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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[ ] FOR THE FISCAL YEAR ENDED DECEMBER 27, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______.
COMMISSION FILE NUMBER 0-20792
FRESH CHOICE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0130849
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2901 TASMAN DRIVE - SUITE 109, SANTA CLARA, CA 95054-1169
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 986-8661
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definite proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
Approximate aggregate market value of the registrant's Common Stock held by
nonaffiliates of the registrant (based on the closing sales price of such stock
as reported in the Nasdaq National Market) on February 26, 1999 was $5,945,000.
Excludes shares of Common Stock held by directors, officers and each person who
holds 5% or more of the outstanding Common Stock at February 26, 1999 because
such persons may be deemed to be affiliates. This exclusion is not a conclusive
determination of such status for other purposes.
Number of shares of Common Stock, $0.001 par value, outstanding as of February
26, 1999 was 5,718,847.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Reference
--------- -------------------
(1) Proxy Statement for the Annual Meeting Part III
of Stockholders scheduled for May 20, 1999
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FRESH CHOICE, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
No.
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PART I ............................................................... 3
Item 1. BUSINESS ..................................................... 3
Item 2. PROPERTIES ................................................... 14
Item 3. LEGAL PROCEEDINGS ............................................ 15
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .......... 15
PART II .............................................................. 15
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS .......................................... 15
Item 6. SELECTED FINANCIAL DATA ...................................... 16
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .......................... 16
Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .. 27
Item 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .................. 27
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .......................... 28
PART III ............................................................. 28
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT .......... 28
Item 11. EXECUTIVE COMPENSATION 28
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT 28
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 28
PART IV .............................................................. 29
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K ................................................. 29
SIGNATURES ........................................................... 51
INDEX TO FORM 10-K EXHIBITS .......................................... 52
FORM 10-K EXHIBITS
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PART I
Certain statements set forth in or incorporated by reference into this
Annual Report on Form 10-K, including anticipated store openings, planned
capital expenditures, settlement of lease obligations and trends in or
expectations regarding the Company's operations, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such statements are based on currently available operating, financial
and competitive information and are subject to various risks and uncertainties.
Actual future results and trends may differ materially depending on a variety of
factors as set forth under the heading "Business - Business Risks". In
particular, the Company's plans to open new restaurants could be affected by the
Company's ability to locate suitable restaurant sites, construct new restaurants
in a timely manner and obtain additional financing.
ITEM 1. BUSINESS.
As of February 26, 1999, the Company operated 51 restaurants in
California (40), the state of Washington (4) and Texas (7) under the names
"Fresh Choice" and "Zoopa." Fresh Choice and Zoopa restaurants feature an
extensive selection of healthy, high-quality, freshly-made specialty and
traditional salads, hot pasta, pizza, hot baked potatoes, soups, fresh breads
and muffins, frozen yogurt and other desserts, offered in a limited-service
format. The Company's goal is to create a distinctive dining experience that
combines the selection, quality and ambiance of full-service, casual restaurants
with the convenience and value appeal of traditional buffet restaurants.
The restaurants use only fresh produce and high-quality ingredients in
its menu offerings. Fresh produce is delivered a minimum of four days per week
to each restaurant, and all menu items are prepared on-site. To reinforce the
Company's commitment to freshness, many of the Company's food offerings are
prepared in exhibition-style cooking areas throughout the day. Guests make their
selections at various arcades including a salad arcade, a soup, baked potato,
hot pasta and pizza arcade, a muffin, breads and bakery goods arcade, and a
fresh fruit, frozen yogurt and specialty dessert arcade.
The Company believes that it provides its guests an excellent
price/value relationship by offering unlimited servings for a current fixed
price of $6.29 at weekday lunch, $6.99 for Saturday and Sunday lunch and $7.79
at dinner, in most locations, plus the cost of a beverage. The Company's wide
variety of high-quality food and attractive prices are designed to appeal to a
broad range of guests, including families, business professionals, students and
senior citizens. In addition, the Company believes the concept appeals to
health-conscious diners who are focused on the nutritional content of their
meals.
The Company views its commitment to its employees or crewmembers as
critical to its long-term success. The Company depends on a high rate of repeat
business, and views the quality of its crewmember interaction with guests as an
important element of its strategy. By providing extensive training and
competitive compensation, the Company seeks to foster a strong corporate culture
and encourage a sense of personal commitment from crewmembers at all levels. The
Company believes that its strong culture helps it attract and retain
highly-motivated crewmembers who provide its guests with a level of service
superior to that traditionally associated with limited-service restaurants.
The Company acquired the Zoopa trade name and three Zoopa restaurants in
fiscal 1997 and opened an additional three new Zoopa restaurants during fiscal
1997 and 1998. In addition the Company opened one new Fresh Choice restaurant in
fiscal 1998. The Company has generally attempted to cluster its restaurants in
each market area to benefit from operating and advertising efficiencies, enhance
brand-name recognition, and discourage competition.
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In December 1992, the Company completed an underwritten initial public
offering of 1,112,500 shares of its Common Stock, with net offering proceeds of
$12,719,000. Stockholders of the Company sold 612,500 shares in this offering.
In July 1993, the Company sold 850,000 shares of its Common Stock in an
underwritten public offering, with net proceeds to the Company of $19,609,000.
Stockholders of the Company sold 525,000 shares in the same offering.
In December 1995, after an analysis of the sales potential and operating
economics of every restaurant in the chain, the Company announced a $23.9
million restructuring plan. The plan called for closing as many as ten of the
Company's restaurants and for a partial write-down of assets to estimated fair
value in other restaurants. The Company closed or sold 11 restaurants under this
plan, including three restaurants in 1995 and an additional eight in 1996. As of
December 27, 1998, the Company had completed this restructuring plan.
In December 1998, the Company recorded a $3.7 million restructuring
charge for the closure of four previously impaired underperforming restaurants
and for the closure of two additional restaurants where it does not intend to
renew the leases. The charge also included the impairment of two additional
restaurants in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-lived Assets to be Disposed Of."
In September, 1996 the Company sold 1,187,906 shares of its Series B
Non-Voting Convertible Preferred Stock to Crescent Real Estate Equities Limited
Partnership ("Crescent") for $4.63 per share receiving net proceeds of
approximately $5,175,000 in a private offering. Crescent and/or its assignees
also has an option to purchase up to 593,953 shares of Series C Non-Voting
Convertible Preferred Stock at a price of $6.00 per share during a period of
three years.
The Company was incorporated in California on October 20, 1986 under the
name Gourmet California, Inc. In August 1988, the Company was recapitalized as a
result of a merger with Moffett Partners, Inc., and the survivor of the merger
was re-named Fresh Choice, Inc. Effective December 4, 1992, the Company was
reincorporated in Delaware. Unless the context otherwise requires, all
references to the "Company" or "Fresh Choice" mean Fresh Choice, Inc. and its
predecessors.
STRATEGY
The Company's objective is to create a distinctive dining experience
that combines the selection, quality and ambiance of full-service, casual dining
restaurants with the convenience and value appeal of traditional buffet
restaurants. Each element of the Company's strategy is designed to exceed
guests' expectations, encourage repeat business, and establish a significant
presence in each of its targeted markets. The key elements of the Company's
strategy include the following:
Fresh, Healthy, High-Quality Food. The Company is committed to using
only fresh produce and high-quality ingredients in its menu offerings. Fresh
produce is delivered a minimum of four days per week to each restaurant, and all
menu items are prepared on-site daily. To reinforce the Company's commitment to
freshness, many of the Company's food offerings are prepared in separate
exhibition-style cooking areas throughout the day. The Company maintains
stringent quality standards in identifying, purchasing and preparing fresh food
and ingredients.
Extensive Food Selection. The restaurant's broad selection of food
offerings is designed to appeal to a wide range of guests. Each restaurant
features a selection of specialty salads daily, prepared from recipes developed
by the Company, as well as salad ingredients and a variety of dressings that
allow guests to create their own salads. Each restaurant also offers a selection
of freshly-prepared soups,
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hot Sizzlin' Pan pasta dishes, pizza, hot breads, muffins and other bakery
goods, baked potatoes, fruits, frozen yogurt and other desserts.
Excellent Price/Value Relationship. The Company believes its pricing
strategy for unlimited servings offers an excellent price/value alternative to
other casual dining restaurants. Discounts are provided for young children and
senior citizens through the Company's Master Club(TM).
Commitment to Guest Service. The Company is committed to providing its
guests with a level of service superior to that traditionally associated with
limited-service restaurants. The Company devotes substantial attention and
resources to maintaining the cleanliness and consistent high-quality
presentation of the salad bar and other exhibition cooking areas in order to
enhance the visual appeal of the Company's offerings. Fresh Choice depends upon
a high rate of repeat business, and views the quality of its crewmember
interaction with guests as critical to its long-term success. By providing
extensive training and competitive compensation, the Company believes it fosters
a strong corporate culture and encourages a sense of personal commitment from
crewmembers at all levels.
Distinctive Design and Decor and Casual Atmosphere. The Company devotes
significant resources to the design and decor of its restaurants. The
restaurants have a flexible design which can accommodate a variety of available
sites. The Company's new restaurant design and decor incorporated into its new
restaurants and the current Fresh Choice restaurants remodel plan, uses an
interior design that is in the style of an open-air international marketplace,
like a farmer's market. The food is displayed in colorful arcades with fun and
distinctive signage segregating each arcade section.
Restaurant Locations. The Company's site selection strategy is generally
to cluster its restaurants in each of its target markets in order to realize
operating and marketing efficiencies, enhance brand-name recognition, and
discourage competition.
RESTAURANT ECONOMICS
For the 52 weeks ended December 27, 1998, the 49 restaurants open
throughout the entire period generated average net sales of approximately
$1,438,000 and average cash flow, after occupancy expenses, of approximately
$163,000 or 11.4% of net sales. During fiscal 1998, the Company opened two new
restaurants in Texas at an average cash cost of $1,140,000, not including
pre-opening expenses.
CONCEPT AND MENU
Each Fresh Choice and Zoopa restaurant features a salad bar offering
signature specialty tossed and prepared salads with an extensive choice of salad
ingredients and dressings. All specialty tossed salads and specialty prepared
salads are clearly marked, and low-fat and fat-free items are prominently
identified. Throughout the day several crewmembers maintain the salad bar and
replenish individual salads and ingredients from the opposite side of the salad
bar, minimizing interference with guests. Separate exhibition-style arcades
offer fresh soups, hot pasta dishes, pizza, baked potatoes, hot breads, muffins
and other bakery goods, fresh fruits, frozen yogurt and other desserts. During
peak hours, each guest is escorted to his or her table. Each guest may obtain
unlimited refills of all food dishes, soft drinks, lemonade, coffee and tea. The
Company is also actively improving the aesthetic appeal of its restaurants by
enhancing the merchandising of many of the fresh products used daily in the
arcades to create a more inviting, warm, and visually abundant atmosphere.
The Company has developed proprietary recipes for a broad assortment of
specialty salads, soups, pasta sauces, and muffins. In each product category,
the restaurants offer several standard dishes daily, and rotates additional
offerings to provide variety for the Company's many repeat guests. Each category
also contains daily offerings that are particularly low in fat. Because the
restaurants utilize a broad
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variety of produce and other ingredients in its dishes and is not overly
dependent on any individual recipe, it is able to substitute dishes and
ingredients in the event that weather conditions or supply factors lead to high
prices or shortages of particular produce items or other ingredients. The
Company believes that the flexibility of its menu allows it to accommodate
regional tastes.
Salads. The restaurants offer signature specialty tossed salads and
specialty prepared salads, each of which is made from recipes created by the
Company, and salads made by the guest from a broad assortment of salad
ingredients. The salad bar in each restaurant features specialty tossed salads
that are prepared exhibition-style and are rotated frequently.
Each day the salad bar features a selection of specialty prepared salads
from among the Company's more than 50 recipes. The Company's salad bar also
offers more than 40 salad ingredients and toppings, allowing guests to create
their own salad. The ingredients include various types of lettuce and a broad
assortment of vegetables, cheeses, and other toppings. The Company offers 10
dressings and a selection of gourmet oils and vinegars.
Soups. The restaurants offer a variety of soups selected daily from
among its more than 30 soup recipes. All soups are prepared on-site utilizing
fresh produce and other high-quality ingredients, and include low-fat and
non-fat selections.
Pasta. The restaurants offer Sizzlin' Pan Pasta, a line of pan-sauteed
pasta recipes prepared for guests continually throughout the day. Recipes
feature high-quality pastas, sauteed in olive oil, garlic, and white wine with
fresh herbs, vegetables, and meats. Individual pastas and sauces are still
offered on a daily basis, in addition to Sizzlin' Pan Pasta dishes.
Pizza. The restaurants offer tasty three-cheese pizza fresh from the
oven all day long. In addition vegetable or other topped pizzas may be offered.
Muffins and Breads. The restaurants offer a variety of muffins daily,
including a low-fat muffin, selected from among its more than 30 muffin recipes.
All muffins are baked in the exhibition bakery area and are replenished
frequently to ensure warmth and freshness. The restaurants also offer a variety
of freshly-baked breads, including sourdough french bread, harvest bread and
herbed bread sticks.
Desserts. The restaurants offer an assortment of desserts, including
fresh fruits, bread pudding, tapioca, chocolate pudding, frozen yogurt, fruit
cobblers, and a triple chocolate decadence brownie.
Beverages. The restaurants offer an assortment of fruit juices, fresh
lemonades and flavored iced teas. Fresh Choice also offers sodas and sparkling
waters, and in most restaurants, beer and wine. Refills of juices, lemonade,
soft drinks, coffee and tea are provided at no extra cost.
GUEST SERVICE
The Company is committed to providing a superior level of service in
order to distinguish itself from traditional limited-service restaurants. During
peak hours, guests are escorted from the salad bar to a table. Crewmembers are
in the dining area during meal hours to provide follow-on beverage service, to
clean and bus tables, and to attend to other guest needs.
The Company devotes substantial attention and resources to maintaining
the cleanliness and consistent high-quality presentation of the salad bar and
other exhibition cooking areas in order to enhance the visual appeal of the
Company's food offerings. The restaurant's crewmembers are present behind the
salad bar and in the exhibition cooking areas to replenish and replace food
offerings, to answer guest questions, and to assist guests in serving
themselves. All crewmembers in each restaurant are required to maintain a high
standard of dress and grooming.
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The Company actively solicits guest input through the use of comment
cards prominently displayed in several areas in each restaurant, and attempts to
respond in writing to all guest complaints and suggestions.
RESTAURANT DESIGN
The Company's restaurants utilize a 60-foot salad bar, with the cash
registers placed at the end of the salad bar in most of the restaurants before
the guest has access to the other food service areas. A few of the Company's
restaurants, including its new restaurants, have been designed so that the cash
registers are positioned toward the front of the restaurant to provide guests
with direct access to the various food service areas. The Company opened two new
restaurants in Texas in 1998. These restaurants incorporate an open, colorful,
fun, brighter, more inviting decor package and a more efficient layout. The new
decor has been incorporated into the Company's ongoing remodel plans.
The Company's restaurants typically range from 5,500 to 7,400 square
feet, seating from 160 to 250 guests. Many of the Company's restaurants provide
limited outdoor seating. The flexible design of the restaurants enables the
Company to take advantage of a broad range of available sites.
REMODELING
Remodeling is an integral part of the Company's strategic plan.
Restaurants typically require remodeling every five to seven years. The Company
has incorporated many of the design elements of its new Zoopa restaurants into
its remodeling plans. Eight restaurants were remodeled in 1998 at a total cost
of approximately $1,500,000. Ten to fifteen restaurants are scheduled to be
remodeled in 1999 at an expected total cost of approximately $1,100,000 to
$1,700,000. Future remodel plans will be developed based upon an evaluation of
the results of these remodels.
SITE SELECTION
To date, the Company has located its restaurants in regional malls,
strip centers and freestanding locations. The Company considers the location of
each restaurant to be critical to its long-term success, and management devotes
significant effort to the investigation and evaluation of potential sites. The
site selection process focuses on market area demographics including targets for
population, household income and education, as well as site specific
characteristics including daytime traffic volumes and patterns, visibility,
accessibility and availability of adequate parking. The Company also reviews
potential competition and guest activity at other restaurants operating in the
area. The Company believes that its flexibility in utilizing its different
restaurant layouts gives it a competitive advantage in selecting sites. The
Company requires approximately six to twelve months after identifying a site to
complete negotiation of a lease and construct and open a new restaurant. While
the Company currently leases most of its restaurant sites and expects to lease
virtually all of its sites in the future, it may purchase one or more sites for
construction of new restaurants if available on acceptable financial terms.
Currently, the Company owns land and buildings at two of its restaurant sites
and owns buildings on leased land at seven others.
EXPANSION STRATEGY
The Company opened two new restaurants in 1998 in Houston and Fort
Worth, Texas and has put further plans for restaurant expansion on hold until
financial performance improves. However, the Company plans to test a new Fresh
Choice Express unit designed for office buildings and other high
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traffic captive locations utilizing our local restaurants for much of the prep
work, thus keeping capital and operating costs down. Further expansion of the
Fresh Choice Express concept will be based upon an evaluation of the results of
this test. In addition, the Company frequently reviews the operating performance
and profitability of its restaurants, and, to the extent they do not meet
expectations for operating performance, restaurants will be evaluated for
possible closure.
By clustering restaurants, the Company seeks to benefit from advertising
and operating efficiencies. In addition, clustering allows the Company to
capture more of the available guest base and to discourage competition. To the
extent that the Company continues to open new restaurants in clusters outside of
its existing Northern California markets, the Company expects that these
restaurants may benefit from certain volume purchasing discounts and operating
efficiencies generally applicable to its Northern California restaurants.
The Company currently operates all of its existing restaurants, and has
no plans to offer franchises or to begin purchasing rather than leasing its
restaurant sites on a regular basis.
There can be no assurance that the restaurants will be successful
outside the Company's existing Northern California markets, in locations where
the Company has limited operating experience, where the weather is more
seasonal, or where regional tastes and restaurant preferences may be different.
In addition, the Company's ability to resume an expansion strategy will depend
upon a variety of factors, including the selection and availability of suitable
restaurant locations, the construction of new restaurants in a timely manner,
the availability of capital to finance expansion, equipment costs and other
factors, many of which are beyond the Company's control. When the Company
resumes expansion, there can be no assurance that the Company will be successful
in opening the number of restaurants anticipated, that those restaurants will be
opened in a timely manner, or that, if opened, those restaurants will be
operated profitably.
MARKETING AND PROMOTION
The Company's marketing strategy in its existing markets is to increase
unaided brand awareness toward building top-of-mind recall of the Fresh Choice
or Zoopa brand resulting in increased usage among targeted consumers.
The Company intends to maximize exposure within its target market with
high impact, broad reaching mediums such as free standing inserts and radio. In
addition, the Company intends to continue to use targeted direct mail throughout
the year in selected markets. These tactics are designed to leverage both the
high level of aided awareness that has been achieved by the brand and build an
identifiable perception of Fresh Choice or Zoopa in the mind of the consumer.
Additionally, by consistently providing a positive dining experience, the
Company believes it benefits from significant word-of-mouth advertising.
In new markets, the marketing strategy is to build brand name awareness
where no or very low awareness exists. The Company intends to accomplish this
through the use of appropriate local advertising mediums and creative messages.
Prior to opening each new restaurant, the Company typically sponsors
fund-raisers and pre-opening parties in the restaurant with local charities or
schools to build community relationships and attract customers to the
restaurant.
RESTAURANT OPERATIONS AND MANAGEMENT
Management and Crewmembers. The Company has endeavored to establish a
strong corporate identity and culture and to maintain quality and consistency in
its restaurants through the careful training of personnel and the establishment
of rigorous standards relating to food purchasing and preparation and
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maintenance of the serving areas and facilities. Responsibility for managing the
Company's restaurant operations is currently shared by seven regional managers,
who report to the Vice President of Operations who reports to the President and
CEO. Regional managers are generally responsible for four to ten restaurants.
The management staff of a typical Fresh Choice restaurant consists of
one general manager, two or three restaurant managers and one to two shift
supervisors. The Company externally recruits most of its restaurant managers,
virtually all of whom have prior restaurant management experience. Most of the
Company's current general managers have been promoted from restaurant managers.
All newly-hired assistant managers participate in the Company's training course.
Each restaurant also employs approximately 40 hourly crewmembers, many of whom
work part-time. The general manager of each restaurant is responsible for the
day-to-day operation and profitability of the restaurant. To enhance quality,
service, cleanliness, maintenance and safety, the Company has developed detailed
systems, procedures and controls with respect to labor and food cost standards,
food preparation, planning and scheduling. The Company's culture emphasizes a
sense of ownership and entrepreneurship. The Company maintains a variety of
programs to reward excellent service and performance by each crewmember at the
restaurant level. In addition to a competitive base salary, the Company has an
incentive plan that rewards restaurant managers based upon achieving sales and
profit targets, controlling costs and quality of operations.
Food Purchasing. The Company has designed systems for determining order
quantities and has developed preparation methods that together ensure freshness,
maximize usage and minimize waste. Most food items are purchased on a
centralized basis to ensure uniform quality and adequate supplies, and to obtain
competitive prices. To the extent possible, the Company purchases food items
pursuant to fixed-price, long-term contracts that are not subject to minimum
quantity requirements. All produce is purchased from sources that have been
pre-qualified to meet the Company's specifications. Produce is delivered
directly to individual restaurants. At each restaurant, the management team is
responsible for assuring that all deliveries meet the Company's guidelines
regarding freshness and quality. The Company believes alternate sources are
available for all products.
Recipe Development. The Company's food development efforts focus on
introducing compelling and innovative new recipes, as well as upgrading the
flavor profiles and presentation standards of existing recipe favorites.
The Company works with outside consultants on food and beverage market
research and consumer trends. Seasonal and upscale produce items are rotated
into the salad bar product mix to continue to have "the best salad bar in the
business".
Training and Support. The Company believes that its training programs
have been successful in developing commitment to the Company, a consistent level
of execution, and high-quality guest service. Upon joining Fresh Choice, each
restaurant manager participates in an eight-week training course that covers all
aspects of restaurant operations and develops management skills. All crewmembers
are instructed through a combination of written materials and hands-on training
prior to their performance being validated by a certified trainer and restaurant
management. In addition, the Company creates and facilitates management and
hourly crewmember workshops that apply to and support the Company's current
goals and objectives.
Information Systems. Each restaurant is equipped with a computer
containing programs to perform crewmember timekeeping and daily cash and sales
reporting. The automation of these important administrative responsibilities
reduces the time spent by restaurant managers preparing daily reports of cash,
deposits, sales, sales mix and guest counts, labor costs, and food waste. The
computer systems at each restaurant are polled nightly by the corporate computer
system for this information, which is then processed by the centralized cash and
sales database. Reports are run and distributed automatically to regional
managers each morning as well as compiled for executive management review.
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Payroll information is processed every two weeks at the restaurants and
transmitted electronically to the corporate office, where the information is
interfaced with the Company's outside payroll service.
Financial controls are maintained centrally through a computerized
accounting system at the Company's corporate office. Sales are posted
electronically to the general ledger from the central cash and sales database.
Profit and loss statements are compiled every four weeks by the accounting
department and provided to the general managers and regional managers for
analysis and comparison to the Company's budgets.
Hours of Restaurant Operation. Most of the Company's restaurants are
open seven days a week, typically from 11:00 a.m. to 9:00 p.m. Sunday through
Thursday, and from 11:00 a.m. to 10:00 p.m. on Fridays and Saturdays.
COMPETITION
The Company's restaurants compete with the rapidly growing mid-price,
full-service casual dining segment; with traditional limited-service buffet,
soup, and salad restaurants; and, increasingly, with quick-service outlets. The
Company's competitors include national and regional chains, as well as local
owner-operated restaurants. Key competitive factors in the industry are the
quality and value of the food products offered, quality and speed of service,
price, dining experience, restaurant location and the ambiance of facilities.
The Company believes that it competes favorably with respect to these factors,
although many of the Company's competitors have been in existence longer than
the Company, have a more established market presence, and have substantially
greater financial, marketing and other resources than the Company, which may
give them certain competitive advantages. The Company believes that its ability
to compete effectively will continue to depend in large measure upon its ability
to offer a diverse selection of high-quality, fresh food products with an
attractive price/value relationship.
GOVERNMENT REGULATION
Each of the Company's restaurants is subject to various federal, state
and local laws, regulations and administrative practices affecting its business,
and must comply with provisions regulating health and sanitation standards,
equal employment, minimum wages and licensing for the sale of food and alcoholic
beverages. Difficulties or failures in obtaining or maintaining required beer
and wine licenses or other required licenses or approvals could delay or prevent
the opening of new restaurants or adversely affect the operations of existing
restaurants. The Company has no reason to believe that any of such future
license applications would not be approved.
TRADEMARKS AND SERVICE MARKS
"Fresh Choice," "Zoopa" and "The Ultimate Soup & Salad Bar" are
registered marks of the Company and the "Fresh Choice Masters Club" is pending
with the United States Patent and Trademark Office. The Company is also pursuing
federal registration of its logo. The Company's policy is to strenuously police
the use of its marks and to oppose infringement of its marks.
EMPLOYEES
As of February 26, 1999, the Company had approximately 2060 crewmembers.
These included approximately 1855 hourly restaurant crewmembers, of whom
approximately 1485 were part-time crewmembers, approximately 164 full-time
restaurant managers and trainees and approximately 41 full-time corporate
management and staff. None of the Company's crewmembers is represented by a
labor union. The Company believes that its employee relations are excellent.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company as of February 26 , 1999 are as
follows:
NAME AGE POSITION
---- --- --------
Everett F. Jefferson 60 President, Chief Executive Officer and Director
David E. Pertl 46 Senior Vice President and Chief Financial Officer
Tim G. O'Shea 51 Senior Vice President, Marketing
Joan M. Miller 47 Senior Vice President, Human Resources
Tina E. Freedman 38 Senior Vice President, Product Development and
Purchasing
Mr. Jefferson was elected President and Chief Executive Officer and as a
director of the Company in February 1997. Mr. Jefferson has an extensive
background in restaurant operations. From June 1996 to February 1997 Mr.
Jefferson was an independent consultant. From June 1993 to June 1996 Mr.
Jefferson was President and Chief Executive Officer of Cucina Holding, Inc., the
operator of Java City coffee and bakery. From March 1990 to June 1993 he was an
independent consultant and independent restaurant operator. From May 1987 to
March 1990 he was President and Chief Executive Officer of Skipper's, Inc.. From
May 1986 to April 1987 he was President of Kings Table, Inc. Earlier in his
career Mr. Jefferson was Senior Vice President of operations for Pizza Hut, Inc.
for five years and Regional Director of the Southeast and Caribbean for Saga
Corporation for ten years.
Mr. Pertl joined Fresh Choice in January 1997 as Vice President and
Chief Financial Officer and was named a Senior Vice President in December 1998.
Mr. Pertl was Vice President and Chief Financial Officer of Summit Family
Restaurants, Inc., a publicly-held family style restaurant company from
September 1989 until July 1996, when Summit was acquired. From September 1977 to
September 1989 he held various financial positions with Ponderosa, Inc.,
including Senior Vice President and Chief Financial Officer from January 1987 to
September 1989.
Mr. O'Shea joined Fresh Choice in March 1996 as Vice President,
Marketing and was named a Senior Vice President in December 1998. From July 1991
to March 1996 he was Vice President, Marketing for retail and foodservice
products for W.R. Grace and Co., a food processor. Mr. O'Shea has over 25 years
of experience in restaurant management and marketing including positions as Vice
President of Foodservice Marketing for Culinary Brands, Inc. from January 1987
to June 1991 and Vice President and General Manager of the hotel foodservices
division of Saga Corporation from October 1975 to January 1987.
Ms. Miller joined Fresh Choice in June, 1995 as Vice President, Human
Resources and was named a Senior Vice President in December 1998. From March
1992 to March 1995 she was Vice President, Human Resources for Medallion
Mortgage Co., a mortgage banking company. From March 1990 to March 1992 she was
an attorney with Littler Mendelson Fastiff Tichy & Mathiason, specializing in
labor law.
Ms. Freedman joined Fresh Choice in May 1992 as a restaurant manager and
was named Vice President, Product Development and Purchasing in August 1996, was
elected as an executive officer in March 1997 and was named a Senior Vice
President in December 1998. Ms. Freedman has held various positions at Fresh
Choice, including Director of Product Development from April 1995 to August
1996, Director of Training from December 1994 to April 1995, Regional Manager
from October 1993 to
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December 1994, and General Manager from September 1992 to October 1993. From
September 1982 to May 1992 she was Director of Food Services for Macy's,
California, a retail/restaurant company.
BUSINESS RISKS
Certain characteristics and dynamics of the Company's business and of
financial markets in general create risks to the Company's long-term success and
to predictable financial results. These risks include:
Recent Operating Losses and Declines in Comparable Store Sales. The
Company's profitability began to decline in the second half of 1994. In the
fourth quarter of 1994, the Company reported its first operating loss, and
reported operating losses in both 1995 and 1996. The Company reported a modest
profit in 1997 but again incurred an operating loss in 1998.
Beginning late in the third quarter of fiscal 1994, the Company began
reporting comparable store sales declines. Comparable store sales have continued
to decline in each quarter through the end of 1998. The Company reported
comparable store sales declines of 4.6%, 15.3%, 5.9%, 2.7% and 4.8% for fiscal
years 1994, 1995, 1996,1997 and 1998 respectively. There can be no assurance
that comparable store sales will improve or that the Company will return to
long-term profitability.
Expansion. The Company experienced substantial growth prior to mid-1995,
having opened 14 restaurants in 1993, 15 restaurants in 1994, and seven in 1995.
In 1995, the Company suspended its expansion plans after opening seven
restaurants, reviewed the operating performance of all of its restaurants, and
identified certain restaurants which did not meet its expectations for operating
performance. As a result, in December 1995 the Company announced a restructuring
plan to close as many as ten restaurants. The Company closed or sold eleven
restaurants under this program, including three at the end of 1995, and eight in
1996. In September 1998, the Company announced a plan to close four additional
previously impaired underperforming restaurants and for the closure of two
additional restaurants where it does not intend to renew the leases. To date
three of these restaurants have been closed. The Company opened one Fresh Choice
restaurant in 1996 and in 1997, acquired the Zoopa trade name and three Zoopa
restaurants and opened an additional two new Zoopa restaurants. In 1998 two
additional restaurants were opened. The Company believes its growth depends to a
significant degree on its ability to open new restaurants and to operate such
restaurants profitably. The Company has currently stopped its expansion plans
and while the Company intends to resume its expansion, assuming its financial
performance improves, there can be no assurance that the Company will be able to
continue expansion. The Company's ability to implement successfully an expansion
strategy will depend on a variety of factors, including the selection and
availability of affordable sites, the selection and availability of capital to
finance restaurant expansion and equipment costs, the ability to hire and train
qualified management and personnel, the ability to control food and other
operating costs, and other factors, many of which are beyond the Company's
control.
While on a long-term basis, the Company intends to expand its operations
in markets outside of California, assuming its financial performance improves,
there can be no assurance as to when or whether the Company will resume its
expansion. The Company's expansion plans may include entering new geographic
regions in which the Company has no previous operating experience. There can be
no assurance that the concept will be successful in regions outside of
California, where tastes and restaurant preferences may be different. As of
February 26, 1999, the Company had opened or purchased nine restaurants in
Texas, six restaurants in the state of Washington and three restaurants in the
Washington, D.C. metropolitan area. Of the fifteen restaurants closed or sold,
two were in Texas, two were in the state of Washington, eight were in
California, and three were in the Washington, D.C. metropolitan area (where the
Company no longer operates).
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Geographic Concentration. As of February 26, 1999, 40 of the Company's
51 restaurants are located in California, primarily in Northern California.
Accordingly, the Company is susceptible to fluctuations in its business caused
by adverse economic conditions in this region. In addition, net sales at certain
of the Company's restaurants have been adversely affected when a new Company
restaurant has been opened in relatively close geographic proximity, and such
pressure may continue to depress annual comparable store sales. There can be no
assurance that expansion within existing or future geographic markets will not
adversely affect the individual financial performance of Company restaurants in
such markets or the Company's overall results of operations. In addition, given
the Company's present geographic concentration in Northern California, adverse
weather conditions in the region or negative publicity relating to an individual
Company restaurant could have a more pronounced adverse affect on net sales than
if the Company's restaurants were more broadly dispersed.
Volatility of Stock Price. The market price of the Company's Common
Stock has fluctuated substantially since the initial public offering of the
Common Stock in December 1992. Changes in general conditions in the economy, the
financial markets or the restaurant industry, natural disasters or other
developments affecting the Company or its competitors could cause the market
price of the Company's Common Stock to fluctuate substantially. In addition, in
recent years the stock market has experienced extreme price and volume
fluctuations. This volatility has had significant effect on the market prices of
securities issued by many companies, including the Company, for reasons
sometimes unrelated to the operating performance of these companies. Any
shortfall in the Company's net sales or earnings from levels expected by
securities analysts could have an immediate and significant adverse effect on
the trading price of the Company's Common Stock in any given period.
Additionally, such shortfalls may not become apparent until late in the fiscal
quarter, which could result in an even more immediate and significant adverse
effect on the trading price of the Company's Common Stock.
Seasonality and Quarterly Fluctuations. The Company's restaurants have
typically experienced seasonal fluctuations, as a disproportionate amount of net
sales and net income are generally realized in the second and third fiscal
quarters. In addition, the Company's quarterly results of operations have been,
and may continue to be, materially impacted by the timing of new restaurant
openings and restaurant closings. The fourth quarter normally includes 16 weeks
of operations as compared with 12 weeks for each of the three prior quarters. As
a result of these factors, net sales and net income in the fourth quarter are
not comparable to results in each of the first three fiscal quarters, and net
sales and net income can be expected to decline in the first quarter of each
fiscal year in comparison to the fourth quarter of the prior fiscal year.
Comparable store sales, which have been negative for four consecutive years, may
continue to be negative.
Dependence on Key Personnel. The success of the Company depends on the
efforts of key management personnel. The Company's success will depend on its
ability to motivate and retain its key crewmembers and to attract qualified
personnel, particularly general managers, for its restaurants. The Company faces
significant competition in the recruitment of qualified crewmembers.
Restaurant Industry. The restaurant industry is affected by changes in
consumer tastes, as well as national, regional and local economic conditions and
demographic trends. The performance of individual restaurants, including the
Company's restaurants, may be affected by factors such as traffic patterns,
demographic considerations, and the type, number and location of competing
restaurants. In addition, factors such as inflation, increased food, labor and
crewmember benefit costs, and the availability of experienced management and
hourly crewmembers may also adversely affect the restaurant industry in general
and the Company's restaurants in particular. Restaurant operating costs are
affected by increases in the minimum hourly wage, unemployment tax rates, and
various federal, state and local governmental regulations, including those
relating to the sale of food and alcoholic beverages. There can be no assurance
that the restaurant industry in general, and the Company in particular, will be
successful.
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Competition. The Company's restaurants compete with the rapidly growing
mid-price, full-service casual dining segment; with traditional limited-service
buffet, soup, and salad restaurants; and, increasingly, with quick-service
outlets. The Company's competitors include national and regional chains, as well
as local owner-operated restaurants. Key competitive factors in the industry are
the quality and value of the food products offered, quality and speed of
service, price, dining experience, restaurant location and the ambiance of
facilities. Many of the Company's competitors have been in existence longer than
the Company, have a more established market presence, and have substantially
greater financial, marketing and other resources than the Company, which may
give them certain competitive advantages. The Company believes that its ability
to compete effectively will continue to depend in large measure upon its ability
to offer a diverse selection of high-quality, fresh food products with an
attractive price/value relationship.
Ability to Obtain Additional Financing. The Company intends to resume
restaurant expansion, assuming its financial performance improves. The Company's
ability to implement an expansion strategy will depend upon a variety of
factors, including the success of its restructuring plan in restoring
profitability and its ability to obtain funds. The Company believes its
near-term capital requirements can be met through its existing cash balances,
cash provided by operations and its available line of credit. However, the
Company may seek additional financing to provide greater flexibility toward
improving its operating performance. There can be no assurance that the Company
will be able to obtain additional financing when needed on acceptable terms or
at all.
Control by Major Shareholder. Crescent Real Estate Equities Limited
Partnership holds 1,187,906 shares of Series B non-voting convertible preferred
stock, which is convertible into Series A voting convertible preferred stock at
any time at the option of the holder. Upon conversion, holders of Series A
preferred stock would be entitled to vote with common stockholders and would
have a separate right to approve certain corporate actions, such as amending the
Company's Certificate of Incorporation or Bylaws, effecting a merger or sale of
the Company, or making a fundamental change in the Company's business activity.
In addition because the Company did not achieve an earnings target (before
interest, taxes, depreciation and amortization) of $5,500,000 in 1998, the
holders of Series A preferred stock would have the right to elect a majority of
the Company's Board of Directors. These factors could have the effect of
delaying, deferring or preventing a change in control of the Company and, as a
result, could discourage acquisition bids for the Company and limit the price
that investors are willing to pay for shares of common stock.
ITEM 2. PROPERTIES.
The Company currently owns both the land and buildings at two of its
restaurant locations, and owns restaurant buildings on leased land at seven
other locations. The Company leases all of its other restaurant locations, but
may purchase future restaurant locations where it believes it is cost-effective
to do so. The Company's restaurants are located in regional malls, strip
centers, and freestanding locations.
The Company's restaurants range from 5,500 to 7,400 square feet seating
from 160 to 250 guests. Many of the Company's restaurants provide limited
outdoor seating.
Restaurant locations leased by the Company are typically leased under
"triple net" leases that require the Company to pay real estate taxes,
maintenance costs and insurance premiums and, in many cases, to pay contingent
rentals based on sales in excess of specified amounts. Generally, the leases
have initial terms of ten to twenty years, with options to renew for additional
periods which range from five to fifteen years. All of the Company's current
leases have remaining terms or renewal options extending more than five years
following the date of this report.
The Company currently leases a separate facility for its executive
headquarters pursuant to a lease which expires December 31, 2000. The Company
believes that such facility is adequate for its office
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space requirements through fiscal 1999. If additional space is required in the
future, the Company further believes that suitable facilities can be leased on
commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company may be involved in litigation relating to
claims arising out of its operations. As of the date of this Annual Report on
Form 10-K, the Company is not engaged in any legal proceedings that are
expected, individually or in the aggregate, to have a material adverse effect on
the Company's business, financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Stock Information. Fresh Choice, Inc.'s common stock trades on The
Nasdaq Stock Market(R) under the Symbol: SALD. At February 26, 1999, 5,718,847
shares were owned by 361 stockholders of record. The following are the Company's
common stock high and low closing sales prices for the fiscal years 1997 and
1998:
1997 High Low
---- ---- ---
First Quarter 4 1/2 3 3/8
Second Quarter 4 1/8 2 15/16
Third Quarter 3 5/8 3 1/16
Fourth Quarter 5 3/4 3 1/4
1998 High Low
---- ---- ---
First Quarter 3 5/8 2 3/4
Second Quarter 4 2 13/16
Third Quarter 3 9/16 2
Fourth Quarter 2 1/8 1 1/8
Fresh Choice, Inc. had its initial public offering on December 9, 1992
at a price of $13.00. Fresh Choice, Inc. had a follow-on public offering on July
15, 1993 at a price of $25.00.
The Company has not paid cash dividends on its common stock, and
presently intends to continue this policy in order to retain its earnings for
the development of the Company's business. In addition, the Company's current
line of credit prohibits the payment of dividends.
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On September 13, 1996, the Company sold to Crescent Real Estate Equities
Ltd. ("Crescent") 1,187,906 shares of Series B Non-Voting Convertible
Participating Preferred Stock ("Series B Preferred Stock"), and granted Crescent
an option to purchase 593,953 shares of Series C Non-Voting Convertible
Participating Preferred Stock ("Series C Preferred Stock") (collectively, the
"Stock") for an aggregate purchase price of approximately $5.5 million, or $4.63
per share of Series B Preferred Stock pursuant to a Preferred Stock Purchase
Agreement dated April 26, 1996. The Series B Preferred Stock is convertible into
Series A Voting Convertible Participating Preferred Stock ("Series A Preferred
Stock") at any time at the option of the holder, and the Series A, Series B and
Series C Preferred Stock is convertible into Common Stock at any time at the
option of the holder. The Company offered and sold the Stock to Crescent, a
sophisticated investor who purchased such shares for investment purposes, as
transactions not involving a public offering pursuant to the exemption from
registration provisions of Section 4(2) of the Securities Act of 1933, as
amended.
ITEM 6. SELECTED FINANCIAL DATA.
A five-year summary of selected financial data follows:
(Dollars in thousands) December 27, December 28, December 29, December 31, December 25,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Net sales $ 73,887 $ 72,978 $ 76,691 $ 84,280 $ 76,969
Operating income (loss) (6,199) 219 (1,818) (30,321) 4,666
Net income (loss) (6,443) 333 (2,001) (27,796) 3,198
Basic net income (loss) per share (1.13) 0.06 (0.36) (5.05) 0.59
Diluted net income (loss) per share (1.13) 0.05 (0.36) (5.05) 0.58
Total assets 33,205 35,608 37,166 37,306 58,528
Working capital (deficiency) (7,201) (3,830) (2,726) (8,912) 2,997
Long-term debt and capital lease
obligations, including current portion 1,647 118 208 615 879
Stockholders' equity $ 19,946 $ 26,318 $ 25,916 $ 22,291 $ 49,336
Number of restaurants open at end of year 51 53 48 55 51
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
Certain statements set forth in this discussion and analysis of
financial condition and results of operations including anticipated store
openings, planned capital expenditures and trends in or expectations regarding
the Company's operations, specifically including the effect of problems
associated with the Year 2000 constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
are based on currently available operating, financial and competitive
information and are subject to various risks and uncertainties. Actual future
results and trends may differ materially depending on a variety of factors as
set forth under the heading "Business - Business Risks."
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RESULTS OF OPERATIONS
Fresh Choice, Inc. operates limited-service restaurants offering
specialty and traditional salads, hot pasta, hot baked potatoes, soups, breads,
pizza, muffins, frozen yogurt and other deserts. The Company operated 51
restaurants at December 27, 1998, 53 restaurants at December 28, 1997, and 48
restaurants at December 29, 1996. The Company's fiscal year ends on the last
Sunday in December. Fiscal years 1998, 1997 and 1996 each contained 52 weeks.
As of December 27, 1998, the Company had completed a restructuring plan
previously announced at the end of 1995. In connection with its 1995
restructuring plan, the Company closed or sold eleven restaurants, three in 1995
and eight in 1996, and curtailed restaurant expansion. The Company returned to
profitability in 1997, reporting net income of $333,000, after incurring
operating losses of $2,001,000 in 1996 and $27,796,000 in 1995 (including a
$23,932,000 restructuring and asset impairment charge). The Company also resumed
restaurant expansion in 1997, purchasing three restaurants in Washington and
building two restaurants in Texas. The Company reported an operating loss of
$6,443,000, including a $3,710,000 restructuring and asset impairment charge, in
1998 and discontinued its restaurant expansion to focus on its core restaurant
operations after opening two additional restaurants in Texas.
After opening its first restaurant in 1986, Fresh Choice expanded
steadily, its early growth driven by the strong unit economics of its
restaurants. The Company operated 22 restaurants at the time of its initial
public offering in December 1992. With $12,719,000 in net proceeds from its
initial offering and an additional $19,609,000 in net proceeds from a secondary
offering in July 1993, the Company accelerated its growth, opening 14 new
restaurants in 1993 (including its first two restaurants outside of California),
15 new restaurants in 1994 (including seven restaurants outside of California),
seven restaurants in 1995 (of which two are located outside of California) and
one restaurant in 1996. The Company opened a number of locations which have not
reached anticipated sales levels and opened a greater percentage of restaurants
in freestanding buildings. The increase in freestanding units and other
refinements and the expansion of the Company's restaurant configuration and
decor resulted in an increase in the Company's initial cash investment in new
units. At the same time, the Company experienced unanticipated declines in sales
at its restaurants, resulting in part from increased competition in the
casual/family dining sector and greater than expected cannibalization of its
existing restaurants. The Company's profitability began to decline in the second
half of 1994, and the Company reported its first operating loss in the fourth
quarter of 1994. The Company reported additional operating losses for each
quarter of 1995. In 1995, after an analysis of the sales potential and operating
economics of every Fresh Choice restaurant, the Company finalized and announced
a restructuring plan to help restore profitability. The plan included closing as
many as ten of the Company's restaurants, of which seven restaurants were
included in a reserve for closures, and a partial write-down of assets to
estimated fair value for thirteen other restaurants,. The Company recorded a
$23.9 million restructuring charge in 1995 in connection with the plan. At year
end 1995, the Company closed three restaurants.
The Company continued to incur an operating loss for 1996. As of year
end 1996, the Company had closed or sold eleven restaurants, including the sale
of two restaurants and the closure of a third restaurant in the Washington, D.C.
market.
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During 1997, the Company successfully introduced a number of cost
control programs which resulted in the Company reporting a modest profit of
$333,000 in 1997. The Company closed no additional restaurants in 1997 but
identified one restaurant for closure at the end of its lease term in 1998. The
restaurant closed in 1998 with no material financial impact.
In the fourth quarter of 1998, the Company announced a plan which
provided for the closure of four previously-impaired restaurants, the closure of
two additional restaurants at the end of their lease terms in 1999, and a
write-down of restaurant assets to fair market value for two other restaurants.
The Company recorded a $3,710,000 restructuring and asset impairment charge in
connection with the plan which was implemented in response to the continued poor
operating performance of the four previously-impaired restaurants, the
cannibalization of sales resulting from over-building in the Company's core
Northern California market and lower-than-anticipated sales at certain new
restaurants. In the fourth quarter, the Company closed three of the restaurants
identified for closure.
The following table presents the components of average operating income
on a per restaurant basis, based on the average number of restaurants open
during the year:
(Dollars in thousands) 1998 1997 1996
----------------- ---------------- -------------------
NET SALES $ 1,393 100.0 % $ 1,456 100.0 % $ 1,451 100.0 %
----------------- ---------------- -------------------
COSTS AND EXPENSES:
Cost of sales 364 26.2 % 389 26.7 % 399 27.5 %
Restaurant operating expenses:
Labor 459 32.9 % 450 30.9 % 470 32.4 %
Occupancy and other 443 31.8 % 440 30.2 % 436 30.0 %
Depreciation and amortization 71 5.1 % 62 4.2 % 63 4.3 %
General and administrative expenses 103 7.4 % 112 7.7 % 134 9.4 %
Gain on sale of restaurants -- - % -- - % (8) (0.6)%
Restructuring and asset impairment expenses 70 5.0 % -- - % (9) (0.6)%
----------------- ---------------- -------------------
Total costs and expenses 1,510 108.4 % 1,452 99.7 % 1,485 102.4 %
----------------- ---------------- -------------------
OPERATING INCOME (LOSS) $ (117) (8.4)% $ 4 0.3 % $ (34) (2.4)%
================= ================ ===================
Average restaurants open 53.0 50.1 52.8
------- ------- -------
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The following table sets forth items in the Company's statements of operations
as a percentage of sales:
(Dollars in thousands) 1998 1997 1996
------------------ ------------------ --------------------
NET SALES $ 73,887 100.0 % $ 72,978 100.0 % $ 76,691 100.0 %
------------------ ------------------ --------------------
COSTS AND EXPENSES:
Cost of sales 19,322 26.2 % 19,480 26.7 % 21,107 27.5 %
Restaurant operating expenses:
Labor 24,345 32.9 % 22,566 30.9 % 24,853 32.4 %
Occupancy and other 23,503 31.8 % 22,041 30.2 % 23,021 30.0 %
Depreciation and amortization 3,739 5.1 % 3,082 4.2 % 3,336 4.3 %
General and administrative expenses 5,467 7.4 % 5,590 7.7 % 7,089 9.4 %
Gain on sale of restaurants -- - % -- - % (446) (0.6)%
Restructuring and asset impairment expenses 3,710 5.0 % -- - % (451) (0.6)%
------------------ ------------------ --------------------
Total costs and expenses 80,086 108.4 % 72,759 99.7 % 78,509 102.4 %
------------------ ------------------ --------------------
OPERATING INCOME (LOSS) (6,199) (8.4)% 219 0.3 % (1,818) (2.4)%
Interest income 12 -- % 166 0.2 % 77 0.1 %
Interest expense (256) (0.3)% (52) - % (260) (0.3)%
------------------ ------------------ --------------------
Interest income (expense), net (244) (0.3)% 114 0.2 % (183) (0.2)%
------------------ ------------------ --------------------
INCOME (LOSS) BEFORE INCOME TAXES (6,443) (8.7)% 333 0.5 % (2,001) (2.6)%
Provision for (benefit from) income taxes -- -- % -- -- % -- -- %
------------------ ------------------ --------------------
NET INCOME (LOSS) $ (6,443) (8.7)% $ 333 0.5 % $ (2,001) (2.6)%
================== ================== ====================
Net sales. In 1998, net sales increased $0.9 million, or 1.2%, to $73.9
million. Two restaurants opened in 1998 and five restaurants acquired or opened
in 1997 contributed $4.9 million to sales offset by a $3.2 million sales decline
in the Company's 44 comparable restaurants. Four restaurants closed in 1998
accounted for a $0.8 million decline in sales.
In 1997, net sales declined $3.7 million, or 4.8%, to $73.0 million.
Eight restaurants closed or sold in 1996 accounted for a $5.9 million decline in
sales and sales at the Company's 47 comparable restaurants accounted for an
additional $2.1 million decline. Five new restaurants acquired or opened in 1997
and one restaurant opened in 1996 contributed incremental sales of $4.3 million.
The Company utilizes an 18-month basis for reporting comparable store
sales which management believes represents a more realistic indication of the
base business trends. On this basis, comparable store sales decreased 4.8% in
1998, 2.7% in 1997, and 5.9% in 1996. Comparable store guest counts declined
6.1% in 1998, 6.8% in 1997, and 10.8% in 1996.
The comparable store average check increased 1.4% and 4.0% in 1998 and
1997, respectively, reflecting price increases in response to federal and
state-mandated increases in the minimum wage and other cost increases.
Cost of sales. Cost of sales (food and beverage costs) were 26.2%, 26.7%
and 27.5% of net sales in 1998, 1997 and 1996, respectively. Food cost per guest
remained approximately the same each year
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as the Company continued to successfully manage food costs at the restaurants
through product rotation. The Company's product rotation program is designed to
maintain a quality product offering to the guest while enabling the Company to
react to changing costs. Food and beverage costs declined as a percentage of
sales each year due to the combined effect of controlling food costs per guest
and increases in the average check.
Restaurant Operating Expenses. Restaurant operating expenses (labor,
occupancy and other) were 64.7%, 61.1% and 62.4% of net sales in 1998, 1997 and
1996, respectively. In 1998, the fixed cost portion of labor became higher as a
percentage of sales as comparable store sales declined and the average wage
increased due to minimum wage increases and a highly competitive labor market.
As a result, labor costs were 2.0% of sales higher than in 1997. In addition,
occupancy and other costs were 1.6% of sales higher primarily due to the impact
of the comparable store sales decline on these mostly fixed costs and to
CPI-related rent increases offset by lower advertising costs. The Company
invested 3.0% of sales in advertising compared to 3.6% of sales in 1997. In
1997, restaurant operating expenses were 1.3% of sales lower than in 1996
primarily as a result of improved labor costs. A higher average check, reduced
restaurant level bonus payouts from the Company's bonus plans, which tied bonus
payouts to achieving planned profits, and improved labor controls, which
included the introduction of a revised hourly labor matrix, accounted for the
improvement.
Depreciation and Amortization. Depreciation and amortization expenses
were 5.1%, 4.2% and 4.3% of sales in 1998, 1997 and 1996, respectively. The 1998
increase is primarily the result of lower average sales per restaurant, the
Company's investment in new and remodeled restaurants and increased amortization
of start-up costs related to four new restaurants. In 1997, a decline in
start-up cost amortization related to fewer new restaurant openings and a
reduction in depreciation from assets write-offs at eleven closed or sold
restaurants and impairment of assets at other restaurants contributed to a
decline in depreciation and amortization expenses.
General and Administrative Expenses. General and administrative expenses
were 7.4%, 7.7% and 9.4% of sales in 1998, 1997 and 1996, respectively.
Continued controls over spending and staffing contributed to a $123,000 decline
in general and administrative expenses in 1998. In addition, the absence of
costs incurred in 1996 related to strategic consulting and other corporate
matters contributed to the $1,499,000 decline in general and administrative
expenses in 1997.
Gain on Sale of Restaurants. In 1996, the Company sold two of its three
restaurants in the Washington, D.C. market and closed the third restaurant which
was previously identified for closure under the 1995 restructuring plan. The
Company received $750,000 for the sale of the two restaurants and recorded a
gain of $446,000. In addition, the Company entered into an agreement not to
compete in the Washington, D.C. and Baltimore markets for a period of four
years. The Company had previously recorded an impairment reserve at each of the
restaurants in connection with the Company's 1995 restructuring plan. The
Company assumed contingent liabilities in connection with assignment agreements
on the two sold restaurants and paid cash to settle the lease obligation with
the landlord of the closed restaurant.
Restructuring and Asset Impairment Expenses. In the fourth quarter of
1998, the Company recorded a restructuring and asset impairment charge for the
closure of four restaurants, the closure of two additional restaurants at the
end of their lease terms in 1999, and a write-down of restaurant assets to fair
market value for two other restaurants. In 1998, the Company also completed a
restructuring plan previously announced at the end of 1995. The plan called for
closing as many as ten of the Company's restaurants, of which seven restaurants
were included in a reserve for closures, and a write-down of
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assets to estimated fair market value for thirteen other restaurants. Management
developed the 1995 restructuring plan to help restore profitability after an
analysis of the sales potential and operating economies of every Fresh Choice
restaurant. The Company had reported its first operating loss in the fourth
quarter of 1994 and additional operating losses for each quarter of 1995. The
Company based its reserve analysis on SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets to be Disposed Of," which establishes standards
to identify and measure impairment of long-lived assets.
In 1995, the Company recorded a $23,932,000 restructuring and asset
impairment charge in connection with the restructuring plan which consisted of
(1) an $18,671,000 non-cash impairment charge of which $8,318,000 related to the
write-down of assets to fair market value at the seven restaurants identified
for closure and $10,353,000 related to a write-down to fair market value at the
thirteen other restaurants, (2) a $4,655,000 charge for estimated cash costs
associated with the restaurant closures and settlement of the related lease
obligations, and (3) a $606,000 charge for other costs, both cash and non-cash,
primarily for consulting and other professional services rendered in connection
with the Company's restructuring. Fair value for the write-down of assets at
restaurants was estimated based on the present value of expected future cash
flows.
The Company closed six of the seven restaurants identified for closure:
three restaurants were closed at the end of 1995 and three were closed in 1996.
The Company decided not to close the seventh restaurant based on its improved
operating performance and reversed $451,000 in 1996 of the previously-recorded
restructuring expense related primarily to anticipated cash payments to close
the restaurant and settle the lease obligation. The Company negotiated cash
payments to landlords to settle the lease obligations for five of the closed
restaurants and assumed a contingent liability in connection with a sublease
agreement for the sixth closed restaurant. The Company settled the lease
obligations at five of the six closed restaurants in 1996 and reversed an
additional $1,618,000 of the previously-recorded restructuring expense due
primarily to lower-than-estimated cash payments to settle the lease obligations.
During 1997, the Company reversed an additional $732,000 of the
previously-recorded restructuring expense based on updated estimates of the
costs to resolve the final lease obligation. The final lease obligation was
settled in 1998, and the Company reversed approximately $32,000 of excess
reserve to other restaurant operating expenses. The Company attributed the
lower-than-estimated cash payments to settle the six lease obligations to
better-than-expected real estate markets which enabled landlords to locate new
tenants for the closed locations.
During 1996, the Company identified and closed or sold five additional
restaurants for a total of eleven closed restaurants. The Company recorded a
$1,618,000 restructuring charge for two of the restaurants which consisted of a
(1) $650,000 non-cash charge for the write-down of assets to fair market value
at one restaurant that was not previously impaired and (2) a $968,000 charge for
estimated cash costs associated with restaurant closures and settlement of lease
obligations for both restaurants. The Company closed both restaurants during
1996 and reached a settlement with the landlord for the lease obligation for one
restaurant in 1996 and for the other restaurant in 1997. In 1997, the Company
reversed $282,000 of the previously-recorded restructuring expense due primarily
to lower-than-estimated cash payments to close the restaurant and settle the
lease obligations. The Company closed a third restaurant in 1996 which did not
require a settlement with the landlord for the lease obligation. The Company had
partially impaired the restaurant's assets in connection with its 1995
restructuring charge and charged its remaining net assets to operations at the
time the restaurant closed. In addition, the Company sold two restaurants in
1996 in the Washington, D.C. market for $750,000 and recorded a gain of
$446,000. The Company had previously recorded a partial write-down of assets for
both of the restaurants in connection with its restructuring reserve recorded at
the end of 1995. The Company is contingently liable under the assigned lease
agreements on the two restaurants.
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The Company closed no restaurants in 1997, but identified one other
restaurant, which was previously impaired in connection with the Company's
restructuring plan, for closure in 1998 at the expiration of its lease term. The
restaurant closed in 1998 with no material impact on the Company's financial
position, results of operations or cash flows. In 1997, the Company recorded a
$1,014,000 impairment charge for the write-down of assets to fair market value
at one other restaurant in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets to be Disposed Of." The Company estimated fair
value for the restaurant's assets based on the present value of expected future
cash flows at the restaurant.
In the fourth quarter of 1998, the Company recorded a restructuring and
asset impairment charge for the closure of four restaurants, the closure of two
additional restaurants at the end of their lease terms in 1999, and a write-down
of restaurant assets to fair market value for two other restaurants. In 1998,
the Company recorded a $3,710,000 restructuring and asset impairment charge
which consisted of (1) a $2,415,000 non-cash charge for the write-down of
restaurant assets to fair market value of which $725,000 related to the six
restaurants identified for closure and $1,690,000 related to the write-down of
restaurant assets to fair market value for two other restaurants and (2) a
$1,295,000 charge for the estimated cash costs associated with restaurant
closures and settlement of lease obligations. Fair value for the write-down of
assets at restaurants was estimated based on the present value of expected
future cash flows.
In 1998, the Company closed three of the four restaurants identified for
closure and negotiated cash payments to settle the lease obligation for one
restaurant. Subsequent to December 27, 1998, the Company negotiated cash
payments to settle the lease obligations at the other two restaurants. The lease
obligations for all three restaurants were settled for substantially the amounts
provided in the restructuring reserve. The reserve balance of $1,257,000 at
December 27, 1998 consists of the estimated cash costs to close and settle the
lease obligations at the six restaurants identified for closure.
The Company reviews the cash flow of each restaurant throughout any
given reporting period, and performs an impairment review of its investment in
property and equipment at any given restaurant during a reporting period if
deemed necessary based on the restaurant's cash flow performance. At least
annually, the Company conducts an impairment review of its investment in
property and equipment for all of its restaurants.
Of the fifteen restaurants closed by the Company, seven restaurants were
outside the Company's core California market. Three closed restaurants,
including the two restaurant which were sold, were in the Washington, D.C.
market. Two closed restaurants were in Dallas, Texas and two closed restaurants
were in the greater Seattle, Washington market area. The Company had opened
three of the closed restaurants in 1995, eight in 1994, one in 1993, two in 1992
and one in 1988.
Interest Income. Interest income was $12,000 in 1998, $166,000 in 1997,
and $77,000 in 1996. In 1997 and 1996, the Company invested the excess proceeds
from its September 1996 sale of series B preferred stock to Crescent Real Estate
Equities Limited Partnership in money market funds. The Company invested the
excess proceeds pending their designated use to build or purchase new
restaurants, remodel existing restaurants, upgrade information systems or
increase working capital. The proceeds were subsequently used in late 1997 and
in 1998 to construct or purchase new restaurants and remodel existing
restaurants which accounted for the decline in interest income in 1998.
Interest Expense. Interest expense was $256,000 in 1998, $52,000 in
1997, and $260,000 in 1996. Interest expense consisted primarily of fees and
interest related to the Company's short-term line
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of credit facility and capital lease obligations for equipment leases. Interest
expense increased in 1998 due primarily to short-term borrowings in the current
year versus no borrowings in 1997 and to equipment leases at the Company's four
new restaurants. Interest expense decreased in 1997 as the Company paid down its
then remaining capital lease obligations. In 1996, the Company financed the
construction of one restaurant through line of credit borrowings. The Company's
only long-term debt during the three year period consisted of a site
construction note, which is included in other long-term liabilities, and capital
lease obligations.
Provision for Income Taxes. The Company recorded no tax provision for
its operating income in 1997 due to the availability of net operating loss
carryforwards to offset taxable income. The Company recorded no tax benefit from
its operating losses in 1998 and 1996 due to valuation allowances against its
net deferred tax assets.
QUARTERLY INFORMATION
The following table sets forth certain quarterly results of operations
for 1998 and 1997:
Year Ended December 27, 1998 Year Ended December 28, 1997
---------------------------------------------- ---------------------------------------------
(In thousands, First 12 Second 12 Third 12 Last 16 First 12 Second 12 Third 12 Last 16
except per share data) Weeks Weeks Weeks Weeks Weeks Weeks Weeks Weeks
---------------------------------------------- ---------------------------------------------
Net sales $ 16,192 $ 17,366 $ 18,644 $ 21,685 $ 16,106 $ 17,379 $ 18,334 $ 21,159
Operating income (loss) (618) (424) 88 (5,245) (696) 200 1,030 (315)
Net income (loss) (647) (467) 29 (5,358) (649) 233 1,065 (316)
Basic net income (loss)
per share(*) $ (0.11) $ (0.08) $ 0.01 $ (0.94) $ (0.11) $ 0.04 $ 0.19 $ (0.06)
Shares used in computing
basic per share amounts 5,682 5,686 5,695 5,701 5,661 5,663 5,669 5,672
Diluted net income (loss)
per share(*) $ (0.11) $ (0.08) $ 0.00 $ (0.94) $ (0.11) $ 0.03 $ 0.16 $ (0.06)
Shares used in computing
diluted per share amounts 5,682 5,686 6,885 5,701 5,661 6,854 6,860 5,672
Number of restaurants open
at end of quarter 53 53 53 51 48 51 51 53
(*)The sum of the quarterly net income (loss) per share amounts will not
necessarily equal the net income (loss) per share for the total fiscal year
The Company's restaurants experience seasonal fluctuations, as a
disproportionate amount of net sales and restaurant operating income are
generally realized in the second and third fiscal quarters. In addition, the
Company's quarterly results of operations have been, and may continue to be,
materially impacted by the timing of new restaurant openings and by restaurant
closings. The fourth quarter normally includes 16 weeks of operations as
compared with 12 weeks for each of the three prior quarters. As a result of
these factors, net sales and net income in the fourth quarter are not comparable
to results in each of the first three fiscal quarters, and net sales and income
can be expected to decline in the first quarter of each fiscal year in
comparison to the fourth quarter of the prior fiscal year. Because of recent
operating losses, restaurant closures, the seasonality of the Company's business
and the impact of new restaurant openings, results for any quarter cannot be
relied upon as indicative of the results that may be achieved for a full fiscal
year.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's primary capital requirements have been for the expansion
and remodeling of its restaurant operations which the Company has traditionally
financed with funds from equity offerings, cash flow from operations, landlord
allowances, equipment leases and short-term bank debt. The Company does not have
significant receivables or inventory and receives trade credit based upon
negotiated terms in purchasing food and supplies.
As of December 27, 1998, the Company had incurred cash costs of
approximately $3.4 million in connection with restaurant closures and the
related settlements of lease obligations under its restructuring plan announced
at the end of 1995 of which $0.7 million was incurred in 1998. At December 27,
1998, the Company had settled all obligations and had no reserve balances
related to the plan.
At December 27, 1998, the Company had a $1.3 million reserve balance
which consisted of the estimated cash costs to close and settle the lease
obligations at an additional six restaurants which were identified for closure
in the fourth quarter. In 1998, the Company closed three of the restaurants
identified for closure and negotiated cash settlement terms for the lease
obligation for one restaurant. Subsequent to December 27, 1998, the Company
negotiated cash settlement terms for the lease obligations at the other two
restaurants. The Company expects to close the three remaining restaurants
identified for closure during 1999.
At December 27, 1998, the Company had $1,155,000 borrowed under a bank
line of credit agreement. Because the Company failed to achieve certain minimum
earnings for the third quarter of 1998 as specified in the bank line of credit
agreement, the bank amended the agreement and reduced the maximum amount
available under the line from $2,850,000 to the $1,283,500 borrowed at the time
of default, increased the interest rate from prime (7.75% at December 27, 1998)
plus 1.25% to prime plus 4.0%, and specified a mandatory repayment schedule
through March 26, 1999. The Company met the required scheduled payments and paid
off the remaining balance on December 30, 1998 when it obtained new financing.
Borrowings under the line were secured by the Company's personal property and by
deeds of trust on certain Company-owned real estate. The amended agreement
required the Company to maintain compliance with the Company's preferred stock
agreement.
On December 29, 1998, the Company entered into a $4,000,000 loan and
security agreement (the "Agreement") with a finance company. The Agreement
expires on December 29, 2001 and provides for one-year renewals thereafter.
Under the terms of the Agreement, the Company may borrow up to $2,330,000
against the value of certain Company-owned real estate secured by deeds of trust
and up to $1,670,000 against the value of any of the Company's restaurant
equipment in which the lender has established a first priority perfected
security interest, subject to a maximum available borrowing against each
restaurant.
Borrowings under the Agreement initially bear interest at the prime rate
plus 1.25% and, once repaid, can be re-borrowed unless converted to a term loan.
Outstanding borrowings, if any, on the first and second anniversaries of the
Agreement convert into term loans which bear interest at the prime rate plus
1.75% and become payable monthly based on a five-year amortization schedule. All
borrowings, including any term loans, are fully payable on December 30, 2001.
Aggregate borrowings in excess of $2,500,000 bear an additional 0.5% interest.
The Agreement also provides for a monthly collateral monitoring fee and a 0.5%
unused line fee.
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The Agreement requires the Company to maintain a minimum net worth and
debt service coverage ratio and to not exceed maximum interest and debt to cash
flow ratios and limits its aggregate indebtedness. The Agreement also requires
approval before paying dividends and limits the Company's fixed asset
acquisitions based on its operating cash flows. On December 30, 1998, the
Company borrowed $2,075,000 of available funds and used $1,155,000 of the amount
borrowed to pay off its bank line of credit. As of February 26, 1999, the
Company had a maximum of $2,623,000 available under the Agreement of which it
had borrowed $2,075,000.
Long-term debt at December 27, 1998 consisted of a $117,000 note for
site construction costs, which is included in other long-term liabilities on the
balance sheet, and capital lease obligations. During 1998, the Company entered
into equipment leases for four restaurants which provided $1,770,000 in
financing under capital lease arrangements that expire in 2002.
For the year ended December 27, 1998, the Company invested $4.7 million
in property and equipment which was funded through existing cash balances,
internally generated cash, line of credit borrowings and capital lease
obligations. Capital expenditures of approximately $2.6 million related to new
restaurants and $1.5 million related to the remodeling of eight restaurants. The
Company plans to remodel between ten and fifteen restaurants in 1999 at a cost
of $1.1 million to $1.7 million and has no new restaurant development planned.
During 1998, the Company paid the remaining liability of $0.6 million
related to its purchase in May 1997 of the Zoopa trade name and three Zoopa
restaurants in Washington. The Company paid $1.3 million upon closing of the
purchase in May 1997 and the additional $0.6 million one year later based on
restaurant sales.
During the year ended December 27, 1998 operating activities provided
$1.4 million, which was net of the $0.6 million cash payment to settle the
remaining liability for the three purchased Zoopa restaurants and a $0.7 million
cash payment to settle the final lease obligation under the Company's 1995
restructuring plan. Operating activities included a $1.1 million increase in
accounts payable that resulted primarily from extended payment terms negotiated
with a major purveyor in the fourth quarter.
The Company's outstanding Series B non-voting convertible preferred
stock is currently held by one entity and is convertible, at the holders'
option, into Series A voting convertible preferred stock on a one-for-one basis.
Although no Series A preferred stock is currently outstanding, holders of Series
A preferred stock would be entitled to vote with common stockholders on all
matters submitted to a vote of stockholders. When and if issued, the holders of
a majority of the outstanding Series A preferred stock will have a separate
right to approve certain corporate actions. The Company did not achieve an
earnings target (before interest, taxes, depreciation and amortization) of
$5,500,000 in 1998 which constituted an event of default under the terms of the
preferred stock agreement and triggered the right of the Series A preferred
stockholders to elect a majority of the Company's Board of Directors. The holder
of the Series B preferred stock has not initiated any action to convert such
shares into shares of Series A preferred stock nor has it exercised its right to
elect a majority of the Board of Directors. Such holder has notified the Company
that it has no present intention of exercising such right; however, it has not
waived any of its rights under the agreement.
Upon achievement of certain per-share market price tests, the Company
may force a mandatory conversion of the Series A preferred stock to common
stock. No shares of Series C preferred stock are currently outstanding but an
option to purchase such shares is outstanding. The Series A, Series B and
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Series C preferred stock are senior to the Company's common stock with respect
to dividends and with respect to distributions on liquidation.
The Company's continued growth depends to a significant degree on its
ability to open new restaurants and to operate such restaurants profitably. The
Company intends to resume its restaurant expansion, assuming its financial
performance improves. The Company's ability to implement an expansion strategy
will depend upon a variety of factors, including the continued success of
efforts to restore profitability and the Company's ability to obtain funds. See
"Business - Business Risks - Expansion." The Company believes its operating cash
requirements and fiscal 1999 capital requirements can be met through existing
cash balances, cash provided by operations, equipment leases and its loan and
security agreement. The Company may continue to seek additional debt or equity
financing to provide greater flexibility toward improving its operating
performance and continuing expansion.
INFLATION
Many of the Company's employees are paid hourly rates related to the
federal and state minimum wage laws. Accordingly, increases in the minimum wage
could materially increase the Company's labor costs. The Federal minimum wage
increased effective September 1, 1997, the State of California minimum wage
increased effective March 1, 1998, and the State of Washington minimum wage
increased effective January 1, 1999. The Company raised prices in responses to
these increases. No further minimum wage increases are scheduled. In addition,
the cost of food commodities utilized by the Company are subject to market
supply and demand pressures. Shifts in these costs may have a significant impact
on the Company's food costs. The Company anticipates that increases in these
costs can be offset through pricing and other cost control efforts; however,
there is no assurance that the Company would be able to pass such costs on to
its guests or that even if it were able to do so, it could do so in a short
period of time.
YEAR 2000 SOFTWARE REQUIREMENTS
The Company has completed a review of all its restaurant and corporate
computer systems for compliance with the year 2000. The Company has determined
that certain of its existing computer systems use only two digits to identify a
year in the date field and, as a result, may improperly identify the year 2000
in calculating and processing information. The Company recognizes this system
design could cause certain systems to potentially fail or create erroneous
results by or at the year 2000 but believes its current strategic information
plan is addressing the problem.
The Company is currently in the process of migrating its critical
processing and information requirements to outsourced processing companies whose
software is represented to be year 2000 compliant. The Company expects to
complete this system migration, begun in 1997, during 1999 with no significant
incremental costs. In accordance with its strategic information plan, the
Company is already replacing certain restaurant systems, primarily its
restaurant point of sale system, used for capturing and transmitting data to the
outsourced systems, with year 2000 compliant systems. The Company expects to
have the critical restaurant systems in place by approximately the middle of
1999 at an estimated equipment cost of $500,000 which is to be capitalized in
accordance with normal policy and which will be funded either through operating
cash flow, equipment lease financing, or borrowings under the Company's loan and
security agreement.
The Company has also contacted outside entities with which it interacts
electronically and requested information regarding whether or not their systems
are or will be year 2000 compliant. The
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Company is monitoring the progress of outside entities that are in the process
of developing year 2000 compliance, but it does not believe there is a material
risk to the Company that these entities will not achieve compliance or if these
entities do not achieve compliance. However, there can be no assurance that the
systems of other entities will be converted timely, or that a failure to convert
by another entity will not have a material adverse effect on the Company. As
part of its continuous monitoring process, the Company will implement
contingency plans as necessary. These plans could include, but are not limited
to, alternate product suppliers, manual recording and accumulation of restaurant
transactions, and restriction of the tender types accepted at the restaurants.
The Company believes it has an effective plan in place to anticipate and
resolve any potential Year 2000 issues in a timely manner. In the event,
however, that the Company does not properly identify Year 2000 issues and
remediation and testing is not conducted on a timely basis with respect to the
Year 2000 issues that are identified, there can be no assurance that Year 2000
issues will not materially and adversely affect the Company. In addition,
disruptions in the economy generally resulting from Year 2000 issues also could
materially and adversely affect the Company.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This statement requires companies to record derivatives on the
balance sheet as assets or liabilities measured at fair value. The Company will
adopt this statement for its fiscal year beginning December 27, 1999. The
Company does not expect that adoption of this statement will impact the
Company's consolidated financial position, results of operations or cash flows.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Cost of
Start-Up Activities," which requires companies to expense the costs of start-up
activities and organization costs as incurred. The Company will adopt SOP 98-5
effective for its fiscal year beginning December 28, 1998 and expense $70,000 of
unamortized pre-opening costs at the time of adoption.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate risk primarily through its
borrowing activities. The Company has not used derivative financial instruments
to hedge such risks. There is inherent roll-over risk for borrowings as they
mature and are renewed at current market rates. The extent of this risk is not
quantifiable or predictable because of the variability of future interest rates
and business financing requirements. If market rates were to increase
immediately by 10 percent from levels at December 27, 1998, the fair value of
the Company's borrowings would not be materially affected as borrowings are
primarily subject to variable interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's financial statements as of December 27, 1998 and December
28, 1997 and for each of the three fiscal years in the period ended December 27,
1998, and the Independent Auditors' Report, are included in the report as listed
on Page 29 of this Report, Item 14(a).
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
Certain information required by Part III is omitted from this Report.
The Company plans to file its Proxy Statement (the "Proxy Statement") pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Report, and certain information included therein is incorporated
herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
There is incorporated by reference the information relating to the
directors of the Company set forth under the caption "Election of Directors" in
the Proxy Statement. Information relating to the executive officers of the
Company is set forth in Part I of this Report under the caption "Executive
Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION.
There is incorporated by reference the information relating to executive
compensation set forth under the caption "Executive Compensation and Other
Matters" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
There is incorporated by reference the information relating to ownership
of equity securities of the Company by certain beneficial owners and management
set forth under the caption "General Information -- Stock Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
There is incorporated by reference the information relating to certain
relationships and related transactions set forth under the caption "Compensation
Committee Interlocks and Insider Participation" in the Proxy Statement.
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