<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
-------------------------------
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 29, 1996.
/ / 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 0-22534-LA
MONTEREY PASTA COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 77-0227341
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
353 SACRAMENTO STREET, SUITE 500
SAN FRANCISCO, CALIFORNIA 94111
(Address of principal executive offices)
TELEPHONE: (415) 397-7782
(Registrant's telephone number, including area code)
Indicate by check mark 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.
Yes X No
----- -----
At November 14, 1996, 8,713,911 shares of common stock, no par value, of the
registrant were outstanding.
This report on Form 10-Q, including all exhibits, contains 22 pages. The
exhibit index is located on page 22 of this report.
<PAGE>
MONTEREY PASTA COMPANY
FORM 10-Q
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets (unaudited)
September 29, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Operations (unaudited)
Three months ended September 29, 1996 and October 1, 1995 and the
Nine months ended September 29, 1996 and October 1, 1995 4
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 29, 1996 and October 1, 1995 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Signature Page 21
Exhibit Index 22
<PAGE>
PART I. FINANCIAL INFORMATION
MONTEREY PASTA COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 29, 1996 December 31, 1995
------------------ -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,319,787 $ 1,937,884
Accounts receivable, net 2,266,408 1,241,248
Inventories 1,197,954 1,094,976
Prepaid expenses and other 1,299,816 1,652,381
---------------- -----------------
Total current assets 6,083,965 5,926,489
Note receivable 350,000 --
Property and equipment, net 5,818,336 5,338,968
Assets held for sale 311,701 --
Intangible assets, net 156,138 295,320
Deposits and other 155,575 130,240
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Total assets $12,875,715 $ 11,691,017
---------------- -----------------
---------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,799,213 $ 1,511,592
Accrued liabilities 1,742,477 852,815
Current portion of long-term debt 204,004 --
Net liability from discontinued
operations 694,247 2,964,415
---------------- -----------------
Total current liabilities 4,439,941 5,328,822
Long-term debt 1,293,573 4,130,599
Commitments and contingencies -- --
Stockholders' equity:
Preferred Stock 3,380,000 --
Common Stock 35,019,875 27,268,263
Accumulated deficit (31,257,674) (25,036,667)
---------------- -----------------
Total stockholders' equity 7,142,201 2,231,596
---------------- -----------------
Total liabilities and
stockholders' equity $ 12,875,715 $ 11,691,017
---------------- -----------------
---------------- -----------------
The accompanying notes are an integral part of these
condensed financial statements.
3
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MONTEREY PASTA COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
-------------------------------------- ----------------------------------------
Sept. 29, 1996 % Oct. 1, 1995 % Sept. 29, 1996 % Oct. 1, 1995 %
-------------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues from continuing operations $ 5,670,820 1.00 $5,089,422 1.00 $18,670,838 1.00 $ 12,878,291 1.00
Cost of sales 4,918,735 .87 2,845,939 .56 12,155,530 .65 6,997,031 .54
-------------- ------------ -------------- ------------
Gross profit 752,085 .13 2,243,483 .44 6,515,308 .35 5,881,260 .46
Selling, general and administration 6,104,487 1.08 2,020,105 .40 11,654,450 .62 5,442,876 .42
Depreciation and amortization 221,889 .04 99,287 .02 662,847 .04 383,462 .03
-------------- ------------ -------------- ------------
Operating income (loss) (5,574,291) (.99) 124,091 .02 (5,801,989) (.31) 54,922 .01
Other expense (3,512) .00 -- .00 (3,512) .00 -- .00
Loss on sale or impairment of assets (382,747) (.06) -- .00 (369,322) (.02) -- .00
Interest income, net 35,622 .01 8,113 .01 (46,183) .00 32,592 .00
-------------- ------------ -------------- ------------
Income (loss) from continuing operations (5,924,928) (1.05) 132,204 .03 (6,221,006) (.33) 87,514 .01
Net loss from discontinued
operations -- (1,092,703) -- (12,041,538)
-------------- ------------ -------------- ------------
Net loss $(5,924,928) $ (960,499) $(6,221,006) $(11,954,024)
-------------- ------------ -------------- ------------
-------------- ------------ -------------- ------------
Net income (loss) per share - Primary and
fully diluted:
Continuing operations $ (0.68) $ 0.02 $ (0.77) $ 0.02
Discontinued operations $ -- (0.17) -- $ (1.91)
-------------- ------------ -------------- ------------
Total net loss per share $ (0.68) $ (0.15) $ (0.77) $ (1.89)
-------------- ------------ -------------- ------------
-------------- ------------ -------------- ------------
Weighted average common shares
outstanding 8,713,911 6,759,079 8,130,471 6,314,005
</TABLE>
The accompanying notes are an integral part of these
condensed financial statements.
4
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<TABLE>
<CAPTION>
MONTEREY PASTA COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED
-----------------
SEPTEMBER 29, 1996 OCTOBER 1, 1995*
-------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(6,221,006) $(11,954,024)
Adjustments to reconcile net loss to net cash
from operating activities:
Restructuring charge 104,230 6,822,000
Depreciation and amortization 664,983 1,474,854
Operating losses of franchise units - (90,925)
Discount on note receivable - 160,000
Decrease in tax benefit valuation allowance 13,057 (37,400)
Loss on sale or impairment of assets 369,322 -
Reserve for inventory spoils, returns, allowances and bad debts 528,782 -
Unrealized interest income from:
Held-to-maturity securities - (24,483)
Notes receivable - (31,507)
Effect of changes in operating working capital:
Accounts receivable (1,553,942) (268,893)
Inventories (102,978) (278,066)
Prepaid expenses and other 400,441 (728,608)
Accounts payable 287,620 838,792
Accrued liabilities 560,121 56,046
Accrued restructuring costs - (340,640)
-------------- --------------
Net cash used in continuing operations* (4,949,370) (4,402,854)
Net cash used in discontinued operations (2,307,562) -
Cash flows from investing activities:
Redemption of held-to-maturity securities - 1,735,616
Proceeds from the sale of assets 70,383 -
Purchase of intangibles and other assets (93,987) -
Purchase of property and equipment (1,547,369) (3,260,089)
Note receivable advances - -
-------------- --------------
Net cash used in investing activities (1,570,973) (1,524,473)
-------------- --------------
Cash flows from financing activities:
Repayment of long-term debt and capital
lease obligations - (575,636)
Net proceeds from issuance of common stock 3,816,206 3,352,854
Net proceeds from issuance of preferred stock 3,380,000 -
Proceeds from issuance of debt - 578,294
Credit facility borrowings 7,984,303 -
Credit facility repayments (6,970,701) -
-------------- --------------
Net cash obtained from financing activities 8,209,808 3,355,512
-------------- --------------
Net decrease in cash (618,097) (2,571,815)
Cash and cash equivalents at beginning of the period 1,937,884 3,117,566
-------------- --------------
Cash and cash equivalents at end of the period $ 1,319,787 $ 545,751
-------------- --------------
-------------- --------------
</TABLE>
* Amounts for 1995 include continuing as well as discontinued operations.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
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MONTEREY PASTA COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements have been prepared by
Monterey Pasta Company (the "Company") and are unaudited. Certain amounts
shown in the 1995 financial statements have been reclassified to conform with
the current presentation. The financial statements have been prepared in
accordance with the instructions for Form 10-Q and, therefore, do not
necessarily include all information and footnotes required by generally
accepted accounting principles, and should be read in conjunction with the
Company's 1995 Annual Report on Form 10-K, as amended by Form 10-K/A. In the
opinion of the Company, all adjustments necessary to present fairly the
Company's consolidated financial position, results of operations and cash
flows as of September 29, 1996, and for all periods presented have been
recorded. A description of the Company's accounting policies and other
financial information is included in the audited consolidated financial
statements as filed with the Securities and Exchange Commission in the
Company's Form 10-K for the year ended December 31, 1995, as amended by Form
10-K/A. The consolidated results of operations for the interim quarterly
periods are not necessarily indicative of the results expected for the full
year.
2. STATEMENT OF CASH FLOWS
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Additions to property, plant and equipment during the nine months ended
September 29, 1996, included $141,722 that were financed by advances from the
equipment revolving line of credit and an additional $216,870 that was
acquired through a capital lease agreement. Also, during the nine months
ended September 29, 1996, debt and accrued interest totaling $4,020,456, net
of expenses, were converted into common stock (see Note 6), and early
settlement of a lease obligation was partially paid by the issuance of
$35,000 of common stock.
During the quarter ended September 29, 1996, property and equipment with a
carrying amount of $311,701 were transferred to assets held for sale (see
Note 5).
3. NEW ACCOUNTING PRONOUNCEMENTS
In October 1995, Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation", which requires adoption of the disclosure provisions no later
than fiscal years beginning after December 15, 1995. The new standard
defines a fair value method of accounting for stock options and other equity
instruments. Under the fair value method, compensation is measured at the
grant date based on the fair value of the award and is recognized over the
service period, which is usually the vesting period.
Pursuant to the new standard, companies are encouraged, but are not required,
to adopt the fair value method of accounting for employee stock-based
transactions. Companies are also permitted to continue to account for
employee stock-based transactions under Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees", but would be
required to disclose in a note to the financial statements pro forma net
income and earnings per share as if the Company had applied the new method of
accounting.
The accounting requirements of the new standard are effective for all
employee awards granted after the beginning of the fiscal year of adoption.
The Company has elected to continue to account for stock-based compensation
under APB No. 25 and will adopt the disclosure requirements of SFAS No. 123
in 1996.
4. INVENTORIES
Inventories consist of the following:
6
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September 29, 1996 December 31, 1995
------------------ -----------------
Product ingredients $ 452,296 $ 530,511
Finished goods 297,388 353,484
Paper and packaging materials 448,270 210,981
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Total $ 1,197,954 $ 1,094,976
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------------ -----------
5. PROPERTY AND EQUIPMENT
Investments in property, plant and equipment are comprised of the following;
September 29, 1996 December 31, 1995
------------------ -----------------
Machinery and equipment $ 3,534,821 $ 3,398,749
Leasehold improvements 1,733,428 1,550,963
Office furniture and equipment 451,729 522,902
Vehicles 582,533 732,424
------------ ------------
Subtotal 6,302,511 6,205,038
Less accumulated depreciation
and amortization (1,409,092) (1,049,380)
------------ ------------
Subtotal 4,893,419 5,155,658
Construction in progress 924,917 183,810
------------ ------------
Total property and equipment 5,818,336 5,338,968
Assets held for sale 311,701 --
------------ ------------
Total $ 6,130,037 $ 5,338,968
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7
<PAGE>
During the third quarter, the Company identified certain property and equipment
assets which are obsolete and/or no longer being used in the Company's
operations. These assets, which are included in assets held for sale in the
accompanying balance sheet, have been reduced to their estimated fair value
of $311,701, resulting in a loss of $382,747 in the third quarter. The
assets are expected to be sold or otherwise disposed of during the coming
year.
6. LONG-TERM DEBT
Components of long-term debt included the following:
September 29, 1996 December 31, 1995
------------------ ------------------
Credit facility:
Receivable and inventory revolver $ - $ 52,375
Equipment revolver 361,683 63,178
Equipment term loan 1,135,894 -
7% Convertible note, due October, 1997 - 4,000,000
Other - 15,046
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1,497,577 4,130,599
Less current portion of
long-term debt 204,004 -
--------------- -----------------
$1,293,573 $ 4,130,599
--------------- -----------------
--------------- -----------------
The Company believes that it may be in technical default of its loan and
security agreement with Coast Business Credit, a division of Southern Pacific
Thrift and Loan Association. This agreement maintains, among other
covenants, that there be no material adverse change in financial condition or
business of the Company as compared to the last statement provided to the
lender. At this time, Coast Business Credit has not informed the Company
that it is in violation of this loan covenant. The Company has not defaulted
on its principal nor interest payments due Coast Business Credit.
During the first nine months of 1996, the 7% convertible note payable and
accrued interest of $20,456 were converted into 973,476 shares of common
stock of the Company. The average conversion price was $4.13 per share.
7. INCOME TAXES
Income tax benefits resulting from the net operating loss carryforward
generated for the nine months ended September 29, 1996, were fully offset
with a valuation allowance due to uncertainties about realization.
8. DISCONTINUED OPERATIONS
Subsequent to year-end 1995, the Company decided to discontinue the
operations of its restaurant and franchise subsidiaries. As a result of this
decision the Company wrote off its entire investment in its restaurant and
franchise subsidiaries as of December 31, 1995.
8
<PAGE>
Net revenues for the restaurant and franchise subsidiaries were $648,184 and
$1,893,494 for the first quarters of 1996 and 1995 respectively, and
$740,546 and $1,796,430 for the six months ended June 30, 1996 and July 2,
1995, respectively, as well as for the nine months ended September 29, 1996
and October 1, 1995 respectively.
On April 19, 1996, the Company closed a transaction pursuant to a Stock
Purchase Agreement between itself and Upscale Acquisitions, Inc., a
California corporation ("Upscale"), dated as of April 1, 1996 (the
"Agreement"). Pursuant to the Agreement, the Company sold its shares in a
wholly-owned subsidiary, Upscale Food Outlets, Inc. ("UFO"), a California
corporation, which owns and operates restaurants in California, Colorado and
Washington that feature pasta products under the name of "Monterey Pasta
Company". The purchase price of the shares was $1,000 in cash and a note
executed by Upscale in the principal amount of $2,500,000 ("Note"). The
Company has elected to use the "cost recovery method" to account for the
transaction, which defers recognition of income until payments are received.
Mr. Lance H. Mortensen is the sole shareholder, Chief Executive Officer,
President and a director of Upscale. Mr. Mortensen is also a director of the
Company, and former Chairman of the Board, former Chief Executive Officer
and former President of the Company.
The Agreement also provided for advances by the Company to Upscale to be added
to the principal amount of the Note. Advances totaling $300,000 were added to
the Note during the quarter ended June 30, 1996. During the third quarter an
additional $50,000 was advanced to UFO by the Company.
In connection with the discontinuance of the restaurant operations, as of
December 31, 1995, the Company established a reserve of approximately
$2,964,000 to cover operating losses prior to sale as well as other costs and
expenses connected with the discontinued operations. While most discontinued
operational issues have been resolved, some issues are not yet completely
settled, primarily compensation-related matters. Accordingly, the Company
continues to carry a reserve of approximately $694,000.
9. STOCKHOLDERS' EQUITY
In April, 1996, the Company sold approximately $3,696,000, net of expenses, of
its common stock in a private offering to accredited investors at an average
net price of $4.04 per share. The shares of common stock are restricted
securities with registration rights. Purchasers of the common stock agreed
not to sell such shares for one year from the date of purchase without the
consent of the placement agent. Spelman & Co. acted as placement agent (the
"Placement Agent") on a "best efforts", "any or all" basis. The Placement
Agent received no cash commissions in the offering, but received warrants to
purchase one share of common stock for each $10 in shares sold, exercisable
at a price of $6.50 per share, for a term of seven years. The net proceeds
from the offering were used by the Company for advertising, marketing,
promotion, capital equipment and working capital. In May, 1996, the Board of
Directors of the Company adopted a shareholders' rights plan, a copy of
which was mailed to shareholders on May 31, 1996.
In August, 1996, the Company sold approximately $3,380,000, net of expenses,
of convertible preferred stock. This preferred stock is convertible into
common stock at 80% of the market value of the Company's common stock as
defined in the subscription agreement. The 3,500 shares sold were privately
placed with Pangaea Fund Ltd
9
<PAGE>
and GFL Performing Fund Ltd, and carry an annual dividend of $40 per share
($10 per quarter). The agreement provided for a ceiling of $9.00 per share
with no minimum conversion price.
The purchaser and issuer entered into a Registration Rights Agreement
providing that if a registration statement registering the related common
shares is not declared effective by November 1, the issuer will pay penalties
equal to 2% of the subscription price for the first month, and 3% thereafter
until the registration becomes effective.
On August 23, 1996 the Company submitted a Form S-3 to the Securities and
Exchange Commission (SEC) regarding registration of the common shares. As of
November 15, 1996, the registration had not been declared effective. The
Company is endeavoring to amend the registration statement to include an
increased number of shares due to a decline in the Company's share price,
and to revise financial information and management discussion. The
Company has incurred penalties of $70,000 in November under the Registration
Rights agreement. The Company is endeavoring to amend the registration, but
cannot forecast the date the registration will become effective.
Dividends on the preferred stock were payable October 1, 1996. The Company
had the option of paying the dividends in common shares or cash. At this
time, the Company has not made a decision relative to this option.
10. EMPLOYEE BENEFITS PLANS
The Company established a voluntary defined contribution 401(k) plan in 1996
that covers all employees who are not covered by a collective bargaining
agreement, beginning on the first day of the calendar quarter after having
completed Nine months of service. The plan allows for employer matching
contributions. The Company is currently matching fifty percent of the first
6% contributed by employees. Employee and employer matching contributions
are always 100% vested. The plan also provides for a voluntary profit
sharing contribution by the Company at its election based on the eligible
employees' salary as a percent of total eligible salaries. Profit sharing
contributions vest over five years at 20% per year.
11. CONTINGENCIES
The Company has been named in a lawsuit filed by Anthony Giannini, the former
Senior Vice President of Sales, claiming wrongful discharge, breach of
contract and defamation of character. A reserve for estimated settlement
costs has been accrued.
There are no other pending material legal proceedings, other than ordinary
routine litigation incidental to the Company's business, to which the Company
is a party or to which any of its property is subject. UFO, a subsidiary
divested in 1996, is a defendant in approximately four lawsuits alleging
breach of lease relating to restaurants closed in the second and third
quarters of 1995.
Although there can be no assurance given as to the result of such legal
proceedings, based upon the information currently available, management does
not believe these proceedings will have a material adverse effect on the
financial position or results of operations of the Company.
See also Footnote 10 of the Company's audited consolidated financial
statements which are included in the Company's Annual Report filed on Form
10-K for the year ended December 31, 1995, as amended by Form 10-K/A, for a
description of other items.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following discussion should be read in conjunction with the financial
statements and related notes and other information included in this report. The
financial results reported herein do not indicate the financial results that may
be achieved by the Company in any future period.
Other than the historical facts contained herein, this Quarterly Report contains
forward-looking statements that involve substantial risks and uncertainties.
For a discussion of such risks and uncertainties, please see the Company's
Annual Report on Form 10-K for the year ended December 31, 1995, as amended by
Form 10-K/A. In addition to the risks and uncertainties discussed in the Annual
Report, the risks set forth herein, including the Company's recent operating
losses, possible need for additional capital, and ability to attract and
retain qualified management, should be considered.
BACKGROUND
Monterey Pasta Company (the "Company") produces and markets premium quality
refrigerated and frozen gourmet pasta and pasta sauces. The Company has
traditionally sought to build national brand recognition and customer loyalty by
employing targeted marketing and advertising programs that focus on developing
complementary channels of distribution and multiple points of sale for the
Company's products.
The Company sells pasta and pasta sauces through leading grocery store chains
and club stores. As of September 29, 1996, more than 6,000 grocery and club
stores offered the Company's products.
The Company currently offers over 30 unique varieties of pasta and sauce
products that are produced using the Company's proprietary recipes, including
refrigerated cut pasta, ravioli, tortelloni, tortellini and pasta sauces. The
Company believes its pasta products appeal to value-conscious consumers who are
seeking excellent quality and convenience.
Subsequent to the year ended December 31, 1995, the Company decided to
discontinue the business of its restaurant and franchise subsidiaries. In
1995, the Company wrote off its entire investment in its restaurant and
franchise subsidiaries and reclassified these subsidiaries as discontinued
operations. On April 19, 1996, the Company closed the sale of its subsidiary
pursuant to a Stock Purchase Agreement between itself and Upscale
Acquisitions, Inc., a California corporation ("Upscale"), dated as of April
1, 1996 (the "Agreement"). The purchase price of the shares was $1,000 in
cash and a note executed by Upscale in the principal amount of $2,500,000
("Note"). Mr. Lance H. Mortensen is the sole shareholder, Chief Executive
Officer, President and a director of Upscale. Mr. Mortensen is also a
director of the Company, and former Chairman of the Board, former Chief
Executive Officer and former President of the Company. The Company has
elected to use the "cost recovery method" to account for the transaction,
which defers recognition of income until payments are received. The
Agreement also provided for advances by the Company to be added to the
principal amount of the Note. Advances totaling $300,000 have been added to
the Note during the quarter ended June 30, 1996. During the third quarter an
additional $50,000 was advanced to UFO by the Company.
11
<PAGE>
As part of the Company's efforts to build national brand recognition and
loyalty, the Company introduced new product labels and promotional materials
during the quarter. The Company also continued its capital investment
program at its Monterey County manufacturing facility, including the
completion of a new production line to increase manufacturing capacity.
As a result of the deterioration of operating results in the third quarter,
the company has now redirected its operating focus on generating improved
financial performance on its existing retail and club store business. In line
with this, the Company has re-evaluated the benefits of advertising and
promotional programs, together with overall expenditure and staffing levels.
In addition, the Company has discontinued its efforts to sell to national
food service distributors/contract feeders and nontraditional venues such as
sports coliseums and universities. The Company will continue to market and
sell its products through grocery and club stores.
RESULTS OF OPERATIONS
Net revenues increased to $5,670,820 for the quarter ended September 29, 1996
as compared to $5,089,044 for the quarter ended October 1, 1995. For the
nine months ended September 29, 1996, net revenues increased to $18,670,838
from $12,878,291 for the nine months ended October 1, 1995. The increase in
sales primarily results from customer gains in the East Coast and the Southern
California markets.
Gross profit was $752,085 or 13% of net revenues for the third quarter of
1996, compared to $2,243,483 or 44% for the third quarter of 1995. The
decline is in part due to higher than expected product returns and allowances
related to market penetration on the East Coast and Los Angeles areas,
partially offset by improved product manufacturing efficiency. For the nine
months ending September 29, 1996, gross profit was $6,515,308 or 35% of net
revenues, as compared to $5,881,260 or 46% for the equivalent period in 1995.
The lower gross margin is associated with a significant marketing effort
during the first three quarters of 1996, which resulted in reducing net sales
and related gross profit due to higher allowances, discounts and product
returns.
Selling, general and administrative expenses increased 202% to $6,104,487 for
the quarter ended September 29, 1996, compared to $2,020,105 for the third
quarter of 1995. For the nine months ending September 29, selling, general and
administrative expenses increased 114%, to $11,654,450 compared to $5,442,876
for the nine months of 1995. Selling costs, particularly costs related to
grocery store trade promotions and club store demonstrations, were higher as a
result of the Company's efforts to obtain new customers and enter new geographic
markets. Additionally, cost increases are attributable to the expansion of the
Company's infrastructure which has required additional costs such as
administrative and management salaries, recruiting and training of new
personnel, modifying computer systems and related indirect costs.
12
<PAGE>
Depreciation and amortization was $221,889 or 4% of net revenues for the
quarter ended September 29, 1996 compared to $99,287 or 2% of net revenues
for the same quarter of 1995. For the nine months ending September 29, 1996,
depreciation and amortization was $662,847 or 3% of net revenues, compared to
$383,462 or 3% of net revenues for the first nine months of 1995. These
increases relate primarily to capital expenditures in the Monterey County
production facility.
IMPACT OF INFLATION
The Company believes that inflation has not had a material impact on its
operations to date. Substantial increases in labor, employee benefits,
ingredients and packaging, rents and other operating expenses could adversely
affect the operations of the Company's business in future periods. The Company
cannot predict whether such increases will occur.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ending September 29, 1996, cashflow used by continuing
operations included $4,949,370 for working capital requirements and
$1,547,369 for capital equipment acquisitions. Cashflow used by discontinued
operations totaling $2,307,562 was related to the funding of wind down
activities associated with the Company's discontinued restaurant and
franchise subsidiaries.
During the first nine months of 1996, the Company raised $3,696,155, net of
expenses, from private placement of 916,000 common shares at an average net
price of $4.04 per share.
In August, 1996, the Company sold approximately $3,380,000, net of expenses,
of convertible preferred stock. This preferred stock is convertible into
common stock at 80% of the market value of the Company's common stock as
defined in the subscription agreement. The Company anticipates using the
proceeds for capital expenditures, working capital and other general
corporate purposes.
On October 1, 1996, a dividend payment of $35,000, was due on the preferred
securities. The Company has not yet elected whether to make the dividend
payments in cash or common stock. The Company will incur interest expense of
12% per annum on the unpaid dividends.
As part of the above mentioned securities offering, the Company undertook its
best effort to complete the registration of 2,622,073 common shares
associated with the convertible offering. Due to decline in the Company's
share price the number of shares to be registered will have to be increased
to reflect the equivalent value of the shares to be converted. In addition,
as a result of the resignation of the Company's auditors and legal counsel,
the Company was unable to complete the timely amendment of the S-3 to reflect
changes in the business. The Company remains committed to completing the
offering, but risk remains regarding the timing of the listing.
At the end of September, the Company had $1,319,787 in cash. There is no
assurance that current funds are sufficient to cover on-going business
operations. The Company is currently seeking additional sources of financing.
13
<PAGE>
SALES AND MARKETING
The Company has expended substantial resources on slotting allowances and
other incentives in order to attract new customers. The Company is currently
evaluating the effectiveness of these expenditures and has reserved
$474,663 for the writeoff of slotting allowances which may be determined
to be non-recoverable, and of no future benefit.
As part of the Company's efforts to build national brand recognition and
loyalty, the Company introduced new product labels and promotional materials
during the quarter. The Company has reserved $323,350 for expected product
returns including those products still outstanding with old labels.
As a part of the Company's restructuring plan, the Company has withdrawn from
the food service and Military markets. As a result, the Company has taken a
writedown of $292,242 for manufacturing equipment and vendor carts directly
associated with these activities. In addition, a writedown to estimated fair
value of $190,483 was taken for certain plant equipment replaced when the
Company updated its production lines.
Further, as part of the Company's strategic refocusing, the Company has
re-evaluated its advertising and marketing strategy. As previously disclosed
in the Company's forms 10-K and 10-Q, the Company's strategy contained risks
associated with expenditures related to attempts to increase market share and
attract new customers. Based on an evaluation of the potential returns from
significant media advertising campaigns, the Company has decided to withdraw
its current media advertising efforts and forego future expenditures for this
promotional mechanism. As a result, the Company has established a reserve of
$324,663 to cover the writeoff of prepaid advertising and advertising
production expense. The Company has also reserved for future commitments for
which there are contractual obligations. As part of this change in strategy,
the Company significantly reduced the staffing of its marketing department.
Going forward, the sales staff will report directly to the interim CEO, and
will consist of regional sales personnel and support staff, focusing on the
retail market, together with a direct store delivery ("DSD") group, supporting
current DSD customers. In addition, the Company will continue its sales efforts
to the club stores, including the in-store demonstration programs previously
used by the Company.
The Company has also implemented an overall price increase effective October 1,
1996.
COST REDUCTIONS
The Company has significantly reduced its total corporate and plant
administrative headcount and costs on a going-forward basis. As part of the
plan to return to profitable operations and optimize the financial
performance, the Company has decided to relocate its San Francisco,
California headquarters to its manufacturing facilities in
14
<PAGE>
Salinas, California. This move, expected to be complete by first quarter of
1997, is anticipated to result in a further substantial reduction of
corporate and overhead costs.
In addition, the Company has significantly reduced the scope of its
advertising and media campaigns. The Company will continue with
those promotional activities, such as in-store demonstrations, that it
considers effective and consistent with its ongoing sales objectives. In
this light, the Company's slotting allowances, for example, are expected to
decline significantly.
Consistent with these cost reduction initiatives, the Company has invested
significant resources in retooling its Salinas production facilities to
increase operating efficiencies as well as the shelf life of the products.
In a complementary move, the Company has announced an overall price increase
and has revised its trade allowance and product return policies.
SETTLEMENT WITH FORMER EMPLOYEES
The Company has outstanding employment related disputes with three employees,
Mr. Anthony Giannini, Mr. William Bender and Mr. Don Milan. Total settlement
costs for Mr. Bender and Milan are included in the reserve for discontinued
operations. Estimated charges associated with Mr. Giannini were charged to
continuing operations.
MAJOR CUSTOMERS
Two of the Company's retail customers, Price/Costco and Safeway,
accounted for 44% and 10%, respectively, of the Company's sales for the nine
months ended September 29, 1996. No other customer accounted for greater
than 10% of net revenues for the period.
BUSINESS RISKS
Certain characteristics and dynamics of the Company's business and of
financial markets generally create risks to the Company's long-term success
and to predictable quarterly results. These risks include:
RECENT OPERATING LOSSES; NO ASSURANCE OF PROFITABILITY. The Company's
profitability began to decline in 1994. In the 2nd quarter of 1994, the
Company reported its first operating loss from continuing operations. The
Company has reported additional operating losses from continuing operations
in seven out of the nine quarters since then. The Company's operating loss
for the quarter ended September 29, 1996 was $5,924,928. At September 29,
1996, the Company had an accumulated deficit of $31,257,674. There can be no
assurance that the Company will return to profitability in the short term or
ever.
LIQUIDITY; NEED FOR ADDITIONAL CAPITAL. The Company believes that it
will have sufficient resources to provide adequate liquidity to meet the
Company's planned capital and operating requirements through March 1997.
Thereafter, the Company's operations will need to be funded either with funds
generated through operations or with additional debt or equity financing. If
the Company's operations do not provide funds sufficient to fund its
operations and the Company seeks outside financing, there can be no assurance
that the Company will be able to obtain such financing when needed, on
acceptable terms or at all. In addition, any future equity financing or
convertible debt financing would cause the Company's shareholders to incur
dilution in net tangible book value per share of Common Stock.
15
<PAGE>
HIRING AND RETENTION OF KEY PERSONNEL; MANAGEMENT TRANSITION. The
success of the Company depends on the efforts of key management personnel. In
the last quarter, a number of the corporate officers have left the Company.
These include its President and Chief Executive Officer and Vice President --
Legal Affairs, who resigned on October 4, 1996 together with three additional
Board members, and its Chief Financial Officer, who resigned on November 8,
1996. The Company currently has an interim Chief Executive Officer and an
interim Chief Financial Officer, neither of whom has previously been a part
of the Company's management team. The interim Chief Financial Officer,
however, has spent several years with the Company as a Board member. The
Company has begun to conduct a search for a new Chief Financial Officer and
intends to begin its search for a new Chief Executive Officer in the fourth
quarter of this fiscal year. The Company's success will depend on its
ability: to operate under interim management; to attract qualified personnel,
particularly in the finance area; to effect a smooth transition to new
management, with minimal disruption in operations; and to motivate and retain
key employees and officers. There can be no assurance that the Company will
be able to effect smooth transitions to its interim management team or a new
management team, that new officers will be hired or if hired will be able to
perform effectively, or that significant management turnover will not
continue in the future.
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 1993. Such volatility may, in part, be attributable
to the Company's operating results or to changes in the direction of the
Company's expansion efforts. In addition, changes in general conditions in the
economy, the financial markets or the food 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 a 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 or the market could have an immediate and
significant adverse effect on the trading price of the Company's Common Stock
in any given period. Additionally, the Company may not learn of such
shortfalls 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.
RISKS INHERENT IN FOOD PRODUCTION. The Company faces all of the risks
inherent in the production and distribution of refrigerated food products,
including contamination, adulteration and spoilage, and the associated risks
of product liability litigation and declines in the price of its stock that
may be associated with even an isolated event. The Company has a modern
production facility, employs what it believes is state-of-the art thermal
processing, temperature-controlled storage, HAACP programs intended to insure
food safety, and has obtained USDA approval for its production plant.
However, there can be no assurance that the Company's procedures will be
adequate to prevent the occurrence of such events.
SEASONALITY AND QUARTERLY RESULTS
The Company's grocery and club store accounts are expected to experience
seasonal fluctuations to some extent. The Company's business in general may
also be affected by a variety of other factors, including , but not limited
to, general economic trends, competition, marketing programs, and special or
unusual events.
COMPETITION AND DEPENDENCE ON COMMON CARRIERS
The Company's business continues to be dominated by several very large
competitors which have significantly greater resources than the Company; such
competitors can outspend the Company and negatively affect the Company's
market share and results of operations. The Company also continues to be
dependent on common carriers to distribute its products. Any disruption in
the Company's distribution system or increase in the costs thereof could have
a material adverse impact on the Company's business.
16
<PAGE>
MARKETING AND SALES RISKS
The future success of the Company's efforts will depend on a number of
factors, including whether grocery and club store chains will continue to
expand the number of their individual stores offering the Company's products
and whether allowances and other incentives to expand retail distribution.
New markets increase the risk of significant product returns resulting from
slower selling product than expected. In addition, grocery and club store
chains continually re-evaluate the products carried in their stores and no
assurances can be given that the chains currently offering the Company's
products will continue to do so in the future. Should these channels choose
to reduce or eliminate products, the Company could experience a significant
reduction in product sales. As indicated previously, the Company remains
dependent on the use of slotting allowances and other incentives to expand
retail distribution. In order to reduce risk the Company has significantly
reduced expansion into new markets.
PART II
ITEM 1. LEGAL PROCEEDINGS
Anthony Giannini, the Company's Senior Vice President of Sales was
terminated on July 26, 1996. On September 23, 1996, Mr. Giannini
filed suit in the Superior Court in the State of California in and
for the County of San Mateo against the Company claiming wrongful
discharge, breach of contract and defamation of character. This suit
is claiming total damages of $1.7 million. Although there can be no
assurance given as to the results of such legal proceedings, based
upon information currently available, management does not believe
these proceeding will have a material adverse effect on the financial
position or results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES
At a Special Meeting held August 1, 1996, the Company's shareholders
approved a proposal to change the Company's state of incorporation
from California to Delaware by merging the Company into its wholly-
owned Delaware subsidiary. On August 7, 1996, the Company was, through
this merger, reincorporated in the state of Delaware. As a result, the
rights of holders of all classes of the Company's stock are now
governed by the Company's Certificate of Incorporation and Bylaws,
which are in accordance with Delaware law, and by Delaware General
Corporation Law.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company believes that it may be in default of the covenants under its
loan and security agreement with Coast Business Credit, a division
of Southern Pacific Thrift and Loan Association. This agreement
requires that there be no material adverse change in financial
condition or business of the Company as compared to the last
statement provided to the lender. At this time, Coast Business
Credit has not informed the Company that it is in violation of this
loan covenant. The Company has not defaulted on its principal nor
interest payments due Coast Business Credit.
In August 1996, the Company sold approximately $3,380,000, net of
expenses, of preferred stock which is convertible into common stock
at 80% of the market value of the Company's common stock shares on
date of conversion. The purchaser and the Company entered into a
Registration Rights Agreement providing that if a registration
statement registering the related common shares is not declared
effective by November 1, the issuer will pay penalties equal to 2%
of the subscription price for the first month, and 3% thereafter
until the registration becomes effective.
On August 23, 1996 the Company submitted a Form S-3 to the Securities
and Exchange Commission (SEC) regarding registration of the common
shares. As of November 15, 1996, the registration had not been
declared effective. The Company is endeavoring to amend the
registration statement to include an increased number of shares due to
a decline in the Company's share price, and to revise financial
information and management discussion. The Company has incurred
penalties of $70,000 in November under the Registration Rights
agreement. The Company cannot forecast the date the registration
will become effective.
17
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Pursuant to a Notice dated June 28, 1996, the
Company held a Special Meeting of Shareholders
on August 1, 1996, and the shareholders voted on
following three proposals:
1. To approve a change in the Company's state of incorporation from
California to Delaware through merger of the Company with and into a
wholly-owned subsidiary incorporated in Delaware, pursuant to an
agreement and plan of merger;
2. To amend the Company's Articles of Incorporation to increase the number
of shares of Common Stock authorized from 20,000,000 to 70,000,000 and
to reduce the number of shares of Preferred Stock authorized from
5,000,000 to 1,000,000; and
3. To amend the Company's First Amended and Restated 1993 Stock Option Plan
to increase the number of shares reserved for issuance thereunder from
1,200,000 to 1,740,000.
(1) Change in state of incorporation:
For: 4,645,774 Against: 420,314 Abstain: 17,435
(2) Amendment of Articles of Incorporation:
For: 5,233,941 Against: 784,200 Abstain: 40,510
(3) Amendment to First Amended and Restated 1993 Stock Option Plan to
increase number of shares reserved for issuance thereunder:
For: 5,258,314 Against: 455,825 Abstain: 49,243
18
<PAGE>
ITEM 5. OTHER INFORMATION
The Company has experienced changes in management and changes in its Board
through the current period.
MANAGEMENT CHANGES:
TONY GIANNINI- SENIOR VICE PRESIDENT OF SALES:
TERMINATED ON JULY 26, 1996
NORMAN E. DEAN- PRESIDENT AND CHIEF EXECUTIVE OFFICER
RESIGNED ON OCTOBER 4, 1996
ROBERT J. OTTO- EXECUTIVE VICE PRESIDENT:
RESIGNED ON OCTOBER 4, 1996
CAROLYN MAR- VICE PRESIDENT AND CORPORATE SECRETARY:
RESIGNED ON OCTOBER 4, 1996
KAREN L. BORIE, DIRECTOR OF SPECIAL SALES:
TERMINATED ON OCTOBER 17, 1996
P. DAWN CALDWELL, SENIOR VICE PRESIDENT OF MARKETING:
TERMINATED ON OCTOBER 17, 1996
MARSHALL STEVENS- APPOINTED INTERIM PRESIDENT:
APPOINTED ON OCTOBER 4, 1996
KENNETH A. STEEL JR.- APPOINTED INTERIM CHIEF EXECUTIVE OFFICE
AND ELECTED TO THE BOARD OF DIRECTORS:
APPOINTED ON OCTOBER 24, 1996
STEPHEN KENNEDY- VICE PRESIDENT AND CHIEF FINANCIAL OFFICER:
RESIGNED ON NOVEMBER 8, 1996
CHARLES BONNER- APPOINTED INTERIM CHIEF FINANCIAL OFFICER:
APPOINTED ON NOVEMBER 11,1996
BOARD MEMBERS CHANGES:
CHRISTOPHER G. GILLIAM- DIRECTOR:
RESIGNED ON OCTOBER 4, 1996
E. MICHAEL MOONE- DIRECTOR:
RESIGNED ON OCTOBER 4, 1996
PAUL MILLER- DIRECTOR:
RESIGNED ON OCTOBER 4, 1996
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: The exhibits listed in the accompanying exhibit index on
page 22 are sequentially numbered and are filed or incorporated by reference as
part of this report.
(b) Reports on Form 8-K:
(1) Report on Form 8-K filed on October 17, 1996, the Board of
Directors, at a special board meeting held October 4, 1996, accepted the
resignation of Mr. Norman "Ned" Dean as President and Chief Executive
Officer. The Board also accepted the resignations of three Board members,
Christopher G. Gilliam, Paul Miller and E. Michael Moone.
(2) Report on Form 8-K filed on October 25, 1996, reported the
resignation of Deloitte & Touche LLP as the Company's independent public
accountants and announced the engagement of BDO Seidman, LLP as its
independent public accountants effective October 25, 1996.
19
<PAGE>
(3) Report on Form 8-K/A filed on November 8, 1996, amended the
October 25, 1996 8-K filing to include reference to
Deloitte & Touche LLP's October 31 letter which noted that
the accountants first notified the Company's Board of
Directors of its concerns about alleged potential
violations of the Company's policy on insider trading by
three directors on October 18, the day it resigned as the
Company's independent public accountants. This filing also
included notice of the resignation of Stephen J. Kennedy,
Vice President and Chief Financial Officer, effective
November 8, 1996.
This filing noted that the Company's Interim Chief
Executive Officer conducted a preliminary investigation,
which revealed margin calls with respect to two directors in
violation of the Company's trading policy, and that the
Company had retained new securities counsel, Gray Cary Ware
and Freidenrich on October 30, 1996 to confirm the results
of this investigation, and to expand the scope of review
through prior periods.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MONTEREY PASTA COMPANY
Date: November 18, 1996 By: /s/ K KENNETH S. STEEL, JR.
----------------------------
Kenneth S. Steel, Jr.
Chief Executive Officer
By: /s/ CHARLES B. BONNER
--------------------------
Charles B. Bonner
Chief Financial Officer
21
<PAGE>
INDEX TO EXHIBITS
NUMBER EXHIBIT TITLE SEQUENTIALLY
NUMBERED
PAGES
27.1 Financial Data Schedule
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-29-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-29-1996
<CASH> 1,319,787
<SECURITIES> 0
<RECEIVABLES> 2,266,408
<ALLOWANCES> 682,049
<INVENTORY> 1,197,954
<CURRENT-ASSETS> 6,083,965
<PP&E> 5,818,336
<DEPRECIATION> 221,889
<TOTAL-ASSETS> 12,875,715
<CURRENT-LIABILITIES> 4,439,941
<BONDS> 0
0
3,380,000
<COMMON> 35,019,874
<OTHER-SE> (31,257,674)
<TOTAL-LIABILITY-AND-EQUITY> 12,875,715
<SALES> 5,670,820
<TOTAL-REVENUES> 5,670,820
<CGS> 4,918,735
<TOTAL-COSTS> 5,924,928
<OTHER-EXPENSES> 350,637
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5,924,928
<INCOME-TAX> 0
<INCOME-CONTINUING> 5,924,921
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,924,928)
<EPS-PRIMARY> (.68)
<EPS-DILUTED> (.68)
</TABLE>
