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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

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

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

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BRIAZZ, INC.

INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 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 September 28, 2003, the Company operated a total of 41 cafés in Seattle (12), San Francisco (13), Chicago (8) and Los Angeles (8). The five-café decrease since year-end resulted from closures of under-performing locations, two in San Francisco, one in Chicago and two in Los Angeles. The Company closed one in the first quarter, two in the second quarter and two in the third quarter of 2003. The Company expects to close one additional café in Seattle before the end of 2003.

Interim financial information – The financial information at September 28, 2003, and for the 13 and 39-week periods ended September 28, 2003 and September 29, 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 September 28, 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 year-to-date period ended September 28, 2003, the Company recorded an impairment write-down of approximately $1.2 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 December 29, 2002 is $157,000 representing the excess of outstanding checks over cash on deposit at the bank on which the checks were drawn. There were no such amounts at September 28, 2003.

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.

Because the determination of the fair value of the Company’s options is based on assumptions such as interest rates, volatility,

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life, and dividend yield, because additional option grants will likely be made in future periods, and due to the full acceleration of vesting for outstanding options in March of 2003, this pro forma information is not likely to be representative of the pro forma effects on reported net income or loss for future periods. Had the Company applied the provisions of SFAS No. 123 to all stock option grants, the Company’s net loss would have been as indicated below (in thousands except share and per share data):

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 (deficit) 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. The adoption of SFAS No. 143 did not have a significant effect on the Company’s results of operations, financial position or cash flows.

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 significant impact on the Company’s results of operations, financial position or cash flows.

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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” (“FIN 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 “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” (“FIN 46”). 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. The adoption of FIN 46 did not have a significant 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 No. 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 No. 133. The Company does not own any derivative instruments and is not engaged in hedging activities. The adoption of SFAS No. 149 did not have a significant impact on its results of operations, financial position or cash flows.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 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 No. 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 adoption of SFAS No. 150 did not 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 $79.8 million and a working capital deficit of $4.1 million at September 28, 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 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 September 28, 2003, the Company had cash and cash equivalents of approximately $0.8 million. The Company has used a combination of cash and cash equivalents, operating revenues and proceeds of borrowings to meet its immediate cash needs; however, it is anticipated that additional cash will 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

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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. In January 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. 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. In July 2003, the terms of the note were further amended to provide that, upon completion of a financing agreement with Deutsche Bank London Ag (“DB”), an affiliate of Deutsche Bank, the Company would make a $300,000 principal payment, and pay the remaining principal amount and accrued interest, plus a $75,000 fee relating to the $300,000 prepayment, in 12 equal installments beginning in September 2003. In August 2003, the DB financing was completed and the Company made the $300,000 payment. On October 1, 2003, the Company was in arrears on its interest and principal payments to Laurus. Subsequently, in October 2003 the Company received a waiver from Laurus in which Laurus agreed to waive any defaults resulting from the late payment of the monthly amount due October 1, 2003. In addition, Laurus agreed to postpone all payments that would have become due and payable under the note between October 1, 2003 and November 15, 2003 to November 16, 2003 and waived any defaults and penalties resulting from such postponement of payments.

In March 2003, the Company completed the offer and sale of $2.0 million in secured promissory notes, Series D Convertible Preferred Stock (“Series D Preferred Stock”) and warrants to purchase common stock to Briazz Venture, L.L.C. (“BV”) pursuant to which the Company issued a $2.0 million secured promissory note in consideration for approximately $0.55 million in cash and conversion of the $1.45 million principal amount of outstanding demand notes issued to Flying Food Group L.L.C. (“FFG”) and its affiliates, $450,000 of which was borrowed by the Company during January and February 2003. Proceeds from the offering were used for working capital. The Company also issued a five-year warrant exercisable for 1,193,546 shares of its common stock at a price per share of $0.50, and 100 shares of Series D Preferred Stock, and granted registration rights covering the shares of common stock issuable upon conversion of the preferred stock and exercise of the warrant. The Company agreed to cause up to one person designated by FFG to be appointed to the Company’s Board of Directors, subject to increase upon receiving shareholder approval. The Company agreed that, if the Company received shareholder approval, the Company would cause up to five persons designated by BV to be appointed to its Board of Directors, in accordance with the rules and regulations of Nasdaq or any exchange on which the Company’s common stock is listed. The promissory note was secured by all of the Company’s assets and bore interest at 10% per year. Interest was payable monthly in arrears, in cash. The note was to mature, and all principal and accrued and unpaid interest was to become due, on March 6, 2004. The terms of the notes included 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.

In April 2003, the Company completed the offer and sale of $550,000 in secured promissory notes, Series E Convertible Preferred Stock (“Series E Preferred Stock”) and warrants to purchase common stock to Spinnaker Investment Partners L.P. (“Spinnaker”). In consideration for $550,000 in cash, Spinnaker was issued a $550,000 secured promissory note, a five-year warrant exercisable for 1,193,546 shares of the Company’s common stock at a price per share of $0.50, and 25 shares of Series E Preferred Stock. The terms of the note, warrant and Series E Preferred Stock were substantially similar to the terms of the note, warrant and Series D Preferred Stock issued to BV in March 2003. The Company also agreed to cause up to one person designated by Spinnaker to be appointed to the Company’s Board of Directors. Proceeds of the financing were used for working capital, after deduction of expenses and a $50,000 management fee payable to Spinnaker Capital Partners, L.L.C. In connection with the financing, Spinnaker, Laurus, BV and FFG, 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.

On May 28, 2003, the Company entered into an agreement with DB, BV, Spinnaker (collectively, the “Investors”), and Delafield Hambrecht, Inc. (“Delafield”) providing for the issuance of an aggregate of $6.0 million of senior secured non-convertible promissory notes (“Senior Notes”) and shares of Series F Convertible Preferred Stock (“Series F Preferred Stock”) to the Investors.

On July 29, 2003, the Company’s shareholders approved both the conversion of the Series D and Series E Preferred Stock held by BV and Spinnaker and the proposed financing with the Investors. As a result of this approval, the Series D and Series E Preferred Stock became convertible into shares of the Company’s common stock and the warrants issued to BV and Spinnaker were terminated.

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On August 1, 2003, the Company issued $6.0 million of Senior Notes to DB ($3.4 million), BV ($2.0 million), Spinnaker ($.5 million), and Delafield ($0.1 million). The Senior Notes are due two years from issuance, bear interest, payable quarterly, at LIBOR plus 1%, and are collateralized by a security interest in all of the Company’s assets pursuant to an inter-creditor agreement among note holders and Laurus. The Senior Notes are not convertible, but the conversion price of the Series F Preferred Stock may be satisfied by the holder surrendering a portion of the notes for cancellation. The Company issued to the Investors and Delafield an aggregate of 7,643,841 shares of Series F Preferred Stock that are initially convertible into 76,438,410 shares of common stock at an initial conversion price $0.10 per share of common stock. In the event that the fair market price of the common stock exceeds the conversion price, the Series F Preferred Stock may also be converted pursuant to a cashless exercise feature. The Company also granted registration rights covering the shares of common stock issuable upon conversion of the Series F Preferred Stock, the right to name new executive officers to be appointed by the Company, and the right to designate up to five of the Company’s directors to DB (2), BV (2) and Spinnaker (1).

The Company recorded a debt discount of approximately $1.5 million relating to the issuance of the Series F Preferred Stock, such value being determined by independent appraisers. The market price of the Company’s common stock exceeded the conversion price of the Series F Preferred Stock on the date of issuance. As a result, the Company also recorded a beneficial conversion feature in accordance with EITF 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features of Contingently Adjustable Conversion Ratios” upon issuance of the Series F Preferred Stock at its estimated fair value of $1.5 million. The beneficial conversion feature is analogous to a non-cash dividend and was immediately recognized as a return to the preferred shareholders. This beneficial conversion feature increased the net loss to common shareholders.

The securities issued to DB, BV, and Spinnaker were issued in consideration of (i) $3.4 million of cash from DB, (ii) cancellation of the Series D Preferred Stock and $2 million of the note held by BV, and (iii) cancellation of the Series E Preferred Stock and $0.55 million of the note held by Spinnaker, respectively. The Company issued the securities to Delafield, made a cash payment to Delafield of $100,000 at closing, and in October paid Delafield an additional $100,000 in full satisfaction of a change of control fee previously owed by the Company to Delafield. The Company used a portion of the $3.4 million of new funds raised to repay certain existing indebtedness, including $300,000 of the amounts due to Laurus pursuant to 14% convertible note, the aforementioned payments of $200,000 to Delafield, $530,000 of professional fees, including fees related to the transaction, and payment of $1.0 million owed to FFG pursuant to the food production agreement.

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 September 28, 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 was amortized generally over the four-year vesting period, until March 2003, when the Company accelerated the vesting of these stock options and the remaining deferred stock compensation was recognized. As a result of these grants and acceleration of vesting in March 2003, the Company recorded deferred stock compensation of approximately $203,000 and $261,000 in the thirty-nine week periods ended September 28, 2003 and September 29, 2002, respectively.

In July 2003, the Company’s Articles of Incorporation were amended to increase the authorized shares of common stock to 250 million shares, a new stock incentive plan was adopted that authorizes the issuance of 12 million shares of common stock upon exercise of stock options or upon the grant of restricted stock, and the Company agreed to issue to certain new and existing members of Company management shares of Series F Preferred Stock convertible into approximately 5.3 million shares of

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Company common stock and stock options exercisable for approximately 5.4 million shares of Company common stock. As of November 1, 2003, none of these options or Series F Preferred Stock had been issued.

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, and catering and 2) wholesale. 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. 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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