FRESH CHOICE INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT under SECTION 13 OR 15(d) of the SECURITIES EXCHANGE ACT OF 1934

	For the quarter ended September 5, 2004

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the transition period from ______________ to ______________.

Commission file number 0-20792

FRESH CHOICE, INC.
(Exact name of registrant as specified in its charter)

Delaware		77-0130849
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employee Identification No.)

485 Cochrane Circle, Morgan Hill, California 95037
(Address of principal executives offices) (Zip Code)

Registrant’s telephone number, including area code: (408) 776-0799

Former name, former address and former fiscal year, if changed since last report.

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.

x 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 x No

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of Common Stock, $.001 par value, outstanding as of October 1, 2004 was 6,037,461.

FRESH CHOICE, INC.

INDEX

PART I - FINANCIAL INFORMATION

	Item 1 - Financial Statements

		Unaudited Condensed Consolidated Balance Sheets at September 5, 2004 and December 28, 2003	3

		Unaudited Condensed Consolidated Statements of Operations for the Twelve and Thirty-Six Weeks ended September 5, 2004 and September 7, 2003	4

		Unaudited Condensed Consolidated Statements of Cash Flows for the Thirty-Six Weeks ended September 5, 2004 and September 7, 2003	5

		Notes to Unaudited Condensed Consolidated Financial Statements	6

	Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations		14

	Item 3 - Quantitative and Qualitative Disclosures About Market Risk		31

	Item 4- Controls and Procedures		31

PART II - OTHER INFORMATION

	Item 1 - Legal Proceedings		32
	Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds		32
	Item 3 - Defaults Upon Senior Securities		32
	Item 4 - Submission of Matters to a Vote of Security Holders		32
	Item 5 - Other Information		32
	Item 6 - Exhibits and Reports on Form 8-K		32

SIGNATURES			33

INDEX TO FORM 10-Q EXHIBITS			34

PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements
FRESH CHOICE, INC. (Debtor in Possession as of July 12, 2004)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)

(Unaudited)	September. 5, 2004				December 28, 2003

ASSETS:

CURRENT ASSETS:
Cash and cash equivalents		$	2,647			$	1,379
Assets held for sale			3,490				-
Inventories			367				357
Prepaid expenses and other current assets			732				609

Total current assets			7,236				2,346

PROPERTY AND EQUIPMENT, net			15,232				19,054
DEPOSITS AND OTHER ASSETS			1,072				720
ASSETS FROM DISCONTINUED OPERATIONS			233				8,735

TOTAL ASSETS		$	23,773			$	30,854

LIABILITIES AND STOCKHOLDERS’ EQUITY:

LIABILITIES

CURRENT LIABILITIES:
Accounts payable		$	547			$	1,500
Other accrued expenses			3,628				3,207
Accrued salaries and wages			1,481				1,293
Sales tax payable			572				465
Current portion of long-term obligations			2,351				579
Liabilities subject to compromise			10,070				-

Total current liabilities			18,649				7,043

CAPITAL LEASE OBLIGATIONS			-				987
LONG-TERM DEBT			110				1,886
OTHER LONG-TERM LIABILITIES			1,900				2,287
LIABILITIES FROM DISCONTINUED OPERATIONS			431				2,940

Total liabilities			21,091				15,144

STOCKHOLDERS’ EQUITY:
Convertible preferred stock, $.001 par value; 3.5 million shares authorized; shares outstanding: 2004 and 2003 - 1,187,906; liquidation preference; 2004-$9,287; 2003-$8,826			5,175				5,175
Common stock - $.001 par value; 15 million shares authorized; shares outstanding: 2004 - 6,037,461; 2003 - 6,017,190			42,744				42,714
Accumulated deficit			(45,237	)			(32,179	)

Total stockholders’ equity			2,682				15,710

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	23,773			$	30,854

The December 28, 2003 amounts are derived from the Company’s audited financial statements.
See accompanying notes to condensed consolidated financial statements.

FRESH CHOICE, INC. (Debtor in Possession as of July 12, 2004)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

	Twelve Weeks Ended								Thirty-Six Weeks Ended

	September 5, 2004				September 7, 2003				September 5, 2004				September 7, 2003


NET SALES		$	15,142			$	16,311			$	44,740			$	46,598

COSTS AND EXPENSES:
Cost of sales			3,447				3,521				9,914				10,263
Restaurant operating expenses:
Labor			4,945				5,054				14,769				14,858
Occupancy and other			5,081				4,982				14,455				14,498
General and administrative expenses			1,270				1,195				3,704				3,865
Depreciation and amortization			571				592				1,764				1,812
Store closure and asset impairment expenses			407				-				3,511				-

Total costs and expenses			15,721				15,344				48,117				45,296


OPERATING INCOME (LOSS)			(579	)			967				(3,377	)			1,302

Chapter 11 related reorganization expenses			(546	)			-				(546	)			-
Interest expense, net			(95	)			(67	)			(256	)			(200	)


INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES			(1,220	)			900				(4,179	)			1,102
Provision for income taxes			-				-				-				-

INCOME (LOSS) FROM CONTINUING OPERATIONS			(1,220	)			900				(4,179	)			1,102
LOSS FROM DISCONTINUED OPERATIONS NET OF TAX			(3,539	)			(1,151	)			(8,878	)			(2,125	)

NET INCOME (LOSS)		$	(4,759	)		$	(251	)		$	(13,057	)		$	(1,023	)

Basic net loss per common share:
Income (loss) from continued operations		$	(0.20	)		$	0.15			$	(0.70	)		$	0.18
Loss from discontinued operations			(0.59	)			(0.19	)			(1.47	)			(0.35	)

Basic net loss per common share:		$	(0.79	)		$	(0.04	)		$	(2.17	)		$	(0.17	)

Shares used in computing basic per share amounts			6,037				5,991				6,025				5,974

Diluted net loss per common share:
Income (loss) from continued operations		$	(0.20	)		$	0.12			$	(0.70	)		$	0.15
Loss from discontinued operations			(0.59	)			(0.19	)			(1.47	)			(0.35	)

Diluted net loss per common share:		$	(0.79	)		$	(0.04	)		$	(2.17	)		$	(0.17	)

Shares used in computing diluted per share amounts from continuing operations			6,037				7,210				6,025				7,166

Shares used in computing diluted per share amounts from discontinued operations and net loss per common share			6,037				5,991				6,025				5,974

See accompanying notes to condensed consolidated financial statements.

FRESH CHOICE, INC. (Debtor in Possession as of July 12, 2004)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)	Thirty-Six Weeks Ended

	September 5, 2004				September 7, 2003


OPERATING ACTIVITIES OF CONTINUING OPERATIONS :
Inome (loss) from continuing operations		$	(4,179	)		$	1,102
Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities from continuing operations:
Depreciation and amortization			1,908				1,961
Non-cash store closure and asset impairment expenses			3,425				-
Chapter 11 related reorganization expenses			546				-
Issuance of common stock for consulting services			-				1
Loss on disposal of property and equipment			6				55
Deferred rent			(410	)			(319	)
Change in operating assets and liabilities:
Inventories			(31	)			(42	)
Prepaid expenses and other current assets			(125	)			(384	)
Accounts payable			(953	)			(991	)
Accrued salaries and wages			274				(44	)
Liabilities subject to compromise			3,869				-
Other accrued expenses			50				300

Net cash provided by operating activities of continuing operations			4,379				1,640

NET CASH USED FOR REORGANIZATION ITEMS			(650	)			-

INVESTING ACTIVITIES:
Capital expenditures			(777	)			(678	)
Proceeds from sale of property and equipment			6				4
Deposits and other assets			12				7

Net cash used in investing activities			(759	)			(667	)

FINANCING ACTIVITIES:
Common stock sales			28				47
Bank borrowings			500				-
Long-term debt - repayments			(73	)			(102	)
Capital lease obligations - repayments			(237	)			(354	)

Net cash provided (used) by financing activities			218				(409	)

CASH PROVIDED BY CONTINUING OPERATIONS			3,188				564
CASH USED BY DISCONTINUED OPERATIONS			(1,919	)			(1,545	)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			1,269				(981	)
CASH AND CASH EQUIVALENTS:

Beginning of period			1,379				2,994

End of period		$	2,647			$	2,013

Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest		$	204			$	306

Cash paid during the period for income taxes		$	5			$	53

See accompanying notes to condensed consolidated financial statements

FRESH CHOICE, INC. (Debtor in Possession as of July 12, 2004)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Twelve and Thirty-Six Weeks Ended September 5, 2004 and September 7, 2003
(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. Certain amounts for the fiscal year ended December 28, 2003 balance sheet have been reclassified to conform to the September 5, 2004 presentation. 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 28, 2003.

On July 12, 2004 (the “Petition Date”), Fresh Choice, Inc. (the “Company”) filed a voluntary petition for relief (the “Filing”) under Chapter 11 (“Chapter 11”) of title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Northern District of California (the “Bankruptcy Court”). The case has been assigned No. 04-54318 (“Chapter 11 Case”). The Company is operating its business and managing its property as a debtor in possession of its assets pursuant to the Bankruptcy Code and the Company’s existing directors and officers continue to oversee operation of the Company’s business as a debtor in possession.

Financial Statement Presentation

The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code,” and on a going concern basis, which contemplates continuity of operations, timely payment for services by customers, control of operating costs and expenses and the realization of asset sales and liquidation of liabilities and commitments. The bankruptcy filing and related circumstances, including the closure of ten stores, the Company’s default on certain pre-petition debt, the losses from operations, as well as current economic conditions, raise substantial doubts about the Company’s ability to continue as a going concern, accordingly, such realization of assets and liquidation of liabilities are subject to uncertainty. In connection with a plan of reorganization, the Company may liquidate or settle liabilities for amounts other than those reflected in the Condensed Consolidated Financial Statements. Further a plan of reorganization could materially change the amounts and classifications reported in the consolidated historical financial statements, which do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of a plan of reorganization.

As reflected in the Condensed Consolidated Financial Statements, “Liabilities subject to compromise” refer to the Company’s liabilities incurred prior to the commencement of the Chapter 11 Case or claims arising from the rejection of certain real property leases. These claims are either unsecured or there is uncertainty about whether the claims are secured or unsecured or whether, in the case of the capital leases, they constitute true leases or are disguised financing agreements under the Uniform Commercial Code. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent the Company’s estimate of known or potential claims to be resolved in connection with the Chapter 11 Case. Such claims remain subject to future adjustment. Adjustments may result from negotiations, actions of the Bankruptcy Court, further developments with respect to disputed claims, rejection of executory contracts and unexpired leases, the determination as to the value of any collateral securing claims, proofs of claim, or other events. Payment terms for these amounts will be established in connection with the Chapter 11 Case.

Pursuant to the Bankruptcy Code, the Company has filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Company. Differences between amounts recorded by the Company and claims filed by creditors with the Bankruptcy Court will be investigated and resolved as part of the Chapter 11 Case. Bar dates for the filing of proofs of claim against the Company have been set for November 9, 2004 for all creditors other than governmental units, and 180 days after the Petition Date for governmental units. As of October 1, 2004, the ultimate number and allowed amounts of such claims were not known.

The Company has received approval from the Bankruptcy Court to pay or otherwise honor certain of its pre-petition obligations, including certain pre-petition employee wages, salaries, benefits and other employee obligations and certain other pre-petition claims. The pre-petition liabilities that have been approved by the Bankruptcy Court to be paid are not included in “Liabilities subject to compromise” on the accompanying condensed consolidated balance sheets at September 5, 2004.

The liabilities subject to compromise in the condensed consolidated debtor in possession balance sheet consist of the following items at September 5, 2004:

(In thousands)	September 5, 2004


Accounts payable		$	2,615
Estimated allowable claims for rejection of unexpired real estate leases			3,854
Sales taxes payable			455
Capital lease obligations			2,486
Accrued expenses			660

		$	10,070

As part of the Filing, the Company rejected certain leases as allowed by the Bankruptcy Code. The Company has recorded a liability of $3.9 million for the estimated maximum amount of allowable claims under the Bankruptcy Code for the ten restaurants closed in early July and the one restaurant closed in March, whose leases were either rejected or otherwise terminated. The ultimate allowance (or disallowance) of any claims relating to the termination or rejection of any leases shall be determined in accordance with the Bankruptcy Code and applicable bankruptcy law. The liability is included in liabilities subject to compromise in the accompanying condensed consolidated balance sheets.

The Chapter 11 related reorganization items in the condensed consolidated statements of operations for the twelve and thirty-six week periods ended September 5, 2004 consists of $528,000 of estimated professional fees, including the US Trustee fees, and $18,000 for the accrual of estimated retention payments under the Company’s non-senior executive key employee retention plans.

Pursuant to the Bankruptcy Code, schedules have been filed by the Company with the Bankruptcy Court setting forth the assets and liabilities of the Company. Differences between amounts recorded and schedules by the Company estimating the Company’s liabilities to its creditors and claims filed by creditors in the Bankruptcy Court will be investigated and resolved as part of the Chapter 11 Case.

2. STOCK-BASED COMPENSATION

The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.” 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.

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

	Twelve Weeks Ended								Thirty-Six Weeks Ended

(In thousands, except per share data)	September 5, 2004				September 7, 2003				September 5, 2004				September 7, 2003


Net loss		$	(4,759	)		$	(251	)		$	(13,057	)		$	(1,023	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards			(37	)			(47	)			(109	)			(167	)

Pro forma net loss		$	(4,796	)		$	(298	)		$	(13,166	)		$	(1,190	)


Net loss per common share:
Basic and diluted- as reported		$	(0.79	)		$	(0.04	)		$	(2.17	)		$	(0.17	)

Basic and diluted-pro forma		$	(0.79	)		$	(0.04	)		$	(2.19	)		$	(0.17	)

3. NET LOSS PER COMMON SHARE

Basic net 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 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:

	Twelve Weeks Ended								Thirty-Six Weeks Ended

(In thousands, except per share data)	September 5, 2004				September 7, 2003				September 5, 2004				September 7, 2003


Basic Net Loss Per Common Share
Income (loss) from continuing operations		$	(1,220	)		$	900			$	(4,179	)		$	1,102
Loss from discontinued operations			(3,539	)			(1,151	)			(8,878	)			(2,125	)

Net Loss		$	(4,759	)		$	(251	)		$	(13,057	)		$	(1,023	)

Weighted average common shares outstanding			6,037				5,991				6,025				5,974

Basic income (loss) per share from continuing operations		$	(0.20	)		$	0.15			$	(0.70	)		$	0.18
Basic loss per share from discontinued operations			(0.59	)			(0.19	)			(1.47	)			(0.35	)

Basic net loss per common share		$	(0.79	)		$	(0.04	)		$	(2.17	)		$	(0.17	)


Diluted Net Loss Per Common Share
Income (loss) from continuing operations		$	(1,220	)		$	900			$	(4,179	)		$	1,102
Loss from discontinued operations			(3,539	)			(1,151	)			(8,878	)			(2,125	)

Net Loss		$	(4,759	)		$	(251	)		$	(13,057	)		$	(1,023	)

Weighted average common shares outstanding			6,037				5,991				6,025				5,974
Dilutive shares:
Stock options			-				31				-				4
Convertible preferred stock			-				1,188				-				1,188

Total shares and dilutive shares			6,037				7,210				6,025				7,166

Diluted income (loss) per share from continuing operations		$	(0.20	)		$	0.12			$	(0.70	)		$	0.15
Diluted loss per share from discontinued operations			(0.59	)			(0.19	)			(1.47	)			(0.35	)

Diluted net loss per common share		$	(0.79	)		$	(0.04	)		$	(2.17	)		$	(0.17	)

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 5, 2004		September 7, 2003		September 5, 2004		September 7, 2003


Potential Dilutive Securities
Stock options excluded		1,142		1,157		1,142		1,157
Stock warrants		100		100		100		100
Convertible preferred stock		1,188		1,188		1,188		1,188

4. ASSETS HELD FOR SALE

Assets held for sale is the net book value of the real property of four restaurants, which are currently listed for sale. Three of these restaurants had been written down to estimated net realizable value, net of costs to sell, in the second quarter of 2004. Depreciation expense is no longer being recorded on these real property assets. The estimated net realizable value, net of costs to sell, is reviewed and is further written down in the period it is determined to be necessary. The operations of these four restaurants are included in discontinued operations.

5. OTHER ACCRUED EXPENSES

The components of other accrued expenses are as follows:

(In thousands)	September 5, 2004			December 28, 2003


Accrued workers’ compensation		$	932		$	836
Unredeemed gift certificates			546			645
Deferred vendor allowances			403			483
Accrued utilities			301			339
Accrued advertising			172			245
Accrued property taxes			71			52
Accrued insurance			104			156
Accrued professional fees			109			108
Accrued Chapter 11 related reorganization expenses			432			-
Accrued rent			382			-
Other			176			343

		$	3,628		$	3,207

6. ASSETS AND LIABILITIES FROM DISCONTINUED OPERATIONS

The components of assets and liabilities from discontinued operations are as follows:

(In thousands)	September 5, 2004			December 28, 2003

ASSETS:

CURRENT ASSETS:
Inventories		$	33		$	116
Prepaid expenses and other current assets			6			171

Total current assets			39			286

PROPERTY AND EQUIPMENT, net			190			8,443

DEPOSITS AND OTHER ASSETS			4			5

ASSETS FROM DISCONTINUED OPERATIONS		$	233		$	8,735

LIABILITIES

CURRENT LIABILITIES:
Accounts payable		$	154		$	448
Other accrued expenses			52			204
Accrued salaries and wages			92			245
Sales tax payable			39			86
Current portion of long-term obligations			-			339

Total current liabilities			337			1,323

CAPITAL LEASE OBLIGATIONS			-			1,136

OTHER LONG-TERM LIABILITIES			95			482

LIABILITIES FROM DISCONTINUED OPERATIONS		$	431		$	2,940

7. BORROWING ARRANGEMENTS

The Company has a $2,200,000 loan (the “Loan”), with a commercial bank. 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, which is currently held for sale. The Note bears interest at the prime rate (4.5% at September 5, 2004) 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 5, 2004 the Company had $1,850,000 of debt outstanding under the Loan described above, all of which was included in the current portion of long-term obligations as the Company was not in compliance with certain covenants and the bank had the right, subject to the automatic stay in effect during the Chapter 11 Case, to demand payment of the balance due. The Deed of Trust requires the Company to maintain a minimum debt service coverage ratio and to maintain a minimum tangible net worth.

In March 2004 the Company amended its $2,000,000 revolving line of credit (the “Agreement”) with its bank to increase the amount to $3,000,000 and extend the Agreement to May 17, 2005. Borrowings bear interest at the prime rate (4.5% at September 5, 2004) plus 0.5%. Certain of the Company’s personal property collateralize borrowings under the Agreement. On September 5, 2004 the Company had $500,000 in borrowings outstanding under the Agreement which was included in the current portion of long-term obligations as the Company was not in compliance with certain covenants under the agreement and the bank had the right, subject to the automatic stay in effect during the Chapter 11 Case, to demand payment of the balance due. In addition, the Company had $2,322,000 utilized to support outstanding letters of credit required under its workers’ compensation program. The letters of credit, which are scheduled to expire March 1, 2005, will automatically extend for a one-year period.

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 not in compliance with certain financial covenants under the amended Agreement at September 5, 2004.

The Company had capital lease obligations at September 5, 2004 that totaled $2,486,000, all of which were included in liabilities subject to compromise as there is uncertainty about whether these claims are secured or unsecured or whether the capital leases constitute true leases or are disguised financing agreements under the Uniform Commercial Code. Three of these capital lease obligations, totaling $935,000, were rejected as of July 12, 2004 and the equipment returned to the lessor pursuant to section 365(d)(10) of the Bankruptcy Code. The Company did not make the July 1, 2004 or the August 1, 2004 payments on the remaining equipment leases, which gave the leasing companies the right, subject to the automatic stay in effect during the Chapter 11 Case, to demand payment of the remaining lease payments.

Long-Term Debt consists of an $111,000 note for site construction costs of which $1,000 was included in the current portion of long-term obligations.

At September 5, 2004 the current portion of long-term obligations consisted of:

(In thousands)
	Current Portion

Secured Note		$	1,850
Secured Line of Credit			500
Other Note Payable			1

Total Current Portion of long- term obligations		$	2,351

The Company’s other long-term liabilities include deferred rent of $1,467,000 at September 5, 2004. The Company’s deferred rent liability consists of the net cumulative rent expensed in excess of rent payments since inception of these leases. In addition other long term liabilities includes $163,000 of deferred income at September 5, 2004 from a gain on the 1993 sale and leaseback of a building and land for one of the Company’s restaurants. The Company is amortizing the gain over the 20-year initial term of the lease. The remaining balance of $270,000 in other long-term liabilities is the non-current portion of certain employee benefit plans.

8. STORE CLOSURE AND ASSET IMPAIRMENT EXPENSES

In the second quarter ended June 13, 2004, the Company recorded a non-cash impairment charge of $6,953,000 ($2,804,000 for continuing operations and $4,149,000 for discontinued operations) for the write-down of buildings, leasehold improvements and equipment to fair value for eighteen of the Company’s restaurants. The Company closed ten of these restaurants in the third quarter (eight of which had been impaired prior to the second quarter). The ten closed restaurants were operating at negative cash flows and were projected to incur future negative cash flows. The Company intends to either sell or discontinue operations at the other eight impaired restaurants. Fifteen of the impaired or closed locations are located in Southern California, Texas and Washington, which are outside of the Company’s core northern California markets. The impairment charge for the eighteen restaurants was required because the carrying amounts of the impaired assets were not recoverable from their currently projected undiscounted cash flows. The impairment loss was calculated as the difference between the carrying amount and fair value of the assets. In addition, the Company closed one previously impaired restaurant in the second quarter and recorded a $300,000 charge in continuing operations for the estimated cash costs associated with the restaurant closure and settlement of the lease obligation.

In the third quarter ended September 5, 2004 the Company recorded a $3,626,000 ($407,000 for continuing operations and $3,219,000 for discontinued operations) store closure and asset impairment charge which consisted of; (i) a $3,492,000 charge to record or adjust the expected cash liability to the maximum amount of allowable claims under the Bankruptcy Code for leases either rejected or otherwise terminated for eleven closed restaurants, (ii) a $443,000 non-cash credit for the reversal of the remaining deferred rent for these eleven rejected leases, (iii) a charge of $177,000 for the cash costs associated with the restaurant closures, and (iv) a non- cash asset impairment charge of $400,000 for the write-down of buildings, leasehold improvements and equipment to fair value primarily for three of the Company’s restaurants, one of which had been previously partially impaired. The impairment charge for the three restaurants was required because the lease terms were amended to allow for an earlier termination and therefore the carrying amounts of the impaired assets were not recoverable from their currently projected undiscounted cash flows. The impairment loss was calculated as the difference between the carrying amount and fair value of the assets. The Company may incur additional impairment charges in the future if sales deteriorate at other restaurants or additional leases are amended to allow for early termination. In addition, as the Company closes restaurants in the future, the Company may incur significant store closure and lease termination charges in the period such restaurants close.

9. 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 would have a separate right to approve certain corporate actions. All shares of Series A and Series B preferred stock are senior to the Company’s common stock with respect to dividends and with respect to distributions on liquidation. Upon any liquidation, after an event of default, the holders of Series A and Series B preferred stock are entitled to be paid in full an amount equal to $4.63 per share, together with all accrued dividends at an annual rate of $0.56 per share calculated from the first date of an event of default, which occurred in fiscal 1998.

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, if any, 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. The holder has entered into a letter agreement waiving this right until the date that such holder elects to sell, transfer, convey or otherwise dispose of all its shares.

10. DISCONTINUED OPERATIONS

When a restaurant is closed or held for sale, the Company makes an evaluation as to whether its results should be reflected as discontinued operations in accordance with Statement of Financial Accounting Standard 144-”Accounting for the Impairment or Disposal of Long-Lived Assets.”

During the second quarter, the Company closed one restaurant. The Company did not consider the closure of this restaurant in the second quarter a discontinued operation as a significant portion of the closed restaurant sales were absorbed by another currently operating restaurant. A summary the results of operations for this restaurant, whose results are included in continuing operations for the twelve and thirty-six weeks ended September 5, 2004 and September 7, 2003 is as follows:

	Twelve Weeks Ended								Thirty-Six Weeks Ended

(In thousands)	September 5, 2004				September 7, 2003				September 5, 2004				September 7, 2003


Net sales		$	-			$	218			$	214			$	649
Cost of sales			-				52				56				157
Restaurant operating expenses:
Labor			-				95				99				286
Occupancy and other			-				112				105				318
Depreciation and amortization			-				4				3				12
Store closure and asset impairment expenses			7				-				307				-

Total costs and expenses			7				263				570				773

Operating loss		$	(7	)		$	(45	)		$	(356	)		$	(124	)

During the third quarter, the Company closed ten restaurants and listed four other restaurants for sale. These fourteen restaurants were deemed to be discontinued operations under the Company’s policies. The consolidated condensed financial statements present these restaurants’ operations as discontinued operations. A summary the results of operations for theses fourteen restaurants for the twelve and thirty-six weeks ended September 5, 2004 and September 7, 2003 is as follows:

	Twelve Weeks Ended								Thirty-Six Weeks Ended

(In thousands)	September 5, 2004				September 7, 2003				September 5, 2004				September 7, 2003


Net sales		$	1,623			$	3,185			$	7,742			$	9,461
Cost of sales			471				806				2,030				2,464
Restaurant operating expenses:
Labor			756				1,316				3,473				4,020
Occupancy and other			692				1,220				3,263				3,425
Depreciation and amortization			9				228				409				626
Store closure and asset impairment expenses			3,219				730				7,368				730
Restaurant opening costs			-				-				-				236
Interest expense			15				36				77				85


Total costs and expenses			5,162				4,336				16,620				11,586

Loss from discontinued operations		$	(3,539	)		$	(1,151	)		$	(8,878	)		$	(2,125	)

The Company anticipates it will have additional discontinued operations as leases expire or other restaurants are closed as part of the Company’s reorganization process. Any future restaurant closures will be evaluated as to whether they should be treated as discontinued operations based upon the Company’s accounting policies.

11. RECENTLY ISSUED ACCOUNTING STANDARDS

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN No. 46), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. FIN No. 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. Variable interest entities that effectively disperse risk will not be consolidated unless a single party holds an interest or combination of interests that effectively recombines risks that were previously dispersed. FIN No. 46 also requires enhanced disclosure requirements related to variable interest entities. FIN No. 46 was revised in December 2003 and is effective for the first financial reporting period ending after March 15, 2004. The Company adopted the provisions of FIN No. 46 for the fiscal quarter ending March 21, 2004, which did not have a material impact on the 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 5, 2004. 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 28, 2003 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 28, 2003.

Certain statements set forth in this discussion and analysis of financial condition and results of operations including, among others, the Company’s ability to continue as a going-concern 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 Risks”, including the ability of the Company to successfully reorganize its remaining operations and restructure its financial affairs under Chapter 11 of the Bankruptcy Code; the ability of the Company to return to positive comparable-store sales and achieve profitability; and the Company’s ability to secure and retain services of experienced personnel during the Chapter 11 proceedings.

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.

On July 12, 2004, the Company filed a voluntary petition for relief under chapter 11 of title 11 of the Bankruptcy Code in the Bankruptcy Court. The case has been assigned No. 04-54318. The Company is operating its business and managing its property as a debtor in possession of its assets and the Company’s existing directors and officers continue to oversee operation of the Company’s business as a debtor in possession.

Consequences of the Chapter 11 Filing

As a consequence of the Filing, all pending claims against the Company are stayed automatically by section 362 of the Bankruptcy Code, and absent further order of the Bankruptcy Court, no party may take any action to recover any pre-petition claims, enforce any lien against or obtain possession of any property from the Company. In addition, pursuant to Section 365 of the Bankruptcy Code, the Company may reject or assume pre-petition executory contracts and unexpired leases. The non-debtor parties to these contracts or leases may file claims with the Bankruptcy Court in accordance with the Chapter 11 reorganization process.

As provided by the Bankruptcy Code, the Company initially will have the exclusive right for 120 days following the Petition Date to propose a plan of reorganization. If the Company fails to file a plan of reorganization during such period or any extension thereof, or if such plan is not accepted by the requisite numbers of creditors and equity holders entitled to vote on the plan within 180 days after the Petition Date or any extension thereof, other parties in interest may be permitted to propose their own plan or plans of reorganization for the Company. The Company is unable to predict at this time what the treatment of creditors and equity holders of the Company will be under any proposed plan or plans of reorganization.

The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and the Company’s stockholders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Case. There can be no assurance that there will be sufficient assets to satisfy the Company’s pre-petition liabilities in whole or that the Company’s equity securities will have any continuing value. As between our two classes of equity securities, preferred stock and common stock, the preferred stockholder is entitled to receive a substantial preference payment before the common stockholders receive any distributions, so it is entirely possible that most or all amounts available to satisfy equity securities holders claims will be distributed to the preferred stockholder with common stockholders possibly receiving little or nothing for their securities. Under a plan of reorganization, pre-petition creditors could receive less than 100% of the face value of their claims and the Company’s equity securities could be cancelled. In addition, the Company has not yet proposed a plan of reorganization. It is not possible to predict the outcome of the Chapter 11 Case, the terms and provisions of any plan of reorganization, or the effect of the Chapter 11 reorganization process on the claims of the creditors of the Company or the interests of the Company’s equity security holders.

The Company believes it may need to obtain additional financing to fund the operations during the Chapter 11 proceedings and the Company is pursuing raising debtor in possession financing. In addition the Company is pursuing the sale of certain assets. There can be no assurance that additional financing will be available on terms acceptable to the Company, or at all. Failure to raise sufficient additional financing, if it is needed, would have a material adverse effect on the Company’s ability to operate as a going concern or to restructure in Chapter 11.

In addition, the ability of the Company to continue as a going concern (including its ability to meet post-petition obligations of the Company) and the appropriateness of using the going concern basis for its financial statements are dependent upon, among other things, any orders entered by the Bankruptcy Court concerning matters outside of the ordinary course of business, and obtaining confirmation of a plan of reorganization under the Bankruptcy Code. The consolidated financial statements contain no adjustments related to this uncertainty.

On July 21, 2004, the Company’s securities were delisted from the NASDAQ National Market. The Company’s common stock currently trades on the NASD OTC listing system under the symbol SALDQ.OB.

Background of Filing

The Company’s operations have produced losses on declining same store sales for much of the past three years. In addition, the Company’s new restaurants, opened during the same time period, have not performed up to the Company’s expectations and have suffered significant losses. The Company’s comparable store sales improved in the first quarter of 2004 and the Company expected that this positive trend would continue into the second and third quarters, traditionally the Company’s strongest sales periods.

The Company’s comparable store sales did not continue to improve as the Company expected. Instead, comparable store sales were down 4.8% in the second quarter of 2004 versus the same quarter a year-ago. In fact, the sales trend grew worse during the second quarter with comparable store sales down, versus the comparable year-ago period, 2.3% in the first four-week period of the second quarter, 3.5% in the second four-week period and 8.6% in the last four-week period of the quarter.

In addition, sales at the Company’s newer restaurants did not improve as expected and continued to perform below expectations. Average restaurant sales at the Company’s five newer locations, open for both lunch and dinner and not included in comparable store sales, were 46.1% below the comparable store sales average for the second quarter.

These declining sales trends resulted in reduced cash flow. As a result of the reduced cash flow, the Company failed to achieve the required minimum debt service coverage or maximum debt to tangible net worth ratios required under the Company’s lending agreements. Failure to achieve these covenants gave the bank the right, subject to the automatic stay in effect during the Chapter 11 Case, to declare the Company’s loans in default and to demand payment of the $1,850,000 of outstanding debt under its secured loan and the $500,000 outstanding debt under its revolving line of credit.

As sales continued to deteriorate, the Company’s revised then-existing internal projections indicated the Company would not generate sufficient cash to cover operating and capital requirements for the remainder of fiscal 2004. The Company, therefore, decided to close ten cash flow negative restaurants in early July and file for protection under Chapter 11 of the Bankruptcy Code on July 12, 2004.

Financial Statement Presentation

The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with AICPA Statement of Position 90-7 (“SOP 90-7”), “Financial Reporting by Entities in Reorganization under the Bankruptcy Code,” and on a going concern basis, which contemplates continuity of operations, timely payment for services by customers, control of operating costs and expenses and the realization of asset sales and liquidation of liabilities and commitments. The bankruptcy filing and related circumstances, including the closure of ten stores, the Company’s default on certain pre-petition debt, the losses from operations, as well as current economic conditions, raise substantial doubts about the Company’s ability to continue as a going concern, accordingly, such realization of assets and liquidation of liabilities are subject to uncertainty. In connection with its plan of reorganization, the Company may liquidate or settle liabilities for amounts other than those reflected in the Condensed Consolidated Financial Statements. Further, a plan of reorganization could materially change the amounts and classifications reported in the consolidated historical financial statements, which do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of a plan of reorganization.

As part of the Filing, the Company rejected certain leases as allowed by the Bankruptcy Code. The Company has recorded a liability of $3.9 million for the estimated maximum amount of allowable claims under the Bankruptcy Code for the ten restaurants closed in early July and the one restaurant closed in March, whose real property leases were either rejected or otherwise terminated. The ultimate allowance (or disallowance) of any claims relating to the termination or rejection of any leases shall be determined in accordance with the Bankruptcy Code and applicable bankruptcy law. The liability is included in liabilities subject to compromise in the accompanying condensed consolidated balance sheets.

The Chapter 11 related reorganization items in the condensed consolidated statements of operations for the twelve and thirty-six week periods ended September 5, 2004 consists of $528,000 of estimated professional fees, including US Trustee fees, and $18,000 for the accrual of estimated retention payments under the Company’s non-senior executive key employee retention plans.

Liquidity and Capital Resources

The Company’s operations have produced losses on declining same store sales for much of the past three years. These declining sales trends resulted in reduced cash flow and an increased net working capital deficit. As sales deteriorated in the second quarter of 2004, the Company’s revised internal projections, at that time, indicated the Company would not generate sufficient cash to cover operating and capital requirements for the remainder of fiscal 2004. The Company, therefore, decided to close ten cash flow negative restaurants in early July and file for protection under Chapter 11 of the Bankruptcy Code on July 12, 2004.

The Company believes it may need to obtain additional financing to fund the operations during the Chapter 11 proceedings and the Company is pursuing raising debtor in possession financing. In addition, the Company is pursuing the sale of certain assets. There can be no assurance that additional financing will be available on terms acceptable to the Company, or at all. Failure to raise sufficient additional financing, if it is needed, would have a material adverse effect on the Company’s ability to operate as a going concern or to restructure in Chapter 11.

The Company’s primary capital requirements had 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.

The Company has a $2,200,000 loan (the “Loan”), with a commercial bank. 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, which is currently held for sale. The Deed of Trust requires the Company to maintain a minimum debt service coverage ratio and to maintain a minimum tangible net worth. The Note bears interest at the prime rate (4.5% at September 5, 2004) 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 5, 2004 the Company had $1,850,000 of debt outstanding under the Loan described above, all of which was included in the current portion of long-term obligations at September 5, 2004 as the Company was not in compliance with the minimum debt service ratio and the bank had the right, subject to the automatic stay in effect during the Chapter 11 Case, to demand payment of the balance due.

Covenant compliance is reported quarterly and the Company was not in compliance with certain financial covenants under the amended Agreement at September 5, 2004.

The Company had capital lease obligations at September 5, 2004 that totaled $2,486,000, all of which was included in liabilities subject to compromise as there is uncertainty about whether these secured claims are secured or unsecured or whether the capital leases constitute true leases or are disguised financing agreements under the Uniform Commercial Code. Three of these capital lease obligations, totaling $935,000, were rejected as of July 12, 2004 and the equipment returned to the lessor pursuant to section 365 (d)(10) of the Bankruptcy Code. The Company did not make the July 1, 2004 or the August 1, 2004 payments on the remaining equipment leases, which gave the leasing companies the right, subject to the automatic stay in effect during the Chapter 11 Case, to demand payment of the remaining lease payments.

Long-Term Debt consists of an $111,000 note for site construction costs of which $1,000 was included in the current portion of long-term obligations.

At September 5, 2004 the current portion of long-term obligations consisted of:

(In thousands)
	Current Portion

Secured Note		$	1,850
Secured Line of Credit			500
Other Note Payable			1

Total Current Portion of long- term obligations		$	2,351

Net cash provided by operating activities of continuing operations for the first thirty-six weeks of 2004 was $4,379,000 and consisted of:

(In thousands)

Loss from continuing operations	$	(4,179	)
Adjustments to reconcile loss from continuing operations to net cash provided by operating activities from continuing operations:
Depreciation and amortization		1,908
Non-cash store closure and asset impairment expenses		3,425
Chapter 11 related reorganization expenses		546
Change in operating assets and liabilities		3,083
Change in deferred rent and other		(404	)

Net cash provided by operating activities from continuing operations	$	4,379

Net cash provided by operating activities of continuing operations for the first thirty-six weeks of 2004 included a change in operating assets and liabilities of $3,083,000. The change in operating assets and liabilities of $3,083,000 was primarily due to the timing of payments, which have been impacted by the Company’s filing for protection under Chapter 11 of the Bankruptcy Code.

Net cash used for reorganization items for the first thirty-six weeks of 2004 included:

	September 5, 2004


Retainers paid to professionals		$	190,000
Professional fees paid			114,000
Vendor deposits			346,000

Total		$	650,000

During the same period the Company’s continuing operations invested $777,000 in property and equipment, consisting primarily of restaurant equipment and the remodeling of one restaurant.

Cash used by discontinued operations for the first thirty-six weeks of 2004 and 2003 is comprised of the following for the fourteen restaurants deemed to be discontinued operations:

	Thirty-Six Weeks Ended

	September 5, 2004				September 7, 2003


Loss from discontinued operations		$	(8,878	)		$	(2,125	)
Depreciation and amortization			409				626
Non-cash store closure and asset impairment expenses			7,190				730
Deferred rent			56				30
Change in operating assets and liabilities:
Inventories			83				(11	)
Prepaid expenses and other current assets			165				-
Accounts payable			(294	)			88
Accrued salaries and wages			(200	)			72
Other accrued expenses			(153	)			(7	)
Capital expenditures			(129	)			(1,670	)
Deposits and other assets			1				13
Capital lease borrowings			-				904
Capital lease repayments			(170	)			(194	)

		$	(1,919	)		$	(1,545	)

The Company’s contractual obligations as of September 5, 2004 are as follows:

(In thousands)
	Total		Remainder of 2004			2005 through 2007			2008 through 2009			2010 and thereafter

Secured Note	$	1,850		$	1,850		$	-		$	-		$	-
Secured Line of Credit		500			500			-			-			-
Other Note Payable		111			1			4			4			102
Liabilities Subject to Compromise		10,070			10,070			-			-			-
Operating Leases		108,139			2,581			21,142			14,340			70,076

Total Contractual Cash Obligations	$	120,670		$	15,002		$	21,146		$	14,344		$	70,178

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. All shares of Series A and Series B preferred stock are senior to the Company’s common stock with respect to dividends and with respect to distributions on liquidation. Upon any liquidation, after an event of default, the holders of Series A and Series B preferred stock are entitled to be paid in full an amount equal to $4.63 per share, together with all accrued dividends at an annual rate of $0.56 per share calculated from the first date of an event of default, which occurred in fiscal 1998.

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 Series A preferred stock nor has it exercised its right to elect a majority of the Board of Directors. In December 2003 such holder entered into a letter agreement whereby the holder of the Series B preferred stock agreed to not convert any of its shares of Series B preferred stock into Series A preferred stock so long as the holder owns the Series B preferred shares.

The Company’s ability to emerge from bankruptcy is dependent upon the success of its plans to increase cash from operations by (i) consolidating its operations primarily to its core northern California markets, (ii) increasing sales in those remaining restaurants while (iii) reducing costs to an appropriate level given the reduced size of the Company. See “Business Risks” included herein.

Post Filing Liquidity

On July 12, 2004 the Company filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, and, as a result, all pending claims against the Company are stayed automatically. Accordingly, subject to the requirements of Bankruptcy Code Section 365, the Company may reject or assume pre-petition executory contracts and leases as allowed by the Bankruptcy Code. The Company has rejected the real and personal property leases at eleven closed restaurants, to the extent that such leases had not been previously terminated, and is currently reviewing all other pre-petition executory contracts to determine which other agreements it will assume or reject.

Currently, subject to resolution of outstanding leases claims and its ability to raise interim financing, the Company believes that all known, non-disputed, non-contingent claims can be paid in full. However, there is no assurance that there will be sufficient assets to satisfy the Company’s pre-petition liabilities in whole. Under a plan of reorganization, pre-petition creditors could receive less than 100% of the face value of their claims. Although it is possible that the Company will have excess assets after payment of liabilities and its equity securities will continue to have value, it is entirely possible, under certain scenarios post Chapter 11, that one or more classes of equity securities will have diminished or no value at all. It is not possible to predict the outcome of the Chapter 11 Case, the terms and provisions of any plan of reorganization, or the effect of the Chapter 11 reorganization process on the claims of the Company’s creditors or the interests of the Company’s equity security holders.

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:

Bankruptcy Filing. On July 12, 2004, the Company filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. As a result, the Company is presently operating its business as a debtor in possession. Currently, neither the Company nor its creditors have proposed a plan of reorganization and there can be no assurance that the Bankruptcy Court will confirm any plan of reorganization that the Company or its creditors committee may propose. As provided by the Bankruptcy Code, the Company initially has the exclusive right to propose a plan of reorganization for 120 days following the filing of its Chapter 11 petition. If the Company fails to file a plan of reorganization during such period or any extension thereof, or if such plan is not accepted by the requisite numbers of creditors and equity holders entitled to vote on the plan within 180 days of the Filing Date or any extension of such period, other parties in interest in the Chapter 11 Case may be permitted to propose their own plan or plans of reorganization. The failure to have a plan of reorganization approved by the Bankruptcy Court could result in a liquidation of the Company’s remaining assets. Furthermore, there can be no assurance that there will be any improvement in the Company’s financial condition or results of operations upon consummation of a plan of reorganization. During the Chapter 11 Case, the Company has incurred, and will continue to incur, significant costs associated with the reorganization, including, but not limited to, professional fees and other cash demands typical in bankruptcy proceedings. These costs, which will be expensed as incurred, are expected to significantly affect the Company’s results of operations and decrease assets available for use in the reorganization. Further, the Chapter 11 filing, and the potential adverse publicity associated with it, may have adverse effects on the Company’s business and ability to reorganize. Customers counts in the Company’s remaining restaurants declined following the announcement of the Chapter 11 filing, and, although improved since, may decline further as the result of publicity surrounding the filing. In addition, the Company’s current vendors may attempt to cancel services or renegotiate existing arrangements as a result of the Chapter 11 filing.

In addition, the Company has not yet proposed its plan of reorganization, and it is uncertain at this time what will be the effect of the plan on its creditors and stockholders. The Company does not know if the plan will provide for payment of the whole or part of the claims of its creditors, nor whether the current equity securities will remain intact. Moreover, the Company may be unable to develop, prosecute, confirm and consummate a plan of reorganization, and may incur unanticipated expenses of and liabilities associated with bankruptcy. The Company may also incur additional, unknown claims, as part of its bankruptcy proceeding that it cannot currently determine. If such claims are filed, they would reduce the amount available for distribution to the Company’s creditors and stockholders.

Operating Losses and Historical Declines in Comparable Store Sales. The Company’s quarterly and annual operating results and same store sales have fluctuated significantly in the past and are likely to fluctuate significantly in the future. The Company has reported a loss for the last two years and for the first thirty-six weeks of 2004 and there can be no assurance that the Company will be profitable over the long or short term.

The Company’s comparable store sales decreased for the three fiscal years of 2001 through 2003 and have decreased 3.2% (for the thirty-eight comparable stores in continuing operations) in the first thirty-six weeks of 2004. This negative trend has continued with comparable store sales for the thirty-nine comparable stores in continuing operations down 3.8% for the first four-week period of the fourth quarter. There can be no assurance that the comparable store sales declines experienced in 2001 through 2003, and through the first thirty-six weeks of 2004, will not continue or not decline further.

Operating as a ‘Going Concern.” The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue to operate as a going concern, which contemplates continuity of operations, timely payment for services by customers, control of operating costs and expenses and the realization of asset sales and liquidation of liabilities and commitments. The bankruptcy filing and related circumstances, including the closure of ten stores, the Company’s default on certain pre-petition debt, the losses from operations, as well as current economic conditions, raise substantial doubts about the Company’s ability to continue as a going concern. The appropriateness of reporting on a going concern basis is dependent upon, among other things, the availability of sufficient capital to meet expenses, confirmation of a plan of reorganization, future profitable operations, customer and employee retention and the ability to generate sufficient cash from operations and financing sources to meet the Company’s obligations as they become due. The Company has assumed all of the foregoing. Should some or all of these assumptions prove to be unfounded or prove to be untrue in the future, the Company’s results of operations and financial condition will be adversely affected and its ability to continue as a going concern will be doubtful.

NASDAQ Delisting. In July 2004 the Company’s common stock was delisted from the NASDAQ National Market. The Company’s common stock is quoted on the NASD Over-the-Counter (OTC) bulletin board quotation service. This has reduced the market and liquidity of the Company’s common stock and consequently the ability of stockholders and broker/dealers to purchase and sell shares of the Company’s stock in an orderly manner or at all. The volume of trading in the Company’s stock has continued to decline since its bankruptcy filing. Trading in the Company’s common stock through market makers and quotation on the OTC Bulletin Board entails other risks. Due in part to the decreased trading price of the Company’s common stock and absence of analyst coverage, the trading price of the Company’s common stock is highly volatile, and market makers may not be able to execute trades as quickly as they could when the common stock was listed on the NASDAQ National Market.

Ability to Obtain Additional Financing. The Company believes it may need to obtain additional financing to fund the operations during the Chapter 11 proceedings and the Company is pursuing raising debtor in possession financing. In addition the Company is pursuing the sale of certain assets. There can be no assurance that additional financing will be available on terms acceptable to the Company, or at all. Failure to raise sufficient additional financing, if it is needed, would have a material adverse effect on the Company’s ability to operate as a going concern or to restructure in Chapter 11.

Employee Retention During Bankruptcy. 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 during the Chapter 11 proceedings. In addition, the loss of the services of any other key administrative personnel could materially adversely affect the Company’s ability to manage its affairs while in bankruptcy. The Company has received approval of certain key employee retention and severance plans from the Bankruptcy Court, which provides cash incentives and certain benefits to key non-senior members of our management team including restaurant managers in locations scheduled to be closed or sold. During the third quarter the Company accrued $18,000 for expected retention bonuses under these programs.

Loan Covenants. The Company did not meet certain financial covenants as required under the Company’s lending agreements. Failure to meet these covenants gives the bank the right, subject to the automatic stay in effect during the Chapter 11 Case, to declare the loans in default and to demand payment of the $1,850,000 of outstanding debt under its secured loan and the $500,000 outstanding debt under its revolving line of credit.

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. The Company has been verbally informed that the lease at one of its locations will not be renewed upon expiration on December 31, 2004.

Geographic Concentration. As of October 1, 2004, 37 of the Company's 46 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, changes in the work force, increased utility costs or other external factors 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 disproportionate amounts of net sales and net income are generally realized in the second and third fiscal quarters. Because of the seasonality of the Company’s business, the fourth quarter has the lowest average sales of any quarter of the year. The decline in average sales results in a substantial decline in the Company’s cash flow due to the significant amount of fixed and semi-fixed costs inherent in operating restaurants. 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, restaurant closings and impairment charges. 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 can be expected to decline in the first quarter of each fiscal year in comparison to the fourth quarter of the prior fiscal year.

Expansion. If the Company successfully emerges from bankruptcy, the Company believes future growth depends to a significant degree on its ability to open new restaurants and to operate such restaurants profitably. The Company currently has no development plans for 2004 or beyond.

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, if and when the Company resumes expansion, it 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.

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, if any, would have the right to elect a majority of the Company’s Board of Directors. Crescent has entered into a letter agreement waiving this right until the date that Crescent elects to sell, transfer, convey or otherwise dispose of all its shares. 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.

Critical Accounting Policies

Our accounting policies are more fully described in Note 1 of the Company’s audited December 28, 2003 financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) 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.

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 and the related equipment 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, generally consisting of leasehold improvements and equipment, 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 and the fair value of impaired assets. Accordingly, if actual results vary from such estimates, significant future impairment could result.

In the second quarter of 2004, the Company identified ten restaurants where the projected undiscounted cash flows, based upon recent results, indicated that the carrying amount of fixed assets would not be recovered. In the third quarter the Company either closed or put up for sale six of these restaurants. The impairment charge related to these restaurants was $6,060,000. Additional impairment charges of $893,000 were recorded for eight restaurants closed in the third quarter, whose assets had been partially impaired, prior to the second quarter, as it was determined based upon revised projections, which reflected deteriorating results, that the carrying value of the remaining equipment would not be recovered.

In the third quarter of 2004, the Company identified three additional restaurants whose lease terms were amended to allow for an earlier termination and therefore the projected undiscounted cash flows indicated that the carrying amount of fixed assets would not be recovered. The impairment charge related to these restaurants was $400,000. If sales continue to deteriorate in other restaurants additional impairment charges may be required.

In addition, US GAAP requires that the operating losses of underperforming restaurants be recorded in the periods incurred. US GAAP also requires that reserves for store closures and lease termination costs for any restaurant to be closed not be recognized until a restaurant ceases operations. Accordingly, the Company recorded a charge of $300,000 in the second quarter for the estimated cash costs associated with the restaurant closure and settlement of lease obligation for the restaurant closed in the second quarter. The Company recorded a charge of $3,626,000 in the third quarter which consisted of; (i) a $3,492,000 charge to record or adjust the expected cash liability from rejection of the leases for eleven closed restaurants under Section 502 (B)(6) of the Bankruptcy Code, (ii) a $443,000 non-cash credit for the reversal of the remaining deferred rent for these eleven rejected leases, and (iii) a charge of $177,000 for the cash costs associated with the restaurant closures. Additionally, as the Company closes restaurants in the future, prior to lease expirations, the Company may incur significant store closure and lease termination charges in the period such restaurants close.

Workers’ compensation claims accrual. The Company records estimates for workers’ compensation claims under its workers’ compensation program. The Company evaluates the adequacy of these accruals by evaluating information periodically provided by its insurance carrier regarding the Company’s historical experience and trends relating to insurance claims and payments and general industry experience regarding the expectation of future trends in claims development. If such information indicates that the accruals are overstated or understated, the Company will reduce or provide additional accruals as appropriate. 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. The accrual for such claims was $932,000 at September 5, 2004 versus $836,000 at December 28, 2003.

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. The Company did not consider the closure of the restaurant in the second quarter a discontinued operation as a significant portion of the closed restaurant sales were absorbed by another currently operating restaurant. Management has determined that the ten restaurants closed in the third quarter as well as the four restaurants held for sale should be classified as discontinued operations. Management anticipates that it will have discontinued operations in future quarters.

Liabilities subject to compromise. Liabilities subject to compromise consist of the Company’s liabilities incurred prior to the commencement of the Chapter 11 Case or claims arising from the rejection of certain real property leases. These claims are either unsecured or there is uncertainty about whether the claims are secured or unsecured or whether, in the case of the capital leases, they constitute true leases or are disguised financing agreements under the Uniform Commercial Code. These amounts represent the Company’s estimate of known or potential claims to be resolved in connection with the Chapter 11 Case. Such claims remain subject to future adjustment. Adjustments may result from negotiations, actions of the Bankruptcy Court, further developments with respect to disputed claims, rejection of executory contracts and unexpired leases, the determination as to the value of any collateral securing claims, proofs of claim, or other events. Payment terms for these amounts will be established in connection with the Chapter 11 Case.

Estimated allowable claims for rejection of certain real estate leases. The Company records the estimated maximum amount of allowable claims under the Bankruptcy Code for real property leases that are either rejected or otherwise terminated. The ultimate allowance (or disallowance) of any claims relating to the termination or rejection of any leases shall be determined in accordance with the Bankruptcy Code and applicable bankruptcy law.

Assets held for sale. The Company records as assets held for sale the lower of either the net book value or the estimated net realizable value, net of costs to sell, of real property that is currently listed for sale. If the net book value exceeds the estimated net realizable value, net of costs to sell, of a property the property is impaired. Three of the four restaurants currently held for sale were written down to estimated net realizable value, net of costs to sell, in the second quarter of 2004. Depreciation expense is no longer being recorded on these real property assets. The estimated net realizable value, net of costs to sell, is reviewed and is further written down in the period it is determined to be necessary.

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.

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.

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 5, 2004					September 7, 2003					September 5, 2004					September 7, 2003


NET SALES	$	15,142		100.0	%	$	16,311		100.0	%	$	44,740		100.0	%	$	46,598		100.0	%
COSTS AND EXPENSES:
Cost of sales		3,447		22.8	%		3,521		21.6	%		9,914		22.2	%		10,263		22.0	%
Restaurant operating expenses:
Labor		4,945		32.6	%		5,054		31.0	%		14,769		33.0	%		14,858		31.9	%
Occupancy and other		5,081		33.5	%		4,982		30.6	%		14,455		32.3	%		14,498		31.1	%
General and administrative expenses		1,270		8.4	%		1,195		7.3	%		3,704		8.3	%		3,865		8.3	%
Depreciation and amortization		571		3.8	%		592		3.6	%		1,764		3.9	%		1,812		3.9	%
Store closure and asset impairment expenses		407		2.7	%		-		-	%		3,511		7.8	%		-		-	%

Total costs and expenses		15,721		103.8	%		15,344		94.1	%		48,117		107.5	%		45,296		97.2	%

OPERATING INCOME (LOSS)		(579	)	(3.8	)%		967		5.9	%		(3,377	)	(7.5	)%		1,302		2.8	%

Chapter 11 related reorganization expenses		(546	)	(3.6	)%		-		-	%		(546	)	(1.2	)%		-		-	%
Interest expense, net		(95	)	(0.7	)%		(67	)	(0.4	) %		(256	)	(0.6	)%		(200	)	(0.4	)%

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		(1,220	)	(8.1	)%		900		5.5	%		(4,179	)	(9.3	)%		1,102		2.4	%

Provision for income taxes		-		-	%		-		-	%		-		-	%		-		-	%

INCOME (LOSS) FROM CONTINUING OPERATIONS		(1,220	)	(8.1%	)		900		5.5	%		(4,179	)	(9.3	)%		1,102		2.4	%
LOSS FROM DISCONTINUED OPERATIONS NET OF TAX		(3,539	)	(23.3	)%		(1,151	)	(7.0	)%		(8,878	)	(19.9	)%		(2,125	)	(4.6	)%

NET LOSS	$	(4,759	)	(31.4	)%	$	(251	)	(1.5	)%	$	(13,057	)	(29.2	)%	$	(1,023	)	(2.2	)%


Number of restaurants:
Open at beginning of period		56					56					57					53

Open at end of period		46					56					46					56

Results of Operations: Twelve Weeks Ended September 5, 2004
Compared to Twelve Weeks Ended September 7, 2003

Net Sales. Net sales from continuing operations for the quarter ended September 5, 2004 were $15,142,000, a decrease of $1,169,000 or 7.2%, from sales of $16,311,000 for the quarter ended September 7, 2003. The primary components of the net decrease in sales were:

(In thousands)

Decrease in comparable Fresh Choice restaurant sales	$	(992	)
Decrease in sales from closed restaurant		(218	)
Increase in sales in Fresh Choice Express/Starbucks		41

	$	(1,169	)

The Company had an average of 39.0 Fresh Choice restaurants included in continuing operations in the third quarter of 2004 compared to 40.0 Fresh Choice restaurants included in continuing operations in the third quarter of 2003. Sales at the Company’s 39 comparable Fresh Choice restaurants included in continuing operations, which include restaurants open at least 18 months, decreased 6.3% in the third quarter of 2004 versus the third quarter of 2003. Comparable store guest counts decreased 6.6%, while the comparable store average check increased 0.3% to $7.84, reflecting price increases and lower coupon discounts.

Net sales per Fresh Choice restaurant in continuing operations averaged $380,000 in the third quarter of 2004, a decrease of 5.2% over net sales per restaurant of $400,000 in the third quarter of 2003. The 5.2% decline in net sales per restaurant is primarily the result of a 6.3% decrease in the 39 comparable Fresh Choice restaurants.

Cost of Sales. Cost of sales (food and beverage costs) was 22.8% of sales in the third quarter of 2004 compared to 21.6% in the third quarter of 2003. Food and beverage costs increased as a percentage of sales due to increases in cost and menu enhancements introduced to increase the value offering of the menu.

Restaurant Operating Expenses. Restaurant operating expenses (labor, occupancy and other) were 66.1% of sales in the third quarter of 2004 compared to 61.6% of sales in the third quarter of 2003, an increase of 4.5% of sales.

Labor costs as a percentage of sales were 32.6% for the third quarter of 2004 compared to 31.0% in the third quarter of 2003. Labor costs, as a percentage of sales, were higher primarily due to lower average restaurant sales, a higher average wage, and higher workers’ compensation and medical benefits costs.

Occupancy and other expenses as a percentage of sales were 33.5% for the third quarter of 2004 compared to 30.6% of sales in the third quarter of 2003, an increase of 2.9% of sales. This increase is due primarily to higher maintenance, advertising, rent, common area maintenance and insurance costs combined with the impact as a percent of sales resulting from the decline in comparable store sales.

Depreciation and Amortization. Depreciation and amortization expenses in the third quarter of 2004 were 3.8% of sales compared to 3.6% of sales in the third quarter of 2003. The increase, as a percent of sales, is primarily the result of the decline in average restaurant sales, which offset the benefit of the decline in depreciation dollars resulting from the impairment of certain assets.

General and Administrative Expenses. General and administrative expenses were 8.4% of sales in the third quarter of 2004 compared to 7.3% in the third quarter of 2003. The percentage increase is primarily the result of higher legal expenses and the decline in sales.

Store Closure and Asset Impairment Expenses. In the third quarter, the Company recorded a store closure and asset impairment charge for continuing operations of $407,000. This charge was composed of: (i) a non-cash charge of $400,000 primarily for the write-down of buildings, leasehold improvements and equipment to fair value for three of the Company’s restaurants and (ii) a charge of $7,000 to reconcile the expected claim for the rejection of the lease on the restaurant closed in the second quarter. The impairment charge for the three restaurants was required because the lease terms were amended to allow for an earlier termination and therefore the carrying amounts of the impaired assets were not recoverable from their currently projected undiscounted cash flows. The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.

Chapter 11 Related Reorganization Expenses. Chapter 11 related reorganization expenses consist of $528,000 of estimated professional fees, including US Trustee fees, and $18,000 for the accrual of estimated retention payments under the Company’s non-senior executive key employee retention plans.

Interest Expense, net. Interest expense, net was $95,000 in the third quarter of 2004 compared to $67,000 in the third quarter of 2003. This increase is due to the write-off of $38,000 in unamortized lease commitment fees. 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 2004 or 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.

Loss from Discontinued Operations. The loss from discontinued operations includes the revenue and expenses of fourteen restaurants. Ten of these restaurants were cash flow negative restaurants and were closed in early July just prior to filing for protection under Chapter 11 of the Bankruptcy Code. The other four are currently listed for sale and the real property is classified as assets held for sale on the consolidated balance sheet of the Company. In addition, the loss from discontinued operations includes a store closure and asset impairment charge of $ 3,219,000. This charge consists of; (i) a $3,485,000 charge to record the expected cash liability from rejection of the leases for ten closed restaurants, (ii) a $443,000 non-cash credit for the reversal of the remaining deferred rent for these ten rejected leases, and (iii) a charge of $177,000 for the cash costs associated with the restaurant closures. The impairment charge for these restaurants was required because the carrying amounts of the impaired assets were not recoverable from their currently projected undiscounted cash flows. The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.

Results of Operations: Thirty-six Weeks Ended September 5, 2004
Compared to Thirty-six Weeks Ended September 7, 2003

Net Sales. Net sales for the thirty-six weeks ended September 5, 2004 were $44,740,000 a decrease of $1,858,000, or 4.0%, from sales of $46,598,000 for the thirty-six weeks ended September 7, 2003. The primary components of the net decrease in sales were:

(In thousands)

Decrease in comparable Fresh Choice restaurant sales	$	(1,404	)
Decrease in sales from closed restaurant		(435	)
Decrease in new Fresh Choice restaurant sales		(139	)
Increase in sales in Fresh Choice Express/Starbucks		120

	$	(1,858	)

The Company had an average of 39.4 Fresh Choice restaurants in the first three quarters of 2004 compared to 40.0 Fresh Choice restaurants in the first three quarters of 2003. Sales at the Company’s 38 comparable Fresh Choice restaurants, which include restaurants open at least 18 months, decreased 3.2% in the first three quarters of 2004 versus the first three quarters of 2003. Comparable store guest counts decreased 5.0%, while the comparable store average check increased 1.8% to $7.90, reflecting price increases and lower coupon discounts.

Net sales per Fresh Choice restaurant averaged $1,112,000 in the first three quarters of 2004, a decrease of 2.8% over net sales per restaurant of $1,143,000 in the first three quarters of 2003. The 2.8% decline in net sales per restaurant is primarily the result of a 3.2% decrease in the 38 comparable Fresh Choice restaurants.

Cost of Sales. Cost of sales (food and beverage costs) was 22.2% of sales in the first three quarters of 2004 compared to 22.0% in the first three quarters of 2003. Food and beverage costs increased as a percentage of sales due to increases in cost and menu enhancements introduced to increase the value offering of the menu.

Restaurant Operating Expenses. Restaurant operating expenses (labor, occupancy and other) were 65.3% of sales in the first three quarters of 2004 compared to 63.0% of sales in the first three quarters of 2003, an increase of 2.3% of sales.

Labor costs as a percentage of sales were 33.0% for the first three quarters of 2004 compared to 31.9% in the first three quarters of 2003. Labor costs, as a percentage of sales, were higher primarily due to lower average restaurant sales, a higher average wage, and higher workers’ compensation and medical benefits costs.

Occupancy and other expenses as a percentage of sales were 32.3% for the first three quarters of 2004 compared to 31.1% of sales in the first three quarters of 2003, an increase of 1.2% of sales. This increase is due primarily to higher, advertising, rent, common area maintenance and insurance costs offset by lower utility costs, combined with the impact as a percent of sales resulting from the decline in comparable store sales.

Depreciation and Amortization. Depreciation and amortization expenses in the third quarter of 2004 were 3.9% of sales, the same as the third quarter of 2003. The percent of sales remained the same as the decline in average restaurant sales offset the benefit of the decline in depreciation dollars resulting from the impairment of certain assets.

General and Administrative Expenses. General and administrative expenses were 8.3% of sales in the first three quarters of 2004, the same as the first three quarters of 2003.

Store Closure and Asset Impairment Expenses. In the first three quarters of 2004, the Company recorded a store closure and asset impairment charge for continuing operations of $3,511,000. This charge was composed of; (i) a $3,204,000 non-cash charge for the write-down of buildings, leasehold improvements and equipment to fair value primarily for eight of the Company’s restaurants and (ii) a $307,000 charge for the estimated cash costs associated with the closure and settlement of the lease obligation for one previously impaired restaurant that closed in the second quarter and is included in continuing operations as a significant portion of the closed restaurant sales were absorbed by another currently operating restaurant. The impairment charge for the eight restaurants was required because the carrying amounts of the impaired assets were not recoverable from their currently projected undiscounted cash flows. The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.

Interest Expense, net. Interest expense, net was $256,000 in the first three quarters of 2004 compared to $200,000 in the first three quarters of 2003. The first three quarters of 2004 includes the write-off of $45,000 of unamortized loan fees for the bank debt classified as current due to the Company not meeting certain loan covenants and the write-off of $38,000 in unamortized lease commitment fees. 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 2004 or 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.

Loss from Discontinued Operations. The loss from discontinued operations includes the revenue and expenses of fourteen restaurants. Ten of these restaurants were cash flow negative restaurants and were closed in early July just prior to filing for protection under Chapter 11 of the Bankruptcy Code. The other four are currently listed for sale and the real property is classified as assets held for sale on the consolidated balance sheet of the Company. In addition, the loss from discontinued operations includes a store closure and asset impairment charge of $ 7,368,000. This charge consists of; (i) a $3,485,000 charge to record the expected cash liability from rejection of the leases for ten closed restaurants, (ii) a $443,000 non-cash credit for the reversal of the remaining deferred rent for these ten rejected leases, (iii) a charge of $177,000 for the cash costs associated with the restaurant closures, and (iv) a non- cash asset impairment charge of $4,149,000 for the write-down of buildings, leasehold improvements and equipment to fair value for thirteen of the Company’s restaurants, eight of which had been previously partially impaired. The impairment charge for these restaurants was required because the carrying amounts of the impaired assets were not recoverable from their currently projected undiscounted cash flows. The impairment loss was calculated as the difference between the carrying amount and fair value of the assets.

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 rollover 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 5, 2004, 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 management, including the principal executive and principal financial officers, the Company evaluated the effectiveness of its disclosure controls and procedures; as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, its 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. There were no changes in internal control over financial reporting that would require additional disclosure under Regulation S-K 308(c).

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 5, 2004.

	- On July 12, 2004, reporting the filing of a voluntary petition for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the Northern District of California.

	- On July 19, 2004 reporting that the Registrant received a Nasdaq Staff Determination indicating that as a result of its recent filing under Chapter 11 of the U.S. Bankruptcy Code the Nasdaq Staff had determined pursuant to Nasdaq Marketplace Rules 4300 and 4450(f) that its securities will be delisted from the Nasdaq National Market as of the opening of business on July 21, 2004.

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/ Tim G. O’Shea

	Tim G. O’Shea
	President and Chief Operating Officer
	(Principal Executive Officer)


	/s/ David E. Pertl

	David E. Pertl
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer)

Dated: October 20, 2004

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

10.43	(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

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

INDEX TO FORM 10-Q EXHIBITS (continued)

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

10.55	(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	(23)		Letter dated August 13, 2003 amending the Revolving Loan Agreement dated October 5, 2001 as amended June 3, 2002, December 10, 2002 and April 7, 2003 with Mid-Peninsula Bank.

10.63	(23)		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.

10.64	(24)		Letter dated November 19, 2003 amending the Revolving Loan Agreement dated October 5, 2001 as amended June 3, 2002, December 10, 2002, April 7, 2003 and August 13, 2003 with Mid-Peninsula Bank.

10.65	(24)		Letter dated November 19, 2003 amending the Commercial Deed of Trust, Financial Security Agreement and Fixture Filing dated Aug 13, 2001 as amended August 13, 2003 with Mid Peninsula Bank.

10.66	(24)	(3)	2004 Home Office Incentive Plan.

10.67	(24)		Letter agreement dated December 11, 2003 whereby Crescent Real Estate Equities Ltd. (‘Crescent”) agrees to not convert any of its shares of Series B Preferred into Series A Preferred so long as Crescent owns the Series B Preferred shares.

10.68	(25)		Change in Terms Agreement dated March 16, 2004 amending the Revolving Loan Agreement dated October 5, 2001 as amended June 3, 2002, December 10, 2002, April 7, 2003, August 13,2003 and November 19, 2003 with Mid-Peninsula Bank.

INDEX TO FORM 10-Q EXHIBITS (continued)

10.69	(26)	Letter dated May 13, 2004 amending the terms of the Revolving Loan Agreement dated October 5, 2001 (as subsequently amended) and the Commercial Deed Of Trust, Financing Statement, Security Agreement and Fixture Filing dated August 13, 2001 (as subsequently amended) with Mid-Peninsula Bank.

10.70	(27)	Separation Agreement and General Release of Claims between Everett F. Jefferson and Fresh Choice, Inc., effective September 20, 2004.

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.

(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.

INDEX TO FORM 10-Q EXHIBITS (continued)

(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.

(23)	Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended September 7, 2003.

(24)	Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Annual Report on Form 10-K for the year ended December 28, 2003.

(25)	Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended March 21, 2004.

(26)	Incorporated by reference from Exhibits with corresponding numbers filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended June 13, 2004.

(27)	Incorporated by reference from Exhibit 99.1 filed with the Company’s Report on Form 8-K dated September 24, 2004.