UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 30, 2002
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
ACT
For the transition period from __________to __________
Commission file number 001-31367
MONTANA MILLS BREAD CO., INC.
--------------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 16-1551461
------------------------------------------ --------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification Number)
2171 Monroe Avenue, Suite 205A
Rochester, New York 14618
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(Address of principal executive offices)
(585) 242-7540
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(Issuer's telephone number)
As of December 16, 2002, 8,107,835 shares of the Issuer's Common Stock, $.001
par value, was outstanding.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
MONTANA MILLS BREAD CO., INC.
FORM 10-QSB
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets as of October 30, 2002 and January 30, 2002 3
Consolidated Statements of Operations for the thirteen and thirty-nine
weeks ended October 30, 2002 and October 31, 2001 4
Consolidated Statement of Stockholder's Equity (Deficit) for the
thirty-nine weeks ended October 30, 2002 5
Consolidated Statements of Cash Flows for the thirty-nine weeks ended
October 30, 2002 and October 31, 2001 6
Notes to Consolidated Financial Statements 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 13
Item 3. CONTROLS AND PROCEDURES 23
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 24
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 24
Item 3. DEFAULTS UPON SENIOR SECURITIES 24
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24
Item 5. OTHER INFORMATION 24
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 25
Signatures and Required Certification 26
Page 2 of 32
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MONTANA MILLS BREAD CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
OCTOBER 30, 2002 JANUARY 30, 2002
---------------- ----------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 272,881 $ 248,243
Short-term investments 7,744,038 518,258
Inventory 386,852 401,426
Income tax receivable 286,971 314,655
Prepaid expenses and other current assets 578,240 426,255
Deferred income taxes -0- 53,000
------------ ------------
Total current assets 9,268,982 1,961,837
Property and equipment, net 6,606,090 6,621,146
Deferred income taxes 0 260,000
Deposits and other assets 200,620 181,482
Unamortized bond issue costs -0- 447,405
------------ ------------
Total assets $ 16,075,692 $ 9,471,870
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,148,704 $ 844,986
Payroll and related expenses 116,835 127,345
Deferred revenue 30,376 101,191
Other current liabilities 28,323 64,648
Current portion of long-term debt 30,379 34,418
------------ ------------
Total current liabilities 1,354,617 1,172,588
Subordinated Convertible Debentures 2,000,000 6,538,500
Long-term debt, net of current portion 21,227 44,185
Other long-term liabilities 66,662 43,000
Deferred tax liability 43,406
------------ ------------
Total liabilities 3,485,912 7,798,273
------------ ------------
Commitments and contingencies
Series A Convertible Preferred Stock, ($.001 par value; 687,500 shares
authorized, none issued and outstanding as of October 30, 2002; 1,000,000
shares authorized, 312,500 issued and outstanding as of
January 30, 2002) -0- 2,500,000
------------ ------------
Common stockholders' equity (deficit):
Common Stock, ($.001 par value; 14,417,989 shares authorized,
8,107,835 issued and outstanding as of October 30,
2002; 5,000,000 issued and outstanding as of January 30, 2002) 8,108 5,000
Additional paid-in capital 16,047,783 -0-
Accumulated deficit (3,466,111) (831,403)
------------ ------------
Total common stockholders' equity (deficit) 12,589,780 (826,403)
------------ ------------
Total liabilities and stockholders' equity $ 16,075,692 $ 9,471,870
============ ============
The accompanying condensed notes are an integral part of these consolidated
financial statements.
Page 3 of 32
MONTANA MILLS BREAD CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED
---------------------------- -------------------------------
OCTOBER 30, OCTOBER 31, OCTOBER 30, OCTOBER 31,
2002 2001 2002 2001
---- ---- ---- ----
Sales $ 2,798,283 $ 2,660,733 8,649,005 6,749,955
Cost of goods sold (exclusive of depreciation
and amortization) 1,601,339 1,365,649 4,738,493 3,396,312
----------- ----------- ----------- -----------
Gross profit 1,196,944 1,295,084 3,910,512 3,353,643
Selling, general and administrative expenses 1,639,904 1,231,345 4,656,970 3,347,002
Pre-opening and grand-opening expenses 202,624 409,504 433,305 782,366
Depreciation and amortization 182,011 128,237 501,231 333,402
----------- ----------- ----------- -----------
Loss from operations (827,595) (474,002) (1,680,994) (1,109,127)
Interest income 38,224 25,941 54,960 145,805
Financing costs (40,750) (190,180) (365,395) (570,809)
----------- ----------- ----------- -----------
Loss before income taxes and extraordinary item (830,121) (638,241) (1,991,429) (1,534,131)
Income tax expense (benefit) 891,126 (249,700) 436,986 (599,450)
----------- ----------- ----------- -----------
Loss before extraordinary item (1,721,247) (388,541) (2,428,415) (934,681)
Extraordinary item-loss on early extinguishment
of debt (net of income tax benefit of $84,000) 131,293
----------- ----------- ----------- -----------
Net loss $(1,721,247) $ (388,541) $(2,559,708) $ (934,681)
=========== =========== =========== ===========
Series A Preferred Stock Dividends -0- (75,000) (125,000) (225,000)
Net loss before extraordinary item applicable
to common stockholders $(1,721,247) $ (463,541) $(2,553,415) $(1,159,681)
=========== =========== =========== ===========
Basic and diluted loss before extraordinary item
per common share applicable to common stockholders $ (.21) $ (.09) $ (.40) $ (.23)
=========== =========== =========== ===========
Net loss applicable to common stockholders $(1,721,247) $ (463,541) $(2,684,708) $(1,159,681)
=========== =========== =========== ===========
Basic and diluted loss per common share applicable
to common stockholders $ (.21) $ (.09) $ (.42) $ (.23)
=========== =========== =========== ===========
Weighted average outstanding common shares 8,107,835 5,000,000 6,391,796 5,000,000
=========== =========== =========== ===========
The accompanying condensed notes are an integral part of these consolidated
financial statements.
Page 4 of 32
MONTANA MILLS BREAD CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
ADDITIONAL
COMMON STOCK PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------- ------- -----
Balance at January 30, 2002 5,000,000 $5,000 $ -0- $ (831,403) $ (826,403)
Net loss for the thirteen weeks ended May 1, 2002 (227,433) (227,433)
Series A Convertible Preferred Stock dividends (75,000) (75,000)
--------- ------ ----------- ----------- -----------
Balance at May 1, 2002 5,000,000 5,000 -0- (1,133,836) (1,128,836)
Contribution and Retirement of Common Stock to
capital by Eugene and Susan O'Donovan (582,011) (582) 582 -0-
Conversion of Subordinated Convertible
Debentures to Common Stock 907,700 908 4,264,618 4,265,526
Cephas Capital Partners, L.P. modification of debt 15,000 15 74,985 75,000
Conversion of Series A Convertible Preferred
Stock into Common Stock 489,696 489 2,499,511 2,500,000
Net proceeds from issuance of Common Stock and Warrants 2,269,950 2,270 8,471,731 8,474,001
Issuance of Underwriter Purchase Option 794,451 794,451
Issuance of Common Stock to consultant 7,500 8 37,492 37,500
Issuance of Warrants to Consultant 71,870 71,870
Net loss for the thirteen weeks ended July 31, 2002 (611,028) (611,028)
Series A Convertible Preferred Stock dividends (50,000) (50,000)
--------- ------ ----------- ----------- -----------
Balance at July 31, 2002 8,107,835 8,108 16,165,240 (1,744,864) 14,428,484
Net loss for the thirteen weeks ended October 30, 2002 (1,721,247) (1,721,247)
Additional costs of issuance of Common Stock and Warrants (117,457) (117,457)
--------- ------ ----------- ----------- -----------
Balance at October 30, 2002 8,107,835 $8,108 $16,047,783 $(3,466,111) $12,589,780
========= ====== =========== =========== ===========
The accompanying condensed notes are an integral part of these consolidated
financial statements.
Page 5 of 32
MONTANA MILLS BREAD CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THIRTY-NINE WEEKS ENDED
-------------------------------
OCTOBER 30, OCTOBER 31,
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,559,708) $ (934,681)
----------- -----------
Adjustments to reconcile net loss to net cash
used in operating activities -
Depreciation and amortization 501,231 333,402
Amortization of bond issuance costs 54,139 97,450
Deferred income taxes 356,406 (482,700)
Consulting agreement stock issuance 37,500
Consulting agreement warrant issuance 71,870
Extraordinary item 195,293
(Increase) decrease in operating assets -
Inventory 14,574 (101,322)
Income tax receivable 27,684 (1,019)
Prepaid expenses and other current assets (151,985) (560,204)
Deposits and other assets (19,138) (116,920)
(Decrease) increase in operating liabilities -
Accounts payable 303,718 393,020
Payroll and related expenses (10,510) (12,703)
Other liabilities (83,479) (119,525)
----------- -----------
Total adjustments 1,297,303 (570,521)
----------- -----------
Net cash used in operating activities (1,262,405) (1,505,202)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments (8,048,348) (2,010,559)
Sale of short-term investments 822,566 1,200,000
Purchase of property and equipment (486,175) (3,168,659)
----------- -----------
Net cash used in investing activities (7,711,957) (3,979,318)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Gross proceeds from issuance of Common Stock and
Redeemable Common Stock Purchase Warrants 11,463,248
Offering costs (2,312,252)
Series A Convertible Preferred Stock dividends (125,000) (225,000)
Repayment of debt (26,996) (26,536)
----------- -----------
Net cash provided by (used in) financing activities 8,999,000 (251,536)
----------- -----------
Net increase (decrease) in cash and cash equivalents 24,638 (5,736,056)
Cash and cash equivalents at beginning of period 248,243 5,805,564
----------- -----------
Cash and cash equivalents at end of period $ 272,881 $ 69,508
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 311,257 $ 473,359
=========== ===========
Income Taxes $ 14,352 $ 250
=========== ===========
Non-cash investing and financing activities
Offering costs included in accounts payable $ 389,996
=========== ===========
Issuance of underwriter's purchase option $ 794,451
=========== ===========
Conversion of Series A Convertible Preferred Stock
into Common Stock $ 2,500,000
===========
Conversion of Subordinated Convertible Debentures to
Common Stock $ 4,265,526
===========
The accompanying condensed notes are an integral part of these consolidated
financial statements.
Page 6 of 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1-BASIS OF PRESENTATION
The accompanying unaudited, consolidated financial statements of
Montana Mills Bread Co., Inc. and its subsidiaries (the "Company") have been
prepared in accordance with instructions to Form 10-QSB and, therefore, do not
include all information and footnotes normally included in financial statements
prepared in conformity with accounting principles generally accepted in the
United States. They should be read in conjunction with the financial statements
of the Company for the fiscal year ended January 30, 2002, included in the
Company's Registration Statement on Form SB-2 filed under the Securities Act of
1933, as amended, in connection with the Company's initial public stock offering
which became effective on June 27, 2002.
The accompanying unaudited consolidated financial statements include
all adjustments (consisting of normal recurring adjustments and accruals) that
management considers necessary for a fair presentation of its financial position
and results of operations for the interim periods. Interim results are not
necessarily indicative of the results that may be expected for the entire year.
NOTE 2-GRAND OPENING AND PRE-OPENING EXPENSES
The Company accounts for pre-opening, grand-opening, and franchise
operation start up expenses representing, payroll, training, advertising, and
consulting costs in accordance with Statement of Position ("SOP") No 98-5,
"Reporting the Costs of Start-up Activities," which requires that pre-opening
and grand-opening costs be expensed as incurred.
NOTE 3-INCOME TAXES
The Company recorded a $1,180,406 charge to establish a valuation
allowance for its net deferred tax asset in October 2002. The valuation
allowance was calculated in accordance with the provisions of FAS 109 which
places primary importance on the Company's most recent operating results when
assessing the need for a valuation allowance. Although management believes the
Company's results for the recent operating periods were heavily affected by
deliberate and planned investments in its growth strategy, the Company's
cumulative loss, including the net loss reported in the quarter ended October
30, 2002, represented negative evidence sufficient to require a full valuation
allowance under FAS 109. The Company intends to maintain a full valuation
allowance for its net deferred tax asset until such time it is determined that
its deferred tax assets are realizable, and that a valuation allowance is no
longer necessary.
NOTE 4-ADOPTION OF SFAS 142
Effective January 31, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets" which establishes new accounting and reporting standards that require
ratable amortization of goodwill and other intangibles be replaced with periodic
tests of the goodwill's impairment and that intangible assets with other than
indefinite lives be amortized over their useful lives. The Company's adoption of
SFAS 142 did not have a material impact on the results of its operations.
Unamortized intangible assets consist of trademarks and goodwill totaling
$133,560 at October 30, 2002.
Page 7 of 32
NOTE 5-INVENTORY
Inventories are comprised of the following:
(unaudited)
OCTOBER 30, JANUARY 30,
2002 2002
---- ----
Ingredients 251,508 243,631
Retail products 102,787 132,232
Paper products 32,557 25,563
------- -------
386,852 401,426
======= =======
NOTE 6-EARNINGS PER SHARE
Basic earnings per common share are computed by dividing net earnings
available to common stockholders by the weighted average number of common shares
outstanding. For the thirteen and thirty-nine weeks ended October 30, 2001, the
Company's calculation of diluted earnings per share does not include the effect
of unexercised stock options and warrants, or the conversion of Series A
Convertible Preferred Stock or the Company's convertible debt representing
1,281,912 potential shares of common stock, since the effect would be
anti-dilutive. For the thirteen and thirty-nine weeks ended October 31, 2002,
the Company's calculation of diluted earnings per share does not include the
effect of unexercised stock options, warrants and the 2,269,950 Common Stock
warrants issued in the Company's initial public offering representing a combined
total of 3,571,512 potential shares of Common Stock, since the overall effect
would be anti-dilutive given the Company's loss position.
The following table sets forth the computation of basic and diluted earnings per
share:
FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED
---------------------------- --------------------------------
OCTOBER 30, OCTOBER 31, OCTOBER 30, OCTOBER 31,
2002 2001 2002 2001
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
Net loss before extraordinary item $(1,721,247) $ (388,541) $(2,428,415) $ (934,681)
Series A Convertible Preferred Stock dividends -0- (75,000) (125,000) (225,000)
----------- ----------- ----------- -----------
Net loss before extraordinary item applicable
to common stockholders $(1,721,247) $ (463,541) $(2,553,415) $(1,159,681)
=========== =========== =========== ===========
Basic and diluted loss before extraordinary
item per common share applicable to
common stockholders $ (.21) $ (.09) $ (.40) $ (.23)
=========== =========== =========== ===========
Net loss $(1,721,247) $ (388,541) $(2,559,708) $ (934,681)
Series A Convertible Preferred Stock dividends -0- (75,000) (125,000) (225,000)
----------- ----------- ----------- -----------
Net loss applicable to common stockholders $(1,721,247) $ (463,541) $(2,684,708) $(1,159,681)
=========== =========== =========== ===========
Basic and diluted loss per common share
applicable to common stockholders $ (.21) $ (.09) $ (.42) $ (.23)
=========== =========== =========== ===========
Weighted average outstanding common shares 8,107,835 5,000,000 6,391,796 5,000,000
=========== =========== =========== ===========
Page 8 of 32
NOTE 7-COMMON STOCK, PREFERRED STOCK AND COMMON STOCK WARRANTS
Contribution of Shares.
On June 27, 2002, the effective date of the Company's initial public
offering, Eugene O'Donovan and Susan O'Donovan, the Company's President and
Chief Executive Officer and Executive Vice President, respectively, contributed
an aggregate of 582,011 shares of Common Stock owned by them to the Company's
capital. Mr. and Mrs. O'Donovan made this capital contribution without receiving
any payment for their shares in response to a request by the Company's
underwriter in its initial public offering to limit the number of shares of the
Company's Common Stock outstanding on a fully diluted basis.
Issue of Common Stock and Redeemable Common Stock Purchase Warrants in
connection with the Company's Initial Public Offering.
The Company's initial public offering was declared effective on June
27, 2002 and closed on July 3, 2002. In connection with the initial public
offering, the Company issued 2,269,950 shares of Common Stock and 2,269,950
Redeemable Common Stock Purchase Warrants. This included the exercise by the
Company's underwriter of 269,950 shares of Common Stock and 269,950 Common Stock
Purchase Warrants to cover over-allotments. The initial public offering price
per share of Common Stock was $5.00 and the Redeemable Common Stock Purchase
Warrants were offered at $.05 per purchase warrant.
Each Common Stock Purchase Warrant entitles the purchaser to purchase
one share of the Company's Common Stock for $7.58 beginning June 27, 2002 and
ending June 27, 2007. The Company may redeem the Common Stock Purchase Warrants,
with the Company's underwriter's prior consent, at any time after they become
exercisable, for $.01 per purchase warrant, on not less than 30 day's prior
written notice if the last sale price of the Company's Common Stock has been at
least $15.16 for the 20 consecutive trading days ending on the third day prior
to the date on which notice was given.
Conversion of Series A Convertible Redeemable Preferred Stock.
Through July 2, 2002, the Company was authorized to issue 1,000,000
shares of $.001 par value Preferred Stock. There were 312,500 shares of Series A
Convertible Preferred Stock issued and outstanding for a total consideration of
$2,500,000 through June 2, 2002. On July 3, 2002, the Company converted all
312,500 outstanding shares of its outstanding Series A Convertible Preferred
Stock into 489,696 shares of Common Stock pursuant to the terms of the Series A
Convertible Redeemable Preferred Stock.
Subject to the provisions of the Company's Certificate of Incorporation
and to the limitations prescribed by law, the Company's Board of Directors has
the authority, without further action by stockholders, to issue up to 687,500
shares of authorized but unissued Preferred Stock in one or more series. The
Preferred Stock allows the Company's Board of Directors the power and authority
to fix the rights, designations, preferences, privileges, qualifications and
restrictions of the preferred stock, including dividend rights, conversion
rights, voting rights, terms of redemption, liquidation preferences and sinking
fund terms, any or all which may be greater than the rights of the Company's
Common Stock. The Company has no present plans to issue any additional shares of
Preferred Stock and has agreed not to issue any shares of preferred
Page 9 of 32
stock for one year after June 27, 2002 without the prior written consent of the
Company's initial public offering underwriter. The issuance by the Company of
shares of preferred stock may discourage or delay bids for the Company's Common
Stock or may otherwise affect the market price of the Company's Common Stock.
Conversion of Subordinated Convertible Debentures.
In fiscal 2001, the Company issued $4,538,500 in principal face value
of five-year Subordinated Convertible Debentures bearing interest at an average
rate of 8.5%. Financing costs, which included 98,062 warrants for the purchase
of Common Stock at $7.50 per share, were issued to the selling agent that
assisted the Company in privately placing the Subordinated Convertible
Debenture. Commissions and legal fees incurred in connection with such private
placement amounted to $648,662 and were amortized over five years using the
effective interest rate method. On June 27, 2002, the effective date of the
Company's initial public offering, all of the Company's outstanding Subordinated
Convertible Debentures were converted into 907,700 shares of the Company's
Common Stock. Accrued interest totaling $156,277 was paid prior to such
conversion.
NOTE 8-EXTRAORDINARY ITEM
On July 3, 2002 Cephas Capital Partners, L.P. was issued 15,000 shares
of the Company's Common Stock and was paid $20,000 in conjunction with the
modification of a Convertible Promissory Note made by the Company in its favor
in 2000. Such modification, among other things, lowered the annual interest rate
from 12% to 8%. The effect of this modification was a one time nonrecurring
charge of $215,293. Such charge included the $20,000 payment, $75,000 for the
fair market value of 15,000 shares of common stock at $5.00 per share and the
write-off of $120,293 of unamortized financing costs associated with the initial
issuance of the Convertible Promissory Note.
NOTE 9-CONSULTING AGREEMENTS
In connection with the Company's initial public offering, the Company's
underwriter was engaged as its financial consultant for a period of two years
beginning June 27, 2002. The consulting agreement requires an annual fee of
$50,000, of which payment for the first year was paid at the closing of the
Company's initial public offering. Additionally, if within five years from June
27, 2002, the Company completes a merger, acquisition, joint venture or other
transaction with a party that such underwriter introduces to the Company, such
underwriter will receive a finder's fee equal to 5% of the consideration paid in
connection with such transaction.
In connection with its initial public offering, the Company also hired
an investor relations firm. The terms of the agreement between the Company and
such firm is for 18 months and calls for monthly payments of $4,000 beginning
July 2002. The agreement, unless terminated in writing, automatically renews for
an additional twelve months. The agreement also includes the payment to such
firm of 7,500 shares of restricted stock and an additional 7,500 shares will be
deemed issued but subject to vesting in equal monthly increments over the
12-month period beginning in month six of the agreement. In addition, the
consultant received 50,000 warrants to purchase shares of the Company's Common
Stock at a price of $10.00 per share and 50,000 warrants to purchase shares of
the Company's Common Stock at a price of $15.00 per share. In the event the
agreement is terminated in the first six months, the consultant will retain 50%
of the
Page 10 of 32
warrants (25,000 at the $10.00 exercise price and 25,000 at the $15.00 exercise
price) with the remaining warrants reverting back to the Company. If the
agreement is terminated in months six through eighteen, the consultant will
receive a pro rata warrant portion of such warrants, based on the number of
months the agreement was in effect commencing in month six of the 18 month
period. The agreement may be terminated at any time upon 30 business days'
notice after the first three-month anniversary of the date of the agreement. In
the event that the agreement is terminated by either party prior to the end of
the 18-month term, the consultant shall be entitled to reimbursement of its
reasonable out - pocket expenses. As a result of the non-forfeitable component
of the Common Stock and warrant component of this agreement, the Company
incurred non-cash expense of $109,370 during the 13 weeks ending October 30,
2002.
NOTE 10-RECENT ACCOUNTING PRONOUNCEMENTS
In October 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No.144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" which supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" and the accounting and reporting provisions of APB
No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal
of Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" for the disposal of a segment of a business. SFAS No.
144 retains many of the provisions of SFAS No. 121, but addresses certain
implementation issues associated with that Statement. The Company adopted SFAS
No. 144 on January 1, 2002 and the adoption did not have a material impact on
the Company's financial condition or its results of operations.
In April 2002, FASB issued SFAS No. 145, "Rescission of FASB Statement
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". The Company adopted the provisions of SFAS No. 145 in its
quarter-ended July 31, 2002. There was no impact on the Company's financial
statements as a result of the adoption of SFAS No. 145.
In June 2002, FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" which nullifies Emerging Issues
Task Force Issue No. 94-3. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. The Company will adopt the provisions of SFAS No. 146 on January 1,
2003. The Company believes the impact of the adoption of the provisions of SFAS
No. 146 will not have a material impact on the Company`s financial statements.
NOTE 11-COMMITMENTS AND CONTINGENT LIABILITIES
The Company is obligated under non-cancelable operating leases for its
administrative offices, bread stores and mall kiosks. Generally, the Company is
required to pay a proportionate share of real estate taxes, insurance, common
area and other operating costs. Some bread store leases provide for contingent
rental (i.e., percentage rent) payments based on sales in excess of specified
amounts. Generally, the Company's leases have initial terms of ten years and
contain provisions for renewal options of five to twenty-five years.
The Company is subject to legal proceedings and claims which arise in
the normal course of business. In the opinion of management, the ultimate
liabilities with respect to these potential
Page 11 of 32
actions will not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
Page 12 of 32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and our results of
operations should be read together with the Company's financial statements and
the accompanying notes. References to we, our, us, the Company, or Montana Mills
shall, unless the context specifically provides otherwise, refer to Montana
Mills Bread Co. Inc and its subsidiaries. This discussion contains statements
about future events and expectations, including anticipated store and market
openings, planned capital expenditures and trends in or expectations regarding
the Company's operations and financing abilities, that constitute
"forward-looking" statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are based on
management's beliefs, assumptions, and expectations of our future economic
performance, taking into account the information currently available to
management. These statements are not statements of historical fact.
Forward-looking statements involve risks and uncertainties that may cause our
actual results, performance or financial condition to differ materially from the
expectations of future results, performance of financial condition we express or
imply in any forward-looking statements. Factors that could contribute to these
differences include, but are not limited to: the Company's ability to continue
and manage growth; delays in store openings; the quality of future franchise
store operations if any; the price and availability of raw materials and
ingredients needed to produce breads and other baked goods; changes in customer
preferences and perceptions; risks associated with competition; risks associated
with fluctuations in operating and quarterly results; compliance with government
regulations; and other factors discussed in Montana Mills periodic reports and
other information statements filed with the Securities and Exchange Commission.
The words "believe", "may", "will", "should", "anticipate", "estimate",
"expect", "intend", "objective", "seek", "strive", or similar words, or the
negative of these words, identify forward-looking statements entirely by these
cautionary factors.
OVERVIEW
Montana Mills was founded in June 1996 and reincorporated as a Delaware
corporation in 1998. Eugene O'Donovan, our president and chief executive
officer, and Susan O'Donovan, our executive vice president, designed our unique
village bread store concept that recreates a community-focused, nostalgic,
special bakery experience for customers. Through our subsidiaries, we offer high
quality, fresh boutique-style bread and other baked goods prepared in small
batches in an open-view baking format using fresh ingredients including freshly
ground wheat and dough made from scratch. All aspects of our baking process are
conducted in full view of customers to emphasize the homemade aspect of our
bread and other baked goods. We also sell our fresh bread and other products at
satellite cafes, which are small stores with up to 45 seats where customers can
enjoy fresh bakery products supplied by one of our nearby village bread stores.
Our locations are decorated with and contain natural colors and hues,
maple counters and tables and educational, in-store displays to further
highlight our image of freshness and quality. Customers generally are greeted by
an employee and offered a free, fresh slice the "size of Montana" of one of any
breads available that day. In addition to bread, we also bake muffins, scones,
cookies, granola and other baked goods. We also offer sandwiches under the
"Breader"
Page 13 of 32
name and sell coffee beverages under the Java Joe's brand name. As of December
15, 2002, we operated 31 permanent locations, including 21 village bread stores
and ten satellite cafes.
The Company's initial public offering was declared effective on June
27, 2002 and closed on July 3, 2002. In connection with the initial public
offering, the company issued 2,269,950 shares of common stock and 2,269,950
purchase warrants. This included the exercise by our underwriter of an
over-allotment option for 269,950 shares of common stock and 269,950 purchase
warrants. The offering price per share of common stock was $5.00 and the
purchase warrants were priced at $.05 per purchase warrant.
Each purchase warrant entitles the holder to purchase one share of our
common stock for $7.58 during the period beginning 90 days after the date of the
prospectus, June 27, 2002 and ending on the fifth anniversary after the date of
the prospectus, June 27, 2007. We may redeem the purchase warrants, with our
underwriter's prior consent, at any time after they become exercisable, for $.01
per purchase warrant, on not less than 30 day's prior written notice if the last
sale price of our common stock has been at least $15.16 for the 20 consecutive
trading days ending on the third day prior to the date on which notice was
given.
GROWTH STRATEGY
Our business strategy is to build a widely recognized and respected
brand name by further penetrating new and existing markets, continuously
improving the experience of our customers, continuing to develop our
off-premises sales to other retailers, further developing our catalog and
internet sales, entering the franchising market, and examining strategic
acquisitions.
FURTHER PENETRATE NEW AND EXISTING MARKETS. Opening additional stores
in existing and new markets is the cornerstone of our effort to build a widely
recognized brand name. Since our inception, we have expanded upon our village
bread store locations to include satellite cafes, kiosks, the Java Joe's coffee
concept and a wide array of products, including baked goods and Breader
sandwiches.
- Build out of existing markets. We believe that clustering new
locations in existing markets will increase recognition of the
Montana Mills brand name and create a strong platform for a
broad regional expansion program. We intend to open new
locations in core markets that are geographically convenient
to our Rochester, New York headquarters. We believe that this
strategy will assist us in strengthening our brand name in our
core markets. During the quarter ended October 30, 2002, we
opened one store in Syracuse, NY.
- Penetrate new markets. Building on the strength of the Montana
Mills brand name in our core markets, we have identified a
number of cities throughout upstate New York, Pennsylvania,
Ohio and Connecticut to open new stores. We have conducted
demographic surveys of these locations and have determined
that their populations fit our profile for store development.
In addition, we believe that these markets have not captured
the attention of larger, national bakery chains. We believe
that we can establish the Montana Mills brand name and develop
a loyal customer base in these areas, thereby creating
significant barriers to entry for competitors in these
markets. During the quarter ended October 30, 2002, we opened
one store in Erie, PA.
Page 14 of 32
CONTINUOUSLY IMPROVE THE EXPERIENCE OF OUR CUSTOMERS. In each of our
stores, we seek to provide value to our customers by continually expanding our
product offerings and further improving our prompt, courteous service and
pleasant customer-service oriented atmosphere.
- Expansion of product offerings. We continually create new
products, illustrated by our expansion from approximately 15
types of bread in 1996 to more than 80 types of bread and a
wide array of baked goods, coffee beverages and related
products. We intend to continue to maintain and improve our
product offerings through customer surveys and independent
research designed to assess consumer demands and preferences.
- Continuously improve customer service. We believe that
superior customer service is critical to achieving customer
satisfaction and operating success. We utilize comprehensive
management training programs to ensure that our employees
provide customers with an enjoyable experience during every
store visit. An integral part of this experience is our policy
to greet each customer with a free slice of bread the "size of
Montana."
OFF-PREMISES SALES TO OTHER RETAILERS AND CAFES. We recently commenced
selling our products off-premises through grocery stores and other retailers
where fresh bread and other baked goods are delivered daily from our bread
stores. These products are displayed on bread racks supplied by us generally
using our branded point of sale signage. The Company currently sells
off-premises from five store locations and expects to sell off-premises from
substantially all of its current bread stores within twelve months. It is
also anticipated that off-premises sales will be an important element of future
stores both owned by us and franchised.
FURTHER DEVELOP OUR CATALOG AND INTERNET PROGRAMS. Our mail order
catalog and internet businesses represented approximately $648,000, or 6.0%, of
our total sales in our fiscal year ended January 30, 2002. We believe that
opportunities exist to grow our catalog and internet businesses substantially,
thereby generating additional revenue as well as expanding awareness of the
Montana Mills brand name. We also believe that we can also utilize our catalog
to direct customers to our website, which achieved approximately 5,500,000 page
views during our fiscal year ended January 30, 2002. Our website was awarded
honors by The Rochester Business Journal in 2001 for the best home page and best
overall website in the small business category for Rochester-based companies. On
our website, customers may place online orders and view our product offerings.
Additionally, we intend to explore opportunities to further capitalize on the
corporate gift segment of mail order catalogs, which we believe can generate
significant revenues. Currently, corporate gifts do not represent a significant
component of our catalog or internet business.
FRANCHISING. We intend to diversify our customer base and expand our
operations into new geographic areas by franchising our stores. Our franchise
strategy will be to grant franchisees the exclusive right and license to operate
Montana Mills stores within a defined territory.
We intend to provide franchisees with stringent guidelines and
specifications for the operation of stores, initial training, and the use of our
name, service marks and proprietary marks. We will also assist franchisees with
identifying site locations and provide franchisees with advice on advertising
and other promotional techniques. Our franchisees will be required to
Page 15 of 32
buy supplies from us or from alternative suppliers that we have pre-approved.
Additionally, our franchisees will be required to purchase promotional
materials, catalogs and various other products from us.
We intend for our franchisees to bear all or a substantial portion of
the financial responsibility for opening and operating franchised stores,
including purchasing insurance, hiring employees, entering into lease agreements
and purchasing or leasing equipment. In exchange for our services and the rights
granted by franchise agreements, franchisees will pay various fees to us.
We also intend for our franchisees to indemnify us and hold us harmless
from any liability, claim or judgment arising from their franchised business. We
will be able to terminate any franchise agreement upon the occurrence of events
of default, which will include a franchisee's failure to pay monies owed to us,
failure to maintain licenses, a franchisee's misuse of our service or
proprietary marks or a franchisee's insolvency. We have not entered into any
franchise agreements as of the date of this Report.
We also recently registered our Uniform Franchise Offering Circular
with the New York State Department of Law. The registration allows us to
immediately offer franchises for sale in 22 states which require no specific
filing (including Ohio and Pennsylvania where we have existing stores). We are
currently offering franchises for sale nationwide and are in discussions with
several potential franchisees and expect to sign franchise agreements for a
number of stores prior to our fiscal year end.
EXPLORE ACQUISITIONS. Due to the fragmented nature of the industry in
which we compete, we believe a significant opportunity exists for consolidation.
We intend to continuously examine potential acquisition opportunities as they
arise and will consider the acquisition of existing companies where we believe
the potential exists for achieving economies of scale, increasing the
recognition of the Montana Mills brand name or where completing an acquisition
will otherwise benefit our growth strategy or results of operations.
CRITICAL ACCOUNTING POLICIES
An understanding of our accounting policies is necessary for a complete
analysis of our results, financial position, liquidity and trends. We focus your
attention on the following:
ASSET IMPAIRMENT. All long-lived assets are evaluated for impairment on
the basis of undiscounted cash flows whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. An
impaired asset is written down to its estimated fair market value based on the
best information available. Estimated fair market value is generally measured by
discounting estimated future cash flows. Considerable management judgment is
necessary to estimate discounted future cash flows. Assumptions used in these
cash flows are consistent with internal forecasts.
INCOME TAXES. Our effective tax rate and the tax bases of our assets
and liabilities reflect our best estimate of the ultimate outcome of tax audits.
Valuation allowances are established where expected future taxable income does
not support the realization of the deferred tax assets. Considerable management
judgment is also necessary in estimating future taxable income. Assumptions used
in these estimates are consistent with internal forecasts.
Page 16 of 32
RESULTS OF OPERATIONS
The following historical financial data, discussion and analysis should
be read in conjunction with the consolidated financial statements and notes
included herein.
FOR THE THIRTEEN WEEKS ENDED FOR THE THIRTY-NINE WEEKS ENDED
---------------------------- -------------------------------
OCTOBER 30, OCTOBER 31, OCTOBER 30, OCTOBER 31,
2002 2001 2002 2001
---- ---- ---- ----
Sales $ 2,798,283 $ 2,660,733 8,649,005 6,749,955
Cost of goods sold (exclusive of depreciation
and amortization) 1,601,339 1,365,649 4,738,493 3,396,312
----------- ----------- ----------- -----------
Gross profit 1,196,944 1,295,084 3,910,512 3,353,643
Selling, general and administrative expenses 1,639,904 1,231,345 4,656,970 3,347,002
Pre-opening and grand-opening expenses 202,624 409,504 433,305 782,366
Depreciation and amortization 182,011 128,237 501,231 333,402
----------- ----------- ----------- -----------
Loss from operations (827,595) (474,002) (1,680,994) (1,109,127)
Interest income 38,224 25,941 54,960 145,805
Financing costs (40,750) (190,180) (365,395) (570,809)
----------- ----------- ----------- -----------
Loss before income taxes and extraordinary item (830,121) (638,241) (1,991,429) (1,534,131)
Income tax expense (benefit) 891,126 (249,700) 436,986 (599,450)
----------- ----------- ----------- -----------
Loss before extraordinary item (1,721,247) (388,541) (2,428,415) (934,681)
Extraordinary item-loss on early extinguishment
of debt (net of income tax benefit of $84,000) 131,293
----------- ----------- ----------- -----------
Net loss $(1,721,247) $ (388,541) $(2,559,708) $ (934,681)
=========== =========== =========== ===========
Series A Preferred Stock Dividends -0- (75,000) (125,000) (225,000)
Net loss before extraordinary item applicable
to common stockholders $(1,721,247) $ (463,541) $(2,553,415) $(1,159,681)
=========== =========== =========== ===========
Basic and diluted loss before extraordinary
item per common share applicable to common stockholders $ (.21) $ (.09) $ (.40) $ (.23)
=========== =========== =========== ===========
Net loss applicable to common stockholders $(1,721,247) $ (463,541) $(2,684,708) $(1,159,681)
=========== =========== =========== ===========
Basic and diluted loss per common share applicable
to common stockholders $ (.21) $ (.09) $ (.42) $ (.23)
=========== =========== =========== ===========
Weighted average outstanding common shares 8,107,835 5,000,000 6,391,796 5,000,000
=========== =========== =========== ===========
SALES.
Sales for the thirteen-weeks ended October 30, 2002 increased 5% to
$2,798,283 compared to $2,660,733 for the thirteen-weeks ended October 31, 2001.
For the thirty-nine weeks ended October 30, 2002 total sales increased 28% to
$8,649,005 compared to $6,749,955 for the thirty-nine weeks ended October 31,
2001. The increase in sales is primarily due to
Page 17 of 32
approximately $368,878 of additional sales from five new stores opened during
the thirteen weeks ended October 30, 2002 and approximately $1,019,327 of
additional sales from the five new stores opened during the thirty-nine
weeks ended October 30, 2002 compared to the corresponding periods for the
previous year. These increases were offset by a 4% decline in comparable store
sales during the thirteen weeks and thirty-nine weeks ended October 31, 2002 as
a result of the cannibalization effect of new store additions in existing
markets and general economic conditions. Comparable store sales from the five
stores where the Company generated off-premises sales during the quarter ended
October 30, 2002 increased an average of 20% over the previous year. The Company
expects to sell off-premises from substantially all of its current bread stores
within twelve months.
COST OF GOODS SOLD (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION).
Cost of goods sold (exclusive of depreciation and amortization)
includes bakery and paper ingredients supplied by outside vendors, production
labor, and occupancy costs. The cost of goods sold and occupancy costs increased
to $1,601,339 or 57% of sales for the thirteen weeks ended October 30, 2002 as
compared to $1,365,649 or 51% of sales for the thirteen weeks ended October 31,
2001. For the thirty-nine weeks ended October 30, 2002, cost of goods sold and
occupancy costs increased to $4,738,493 or 55% of sales from $3,396,312 or 50%
of sales for the thirty-nine weeks ended October 31, 2001. The cost of goods
sold and occupancy costs for the thirteen weeks and thirty-nine weeks ended
October 30, 2002 increased primarily as a result of increased labor costs in
existing and new markets and increased product costs related to a shift in
product sales to other offerings including coffee and sandwiches which have a
lower margin than our historical bakery products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.
Selling, general and administrative expenses were $1,639,904 or 59% of
sales for the thirteen weeks ended October 30, 2002 compared to $1,231,345 or
46% of sales for the thirteen weeks ended October 31, 2001. Selling, general and
administrative expenses were $4,656,970 or 54% of sales for the thirty-nine
weeks ended October 30, 2002 compared to $3,347,002 or 50% of sales for the
thirty-nine weeks ended October 31, 2001.
Store selling expenses were $431,131 or 15% of sales for the thirteen
weeks ended October 30, 2002 compared to $312,058 or 12% for the thirteen weeks
ended October 31, 2001. This increase is largely attributable to start up
expense incurred by our off premises sales program. Store selling expenses were
$1,158,484 or 13% of sales for the thirty-nine weeks ended October 30, 2002
compared to $815,464 of sales or 12% for the thirty-nine weeks ended October 31,
2001.
Corporate general and administrative expenses were $510,584 (18% of
sales) for the thirteen weeks ended October 30, 2002 compared to $389,991 (15%
of sales) for the comparable period ended October 31, 2001. Corporate general
and administrative expenses for the thirty-nine weeks ended October 30, 2002
included $125,000 (of which $109,000 is a non-cash charge) for a public
relations consultant hired by the Company subsequent to its Initial Public
Offering. Excluding this charge, corporate general and administrative expenses
for the thirty-nine weeks ended October 30, 2002 were $1,389,982 (16% of sales)
compared to $1,174,403 (17% of sales) for the thirty-nine weeks ended October
31, 2001.
PRE-OPENING AND GRAND-OPENING EXPENSES.
Pre-opening and grand-opening expenses, including franchise start up
expenses, were $202,624 or 7% of sales for the thirteen weeks ended October 30,
2002 compared to $409,504 or 15% of sales for the thirteen weeks ended October
31, 2001. Pre-opening and grand-opening expenses were $433,305 or 5% of sales
for the thirty-nine weeks ended October 30, 2002
Page 18 of 32
compared to $782,366 or 12% of sales for the thirty-nine weeks ended
October 31, 2001. Pre-opening and grand-opening expenses decreased as a
percentage of sales for the thirteen and thirty-nine weeks ended October 30,
2002 compared to the corresponding periods in the previous year primarily as a
result of opening fewer new stores during that time period.
DEPRECIATION AND AMORTIZATION.
Depreciation and amortization was $182,011 or 7% of sales for the
thirteen weeks ended October 30, 2002 compared to $128,237 or 5% of sales for
the thirteen weeks ended October 31, 2001. For the thirty-nine weeks ended
October 30, 2002, depreciation and amortization was $501,231 or 6% of sales
compared to $333,402 or 5% of sales for the thirty-nine weeks ended October 31,
2001.
FINANCING COSTS, NET OF INTEREST INCOME.
Interest payments were $40,750 for the thirteen weeks ended October 30,
2002 compared to $157,697 for the thirteen weeks ended October 31, 2001.
Interest payments were $311,257 for the thirty-nine weeks ended October 30, 2002
compared to $473,360 for the thirty-nine weeks ended October 31, 2001. Interest
payments decreased for the thirteen and thity-nine weeks ended October 30, 2002
compared to the corresponding periods for the previous year as a result of the
Company's conversion of $4,538,500 of Subordinated Convertible Debentures into
common stock at the time of the Company's initial public offering which was
effective on June 27, 2002. The Company expects that significant interest
expense savings will positively impact future earnings and cash flow.
Amortization of bond issue costs decreased to $0 for the thirteen weeks
ended October 30, 2002 compared to $32,483 for the thirteen weeks ended October
31, 2001. Amortization of bond issue costs decreased to $54,139 for the
thirty-nine weeks ended October 30, 2002 compared to $97,450 for the thirty-nine
weeks ended October 31, 2001. These decreases resulted from the Company's
conversion of $4,538,500 of subordinated convertible debentures to common stock
at the time of the Company's initial public offering which became effective on
June 27.
Interest income increased to $38,224 for the thirteen weeks ended
October 30, 2002 compared to $25,941 for the thirteen weeks ended October 31,
2001. This increase is attributable to an increase in cash on hand as a result
of the initial public offering, despite a decline in interest rates earned on
investments. Interest income decreased to $54,960 for the thirty-nine weeks
ended October 30, 2002 compared to $145,805 for the thirty-nine weeks ended
October 31, 2001. This decrease resulted from a decline in interest rates earned
on investments and reduced average cash and cash equivalent balances.
INCOME TAX EXPENSE (benefit)
The Company recorded a charge of approximately $1.2 million to
establish a valuation allowance for its net deferred tax asset related to the
realization of net operating loss carryforwards. Approximately $900,000 related
to previously recognized deferred tax assets and approximately $300,000 related
to the current thirteen week period loss. The valuation allowance was calculated
in accordance with the provisions of FAS 109 which places primary importance on
the Company's most recent operating results. Management believes the results for
those periods were heavily affected by deliberate and planned investments in new
store development, off-premises sales and franchising opportunities.
Page 19 of 32
EXTRAORDINARY ITEM - LOSS ON EARLY EXTINGUISHMENTS OF DEBT.
On July 3, 2002 Cephas Capital Partners, L.P. was issued 15,000 shares
of the Company's Common Stock and was paid $20,000 in conjunction with the
modification of a Convertible Promissory Note made by the Company. Such
modification lowered the annual interest rate from 12% to 8%. The effect of this
modification was a one time nonrecurring charge of $215,293. This charge
included the $20,000 payment, $75,000 for the fair market value of 15,000 shares
of common stock at $5.00 per share and the write-off of $120,293 of unamortized
financing costs associated with the initial issuance of the Convertible
Promissory Note.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operating activities for the thirty-nine weeks ended October 30,
2002, was $1,262,405 compared to $1,505,202 for the thirty-nine weeks ended
October 31, 2001. The decrease in cash outflows was primarily a result of a
lower requirement for working capital and the use of the Company's stock for
Consulting Compensation.
Cash used in investing activities for the thirty-nine weeks ended October 30,
2002 increased to $7,711,957 compared to $3,979,318 for the thirty-nine weeks
ended October 31, 2001, primarily as a result of decreased purchases of property
and equipment and increased short term investments of the proceeds of the
Company's initial public offering completed in July 2002.
Cash provided by financing activities was $8,999,000 for the thirty-nine weeks
ended October 30, 2002 and consisted primarily of the net proceeds of the
Company's initial public offering less $125,000 in dividend payments to
preferred stockholders prior to the conversion of the preferred shares into
common stock at the date of the Company's initial public offering. For the
period ended October 31, 2001, cash used by financing activities was $251,536.
The Company had working capital of approximately $7.9 million at October 30,
2002 consisting principally of cash and cash equivalents and short term
investments invested in short term money market funds. The Company expects to
open up to ten stores in the next twelve months at a projected cost of $2.6
million. The Company believes it has sufficient cash to conduct operations for
at least the next 12 months.
IMPACT OF INFLATION AND SEASONALITY
We anticipate that our business will be affected by general trends that
affect retailers. We do not believe that we have operated during a period of
high inflation. Based on our experience, we expect to be able to pass on
increased costs resulting from inflation to our customers. Our business could be
affected by increased wheat prices, coffee prices, sugar prices, acquisitions of
existing bakeries, weather, marketing programs, variations in the number of
store openings and general economic conditions and diet trends. In the past, the
Company has been able to recover inflationary costs and commodity price
increases through increase menu prices. There have been and there may be in the
future, delays in implementing such menu price increases, and competitive
pressures may limit the Company's ability to recover such cost increases in
their entirety. Historically, the effects of inflation on the Company's net
income have not been materially adverse.
Page 20 of 32
A majority of the Company's employees are paid hourly rates related to
federal and state minimum wage laws. Although the Company has and will continue
to attempt to pass along any increased labor costs through food price increases,
there can be no assurance that all such increased labor costs can be reflected
in its prices or that increased prices will be absorbed by consumers without
diminishing to some degree consumer spending at the bread stores. However, the
Company has not experienced to date a significant reduction in gross profit
margins as a result of changes in such laws, and management does not anticipate
any related future significant reductions in gross profit margins.
Page 21 of 32
TRANSACTIONS WITH RELATED PARTIES
Transactions with related parties included the purchase of coffee and
the leasing of three properties from entities owned by Eugene O'Donovan, the
Company's President and Chief Executive Officer and its largest stockholder. The
Company believes that these arrangements are consistent in all respects with
other arrangements that could have been made with unaffiliated third parties. On
July 3, 2002, the closing of the Company's initial pubic offering, the Company
purchased Java Joe's Public Market Roastery, Inc. from Eugene O'Donovan for
$30,000. The Company is now purchasing and roasting coffee for use in its bread
stores.
CAPITAL RESOURCES, CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
OPERATING LEASES.
The Company is obligated under noncancelable operating leases for its
administrative offices, bread stores and mall kiosks. Generally, the Company is
required to pay a proportionate share of real estate taxes, insurance, common
area and other operating costs. Some bread store leases provide for contingent
rental (i.e., percentage rent) payments based on sales in excess of specified
amounts. Generally, theses leases have initial terms of ten years and contain
provisions for renewal options of five to twenty five years. We anticipate
utilizing operating leases as a financing tool for future locations.
CEPHAS CAPITAL PARTNERS CONVERTIBLE PROMISSORY NOTE.
On July 3, 2002 a $2,000,000 Convertible Promissory Note was issued in
favor of Cephas Capital Partners, L.P. This Convertible Promissory Note
represented a modification of a previous $2,000,000 Convertible Promissory Note
dated June 22, 2000, issued pursuant to a Note Purchase Agreement between the
Company and Cephas Capital Partners, L.P. In connection with this modification,
the Company paid $20,000 and issued 15,000 shares of common stock to Cephas
Capital Partners, L.P. The Convertible Promissory Note is collateralized by all
of the Company's assets. Cephas Capital Partners, L.P. has agreed to subordinate
its security interest to a senior lender if we secure a senior finance facility.
The Company is required to make monthly payments of interest on the note through
June 2005, at which time the Company will be required to make amortized payments
of principal and interest through June 2007. The Convertible Promissory Note is
convertible, at Cephas Capital Partner, L.P.'s option, into shares of the
Company's Common Stock at $5.00 per share. Cephas Capital Partners, L.P. has
signed a lock-up agreement which prohibits it from transferring any of our
securities for a period of thirteen months following June 27, 2002. The Company
may prepay the Note at any time upon the payment by us of up to a 3% prepayment
premium.
OFF BALANCE SHEET ARRANGEMENTS.
The Company does not have any off balance sheet debt nor does it have
any transactions, arrangements, or relationships with any "special purpose"
entities.
RECENT ACCOUNTING PRONOUNCEMENTS
In October 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No.144, "Accounting
for the Impairment or
Page 22 of 32
Disposal of Long-Lived Assets" which supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
and the accounting and reporting provisions of APAB No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" for the disposal of a segment of a business. SFAS No. 144 retains
many of the provisions of SFAS No. 121, but addresses certain implementation
issues associated with that Statement. The Company has adopted SFAS No. 144 on
January 21, 2002 and the adoption did not have a material impact on the
Company's financial condition or its results of operations.
In April 2002, FASB issued SFAS No. 145, "Rescission of FASB Statement
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". The Company adopted the provisions of SFAS No. 145 in its quarter
ended July 31, 2002. There was no impact on the Company's financial statements
as a result of the adoption of SFAS No. 145.
In June 2002, FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" which nullifies Emerging Issues
Task Force (EITF) Issue No. 94-3. SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. The Company will to adopt the provisions of SFAS No. 146
on January 1, 2003. The Company believes the impact of the adoption of the
provisions of SFAS No. 146 will not have a material impact on the Company's
financial statements.
ITEM 3. CONTROLS AND PROCEDURES
(a) EXPLANATION OF DISCLOSURE CONTROLS AND PROCEDURES. The Company's President
and Chief Executive Officer and Chief Financial Officer after evaluating the
effectiveness of the Company's disclosure controls and procedures (as defined in
Securities Exchange Act Rules 13a-14(c) and 15d-14(c)) as of a date within 90
days of the filing date of this quarterly report (the "Evaluation Date") have
concluded that as of the Evaluation Date, the Company's disclosure controls and
procedures were adequate and effective to ensure that material information
relating to the Company and its consolidated subsidiaries would be made known to
such officers by others within those entities, particularly during the period in
which this quarterly report was being prepared.
(b) CHANGES IN INTERNAL CONTROLS. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
the Company's disclosure controls and procedures subsequent to the Evaluation
Date, nor any significant deficiencies or material weaknesses in such disclosure
controls and procedures requiring corrective actions. As a result, no corrective
actions were taken.
Page 23 of 32
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company's Registration Statement on Form SB-2 filed under the
Securities Act of 1933 (Commission File No. 333-86956), relating to the
Company's initial public offering, was declared effective by the Securities and
Exchange Commission on June 27, 2002.
The net proceeds from the Company's initial public offering, after
deducting the underwriting discount and the offering expenses incurred by the
Registrant, approximated $9,151,000. Uses of proceeds to date have been for
working capital and general corporate purposes, which have amounted to an
aggregate of $1,134,000. The remaining $8,017,000 of the proceeds from the
offering will be used for general corporate purposes, including working capital.
Pending these uses, the remaining net proceeds have been invested in short-term
interest bearing investment grade marketable securities.
None of the net proceeds of the Registrant's initial public offering
have been paid, directly or indirectly to any of the Registrant's directors or
officers or any of their associates, or to any persons owning 10 percent or more
of the Registrant's common stock, or to any of the Registrant's affiliates.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
See Index to Exhibits.
(b) REPORTS ON FORM 8-K. There have been no reports on Form 8-K filed during the
fiscal quarter for which this report is filed.
Page 24 of 32
SIGNATURES
In accordance with 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.
MONTANA MILLS BREAD CO., INC.
(REGISTRANT)
Date: December 17, 2002 By: /s/ Eugene O'Donovan
--------------------------------
Eugene O'Donovan, President,
Chairman of the Board and Chief
Executive Officer
Page 25 of 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Eugene O'Donovan, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Montana Mills Bread
Co., Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
Page 26 of 32
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: December 17, 2002 /s/ Eugene O'Donovan
----------------------------
Eugene O'Donovan,
President and Chief Executive Officer
Page 27 of 32
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, David Klein, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Montana Mills Bread
Co., Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
Page 28 of 32
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: December 17, 2002 /s/ David Klein
----------------------------
David Klein,
Chief Financial Officer
Page 29 of 32
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
--- -----------
3.1 Certificate of Incorporation of the Registrant, including
Certificate of Designation, incorporated herein by reference to
Exhibit 3.1 of the Registrant's Registration Statement on Form SB-2
(Registration No. 333-86956).
3.2 Amended and Restated By-Laws of the Registrant, incorporated herein
by reference to Exhibit 3.2 of the Registrant's Registration
Statement on Form SB-2 (Registration No. 333-86956).
4.1 Specimen Common Stock Certificate of the Registrant, incorporated
herein by reference to Exhibit 4.1 of the Registrant's Registration
Statement on Form SB-2 (Registration No. 333-86956).
4.2 Specimen Redeemable Common Stock Purchase Warrant Certificate,
incorporated herein by reference to Exhibit 4.2 of the Registrant's
Registration Statement on Form SB-2 (Registration No. 333-86956).
4.3 Form of Redeemable Common Stock Purchase Warrant Agreement between
the Registrant and Continental Stock Transfer & Trust Company,
incorporated herein by reference to Exhibit 4.3 of the Registrant's
Registration Statement on Form SB-2 (Registration No. 333-86956).
4.4 Form of Purchase Option issued to Kirlin Securities, Inc. ,
incorporated herein by reference to Exhibit 4.4 of the Registrant's
Registration Statement on Form SB-2 (Registration No. 333-86956).
99.1 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive
Officer.
99.2 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Financial
Officer.
Page 30 of 32