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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(MARK ONE)

OR

COMMISSION FILE NUMBER 000-32527

BRIAZZ, INC.

3901 7TH AVENUE SOUTH, SUITE 200
SEATTLE, WASHINGTON 98108-5206
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

(206) 467-0994
(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   o

The number of outstanding shares of common stock, no par value, of the Registrant at August 1, 2003 was 5,990,916.

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

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BRIAZZ, INC.

INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 29, 2003

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BRIAZZ, INC.
BALANCE SHEETS
(in thousands, except share data)
(unaudited)

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

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BRIAZZ, INC.
STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)

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

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BRIAZZ, INC.
Statement of Stockholders’ Equity (Deficit)
(in thousands)
(unaudited)

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

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BRIAZZ, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

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

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BRIAZZ, INC.
NOTES TO FINANCIAL STATEMENTS
(unaudited)

Note 1. Summary of operations and significant accounting policies

Operations – BRIAZZ, INC. (“BRIAZZ” or the “Company”) 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 its current markets and as funding becomes available, 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 and catered platter delivery. The Company also distributes its products through select wholesale accounts. Each market obtains products from a central kitchen, which prepares meals daily. Until December 2002 the Company operated a central kitchen in each market. The Company’s Chicago and Los Angeles central kitchens were closed in late 2002 and the Seattle central kitchen was closed in February 2003. It is expected the San Francisco central kitchen will also close. Upon closure of the central kitchens, the Company has contracted for the production of its products.

At June 29, 2003, the Company operated 12 cafés in Seattle, 14 cafés in San Francisco, 8 cafés in Chicago and 9 cafés in Los Angeles. In July, the company closed a café in San Francisco.

Interim financial information – The financial information at June 29, 2003, and for the 13 and 26-week periods ended June 29, 2003 and June 30, 2002 is unaudited, but includes all adjustments, consisting only of 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 periods ended June 29, 2003 are not necessarily indicative of results to be expected for the entire fiscal year or future periods.

Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Impairment of long-lived assets – The Company reviews its long-lived assets for impairment, whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. When such an event occurs, management determines whether there has been an impairment by comparing projected undiscounted net cash flows at the lowest level for which there are identifiable cash flows, which is at the store level, to the related asset’s carrying value. If an asset is considered impaired, the asset is written down to estimated fair value, which is determined based either on discounted projected cash flows or appraised values, depending on the nature of the asset. During the fiscal quarter ended June 29, 2003, the Company recorded an impairment write-down of approximately $1.06 million related to certain café locations. These write-downs consisted primarily of leasehold improvements and, to a lesser extent, equipment.

Accounts Payable – The Company’s banking system provides for the daily replenishment of disbursement bank accounts as checks are presented. Included in accounts payable at June 29, 2003 and December 29, 2002 is $319,000 and $157,000, respectively, representing the excess of outstanding checks over cash on deposit at the bank on which the checks were drawn.

Stock-based compensation – The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees” and complies with the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (“SFAS No. 123”), “Accounting for Stock-Based Compensation.” As amended by SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure.” Under APB No. 25, compensation expense is based on the difference, if any, on the date of grant, between the deemed fair value of the Company’s stock and the exercise price of the option. Unearned compensation is amortized on a straight-line basis over the vesting period of the individual options. Certain warrants owned by employees contain provisions which result in the application of variable plan accounting in accordance with the provisions of FASB Interpretation No. 44 (“FIN No. 44”). For those warrants, compensation expense is adjusted quarterly as the market price of the Company’s common stock changes at prices in excess of the exercise price.

Had the Company applied the provisions of SFAS No. 123 to all stock option grants, the Company’s net loss would have been increased to the pro forma amounts indicated below (in thousands except share and per share data):

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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, and excludes all outstanding 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):

Reclassifications – Certain components of prior year revenues and expenses have been reclassified to conform to current year classifications. The reclassifications have no effect on stockholder’s equity or net loss.

Recent accounting pronouncements – In July 2001, the Financial Accounting Standards Board (“FASB”) 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. At adoption of SFAS No. 143 the Company did not have any material asset retirement obligations.

In June 2002, the FASB 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 adoption of SFAS No 146 did not have a material impact on the Company’s results of operations, financial position or cash flows.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”), which amends and clarifies financial accounting and reporting for derivative instruments including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133. The Company does not own any derivative instruments and is not engaged in hedging activities, and does not believe the adoption of SFAS 149 will have a significant impact on its results of operations, financial position or cash flows.

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In May 2003, the FASB issued SFAS no. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”), which clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of these financial instruments were classified as equity. SFAS 150 is effective for all financial instruments entered into or modified after May 2003 and is otherwise effective at the beginning of the first interim period after June 15, 2003. The Company does not believe the adoption of SFAS 150 will have a significant impact on its results of operations, financial position or cash flows.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements of Guarantees, Including Guarantees of Indebtedness of Others – an Interpretation of FASB Statements 5, 57, and 107 and Rescission of FASB Interpretation No. 34” (“Interpretation No. 45”). This interpretation expands on the existing accounting guidance and disclosure requirements for most guarantees. The Company has not guaranteed indebtedness of others. The adoption of FIN 45 did not have a significant impact on the Company’s results of operations, financial position or cash flows.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”) “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity under certain conditions. The Company does not have any involvement in variable interest entities, and does not believe FIN 46 will have a significant impact on its results of operations, financial position or cash flows.

Note 2. Financial condition and basis of presentation

The Company has incurred substantial operating losses and negative cash flows from operations since inception and had an accumulated deficit of $76.4 million and a working capital deficit of $8.9 million at June 29, 2003. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The Company has financed its operations principally through the net proceeds from debt and equity offerings. The Company’s ability to continue as a going concern is dependant upon numerous factors, including its ability to obtain additional financing, its ability to increase its level of future revenues and its ability to reduce operating expenses. The accompanying financial statements have been prepared on the basis that the Company 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.

At June 29, 2003, the Company had cash and cash equivalents of approximately $0.5 million. As described in Note 8, subsequent to June 29, 2003, the Company has raised additional cash from the sale of its debt and equity securities, substantially all of which has been or will be used to repay existing indebtedness and accounts payable. The Company has used a combination of cash and cash equivalents, operating revenues and proceeds of additional borrowings to meet its immediate cash needs; however, it is anticipated that additional cash may be needed by the end of 2003 in order to continue operating. The Company is attempting to conserve cash by reducing expenses and by delaying or deferring payments to some of the Company’s suppliers and on some of the Company’s leases. Poor financial results, inability to comply with the terms of borrowings, unanticipated expenses or unanticipated opportunities that require financial commitments could give rise to additional financing requirements sooner than expected. The Company will need to raise additional cash to finance its operations, as well as to enhance operations, fund any expansion, respond to competitive pressures and repay borrowings when they become due. If the Company raises additional funds through the issuance of equity or convertible debt securities, the percentage ownership of existing shareholders would be reduced, and these securities may have rights, preferences or privileges senior to those of the Company’s common stock. There can be no assurance that the Company will be able to obtain additional financing at terms favorable to the Company, or at all, reduce expenses or successfully complete other steps to continue as a going concern. If the Company is unable to obtain sufficient funds to satisfy its cash requirements within the required timeframe on acceptable terms, the Company may be forced to curtail operations, dispose of assets, or seek extended payment terms. Such events would materially and adversely affect the Company’s financial position and results of operations. In the event that such steps are not sufficient, or that Company directors and management believe that such actions will not be sufficient, the Company may be required to discontinue its operations

Note 3. Notes payable and other borrowings

In June 2002, the Company entered into a Securities Purchase Agreement with Laurus Master Fund, Ltd. (“Laurus”) in connection with the issuance of a $1.25 million 14% convertible note (the “14% convertible note”) to Laurus and a warrant to purchase 250,000 shares of common stock. The 14% convertible note is collateralized by all of the Company’s assets. During the twenty-six weeks ended June 29, 2003, convertible notes of approximately $8,000 were converted into 40,200 shares of company stock. During the fiscal quarter ended March 30, 2003, the 14% convertible note was amended to among other things, change the fixed conversion price to $0.10 per share and defer principal payments, under certain conditions, to July 2003.

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Additionally, in March 2003, terms of the 250,000 warrants issued in June 2002 were amended to, among other things, change the exercise price to $0.10 per share and suspend the right of Laurus to exercise the warrant until the earlier of June 30, 2003 or the closing on an investment by Deutsche Bank or any of its affiliates. As a result of the amended conversion price for the notes and exercise price for the warrants being less than the market price of the common stock on the amendment date, the Company recorded the related beneficial conversion features estimated fair value of $107,000 as original issue discount and an increase in common stock and additional paid-in capital during the fiscal quarter ended March 30, 2003. As described in Note 8, the terms of the 14% convertible note were further amended in connection with a financing completed in August 2003.

In March 2003, the Company issued $2 million of promissory notes, 100 shares of series D convertible preferred stock (“Series D Preferred Stock”), and warrants to purchase 1,193,546 shares of the Company’s common stock at a price per share of $0.50 to Briazz Venture L.L.C. (“BV”) an affiliate of Flying Food Group, L.L.C. (“FFG”), in consideration for approximately $550,000 cash and conversion of $1.45 million of outstanding demand notes. Proceeds from the sale of these securities were used for working capital. The Company recorded a debt discount of approximately $21,000 relating to the issuance of warrants. All Company assets are pledged as collateral for the notes. The notes bear interest at 10% per year, payable monthly, and are due March 6, 2004, subject to earlier maturity under certain conditions. Terms of the notes include certain covenants, including, among others, restrictions on the payment of dividends, limitation on additional indebtedness, and compliance with financial covenants, including minimum future EBITDA and maximum accounts payable. The warrants are immediately exercisable and have a five year term, subject to shareholder approval of conversion of Series D Preferred Stock into common stock at which time the warrants are cancelled. Subject to shareholder approval, Series D Preferred Stock would be convertible, for a term of five years, at the option of the holder, into approximately 66.7% of the Company’s outstanding common stock on a fully-diluted post-conversion basis, such percentage being adjustable under certain conditions. Upon the occurrence of any event of default under this note, the amount due and owing under the note shall be increased to 130% of the then outstanding aggregate principal amount of the note together with any accrued and unpaid interest and fees. While any event of default is continuing, a default rate of 14% will apply and BV may declare all amounts owing under the note immediately due and payable.

In April 2003, the Company issued a $550,000 secured promissory note, 25 shares of series E convertible preferred stock (“Series E Preferred Stock”), and warrants to purchase 1,193,546 shares of the Company’s common stock at a price per share of $0.50 to Spinnaker Investment Partners, L.P. (“Spinnaker”), a fund managed by Spinnaker Capital Partners, LLC (“Spinnaker Capital”), in consideration for $550,000 cash. One of the Company’s directors is a director of Spinnaker Capital. The terms of the note, warrant and Series E Preferred Stock are substantially similar to the terms of the note, warrant and Series D Preferred Stock issued to BV in March 2003. Proceeds of the financing were used for working capital, after deduction of expenses and a $50,000 fee paid to Spinnaker Capital. In connection with the financing, Spinnaker, Laurus and FFG and its affiliates, including BV, entered into an inter-creditor agreement in which they agreed that their respective security interests in the Company’s assets would rank equally in priority.

If shareholders approved the conversion of Series D and Series E Preferred Stock, the Series E Preferred Stock would be convertible at the option of the holder, for an aggregate conversion price of up to $500,000 for a period of five years, into approximately one quarter (1/4) of the number of shares of common stock into which the Series D Preferred Stock is convertible. The number of shares of common stock into which Series E Preferred Stock may be converted and the conversion price per share of common stock would initially be fixed on the date that the Series E Preferred Stock first becomes convertible. If the Company’s shareholders approved the conversion of preferred stock, then based upon outstanding securities as of April 10, 2003, assuming that the Company did not issue, cancel or modify any of its securities prior to the date of shareholder approval and assuming that BV and Spinnaker did not exercise their warrants prior to the date of shareholder approval, the Series D Preferred Stock would initially have been convertible into a total of approximately 33.2 million shares of common stock at a conversion price of approximately $0.06 per share of common stock, and the Series E Preferred Stock would initially have been convertible into a total of approximately 8.3 million shares of common stock at a conversion price of approximately $0.06 per share. The exact number of shares of common stock that would have been issued on conversion of the Series D and Series E Preferred Stock and the exact conversion price of the Series D and Series E Preferred Stock could not be determined until the date shareholder approval is received.

As described in Note 8, in July 2003 the Company obtained shareholder approval of the conversion of Series D and Series E Preferred Stock, which caused the preferred stock to become convertible and the warrants to terminate; in August 2003, the Company completed a financing in which the promissory notes and Series D and Series E Preferred Stock issued to BV and Spinnaker were cancelled in exchange for new promissory notes and series F convertible preferred stock. No shares of Series D or Series E Preferred Stock were converted prior to such time.

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Note 4. Stock Options

The Company maintains the BRIAZZ 1996 Stock Option Plan (the “Plan”) to provide for granting of incentive stock options and nonqualified stock options to employees, directors, consultants and certain other non-employees as determined by the Plan Administrator. The Company has authorized 1,165,000 shares of common stock for issuance under the Plan. The date of grant, option price, vesting period and other terms specific to options granted under the Plan are determined by the Plan Administrator. Options granted under the Plan generally expire ten years from date of grant and vest over periods ranging from date of grant to five years. In March 2003, the Company Board of Directors accelerated vesting on stock options such that all outstanding options became fully vested. The following summarizes stock option activity from December 29, 2002 to June 29, 2003 (shares in thousands, except exercise price):

Prior to 2002, the Company granted stock options to employees (which vested over four years) and directors at exercise prices deemed to be below the fair value of the underlying stock on the date of grant. Related deferred stock compensation is being amortized generally over a four-year vesting period. As a result of these grants and acceleration of vesting in March 2003, the Company recorded deferred stock compensation of approximately $203,000 and $174,000 in twenty-six week periods ended June 29, 2003 and June 30, 2002, respectively.

As disclosed in Note 8, the Company adopted a new stock incentive plan in the third quarter of 2003.

Note 5. Segment information

The Company manages 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 which 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 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). Information regarding the Company’s assets is not disaggregated by segment or otherwise. The following table presents certain financial information for each segment (amounts in thousands):

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