**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION**

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

#  

**FORM 10-K**

 

**(Mark One)**
| **ý** | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**     |
|------------|------------|----------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                     |
| ** ** | ** ** | **For  the fiscal year ended December 25, 2004**                                                    |
| ** ** | ** ** | ** **                                                                                               |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 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  incorporation or organization)                     |   | (I.R.S.  Employer Identification No.) |
|                                                                                 |   |                                  |
| **3500  South La Cometa Drive**                                                      |
| **Goodyear,  Arizona 85338**                                                         |
| (Address of  principal executive offices)(Zip Code)                                  |
|                                                                                 |   |                                  |
| Registrant’s  telephone number, including area code: **(623) 932-6200**    |
|                                                                                 |   |                                  |
| Securities  registered pursuant to Section 12(b) of the Act: **None** |

 

Securities registered pursuantto Section 12(g) of the Act:
| **Title of Class**            | ** ** | **Name of exchange on which registered** |
|-------------------------------|------------|------------------------------------------|
| Common  Stock, $.01 par value |       | Nasdaq                                   |

 

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 an accelerated filer (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 $26,187,413 based upon theclosing market price on June 25, 2004, the last business day of theRegistrant’s most recently completed second fiscal quarter.

 

The number of issued and outstanding shares of Common Stock, $.01 parvalue, as of March 11, 2005 was 19,647,561.

 

 

----

 

DOCUMENTS INCORPORATED BYREFERENCE

 

Portions of the Proxy Statement for the Registrant’s Annual Meeting ofShareholders to be held on May 17, 2005 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,Current Reports on Form 8-K, Proxy Statement on Schedule 14Arelated to the Company’s Annual Shareholders Meeting, and any amendments tothose reports or statements filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934.

 

2

----

 

**TABLE OFCONTENTS**

 
| **PART I**   |                                                                                                                |
|-------------------|---------------------------------------------------------------------------------------------------------------------|
|              |                                                                                                                |
| Item 1.           | Business                                                                                                            |   |
| 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  Shareholder Matters                    |   |
| Item 13.          | Certain Relationships and Related  Transactions                                                                     |   |
| Item 14.          | Principal Accountant Fees and Services                                                                              |   |
|              |                                                                                                                |   |
| **PART IV**  |                                                                                                                |
|              |                                                                                                                |   |
| Item 15.          | Exhibits and Financial Statement Schedules                                                                          |   |

 

 

3

----

 

**CAUTIONARYSTATEMENT REGARDING****FORWARD-LOOKINGSTATEMENTS**

 

ThisAnnual Report on Form 10-K, including all documents incorporated byreference, includes “forward-looking” statements within the meaning of Section 27Aof the Securities Act of 1933, as amended (the “Securities Act”) and Section 21Eof the Securities Exchange Act of 1934, as amended, and the Private SecuritiesLitigation Reform Act of 1995, and Poore Brothers, Inc. (the “Company”)desires to take advantage of the “safe harbor” provisions thereof.  Therefore, the Company is including thisstatement for the express purpose of availing itself of the protections of thesafe harbor with respect to all of such forward-looking statements. In this AnnualReport on Form 10-K, the words “anticipates,” “believes,” “expects,”“intends,” “estimates,” “projects,” “will likely result,” “will continue,” “future”and similar terms and expressions identify forward-looking statements. Theforward-looking statements in this Annual Report on Form 10-K reflectthe 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 integrationof acquired 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, significant competition,risks related to the food products industry, volatility of the market price ofthe Company’s common stock, par value $.01 per share (the “Common Stock”), thepossible de-listing of the Common Stock from the Nasdaq SmallCap Market if theCompany fails to satisfy the applicable listing criteria (including a minimumshare price) in the future and those other risks and uncertainties discussedherein, that could cause actual results to differ materially from historicalresults or those anticipated.  In lightof these risks and uncertainties, there can be no assurance that theforward-looking information contained in this Annual Report on Form 10-Kwill in fact transpire or prove to be accurate. Readers are cautioned to consider the specific risk factors describedherein and in “Risk Factors,” and not to place undue reliance on theforward-looking statements contained herein, which speak only as of the datehereof. The Company undertakes no obligation to publicly revise theseforward-looking statements to reflect events or circumstances that may ariseafter the date hereof. All subsequent written or oral forward-lookingstatements attributable to the Company or persons acting on its behalf areexpressly qualified in their entirety by this section.

 

4

----

 

**Item 1.  Business**

 

**Description of Business**

 

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 and sells nationally T.G.I. Friday’s®brand salted snacks under license from TGI Friday’s Inc.  The Company also currently (i) manufacturesand sells regionally its own brands of salted snack food products, includingPoore Brothers®, Bob’s Texas Style®, and Boulder Potato Company® brandbatch-fried potato chips and Tato Skins® brand potato snacks, (ii) manufacturesprivate label potato chips for grocery retail chains in the southwest, and (iii)distributes in Arizona snack food products that are manufactured byothers.  The Company sells its T.G.I.Friday’s® brand salted snack products to mass merchandisers, grocery, club anddrug stores directly and to primarily convenience stores and vend operatorsthrough independent distributors.  TheCompany’s other brands are also sold through independent distributors.  For the fiscal years 2004, 2003 and 2002, netrevenues totaled $68,734,763, $66,417,836 and $59,348,471, respectively, andT.G.I. Friday’s® brand salted snacks represented 72%, 61% and 60%,respectively, of the Company’s total net revenues.  See Note 11 “*BusinessSegments and Significant Customers*” to the financial statementsincluded in Item 8.

 
| ** **                                    | ** ** | **Percent of Total Revenues** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| Branded  products                             |       | 94                            | %          | 91 | % | 90 | % |
| Private  label products                       |       | 3                             | %          | 3 | % | 3 | % |
| Total  manufactured products segment revenues |       | 97                            | %          | 94 | % | 93 | % |
|                                          |       |                          |       |   |   |   |   |
| Distributed  products segment revenues        |       | 3                             | %          | 6 | % | 7 | % |
|                                          |       |                          |       |   |   |   |   |
| 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 salted snacks and TatoSkins® brand potato snacks are offered in several different flavors andformulations.  All of these products aremanufactured at the Company’s leased facility in Bluffton, Indiana, except forMozzarella Snack Sticks, Onion Rings and Hot Pepper Jack Cheese Fries productswhich are produced by contract manufacturers on behalf of the Company and soldunder the T.G.I. Friday’s® brand name.

 

Poore Brothers®, Bob’s Texas Style® andBoulder Potato Company® brand potato chips are manufactured with a batch-fryingprocess that the Company believes produces potato chips with enhanced crispnessand flavor. Poore Brothers® potato chips are currently offered in ten flavors,Bob’s Texas Style® and Boulder Potato Company® potato chips are each offered inseven flavors.  The Company alsomanufactures potato chips for sale on a private label basis using a continuousfrying process.  The Company’s potatochips are manufactured at a Company-owned facility 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 innovativesnack food brands that provide strategic fit and possess strong national brandequity in order to expand, complement or diversify the Company’s existingbusiness.  The Company also plans toincrease sales of its existing brands and continue to improve profit marginsthrough increased operating efficiencies and manufacturing capacityutilization.  See “*Business Strategy*.”

 

The Company’s executive offices are locatedat 3500 South La Cometa Drive, Goodyear, Arizona 85338, and its telephonenumber is (623) 932-6200.

 

5

----

 

**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 Company completedan initial public offering of its Common Stock. In November 1998, the Company acquired the business and certainassets (including the Bob’s Texas Style® potato chip brand) of Tejas Snacks,L.P. (“Tejas”), a Texas-based potato chip manufacturer.  In October 1999, the Company acquiredWabash Foods, LLC (“Wabash”) including the Tato Skins®, O’Boisies®, andPizzarias® trademarks, the Bluffton, Indiana manufacturing operation andassumed all of Wabash Foods’ liabilities. In June 2000, the Company acquired Boulder Natural Foods, Inc.(“Boulder”) and the Boulder Potato Company® brand of totally natural potatochips.  As part of the Boulderacquisition, the Company was required to issue additional unregistered sharesof Common Stock to the seller on each of the first three anniversaries of theclosing of the acquisition.  The issuanceof such shares was dependent upon increases in sales of Boulder product ascompared to previous periods.  In 2003,2002 and 2001, the Company was required to issue 93,728 shares valued at$420,566, 88,864 shares valued at $210,786 and 57,898 shares valued at$185,274, respectively.  With eachissuance of shares the Company increased the goodwill recorded from thisacquisition.

 

In October 2000, the Company launchedits T.G.I. Friday’s® brand salted snacks pursuant to a license agreement withTGI Friday’s Inc., which expires in 2014.

 

On December 27, 2001, the Companycompleted the sale of 586,855 shares of Common Stock at an offering price of$2.13 per share to BFS US Special Opportunities Trust PLC, a fund managed byRenaissance Capital, in a private placement transaction.

 

In June 2003, the Company launched itsCrunch Toons® brand potato snacks, initially featuring characters pursuant to amulti-year license agreement with Warner Bros. Consumer Products.  The Company decided to discontinue the brandin June 2004 and amended its license agreements with Warner Bros. ConsumerProducts.  See *“Note7.  Brand Discontinuance.”*

 

In September 2004, the Company signed amulti-year license agreement with Cinnabon, Inc. pursuant to which theCompany plans to develop and sell a variety of snack products, to includecookies and bars under the Cinnabon® brand.

 

### **BusinessStrategy**

 

The Company has recently developed a moreaggressive strategic plan to achieve a new long-term vision of being a $200million marketer of *Intensely Different*TMfood brands.  The Company’s businessstrategy is to continue building a diverse portfolio of national niche foodbrands with annualized revenues of $20 million to $50 million each throughlicensing, acquisition or development. This represents a broadening of the Company’s strategy which previouslywas focused exclusively on salted snack foods. The goals of this new strategy are to (i) capitalize on nationalniche market opportunities, (ii) deliver incremental category growth forretailers, (iii) provide product innovation targeted to a defined consumersegment, (iv) complement, rather than compete directly against, largenational 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.  The primary elements of the Company’slong-term business strategy are as follows:

 

*Develop,Acquire or License Innovative Food Brands.*  A significant element of the Company’sbusiness strategy is to develop, acquire or license new innovative food brandsthat provide strategic fit and possess strong national brand equity in order toexpand, complement or diversify the Company’s existing business.  In October 2000 the Company initiatedthis element of its strategy by launching its first national niche brand,T.G.I. Friday’s® brand salted snacks, under an exclusive license from TGIFriday’s Inc.  In June 2003 theCompany launched its second national niche brand, Crunch Toons®, featuringLooney TunesTM characters, under a multi-year agreement with Warner Bros.Consumer Products.  This brand launch wasunsuccessful and the brand was discontinued in June 2004.  The Company signed a license agreement in September 2004to develop and sell Cinnabon® brand salted snacks, shelf-stable cookies andbreakfast/snack bars under an exclusive license from Cinnabon, Inc.  These products are expected to commenceinitial shipments in the second quarter of 2005.  The Company plans to continue developing,acquiring or licensing additional national niche brands.

 

6

----

 

*BroadenDistribution of Existing Brands.*  The Company plans to increase distributionand build the market share of its existing branded products through selectedtrade activity in various existing or new markets and channels.  For example, the Company plans to expandsales to Canadian customers that it commenced in 2004 and is exploring otherinternational market opportunities 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, the Company plans to continueits innovation activities to identify and develop (i) new line extensionsfor its brands, such as new flavors or products, and (ii) new food segmentsin which to expand the brand’s presence. For example, in the second quarter of 2005 the Company plans to commenceinitial shipments of a new line of tender meat snacks under the T.G.I. Friday’s®brand.  In June 2000 the Companyacquired the Boulder Potato Company® brand natural potato chips and plans in2005 to re-position this brand.  Thiswould allow the Company to identify potential additional food segments besidessalted snacks in which to develop and launch new products.

 

*LeverageInfrastructure and Capacity.*  The Company’s Indiana and Arizona facilitiesare currently operating at approximately 40% and 50% of their respectivemanufacturing capacities.  The Companycurrently has arrangements with several grocery chains for the manufacture anddistribution by the Company of their respective private label potato chips andbelieves that additional contract manufacturing opportunities exist.  While they are extremely price competitiveand can be short in duration, the Company believes that they may provide aprofitable opportunity for the Company to improve the capacity utilization ofits facilities.  The Company intends toseek additional private label and contract manufacturing customers located nearits facilities who demand superior 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 increase gross profitmargins through increased revenues, improved operating efficiencies, and highermargin new products.  It believes thatadditional improvements to its manufactured products’ gross profit margins arepossible with the achievement of the business strategies discussed above.  Depending on product mix, the Companybelieves that the existing manufacturing facilities could produce, in theaggregate, up to $150 million in annual revenue volume and thereby furtherreduce manufacturing product costs as a percentage of net revenue.

 

#### **Products**

#### ** **

*ManufacturedSnack Food Products*.  The Company produces T.G.I. Friday’s® brandPotato Skins salted snacks and Tato Skins® brand potato crisps utilizing asheeting and frying process.  T.G.I.Friday’s® brand salted snacks and Tato Skins® brand potato crisps are offeredin several different flavors and formulations. All of these products aremanufactured at the Company’s leased facility in Bluffton, Indiana, except forMozzarella Snack Sticks, Onion Rings and Hot Pepper Jack Cheese Fries productswhich are produced by contract manufacturers on behalf of the Company and soldunder the T.G.I. Friday’s® brand name. The Company expects that its licensed Cinnabon® brand salted snacks,packaged cookies and breakfast/snack bars will be produced by contractmanufacturers and sold under the Cinnabon® name.

 

Poore Brothers®, Bob’s Texas Style®, andBoulder Potato Company® brand potato chips are produced utilizing abatch-frying process and are marketed by the Company as premium products basedon their distinctive combination of cooking method and variety of distinctiveflavors.  Poore Brothers® potato chipsare currently offered in ten flavors, Bob’s Texas Style® and Boulder PotatoCompany® potato chips are each offered in seven flavors.. The Company currentlyhas agreements with several grocery chains pursuant to which the Companyproduces their respective private label potato chips in the styles and flavorsspecified by each grocery chain.

 

*DistributedSnack Food Products*.  The Company purchases and resells throughoutArizona snack food products manufactured by others.  Such products include pretzels, popcorn,dips, and meat snacks.  Effective February 1,2004, the Company ceased distribution of Snyders’ pretzels which representedapproximately 50%, or $2 million, of the distributed products segment revenuesin 2003.  This revenue loss did not havea material adverse effect on the Company’s overall profitability in 2004.

 

7

----

 

**Manufacturing**

 

The Company’s manufacturing facility inBluffton, Indiana includes three fryer lines that can produce an aggregate ofup to approximately 9,000 pounds per hour of T.G.I. Friday’s® and Tato Skins®brand products.  The Indiana facility iscurrently operating at approximately 40% of capacity.  Certain T.G.I. Friday’s® and Tato Skins®brand products are produced utilizing a sheeting and frying process thatincludes some patented technology.  SomeT.G.I. Friday’s® brand salted snack products are produced by contractmanufacturers on behalf of the Company. See “*Patents, Trademarks and Licenses*.”

 

The Company believes that a key element ofthe success to date of the Poore Brothers®, Bob’s Texas Style® and BoulderPotato Company® brand potato chips has been the Company’s use of certaincooking techniques and key ingredients in the manufacturing process to producepotato chips with improved flavor.  Thesetechniques currently involve two elements: the Company’s use of a batch-fryingprocess, as opposed to the conventional continuous line cooking method, and theCompany’s use of distinctive seasonings to produce potato chips in a variety offlavors.  The Company believes thatalthough the batch- frying process produces less volume, it is superior toconventional continuous line cooking methods because it enhances crispness andflavor through 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 owns additional batch-fryingequipment which, if needed, could be installed without significant time orcost, and which would result in increased capacity to produce the batch-friedpotato chips.  The Arizona facility iscurrently operating 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 attributesthe success of its products in these markets to consumer loyalty.  The Company believes this loyalty resultsfrom the products’ differentiated taste, texture and flavor variety whichresult from its manufacturing processes. The Company has retained Acosta, Inc., a leading national sales andmarketing agency with employees and offices nationwide to represent T.G.I.Friday’s® brand salted snacks on behalf of the Company in the grocery andconvenience store channels.  T.G.I.Friday’s® brand salted snacks are now sold in nearly 50% of U.S. grocery storesnationwide and in over 75% of the top 50 convenience store chains.  The Company’s own sales organization sellsT.G.I. Friday’s® brand salted snacks in the mass, club and drug channels.  The Company also obtains significant sales onT.G.I. Friday’s® brand salted snacks in the vending channel nationwide throughan independent network of brokers and distributors.  The Company expects to use these same sellingand distribution methods to achieve a strong retail presence on its line ofCinnabon® branded products, which it expects to begin shipping in the secondquarter of 2005.

 

The Company’s potato chip brands aredistributed to grocery and other retailers primarily by a select group ofindependent distributors.  PooreBrothers® brand potato chip products have achieved significant market presencein 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 Boulder Potato Company® brandpotato chip products have achieved significant market presence in Colorado andin natural food stores nationwide.  TheCompany selects brokers and distributors for its branded products primarily onthe basis of quality of service, call frequency on customers, financialcapability and relationships they have with supermarkets and vendingdistributors, including access to shelf space for snack food.

 

The Company’s distribution throughout Arizonaincludes 51 independently operated service routes.  Each route is operated by an independentdistributor who purchases from the Company and merchandises as many as 72 itemsat major grocery store chains in Arizona, such as Albertson’s, Basha’s, Fry’s,and Safeway stores.  In addition toservicing major supermarket chains, the Company’s distributors service manyindependent grocery stores, club stores, and military facilities throughoutArizona.  In addition to Poore Brothers®brand products, the Company distributes throughout Arizona a wide variety ofsnack food items manufactured by other companies, including pretzels, popcorn,dips, and meat snacks.

 

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

 

8

----

 

Successful marketing of the Company’sproducts depends, in part, upon obtaining adequate shelf space for such products,particularly in supermarkets and vending machines.  Frequently, the Company incurs additionalmarketing costs in order to obtain additional shelf space.  Whether or not the Company will continue toincur such costs in the future will depend upon a number of factors including,demand for the Company’s products, relative availability of shelf space andgeneral competitive conditions.  TheCompany may incur significant shelf space, consumer marketing or otherpromotional costs as a necessary condition of entering into competition ormaintaining market share in particular markets or channels.  Any such costs may materially affect theCompany’s financial performance.

 

The Company’s marketing programs are designedto increase product trial and build brand awareness in core markets.  Most of the Company’s marketing spending hastraditionally been focused on trade advertising and trade promotions designedto attract new consumers to the products at a reduced retail price, except in2003, when the Company conducted national television advertising and couponprograms in connection with the launch of the Crunch Toons® brand.  The Company’s marketing programs also includeselective event sponsorship designed to increase brand awareness and to provideopportunities to mass sample branded products. Sponsorship of the Arizona Diamondbacks typifies the Company’s effortsto reach targeted consumers and provide them with a sample of the Company’sproducts to encourage new and repeat purchases.

 

**Suppliers**

 

The principal raw materials used by theCompany are potatoes, potato flakes, wheat flour, corn and oil.  The Company believes that the raw materialsit needs to produce its products are readily available from numerous supplierson commercially reasonable terms. Potatoes, potato flakes, wheat flour and corn are widely availableyear-round.  The Company uses a varietyof oils in the production of its products and the Company believes thatalternative sources for such oils, as well as alternative oils, are readilyabundant and available.  The Company alsouses seasonings and packaging materials in its manufacturing process.

 

The Company chooses its suppliers basedprimarily on price, availability and quality and does not have any long-termcommitments with any supplier.  Althoughthe Company believes that its required products and ingredients are readilyavailable, and that its business success is not dependent on any singlesupplier, the failure of certain suppliers to meet the Company’s performancespecifications, quality standards or delivery schedules could have a materialadverse effect on the Company’s operations. In particular, a sudden scarcity, a substantial price increase, or anunavailability of product ingredients could materially adversely affect theCompany’s operations.  There can be noassurance that alternative ingredients would be available when needed and oncommercially attractive 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 21% and 14%, respectively, of theCompany’s 2004 net revenues.  Theremainder of the Company’s revenues were derived from sales to a limited numberof additional customers, either grocery chains, club stores or regionaldistributors, none of which individually accounted for more than 10% of theCompany’s revenues in 2004.  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 the Company’s assets are located inthe United States.

 

### **MarketOverview and Competition**

### ** **

According to the Snack Food Association (“SFA”),the U.S. market for salted snack foods reached $23.5 billion at retail in 2003(the latest year for which data is available) with potato chips, tortilla chipsand potato crisps, accounting for nearly 50% of the market, and corn snacks,popcorn, pretzels, nuts, meat snacks and other products accounting for thebalance.  Total salted snack sales, indollar terms, increased in each of the last ten years, ranging from an increaseof 8.5% (in 1997) to 0.3% (in 1995), with a 2003 increase of 4.5%.  Potato chip, tortilla chips and potato crispscombined sales in 2003 were $10.6 billion, a 0.2% increase over 2002 sales of$10.4 billion.

 

The Company expects to test-market newCinnabon® branded products, such as bars and cookies, in the first half of2005.

 

9

----

 

According to the Snack Food Association (“SFA”),the U.S. market for bakery foods reached $34.7 billion at retail in 2003 (thelatest year for which data is available) with snack bars and cookies &crackers, accounting for nearly 40% of the market, and bread, baked sweetgoods, refrigerated & frozen baked goods and other products accountingfor the balance.

 

The Company’s products compete generallyagainst other snack foods, including potato chips, tortilla chips, cookies,etc.  The snack food industry is largeand highly competitive and is dominated by large food companies, includingFrito-Lay, Inc., a subsidiary of PepsiCo, Inc., Nabisco, Keebler andKraft.  These Companies possesssubstantially greater financial, production, marketing, distribution and otherresources than the Company and brands that are more widely recognized than theCompany’s products.  Numerous othercompanies that are actual or potential competitors of the Company, many withgreater financial and other resources (including more employees and moreextensive facilities) than the Company, offer products similar to those of theCompany.  In addition, many of suchcompetitors offer a wider range of products than offered by the Company.  Local or regional markets often havesignificant smaller competitors, many of whom offer products similar to thoseof the Company.  Expansion of the Company’soperations into new markets has and will continue to encounter significantcompetition from national, regional and local competitors that may be greaterthan that encountered by the Company in its existing markets.  In addition, such competitors may challengethe Company’s position in its existing markets. While the Company believes that it has innovative products and methodsof operation that will enable it to compete successfully, there can be noassurance 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 competesin the market principally on the basis of 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 is 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 not have exclusive rights tothe use of either element; consequently, competitors may incorporate suchelements 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 the Nutrition Labeling and Education Act of 1990 (“NLEA”),which requires specified nutritional information to be disclosed on allpackaged foods, concerning labeling of food products, including permissible useof nutritional claims such as “fat-free” and “low-fat,” became effective.  The Company believes that it is complying inall material respects with the NLEA regulations and closely monitors the fatcontent of its products through various testing and quality controlprocedures.  The Company does not believethat compliance with the NLEA regulations materially increases the Company’smanufacturing 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.  Whilethere are four parts to the Act, only two of the provisions impact theCompany.  One requirement for the Companywas registration with the FDA as a U.S. Food Manufacturing Company, which theCompany completed prior to the required date of December 12, 2003.  The second of the Act’s provisions pertainingto the Company relates to record retention. 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 is effective January 1, 2005,and the Company believes it is currently compliant 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 fat be declared on a separate line inthe standard Nutrition Facts below total fat and saturated fat and becalculated to the nearest 0.5 grams, unless it is less than 0.5 grams in whichcase it may be expressed as 0 grams. Currently, the Company has plans in place to comply with the FDA’s rule onTrans Fat Labeling by the January 1, 2006 deadline.

 

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 theCompany.  Such changes could affect salesof the Company’s products and have a material adverse 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.  TheCompany believes that it presently complies in all material respects with suchlaws and regulations.

 

10

----

 

### **Employees**

### ** **

As of December 25, 2004, the Company had271 full-time employees, including 225 in manufacturing and distribution, 21 insales and marketing and 25 in administration and finance.  The Company’s employees are not represented byany collective bargaining organization and the Company has never experienced awork stoppage.  The Company believes thatits 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 agreementbetween the Company and Miles Willard, the Company has an exclusive right touse the patented technology within North America until the patents expirebetween 2004 and 2008.  In considerationfor the use of these patents, the Company is required to make royalty paymentsto Miles Willard on sales of products manufactured utilizing the patentedtechnology.  The Company does not believethat the expiration of these patents will have an adverse effect on the Company.

 

TheCompany licenses the T.G.I. Friday’s® brand salted snacks trademark from TGIFriday’s Inc. under a license agreement with a term expiring in 2014.  Pursuant to the license agreement, theCompany is required to make royalty payments on sales of T.G.I. Friday’s® brandsalted snack products and is required to achieve certain minimum sales levelsby certain dates during the contract term.

 

TheCompany licenses the Cinnabon® brand for salted snacks, shelf-stablepackaged cookies 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 its existing T.G.I. Friday’s® and Cinnabon® productlines through the introduction of new products in salted snacks as well asother food categories.

 

TheCompany owns the following trademarks in the United States: Poore Brothers®, AnIntensely Different Taste®, Texas Style®, Boulder Potato Company®, 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 ofany circumstances that would have a material adverse effect on the Company’sability to use its trademarks. Any termination of the Company’s license agreements, whether at theexpiration of its term or prior thereto, could have a material adverse effecton the Company’s financial condition and results of operations.

 

### **RiskFactors**

### ** **

The following factors could affect operatingresults and should be considered in evaluating the Company.

 

*SignificantFuture Expenses due to Implementation of Business Strategy.*The Company has recently developed a more aggressive strategic plan to achievea new long-term vision of being a $200 million marketer of *IntenselyDifferent*TM food brands. Such action is subject to the substantial risks, expenses anddifficulties frequently encountered in the implementation of a new businessstrategy.  Even if the Company issuccessful in developing, acquiring and/or licensing new brands, and increasingdistribution and sales volume of the Company’s existing products, it mayrequire the Company to incur substantial additional expenses, includingadvertising and promotional costs, “slotting” expenses (i.e., the cost of obtainingshelf space in certain grocery stores), and integration costs of any futureacquisitions. Accordingly, the Company may incur additional losses in thefuture as a result of the implementation of the Company’s business strategy,even if revenues increase significantly. There can be no assurance that theCompany will be able to implement its new strategic plan, that its businessstrategy will prove successful or that it will be able to maintainprofitability during such implementation.

 

11

----

 

*Need forAdditional Financing.*  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/or diversifyingthe Company’s business. In connection with each of the Company’s previous brandacquisitions, the Company borrowed funds or assumed additional indebtedness inorder to satisfy a substantial portion of the consideration required to be paidby the Company.  The Company may, in thefuture, require additional third party financing (debt or equity) as a resultof any future operating losses, in connection with the expansion of the Company’sbusiness through non-acquisition means, in connection with any additionalacquisitions completed by the Company, or to provide working capital forgeneral corporate purposes.  There can beno assurance that any such required financing will be available or, ifavailable, on terms attractive to the Company. Any third party financing obtained by the Company may result in dilutionof the equity interests of the Company’s shareholders.

 

*Acquisition-RelatedRisks.* A significant element of the Company’sbusiness strategy is the pursuit of selected strategic acquisition opportunitiesfor the purpose of expanding, complementing and/or diversifying the Company’sbusiness.   However, no assurance can begiven that the Company will be able to identify, finance and completeadditional suitable acquisitions on acceptable terms, or that futureacquisitions, if completed, will be successful. Any future acquisitions could divert management’s attention from thedaily operations of the Company and otherwise require additional management,operational and financial resources. Moreover, there can be no assurance that the Company will be able tosuccessfully integrate acquired companies or their management teams into theCompany’s operating structure, retain management teams of acquired companies ona long-term basis, or operate acquired companies profitably. Acquisitions mayalso involve a number of other risks, including adverse short-term effects onthe Company’s operating results, dependence on retaining key personnel andcustomers, and risks associated with unanticipated liabilities or contingencies.

 

*FinancialCovenants Pursuant to U.S. Bancorp Credit Agreement; Possible Acceleration ofIndebtedness.* At December 25, 2004, the Company had outstanding indebtednessunder a credit agreement with U.S. Bancorp (the “U.S. Bancorp Credit Agreement”)in the aggregate principal amount of $1,347,069. The indebtedness under theU.S. Bancorp Credit Agreement is secured by substantially all of the Company’sassets. The Company is required to comply with certain financial covenantspursuant to the U.S. Bancorp Credit Agreement so long as borrowings from U.S.Bancorp remain outstanding. Should the Company be in default under any of suchcovenants, U.S. Bancorp shall have the right, upon written notice and after theexpiration of any applicable period during which such default may be cured, todemand immediate payment of all of the then unpaid principal and accrued butunpaid interest under the U.S. Bancorp Credit Agreement.  At December 25, 2004, the Company was incompliance with all financial covenants under the U.S. Bancorp Credit Agreement(including minimum annual operating results, minimum fixed charge coverage andminimum tangible capital requirements). As the Company implements its business strategy, there can be noassurance 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 maturity dates could have amaterial adverse effect upon the Company. See “*Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations — Liquidity and Capital Resources*.”

 

*Volatilityof Market Price of Common Stock*. The market priceof the Common Stock has experienced a high level of volatility since thecompletion of the Company’s initial public offering in December 1996.Commencing with an offering price of $3.50 per share in the initial publicoffering, the market price of the Common Stock experienced a substantialdecline, reaching a low of $0.50 per share (based on last reported sale priceof the Common Stock on the Nasdaq SmallCap Market) on December 22, 1998.During fiscal 2004, the market price of the Common Stock (based on lastreported sale price of the Common Stock on the Nasdaq SmallCap Market) ranged froma high of $4.05 per share to a low of $2.07 per share.  The last reported sales price of the CommonStock on the Nasdaq SmallCap Market on March 11, 2005 was $3.25 per share.There can be no assurance as to the future market price of the Common Stock.  See *“Compliance with NasdaqListing Maintenance Requirements.”*

 

*Compliancewith Nasdaq Listing Maintenance Requirements.*  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 requirements is that the bidprice of listed securities be equal to or greater than $1.00.  If, in the future, the Company’s Common Stockfails to be in compliance with the minimum closing bid price requirement for atleast thirty consecutive trading days or the Company fails to be in compliancewith any other Nasdaq continued listing requirements, then the Common Stockcould be de-listed from the Nasdaq SmallCap Market. Upon any such de-listing,trading, if any, in the Common Stock would thereafter be conducted in theover-the-counter market on the so-called “pink sheets” or the “ElectronicBulletin Board” of the National Association of Securities Dealers, Inc. (“NASD”).As a consequence of any such de-listing, an investor could find it moredifficult to dispose of, or to obtain accurate quotations as to the price of,the Company’s Common Stock.  See *“Volatility of Market Price of Common Stock.”*

 

12

----

 

*Competition*.  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. Expansion of Company operations into newmarkets 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. Whilethe Company believes that its innovative products and methods of operation willenable it to compete successfully, there can be no assurance of its ability todo so.

 

*Promotionaland Shelf Space Costs.*  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 or otherpromotional costs as a necessary condition of entering into competition ormaintaining market share in particular markets or stores. If incurred, suchcosts may materially affect the Company’s financial performance.

 

*NoAssurance of Consumer Acceptance of Company’s Existing and Future Products*.  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. In the first half of 2005, the Companyplans to test-market new Cinnabon® brandedproducts, such as cookies and bars, as well as a new product category, meat snacks,several new salted snack products under the T.G.I. Friday’s® brand, andintends to introduce more new product lines in the future.  The success of new products will be key tothe success of the Company’s business plan and there can be no assurance thatthe Company will succeed in the development of any new products or that any newproducts developed by the Company will achieve market acceptance or generatemeaningful revenue for the Company.

 

*Risks fromInternational Expansion. *TheCompany plans to expand sales to Canadian customers that it commenced in 2004and is exploring other international market opportunities for its brands.  Such expansion may require significantmanagement attention and financial resources and may not produce desired levelsof revenue.  International business issubject to inherent risks, including longer accounts receivable collectioncycles, difficulties in managing operations across disparate geographicalareas, difficulties enforcing agreements and intellectual property rights,fluctuations in local economic, market and political conditions, compliancerequirements with U.S. and foreign export regulations, potential adverse taxconsequences and currency exchange rate fluctuations.

 

*Uncertaintiesand Risks of Food Product Industry.*  The food product industry in which theCompany is engaged is subject to numerous uncertainties and risks outside ofthe Company’s control.  Profitability inthe food product industry is subject to adverse changes in general business andeconomic conditions, oversupply of certain food products at the wholesale andretail levels, seasonality, the risk that a food product may be banned or itsuse limited or declared unhealthful, the risk that product tampering may occurthat may require a recall of one or more of the Company’s products, and therisk that sales of a food product may decline due to perceived health concerns,changes in consumer tastes or other reasons beyond the control of the Company.

 

*Fluctuationsin Prices of Supplies; Dependence Upon Availability of Supplies and Performanceof Suppliers.* The Company’s manufacturing costs are subject to fluctuations in theprices of potatoes, potato flakes, wheat flour, corn and oil, as well as otheringredients of the Company’s products. Potatoes, potato flakes, wheat flour and corn are widely availableyear-round.  The Company uses a varietyof oils in the production of its products. The Company is dependent on its suppliers to provide the Company withproducts and ingredients in adequate supply and on a timely basis.  Although the Company believes that itsrequirements for products and ingredients are readily available, and that itsbusiness success is not dependent on any single supplier, 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 suddenscarcity, a substantial

 

13

----

 

price increase, or an unavailability of product ingredients couldmaterially adversely affect the Company’s operations.  There can be no assurance that alternativeingredients would be available when needed and on commercially attractiveterms, if at all.

 

*Lack ofProprietary Manufacturing Methods for Certain 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 between 2004 and 2008.  Competitors of the Company, certain of whichmay have significantly greater resources than the Company, may utilizedifferent technology in the manufacture of products that are similar to thosecurrently manufactured, or that may in the future be manufactured, by theCompany.  The entry of any such productsinto the marketplace could have a material adverse effect on sales of T.G.I.Friday’s ® and Tato Skins® brand products, as well as any such future products,by the Company.

 

The taste and quality of Poore Brothers®, Bob’sTexas Style®, and Boulder Potato Company® brand potato chips is largely due totwo elements of the Company’s manufacturing process: its use of batch-fryingand its use of distinctive seasonings to produce a variety of flavors.  The Company does not have exclusive rights tothe use of either element; consequently, competitors may incorporate suchelements into their own processes.

 

*DependenceUpon Key Snack Food Brands; Dependence Upon T.G.I. Friday’s*®and *Cinnabon*®*LicenseAgreements and Future License Agreements**. *The Company derives a substantial portion of its revenue from a limitednumber of snack food brands.  For theyear ended December 25, 2004, over 70% of the Company’s net revenues wereattributable to the T.G.I. Friday’s® brand products and the PooreBrothers® brand products.  A decrease inthe popularity of a particular snack food brand during any year could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.  There can be noassurance that any of the Company’s snack food brands will retain theirhistorical levels of popularity or increase in popularity.  Any impact to a licensed brand’s reputationcould also lead to an impact on the Company’s snack food products associatedwith that brand.  Decreased sales fromany one of the key snack food brands without a corresponding increase in salesfrom other existing or newly introduced products would have a material adverseeffect on the Company’s financial condition and results of operations.  Furthermore, the T.G.I. Friday’s® brandproducts are manufactured and sold by the Company pursuant to a licenseagreement by and between the Company and TGI Friday’s Inc. which expires in 2014.  Pursuant to the license agreement, theCompany is subject to various requirements and conditions (including, withoutlimitation, minimum sales targets).  Thefailure of the Company to comply with certain of such requirements andconditions could result in the early termination of the license agreement byTGI Friday’s Inc.  Any termination of thelicense agreement, whether at the expiration of its term or prior thereto,could have a material adverse effect on the Company’s financial condition andresults of operations.

 

The Company may introduce one or more newproduct 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 licenseagreements, the Company will likely be subject to various requirements andconditions (including minimum sales targets or royalty payments).  The failure of the Company to comply withcertain of such requirements and conditions could result in the early terminationof such additional license agreements. Depending upon the success of any such new product lines, a terminationof the applicable license agreements, whether at the expiration of theirrespective terms or prior thereto, could have a material adverse effect on theCompany’s financial condition and results of operations.

 

*DependenceUpon Major Customers*.  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 21% and 14%, respectively, of theCompany’s 2004 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 2004.  A decision by any major customer to cease orsubstantially reduce its purchases could have a material adverse effect on theCompany’s business.

 

*Reliance onKey Employees*. The Company’s success is dependent in large part upon the abilities ofits executive officers, including Thomas W. Freeze, President and ChiefExecutive Officer, Glen E. Flook, Executive Vice President of Innovation,Thomas F. Tierney, Senior Vice President of Sales and Richard M. Finkbeiner,Senior Vice President and Chief Financial Officer.  The Company’s refocused business strategywill challenge its executive officers, and the inability of such officers toperform their duties or the inability of the Company to attract and retainother highly qualified personnel could have a material adverse effect upon theCompany’s business and prospects.

 

*GovernmentalRegulation.* The packaged food industry is subject to numerous federal, state andlocal governmental regulations, including those relating to the preparation,labeling and marketing of food products. The Company is particularly affected by the Nutrition Labeling andEducation Act of 1990 (“NLEA”), which requires specified nutritionalinformation to be disclosed on all packaged foods.  The Company believes that the labeling on itsproducts currently meets these requirements.

 

14

----

 

The Company does not believe that complyingwith the NLEA regulations materially increases the Company’s manufacturingcosts.

 

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.  Whilethere are four parts to the Act, only two of the provisions impact theCompany.  One requirement for the Companywas registration with the FDA as a U.S. Food Manufacturing Company, which theCompany completed prior to the required date of December 12, 2003.  The second of the Act’s provisions pertainingto the Company relates to record retention. 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 is effectiveJanuary 1, 2005, and the Company believes it is currently compliant withthis 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 fat be declared on a separate line inthe standard Nutrition Facts below total fat and saturated fat and becalculated to the nearest 0.5 grams, unless it is less than 0.5 grams in whichcase it may be expressed as 0 grams. Currently, the Company has plans in place to comply with the FDA’s rule onTrans Fat Labeling by the January 1, 2006 deadline.

 

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 theCompany.  Such changes could affect salesof the Company’s products and have a material adverse effect on the Company.

 

*ProductLiability Claims*. As a manufacturer and marketer of food products, the Company may besubjected to various product liability claims. There can be no assurance that the product liability insurancemaintained by the Company will be adequate to cover any loss or exposure forproduct liability, or that such insurance will continue to be available onterms acceptable to the Company.  Anyproduct liability claim not fully covered by insurance, as well as any adversepublicity from a product liability claim, could have a material adverse effecton the financial condition or results of operations of the Company.

 

*SignificantShareholders; Possible Change in Control. *As a result of the Wabash Foodsacquisition, Capital Foods, LLC (“Capital Foods”) (an affiliate of the formerowner of Wabash Foods) became the single largest shareholder of the Company,currently holding approximately 23% of the outstanding shares of Common Stockbased on Capital Foods’ Schedule 13G filing.  Accordingly, Capital Foods is in a positionto exercise substantial influence on the business and affairs of theCompany.  In addition, RenaissanceCapital Group, Inc. manages three funds, Renaissance Capital Growth &Income Fund III, Inc., Renaissance U.S. Growth & Income TrustPLC, and BFS US Special Opportunities Trust PLC, which, based on their Schedule 13Gfilings, are currently the beneficial owners of approximately 7%, 4% and 4%,respectively, of the outstanding shares of Common Stock of the Company.  Capital Foods, Renaissance Capital Growth &Income Fund III, Inc., Renaissance U.S. Growth & Income TrustPLC, and BFS US Special Opportunities Trust PLC are hereinafter referred tocollectively as the “Significant Shareholders”. Although the Company is not aware of any plans or proposals on the partof any Significant Shareholder to recommend or undertake any material change inthe management or business of the Company, there is no assurance that aSignificant Shareholder will not adopt or support any such plans or proposalsin the future.

 

Apart from transfer restrictions arisingunder applicable provisions of the securities laws, there are no restrictionson the ability of the Significant Shareholders to transfer any or all of theirrespective shares of Common Stock at any time. One or more of such transfers could have the effect of transferringeffective control of the Company, including to one or more parties notcurrently known to the Company.

 

*Possibilitythe Company Will be Required to Register Shares of Certain Stockholders forResale; Shares Available for Future Sale.*  On December 27, 2001, the Companycompleted the sale of 586,855 shares of Common Stock, $0.01 par value, to BFSUS Special Opportunities Trust PLC (“BFS”), a fund managed by RenaissanceCapital Group, Inc., in a private placement transaction.  The net proceeds of the transaction wereutilized by the Company to reduce the Company’s outstanding indebtedness.  In connection with such transaction, theCompany granted demand and piggyback registration rights to BFS.  Pursuant to the demand registration rights,the Company may be required, upon demand of BFS, to file a registrationstatement (the “BFS Registration Statement”) with the Securities and ExchangeCommission covering the resale of the shares of Common Stock issued to BFS inthe transaction.  The Company will berequired to pay all expenses relating to any such registration, other thanunderwriting discounts, selling commissions and stock transfer taxes applicableto the shares, and any other fees and expenses incurred by the holder(s) of theshares (including, without limitation, legal fees and expenses) in connectionwith the registration.

 

15

----

 

Approximately 5,699,900 shares of outstandingCommon Stock issued by the Company are subject to “piggyback” registrationrights granted by the Company, pursuant to which such shares of Common Stockmay be registered under the Securities Act and, as a result, become freelytradable in the future.  All or a portionof such shares may, at the election of the holders thereof, be included in theBFS Registration Statement and, upon the effectiveness thereof, may be sold inthe public markets.

 

No prediction can be made as to the effect,if any, that future sales of shares of Common Stock will have on the marketprice of the Common Stock prevailing from time to time.  Sales of substantial amounts of Common Stock,or the perception that these sales could occur, could adversely affectprevailing market prices for the Common Stock and could impair the ability ofthe Company to raise additional capital through the sale of its equitysecurities or through debt financing.

 

*CertainAnti-takeover Provisions*.  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 from timeto time by the Board of Directors of the Company.  The Company may issue such shares ofpreferred stock in the future without shareholder approval.  The rights of the holders of Common Stockwill be subject to, and may be adversely affected by, the rights of the holdersof any preferred stock that may be issued in the future.  The issuance of preferred stock, whileproviding desirable 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 203 of the Delaware General CorporationLaw (the “DGCL”), the Company is prohibited from engaging in any businesscombination (as defined in the DGCL) with any interested shareholder (asdefined in the DGCL) unless certain conditions are met.  This statutory provision could also have ananti-takeover effect.

 

**Item 2.  Properties**

### ** **

The Company leases a 140,000 square footfacility located on 15 acres of land in Bluffton, Indiana, approximately 20miles south of Ft. Wayne, Indiana.  TheCompany has entered into a lease expiring in April 2018 with respect tothe facility and the lease has two five-year renewal options.  Current lease payments are approximately$22,000 per month.  The lease paymentsare subject to an annual CPI-based increase. The Company produces its T.G.I. Friday’s® brand snacks and Tato Skins®brand potato snacks 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 alease expiring in November 2006 with respect to the facility and the leasehas two three-year renewal options. Current lease 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.  Thefacility is financed by a mortgage with Morgan Guaranty Trust Company of NewYork that matures in June 2012.  TheCompany produces its Poore Brothers®, Bob’s Texas Style® and Boulder PotatoCompany® brand potato chips, as well as its private label potato chips at theGoodyear, 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.  Management believes, based on discussionswith legal counsel, that the resolution of such lawsuits, individually and inthe aggregate, will not have a material adverse effect on the Company’sfinancial position or results of operations.

 

**Item 4.  Submission of Matters to aVote of Security Holders**

### ** **

None.

 

16

----

 

#### **PART II**

#### ** **

**Item 5.  Market for Registrant’sCommon Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities**

#### ** **

The Company’s Common Stock is traded on theNasdaq SmallCap Market tier of the Nasdaq Stock Market under the symbol “SNAK”.  There were approximately 4,000 shareholdersof record on March 20, 2005.  TheCompany has never declared or paid any dividends on the shares of CommonStock.  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 foreseeablefuture.  Additionally, certain debtagreements of the Company limit the Company’s ability to declare and paydividends.

 

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 25,2004 and December 27, 2003.

 

| ** **              | ** ** | **Sales Prices** | ** ** |
|-------------------------|------------|------------------|------------|
| **Period of Quotation** | ** ** | **High**         | ** ** | **Low** | ** ** |
| Fiscal 2003:            |       |             |       |   |   |
| First  Quarter          |       | $                | 2.55       |   | $ | 1.90 |   |
| Second  Quarter         |       | $                | 4.15       |   | $ | 1.99 |   |
| Third  Quarter          |       | $                | 5.60       |   | $ | 3.91 |   |
| Fourth  Quarter         |       | $                | 5.28       |   | $ | 3.30 |   |
|                    |       |             |       |   |   |
| 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 |   |

 

**Item 6.  Selected Financial Data**

 

**FIVE YEARFINANCIAL SUMMARY**

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

 
| ** **                           | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**   | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **Statements  of Earnings Data**     |       |       |       |       |       |       |       |       |       |       |       |
| Net revenues                         |       | $          | 68.7       |       | $          | 66.4       |       | $          | 59.3       |       | $          | 53.9 |   | $ | 39.1 |   |
| Gross profit                         |       | 14.3       |       | 13.3       |       | 11.3       |       | 10.9       |       | 7.7        |       |
| Operating  income                    |       | 3.7        |       | 0.0        |       | 2.7        |       | 2.1        |       | 1.9        |       |
| Net income                           |       | 2.1        |       | 1.1        |       | 2.6        |       | 1.0        |       | 0.7        |       |
|                                 |       |       |       |       |       |       |       |       |       |       |       |
| Net income  per share – diluted |       | $          | 0.11       |       | $          | 0.06       |       | $          | 0.15       |       | $          | 0.06 |   | $ | 0.05 |   |
| Weighted average  common shares      |       | 18,947,533 |       | 18,476,486 |       | 17,826,953 |       | 17,198,648 |       | 15,129,593 |       |
|                                 |       |       |       |       |       |       |       |       |       |       |       |
| **Balance  Sheet Data**              |       |       |       |       |       |       |       |       |       |       |       |
| Net working  capital                 |       | $          | 11.7       |       | $          | 7.9        |       | $          | 2.0        |       | $          | 2.0 |   | $ | 0.8 |   |
| Total assets                         |       | 40.1       |       | 36.6       |       | 31.8       |       | 31.7       |       | 30.3       |       |
| Long-term  debt                      |       | 1.7        |       | 3.1        |       | 4.1        |       | 8.7        |       | 9.0        |       |
| Shareholders’  equity           |       | 28.8       |       | 25.1       |       | 20.7       |       | 16.8       |       | 14.3       |       |

 

17

----

 

**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 the “Risk Factors” section. Accordingly, the Company’s actual future results may differ materiallyfrom 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 and sells nationally T.G.I. Friday’s®brand salted snacks under license from TGI Friday’s Inc. The Company alsocurrently (i) manufactures and sells regionally its own brands of saltedsnack food products, including Poore Brothers®, Bob’s Texas Style®, and BoulderPotato Company® brand batch-fried potato chips and Tato Skins® brand potatosnacks, (ii) manufactures private label potato chips for grocery retailchains in the southwest, and (iii) distributes in Arizona snack foodproducts that are manufactured by others.

 

Fiscal 2004 results were the sixth straightyear of profitability and increased revenue for the Company.  The Company’s net revenue grew 3% in fiscal2004.  T.G.I. Friday’s®, which comprised72% of total net revenue, grew 21%.  Ourbatch-fried chips growth rate was flat. Tato Skins® brand declined, mostly because of the cannibalization ofT.G.I. Friday’s® brand.  Excludingdiscontinued products, our growth rate was 12%. The introduction of the Crunch Toons® brand during fiscal 2003 did notmeet expectations and was discontinued in June 2004.  Net revenue from Crunch Toons® was $0.3million and $3.4 million in fiscal 2004 and 2003, respectively.  Also, a distributed product was discontinuedin early 2004 which represented a $2.0 million decline in net revenue in fiscal2004.  The table below highlights thechanges between years:

 

**NetRevenue Comparison**

**($ inmillions)**

 
| ** **                  | ** ** | **2004** | ** ** | **2003** | ** ** | **% Change** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|--------------|------------|
| T.G.I.  Friday’s® |       | $        | 49.1       |     | $          | 40.5         |       | +21 | % |
| Potato Chips  and Other     |       | 19.3     |       | 20.5     |       | -6           |       |
| Subtotal                    |       | 68.4     |       | 61.0     |       | +12          |       |
| Discontinued  Products      |       | 0.3      |       | 5.4      |       | -94          |       |
| Total                       |       | $        | 68.7       |     | $          | 66.4         |       | +3 | % |

 

The market for snackfoods, such as potato chips, tortilla chips, meat snacks and cookies, is largeand intensely competitive.  The industryis dominated by several significant competitors and include many othercompetitors with greater financial and other resources than the Company.  However, the Company’s growth has exceededthe industry average over the last few years primarily due to its growth fromT.G.I. Friday’s® branded products.  Thisgrowth has been due to penetration into new and existing accounts, primarily invend, mass, grocery and convenience stores. However, this growth will slow unless the

 

18

----

 

Company continues to addnew products to stimulate consumer purchases. In addition, the Company needs to diversify and expand into other foodcategories in an effort to reduce its reliance on a single brand.

 

The Company has been profitable for sixstraight years.  This has beenaccomplished through sales growth, operating efficiency gains and tightcontrols over spending.  The Companygenerally has kept spending in line with revenue growth, except with respect toour national advertising for Crunch Toons® in 2003.

 

In late 2004 the Company developed a moreaggressive strategic plan to achieve a new vision of being a $200 millionmarketer of *Intensely Different*TM food brands.  Our plans include continuing to identify newlicensing opportunities, such as Cinnabon®, to broaden our product offering andto complement the growth of our existing T.G.I. Friday’s® products through theintroduction of new products in snacks as well as other food categories.  The Company commenced selling internationallyto Canadian customers during the fourth quarter of fiscal 2004 and it willcontinue to seek opportunities to selectively expand its growth in othercountries.  In addition, we haveactivated an acquisition strategy to help us accelerate our growth in order toleverage our existing competencies or gain new ones.  Specifically, in the first half of 2005, wewill be test-marketing our new Cinnabon® branded products, such as cookies andbars, as well as a new product category, meat snacks, and several new salted snackproducts under our T.G.I. Friday’s® brand.

 

In connection with the implementation of theCompany’s new business strategy, the Company is likely to require future debtor equity financings (particularly in connection with future strategicacquisitions).  Expenditures stemmingfrom acquisition-related integration costs, trade and consumer marketingprograms and new product development may adversely affect operating expensesand consequently may adversely affect operating and net income.

 

**Results of Operations**

 

The following discussion summarizes thesignificant factors affecting the consolidated operating results, financialcondition, liquidity and capital resources of the Company.  This discussion should be read in conjunctionwith Item 8: “Financial Statements and Supplementary Data” and the “CautionaryStatement on Forward-Looking Statements” on page 4.

 

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

 
| ** **                                    | ** ** | **2004** | ** ** | **2003**     | ** ** | **Difference** | ** ** |
|-----------------------------------------------|------------|----------|------------|--------------|------------|----------------|------------|
| **(dollars in millions)**                     | ** ** | **$**    | ** ** | **% of Rev** | ** ** | **$**          | ** ** | **% 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/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            |       | 0.0 |   | 3.7 |   | 3700 |   |
| Insurance  claim settlement income, net       |       | —   |       | 0.0          |       | 1.9            |       | 2.9 |   | (1.9 | ) | (100.0 | ) |
| Interest  expense, net                        |       | (0.2     | )          | (0.3         | )          | (0.2           | )          | (0.4 | ) | 0.0 |   | 0.0 |   |
| Income  before income taxes                   |       | 3.5      |       | 5.1          |       | 1.7            |       | 2.6 |   | 1.8 |   | 109.1 |   |
| Income tax  (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 revenue increased 3% to $68.7 million, compared with net revenue of$66.4 million for the previous fiscal year. T.G.I. Friday’s® brand snacks netrevenue increased 21% over fiscal 2003, accounting for 72% of the Company’stotal net revenue for fiscal 2004.  TheCompany’s batch-fried kettle chip brands were flat in comparison to fiscal 2003and the Tato Skin® brand declined in fiscal 2004.  The Company’s discontinued Crunch Toons®brand snacks declined $3.1 million in net revenue versus last year anddistributed products segment revenue declined $2.0 million due to thediscontinuance of a product line.

 

Gross profit for 2004 increased to $14.3million, or 21% of net revenue, compared to $13.3 million, or 20% of netrevenue, in 2003.  Cost of revenuesdecreased from 78.4% of net revenue last year to 76.7% this year.  The improvement was due to efficiency gainsin manufacturing and supply chain partially offset by an increase in freightcosts.  Due to some idled

 

19

----

 

packaging equipment, there were $0.3 million and $1.0 million ofequipment write-downs in 2004 and 2003, respectively.  Also included in 2004 cost 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 revenue.  Thedecrease was primarily due to $3.5 million of consumer marketing costsassociated with the Crunch Toons® brand launch in 2003.

 

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.

 

*Year ended December 27,2003 compared to the year ended December 28, 2002*

 
| ** **                                    | ** ** | **2003** | ** ** | **2002**     | ** ** | **Difference** | ** ** |
|-----------------------------------------------|------------|----------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **$**    | ** ** | **% of Rev** | ** ** | **$**          | ** ** | **% of Rev** | ** ** | **$** | ** ** | **%** | ** ** |
| Net revenues                                  |       | $        | 66.4       |         | 100.0      | %              | $          | 59.3 |   | 100.0 | % | $ | 7.1 |   | 11.9 | % |
| Cost of  revenues                             |       | 52.1     |       | 78.3         |       | 48.0           |       | 80.9 |   | 4.1 |   | 8.4 |   |
| Write-down  of equipment/brand discontinuance |       | 1.0      |       | 1.6          |       | 0.0            |       | 0.0 |   | 1.0 |   | 100.0 |   |
| Gross profit                                  |       | 13.3     |       | 20.1         |       | 11.3           |       | 19.1 |   | 2.0 |   | 17.7 |   |
| Selling,  general and administrative expenses |       | 13.3     |       | 20.0         |       | 8.6            |       | 14.6 |   | 4.7 |   | 53.9 |   |
| Operating  income                             |       | 0.0      |       | 0.0          |       | 2.7            |       | 4.5 |   | (2.7 | ) | (99.0 | ) |
| Insurance  claim settlement income, net       |       | 1.9      |       | 2.9          |       | 0.3            |       | 0.4 |   | 1.6 |   | 639.8 |   |
| Interest  expense, net                        |       | (0.2     | )          | (0.4         | )          | (0.5           | )          | (0.9 | ) | 0.3 |   | 53.2 |   |
| Income  before income taxes                   |       | 1.7      |       | 2.6          |       | 2.4            |       | 4.0 |   | (0.7 | ) | (29.2 | ) |
| Income tax  benefit (provision)               |       | (0.6     | )          | (1.0         | )          | 0.2            |       | 0.4 |   | (0.8 | ) | (364.3 | ) |
| Net income                                    |       | $        | 1.1        |         | 1.6        | %              | $          | 2.6 |   | 4.4 | % | $ | (1.5 | ) | (60.1 | )% |

 

For the fiscal year ended December 27,2003, net revenue increased 12% to $66.4 million, compared with revenue of$59.3 million for the previous fiscal year. The Company’s net revenue increased in the manufactured products segmentas a result of growth in the T.G.I. Friday’s® brand snacks.  Overall, T.G.I. Friday’s® brand snacksrevenue was 13% higher than in 2002, accounting for approximately 61% of theCompany’s net revenue for the year.  TheCompany’s Crunch Toons® brand snacks contributed $3.4 million in net revenueduring the year.  The growth from thesebrands was partially offset by anticipated lower shipments of Tato Skins® brandsnacks in the vending channel which resulted from our deliberate efforts tocannibalize the brand with T.G.I. Friday’s® brand snacks, and by slightly lowerrevenue from private label potato chips. The Company’s batch-fried kettle chip brands were flat versus 2002 andthe distributed products segment rose modestly.

 

Gross profit for 2003 increased to $13.3million, or 20% of net revenue, compared to $11.3 million, or 19% of netrevenue, in 2002 due to the revenue increase, improved manufacturing efficienciesand despite a $1.0 million pretax impairment write-down of idle packagingequipment during 2003.

 

Selling, general and administrative expensesincreased to $13.3 million in fiscal 2003, up from $8.6 million in 2002, or 20%versus 15% of net revenue.  The increasewas driven by introductory consumer marketing programs, such as nationaltelevision advertising, and other costs associated with the new Crunch Toons®brand launch.

 

Other income and expense included $1.9million and $0.3 million of pre-tax income from an insurance claim settlementin fiscal years 2003 and 2002, respectively.

 

In fiscal 2002, the Company benefited fromthe reversal of a deferred tax valuation allowance of approximately $1.2million related to the Company’s net operating loss carryforward.

 

Net income for 2003 declined 60% to $1.1million, or $0.06 per basic and diluted share, compared with net income of $2.6million, or $0.16 per basic and $0.15 per diluted share, in the prior-yearperiod.  As expected, net income wasimpacted

 

20

----

 

significantly in fiscal 2003 by approximately $3.5 million in plannedintroductory consumer marketing programs, such as national televisionadvertising, as well as other costs associated with the launch of the CrunchToons® brand.

 

**Liquidity and Capital Resources**

 

Net working capital was $11.7 million (acurrent ratio of 2.6:1) and $7.9 million (a current ratio of 2.2:1) at December 25,2004 and December 27, 2003, respectively. For the fiscal year ended December 25, 2004, the Company generatedcash flow of $6.5 million from operating activities, invested $0.5 million innew equipment, made $1.0 million in payments on long-term debt and received$1.3 million in proceeds from the issuance of Common Stock.  For the fiscal year ended December 27,2003, the Company generated cash flow of $2.0 million from operatingactivities, invested $1.1 million in new equipment, made $1.1 million inpayments on long-term debt and received $2.0 million in proceeds from issuanceof Common Stock pursuant to the exercise of stock options.  For the fiscal year ended December 28,2002, the Company generated cash flow of $5.8 million from operatingactivities, invested $0.6 million in new equipment, and made $5.4 million innet payments on long-term debt.

 

The U.S. Bancorp Credit Agreement consists ofa $5.0 million Line of Credit, a $0.5 million capital expenditure line ofcredit (CapEx Term Loan”) and a $5.8 million term loan (“Term Loan A”).  The Company is evaluating its options toeither payoff the Term Loan A and/or negotiate a new credit facility with abank.  In July 2004, the U.S.Bancorp Credit Agreement was amended again to modify certain financialcovenants that allow the Company to exclude one-time extraordinary, non-operatinggains/losses during the applicable period.

 

The U.S. Bancorp Credit Agreement is securedby accounts receivable, inventories, equipment and general intangibles.  Borrowings under the line of credit arelimited to 80% of eligible receivables 60% of eligible finished goodsinventories and 50% of eligible raw materials inventories.  At December 25, 2004, the Company had aborrowing base of approximately $4.2 million under the U.S. Bancorp Line ofCredit.  The U.S. Bancorp CreditAgreement requires the Company to be in compliance with certain financialperformance criteria, including minimum annual operating results, a minimumtangible capital base and a minimum fixed charge coverage ratio.  At December 25, 2004, the Company was incompliance with all of the financial covenants. Management believes that the fulfillment of the Company’s plans andobjectives will enable the Company to attain a sufficient level ofprofitability to remain in compliance with these financial covenants. There canbe no assurance, however, that the Company will attain any such profitabilityand remain in compliance.  As of December 25,2004, there was no outstanding balance on the U.S. Bancorp Line of Credit and$1.3 million on the U.S. Bancorp Term Loan A.

 

The Company’s Goodyear, Arizonamanufacturing, distribution and headquarters facility is subject to a $1.8million 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 onJuly 1, 2012; however monthly principal and interest installments of$16,825 are determined based on a twenty-year amortization period.

 

During 2004, 2003 and 2002, the Companyreceived $1.3 million, $2.0 million and $0.6 million of proceeds from theissuance of Common Stock.  Proceeds in2004 and 2003 were primarily due to the exercise of stock options.

 

At December 25, 2004, the Company had anet operating loss carryforward available for federal income taxes ofapproximately $1.9 million.  The Company’saccumulated net operating loss carryforward will begin to expire in varyingamounts between 2010 and 2018.

 

**Off-Balance Sheet Arrangements**

 

Under SEC regulations, in certaincircumstances, we are required to make certain disclosures regarding thefollowing off-balance sheet arrangements, if material:

 

•      Any obligationunder certain guarantee contracts;

•      Any retained orcontingent interest in assets transferred to an unconsolidated entity orsimilar arrangement that serves as credit, liquidity or market risk support tothat entity for such assets;

•      Any obligationunder certain derivative instruments;

•      Any obligationarising out of a material variable interest held by us in an unconsolidatedentity that provides financing, liquidity, market risk or credit risk supportto us, or engages in leasing, hedging or research and development services withus.

 

21

----

 

We do not have any off-balance sheetarrangements that we are required to disclose pursuant to these regulations,other than those described in the Notes to Consolidated FinancialStatements.  We do not have, nor do weengage in, transactions with any special purpose entities.  We are not engaged in hedging activities andhad no forward exchange contracts or other derivatives outstanding at December 25,2004.  In the ordinary course ofbusiness, we enter into operating lease commitments, purchase commitments andother contractual obligations.  Thesetransactions are recognized in our financial statements in accordance withgenerally accepted accounting principles in the United States, and are morefully discussed below.

 

**Contractual Obligations**

 

The following table outlines the Company’sfuture contractual financial obligations as of December 25, 2004, due byperiod: 

 
| ** **                                       | ** ** | **Total** | ** ** | **Less than 1  Year** | ** ** | **1 – 3 Years** | ** ** | **3 – 5 Years** | ** ** | **More than 5  Years** | ** ** |
|--------------------------------------------------|------------|-----------|------------|-----------------------|------------|----------------------|------------|----------------------|------------|------------------------|------------|
| Long-term debt                                   |       | $         | 3,119,801  |                  | $          | 1,390,667            |       | $                    | 99,894     |                   | $          | 119,585 |   | $ | 1,509,655 | ** ** |
| Operating  leases                                |       | 6,879,564 |       | 1,419,066             |       | 2,297,894            |       | 892,922              |       | 2,269,682              |       |
| Outside  Warehouse Minimum Monthly Usage Charges |       | 4,752,000 |       | 1,188,000             |       | 2,376,000            |       | 1,188,000            |       | —                 |       |
| Royalty  payments (i)                            |       | 633,600   |       | 258,400               |       | 276,800              |       | 98,400               |       | —                 |       |
| Lease  payments on machine (ii)                  |       | 326,904   |       | 163,452               |       | 163,452              |       | —               |       | —                 |       |
| Total  contractual cash obligations              |       | $         | 15,711,869 |                  | $          | 4,419,585            |       | $                    | 5,214,040  |                   | $          | 2,298,907 |   | $ | 3,779,337 |   |

 

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

 

The Company has entered into a variety ofoperating leases for equipment and facilities. For information regarding the Company’s facility leases, please read “Item2:  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 and (ii) remaininglease payments relating to a machine the Company determined as not to be usedin the future discussed in “Item 7: Brand Discontinuance.”

 

The Company currently has no materialmarketing or capital expenditure commitments.

 

**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 higher assetreplacement costs and related depreciation and higher material costs.  Additionally, the Company may be subject toseasonal price increases for raw materials. The Company attempts to minimize the fluctuation in seasonal costs byentering into purchase commitments in advance, which have the effect ofsmoothing out price volatility. The Company will attempt to minimize overallprice inflation, if any, through increased sales prices and productivityimprovements.

 

**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 and Exchange Commissionindicated that a “critical accounting policy” is one which is both important tothe portrayal of the Company’s financial condition and results and requiresmanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about

 

22

----

 

the effect of matters that are inherently uncertain.  The Company believes that the followingaccounting policies fit this definition:

 

*Allowance for Doubtful Accounts. *The Companymaintains an allowance for doubtful accounts for estimated losses resultingfrom the inability of its customers to make required payments.  If the financial condition of the Company’scustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required.  The allowance for doubtful accounts was$89,000 and $347,000 at December 25, 2004 and December 27, 2003,respectively.

 

*Inventories.*** **The Company’sinventories are stated at the lower of cost (first-in, first-out) ormarket.  The Company identifies slowmoving or obsolete inventories and estimates appropriate loss provisionsrelated thereto.  Historically, theseloss provisions have not been significant; however, if actual market conditionsare less favorable than those projected by management, additional inventorywrite-downs may be required.

 

*Goodwill and Trademarks.*  Goodwill and trademarks are reviewed forimpairment annually, or more frequently if impairment indicators arise.  Goodwill is required to be tested forimpairment between the annual tests if an event occurs or circumstances changethat more-likely-than-not reduce the fair value of a reporting unit below itscarrying value.  Intangible assets withindefinite lives are required to be tested for impairment between the annualtests if an event occurs or circumstances change indicating that the assetmight be impaired.  The Company believesat this time that the carrying values continue to be appropriate.

 

*Advertising and Promotional Expenses.*  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.  Costs associated with obtaining shelf space(i.e. “slotting fees”) are expensed in the period in which such costs areincurred by the Company.  Anytime theCompany offers consideration (cash or credit) as a trade advertising orpromotion allowance to a purchaser of products at any point along thedistribution chain, the amount is accrued and recorded as a reduction inrevenue.  Any marketing programs thatdeal directly with the consumer are recorded in selling, general andadministrative expenses.

 

*Income Taxes.*  The Company has been profitable since 1999; however,it experienced significant net losses in prior fiscal years resulting in a netoperating loss (“NOL”) carryforward for federal income tax purposes ofapproximately $1.9 million at December 25, 2004.  Generally accepted accounting principlesrequire that the Company record a valuation allowance against the deferred taxasset associated with this NOL if it is “more likely than not” that the Companywill not be able to utilize it to offset future taxes.

 

The above listing is not intended to be acomprehensive list of all of the Company’s accounting policies.  In many cases the accounting treatment of aparticular transaction is specifically dictated by generally acceptedaccounting principles, with no need for management’s judgment in theirapplication.  See the Company’s auditedfinancial statements and notes thereto included in this Annual Report on Form 10-Kwhich contain accounting policies and other disclosures required by accountingprinciples generally accepted in the United States.

 

**New Accounting Pronouncements**

 

In January 2003, the FASB issuedinterpretation (“FIN”) No. 46, “Consolidation of Variable InterestEntities – An Interpretation of Accounting Research Bulletin (“ARB”) No. 51.”  This interpretation was subsequently revisedby FIN 46 (Revised 2003) in December 2003. This revised interpretation states that consolidation of variableinterest entities will be required by the primary beneficiary if the entitiesdo not effectively disperse risks among the parties involved.  The requirements are effective for fiscalyears ending after December 15, 2003 for special-purpose entities and forall other types of entities for periods ending after March 31, 2004.  The Company has no variable interest entitiesand the adoption of FIN No. 46 (R) did not impact our operations orfinancial position.

 

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. This standard is effective for periods beginningafter June 15, 2005 and includes two transition methods. Upon adoption, wewill be required to use either the modified prospective or 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

 

23

----

 

restated (either to the beginning of the year of adoption or for allperiods presented) to reflect the SFAS 123 amounts in the incomestatement. We are currently evaluating the impact of this standard and itstransitional alternatives.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs”.  This statementclarifies the accounting for the abnormal amount of idle facilities expense,freight, handling costs and wasted material. This statement requires that those items be recognized as current-periodexpense.  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 is effective for inventorycosts incurred after December 31, 2005. Adoption of this statement will not have a material effect on thefinancial statements of the Company.

 

**Item 7A.  Quantitative and Qualitative Disclosures aboutMarket 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 nomarket risk sensitive instruments held for trading purposes.

 

Raw materials used by the Company are exposedto the impact of changing commodity prices. The Company’s most significant raw material requirements includepotatoes, potato flakes, wheat flour, corn and oil.  The Company attempts to minimize the effectof future price fluctuations related to the purchase of raw materials primarilythrough forward purchasing to cover future manufacturing requirements,generally for periods from one to 12 months. Futures contracts are not used in combination with the forwardpurchasing of these raw materials.  TheCompany’s procurement practices are intended to reduce the risk of future priceincreases, but also may potentially limit the ability to benefit from possibleprice decreases.

 

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 in those rates.  At December 25, 2004 and December 27,2003, the Company had $1.3 million and $2.3 million of variable rate debtoutstanding.  A hypothetical 10% adversechange in weighted average interest rates during fiscal 2004 and 2003 wouldhave had minimal impact on both the Company’s net earnings and cash flows.

 

The Company’s primary concentration of creditrisk is related to certain trade accounts receivable.  In the normal course of business, the Companyextends unsecured credit to its customers. In 2004 and 2003, substantially all of the Company’s customers weredistributors or retailers whose sales were concentrated in the groceryindustry, throughout the United States. The Company investigates a customer’s credit worthiness before extendingcredit.  At December 25, 2004, twocustomers accounted for approximately 32% of the Company’s accounts receivable.

 

**Item 8.  Financial Statements andSupplementary Data**

 
| Report of Independent Registered Public  Accounting Firm                                                                                             |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated balance sheets as of December 25, 2004 and December 27,  2003                                                                 |   |
| Consolidated statements of income for the  years ended December 25, 2004,  December 27, 2003 and December 28, 2002                    |   |
| Consolidated statements of shareholders’  equity for the years ended December 25,  2004, December 27, 2003 and December 28, 2002 |   |
| Consolidated statements of cash flows for  the years ended December 25, 2004,  December 27, 2003 and December 28, 2002                |   |
| Notes to consolidated financial statements                                                                                                           |   |

 

**Item 9.  Changes in andDisagreements with Accountants on Accounting and Financial Disclosure**

### ** **

None.

 

24

----

 

**Item 9A.  Controls and Procedures.**

 

**(a)****     Evaluationof Disclosure Controls and Procedures**

 

The Company’smanagement, with the participation of the Company’s Chief Executive Officer andChief Financial Officer, evaluated the effectiveness of the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport.  Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport have been designed and are functioning effectively to provide reasonableassurance that the information required to be disclosed by the Company inreports filed under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time period specified in the SEC’s rules andforms.

 

**(b)****     Changein Internal Control over Financial Reporting**

 

No change inthe Company’s internal control over financial reporting occurred during theCompany’s most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**Item 9B.  Other Information.**

 

**None.**

 

**PART III**

 

**Item 10.  Directors and ExecutiveOfficers of the Registrant**

 

Code of Ethics.

Each of the Company’s directors, officers andemployees are required to comply with the Poore Brothers, Inc. Code of BusinessConduct and Ethics adopted by the Company. The Code of Business Conduct andEthics sets forth policies covering a broad range of subjects and requiresstrict adherence to laws and regulations applicable to the Company’s business.The Company has also adopted a Financial Code of Ethics for its Chief ExecutiveOfficer, Chief Financial Officer and all other finance managers. The FinancialCode of Ethics supplements the Code of Business Conduct and Ethics and isintended to emphasize the importance of honest and ethical conduct inconnection with the Company’s financial reporting obligations.  The Code of Business Conduct and Ethics andthe Financial Code of Ethics are available on the Company’s website at www.poorebrothers.com,under the “Investors-Governance” captions. Copies of these Codes may also beobtained, without charge, by any shareholder upon written request directed tothe Secretary of the Company at 3500 South La Cometa Drive, Goodyear, Arizona85338. The Company will post to its website any amendments to these Codes, orwaiver from the provisions thereof, applicable to the Company’s directors orany principal executive officer, principal financial officer, principalaccounting officer or controller, or any person performing similar functionsunder the “Investor-Governance-Code of 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 2005 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 2005Proxy Statement is incorporated by reference.

 

**Item 12.  Security Ownership ofBeneficial Owners and Management and Related Stockholder Matters**

 

The information appearing in the Company’s2005 Proxy Statement under the heading “Security Ownership of CertainBeneficial Owners and Management” and “Securities Authorized for Issuance UnderEquity Compensation Plans” is incorporated by reference.

 

25

----

 

**Item 13.  Certain Relationships andRelated Transactions**

 

The information appearing in the Company’s2005 Proxy Statement under the heading “Certain Relationships and RelatedTransactions” is incorporated by reference.

 

**Item 14.  Principal AccountantFees and Services**

 

Information appearing in the Company’s 2005Proxy Statement under the heading “Independent Auditors” is incorporated byreference.

 

**PART IV**

 

**Item 15.  Exhibits and FinancialStatement Schedules:**

 
| The following documents are filed as part  of this Annual Report on Form 10-K: |
|-------------------------------------------------------------------------------------|
|                                                                                |   |   |
| (a)1.                                                                               | ** ** | **Financial Statements** |
|                                                                                |   |   |
|                                                                                |   | Report of Independent Registered Public  Accounting Firm |
|                                                                                |   | Consolidated balance sheets as of December 25, 2004 and December 27,  2003 |
|                                                                                |   | Consolidated statements of income for the  years ended December 25, 2004, December 27, 2003 and  December 28, 2002 |
|                                                                                |   | Consolidated statements of shareholders’  equity for the years ended December 25, 2004, December 27,  2003 and December 28, 2002 |
|                                                                                |   | Consolidated statements of cash flows for  the years ended December 25, 2004, December 27, 2003 and December 28,  2002 |
|                                                                                |   | Notes to consolidated financial statements |
|                                                                                |   |   |
| (a)2.                                                                               | ** ** | **Financial Schedules** |
|                                                                                | ** ** | ** ** |
|                                                                                |   | Schedules have been omitted because of the  absence of conditions under which they are required or because information  required is included in the Company’s financial statements or notes thereto. |
|                                                                                |   |   |
| (a)3.                                                                               | ** ** | **Exhibits required by Item 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. (17)                                                                                                                                               |
| 4.1 —          |       | Specimen Certificate for shares of Common  Stock. (1)                                                                                                                      |
| 4.2 —          |       | Convertible Debenture Loan Agreement dated May 31,  1995 by and among the Company (and certain of its subsidiaries), Renaissance  Capital and Wells Fargo. (1)        |
| 4.3 —          |       | 9.00% Convertible Debenture dated May 31,  1995, issued by the Company to Renaissance Capital. (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)       |
| 4.6 —          |       | Warrant to purchase 50,000 shares of Common  Stock, 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)    |
| 10.2*—         |       | Non-Qualified Stock Option Agreements dated  August 1, 1995, August 31, 1995 and February 29, 1996, by and  between the Company and Jeffrey J. Puglisi. (1) |

 

26

----

 
| 10.3*—  |   | Letter Agreement dated November 5,  1996, amending the Non-Qualified Stock Option Agreement dated February 29,  1996, by and between the Company and Mark S. Howells. (1)                                                                                                                               |
|--------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.4*—  |   | Letter Agreement dated November 5,  1996, amending the Non-Qualified Stock Option Agreement dated February 29,  1996, by and between the Company and Jeffrey J. Puglisi. (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)                                                                                                                                                                                 |
| 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)                       |
| 10.26 — |   | Share Purchase Agreement, dated December 27,  2001, by and between the Company and BFS US Special Opportunities Trust PLC.  (Incorporated by reference to the Company’s Current Report on Form 8-K  filed with the Securities and Exchange Commission on January 10, 2002.)                   |
| 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)                         |

 

27

----

 
| 10.31*—                |   | Executive Employment Agreement entered into  as of January 5, 2003, by and between Poore Brothers, Inc. and Eric  J. Kufel (12)                                                                                                                                         |   |
|-----------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 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)                                                                                                                                                                                                                    |
| 21.1 —                 |   | List of Subsidiaries of the Company. (19)                                                                                                                                                                                                                                         |
| 23.1 —                 |   | Consent of Deloitte & Touche, LLP.  (19)                                                                                                                                                                                                                                 |
| 31.1 —                 |   | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a) or Rule 15(d)-14(a).  (19)                                                                                                                                                                    |
| 31.2 —                 |   | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a) or Rule 15(d)-14(a).  (19)                                                                                                                                                                    |
| 32    — |   | Certification of 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. (19)                                                |

 

----

|   * | 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)     | Filed  herewith.                                                                                                                                                                |

 

28

----

 

**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 22, 2005 | POORE BROTHERS, INC. |
|---------------------------------------------|----------------------|
|                                        |                 |
|                                        | By:                  | /s/   Thomas  W. Freeze |   |
|                                        |                 | Thomas W.  Freeze |   |
|                                        |                 | President  and 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/  Thomas  W. Freeze               |       | President,  Chief Executive Officer, and Director   |       | March 22,  2005 |       |
| Thomas W.  Freeze                              |       | (Principal  Executive Officer)                      |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/  Richard  M. Finkbeiner          |       | Senior Vice  President and Chief Financial Officer, |       | March 22,  2005 |       |
| Richard M.  Finkbeiner                         |       | (Principal  Financial Officer and                   |       |                 |       |
|                                           |       | Principal  Accounting Officer)                      |       |                 |       |
|                                           |       |                                                |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/  Eric  J. Kufel                  |       | Chairman,  Director                                 |       | March 22,  2005 |       |
| Eric J.  Kufel                                 |       |                                                |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/  Mark  S. Howells                |       | Director                                            |       | March 22,  2005 |       |
| Mark S.  Howells                               |       |                                                |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/    F. Phillips Giltner, III |       | Director                                            |       | March 22,  2005 |       |
| F. Phillips  Giltner, III                 |       |                                                |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/  James  W. Myers                 |       | Director                                            |       | March 22,  2005 |       |
| James W.  Myers                                |       |                                                |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/  Larry  R. Polhill               |       | Director                                            |       | March 22,  2005 |       |
| Larry R.  Polhill                              |       |                                                |       |                 |       |
|                                           |       |                                                |       |                 |       |
| /s/  Shannon  Bard                   |       | Director                                            |       | March 22,  2005 |       |
| Shannon Bard                                   |       |                                                |       |                 |       |

 

29

----

 

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 25, 2004 and December 27,2003, and the related consolidated statements of income, stockholders’ equity,and cash flows for each of the three years in the period ended December 25,2004.  These financial statements are theresponsibility of the Company’s management.  Our responsibility is toexpress an opinion on the financial statements 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 andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, anaudit of its internal control over financial reporting.  An audit includes consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting.  Accordingly, we express no such opinion.  An audit alsoincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation.  We believe that our auditsprovide 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 25, 2004 and December 27, 2003, and the results oftheir operations and their cash flows for each of the three years in the periodended December 25, 2004, in conformity with accounting principlesgenerally accepted in the United States of America.

 

 

*DELOITTE & TOUCHE LLP*

 

Phoenix, ArizonaMarch 21, 2005

 

30

----

 

**POORE BROTHERS, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                | ** ** | **December 25,** | ** ** | **December 27,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **2004**              | ** ** | **2003**              | ** ** |
| **ASSETS**                                                                                                                                                                                |       |                  |       |                  |       |
| Current  assets:                                                                                                                                                                          |       |                  |       |                  |       |
| Cash and  cash equivalents                                                                                                                                                                |       | $                     | 9,675,490  |                  | $          | 3,239,570 |   |
| Accounts  receivable, net of allowance of $89,000 in 2004 and $347,000 in 2003                                                                                                            |       | 5,379,362             |       | 5,714,106             |       |
| Inventories                                                                                                                                                                               |       | 2,145,742             |       | 2,400,503             |       |
| Deferred  income tax asset                                                                                                                                                                |       | 1,341,723             |       | 2,254,996             |       |
| Other  current assets                                                                                                                                                                     |       | 471,051               |       | 889,003               |       |
| Total  current assets                                                                                                                                                                     |       | 19,013,368            |       | 14,498,178            |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Property and  equipment, net                                                                                                                                                              |       | 10,815,963            |       | 11,755,096            |       |
| Goodwill                                                                                                                                                                                  |       | 5,986,252             |       | 5,986,252             |       |
| Trademarks                                                                                                                                                                                |       | 4,207,032             |       | 4,207,032             |       |
| Other assets                                                                                                                                                                              |       | 94,672                |       | 133,762               |       |
| Total assets                                                                                                                                                                              |       | $                     | 40,117,287 |                  | $          | 36,580,320 |   |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                            |       |                  |       |                  |       |
| Current  liabilities:                                                                                                                                                                     |       |                  |       |                  |       |
| Accounts  payable                                                                                                                                                                         |       | $                     | 2,809,187  |                  | $          | 3,012,059 |   |
| Accrued  liabilities                                                                                                                                                                      |       | 2,656,887             |       | 2,703,040             |       |
| Current  portion of long-term debt                                                                                                                                                        |       | 1,390,667             |       | 932,155               |       |
| Current  portion of accrued costs related to brand discontinuance and other current  liabilities                                                                                          |       | 442,533               |       | —                |       |
| Total  current liabilities                                                                                                                                                                |       | 7,299,274             |       | 6,647,254             |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Long-term  debt, less current portion                                                                                                                                                     |       | 1,729,134             |       | 3,139,801             |       |
| Non-current  portion of accrued costs related to brand discontinuance and other  liabilities                                                                                              |       | 492,541               |       | —                |       |
| Deferred  income tax liability                                                                                                                                                            |       | 1,788,252             |       | 1,731,625             |       |
| Total  liabilities                                                                                                                                                                        |       | 11,309,201            |       | 11,518,680            |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Commitments  and contingencies (Note 8)                                                                                                                                                   |       |                  |       |                  |       |
|                                                                                                                                                                                      |       |                  |       |                  |       |
| Shareholders’  equity:                                                                                                                                                               |       |                  |       |                  |       |
| Preferred  stock, $100 par value; 50,000 shares authorized; no shares issued or  outstanding at December 25, 2004 and December 27, 2003                                         |       | —                |       | —                |       |
| Common  stock, $.01 par value; 50,000,000 shares authorized; 19,647,561 and  18,581,788 shares issued and outstanding at December 25, 2004 and December 27,  2003, respectively |       | 196,476               |       | 185,817               |       |
| Additional  paid-in capital                                                                                                                                                               |       | 27,274,825            |       | 25,673,752            |       |
| Retained  earnings (deficit)                                                                                                                                                              |       | 1,336,785             |       | (797,929              | )          |
| Total  shareholders’ equity                                                                                                                                                          |       | 28,808,086            |       | 25,061,640            |       |
| Total  liabilities and shareholders’ equity                                                                                                                                          |       | $                     | 40,117,287 |                  | $          | 36,580,320 |   |

 

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

 

31

----

 

**POORE BROTHERS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFINCOME**

 
| ** **                                    | ** ** | **Years Ended**       | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **December 25,** | ** ** | **December 27,** | ** ** | **December 28,** | ** ** |
| ** **                                    | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                          |       |                  |       |   |   |   |   |
| Net revenues                                  |       | $                     | 68,734,763 |   | $ | 66,417,836 |   | $ | 59,348,471 |   |
|                                          |       |                  |       |   |   |   |   |
| Cost of  revenues                             |       | 52,747,106            |       | 52,068,963 |   | 48,036,462 |   |
|                                          |       |                  |       |   |   |   |   |
| Write-down  of equipment                      |       | 308,104               |       | 1,030,352 |   | — |   |
|                                          |       |                  |       |   |   |   |   |
| Costs  related to brand discontinuance        |       | 1,414,759             |       | — |   | — |   |
|                                          |       |                  |       |   |   |   |   |
| Gross profit                                  |       | 14,264,794            |       | 13,318,521 |   | 11,312,009 |   |
|                                          |       |                  |       |   |   |   |   |
| Selling,  general and administrative expenses |       | 10,558,544            |       | 13,290,660 |   | 8,637,652 |   |
|                                          |       |                  |       |   |   |   |   |
| Operating  income                             |       | 3,706,250             |       | 27,861 |   | 2,674,357 |   |
|                                          |       |                  |       |   |   |   |   |
| Insurance  claim settlement income, net       |       | —                |       | 1,918,784 |   | 259,376 |   |
|                                          |       |                  |       |   |   |   |   |
| Interest  expense, net                        |       | (164,797              | )          | (252,820 | ) | (539,733 | ) |
|                                          |       |                  |       |   |   |   |   |
| Total other  (expense) income                 |       | (164,797              | )          | 1,665,964 |   | (280,357 | ) |
|                                          |       |                  |       |   |   |   |   |
| Income  before income tax (provision) benefit |       | 3,541,453             |       | 1,693,825 |   | 2,394,000 |   |
|                                          |       |                  |       |   |   |   |   |
| Income tax  (provision) benefit               |       | (1,406,739            | )          | (641,861 | ) | 242,837 |   |
|                                          |       |                  |       |   |   |   |   |
| Net income                                    |       | $                     | 2,134,714  |   | $ | 1,051,964 |   | $ | 2,636,837 |   |
|                                          |       |                  |       |   |   |   |   |
| Earnings per  common share:                   |       |                  |       |   |   |   |   |
| Basic                                         |       | $                     | 0.11       |   | $ | 0.06 |   | $ | 0.16 |   |
| Diluted                                       |       | $                     | 0.11       |   | $ | 0.06 |   | $ | 0.15 |   |
|                                          |       |                  |       |   |   |   |   |
| Weighted  average number of common shares:    |       |                  |       |   |   |   |   |
| Basic                                         |       | 18,794,977            |       | 17,572,951 |   | 16,146,081 |   |
| Diluted                                       |       | 18,947,553            |       | 18,476,486 |   | 17,826,953 |   |

 

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

 

32

----

 

**POORE BROTHERS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY**

 
| ** **                                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Retained Earnings** | ** ** | ** **    | ** ** |
|------------------------------------------------------------------|------------|------------------|------------|-------------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                                       | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**           | ** ** | **(Deficit)** | ** ** | **Total** | ** ** |
|                                                             |       |             |       |                    |       |                  |       |          |       |   |   |
| Balance, December 31,  2001                                 |       | 15,687,518       |       | $                       | 156,875    |                  | $          | 21,175,485    |       | $ | (4,486,729 | ) | $ | 16,845,631 |   |
| Exercise of  common stock options                                |       | 349,016          |       | 3,490                   |       | 508,304               |       | —        |       | 511,794 |   |
| Other  issuances of common stock                                 |       | 693,377          |       | 6,934                   |       | 721,044               |       | —        |       | 727,978 |   |
| Net income                                                       |       | —           |       | —                  |       | —                |       | 2,636,837     |       | 2,636,837 |   |
| 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 |   |

 

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

 

33

----

 

**POORE BROTHERS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFCASH FLOWS**

 
| ** **                                                                         | ** ** | **Years Ended**             | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                         | ** ** | **December 25,  2004** | ** ** | **December 27,  2003** | ** ** | **December 28,  2002** | ** ** |
| **Cash  flows provided by (used in) operating activities:**                        |       |                        |       |   |   |   |   |
| Net income                                                                         |       | $                           | 2,134,714  |   | $ | 1,051,964 |   | $ | 2,636,837 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                        |       |   |   |   |   |
| Depreciation                                                                       |       | 1,340,453                   |       | 1,285,221 |   | 1,288,333 |   |
| Amortization                                                                       |       | 25,163                      |       | 31,064 |   | 33,939 |   |
| Provision  for bad debts                                                           |       | (111,623                    | )          | 23,822 |   | 379,000 |   |
| Other asset  amortization                                                          |       | 44,066                      |       | 121,413 |   | 423,088 |   |
| Deferred  income taxes                                                             |       | 969,899                     |       | 641,861 |   | (341,430 | ) |
| Costs  related to brand discontinuance                                             |       | 1,758,919                   |       | — |   | — |   |
| Tax benefit  from exercise of stock options                                        |       | 315,017                     |       | 830,371 |   | — |   |
| Write-down  of equipment and accrual of lease costs                                |       | 308,104                     |       | 1,030,352 |   | — |   |
| (Gain) loss  on disposition of fixed assets                                        |       | 16,571                      |       | (926 | ) | 7,073 |   |
| Change in  operating assets and liabilities:                                       |       |                        |       |   |   |   |   |
| Accounts  receivable                                                               |       | 446,367                     |       | (1,225,065 | ) | 316,778 |   |
| Inventories,  net of brand discontinuance write-offs                               |       | (1,390                      | )          | (725,434 | ) | (13,045 | ) |
| Other assets  and liabilities                                                      |       | (139,705                    | )          | (1,030,146 | ) | (794,934 | ) |
| Accounts  payable and accrued liabilities                                          |       | (559,426                    | )          | (28,652 | ) | 1,906,049 |   |
|                                                                               |       |                        |       |   |   |   |   |
| Net cash  provided by operating activities                                         |       | 6,547,129                   |       | 2,005,845 |   | 5,841,688 |   |
| **Cash  flows provided by (used in) investing activities:**                        |       |                        |       |   |   |   |   |
| Purchase of  property and equipment                                                |       | (455,769                    | )          | (1,120,795 | ) | (581,087 | ) |
| Proceeds  from disposition of property and equipment                               |       | —                      |       | 61,000 |   | 6,006 |   |
| Net cash  (used in) investing activities                                           |       | (455,769                    | )          | (1,059,795 | ) | (575,081 | ) |
| **Cash  flows provided by (used in) financing activities:**                        |       |                        |       |   |   |   |   |
| Proceeds  from issuance of common stock                                            |       | 1,296,715                   |       | 2,036,499 |   | 627,494 |   |
| Payments  made on long-term debt                                                   |       | (952,155                    | )          | (1,138,166 | ) | (1,954,844 | ) |
| Net increase  (decrease) in working capital line of credit                         |       | —                      |       | — |   | (3,438,268 | ) |
| Net cash  provided by (used in) financing activities                               |       | 344,560                     |       | 898,333 |   | (4,765,618 | ) |
| Net increase  in cash and cash equivalents                                         |       | 6,435,920                   |       | 1,844,383 |   | 500,989 |   |
| Cash and  cash equivalents at beginning of year                                    |       | 3,239,570                   |       | 1,395,187 |   | 894,198 |   |
| Cash and  cash equivalents at end of year                                          |       | $                           | 9,675,490  |   | $ | 3,239,570 |   | $ | 1,395,187 |   |
|                                                                               |       |                        |       |   |   |   |   |
| **Supplemental  disclosures of cash flow information:**                            |       |                        |       |   |   |   |   |
| Cash paid  during the year for interest                                            |       | $                           | 293,908    |   | $ | 248,587 |   | $ | 521,420 |   |
| Summary of  non-cash investing and financing activities:                           |       |                        |       |   |   |   |   |
| Common Stock  issued for acquisition earnout                                       |       | —                      |       | 420,566 |   | 210,786 |   |
| Conversion  of Convertible Debenture into Common Stock                             |       | —                      |       | — |   | 401,497 |   |

 

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

 

34

----

 

**POORE BROTHERS, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

 

**1.Organization, Business and Summary 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 Company completed an initial public offering of its Common Stock.  In November 1998, the Company acquiredthe business and certain assets (including the Bob’s Texas Style® potato chipbrand) of Tejas Snacks, L.P. (“Tejas”), a Texas-based potato chipmanufacturer.  In October 1999, theCompany acquired Wabash Foods, LLC (“Wabash”) including the Tato Skins®, O’Boisies®,and Pizzarias® trademarks, the Bluffton, Indiana manufacturing operation andassumed all of Wabash Foods’ liabilities. In June 2000, the Company acquired Boulder Natural Foods, Inc.(“Boulder”) and the Boulder Potato Company® brand of totally natural potatochips.

 

As partof the Boulder acquisition, the Company was required to issue additionalunregistered shares of Common Stock to the seller on each of the first threeanniversaries of the closing of the acquisition.  The issuance of such shares was dependentupon increases in sales of Boulder product as compared to previousperiods.  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.  With each issuance of shares the Companyincreased the goodwill recorded from this acquisition.

 

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 decidedto discontinue the brand in June 2004, and amended its license agreementswith Warner Bros. Consumer Products.

 

In September 2004,the Company signed a multi-year license agreement with Cinnabon, Inc.pursuant to which the Company plans to develop and sell a variety of snackproducts, to include cookies and bars under the Cinnabon® brand.

 

The Company’s fiscal year ends on the lastSaturday occurring in the month of December of each calendar year.  Accordingly, fiscal 2004 commenced December 28,2003 and ended December 25, 2004.

 

***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 and sells nationally T.G.I. Friday’s®brand snacks under license from TGI Friday’s Inc.  The Company also currently (i) manufacturesand sells regionally its own brands of salted snack food products, includingPoore Brothers®, Bob’s Texas Style®, and Boulder Potato Company® 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 Company sells its T.G.I. Friday’s® brandsnack products to mass merchandisers, grocer, club and drug stores directly andto primarily convenience stores and vend operators through independentdistributors.  The Company’s other brandsare also sold through independent distributors.

 

***Principlesof Consolidation***

 

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

 

35

----

 

***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 routinelyevaluates its estimates, including those related to accruals for customerprograms and incentives, product returns, brand discontinuance costs, baddebts, income taxes, long-lived assets, inventories and contingencies.  The Company bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances.  Actual resultscould differ from those estimates.

 

***FairValue of Financial Instruments***

 

At December 25,2004 and December 27, 2003, the carrying value of cash, accountsreceivable, accounts payable, and accrued liabilities approximate fair valuessince they are short-term in nature.  Thecarrying value of the long-term debt approximates fair-value based on theborrowing rates currently available to the Company for long-term borrowingswith similar terms, except for the mortgage loan with interest at 9.03%, which hasa fair value of approximately $1.4 million at December 25, 2004.  The Company estimates fair values offinancial instruments by using available market information.  Considerable judgment is required ininterpreting market data to develop the estimates of fair value.  Accordingly, the estimates may not beindicative of the amounts that the Company could realize in a current marketexchange.  The use of different marketassumptions or valuation methodologies could have a material effect on theestimated fair value amounts.

 

***Inventories***

 

Inventories arestated at the lower of cost (first-in, first-out) or market.  The Company identifies slow moving orobsolete inventories and estimates appropriate loss provisions related thereto.  Historically, these loss provisions have notbeen significant; however, 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 includesexpenditures for major improvements and replacements.  Maintenance and repairs are charged tooperations when incurred.  When assetsare retired or otherwise disposed of, the related costs and accumulateddepreciation are removed from the appropriate accounts, and the resulting gainor loss is recognized.  Depreciationexpense is computed using the straight-line method over the estimated usefullives of the assets, 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”, we evaluate the recoverability of property and equipmentnot held for sale by comparing the carrying amount of the asset or group ofassets against the estimated undiscounted future cash flows expected to resultfrom the use of the asset or group of assets and their eventualdisposition.  If the undiscounted futurecash flows are less than the carrying value of the asset or group of assetsbeing evaluated, an impairment loss is recorded.  The loss is measured as the differencebetween the fair value and carrying value of the asset or group of assets beingevaluated.  Assets to be disposed of arereported at the lower of the carrying amount or the fair value less cost tosell.  The estimated fair value would bebased on the best information available under the circumstances, includingprices for similar assets or the results of valuation techniques, including thepresent value of expected future cash flows using a discount rate commensuratewith the risks involved.

 

***IntangibleAssets***

 

In June 2001,the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets”.  SFAS No. 142 changes the method by whichcompanies recognize intangible assets in purchase business combinations andgenerally requires identifiable intangible assets to be recognized separatelyfrom goodwill.  In addition, iteliminates the amortization of all existing and newly acquired goodwill on aprospective basis and requires companies to assess goodwill for impairment, atleast annually, based on the fair value of the reporting unit.

 

36

----

 

Upon adoption on January 1,2002, the Company ceased the amortization of goodwill and other intangibleassets with indefinite lives in accordance with SFAS No. 142.

 

Goodwill andtrademarks are reviewed for impairment annually, or more frequently, ifimpairment indicators arise.  Goodwill isrequired to be tested for impairment between the annual tests if an eventoccurs or circumstances change that more-likely-than-not reduce the fair valueof a reporting unit below its carrying value. Trademarks with indefinite lives, are required to be tested forimpairment between the annual tests if an event occurs or circumstances changeindicating that the asset might be impaired. The Company believes at this time that the carrying values continue tobe appropriate.  See Note 2.

 

***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.

 

***Advertisingand Promotion***

 

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.  Costsassociated with obtaining shelf space (i.e., “slotting fees”) are expensed inthe period in which such costs are incurred by the Company.  Anytime the Company offers consideration (cashor credit) 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.  Anymarketing programs that deal directly with the consumer are recorded inselling, general and administrative expenses. Accrued advertising and promotion, which is included in the currentliabilities section of the accompanying consolidated balance sheet, was$547,000 and $1,157,000 on December 25, 2004 and December 27, 2003,respectively.  The 2003 balance includedamounts related to our Crunch Toons® brand, which we discontinued during 2004.

 

***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 andliabilities are determined based on the difference between the financialstatement and tax bases of assets and liabilities using enacted rates expectedto apply to taxable income in the years in which those differences are expectedto be recovered or settled.  The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin the period that includes the enactment date.

 

37

----

 

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

 

The Company’sstock-based compensation plan, described in Note 9, is accounted for under therecognition and measurement provisions of APB Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations.

 

The Company hasadopted the disclosure-only provisions of SFAS No. 123, “Accounting forStock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure”.  Accordingly, no compensation cost has beenrecognized for the stock option plan. Awards under the plan vest over periods ranging from one to three years,depending on the type of award.  Thefollowing table illustrates the effect on net income and earnings per share ifthe fair value based method had been applied to all option grants, using theBlack-Scholes valuation model, for the years ended December 25, 2004, December 27,2003 and December 28, 2002:

 
| ** **                                                                                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net income  as reported                                                                                                                 |       | $        | 2,134,714  |     | $          | 1,051,964  |       | $ | 2,636,837 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  method for all awards, net of related tax effects |       | (518,950 | )          | (382,380 | )          | (1,010,139 | )          |
| Pro forma  net income                                                                                                                   |       | $        | 1,615,764  |     | $          | 669,584    |       | $ | 1,626,698 |   |
|                                                                                                                                    |       |     |       |     |       |       |       |
| Net income  per share – basic – as reported                                                                                   |       | $        | 0.11       |     | $          | 0.06       |       | $ | 0.16 |   |
| Pro forma  net income per share – basic                                                                                            |       | $        | 0.09       |     | $          | 0.04       |       | $ | 0.10 |   |
| Net income  per share – diluted – as reported                                                                                 |       | $        | 0.11       |     | $          | 0.06       |       | $ | 0.15 |   |
| Pro forma  net income per share – diluted                                                                                          |       | $        | 0.09       |     | $          | 0.04       |       | $ | 0.09 |   |

 

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%, 57% and 44%; risk-free interest rate of 3.15%, 2.4% and3.8%; and expected lives of 3 years for 2004, 2003 and 2002, respectively.

 

38

----

 

***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 of outstanding stock options orwarrants and conversion of convertible debentures are assumed to occur for purposesof calculating diluted earnings per share for periods in which their effectwould not be anti-dilutive.  Earnings percommon share was computed as follows for the years ended December 25,2004, December 27, 2003 and December 28, 2002:

 
| ** **                                         | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Basic  Earnings Per Common Share:**              |       |       |       |       |       |       |       |
| Net income                                         |       | $          | 2,134,714  |       | $          | 1,051,964  |       | $ | 2,636,837 |   |
|                                               |       |       |       |       |       |       |       |
| Weighted  average number of common shares          |       | 18,794,977 |       | 17,572,951 |       | 16,146,081 |       |
|                                               |       |       |       |       |       |       |       |   |   |   |
| Earnings per  common share                         |       | $          | 0.11       |       | $          | 0.06       |       | $ | 0.16 |   |
|                                               |       |       |       |       |       |       |       |
| **Diluted  Earnings Per Common Share:**            |       |       |       |       |       |       |       |
| Net income                                         |       | $          | 2,134,714  |       | $          | 1,051,964  |       | $ | 2,636,837 |   |
|                                               |       |       |       |       |       |       |       |
| Weighted  average number of common shares          |       | 18,794,977 |       | 17,572,951 |       | 16,146,081 |       |
| Incremental  shares from assumed conversions -     |       |       |       |       |       |       |       |
| Debentures                                         |       | —     |       | —     |       | 120,279    |       |
| Warrants                                           |       | —     |       | 325,496    |       | 476,019    |       |
| Stock  options                                     |       | 152,576    |       | 578,039    |       | 1,084,574  |       |
| Adjusted  weighted average number of common shares |       | 18,947,553 |       | 18,476,486 |       | 17,826,953 |       |
|                                               |       |       |       |       |       |       |       |   |   |   |
| Earnings per  common share                         |       | $          | 0.11       |       | $          | 0.06       |       | $ | 0.15 |   |

 

 

***New Accounting Pronouncements***

 

In January 2003, the FASB issuedinterpretation FIN No. 46, “Consolidation of Variable Interest Entities –An Interpretation of Accounting Research Bulletin (“ARB”) No. 51.”  This interpretation was subsequently revisedby FIN 46 (Revised 2003) in December 2003. This revised interpretation states that consolidation of variableinterest entities will be required by the primary beneficiary if the entitiesdo not effectively disperse risks among the parties involved.  The requirements are effective for fiscalyears ending after December 15, 2003 for special-purpose entities and forall other types of entities for periods ending after March 31, 2004.  The Company has no variable interest entitiesand the adoption of FIN No. 46 (R) did not impact our operations orfinancial position.

 

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. This standard is effective for periods beginningafter June 15, 2005 and includes two transition methods. Upon adoption, wewill be required to use either the modified prospective or 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. We are currently evaluatingthe impact of this standard and its transitional alternatives.

 

39

----

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs”.  This statementclarifies the accounting for the abnormal amount of idle facilities expense,freight, handling costs and wasted material. This statement requires that those items be recognized as current-periodexpense.  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 is effective for inventorycosts incurred after December 31, 2005. Adoption of this statement will not have a material effect on thefinancial statements of the Company.

 

**2.****     Goodwilland Trademarks:**

 

Goodwill and trademarks relate to the 1998,1999 and 2000 acquisitions described in Note 1. Intangibles not subject to amortization consisted of the following as ofDecember 25, 2004 and December 27, 2003:

 

| ** ** | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------|------------|-----------|------------|-----------|------------|
|       |       |      |       |      |       |   |   |
| Goodwill   |       | $         | 5,986,252  |      | $          | 5,986,252 |   |
|       |       |      |       |      |       |
| Trademarks |       | 4,207,032 |       | 4,207,032 |       |
|       |       | $         | 10,193,284 |      | $          | 10,193,284 |   |

 

 

**3.****    ****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 Federalinsurance limits.

 

The Company’sprimary concentration of credit risk is related to certain trade accountsreceivable.  In the normal course ofbusiness, the Company extends unsecured credit to its customers.  In 2004 and 2003, substantially all of theCompany’s customers were distributors or retailers whose sales wereconcentrated in the grocery industry, throughout the United States.  The Company investigates a customer’s creditworthiness before extending credit.  At December 25,2004, two customers accounted for approximately 32% of accounts receivable inthe accompanying Consolidated Balance Sheets.

 

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

 

Inventoriesconsisted of the following as of December 25, 2004 and December 27,2003:

 
| ** **      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
| Finished  goods |       | $        | 1,537,488  |     | $          | 1,610,776 |   |
| Raw  materials  |       | 608,254  |       | 789,727  |       |
|            |       | $        | 2,145,742  |     | $          | 2,400,503 |   |

 

40

----

 

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

 

Property andequipment consisted of the following as of December 25, 2004 and December 27,2003:

 
| ** **                                      | ** ** | **Useful Lives**    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------------|------------|---------------------|------------|------------|------------|------------|------------|
| Buildings  and improvements                     |       | 20 – 30  years |       | $          | 5,364,778  |       | $          | 5,313,578 |   |
| Equipment                                       |       | 7 – 15 years   |       | 10,768,784 |       | 10,700,679 |       |
| Land                                            |       | —              |       | 272,006    |       | 272,006    |       |
| Vehicles                                        |       | 5 years             |       | 16,825     |       | 34,893     |       |
| Furniture  and office equipment                 |       | 2 – 5 years    |       | 1,547,608  |       | 1,447,145  |       |
|                                            |       |                |       | 17,970,001 |       | 17,768,301 |       |
| Less  accumulated depreciation and amortization |       |                |       | (7,154,038 | )          | (6,013,205 | )          |
|                                            |       |                |       | $          | 10,815,963 |       | $          | 11,755,096 |   |

 

On October 28, 2000, the Companyexperienced a fire at the Goodyear, Arizona manufacturing plant.  In 2002 and 2003, the Company recorded incomeof $259,376 and $1,918,784, respectively, 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 SFAS144, “Accounting for the Impairment or Disposal of Long-lived Assets,” theCompany performed an assessment of the equipment’s fair value, which resultedin the need to write-down the equipment by $1,030,352.  In addition, in December, 2004, the Companyconcluded that a packaging machine in its Indiana plant was no longer likely tobe used.

 

**6.****     Long-TermDebt:**

 

Long-term debt consisted of the following as of December 25, 2004and December 27, 2003:

 
| ** **                                                                                                                                                                                                         | ** ** | **2004**   | ** ** | **2003**  | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------|------------|
| Term loan  due in monthly installments through July 1, 2006; interest at prime rate  (4.0% at December 25, 2004); collateralized by accounts receivable,  inventories, equipment and general intangibles |       | $          | 1,347,069  |      | $          | 2,259,377 |   |
| Mortgage  loan due in monthly installments through July 2012; interest at 9.03%;  collateralized by land and building                                                                                         |       | 1,772,732  |       | 1,812,579 |       |
|                                                                                                                                                                                                               |       | 3,119,801  |       | 4,071,956 |       |
| Less current  portion                                                                                                                                                                                              |       | (1,390,667 | )          | (932,155  | )          |
|                                                                                                                                                                                                               |       | $          | 1,729,134  |      | $          | 3,139,801 |   |

 

Annual maturities of long-term debt as of December 25,2004 are as follows:

 
| **Year**   | ** ** | ** ** | ** ** |
|------------|------------|------------|------------|
| 2005       |       | $          | 1,390,667  |   |
| 2006       |       | 47,702     |       |
| 2007       |       | 52,192     |       |
| 2008       |       | 57,105     |       |
| 2009       |       | 62,480     |       |
| Thereafter |       | 1,509,655  |       |
|       |       | $          | 3,119,801  |   |

 

41

----

 

Interest expense consisted of the followingat December 25, 2004, December 27, 2003 and December 28, 2002:

 
| ** **             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest  expense      |       | $        | 221,258    |     | $          | 275,619  |       | $ | 541,754 |   |
| Interest  income       |       | (56,461  | )          | (22,799  | )          | (2,021   | )          |
| Interest  expense, net |       | $        | 164,797    |     | $          | 252,820  |       | $ | 539,733 |   |

 

The Company’s Goodyear, Arizonamanufacturing, distribution and headquarters facility is subject to a $1.8million 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 onJuly 1, 2012; however monthly principal and interest installments of$16,825 are determined based on a twenty-year amortization period.

 

During 2002, the Company’s remainingoutstanding 9% Convertible Debenture due July 1, 2002 in the principalamount of $401,497 held by Wells Fargo Small Business Investment Company, Inc.(“Wells Fargo SBIC”) was converted into 401,497 shares of the Company’s Commonstock.

 

The U.S. Bancorp Credit Agreement consists ofa $5.0 million line of credit, a $0.5 million capital expenditure line ofcredit (“CapEx Term Loan”) and a $5.8 million Term Loan A.  At December 25, 2004, there were nobalances on either the line of credit or the CapEx Term Loan, and $1.3 millionoutstanding on Term Loan A.  Borrowingsunder the line of credit are limited to 80% of eligible receivables 60% ofeligible finished goods inventories and 50% of eligible raw materialsinventories.  At December 25, 2004,the Company had a borrowing base of approximately $4.2 million under the U.S.Bancorp Line of Credit.  The U.S. BancorpCredit Agreement requires the Company to be in compliance with certainfinancial performance criteria, including minimum annual operating results, aminimum tangible capital base and a minimum fixed charge coverage ratio.  In July 2004, the U.S. Bancorp CreditAgreement was amended to modify certain financial covenants that allow theCompany to exclude one-time extraordinary, non-operating gains/losses duringthe applicable period.  At December 25,2004, the Company was in compliance with all of the financial covenants.

 

**7.****     BrandDiscontinuance:**

 

On June 11, 2004, the Company discontinued its Crunch Toons®brand.  As a result of thediscontinuance, the Company recorded expenses in the second quarter ofapproximately $1.8 million.  The chargecovered approximately $1.1 million related to minimum royalties under thelicense agreements and $0.3 million in inventories, which are shown in “Costsrelated to brand discontinuance” on the accompanying Consolidated Statement ofIncome for 2004.  In addition, a chargeof $0.3 million in estimated allowances given to the Company’s customers tosell-off remaining distributor and retailer inventories were recorded and areincluded in “Net revenues” on the accompanying Consolidated Statement of Incomefor 2004.

 

In connection with the brand discontinuation, and included in the $1.1million charge above, the Company negotiated amendments to its licenseagreements with Warner Bros. Consumer Products pursuant to which the Agreementswill remain in effect but become non-exclusive. However, because the Company has ceased using the Crunch Toons® brand inaccordance with SFAS No. 146, “Accounting for Costs Associated with Exitor Disposal Activities”, the Company estimated the fair value of the remainingguaranteed future minimum payments under the agreements by computing thepresent value of the future cash payments.

 

42

----

 

The following table summarizes the activity of the accrued costsrelated to brand discontinuance and other for the year ended December 25,2004:

 
| ** **                                                                                | ** ** | **June 11, 2004  Balance** | ** ** | **Write-offs and  Payments** | ** ** | **Dec. 25, 2004  Balance** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                                                                                      |       |                            |       |                         |       |                            |       |   |   |   |
| Inventory  and equipment write-offs                                                       |       | $                               | 294,768    |                         | $          | (294,768                        | )          | $ | — |   |
| Write-down  of prepaid royalties and present value of guaranteed minimum royalty payments |       | 1,119,991                       |       | (527,519                     | )          | 592,472                         | (1,2)      |
| Reclamation  costs                                                                        |       | 344,160                         |       | (309,662                     | )          | 34,498                          | (1)        |
| Present  value of remaining lease payments on equipment                                   |       | —                          |       | 308,104                      |       | 308,104                         | (1,3)      |
|                                                                                      |       | $                               | 1,758,919  |                         | $          | (823,845                        | )          | $ | 935,074 |   |

 

----

(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 amended agreements.

(3)           Inaccordance with SFAS No. 146, the fair value of remaining operating leasepayments were recorded relating to a machine the Company determined as not tobe used in the future.  Future operatinglease payments will be made in accordance with the existing lease agreement.

 

43

----

 

**8.****     Commitmentsand Contingencies:**

 

The Company is periodically a party tovarious lawsuits arising in the ordinary course of business.  Management believes, based on discussionswith legal counsel, that the resolution of such lawsuits, individually and inthe aggregate, will not have a material adverse effect on the Company’sfinancial 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.  TheCompany has entered into a lease expiring in April 2018 with respect tothe facility and the lease has two five-year renewal options.  Current lease payments are approximately$22,000 per month.  The lease paymentsare subject to an annual CPI-based increase. The Company produces its T.G.I. Friday’s® brand snacks and Tato Skins®brand potato snacks 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 alease expiring in November 2006 with respect to the facility and the leasehas two three-year renewal options. Current lease payments are approximately $31,500 per month.  The Company also has entered into a serviceagreement expiring in December 2008 with a third party for warehousingservices.  The service agreement includescertain minimum monthly usage commitments. See *“Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations - Contractual Obligations.”*

 

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$1,666,000, $1,158,000 and $956,000 for each of fiscal 2004, 2003 and 2002,respectively.  Minimum future rentalcommitments under non-cancelable leases as of December 25, 2004 are asfollows:

 
| **Year**   | ** ** | **Operating  Leases** | ** ** |
|------------|------------|-----------------------|------------|
| 2005       |       | $                     | 1,419,066  |   |
| 2006       |       | 1,336,307             |       |
| 2007       |       | 961,587               |       |
| 2008       |       | 518,403               |       |
| 2009       |       | 374,519               |       |
| Thereafter |       | 2,269,682             |       |
| Total      |       | $                     | 6,879,564  |   |

 

The Company licenses patented technology fromMiles Willard in connection with the manufacture of its T.G.I. Friday’s® andTato Skins® brand products.  Pursuant tothe license agreement between the Company and Miles Willard, the Company has anexclusive right to use the patented technology within North America until thepatents expire between 2004 and 2008.  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.

 

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 license agreement, theCompany is required to make royalty payments on sales of T.G.I. Friday’s® brandsnack products and is required to achieve certain minimum sales levels bycertain 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.

 

44

----

 

**9.****     Shareholders’Equity:**

 

***Common Stock***

 

On December 27, 2001, the Companycompleted the sale of 586,855 shares of Common Stock, $0.01 par value, to BFSUS Special Opportunities Trust PLC (“BFS”), a fund managed by RenaissanceCapital Group, Inc., in a private placement transaction.  The net proceeds of the transaction wereutilized by the Company to reduce the Company’s outstanding indebtedness.  In connection with such transaction, theCompany granted demand and piggyback registration rights to BFS.  Pursuant to the demand registration rights,the Company may be required, upon demand of BFS, to file a registrationstatement (the “BFS Registration Statement”) with the Securities and ExchangeCommission covering the resale of the shares of Common Stock issued to BFS inthe transaction.  The Company will berequired to pay all expenses relating to any such registration, other thanunderwriting discounts, selling commissions and stock transfer taxes applicableto the shares, and any other fees and expenses incurred by the holder(s) of theshares (including, without limitation, legal fees and expenses) in connectionwith the registration.

 

Approximately 5,699,900 shares of outstandingCommon Stock issued by the Company are subject to “piggyback” registrationrights granted by the Company, pursuant to which such shares of Common Stockmay be registered under the Securities Act and, as a result, become freelytradable in the future.  All or a portionof such shares may, at the election of the holders thereof, be included in theBFS Registration Statement and, upon the effectiveness thereof, may be sold inthe public markets.

 

***Preferred Stock***

 

The Company has authorized 50,000 shares of$100 par value Preferred Stock, none of which was outstanding at December 25,2004 or December 27, 2003.  TheCompany may issue such shares of Preferred Stock in the future withoutshareholder approval.

 

***Warrants***

 

During the fiscal years 2002, 2003 and 2004warrant activity was as follows:

 
| ** **                       | ** ** | **Warrants  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|----------------------------------|------------|---------------------------|------------|---------------------------------------|------------|
| Balance, December 31,  2001 |       | 1,283,298                 |       | $                                     | 1.11       |   |
| Exercised                        |       | (269,505                  | )          | 1.00                                  |       |
| 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 |       | 0                         |       | $                                     | 0.00       |   |

 

Warrants had been issued in connection withprior financings and the acquisition of Wabash. At December 25, 2004 there were no longer any outstanding warrants.

 

45

----

 

As of July 30, 1999, the Company agreedto the assignment of a five-year warrant from Everen Securities, Inc. toStifel, Nicolaus & Company Incorporated (the Company’s acquisitions andfinancial advisor) representing the right to purchase 296,155 unregisteredshares of Common Stock at an exercise price of $.875 per share.  The warrant provided the holder thereofcertain anti-dilution and piggyback registration rights.  The warrant was exercisable as to 50% of theshares when the Company’s pro forma annual sales reached $30 million, which itdid when the Company completed the Wabash acquisition in October 1999.  The remaining 50% of the warrant wasexercisable if the Company’s pro forma annual sales reached $100 million.  This warrant expired during 2004.

 

***Stock Options***

 

The Company’s 1995 Stock Option Plan (the “Plan”), asamended, provides for the issuance of options to purchase 3,000,000 shares ofCommon Stock.  The options granted pursuantto the Plan expire over a five-yearperiod and generally vest over three years.  In addition to options granted under thePlan, the Company also issued non-qualified options (non-plan options) topurchase Common Stock to certain Directors and Officers which are exercisableand expire either five or ten years from date of grant.  All options are issued at an exercise priceof fair market value at the date of grant and are non-compensatory.

 

During fiscal years 2002, 2003 and 2004, stock optionactivity was as follows:

 
| ** **                       | ** ** | **Plan Options**         | ** ** | **Non-Plan Options**                  | ** ** |
|----------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Balance, December 31,  2001 |       | 2,010,317                |       | $                                     | 1.97       |   | 1,645,000 |   | $ | 1.54 |   |
| Granted                          |       | 367,500                  |       | 2.86                                  |       | — |   | — |   |
| Canceled                         |       | (324,334                 | )          | 2.78                                  |       | (66,667 | ) | 2.61 |   |
| Exercised                        |       | (315,683                 | )          | 1.19                                  |       | (33,333 | ) | 2.61 |   |
| 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 |   |

 

Tax benefits on stock options exercised are recorded as increases toadditional paid-in capital and totaled $315,017, $830,371 and $0 for each offiscal 2004, 2003 and 2002, respectively.

 

The following table summarizes informationabout stock options outstanding and exercisable at December 25, 2004:

 
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life  (in years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-------------------------------|------------|--------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| $1.0819-$1.8438               |       | 170,500                  |       | 0.48                                                          |       | $                                      | 1.17       |                     | 170,500    |                                   | $          | 1.17 |   |
| $2.10 -  $2.99                |       | 855,833                  |       | 3.25                                                          |       | $                                      | 2.57       |                     | 353,055    |                                   | $          | 2.69 |   |
| $3.08 -  $3.60                |       | 592,500                  |       | 3.21                                                          |       | $                                      | 3.26       |                     | 289,167    |                                   | $          | 3.23 |   |
| $4.20 -  $4.94                |       | 30,000                   |       | 3.72                                                          |       | $                                      | 4.59       |                     | 16,666     |                                   | $          | 4.43 |   |
|                          |       | 1,648,833                |       | 2.96                                                          |       | $                                      | 2.68       |                     | 829,388    |                                   | $          | 2.60 |   |

 

46

----

 

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

 
| ** **              | ** ** | **Plan Options**                     | ** ** | **Non-Plan Options**                 | ** ** |
|-------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **              | ** ** | **Exercisable Options  Outstanding** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Exercisable Options  Outstanding** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| December 25,  2004 |       | 553,555                              |       | $                                    | 2.89       |   | 275,833 |   | $ | 2.02 |   |
| December 27,  2003 |       | 603,997                              |       | $                                    | 2.51       |   | 940,000 |   | $ | 1.47 |   |
| December 28,  2002 |       | 1,034,793                            |       | $                                    | 1.60       |   | 1,019,999 |   | $ | 1.37 |   |

 

**10.****  IncomeTaxes:**

 

The (provision) benefit for income taxesconsisted of the following for the years ended December 25, 2004, December 27,2003 and December 28, 2002:

 
| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current:                                    |       |     |       |     |       |     |       |
| Federal                                     |       | $        | —     |     | $          | —   |       | $ | — |   |
| State                                       |       | (83,855  | )          | —   |       | (98,593  | )          |
|                                        |       | $        | (83,855    | )        | $          | —   |       | $ | (98,593 | ) |
| Deferred:                                   |       |     |       |     |       |     |       |
| Federal                                     |       | $        | (1,220,220 | )        | $          | (559,000 | )          | $ | 413,430 |   |
| State                                       |       | (102,664 | )          | (82,861  | )          | (72,000  | )          |
|                                        |       | $        | (1,322,884 | )        | $          | (641,861 | )          | $ | 341,430 |   |
|                                        |       |     |       |     |       |     |       |
| Total  (provision) benefit for income taxes |       | $        | (1,406,739 | )        | $          | (641,861 | )          | $ | 242,837 |   |

 

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 25, 2004, December 27,2003 and December 28, 2002:

 
| ** **                                                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002**  | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Provision at  statutory rate                                     |       | $        | (1,204,094 | )        | $          | (575,900  | )          | $ | (813,960 | ) |
| State income  tax, net                                           |       | (173,530 | )          | (54,961  | )          | (170,593  | )          |
| Nondeductible  expenses                                          |       | (29,115  | )          | (11,000  | )          | (11,983   | )          |
| Net  operating loss utilized and reversal of valuation allowance |       | —   |       | —   |       | 1,239,373 |       |
| Income tax  (provision) benefit                                  |       | $        | (1,406,739 | )        | $          | (641,861  | )          | $ | 242,837 |   |
|                                                                  |            |          |            |          |            |           |            |  |  |  |  |

 

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 25,2004 and December 27, 2003:

 
| ** **                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|
| **Deferred  Tax Asset – current**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  operating loss carryforward              |       | $          | 639,000    |       | $          | 1,707,000 |   |
| Allowance  for doubtful accounts              |       | 35,000     |       | 134,000    |       |
| Accrued  liabilities                          |       | 292,000    |       | 174,000    |       |
| Other                                         |       | 375,723    |       | 239,996    |       |
|                                          |       | 1,341,723  |       | 2,254,996  |       |
| **Deferred  Tax Liability – noncurrent** |       |       |       |       |       |
| Depreciation  and amortization                |       | (1,829,252 | )          | (1,731,625 | )          |
| AMT minimum  tax credit carryforward          |       | 41,000     |       | —     |       |
|                                          |       | (1,788,252 | )          | (1,731,625 | )          |
| Net deferred  tax (liability) asset           |       | $          | (446,529   | )          | $          | 523,371 |   |

 

47

----

 

The Company experienced significant netlosses in prior fiscal years resulting in a net operating loss (“NOL”)carryforward for federal income tax purposes of approximately $1.9 million at December 25,2004.  The Company’s NOL will begin toexpire in varying amounts between 2010 and 2018.  The Company also has an alternative minimumtax (“AMT”) credit carryforward for federal income tax purposes of $41,000 at December 25,2004.

 

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 valuationallowances from period to period are included in the tax provision in theperiod of change.  In determining whethera valuation allowance is required, the Company takes into account all positiveand negative evidence with regard to the utilization of a deferred tax assetincluding our past earnings history, expected future earnings, the characterand jurisdiction of such earnings, unsettled circumstances that, if unfavorablyresolved, would adversely affect utilization of a deferred tax asset, carrybackand carryforward periods, and tax strategies that could potentially enhance thelikelihood of realization of a deferred tax asset.  The Company provides for income taxes at arate equal to the combined federal and state effective rates, whichapproximated 39% under current tax rates.

 

**11.****  BusinessSegments and Significant Customers:**

 

For the year ended December 25, 2004,Wal*Mart (including its SAM’s Clubs) and Vistar, a national vendingdistributor, were the only two customers with revenues over 10% of totalCompany revenue.  Wal*Mart accounted for$14,211,000, or 21%, $13,237,000, or 20%, and $12,414,000, or 21%, for fiscalyears 2004, 2003 and 2002, respectively. Vistar accounted for $9,373,000, or 14%, $8,751,000, or 13%, and$7,784,000, or 13%, for fiscal years 2004, 2003 and 2002, respectively.

 

The Company’s operations consist of two segments:manufactured products and distributed products. The manufactured products segment produces potato chips, potato crisps,and potato skins for sale primarily to snack food distributors and retailers.  The distributed products segment sells snackfood products manufactured by other companies to the Company’s Arizona snackfood distributors.  The Company’sreportable segments offer 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** | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **2004**                      | ** ** | **2003** | ** ** | **2002** | ** ** |
| Branded  products                             |       | 94                            | %          | 91 | % | 90 | % |
|                                          |       |                          |       |   |   |   |   |
| Private  label products.                      |       | 3                             | %          | 3 | % | 3 | % |
|                                          |       |                          |       |   |   |   |   |
| Total  manufactured products segment revenues |       | 97                            | %          | 94 | % | 93 | % |
|                                          |       |                          |       |   |   |   |   |
| Distributed  products segment revenues        |       | 3                             | %          | 6 | % | 7 | % |
|                                          |       |                          |       |   |   |   |   |
| Total  revenues                               |       | 100                           | %          | 100 | % | 100 | % |

 

 

In fiscal years 2004, 2003 and 2002, theT.G.I. Friday’s® brand snacks represented 72%, 61% and 60%, respectively, ofthe Company’s total net revenues. Effective February 1, 2004, the Company ceased distribution ofSnyders’ pretzels which represented approximately 50%, or $2 million, ofdistributed products segment revenues in 2003.

 

48

----

 

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

 
| ** **                                                      | ** ** | **Manufactured  Products** | ** ** | **Distributed  Products** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|------------------|------------|
| **2004**                                                        | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| 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          |       |
| Segment gross  profit                                           |       | 13,958,782                 |       | 306,012                   |       | 14,264,794       |       |
| ** **                                                      | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| **2003**                                                        | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| 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       |       |
|                                                            |       |                       |       |                      |       |             |       |
| **2002**                                                        | ** ** | ** **                 | ** ** | ** **                | ** ** | ** **       | ** ** |
| Revenues  from external customers                               |       | $                          | 55,321,985 |                      | $          | 4,026,486        |       | $ | 59,348,471 |   |
| Depreciation  and amortization included in segment gross profit |       | 936,499                    |       | —                    |       | 936,499          |       |
| Segment gross  profit                                           |       | 10,797,357                 |       | 514,652                   |       | 11,312,009       |       |

 

The following table reconciles reportable segment gross profit to theCompany’s consolidated income before income tax provision for the years ended December 25,2004, December 27, 2003 and December 28, 2002:

 
| ** **                                    | ** ** | **2004**    | ** ** | **2003**    | ** ** | **2002**   | ** ** |
|-----------------------------------------------|------------|-------------|------------|-------------|------------|------------|------------|
| Segment  gross profit                         |       | $           | 14,264,794 |        | $          | 13,318,521 |       | $ | 11,312,009 |   |
| Unallocated  amounts:                         |       |        |       |        |       |       |       |
| Selling,  general and administrative expenses |       | (10,558,544 | )          | (13,290,660 | )          | (8,637,652 | )          |
| Insurance  claim settlement income, net       |       | —      |       | 1,918,784   |       | 259,376    |       |
| Interest  expense, net                        |       | (164,797    | )          | (252,820    | )          | (539,733   | )          |
| Income  before income taxes                   |       | $           | 3,541,453  |        | $          | 1,693,825  |       | $ | 2,394,000 |   |

 

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

 

The Company isperiodically a party to various lawsuits arising in the ordinary course ofbusiness.  Management believes, based ondiscussions with legal counsel, that the resolution of any such lawsuits willnot have a material effect on the financial 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 extendsthrough April 2018 and contains two additional five-year lease renewalperiods at the option of the Company. Lease payments are approximately $22,000per month, plus CPI adjustments, and the Company is responsible for all real estatetaxes, utilities and insurance.  AmericanPacific Financial Corporation is an affiliate of Capital Foods, LLC the singlelargest shareholder of the Company, currently holding approximately 23% of theoutstanding shares of Common Stock.

 

49

----

 

The results forany single quarter are not necessarily indicative of the Company’s results forany other quarter or the full year.

 

**14.****   QuarterlyFinancial Data (unaudited):**

 
| **(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    |       |

 

Thesum of quarterly earnings per share information may not agree to the annualamount due to the use of the treasury stock method of calculating earnings pershare.

 

50

----

 
| **(in 000’s, except for share and per share data)** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Full Year** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|---------------|------------|
| ** **                                               | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** | ** **    | ** ** |
| **Fiscal  2003**                                         | ** ** | ** **         | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** | ** **    | ** ** |
| Net revenues                                             |       | $                  | 15,218     |                | $          | 18,581             |       | $                   | 16,661     |          | $          | 15,958 |   | $ | 66,418 |   |
| Gross profit                                             |       | 3,031              |       | 3,724               |       | 3,609              |       | 2,955               |       | 13,319        |       |
| Operating  income (loss)                                 |       | 558                |       | 1,294               |       | 516                |       | (2,340              | )          | 28            |       |
| Net income  (loss)                                       |       | $                  | 303        |                | $          | 1,971              |       | $                   | 288        |          | $          | (1,510 | ) | $ | 1,052 |   |
|                                                     |       |               |       |                |       |               |       |                |       |          |       |
| Earnings  (loss) per common share:                       |       |               |       |                |       |               |       |                |       |          |       |
| Basic                                                    |       | $                  | 0.02       |                | $          | 0.12               |       | $                   | 0.02       |          | $          | (0.08 | ) | $ | 0.06 |   |
| Diluted                                                  |       | $                  | 0.02       |                | $          | 0.11               |       | $                   | 0.01       |          | $          | (0.08 | ) | $ | 0.06 |   |
|                                                     |       |               |       |                |       |               |       |                |       |          |       |
| Weighted  average number of common shares:               |       |               |       |                |       |               |       |                |       |          |       |
| Basic                                                    |       | 16,730,642         |       | 16,984,728          |       | 17,997,911         |       | 18,578,407          |       | 17,572,951    |       |
| Diluted                                                  |       | 18,025,514         |       | 18,343,696          |       | 19,369,977         |       | 18,578,407          |       | 18,476,486    |       |

 

Thesum of quarterly earnings per share information may not agree to the annualamount due to the use of the treasury stock method of calculating earnings pershare.

 

Selling, generaland administrative expenses increased to $5.3 million in the fourth quarter of2003, resulting in an operating loss of $2.3 million.  The increase was driven by the plannedintroductory consumer marketing programs and other costs associated with thelaunch of Crunch Toons®.

 

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

 

Changes to the allowancefor doubtful accounts during the three years ended December 25, 2004 aresummarized below:

 
| ** **  | ** ** | **Balance at  beginning of period** | ** ** | **Charges  (Reductions) to  Expense** | ** ** | **Write-offs  (Collections)** | ** ** | **Balance at end  of period** | ** ** |
|-------------|------------|-------------------------------------|------------|---------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| Fiscal 2002 |       | $                                   | 219,000    |                                  | 379,000    |                          | 189,000    |                          | $          | 409,000 |   |
| Fiscal 2003 |       | $                                   | 409,000    |                                  | 24,000     |                          | 86,000     |                          | $          | 347,000 |   |
| Fiscal 2004 |       | $                                   | 347,000    |                                  | (112,000   | )                             | (146,000   | )                             | $          | 89,000 |   |

 

51

----

 

**EXHIBIT INDEX**

 
| 10.42*—                | Form of Officer Nonstatutory Stock  Option Agreement                                                                                                                                                                                                |
|-----------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                        |                                                                                                                                                                                                                                                     |
| 21.1 —                 | List of subsidiaries of Poore Brothers, Inc.                                                                                                                                                                                                        |
|                        |                                                                                                                                                                                                                                                     |
| 23.1 —                 | Consent of Deloitte & Touche LLP                                                                                                                                                                                                                |
|                        |                                                                                                                                                                                                                                                     |
| 31.1 —                 | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a) or Rule 15(d)-14(a)                                                                                                                                                  |
|                        |                                                                                                                                                                                                                                                     |
| 31.2 —                 | Certification of Chief Financial Officer  and Principal Accounting 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 |

 

----

* - Management compensatory plan or arrangement

 

52

----