Washington, D.C. 20549

 

 

FORM 10-Q

 

 

Commission file number 0-20792

 

FRESH CHOICE, INC.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check 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.

ý  Yes    o  No

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12B-2 of the Exchange Act).

o  Yes    ý  No

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of Common Stock, $.001 par value, outstanding as of October 6, 2003 was 5,994,043.

 

 

FRESH CHOICE, INC.

 

INDEX

 

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

Condensed Consolidated Balance Sheets at September 7, 2003 and December 29, 2002

Condensed Consolidated Statements of Operations for the Twelve and Thirty-Six Weeks ended September 7, 2003 and September 8, 2002

Condensed Consolidated Statements of Cash Flows for the Thirty-Six Weeks ended September 7, 2003 and September 8, 2002

Notes to Condensed Consolidated Financial Statements

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3 - Quantitative and Qualitative Disclosures About Market Risk

Item 4- Controls and Procedures

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

Item 2 - Changes in Securities

Item 3 - Defaults Upon Senior Securities

Item 4 - Submission of Matters to a Vote of Security Holders

Item 5 - Other Information

Item 6 - Exhibits and Reports on Form 8-K

SIGNATURES

INDEX TO FORM 10-Q EXHIBITS

 

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PART I.  FINANCIAL INFORMATION

 

Item 1 - Financial Statements

 

FRESH CHOICE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

 

		September 7, 2003			December 29, 2002
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	2,013		$	2,994
Receivables		143			165
Inventories		502			467
Prepaid expenses and other current assets		764			359
Total current assets		3,422			3,985
PROPERTY AND EQUIPMENT, net		30,519			31,475
DEPOSITS AND OTHER ASSETS		796			869
TOTAL ASSETS		$	34,737		$	36,329
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	1,922		$	2,825
Other accrued expenses		2,481			2,331
Accrued salaries and wages		1,591			1,582
Sales tax payable		759			614
Current portion of long-term obligations		919			737
Total current liabilities		7,672			8,089
CAPITAL LEASE OBLIGATIONS		2,310			2,132
LONG-TERM DEBT		1,939			2,047
OTHER LONG-TERM LIABILITIES		2,159			2,429
Total liabilities		14,080			14,697
STOCKHOLDERS’ EQUITY:
Convertible preferred stock, $.001 par value; 3.5 million shares authorized; shares outstanding: 2003 and 2002 - 1,187,906; liquidation preference; 2003-$8,621; 2002-$8,161		5,175			5,175
Common stock - $.001 par value; 15 million shares authorized; shares outstanding: 2003 - 5,992,356; 2002 - 5,964,068		42,678			42,630
Accumulated deficit		(27,196		)	(26,173		)
Total stockholders’ equity		20,657			21,632
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	34,737		$	36,329

 

The December 29, 2002 amounts are derived from the Company’s audited financial statements.

See accompanying notes to condensed consolidated financial statements.

 

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FRESH CHOICE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

		Twelve Weeks Ended						Thirty-Six Weeks Ended
		September 7, 2003			September 8, 2002			September 7, 2003			September 8, 2002
NET SALES		$	19,496		$	18,507		$	56,059		$	53,023
COSTS AND EXPENSES:
Cost of sales		4,327			4,126			12,727			11,797
Restaurant operating expenses:
Labor		6,370			5,807			18,878			17,069
Occupancy and other		6,202			5,511			17,923			15,999
General and administrative expenses		1,195			1,339			3,865			4,050
Depreciation and amortization		820			748			2,438			2,266
Asset impairment expense		730			—			730			—
Restaurant opening costs		—			162			236			249
Total costs and expenses		19,644			17,693			56,797			51,430
OPERATING INCOME (LOSS)		(148		)	814			(738		)	1,593
Interest income		1			16			3			41
Interest expense		(104		)	(61		)	(288		)	(179		)
Interest expense, net		(103		)	(45		)	(285		)	(138		)
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		(251		)	769			(1,023		)	1,455
Provision for income taxes		—			81			—			89
INCOME (LOSS) FROM CONTINUING OPERATIONS		(251		)	688			(1,023		)	1,366
LOSS FROM DISCONTINUED OPERATIONS		—			(42		)	—			(133		)
NET INCOME (LOSS)		$	(251	)	$	646		$	(1,023	)	$	1,233
Basic net income (loss) per common share:
Basic income (loss) from continuing operations		$	(0.04	)	$	0.12		$	(0.17	)	$	0.23
Basic loss from discontinued operations		—			(0.01		)	—			(0.02		)
Basic net income (loss) per common share:		$	(0.04	)	$	0.11		$	(0.17	)	$	0.21
Shares used in computing basic per share amounts		5,991			5,939			5,974			5,922
Diluted net income (loss) per common share:
Diluted income (loss) from continuing operations		$	(0.04	)	$	0.10		$	(0.17	)	$	0.19
Diluted loss from discontinued operations		—			(0.01		)	—			(0.02		)
Diluted net income (loss) per common share:		$	(0.04	)	$	0.09		$	(0.17	)	$	0.17
Shares used in computing diluted per share amounts		5,991			7,173			5,974			7,174

 

See accompanying notes to condensed consolidated financial statements.

 

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FRESH CHOICE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Thirty-Six Weeks Ended
		September 7, 2003			September 8, 2002
OPERATING ACTIVITIES OF CONTINUING OPERATIONS:
Income (loss) from continuing operations		$	(1,023	)	$	1,366
Adjustments to reconcile income (loss) from continuing operations to net cash used by operating activities from continuing operations:
Depreciation and amortization		2,587			2,405
Asset impairment expense		730			—
Issuance of common stock for consulting services		1			4
Loss on disposal of property and equipment		55			90
Deferred rent		(289		)	(289		)
Change in operating assets and liabilities:
Receivables		21			(372		)
Inventories		(53		)	(82		)
Prepaid expenses and other current assets		(405		)	576
Accounts payable		(903		)	455
Accrued salaries and wages		28			269
Other accrued expenses		293			387
Net cash provided by operating activities of continuing operations		1,042			4,809
INVESTING ACTIVITIES:
Capital expenditures		(2,348		)	(4,733		)
Proceeds from sale of property and equipment		4			24
Deposits and other assets		20			(42		)
Net cash used in investing activities		(2,324		)	(4,751		)
FINANCING ACTIVITIES:
Common stock sales		47			57
Long-term debt - repayments		(102		)	(87		)
Capital lease obligations - borrowings		904			490
Capital lease obligations - repayments		(548		)	(470		)
Net cash provided (used) by financing activities		301			(10		)
CASH PROVIDED (USED) BY CONTINUING OPERATIONS		(981		)	48
CASH USED BY DISCONTINUED OPERATIONS		—			(103		)
DECREASE IN CASH AND CASH EQUIVALENTS		(981		)	(55		)
CASH AND CASH EQUIVALENTS:
Beginning of period		2,994			4,368
End of period		$	2,013		$	4,313
Noncash Investing and Financing Actvities - Equipment acquired under capital leases		$	—		$	565
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest		$	306		$	183
Cash paid during the period for income taxes		$	53		$	15

 

See accompanying notes to condensed consolidated financial statements

 

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FRESH CHOICE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Twelve and Thirty-Six Weeks Ended September 7, 2003 and September 8, 2002

(Unaudited)

 

1.             CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The accompanying condensed consolidated financial statements have been prepared by the Company without audit and reflect all adjustments, consisting of normal recurring adjustments and accruals, which are, in the opinion of management, necessary for a fair statement of financial position and the results of operations for the interim periods.  The statements have been prepared in accordance with the regulations of the Securities and Exchange Commission, but omit certain information and footnote disclosures necessary to present the statements in accordance with accounting principles generally accepted in the United States of America.  For further information, refer to the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2002.

 

2.             NET INCOME (LOSS) PER COMMON SHARE

 

Basic net income (loss) per common share excludes dilution and is computed by dividing net income by the weighted average of its common shares outstanding for the period.  Diluted net income (loss) per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.  The Company converts common stock options and warrants into potential dilutive shares using the treasury stock method and converts preferred stock into potential dilutive shares using the “if converted” method.

 

A reconciliation of the components of basic and diluted net income per share follows:

 

 

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The following table presents the total dilutive securities which the Company excluded for each period presented from its diluted EPS computation because the exercise price of the securities exceeded the average fair value of the Company’s common stock or the Company had a net loss and therefore, these securities were anti-dilutive:

 

		Twelve Weeks Ended				Thirty-Six Weeks Ended
(In thousands)		September 7, 2003		September 8, 2002		September 7, 2003		September 8, 2002
Potential Dilutive Securities
Stock options excluded		1,157		1,024		1,157		957
Stock warrants		100		100		100		100
Convertible preferred stock		1,188		—		1,188		—

 

3.             OTHER ACCRUED EXPENSES

 

The components of other accrued expenses are as follows:

 

 

4.             BORROWING ARRANGEMENTS

 

On August 13, 2003, the Company amended its $2,200,000 loan (the “Loan”), with a commercial bank to exclude restaurant opening costs in calculating the minimum debt service coverage ratio.  Under the terms of the Loan, the Company issued a promissory note (the “Note”) in the amount of $2,200,000.  The Note is secured by a deed of trust on certain Company-owned real estate.  The Note bears interest at the prime rate (4.0% at September 7, 2003) plus 0.625%.  The Note has a fifteen-year amortization period and matures after 84 monthly payments of principal and interest.  All unpaid principal and interest shall be due and payable on the Note’s maturity date of September 2, 2008.

 

On September 7, 2003 the Company had $1,958,000 of debt outstanding under the Loan described above.  At September 7, 2003 $1,828,000 was included in long-term debt and $130,000 was included in the current portion of long-term obligations.  The amended Deed of Trust requires the Company to maintain a minimum debt service coverage ratio and to maintain a minimum tangible net worth.

 

On August 13, 2003 the Company amended its $2,000,000 revolving line of credit (the  “Agreement”) with its bank, to exclude restaurant opening costs in calculating the minimum debt service coverage ratio.  Borrowings bear interest at the prime rate (4.0% at September 7, 2003) plus 0.5%.  Borrowings under the Agreement are collateralized by the Company’s personal property.  On September 7, 2003 the Company had no borrowings under the Agreement.

 

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The amended Agreement requires the Company to maintain (i) a minimum tangible net worth, (ii) a minimum debt service coverage ratio and (iii) a maximum debt to tangible net worth ratio.  The Agreement also limits the Company’s fixed asset acquisitions and requires approval before paying dividends or repurchasing outstanding shares of stock.  In addition the Agreement requires the outstanding principal balance of the loan to be zero for at least one period of thirty consecutive days during the term of the loan.  Covenant compliance is reported quarterly and the Company was in compliance with all covenants under the amended Agreement at September 7, 2003.

 

On September 7, 2003 the Company had a commitment from the bank separate from the Agreement, which makes $1,372,000 available to the Company in support of outstanding letters of credit required under its workers’ compensation program.  The commitment, which is scheduled to expire February 28, 2004, will automatically extend for a one-year period.

 

5.             CONVERTIBLE PREFERRED STOCK

 

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, if any, 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.

 

In fiscal 1998, the Company failed to achieve a specified earnings target which constituted an event of default of the terms of the preferred stock agreement and which 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.  In March, 2003 such holder notified the Company that it had no intention, at that time, of exercising such right; however, it has not waived any of its rights under the agreement.  As of October 6, 2003 management is not aware of any change in the shareholder’s intention.

 

6.             ASSET IMPAIRMENT EXPENSE

 

The Company recorded a non-cash impairment charge of $730,000 for the write-down of assets to fair value for one of the Company’s new restaurants. This restaurant has operated at a negative cash flow since opening and has projected future negative cash flows.  The impairment charge for this restaurant was required because the carrying amount of the impaired assets was not recoverable from its undiscounted cash flows.  The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.  The Company does not intend to close this restaurant in 2003.

 

7.             RECENTLY ISSUED ACCOUNTING STANDARDS

 

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” which addresses accounting for restructuring and similar costs.  SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (“EITF”) Issue No. 94-3.  The Company adopted the provisions of SFAS No. 146 for restructuring activities initiated after December 29, 2002.  SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred.  Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company’s commitment to an exit plan.  SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value.  Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.  In accordance with SFAS No. 146, the Company incurred a charge of approximately $50,000 in the second quarter of 2003 resulting from severance costs associated with the

 

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elimination of eleven positions in its corporate office that occurred during the second quarter of 2003.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” which amends SFAS No. 123, “Accounting for Stock-Based Compensation,” and provides alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation.  SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 and Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting,” to require disclosure of the effects of an entity’s accounting policy with respect to stock-based compensation on reported net income and earnings per share in annual and interim financial statements.  The disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether the compensation is accounted for using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25.  As allowed by SFAS No. 123, the Company utilizes the accounting method prescribed by APB Opinion No. 25 and has adopted the disclosure requirements of SFAS No. 148.

 

The following table illustrates the effect on net income (loss) and net income (loss) per common share if the Company had applied fair value recognition provisions of SFAS No. 123 to stock based employee compensation.

 

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150).  The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 31, 2003 and with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of SFAS 150 will not have a material effect on the Company’s financial statements.

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion is intended to highlight significant changes in the Company’s financial position and results of operations for the twelve and thirty-six weeks ended September 7, 2003.  The interim financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto for the fiscal year ended December 29, 2002 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2002.

 

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 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

 

9

 

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 Risks”.  In particular, any future plans by the Company 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.

 

Forward-looking statements reflect the expectations of the Company at the time they are made, and investors should rely on them only as expressions of opinion about what may happen in the future and only at the time they are made.  The Company undertakes no obligation to update any forward-looking statements.  Although the Company believes it has an appropriate business strategy and the resources necessary for its operations, future revenue and margin trends cannot be reliably predicted and the Company may alter its business strategies to address changing conditions.

 

Liquidity and Capital Resources

 

The Company’s primary capital requirements have been for the expansion of its restaurant operations and remodeling of its restaurants.  The Company has traditionally financed these requirements with funds from equity offerings, cash flow from operations, landlord allowances, capital equipment leases and short-term bank debt.  The Company does not have significant trade receivables or inventory and receives trade credit based upon negotiated terms in purchasing food and supplies.

 

On August 13, 2003, the Company amended its $2,200,000 loan (the “Loan”) with a commercial bank to exclude restaurant opening costs in calculating the minimum debt service coverage ratio.  Under the terms of the Loan, the Company issued a promissory note (the “Note”) in the amount of $2,200,000.  The Note is secured by a deed of trust on certain Company-owned real estate.  The Note bears interest at the prime rate (4.0% at September 7, 2003) plus 0.625%.  The Note has a fifteen-year amortization period and matures after 84 monthly payments of principal and interest.  All unpaid principal and interest shall be due and payable on the Note’s maturity date of September 2, 2008.

 

On September 7, 2003 the Company had $1,958,000 of debt outstanding under the Loan described above.  At September 7, 2003 $1,828,000 was included in long-term debt and $130,000 was included in the current portion of long-term obligations.  The amended Deed of Trust requires the Company to maintain a minimum debt service coverage ratio and to maintain a minimum tangible net worth.

 

On August 13, 2003 the Company amended its $2,000,000 revolving line of credit (the  “Agreement”) with its bank, to exclude restaurant opening costs in calculating the minimum debt service coverage ratio.  Borrowings bear interest at the prime rate (4.0% at September 7, 2003) plus 0.5%.  Borrowings under the Agreement are collateralized by the Company’s personal property.  On September 7, 2003 the Company had no borrowings under the Agreement.

 

The amended Agreement requires the Company to maintain (i) a minimum tangible net worth, (ii) a minimum debt service coverage ratio and (iii) a maximum debt to tangible net worth ratio.  The Agreement also limits the Company’s fixed asset acquisitions and requires approval before paying dividends or repurchasing outstanding shares of stock.  In addition the Agreement requires the outstanding principal balance of the loan to be zero for at least one period of thirty consecutive days during the term of the loan.

 

Covenant compliance is reported quarterly and the Company was in compliance with all covenants under the amended Agreement at September 7, 2003.  Based on the Company’s most current financial projections the Company is likely to be out of compliance with one or more of these covenants by the end of the Company’s fourth quarter 2003.  The Company believes it can obtain a waiver or renegotiate these covenants with its bank.  However, there can be no assurance that the Company will be able to obtain a waiver or renegotiate its covenants.

 

On September 7, 2003 the Company had a commitment from the bank separate from the Agreement, which makes $1,372,000 available to the Company in support of outstanding letters of credit required under its workers’ compensation program.  The commitment, which is scheduled to expire February 28, 2004, will automatically extend for a one-year period.

 

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During the first thirty-six weeks of 2003 the Company entered into capital equipment leases for $904,000.  This and other capital lease obligations at September 7, 2003 totaled $3,098,000 of which $788,000 was included in the current portion of long-term obligations.  Long-Term Debt also included a $ 112,000 note for site construction costs of which $1,000 was included in the current portion of long-term obligations.

 

Net cash provided by operating activities of continuing operations for the first thirty-six weeks of 2003 was $1,042,000 and consisted of:

 

(In thousands)

 

 

Net cash provided by operating activities for the first thirty-six weeks of 2003 included a change in operating assets and liabilities of $1,019,000.  The change in operating assets and liabilities was primarily due to a reduction in accounts payable as the result of payments for construction invoices that were included in accounts payable at December 29, 2002.

 

During the same period the Company invested $2,348,000 in property and equipment, which includes equipment under capital leases.

 

The Company’s contractual obligations as of September 7, 2003 are as follows:

 

(In thousands)

 

 

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, if any, 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.

 

In fiscal 1998, the Company failed to achieve a specified earnings target (before interest, taxes, depreciation and amortization) of at least $5.5 million which constituted an event of default of the terms of the preferred stock agreement and which 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

 

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Series A preferred stock nor has it exercised its right to elect a majority of the Board of Directors.  In March 2003 such holder notified the Company that it had no intention, at that time, of exercising such right; however, the holder has not waived any of its rights under the agreement.  As of October 6, 2003 management is not aware of any change in the shareholder’s intention.

 

The Company’s continued growth depends to a significant degree on its ability to open new restaurants and to operate such restaurants profitably.  As of October 6, 2003, three new Fresh Choice restaurants have opened in fiscal 2003 and one additional Fresh Choice restaurant is under construction, with a projected opening late in the fourth quarter.  The total leasehold improvements and equipment costs for this additional location is estimated to be approximately $1.0 million, of which approximately $0.3 million has been expended through September 7, 2003.

 

The Company has no development plans beyond 2003.  The Company’s ability to resume an expansion strategy will depend upon a variety of factors, including its return to profitability and the Company’s ability to obtain funds.  See “Business Risks” included herein.

 

The Company intends to finance its operating cash requirements and fiscal 2003 capital requirements through existing cash balances, cash provided by operations, its borrowing arrangements and equipment lease financing.

 

The Company’s ability to resume an expansion strategy will depend upon a variety of factors, including, maintaining a sufficient cash flow from operations and its ability to obtain additional funds.  The Company believes its near-term capital requirements can be met through its existing cash balances, cash provided by operations and its borrowing arrangements.  However, the Company’s operating cash flow is impacted by the Company’s comparable store sales increases or decreases as well as the Company’s new restaurants’ sales performance.  In the first thirty-six weeks of 2003 comparable store sales declined 1.5% and average sales for the nine new restaurants, opened over the last eighteen months, has been 24.2% below the comparable-store average sales.  The Company expects comparable store sales to improve and the sales performance of its new restaurants to improve, but there can be no assurance that comparable store sales will improve or new restaurant sales will improve.  In addition, should the Company seek new financing there can be no assurance that the Company would be able to obtain additional financing on acceptable terms or at all.  To the extent operating cash flow continues to decline, the Company may need to further reduce its capital spending plans.

 

Impact of 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.  In addition, the cost of food commodities utilized by the Company is 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 may 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.

 

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:

 

Operating Losses and Historical Declines in Comparable Store Sales.  Our quarterly and annual operating results and same store sales have fluctuated significantly in the past and are likely to fluctuate significantly in the future. Although the Company has reported a profit for three of the last four years, there can be no assurance that the Company will be profitable over the long or short term.

 

The Company’s comparable store sales declined for both fiscal years 2001 and 2002 and for the first three quarters of 2003.  There can be no assurance that the comparable store sales declines experienced in 2001, 2002 and the first three quarters of 2003 will not continue or not decline further.  If comparable store sales fail to improve, additional impairment charges may be required.

 

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Expansion.  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 resumed its expansion with one new Fresh Choice restaurant opening in 2001, five opening in 2002 and, as of October 6, 2003, three restaurants opening in 2003.  Through the first thirty-six weeks of 2003 the nine new restaurants have not met the Company’s financial expectations with average sales 24.2% below the comparable-store average sales.  There can be no assurance that the nine newly opened restaurants or future restaurants will be profitable.  In the third quarter the Company recorded a $730,000 impairment expense for one of these restaurants.  If performance does not improve, or deteriorates further in certain other new restaurants, the Company may be required to record additional impairment expenses.

 

The Company has one additional Fresh Choice restaurant under construction, which is expected to open late in the fourth quarter.  The Company currently has no development plans beyond 2003.  The Company’s ability to successfully resume an expansion strategy will depend upon a variety of factors, many of which may be beyond the Company’s control, including the Company’s ability to locate suitable restaurant locations, negotiate acceptable lease terms, obtain required government approvals, construct new restaurants in a timely manner, attract, train and retrain qualified and experienced personnel and management, operate its restaurants profitably and obtain additional capital to finance expansion and  equipment costs, as well as general economic conditions and the degree of competition in the particular market

 

The Company’s future expansion plans may include entering new geographic regions in which the Company has no previous operating experience.  There can be no assurance that the Fresh Choice concept will be successful in new geographic regions.  In addition the Company expects intense competition for restaurant sites, which may result in the Company having difficulty leasing desirable sites on terms that are acceptable to the Company. The Company expects that in some cases competitors may be willing to pay more than the Company for sites.  These potential difficulties may make it difficult for the Company to achieve any new store growth objectives.

 

Lease Renewals.  As existing restaurant leases expire, the Company must negotiate new leases or lease extensions in order to continue operations at existing restaurants.  There can be no assurance that the Company will be able to renew these leases on favorable terms or at all.  If the Company is unable to obtain favorable terms on new leases or extensions on existing leases, it would increase costs and reduce the Company’s operating margins.  Moreover, if the Company is unable to renew existing leases and is unable to find suitable alternate locations, the Company’s revenue and operating results would be adversely affected.

 

Geographic Concentration.  As of October 6, 2003, 42 of the Company’s 56 restaurants were 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.  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 or increased utility costs in the region or negative publicity relating to an individual Company restaurant could have a more pronounced adverse effect on results of operations than if the Company’s restaurants were more broadly dispersed.

 

Sensitivity to Economic Conditions and Consumer Spending.  The restaurant industry historically has been subject to substantial cyclical variation.  The California economy has slowed and there has been a downturn in the general economy and a decline in consumer spending in the restaurant industry.  A continued decline could have a material adverse effect on the Company’s financial performance, as restaurant sales tend to decline during recessionary periods.  A prolonged economic downturn could alter customers’ purchasing decisions, which most likely would have a material adverse impact on the Company’s revenue and results of operations.

 

Seasonality and Quarterly Fluctuations The Company’s restaurants have typically experienced seasonal fluctuations, as a disproportionate amount of net sales and net income is 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

 

13

 

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 can be expected to decline in the first quarter of each fiscal year in comparison to the fourth quarter of the prior fiscal year.

 

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.

 

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 fast-casual and 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.  In addition the Company expects intense competition for restaurant sites, which may result in the Company having difficulty leasing desirable sites on terms that are acceptable to the Company.  The Company expects that in some cases competitors may be willing to pay more than the Company for sites.

 

Ability to Obtain Additional Financing.  The Company resumed its restaurant expansion in 2001.  The Company currently has no expansion plans beyond 2003.  The Company’s ability to resume an expansion strategy will depend upon a variety of factors, including 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 borrowing arrangements. Should the Company seek new financing there can be no assurance that the Company would be able to obtain additional financing on acceptable terms or at all.

 

Control by Major Shareholder.  Crescent Real Estate Equities Limited Partnership (“Crescent”) 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 a specified earnings target 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.

 

14

 

Critical Accounting Policies

 

Our accounting policies are more fully described in Note 1 of the Company’s audited December 29, 2002 financial statements.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities as of the dates and for the periods presented.  Management believes the following accounting policies, among others, represent its more critical or complex estimates and assumptions used in preparation of its consolidated financial statements.

 

The Company evaluates its estimates and assumptions on an on-going basis and believes its estimates and assumptions are reasonable based on historical experience and other factors.  However, actual results could differ from those estimates and these differences could be material to the consolidated financial statements.  The accounting policies management has identified as critical or complex accounting policies are described below.

 

Income taxes.  The Company’s net deferred tax assets consist primarily of the tax benefit related to operating loss carryforwards, alternative minimum tax credits and asset write-downs, in connection with store asset impairments, that are not deductible for tax purposes until the assets are disposed.  The Company has provided valuation allowances against its deferred net tax assets based on management’s most recent assessment that it is not deemed more likely than not that the deferred tax assets will be realized.  If future assessments by management were to determine that the Company would be able to realize its deferred tax assets in excess of their net recorded amounts, an adjustment to the deferred tax assets could result in an increase in net income in the period such determination was made.

 

Long-lived assets impairment.  The Company reviews its long-lived assets related to each restaurant annually for impairment, or whenever events or changes in circumstances indicate that the carrying amount of a restaurant may not be recoverable.  The Company considers a history of operating losses to be its primary indicator of potential impairment, therefore new restaurants are generally not identified for impairment until a sufficient operating history has been developed.  Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows, the individual restaurants.  Impairment evaluations require an estimation of cash flows over the remaining useful life of the restaurants.  If the long-lived assets of a restaurant are not recoverable based upon forecasted undiscounted cash flows, the Company writes down an impaired restaurant to its estimated fair value, which becomes its new cost basis.  Generally, management considers the present value of a restaurant’s projected future cash flows and estimated sales values of a restaurant’s long-lived assets in determining fair value.  Considerable management judgment is necessary to estimate projected future operating cash flows.  Accordingly, if actual results vary from such estimates, significant future impairment could result.

 

Discontinued Operations.  Considerable management judgment is necessary to determine whether a closed restaurant should be classified as discontinued operations.  In general, the Company considers the extent to which the restaurant’s operations and cash flow are expected to be absorbed by other currently operated restaurants or replaced with a new restaurant in making this determination.  A closed restaurant, or group of restaurants, which is located in an isolated market and not replaced, would generally be classified as discontinued operations.

 

Property and equipment.  Property and equipment are stated at cost.  Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets which range from 5 to 30 years or the lease term of a restaurant including option periods, as appropriate, not to exceed 25 years.

 

Stock-based compensation.  The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”  Accordingly, no compensation expense has been recognized in the financial statements for employee stock arrangements.  The Company accounts for stock-based awards to non employees in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation” and Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”.

 

15

 

Workers’ Compensation Claims Accrual.  The Company records estimates for workers’ compensation claims under its workers’ compensation program.  Estimated reserves are based on available historical claim settlement data for reported claims.  If a greater number of claims occur in comparison to the amount of claims estimated or medical costs increase beyond anticipated costs, additional charges may be required in the period such determination was made.

 

Results of Operations

 

The following table sets forth items in the Company’s statements of operations as a percentage of sales and certain operating data for the periods indicated:

 

		Twelve Weeks Ended										Thirty-Six Weeks Ended
(Dollars in thousands)		September 7, 2003					September 8, 2002					September 7, 2003					September 8, 2002
NET SALES		$	19,496		100.0	%	$	18,507		100.0	%	$	56,059		100.0	%	$	53,023		100.0	%
COSTS AND EXPENSES:
Cost of sales		4,327			22.2	%	4,126			22.3	%	12,727			22.7	%	11,797			22.2	%
Restaurant operating expenses:
Labor		6,370			32.7	%	5,807			31.4	%	18,878			33.7	%	17,069			32.2	%
Occupancy and other		6,202			31.8	%	5,511			29.8	%	17,923			32.0	%	15,999			30.2	%
General and administrative expenses		1,195			6.1	%	1,339			7.2	%	3,865			6.9	%	4,050			7.6	%
Depreciation and amortization		820			4.2	%	748			4.0	%	2,438			4.3	%	2,266			4.3	%
Asset impairment expense		730			3.8	%	—			—	%	730			1.3	%	—			—	%
Restaurant opening costs		—			—	%	162			0.9	%	236			0.4	%	249			0.5	%
Total costs and expenses		19,644			100.8	%	17,693			95.6	%	56,797			101.3	%	51,430			97.0	%
OPERATING INCOME (LOSS)		(148		)	(0.8	)%	814			4.4	%	(738		)	(1.3	)%	1,593			3.0	%
Interest income		1			—	%	16			0.1	%	3			—	%	41			—	%
Interest expense		(104		)	(0.5	)%	(61		)	(0.4	)%	(288		)	(0.5	)%	(179		)	(0.3	)%
Interest expense, net		(103		)	(0.5	)%	(45		)	(0.3	)%	(285		)	(0.5	)%	(138		)	(0.3	)%
INCOME (LOSS) BEFORE INCOME TAXES		(251		)	(1.3	)%	769			4.1	%	(1,023		)	(1.8	)%	1,455			2.7	%
Provision for income taxes		—			—	%	81			0.4	%	—			—	%	89			0.1	%
INCOME (LOSS) FROM CONTINUING OPERATIONS		(251		)	(1.3	)%	688			3.7	%	(1,023		)	(1.8	)%	1,366			2.6	%
LOSS FROM DISCONTINUED OPERATIONS		—			—	%	(42		)	(0.2	)%	—			—	%	(133		)	(0.3	)%
NET INCOME (LOSS)		$	(251	)	(1.3	)%	$	646		3.5	%	$	(1,023	)	(1.8	)%	$	1,233		2.3	%
Number of restaurants:
Open at beginning of period		56					51					53					51
Open at end of period		56					53					56					53

 

16

 

The following table presents the components of average restaurant operating income on a per restaurant basis, based on the average number of restaurants open during the period (the Company’s three Fresh Choice Express restaurants, one licensed Starbucks retail store and discontinued operations are excluded):

 

		Twelve Weeks Ended										Thirty-Six Weeks Ended
(Dollars in thousands)		September 7, 2003					September 8, 2002					September 7, 2003					September 8, 2002
NET SALES		$	368		100.0	%	$	388		100.0	%	$	1,067		100.0	%	$	1,121		100.0	%
COSTS AND EXPENSES:
Cost of sales		81			21.9	%	86			22.1	%	240			22.5	%	247			22.0	%
Restaurant operating expenses:
Labor		120			32.7	%	122			31.3	%	359			33.7	%	360			32.1	%
Occupancy and other		117			31.7	%	115			29.7	%	340			31.9	%	337			30.1	%
Depreciation and amortization		15			4.1	%	15			3.8	%	45			4.1	%	46			4.1	%
Total costs and expenses		332			90.4	%	337			86.9	%	984			92.2	%	989			88.3	%
RESTAURANT OPERATING INCOME		$	35		9.6	%	$	51		13.1	%	$	83		7.8	%	$	131		11.7	%
Fresh Choice & Zoopa restaurants open		52.0					46.7					51.5					46.4

 

Restaurant operating income excludes restaurant opening costs and general and administrative expenses.

 

Results of Operations:  Twelve Weeks Ended September 7, 2003

Compared to Twelve Weeks Ended September 8, 2002

 

Net Sales.  Net sales for the quarter ended September 7, 2003 were $19,496,000, an increase of $989,000, or 5.3%, from sales of $18,507,000 for the quarter ended September 8, 2002. The primary components of the net increase in sales were:

 

(In thousands)

 

 

The Company had an average of 52.0 Fresh Choice restaurants included in sales in the third quarter of 2003 compared to 46.7 Fresh Choice restaurants in the third quarter of 2002.  Sales at the Company’s 44 comparable Fresh Choice restaurants, which include restaurants open at least 18 months, decreased 0.3% in the third quarter of 2003 versus the third quarter of 2002.  Comparable store guest counts decreased 3.2%, while the comparable store average check increased 3.0% to $7.81, reflecting price increases and lower coupon discounts.

 

Net sales per Fresh Choice restaurant averaged $368,000 in the third quarter of 2003, a decrease of 5.2% over net sales per restaurant of $388,000 in the third quarter of 2002 due primarily to the lower than expected sales per restaurant from the eight new restaurants not included in comparable store sales.  Sales at these restaurants were 34.6% below the comparable store average sales.

 

Costs and Expenses.  Cost of sales (food and beverage costs) was 22.2% of sales in the third quarter of 2003 compared to 22.3% in the third quarter of 2002.  Food and beverage costs declined as a percentage of sales due to the combined effect of controlling food cost per guest and increases in the average check.

 

17

 

Restaurant Operating Expenses.  Restaurant operating expenses (labor, occupancy and other) were 64.5% of sales in the third quarter of 2003 compared to 61.2% of sales in the third quarter of 2002, an increase of 3.3% of sales.

 

Labor costs as a percentage of sales were 32.7% for the third quarter of 2003 compared to 31.4% in the third quarter of 2002.  Labor costs, as a percentage of sales, were higher primarily due to lower average restaurant sales, a higher average wage, and higher workers’ compensation costs.

 

Occupancy and other expenses as a percentage of sales were 31.8% for the third quarter of 2003 compared to 29.8% of sales in the third quarter of 2002, an increase of 2.0% of sales.  The increase is due primarily to lower average restaurant sales, higher gas and electricity expenses and higher management training costs.

 

Depreciation and Amortization.  Depreciation and amortization expenses in the third quarter of 2003 were 4.2% of sales, an increase of 0.2% of sales.

 

General and Administrative Expenses.  General and administrative expenses were 6.1% of sales in the third quarter of 2003 compared to 7.2% of sales in the third quarter of 2002.  The decrease is primarily the result of reduced spending compared to last year and higher sales.  During the second quarter the Company eliminated eleven mid-level management and clerical positions or approximately 30% of its corporate office staff.

 

Asset Impairment Expense.  The Company recorded a non-cash impairment charge of $730,000 for the write-down of assets to fair value for one of the Company’s new restaurants. This restaurant has operated at a negative cash flow since opening and has projected future negative cash flows.  The impairment charge for this restaurant was required because the carrying amount of the impaired assets was not recoverable from its undiscounted cash flows.  The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.  The Company does not intend to close this restaurant in 2003.

 

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 events or changes in circumstances indicate that the carrying amount of a restaurant may not be recoverable.  At least annually, the Company conducts an impairment review of its investment in property and equipment for all its restaurants.

 

Restaurant Opening Costs.  The Company had no restaurant opening costs in the third quarter of 2003 versus $162,000 in the third quarter of 2002.  The decrease is due to the Company opening no new locations in the third quarter of 2003 versus two in the third quarter of 2002.

 

Interest Expense, net.  Interest expense, net was  $103,000 in the third quarter of 2003 compared to $45,000 in the third quarter of 2002. This increase is due to additional equipment lease financing for the new stores and lower interest earned on the Company’s average cash balances.  Interest expense consists of fees related to securing the Company’s borrowing arrangements and interest expense on outstanding borrowings and capital lease obligations.

 

Income Taxes.  The Company recorded no tax benefit from its operating loss in the third quarter of 2003 due to valuation allowances against its net deferred tax assets.  The Company’s net deferred tax assets consist primarily of the tax benefit related to operating loss carryforwards, alternative minimum tax credits and asset write-downs, in connection with store asset impairments, that are not deductible for tax purposes until the assets are disposed.  The Company will continue to provide a full valuation allowance for its deferred tax assets until it becomes more likely than not, in management’s assessment, that any portion of the Company’s deferred tax assets will be realized.  The Company recorded an income tax provision for the third quarter of 2002, despite net operating loss carryforwards available to offset taxable income, due to projected 2002 net income being subject to state alternative minimum tax.

 

18

 

Results of Operations:  Thirty-Six Weeks Ended September 7, 2003

Compared to Thirty-Six Weeks Ended September 8, 2002

 

Net Sales.  Net sales for the thirty-six weeks ended September 7, 2003 were $56,059,000, an increase of $3,036,000, or 5.7%, from sales of $53,023,000 for the thirty-six weeks ended September 8, 2002. The primary components of the net increase in sales were:

 

(In thousands)

 

 

The Company had an average of 51.5 Fresh Choice restaurants included in sales in the first three quarters of 2003 compared to 46.4 Fresh Choice restaurants in the first three quarters of 2002.  Sales at the Company’s 43 comparable Fresh Choice restaurants, which include restaurants open at least 18 months, decreased 1.5% in the first three quarters of 2003 versus the first three quarters of 2002.  Comparable store guest counts decreased 3.7%, while the comparable store average check increased 2.4% to $7.75, reflecting price increases and lower coupon discounts.

 

Net sales per Fresh Choice restaurant averaged $1,067,000 in the first three quarters of 2003, a decrease of 4.8% over net sales per restaurant of $1,121,000 in the first three quarters of 2002 due primarily to the comparable store sales decreases as noted above and lower than expected sales per restaurant from the nine new restaurants not included in comparable store sales.  Sales at these restaurants were 24.2% below the comparable store average sales.

 

Costs and Expenses.  Cost of sales (food and beverage costs) was 22.7% of sales in the first three quarters of 2003 compared to 22.2% in the first three quarters of 2002.  Food and beverage costs increased as a percentage of sales primarily from inflationary cost increases and the introduction of a new menu rotation intended to increase the value offering to the guest.

 

Restaurant Operating Expenses.  Restaurant operating expenses (labor, occupancy and other) were 65.7% of sales in the first three quarters of 2003 compared to 62.4% of sales in the first three quarters of 2002, an increase of 3.3% of sales.

 

Labor costs as a percentage of sales were 33.7% for the first three quarters of 2003 compared to 32.2% in the first three quarters of 2002.  Labor costs, as a percentage of sales, were higher primarily due to lower average restaurant sales, a higher average wage, higher workers’ compensation costs and labor inefficiencies at our new locations.  It typically takes six to ten weeks for a new store to bring its labor in line with our scheduling matrix as the store’s new crewmembers become more productive and guest traffic patterns are developed.

 

Occupancy and other expenses as a percentage of sales were 32.0% for the first three quarters of 2003 compared to 30.2% of sales in the first three quarters of 2002, an increase of 1.8% of sales.  The increase is due primarily to lower average restaurant sales, higher gas and electricity expenses and higher management training costs.

 

Depreciation and Amortization.  Depreciation and amortization expenses in the first three quarters of 2003 were 4.3% of sales, which is flat with the first three quarters in 2002.

 

19

 

General and Administrative Expenses.  General and administrative expenses were 6.9% of sales in the first three quarters of 2003 compared to 7.6% of sales in the first three quarters of 2002.  The decrease is primarily the result of reduced spending compared to last year and higher sales.  During the second quarter the Company eliminated eleven mid-level management and clerical positions or approximately 30% of its corporate office staff.

 

Asset Impairment Expense.  The Company recorded a non-cash impairment charge of $730,000 for the write-down of assets to fair value for one of the Company’s new restaurants. This restaurant has operated at a negative cash flow since opening and has projected future negative cash flows.  The impairment charge for this restaurant was required because the carrying amount of the impaired assets was not recoverable from its undiscounted cash flows.  The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.  The Company does not intend to close this restaurant in 2003.

 

Restaurant Opening Costs.  Restaurant opening costs were $236,000 in the first three quarters of 2003 compared to $249,000 in the first three quarters of 2002.  The Company opened three new Fresh Choice restaurants in both periods.

 

Interest Expense, net.  Interest expense, net was  $285,000 in the first three quarters of 2003 compared to $138,000 in the first three quarters of 2002. This increase is due to additional equipment lease financing for the new stores and lower interest earned on the Company’s average cash balances.  Interest expense consists of fees related to securing the Company’s borrowing arrangements and interest expense on outstanding borrowings and capital lease obligations.

 

Income Taxes.  The Company recorded no tax benefit from its operating loss in the first thirty-six weeks of 2003 due to valuation allowances against its net deferred tax assets.  The Company’s net deferred tax assets consist primarily of the tax benefit related to operating loss carryforwards, alternative minimum tax credits and asset write-downs, in connection with store asset impairments, that are not deductible for tax purposes until the assets are disposed.  The Company will continue to provide a full valuation allowance for its deferred tax assets until it becomes more likely than not, in management’s assessment, that any portion of the Company’s deferred tax assets will be realized.  The Company recorded an income tax provision for the first thirty-six weeks of 2002, despite net operating loss carryforwards available to offset taxable income, due to projected 2002 net income being subject to state alternative minimum tax.

 

Item 3 - 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 September 7, 2003, the fair value of the Company’s borrowings would not be materially affected as borrowings are primarily subject to variable interest rates.

 

Item 4 - Controls and Procedures

 

Under the supervision and with the participation of the Company’s management, including its principal executive officer and principal financial officer, the Company evaluated the effectiveness of its disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended.  Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

 

20

 

PART II.  OTHER INFORMATION

 

Item 1 - Legal Proceedings		Not Applicable.
Item 2 - Changes in Securities		Not Applicable.
Item 3 - Defaults upon Senior Securities		Not Applicable.
Item 4 - Submission of Matters to a Vote of Security Holders		Not Applicable.
Item 5 - Other Information		Not Applicable.
Item 6 - Exhibits and Reports on Form 8-K

 

(a)         Exhibits.  The exhibits listed in the accompanying index to Form 10-Q Exhibits are filed or incorporated by reference as part of this report.

 

(b)         Reports on Form 8-K.  The registrant filed the following report on Form 8-K during the quarter ended September 7, 2003.

•      on July 10, 2003 reporting the issuance of a press release announcing the results for the second quarter ended June 15, 2003.

 

21

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

	FRESH CHOICE, INC.
	(Registrant)
	/S/ Everett F. Jefferson
	Everett F. Jefferson
	President and Chief Executive Officer
	(Principal Executive Officer)
	/S/ David E. Pertl
	David E. Pertl
	Senior Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)
Dated:  October 10, 2003

 

22

 

INDEX TO FORM 10-Q EXHIBITS

 

Exhibit No.				Description
3.1	(1)			Restated Certificate of Incorporation of Fresh Choice, Inc.
3.2	(8)			Amended By-Laws of Fresh Choice, Inc. dated April 11, 1996
3.3	(10)			Certificate of Amendment of Restated Certificate of Incorporation of Fresh Choice, Inc.
3.4	(10)			Certificate of Designation of Series A Voting Participating Convertible Preferred Stock of Fresh Choice, Inc.
3.5	(10)			Certificate of Designation of Series B Non-Voting Participating Convertible Preferred Stock of Fresh Choice, Inc.
3.6	(10)			Certificate of Designation of Series C Non-Voting Participating Convertible Preferred Stock of Fresh Choice, Inc.
4.1	(10)			Registration Rights Agreement dated September 13, 1996 between Fresh Choice, Inc. and Crescent Real Estate Equities Limited Partnership
10.1	(1)			Form of Indemnity Agreement for directors and officers
10.2	(2)	(3)		Second Amended and Restated 1988 Stock Option Plan
10.3	(2)	(3)		1992 Employee Stock Purchase Plan
10.8	(8)			Preferred Stock Purchase Agreement with Crescent Real Estate Equities Limited Partnership dated April 26, 1996
10.18	(6)			Warrant to Purchase up to 75,000 Shares of the Company’s Common Stock issued to Silicon Valley Bank on December 20, 1995
10.19	(6)			Common Stock Purchase Warrant to Purchase 100,000 Shares of the Company’s Common Stock issued to Bain & Company, dated December 15, 1995
10.26	(11)	(3)		Employment Offer Letter to David E. Pertl dated January 24, 1997
10.27	(11)	(3)		Employment Offer Letter to Everett F. Jefferson dated January 30, 1997
10.28	(11)	(3)		Amendment to Employment Offer Letter to Everett F. Jefferson dated February 10, 1997
10.34	(13)	(3)		Consulting Agreement with Charles A. Lynch dated April 17, 1998
10.36	(14)			Loan and Security Agreement dated December 29, 1998 with FINOVA Capital Corporation
10.37	(14)	(3)		Form of Severance Agreement with Senior Vice Presidents
10.41	(16)	(3)		2001 Home Office Incentive Plan
10.42	(16)	(3)		Senior Vice President of Operations 2001 Incentive Plan
10.43	(17)	(3)		Amendment to Employment offer letter to David E. Pertl dated August 23, 2001
10.44	(17)	(3)		Employment Agreement with Everett F. Jefferson dated October 9, 2001
10.45	(17)	(3)		Amended and Restated Form of Severance Agreement with Senior Vice Presidents dated August 14, 2001
10.46	(17)	(3)		2001 Employee Stock Purchase Plan

 

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EXHIBIT NO.				DESCRIPTION
10.47	(17)	(3)		Second Amended and Restated 1988 Stock Option Plan as amended through July 12, 2001
10.48	(17)			Promissory Note Secured by Deed of Trust dated August 13, 2001 with Mid-Peninsula Bank
10.49	(17)			Commercial Deed of Trust, Financing Statement, Security Agreement and Fixture Filing dated August 13, 2001 with Mid-Peninsula Bank
10.50	(17)			Revolving Loan Agreement dated October 5, 2001 with Mid-Peninsula Bank
10.51	(17)			Pledge Agreement dated October 5, 2001 with Mid-Peninsula Bank
10.52	(17)			Promissory Note dated October 5, 2001 with Mid Peninsula Bank
10.53	(18)	(3)		2002 Home Office Incentive Plan
10.54	(18)	(3)		Senior Vice President of Operations 2002 Incentive Plan
10.55	(18)	(3)		Non Qualified Deferred Compensation Plan of Fresh Choice, Inc. effective as of December 1, 2001
10.56	(18)	(3)		Trust Agreement Under The Non Qualified Deferred Compensation Plan of Fresh Choice, Inc. dated December 17, 2001
10.57	(19)			Letter dated April 25, 2002 amending the Revolving Loan Agreement dated October 5, 2001 with Mid-Peninsula Bank
10.58	(20)			Change in Terms Agreement dated June 3, 2002 amending the Revolving Loan Agreement dated October 5, 2001 with Mid-Peninsula Bank
10.59	(21)			Letter dated December 10, 2002 amending the Revolving Loan Agreement dated October 5, 2001 as amended June 3, 2002 with Mid-Peninsula Bank
10.60	(21)	(3)		2003 Home Office Incentive Plan
10.61	(22)			Letter dated April 7, 2003 amending the Revolving Loan Agreement dated October 5, 2001 as amended June 3, 2002 and December 10, 2002 with Mid-Peninsula Bank
10.62				Letter dated August 13, 2003 amending the Revolving Loan Agreement dated October 5, 2001 as amended June 3, 2003, December 10, 2002 and April 7, 2003 with Mid-Peninsula Bank.
10.63				Letter dated August 13, 2003 amending the Commercial Deed of Trust, Financial Security Agreement and Fixture Filing dated Aug 13, 2001 with Mid Peninsula Bank.
31.1				Certification by the Chief Executive Officer of his responsibility for financial reports under section 302 of the Sarbanes-Oxley Act.
31.2				Certification by the Chief Financial Officer of his responsibility for financial reports under section 302 of the Sarbanes-Oxley Act.
32.1				Certification by the Chief Executive Officer of his responsibility for financial reports under section 906 of the Sarbanes-Oxley Act.
32.2				Certification by the Chief Financial Officer of his responsibility for financial reports under section 906 of the Sarbanes-Oxley Act.

 

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(1)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Registration Statement on Form S-1 (No. 33-53904) filed October 29, 1992, as amended by Amendment No. 1 to Form S-1 (No. 33-53904) filed December 7, 1992, except that Exhibit 3.1 is incorporated by reference from Exhibit 3.1C and Exhibit 3.2 is incorporated by reference from Exhibit 3.2B.

 

(2)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended September 4, 1994.

 

(3)  Agreements or compensatory plans covering executive officers and directors of Fresh Choice, Inc.

 

(6)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 1995.

 

(8)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Quarterly Report on form 10-Q for the quarter ended March 24, 1996.

 

(10)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended September 8, 1996.

 

(11)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 29, 1996.

 

(13)  Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended June 14, 1998.

 

(14)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 27, 1998.

 

(15)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 26, 1999.

 

(16)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.

 

(17)  Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended March 24, 2002.

 

(18)  Incorporated by reference from the Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 30, 2001.

 

(19)  Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended March 24, 2002.

 

(20)  Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended June 16, 2002.

 

(21)  Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 29, 2002.

 

(22)  Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended March 23, 2003.

 

25