Back to GetFilings.com

Table of Contents

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, 2002
	OR
o	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 000-32527

BRIAZZ, INC.

3901 7TH AVENUE SOUTH, SUITE 200
SEATTLE, WASHINGTON 98108-5206

(206) 467-0994

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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of outstanding shares of common stock, no par value, of the Registrant at October 24, 2002 was 5,870,173.

Table of Contents

BRIAZZ, INC.

INDEX TO THE FORM 10-Q
FOR THE 39-WEEK PERIOD ENDED SEPTEMBER 29, 2002

Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BRIAZZ, INC.

BALANCE SHEETS
(in thousands)

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

2

Table of Contents

BRIAZZ, INC.

STATEMENTS OF OPERATIONS
(in thousands, except share data)

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

3

Table of Contents

Briazz, Inc.
Statement of Stockholders’ Equity
(in thousands)
(unaudited)

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

4

Table of Contents

BRIAZZ, INC.

STATEMENTS OF CASH FLOWS
(in thousands)

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

5

Table of Contents

BRIAZZ, INC.

NOTES TO FINANCIAL STATEMENTS
(unaudited)

1. Summary of operations and significant accounting policies

Operations

     BRIAZZ, Inc. (“Briazz” or the “Company”) manufactures and distributes branded lunch and breakfast foods through multiple points of distribution in urban and suburban locations. The Company commenced operations in 1995 in Seattle, and opened new markets in San Francisco in 1996, Chicago in 1997 and Los Angeles in 1998. The Company’s business strategy is to solidify current markets and build Briazz into a national brand by expanding in major metropolitan areas across the United States. The Company’s retail distribution network includes Briazz cafés, as well as box lunch delivery. The Company also distributes its products through select strategic alliances. Each market operates a central kitchen, which prepares meals daily.

Interim financial information

     The financial information at September 29, 2002, and for the 13-week and 39-week periods ended September 29, 2002 and September 30, 2001 is unaudited but includes all adjustments, consisting of only normal recurring adjustments, that the Company considers necessary for a fair presentation, in all material respects, of its financial position, operating results and cash flows for the interim dates and periods presented. The results of operations for the 13-week and 39-week periods ended September 29, 2002 and September 30, 2001 are not necessarily indicative of results for the entire fiscal year or future periods.

Financial conditions and basis of presentation

     The accompanying financial statements have been prepared assuming that we will continue as a going concern and do not include any adjustments to reflect the possible future effects on the recoverability of assets and liquidation of liabilities that may result from this uncertainty. The Company has incurred substantial operating losses and negative cash flows from operations since inception and had an accumulated deficit of $64.5 million at September 29, 2002. These matters raise substantial doubt about the Company’s ability to continue as a going concern. To date, the Company has finalized it’s operations principally through the net proceeds of debt and equity offering (see note 8). The Company’s ability to continue as a going concern is dependent upon numerous factors, including the ability to obtain additional financing, the ability to increase the level of future revenues or the ability to reduce operating expenses.

     There can be no assurance that the Company will be able to obtain additional financing, reduce expenses or successfully complete other steps to continue as a going concern. If the Company is unable to unable to obtain sufficient funds to satisfy its cash requirements, it may be forced to curtail operations, dispose of assets, or seek extended payments terms from its vendors. Such events would materially and adversely affect the Company’s financial position and results of operations.

Recent accounting pronouncements

     In July 2001, the Financial Accounting Standards Board issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The provisions of SFAS No. 143 will be effective for fiscal years beginning after June 15, 2002, however early application is permitted. The Company is currently evaluating the implications of adoption of SFAS No. 143.

     In April 2002, the Financial Accounting Standards Board issued SFAS 145, “Rescission of FAS Nos. 4, 44, and 64, Amendment of FAS 13, and Technical Corrections” which is generally effective for transitions occurring after May 15, 2002. Through the rescission of FASB statement 4 and 64, SFAS 145 eliminates the requirement that gain and losses from extinguishment of debt be aggregated and, if material, be classified as an extraordinary item net of and income tax effect. SFAS 145 makes several other technical connections to existing pronouncements that may change accounting practice. The adoption of SFAS 145 is not expected to have a material effect on the Company’s results of operations.

6

Table of Contents

     In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”). SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged.

2. Net loss per share

     The computation of basic and diluted net loss per share is based on the weighted-average number of shares of common stock outstanding during the period. The Company has excluded all outstanding convertible debt, options and warrants to purchase common stock from the calculation of diluted net loss per share, as such securities are anti-dilutive for all periods presented.

The following table presents the calculation of basic and diluted net loss per share (in thousands, except share and per share data):

3. Convertible debt, mandatorily redeemable convertible preferred stock and stockholders’ equity

     In connection with a $3 million private placement offering of shares of Series C preferred stock in January and February 2001, the Company issued approximately 500,000 shares at $6.00 per share. At the time of issuance of the Series C preferred stock, the Company determined that the fair value of its common stock exceeded the conversion price of the convertible preferred stock. As a result, the Company recorded a beneficial conversion feature in accordance with EITF 00- 27 “Application of Issue 98-5 to Certain Convertible Instruments” at the time of issuance of the preferred stock. Accordingly, the beneficial conversion feature was calculated as of January 29, 2001, the commitment date, as the difference between the conversion price and the fair value of the common stock multiplied by the number of shares into which the security was convertible (intrinsic value). The Company recorded a beneficial conversion feature of approximately $3 million. The beneficial conversion feature is analogous to a dividend and was being recognized as a return to the preferred shareholders over the period from date of issuance to the redemption date (October 2005) using the effective interest yield method. As of May 1, 2001, the beneficial conversion feature of $3.0 million was fully amortized upon the conversion of the Series C preferred stock to common stock. This beneficial conversion feature was recognized as a dividend, increasing the net loss attributable to common stockholders.

     The warrants outstanding to purchase 907,240 (947,817 as adjusted for anti-dilution) shares of Series C preferred stock were converted into warrants to purchase common stock on May 7, 2001. In February 2001, the Company modified the warrants to remove the automatic expiration date upon an initial public offering, thereby allowing the warrant holders the ability to exercise the warrants through the original expiration date. This modification initially resulted in a non-cash charge to expense of approximately $635,000 at the time of the initial public offering, related to approximately 100,000 warrants held by an officer of the Company. This charge to expense was reversed as of September 30, 2001 when the market price of the Company’s common stock dropped to a level below the exercise price of $6.00.

7

Table of Contents

     On June 18, 2002, the Company entered into a Securities Purchase Agreement with Laurus Master Fund, Ltd. in connection with the issuance of a 14% convertible note to the Laurus Master Fund, Ltd. in the amount of $1.25 million and a warrant to purchase 250,000 shares of common stock at exercise prices ranging from $1.43 to $1.95. The note matures on December 18, 2003, and is collateralized by all of the Company’s assets. The note is initially convertible into 1,041,667 shares of common stock. Net proceeds to the Company after paying escrow fees, legal fees of Laurus and a fee to Laurus’ fund manager were $1.14 million. The Company recorded a debt discount of approximately $225,000 related to the issuance of the warrants and the beneficial conversion feature. The note was convertible into common stock from the date of issuance at an initial conversion price of $1.20 per share. If the Company elects to convert at a time when the market price is less than $1.50 per share, the conversion price would be at a discount to market. Accordingly, the Company fully recognized the beneficial conversion feature of approximately $112,000 as interest expense during the period. The debt discount related to the warrant is being amortized to interest expense over the term of the note.

     On August 30, 2002, the Company entered into a $1.0 million nonconvertible revolving credit line based upon and secured by the Company’s accounts receivable. A fee equal to 0.0667% is applied to the outstanding daily balance (equivalent to 2% per month). As of September 29, 2002, the Company qualified for approximately $0.36 million under this credit line and this amount had been fully drawn. The credit line has a term of 12 months.

4. Commitments and contingencies

     The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. Company management currently believes that resolution of such legal matters will not have a material adverse impact on the Company’s financial position, results of operations or cash flows.

5. Segment information

     The Company changed its segment disclosures in the fourth quarter of fiscal 2001, to more closely match how it currently manages its business. In previous periods, the Company disclosed two reportable segments: Retail, and Wholesale and Other. Beginning in the fourth quarter of fiscal 2001, the Company has managed its business through four reportable segments: Retail, Branded Sales, Kitchens and General and Administrative. Retail consists of sales generated through the Company’s cafés. Branded Sales consists of two subgroups: 1) box lunch, catering and vending and 2), wholesale and grocery. Branded Sales subgroups consist of sales that are aggregated because they have similar economic characteristics. Kitchens consist of unallocated cost of products and packaging, along with unallocated costs of kitchen operations. General and Administrative consists of all costs incurred by the corporate office as well as those administrative costs incurred by Retail. Management evaluates segment performance primarily based on sales and segment operating income (loss). Prior periods have been restated to reflect the new classifications. Following the anticipated fourth quarter closure of the kitchens, the kitchen segment will no longer exist.

     In the table below and elsewhere in this report, EBITDA represents earnings before interest income and expense, income taxes and depreciation and amortization.

     The following table presents certain financial information for each segment (amounts in thousands).

8

Table of Contents

Briazz, Inc.
Segment Information (in thousands)
(unaudited)

7. Asset Impairment

     In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. SFAS No. 144 requires recording an impairment loss if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and to measure the impairment loss as the difference between the carrying amount

9

Table of Contents

and fair value of the asset. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. During the quarter ended September 29, 2002, the Company wrote down approximately $2.1 million of long-lived assets in accordance with SFAS No. 144. These write-downs consisted primarily of leasehold improvements at certain café locations.

8. Equity-based compensation

Stock options

     In February 2002, the board of directors approved a grant of option of approximately 29,000 shares of common stock to employees with exercise prices of $1.66 per share. Since the exercise price was equal to the fair value at the date of grant, no deferred compensation was recognized.

     In June 2002, the board of directors approved a grant of options of approximately 81,000 shares of common stock to employees with exercise prices of $1.26 per share. Since the exercise price was equal to the fair value at the date of grant, no deferred compensation was recognized.

     In August 2002, the board of directors approved a grant of options of approximately 120,000 shares of common stock to employees with exercise prices of $0.69 per share. Since the exercise price was equal to the fair value at the date of board approval, no deferred compensation was recognized.

8. Subsequent events

     On October 3, 2002, the Company completed a $0.5 million financing by issuing a nonconvertible note to a commercial bank. The note bears interest at an annual rate of 3.590% and is secured by a certificate of deposit from the Company’s CEO, Victor D. Alhadeff. The note matures on March 31, 2003. Interest on the note is payable monthly.

     The Company is currently in negotiations to offer and sell up to $2.0 million in secured convertible notes to Flying Food Group (“FFG”) or one or more of its affiliates. Flying Food Group is a provider of in-flight catering services at major international airports in the United States, and freshly-made food products for grocery and specialty retail. The notes would be secured by the assets of the Company and would be convertible into the common stock of the Company at $1.00 per share, at the option of the investors, or upon the occurrence of certain events, such as a subsequent equity financing. The investor would have registration rights covering the shares issuable upon conversion of the notes. The investment in the convertible notes would be made over the next few months in a series of closings. There can be no assurance that the negotiations with the investor will be successful or that the offering will be completed on the terms described, or at all. In addition to the $2.0 million debt financing, the Company is in initial discussions with institutional investors for an additional $3.0 to $4.0 million of capital. There can be no assurance that the negotiations with institutional investors will be successful or that the offering will be completed.

     While the Company negotiates these additional financings, it is attempting to conserve cash to the greatest extent permitted while continuing to operate its business by reducing expenses and by delaying or deferring payments to certain of its suppliers and on certain of its leases. As of the date of this report, FFG or its affiliates have purchased demand notes having an aggregate principal amount of $0.35 million. These notes are secured by the Company’s assets and will convert into, and be part of, the $2.0 million investment once the terms of such investment has been finalized. The Company has used the proceeds received to date, and will use the proceeds received in the future, to pay down existing debts and for general working capital. There can be no assurance that the investor will purchase additional demand notes in amounts sufficient to meet the Company’s immediate capital needs. The investor may require payment on the demand notes at any time.

     In connection with the $2.0 million financing, the Company is negotiating with FFG to produce its food at FFG’s central kitchens. FFG has central kitchen facilities in each of the Company’s geographic markets. The Company’ss intent is to close its own central kitchens following the move of the food preparation operations to FFG. Briazz anticipates that all of its central kitchens will be closed by early December. The estimated charge to expense associated with closing the kitchens is approximately $2.1 million.

     The Company proposes to enter into a management services contract with FFG, outlining the terms on which the Company will outsource its food production and provide other services to the Company. Under the proposed terms of the agreement, the Company would grant FFG a five-year right to purchase up to 2 million shares of common stock at $1.10 per share. FFG would have registration rights covering the shares issuable upon exercise of the right. Unless and until the Company obtained shareholder approval, exercise of the right, together with conversion of the convertible notes, would be

10

Table of Contents

limited to 19.9% of the Company’s outstanding common stock.

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     This report, including the following discussion of our financial condition and results of operations, contains forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those described in connection with the forward-looking statement, fluctuation of the Company’s operating results, the Company’s ability to negotiate a management services agreement with Flying Food Group, LLC (“FFG”) and to obtain additional financing from FFG and other investors on terms favorable to the Company, or at all, the ability of the company to compete successfully, office occupancy, the ability of the company to maintain current café locations and secure new ones, food and labor costs, operation in only four geographic areas and reliance upon distributors and wholesale customers and the factors listed on Exhibit 99.1 to this report, which factors are hereby incorporated by reference in this report.

     In some cases, you can identify forward-looking statements by our use of words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative or other variations of these words, or other comparable words or phrases.

     Although we believe the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements or other future events. Moreover, neither we nor anyone else assumes responsibility for the accuracy and completeness of forward-looking statements. We are under no duty to update any of our forward-looking statements after the date of this filing. You should not place undue reliance on forward-looking statements.

OVERVIEW

     BRIAZZ prepares and sells high-quality, branded lunch and breakfast foods for the “on-the-go” consumer. We sell our products primarily through our Company-operated cafés, through delivery of box lunches and catered platters directly to corporate customers and through selected wholesale accounts. Our core products are sandwiches, salads and soups, which are complemented by a variety of fresh baked goods, premium juices, Starbucks coffees and fresh fruit.

     We currently operate 46 cafés in the Seattle, San Francisco, Chicago and Los Angeles metropolitan areas, a net increase of three cafés since December 30, 2001. The three café increase in 2002 is due to the opening of a café in the first quarter and four cafés in the second quarter of 2002 as well as the closure of a location in the first quarter and another in the third quarter of 2002. The first closure resulted from decreased sales as the café’s building occupancy shifted from normal office occupancy to a data-center. The second café closure resulted from an occupancy level significantly below capacity in the building the café was located. We discontinued plans to open one more additional café (which would have been the sixth café opened during 2002) following the change of the development site to a less desirable location. Due to the discontinuation of this planned opening and due to capital restrictions, we do not currently plan to open any additional cafés during 2002. Our growth strategy is to open new cafés in our existing markets and, when appropriate, enter into new markets.

     During the fourth quarter 2001, we reduced our workforce at our general and administrative office. The cost of this reduction approximated the salary expense in the fourth quarter of 2001 that would have been incurred without the reduction. The expected annual cash savings in the fiscal year 2002 will approximate $0.64 million.

     On May 20, 2002, we began testing our new frozen panini products in eight Target stores (four in Seattle, four in Chicago), and we began testing our fresh food products in 18 Albertson’s stores in southern California on July 16, 2002.

     On June 18, 2002, we entered into a Securities Purchase Agreement with Laurus Master Fund, Ltd. in connection with the issuance of a 14% convertible note to the Laurus Master Fund, Ltd. in the amount of $1.25 million and a warrant to purchase 250,000 shares of common stock at exercise prices ranging from $1.43 to $1.95. The note matures on December 18, 2003, and is collateralized by all of our assets. The note is initially convertible into 1,041,667 shares of our common stock. The conversion price and the number of shares into which the note is convertible are subject to adjustment for stock splits, dilutive issuances, defaults and, in the case of conversion at the Company’s option, the prevailing market price at the time of such conversion. Net proceeds to us after paying escrow fees, legal fees of Laurus and a fee to Laurus’ fund manager were $1.14 million. The Company recorded a debt discount of approximately $0.22 million related to the issuance of the warrants and the beneficial conversion features. The note was convertible into common stock from the date of issuance at $1.20 per share.

11

Table of Contents

Accordingly, the Company fully recognized the beneficial conversion feature of approximately $0.11 million as interest expense during the period. For a more detailed description of the financing, see “Sales of Unregistered Securities” in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, and for its impact on our financial position, see “Liquidity and Capital Resources”. For certain risks related to this financing, see the risk factors set forth in Exhibit 99.1 to this report.

     During the third quarter 2002, we made a reduction in our entire workforce of approximately twenty percent. The cost of this reduction approximated the salary expense in the third quarter of 2002 that would have been incurred without the reduction. The expected cash savings in the fourth quarter of 2002 will approximate $0.64 million.

     On August 30, 2002, the Company entered into a $1.0 million nonconvertible revolving credit line based upon and secured by the Company’s accounts receivable. A fee equal to 0.0667% is applied to the outstanding daily balance (equivalent to 2% per month). As of September 29, 2002, the Company qualified for approximately $0.36 million under this credit line and this amount had been fully drawn. The credit line has a term of 12 months. As of November 10, 2002, the Company qualified for $0.54 million, which amount has been fully drawn.

     On October 3, 2002, the Company completed a $0.5 million financing by issuing a nonconvertible note to a commercial bank. The note bears interest at an annual rate of 3.590% and is secured by a certificate of deposit from Victor D. Alhadeff. The note matures on March 31, 2003. Interest on the note is payable monthly.

     Commencing on October 21, 2002, Briazz began supplying sandwiches and salads to 40 Starbucks locations in the Chicago metro area as part of a test program to introduce new sandwich and salad menus at Starbucks in Chicago. The test program will continue through December 31, 2002.

     The Company is currently in negotiations to offer and sell up to $2.0 million in secured convertible notes to Flying Food Group (“FFG”) or one or more of its affiliates. Flying Food Group is a provider of in-flight catering services at major international airports in the United States, and freshly-made food products for grocery and specialty retail. The notes would be secured by the assets of the Company and would be convertible into the common stock of the Company at $1.00 per share, at the option of the investors, or upon the occurrence of certain events, such as a subsequent equity financing. The investor would have registration rights covering the shares issuable upon conversion of the notes. The investment in the convertible notes would be made over the next few months in a series of closings. There can be no assurance that the negotiations with the investor will be successful or that the offering will be completed on the terms described, or at all. In addition to the $2.0 million debt financing, the Company is in initial discussions with institutional investors for an additional $3.0 to $4.0 million of capital. There can be no assurance that the negotiations with institutional investors will be successful or that the offering will be completed.

     While the Company negotiates these additional financings, it is attempting to conserve cash to the greatest extent permitted while continuing to operate its business by reducing expenses and by delaying or deferring payments to certain of its suppliers and on certain of its leases. FFG has assisted the Company in negotiating more favorable payment terms with some of the Company’s suppliers as part of the transition of its production to FFG. As of the date of this report, FFG or its affiliates have purchased demand notes having an aggregate principal amount of $0.35 million. These notes are secured by the Company’s assets and will convert into, and be part of, the $2.0 million investment once the terms of such investment has been finalized. The Company has used the proceeds received to date, and will use the proceeds received in the future, to pay down existing debts and for general working capital. There can be no assurance that the investor will purchase additional demand notes in amounts sufficient to meet the Company’s immediate capital needs. The investor may require payment on the demand notes at any time.

     In connection with the $2.0 million financing, the Company is negotiating with FFG to produce its food at FFG’s central kitchens. FFG has central kitchen facilities in each of the Company’s geographic markets. The Company’s intent is to close its own central kitchens following the move of the food preparation operations to FFG. Briazz anticipates that all of its central kitchens will be closed by mid December. The estimated charge to expense associated with closing the kitchens is approximately $2.1 million.

     The Company’s central kitchens are currently underutilized. The Company reported $3.7 million of unallocated central kitchen losses in 2001 and $2.9 million in the first three quarters of 2002. The Company believes that outsourcing its food production to FFG would maintain the advantages of central kitchens, while limiting overhead. The Company believes that outsourcing its food production would also allow it to move into new geographic markets more quickly, and allow it to work with FFG cooperatively to better serve shared customers. For example, Starbuck’s is a customer of both the Company and FFG. If the Company successfully negotiates an agreement with FFG, it anticipates that the two companies would work cooperatively to better serve Starbuck’s.

12

Table of Contents

     The Company proposes to enter into a management services contract with FFG, outlining the terms on which the Company will outsource its food production. Under the proposed terms of the agreement, the Company would grant FFG a five-year right to purchase up to 2 million shares of common stock at $1.10 per share. FFG would have registration rights covering the shares issuable upon exercise of the right. Unless and until the Company obtained shareholder approval, exercise of the right, together with conversion of the convertible notes, would be limited to 19.9% of our outstanding common stock.

     There can be no assurance that the negotiations with FFG regarding food preparation will be successful or that the transition to a third-party’s central kitchens for food preparation will be completed.

     In conjunction with the closure of the central kitchens, the Company will reduce the operational complexity of the business and the related general and administrative expenses. In addition to the expected savings resulting from its central kitchen closures, the Company expects to reduce its overhead by eliminating approximately 15 to 17 corporate positions. The Company has begun and expects to complete these reductions by mid December. The Company’s total general and administrative staff including field level management will be reduced from 54 on August 13, 2002 to 27 by year end. We anticipate that total Company employment as a result of the restructuring and closure of the kitchens will be reduced from 526 employees on August 13, 2002 to 272 by year end. The savings from the recent work force reduction may not be realized until the first quarter of 2002.

     Due to the Company’s decision to move its food preparation to FFG, the Company is reevaluating its grocery business and has withdrawn from the test with Albertson’s.

RESULTS OF OPERATIONS 13-WEEK PERIOD ENDED SEPTEMBER 29, 2002 COMPARED WITH 13-WEEK PERIOD ENDED SEPTEMBER 30, 2001

Sales

     Total sales decreased by $0.17 million, or 2.1%, from $7.94 million to $7.77 million.

     Retail sales increased by $0.04 million, or 0.7%, from $5.64 million to $5.68 million. This increase was due to the opening of five additional cafés during the fiscal year 2001 and five cafés opening in the first half of 2002, offset by the closure of two cafés in 2002. Same-store sales decreased by $0.67 million, or 12.5%, from $5.36 million to $4.69 million. Same-store sales consist only of sales from cafés, and do not include Branded Sales. The decrease in same-store sales was primarily due to the decrease in occupancy rates of many of the buildings in which the Company is located.

     Branded sales decreased by $0.21 million, or 9.1%, from $2.30 million to $2.09 million. This decrease was primarily due to a decrease in Tully’s and QFC’s sales.

Operating expenses

     Operating expenses consist of costs of food and packaging, occupancy, labor, depreciation and amortization, other operating expenses, general and administrative and provision for asset impairment and store closure. Total operating expenses increased by $2.53 million, or 25.6%, from $9.89 million to $12.42 million. As a percentage of sales, our operating expenses increased from 124.5% to 159.8%. The increase in operating expense as a percentage of sales was primarily due to the costs related to occupancy expenses for new retail locations and decreased sales.

     Cost of food and packaging decreased by $0.10 million, or 3.4%, from $3.10 million to $3.00 million due primarily to lower sales volume. Cost of food and packaging decreased as a percentage of sales from 39.0% to 38.5%.

     Cost of food and packaging for retail sales decreased by $0.01 million, or 0.4%, from $2.05 million to $2.04 million. This decrease was due primarily to lower sales volume. Cost of food and packaging for branded sales decreased by $0.07 million, or 7.2%, from $0.93 million to $0.86 million. The decrease for branded sales was due to the lower sales volumes. Unallocated cost of food and packaging for kitchens decreased by $0.03 million, or 23.7%, from $0.12 million to $0.09 million. This decrease was due to implementing a series of changes in the management and operations of our central kitchens to reduce our operating costs, particularly with respect to unit labor costs.

     Occupancy expense consists of costs related to the leasing of retail space for our cafés and our central kitchens. Occupancy expense increased by $0.13 million, or 13.3%, from $0.99 million to $1.12 million. This increase was due to the

13

Table of Contents

opening of five additional cafés during the fiscal year 2001 and five cafés in the first half of 2002, offset by the closure of two cafés in 2002. As a percentage of sales, occupancy expenses increased from 12.5% to 14.4%, primarily due to decreased sales. Our rents are fixed or variable determined as a percentage of sales, or a combination of both.

     Labor expenses consist of wages and salaries paid to employees. Labor expenses decreased by $0.03 million, or 1.2%, from $2.84 million to $2.81 million. This decrease was due to the reduction in workforce in the third quarter of 2002. As a percentage of sales, labor expenses increased from 35.8% to 36.1%. This increase was primarily due to decreased sales. Labor expenses are expected to decrease following the closure of the kitchens.

     Depreciation and amortization relates to leasehold improvements, equipment and vehicles. Depreciation and amortization expense increased by $0.31 million, or 48.4%, from $0.64 million to $0.95 million, primarily as a result of opening new cafés. As a percentage of sales, depreciation and amortization increased from 8.1% to 12.3%. This increase was primarily due to decreased sales.

     Other operating expenses consist of direct operating, marketing, repair and maintenance expense. Other operating expenses increased by $0.07 million, or 13.2%, from $0.51 million to $0.58 million, primarily as a result of opening new cafés. As a percentage of sales, other operating expenses increased from 6.4% to 7.4%. This increase was primarily due to decreased sales.

     General and administrative expenses relate to the support functions performed by our corporate office, such as finance, human resources, marketing, food development and information systems. This expense primarily consists of salaries of our corporate executives, senior management and staff, and our corporate office lease and related office expenses. General and administrative expenses remained the same at $1.81 million. As a percentage of sales, general and administrative expenses increased from 22.8% to 23.2%, primarily due to decreased sales. General and administrative expenses are to decrease beginning in 2003 following the 2002 fourth quarter personnel reductions.

     Provision for asset impairment and store closure relates to the write-down of leasehold improvements at some café locations. Provision for asset impairment and store closure increased by $2.17 million in the thirteen weeks ended September 29, 2002, due to the closure of the E-Port store located in Chicago in the third quarter of 2002 and a write down of fixed assets. We performed an impairment analysis of our café locations by comparing the carrying amount of the long-term assets to their associated undiscounted cash flow. Because the carrying amount exceeded the associated undiscounted cash flow we recorded an impairment charge. No other store closures are planned in fiscal 2002.

Other (Expense) Income

     Other (expense) income includes interest and other expense and interest and other income. Other (expense) income decreased by $0.20 million, or 230.2%, from $.09 million to ($.11) million. This decrease was due to the interest expense associated with the new note payable obtained in the second quarter of 2002 and lower interest income in 2002 resulting from lower cash and cash equivalents. As a percentage of sales, other (expense) income increased from 1.1% to (1.4%) due to the new note payable.

Net Loss

     Net loss increased by $2.90 million, or 155.7%, from $1.86 million to $4.76 million. This increase was primarily due to decreased same-store and branded sales and increased occupancy expense, depreciation and amortization, and the asset impairment of $2.11 million. As a percentage of sales, net loss increased from 23.4% to 61.3%. The Company recognized no tax benefit from its losses in 2002 and 2001.

     EBITDA represents earnings before interest income and expense, income taxes and depreciation and amortization. EBITDA for the 13-week periods ended September 29, 2002 and September 30, 2001 was ($3.70) million and ($1.30) million, respectively.

RESULTS OF OPERATIONS 39-WEEK PERIOD ENDED SEPTEMBER 29, 2002 COMPARED WITH 39-WEEK PERIOD ENDED SEPTEMBER 30, 2001

14

Table of Contents

Sales

     Total sales decreased by $1.28 million, or 5.2%, from $24.60 million to $23.32 million.

     Retail sales decreased by $0.36 million, or 2.0%, from $17.43 million to $17.07 million. This decrease was primarily due to reduced same store sales which more than offset the sales from cafés opened in 2001 and 2002. Same-store sales decreased by $2.13 million, or 12.6%, from $16.93 million to $14.80 million. Same-store sales consist only of sales from cafés, and do not include Branded sales. The decrease in same-store sales was primarily due to the decrease in occupancy rates of many of the buildings in which we are located.

     Branded sales decreased by $0.92 million, or 12.9%, from $7.17 million to $6.25 million. This decrease was primarily due to a decrease in Tully’s and QFC’s sales and the discontinuation of sales to Kozmo.com. Sales to Kozmo.com were eliminated due to discontinuance of that company.

Operating expenses

     Operating expenses consist of cost of food and packaging, occupancy, labor, depreciation and amortization, other operating, general and administrative and provision for asset impairment and store closure. Total operating expenses increased by $3.59 million, or 12.4%, from $29.00 million to $32.59 million. As a percentage of sales, our operating expenses increased from 117.9% to 139.7%. The increase in operating expense as a percentage of sales was primarily due to the costs related to being a public company, occupancy expenses for new retail locations , decreased sales, and the asset impairment.

     Cost of food and packaging decreased by $0.66 million, or 6.9%, from $9.47 million to $8.81 million due to lower sales volume. Cost of food and packaging decreased as a percentage of sales from 38.5% to 37.8%.

     Cost of food and packaging for retail sales decreased by $0.10 million, or 1.6%, from $6.27 million to $6.17 million. Cost of food and packaging for branded sales decreased by $0.46 million, or 15.8%, from $2.92 million to $2.46 million. The decrease for both retail sales and branded sales was due to the lower sales volumes. Unallocated cost of food and packaging for kitchens decreased by $0.09 million, or 33.0%, from $0.28 million to $0.19 million. This decrease was due to implementing a series of changes in the management and operations of our central kitchens to reduce our operating costs, particularly with respect to unit labor costs.

     Occupancy expense consists of costs related to the leasing of retail space for our cafés and our central kitchens. Occupancy expense increased by $0.29 million, or 10.3%, from $2.86 million to $3.15 million. This increase was due to the opening of five additional cafés during the fiscal year 2001 and five cafés in the first half of 2002, offset by the closure of two cafés in 2002. As a percentage of sales, occupancy expense increased from 11.6% to 13.5%, primarily due to decreased sales. Our rents are fixed or variable determined as a percentage of sales, or a combination of both.

     Labor expenses consist of wages and salaries paid to employees. Labor expenses remained the same at $8.43 million. This stayed constant despite the opening of five additional cafés during the fiscal year 2001 and five cafés in the first half of 2002, offset by the closure of two cafés in 2002 because of a workforce reduction in the fourth quarter of 2001 and the third quarter of 2002. As a percentage of sales, labor expenses increased from 34.3% to 36.1%. This increase was primarily due to decreased sales.

     Depreciation and amortization relates to leasehold improvements, equipment and vehicles. Depreciation and amortization expense increased by $0.74 million, or 38.6%, from $1.89 million to $2.63 million, primarily as a result of opening new cafés. As a percentage of sales, depreciation and amortization increased from 7.7% to 11.3%. This increase was primarily due to decreased sales.

     Other operating expenses consist of direct operating, marketing, repair and maintenance expense. Other operating expenses increased by $0.34 million, or 22.7%, from $1.49 million to $1.83 million, primarily as a result of opening new cafés. As a percentage of sales, other operating expenses increased from 6.1% to 7.9%. This increase was primarily due to decreased sales.

     General and administrative expenses relate to the support functions performed by our corporate office, such as finance, human resources, marketing, food development and information systems. This expense primarily consists of salaries of our corporate executives, senior management and staff, and our corporate office lease and related office expenses. General and

15

Table of Contents

administrative expenses increased by $0.70 million, or 14.4%, from $4.85 million to $5.55 million. The increase was primarily due to expenses relating to being a public company such as additional legal and accounting expenses. As a percentage of sales, general and administrative expenses increased from 19.7% to 23.8%, primarily due to decreased sales.

     Provision for asset impairment and store closure relates to the write-down of leasehold improvements at some café locations. Provision for asset impairment and store closure increased by $2.19 million in the thirty-nine weeks ended September 29, 2002, due to the closure of the Westin café located in Seattle in the first quarter of 2002, the closure of the E-Port store located in Chicago in the third quarter of 2002 and a write down of fixed assets. We performed an impairment analysis of our café locations by comparing the carrying amount of the long-term assets to their associated undiscounted cash flows. Because the carrying amount exceeded the associated undiscounted cash flows we recorded an impairment charge. No other store closures are planned in fiscal 2002.

Other (Expense) Income

     Other (expense) income includes interest and other expense and interest and other income. Other (expense) income decreased by $0.39 million, or 218.3%, from $0.18 million to ($0.21) million. This decrease was due to the interest expense associated with the new note payable obtained in the second quarter of 2002 and lower interest income in 2002 resulting from lower cash and cash equivalents. As a percentage of sales, other (expense) income increased from 0.7% to (0.9%).

Net Loss

     Net loss increased by $5.24 million, or 124.2%, from $4.23 million to $9.47 million. This increase was primarily due to decreased sales and increased occupancy, general and administrative expenses, and the asset impairment of $2.11 million. As a percentage of sales, net loss increased from 17.2% to 40.6%. The Company recognized no tax benefit from its losses in 2002 and 2001.

     EBITDA for the 39-week periods ended September 29, 2002 and September 30, 2001 was ($6.64) million and ($2.51) million, respectively.

LIQUIDITY AND CAPITAL RESOURCES

     Net cash used in operating activities during the 39 weeks ending September 29, 2002 and September 30, 2001 was $4.53 million and $4.43 million, respectively. Net cash used in operating activities resulted primarily from net loss before non-cash charges.

     Net cash used in investing activities for the 39 weeks ending September 29, 2002 and September 30, 2001 was approximately $2.24 million and $1.90 million, respectively. Net cash used in investing activities resulted from capital additions primarily related to cafés opened in 2001 and 2002. During the 39 weeks ended September 29, 2002 we opened five additional cafés.

     Net cash provided by financing activities for the 39 weeks ending September 29, 2002 was approximately $1.34 million. The financing activities consisted primarily of cash received from the net proceeds of $1.61 million in debt financing ($1.25 million from Laurus and $0.36 million from revolving line of credit), and a $0.07 million decrease in the book overdraft. Net cash provided by financing activities for the 39 week ending September 30, 2001 was $15.20 million. Net cash provided by financing activities in the first three quarters of 2001 resulted primarily from the issuance of capital stock, which was partially offset by financing costs, the repayment of the line of credit of $2.0 million in May 2001 and scheduled principal repayments primarily relating to delivery vehicle financing. In January and February 2001, net cash provided from the issuance of additional shares of Series C preferred stock was $3.0 million. In May 2001, net cash provided from our initial public offering was approximately $13.7 million.

     We have lease obligations in 2002 of $2.9 million which are due primarily to operating leases on our facilities, of which $2.2 million has been paid. Capital vehicle leases make up $0.1 million of our total 2002 lease obligation. A small portion of our 2002 lease obligation is for office equipment. The increase in rental expense in future years is not material. The lease obligation amount will increase with the addition of each new café.

16

Table of Contents

     At December 30, 2001, we had the contractual cash obligations as set forth in the table below. The $1.25 million convertible debt and the $0.36 million in additional financing is not included in the table. For a description of the $1.25 million and $0.36 financings, see below: