Filed
Pursuant to Rule 424(b)(3)
Registration
No. 333-142220
Prospectus
Supplement No. 3 dated December 16, 2008
(To
Prospectus dated May 14, 2008 and filed on May 14, 2008 - File No.
333-142220)
ORGANIC
TO GO FOOD
CORPORATION
PROSPECTUS
13,864,343 shares
of Common Stock
This
Prospectus Supplement No. 3 (the “Prospectus Supplement”) supplements our
prospectus dated May 14, 2008, as previously supplemented by the prospectus
supplements dated May 16, 2008 and August 15, 2008 (the “Prospectus”). This
Prospectus Supplement and the Prospectus are required to be delivered by certain
holders of the above-referenced shares or by their transferees, pledges, donees
or their successors in connection with the offer and sale of the
above-referenced shares.
This
Prospectus Supplement includes financial information for the period ended
September 30, 2008.
The
information contained herein, including the information attached hereto,
supplements and supercedes, in part, the information contained in the
Prospectus. This Prospectus Supplement should be read in conjunction with the
Prospectus, and is qualified by reference to the Prospectus except to the extent
that the information in this Prospectus Supplement supercedes the information
contained in the Prospectus.
INDEX
TO FILINGS
|
|
Annex
|
|
|
|
|
Financial
Information for the period ended September 30, 2008
|
A
|
ANNEX A
Unaudited
Condensed Consolidated Financial Statements
Organic
To Go Food Corporation and its wholly-owned subsidiary, Organic To Go,
Inc.
Condensed
Consolidated Balance Sheets
(In
thousands, except per share amounts)
|
|
|
(audited)
December 31,
2007
|
|
|
(unaudited)
September 30,
2008
|
|
|
ASSETS
|
|
|
Current assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
668 |
|
|
$ |
1,437 |
|
|
Accounts
receivable, net
|
|
|
1,099 |
|
|
|
1,215 |
|
|
Inventory
|
|
|
845 |
|
|
|
2,554 |
|
|
Prepaid
expenses and other current assets
|
|
|
489 |
|
|
|
1,200 |
|
|
Total
current assets
|
|
|
3,101 |
|
|
|
6,406 |
|
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
5,465 |
|
|
|
10,886 |
|
|
Identifiable
intangible assets, net
|
|
|
3,853 |
|
|
|
4,512 |
|
|
Deposits
and other assets
|
|
|
521 |
|
|
|
333 |
|
|
TOTAL
ASSETS
|
|
$ |
12,940 |
|
|
$ |
22,137 |
|
| |
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
2,040 |
|
|
$ |
4,331 |
|
|
Accrued
liabilities
|
|
|
780 |
|
|
|
1,142 |
|
|
Current
portion of notes payable,
|
|
|
1,474 |
|
|
|
1,403 |
|
|
Current
portion of capital lease obligations
|
|
|
463 |
|
|
|
796 |
|
|
Total
current liabilities
|
|
|
4,757 |
|
|
|
7,803 |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
rent
|
|
|
52 |
|
|
|
210 |
|
|
Notes
payable, net of current portion
|
|
|
1,044 |
|
|
|
1,347 |
|
|
Capital
lease obligations, net of current portion
|
|
|
440 |
|
|
|
1,254 |
|
|
TOTAL
LIABILITIES
|
|
|
6,293 |
|
|
|
10,483 |
|
|
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies (see Note 8)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
subscription
|
|
|
— |
|
|
|
7,000 |
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
|
|
Preferred
Stock - $0.001 par value per share, 10,000,000 shares authorized, no
shares issued and outstanding
|
|
|
— |
|
|
|
— |
|
|
Common
stock and additional paid-in capital - $0.001 par value per share,
500,000,000 shares authorized, 27,758,326 and 36,903,543 shares issued and
outstanding
|
|
|
33,215 |
|
|
|
44,776 |
|
|
Accumulated
deficit
|
|
|
(26,568 |
) |
|
|
(40,122 |
) |
|
TOTAL
SHAREHOLDERS’ EQUITY
|
|
|
6,647 |
|
|
|
4,654 |
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
$ |
12,940 |
|
|
$ |
22,137 |
|
See
accompanying notes to condensed consolidated financial statements.
Organic
To Go Food Corporation and its wholly-owned subsidiary, Organic To Go,
Inc.
Condensed
Consolidated Statements of Operations
(Unaudited
and in thousands, except per share amounts)
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$ |
3,716 |
|
|
$ |
6,319 |
|
|
$ |
11,188 |
|
|
$ |
17,514 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
1,750 |
|
|
|
2,953 |
|
|
|
5,391 |
|
|
|
7,312 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
1,966 |
|
|
|
3,366 |
|
|
|
5,797 |
|
|
|
10,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
4,797 |
|
|
|
7,660 |
|
|
|
12,196 |
|
|
|
16,998 |
|
|
Depreciation
and amortization
|
|
|
871 |
|
|
|
2,740 |
|
|
|
2,009 |
|
|
|
6,576 |
|
|
Total
operating expenses
|
|
|
5,668 |
|
|
|
10,400 |
|
|
|
14,205 |
|
|
|
23,574 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
|
(3,702 |
) |
|
|
(7,034 |
) |
|
|
(8,408 |
) |
|
|
(13,372 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income (expense), net
|
|
|
(45 |
) |
|
|
(75 |
) |
|
|
(460 |
) |
|
|
(182 |
) |
|
Loss
before income taxes
|
|
|
(3,747 |
) |
|
|
(7,109 |
) |
|
|
(8,868 |
) |
|
|
(13,554 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(3,747 |
) |
|
$ |
(7,109 |
) |
|
$ |
(8,868 |
) |
|
$ |
(13,554 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted net loss per share
|
|
$ |
(0.15 |
) |
|
$ |
(0.19 |
) |
|
$ |
(0.47 |
) |
|
$ |
(0.39 |
) |
|
Weighted
average shares outstanding
|
|
|
24,280 |
|
|
|
36,904 |
|
|
|
19,058 |
|
|
|
35,001 |
|
See
accompanying notes to condensed consolidated financial statements.
Organic
To Go Food Corporation and its wholly-owned subsidiary, Organic To Go,
Inc.
Condensed
Consolidated Statement of Stockholders’ Equity
(Unaudited
and in thousands, except share amounts)
|
|
|
Common
Stock
and
Additional
Paid In Capital
|
|
|
Accumulated
Deficit
|
|
|
Total
Stockholders’
Equity
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2007
|
|
|
27,758,326 |
|
|
$ |
33,215 |
|
|
$ |
(26,568 |
) |
|
$ |
6,647 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of common shares and warrants for cash
|
|
|
8,571,429 |
|
|
|
12,000 |
|
|
|
— |
|
|
|
12,000 |
|
|
Stock
issued in connection with acquisition of assets
|
|
|
573,788 |
|
|
|
750 |
|
|
|
|
|
|
|
750 |
|
|
Stock
issuance costs
|
|
|
— |
|
|
|
(1,386 |
) |
|
|
— |
|
|
|
(1,386 |
) |
|
Stock
subscription issuance costs
|
|
|
— |
|
|
|
(338 |
) |
|
|
— |
|
|
|
(338 |
) |
|
Fair
value of options issued in connection with prior
acquisition
|
|
|
|
|
|
|
35 |
|
|
|
|
|
|
|
35 |
|
|
Share
based compensation
|
|
|
— |
|
|
|
500 |
|
|
|
— |
|
|
|
500 |
|
|
Net
loss
|
|
|
— |
|
|
|
— |
|
|
|
(13,554 |
) |
|
|
(13,554 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at September 30, 2008
|
|
|
36,903,543 |
|
|
$ |
44,776 |
|
|
$ |
(40,122 |
) |
|
$ |
4,654 |
|
See
accompanying notes to condensed consolidated financial statements.
Organic
To Go Food Corporation and its wholly-owned subsidiary, Organic To Go,
Inc.
Condensed
Consolidated Statements of Cash Flows
(Unaudited
and in thousands)
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2007
|
|
|
2008
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(8,868 |
) |
|
$ |
(13,554 |
) |
|
Adjustments
to reconcile net loss to net cash used by operating
activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
2,009 |
|
|
|
6,576 |
|
|
Share-based
compensation cost
|
|
|
248 |
|
|
|
500 |
|
|
Amortization
of debt issue costs and debt discount included in interest
expense
|
|
|
386 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(613 |
) |
|
|
(116 |
) |
|
Inventory
|
|
|
(213 |
) |
|
|
(1,709 |
) |
|
Prepaid
expenses and other current assets
|
|
|
(512 |
) |
|
|
(711 |
) |
|
Accounts
payable
|
|
|
392 |
|
|
|
2,038 |
|
|
Accrued
liabilities
|
|
|
328 |
|
|
|
362 |
|
|
Other
|
|
|
(466 |
) |
|
|
50 |
|
|
Net
cash used by operating activities
|
|
|
(7,308 |
) |
|
|
(6,564 |
) |
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
Purchases
of property, equipment and other assets
|
|
|
(2,451 |
) |
|
|
(4,585 |
) |
|
Purchase
of intangible assets
|
|
|
(1,923 |
) |
|
|
(4,179 |
) |
|
Net
cash used in investing activities
|
|
|
(4,374 |
) |
|
|
(8,764 |
) |
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
Principal
payments on notes payables
|
|
|
(469 |
) |
|
|
(734 |
) |
|
Principal
payments on capital lease obligations
|
|
|
(88 |
) |
|
|
(775 |
) |
|
Proceeds
from issuance of notes payable, net
|
|
|
500 |
|
|
|
50 |
|
|
Proceeds
from sale of common stock, net
|
|
|
— |
|
|
|
10,894 |
|
|
Proceeds
from stock subscription, net
|
|
|
— |
|
|
|
6,662 |
|
|
Redemption
of common stock
|
|
|
11,766 |
|
|
|
— |
|
|
Net
cash provided by financing activities
|
|
|
11,709 |
|
|
|
16,097 |
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
27 |
|
|
|
769 |
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
865 |
|
|
|
668 |
|
|
End
of period
|
|
$ |
892 |
|
|
$ |
1,437 |
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$ |
112 |
|
|
$ |
273 |
|
|
Cash
paid for income taxes
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash
investing and financing activities:
|
|
|
|
|
|
|
|
|
|
Assets
acquired through issuance of notes payable
|
|
$ |
225 |
|
|
$ |
1,130 |
|
|
Assets
purchased through issuance of common stock
|
|
$ |
782 |
|
|
$ |
785 |
|
|
Fixed
assets acquired though capital lease
|
|
$ |
572 |
|
|
$ |
1,671 |
|
|
Assets
purchased through accounts payable
|
|
|
— |
|
|
|
150 |
|
|
Conversion
of debt into common stock
|
|
$ |
4,225 |
|
|
$ |
— |
|
|
Conversion
of preferred stock into common stock
|
|
$ |
5,700 |
|
|
$ |
— |
|
See
accompanying notes to condensed consolidated financial statements.
Organic
To Go Food Corporation and its wholly-owned subsidiary, Organic To Go,
Inc.
Notes
to Condensed Consolidated Financial Statements
September
30, 2008
Note
1. Description of Business, Basis of Presentation and Summary of
Significant Accounting Policies
Organization
and Business
Organic
To Go Food Corporation, formerly SP Holding Corporation (“SP”) prior to May
2007, and its wholly owned subsidiary Organic To Go, Inc. (“Organic” and
together with Organic To Go Food Corporation, collectively, the “Company”),
which was acquired in a reverse merger on February 12, 2007, provides convenient
retail cafes and delivery and catering services, preparing and serving “grab and
go” breakfast, lunch and dinner foods and beverages prepared using organic
ingredients, whenever possible. The Company also distributes its products
through select wholesale accounts. In October 2006, Organic expanded its
catering operations in the California area by acquiring the assets of a catering
operation headquartered in Los Angeles, California, and in March 2007, it
expanded its catering operations by acquiring the assets of a catering operation
located in Seattle, Washington. During 2007, the Company further expanded its
operations by acquiring the assets of three separate businesses, for a total of
six additional locations in San Diego, California. During the second quarter of
2008, the Company acquired the assets of a retail and catering operation in
Seattle, Washington, adding three additional retail locations in downtown
Seattle. Also during the second quarter of 2008, the Company gained
its first foothold on the East coast of the United States with the acquisition
of the assets of a business with catering operations and four retail locations
in Washington, D.C. As of September 30, 2008, the Company operates nine stores
in Washington, eighteen stores in California, and six stores in the Washington,
D.C. metropolitan area, for a total of 33 retail locations
nationwide.
Basis
of Presentation
In the
opinion of management, the accompanying Condensed Consolidated Balance Sheets
and related Condensed Consolidated Statements of Operations, Condensed
Consolidated Statement of Stockholders’ Equity and Statements of Cash Flows have
been prepared in accordance with accounting principles generally accepted in the
United States of America (“GAAP”) for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and notes required by GAAP for complete
financial statements. Management believes that all adjustments (consisting of
normal recurring adjustments) considered necessary for fair presentation have
been included. Interim results are not necessarily indicative of results for a
full year. The information included in this Form 10-Q should be read in
conjunction with “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and the financial statements and notes thereto
included in the Company’s Annual Report on Form 10-K for the fiscal year ended
December 31, 2007.
The
presentation of financial statements prepared in conformity with GAAP
contemplates continuation of the Company as a going concern. The Company has
reported recurring losses and cash used by operating activities, and at
September 30, 2008
has an accumulated deficit that could raise doubt about its ability to continue
as a going concern.
Since
inception, the Company has funded its operations, business development and
growth through debt and equity financings. During the three months ended March
31, 2007, proceeds of approximately $6.9 million were received from the sale of
equity securities in connection with its reverse merger and private placement,
and during that same time period, approximately $5.3 million of notes payable
were converted into common shares. In October 2007, the Company closed its
private placement offering and issued approximately 3.2 million shares of
Company common stock and warrants to purchase approximately 1.5 million shares
of Company common stock. The aggregate gross proceeds raised by the Company were
approximately $5.7 million. In January 2008, the Company closed a private
placement offering and issued approximately 1.4 million shares of Company common
stock and warrants to purchase approximately 0.6 million shares of Company
common stock. The aggregate gross proceeds raised by the Company were
approximately $2.0 million. In February 2008, the Company closed another private
placement offering and issued approximately 7.1 million shares of Company common
stock and a warrant to purchase approximately 4.3 million shares of Company
common stock and a conditional warrant to purchase shares of Company common
stock, which may only be exercised under certain circumstances. The aggregate
gross proceeds raised by the Company were approximately $10.0 million. In June
2008, the Company raised an additional $5.0 million through the issuance of a
subscription agreement convertible into shares of the Company’s common stock at
a future specified date. The Company raised an additional $2.0
million under the same agreement in September 2008, and completed its available
draws under the subscription agreement with the receipt of the final $3.0
million in October 2008. Company management intends to continue to be
engaged in additional fund-raising activities to fund future capital
expenditures, potential acquisitions of businesses, and to provide additional
working capital. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classifications of liabilities that
could result should the Company not continue as a going concern.
Use
of Estimates
Preparation
of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates. The more significant
accounting estimates inherent in the preparation of the Company's financial
statements include estimates as to the depreciable lives of property and
equipment, recoverability of receivables, valuation and recoverability of
inventories, recoverability of long-lived assets, valuation of intangible assets
and allocation of purchase price, valuation of equity-related instruments
issued, and valuation allowance for deferred income tax assets.
Summary
of Significant Accounting Policies
Cash and cash
equivalents - The Company considers all highly liquid investments
purchased with maturities of three months or less to be cash equivalents. The
Company places its cash balances on deposit with high credit, highly-rated
financial institutions. At times, such balances may be in excess of the FDIC
insurance limit. At September 30, 2008, approximately $232,000 was in
excess of the FDIC limit.
Contingencies -
Certain conditions may exist as of the date financial statements are issued,
which may result in a loss to the Company, but which will only be resolved when
one or more future events occur or fail to occur. Company management and its
legal counsel assess such contingent liabilities, and such assessment inherently
involves an exercise of judgment. In assessing loss contingencies related to
legal proceedings that are pending against the Company or unasserted claims that
may result in such proceedings, the Company's legal counsel evaluates the
perceived merits of any legal proceedings or unasserted claims as well as the
perceived merits of the amount of relief sought or expected to be sought
therein. If the assessment of a contingency indicates that it is probable that a
liability has been incurred and the amount of the liability can be estimated,
then the estimated liability would be accrued in the Company's financial
statements. If the assessment indicates that a potentially material loss
contingency is not probable, but is reasonably possible, or is probable but
cannot be estimated, then the nature of the contingent liability, together with
an estimate of the range of possible loss if determinable would be
disclosed.
Concentrations - All of the Company’s
operations are currently located in Washington, California and Washington, D.C.
As a result, the Company is sensitive to negative occurrences in markets where
the Company is located, and particularly susceptible to adverse trends and
economic conditions including labor markets. In addition, given geographic
concentration, negative publicity regarding any of our operations in Washington,
California or Washington D.C. could have a material adverse effect on the
Company’s business and operations, as could other regional occurrences such as
local strikes, earthquakes or other natural disasters.
Fair value of financial
instruments - The Company measures its financial assets and liabilities
in accordance with GAAP. For certain of the Company's financial instruments,
including cash and cash equivalents, accounts receivable, accounts payable and
accrued liabilities, the carrying amounts approximate fair value due to their
short maturities. Amounts recorded for notes payable also approximate fair value
because current interest rates offered to the Company for debt of similar
maturities are substantially the same.
Accounts receivable -
The Company extends credit to certain of its customers. Accounts receivable are
customer obligations due under normal trade terms. The Company performs credit
evaluations of its customers’ financial condition. Management reviews accounts
receivable on a regular basis on contracted terms and how recent payments have
been received in order to determine estimates of amounts that could potentially
be uncollectible. The Company includes an estimate of the amount that is more
likely than not to be uncollectible in its allowance for doubtful accounts.
Accounts uncollected are ultimately written off after all reasonable collection
efforts have been exhausted.
Inventory - Inventory, which consists
primarily of food, beverages and packaging products, is stated at the lower of
cost or market. Cost is determined according to the first-in, first-out method.
In assessing the ultimate realization of inventories, Company management makes
judgments as to future demand requirements compared to current inventory
levels.
Property and
equipment - Property and equipment is stated at cost. Additions and
improvements that significantly add to the productive capacity or extend the
life of an asset are capitalized. Maintenance and repairs are expensed as
incurred. Depreciation is computed using the straight-line method over five to
seven years for furniture, fixtures, equipment and vehicles, and over three
years for computer software and hardware. Leasehold improvements are amortized
over the shorter of the lease term or ten years.
Identifiable intangible
assets - Through its acquisitions of other businesses, the Company has
acquired certain identifiable intangible assets including customer-based
intangibles and a covenant not to compete. All such intangible assets have been
accounted for in accordance with Statement of Financial Accounting Standards No.
141, “Business Combinations” (“SFAS 141”). The estimate of useful lives of each
intangible asset was based on an analysis by management of all pertinent
factors, and selection of an estimated useful life of up to two years has been
identified for each intangible asset. Customer based intangible assets are
amortized utilizing an accelerated method and non-compete intangible assets are
amortized on a straight-line basis.
Statement
of Financial Accounting Standards No. 142, “Goodwill and Other Intangible
Assets,” (“SFAS 142”) requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net discounted cash
flows expected to be generated by the asset or other valuation methods. If such
assets are considered to be impaired, impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the asset’s fair
value.
Impairment of long-lived
assets - Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be recoverable. Impairment of long-lived assets would be recognized in the event
that the net book values of such assets exceed the future undiscounted cash
flows attributable to such assets.
Debt discount - The
Company records the fair value of warrants issued with debt securities as a debt
discount, which is amortized as an adjustment to interest expense over the life
of the borrowing.
Revenue recognition -
Revenues are recognized at the point of sale at retail locations or upon
delivery of the product for delivery and wholesale transactions.
Cost of sales - Cost
of sales includes the cost of food and paper products.
Pre-operating costs -
Costs incurred in connection with start-up and promotion of new store openings
are expensed as incurred.
Income taxes - The
Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109, “Accounting for Income Taxes”
(“SFAS 109”), which requires recognition of deferred tax assets and liabilities
for expected future tax consequences of events that have been included in
financial statements or tax returns. Under this method, deferred income taxes
are recognized for the tax consequences in future years of differences between
the tax bases of assets and liabilities and their financial reporting amounts at
each period end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to amounts expected to be realized. The Company continues to provide a
full valuation allowance to reduce its net deferred tax asset to zero, inasmuch
as Company management has not determined that realization of deferred tax assets
is more likely than not.
Stock-based
compensation - The Company accounts for its share-based compensation
under the provisions of Financial Accounting Standards Board (“FASB”) Statement
No. 123(R), Share-Based
Payment, (“FAS 123R”).The Company adopted FAS 123R effective beginning
January 1, 2006 using the modified prospective method.
The
Company accounts for equity instruments issued to non-employees in accordance
with the provisions of FAS 123R and Emerging Task Force 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.” Compensation
expense related to equity instruments issued to non-employees is recognized as
the equity instruments vest.
Basic and diluted net loss
per share - Basic net loss per common share is computed by dividing net
loss by the weighted-average number of common shares outstanding during the
period. Diluted net loss per common share is determined using the
weighted-average number of common shares outstanding during the period. In
periods where losses are reported, the weighted-average number of common shares
outstanding excludes common stock equivalents, because their inclusion would be
anti-dilutive. Computations of net loss per share for the periods ending
September 30, 2007 and 2008 exclude approximately 5.8 million and 13.3 million
common shares, respectively, issuable upon exercise of outstanding and issuable
warrants, 3.0 million and 5.6 million shares, respectively, of common stock
issuable upon exercise of outstanding stock options, and 312,500 and 3.2 million
shares, respectively, of common stock issuable upon conversion of convertible
notes payable. These common stock equivalents could have the effect of
decreasing diluted net income per share in future periods when the Company
generates net income.
Recent accounting
pronouncements – In May 2008, the FASB issued Statement of Financial
Accounting Standards (“SFAS”) SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“SFAS 162”). SFAS 162 identifies the
sources of accounting principles and the framework for selecting the principles
to be used in the preparation of financial statements for nongovernmental
entities that are presented in conformity with GAAP. SFAS 162 will be
effective 60 days following the SEC’s approval. The Company does not expect
that this statement will result in a change in current
practice.
In April
2008, the FASB issued Staff Position No. 142-3, Determination of the Useful Life of
Intangible Assets (“FSP 142-3”). FSP 142-3 amends the factors
that should be considered in developing assumptions about renewal or extension
used in estimating the useful life of a recognized intangible asset under
SFAS No. 142, Goodwill and Other Intangible Assets
(“SFAS 142”). This standard is intended to improve the consistency
between the useful life of a recognized intangible asset under SFAS 142 and
the period of expected cash flows used to measure the fair value of the asset
under SFAS No. 141 (revised 2007), Business Combinations
(“SFAS 141(R)”) and other GAAP. FSP 142-3 is effective for
financial statements issued for fiscal years beginning after December 15,
2008. The measurement provisions of this standard will apply only to intangible
assets acquired after the effective date.
In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No.
133 (“SFAS 161”). SFAS 161 requires enhanced disclosures about a
company's derivative and hedging activities. These enhanced disclosures will
discuss (a) how and why a company uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under FASB
Statement No. 133 and its related interpretations and (c) how derivative
instruments and related hedged items affect a company's financial position,
results of operations and cash flows. SFAS 161 is effective for fiscal years
beginning on or after November 15, 2008, with earlier adoption allowed. The
Company does not anticipate that the adoption of this accounting pronouncement
will have a material effect on its consolidated financial
statements.
In
February 2008, the FASB issued FASB Staff Position No. 157-2, Effective
Date of FASB Statement No. 157, which delays the effective date of SFAS 157
for nonfinancial assets and nonfinancial liabilities to fiscal years beginning
after November 15, 2008. Therefore, the Company will delay
application of SFAS 157 to its nonfinancial assets and nonfinancial
liabilities. The Company does not anticipate that the delayed
adoption of this accounting pronouncement will have a material effect on its
consolidated financial statements.
In
December 2007, the FASB issued SFAS No. 141(revised 2007), Business Combinations
(“SFAS 141R”), which revises current purchase accounting guidance in
SFAS 141, Business
Combinations. SFAS 141R requires most assets acquired and
liabilities assumed in a business combination to be measured at their fair
values as of the date of acquisition. SFAS 141R also modifies the initial
measurement and subsequent remeasurement of contingent consideration and
acquired contingencies, and requires that acquisition related costs be
recognized as expense as incurred rather than capitalized as part of the cost of
the acquisition. The Company will adopt SFAS 141R beginning in the first
quarter of fiscal 2009. This standard will change the Company’s
accounting treatment for business combinations on a prospective basis. The
impact of SFAS 141R on the Company’s consolidated financial statements will
depend on the nature and extent of the Company’s future acquisition
activities.
In
December 2007, the FASB issued SFAS 160, Accounting and Reporting of
Noncontrolling Interests in Consolidated Financial Statements – an amendment of
ARB No. 51 (“SFAS 160”). SFAS 160 establishes accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS 160 clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements and requires retroactive adoption of the presentation and
disclosure requirements for existing minority interests, of which the Company
currently has none. All other requirements of SFAS 160 shall be
applied prospectively. SFAS 160 is effective for fiscal years
beginning after December 15, 2008.
Note
2. Inventories
|
Inventories consist of the following (in thousands):
|
|
December 31,
2007
|
|
|
September 30,
2008
|
|
|
Food and beverages
|
|
$ |
820 |
|
|
$ |
2,252 |
|
|
Paper
products
|
|
|
25 |
|
|
|
302 |
|
|
Total
inventories
|
|
$ |
845 |
|
|
$ |
2,554 |
|
Note
3. Property and Equipment
|
Property and equipment consists of the following (in thousands):
|
|
December 31,
2007
|
|
|
September 30,
2008
|
|
|
Leasehold improvements
|
|
$ |
2,389 |
|
|
$ |
4,687 |
|
|
Furniture,
fixtures and equipment
|
|
|
3,878 |
|
|
|
6,575 |
|
|
Vehicles
|
|
|
1,156 |
|
|
|
1,644 |
|
|
Leased
equipment
|
|
|
686 |
|
|
|
1,976 |
|
|
|
|
|
8,109 |
|
|
|
14,882 |
|
|
Less
accumulated depreciation and amortization
|
|
|
(2,644 |
) |
|
|
(3,996 |
) |
|
Total
property and equipment, net
|
|
$ |
5,465 |
|
|
$ |
10,886 |
|
Amortization
of leased equipment is included in depreciation and amortization
expense.
Note
4. Identifiable Intangible Assets
|
Identifiable intangible assets consist of the following (in thousands):
|
|
December 31,
2007
|
|
|
September 30,
2008
|
|
|
Customer based intangible assets
|
|
$ |
6,303 |
|
|
$ |
11,864 |
|
|
Non-compete
intangible assets
|
|
|
589 |
|
|
|
589 |
|
|
Other
identifiable intangible assets
|
|
|
— |
|
|
|
53 |
|
|
Total
identifiable intangible assets, gross
|
|
|
6,892 |
|
|
|
12,506 |
|
|
Less
accumulated amortization
|
|
|
(3,039 |
) |
|
|
(7,994 |
) |
|
Total
identifiable intangible assets, net
|
|
$ |
3,853 |
|
|
$ |
4,512 |
|
The
Company recorded amortization expense on intangible assets of $553,000 and $2.1
million, respectively, for the quarterly periods ended September 30, 2007 and
2008, and $1.3 million and $5.0 million, respectively, for the nine month
periods ended September 30, 2007 and 2008.
Note
5. Notes Payable
|
Notes payable consist of the following (in thousands):
|
|
December 31,
2007
|
|
|
September 30,
2008
|
|
|
Notes payable, 6% to 25% interest collateralized by vehicles and equipment
|
|
$ |
141 |
|
|
$ |
— |
|
|
Convertible
note payable, 8.25% and 6%, respectively, interest, collateralized by
substantially all assets
|
|
|
759 |
|
|
|
506 |
|
|
Notes
payable, 7.75% interest, collateralized by certain assets, due April
2010
|
|
|
418 |
|
|
|
418 |
|
|
Note
payable, 9.25% interest, due March 2009
|
|
|
97 |
|
|
|
40 |
|
|
Note
payable, 8.0% interest, due October 2009
|
|
|
54 |
|
|
|
32 |
|
|
Notes
payable, 12% interest, due May 2009
|
|
|
500 |
|
|
|
400 |
|
|
Notes
payable, 10.5% interest, due December 2009
|
|
|
549 |
|
|
|
550 |
|
|
Notes
payable, no interest, monthly straight-line payment
|
|
|
— |
|
|
|
79 |
|
|
Note
payable, 5% (prime rate) interest, due November 2009
|
|
|
— |
|
|
|
725 |
|
|
Total
notes payable
|
|
|
2,518 |
|
|
|
2,750 |
|
|
Less:
current portion of notes payable
|
|
|
(1,474 |
) |
|
|
(1,403 |
) |
|
Notes
payable, net of current portion
|
|
$ |
1,044 |
|
|
$ |
1,347 |
|
The
Company has a borrowing agreement with a vendor pursuant to which the Company
has outstanding borrowings of approximately $506,000 as of September 30, 2008.
This term loan requires monthly payments of interest at prime rate plus 1%
(8.25% at December 31, 2007 and 6.00% at September 30, 2008), and provides for
thirty-six equal monthly payments and a final maturity date in September 2010.
The note is collateralized by a pledge of Company assets.
In
December 2007, the proceeds from the issuance of two separate promissory notes
payable in the amounts of $258,500 and $291,500 were used to pay off a prior
note payable in the amount of $550,000. Each bears interest at 10.5%
per annum and both are due in December, 2009. The holder of each note can elect
to require payment in full in December, 2008.
During
2007, the Company borrowed $500,000 from three of the Company’s equity and
bridge note investors pursuant to a promissory note payable of $500,000, bearing
interest at 18% per annum, all of which were due in May, 2008. Two of
the promissory notes totaling $400,000 were replaced pursuant to promissory
notes payable of $200,000 each bearing interest at 12% per annum, both of which
are due in May 2009. The third promissory note in the amount of
$150,000 was paid off in May 2008.
Also
during 2007, as part of asset purchase agreements, the Company issued to the
sellers promissory notes of $150,000 and $75,000, bearing interest at 9.25% and
8% per annum, payable monthly and due in March, 2009 and October, 2010,
respectively.
In May
2008, as part of an asset purchase agreement, the Company issued the seller a
promissory note in the amount of $950,000, bearing interest at prime rate (5.00%
at September 30, 2008), payable quarterly and due in November 2009.
Future
minimum principal payments on notes payable at September 30, 2008 are as follows
(in thousands):
|
One
year (10/2008 – 9/2009)
|
|
$
|
1,403
|
|
|
Two
years (10/2009 – 9/2010)
|
|
|
1,347
|
|
|
Three
years
|
|
|
—
|
|
|
Total
|
|
$
|
2,750
|
|
Note
6. Stockholders’ Equity
Authorized shares –
The Company is currently authorized under its Amended and Restated Certificate
of Incorporation to issue 500,000,000 shares of its common stock and 10,000,000
shares of its preferred stock. During the period ended June 30, 2008,
the Company issued a convertible instrument in exchange for $5.0 million which
allows its holder to receive shares of the Company’s common stock, the number of
which will be determined according to a formula specified in such instrument, to
occur on or before March 2010. During the period ended September 30, 2008, the
Company received an additional $2.0 million under this same agreement, and in
October 2008 received the final $3.0 million available under this agreement. See
Note 9, “Subscription Agreement” for more details.
Warrants - During the
six months ended June 30, 2008, in conjunction with various debt and equity
financing related agreements and related issuance of debt and equity securities,
the Company issued warrants for a term of approximately 5 years to purchase
shares of the Company’s common stock at an exercise price of $2.50 and $3.00 per
share for approximately 4.9 million and 625,000 shares, respectively. During the
period ended September 30, 2008, the Company issued an additional 625,000
warrants at a price of $3.00 per share. As of September 30, 2008, there were a
total of 13.6 million warrants outstanding as follows:
|
Exercise Price
|
|
Number of warrants
|
|
|
$
1.38
|
|
|
66,629 |
|
|
1.68
|
|
|
2,151,986 |
|
|
2.10
|
|
|
2,229,430 |
|
|
2.50
|
|
|
7,938,563 |
|
|
3.00
|
|
|
875,000 |
|
|
Total
|
|
|
13,261,608 |
|
Stock options – From
time to time, the Company grants to its directors, officers, employees and
consultants options to purchase shares of the Company’s common
stock. The Company accounts for its share-based compensation under
the provisions of FAS 123R. Options generally have a term of 10 years from the
date of grant, with exercise prices at no less than the market price of a share
of the Company’s common stock on the date of grant. The Company uses the
Black-Scholes option pricing model to estimate the fair value of its stock
options on the date of grant. Fair value determination using this
model is affected by the Company’s stock price on the date of grant as well as
the expected life of the award, expected stock price volatility over the term of
the award and actual and projected exercise behaviors. FAS 123R requires that
the Company recognize compensation expense for only the portion of options that
are expected to vest. Therefore, management applies an estimated forfeiture rate
for projected future employee turnover rates. The estimated forfeiture rate is
approximately 12%. If the actual number of forfeitures differs from those
estimated by management, additional adjustments to compensation expense may be
required in future periods. The Company’s stock price volatility, option lives
and expected forfeiture rates involve management’s best estimates at the time of
such determination, all of which impact the fair value of the option calculated
under the Black-Scholes methodology and, ultimately, the expense that will be
recognized over the life of the option. The Company typically issues stock
options with a four-year vesting period (defined by FAS 123R as the requisite
service period). The Company amortizes stock compensation cost ratably over the
requisite service period.
Although
the fair value of share-based awards is determined in accordance with FAS 123R
and SAB 107, the Black-Scholes option pricing model requires the input of highly
subjective assumptions, and other reasonable assumptions could provide different
results.
The
weighted average fair value of stock options granted during the three and nine
month periods ended September 30, 2007 and 2008, determined using the
Black-Scholes option pricing model, was as follows with the following related
assumptions:
|
|
Three
Months Ended
September 30,
|
|
Nine
Months Ended
September 30,
|
|
|
2007
|
|
2008
|
|
2007
|
|
2008
|
|
Weighted
average fair value of options granted
|
$0.90
|
|
$0.51
|
|
$0.74
|
|
$0.62
|
|
Assumptions:
|
|
|
|
|
|
|
|
|
Dividend
yield
|
0%
|
|
0%
|
|
0%
|
|
0%
|
|
Expected
volatility
|
50%
|
|
50%
|
|
50%
|
|
50%
|
|
Risk-free
rate of return
|
4.3%
|
|
2.7%
– 3.3%
|
|
4.0%
- 4.8%
|
|
2.6%
- 3.5%
|
|
Estimated
life
|
5
years
|
|
5
years
|
|
5
years
|
|
5
years
|
Compensation
expense recognized for stock options and restricted stock approximated $152,000
and $210,000, respectively, for the three months ended September 30, 2007 and
2008, and $248,000 and $500,000 for the nine months ended September 30, 2007 and
2008, respectively. As of September 30, 2008, there was approximately $2.2
million of unrecognized compensation cost related to unvested stock options and
restricted stock, which is expected to be recognized as expense over a period of
approximately 3 years. The following table summarizes activity for stock options
over the first nine months of 2008:
|
|
|
Options
|
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
|
|
|
Outstanding
at December 31, 2007
|
|
|
3,050,938 |
|
|
$ |
1.50 |
|
|
|
|
|
|
Grants
|
|
|
3,089,230 |
|
|
|
1.32 |
|
|
|
|
|
|
Cancellations
|
|
|
(474,869 |
) |
|
|
2.08 |
|
|
|
|
|
|
Outstanding
at September 30, 2008
|
|
|
5,665,299 |
|
|
$ |
1.35 |
|
7.9 years
|
|
$ |
344,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30, 2008
|
|
|
1,369,983 |
|
|
$ |
1.20 |
|
8.0 years
|
|
$ |
284,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available
for grant at September 30, 2008
|
|
|
1,637,794 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
aggregate intrinsic value in the table above represents the total pretax
intrinsic value for all “in-the-money” options (i.e., the difference between the
Company’s closing stock price on the last trading day of its second quarter of
2008 and the exercise price, multiplied by the number of shares) that would have
been received by the option holders had all option holders exercised their
options on September 30, 2008. Aggregate intrinsic value changes, based on the
fair market value of the Company’s stock on a daily basis. The intrinsic value
of stock options outstanding and exercisable at September 30, 2008 is based on
the closing price for the Company’s common stock as reported by the OTCBB of
$1.02 per share.
Additional
information regarding stock options outstanding as of September 30, 2008, is as
follows:
| |
|
|
Outstanding Options
|
|
|
Exercisable Options
|
|
|
Range
of
Exercise
Prices
Per Share
|
|
|
Number
Outstanding
|
|
|
Weighted
Average
Remaining
Life (Years)
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Number
Exercisable
|
|
|
Weighted
Average
Exercise
Price
|
|
|
$
0.17
|
|
|
|
307,385 |
|
|
|
7.4 |
|
|
$ |
0.17 |
|
|
|
280,386 |
|
|
$ |
0.17 |
|
|
$
0.34
|
|
|
|
118,628 |
|
|
|
7.8 |
|
|
$ |
0.34 |
|
|
|
66,728 |
|
|
$ |
0.34 |
|
|
$
1.01 - $ 1.16
|
|
|
|
649,500 |
|
|
|
8.6 |
|
|
$ |
1.08 |
|
|
|
65,000 |
|
|
$ |
1.13 |
|
|
$
1.30 - $ 1.38
|
|
|
|
2,797,674 |
|
|
|
9.0 |
|
|
$ |
1.38 |
|
|
|
444,530 |
|
|
$ |
1.38 |
|
|
$
1.40 - $ 1.48
|
|
|
|
1,090,511 |
|
|
|
9.2 |
|
|
$ |
1.43 |
|
|
|
291,292 |
|
|
$ |
1.41 |
|
|
$
1.60 - $ 1.92
|
|
|
|
240,000 |
|
|
|
9.0 |
|
|
$ |
1.82 |
|
|
|
58,563 |
|
|
$ |
1.83 |
|
|
$
2.23
|
|
|
|
461,601 |
|
|
|
8.6 |
|
|
$ |
2.23 |
|
|
|
163,484 |
|
|
$ |
2.23 |
|
|
$
0.17 - $ 2.23
|
|
|
|
5,665,299 |
|
|
|
7.9 |
|
|
$ |
1.35 |
|
|
|
1,369,983 |
|
|
$ |
1.20 |
|
Note
7. Business Acquisitions
On May
14, 2008, pursuant to terms of an asset purchase agreement, the Company acquired
for $250,000 cash, shares of Company’s common stock having a fair value of
$500,000 and another $950,000 due in six quarterly installments beginning August
14, 2008, all furniture, fixtures, equipment, customer lists, trade names and
leasehold improvements used in connection with a retail business operating three
stores in Seattle, Washington. The Company also entered into a consulting
agreement with the seller wherein that individual will provide consulting
services to the Company for a one year period, pursuant to which, among other
things, the Company will pay monthly fees totaling $100,000 over the course of a
year. The Company assumed operating leases for the three locations, as well as
various equipment leases and financing agreements. The total purchase price of
approximately $1.8 million has been allocated to assets acquired based on
estimated fair values, which will result in the majority being allocated to
customer based identifiable intangible assets, which will be amortized using an
accelerated amortization method over a 16-month period and is summarized as
follows (in thousands):
|
Furniture,
fixtures, equipment and vehicles
|
|
$
|
105
|
|
|
Customer
based intangible assets
|
|
|
1,731
|
|
|
Total
|
|
$
|
1,836
|
|
On May
29, 2008, the Company entered into a purchase and sale of assets agreement
whereby it purchased substantially all of the assets of High Noon Holdings,
which owned and operated four cafés in the Washington D.C. metropolitan
area. Under the terms of the agreement, the total purchase price was
$3.9 million, of which $3.5 million was paid in cash at closing and $250,000 was
satisfied by the issuance of 198,413 shares of the Company’s common
stock. The Company assumed operating leases for the four locations,
as well as various equipment leases and financing agreements. The total purchase
price has been allocated to assets acquired based on estimated fair values,
which resulted in the majority being allocated to trade names and customer-based
intangible assets, which will be amortized using an accelerated amortization
method over a 16-month period and is summarized as follows (in
thousands):
|
Furniture,
fixtures and equipment
|
|
$
|
186
|
|
|
Customer
based intangible assets
|
|
|
3,721
|
|
|
Total
|
|
$
|
3,907
|
|
Note
8. Commitments and Contingencies
The
Company leases its cafes, central kitchens and office facilities under
non-cancelable operating leases, some with renewal options. Rents are fixed base
amounts, some with escalating rents and some with contingent rentals based on
sales. Lease provisions also require additional payments for maintenance and
other expenses. Rent is expensed on a straight-line basis over the term of the
lease. The difference between amounts paid and expensed is recorded as a
deferred rent credit. The Company also leases certain point-of-sale computer
hardware and software pursuant to capital leases. At September 30, 2008, minimum
future annual lease obligations are as follows (in thousands):
|
|
|
Operating
Leases
|
|
|
Capital
Leases
|
|
|
Total
|
|
|
1
year (October 2008 – September 2009)
|
|
$ |
2,325 |
|
|
$ |
903 |
|
|
$ |
3,228 |
|
|
2
years (October 2009 – September 2010)
|
|
|
2,245 |
|
|
|
845 |
|
|
|
3,093 |
|
|
3
years (October 2010 – September 2011)
|
|
|
2,022 |
|
|
|
405 |
|
|
|
2,427 |
|
|
4
years (October 2011 – September 2012)
|
|
|
1,667 |
|
|
|
162 |
|
|
|
1,829 |
|
|
5
years and thereafter (October 2012 and beyond)
|
|
|
6,815 |
|
|
|
40 |
|
|
|
6,855 |
|
|
|
|
|
15,077 |
|
|
|
2,355 |
|
|
|
17,432 |
|
|
Less
amounts representing interest
|
|
|
— |
|
|
|
(305 |
) |
|
|
(305 |
) |
|
Total
lease obligations
|
|
$ |
15,077 |
|
|
$ |
2,050 |
|
|
$ |
17,127 |
|
The
Company is currently in mediation pursuant to the Standard Form of Agreement
with Wheelihan Construction, Inc. This matter arose out of tenant improvements
made by Wheelihan Construction, Inc. and its subcontractors at one of the
Company’s retail locations in San Diego, California. In connection
with the matter, four subcontractors/suppliers have commenced actions against
the Company, Wheelihan Construction, Inc. and other defendants.
From time
to time, the Company is subject to various legal proceedings and claims that may
arise in the ordinary course of business. Further, in the past, certain vendors
have taken legal action against the Company as a result of untimely payment of
invoices. In some cases, the courts have stipulated judgment requiring the
Company to pay interest and comply with payment schedules. Company management
currently believes that resolution of such legal matters will not have a
material adverse impact on the Company’s financial statements. The
Company is not a party to any other material legal proceedings other than those
disclosed above, nor is it aware of any circumstance that may reasonably lead a
third party to initiate material legal proceedings against it at this
time.
Note
9. Subscription Agreement
On June
1, 2008, the Company entered into an agreement with W. Health L.P., relating to
the sale of a $5.0 million convertible instrument and a warrant to purchase
625,000 shares of the Company’s common stock. The instrument is
convertible into shares of the Company’s common stock at the earlier of the
maturity date, which is March 2010, or the date at which the Company’s stock has
traded for a period of 60 consecutive days at a price equal to or greater than
$3.00 per share. In September 2008, the Company sold an additional $2.0 million
in convertible instruments and an additional warrant to purchase 250,000 shares
of the Company’s common stock under this same agreement. Subsequent to the end
of the Company’s fiscal quarter, in October 2008, the Company sold $3.0 million
in convertible instrument and an additional warrant to purchase 375,000 shares
of the Company’s common stock, finalizing the maximum cash and convertible
instruments exchangeable under this agreement. For accounting purposes, this
$10.0 million has been recorded as a stock subscription, $7.0 million of which
was received within the first nine months of the year covered by this report on
Form 10-Q.
Note
10. Subsequent Event
As
discussed in Note 9 above, in October 2008 the Company received $3.0 million in
cash in exchange for warrants and convertible instruments to purchase shares of
the Company’s common stock at a future date
On
November 18, 2008, the Company entered into a Note Purchase Agreement (the “Note
Purchase Agreement”) with W. Health L.P. (the “Investor”), relating to the sale
(the “Debt Financing”) of a $3.0 million secured promissory note (the “Note”).
The Note has an interest rate of 15% per annum and is scheduled to mature six
months following the closing of the Debt Financing that occurred on December 2,
2008. The Company also entered into a Security Agreement with the
Investor to secure the Company’s obligation to repay the Note and the notes
previously issued to the Investor with a lien on all of the Company’s personal
property and assets.
Management’s
Discussion and Analysis or Plan of Operation
The
following discussion and analysis of the results of operations and financial
condition of Organic To Go Food Corporation for the periods ended June 30, 2007
and 2008 should be read in conjunction with our financial statements and the
notes to those financial statements that are included elsewhere in this Form
10-Q. This discussion includes forward-looking statements based upon current
expectations that involve risks and uncertainties, such as plans, objectives,
expectations and intentions. Actual results and the timing of events could
differ materially from those anticipated in these forward-looking statements as
a result of a number of factors. Words such as “anticipate,” “estimate,” “plan,”
“continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,”
“could,” and similar expressions are used to identify forward-looking
statements.
Overview
Organization and Business -
Organic Holding Company, Inc., d/b/a Organic To Go, whose name was
changed to Organic To Go, Inc. effective February 27, 2007, is a wholly owned
subsidiary of Organic To Go Food Corporation and was incorporated in the state
of Delaware in February 2004. We are the nation’s first fast casual café chain
to be certified as an organic retailer, with our food available in more than 170
locations. We provide convenient cafés which prepare and serve fresh
custom-made and “grab and go” breakfast, lunch and dinner foods and beverages
prepared using organic ingredients, whenever possible. We also distribute our
products through delivery, catering and wholesale accounts. Our company has
grown through both organic expansion and acquisitions. In October
2006, we expanded our catering operations in the California area by acquiring
the assets of a catering operation headquartered in Los Angeles, California. In
March 2007, we expanded our catering operations by acquiring the assets of a
catering operation located in Seattle, Washington, and in July, September and
October 2007, we further expanded our operations by acquiring the assets of six
retail and catering stores in San Diego, California. During the second quarter
of 2008, we acquired the assets of a retail and catering operation in Seattle,
Washington, adding three additional retail locations in downtown
Seattle. Also during the second quarter of 2008, we gained our first
foothold on the East coast of the United States with the acquisition of the
assets of a business with four catering and retail locations in Washington, D.C.
As of September 30, 2008, we operated nine stores in Washington, eighteen stores
in California, and six stores in Washington, D.C., with central kitchens in
Seattle, Los Angeles, San Diego and Washington, D.C. In addition to the 33
cafés, our food is available in more than 120 wholesale locations, 14
universities and 11 locations at Los Angeles International Airport.
Management
believes we have the opportunity to capture increasing market share in all three
of our business channels: Retail Cafes, Delivery and Catering, and Wholesale of
our “grab & go” sandwiches, wraps and salads, by providing customers with
delicious, healthy, wholesome and organic food choices. Management is focused in
the near and long term on the challenges and risks that we face in expanding our
business. These include our ability to obtain retail cafés, catering customers
and wholesale locations, building a sufficient infrastructure to support our
expansion, and obtaining a customer base and margin improvement sufficient to
achieve and sustain profitability. In addition, the Company has
reviewed its business in light of the current economic downturn and has been
making changes in its operations to focus on operational
efficiencies. Changes include a reduction in its workforce and
operating costs in addition to delaying further expansion.
Basis of Presentation and Liquidity
- Since our inception, we have funded operations, business development
and growth through debt and equity financings. In this regard, during the first
six months of 2008, we closed two private placement offerings, raising a total
of approximately $12.0 million. The proceeds are intended to be used
for the expansion of the Company and working capital needs. In
January 2008, we closed a private placement offering and issued approximately
1.4 million shares of Company common stock and warrants to purchase
approximately 0.6 million shares of common stock. The aggregate gross proceeds
raised by the Company in this transaction were approximately $2.0 million.
Additionally, in February 2008, we closed a private placement offering and
issued approximately 7.1 million shares of common stock, a warrant to purchase
approximately 4.3 million shares of common stock and a conditional warrant to
purchase shares of common stock, which may be exercised only under certain
circumstances. In June 2008, we issued a stock subscription in exchange for $5.0
million which is convertible into shares of the Company’s common stock on or
before March 2010, and increased this subscription in September 2008 for another
$2.0 million under the same agreement. Our management intends to continue to be
engaged in additional fund-raising activities to fund future capital
expenditures, potential acquisitions of businesses, and provide additional
working capital.
Critical
Accounting Policies and Estimates
Management's
discussion and analysis of financial condition and results of operations are
based on our financial statements, which have been prepared in accordance with
GAAP. The preparation of these financial statements requires our management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements, as well as the reported net sales and expenses
during the reporting periods. On an ongoing basis, estimates and assumptions are
evaluated. Estimates are based on historical experience and on various other
factors believed reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying value of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. A summary
of significant accounting policies is presented in Note 1 to our financial
statements included elsewhere in this Form 10-Q. The following accounting
policies are considered the more critical to aid in understanding and evaluating
our results of operations and financial condition.
Use of Estimates - In
preparing the financial statements in conformity with GAAP, management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the dates of
the financial statements, as well as the reported amounts of revenues and
expenses during the reporting years. Actual results could differ from those
estimates. The more significant accounting estimates inherent in the preparation
of our financial statements include estimates as to the depreciable lives of
property and equipment, recoverability of long-lived assets, valuation of
inventories, valuation of equity related instruments issued, and valuation
allowance for deferred income tax assets.
Inventory - Inventory, which
consists primarily of food, beverages and packaging products, is stated at the
lower of cost or market. Cost is determined on a first-in, first-out basis. In
assessing the ultimate realization of inventories, our management makes
judgments as to future demand requirements compared to current inventory
levels.
Intangible Assets - In
connection with our 2006, 2007 and 2008 asset acquisitions, we acquired certain
identifiable intangible assets including customer-based intangibles. These
acquisitions have been accounted for in accordance with SFAS No. 141. Amounts
allocated to intangible assets were identified by management and have been
valued based on a number of factors. The estimate of useful lives of each
intangible asset was based on an analysis by management of all pertinent
factors. Management estimated a useful life of nearly two years for each
identifiable intangible asset.
Revenue Recognition -
Revenues are recognized at the point of sale at retail locations or upon
delivery of products for delivery and wholesale transactions.
Cost of Sales - Cost of sales
includes the cost of food, beverages and paper products.
Stock-based Compensation – We
account for share-based compensation under the provisions of FAS 123R, which we
adopted effective beginning January 1, 2006 using the modified prospective
method.
Results
of Operations
Sales - Sales for the third
quarter of 2008 increased approximately 70%, to $6.3 million, as compared with
$3.7 million in the third quarter of 2007. Our third quarter sales in
the past have always been our slowest quarter due to summer holidays for people
at work and universities in summer session. Sales for the nine months
ended September 30, 2008 increased approximately 57% to $17.5 million, compared
to $11.2 million for the nine months ended September 30, 2007. Retail café sales
were $3.3 million during the quarter ended September 30, 2008, an increase of
approximately 83% over $1.6 million during the comparable prior year period.
Café sales comprised 51% of total sales in the 2008 quarter compared to 44% of
total sales in the third quarter of 2007. Café sales for the nine
months ended September 30, 2008 and 2007 were 8.3 million and $4.6 million,
respectively, and comprised 47% and 41% of total sales. The increases in
year-over-year retail sales for both the quarter and nine month periods is
primarily a result of the addition of all San Diego and Washington, DC Retail
Cafés, in addition to four new locations in Seattle and two in Los Angeles that
were opened or acquired subsequent to September 30, 2007. We ended the third
quarter of 2008 with 33 Retail Cafés as compared with 13 at the end of the same
period in 2007.
Delivery
and Catering sales were $2.3 million for the third quarter of 2008, an increase
of over $800,000, or approximately 75%, over $1.5 million during the third
quarter of 2007. Delivery and Catering sales comprised 36% of total sales in the
third quarter of 2008 as compared with 41% for the same period of the prior
year. Delivery and catering sales for the nine months ended September
30, 2008 and 2007 were $6.9 million and $5.1 million, respectively, and
comprised 39% and 45% of total sales. In addition to increased business volume
in all delivery and catering operations, the increase in delivery and catering
sales in 2008 is attributable to the mid- to late-2007 fiscal year and second
quarter 2008 acquisitions of catering businesses in Seattle, San Diego and
Washington, D.C.
Wholesale
sales were $794,000 in the quarter ending September 30, 2008, an increase of
37%, as compared with $548,000 in the comparable quarter of 2007. Wholesale
sales comprised 14% of total sales in the 2008 period as compared with 15%
in the comparable 2007 period. Wholesale sales for the nine months ended
September 30, 2008 and 2007 were $2.4 million and $1.5 million,
respectively, and comprised 14% and 13% of total sales. In addition to increased
sales efforts in all markets, the increase in wholesale sales is due to our
entrance into the San Diego market in mid-2007, growth in sales to universities
and hospital and our entrance in the Washington, DC marketplace.
Cost of Sales - Cost of sales
includes the cost of food and paper products. Cost of sales for the third
quarter of 2008 increased 69%, to nearly $3.0 million, as compared with
$1.8 million for the third quarter of 2007. Cost of sales for the quarter ended
September 30, 2008 was approximately 47% as a percent of sales as
compared with 47% during the comparable prior year period. For
the nine month period ending September 30, 2008, cost of sales were $7.3
million, or 42% of sales, as compared to $5.4 million, or 48% of sales, for the
comparable 2007 period. During the third quarter of 2008, cost of sales
increased due to our entrance into the Washington, DC market, which had higher
food costs and initially higher waste associated with the start-up in a new
market. In addition, we realized price increases on food products and
packaging in all of our markets which was partially offset by select retail
price increases.
Gross Profit - Gross profit
increased approximately 71%, to $3.4 million for the third quarter in 2008, as
compared with $2.0 million for the third quarter in 2007. Gross profit for our
2008 period was approximately 53% of sales as compared with 53% during the
comparable 2007 period. Gross profit for the nine months ended
September 30, 2008, was $10.2 million, or 58% of sales, and $5.8 million,
or 52% of sales, for the comparable period in 2007. During the third
quarter of 2008, gross profit decreased due to our entrance in the Washington,
DC market, which had higher food costs and initially higher waste associated
with the start-up in a new market. In addition, we realized price
increases on food products and packaging in all of our markets which was
partially offset by select retail price increases.
Operating Expenses -
Operating expenses for the third quarter of 2008 were $7.6 million, as
compared with $4.8 million for the comparable 2007 period. For the nine
month period ended September 30, 2008, operating expenses were $16.9
million, or 97% of sales, as compared to $12.2 million, or 109% of sales, for
the comparable 2007 period. Operating expenses are comprised
primarily of labor, and, to a lesser extent, occupancy, utilities, and selling,
general and administrative expenses. Operating expenses increased in 2008 as
compared with 2007, primarily due to increased labor and related costs as a
result of continued growth since the prior year periods, including the
acquisition of four catering businesses, increasing the number of Retail Cafés
from thirteen as of September 30, 2007 to 33 as of September 30, 2008,
and preparing for future growth, both in facilities leases and with the hiring
of members to the executive management team. Included in the third
quarter 2008 operating expenses are approximately $707,000 of nonrecurring
expenses associated with the opening in a new region (Washington,
DC).
Depreciation and Amortization -
Depreciation and amortization expense for the third quarter and first
nine months of 2008 increased to $2.7 million and $6.6 million, respectively, as
compared with $871,000 and $2.0 million during the comparable 2007 periods.
This increase was due primarily to amortization of identifiable intangible
assets acquired in the catering and retail business in the latter part of 2006,
throughout 2007 and the first nine months of 2008. Depreciation and amortization
for the nine month periods ended September 30, 2007 and 2008 were
approximately 18% and 38% of sales, respectively. We amortize identifiable
intangibles over a relatively short period, generally no more than two
years.
Loss from Operations - Loss
from operations during the third quarter of 2008 increased to approximately $7.0
million as compared with $3.7 million during the third quarter of
2008. For the nine months ended September 30, 2008, the loss
from operations was $13.4 million as compared with a loss of $8.4 million for
the first nine months of 2007. The increase in loss from operations
over the prior year period is the result of an increase in gross profit of $1.4
million for the quarter and $4.4 million for the nine month period, being offset
by a $4.7 million and $9.3 million increase in total operating, depreciation and
amortization expenses for the quarterly and nine month periods,
respectively.
Interest and Other Expense, Net –
Net interest and other expense for the quarter ended September 30,
2008 increased to $75,000 as compared with $45,000 for the quarter ended
September 30, 2007. The increase is primarily due to the
increase in capital lease obligations since the end of the third quarter
2007. For the nine months ended September 30, 2007 and 2008, net
interest and other expense was $460,000 and $182,000, respectively. The increase
was primarily due to the increase in capital lease obligations since the end of
the third quarter 2007.
Net Loss - Net loss in the
third quarter of 2008 increased to $7.1 million, or $(0.19) basic and diluted
net loss per share, as compared with $3.7 million, or $(0.15) basic and
diluted net loss per share in the third quarter of 2007. Net loss for
the nine months ended September 30, 2008 was $13.6 million or $(0.39) basic
and diluted net loss per share, as compared with $8.9 million or $(0.47) basic
and diluted net loss per share in the nine months ended September 30,
2007.
Liquidity
and Capital Resources
As
planned, we have funded operations through financing activities consisting
primarily of private placements of debt and equity securities. In
January and February 2008, gross proceeds of approximately $12.0 million were
received from the sales of equity securities, and in June and September 2008 we
received $5.0 million and $2.0 million, respectively, from the sale of
convertible instruments. We intend to continue to engage in additional
fund-raising activities to fund future capital expenditures, potential
acquisitions of businesses, and provide additional working capital.
Net cash
used by operating activities was approximately $7.3 million during the first
nine months of 2007 and $6.6 million in the comparable 2008 period. The decrease
in cash used by operating activities was due primarily to an increase in net
loss offset by an adjustment for depreciation and amortization expense, most of
which represented amortization of identifiable intangible assets, as well as an
increase in accounts payable offset by an increase in inventory during the first
nine months of 2008.
Net cash
used in investing activities was approximately $4.4 million and $8.8 million for
the nine month periods ended September 30, 2007 and 2008, respectively.
Uses of cash flow for investing activities in both periods was primarily related
to capital expenditures associated with business expansion, the acquisition of
store, kitchen fixtures and equipment, and leasehold improvements to existing
locations and locations obtained through acquisitions. Additionally, intangible
assets were added during both year-to-date periods as we acquired existing
businesses to support our expansion plans.
Net cash
provided by financing activities was approximately $11.7 million and $16.1
million for the nine months ended September 30, 2007 and 2008,
respectively. The increase of net cash provided during the first nine months of
2008 was due to an increase in proceeds, net of issuance costs, from the
issuance of common stock in private placements and proceeds from the issuance of
a subscription agreement during the second and third quarters of
2008.
Quantitative
and Qualitative Disclosures About Market Risk
Not
applicable.
Controls
and Procedures
(a) Evaluation of Disclosure
Controls and Procedures
Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures (as defined in the rules and regulations of the Securities and
Exchange Commission under the Securities Exchange Act of 1934, as amended) as of
the end of the period covered by this report (the “Evaluation Date”). Based on
this evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures were effective as of the
Evaluation Date.
(b) Changes in Internal Control
Over Financial Reporting
During
the fiscal quarter ended September 30, 2008, there were no changes to our
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal controls over financial
reporting.
- 19
-