Form 8-K/A filed on February 16, 2006.                                                             |
| (26)          |   | Filed herewith.                                                                                                                                                                 |

 

30

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
| Dated: | March 29, 2006 | POORE BROTHERS, INC.                                                               |
|--------|---------------------|-----------------------------------------------------------------------------------------|
|   |                |                                                                                    |
|   | By:                 | /s/    Eric  J. Kufel                                               |   |
|   |                |               Eric J. Kufel |   |
|   |                | Chief  Executive Officer                                                                |   |

 

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant, in thecapacities and on the dates indicated.

 

 
| **Signature**                      | ** ** | **Title**                                                                                     | ** ** | **Date**             |
|------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------|
|                               |       |                                                                                          |       |                 |
| /s/ Eric J.  Kufel                 |       | Chief  Executive Officer and Director                                                         |       | March 29,  2006 |
| Eric J.  Kufel                     |       | (Principal  Executive Officer, Principal Financial Officer and Principal Accounting  Officer) |       |                 |
|                               |       |                                                                                          |       |                 |
| /s/ Larry R.  Polhill              |       | Chairman and  Director                                                                        |       | March 29,  2006 |
| Larry R.  Polhill                  |       |                                                                                          |       |                 |
|                               |       |                                                                                          |       |                 |
| /s/ Ashton  D. Asensio             |       | Director                                                                                      |       | March 29,  2006 |
| Ashton D.  Asensio                 |       |                                                                                          |       |                 |
|                               |       |                                                                                          |       |                 |
| /s/ Mark S.  Howells               |       | Director                                                                                      |       | March 29,  2006 |
| Mark S.  Howells                   |       |                                                                                          |       |                 |
|                               |       |                                                                                          |       |                 |
| /s/ F.  Phillips Giltner, III |       | Director                                                                                      |       | March 29,  2006 |
| F. Phillips  Giltner, III     |       |                                                                                          |       |                 |
|                               |       |                                                                                          |       |                 |
| /s/ James W.  Myers                |       | Director                                                                                      |       | March 29,  2006 |
| James W.  Myers                    |       |                                                                                          |       |                 |

 

31

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM

 

To the Board ofDirectors and Stockholders ofPoore Brothers, Inc.Goodyear, Arizona

 

We have audited theaccompanying consolidated balance sheets of Poore Brothers, Inc. andsubsidiaries (the “Company”) as of December 31, 2005 and December 25,2004, and the related consolidated statements of income, stockholders’ equityand cash flows for each of the three years in the period ended December 31,2005. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on the financialstatements based on our audits.

 

We conducted ouraudits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. The Company is not required to have, nor were weengaged to perform, an audit of its internal control over financial reporting.An audit includes consideration of internal control over financial reporting asa basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit also includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion,such consolidated financial statements present fairly, in all materialrespects, the financial position of Poore Brothers, Inc. and subsidiariesas of December 31, 2005 and December 25, 2004, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2005, in conformity with accounting principlesgenerally accepted in the United States of America.

 

 
| */s/ DELOITTE & TOUCHE LLP* |   |
|--------------------------------------|--------|
|                                 |
| Phoenix,  Arizona                    |
| March 27,  2006                 |

 

32

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**POORE BROTHERS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                | ** ** | **December 31,** | ** ** | **December 25,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| **ASSETS**                                                                                                                                                                                |       |                  |       |                  |       |
| Current  assets:                                                                                                                                                                          |       |                  |       |                  |       |
| Cash and  cash equivalents                                                                                                                                                                |       | $                     | 9,695,245  |                  | $          | 9,675,490 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $187,000 in 2005 and  $89,000 in 2004                                                                                     |       | 6,671,521             |       | 5,379,362             |       |
| Inventories                                                                                                                                                                               |       | 2,816,246             |       | 2,145,742             |       |
| Deferred  income tax asset                                                                                                                                                                |       | 1,806,718             |       | 1,341,723             |       |
| Other  current assets                                                                                                                                                                     |       | 422,065               |       | 471,051               |       |
| Total  current assets                                                                                                                                                                     |       | 21,411,795            |       | 19,013,368            |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Property and  equipment, net                                                                                                                                                              |       | 10,109,654            |       | 10,815,963            |       |
| Goodwill                                                                                                                                                                                  |       | 5,986,252             |       | 5,986,252             |       |
| Trademarks                                                                                                                                                                                |       | 4,207,032             |       | 4,207,032             |       |
| Other assets                                                                                                                                                                              |       | 88,836                |       | 94,672                |       |
| Total assets                                                                                                                                                                              |       | $                     | 41,803,569 |                  | $          | 40,117,287 |   |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                            |       |                  |       |                  |       |
| Current  liabilities:                                                                                                                                                                     |       |                  |       |                  |       |
| Accounts  payable                                                                                                                                                                         |       | $                     | 3,309,591  |                  | $          | 2,809,187 |   |
| Accrued  liabilities                                                                                                                                                                      |       | 3,506,332             |       | 2,656,887             |       |
| Current  portion of long-term debt                                                                                                                                                        |       | 529,176               |       | 1,390,667             |       |
| Current  portion of accrued costs related to brand discontinuance and other exit cost  accruals                                                                                           |       | 177,424               |       | 442,533               |       |
| Total  current liabilities                                                                                                                                                                |       | 7,522,523             |       | 7,299,274             |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Long-term  debt, less current portion                                                                                                                                                     |       | 1,681,432             |       | 1,729,134             |       |
| Non-current  portion of accrued costs related to brand discontinuance and other exit cost  accruals                                                                                       |       | 179,617               |       | 492,541               |       |
| Deferred  income tax liability                                                                                                                                                            |       | 2,177,140             |       | 1,788,252             |       |
| Total  liabilities                                                                                                                                                                        |       | 11,560,712            |       | 11,309,201            |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Commitments  and contingencies (Notes 8 and 12)                                                                                                                                           |       |                  |       |                  |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Shareholders’  equity:                                                                                                                                                               |       |                  |       |                  |       |
| Preferred  stock, $100 par value; 50,000 shares authorized; no shares issued or  outstanding at December 31, 2005 and December 25, 2004                                         |       | —                |       | —                |       |
| Common  stock, $.01 par value; 50,000,000 shares authorized; 20,077,080 and  19,647,561 shares issued and outstanding at December 31, 2005 and December 25,  2004, respectively |       | 200,771               |       | 196,476               |       |
| Additional  paid-in capital                                                                                                                                                               |       | 28,424,817            |       | 27,274,825            |       |
| Retained earnings                                                                                                                                                                         |       | 1,617,269             |       | 1,336,785             |       |
| Total  shareholders’ equity                                                                                                                                                          |       | 30,242,857            |       | 28,808,086            |       |
| Total  liabilities and shareholders’ equity                                                                                                                                          |       | $                     | 41,803,569 |                  | $          | 40,117,287 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

33

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**POORE BROTHERS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

 
| ** **                                    | ** ** | **Years Ended**  | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **December 31,** | ** ** | **December 25,** | ** ** | **December 27,** | ** ** |
| ** **                                    | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                          |       |                  |       |   |   |   |   |
| Net revenues                                  |       | $                     | 75,332,541 |   | $ | 68,734,763 |   | $ | 66,417,836 |   |
|                                          |       |                  |       |   |   |   |   |
| Cost of  revenues                             |       | 61,435,762            |       | 52,747,106 |   | 52,068,963 |   |
|                                          |       |                  |       |   |   |   |   |
| (Gain on  sale)/write-down of equipment       |       | (194,359              | )          | 308,104 |   | 1,030,352 |   |
|                                          |       |                  |       |   |   |   |   |
| Costs  related to brand discontinuance        |       | —                |       | 1,414,759 |   | — |   |
|                                          |       |                  |       |   |   |   |   |
| Gross profit                                  |       | 14,091,138            |       | 14,264,794 |   | 13,318,521 |   |
|                                          |       |                  |       |   |   |   |   |
| Selling,  general and administrative expenses |       | 13,638,684            |       | 10,558,544 |   | 13,290,660 |   |
|                                          |       |                  |       |   |   |   |   |
| Operating  income                             |       | 452,454               |       | 3,706,250 |   | 27,861 |   |
|                                          |       |                  |       |   |   |   |   |
| Insurance  claim settlement income, net       |       | —                |       | — |   | 1,918,784 |   |
|                                          |       |                  |       |   |   |   |   |
| Interest  income (expense), net               |       | 49,274                |       | (164,797 | ) | (252,820 | ) |
|                                          |       |                  |       |   |   |   |   |
| Total other  income (expense)                 |       | 49,274                |       | (164,797 | ) | 1,665,964 |   |
|                                          |       |                  |       |   |   |   |   |
| Income  before income tax provision           |       | 501,728               |       | 3,541,453 |   | 1,693,825 |   |
|                                          |       |                  |       |   |   |   |   |
| Income tax  provision                         |       | (221,244              | )          | (1,406,739 | ) | (641,861 | ) |
| Net income                                    |       | $                     | 280,484    |   | $ | 2,134,714 |   | $ | 1,051,964 |   |
|                                          |       |                  |       |   |   |   |   |
| Earnings per  common share:                   |       |                  |       |   |   |   |   |
| Basic                                         |       | $                     | 0.01       |   | $ | 0.11 |   | $ | 0.06 |   |
| Diluted                                       |       | $                     | 0.01       |   | $ | 0.11 |   | $ | 0.06 |   |
|                                          |       |                  |       |   |   |   |   |
| Weighted  average number of common shares:    |       |                  |       |   |   |   |   |
| Basic                                         |       | 19,763,992            |       | 18,794,977 |   | 17,572,951 |   |
| Diluted                                       |       | 19,946,941            |       | 18,947,553 |   | 18,476,486 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

34

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**POORE BROTHERS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY**

 
| ** **                                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Retained  Earnings** | ** ** | ** **    | ** ** |
|------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------------------|------------|---------------|------------|
| ** **                                                       | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**            | ** ** | **(Deficit)** | ** ** | **Total** | ** ** |
|                                                             |       |                  |       |                    |       |                   |       |          |       |   |   |
| Balance, December 28,  2002                                 |       | 16,729,911            |       | $                       | 167,299    |                   | $          | 22,404,835    |       | $ | (1,849,893 | ) | $ | 20,722,241 |   |
| Exercise of  common stock options, including related tax benefit |       | 1,362,633             |       | 13,626                  |       | 2,810,606              |       | —        |       | 2,824,232 |   |
| Other  issuances of common stock                                 |       | 489,244               |       | 4,892                   |       | 458,311                |       | —        |       | 463,203 |   |
| Net income                                                       |       | —                |       | —                  |       | —                 |       | 1,051,964     |       | 1,051,964 |   |
| Balance, December 27,  2003                                 |       | 18,581,788            |       | 185,817                 |       | 25,673,752             |       | (797,929      | )          | 25,061,640 |   |
| Exercise of  common stock options, including related tax benefit |       | 878,499               |       | 8,785                   |       | 1,602,947              |       | —        |       | 1,611,732 |   |
| Other  issuances of common stock                                 |       | 187,274               |       | 1,874                   |       | (1,874                 | )          | —        |       | — |   |
| Net income                                                       |       | —                |       | —                  |       | —                 |       | 2,134,714     |       | 2,134,714 |   |
| Balance, December 25,  2004                                 |       | 19,647,561            |       | 196,476                 |       | 27,274,825             |       | 1,336,785     |       | 28,808,086 |   |
| Exercise of  common stock options, including related tax benefit |       | 394,166               |       | 3,942                   |       | 1,130,586              |       | —        |       | 1,134,528 |   |
| Issuance of  restricted stock                                    |       | 35,353                |       | 353                     |       | 174,647                |       | —        |       | 175,000 |   |
| Deferred  compensation expense, net of amortization              |       | —                |       | —                  |       | (155,241               | )          | —        |       | (155,241 | ) |
| Net income                                                       |       | —                |       | —                  |       | —                 |       | 280,484       |       | 280,484 |   |
| Balance, December 31,  2005                                 |       | 20,077,080            |       | $                       | 200,771    |                   | $          | 28,424,817    |       | $ | 1,617,269 |   | $ | 30,242,857 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

35

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**POORE BROTHERS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

 
| ** **                                                                                    | ** ** | **Years Ended**        | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                    | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** | **December 27,  2003** | ** ** |
| **Cash  flows provided by (used in) operating activities:**                                   |       |                        |       |   |   |   |   |
| Net income                                                                                    |       | $                           | 280,484    |   | $ | 2,134,714 |   | $ | 1,051,964 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities: |       |                        |       |   |   |   |   |
| Depreciation                                                                                  |       | 1,214,262                   |       | 1,340,453 |   | 1,285,221 |   |
| Amortization                                                                                  |       | 5,836                       |       | 25,163 |   | 31,064 |   |
| Provision  for bad debts                                                                      |       | 83,456                      |       | (111,623 | ) | 23,822 |   |
| Other asset  amortization                                                                     |       | —                      |       | 44,066 |   | 121,413 |   |
| Deferred  income taxes                                                                        |       | (76,107                     | )          | 969,899 |   | 641,861 |   |
| Amortization of deferred compensation  expense                                                |       | 19,406                      |       | — |   | — |   |
| Costs  related to brand discontinuance                                                        |       | —                      |       | 1,758,919 |   | — |   |
| Tax benefit  from exercise of stock options                                                   |       | 330,559                     |       | 315,017 |   | 830,371 |   |
| (Gain on  sale)/write-down of equipment                                                       |       | (194,359                    | )          | 308,104 |   | 1,030,352 |   |
| (Gain) loss  on disposition of equipment                                                      |       | 49,046                      |       | 16,571 |   | (926 | ) |
| Change in  operating assets and liabilities:                                                  |       |                        |       |   |   |   |   |
| Accounts  receivable                                                                          |       | (1,375,615                  | )          | 446,367 |   | (1,225,065 | ) |
| Inventories,  net of brand discontinuance write-offs                                          |       | (670,504                    | )          | (1,390 | ) | (725,434 | ) |
| Other assets  and liabilities                                                                 |       | (529,047                    | )          | (139,705 | ) | (1,030,146 | ) |
| Accounts  payable and accrued liabilities                                                     |       | 1,349,849                   |       | (559,426 | ) | (28,652 | ) |
| Net cash  provided by (used in) operating activities                                          |       | 487,266                     |       | 6,547,129 |   | 2,005,845 |   |
| **Cash  flows provided by (used in) investing activities:**                                   |       |                        |       |   |   |   |   |
| Purchase of  equipment                                                                        |       | (563,249                    | )          | (455,769 | ) | (1,120,795 | ) |
| Proceeds  from disposition of equipment                                                       |       | 281,250                     |       | — |   | 61,000 |   |
| Net cash  provided by (used in) investing activities                                          |       | (281,999                    | )          | (455,769 | ) | (1,059,795 | ) |
| **Cash  flows provided by (used in) financing activities:**                                   |       |                        |       |   |   |   |   |
| Proceeds  from issuance of common stock                                                       |       | 804,322                     |       | 1,296,715 |   | 2,036,499 |   |
| Payments  made on long-term debt                                                              |       | (989,834                    | )          | (952,155 | ) | (1,138,166 | ) |
| Net cash  provided by (used in) financing activities                                          |       | (185,512                    | )          | 344,560 |   | 898,333 |   |
| Net increase  in cash and cash equivalents                                                    |       | 19,755                      |       | 6,435,920 |   | 1,844,383 |   |
| Cash and  cash equivalents at beginning of year                                               |       | 9,675,490                   |       | 3,239,570 |   | 1,395,187 |   |
| Cash and  cash equivalents at end of year                                                     |       | $                           | 9,695,245  |   | $ | 9,675,490 |   | $ | 3,239,570 |   |
|                                                                                          |       |                        |       |   |   |   |   |
| **Supplemental  disclosures of cash flow information:**                                       |       |                        |       |   |   |   |   |
| Cash paid  during the year for interest                                                       |       | $                           | 150,979    |   | $ | 293,908 |   | $ | 248,587 |   |
| Cash paid  during the year for taxes                                                          |       | 442,392                     |       | — |   | — |   |
| Summary of  non-cash investing and financing activities:                                      |       |                        |       |   |   |   |   |
| Common stock  issued for acquisition earnout                                                  |       | —                      |       | — |   | 420,566 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

36

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**POORE BROTHERS, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.****             ****Organization, Business andSummary of Significant Accounting Policies:**

 

Poore Brothers, Inc., (“the Company”, aDelaware corporation, was formed in 1995 as a holding company to acquire apotato chip manufacturing and distribution business which had been founded byDonald and James Poore in 1986.

 

In December 1996, the Companycompleted an initial public offering of its Common Stock. In November 1998,the Company acquired the business and certain assets (including the Bob’s TexasStyle® potato chip brand) of Tejas Snacks, L.P. (“Tejas”), a Texas-based potatochip manufacturer. In October 1999, the Company acquired Wabash Foods, LLC(“Wabash”) including the Tato Skins®, O’Boisies®, and Pizzarias® trademarks andthe Bluffton, Indiana manufacturing operation and assumed all of Wabash Foods’liabilities. In June 2000, the Company acquired Boulder Natural Foods, Inc.(“Boulder”) and the Boulder Canyon Natural FoodsTM brand oftotally natural potato chips. As part of the Boulder acquisition, theCompany was required to issue additional unregistered shares of Common Stock tothe seller on each of the first three anniversaries of the closing of theacquisition. The issuance of such shares was dependent upon increases in salesof Boulder product as compared to previous periods. In 2003, 2002 and 2001, theCompany was required to issue 93,728 shares valued at $420,566, 88,864 sharesvalued at $210,786 and 57,898 shares valued at $185,274, respectively. Witheach issuance of shares the Company increased the goodwill recorded from thisacquisition.

 

In October 2000,the Company launched its T.G.I. Friday’s® brand salted snacks pursuant to alicense agreement with TGI Friday’s Inc., which expires in 2014.

 

In June 2003,the Company launched its Crunch Toons® brand potato snacks, initially featuringcharacters pursuant to a multi-year license agreement with Warner Bros.Consumer Products. The Company decided to discontinue the brand in June 2004,and ceased using its license agreements with Warner Bros. Consumer Products.

 

In April 2005,the Company launched its Cinnabon® brand pursuant to a license agreement withCinnabon, Inc, the initial term of which expires in 2011. A renewal term for anadditional five years exists at the end of the initial term. The Company plansto develop and sell a variety of snack products, including cookies, under theCinnabon® brand. However, the Cinnabon® brand has not met consumer demandexpectations in many channels during its 2005 introduction and the Company isdetermining future prospects for the brand.

 

In September 2005,the Company signed a licensing agreement with Panda Restaurant Group, Inc.for the development, manufacture and sale of snack food products under thePanda Express® brand name. The Company is currently determining products it canmarket using this brand name.

 

The Company’s fiscal year ends on the lastSaturday occurring in the month of December of each calendar year.Accordingly, fiscal 2005 commenced December 26, 2004 and ended December 31,2005.

 

***Business***

 

The Company isengaged in the development, production, marketing and distribution ofinnovative snack food products that are sold primarily through groceryretailers, mass merchandisers, club stores, convenience stores and venddistributors across the United States. The Company currently manufactures andsells nationally T.G.I. Friday’s® brand snacks under license from TGI Friday’sInc. and sells nationally Cinnabon® brand snacks under license from Cinnabon, Inc.The Company also currently (i) manufactures and sells regionally its ownbrands of salted snack food products, including Poore Brothers®, Bob’s TexasStyle® and Boulder Canyon Natural FoodsTM brandbatch-fried potato chips and Tato Skins® brand potato snacks, (ii) manufacturesprivate label potato chips for grocery retail chains in the southwest and (iii) distributesin Arizona snack food products that are manufactured by others. The Companysells its T.G.I. Friday’s® brand snack products to mass merchandisers, grocery,club and drug stores directly and to primarily convenience stores and vendoperators through independent distributors. The Company’s other brands are alsosold through independent distributors.

 

***Principlesof Consolidation***

 

The consolidatedfinancial statements include the accounts of Poore Brothers, Inc. and allof its wholly owned subsidiaries. All significant intercompany amounts andtransactions have been eliminated.

 

37

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***Useof Estimates***

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. The Company routinely evaluates its estimates, includingthose related to accruals for customer programs and incentives, productreturns, brand discontinuance costs, bad debts, income taxes, long-livedassets, inventories and contingencies. The Company bases its estimates onhistorical experience and on various other assumptions that are believed to bereasonable under the circumstances. Actual results could differ from thoseestimates.

 

***FairValue of Financial Instruments***

 

At December 31,2005 and December 25, 2004, the carrying value of cash, accountsreceivable, accounts payable and accrued liabilities approximate fair valuessince they are short-term in nature. The carrying value of the long-term debtapproximates fair-value based on the borrowing rates currently available to theCompany for long-term borrowings with similar terms, except for the mortgageloan with interest at 9.03%, which has a fair value of $1.3 million and $1.4million at December 31, 2005 and December 25, 2004, respectively. TheCompany estimates fair values of financial instruments by using availablemarket information. Considerable judgment is required in interpreting marketdata to develop the estimates of fair value. Accordingly, the estimates may notbe indicative of the amounts that the Company could realize in a current marketexchange. The use of different market assumptions or valuation methodologiescould have a material effect on the estimated fair value amounts.

 

***Inventories***

 

Inventories arestated at the lower of cost (first-in, first-out) or market. The Companyidentifies slow moving or obsolete inventories and estimates appropriate lossprovisions related thereto. If actual market conditions are less favorable thanthose projected by management, additional inventory write-downs may berequired.

 

***Propertyand Equipment***

 

Property andequipment are recorded at cost. Cost includes expenditures for majorimprovements and replacements. Maintenance and repairs are charged tooperations when incurred. When assets are retired or otherwise disposed of, therelated costs and accumulated depreciation are removed from the appropriateaccounts, and the resulting gain or loss is recognized. Depreciation expense iscomputed using the straight-line method over the estimated useful lives of theassets, ranging from 2 to 30 years.

 

In accordance withFinancial Accounting Standards Board (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,”, the Company evaluates the recoverability of property andequipment not held for sale by comparing the carrying amount of the asset orgroup of assets against the estimated undiscounted future cash flows expectedto result from the use of the asset or group of assets and their eventualdisposition. If the undiscounted future cash flows are less than the carryingvalue of the asset or group of assets being evaluated, an impairment loss isrecorded. The loss is measured as the difference between the fair value andcarrying value of the asset or group of assets being evaluated. Assets to bedisposed of are reported at the lower of the carrying amount or the fair valueless cost to sell. The estimated fair value would be based on the bestinformation available under the circumstances, including prices for similarassets or the results of valuation techniques, including the present value ofexpected future cash flows using a discount rate commensurate with the risksinvolved.

 

***IntangibleAssets***

 

Goodwill andtrademarks are reviewed for impairment annually, or more frequently, ifimpairment indicators arise. Goodwill is required to be tested for impairmentbetween the annual tests if an event occurs or circumstances change that more-likely-than-notreduce the fair value of a reporting unit below its carrying value. Trademarkswith indefinite lives are required to be tested for impairment between theannual tests if an event occurs or circumstances change indicating that theasset might be impaired. The Company believes at this time that the carryingvalues continue to be appropriate. See Note 2.

 

38

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***RevenueRecognition***

 

In accordance withaccounting principles generally accepted in the United States, the Companyrecognizes operating revenues upon shipment of products to customers when titleand risk of loss pass to its customers. Provisions and allowances for salesreturns, promotional allowances and discounts are also recorded as a reductionof revenues in the Company’s consolidated financial statements.

 

***Advertising,Promotion and Trade Spending***

 

The Companyexpenses production costs of advertising the first time the advertising takesplace, except for cooperative advertising costs which are expensed when therelated sales are recognized. Costs associated with obtaining shelf space(i.e., “slotting fees”) are expensed in the period in which such costs areincurred by the Company. Anytime the Company offers consideration (cash orcredit) as trade advertising or promotional allowance to a purchaser ofproducts at any point along the distribution chain, the amount is accrued andrecorded as a reduction in revenue. Any marketing programs that deal directlywith the consumer are recorded in selling, general and administrative expenses.Accrued advertising and promotion, which is included in the current liabilitiessection of the accompanying consolidated balance sheets, was $1,369,000and $547,000 on December 31, 2005 and December 25, 2004, respectively.

 

***IncomeTaxes***

 

Deferred taxassets and liabilities are recognized for the expected future tax consequencesof events that have been included in the financial statements or income taxreturns. Deferred tax assets and liabilities are determined based on thedifference between the financial statement and tax bases of assets andliabilities using enacted rates expected to apply to taxable income in theyears in which those differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in the period that includes the enactment date.

 

***StockOptions and Stock-Based Compensation***

 

The Company’sstock-based compensation plans, described in Note 9, are currently accountedfor under the recognition and measurement provisions of APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations. SeeNote 1–”New Accounting Pronouncements” for discussion of the Company’s adoptionof SFAS No. 123R for employee stock-based compensation, effective January 1,2006.

 

The Companycurrently follows the disclosure-only provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure”. Accordingly, nocompensation cost has been recognized for the stock option plan. Awards underthe plan vest over periods ranging from one to three years, depending on thetype of award. The following table illustrates the effect on net income andearnings per share if the fair value based method had been applied to alloption grants, using the Black-Scholes valuation model, for the years ended December 31,2005, December 25, 2004 and December 27, 2003:

 
| ** **                                                                                                                              | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  as reported                                                                                                                 |       | $          | 280,484    |       | $          | 2,134,714  |       | $ | 1,051,964 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  method for all awards, net of related tax effects |       | (176,574   | )          | (518,950   | )          | (382,380   | )          |
| Pro forma  net income                                                                                                                   |       | $          | 103,910    |       | $          | 1,615,764  |       | $ | 669,584 |   |
| Net income  per share – basic – as reported                                                                                   |       | $          | 0.01       |       | $          | 0.11       |       | $ | 0.06 |   |
| Pro forma  net income per share – basic                                                                                            |       | $          | 0.01       |       | $          | 0.09       |       | $ | 0.04 |   |
| Net income  per share – diluted – as reported                                                                                 |       | $          | 0.01       |       | $          | 0.11       |       | $ | 0.06 |   |
| Pro forma  net income per share – diluted                                                                                          |       | $          | 0.01       |       | $          | 0.09       |       | $ | 0.04 |   |

 

39

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The fair value of each option grant isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted-average assumptions: dividend yield of 0%; expectedvolatility of 62%, 62% and 57%; risk-free interest rate of 3.15%, 3.15% and2.4%; and expected lives of 3 years for 2005, 2004 and 2003, respectively.Under this method, the weighted-average fair value of the options granted was$2.18 in 2005, $1.15 in 2004 and $1.86 in 2003.

 

***Earnings Per Common Share***

 

Basic earnings percommon share is computed by dividing net income by the weighted average numberof shares of common stock outstanding during the period. Exercises ofoutstanding stock options or warrants are assumed to occur for purposes ofcalculating diluted earnings per share for periods in which their effect wouldnot be anti-dilutive. Earnings per common share was computed as follows for theyears ended December 31, 2005, December 25, 2004 and December 27,2003:

 
| ** **                                         | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic  Earnings Per Common Share:**              |       |       |       |       |       |       |       |
| Net income                                         |       | $          | 280,484    |       | $          | 2,134,714  |       | $ | 1,051,964 |   |
|                                               |       |       |       |       |       |       |       |
| Weighted  average number of common shares          |       | 19,763,992 |       | 18,794,977 |       | 17,572,951 |       |
|                                               |       |       |       |       |       |       |       |
| Earnings per  common share                         |       | $          | 0.01       |       | $          | 0.11       |       | $ | 0.06 |   |
|                                               |       |       |       |       |       |       |       |
| **Diluted  Earnings Per Common Share:**            |       |       |       |       |       |       |       |
| Net income                                         |       | $          | 280,484    |       | $          | 2,134,714  |       | $ | 1,051,964 |   |
|                                               |       |       |       |       |       |       |       |
| Weighted  average number of common shares          |       | 19,763,992 |       | 18,794,977 |       | 17,572,951 |       |
| Incremental  shares from assumed conversions -     |       |       |       |       |       |       |       |
| Warrants                                           |       | —     |       | —     |       | 325,496    |       |
| Stock  options                                     |       | 182,949    |       | 152,576    |       | 578,039    |       |
| Adjusted  weighted average number of common shares |       | 19,946,941 |       | 18,947,553 |       | 18,476,486 |       |
|                                               |       |       |       |       |       |       |       |
| Earnings per  common share                         |       | $          | 0.01       |       | $          | 0.11       |       | $ | 0.06 |   |

 

***New Accounting Pronouncements***

 

On December 16, 2004, the FASB issuedSFAS No. 123R, “Share-Based Payment,” requiring all share-basedpayments to employees, including grants of employee stock options, to berecognized as compensation expense in the consolidated financial statementsbased on their fair values. Pro forma disclosure is no longer an alternative. Thisstandard is effective for periods beginning after December 15, 2005 andincludes two transition methods, the modified prospective and the modifiedretrospective transition method. Under the modified prospective method, awardsthat are granted, modified or settled after the date of adoption should bemeasured and accounted for in accordance with SFAS 123R. Unvestedequity-classified awards that were granted prior to the effective date shouldcontinue to be accounted for in accordance with SFAS 123 except thatamounts must be recognized in the income statement. Under the modified retrospectiveapproach, the previously-reported amounts are restated (either to the beginningof the year of adoption or for all periods presented) to reflect theSFAS 123 amounts in the income statement. The Company will use themodified prospective method upon adoption of SFAS 123R effective January 1,2006. As permitted by SFAS 123R, we currently account for share-based paymentsto employees using APB Opinion 25’s intrinsic value method and, as such,generally recognize no compensation cost for employee stock options. As aresult of the adoption of SFAS 123R, the compensation expense that the Companywould have recognized in 2005 relating to employee stock options would haveapproximated the pro forma compensation expense described in the table above.As of December 31, 2005, the amount of unrecognized compensation expenseto be recognized in future periods, in accordance with SFAS 123R, isapproximately $0.3 million. This expected compensation expense does not reflectany new awards, or modifications to existing awards, that could occur in thefuture.

 

40

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In November 2004, the FASB issued SFAS No. 151,“Inventory Costs.”  This statementclarifies the accounting for abnormal amounts of idle facilities expense, freight,handling costs and wasted material. This statement requires that those items berecognized as current-period expense. In addition, the statement requires thatallocation of fixed overhead to the cost of conversion be based on the normalcapacity of the production facilities. This statement is effective forinventory costs incurred after December 31, 2005. The Company is currentlyevaluating the impact that SFAS No. 151 will have on its financialposition and results of operations.

 

In March 2005, the FASB issuedInterpretation No. 47 “Accounting for Conditional Asset RetirementObligations” to clarify that the term “conditional asset retirement obligation”as used in SFAS No. 143 is a legal obligation to perform an assetretirement activity in which the timing and (or) method of settlement areconditional on a future event that the enterprise may or may not havecontrol over. This Interpretation requires recognition of a liability for thefair value of a conditional asset retirement obligation when incurred if theliability’s fair value can be reasonably determined. This Interpretation iseffective no later than fiscal years ending after December 15, 2005 (December 31,2005 for calendar year end enterprises). The implementation of thisInterpretation did not have a material impact on the Company’s consolidatedfinancial statements.

 

**2.****               Goodwill****and Trademarks:**

 

Goodwill and trademarks relate to the 1998,1999 and 2000 acquisitions described in Note 1. Intangibles not subject toamortization consisted of the following as of December 31, 2005 and December 25,2004:

 

| ** ** | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Goodwill   |       | $          | 5,986,252  |       | $          | 5,986,252 |   |
| Trademarks |       | 4,207,032  |       | 4,207,032  |       |
|       |       | $          | 10,193,284 |       | $          | 10,193,284 |   |

 

**3.****             ****Accrued Liabilities:**

 

Accruedliabilities consisted of the following as of December 31, 2005 and December 25,2004:

 
| ** **                         | ** ** | **2005**  | ** ** | **2004** | ** ** |
|------------------------------------|------------|-----------|------------|----------|------------|
| Accrued  payroll and payroll taxes |       | $         | 1,454,697  |     | $          | 1,170,354 |   |
| Accrued  royalties and commissions |       | 554,434   |       | 517,917  |       |
| Accrued  advertising and promotion |       | 1,368,929 |       | 547,054  |       |
| Accrued  other                     |       | 128,272   |       | 421,562  |       |
|                               |       | $         | 3,506,332  |     | $          | 2,656,887 |   |

 

During the fourth quarter of 2005, theCompany announced the departure of two executives and recorded chargesconsisting of severance and certain other personnel costs. The amount owed onthese two severance agreements at December 31, 2005 is $491,000 and isincluded in accrued payroll and payroll taxes above.

 

**4.****             ****Inventories:**

 

Inventoriesconsisted of the following as of December 31, 2005 and December 25,2004:

 
| ** **      | ** ** | **2005**  | ** ** | **2004** | ** ** |
|-----------------|------------|-----------|------------|----------|------------|
| Finished  goods |       | $         | 1,731,531  |     | $          | 1,537,488 |   |
| Raw  materials  |       | 1,084,715 |       | 608,254  |       |
|            |       | $         | 2,816,246  |     | $          | 2,145,742 |   |

 

41

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**5.****             ****Property and Equipment:**

 

Property andequipment consisted of the following as of December 31, 2005 and December 25,2004:

 
| ** **                                      | ** ** | **Useful Lives** | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| Buildings  and improvements                     |       | 20 – 30  years   |       | $          | 5,437,524  |       | $          | 5,364,778 |   |
| Equipment                                       |       | 7 – 15 years     |       | 10,998,189 |       | 10,768,784 |       |
| Land                                            |       | —                |       | 272,006    |       | 272,006    |       |
| Vehicles                                        |       | 5 years               |       | 5,432      |       | 16,825     |       |
| Furniture  and office equipment                 |       | 2 – 5 years      |       | 1,679,815  |       | 1,547,608  |       |
|                                            |       |                  |       | 18,392,966 |       | 17,970,001 |       |
| Less  accumulated depreciation and amortization |       |                  |       | (8,283,312 | )          | (7,154,038 | )          |
|                                            |       |                  |       | $          | 10,109,654 |       | $          | 10,815,963 |   |

 

On October 28, 2000, the Companyexperienced a fire at the Goodyear, Arizona manufacturing plant. In 2003, theCompany recorded income of $1,918,784 for net proceeds from the insurancecompany for final settlement of outstanding claims related to the fire.

 

In June 2003, the Company concluded thatsome of its packaging equipment that had recently been replaced by moretechnologically advanced machinery was no longer likely to be reinstalled andused. Therefore, in accordance with SFAS 144, “Accounting for the Impairment orDisposal of Long-lived Assets,” the Company performed an assessment of theequipment’s fair value, which resulted in the need to write-down the equipmentby $1,030,352. In addition, in December, 2004, the Company concluded that apackaging machine in its Indiana plant was no longer likely to be used, whichresulted in a $308,104 impairment charge in 2004.

 

**6.****              ****Long-Term Debt:**

 

Long-term debt consisted of the following asof December 31, 2005 and December 25, 2004:

 
| ** **                                                                                                                                                              | ** ** | **2005**  | ** ** | **2004**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|------------|------------|
| Term loan  due in monthly installments through July 1, 2006; interest at prime rate  (7.25% at December 31, 2005); collateralized by substantially all assets |       | $         | 481,474    |       | $          | 1,347,069 |   |
| Mortgage  loan due in monthly installments through July 2012; interest at 9.03%;  collateralized by land and building                                              |       | 1,729,134 |       | 1,772,732  |       |
|                                                                                                                                                                    |       | 2,210,608 |       | 3,119,801  |       |
| Less current  portion                                                                                                                                                   |       | (529,176  | )          | (1,390,667 | )          |
|                                                                                                                                                                    |       | $         | 1,681,432  |       | $          | 1,729,134 |   |

 

Annual maturities of long-term debt as of December 31,2005 are as follows:

 
| **Year**   | ** ** | ** ** | ** ** |
|------------|------------|------------|------------|
| 2006       |       | $          | 529,176    |   |
| 2007       |       | 52,192     |       |
| 2008       |       | 57,105     |       |
| 2009       |       | 62,480     |       |
| 2010       |       | 68,362     |       |
| Thereafter |       | 1,441,293  |       |
|       |       | $          | 2,210,608  |   |

 

42

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Interest income (expense), net consisted ofthe following for the fiscal years ended December 31, 2005, December 25,2004 and December 27, 2003:

 
| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest  expense               |       | $        | (275,853   | )        | $          | (221,258 | )          | $ | (275,619 | ) |
| Interest  income                |       | 325,127  |       | 56,461   |       | 22,799   |       |
| Interest  income (expense), net |       | $        | 49,274     |     | $          | (164,797 | )          | $ | (252,820 | ) |

 

The Company’s Goodyear, Arizonamanufacturing, distribution and headquarters facility is subject to a $1.7million mortgage loan from Morgan Guaranty Trust Company of New York, bearsinterest at 9.03% per annum and is secured by the building and the land onwhich it is located. The loan matures on July 1, 2012; however monthlyprincipal and interest installments of $16,825 are determined based on atwenty-year amortization period.

 

On August 19, 2005, the Companyrefinanced its U.S. Bancorp Credit Agreement into a new $5.0 million Line ofCredit and a $756,603 Term Loan (collectively, the “New Credit Agreement”) withthe same bank. The original credit facility consisted of: (i) a $5.0million line of credit with a borrowing limit calculated based on specifiedpercentages of eligible receivables and inventories; (ii) a $0.5 millioncapital expenditures line of credit; and (iii) a $5.8 million term loanwith a remaining balance of $756,603 at the time of the refinancing.

 

The Line of Credit bears interest at theprime rate less 0.5% (6.75% at December 31, 2005) and matures on June 30,2007. Interest is due monthly, with the outstanding principal balance due infull at the maturity date. The Term Loan bears interest at the prime rate(7.25% at December 31, 2005) and matures on July 1, 2006. Monthlyprincipal payments of $68,782 plus interest are due under the Term Loan. At December 31,2005, there was no outstanding balance on the Line of Credit and $0.5 millionoutstanding on the Term Loan.

 

The New Credit Agreement is secured bysubstantially all assets of the Company. The Company’s obligations under theNew Credit Agreement are guaranteed by each of its subsidiaries. The agreementrequires the Company to maintain compliance with certain financial covenants,including a minimum tangible net worth, a minimum fixed charge coverage ratioand a minimum current ratio. At December 31, 2005, the Company was incompliance with all covenants of the New Credit Agreement.

 

**7.****               Brand****Discontinuance:**

 

On June 11, 2004, the Companydiscontinued its Crunch Toons® brand. As a result of the discontinuance, theCompany recorded expenses of approximately $1.8 million. The charge includedapproximately $1.1 million related to minimum royalties under the licenseagreements and $0.3 million in inventory write-downs, which are shown in “Costsrelated to brand discontinuance” on the accompanying Consolidated Statements ofIncome. In addition, charges of $0.3 million in estimated allowances given tothe Company’s customers to sell-off remaining distributor and retailerinventories were recorded and are included in “Net revenues” on theaccompanying Consolidated Statements of Income.

 

In connection with the brand discontinuation,and included in the $1.1 million charge above, the Company negotiatedamendments to its license agreements with Warner Bros. Consumer Productspursuant to which the Agreements will remain in effect, but will becomenon-exclusive. However, because the Company has ceased using the Crunch Toons®brand, the Company accrued the fair value of remaining royalties in accordancewith SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities.”  The Company estimated thefair value of the remaining guaranteed future minimum payments under theagreements by computing the present value of the future cash payments.

 

43

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The following table summarizes the activityof the accrued costs related to brand discontinuance and other exit costs forthe years ended December 31, 2005 and December 25, 2004:

 
| ** **                                                                                         | ** ** | **June 11, 2004  Brand  Discontinuance  Charges** | ** ** | **Other Exit  Costs** | ** ** | **Write-offs  and  Payments** | ** ** | **Dec. 25,  2004  Accrued  Expense  Balance** | ** ** | **Payments** | ** ** | **Dec. 31,  2005  Accrued  Expense  Balance** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|----------------------------------------------------|------------|--------------|------------|----------------------------------------------------|------------|
| Inventory  and equipment write-offs                                                                |       | $                                                           | 294,768    |                       | $          | —                        |       | $                                                  | (294,768   | )            | $          | —                                             |       | $ | — |   | $ | — |   |
| Write-down  of prepaid royalties and present value of guaranteed minimum royalty payments  (1),(2) |       | 1,119,991                                                   |       | —                     |       | (527,519                      | )          | 592,472                                            |       | (235,431     | )          | 357,041                                            |       |
| Reclamation  costs (1)                                                                             |       | 344,160                                                     |       | —                     |       | (309,662                      | )          | 34,498                                             |       | (34,498      | )          | —                                             |       |
| Present  value of remaining lease payments on equipment (1),(3)                                    |       | —                                                      |       | 308,104                    |       | —                        |       | 308,104                                            |       | (308,104     | )          | —                                             |       |
|                                                                                               |       | $                                                           | 1,758,919  |                       | $          | 308,104                       |       | $                                                  | (1,131,949 | )            | $          | 935,074                                            |       | $ | (578,033 | ) | $ | 357,041 |   |

 

----

(1)                                  Theseamounts are reflected in the Consolidated Balance Sheets as “Current andNon-current portions of accrued costs related to brand discontinuance and otherliabilities.”

(2)                                  Inaccordance with SFAS No. 146, interest accretion was recorded for the yearand future royalty payments will be made in accordance with the amendedagreements.

(3)                                  Inaccordance with SFAS No. 146, the fair value of remaining operating leasepayments were recorded relating to a machine the Company determined would nolonger be used. This machine lease was paid off in July 2005.

 

**8.****              ****Commitments andContingencies:**

 

The Company is periodically a party tovarious lawsuits arising in the ordinary course of business. Managementbelieves, based on discussions with legal counsel, that the resolution of suchlawsuits, individually and in the aggregate, will not have a material adverseeffect on the Company’s financial position or results of operations.

 

The Company leases a 140,000 square footfacility located on 15 acres of land in Bluffton, Indiana, approximately 20miles south of Ft. Wayne, Indiana. The Company has entered into a lease expiringin April 2018 with respect to the facility and the lease has two five-yearrenewal options. Current lease payments are approximately $23,000 per month.The lease payments are subject to an annual CPI-based increase. The Companyproduces its T.G.I. Friday’s® brand snacks and Tato Skins® brand potato snacksat the Bluffton, Indiana facility.

 

The Company also leases one-half of a 200,000square foot facility in Bluffton, Indiana which is used as a distributioncenter. The Company has entered into a lease expiring in November 2006with respect to the facility and the lease has two three-year renewal options.Current lease payments are approximately $31,500 per month. The Company alsohas entered into a service agreement expiring in December 2008 with athird party for warehousing services. The service agreement includes certainminimum monthly usage commitments amounting to $1,188,000 for 2006 and$2,376,000 from 2007-2008.

 

44

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In addition to the Company’s facility leases,the Company has entered into a variety of operating leases for equipment andvehicles. Rental expense under all operating leases was $1,553,000, $1,666,000and $1,158,000 for fiscal 2005, 2004 and 2003, respectively. Minimum futurerental commitments under non-cancelable leases as of December 31, 2005 areas follows:

 
| **Year**   | ** ** | **Operating  Leases** | ** ** |
|------------|------------|-----------------------|------------|
| 2006       |       | $                     | 1,469,000  |   |
| 2007       |       | 1,431,000             |       |
| 2008       |       | 966,000               |       |
| 2009       |       | 797,000               |       |
| 2010       |       | 695,000               |       |
| Thereafter |       | 2,824,000             |       |
| Total      |       | $                     | 8,182,000  |   |

 

The Company licenses patented technology fromMiles Willard Technologies, LLC in connection with the manufacture of itsT.G.I. Friday’s® and Tato Skins® brand products. Pursuant to the licenseagreement between the Company and Miles Willard, the Company has an exclusive rightto use the patented technology within North America until the patents expire onDecember 26, 2006. In consideration for the use of these patents, the Companyis required to make royalty payments to Miles Willard on sales of productsmanufactured utilizing the patented technology until the expiration date. Oncethe patents expire, the Company will no longer have exclusive rights to thistechnology.

 

The Companylicenses the T.G.I. Friday’s® brand snacks trademark from TGI Friday’s Inc.under a license agreement with a term expiring in 2014. Pursuant to the licenseagreement, the Company is required to make royalty payments on sales of T.G.I.Friday’s® brand snack products and is required to achieve certain minimum saleslevels by certain dates during the contract term.

 

The Companylicenses the Cinnabon® brand for salted snacks, shelf-stable packaged cookiesand breakfast/snack bars from Cinnabon Inc. under a license agreement withterms and options extending through 2015. Pursuant to the license agreement,the Company is required to make royalty payments on sales of Cinnabon® brandproducts and is required to achieve certain minimum sales levels by certaindates during the contract term.

 

**9.****              ****Shareholders’Equity:**

 

***Common Stock***

 

Approximately 4.3 million shares ofoutstanding Common Stock issued by the Company are subject to “piggyback”registration rights granted by the Company, pursuant to which such shares ofCommon Stock may be registered under the Securities Act and, as a result,become freely tradable in the future. The Company will be required to pay allexpenses relating to any such registration, other than underwriting discounts,selling commissions and stock transfer taxes applicable to the shares, and anyother fees and expenses incurred by the holder(s) of the shares (including,without limitation, legal fees and expenses) in connection with theregistration. All or a portion of such shares may, at the election of theholders thereof, be included in a future registration statement of the Companyand, upon the effectiveness thereof, may be sold in the public markets.

 

On August 1, 2005, the Company issued toits Senior Vice President of Marketing 35,353 shares of restricted stock underthe Company’s 2005 Equity Incentive Plan, subject to vesting in equal annualinstallments over three years. The restricted stock was valued at the fairmarket value of the Common Stock on the date of grant, and the resultingdeferred compensation expense of $175,000 was included in additional paid-incapital and is being amortized over the vesting period. During 2005,amortization expense of $19,406 related to this grant is included in selling,general and administrative expenses.

 

45

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***Preferred Stock***

 

The Company has authorized 50,000 shares of$100 par value Preferred Stock, none of which is outstanding. The Company may issuesuch shares of Preferred Stock in the future without shareholder approval.

 

***Warrants***

 

Warrants had been issued in connection withprior financings and the acquisition of Wabash. During fiscal years 2003 and2004, warrant activity was as follows:

 
| ** **                       | ** ** | **Warrants  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|----------------------------------|------------|---------------------------|------------|--------------------------------------------|------------|
| Balance, December 28,  2002 |       | 1,013,793                 |       | $                                          | 1.11       |   |
| Exercised                        |       | (395,516                  | )          | 1.16                                       |       |
| Cancelled                        |       | (160,277                  | )          | 1.26                                       |       |
| Balance, December 27,  2003 |       | 458,000                   |       | 1.02                                       |       |
| Exercised                        |       | (187,274                  | )          | 1.00                                       |       |
| Cancelled                        |       | (270,726                  | )          | 1.05                                       |       |
| Balance, December 25,  2004 |       | —                    |       | $                                          | —     |   |

 

***Stock Options***

 

The Company’s 1995 Stock Option Plan (the “1995 Plan”),as amended, provided for the issuance of options to purchase 3,000,000 sharesof Common Stock. The options granted pursuant to the 1995 Plan expire over afive-year period and generally vest over three years. In addition to optionsgranted under the 1995 Plan, the Company also issued non-qualified options(non-plan options) to purchase Common Stock to certain Directors and Officerswhich are exercisable and expire either five or ten years from date of grant.All options are issued at an exercise price of fair market value at the date ofgrant and are non-compensatory. The 1995 Plan expired in May 2005 and wasreplaced by the Poore Brothers, Inc. 2005 Equity Incentive Plan (the “2005Plan”) as described below.

 

The 2005 Plan was approved at the Company’s 2005 Annual Meeting ofShareholders, and expires in May 2015. The 2005 Plan provides for theissuance of Awards (as defined in the plan document) covering 410,518 shares ofCommon Stock. Awards granted under the 2005 Plan may include: nonqualifiedstock options, incentive stock options, restricted stock, restricted stockunits, stock appreciation rights, performance units and stock-reference awards.If any shares of Common Stock subject to awards granted under the 1995 Plan orthe 2005 Plan are canceled, those shares will be available for future awardsunder the 2005 Equity Incentive Plan. The Awards granted pursuant to the 2005Plan generally expire over a five-year period and generally vest over threeyears. As of December 31, 2005, there were 540,665 shares of Common Stockavailable for Awards under the 2005 Plan.

 

46

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During fiscal years 2003, 2004 and 2005, stock optionactivity was as follows:

 
| ** **                       | ** ** | **Plan Options**    | ** ** | **Non-Plan Options**                  | ** ** |
|----------------------------------|------------|--------------------------|------------|--------------------------------------------|------------|
| ** **                       | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Balance, December 28,  2002 |       | 1,737,800                |       | $                                          | 2.15       |   | 1,545,000 |   | $ | 1.47 |   |
| Granted                          |       | 230,000                  |       | 3.44                                       |       | 117,500 |   | 3.60 |   |
| Canceled                         |       | (28,667                  | )          | 3.03                                       |       | — |   | — |   |
| Exercised                        |       | (782,633                 | )          | 1.51                                       |       | (580,000 | ) | 1.40 |   |
| Balance, December 27,  2003 |       | 1,156,500                |       | 2.82                                       |       | 1,082,500 |   | 1.74 |   |
| Granted                          |       | 625,000                  |       | 2.69                                       |       | — |   | — |   |
| Canceled                         |       | (335,001                 | )          | 2.96                                       |       | (10,000 | ) | 3.60 |   |
| Exercised                        |       | (145,166                 | )          | 1.66                                       |       | (725,000 | ) | 1.42 |   |
| Balance, December 25,  2004 |       | 1,301,333                |       | 2.85                                       |       | 347,500 |   | 2.35 |   |
| Granted                          |       | 40,000                   |       | 4.99                                       |       | — |   | — |   |
| Canceled                         |       | (355,500                 | )          | 2.80                                       |       | (13,334 | ) | 3.60 |   |
| Exercised                        |       | (202,500                 | )          | 2.56                                       |       | (191,666 | ) | 1.49 |   |
| Balance, December 31,  2005 |       | 783,333                  |       | $                                          | 3.04       |   | 142,500 |   | $ | 3.38 |   |

 

Tax benefits on stock options exercised arerecorded as increases to additional paid-in capital and totaled $330,559,$315,017 and $830,371 for fiscal 2005, 2004 and 2003, respectively.

 

The following table summarizes informationabout stock options outstanding and exercisable at December 31, 2005:

 
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life  (in years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-----------------------------------------|------------|--------------------------|------------|------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| $2.10 - $2.99                           |       |                     | 453,333    |                                                                         | 2.3        |                                   | $          | 2.67                     |       | 366,666                                |       | $ | 2.71 |   |
| $3.08 - $3.60                           |       |                     | 407,500    |                                                                         | 1.7        |                                   | $          | 3.28                     |       | 368,333                                |       | $ | 3.25 |   |
| $4.20 - $5.00                           |       |                     | 65,000     |                                                                         | 3.9        |                                   | $          | 4.83                     |       | 20,000                                 |       | $ | 4.50 |   |
|                                    |       |                     | 925,833    |                                                                         | 2.2        |                                   | $          | 3.09                     |       | 754,999                                |       | $ | 3.02 |   |

 

The table below summarizes the number ofexercisable options outstanding and the weighted average exercise prices foreach of the previous three fiscal years:

 
| ** **              | ** ** | **Plan Options**                     | ** ** | **Non-Plan Options**                      | ** ** |
|-------------------------|------------|-------------------------------------------|------------|------------------------------------------------|------------|
| ** **              | ** ** | **Exercisable Options  Outstanding** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Exercisable Options  Outstanding** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| December 31,  2005 |       | 636,666                                   |       | $                                              | 2.97       |   | 118,333 |   | $ | 3.34 |   |
| December 25,  2004 |       | 553,555                                   |       | $                                              | 2.89       |   | 275,833 |   | $ | 2.02 |   |
| December 27,  2003 |       | 603,997                                   |       | $                                              | 2.51       |   | 940,000 |   | $ | 1.47 |   |

 

47

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**10.****        ****Income Taxes:**

 

The provision for income taxes consisted ofthe following for the years ended December 31, 2005, December 25,2004 and December 27, 2003:

 
| ** **                        | ** ** | **2005** | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------|------------|----------|------------|------------|------------|------------|------------|
| Current:                          |       |     |       |       |       |       |       |
| Federal                           |       | $        | —     |       | $          | —     |       | $ | — |   |
| State                             |       | —   |       | (83,855    | )          | —     |       |
|                              |       | —   |       | (83,855    | )          | —     |       |
| Deferred:                         |       |     |       |       |       |       |       |
| Federal                           |       | (193,655 | )          | (1,220,220 | )          | (559,000   | )          |
| State                             |       | (27,589  | )          | (102,664   | )          | (82,861    | )          |
|                              |       | (221,244 | )          | (1,322,884 | )          | (641,861   | )          |
| Total  provision for income taxes |       | $        | (221,244   | )          | $          | (1,406,739 | )          | $ | (641,861 | ) |

 

The following table provides a reconciliationbetween the amount determined by applying the statutory federal income tax rateto the pretax income amount for the years ended December 31, 2005, December 25,2004 and December 27, 2003:

 
| ** **                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**   | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Provision at  statutory rate      |       | $        | (170,588   | )        | $          | (1,204,094 | )          | $ | (575,900 | ) |
| State income  tax, net            |       | (24,530  | )          | (173,530 | )          | (54,961    | )          |
| Nondeductible  expenses and other |       | (26,126  | )          | (29,115  | )          | (11,000    | )          |
| Income tax  provision             |       | $        | (221,244   | )        | $          | (1,406,739 | )          | $ | (641,861 | ) |

 

The income tax effects of loss carryforwards andtemporary differences between financial and income tax reporting that give riseto the deferred income tax asset and liability are as follows as of December 31,2005 and December 25, 2004:

 
| ** **                                                | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------------|------------|------------|------------|------------|------------|
| **Deferred Tax Asset – current** |       |       |       |       |       |
| Net  operating loss carryforward                          |       | $          | 827,000    |       | $          | 639,000 |   |
| Allowance  for doubtful accounts                          |       | 73,000     |       | 35,000     |       |
| Accrued  liabilities                                      |       | 413,000    |       | 292,000    |       |
| Other                                                     |       | 493,718    |       | 375,723    |       |
|                                                      |       | 1,806,718  |       | 1,341,723  |       |
| **Deferred  Tax Liability – noncurrent**             |       |       |       |       |       |
| Depreciation  and amortization                            |       | (2,208,530 | )          | (1,829,252 | )          |
| AMT minimum  tax credit carryforward                      |       | 31,390     |       | 41,000     |       |
|                                                      |       | (2,177,140 | )          | (1,788,252 | )          |
| Net deferred  tax liability                               |       | $          | (370,422   | )          | $          | (446,529 | ) |

 

The Company experienced significant netlosses in prior fiscal years resulting in a net operating loss (“NOL”) carryforwardfor federal income tax purposes of approximately $2.4 million at December 31,2005. The Company’s NOL will begin to expire in varying amounts between 2010and 2018. The Company also has an alternative minimum tax (“AMT”) creditcarryforward for federal income tax purposes of $31,390 at December 31,2005.

 

Generally accepted accounting principlesrequire that a valuation allowance be established when it ismore-likely-than-not that all or a portion of a deferred tax asset will not berealized. Changes in valuation allowances from period to period are included inthe tax provision in the period of change. In determining whether a valuationallowance is required, the Company takes into account all positive and negativeevidence with regard to the utilization of a deferred tax asset including ourpast earnings history, expected future earnings, the character and jurisdictionof such earnings, unsettled circumstances that, if unfavorably resolved, wouldadversely affect utilization of a deferred tax asset, carryback andcarryforward periods and tax strategies that could potentially enhance thelikelihood of realization of a deferred tax asset. The Company provides forincome taxes at a rate equal to the combined federal and state effective rates,which approximated 39% under current tax rates.

 

48

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**11.****         Business****Segments andSignificant Customers:**

 

For the year ended December 31, 2005,Wal*Mart (including its SAM’s Clubs) and Vistar, a national vending distributor,were the only two customers accounting for more than 10% of total Companyrevenue. Wal*Mart accounted for $14,043,000, or 19%, $14,211,000, or 21%, and$13,237,000, or 20%, for fiscal years 2005, 2004 and 2003, respectively. Vistaraccounted for $8,504,000, or 11%, $9,373,000, or 14%, and $8,751,000, or 13%,for fiscal years 2005, 2004 and 2003, respectively.

 

The Company’s operations consist of two segments:manufactured products and distributed products. The manufactured productssegment produces potato chips, potato crisps and potato skins for saleprimarily to snack food distributors and retailers. The distributed productssegment sells snack food products manufactured by other companies to theCompany’s Arizona snack food distributors. The Company’s reportable segmentsoffer different products and services. All of the Company’s revenues areattributable to external customers in the United States and Canada and all ofits assets are located in the United States.

 
| ** **                                    | ** ** | **Percent of Total Revenues** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Branded  products                             |       | 93                                           | %          | 94 | % | 91 | % |
| Private  label products                       |       | 3                                            | %          | 3 | % | 3 | % |
| Total  manufactured products segment revenues |       | 96                                           | %          | 97 | % | 94 | % |
|                                          |       |                                         |       |   |   |   |   |
| Distributed  products segment revenues        |       | 4                                            | %          | 3 | % | 6 | % |
|                                          |       |                                         |       |   |   |   |   |
| Total  revenues                               |       | 100                                          | %          | 100 | % | 100 | % |

 

In fiscal years 2005, 2004 and 2003, theT.G.I. Friday’s® brand snacks represented 65%, 72% and 61%, respectively, ofthe Company’s total net revenues. Effective February 1, 2004, the Companyceased distribution of Snyders’ pretzels which represented approximately 50%,or $2 million, of distributed products segment revenues in 2003.

 

The accounting policies of the segments arethe same as those described in the Summary of Significant Accounting Policies(Note 1). The Company does not allocate assets, selling, general andadministrative expenses, income taxes or other income and expense to segments.

 
| ** **                                                      | ** ** | **Manufactured  Products** | ** ** | **Distributed  Products** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|------------------|------------|
| **2005**                                                        | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| Net revenues  from external customers                           |       | $                          | 72,028,649 |                      | $          | 3,303,892        |       | $ | 75,332,541 |   |
| Depreciation  and amortization included in segment gross profit |       | 842,238                    |       | —                    |       | 842,238          |       |
| Segment  gross profit                                           |       | 13,593,005                 |       | 498,133                   |       | 14,091,138       |       |
| ** **                                                      | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| **2004**                                                        | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| Net revenues  from external customers                           |       | $                          | 66,629,008 |                      | $          | 2,105,755        |       | $ | 68,734,763 |   |
| Depreciation  and amortization included in segment gross profit |       | 998,415                    |       | —                    |       | 998,415          |       |
| Costs  related to brand discontinuance                          |       | 1,414,759                  |       | —                    |       | 1,414,759        |       |
| Segment  gross profit                                           |       | 13,958,782                 |       | 306,012                   |       | 14,264,794       |       |
|                                                            |       |                       |       |                      |       |             |       |
| **2003**                                                        | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| Net revenues  from external customers                           |       | $                          | 62,278,649 |                      | $          | 4,139,187        |       | $ | 66,417,836 |   |
| Depreciation  and amortization included in segment gross profit |       | 943,541                    |       | —                    |       | 943,541          |       |
| Segment  gross profit                                           |       | 12,660,767                 |       | 657,754                   |       | 13,318,521       |       |

 

49

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The following table reconciles reportablesegment gross profit to the Company’s consolidated income before income taxprovision for the years ended December 31, 2005, December 25, 2004and December 27, 2003:

 
| ** **                                    | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-----------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Segment  gross profit                         |       | $           | 14,091,138 |        | $          | 14,264,794  |       | $ | 13,318,521 |   |
| Unallocated  amounts:                         |       |        |       |        |       |        |       |
| Selling,  general and administrative expenses |       | (13,638,684 | )          | (10,558,544 | )          | (13,290,660 | )          |
| Insurance  claim settlement income, net       |       | —      |       | —      |       | 1,918,784   |       |
| Interest  income (expense), net               |       | 49,274      |       | (164,797    | )          | (252,820    | )          |
| Income  before income taxes                   |       | $           | 501,728    |        | $          | 3,541,453   |       | $ | 1,693,825 |   |

 

**12.****        ****Litigation:**

 

The Company isperiodically a party to various lawsuits arising in the ordinary course ofbusiness. Management believes, based on discussions with legal counsel, thatthe resolution of any such lawsuits will not have a material effect on thefinancial statements taken as a whole.

 

**13.****      ****Related Party Transactions:**

 

The land and building (140,000 square feet)occupied by the Company in Bluffton, Indiana is leased pursuant to a twentyyear lease dated May 1, 1998 with American Pacific Financial Corporation,an affiliate of Pate Foods Corporation from whom the Company purchased Wabashin October 1999. The lease extends through April 2018 and containstwo additional five-year lease renewal periods at the option of the Company.Lease payments are approximately $23,000 per month, plus CPI adjustments, andthe Company is responsible for all real estate taxes, utilities and insurance.American Pacific Financial Corporation is an affiliate of Capital Foods, LLCthe single largest shareholder of the Company, currently holding approximately21% of the outstanding shares of Common Stock.

 

50

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**14.****      ****Quarterly Financial Data(Unaudited):**

 

The results forany single quarter are not necessarily indicative of the Company’s results forany other quarter or the full year. The sum of quarterly earnings (loss) pershare information may not agree to the annual amount due to rounding anduse of the treasury stock method of calculating earnings (loss) per share.

 
| **(in 000’s, except for share and  per share data)** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Full Year** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| **Fiscal  2005**                                                                             |       |               |       |                |       |               |       |                |       |               |       |
| Net revenues                                                                                 |       | $                  | 16,557     |                | $          | 23,134             |       | $                   | 18,626     |               | $          | 17,016 |   | $ | 75,333 |   |
| Gross profit                                                                                 |       | 3,388              |       | 5,870               |       | 2,724              |       | 2,109               |       | 14,091             |       |
| Operating  income (loss)                                                                     |       | 340                |       | 2,275               |       | (509               | )          | (1,654              | )          | 452                |       |
| Net income  (loss) (1), (2)                                                                  |       | $                  | 208        |                | $          | 1,407              |       | $                   | (269       | )                  | $          | (1,066 | ) | $ | 280 |   |
|                                                                                         |       |               |       |                |       |               |       |                |       |               |       |
| Earnings  (loss) per common share:                                                           |       |               |       |                |       |               |       |                |       |               |       |
| Basic                                                                                        |       | $                  | 0.01       |                | $          | 0.07               |       | $                   | (0.01      | )                  | $          | (0.05 | ) | $ | 0.01 |   |
| Diluted                                                                                      |       | $                  | 0.01       |                | $          | 0.07               |       | $                   | (0.01      | )                  | $          | (0.05 | ) | $ | 0.01 |   |
|                                                                                         |       |               |       |                |       |               |       |                |       |               |       |
| Weighted  average number of common shares:                                                   |       |               |       |                |       |               |       |                |       |               |       |
| Basic                                                                                        |       | 19,647,561         |       | 19,681,902          |       | 19,842,862         |       | 20,053,509          |       | 19,763,992         |       |
| Diluted                                                                                      |       | 19,854,440         |       | 19,841,862          |       | 19,842,862         |       | 20,053,509          |       | 19,946,941         |       |

 

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(1)  Netincome (loss) during the third quarter of 2005 includes $535,000 in chargesassociated with slow-moving new product, mainly attributable to the Cinnabon®branded product.

 

(2)  Netincome (loss) during the fourth quarter of 2005 includes $553,000 in severancecharges for two executives and $615,000 in charges associated with slow-movingnew product, mainly attributable to the Cinnabon® branded product.

 
| **(in 000’s, except for share and  per share data)** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Full Year** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|
| **Fiscal  2004**                                                                             |       |               |       |                |       |               |       |                |       |               |       |
| Net revenues                                                                                 |       | $                  | 17,719     |                | $          | 17,441             |       | $                   | 17,176     |               | $          | 16,399 |   | $ | 68,735 |   |
| Gross profit                                                                                 |       | 3,580              |       | 2,687               |       | 4,305              |       | 3,693               |       | 14,265             |       |
| Operating  income                                                                            |       | 916                |       | 53                  |       | 1,610              |       | 1,127               |       | 3,706              |       |
| Net income                                                                                   |       | $                  | 534        |                | $          | 1                  |       | $                   | 956        |               | $          | 644 |   | $ | 2,135 |   |
|                                                                                         |       |               |       |                |       |               |       |                |       |               |       |
| Earnings per  common share:                                                                  |       |               |       |                |       |               |       |                |       |               |       |
| Basic                                                                                        |       | $                  | 0.03       |                | $          | 0.00               |       | $                   | 0.05       |               | $          | 0.03 |   | $ | 0.11 |   |
| Diluted                                                                                      |       | $                  | 0.03       |                | $          | 0.00               |       | $                   | 0.05       |               | $          | 0.03 |   | $ | 0.11 |   |
|                                                                                         |       |               |       |                |       |               |       |                |       |               |       |
| Weighted  average number of common shares:                                                   |       |               |       |                |       |               |       |                |       |               |       |
| Basic                                                                                        |       | 18,602,978         |       | 18,622,839          |       | 18,831,954         |       | 19,141,844          |       | 18,794,977         |       |
| Diluted                                                                                      |       | 19,317,706         |       | 19,164,767          |       | 19,202,074         |       | 19,319,000          |       | 18,947,553         |       |

 

51

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**15.****      ****Accounts Receivable Allowance:**

 

Changes to theallowance for doubtful accounts during the each of the three fiscal years endedDecember 31, 2005 are summarized below:

 
| ** **  | ** ** | **Balance at  beginning of period** | ** ** | **Charges  (Reductions) to  Expense** | ** ** | **(Write-offs)  Collections** | ** ** | **Balance at end  of period** | ** ** |
|-------------|------------|----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------|------------|-----------------------------------------|------------|
| Fiscal 2003 |       | $                                                  | 409,000    |                                       | 24,000     |                          | (86,000    | )                                       | $          | 347,000 |   |
| Fiscal 2004 |       | $                                                  | 347,000    |                                       | (112,000   | )                             | (146,000   | )                                       | $          | 89,000 |   |
| Fiscal 2005 |       | $                                                  | 89,000     |                                       | 83,000     |                          | 15,000     |                                    | $          | 187,000 |   |

 

**16.****      ****Concentrations of Credit Risk:**

 

The Company’s cashis placed with major banks. The Company, in the normal course of business,maintains balances in excess of Federal insurance limits.

 

The Company’sprimary concentration of credit risk is related to certain trade accountsreceivable. In the normal course of business, the Company extends unsecuredcredit to its customers. In 2005 and 2004, substantially all of the Company’scustomers were distributors or retailers whose sales were concentrated in thegrocery industry, throughout the United States. The Company investigates acustomer’s credit worthiness before extending credit. At December 31, 2005and December 25, 2004, two customers accounted for 23% and 32% of accountsreceivable, respectively.

 

**17.****        ****Subsequent Event:**

 

On February 14, 2006, the Companyterminated the non-binding letter of intent to acquire certain assets andliabilities of Shadewell Grove Foods, Inc., and Shadewell Grove IP, LLC,including licenses to produce and sell Mrs. Field’s® brand products. Acharge of approximately $175,000 to write-off deferred acquisition costs isincluded in the 2005 fourth quarter results.

 

52

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**EXHIBIT INDEX**

 
| 10.55* — |   | Form of Director Nonstatutory Stock  Option Agreement — 2005 Equity Incentive Plan.                                                                                                                                                             |
|---------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |   |                                                                                                                                                                                                                                                      |
| 10.56* — |   | Form of Employee Incentive Stock  Option Agreement — 2005 Equity Incentive Plan.                                                                                                                                                                |
|          |   |                                                                                                                                                                                                                                                      |
| 21.1 —   |   | List of subsidiaries of Poore Brothers, Inc.                                                                                                                                                                                                         |
|          |   |                                                                                                                                                                                                                                                      |
| 23.1 —   |   | Consent of Deloitte & Touche LLP.                                                                                                                                                                                                                |
|          |   |                                                                                                                                                                                                                                                      |
| 31 —     |   | Certification of Chief Executive Officer  and Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15(d)-14(a).                                                                                                                      |
|          |   |                                                                                                                                                                                                                                                      |
| 32 —     |   | Certification of Chief Executive Officer and  Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(b) and  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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* - Management compensatory plan or arrangement.

 

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