P.F. Chang's Form 10-K for year ended 12/31/1999

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended January 2, 2000

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number: 0-25123

P.F. CHANG’S CHINA BISTRO, INC.

(Exact name of registrant as specified in its charter)






Delaware		86-0815086
State or other jurisdiction of incorporation or organization		(I.R.S. Employer Identification No.)

5090 North 40th Street, Suite #160		85018
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (602) 957-8986

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 par value

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Based on the closing sale price of $25.69 on February 15, 2000, the aggregate market value of the voting stock held by non-affiliates of the registrant was $223,262,002.

On February 15, 2000 there were outstanding 10,265,257 shares of the Registrant’s Common Stock.

Documents Incorporated by Reference

(to the extent indicated herein)

Registrant’s Proxy Statement (specified portions) with respect to the Annual Meeting of Stockholders to be held April 26, 2000.

TABLE OF CONTENTS


Item		Page

	PART I




1.	Business		2




2.	Properties		13




3.	Legal Proceedings		14




4.	Submission of Matters to a Vote of Security Holders		14
	PART II




5.	Market for the Registrant’s Common Stock and Related Stockholder Matters		15




6.	Selected Financial Data		16




7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17




7A.	Quantitative and Qualitative Disclosures About Market Risks		25




8.	Financial Statements and Supplementary Data		F-1




9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		26
	PART III




10.	Directors and Executive Officers of the Registrant		26




11.	Executive Compensation		26




12.	Security Ownership of Certain Beneficial Owners and Management		26




13.	Certain Relationships and Related Transactions		26
	PART IV




14.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K		26

PART I

Item 1. Business

The following Business section contains forward-looking statements which involve risks and uncertainties. Such forward-looking statements may be deemed to include anticipated restaurant openings, anticipated costs and sizes of future restaurants and the adequacy of anticipated sources of cash to fund the Company’s future capital requirements. Words such as “believes,” “anticipates,” “expects,” “intends,” “plans” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. The Company’s actual results may differ materially from those discussed in the forward-looking statements. Factors that might cause actual events or results to differ materially from those indicated by such forward-looking statements may include the matters set forth under “Risk Factors” and elsewhere in this Form 10-K, such as development and construction risks, potential labor shortages, fluctuations in operating results, and changes in food costs.

General

P.F. Chang’s owns and operates 36 full service restaurants (as of January 2, 2000) that feature a blend of high quality, traditional Chinese cuisine and American hospitality in a sophisticated, contemporary bistro setting. The Company’s restaurants offer intensely flavored, highly memorable culinary creations, prepared from fresh ingredients, including premium herbs and spices imported directly from China. The menu is focused on select dishes created to capture the distinct flavors and styles of the five major culinary regions of China: Canton, Hunan, Mongolia, Shanghai and Szechwan. By adhering to the Chinese culinary precepts of fan and t’sai, a balancing of rice, noodles and grains with meat, seafood and vegetables, the P.F. Chang’s menu offers an array of taste, texture, color and aroma. The menu is highlighted by dishes such as Chang’s Spicy Chicken, Orange Peel Beef, Peking Ravioli, Chicken in Soothing Lettuce Wrap, Szechwan-Style Long Beans and Dan Noodles. The traditional cuisine is complemented by a full service bar offering an extensive selection of wines, specialty drinks, Asian beers, cappuccino and espresso. The Company offers superior customer service in a high energy atmosphere featuring a display kitchen, exhibition wok cooking and a decor that includes wood and slate floors, mounted life-size terra cotta replicas of Xi’an warriors and narrative murals depicting 12th century China.

Concept and Strategy

The Company’s objectives are to (i) develop and operate a nationwide system of restaurants that offer guests a sophisticated dining experience, (ii) create a loyal customer base that generates a high level of repeat business and (iii) provide superior returns to its investors. To achieve its objectives, the Company strives to offer high quality Chinese cuisine in a memorable atmosphere while delivering superior customer service and an excellent dining value. Key to the Company’s expansion strategy and success at the restaurant level is the Company’s management philosophy pursuant to which regional managers (“Market Partners”), certain general managers (“Operating Partners”) and certain executive chefs (“Culinary Partners”) are allowed to participate in the cash flows of the restaurants for which they have responsibility. The Company believes it has demonstrated the viability of the P.F. Chang’s concept in a wide variety of markets across the United States. The Company intends to continue its expansion program and believes the management incentives provided by its Market, Operating and Culinary Partners’ programs should position the Company to continue this expansion without sacrificing the Company’s restaurant level operating performance and return on investment.

Menu

The P.F. Chang’s menu offers a harmony of taste, texture, color and aroma by balancing the principles of fan and t’sai foods. Fan foods include rice, noodles, grains and dumplings, while vegetables, meat, poultry and seafood are t’sai foods. The Company’s chefs are trained to produce distinctive Chinese cuisine with traditional recipes from the five major culinary regions of China: Canton, Hunan, Mongolia, Shanghai and Szechwan. The intense heat of Mandarin-style wok cooking sears in the clarity and distinct flavor of fresh ingredients. Slow roasted Cantonese-style ducklings, chickens, BBQ spare ribs and BBQ pork are prepared in

vertical ovens, while handmade shrimp, pork and vegetable dumplings, as well as flavorful fish and vegetables, are prepared in custom-made steamer cabinets. MSG is not used in any P.F. Chang’s menu items.

In addition to the core menu, P.F. Chang’s also offers special lunch and dinner selections. These menus offer specials developed by the Company’s Culinary Partners around the country and are changed two to three times a year. Individual items that are received well by guests migrate to the core menu. The fresh produce, seafood, meat, poultry and specialty items that are specific to a certain region of the United States or to a specific season are featured on a daily basis. Extensive research and development, including annual trips to China by the P.F. Chang’s corporate executive chef, continually reinforce the Company’s commitment to training the P.F. Chang’s chefs and enhancing the menu offerings.

The Company’s entrees range in price from $8.00 to $13.00, and its appetizers range in price from $3.00 to $8.00. The Company’s average check per guest, including alcoholic beverages, is approximately $17 to $18. Sales of alcoholic beverages, featuring an extensive selection of wines, all of which are offered by the glass, constitute approximately 20% of revenues. Lunch and dinner contribute roughly 30% and 70% of revenues, respectively.

Operations

In order to provide incentive to key management personnel, the Company has entered into a series of partnership agreements with its regional managers (“Market Partners”), certain of its general managers (“Operating Partners”) and certain of its executive chefs (“Culinary Partners”). These partnership agreements entitle the Market Partner to a specified percentage of the cash flows from the restaurants that partner has developed and oversees as the regional manager. Similarly, the general manager and the executive chef at most of the Company’s restaurants are offered the opportunity to become Operating Partners and Culinary Partners, respectively, and to receive a percentage of the cash flows from the restaurant in which they work. Each partner is required, as a condition of employment, to sign a five-year employment agreement and is required to purchase a specified interest in the restaurant or region the partner is employed to manage. The ownership interest purchased by each partner generally ranges between two and seven percent of the restaurant or region the partner oversees. During the five-year employment term, each partner is prohibited from selling or transferring his interest to another party. At the termination of the employment agreement, the Company has the right to purchase the minority partners’ interests in the partners’ respective restaurants at fair market value, as calculated according to the partnership agreements. The Company has implemented this partnership structure to facilitate the development and operation of its restaurants. By requiring this level of commitment and by providing the Market, Operating and Culinary Partners with a significant stake in the success of the restaurant, the Company believes that it is able to attract and retain experienced and highly motivated managers.

Each of the Company’s Market Partners oversees a territory that can support seven to ten restaurants. The Market Partner’s role is to ensure that each restaurant within his or her territory achieves a competitive return on investment through the successful execution of the concept. The typical Market Partner is an individual who has achieved a leadership position (such as Director of Operations) at a multi-unit, full-service restaurant company.

The Company strives to create a sophisticated dining experience through the careful selection, training and supervision of personnel. The staff of a typical restaurant consists of an Operating Partner, two or three managers, a Culinary Partner, one or two sous chefs and approximately 125 hourly employees, many of whom work part-time. The Operating Partner of each restaurant is responsible for the day-to-day operations of that restaurant, including hiring, training and development of personnel, as well as operating results. The Culinary Partner is responsible for product quality, purchasing, food costs and kitchen labor costs. The Company requires its Operating Partners and Culinary Partners to have significant experience in the full-service restaurant industry.

The Company has a comprehensive 12 week management development program. This program consists of six weeks of culinary training, including both culinary job functions and culinary management. The remaining six weeks focus on service strategies, guest relations, office management and shift management. All

management and culinary personnel are required to successfully complete all sections of this program. Upon the completion of each six week section each trainee must successfully complete a comprehensive certification administered by the Market Partner, Director of Culinary Development or the Director of Training.

The Operating Partners and Culinary Partners are responsible for selecting employees for their restaurants. The Partners are responsible for administering the Company’s staff training programs that are developed by the training and culinary departments. The employee development program lasts between one and two weeks and focuses on both technical and cultural knowledge.

Marketing

The Company focuses its business strategy on providing high quality, traditional Chinese cuisine served by an attentive staff in a distinctive environment at an affordable price. By focusing on the food, service and ambiance of the restaurant, the Company has created an environment that fosters repeat patronage and encourages word-of-mouth recommendations. The Company believes that word-of-mouth advertising is a key component in driving guest trial and usage.

To attract new customers, the Company has also implemented a local, regional and national marketing strategy through paid advertising, public relations efforts and community involvement to maintain and build awareness throughout each community in which it operates. In order to increase local awareness of its restaurants, the Company builds relationships with local radio personalities who provide testimonials to their listening audiences. The partnered stations are consistently among the highest rated stations in their markets. Likewise, the radio personalities are very well recognized in their communities, not only on their station, but also in the market as a whole.

The Company also undertakes specialty programs such as concierge and accommodation programs targeted to build relationships with the local hotel concierges, who offer personal recommendations to the guests of their establishments. Community involvement with local organizations, participation in non-profit benefits and auctions, chef demonstrations and cooking classes also increase consumer awareness.

A national advertising campaign comprised of advertisements in inflight magazines, which carry a high level of traffic in the Company’s markets, is designed to make frequent travelers aware of P.F. Chang’s locations across the country.

Competition

The restaurant business is intensely competitive with respect to food quality, price-value relationships, ambiance, service and location, and many existing restaurants compete with the Company at each of its locations. Key competitive factors in the industry include the quality and value of the food, quality of service, price, dining experience, restaurant location and the ambiance of the facilities. The Company’s primary competitors include mid-price, full service casual dining restaurants and locally-owned and operated Chinese restaurants. There are many well-established competitors with substantially greater financial, marketing, personnel and other resources than the Company. In addition, many of the Company’s competitors are well established in the markets where the Company’s operations are, or in which they may be, located. While the Company believes that its restaurants are distinctive in design and operating concept, other companies may develop restaurants that operate with similar concepts.

Management Information Systems

The Company utilizes an integrated information system to manage the flow of information within each restaurant and between the restaurants and the corporate office. This system includes a point-of-sales (“POS”) local area network that helps facilitate the operations of the restaurant by recording sales transactions and printing orders in the appropriate locations within the restaurant. Additionally, the POS system is utilized to authorize, batch and transmit credit card transactions, to record employee time clock information, to schedule labor and to produce a variety of management reports. Select information that is captured from the POS system is transmitted to the corporate office on a daily basis, which enables senior

management to continually monitor operating results. The Company believes that its current POS system will be an adequate platform to support its planned expansion.

The Company uses software and hardware developed by reputable vendors and commonly used in the restaurant industry. These systems are integrated to provide senior management with daily and weekly sales and cost analysis, monthly detailed profit statements and comparisons between actual and budgeted operating results.

Purchasing

The Company’s purchasing programs provide its restaurants with high quality ingredients at competitive prices from reliable sources. Consistent menu specifications as well as purchasing and receiving guidelines ensure freshness and quality. Because the Company utilizes only fresh ingredients in all of its menu offerings, inventory is maintained at a modest level. The Company negotiates short-term and long-term contracts depending on demand for its products. These contracts range in duration from two to twelve months. With the exception of produce, which is purchased locally, the Company utilizes Distributors Marketing Alliance as the primary distributor of product to all of its restaurants. Distributors Marketing Alliance is a cooperative of multiple food distributors located throughout the nation. The Company has a non-exclusive short term contract with Distributors Marketing Alliance on terms and conditions which the Company believes are consistent with those made available to similarly situated restaurant companies. The Company believes that competitively priced alternative distribution sources are available should such channels be necessary. Chinese-specific ingredients are usually sourced directly from Hong Kong, China and Taiwan. The Company has developed an extensive network of importers in order to maintain an adequate supply of items that conform to the Company’s brand and product specifications.

Employees

At January 2, 2000, the Company employed approximately 5,000 persons, 47 of whom were executive office personnel, 305 of whom were unit management personnel and the remainder of whom were hourly restaurant personnel. The Company’s employees are not covered by a collective bargaining agreement. The Company considers its employee relations to be good.

Unit Economics

The Company believes that, in addition to other important information concerning the Company (i.e., uniqueness of concept, quality of management, rate of unit openings and earnings growth, etc.), investors and restaurant industry analysts focus on three major factors in their evaluation of a restaurant’s unit economics. These three factors are: (1) restaurant sales (average weekly sales and change in comparable restaurant sales); (2) restaurant-level operating margin; and (3) restaurant-level return on invested capital. These unit economics are set forth below.

PLEASE NOTE THAT THE RESTAURANT-LEVEL RETURN ON INVESTED CAPITAL IS NOT A GENERALLY ACCEPTED ACCOUNTING PRINCIPLE MEASURE OF PERFORMANCE AND DOES NOT REPRESENT A RETURN ON AN INDIVIDUAL STOCKHOLDER’S INVESTMENT IN THE COMPANY. Rather, it measures the return on the capital invested in the restaurants by the Company. The restaurant-level return on invested capital is calculated as the quotient of the restaurant income (loss) before minority interests, interest (income) expense, net, income taxes, rent expense and preopening adjustment divided by the total restaurant invested capital. Interest (income) expense, net, income taxes and rent expense are excluded from this calculation to provide for an evaluation of operational results of individual restaurants without the variability introduced by different forms of financing and ownership (i.e., purchased and financed versus leased).



	Units opened in																		Total
																			Restaurant
	Pre 1996			1996			1997			1998			1999			2000			Operations			Corporate			Total


	(dollars in thousands, except average weekly sales)




Fiscal 1999





Units(1)		4			3			6			10			13						36						36




Sales weeks		212			159			318			530			330						1,549						1,549




Average weekly sales	$	115,119		$	123,509		$	92,685		$	96,119		$	87,378					$	98,964					$	98,964




Change in comparable store sales(2)		9.5	%		11.5	%		15.2	%		13.4	%								12.0	%					12.0	%




Restaurant-level operating margin		23.8	%		23.4	%		20.8	%		19.6	%		11.5	%					19.5	%					19.5	%




Revenues	$	24,405		$	19,638		$	29,474		$	50,943		$	28,835		$	—		$	153,295		$	—		$	153,295




Total restaurant operating costs		18,605			15,044			23,344			40,972			25,512			—			123,477			—			123,477




General and administrative		—			—			—			—			—			—			—			9,648			9,648




Depreciation and amortization		347			369			827			1,852			1,020			—			4,415			560			4,975




Preopening expense		—			—			—			(33	)		3,826			551			4,344			—			4,344




Interest (income) expense, net		7			163			—			—			—			—			170			(602	)		(432	)

Income (loss) before minority interest and income taxes(3)		5,446			4,062			5,303			8,152			(1,523	)		(551	)		20,889		$	9,606		$	11,283

Rent expense(4)		1,404			1,044			1,463			1,986			1,013			—			6,910




Interest expense, net		7			163			—			—			—			—			170




Preopening adjustment(5)		—			—			—			—			(405	)		551			146

Restaurant income (loss), as adjusted	$	6,857		$	5,269		$	6,766		$	10,138		$	(915	)	$	—		$	28,115

Average restaurant assets employed(6)	$	1,507		$	3,342		$	6,981		$	19,729		$	12,797					$	44,356




Present value of remaining lease obligations(7)		4,171			4,156			7,621			13,440			6,600						35,988

Total restaurant invested capital	$	5,678		$	7,498		$	14,602		$	33,169		$	19,397					$	80,344

Restaurant-level return on invested capital		120.8	%		70.3	%		46.3	%		30.6	%		(4.7	)%					35.0	%



	Units opened in																	Total
																		Restaurant
	Pre 1996			1996			1997			1998			1999			2000		Operations			Corporate			Total


	(dollars in thousands, except average weekly sales)




Fiscal 1998





Units(1)		4			3			6			10								23						23




Sales weeks		208			156			312			149								825						825




Average weekly sales	$	104,637		$	110,374		$	80,171		$	94,207							$	94,586					$	94,586




Change in comparable store sales(2)		10.6	%		17.7	%		7.8	%										12.8	%					12.8	%




Restaurant-level operating margin		24.3	%		22.6	%		16.8	%		10.6	%							19.1	%					19.1	%




Revenues	$	21,765		$	17,218		$	25,013		$	14,037		$	—		$	—	$	78,033		$	—		$	78,033




Total restaurant operating costs		16,479			13,324			20,823			12,552			—			—		63,178			—			63,178




General and administrative		—			—			—			—			—			—		—			6,245			6,245




Depreciation and amortization		301			393			798			383			—			—		1,875			509			2,384




Preopening expense		—			—			82			3,696			405			—		4,183			—			4,183




Interest expense, net		12			207			—			—			—			—		219			958			1,177

Income (loss) before minority interest and income taxes(3)		4,973			3,294			3,310			(2,594	)		(405	)		—		8,578		$	(7,712	)	$	866

Rent expense(4)		1,241			872			1,297			604			—			—		4,014




Interest expense, net		12			207			—			—			—			—		219




Preopening adjustment(5)		—			—			82			(191	)		405			—		296

Restaurant income (loss), as adjusted	$	6,226		$	4,373		$	4,689		$	(2,181	)	$	—		$	—	$	13,107

Average restaurant assets employed(6)	$	1,648		$	3,681		$	7,598		$	5,642							$	18,569




Present value of remaining lease obligations(7)		4,568			4,232			7,876			3,623								20,299

Total restaurant invested capital	$	6,216		$	7,913		$	15,474		$	9,265							$	38,868

Restaurant-level return on invested capital		100.2	%		55.3	%		30.3	%		(23.5	)%							33.7	%




Fiscal 1997





Units(1)		4			3			6											13						13




Sales weeks		208			156			76											440						440




Average weekly sales	$	94,578		$	92,930		$	73,675										$	90,383					$	90,383




Change in comparable store sales(2)		13.8	%																13.8	%					13.8	%




Restaurant-level operating margin		23.7	%		16.9	%		3.2	%										18.4	%					18.4	%




Revenues	$	19,672		$	14,497		$	5,599		$	—		$	—		$	—	$	39,768		$	—		$	39,768




Total restaurant operating costs		15,000			12,051			5,419			—			—			—		32,470			—			32,470




General and administrative		—			—			—			—			—			—		—			4,276			4,276




Depreciation and amortization		308			362			148			—			—			—		818			284			1,102




Preopening expense		—			25			1,706			191			—			—		1,922			—			1,922




Interest expense, net		21			193			—			—			—			—		214			103			317

Income (loss) before minority interest and income taxes(3)		4,343			1,866			(1,674	)		(191	)		—			—		4,344		$	(4,663	)	$	(319	)

Rent expense(4)		1,125			717			282			—			—			—		2,124




Interest expense, net		21			193			—			—			—			—		214




Preopening adjustment(5)		—			—			(53	)		191			—			—		138

Restaurant income (loss), as adjusted	$	5,489		$	2,776		$	(1,445	)	$	—		$	—		$	—	$	6,820

Average restaurant assets employed(6)	$	1,953		$	4,060		$	2,230										$	8,243




Present value of remaining lease obligations(7)		4,910			4,294			2,068											11,272

Total restaurant invested capital	$	6,863		$	8,354		$	4,298										$	19,515

Restaurant-level return on invested capital		80.0	%		33.2	%		(33.6	)%										34.9	%


(1)	Units include all restaurants opened in the period indicated.

(2)	A unit becomes comparable in the eighteenth month of operation.

(3)	For purposes of this calculation, restaurant income (loss) before minority interest and income taxes represents restaurant revenues less all restaurant-specific operating costs, depreciation and amortization, preopening expenses and interest (income) expense, net. Preopening costs are aggregated in the month in which a restaurant opens. General and administrative expense, interest expense on general corporate debt, depreciation on general corporate assets and amortization of goodwill are excluded from the calculation.

(4)	Rent expense consists of minimum contractual rents plus contingent percentage rents.

(5)	Preopening adjustment represents preopening costs incurred in a fiscal year other than the fiscal year in which a restaurant opened. As noted in footnote (3) above, for purposes of this calculation, preopening costs are aggregated and expensed in the month in which a restaurant opens rather than in the fiscal year in which the costs were incurred and expensed for financial statement purposes.

(6)	Average restaurant assets employed represents the 12 month average of all restaurant-specific long-term assets, net of any accumulated depreciation and amortization, determined on a prorated basis for restaurants opened within the period.

(7)	Present value of remaining lease obligations represents the 12 month average discounted present value of restaurant lease payments to the date of lease expiration, using a 10 percent discount rate, determined on a prorated basis for restaurants opened within the period.

Risk Factors

Uncertainties Associated with Expanding Operations

The Company operates 36 restaurants (as of January 2, 2000), 13 of which have been opened within the last twelve months. The results achieved to date by the Company’s relatively small number of restaurants may not be indicative of longer term performance or the potential market acceptance of restaurants in other locations. Further, there can be no assurance that any new restaurant which the Company opens will obtain similar operating results to those of prior restaurants. The Company anticipates that its new restaurants will commonly take several months to reach planned operating levels due to certain inefficiencies typically associated with new restaurants, including lack of market awareness, inability to hire sufficient staff and other factors.

A critical factor in the Company’s future success is its ability to successfully expand its operations. The Company expanded from seven restaurants at the end of 1996 to 36 restaurants as of January 2, 2000. The Company expects to open 15 restaurants in 2000 (three of which have been opened since January 2, 2000). The Company’s ability to expand successfully will depend on a number of factors, including the identification and availability of suitable locations, competition for restaurant sites, the negotiation of favorable lease arrangements, timely development in certain cases of commercial, residential, street or highway construction near the Company’s restaurants, management of the costs of construction and development of new restaurants, securing required governmental approvals and permits, recruitment of qualified operating personnel (particularly managers and chefs), the competition in new markets, general economic conditions and other factors, some of which are beyond the control of the Company. The opening of additional restaurants in the future will depend in part upon the Company’s ability to generate sufficient funds from operations or to obtain sufficient equity or debt financing on favorable terms to support such expansion. There can be no assurance that the Company will be successful in addressing these risks, that the Company will be able to open its planned new operations on a timely basis, if at all, or, if opened, that those operations will be operated profitably. The Company has experienced, and expects to continue to experience, delays in restaurant openings from time to time. Delays or failures in opening planned new restaurants could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

The Company’s growth strategy may strain the Company’s management, financial and other resources. To manage its growth effectively, the Company must maintain a high level of quality and service at its existing and future restaurants, continue to enhance its operational, financial and management capabilities and locate, hire, train and retain experienced and dedicated operating personnel, particularly managers and chefs. There can be no assurance that the Company will be able to effectively manage these and other factors necessary to permit it to achieve its expansion objectives, and any failure to do so could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

Development and Construction Risks

Because each P.F. Chang’s restaurant is distinctively designed to accommodate particular characteristics of each location and to blend local or regional design themes with the Company’s principal trade dress and other common design elements, each location presents its own development and construction risks. Many factors may affect the costs associated with the development and construction of the Company’s restaurants, including labor disputes, shortages of materials and skilled labor, weather interference, unforeseen engineering problems, environmental problems, construction or zoning problems, local government regulations, modifications in design to the size and scope of the projects and other unanticipated increases in costs, any of which could give rise to delays or cost overruns. There can be no assurance that the Company will be able to develop additional P.F. Chang’s restaurants within anticipated budgets or time periods, and any such failure could materially adversely affect the Company’s business, financial condition, results of operations or cash flows.

Potential Labor Shortages

The success of the Company will continue to be dependent on its ability to attract and retain a sufficient number of qualified employees, including kitchen staff and waitstaff, to keep pace with its expansion schedule.

Qualified individuals needed to fill these positions are in short supply in certain areas, and the inability to recruit and retain such individuals may delay the planned openings of new restaurants or result in high employee turnover in existing restaurants which could have a material adverse effect on the Company’s business, financial condition, cash flows or results of operations.

Fluctuations in Operating Results

The Company’s operating results may fluctuate significantly as a result of a variety of factors, including general economic conditions, consumer confidence in the economy, changes in consumer preferences, competitive factors, weather conditions, the timing of new restaurant openings and related expenses, revenues contributed by new restaurants and increases or decreases in comparable restaurant revenues. Historically, the Company has experienced variability in the amount and percentage of revenues attributable to preopening expenses. The Company typically incurs the most significant portion of preopening expenses associated with a given restaurant within the two months immediately preceding and the month of the opening of the restaurant. In addition, the Company’s experience to date has been that labor and operating costs associated with a newly opened restaurant for the first several months of operation are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Accordingly, the volume and timing of new restaurant openings has had and is expected to have a meaningful impact on preopening expenses and labor and operating costs until such time as a larger base of restaurants in operation mitigates such impact. Due to the foregoing factors, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for a full fiscal year, and, from time to time in the future, the Company’s results of operations may be below the expectations of public market analysts and investors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Restaurant Industry and Competition

The restaurant industry is intensely competitive with respect to food quality, price-value relationships, ambiance, service and location, and many restaurants compete with the Company at each of its locations. The Company’s competitors include mid-price, full-service casual dining restaurants and locally owned and operated Chinese restaurants. There are many well-established competitors with substantially greater financial, marketing, personnel and other resources than the Company, and many of the Company’s competitors are well established in the markets where the Company’s operations are, or in which they may be, located. Additionally, other companies may develop restaurants that operate with similar concepts.

The restaurant business is often affected by changes in consumer tastes, national, regional or local economic conditions, demographic trends, consumer confidence in the economy, discretionary spending priorities, weather conditions, tourist travel, traffic patterns and the type, number and location of competing restaurants. Changes in these factors could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows. In the future, changes in consumer tastes may require the Company to modify or refine elements of its restaurant system to evolve its concept in order to compete with popular new restaurant formats or concepts that develop from time to time, and there can be no assurance that the Company will be successful in implementing such modifications.

Minimum Wage

A number of the Company’s employees are subject to various minimum wage requirements. The federal minimum wage increased to $5.15 per hour effective September 1, 1997. In addition, many of the Company’s employees work in restaurants located in California and receive salaries equal to the California minimum wage, which rose from $5.00 per hour effective March 1, 1997 to $5.75 per hour effective March 1, 1998. There can be no assurance that similar increases will not be implemented in other jurisdictions in which the Company operates or seeks to operate. The Company believes that the federal minimum wage will be increased again within the next 12 months. Such minimum wage increases could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

Dependence on Key Personnel

The success of the Company’s business will continue to be highly dependent on its key operating officers and employees, including Richard Federico, the Company’s Chief Executive Officer and President, Robert Vivian, the Company’s Chief Financial Officer, Greg Carey, the Company’s Chief Operating Officer, and Frank Ziska, the Company’s Chief Development Officer. The Company’s success in the future will be dependent on its ability to attract, retain and motivate a sufficient number of qualified management and operating personnel, including Market Partners, Operating Partners and Culinary Partners, to keep pace with an aggressive expansion schedule. Such qualified individuals are historically in short supply and any inability of the Company to attract and retain such key employees may limit its ability to effectively penetrate new market areas. Additionally, the ability of these key personnel to maintain consistency in the quality and atmosphere of the Company’s restaurants in various markets is a critical factor in the Company’s success. Any failure to do so may harm the Company’s reputation and could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

Changes in Food Costs

The Company’s profitability is dependent in part on its ability to anticipate and react to changes in food costs. Other than for produce, which is purchased locally by each restaurant, the Company relies on Distributors Marketing Alliance as the primary distributor of its food. Distributors Marketing Alliance is a cooperative of multiple food distributors located throughout the nation. The Company has a non-exclusive short-term contract with Distributors Marketing Alliance on terms and conditions which the Company believes are consistent with those made available to similarly situated restaurant companies. Although the Company believes that alternative distribution sources are available, any increase in distribution prices or failure to perform by the Distributors Marketing Alliance could cause the Company’s food costs to fluctuate. Further, various factors beyond the Company’s control, including adverse weather conditions and governmental regulation, may affect the Company’s food costs. There can be no assurance that the Company will be able to anticipate and react to changing food costs through its purchasing practices and menu price adjustments in the future, and failure to do so could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

Governmental Regulation

The Company’s restaurants are subject to regulation by federal agencies and to licensing and regulation by state and local health, sanitation, building, zoning, safety, fire and other departments relating to the development and operation of restaurants. These regulations include matters relating to environmental, building construction, zoning requirements and the preparation and sale of food and alcoholic beverages. The Company’s facilities are licensed and subject to regulation under state and local fire, health and safety codes.

The development and construction of additional restaurants will be subject to compliance with applicable zoning, land use and environmental regulations. There can be no assurance that the Company will be able to obtain necessary licenses or other approvals on a cost-effective and timely basis in order to construct and develop restaurants in the future. Various federal and state labor laws govern the Company’s operations and its relationship with its employees, including minimum wage, overtime, working conditions, fringe benefit and citizenship requirements. In particular, the Company is subject to the regulations of the INS. Given the location of many of the Company’s restaurants, even if the Company’s operation of those restaurants is in strict compliance with INS requirements, the Company’s employees may not all meet federal citizenship or residency requirements, which could lead to disruptions in its work force.

Approximately 20% of the Company’s revenues are attributable to the sale of alcoholic beverages. The Company is required to comply with the alcohol licensing requirements of the federal government, states and municipalities where its restaurants are located. Alcoholic beverage control regulations require applications to state authorities and, in certain locations, county and municipal authorities for a license and permit to sell alcoholic beverages. Typically, licenses must be renewed annually and may be revoked or suspended for cause at any time. Alcoholic beverage control regulations relate to numerous aspects of the daily operations of the

restaurants, including minimum age of guests and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, storage and dispensing of alcoholic beverages. Failure to comply with federal, state or local regulations could cause the Company’s licenses to be revoked or force it to terminate the sale of alcoholic beverages at one or more of its restaurants.

The Company is subject to state “dram shop” laws and regulations, which generally provide that a person injured by an intoxicated person may seek to recover damages from an establishment that wrongfully served alcoholic beverages to such person. While the Company carries liquor liability coverage as part of its existing comprehensive general liability insurance, there can be no assurance that it will not be subject to a judgment in excess of such insurance coverage or that it will be able to obtain or continue to maintain such insurance coverage at reasonable costs, or at all.

The federal Americans With Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment. The Company is required to comply with the Americans With Disabilities Act and regulations relating to accommodating the needs of the disabled in connection with the construction of new facilities and with significant renovations of existing facilities.

Litigation

The Company is from time to time the subject of complaints or litigation from guests alleging illness, injury or other food quality, health or operational concerns. Adverse publicity resulting from such allegations may materially adversely affect the Company and its restaurants, regardless of whether such allegations are valid or whether the Company is liable. The Company also is the subject of complaints or allegations from former or prospective employees from time to time. A lawsuit or claim could result in an adverse decision against the Company that could materially adversely affect the Company or its business.

Item 2. Properties

The following table depicts existing restaurants as of the effective date of this 10-K.


		Approximate Square		Interior
Existing Locations	Opening Date	Footage		Seating*

Scottsdale, AZ (Fashion Square)	July 1993		6,050		177
Newport Beach, CA (Fashion Island)	June 1994		5,050		155
La Jolla, CA (UTC)	August 1995		7,400		257
Irvine, CA (Spectrum Center)	November 1995		7,000		208
Las Vegas, NV (Paradise & Flamingo)	October 1996		7,000		220
Houston, TX (Highland Village)	December 1996		6,500		182
Littleton, CO (Park Meadows)	December 1996		7,600		245
Metarie, LA (Lakeside)	April 1997		5,850		201
Miami, FL (The Falls)	September 1997		5,800		206
Charlotte, NC (Phillips Place)	October 1997		6,900		211
N. Miami, FL (Aventura)	October 1997		7,000		244
Tempe, AZ (Centerpoint)	December 1997		6,600		228
McLean, VA (Tysons Corner)	December 1997		6,500		204
Dallas, TX (North Tollway)	March 1998		6,900		192
El Segundo, CA (Manhattan Beach)	June 1998		6,950		220
Austin, TX (Jollyville Road)	July 1998		7,000		196
Dallas, TX (NorthPark)	August 1998		6,100		178
Atlanta, GA (Ashwood & Perimeter)	October 1998		7,000		225
Birmingham, AL (The Summit)	October 1998		7,150		230
Denver, CO (LoDo)	October 1998		7,150		230
Northbrook, IL (Northbrook Court)	November 1998		7,000		210
Troy, MI (Somerset)	November 1998		7,000		217
West Hollywood, CA (Beverly Center)	December 1998		6,600		212
Boston, MA (CityPlace)	January 1999		5,750		182
Winter Park, FL (Winter Park Village)	March 1999		6,900		212
Westbury, NY (The Source)	April 19, 1999		7,600		239
Raleigh, NC (Crabtree Valley)	June 14, 1999		6,700		174
Scottsdale, AZ (Kierland Commons)	June 21, 1999		7,000		211
Salt Lake City, UT (Bandaloops)	June 28, 1999		7,000		242
Santa Monica, CA (Wilshire Blvd.)	July 5, 1999		6,700		200
Las Vegas, NV (Summerlin)	July 19, 1999		7,000		211
Walnut Creek, CA (Broadway Plaza)	August 9, 1999		6,400		197
Columbus, OH (Easton Town Center)	September 6, 1999		7,300		232
Alpharetta, GA (Mauel Road)	September 22, 1999		6,900		224
Kansas City, MO (Country Club Plaza)	November 8, 1999		7,000		287
Bethesda, MD (White Flint)	November 30, 1999		6,300		199
Chicago, IL (Downtown)	January 17, 2000		9,500		220
Buford, GA (Mall of Georgia)	January 31, 2000		5,600		142
Tucson, AZ (Joesler Village)	February 7, 2000		6,600		197


*	Many of the Company’s restaurants have outdoor seating in addition to interior seating.

In 2000, the Company intends to open 15 new restaurants (three of which have opened since January 2, 2000) in approximately seven new markets.

Expansion Strategy and Site Selection

The Company is actively developing restaurants in both new and existing markets and has planned an expansion strategy targeted at major metropolitan areas throughout the United States. Within each targeted metropolitan area, the Company identifies specific trade areas with high traffic patterns and suitable demographic characteristics, including population density, consumer attitudes and affluence. Within an appropriate trade area, the Company evaluates specific sites that provide visibility, accessibility and exposure to traffic volume. The Company’s site criteria are flexible, as is evidenced by the variety of environments and facilities in which the Company currently operates. These facilities include freestanding buildings, regional malls, urban properties and entertainment centers. Each restaurant is designed to convey a unique expression of local styles incorporated into the P.F. Chang’s decor that maximizes the value and visibility of the site.

The Company intends to continue to develop restaurants that typically range in size from 6,000 square feet to 7,000 square feet, and that require, on average, a total capitalized investment of between $2.8 million and $3.3 million per restaurant. This total investment includes the capitalized lease value of the property, which can vary greatly depending on the specific trade area. The Company expects that its planned future restaurants will require, on average, a total cash investment per restaurant, exclusive of landlord contributions, of approximately $2.0 million. Preopening expenses are expected to average approximately $300,000 per restaurant. The Company currently leases the sites for all of its restaurants and does not intend to purchase real estate for its sites in the future.

Current restaurant leases have expiration dates ranging from 2004 to 2020, with the majority of the leases providing for five-year options to renew for at least one additional term. Generally, the Company’s leases provide for a minimum annual rent, and most leases require additional percentage rent based on sales volume in excess of minimum levels at the particular location. Most of the leases require the Company to pay the costs of insurance, taxes, and a portion of the lessor’s operating costs. The Company does not anticipate any difficulties renewing existing leases as they expire.

The Company’s executive offices are currently located in approximately 4,400 square feet of leased space in Phoenix, Arizona. In order to support the growth in operations, the Company will relocate its executive offices to a larger lease space in April, 2000.

Item 3. Legal Proceedings

The Company was not involved in any material legal proceedings as of January 2, 2000.

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

The Company’s Annual Meeting of Stockholders was held on May 18, 1999. The election of seven directors was presented for stockholder approval. The results are listed below:


			Total
	Total		Votes
	Votes For		Against

Richard L. Federico		7,811,307		4,205




Paul M. Fleming		7,811,307		4,205




J. Michael Chu		7,811,837		3,675




Gerald R. Gallagher		7,811,687		3,825




R. Michael Welborn		7,811,157		4,355




James G. Shennan, Jr.		7,811,687		3,825




Yves Sisteron		7,811,307		4,205

PART II

Item 5. Market for the Registrant’s Common Stock and Related Stockholder Matters

The Company’s Common Stock is traded on the Nasdaq Stock Market under the symbol “PFCB”. Public trading of the Common Stock commenced on December 4, 1998. Prior to that, there was no public market for the Common Stock. The following table sets forth for the period indicated the high and low price per share of the Common Stock on the Nasdaq Stock Market.


	High	Low

Period from December 4, 1998 to December 27, 1998	$18.50	$12.00




Quarter Ended March 28, 1999	30.12	19.25




Quarter Ended June 27, 1999	31.12	21.50




Quarter Ended September 26, 1999	24.62	20.12




Quarter Ended January 2, 2000	27.62	18.12

The Company presently intends to retain earnings for use in the operation and expansion of its business and therefore does not anticipate paying any cash dividends in the foreseeable future.

On February 15, 2000, there were 71 holders of record of the Company’s Common Stock.

Changes in Securities and Use of Proceeds

The Company registered and sold 3,922,500 shares of Common Stock, par value $0.001 (the “Shares”) on registration statement No. 333-59749 at an aggregate offering price of $47,070,000 (or $12.00 per share), which was declared effective on December 4, 1998 (the “Offering”).

The co-managing underwriters of the Offering were Donaldson, Lufkin & Jenrette, NationsBanc Montgomery Securities LLC, and Dain Rauscher Wessels.

The Company incurred the following expenses in connection with the Offering:






Underwriting discounts and commissions		$3,294,900




Other expenses (audit, legal, etc.)		1,100,000

	Total expenses	$4,394,900

The net offering proceeds to the Company after deducting the total expenses above were $42,675,100.

The Company’s use of proceeds conformed to the intended use of proceeds described in the Company’s prospectus related to the Offering. The Company’s intended use of proceeds as stated in its prospectus was the repayment of all amounts outstanding under its revolving line of credit as well as the development of new restaurants in 1999 and for general corporate purposes. In December 1998, the Company used $25,000,000 of its net proceeds to repay the entire balance outstanding under its revolving line of credit, which has now expired. Additionally, the Company used the balance of the net proceeds from December 1998 through the end of 1999 for the development of its restaurants opened during 1999 or currently under construction, as well as for general corporate purposes.

Item 6. Selected Financial Data

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

SELECTED CONSOLIDATED FINANCIAL DATA

(In thousands, except per share data)



				Predecessors(1)						Company

							Period			Period
				Fiscal			From			From			Total			Fiscal			Fiscal			Fiscal
				Year			1/1/96 to			2/29/96 to			Year			Year			Year			Year
				1995			2/28/96			12/29/96			1996(2)			1997			1998			1999

Statements of Operations Data:




Revenues				$	10,465		$	2,815		$	15,630		$	18,445		$	39,768		$	78,033		$	153,295




Costs and expenses:




	Restaurant operating costs:




		Cost of sales			2,957			772			4,454			5,226			11,317			21,709			42,136




		Labor			3,347			918			4,736			5,654			11,683			22,721			45,569




		Operating			1,528			527			2,944			3,471			6,727			13,319			25,907




		Occupancy			1,059			205			1,279			1,484			2,743			5,429			9,865

			Total restaurant operating costs		8,891			2,422			13,413			15,835			32,470			63,178			123,477




		General and administrative			192			17			1,368			1,385			4,276			6,245			9,648




		Depreciation and amortization			322			82			352			434			1,102			2,384			4,975




		Preopening expense			400			17			765			782			1,922			4,183			4,344

Income (loss) from operations					660			277			(268	)		9			(2	)		2,043			10,851




Interest income (expense), net					(13	)		(4	)		(127	)		(131	)		(317	)		(1,177	)		432

Income (loss) before elimination of minority interests and provision for income taxes					647			273			(395	)		(122	)		(319	)		866			11,283




Elimination of minority interests					—			—			(720	)		(993	)		(1,308	)		(669	)		(2,469	)

Income (loss) before provision for income taxes					647			273			(1,115	)		(1,115	)		(1,627	)		197			8,814




Provision for income taxes					—			—			(30	)		(30	)		(69	)		(48	)		(2,778	)

Net income (loss)				$	647		$	273			(1,145	)		(1,145	)		(1,696	)		149			6,036

Convertible Redeemable Preferred Stock accretion											(504	)		(504	)		(876	)		(888	)		—

Net income (loss) available to common stockholders										$	(1,649	)	$	(1,649	)	$	(2,572	)	$	(739	)	$	6,036

Basic net income (loss) per share										$	(0.66	)				$	(1.03	)	$	(0.25	)	$	0.59

Diluted net income (loss) per share										$	(0.66	)				$	(1.03	)	$	(0.25	)	$	0.54

Shares used in calculation of basic net income (loss) per share(3)											2,500						2,500			2,986			10,217

Shares used in calculation of diluted net income (loss) per share(3)											2,500						2,500			2,986			11,155



			Company
	Predecessors
	As of		As of
	December 31,		December 29,			December 28,			December 27,		January 2,
	1995		1996			1997			1998		2000

Balance Sheet Data:




Cash and cash equivalents	$	480	$	1,877		$	2,739		$	18,857		5,333




Total assets		2,997		13,044			28,489			69,187		81,707




Short- and long-term debt		350		1,763			8,372			2,352		1,829




Deferred Purchase Price Liability		—		—			2,426			—		—




Convertible Redeemable Preferred Stock		—		10,517			17,808			—		—




Common stockholders’ and members’ equity (deficit)		1,295		(1,874	)		(4,446	)		58,229		64,790



				Company
	Predecessors
	Year Ended			Year Ended
	December 31,			December 29,			December 28,			December 27,			January 2,
	1995			1996			1997			1998			2000

Consolidated Financial Ratios:




Return on Total Average Assets		27.60	%		(14.28	)%		(8.17	)%		0.31	%		8.00	%




Return on Average Stockholders’ and Members’ Equity		51.51	%		N/A			N/A			0.55	%		9.81	%


(1)	Information for fiscal 1995 and the period from January 1, 1996 to February 28, 1996 relate to the Predecessors. The Company was formed in January 1996, and in February 1996 purchased majority interests in four corporations operating restaurants (“Predecessors”). The acquisitions of the ownership interests in the various entities were accounted for under the purchase method of accounting for business combinations. Prior to February 1996, the Company’s business was conducted by the Predecessors.

(2)	Total year 1996 information reflects the combined results of the Predecessors for the period from January 1, 1996 to February 28, 1996 and of the Company for the period beginning February 29, 1996 to December 29, 1996.

(3)	See Notes 1, 5 and 8 of Notes to Consolidated Financial Statements.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following section contains forward-looking statements which involve risks and uncertainties. Such forward-looking statements may be deemed to include anticipated restaurant openings, anticipated costs and sizes of future restaurants and the adequacy of anticipated sources of cash to fund the Company’s future capital requirements. Words such as “believes,” “anticipates,” “expects,” “intends,” “plans” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. The Company’s actual results may differ materially from those discussed in the forward-looking statements. Factors that might cause actual events or results to differ materially from those indicated by such forward-looking statements may include the matters set forth under “Risk Factors” and elsewhere in this Form 10-K, such as development and construction risks, potential labor shortages, fluctuations in operating results, and changes in food costs.

OVERVIEW

P.F. Chang’s owns and operates 36 full service restaurants (as of January 2, 2000) that feature a distinctive blend of high quality, traditional Chinese cuisine and American hospitality in a sophisticated, contemporary bistro setting. The Company was formed in early 1996 with the acquisition of the four original P.F. Chang’s restaurants and the hiring of an experienced management team, led by Richard Federico and Robert Vivian, the Company’s Chief Executive Officer and Chief Financial Officer, respectively, to support the Company’s founder, Paul Fleming. Utilizing a partnership management philosophy, the Company

embarked on a strategic expansion of the concept targeted at major metropolitan areas throughout the United States and opened three additional restaurants in 1996, six in 1997, 10 in 1998 and 13 in 1999.

The Company intends to open 15 new restaurants in 2000 (three of which have opened since January 2, 2000). The 15 units that the Company intends to develop in 2000 will be situated in approximately 7 new cities across the United States. The Company has signed lease agreements for all of the 15 units planned for fiscal 2000. The Company intends to continue to develop restaurants that typically range in size from 6,000 square feet to 7,000 square feet, and that require, on average, a total cash investment of approximately $2.0 million, excluding landlord contributions and total invested capital of between $2.8 million and $3.3 million per restaurant. Preopening expenses are expected to average approximately $300,000 per restaurant. This total capitalized investment includes the capitalized lease value of the property, which can vary greatly depending on the specific trade area. See “Risk Factors — Development and Construction Risks.”

Elimination of minority interests for all periods subsequent to 1996 includes the effect of the Company’s partnership management structure. The Company has entered into a series of partnership agreements with each of its Market Partners, Operating Partners and Culinary Partners. These partnership agreements typically provide that the Market Partner is entitled to a specified percentage of the cash flows from the restaurants that partner has invested in, developed and oversees as the regional manager. Similarly, the Operating Partners and Culinary Partners receive a percentage of the cash flows from the restaurant in which they work. See “Business — Operations.”

RESULTS OF OPERATIONS

The operating results of the Company for the fiscal years ended December 28, 1997 (fiscal year 1997), December 27, 1998 (fiscal year 1998) and January 2, 2000 (fiscal year 1999), expressed as a percentage of revenues, were as follows:


				Fiscal Year			Fiscal Year			Fiscal Year
				1997			1998			1999

Statements of Operations Data:




Revenues					100.0	%		100.0	%		100.0	%




Costs and expenses:




	Restaurant operating costs:




		Cost of sales			28.4			27.8			27.5




		Labor			29.4			29.1			29.7




		Operating			16.9			17.1			16.9




		Occupancy			6.9			7.0			6.4

			Total restaurant operating costs		81.6			81.0			80.5




		General and administrative			10.8			8.0			6.3




		Depreciation and amortization			2.8			3.1			3.3




		Preopening expense			4.8			5.4			2.8

Income (loss) from operations					—			2.6			7.1




Interest income (expense), net					(0.8	)		(1.5	)		0.3




Elimination of minority interests					(3.3	)		(0.9	)		(1.6	)

Income (loss) before provision for income taxes					(4.1	)		0.3			5.8




Provision for income taxes					(0.2	)		(0.1	)		(1.8	)

Net income (loss)					(4.3	)%		0.2	%		4.0	%

The Company operates on a 52/53 week year, with the fiscal year ending on the Sunday closest to December 31. Fiscal years 1997 and 1998 include 52 weeks and fiscal year 1999 includes 53 weeks.

Year Ended January 2, 2000 Compared to Year Ended December 27, 1998

Revenues

The Company’s revenues are derived entirely from food and beverage sales. Revenues increased by $75.3 million, or 96.5%, to $153.3 million in the year ended January 2, 2000 from $78.0 million in the year ended December 27, 1998. The increase was primarily attributable to revenues of $28.8 million generated by new restaurants opened in 1999, a $36.9 million increase in revenues in 1999 for restaurants that opened in 1998 and a $9.6 million increase in revenues for restaurants opened prior to 1998. Additionally, the current fiscal year included one additional week of sales (a 53 week year in 1999 versus a 52 week year in 1998). Increased customer visits produced comparable restaurant sales gains of 12.0% in 1999. The Company did not implement any meaningful price increases in fiscal 1999 or fiscal 1998.

Costs and Expenses

Cost of sales. Cost of sales is composed of the cost of food and beverages. Cost of sales decreased as a percentage of revenues to 27.5% in the year ended January 2, 2000 from 27.8% in the year ended December 27, 1998. This decrease was primarily the result of cost efficiencies achieved through the improved management of product purchasing, food preparation and waitstaff performance as the Company’s restaurants mature.

Labor. Labor expenses consist of restaurant management salaries, hourly staff payroll costs and other payroll-related items. Labor expenses as a percentage of revenues increased to 29.7% in the year ended January 2, 2000 from 29.1% in the year ended December 27, 1998. The increase in labor expenses was primarily due to the fact that the Company opened 13 new restaurants in 1999 compared to 10 new restaurants in 1998. The Company’s experience to date has been that labor costs associated with a newly opened restaurant (for approximately its first four to six months of operation) are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Additionally as a result of tightening labor markets around the country, the Company has experienced an increase in its labor costs across the system. The Company expects that tighter labor markets will continue to exert upward pressure on its labor costs on a year-over-year basis in 2000.

Operating. Operating expenses consist primarily of various restaurant-level costs, which are generally variable and are expected to fluctuate with revenues. In addition, the Company’s experience to date has been that operating costs associated with a newly opened restaurant (for approximately its first four to six months of operation) are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Operating expenses decreased nominally as a percentage of revenues to 16.9% in the year ended January 2, 2000 from 17.1% in the year ended December 27, 1998.

Occupancy. Occupancy costs include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes. Occupancy costs decreased as a percentage of revenues to 6.4% in the year ended January 2, 2000 from 7.0% in the year ended December 27, 1998. The decrease in occupancy was primarily the result of the increased revenue base and, to a lesser extent, more favorable lease terms associated with new restaurants.

General and administrative. General and administrative expenses are composed of expenses associated with corporate and administrative functions that support development and restaurant operations and provide an infrastructure to support future growth, including management and staff salaries, employee benefits, travel, legal and professional fees, technology and market research. General and administrative expenses increased to $9.6 million (6.3% of revenues) in the year ended January 2, 2000 from $6.2 million (8.0% of revenues) in the year ended December 27, 1998, due primarily to the addition of corporate management personnel, which resulted in approximately $1.7 million of additional compensation and benefits expense, as well as additional costs to support a larger restaurant base, including an additional $564,000 in travel and consulting fees and an additional $623,000 in accounting and legal fees. The decrease as a percentage of revenues was due primarily to the Company’s expanding revenue base and its ability to leverage the duties and responsibilities of its Market Partners.

Depreciation and amortization. Depreciation and amortization expenses include the depreciation of fixed assets and the amortization of goodwill costs associated with the acquisition of the ownership interests in the original restaurants. Depreciation and amortization increased to $5.0 million in the year ended January 2, 2000 from $2.4 million in the year ended December 27, 1998. This increase was primarily due to depreciation and amortization on restaurants opened in 1999 totaling $1.0 million as well as a full year’s depreciation and amortization on restaurants opened in 1998.

Preopening expense. Preopening costs, which are expensed as incurred, consist of expenses incurred prior to opening a new restaurant and are comprised principally of manager salaries and relocation, employee payroll and related training costs. Preopening expenses in the year ended January 2, 2000 increased to $4.3 million from $4.2 million in the year ended December 27, 1998 due to the greater number of restaurants opened or under development during the 1999 period, offset by better management of costs incurred.

Interest income (expense), net. Net interest income (expense) was $432,000 in the year ended January 2, 2000 as compared to ($1.2) million in the year ended December 27, 1998. The decrease in the expense was principally due to the payoff of the Company’s revolving line of credit in December of 1998 from the proceeds of the Company’s initial public offering.

Elimination of Minority Interests

Elimination of minority interests represents the portion of the Company’s net earnings (losses) which are attributable to the collective ownership interests of its partners. The Company has provided a partnership management structure in which it has entered into a series of partnership agreements with its regional managers (“Market Partners”), certain of its general managers (“Operating Partners”), and certain of its executive chefs (“Culinary Partners”).

Elimination of minority interests for the year ended January 2, 2000 increased to $2.5 million from $669,000 for the year ended December 27, 1998, due primarily to the addition of new restaurants and an increase in the operating profit of those restaurants.

Provision for Income Taxes

The provision for income taxes increased to $2.8 million for the year ended January 2, 2000 from $48,000 for the year ended December 27, 1998 due primarily to the fact that the Company’s taxable income, which was in excess of the Company’s net operating loss carryforward, increased substantially from the prior period. The income tax provision for 1999 differs from the expected provision for income taxes, derived by applying the statutory income tax rate, as a result of the Company’s expected utilization in 1999 of its net operating loss carryforward and the resulting decrease in the related deferred income tax valuation allowance.

The provision for income taxes for the year ended December 27, 1998 represents certain minimum state taxes based on taxable factors other than earnings. The income tax provision for the year ended December 27, 1998 differs from the expected provision for income taxes, derived by applying the statutory income tax rate, as a result of a reduction in the previously provided deferred income tax valuation allowance.

Year Ended December 27, 1998 Compared to Year Ended December 28, 1997

Revenues

The Company’s revenues are derived entirely from food and beverage sales. Revenues increased by $38.3 million, or 96.2%, to $78.0 million in the year ended December 27, 1998 from $39.8 million in the year ended December 28, 1997. The increase was primarily attributable to revenues of $14.0 million generated by new restaurants opened in 1998 and a $19.4 million increase in revenues in 1998 for restaurants that opened in 1997 and a $4.9 million increase in revenues for restaurants opened prior to 1997. Increased customer visits produced comparable restaurant sales gains of 12.8% in 1998. The Company did not implement any meaningful price increases in fiscal 1998 or fiscal 1997.

Costs and expenses

Cost of sales. Cost of sales is composed of the cost of food and beverages. Cost of sales decreased as a percentage of revenues to 27.8% in the year ended December 27, 1998 from 28.4% in the year ended December 28, 1997. This decrease was primarily the result of cost efficiencies achieved through the improved management of product purchasing, food preparation and waitstaff performance as the Company’s restaurants mature.

Labor. Labor expenses consist of restaurant management salaries, hourly staff payroll costs and other payroll-related items. Labor expenses as a percentage of revenues decreased to 29.1% in the year ended December 27, 1998 from 29.4% in the year ended December 28, 1997. The decrease in labor expenses was primarily due to improvements in the management of hourly staff levels in the restaurants as the Company’s restaurants mature. These improved efficiencies more than offset the increase in hourly wages mandated by the federal government and the State of California. The Company expects that the increase in minimum wage will continue to exert upward pressure on its labor costs on a year-over-year basis for the first quarter of 1999.

Operating. Operating expenses consist primarily of various restaurant-level costs, which are generally variable and are expected to fluctuate with revenues. In addition, the Company’s experience to date has been that operating costs associated with a newly opened restaurant (for approximately its first four to six months of operation) are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Operating expenses increased nominally as a percentage of revenues to 17.1% in the year ended December 27, 1998 from 16.9% in the year ended December 28, 1997.

Occupancy. Occupancy costs include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes. Occupancy costs increased nominally as a percentage of revenues to 7.0% in the year ended December 27, 1998 from 6.9% in the year ended December 28, 1997.

General and administrative. General and administrative expenses are composed of expenses associated with corporate and administrative functions that support development and restaurant operations and provide an infrastructure to support future growth, including management and staff salaries, employee benefits, travel, legal and professional fees, technology and market research. General and administrative expenses increased to $6.2 million (8.0% of revenues) in the year ended December 27, 1998 from $4.3 million (10.8% of revenues) in the year ended December 28, 1997, due primarily to the addition of corporate management personnel which resulted in approximately $1.2 million of additional compensation and benefits expense as well as additional costs to support a larger restaurant base, including an additional $400,000 in travel and consulting fees. The decrease as a percentage of revenues was due primarily to the Company’s expanding revenue base and its ability to leverage the duties and responsibilities of its Market Partners.

Depreciation and amortization. Depreciation and amortization expenses include the depreciation of fixed assets and the amortization of goodwill costs associated with the acquisition of the ownership interests in the original restaurants. Depreciation and amortization increased to $2.4 million in the year ended December 27, 1998 from $1.1 million in the year ended December 28, 1997. This increase was primarily due to depreciation and amortization on new restaurants totaling $670,000, a full year’s depreciation and amortization on restaurants opened in 1997 and an additional $192,000 of amortization of the goodwill associated with the acquisition in October 1997 of the remaining minority interests in three of the four original restaurants.

Preopening expense. Preopening costs, which are expensed as incurred, consist of expenses incurred prior to opening a new restaurant and are comprised principally of manager salaries and relocation, employee payroll and related training costs. Preopening expenses in the year ended December 27, 1998 increased to $4.2 million from $1.9 million in the year ended December 28, 1997, due to the greater number of restaurants opened or under development during the 1998 period, as well as unexpected delays in the timing of restaurant openings in 1998.

Interest income (expense), net. Interest income (expense), net increased to $1.2 million in the year ended December 27, 1998 from $317,000 in the year ended December 28, 1997 principally due to borrowings under the Company’s line of credit.

Elimination of minority interests

Elimination of minority interests for the year ended December 28, 1997 includes approximately $1.2 million attributable to the minority interests in the Scottsdale, Newport Beach and La Jolla restaurants. As a result of the acquisition of substantially all of these minority interests in October 1997, elimination of minority interests for the year ended December 27, 1998 declined to $669,000. Approximately $110,000 and $635,000 was attributable to the collective minority interests of Market Partners, Operating Partners and Culinary Partners in the years ended December 28, 1997 and December 27, 1998, respectively.

Provision for income taxes

The provision for income taxes for the years ended December 27, 1998 and December 28, 1997 represents certain minimum state taxes based on taxable factors other than earnings. The Company did not record a tax benefit for the losses generated for the year ended December 28, 1997, as utilization of such losses in future periods was deemed uncertain. The income tax provision for the year ended December 27, 1998 differs from the expected provision for income taxes, derived by applying the statutory income tax rate, as a result of a reduction in the previously provided deferred income tax valuation allowance.

Quarterly Results

The following tables set forth certain unaudited quarterly information for each of the eight fiscal quarters, expressed as a percentage of revenues, except for revenues which are expressed in thousands, in the two year period ended January 2, 2000. This quarterly information has been prepared on a consistent basis with the audited financial statements and, in the opinion of management, includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information for the periods presented. The Company’s quarterly operating results may fluctuate significantly as a result of a variety of factors, and operating results for any quarter are not necessarily indicative of results for a full fiscal year.

The operating results of the Company for such eight fiscal quarters expressed as a percentage of revenues, except for revenues which are expressed in thousands, were as follows:



				Fiscal 1998												Fiscal 1999

				First			Second			Third			Fourth			First			Second			Third			Fourth
				Quarter			Quarter			Quarter			Quarter			Quarter			Quarter			Quarter			Quarter

Revenues				$	15,728		$	17,209		$	20,239		$	24,857		$	30,473		$	32,956		$	40,961		$	48,905




Costs and expenses:




	Restaurant operating costs:




		Cost of sales			27.9	%		27.4	%		27.9	%		28.0	%		27.5	%		27.6	%		27.8	%		27.1	%




		Labor			29.0			28.1			28.8			30.2			29.9			29.8			30.0			29.4




		Operating			16.4			16.6			17.1			17.8			16.8			17.2			17.2			16.5




		Occupancy			7.0			7.3			7.0			6.6			6.9			6.8			6.3			6.0

			Total restaurant operating costs		80.3			79.4			80.8			82.6			81.1			81.4			81.3			79.0




		General and administrative			8.6			8.2			7.7			7.7			7.0			6.1			6.0			6.2




		Depreciation and amortization			3.1			3.0			2.9			3.2			3.2			3.3			3.2			3.2




		Preopening expense			2.7			4.6			5.9			7.1			2.3			4.0			3.2			2.1

Income (loss) from operations					5.3			4.8			2.7			(0.6	)		6.4			5.2			6.3			9.5




Interest income (expense), net					(1.4	)		(1.4	)		(1.5	)		(1.7	)		0.7			0.4			0.1			0.1

Income (loss) before elimination of minority interests and provision for income taxes					3.9			3.4			1.2			(2.3	)		7.1			5.6			6.4			9.6




Elimination of minority interests					(1.0	)		(1.1	)		(1.0	)		(0.5	)		(1.4	)		(1.2	)		(1.6	)		(2.0	)

Income (loss) before provision for income taxes					2.9			2.3			0.2			(2.8	)		5.7			4.4			4.8			7.6




Provision for income taxes					—			—			—			(0.1	)		(1.6	)		(1.3	)		(1.5	)		(2.6	)

Net income (loss)					2.9	%		2.3	%		0.2	%		(2.9	)%		4.1	%		3.1	%		3.3	%		5.0	%

Historically, the Company has experienced variability in the amount and percentage of revenues attributable to preopening expenses. The Company typically incurs the most significant portion of preopening expenses associated with a given restaurant within the two months immediately preceding and the month of the opening of the restaurant. In addition, the Company’s experience to date has been that labor and operating costs associated with a newly opened restaurant (for approximately its first four to six months of operation) are materially greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenues. Accordingly, the volume and timing of new restaurant openings has had and is expected to have a

meaningful impact on preopening expenses, labor and operating costs until such time as a larger base of restaurants in operation mitigates such impact.

Liquidity and Capital Resources

The Company has funded its capital requirements since its inception through sales of equity securities, debt financing and cash flows from operations. Net cash provided by operating activities was $139,000, $5.8 million and $19.6 million for fiscal years 1997, 1998 and 1999, respectively. Net cash provided by operating activities exceeded the net income and losses for the periods due principally to the effect of minority interests, depreciation and amortization and an increase in income tax payable.

The Company uses cash primarily to fund the development and construction of new restaurants. Net cash used in investing activities in fiscal years 1997, 1998 and 1999 was $11.5 million, $25.7 million and $31.0 million, respectively, which included payments of $2.5 million and $397,000 in fiscal years 1997 and 1998, respectively, made in connection with the acquisition of minority interests. Capital expenditures were $8.7 million, $24.8 million and $31.1 million in fiscal years 1997, 1998 and 1999, respectively. The Company intends to open 15 restaurants in 2000 (three of which have opened since January 2, 2000). The Company expects that its planned future restaurants will require, on average, a total cash investment per restaurant, exclusive of landlord contributions, of approximately $2.0 million. Preopening expenses are expected to average approximately $300,000 per restaurant.

Net cash provided by (used in) financing activities in fiscal years 1997, 1998 and 1999 was $12.2 million, $36.0 million and ($2.2 million), respectively. Financing activities in 1997 consisted principally of sales of Preferred Stock of $6.4 million and line of credit borrowings of $5.5 million, while 1998 financing activities consisted primarily of sales of common stock, offset by repayments under the Company’s revolving line of credit. Financing activities in 1999 consisted primarily of distributions to the Company’s partners.

In December of 1999, the Company entered into a revolving line of credit with a commercial lending institution. The line of credit allows for borrowings up to $15 million at an interest rate ranging from 150 to 225 basis points over the applicable London Interbank Offered Rate (LIBOR). The revolving line of credit matures on November 30, 2002 and contains certain restrictions and conditions which require the Company to: maintain tangible net worth of $45 million, a leverage ratio at a maximum of 2.00: 1.00, a fixed-charge ratio no less than 1.25: 1.00 and limit annual capital expenditures to $35 million. The line of credit has been collaterized by substantially all of the assets of the Company. The Company had no borrowings under the line of credit as of January 2, 2000.

The Company’s capital requirements, including development costs related to the opening of additional restaurants, have been and will continue to be significant. The Company’s future capital requirements and the adequacy of its available funds will depend on many factors, including the pace of expansion, real estate markets, site locations and the nature of the arrangements negotiated with landlords. Although no assurance can be given, the Company believes that its cash flow from operations together with its current cash reserves and borrowings available under its line of credit will be sufficient to fund its capital requirements through 2000. In the event that additional capital is required, the Company may seek to raise such capital through public or private equity or debt financings. Future capital funding transactions may result in dilution to current shareholders. There can be no assurance that such capital will be available on favorable terms, if at all.

Partnership Agreements

The Company has implemented a partnership structure to facilitate the development and operation of its restaurants. Each partner is required, as a condition of employment, to sign a five-year employment agreement and is required to purchase a specified interest in the restaurant or region the partner is employed to manage. The ownership interest purchased by each partner generally ranges between two and seven percent of the restaurant or region the partner oversees. During the five-year employment term, each partner is prohibited from selling or transferring his interest to another party. At the termination of the employment agreement, the Company has the right to purchase the minority partners’ interests in the partners’ respective restaurants at fair market value, as calculated according to the partnership agreements.

Preferred Stock and Accretion

In February 1996 and September 1996, the Company sold shares of its Series A Preferred Stock convertible into 2,677,135 shares of Common Stock at $4.00 per common share, and in May 1997, the Company sold shares of its Series B Preferred Stock convertible into 758,565 shares of Common Stock at $8.70 per common share. The Series A Preferred Stock had an annual six percent dividend payable quarterly in shares of Series A Preferred Stock on a cumulative basis beginning January 1, 1998. The Series B Preferred Stock had an annual six percent dividend payable quarterly in shares of Series B Preferred Stock on a cumulative basis beginning April 1, 1999. Dividend accretion on the Series A and Series B Preferred Stock was approximately $876,000 and $888,000 for the fiscal years 1997 and 1998, respectively. At the time of the Company’s public offering, each two shares of Series A Preferred Stock and Series B Preferred Stock were converted into one share of Common Stock.

Year 2000 Compliance

The Company experienced no significant disruption to business as a result of the rollover to year 2000.

New Accounting Standards

In June 1999, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 137, “Accounting for Derivatives and Hedging Activities — Deferral of the effective date of FASB Statement No. 133.” This statement defers the effective date of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS No. 133) to all fiscal quarters beginning after June 15, 2000. SFAS No. 133 standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, by recognition of those items as assets or liabilities in the statements of financial position and measurements of fair value. The impact of SFAS No. 133 on the Company’s financial position and results of operations has not yet been determined.

Inflation

The primary inflationary factors affecting the Company’s operations are food and labor costs. A large number of the Company’s restaurant personnel are paid at rates based on the applicable minimum wage, and increases in the minimum wage directly affect the Company’s labor costs. To date, inflation has not had a material impact on the Company’s results of operations. See “Risk Factors — Changes in Food Costs.”

Item 7A. Quantitative and Qualitative Disclosures about Market Risks

Management believes that the market risk associated with the Company’s market risk sensitive instruments as of January 2, 2000 is not material, and therefore, disclosure is not required.

Item 8. Financial Statements and Supplementary Data

P.F. CHANG’S CHINA BISTRO, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


	Page

Report of Independent Auditors		F-2




Consolidated Financial Statements:




Consolidated Balance Sheets at December 27, 1998 and January 2, 2000		F-3




Consolidated Statements of Operations for the Years Ended December 28, 1997, December 27, 1998 and January 2, 2000		F-4




Consolidated Statements of Convertible Redeemable Preferred Stock and Common Stockholders’ Equity (Deficit) for the Years Ended December 28, 1997, December 27, 1998 and January 2, 2000		F-5




Consolidated Statements of Cash Flows for the Years Ended December 28, 1997, December 27, 1998 and January 2, 2000		F-6




Notes to Consolidated Financial Statements		F-7

F-1

REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

P.F. Chang’s China Bistro, Inc.

We have audited the accompanying consolidated balance sheets of P.F. Chang’s China Bistro, Inc. (the “Company”) as of December 27, 1998 and January 2, 2000, and the related consolidated statements of operations, convertible redeemable preferred stock and common stockholders’ equity (deficit), and cash flows for the years ended December 28, 1997, December 27, 1998 and January 2, 2000. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of P.F. Chang’s China Bistro, Inc. at December 27, 1998 and January 2, 2000 and the results of its operations and its cash flows for the years ended December 28, 1997, December 27, 1998 and January 2, 2000, in conformity with accounting principles generally accepted in the United States.

ERNST & YOUNG LLP

Phoenix, Arizona

February 9, 2000

F-2

P.F. CHANG’S CHINA BISTRO, INC.

CONSOLIDATED BALANCE SHEETS


			December 27,			January 2,
			1998			2000


			(In thousands)




ASSETS




Current assets:




	Cash and cash equivalents		$	18,857		$	5,333




	Receivables			2,792			1,275




	Inventories			673			1,085




	Current portion of notes receivable from related parties			225			386




	Prepaids and other current assets			631			1,204

Total current assets				23,178			9,283




Construction-in-progress				4,627			7,041




Property and equipment, net				32,246			56,395




Goodwill, net of accumulated amortization of $834,000 and $1,270,000 in 1998 and 1999, respectively				7,874			7,438




Notes receivable from related parties, less current portion				545			251




Other assets				717			1,299

Total assets			$	69,187		$	81,707


LIABILITIES AND STOCKHOLDERS’ EQUITY




Current liabilities:




	Accounts payable		$	2,938		$	3,789




	Accrued payroll			1,943			2,148




	Sales and use tax payable			619			1,317




	Other accrued expenses			2,179			3,376




	Unearned revenue			744			1,676




	Current portion of long-term debt, including $268,000 and $71,000 due to related parties in 1998 and 1999, respectively			523			281




	Income tax payable			—			1,687

Total current liabilities				8,946			14,274




Long-term debt, including $340,000 due to related parties in 1998				1,829			1,548




Deferred income tax liability				—			601




Interests of minority partners in consolidated partnerships				183			494
Commitments and contingencies




Stockholders’ equity:




	Common stock, $0.001 par value, 20,000,000 shares authorized:




		10,192,769 and 10,254,856 shares issued and outstanding at December 27, 1998 and January 2, 2000, respectively		10			10




	Additional paid-in capital			63,409			63,934




	Retained earnings (deficit)			(5,190	)		846

Total stockholders’ equity				58,229			64,790

Total liabilities and stockholders’ equity			$	69,187		$	81,707

See accompanying notes.

F-3

P.F. CHANG’S CHINA BISTRO, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS


				Year Ended			Year Ended			Year Ended
				December 28,			December 27,			January 2,
				1997			1998			2000


				(In thousands, except per share amounts)




Revenues				$	39,768		$	78,033		$	153,295




Costs and expenses:




	Restaurant operating costs:




		Cost of sales			11,317			21,709			42,136




		Labor			11,683			22,721			45,569




		Operating			6,727			13,319			25,907




		Occupancy			2,743			5,429			9,865

			Total restaurant operating costs		32,470			63,178			123,477




	General and administrative				4,276			6,245			9,648




	Depreciation and amortization				1,102			2,384			4,975




	Preopening expense				1,922			4,183			4,344

Income (loss) from operations					(2	)		2,043			10,851




Interest income (expense):




	Interest expense				(380	)		(1,406	)		(228	)




	Interest income				63			229			660

Income (loss) before elimination of minority interests and provision for income taxes					(319	)		866			11,283




Elimination of minority interests					(1,308	)		(669	)		(2,469	)

Income (loss) before provision for income taxes					(1,627	)		197			8,814




Provision for income taxes					(69	)		(48	)		(2,778	)

Net income (loss)					(1,696	)		149			6,036




Redeemable Preferred Stock accretion					(876	)		(888	)		—

Net income (loss) available to common stockholders				$	(2,572	)	$	(739	)	$	6,036

Net income (loss) per share:




	Basic			$	(1.03	)	$	(0.25	)	$	0.59

	Diluted			$	(1.03	)	$	(0.25	)	$	0.54

Weighted average shares used in computation:




	Basic				2,500			2,986			10,217

	Diluted				2,500			2,986			11,155

See accompanying notes.

F-4

P.F. CHANG’S CHINA BISTRO, INC.

CONSOLIDATED STATEMENTS OF CONVERTIBLE REDEEMABLE PREFERRED STOCK

AND COMMON STOCKHOLDERS’ EQUITY (DEFICIT)



	Convertible Redeemable Preferred Stock


	Series A						Series B

	Shares			Amount			Shares			Amount


	(In thousands)




Balances, December 29, 1996		5,354		$	10,517			—		$	—




Issuance of Series B preferred stock, net of issuance costs of $184,000		—			—			1,517			6,415




Redeemable preferred stock accretion		—			658			—			218




Net loss		—			—			—			—

Balances, December 28, 1997		5,354			11,175			1,517			6,633




Series A preferred stock dividend paid		329			—			—			—




Redeemable preferred stock accretion		—			587			—			301




Conversion of preferred stock to common stock		(5,683	)		(11,762	)		(1,517	)		(6,934	)




Conversion of deferred purchase price liability to common stock		—			—			—			—




Issuance of common stock, net of issuance costs of $4,394,900		—			—			—			—




Net income		—			—			—			—

Balances, December 27, 1998		—			—			—			—




Issuance of common stock under stock option plan		—			—			—			—




Issuance of common stock under employee stock purchase plan		—			—			—			—




Net income		—			—			—			—

Balances, January 2, 2000		—		$	—			—		$	—

[Additional columns below]

[Continued from above table, first column(s) repeated]

Common Stockholders’ and Members’ Equity (Deficit)

Common Stock Additional Retained

Paid-In Earnings

Shares Amount Capital (Deficit) Total

(In thousands)

Balances, December 29, 1996 2,500 $ 3 $ 2 $ (1,879 ) $ (1,874 )

Issuance of Series B preferred stock, net of issuance costs of $184,000 — — — — —

Redeemable preferred stock accretion — — — (876 ) (876 )

Net loss — — — (1,696 ) (1,696 )

Balances, December 28, 1997 2,500 3 2 (4,451 ) (4,446 )

Series A preferred stock dividend paid — — — — —

Redeemable preferred stock accretion — — — (888 ) (888 )

Conversion of preferred stock to common stock 3,600 3 18,693 — 18,696

Conversion of deferred purchase price liability to common stock 170 — 2,043 — 2,043

Issuance of common stock, net of issuance costs of $4,394,900 3,923 4 42,671 — 42,675

Net income — — — 149 149

Balances, December 27, 1998 10,193 10 63,409 (5,190 ) 58,229

Issuance of common stock under stock option plan 37 — 266 — 266

Issuance of common stock under employee stock purchase plan 25 — 259 — 259

Net income — — — 6,036 6,036

Balances, January 2, 2000 10,255 $ 10 $ 63,934 $ 846 $ 64,790

See accompanying notes.

F-5

P.F. CHANG’S CHINA BISTRO, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


			Year Ended			Year Ended			Year Ended
			December 28,			December 27,			January 2
			1997			1998			2000


			(In thousands)




Operating Activities:




Net income (loss)			$	(1,696	)	$	149		$	6,036




Adjustments to reconcile net income (loss) to net cash provided by operating activities:




	Depreciation and amortization			858			1,948			4,539




	Amortization of goodwill			244			436			436




	Deferred income taxes			—			—			601




	Minority interests			1,308			669			2,469




	Changes in operating assets and liabilities:




		Receivables		(1,403	)		(730	)		1,517




		Inventories		(169	)		(310	)		(412	)




		Prepaids and other current assets		(338	)		(214	)		(573	)




		Other assets		(207	)		(410	)		(582	)




		Accounts payable		609			1,280			851




		Accrued payroll		590			729			205




		Sales and use tax payable		161			324			698




		Other accrued expenses		10			1,486			1,197




		Unearned revenue		172			439			932




		Income tax payable		—			—			1,687

Net cash provided by operating activities				139			5,796			19,601




Investing Activities:




Capital expenditures				(8,696	)		(24,817	)		(31,102	)




Decrease (increase) in notes receivable from related parties				(292	)		(478	)		133




Purchase of minority interests				(2,520	)		(397	)		—

Net cash used in investing activities				(11,508	)		(25,692	)		(30,969	)




Financing Activities:




Proceeds from revolving line of credit, net of repayments				5,500			(5,500	)		—




Proceeds from issuance of long-term debt				1,600			—			—




Repayments of long-term debt				(491	)		(520	)		(523	)




Proceeds from issuance of common stock				—			42,675			—




Proceeds from issuance of redeemable preferred stock				6,415			—			—




Proceeds from stock options exercised and employee stock purchases				—			—			525




Proceeds from minority interest contributions				441			506			455




Distributions to minority interests				(1,234	)		(1,147	)		(2,613	)

Net cash provided by (used in) financing activities				12,231			36,014			(2,156	)

Net increase (decrease) in cash and cash equivalents				862			16,118			(13,524	)




Cash and cash equivalents at the beginning of the year				1,877			2,739			18,857

Cash and cash equivalents at the end of the year			$	2,739		$	18,857		$	5,333

Supplemental Disclosures of Cash Flow Information:




Cash paid for interest			$	319		$	1,475		$	231




Cash paid for income taxes				69			48			490




Purchase of members’ and partners’ interest through deferred purchase price and conversion to common stock				2,426			2,043			—

See accompanying notes.

F-6

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000

1. Summary of Significant Accounting Policies

Organization and Nature of Operations

P.F. Chang’s China Bistro, Inc. (the “Company”) operates in a single segment consisting of restaurants throughout the United States under the name of “P.F. Chang’s China Bistro.” The Company successfully completed an initial public offering (the “Offering”) on December 4, 1998, in which 3,922,500 new shares of common stock were issued at a price of $12 per share. Proceeds from the offering were $42,675,100, net of issuance costs totaling $4,394,900. From the proceeds, $25,000,000 was used to repay certain indebtedness of the Company outstanding under its revolving line of credit. The Company used the balance of the net proceeds for development of new restaurants in 1999 and for general corporate purposes.

Upon completion of the Offering, all outstanding shares of preferred stock were converted to shares of common stock at a ratio of one share of common stock for each two shares of preferred stock. Additionally, the deferred purchase price liability, resulting from the Company’s acquisition of substantially all of the remaining minority interests in the three original restaurants in 1997, was converted into common stock. The number of shares issued relating to the deferred purchase price liability was determined by dividing the remaining purchase price liability by the price per share of the common stock sold.

Fiscal Year

The Company’s fiscal year ends on the Sunday closest to the end of December and includes 52 weeks in 1997 and 1998 and 53 weeks in 1999.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Principles of Consolidation

The Company’s consolidated financial statements include the accounts and operations of the Company and its subsidiaries and partnerships in which it owns more than a 50 percent interest. All material balances and transactions between the consolidated entities have been eliminated.

Revenue Recognition

Revenue from food, beverage and alcohol sales are recognized as products are sold.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity date of three months or less when purchased to be cash equivalents.

Receivables

Receivables consist primarily of amounts due from landlords or other parties for the reimbursement of leasehold improvements paid by the Company.

F-7

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

Inventories

Inventories consist of food and beverages and are stated at the lower of cost or market using the first-in, first-out method.

Notes Receivable From Related Parties

Notes receivable from related parties represent amounts due the Company from limited partners of consolidated partnerships. Payments of principal, amortized over five years, with interest at 11.0%, are due monthly, with a balloon payment for the outstanding principal and interest due at the end of two years.

Property and Equipment

Property and equipment are stated at cost. Furniture, fixtures and equipment are depreciated on a straight-line basis over the estimated useful service lives of the related assets, which approximates seven years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the length of the related lease term. China and smallwares are depreciated over two years up to 50 percent of their original cost, and subsequent additions are expensed as purchased.

Goodwill

Goodwill represents the excess of cost over net assets acquired in the purchase of interests in various restaurants and is being amortized over 20 years on a straight-line basis. The Company assesses the recoverability of goodwill based upon expected future undiscounted cash flows resulting from the acquired interests in the restaurants.

Unearned Revenue

Unearned revenue represents gift certificates sold but not yet redeemed. Revenues are recognized upon redemption of the gift certificates.

Advertising

The Company expenses advertising as incurred. Advertising expense for the years ended December 28, 1997, December 27, 1998 and January 2, 2000 was approximately $901,000, $1,255,000 and $2,004,000, respectively.

Preopening Expense

Preopening expenses, consisting primarily of manager salaries and relocation expense, employee payroll and related training costs incurred prior to the opening of a restaurant, are expensed as incurred.

Income Taxes

The Company utilizes the liability method of accounting for income taxes as set forth in Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes.” Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Recognition of deferred tax assets is limited to amounts considered by management to be more likely than not of realization in future periods.

F-8

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

Minority partners’ interests in income or loss of consolidated partnerships includes no provision for income taxes as any tax liability related thereto is the responsibility of the individual minority partners.

Stock Based Compensation

The Company grants stock options for a fixed number of shares to certain employees with an exercise price equal to or greater than the fair value of the shares at the date of grant. The Company accounts for stock option grants to employees in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25), and, accordingly, recognizes no compensation expense for the stock option grants.

Net Income (Loss) Per Share

Net income (loss) per share is computed in accordance with SFAS No. 128, “Earnings per Share.”

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, receivables, accounts payable, and accrued expenses approximate fair value because of the immediate or short-term maturity of these financial instruments. The fair value of long-term debt is determined using current applicable rates for similar instruments and collateral as of the balance sheet date and approximates the carrying value of such debt.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash investments and receivables. The Company maintains cash and cash equivalents, restricted funds on deposit and certain other financial instruments with financial institutions that are considered in the Company’s investment strategy. Concentrations of credit risk with respect to receivables are limited as the Company’s receivables are primarily with its landlords for the reimbursement of tenant improvements.

Reclassifications

Certain amounts shown in the prior periods consolidated financial statements have been reclassified to conform with the current year consolidated financial statements presentation.

2. Property and Equipment

Property and equipment consists of the following:


	December 27,		January 2,
	1998		2000


	(In thousands)




Leasehold improvements	$	25,290	$	47,367




Furniture, fixtures and equipment		9,390		15,197




China and smallwares		1,012		1,782

		35,692		64,346




Less accumulated depreciation and amortization		3,446		7,951

	$	32,246	$	56,395

F-9

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

3. Revolving Line of Credit

4. Long-Term Debt

Long-term debt consists of the following:


		December 27,		January 2,
		1998		2000


		(In thousands)




$1,100,000 promissory note, collateralized by leasehold improvements, payable in monthly installments of $11,354 including interest at 11.0 percent, until March 1, 2017, when all remaining principal and interest is due and payable. Additional payments may be required under the promissory note based on a percentage of gross sales		$	1,071	$	1,051




$500,000 promissory note, collateralized by equipment, payable in monthly installments of $8,561 including interest at 11.0 percent until March 1, 2004 when all remaining principal and interest is due and payable			408		348




$1,266,000 unsecured promissory notes, a portion of which is payable to related parties, in quarterly installments of $96,967 including interest at 10.0 percent, until March 1, 2000, when all remaining principal and interest is due and payable			444		93




$421,000 equipment loan, collateralized by furniture, fixtures and equipment, payable in monthly installments of $7,202 including interest at 11.0 percent, until January 1, 2004, when all remaining principal and interest is due and payable			335		283




$200,000 unsecured promissory note, payable in monthly installments of $3,333 plus interest at prime plus one percent, until April 2001, when all remaining principal and interest is due and payable. The note is guaranteed by a stockholder of the Company			94		54

			2,352		1,829




	Less current portion		523		281

		$	1,829	$	1,548

The aggregate annual payments of long-term debt outstanding at January 2, 2000, for the next five years and thereafter, are summarized as follows: 2000 — $281,000; 2001 — $178,000; 2002 — $184,000; 2003 — $205,000; 2004 — $66,000 and thereafter — $915,000.

5. Preferred Stock and Common Stockholders’ Equity

Preferred Stock

The board of directors is authorized to issue up to 10,000,000 shares of preferred stock and to determine the powers, preferences, privileges, rights, including voting rights, qualifications, limitations and restrictions of

F-10

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

those shares without any further vote or act by the common stockholders. There is no outstanding preferred stock as of December 27, 1998 and January 2, 2000.

In connection with the original capitalization of the Company, a warrant to purchase 124,380 shares of preferred stock, convertible into 62,190 shares of common stock, was issued to an investment bank with an exercise price of $4.00 per common share. The warrant expires February 28, 2001.

Stock Option Plans

The Company has elected to follow APB No. 25 and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123, “Accounting for Stock-Based Compensation,” requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB No. 25, because the exercise price of the Company’s employee stock options equals or exceeds the fair value of the underlying stock on the date of grant, no compensation expense is recognized.

In August 1996, the Company adopted the 1996 Stock Option Plan (1996 Plan), and in July 1997, the Company adopted the 1997 Restaurant Management Stock Option Plan (1997 Plan). Options under the 1996 Plan may be granted to employees, consultants and directors to purchase the Company’s common stock at an exercise price that equals or exceeds the fair value of such shares on the date such option is granted. Options under the 1997 Plan may be granted to key employees of the Company who are actively engaged in the management and operation of the Company’s restaurants to purchase the Company’s common stock at an exercise price that equals or exceeds the fair value of such shares on the date such option is granted. Vesting periods are determined at the discretion of the board of directors, and options currently outstanding at January 2, 2000 vest over five years. Options may be exercised immediately upon grant, subject to a right by the Company to repurchase any unvested shares at the exercise price. Any options granted shall not be exercisable after ten years. Upon certain changes in control of the Company, the 1996 and 1997 Plans provide for two additional years of immediate vesting. The Company has reserved a total of 1,086,500 shares of common stock for issuance under the 1996 and 1997 Plans.

During 1998, the Company’s Board of Directors approved the 1998 Stock Option Plan (1998 Plan) which provides for discretionary grants of incentive stock options and nonqualified stock options to the Company’s employees, including officers, directors, consultants, advisors, and other independent contractors. A total of 206,885 additional shares of common stock have been reserved for issuance under the 1998 Plan. The option price per share for an incentive stock option may not be less than 100 percent of the fair market value of a share of common stock on the grant date. The option price per share for a nonstatutory stock option may not be less than 85 percent of the fair market value of a share of common stock on the grant date. The Company’s Compensation Committee has the authority to, among other things, determine the vesting schedule for each option granted. All options expire within 10 years. The 1998 Plan includes an automatic grant program for outside directors. Pursuant to this program, each outside director will be granted an option to purchase 10,000 shares of common stock at the time he or she is first elected or appointed a director of the Company. In addition, each outside director remaining in office will be granted an option to purchase 2,500 shares on the day following each annual meeting of stockholders.

During 1999, the Company’s Board of Directors approved the 1999 Nonstatutory Stock Option Plan (1999 Plan) which provides for discretionary grants of nonqualified stock options to the Company’s employees. The 1999 Plan prohibits grants to officers or directors. A total of 100,000 shares of common stock have been reserved for issuance under the 1999 Plan. The option price per share may not be less than 85 percent of the fair market value of a share of common stock on the grant date. The Company’s Compensation Committee has the authority to, among other things, determine the vesting schedule for each option granted. All options expire within 10 years.

F-11

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

Pro forma information regarding net income (loss) is required by SFAS No. 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997, 1998 and 1999: risk-free interest rate of 5.5 percent; a dividend yield of -0- percent; volatility factors of the expected market price of the Company’s common stock of .122, .41 and .497, respectively; and a weighted-average expected life of the option of five years.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

Because SFAS No. 123 is applicable to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until approximately 2002. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information follows:


		Year ended			Year ended			Year ended
		December 28,			December 27,			January 2,
		1997			1998			2000


		(In thousands, except per share amounts)




Net income (loss), as reported		$	(1,696	)	$	149		$	6,036




	Pro forma compensation expense for stock options		82			185			697

Pro forma net income (loss)		$	(1,778	)	$	(36	)	$	5,339

Net income (loss) per share:




	Basic	$	(1.06	)	$	(0.31	)	$	0.52

	Diluted	$	(1.06	)	$	(0.31	)	$	0.48

Weighted average shares used in computation:




	Basic		2,500			2,986			10,217

	Diluted		2,500			2,986			11,155

F-12

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

Information regarding activity for stock options outstanding under the Plans is as follows:



					Outstanding Options

		Shares						Weighted-
		Available						Average
		for						Exercise
		Options			Shares			Price

Outstanding at December 29, 1996			98,490			791,510		$	2.98




	Authorized		196,500			—			—




	Granted		(170,000	)		170,000			5.40




	Exercised		—			—			—




	Forfeited (canceled)		—			—			—

Outstanding at December 28, 1997			124,990			961,510			3.40




	Authorized		206,885			—			—




	Granted		(174,125	)		174,125			11.82




	Exercised		—			—			—




	Forfeited (canceled)		—			—			—

Outstanding at December 27, 1998			157,750			1,135,635			4.71




	Authorized		100,000			—			—




	Granted		(257,000	)		257,000			22.31




	Exercised		—			(36,653	)		7.17




	Forfeited (canceled)		18,225			(18,225	)		9.18

Outstanding at January 2, 2000			18,975			1,337,757		$	7.97

Information regarding options outstanding and exercisable at January 2, 2000 is as follows:



		Options Outstanding
								Options Exercisable
				Weighted-
				Average		Weighted-				Weighted-
Range of		Number		Remaining		Average		Number		Average
Exercise Prices		Outstanding		Contractual Life		Exercise Price		Exercisable		Exercise Price

	$2.40-$10.00		933,257		4.87 years	$	3.42		663,953	$	3.27
	$10.01-$20.00		183,750		8.77 years		13.39		35,380		12.13
	$20.01-$30.00		220,750		9.49 years		22.69		15,000		23.26

Since options are generally exercisable upon date of grant, options exercisable, included in the above table, represent vested options that are not subject to repurchase by the Company. The weighted-average fair value of options granted for the years ended December 28, 1997, December 27, 1998 and January 2, 2000 was $1.38, $5.27 and $11.16, respectively.

Employee Stock Purchase Plan

During 1998, the Company’s Board of Directors approved the 1998 Employee Stock Purchase Plan (Purchase Plan) and reserved 400,000 shares for issuance thereunder. The Purchase Plan permits eligible employees to purchase common stock at a discount, but only through payroll deductions, during concurrent 24 month offering periods. Each offering period will be divided into four consecutive 6 month purchase periods. The price at which stock is purchased under the Purchase Plan is equal to 85 percent of the lower of the fair market value of the common stock on the first day of the offering period and the fair market value of the common stock on the last day of the purchase period.

F-13

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

6. Partnership Agreements

The Company has entered into a series of partnership agreements with each of its regional managers (Market Partners), certain of its general managers (Operating Partners) and certain of its executive chefs (Culinary Partners). These partnership agreements entitle the Market Partner to a specified percentage of the cash flows from the restaurants that partner has invested in and developed and oversees as the regional manager. Similarly, the general manager and the executive chef at most of the Company’s restaurants are offered the opportunity to become Operating Partners and Culinary Partners, respectively, and to receive a percentage of the cash flows from the restaurant in which they invested in and work. At the time an individual becomes a Market Partner, Operating Partner or Culinary Partner, that person is required to make an equity investment in the partnership and to enter into a five year employment agreement with the Company. The Company has the right, in its sole discretion, to terminate the employment of any Market Partner, Operating Partner or Culinary Partner, and, upon such termination, to repurchase that partner’s interest in the partnership at such partners then-current basis in the partnership. If an individual continues to serve as Market Partner, Operating Partner or Culinary Partner for five years, then the Company has the right to repurchase that person’s interest in the partnership for a value, which is determined by reference to trailing cash flows.

7. Income Taxes

Income tax expense consisted of the following:


		Year Ended		Year Ended		Year Ended
		December 28,		December 27,		January 2,
		1997		1998		2000


		(In thousands)




Federal:




	Current	$	—	$	21	$	1,795




	Deferred		—		—		511

			—		21		2,306




State:




	Current		69		27		382




	Deferred		—		—		90

			69		27		472

		$	69	$	48	$	2,778

The Company’s effective tax rate differs from the federal statutory rate for the following reasons:


	Year Ended			Year Ended			Year Ended
	December 28,			December 27,			January 2,
	1997			1998			2000


	(In thousands)




Income tax expense (benefit) at federal statutory rate	$	(553	)	$	67		$	2,996




State taxes, net of federal expense (benefit)		69			19			311




Increase (decrease) in valuation allowance		425			(288	)		(605	)




Other, net		128			250			76

	$	69		$	48		$	2,778

F-14

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

The income tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:


		December 28,			December 27,			January 2,
		1997			1998			2000


		(In thousands)




Deferred tax assets:




	Preopening expenses	$	267		$	627		$	745




	Net operating loss carryforwards		760			235			—




	Other		2			21			134

			1,029			883			879




Deferred tax liabilities:




	Depreciation on property and equipment		—			84			1,228




	Goodwill amortization		136			194			252

			893			605			1,480




Valuation allowance			(893	)		(605	)		—

Net deferred tax assets (liabilities)		$	—		$	—		$	(601	)

For the years ended December 28, 1997, December 27, 1998 and January 2, 2000 the valuation allowance increased (decreased) $425,000, $(288,000) and $(605,000), respectively.

F-15

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

8. Net Income (Loss) Per Share

The following table sets forth the computation of basic and diluted net income (loss) per share:


			Year Ended			Year Ended			Year Ended
			December 28,			December 27,			January 2,
			1997			1998			2000


			(In thousands, except per share amounts)




Numerator:




	Net income (loss)		$	(1,696	)	$	149		$	6,036




	Convertible redeemable preferred stock accretion			(876	)		(888	)		—

	Numerator for basic net income (loss) per share — net income (loss) available to common stockholders			(2,572	)		(739	)		6,036




	Effect of dilutive securities:




		Convertible redeemable preferred stock accretion		—			—			—

	Numerator for diluted net income (loss) per share — net income (loss) available to common stockholders after assumed conversions		$	(2,572	)	$	(739	)	$	6,036

Denominator:




	Denominator for basic net income (loss) per share — weighted-average shares			2,500			2,986			10,217




Effect of dilutive securities:




	Employee and director stock options			—			—			887




	Warrants			—			—			51

Denominator for diluted net income (loss) per share — adjusted for weighted average shares and assumed conversions				2,500			2,986			11,155

Net income (loss) per share:




	Basic		$	(1.03	)	$	(0.25	)	$	0.59

	Diluted		$	(1.03	)	$	(0.25	)	$	0.54

Warrants to purchase 62,190 shares of common stock and options to purchase 1,392,635 shares of common stock ranging from $2.40 to $27.38 per share were outstanding at January 2, 2000. The preferred stock convertible to common stock is not included in the computation of diluted net income (loss) per share for the years ended December 28, 1997 and December 27, 1998, because the conversions would be antidilutive.

9. Commitments and Contingencies

Operating Leases

The Company leases restaurant and office facilities and equipment and certain real property under operating leases having terms expiring between 2000 and 2020. The restaurant facility and real property leases primarily have renewal clauses of five to 15 years exercisable at the option of the Company with rent escalation clauses stipulating specific rent increases, some of which are based on the consumer price index. Certain of these leases require the payment of contingent rentals based on a percentage of gross revenues, as defined. Rent expense for the years ended December 28, 1997, December 27, 1998 and January 2, 2000 was approximately $2,203,000, $4,110,000 and $7,006,000, respectively. Contingent rent included in rent expense

F-16

P.F. CHANG’S CHINA BISTRO, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 1998 and January 2, 2000 — (Continued)

for the years ended December 28, 1997, December 27, 1998 and January 2, 2000 was approximately $605,000, $1,135,000 and $1,959,000, respectively.

At January 2, 2000, the Company had entered into other lease agreements for restaurant facilities currently under construction or yet to be constructed. In addition, the leases also contain provisions for additional contingent rent based upon gross sales, as defined in the leases. Future minimum lease payments under operating leases (including restaurants to be opened after January 2, 2000) are as follows (in thousands):






2000		$	7,443




2001			8,468




2002			8,250




2003			8,136




2004			8,165




Thereafter			75,489

	Total minimum lease payments	$	115,951

The Company leases a building and certain furniture and equipment from a partnership in which the Company owns an approximate six percent interest. Annual rent payments are contingent based on a percentage of gross revenues. The respective period rent expense is included in the above disclosed amounts.

10. Benefit Plan

Effective July 1, 1997, the Company adopted a 401(k) Defined Contribution Benefit Plan (the Plan), which covers substantially all employees of the Company that have completed one year of service and have attained the age of 21 years old. The Plan permits participants to contribute to the Plan, subject to Internal Revenue Code restrictions, and the plan also permits the Company to make discretionary matching contributions. During the years ended December 28, 1997, December 27, 1998 and January 2, 2000, the Company did not make any contributions to the Plan.

11. Employment Agreement

On September 2, 1998, the Company amended the employment agreement with its Founder, Mr. Fleming, to provide for Mr. Fleming’s transition from an employee of the Company to a consultant of the Company. Pursuant to the terms of the employment agreement, as amended, the Company shall retain Mr. Fleming as a consultant and shall nominate him as a director each year during the period beginning January 1, 1999 and ending December 31, 2000. Mr. Fleming will be compensated for services rendered as a consultant and reimbursed for all actual, out-of-pocket expenses incurred in providing such services to the Company. The agreement prohibits Mr. Fleming from competing with the Company in the area of Chinese and Asian food concepts during the term of the agreement and for two years after the termination thereof.

F-17


Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

PART III

Item 10. Directors and Executive Officers of the Registrant

The information required by Item 10 with respect to Directors and Executive Officers is incorporated by reference from the information under the captions “Director Nominees” and “Executive Officers,” respectively, contained in the Company’s definitive proxy statement in connection with the solicitation of proxies for the Company’s 1999 Annual Meeting of Stockholders to be held on April 26, 2000 (the “Proxy Statement”).

Item 11. Executive Compensation

The information required by this item is incorporated by reference from the information under the caption “Executive Compensation” contained in the Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management

The information required by this item is incorporated by reference from the information under the caption “Security Ownership of Certain Beneficial Owners and Management” contained in the Proxy Statement.

Item 13. Certain Relationships and Related Transactions

The information required by this item is incorporated by reference from the information under the caption “Certain Relationships and Related Transactions” contained in the Proxy Statement.

PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) Documents filed as part of this report:

1. The following Financial Statements of the Company are included in Part II, Item 8 of this Annual Report on Form 10-K:

Report of Independent Auditors;

Consolidated Balance Sheets as of December 27, 1998 and January 2, 2000;

Consolidated Statements of Operations for the years ended December 28, 1997, December 27, 1998, and January 2, 2000;

Consolidated Statements of Convertible Redeemable Preferred Stock and Common Stockholders’ Equity (Deficit) for the years ended December 28, 1997, December 27, 1998 and January 2, 2000.

Consolidated Statements of Cash Flows for the years ended December 28, 1997, December 27, 1998 and January 2, 2000.

Notes to Consolidated Financial Statements.

2. Schedule to Financial Statements:

All financial statement schedules have been omitted because they are either inapplicable or the information required is provided in the Company’s Consolidated Financial Statements and Notes thereto, included in Part II, Item 8 of this Annual Report on Form 10-K.

3. Index to Exhibits


Exhibit
Number		Description Document

	3.1*	Certificate of Incorporation of the Company.
	3.2*	By-laws.
	4.1*	Specimen Common Stock Certificate.
	4.2*	Amended and Restated Registration Rights Agreement dated May 1, 1997.
	†10.1*	Form of Indemnification Agreement for directors and executive officers.
	†10.2*	1998 Stock Option Plan and forms of agreement thereunder.
	†10.3*	1997 Restaurant Manager Stock Option Plan and forms of Agreement thereunder.
	†10.4*	1996 Stock Option Plan and forms of Agreement thereunder.
	†10.5*	1998 Employee Stock Purchase Plan.
	†10.6*	Employment Agreement between Paul M. Fleming and the Company dated January 1, 1996, as amended September 2, 1998.
	10.8*	Series B Preferred Stock Purchase Agreement dated May, 1, 1997.
	10.9*	Amended and Restated Revolving Line of Credit Loan Agreement between the Company and FFCA dated November 20, 1998.
	10.10*	Office Lease Between the Company and U.S. West Business Resources, Inc., dated February 15, 1997.
	10.11	Office Lease Between the Company and PHXAZ-Kierland Commons, LLC, dated September 17, 1999.
	10.12	Line of Credit Agreement between the Company and Bank of America dated December 6, 1999.
	†10.13	1999 Nonstatutory Stock Option Plan.
	21.1*	List of Subsidiaries.
	23.1	Consent of Independent Auditors.
	27.1	Financial Data Schedule.


*	Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (File No. 333-59749).

† Management Contract or Compensatory Plan

(b) Reports on Form 8-K:

None.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on March 3, 2000.

P.F. CHANG’S CHINA BISTRO, INC.

By: /s/ RICHARD FEDERICO

Richard Federico

Chief Executive Officer

Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ RICHARD L. FEDERICO Richard L. Federico	Chief Executive Officer, President and Director (Principal Executive Officer)	March 3, 2000

/s/ ROBERT T. VIVIAN Robert T. Vivian	Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)	March 3, 2000

/s/ PAUL M. FLEMING Paul M. Fleming	Director	March 3, 2000

/s/ J. MICHAEL CHU J. Michael Chu	Director	March 3, 2000

/s/ GERALD R. GALLAGHER Gerald R. Gallagher	Director	March 3, 2000

/s/ R. MICHAEL WELBORN R. Michael Welborn	Director	March 3, 2000

/s/ JAMES G. SHENNAN, JR. James G. Shennan, Jr.	Director	March 3, 2000

/s/ LANE CARDWELL Lane Cardwell	Director	March 3, 2000


[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE



	Common Stockholders’ and Members’ Equity (Deficit)


	Common Stock				Additional		Retained
					Paid-In		Earnings
	Shares		Amount		Capital		(Deficit)			Total


	(In thousands)




Balances, December 29, 1996		2,500	$	3	$	2	$	(1,879	)	$	(1,874	)




Issuance of Series B preferred stock, net of issuance costs of $184,000		—		—		—		—			—




Redeemable preferred stock accretion		—		—		—		(876	)		(876	)




Net loss		—		—		—		(1,696	)		(1,696	)

Balances, December 28, 1997		2,500		3		2		(4,451	)		(4,446	)




Series A preferred stock dividend paid		—		—		—		—			—




Redeemable preferred stock accretion		—		—		—		(888	)		(888	)




Conversion of preferred stock to common stock		3,600		3		18,693		—			18,696




Conversion of deferred purchase price liability to common stock		170		—		2,043		—			2,043




Issuance of common stock, net of issuance costs of $4,394,900		3,923		4		42,671		—			42,675




Net income		—		—		—		149			149

Balances, December 27, 1998		10,193		10		63,409		(5,190	)		58,229




Issuance of common stock under stock option plan		37		—		266		—			266




Issuance of common stock under employee stock purchase plan		25		—		259		—			259




Net income		—		—		—		6,036			6,036

Balances, January 2, 2000		10,255	$	10	$	63,934	$	846		$	64,790


	Report of Independent Auditors;

	Consolidated Balance Sheets as of December 27, 1998 and January 2, 2000;

	Consolidated Statements of Operations for the years ended December 28, 1997, December 27, 1998, and January 2, 2000;

	Consolidated Statements of Convertible Redeemable Preferred Stock and Common Stockholders’ Equity (Deficit) for the years ended December 28, 1997, December 27, 1998 and January 2, 2000.

	Consolidated Statements of Cash Flows for the years ended December 28, 1997, December 27, 1998 and January 2, 2000.

	Notes to Consolidated Financial Statements.