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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT under SECTION 13 OR 15(d) of the SECURITIES EXCHANGE ACT
OF 1934
For the quarter ended September 5, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________.
Commission file number 0-20792
FRESH CHOICE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0130849
(State or other jurisdiction of (I.R.S. Employee
incorporation or organization) Identification No.)
2901 TASMAN DRIVE - SUITE 109, SANTA CLARA, CALIFORNIA 95054
(Address of principal executives offices) (Zip Code)
Registrant's telephone number, including area code: (408) 986-8661
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ] No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING
THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. [ ] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares of Common Stock, $.001 par value, outstanding as of October
13, 1999 was 5,741,697.
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FRESH CHOICE, INC.
INDEX
<TABLE>
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets at September 5, 1999
and December 27, 1998.....................................................................3
Condensed Consolidated Statements of Operations for the Twelve and Thirty-Six Weeks
ended September 5, 1999 and September 6, 1998 ............................................4
Condensed Consolidated Statements of Cash Flow for the Thirty-Six Weeks
ended September 5, 1999 and September 6, 1998.............................................5
Notes to Unaudited Condensed Consolidated Financial Statements............................6
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................................9
Item 3 - Quantitative and Qualitative Disclosures About Market Risk..........................19
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings...................................................................19
Item 2 - Changes in Securities...............................................................19
Item 3 - Defaults Upon Senior Securities.....................................................19
Item 4 - Submission of Matters to a Vote of Security Holders.................................19
Item 5 - Other Information...................................................................19
Item 6 - Exhibits and Reports on Form 8-K....................................................19
SIGNATURES ......................................................................................20
INDEX TO FORM 10-Q EXHIBITS......................................................................21
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FRESH CHOICE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
September 5, December 27,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,344 $ 1,830
Receivables 117 126
Inventories 595 571
Pre-opening costs, net -- 70
Prepaid expenses and other current assets 568 503
-------- --------
Total current assets 4,624 3,100
PROPERTY AND EQUIPMENT, net 27,258 29,168
LEASE ACQUISITION COSTS, net 355 406
DEPOSITS AND OTHER ASSETS 594 531
-------- --------
TOTAL ASSETS $ 32,831 $ 33,205
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,124 $ 3,324
Accrued salaries and wages 1,474 1,335
Sales tax payable 718 876
Other accrued expenses 1,674 1,995
Restructuring reserve 869 1,257
Line of credit borrowings -- 1,155
Current portion of long-term obligations 784 359
-------- --------
Total current liabilities 7,643 10,301
CAPITAL LEASE OBLIGATIONS 1,137 1171
OTHER LONG-TERM LIABILITIES 1,417 1787
LONG-TERM DEBT 2,125 --
-------- --------
Total liabilities 12,322 13,259
-------- --------
STOCKHOLDERS' EQUITY
Convertible preferred stock, $.001 par value; 3.5 million shares
authorized; shares outstanding: 1999 and 1998-1,187,906 5,175 5,175
Common stock, $.001 par value; 15 million shares authorized;
shares outstanding: 1999-5,741,697; 1998-5,718,847 42,260 42,210
Accumulated deficit (26,926) (27,439)
-------- --------
Total stockholders' equity 20,509 19,946
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 32,831 $ 33,205
======== ========
</TABLE>
The December 27, 1998 amounts are derived from the Company's audited financial
statements.
See accompanying notes to unaudited condensed consolidated financial statements
3
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FRESH CHOICE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Twelve Weeks Ended Thirty-Six Weeks Ended
----------------------------- ----------------------------
September 5, September 6, September 5, September 6,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET SALES $ 18,446 $ 18,644 $ 52,378 $ 52,202
COSTS AND EXPENSES:
Cost of sales 4,471 4,886 12,766 13,723
Restaurant operating expenses:
Labor 5,765 5,879 16,792 16,920
Occupancy and other 5,213 5,683 15,730 16,175
Depreciation and amortization 818 889 2,442 2,558
General and administrative expenses 1,293 1,219 3,784 3,780
Gain on sale of property and equipment (452) -- (452) --
Restructuring and asset impairment expenses 443 -- 443 --
-------- -------- -------- --------
Total costs and expenses 17,551 18,556 51,505 53,156
-------- -------- -------- --------
OPERATING INCOME (LOSS) 895 88 873 (954)
Interest income 28 -- 53 8
Interest expense (121) (59) (341) (139)
-------- -------- -------- --------
Interest income (expense), net (93) (59) (288) (131)
-------- -------- -------- --------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 802 29 585 (1,085)
Cumulative effect of change in accounting principle-adoption
of SOP 98-5, "Reporting on the Costs of Start-Up Activities" -- -- (70) --
-------- -------- -------- --------
NET INCOME (LOSS) $ 802 $ 29 $ 515 $ (1,085)
======== ======== ======== ========
Basic net income (loss) per common share before
cumulative effect of change in accounting principle $ 0.14 $ 0.01 $ 0.10 $ (0.19)
Cumulative effect of change in accounting principle -- -- (0.01) --
-------- -------- -------- --------
Basic net income (loss) per common share $ 0.14 $ 0.01 $ 0.09 $ (0.19)
-------- -------- -------- --------
Shares used in computing basic per share amounts 5,742 5,695 5,728 5,688
======== ======== ======== ========
Diluted net income (loss) per common share before
cumulative effect of change in accounting principle $ 0.12 $ 0.00 $ 0.08 $ (0.19)
Cumulative effect of change in accounting principle -- -- (0.01) --
-------- -------- -------- --------
Diluted net income (loss) per common share $ 0.12 $ 0.00 $ 0.07 $ (0.19)
======== ======== ======== ========
Shares used in computing diluted per share amounts 6,944 6,885 6,932 5,688
======== ======== ======== ========
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
4
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FRESH CHOICE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Thirty-Six Weeks Ended
-------------------------------
September 5, September 6,
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 515 $(1,085)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 2,617 2,698
Restructuring and asset impairment expenses 252 --
Cumulative effect of change in accounting principle 70 --
Issuance of stock options for consulting services 20 --
(Gain) loss on disposal of property and equipment (439) 197
Deferred rent (330) (350)
Change in operating assets and liabilities:
Receivables 10 47
Inventories (91) (66)
Pre-opening costs -- (42)
Prepaid expenses and other current assets (67) (116)
Accounts payable (1,199) 694
Accrued salaries and wages 139 122
Other accrued expenses (481) (373)
Restructuring reserve (623) (721)
------- -------
Net cash provided by operating activities 393 1,005
------- -------
INVESTING ACTIVITIES:
Capital expenditures (899) (4,741)
Proceeds from sale of property and equipment 692 --
Deposits and other assets (63) (29)
------- -------
Net cash used in investing activities (270) (4,770)
------- -------
FINANCING ACTIVITIES:
Common stock sales 30 31
Line of credit borrowings (repayments), net (1,155) 1,118
Long term debt - borrowings 2,500 --
Capital lease obligations - borrowings 294 1,265
Capital lease obligations - repayments (278) (152)
Other note payable-borrowings (repayments) -- (1)
------- -------
Net cash provided by financing activities 1,391 2,261
------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,514 (1,504)
CASH AND CASH EQUIVALENTS:
Beginning of period 1,830 2,415
------- -------
End of period $ 3,344 $ 911
======= =======
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest $ 326 $ 101
======= =======
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Twelve Weeks and Thirty-Six Weeks Ended September 5, 1999 and September
6, 1998
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements have been
prepared by the Company without audit and reflect all adjustments, consisting of
normal recurring adjustments and accruals, which are, in the opinion of
management, necessary for a fair statement of financial position and the results
of operations for the interim periods. The statements have been prepared in
accordance with the regulations of the Securities and Exchange Commission, but
omit certain information and footnote disclosures necessary to present the
statements in accordance with generally accepted accounting principles. For
further information, refer to the financial statements and notes thereto
included in the Company's Annual Report on Form 10-K/A for the fiscal year ended
December 27, 1998.
2. NET INCOME (LOSS) PER SHARE
Basic EPS excludes potentially dilutive securities and is computed by
dividing the Company's net income (loss) by the weighted average of its common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. The Company converts common stock
options and warrants into dilutive potential shares using the treasury stock
method and converts preferred stock into dilutive potential shares using the "if
converted" method.
A reconciliation of the components of basic and diluted net income
(loss) per common share follows:
<TABLE>
<CAPTION>
Twelve Weeks Ended Thirty-Six Weeks Ended
------------------------------ -----------------------------
September 5, September 6, September 5, September 6,
(In thousands, except per share data) 1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss) $ 802 $ 29 $ 515 $(1,085)
======= ======= ======= =======
Basic Net Income (Loss) Per Common Share
Average common shares outstanding 5,742 5,695 5,728 5,688
======= ======= ======= =======
Diluted Net Income (Loss) Per Common Share
Average common shares outstanding 5,742 5,695 5,728 5,688
Dilutive shares:
Stock options 14 2 16 --
Convertible preferred stock 1,188 1,188 1,188 --
------- ------- ------- -------
Total shares and dilutive shares 6,944 6,885 6,932 5,688
======= ======= ======= =======
Basic net income (loss) per common share $ 0.14 $ 0.01 $ 0.09 $ (0.19)
======= ======= ======= =======
Diluted net income (loss) per common share $ 0.12 $ 0.00 $ 0.07 $ (0.19)
======= ======= ======= =======
</TABLE>
Diluted EPS presented for the thirty-six weeks ended September 6, 1998
is the same as basic EPS since the Company had net losses and, therefore, all
potential dilutive securities are anti-dilutive and are excluded from the
computation. The following table presents the total dilutive securities which
the Company excluded for each period presented from its diluted EPS computation
because either the exercise price of the
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securities exceeded the average fair value of the Company's common stock or the
Company had net losses, and, therefore, these securities were anti-dilutive:
<TABLE>
<CAPTION>
Twelve Weeks Ended Thirty-Six Weeks Ended
--------------------------- -----------------------------
September 5, September 6, September 5, September 6,
(In thousands) 1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Potential Dilutive Securities
Stock options 610 560 610 564
Stock warrants 732 732 732 732
Convertible preferred stock -- -- -- 1,188
</TABLE>
3. INCOME TAXES
The Company recorded no tax provision for its operating income during
the thirty-six weeks ended September 5, 1999 due to the availability of net
operating loss carryforwards to offset taxable income. The Company recorded no
income tax benefit from its operating losses during the thirty-six weeks ended
September 6, 1998 due to valuation allowances against its net deferred tax
assets. The Company's net deferred taxes consist primarily of the tax benefit
related to operating loss carryforwards and non-deductible asset write-downs in
connection with restructuring reserves. The Company will continue to provide a
valuation allowance for its deferred tax assets until it becomes more likely
than not, in management's assessment, that the Company's deferred tax assets
will be realized.
4. BORROWING ARRANGEMENTS
During the third quarter ended September 5, 1999, the Company
decreased its borrowings under its loan and security agreement ("Agreement") to
$2,500,000. Under the terms of the Agreement, the Company may borrow up to
$2,330,000 against the value of certain Company-owned real estate secured by
deeds of trust and up to an additional $1,670,000 against the value of any of
the Company's restaurant equipment in which the lender has established a first
priority perfected security interest, subject to a maximum available borrowing
against each restaurant. As of September 5, 1999 the Company had a maximum of
$2,950,000 available for borrowing under the Agreement of which it had borrowed
$2,500,000. Of the total amount borrowed, $375,000 was included in the current
portion of long-term obligations.
The Agreement requires the Company to maintain a minimum net worth and
debt service coverage ratio and to not exceed maximum interest and debt to cash
flow ratios and limits its aggregate indebtedness. The Agreement also requires
approval before paying dividends and limits the Company's fixed asset
acquisitions based on its operating cash flows. The Company was in compliance
with the covenants under the Agreement at September 5, 1999.
5. SALE OF RESTAURANT
In accordance with the Company's continuing strategy to close
restaurants that compete with other Fresh Choice restaurants, the Company sold
the property and equipment of one restaurant in the third quarter. The Company
received cash proceeds of $692,000 for the restaurant and recorded a gain of
$452,000. The restaurant was leased back from the buyer for approximately two
months and was closed during the fourth quarter of 1999.
7
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6. RESTRUCTURING AND RESTAURANT CLOSURE RESERVE
The Company's restructuring reserve of $1,257,000 at December 27, 1998
consisted of the estimated cash costs to settle the lease obligations at three
closed restaurants, the estimated cash costs to close and settle the lease
obligation at one other restaurant identified for closure and the estimated cash
costs to close two additional restaurants at the end of their lease terms in
1999.
In accordance with the Company's continuing strategy to dispose of
under-performing restaurants, the Company closed a previously impaired
restaurant in the third quarter of 1999 and recorded a restructuring and asset
impairment charge of $443,000, primarily for the estimated lease settlement and
other closure costs.
The Company made payments of $814,000 in the first thirty-six weeks of
1999 primarily in accordance with the terms of negotiated lease settlements for
the closed restaurants. The Company negotiated the lease settlements at
substantially the same amounts as provided for in the restructuring reserve.
At September 5, 1999, the Company's restructuring reserve of $869,000
consisted of the estimated cash costs to close and settle the lease obligation
for the restaurant closed in the third quarter, the estimated cash costs to
close and settle the lease obligation on one other restaurant identified for
closure, the estimated cash costs associated with the closure of a restaurant
sold in the third quarter and the estimated cash costs to close one additional
restaurant at the end of its lease term in 1999.
7. ADOPTION OF SOP 98-5, "REPORTING ON THE COSTS OF START-UP ACTIVITIES"
In 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up
Activities," which requires companies to expense the costs of start-up
activities and organization costs as incurred. The Company adopted SOP 98-5
effective the beginning of fiscal 1999 and expensed $70,000 of unamortized
pre-opening costs at the time of adoption. The Company's pre-opening costs
consist of the direct costs associated with opening a new restaurant, including
the costs of hiring and training the initial workforce. The Company accounted
for the adoption of SOP 98-5 as the cumulative effect of a change in accounting
principle.
8. CONVERTIBLE PREFERRED STOCK
The Company's outstanding Series B non-voting convertible preferred
stock is currently held by one entity and is convertible, at the holders'
option, into Series A voting convertible preferred stock on a one-for-one basis.
Although no Series A preferred stock is currently outstanding, holders of Series
A preferred stock, if any, would be entitled to vote with common stockholders on
all matters submitted to a vote of stockholders. When and if issued, the holders
of a majority of the outstanding Series A preferred stock will have a separate
right to approve certain corporate actions.
In fiscal 1998, the Company failed to achieve a specified earnings
target (before interest, taxes, depreciation and amortization) of at least
$5,500,000 which constituted an event of default of the terms of the preferred
stock agreement and which triggered the right of the Series A preferred
stockholders to elect a majority of the Company's Board of Directors. The holder
of the Series B preferred stock has not initiated any action to convert such
shares into shares of Series A preferred stock nor has it exercised its right to
elect a majority of the Board of Directors. Such holder has notified the Company
that it has no present intention of exercising such right; however, it has not
waived any of its rights under the agreement.
8
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to highlight significant changes
in the Company's financial position and results of operations for the thirty-six
weeks ended September 5, 1999. The interim Financial Statements and this
Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the Consolidated Financial
Statements and Notes thereto for the fiscal year ended December 27, 1998 and the
related Management's Discussion and Analysis of Financial Condition and Results
of Operations, both of which are contained in the Company's Annual Report on
Form 10-K/A for the fiscal year ended December 27, 1998.
Certain statements set forth in this discussion and analysis of
financial condition and results of operations including anticipated store
openings, planned capital expenditures and trends in or expectations regarding
the Company's operations, specifically including the effect of problems
associated with the Year 2000, constitute "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are based on currently available operating, financial and competitive
information and are subject to various risks and uncertainties. Actual future
results and trends may differ materially depending on a variety of factors as
set forth herein. Among the risks and uncertainties are the continuation of
positive comparable store sales; future profitability; the Company's successful
efforts to close, sell or improve operating results of under-performing stores
which depend on many factors not within the Company's control such as the
negotiation of settlements of existing lease obligations under acceptable terms;
the ability to obtain additional financing on favorable terms; and the Company's
ability to locate suitable restaurant sites and construct new restaurants in a
timely manner.
Liquidity and Capital Resources
The Company's primary capital requirements have been for the expansion
of its restaurant operations and remodeling of its restaurants. The Company has
traditionally financed these requirements with funds from equity offerings, cash
flow from operations, landlord allowances, capital equipment leases and
short-term bank debt. The Company does not have significant receivables or
inventory and receives trade credit based upon negotiated terms in purchasing
food and supplies.
At the beginning of fiscal 1999, the Company entered into a $4,000,000
loan and security agreement (the "Agreement") with a finance company. The
Agreement expires on December 29, 2001 and provides for one-year renewals
thereafter. Under the terms of the Agreement, the Company may borrow up to
$2,330,000 against the value of certain Company-owned real estate secured by
deeds of trust and up to an additional $1,670,000 against the value of any of
the Company's restaurant equipment in which the lender has established a first
priority perfected security interest, subject to a maximum available borrowing
against each restaurant. During the thirty-six weeks ended September 5, 1999,
the Company borrowed $2,500,000 under the Agreement and used $1,155,000 of the
amount borrowed to pay off its bank line of credit. At September 5, 1999, the
Company had $2,500,000 of long-term debt borrowed under the terms of the
Agreement, of which $375,000 was included in the current portion of long-term
obligations. As of September 5, 1999, the Company had a maximum of $2,950,000
available for borrowing under the Agreement of which it had borrowed $2,500,000.
Borrowings under the Agreement initially bear interest at the prime
rate (8.25% at September 5, 1999) plus 1.25% and, once repaid, can be
re-borrowed unless converted to a term loan. Outstanding borrowings, if any, on
the first and second anniversaries of the Agreement convert into term loans
which bear interest at the prime rate plus 1.75% and become payable monthly
based on a five-year amortization schedule. All borrowings, including any term
loans, are fully payable on December 29, 2001. Aggregate borrowings in excess of
$2,500,000 bear an additional 0.5% interest. The Agreement also provides for a
monthly collateral monitoring fee and a 0.5% unused line fee.
9
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The Agreement requires the Company to maintain a minimum net worth and
debt service coverage ratio and to not exceed maximum interest and debt to cash
flow ratios and limits its aggregate indebtedness. The Agreement also requires
approval before paying dividends and limits the Company's fixed asset
acquisitions based on its operating cash flows. The Company was in compliance
with the covenants under the Agreement at September 5, 1999.
Long-term debt at September 5, 1999 also included $1,546,000 of
capital lease obligations, of which $409,000 was included in the current portion
of long term obligations, and a $117,000 note for site construction costs, which
is included in other long-term liabilities.
Operating activities for the thirty-six weeks ended September 5, 1999
provided $393,000 of cash flow which included a $1,199,000 reduction in accounts
payable and $814,000 of restructuring reserve payments. The restructuring
reserve payments were primarily in accordance with the terms of negotiated lease
settlements for closed restaurants. The Company negotiated the lease settlements
at substantially the same amounts as provided for in the restructuring reserve.
The Company's restructuring reserve of $869,000 at September 5, 1999
consisted of the estimated cash costs to close and settle the lease obligation
for the restaurant closed in the third quarter, the estimated cash costs to
close and settle the lease obligation on one other restaurant identified for
closure, the estimated cash costs associated with the closure of a restaurant
sold in the third quarter and the estimated cash costs to close one additional
restaurant at the end of its lease term in 1999. In addition, in accordance with
the Company's continuing strategy to close restaurants that compete with other
Fresh Choice restaurants, the Company sold the property and equipment of one
restaurant in the third quarter receiving cash proceeds of $692,000.
For the thirty-six weeks ended September 5, 1999, the Company invested
$899,000 in property and equipment, including restaurant point of sale systems
in connection with its strategic information systems plan. The Company did not
remodel any restaurants in the first thirty-six weeks of 1999, but resumed its
remodeling program in the fourth quarter of 1999 and anticipates remodeling up
to seven restaurants during the quarter. In addition, the Company opened its
first Fresh Choice Express, on a test basis, in Fort Worth, Texas in the third
quarter of 1999.
The Company's outstanding Series B non-voting convertible preferred
stock is currently held by one entity and is convertible, at the holders'
option, into Series A voting convertible preferred stock on a one-for-one basis.
Although no Series A preferred stock is currently outstanding, holders of Series
A preferred stock, if any, would be entitled to vote with common stockholders on
all matters submitted to a vote of stockholders. When and if issued, the holders
of a majority of the outstanding Series A preferred stock will have a separate
right to approve certain corporate actions.
In fiscal 1998, the Company failed to achieve a specified earnings
target (before interest, taxes, depreciation and amortization) of at least
$5,500,000 which constituted an event of default of the terms of the preferred
stock agreement and which triggered the right of the Series A preferred
stockholders to elect a majority of the Company's Board of Directors. The holder
of the Series B preferred stock has not initiated any action to convert such
shares into shares of Series A preferred stock nor has it exercised its right to
elect a majority of the Board of Directors. Such holder has notified the Company
that it has no present intention of exercising such right; however, it has not
waived any of its rights under the agreement.
The Company's continued growth depends to a significant degree on its
ability to open new restaurants and to operate such restaurants profitably.
Although the Company currently has no further new restaurant development plans
for 1999, the Company intends to expand the testing of the Fresh Choice Express
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concept with an additional location in fiscal 2000 and intends to resume its
Fresh Choice restaurant expansion once the Company's financial performance
improves. The Company's ability to implement an expansion strategy will depend
upon a variety of factors, including the continued success of efforts to restore
annual profitability and the Company's ability to obtain financing. See
"Business Risks" included herein. The Company believes its operating cash
requirements and fiscal 1999 capital requirements can be met through existing
cash balances, cash provided by operations and its borrowing arrangements. The
Company may continue to seek additional debt or equity financing to provide
greater flexibility toward improving its operating performance and resuming
restaurant expansion.
Impact of Inflation
Many of the Company's employees are paid hourly rates related to the
federal and state minimum wage laws. Accordingly, increases in the minimum wage
could materially increase the Company's labor costs. The Federal minimum wage
increased effective September 1, 1997, the State of California minimum wage
increased effective March 1, 1998 and the State of Washington minimum wage
increased effective January 1, 1999. The Company raised prices in response to
these increases. The State of Washington (where the Company operates four
restaurants) has another increase scheduled for January 1, 2000. In addition,
the cost of food commodities utilized by the Company are subject to market
supply and demand pressures. Shifts in these costs may have a significant impact
on the Company's food costs. The Company anticipates that increases in these
costs may be offset through pricing and other cost control efforts; however,
there is no assurance that the Company would be able to pass such costs on to
its guests or that even if it were able to do so, it could do so in a short
period of time.
Year 2000 Software Requirements
The Company has completed a review of all its restaurant and corporate
computer systems for compliance with the year 2000. The Company has determined
that certain of its existing computer systems use only two digits to identify a
year in the date field and, as a result, may improperly identify the year 2000
in calculating and processing information. The Company recognizes this system
design could cause certain systems to potentially fail or create erroneous
results by or at the year 2000 but believes its current strategic information
plan is addressing the problem.
The Company has migrated its critical processing and information
requirements to outsourced processing companies whose software is represented to
be year 2000 compliant. In accordance with its strategic information plan, the
Company is already replacing certain restaurant systems, primarily its
restaurant point of sale system, used for capturing and transmitting data to the
outsourced systems, with year 2000 compliant systems. At September 30, 1999, the
Company had new point of sale systems in 27 of its 51 locations. The Company
expects to complete point of sale installations by the end of 1999. In addition,
the Company is currently completing the testing of the year 2000 upgrade for its
labor management software. The labor management software upgrade program is
expected to be completed and year 2000 compliant by the end of 1999. The
estimated cost of $500,000 for year 2000 compliance upgrades will be capitalized
in accordance with normal policy and will be funded either through operating
cash flow, equipment lease financing or borrowings under the Company's loan and
security agreement.
The Company has completed surveying all of its vendors and has
received confirmation that all programs and systems used by vendors are, or are
expected to be, year 2000 compliant by year-end.
The Company has also contacted outside entities with which it
interacts electronically and has requested information regarding whether or not
their systems are or will be year 2000 compliant. The Company plans to monitor
the progress of outside entities that are in the process of developing year 2000
compliance, but it
11
<PAGE> 12
does not believe there is a material risk to the Company if these entities do
not achieve compliance. However, there can be no assurance that the systems of
other entities will be converted timely, or that a failure to convert by another
entity will not have a material adverse effect on the Company. As part of its
continuous monitoring process, the Company will implement contingency plans as
necessary. These plans could include, but are not limited to, alternate product
suppliers, manual recording and accumulation of restaurant transactions, and
restriction of the tender types accepted at the restaurants.
The Company believes it has an effective plan in place to anticipate
and resolve any potential year 2000 issues in a timely manner. In the event,
however, that the Company does not properly identify year 2000 issues and
remediation and testing is not conducted on a timely basis with respect to the
year 2000 issues that are identified, there can be no assurance that year 2000
issues will not materially and adversely affect the Company. In addition,
disruptions in the economy generally resulting from year 2000 issues also could
materially and adversely affect the Company.
Business Risks
Certain characteristics and dynamics of the Company's business and of
financial markets in general create risks to the Company's long-term success and
to predictable financial results. These risks include:
Recent Operating Losses and Declines in Comparable Store Sales. The
Company's profitability began to decline in the second half of 1994. In the
fourth quarter of 1994, the Company reported its first operating loss, and
reported operating losses in both 1995 and 1996. The Company reported a modest
profit in 1997 but again incurred an operating loss in 1998 and, although the
Company is profitable for the first thirty-six weeks of 1999 there can be no
assurance that the Company will be profitable for the full fiscal year.
Beginning late in the third quarter of fiscal 1994, the Company began
reporting comparable store sales declines. Comparable store sales continued to
decline in each quarter through the end of 1998. The Company reported comparable
store sales declines of 4.6%, 15.3%, 5.9%, 2.7% and 4.8% for fiscal years 1994,
1995, 1996, 1997 and 1998, respectively. For the first thirty-six weeks of 1999,
the Company reported a comparable store sales increase of 2.1%, however, there
can be no assurance that comparable store sales will continue to improve or that
the Company will return to long-term profitability.
Expansion. The Company experienced substantial growth prior to
mid-1995, having opened 14 restaurants in 1993, 15 restaurants in 1994, and
seven in 1995. In 1995, the Company suspended its expansion plans after opening
seven restaurants, reviewed the operating performance of all of its restaurants,
and identified certain restaurants which did not meet its expectations for
operating performance. As a result, in December 1995 the Company announced a
restructuring plan to close as many as ten restaurants. The Company closed or
sold eleven restaurants, including three at the end of 1995 and eight in 1996.
The Company closed no restaurants in 1997 and closed one restaurant at the
expiration of its lease term in early 1998. In 1998, the Company announced a
plan to close an additional four previously impaired restaurants and for the
closure of two additional restaurants where it does not intend to renew the
leases. To date, three of these restaurant have been closed and the Company has
renewed the lease on one of the leases that was expiring. The Company intends to
close the other restaurant upon expiration of the lease. In addition the Company
closed a restaurant and sold another restaurant during the third quarter of
1999. The Company opened one Fresh Choice restaurant in 1996 and in 1997,
acquired the Zoopa trade name and three Zoopa restaurants and opened an
additional two new Zoopa restaurants. In 1998 two additional restaurants were
opened. The Company believes its growth depends to a significant degree on its
ability to open new restaurants and to operate such restaurants profitably. The
Company opened its first Fresh Choice Express, on a test basis, in Fort Worth,
Texas in the third quarter of 1999 and currently has no further expansion plans
for 1999. While the Company intends to resume its expansion, once its financial
performance improves, there can be no assurance that the Company will be able to
continue expansion. The Company's ability to successfully implement an expansion
strategy will depend on a variety of factors, including the selection and
availability of affordable sites, the selection and availability of capital to
finance restaurant expansion and equipment costs, the
12
<PAGE> 13
ability to hire and train qualified management and personnel, the ability to
control food and other operating costs, and other factors, many of which are
beyond the Company's control.
While on a long-term basis, the Company intends to expand its
operations in markets outside of California, assuming its financial performance
improves, there can be no assurance as to when or whether the Company will
resume its expansion. The Company's expansion plans may include entering new
geographic regions in which the Company has no previous operating experience.
There can be no assurance that the concept will be successful in regions outside
of California, where tastes and restaurant preferences may be different. As of
September 5, 1999, the Company had opened or purchased ten restaurants in Texas,
including its test Fresh Choice Express, six restaurants in the state of
Washington and three restaurants in the Washington, D.C. metropolitan area. Of
the seventeen restaurants closed or sold, three were in Texas, two were in the
state of Washington, nine were in California, and three were in the Washington,
D.C. metropolitan area (where the Company no longer operates).
Geographic Concentration. As of September 5, 1999, 40 of the Company's
51 restaurants are located in California, primarily in Northern California.
Accordingly, the Company is susceptible to fluctuations in its business caused
by adverse economic conditions in this region. In addition, net sales at certain
of the Company's restaurants have been adversely affected when a new Company
restaurant has been opened in relatively close geographic proximity, and such
pressure may continue to depress annual comparable store sales. There can be no
assurance that expansion within existing or future geographic markets will not
adversely affect the individual financial performance of Company restaurants in
such markets or the Company's overall results of operations. In addition, given
the Company's present geographic concentration in Northern California, adverse
weather conditions in the region or negative publicity relating to an individual
Company restaurant could have a more pronounced adverse affect on net sales than
if the Company's restaurants were more broadly dispersed.
Volatility of Stock Price. The market price of the Company's Common
Stock has fluctuated substantially since the initial public offering of the
Common Stock in December 1992. Changes in general conditions in the economy, the
financial markets or the restaurant industry, natural disasters or other
developments affecting the Company or its competitors could cause the market
price of the Company's Common Stock to fluctuate substantially. In addition, in
recent years the stock market has experienced extreme price and volume
fluctuations. This volatility has had significant effect on the market prices of
securities issued by many companies, including the Company, for reasons
sometimes unrelated to the operating performance of these companies. Any
shortfall in the Company's net sales or earnings from levels expected by
securities analysts could have an immediate and significant adverse effect on
the trading price of the Company's Common Stock in any given period.
Additionally, such shortfalls may not become apparent until late in the fiscal
quarter, which could result in an even more immediate and significant adverse
effect on the trading price of the Company's Common Stock.
Seasonality and Quarterly Fluctuations. The Company's restaurants have
typically experienced seasonal fluctuations, as a disproportionate amount of net
sales and net income are generally realized in the second and third fiscal
quarters. In addition, the Company's quarterly results of operations have been,
and may continue to be, materially impacted by the timing of new restaurant
openings and restaurant closings. The fourth quarter normally includes 16 weeks
of operations as compared with 12 weeks for each of the three prior quarters. As
a result of these factors, net sales and net income in the fourth quarter are
not comparable to results in each of the first three fiscal quarters, and net
sales and net income can be expected to decline in the first quarter of each
fiscal year in comparison to the fourth quarter of the prior fiscal year.
Comparable store sales, which were negative for four consecutive years through
1998, may not continue the positive trend of the first thirty-six weeks of 1999.
Dependence on Key Personnel. The success of the Company depends on the
efforts of key management personnel. The Company's success will depend on its
ability to motivate and retain its key crewmembers and to attract qualified
personnel, particularly general managers, for its restaurants. The Company faces
significant competition in the recruitment of qualified crewmembers.
Restaurant Industry. The restaurant industry is affected by changes in
consumer tastes, as well as national, regional and local economic conditions and
demographic trends. The performance of individual restaurants, including the
Company's restaurants, may be affected by factors such as traffic patterns,
13
<PAGE> 14
demographic considerations, and the type, number and location of competing
restaurants. In addition, factors such as inflation, increased food, labor and
crewmember benefit costs, and the availability of experienced management and
hourly crewmembers may also adversely affect the restaurant industry in general
and the Company's restaurants in particular. Restaurant operating costs are
affected by increases in the minimum hourly wage, unemployment tax rates, and
various federal, state and local governmental regulations, including those
relating to the sale of food and alcoholic beverages. There can be no assurance
that the restaurant industry in general, and the Company in particular, will be
successful.
Competition. The Company's restaurants compete with the rapidly
growing mid-price, full-service casual dining segment; with traditional
limited-service buffet, soup, and salad restaurants; and, increasingly, with
quick-service outlets. The Company's competitors include national and regional
chains, as well as local owner-operated restaurants. Key competitive factors in
the industry are the quality and value of the food products offered, quality and
speed of service, price, dining experience, restaurant location and the ambiance
of facilities. Many of the Company's competitors have been in existence longer
than the Company, have a more established market presence, and have
substantially greater financial, marketing and other resources than the Company,
which may give them certain competitive advantages. The Company believes that
its ability to compete effectively will continue to depend in large measure upon
its ability to offer a diverse selection of high-quality, fresh food products
with an attractive price/value relationship.
Ability to Obtain Additional Financing. The Company intends to resume
restaurant expansion, once its financial performance improves. The Company's
ability to implement an expansion strategy will depend upon a variety of
factors, including the success of its restructuring plan in restoring
profitability and its ability to obtain financing. The Company believes its
near-term capital requirements can be met through its existing cash balances,
cash provided by operations and its borrowing arrangements. However, the Company
may seek additional financing to provide greater flexibility toward improving
its operating performance. There can be no assurance that the Company will be
able to obtain additional financing when needed on acceptable terms or at all.
Control by Major Shareholder. Crescent Real Estate Equities Limited
Partnership holds 1,187,906 shares of Series B non-voting convertible preferred
stock, which is convertible into Series A voting convertible preferred stock at
any time at the option of the holder. Upon conversion, holders of Series A
preferred stock would be entitled to vote with common stockholders and would
have a separate right to approve certain corporate actions, such as amending the
Company's Certificate of Incorporation or Bylaws, effecting a merger or sale of
the Company, or making a fundamental change in the Company's business activity.
In addition, because the Company did not achieve an earnings target (before
interest, taxes, depreciation and amortization) of $5,500,000 in 1998, the
holders of Series A preferred stock have the right to elect a majority of the
Company's Board of Directors. These factors could have the effect of delaying,
deferring or preventing a change in control of the Company and, as a result,
could discourage acquisition bids for the Company and limit the price that
investors are willing to pay for shares of common stock.
14
<PAGE> 15
Results of Operations
The following table sets forth items in the Company's statements of
operations as a percentage of sales and certain operating data for the periods
indicated:
<TABLE>
<CAPTION>
Twelve Weeks Ended
----------------------------------------------------------
(Dollars in thousands) September 5, 1999 September 6, 1998
----------------------------------------------------------
<S> <C> <C> <C> <C>
NET SALES $ 18,446 100.0 % $ 18,644 100.0 %
COSTS AND EXPENSES:
Cost of sales 4,471 24.2 % 4,886 26.2 %
Restaurant operating expenses:
Labor 5,765 31.3 % 5,879 31.5 %
Occupancy and other 5,213 28.3 % 5,683 30.5 %
Depreciation and amortization 818 4.4 % 889 4.8 %
General and administrative expenses 1,293 7.0 % 1,219 6.5 %
Gain on sale of property and equipment (452) (2.5)% -- - %
Restructuring and asset impairment expenses 443 2.4 % -- - %
-------- ----- -------- -----
Total costs and expenses 17,551 95.1 % 18,556 99.5 %
-------- ----- -------- -----
OPERATING INCOME (LOSS) 895 4.9 % 88 0.5 %
Interest income 28 0.2 % -- - %
Interest expense (121) (0.8)% (59) (0.3)%
-------- ----- -------- -----
Interest income (expense), net (93) (0.6)% (59) (0.3)%
-------- ----- -------- -----
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 802 4.3 % 29 0.2 %
Cumulative effect of change in accounting principle-adoption
of SOP 98-5, "Reporting on the Costs of Start-Up Activities" -- - % -- - %
-------- ----- -------- -----
NET INCOME (LOSS) $ 802 4.3 % $ 29 0.2 %
======== ===== ======== =====
Number of restaurants:
Open at beginning of period 51 53
======== ========
Open at end of period 51 53
======== ========
</TABLE>
<TABLE>
<CAPTION>
Thirty-Six Weeks Ended
----------------------------------------------------------
(Dollars in thousands) September 5, 1999 September 6, 1998
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
NET SALES $ 52,378 100.0 % $ 52,202 100.0 %
COSTS AND EXPENSES:
Cost of sales 12,766 24.4 % 13,723 26.3 %
Restaurant operating expenses:
Labor 16,792 32.1 % 16,920 32.4 %
Occupancy and other 15,730 30.0 % 16,175 31.0 %
Depreciation and amortization 2,442 4.7 % 2,558 4.9 %
General and administrative expenses 3,784 7.2 % 3,780 7.2 %
Gain on sale of property and equipment (452) (0.9)% -- - %
Restructuring and asset impairment expenses 443 0.8 % -- - %
-------- ----- -------- -----
Total costs and expenses 51,505 98.3 % 53,156 101.8 %
-------- ----- -------- -----
OPERATING INCOME (LOSS) 873 1.7 % (954) (1.8)%
Interest income 53 0.1 % 8 - %
Interest expense (341) (0.7)% (139) (0.3)%
-------- ----- -------- -----
Interest income (expense), net (288) (0.6)% (131) (0.3)%
-------- ----- -------- -----
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 585 1.1 % (1,085) (2.1)%
Cumulative effect of change in accounting principle-adoption
of SOP 98-5, "Reporting on the Costs of Start-Up Activities" (70) (0.1)% -- - %
-------- ----- -------- -----
NET INCOME (LOSS) $ 515 1.0 % $ (1,085) (2.1)%
======== === ======== ====
Number of restaurants:
Open at beginning of period 51 53
======== ========
Open at end of period 51 53
======== ========
</TABLE>
The following table presents the components of average operating
income (loss) on a per restaurant basis, based on the average number of Fresh
Choice restaurants open during the period (The Company's Fresh Choice Express is
excluded):
<TABLE>
<CAPTION>
Twelve Weeks Ended
-----------------------------------------------------------
(Dollars in thousands) September 5, 1999 September 6, 1998
------------------------ ------------------------
<S> <C> <C> <C> <C>
NET SALES $ 362 100.0 % $ 352 100.0 %
COSTS AND EXPENSES:
Cost of sales 88 24.3 % 92 26.2 %
Restaurant operating expenses:
Labor 113 31.2 % 111 31.5 %
Occupancy and other 102 28.2 % 107 30.4 %
Depreciation and amortization 16 4.4 % 17 4.8 %
------ ----- ------ -----
Total costs and expenses 319 88.1 % 327 92.9 %
------ ----- ------ -----
RESTAURANT OPERATING INCOME $ 43 11.9 % $ 25 7.1 %
====== ===== ====== =====
Average Fresh Choice restaurants open 50.8 53.0
====== ======
</TABLE>
<TABLE>
<CAPTION>
Thirty-Six Weeks Ended
-----------------------------------------------------------
(Dollars in thousands) September 5, 1999 September 6, 1998
------------------------ ------------------------
<S> <C> <C> <C> <C>
NET SALES $1,027 100.0 % $ 987 100.0 %
COSTS AND EXPENSES:
Cost of sales 250 24.3 % 259 26.2 %
Restaurant operating expenses:
Labor 329 32.0 % 320 32.4 %
Occupancy and other 309 30.1 % 306 31.0 %
Depreciation and amortization 49 4.8 % 48 4.9 %
------ ----- ------ -----
Total costs and expenses 937 91.2 % 933 94.5 %
------ ----- ------ -----
RESTAURANT OPERATING INCOME $ 90 8.8 % $ 54 5.5 %
====== ===== ====== =====
Average Fresh Choice restaurants open 50.9 52.9
====== ======
</TABLE>
15
<PAGE> 16
Results of Operations: Twelve Weeks Ended September 5, 1999
Compared to Twelve Weeks Ended September 6, 1998
Net Sales. Net sales for the quarter ended September 5, 1999 were
$18,446,000, a decrease of $198,000 or 1.1%, from net sales of $18,644,000 for
the quarter ended September 6, 1998. The primary components of the net change in
sales were:
<TABLE>
<S> <C>
Incremental sales from new restaurants $ 367,000
Increase in comparable store sales 94,000
Absence of sales from closed restaurants (659,000)
--------------
$ (198,000)
==============
</TABLE>
The Company operated 51 restaurants in the third quarter of 1999
compared to 53 restaurants in the third quarter of 1998. Sales at the Company's
49 comparable stores, which include restaurants open at least 18 months,
increased 0.5% in the third quarter of 1999 versus the third quarter of 1998.
Comparable store guest counts decreased 6.5%, while the comparable store average
check increased 7.5% to $7.33, reflecting menu price increases and a reduction
in the level of discounting.
Net sales per Fresh Choice restaurant averaged $362,000 in the third
quarter of 1999, an increase of 3.0% over net sales per Fresh Choice restaurant
of $352,000 in the third quarter of 1998.
Costs and Expenses. Cost of sales (food and beverage costs) was 24.2%
of sales in the third quarter of 1999 compared to 26.2% in the third quarter of
1998, a decrease of 2.0% of sales. The decline is primarily the result of the
increased average check. In addition, food costs continued to benefit from the
Company's food program which manages food costs through an efficient product
rotation while maintaining a quality menu offering to guests, from cost
efficiencies experienced with new products and new production methods.
Restaurant Operating Expenses. Restaurant operating expenses (labor,
occupancy and other) were 59.6% of sales in the third quarter of 1999 compared
to 62.0% of sales in the third quarter of 1998, a decrease of 2.4% of sales.
Labor costs were 31.3% of sales in the third quarter of 1999 compared
to 31.5% in the third quarter of 1998, a decrease of 0.2% of sales. Labor costs
as a percentage of sales benefited from the Company's higher average check as
well as labor savings from improved food production methods, offsetting an
increased average wage rate.
Occupancy and other expenses of 28.3% of sales in the third quarter of
1999 compared to 30.5% of sales in the third quarter of 1998, a decrease of 2.2
% of sales. The decline is primarily the result of a reduction in marketing and
promotional expenditures, and higher average sales on these mostly fixed costs.
Depreciation and Amortization. Depreciation and amortization expenses
were 4.4% of sales in the third quarter of 1999 compared to 4.8% of sales in the
third quarter of 1998. This decrease is primarily a result of higher average
unit sales compared to the third quarter of 1998.
General and Administrative Expenses. General and administrative
expenses were 7.0% of sales in the third quarter of 1999 compared to 6.5% of
sales in the third quarter of 1998. General and administrative expenses
increased $74,000 in the third quarter of 1999 compared to the third quarter of
1998 primarily as a result of salary and wage increases and higher travel costs
partially related to the opening of the Fresh Choice Express test location.
16
<PAGE> 17
Gain on Sale of Property and Equipment. In accordance with the
Company's continuing strategy to close restaurants that compete with other Fresh
Choice restaurants, the Company sold the property and equipment of one
restaurant in the third quarter. The Company received cash proceeds of $692,000
and recorded a gain of $452,000. The restaurant was leased back from the buyer
for approximately two months and was closed during the fourth quarter of 1999.
Restructuring and Asset Impairment Expenses. In accordance with the
Company's continuing strategy to dispose of under-performing restaurants, the
Company closed a previously impaired restaurant in the third quarter of 1999 and
recorded a restructuring and asset impairment charge of $443,000, primarily for
the estimated lease settlement and other closure costs.
Interest Income (Expense), Net. Interest income (expense), net
increased to $93,000 in the third quarter of 1999 compared to $59,000 in the
third quarter of 1998 due primarily to long-term borrowings in the current year
under the Company's new loan and security agreement and additional capital lease
obligations.
Income Taxes. In the third quarters of 1999 and 1998, the Company
offset currently taxable income with available net operating loss carryforwards
and, as a result, recorded no tax provision for its operating income
Results of Operations: Thirty-Six Weeks Ended September 5, 1999
Compared to Thirty-Six Weeks Ended September 6, 1998
Net Sales. Net sales for the thirty-six weeks ended September 5, 1999
were $52,378,000, an increase of $176,000, or 0.3%, from sales of $52,202,000
for the thirty-six weeks ended September 6, 1998. The primary components of the
net change in sales were:
<TABLE>
<S> <C>
Incremental sales from new restaurants $ 947,000
Increase in comparable store sales 1,062,000
Absence of sales from closed restaurants (1,833,000)
--------------
$ 176,000
==============
</TABLE>
The Company operated 51 restaurants in the first thirty-six weeks of
1999 compared to 53 restaurants in the first thirty-six weeks of 1998. Sales at
the Company's 49 comparable stores, which include restaurants open at least 18
months, increased 2.1% in the first thirty-six weeks of 1999 versus the first
thirty-six weeks of 1998. Comparable store guest counts decreased 4.1%, while
the comparable store average check increased 6.5% to $7.34, reflecting menu
price increases and a reduction in the level of discounting.
Net sales per Fresh Choice restaurant averaged $1,027,000 in the first
thirty-six weeks of 1999, an increase of 4.1% over net sales per Fresh Choice
restaurant of $987,000 in the first thirty-six weeks of 1998.
Costs and Expenses. Cost of sales (food and beverage costs) was 24.4%
of sales in the first thirty-six weeks of 1999 compared to 26.3% in the first
thirty-six weeks of 1998, a decrease of 1.9% of sales. In addition to the
increase in the Company's average check, food and beverage costs per guest were
lower in the first thirty-six weeks of 1999 compared to the first thirty-six
weeks of 1998. Food costs continued to benefit from the Company's food program
which manages food costs through an efficient product rotation while maintaining
a quality menu offering to guests. In addition, food costs benefited from cost
efficiencies experienced with new products and new production methods.
17
<PAGE> 18
Restaurant Operating Expenses. Restaurant operating expenses (labor,
occupancy and other) were 62.1% of sales in the first thirty-six weeks of 1999
compared to 63.4% of sales in the first thirty-six weeks of 1998, a decrease of
1.3% of sales.
Labor costs were 32.1% of sales in the first thirty-six weeks of 1999
compared to 32.4% in the first thirty-six weeks of 1998, a decrease of 0.3% of
sales. Labor costs as a percentage of sales benefited from the Company's higher
average check as well as labor savings from improved food production methods,
offsetting the negative impact of a higher average wage rate.
Occupancy and other expenses were 30.0% of sales in the first
thirty-six weeks of 1999 compared to 31.0% in the first thirty-six weeks of
1998, a decrease of 1.0% of sales. The decline is primarily the result of a
reduction in marketing and promotional expenditures, and higher average sales on
these mostly fixed costs.
Depreciation and Amortization. Depreciation and amortization expenses
were 4.7% of sales in the first thirty-six weeks of 1999 compared to 4.9% of
sales in the first thirty-six weeks of 1998. The decrease is primarily the
result of higher average store sales.
General and Administrative Expenses. General and administrative
expenses were 7.2% of sales in the first thirty-six weeks of 1999 and 1998.
These expenses increased only $4,000 in the first thirty-six weeks of 1999
compared to the first thirty-six weeks of 1998 as a result of continued staffing
and cost controls.
Gain on Sale of Property and Equipment. In accordance with the
Company's continuing strategy to close restaurants that compete with other Fresh
Choice restaurants, the Company sold the property and equipment of one
restaurant in the third quarter. The Company received cash proceeds of $692,000
and recorded a gain of $452,000. The restaurant was leased back from the buyer
for approximately two months and was closed during the fourth quarter of 1999.
Restructuring and Asset Impairment Expenses. In accordance with the
Company's continuing strategy to dispose of under-performing restaurants, the
Company closed a previously impaired restaurant in the third quarter of 1999 and
recorded a restructuring and asset impairment charge of $443,000, primarily for
the estimated lease settlement and other closure costs.
Interest Income (Expense), Net. Interest income (expense), net
increased to $288,000 in the first thirty-six weeks of 1999 compared to $131,000
in the first thirty-six weeks of 1998 due primarily to long-term borrowings in
the current year under the Company's new loan and security agreement and
additional capital lease obligations.
Income Taxes. The Company recorded no tax provision for its operating
income during the thirty-six weeks ended September 5, 1999 due to the
availability of net operating loss carryforwards to offset taxable income. The
Company recorded no income tax benefit from its operating losses during the
thirty-six weeks ended September 6, 1998 due to valuation allowances against its
net deferred tax assets.
Cumulative Effect of Change in Accounting Principle. In 1998, the
American Institute of Certified Public Accountants issued Statement of Position
98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up Activities", which
requires companies to expense the costs of start-up activities and organization
costs as incurred. The Company adopted SOP 98-5 effective the beginning of
fiscal 1999 and expensed $70,000 of unamortized pre-opening costs at the time of
adoption. The Company's pre-opening costs consist of the direct costs associated
with opening a new restaurant, including the costs of hiring and training the
initial workforce. The Company accounted for the adoption of SOP 98-5 as the
cumulative effect of a change in accounting principle.
18
<PAGE> 19
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk primarily through its
borrowing activities. The Company has not used derivative financial instruments
to hedge such risks. There is inherent roll-over risk for borrowings as they
mature and are renewed at current market rates. The extent of this risk is not
quantifiable or predictable because of the variability of future interest rates
and business financing requirements. If market rates were to increase
immediately by 10 percent from levels at September 5, 1999, the fair value of
the Company's borrowings would not be materially affected as borrowings are
primarily subject to variable interest rates.
PART II. OTHER INFORMATION
<TABLE>
<S> <C>
ITEM 1 - LEGAL PROCEEDINGS Not Applicable.
ITEM 2 - CHANGES IN SECURITIES Not Applicable.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES Not Applicable.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable.
ITEM 5 - OTHER INFORMATION Not Applicable.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
</TABLE>
(a) Exhibits. The exhibits listed in the accompanying index to Form 10-Q
Exhibits are filed or incorporated by reference as part of this report.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter
ended September 5, 1999.
19
<PAGE> 20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FRESH CHOICE, INC.
(Registrant)
/s/ EVERETT F. JEFFERSON
--------------------------------------------
Everett F. Jefferson
President and Chief Executive Officer
(Principal Executive Officer)
/s/ DAVID E. PERTL
--------------------------------------------
David E. Pertl
Senior Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)
Dated: October 19, 1999
20
<PAGE> 21
INDEX TO FORM 10-Q EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------
<S> <C> <C>
3.1 (1) Restated Certificate of Incorporation of Fresh Choice, Inc.
3.2 (8) Amended By-Laws of Fresh Choice, Inc. dated April 11, 1996
3.3 (10) Certificate of Amendment of Restated Certificate of
Incorporation of Fresh Choice, Inc.
3.4 (10) Certificate of Designation of Series A Voting
Participating Convertible Preferred Stock of Fresh Choice,
Inc.
3.5 (10) Certificate of Designation of Series B Non-Voting
Participating Convertible Preferred Stock of Fresh Choice,
Inc.
3.6 (10) Certificate of Designation of Series C Non-Voting
Participating Convertible Preferred Stock of Fresh Choice,
Inc.
4.1 (10) Registration Rights Agreement dated September 13, 1996
between Fresh Choice, Inc. and Crescent Real Estate Equities
Limited Partnership
10.1 (1) Form of Indemnity Agreement for directors and officers
10.2 (2)(3) Second Amended and Restated 1988 Stock Option Plan
10.3 (2)(3) 1992 Employee Stock Purchase Plan
10.4 (1) Series A Preferred Stock Purchase Agreement dated August 10,
1988
10.5 (1) Series B Preferred Stock Purchase Agreement dated July 21,
1989
10.6 (1) Series C Preferred Stock Purchase Agreement dated January
15, 1990
10.7 (1) Master Lease and Warrant Agreement with Equitec Leasing
Company and Warrant dated January 18, 1990
10.8 (8) Preferred Stock Purchase Agreement with Crescent Real Estate
Equities Limited Partnership dated April 26, 1996
10.9 (1) Series D Preferred Stock Purchase Agreement dated April 17,
1991
10.10 (5) Amendment No. 1 dated September 3, 1993 to the Business Loan
Agreement dated September 3, 1993.
10.11 (5) Amendment No. 2 dated November 15, 1993 to the Business Loan
Agreement dated September 3, 1993.
10.12 (1) Amendment dated December 1, 1992 to Preferred Stock Purchase
Agreements
10.13 (4) Business Loan Agreement dated September 3, 1993 with Bank of
America National Trust and Savings Association
10.14 (5) Amendment No. 4 dated March 31, 1995 to the Business Loan
Agreement dated September 3, 1993
</TABLE>
21
<PAGE> 22
INDEX TO FORM 10-Q EXHIBITS continued
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------
<S> <C> <C>
10.15 (5) Amendment No. 3 dated April 27, 1994 to the Business Loan
Agreement dated September 3, 1993
10.16 (6) Loan and Security Agreement dated December 20, 1995 with
Silicon Valley Bank
10.17 (6) Third Party Security agreement dated December 20, 1995
between Silicon Valley Bank and Moffett Design Corporation
10.18 (6) Warrant to Purchase up to 75,000 Shares of the Company's
Common Stock issued to Silicon Valley Bank on December 20,
1995
10.19 (6) Common Stock Purchase Warrant to Purchase 100,000 Shares of
the Company's Common Stock issued to Bain & Company, dated
December 15, 1995
10.20 (6)(3) Employment Offer Letter to Robert Ferngren dated November 9,
1995
10.21 (9)(3) Amendment dated July 29, 1996 to Employment Offer Letter to
Robert Ferngren
10.22 (10)(3) Severance Agreement with Charles A. Lynch dated July 18,
1996
10.23 (10)(3) Severance Agreement with David Anderson dated July 18, 1996
10.24 (10)(3) Severance Agreement with Tim G. O'Shea dated July 18, 1996
10.25 (10)(3) Severance Agreement with Joan M. Miller dated July 18, 1996
10.26 (11)(3) Employment Offer Letter to David E. Pertl dated January 24,
1997
10.27 (11)(3) Employment Offer Letter to Everett F. Jefferson dated
January 30, 1997
10.28 (11)(3) Amendment to Employment Offer Letter to Everett F. Jefferson
dated February 10, 1997
10.29 (11) Loan Modification Agreement dated November 27, 1996 with
Silicon Valley Bank
10.30 (11)(3) Severance Agreement with Tina Freedman dated March 13, 1997
10.31 (12) Agreement of Sale and Purchase dated April 2, 1997 with RUI
One Corp.
10.32 (12) Amendment to Loan and Security Agreement dated July 9, 1997
with Silicon Valley Bank
10.33 (13) Amendment to Loan and Security Agreement dated May 27, 1998
with Silicon Valley Bank
10.34 (13)(3) Consulting Agreement with Charles A. Lynch dated April 17,
1998
10.35 (14) Amendment to Loan and Security Agreement dated October 28,
1998 with Silicon Valley Bank
10.36 (14) Loan and Security Agreement dated December 29, 1998 with
FINOVA Capital Corporation
10.37 (14)(3) Form of Severance Agreement with Senior Vice Presidents
10.38 (14)(3) Officer Incentive Plan for fiscal year 1999
27 (7) Financial Data Schedule
</TABLE>
- -------------------------
(1) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Registration Statement on Form S-1 (No. 33-53904)
filed October 29, 1992, as amended by Amendment No. 1 to Form S-1 (No.
33-53904) filed December 7, 1992, except that Exhibit 3.1 is incorporated
by reference from Exhibit 3.1C and Exhibit 3.2 is incorporated by reference
from Exhibit 3.2B.
22
<PAGE> 23
(2) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended September 4, 1994.
(3) Agreements or compensatory plans covering executive officers and directors
of Fresh Choice, Inc.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K for
the period ended December 26, 1993.
(5) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended March 19, 1995.
(6) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Annual Report on Form 10-K for the year ended
December 31, 1995.
(7) Included in EDGAR filing only.
(8) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended March 24, 1996.
(9) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended June 16, 1996.
(10) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended September 8, 1996.
(11) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Annual Report on Form 10-K for the year ended
December 29, 1996.
(12) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended June 15, 1997.
(13) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended June 14, 1998.
(14) Incorporated by reference from the Exhibits with corresponding numbers
filed with the Company's Annual Report on Form 10-K/A for the year ended
December 27,1998.
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-26-1999
<PERIOD-START> DEC-28-1998
<PERIOD-END> SEP-05-1999
<CASH> 3,344
<SECURITIES> 0
<RECEIVABLES> 117
<ALLOWANCES> 0
<INVENTORY> 595
<CURRENT-ASSETS> 4,624
<PP&E> 45,084
<DEPRECIATION> (17,826)
<TOTAL-ASSETS> 32,831
<CURRENT-LIABILITIES> 7,643
<BONDS> 0
0
5,175
<COMMON> 42,260
<OTHER-SE> (26,926)
<TOTAL-LIABILITY-AND-EQUITY> 32,831
<SALES> 52,378
<TOTAL-REVENUES> 52,378
<CGS> 12,766
<TOTAL-COSTS> 51,505
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 341
<INCOME-PRETAX> 585
<INCOME-TAX> 0
<INCOME-CONTINUING> 585
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (70)
<NET-INCOME> 515
<EPS-BASIC> 0.09
<EPS-DILUTED> 0.07
</TABLE>
