-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PtpRNcBEvG7G9nnuCc4sEl/bpiDdRKt7pkAq3DGVX8oWQ/+Uhbo7Y8TpwcmMb2J+ 4+N9iVzIZXuUp+URfsJu+A== 0000950153-98-001033.txt : 19980904 0000950153-98-001033.hdr.sgml : 19980904 ACCESSION NUMBER: 0000950153-98-001033 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 19980903 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: P F CHANGS CHINA BISTRO INC CENTRAL INDEX KEY: 0001039889 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-59749 FILM NUMBER: 98703880 BUSINESS ADDRESS: STREET 1: 5090 N 40TH ST STE 160 CITY: PHOENIX STATE: AZ ZIP: 85018 MAIL ADDRESS: STREET 1: 5090 N. 40TH ST STREET 2: SUITE 160 CITY: PHOENIX STATE: AZ ZIP: 85018 S-1/A 1 S-1/A 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 3, 1998 REGISTRATION NO. 333-59749 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ P.F. CHANG'S CHINA BISTRO, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------------ DELAWARE 5812 86-0815086 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
5090 NORTH 40TH STREET, SUITE 160 PHOENIX, AZ 85018 (602) 957-8986 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ------------------------ ROBERT T. VIVIAN CHIEF FINANCIAL OFFICER P.F. CHANG'S CHINA BISTRO, INC. 5090 NORTH 40TH STREET, SUITE 160 PHOENIX, AZ 85018 (602) 957-8986 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: CAMERON JAY RAINS, ESQ. CECIL SCHENKER, P.C. SCOTT M. STANTON, ESQ. J. PATRICK RYAN, ESQ. CHRISTIAN WAAGE, ESQ. AKIN, GUMP, STRAUSS, HAUER & FELD, L.L.P. GRAY CARY WARE & FREIDENRICH LLP 300 CONVENT STREET, SUITE 1500 4365 EXECUTIVE DRIVE, SUITE 1600 SAN ANTONIO, TX 78205 SAN DIEGO, CA 92121 (210) 281-7000 (619) 677-1400
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED SEPTEMBER 3, 1998 PROSPECTUS , 1998 SHARES [P.F. CHANG'S LOGO] P.F. CHANG'S CHINA BISTRO, INC. COMMON STOCK Of the shares of common stock offered hereby (the "Common Stock"), shares are being offered by P.F. Chang's China Bistro, Inc. ("P.F. Chang's" or the "Company") and shares are being offered by the Selling Stockholders. See "Principal and Selling Stockholders." The Company will not receive any of the proceeds from the sale of the shares by the Selling Stockholders. Prior to this offering, there has been no public market for the Common Stock. It is currently estimated that the initial public offering price will be between $ and $ per share. See "Underwriting" for information relating to the factors to be considered in determining the initial public offering price. Application has been made for the Common Stock to be approved for quotation on the Nasdaq National Market under the symbol "PFCB." SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- ------------------------------------------------------------------------------------------------------------------------- PRICE UNDERWRITING PROCEEDS PROCEEDS TO TO THE DISCOUNTS AND TO THE THE SELLING PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDERS - ------------------------------------------------------------------------------------------------------------------------- Per Share............................ $ $ $ $ Total(3)............................. $ $ $ $ - -------------------------------------------------------------------------------------------------------------------------
(1) The Company and Selling Stockholders have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (2) Before deducting expenses payable by the Company estimated at $650,000. (3) The Company and the Selling Stockholders have granted to the Underwriters an option, exercisable within 30 days after the date hereof to purchase up to additional shares of Common Stock on the same terms and conditions set forth above solely to cover over-allotments, if any. If such option is exercised in full, the total Price to the Public, Underwriting Discounts and Commissions, Proceeds to the Company and Proceeds to the Selling Stockholders will be $ , $ , $ and $ , respectively. See "Underwriting." The shares of Common Stock are offered by the several Underwriters subject to prior sale, when, as and if delivered to and accepted by the Underwriters and subject to certain prior conditions including the right of the Underwriters to reject any order in whole or in part. It is expected that delivery of the certificates representing the shares of Common Stock will be made in New York, New York on or about , 1998. DONALDSON, LUFKIN & JENRETTE NATIONSBANC MONTGOMERY SECURITIES LLC DAIN RAUSCHER WESSELS a division of Dain Rauscher Incorporated 3 The inside front cover of the prospectus contains a map of the United States which identifies the cities in which the Company has existing restaurants and restaurants scheduled to be opened in 1998. Above the map is a photograph of the exterior of the Scottsdale, Arizona restaurant. The inside cover folds out to display photographs of the interiors of other P.F. Chang's China Bistro restaurants set over the background of a mural depicting 12th century China. [INSIDE FRONT COVER] The Company has registered the servicemark "P.F. Chang's China Bistro." All other brand names and trademarks appearing in this Prospectus are the property of their respective holders. CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING AND MAY BID FOR AND PURCHASE SHARES OF COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and Consolidated Financial Statements and Notes thereto appearing elsewhere in this Prospectus. As used in this Prospectus, unless the context otherwise requires, the terms "Company" and "P.F. Chang's" include P.F. Chang's China Bistro, Inc. and all of its subsidiaries and affiliates and their respective predecessors. Except as otherwise noted, all information in this Prospectus assumes (i) no exercise of the Underwriters' over-allotment option, (ii) no exercise of options or warrants to purchase shares of Common Stock and (iii) the conversion into shares of Common Stock upon the closing of this offering of all outstanding shares of Convertible Redeemable Preferred Stock and the deferred purchase price liability representing the balance of the purchase price from the acquisition of minority interests in three of the four original restaurants (the "Deferred Purchase Price Liability"). Information in this Prospectus also gives effect to a one-for-two reverse split of the Common Stock effected in August 1998. See "Description of Capital Stock" and "Underwriting." THE COMPANY P.F. Chang's owns and operates 17 full service restaurants 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 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 average check per customer, including beverage, is approximately $17.00. 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. 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. P.F. Chang's opened three additional restaurants in 1996, six in 1997 and expects to open ten restaurants in 1998 (four of which are open) and 13 in 1999. 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 has demonstrated the viability of the P.F. Chang's concept in a wide variety of markets across the United States, including the Southwest, southern California, Texas and southern Florida. The P.F. Chang's concept was developed in 1993 by Paul Fleming, a Phoenix-based restaurateur, in collaboration with Philip Chiang, the owner of the Mandarin restaurant in Beverly Hills, California. 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. 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. ------------------ The Company was incorporated in January 1996 as a Delaware corporation in connection with the acquisition of the four original P.F. Chang's restaurants. The Company's principal executive office is located at 5090 North 40th Street, Suite 160, Phoenix, Arizona 85018. The Company's telephone number is (602) 957- 8986, and its facsimile number is (602) 957-8998. 3 5 THE OFFERING Common Stock offered by the Company........... shares Common Stock offered by the Selling Stockholders.................................. shares Common Stock to be outstanding after the offering...................................... shares(1) Use of proceeds............................... Development of new restaurants, repayment of certain indebtedness and general corporate purposes including working capital. See "Use of Proceeds." Proposed Nasdaq National Market symbol........ PFCB - ------------------------------ (1) Based on shares outstanding at June 28, 1998, which includes (i) 3,475,854 shares issuable on conversion of outstanding shares of Series A Convertible Redeemable Preferred Stock (the "Series A Preferred Stock") and outstanding shares of Series B Convertible Redeemable Preferred Stock (the "Series B Preferred Stock" and together with the Series A Preferred Stock, the "Preferred Stock"), (ii) 82,130 shares of Common Stock issuable upon conversion of paid-in-kind dividends paid to holders of Series A Preferred Stock of the Company prior to consummation of the offering and (iii) shares issuable upon consummation of this offering upon conversion of the Deferred Purchase Price Liability, assuming an initial public offering price of $ . Excludes (i) 1,009,635 shares reserved as of such date for issuance upon the exercise of outstanding stock options at a weighted average exercise price of $3.87 per share, (ii) an aggregate of 680,000 shares reserved for future grant under the Company's stock option and stock purchase plans and (iii) 62,190 shares reserved for issuance upon the exercise of outstanding warrants at an exercise price of $4.00 per share. See "Management--Benefit Plans" and "Description of Capital Stock." SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA(1) (IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
SIX MONTHS ENDED -------------------- FISCAL YEAR TOTAL YEAR FISCAL YEAR JUNE 29, JUNE 28, 1995(2) 1996(3) 1997 1997 1998 STATEMENTS OF OPERATIONS DATA: Revenues..................................... $10,465 $18,445 $39,768 $17,703 $32,937 Total restaurant operating costs............. 8,891 15,835 32,470 14,334 26,296 Income (loss) from operations................ 660 9 (2) 696 1,658 Net income (loss)............................ $ 647 $(1,145) $(1,696) $ (241) $ 847 Diluted net income (loss) per share.......... -- -- $ (1.03) $ (0.25) $ 0.13 Shares used in calculation of diluted net income (loss) per share(4)................. -- -- 2,500 2,500 6,655 PRO FORMA DATA:(5) Pro forma diluted net income (loss) per share...................................... -- $ $ $ $ Shares used in calculation of pro forma diluted net income (loss) per share........ -- OPERATING DATA: Comparable restaurant sales increase(6)...... 25.1% 13.0% 13.8% 12.6% 11.7% Average weekly restaurant sales.............. $81,122 $81,976 $90,383 $91,250 $93,839 Return on investment(7)...................... 25.2% 34.4% 34.9% -- -- Restaurants open at end of period............ 4 7 13 8 14
JUNE 28, 1998 ----------------------------------------- PRO FORMA ACTUAL PRO FORMA(8) AS ADJUSTED(9) CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents................................... $ 1,802 $ 1,802 $ Total assets................................................ 34,265 34,265 Short- and long-term debt................................... 11,600 11,600 2,600 Deferred Purchase Price Liability........................... 2,426 -- -- Convertible Redeemable Preferred Stock...................... 18,285 -- -- Common stockholders' equity (deficit)....................... (4,076) 16,635
4 6 - ------------------------------ (1) The Company's fiscal quarters typically consist of thirteen week periods ending on the Sunday closest to the last day of the calendar quarter, and its fiscal year ends on the Sunday closest to December 31 in each year. (2) Fiscal year 1995 information reflects the combined results of operations of the Predecessors. Accordingly, net income (loss) per share for fiscal year 1995 is not presented because it is not meaningful. See "Certain Transactions" and Note 1 of Notes to Consolidated Financial Statements. (3) Prior to February 29, 1996, the Company's business was conducted by four business entities controlled by Paul Fleming: Fleming Chinese Restaurants, Inc. (Scottsdale), P.F. Chang's II, Inc. (Newport Beach), P.F. Chang's III, L.L.C. (La Jolla) and P.F. Chang's IV, L.L.C. (Irvine) (collectively, the "Predecessors"). Total year 1996 information reflects the combined results of the Predecessors for the period beginning January 1, 1996 and ending February 28, 1996 and the results of the Company for the period beginning February 29, 1996 and ending December 29, 1996. Accordingly, net income (loss) per share for total year 1996 is not presented because it is not meaningful. The allocation of the purchase price in connection with the purchase of minority interests resulted in no material adjustment to the historical recorded basis in the assets and liabilities except for goodwill. Therefore, the effect to the statement of operations is primarily amortization of goodwill subsequent to the date of acquisition. See "Selected Consolidated Financial and Operating Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Certain Transactions" and Note 1 of Notes to Consolidated Financial Statements. (4) See Notes 2, 6 and 8 of Notes to Consolidated Financial Statements. (5) Pro forma information gives effect as of the beginning of each period to (i) the purchase of substantially all of the minority interests in the Predecessors, (ii) the repayment of the Company's revolving line of credit through the application of the net proceeds from the sale of a sufficient number of shares of Common Stock at the assumed initial public offering price of $ per share, and (iii) the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share. (6) A new restaurant is included in the calculation of the change in comparable restaurant sales in the eighteenth month of that restaurant's operation. (7) Return on investment for each restaurant is determined as the quotient of earnings of such restaurant before interest, taxes and rent divided by the Company's total investment in restaurant assets. The information presented in the table is the aggregate return on investment for all restaurants open during the respective periods. The computation of return on investment excludes rents, interest and taxes 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). See "Business--Unit Economics." (8) Adjusted to give effect to the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability. (9) Adjusted to give effect as of June 28, 1998 to (i) the receipt by the Company of the estimated net proceeds of $ from the sale of shares of Common Stock offered hereby by the Company at an assumed initial public offering price of $ per share, (ii) application of a portion of the net proceeds of this offering to repay the Company's revolving line of credit, and (iii) the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share. 5 7 RISK FACTORS In addition to the other information in this Prospectus, prospective investors should carefully consider the following risk factors in evaluating an investment in the Company before purchasing any shares of Common Stock offered hereby. This Prospectus 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, including the proceeds from this offering, 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. Prospective investors are cautioned that actual events or 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 below and elsewhere in this Prospectus. HISTORY OF NET LOSSES Although the Company has achieved positive cash flow from its restaurant operations since inception, the significant investment of resources in acquiring and opening its restaurants resulted in the Company incurring net losses in each fiscal period from inception through December 28, 1997. As of June 28, 1998, the Company had an accumulated deficit of approximately $4.1 million. Although the Company achieved net income in the first two quarters of fiscal 1998, there can be no assurance that the Company will be able to sustain profitable operations in the future. See "Management's Discussion and Analysis of Financial Condition and Results of Operation." UNCERTAINTIES ASSOCIATED WITH EXPANDING OPERATIONS Because the Company currently operates only 17 restaurants, several 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 those restaurants' long-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 17 restaurants as of August 1998. The Company expects to open a total of ten restaurants during 1998 (four of which are open) and an additional 13 in 1999. 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 6 8 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. 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, and Robert Vivian, the Company's Chief Financial 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 chefs, 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. See "Business--Operations" and "Management." 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. See "Business--Competition." 7 9 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." 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 the 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. 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. GOVERNMENTAL REGULATION; MINIMUM WAGE The Company's operations are subject to regulation by federal agencies and to licensing and regulation by state and local health, environmental, labor relations, sanitation, building, zoning, safety, fire and other departments relating to the development and operation of restaurants and retail establishments. The Company's activities are also subject to the federal Americans With Disabilities Act and related regulations, which prohibit discrimination on the basis of disability in public accommodations and employment. The Company is also 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. Given the location of many of the Company's restaurants, even if the Company's operation of those restaurants is in strict compliance with the requirements of the Immigration and 8 10 Naturalization Service (the "INS"), the Company's employees may not all meet federal citizenship or residency requirements, which could lead to disruptions in its work force. Changes in any or all of these laws or regulations, such as government-imposed paid leaves of absence or mandated health benefits, or increased tax reporting and tax payment requirements for employees who receive gratuities, could have a material adverse effect on the Company's business, financial condition and results of operations. Delays or failures in obtaining or maintaining required construction and operating licenses, permits or approvals could delay or prevent the opening of new restaurants or could materially and adversely affect the operation of existing restaurants. In addition, there can be no assurance that the Company will be able to obtain necessary variances or amendments to required licenses, permits or other approvals on a cost-effective and timely basis in order to construct and develop restaurants in the future. See "Business--Governmental Regulation." A number of the Company's employees are subject to various minimum wage requirements. Many of the Company's employees work in restaurants located in California and receive salaries equal to the California minimum wage. The minimum wage in California 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. In addition, the federal minimum wage increased to $5.15 per hour effective September 1, 1997. There can be no assurance that the Company will be able to pass additional increases in labor costs through to its guests in the form of menu price adjustments and, accordingly, such minimum wage increases could have a material adverse effect on 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. CONTROL BY EXISTING STOCKHOLDERS AND MANAGEMENT Following the closing of this offering, the Company's directors, officers and their affiliates will beneficially own approximately % of the outstanding Common Stock. As a result of such Common Stock ownership, the Company's directors, officers and their affiliates, if they voted together, would be able to elect all members of the Company's Board of Directors and control corporate actions requiring stockholder approval. See "Principal and Selling Stockholders." CERTAIN ANTI-TAKEOVER MEASURES The Company's Amended and Restated Certificate of Incorporation (the "Charter") authorizes the Board of Directors 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 those shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The Charter and By-laws, among other things, require that stockholder actions occur at duly called meetings of the stockholders, limit who may call special meetings of stockholders, do not permit cumulative voting in the election of directors and require advance notice of stockholder proposals and director nominations. Also, Section 203 of the Delaware General Corporation Law (the "DGCL") restricts certain business combinations with any "interested stockholder" as defined by such statute. These and other provisions could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company, discourage a hostile bid or delay, prevent or deter a merger, acquisition or tender offer in which the Company's stockholders could receive a premium for their shares, or a proxy contest for control of the Company or other change in the Company's management. See "Management" and "Description of Capital Stock." 9 11 ABSENCE OF PRIOR TRADING MARKET; POTENTIAL VOLATILITY OF STOCK PRICE Prior to this offering, there has been no public market for the Common Stock. There can be no assurance that an active trading market will develop or, if one develops, that it will be maintained. The initial public offering price of the Common Stock will be established by negotiation among the Company, the Selling Stockholders and the Underwriters. See "Underwriting" for a discussion of factors to be considered in determining the initial public offering price. The market price of the Common Stock could be subject to significant fluctuations in response to the Company's operating results and other factors, including general economic and market conditions. In addition, the stock market in recent periods has experienced and continues to experience significant price and volume fluctuations, which have affected the market price of the stock of many companies and which have often been unrelated or disproportionate to the operating performance of these companies. These fluctuations, as well as a shortfall in sales or earnings compared to securities analysts' expectations, changes in analysts' recommendations or projections or general economic and market conditions, may adversely affect the market price of the Common Stock. In the past, securities class action litigation has often been instituted following periods of volatility in the market price for a company's securities. Such litigation could result in substantial costs and a diversion of management attention and resources, which could have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. ADDITIONAL SHARES ELIGIBLE FOR FUTURE SALE IN THE PUBLIC MARKET The sale of a substantial number of shares of Common Stock in the public market following this offering could adversely affect the market price of the Common Stock. Upon the closing of this offering, the Company will have outstanding an aggregate of shares of Common Stock (including shares issuable upon conversion of the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share), assuming no exercise of outstanding options, warrants or the Underwriters' over-allotment option. The shares of Common Stock sold in this offering (and any shares sold upon exercise of the Underwriters' over-allotment option) will be freely tradable without restriction under the Securities Act of 1933, as amended (the "Securities Act"). The remaining shares of Common Stock are "restricted shares" within the meaning of Rule 144 promulgated under the Securities Act and are subject to restrictions under the Securities Act. Of these restricted shares, are subject to lock-up agreements under which the holders have agreed not to sell or otherwise dispose of any of their shares for a period of 180 days after the date of this Prospectus without the prior written consent of Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"). In its sole discretion and at any time without notice, DLJ may release all or any portion of the shares subject to the lock-up agreements. All of the restricted shares subject to lock-up agreements will become available for sale in the public market immediately following expiration of the 180-day lock-up period, subject (to the extent applicable) to the volume and other limitations of Rule 144 or Rule 701 promulgated under the Securities Act. In addition, beginning 90 days after the date of this Prospectus, restricted shares not subject to lock-up agreements or contractual restrictions will become available for sale in the public market, subject to the volume and other limitations of Rule 144 or Rule 701. In addition, after expiration of the lock-up period, certain securityholders of the Company have the contractual right to require the Company to register certain of their shares of Common Stock for future sale. The Company is unable to predict the effect that future sales made pursuant to any such registration rights, under Rule 144 or otherwise, may have on the prevailing market price of the Common Stock. See "Description of Capital Stock--Registration Rights" and "Shares Eligible for Future Sale." DILUTION The price to the public in this offering is substantially higher than the net tangible book value per share of Common Stock. Investors purchasing shares of Common Stock in this offering will therefore incur immediate and substantial dilution of $ per share (assuming an initial public offering price of $ per share). See "Dilution." 10 12 USE OF PROCEEDS The net proceeds to the Company from the sale of the shares of Common Stock being offered by the Company hereby are estimated to be approximately $ ($ if the Underwriters' over-allotment option is exercised in full), assuming an initial public offering price of $ per share and after deducting estimated underwriting discounts and commissions and other estimated offering expenses. The Company intends to use approximately $18.0 million of the net proceeds to repay certain indebtedness incurred for the development of restaurants. As a result of this offering, the Company's commercial lender has the right to require the Company to repay all amounts outstanding under its revolving line of credit ($9.0 million at June 28, 1998), which bears interest at LIBOR plus 3.5% (9.16% at June 28, 1998) and expires July 1, 1999. In addition, the Company intends to use approximately $6.0 million of the net proceeds for the development of new restaurants in the remainder of 1998 and the balance of the net proceeds for development of new restaurants thereafter and for general corporate purposes. The Company expects that its planned future restaurants will require, on average, a total cash investment per restaurant, exclusive of landlord contributions, of approximately $1.5 million to $2.0 million. Preopening expenses are expected to average approximately $250,000 per restaurant. Pending such uses, the Company intends to invest the net proceeds in short-term, investment-grade, interest-bearing securities. DIVIDEND POLICY The Company has not declared or paid any cash dividends on its Common Stock in the past and does not anticipate paying dividends in the foreseeable future. In addition, the Company's current credit agreements prohibit the payment of cash dividends. The Company currently intends to retain its earnings for the operation and development of its business. Any future payment of dividends is within the discretion of the Company's Board of Directors and will depend, among other factors, upon the capital requirements, operating results and financial condition of the Company from time to time and restrictions under credit agreements existing from time to time. 11 13 CAPITALIZATION The following table sets forth the consolidated cash and cash equivalents, short-term debt and capitalization of the Company as of June 28, 1998: (i) on an actual basis; (ii) on a pro forma basis to reflect the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share; and (iii) on a pro forma as adjusted basis to reflect the sale of the shares of Common Stock offered by the Company hereby, the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share, and the application of the estimated net proceeds from the offering. This table should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere in this Prospectus. See "Use of Proceeds."
JUNE 28, 1998 ----------------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED(1) (IN THOUSANDS) Cash and cash equivalents.............................. $ 1,802 $ 1,802 $ ======= ======= ======= Revolving line of credit and current portion of long-term debt....................................... $ 9,441 $ 9,441 $ 441 ======= ======= ======= Deferred Purchase Price Liability(2)................... $ 2,426 $ -- $ -- Long-term debt, less current portion................... 2,159 2,159 2,159 Convertible Redeemable Preferred Stock: $0.001 par value; 10,000,000 shares authorized; 6,951,708 shares issued and outstanding, actual; no shares issued and outstanding, pro forma and pro forma as adjusted..... 18,285 -- -- Common stockholders' equity (deficit): Common stock: $0.001 par value; 20,000,000 shares authorized; 2,500,000 shares issued and outstanding, actual; shares issued and outstanding, pro forma; shares issued and outstanding, pro forma as adjusted(3)............. 3 6 Additional paid-in capital........................ 2 20,710 Accumulated deficit............................... (4,081) (4,081) (4,081) ------- ------- ------- Total common stockholders' equity (deficit)..... (4,076) 16,635 ------- ------- ------- Total capitalization............................ $18,794 $18,794 $ ======= ======= =======
- ------------------------------ (1) Adjusted to give effect as of June 28, 1998 to (i) the receipt by the Company of the estimated net proceeds of $ from the sale of shares of Common Stock offered hereby by the Company, assuming an initial public offering price of $ per share, (ii) application of a portion of the net proceeds of this offering to repay the Company's revolving line of credit and (iii) the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share. (2) See Note 1 of Notes to Consolidated Financial Statements. (3) Based on shares outstanding at June 28, 1998, which includes (i) 3,475,854 shares issuable on conversion of outstanding Preferred Stock, (ii) 82,130 shares of Common Stock issuable upon conversion of paid-in-kind dividends paid to holders of Series A Preferred Stock of the Company prior to consummation of the offering and (iii) shares issuable upon consummation of this offering upon conversion of the Deferred Purchase Price Liability, assuming an initial public offering price of $ . Excludes (i) 1,009,635 shares reserved as of such date for issuance upon the exercise of outstanding stock options at a weighted average price of $3.87 per share, (ii) an aggregate of 680,000 shares reserved for future grant under the Company's stock option and stock purchase plans and (iii) 62,190 shares reserved for issuance upon the exercise of outstanding warrants at an exercise price of $4.00 per share. See "Management -- Benefit Plans" and "Description of Capital Stock." 12 14 DILUTION At June 28, 1998, the Company had a net tangible book value of $8.5 million, or $ per share of Common Stock. "Net tangible book value" per share represents the amount of total tangible assets of the Company reduced by the amount of its total liabilities and divided by the total number of outstanding shares of Common Stock, giving effect to the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share. The pro forma net tangible book value of the Company as of June 28, 1998, giving effect to the sale by the Company of the shares offered hereby, assuming an initial public offering price of $ per share, would have been approximately $ , or $ per share. This represents an immediate increase in net tangible book value of $ per share to existing stockholders and an immediate dilution in net tangible book value of $ per share to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per share............. $ ------ Net tangible book value per share before the offering..... $ ------ Increase attributable to new investors.................... ------ Pro forma net tangible book value per share after the offering.................................................. ------ Dilution per share to new investors......................... $ ======
The following table summarizes, on a pro forma basis as of June 28, 1998, the differences between the existing stockholders (including persons who will receive Common Stock upon conversion of the Deferred Purchase Price Liability) and the new investors with respect to the number of shares of Common Stock purchased from the Company, the total consideration paid to the Company and the average price per share paid by existing stockholders and new investors:
SHARES PURCHASED TOTAL CONSIDERATION ------------------- ------------------------- AVERAGE NUMBER PERCENT AMOUNT PERCENT PRICE (IN THOUSANDS) PER SHARE Existing stockholders(1)....... % $ % $ New investors(1)............... -------- ----- ---- ----- Total................ 100.0% $ 100.0% ======== ===== ==== =====
- ------------------------------ (1) Sales by Selling Stockholders in this offering will reduce the number of shares held by existing stockholders to , or % of the total number of shares of Common Stock outstanding, and will increase the number of shares held by new investors to , or % of the total number of shares of Common Stock outstanding after the offering. 13 15 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA) The selected statements of operations data set forth below for the fiscal year ended December 31, 1995, the period from January 1, 1996 to February 28, 1996, the period from February 29, 1996 to December 29, 1996 and the fiscal year ended December 28, 1997 and the consolidated balance sheet data set forth below as of December 29, 1996 and December 28, 1997 have been derived from the financial statements of the Company and the Predecessors audited by Ernst & Young LLP, independent auditors, which are included elsewhere in this Prospectus. The selected combined statements of operations data for the fiscal years ended December 31, 1993 and December 31, 1994 and the combined balance sheet data set forth below as of December 31, 1993, December 31, 1994 and December 31, 1995 are derived from the unaudited combined financial statements of the Predecessors. The selected consolidated financial data as of June 28, 1998 and for the six months ended June 28, 1998 and June 29, 1997 has been derived from the unaudited consolidated financial statements of the Company included elsewhere in this Prospectus. In the opinion of management, all adjustments, consisting of only normal recurring accruals, considered necessary for a fair presentation have been made. The results of operations for the six months ended June 28, 1998 are not necessarily indicative of the results to be expected for the entire fiscal year. The following table is qualified by reference to and should be read in conjunction with the consolidated financial statements, related notes thereto and other financial data included elsewhere herein. The Company's fiscal quarters typically consist of thirteen week periods ending on the Sunday closest to the last day of the calendar quarter, and its fiscal year ends on the Sunday closest to December 31 in each year.
PREDECESSORS(1) COMPANY ------------------------------------- ---------------------------------------------------- PERIOD PERIOD SIX MONTHS ENDED FISCAL FISCAL FISCAL FROM FROM TOTAL FISCAL ------------------- YEAR YEAR YEAR 1/1/96 TO 2/29/96 TO YEAR YEAR JUNE 29, JUNE 28, 1993 1994 1995 2/28/96 12/29/96 1996(2) 1997 1997 1998 STATEMENTS OF OPERATIONS DATA: Revenues........................ $1,478 $5,348 $10,465 $2,815 $15,630 $18,445 $39,768 $17,703 $32,937 Costs and expenses: Restaurant operating costs: Cost of sales............. 368 1,422 2,957 772 4,454 5,226 11,317 5,029 9,099 Labor..................... 516 1,728 3,347 918 4,736 5,654 11,683 5,228 9,400 Operating................. 243 917 1,528 527 2,944 3,471 6,727 2,871 5,440 Occupancy................. 134 454 1,059 205 1,279 1,484 2,743 1,206 2,357 ------ ------ ------- ------ ------- ------- ------- ------- ------- Total restaurant operating costs...... 1,261 4,521 8,891 2,422 13,413 15,835 32,470 14,334 26,296 General and administrative............ 7 57 192 17 1,368 1,385 4,276 1,823 2,753 Depreciation and amortization.............. 26 70 322 82 352 434 1,102 451 1,013 Preopening.................. 204 249 400 17 765 782 1,922 399 1,217 ------ ------ ------- ------ ------- ------- ------- ------- ------- Income (loss) from operations... (20) 451 660 277 (268) 9 (2) 696 1,658 Interest income (expense), net........................... (1) (10) (13) (4) (127) (131) (317) (127) (455) ------ ------ ------- ------ ------- ------- ------- ------- ------- Income (loss) before elimination of minority interests and provision for income taxes.... (21) 441 647 273 (395) (122) (319) 569 1,203 Elimination of minority interests..................... -- -- -- -- (720) (993) (1,308) (758) (345) ------ ------ ------- ------ ------- ------- ------- ------- ------- Income (loss) before provision for income taxes.............. (21) 441 647 273 (1,115) (1,115) (1,627) (189) 858 Provision for income taxes...... -- -- -- -- (30) (30) (69) (52) (11) ------ ------ ------- ------ ------- ------- ------- ------- ------- Net income (loss)............... $ (21) $ 441 $ 647 $ 273 (1,145) (1,145) (1,696) (241) 847 ====== ====== ======= ====== Convertible Redeemable Preferred Stock accretion....................... (504) (504) (876) (396) (477) ------- ------- ------- ------- ------- Net income (loss) available to common stockholders..................... $(1,649) $(1,649) $(2,572) $ (637) $ 370 ======= ======= ======= ======= ======= Basic net income (loss) per share...................................... $ (0.66) $ (1.03) $ (0.25) $ 0.15 ======= ======= ======= ======= Diluted net income (loss) per share.................................... $ (0.66) $ (1.03) $ (0.25) $ 0.13 ======= ======= ======= ======= Shares used in calculation of basic net income (loss) per share(3)..... 2,500 2,500 2,500 2,500 ======= ======= ======= ======= Shares used in calculation of diluted net income (loss) per share(3)... 2,500 2,500 2,500 6,655 ======= ======= ======= =======
14 16
SIX MONTHS ENDED ------------------- FISCAL YEAR TOTAL YEAR FISCAL YEAR JUNE 29, JUNE 28, 1995(1) 1996(2) 1997 1997 1998 PRO FORMA DATA:(4) Pro forma diluted net income (loss) per share............... -- $ $ $ $ Shares used in calculation of pro forma diluted net income (loss) per share.......................................... -- OPERATING DATA: Comparable restaurant sales increase(5)..................... 25.1% 13.0% 13.8% 12.6% 11.7% Average weekly restaurant sales............................. $81,122 $81,976 $90,383 $91,250 $93,839 Return on investment(6)..................................... 25.2% 34.4% 34.9% -- -- Restaurants open at end of period........................... 4 7 13 8 14
PREDECESSORS COMPANY ------------------------------------------ -------------------------------------- AS OF AS OF ------------------------------------------ -------------------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 29, DECEMBER 28, JUNE 28, 1993 1994 1995 1996 1997 1998 BALANCE SHEET DATA: Cash and cash equivalents............. $153 $ 347 $ 480 $ 1,877 $ 2,739 $ 1,802 Total assets.......................... 716 1,692 2,997 13,044 28,489 34,265 Short- and long-term debt............. 33 222 350 1,763 8,372 11,600 Deferred Purchase Price Liability..... -- -- -- -- 2,426 2,426 Convertible Redeemable Preferred Stock............................... -- -- -- 10,517 17,808 18,285 Common stockholders' and members' equity (deficit).................... 500 1,217 1,295 (1,874) (4,446) (4,076)
- ------------------------------ (1) Information for fiscal years 1993, 1994 and 1995 and the period beginning January 1, 1996 and ending February 28, 1996 as well as information as of December 31, 1993, December 31, 1994 and December 31, 1995 relate to the Predecessors. See "Certain Transactions" and Note 1 of Notes to Consolidated Financial Statements. (2) Total year 1996 information reflects the combined results of the Predecessors for the period beginning January 1, 1996 and ending February 28, 1996 and of the Company for the period beginning February 29, 1996 and ending December 29, 1996. See "Certain Transactions" and Note 1 of Notes to Consolidated Financial Statements. (3) See Notes 2, 6 and 8 of Notes to Consolidated Financial Statements. (4) Pro forma information gives effect as of the beginning of each period to (i) the purchase of substantially all of the minority interests in the Predecessors, (ii) the repayment of the Company's revolving line of credit through the application of the net proceeds from the sale of a sufficient number of shares of Common Stock, assuming an initial public offering price of $ per share and (iii) the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability, assuming an initial public offering price of $ per share. (5) A new restaurant is included in the calculation of the change in comparable restaurant sales in the eighteenth month of that restaurant's operation. (6) Return on investment for each restaurant is determined as the quotient of earnings of such restaurant before interest, taxes and rent divided by the Company's total investment in restaurant assets. The information presented in the table is the aggregate return on investment for all restaurants open during the respective periods. The computation of return on investment excludes rents, interest and taxes 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). See "Business--Unit Economics." 15 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW P.F. Chang's owns and operates 17 full service restaurants 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 and six in 1997. The Company intends to open ten new restaurants in 1998 (four of which are open and six of which are under development) and 13 restaurants in 1999. The 23 units that the Company intends to develop in 1998 and 1999 will be situated in approximately 15 new cities across the United States. The Company has signed lease agreements for six of the 13 units planned for 1999 and has signed letters of intent for all of the remaining planned restaurants. 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 between $1.5 million and $2.0 million and a total capitalized investment of between $2.5 million and $3.0 million per restaurant. This total 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." Prior to February 29, 1996, the Company's business was conducted by four business entities controlled by Paul Fleming: Fleming Chinese Restaurants, Inc. (Scottsdale), P.F. Chang's II, Inc. (Newport Beach), P.F. Chang's III, L.L.C. (La Jolla) and P.F. Chang's IV, L.L.C. (Irvine)(collectively, the "Predecessors"). In February 1996, the Company acquired from Paul Fleming and certain other investors in the Predecessors approximately 70% of the Scottsdale restaurant, 43% of the Newport Beach restaurant, 50% of the La Jolla restaurant and 54% of the Irvine restaurant. In May 1996, the Company acquired the remaining minority interests in the Irvine restaurant, and in October 1997, the Company acquired all of the outstanding minority interests in the Scottsdale and Newport Beach restaurants and all but 2.5% of the La Jolla restaurant. As a result of the ownership structure in place from February 29, 1996 to October 1997, historical financial results for that period reflect an increase in the Company's net loss attributable to those ownership interests which is reflected in the elimination of minority interests. The acquisitions of minority interests in February 1996 and October 1997 were accounted for using the purchase method of accounting and resulted in goodwill of $4.1 million and $4.6 million, respectively, which is being amortized over 20 years on a straight-line basis. See "Certain Transactions." In addition, 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 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." 16 18 RESULTS OF OPERATIONS The operating results of the Company for fiscal years 1995, 1996 and 1997 and for the six months ended June 29, 1997 and June 28, 1998 expressed as a percentage of revenues were as follows:
SIX MONTHS ENDED -------------------- FISCAL YEAR TOTAL YEAR FISCAL YEAR JUNE 29, JUNE 28, 1995 1996(1) 1997 1997 1998 STATEMENTS OF OPERATIONS DATA: Revenues............................... 100.0% 100.0% 100.0% 100.0% 100.0% Costs and expenses: Restaurant operating costs: Cost of sales................... 28.3 28.3 28.4 28.4 27.6 Labor........................... 32.0 30.7 29.4 29.5 28.5 Operating....................... 14.6 18.8 16.9 16.2 16.5 Occupancy....................... 10.1 8.0 6.9 6.8 7.2 ----- ----- ----- ----- ----- Total restaurant operating costs...................... 85.0 85.8 81.6 80.9 79.8 General and administrative........ 1.8 7.5 10.8 10.3 8.4 Depreciation and amortization..... 3.1 2.4 2.8 2.6 3.1 Preopening........................ 3.8 4.3 4.8 2.3 3.7 ----- ----- ----- ----- ----- Income (loss) from operations.......... 6.3 -- -- 3.9 5.0 Interest income (expense), net......... (0.1) (0.7) (0.8) (0.7) (1.4) Elimination of minority interests...... -- (5.3) (3.3) (4.3) (1.0) ----- ----- ----- ----- ----- Income (loss) before provision for income taxes......................... 6.2 (6.0) (4.1) (1.1) 2.6 Provision for income taxes............. -- (0.2) (0.2) (0.3) -- ----- ----- ----- ----- ----- Net income (loss)...................... 6.2% (6.2)% (4.3)% (1.4)% 2.6% ===== ===== ===== ===== =====
- ------------------------------ (1) Total fiscal year 1996 information reflects the combined results of the Predecessors and the Company. See "Selected Consolidated Financial and Operating Data." SIX MONTHS ENDED JUNE 28, 1998 COMPARED TO SIX MONTHS ENDED JUNE 29, 1997 REVENUES The Company's revenues are derived entirely from food and beverage sales. Revenues increased by $15.2 million, or 86.1%, to $32.9 million in the six months ended June 28, 1998 from $17.7 million in the six months ended June 29, 1997. The increase was primarily attributable to revenues of $12.2 million generated by new restaurants opened in the second half of 1997 and the first half of 1998. Increased customer visits produced comparable restaurant sales gains of 11.7% in the first half of 1998. The Company did not implement any meaningful price increases in the first six months of 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 27.6% in the six months ended June 28, 1998 from 28.4% in the six months ended June 29, 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 28.5% in the six months ended June 28, 1998 from 29.5% in the six months ended June 29, 1997. The decrease in labor expenses was primarily due to improvements in the management of hourly staff levels in the restaurants that opened in 1996. 17 19 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 remainder of 1998 and 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 16.5% in the six months ended June 28, 1998 from 16.2% in the six months ended June 29, 1997. Occupancy. Occupancy costs include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes. Occupancy costs increased as a percentage of revenues to 7.2% in the six months ended June 28, 1998 from 6.8% in the six months ended June 29, 1997, due primarily to an increase in property taxes. 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 $2.8 million (8.4% of revenues) in the six months ended June 28, 1998 from $1.8 million (10.3% of revenues) in the six months ended June 29, 1997, due primarily to the addition of corporate management personnel which resulted in approximately $550,000 of additional compensation and benefits expense as well as additional costs to support a larger restaurant base including an additional $200,000 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 $1.0 million in the six months ended June 28, 1998 from $451,000 in the six months ended June 29, 1997. This increase was primarily due to depreciation on new restaurants totaling $400,000 as well as an additional $115,000 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. 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, advertising and employee payroll and related training costs. Preopening expenses in the six months ended June 28, 1998 increased to $1.2 million from $399,000 in the six months ended June 29, 1997 due to the greater number of restaurants opened or under development during the 1998 period. Interest income (expense), net. Net interest expense increased to $455,000 in the six months ended June 28, 1998 from $127,000 in the six months ended June 29, 1997 principally due to borrowings under the Company's line of credit. ELIMINATION OF MINORITY INTERESTS Elimination of minority interests for the six months ended June 29, 1997 includes approximately $717,000 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 six months ended June 28, 1998 declined to $345,000. Approximately $41,000 and $332,000 was attributable to the collective minority interests of Market Partners, Operating Partners and Culinary Partners in the six months ended June 29, 1997 and June 28, 1998, respectively. 18 20 PROVISION FOR INCOME TAXES The provision for income taxes for the six months ended June 28, 1998 and June 29, 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 six months ended June 29, 1997 as utilization of such losses in future periods was deemed uncertain. The income tax provision for the six months ended June 28, 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 asset valuation allowance. YEAR ENDED DECEMBER 28, 1997 COMPARED TO YEAR ENDED DECEMBER 29, 1996 The following discussion of the Company's results of operations for the year ended December 29, 1996 relates to the combined operating results of the Company and the Predecessors. The Company has not presented separate analyses regarding the two month period ended February 28, 1996 relating to the Predecessors or the ten month period ended December 29, 1996 relating to the Company because the Company believes that such discussion would not be meaningful. REVENUES Revenues increased by $21.3 million, or 115.6%, to $39.8 million in 1997 from $18.4 million in 1996. The increase was primarily attributable to $19.0 million of additional revenues generated by new restaurants opened in 1997 and the increase in revenues in 1997 for restaurants opened in 1996. Comparable restaurant sales, driven by increased customer visits, increased 13.8% in 1997. The Company did not implement any meaningful price increases in 1997. COSTS AND EXPENSES Cost of sales. Cost of sales increased nominally as a percentage of revenues to 28.4% in 1997 from 28.3% in 1996. Labor. Labor costs decreased as a percentage of revenues to 29.4% in 1997 from 30.7% in 1996. This decrease was primarily the result of improvements in the management of hourly staff levels in new and existing restaurants. Operating. Operating expenses decreased as a percentage of revenues to 16.9% in 1997 from 18.8% in 1996, due primarily to the maturation of restaurants opened in 1996 (which resulted in lower operating expenses as a percentage of sales for those restaurants) and the larger and more mature restaurant base that existed in 1997, which mitigated the impact of higher operating expenses associated with restaurants opened in 1997. Occupancy. Occupancy costs decreased as a percentage of revenues to 6.9% in 1997 from 8.0% in 1996. This decrease was primarily the result of the increase in revenues and, to a lesser extent, more favorable lease terms associated with the new restaurants opened in 1997. General and administrative. General and administrative expenses increased to $4.3 million (10.8% of revenues) in 1997, from $1.4 million (7.5% of revenues) in 1996. This increase was primarily the result of the addition of corporate management personnel in 1996 and 1997, resulting in $1.7 million of additional compensation and benefits in 1997 as well as the increased cost of supporting a larger restaurant base including $240,000 in additional accounting and legal fees, $520,000 in additional travel and consulting fees, and an additional $175,000 in facility expenses. Depreciation and amortization. Depreciation and amortization increased to $1.1 million in 1997 from $434,000 in 1996. This increase was primarily the result of depreciation recognized on capital expenditures for new restaurants and an additional $90,000 of amortization of goodwill associated with the purchase of minority interests in October 1997. Preopening. Preopening expenses in 1997 increased to $1.9 million from $782,000 in 1996 due to a greater number of restaurants which were developed in 1997 compared to 1996. 19 21 Interest income (expense), net. Net interest expense increased to $317,000 in 1997 from $131,000 in 1996 due to borrowings on the Company's line of credit and an increase in long-term debt. ELIMINATION OF MINORITY INTERESTS Elimination of minority interests increased to $1.3 million in 1997 from $993,000 in 1996 primarily due to the increased income generated by the Scottsdale, Newport Beach and La Jolla restaurants. Elimination of minority interests in 1997 was also higher due to approximately $110,000 attributable in 1997 to the collective minority interests of Market Partners, Operating Partners and Culinary Partners; such partnership arrangements were not in place in 1996. These increases were offset in part by the repurchase in October 1997 of the minority interests in the Scottsdale, Newport Beach and La Jolla restaurants. PROVISION FOR INCOME TAXES The provision for income taxes for 1997 and 1996 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 fiscal years 1997 and 1996 as utilization of such losses in future periods was deemed uncertain. At December 28, 1997, the Company had a net operating loss carryforward of approximately $1.9 million which will expire for federal tax purposes in 2011 and for state tax purposes in 2001. The expected income tax benefit derived by applying the statutory income tax rate has been eliminated as a result of an increase in the deferred income tax asset valuation allowance. YEAR ENDED DECEMBER 29, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 The following discussion of the Company's results of operations for the year ended December 29, 1996 relates to the combined operating results of the Company and the Predecessors. The Company has not presented separate analyses regarding the two month period ended February 28, 1996 relating to the Predecessors or the ten month period ended December 29, 1996 relating to the Company because the Company believes that such discussion would not be meaningful. REVENUES Revenues increased by $8.0 million, or 76.3%, to $18.4 million in 1996 from $10.5 million in 1995. The increase was primarily attributable to revenues of $6.9 million generated by new restaurants opened in 1996 and the increase in revenues in 1996 for restaurants opened in 1995. Increased customer visits generated comparable restaurant sales gains of 13.0% in 1996. The Company did not implement any meaningful price increases in 1996. COSTS AND EXPENSES Cost of sales. Cost of sales remained constant as a percentage of revenues at 28.3% in both 1996 and 1995. Labor. Labor costs decreased as a percentage of revenues to 30.7% in 1996 from 32.0% in 1995. This decrease was primarily the result of improvements in the management of hourly staff levels in new and existing restaurants. Operating. Operating costs increased as a percentage of revenues to 18.8% in 1996 from 14.6% in 1995. This increase was primarily the result of new restaurant openings in the last quarter of 1996 which resulted in additional restaurant administration and facility costs. Occupancy. Occupancy costs decreased as a percentage of revenues to 8.0% in 1996 from 10.1% in 1995. This decrease was primarily the result of the increased revenue base and to a lesser extent, more favorable lease terms associated with the new restaurants opened in 1996. 20 22 General and administrative. General and administrative expenses increased in 1996 to $1.4 million, or 7.5% of revenues, from $192,000, or 1.8% of revenues, in 1995. This increase was primarily attributable to the initial formation of the Company, including the addition of management personnel. Depreciation and amortization. Depreciation and amortization expenses increased to $434,000 in 1996 from $322,000 in 1995. This increase was principally the result of depreciation recognized on capital expenditures on new restaurants opened in 1996 and $154,000 of amortization of goodwill associated with the February 1996 acquisition. See "Certain Transactions." Preopening. Preopening expenses increased to $782,000 in 1996 from $400,000 in 1995, due to a greater number of restaurants under development in 1996. Interest income (expense), net. Net interest expense increased to $131,000 in 1996 from $13,000 in 1995 due to interest expense incurred on notes payable to minority stockholders in connection with the February 1996 acquisition. See "Certain Transactions." ELIMINATION OF MINORITY INTERESTS The elimination of minority interests of $993,000 in 1996 was the result of the formation of the Company in February 1996 and the related acquisition of the majority of the interests in the original restaurants. In 1995, because the operating results of the Predecessors are presented on a combined basis, there were no minority interests. PROVISION FOR INCOME TAXES The provision for income taxes in 1996 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 fiscal year 1996 as utilization of such losses in future periods was deemed uncertain. The expected income tax benefit derived by applying the statutory income tax rate has been eliminated as a result of a deferred income tax asset valuation allowance. The Company's taxable income for the year ended December 31, 1995 was allocated and taxed directly to the stockholders and members of the Predecessors resulting in no tax provision. 21 23 QUARTERLY RESULTS The following tables set forth certain unaudited quarterly information for each of the eight fiscal quarters in the two year period ended June 28, 1998. 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. See "Risk Factors--Fluctuations in Operating Results."
FISCAL 1996 FISCAL 1997 FISCAL 1998 ----------------- ------------------------------------- ----------------- THIRD FOURTH FIRST SECOND THIRD FOURTH FIRST SECOND QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER (DOLLARS IN THOUSANDS) Revenues........................ $4,363 $5,458 $8,175 $9,528 $9,935 $12,130 $15,728 $17,209 Costs and expenses: Restaurant operating costs: Cost of sales............. 1,239 1,575 2,324 2,705 2,798 3,490 4,394 4,705 Labor..................... 1,290 1,713 2,384 2,844 2,885 3,570 4,556 4,844 Operating................. 850 1,063 1,284 1,587 1,705 2,151 2,579 2,861 Occupancy................. 348 491 564 642 681 856 1,103 1,254 ------ ------ ------ ------ ------ ------- ------- ------- Total restaurant operating costs...... 3,727 4,842 6,556 7,778 8,069 10,067 12,632 13,664 General and administrative.... 416 642 760 1,063 1,162 1,291 1,348 1,405 Depreciation and amortization................ 147 159 209 242 262 389 489 524 Preopening.................... 268 467 146 253 683 840 432 785 ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) from operations... (195) (652) 504 192 (241) (457) 827 831 Interest income (expense), net........................... (10) (72) (81) (46) (38) (152) (210) (245) ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) before elimination of minority interests and provision for income taxes.... (205) (724) 423 146 (279) (609) 617 586 Elimination of minority interests..................... (319) (103) (383) (375) (335) (215) (156) (189) ------ ------ ------ ------ ------ ------- ------- ------- Income (loss) before provision for income taxes.............. (524) (827) 40 (229) (614) (824) 461 397 Provision for income taxes...... (4) (1) (32) (20) (10) (7) (4) (7) ------ ------ ------ ------ ------ ------- ------- ------- Net income (loss)............... $ (528) $ (828) $ 8 $ (249) $ (624) $ (831) $ 457 $ 390 ====== ====== ====== ====== ====== ======= ======= ======= Restaurants open at end of period........................ 4 7 7 8 9 13 13 14
22 24 The operating results of the Company for such eight fiscal quarters expressed as a percentage of revenues were as follows:
FISCAL 1996 FISCAL 1997 FISCAL 1998 ----------------- ------------------------------------- ----------------- THIRD FOURTH FIRST SECOND THIRD FOURTH FIRST SECOND QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER Revenues.............................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Costs and expenses: Restaurant operating costs: Cost of sales................... 28.4 28.8 28.4 28.4 28.2 28.8 27.9 27.4 Labor........................... 29.5 31.4 29.2 29.8 29.0 29.4 29.0 28.1 Operating....................... 19.5 19.5 15.7 16.7 17.1 17.7 16.4 16.6 Occupancy....................... 8.0 9.0 6.9 6.7 6.9 7.1 7.0 7.3 ----- ----- ----- ----- ----- ----- ----- ----- Total restaurant operating costs...................... 85.4 88.7 80.2 81.6 81.2 83.0 80.3 79.4 General and administrative.......... 9.5 11.8 9.3 11.2 11.7 10.6 8.6 8.2 Depreciation and amortization....... 3.4 2.9 2.5 2.5 2.6 3.2 3.1 3.0 Preopening.......................... 6.1 8.6 1.8 2.7 6.9 6.9 2.7 4.6 ----- ----- ----- ----- ----- ----- ----- ----- Income (loss) from operations......... (4.4) (12.0) 6.2 2.0 (2.4) (3.7) 5.3 4.8 Interest income (expense), net........ (0.3) (1.3) (1.0) (0.5) (0.4) (1.3) (1.4) (1.4) ----- ----- ----- ----- ----- ----- ----- ----- Income (loss) before elimination of minority interests and provision for income taxes........................ (4.7) (13.3) 5.2 1.5 (2.8) (5.0) 3.9 3.4 Elimination of minority interests..... (7.3) (1.9) (4.7) (3.9) (3.4) (1.8) (1.0) (1.1) ----- ----- ----- ----- ----- ----- ----- ----- Income (loss) before provision for income taxes........................ (12.0) (15.2) 0.5 (2.4) (6.2) (6.8) 2.9 2.3 Provision for income taxes............ (0.1) -- (0.4) (0.2) (0.1) (0.1) -- -- ----- ----- ----- ----- ----- ----- ----- ----- Net income (loss)..................... (12.1)% (15.2)% 0.1% (2.6)% (6.3)% (6.9)% 2.9% 2.3% ===== ===== ===== ===== ===== ===== ===== =====
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 private sales of equity securities, debt financing, sale-leaseback arrangements and cash flow from operations. Net cash provided by operating activities was $625,000, $139,000 and $4.6 million for total year 1996, fiscal year 1997 and the six months ended June 28, 1998, respectively. Net cash provided by operating activities exceeded the net losses for the periods due principally to the effect of minority interests and depreciation. The Company uses cash primarily to fund the development and construction of new restaurants. Net cash used in investing activities in total year 1996, fiscal year 1997 and the six months ended June 28, 1998 was $8.2 million, $11.5 million and $8.5 million, respectively, which included payments of $4.2 million and $2.5 million in total year 1996 and fiscal year 1997, respectively, made in connection with the acquisition of minority interests. Capital expenditures were $4.0 million, $8.7 million and $8.6 million in total year 1996, fiscal year 1997 and the six months ended June 28, 1998, respectively. The Company intends to open ten restaurants in 1998 (four of which are open) and 13 in 1999. Total capital expenditures are expected to be approximately $21 million in 1998. The Company expects that its planned future restaurants will require, on average, a total 23 25 cash investment per restaurant, exclusive of landlord contributions, of approximately $1.5 million to $2.0 million. Preopening expenses are expected to average approximately $250,000 per restaurant. Net cash provided by financing activities in 1996, 1997 and the six months ended June 28, 1998 was $9.0 million, $12.2 million, and $3.0 million, respectively. Financing activities in 1996 and 1997 consisted principally of sales of Preferred Stock. The Company has a line of credit agreement which permits borrowings of up to $20 million and bears interest at LIBOR plus 3.5% (9.16% at June 28, 1998). As of June 28, 1998, the Company had $9.0 million outstanding under this facility, and the Company estimates that it will have approximately $18.0 million outstanding under this facility upon completion of this offering. Pursuant to its terms, the lender has the right to require that all borrowings under the credit agreement be repaid upon the consummation of this offering; however, the Company will continue to be eligible to borrow funds under such line of credit after repayment. The terms of the line of credit require the Company to maintain a net worth of at least $10 million, including convertible redeemable preferred stock. The line of credit agreement also contains covenants which place various restrictions on sales of properties, transactions with affiliates, creation of additional debt, and other customary nonfinancial covenants. The line of credit agreement is collateralized by the Company's interests in certain affiliated partnerships. The Company does not anticipate that the above covenants and restrictions will have a significant impact on the Company. Although the line of credit matures in fiscal 1999, the Company believes that the lender will be willing to extend the term of the line of credit on terms and conditions which are comparable to those contained in the existing line of credit, or that other financing will be available in an amount and on terms and conditions which are adequate to meet the Company's working capital and liquidity needs, but there can be no assurance that such financing will be available. Although the Company has achieved positive cash flow from its restaurant operations since inception and has not budgeted any material portion of the net proceeds of this offering for the operation of its restaurants, the significant investment of resources in acquiring and opening its restaurants resulted in the Company incurring net losses in each fiscal period from inception through December 28, 1997. As a result, the Company had negative working capital at June 28, 1998 despite the fact that it achieved net income in the first two quarters of fiscal 1998. Such working capital deficiency will be substantially reduced by the anticipated repayment of its line of credit from the proceeds of this offering and by the conversion of the Deferred Purchase Price Liability into Common Stock. The Company's capital requirements, including development costs related to the opening of additional restaurants, have been and will continue to be significant. To date, the Company has been substantially dependent upon loans from lending institutions and private equity funding to develop its restaurants. In addition to the repayment of borrowings under its line of credit, most of which have been incurred for the development of new restaurants, the Company intends to use approximately $6.0 million of the net proceeds of this offering for the development of new restaurants in the remainder of 1998 and the balance of the net proceeds for development of new restaurants thereafter and for general corporate purposes. 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 cash flow from operations together with the net proceeds from this offering and borrowings under its line of credit will be sufficient to fund its capital requirements through 1999. 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 purchasers in this offering. There can be no assurance that such capital will be available on favorable terms, if at all. The Company leases restaurant and office facilities and equipment and certain real property under operating leases expiring between 2000 and 2019. Future minimum lease payments under operating leases, including restaurant facilities currently under construction or yet to be constructed as of June 28, 1998 were as follows: remainder of 1998 - $1.9 million; 1999 - $5.2 million; 2000 - $5.4 million; 2001 - $5.4 million; 2002 - $5.4 million; and thereafter - $53.5 million. 24 26 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 758,566 shares of Common Stock at $8.70 per common share. The Series A Preferred Stock has an annual six percent dividend payable quarterly on March 31, June 30, September 30, and December 31 in shares of Series A Preferred Stock on a cumulative basis beginning January 1, 1998. The Series B Preferred Stock has an annual six percent dividend payable quarterly on March 31, June 30, September 30, and December 31 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 $504,000 for the year ended December 29, 1996, $876,000 for the year ended December 28, 1997, and $477,000 for the six month ended June 28, 1998, respectively. At June 28, 1998, the carrying basis of the Preferred Stock was $18.3 million. As a result of this offering, each two shares of Series A Preferred Stock and Series B Preferred Stock will be automatically converted into one share of Common Stock. 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." YEAR 2000 COMPLIANCE The Company is aware of the issues associated with the programming code in existing computer systems as the year 2000 approaches. The "year 2000 problem" is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two digit year value to "00". This issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company has reviewed both its information technology and its non-information technology systems to determine whether they are year 2000 compliant, and the Company has not identified any material systems which are not year 2000 compliant. The Company has initiated formal communications with all significant suppliers and service providers to determine the extent to which the Company is vulnerable to those third parties' failure to remediate the year 2000 problem. The Company has received written assurances of year 2000 compliance from a majority of the third parties with whom it has relationships, including its POS, payroll and credit card service providers. Unless public suppliers of water, electricity and natural gas are disrupted for a substantial period of time (in which case the Company's business may be materially adversely affected), the Company believes its operations will not be significantly disrupted even if third parties with whom the Company has relationships are not year 2000 compliant. Further, the Company believes that it will not be required to make any material expenditure to address the year 2000 problem. However, uncertainty exists concerning the potential costs and effects associated with any year 2000 compliance, and the Company intends to continue to make efforts to ensure that third parties with whom it has relationships are year 2000 compliant. Any year 2000 compliance problem of either the Company or its vendors could materially adversely affect the Company's business, financial condition or operating results. 25 27 BUSINESS P.F. Chang's owns and operates 17 full service restaurants that feature a distinctive 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 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 average check per customer, including beverage, is approximately $17.00. 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. 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. P.F. Chang's opened three additional restaurants in 1996, six in 1997 and expects to open ten restaurants in 1998 (four of which are open) and 13 in 1999. Key to the Company's expansion strategy and success at the restaurant level is the P.F. Chang's management philosophy utilizing Market, Operating and Culinary Partners. The Company has demonstrated the viability of the P.F. Chang's concept in a wide variety of markets across the United States, including the Southwest, southern California, Texas and southern Florida. P.F. CHANG'S CHINA BISTRO CONCEPT AND STRATEGY The P.F. Chang's concept was developed in 1993 by Paul Fleming, a Phoenix-based restaurateur, in collaboration with Philip Chiang, the owner of the Mandarin restaurant in Beverly Hills, California. 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 has developed the following strategies: Offer High Quality Chinese Cuisine. P.F. Chang's seeks to differentiate itself from other Chinese restaurants by offering only premium products made from scratch upon order, from original regional Chinese recipes. The Company utilizes traditional Hong Kong preparation techniques, which combine high temperature wok cooking, fresh ingredients and reduced oil to produce dishes with a distinct, outstanding and highly memorable flavor. A core menu is served at both lunch and dinner featuring a variety of freshly prepared wok-fired creations, roasted duck and chicken, fresh seafood, homemade soups, signature salads and desserts. All products are served family-style allowing the guests to build a meal of complementary flavors, colors and aromas. Create a Memorable Atmosphere. The Company seeks to design a unique atmosphere for each restaurant that it operates. Common design elements of the restaurants include natural wood and slate floors, custom millwork, special light fixtures, hand-painted murals depicting ancient Chinese history and life-size terra cotta soldiers, all of which create a warm and elegant ambiance. Exhibition-style kitchens, featuring the Company's classically trained wok chefs, reinforce the perceptions of quality, freshness, authenticity and cleanliness and add flash and fire to the energy of the restaurant. Deliver Superior Customer Service. Significant time and resources are spent in the development and implementation of a comprehensive service system at each restaurant. The Company offers guests prompt, friendly and efficient service, keeping waitstaff-to-table ratios high, and staffing each restaurant with an experienced management team to ensure consistent and attentive customer service. The Company employs 26 28 food runners to ensure prompt delivery of fresh food at the appropriate temperature, allowing the waitstaff to focus on overall customer satisfaction. All service personnel are thoroughly trained in the subtle flavors of each dish. Using a thorough knowledge and understanding of the Company's menu, the waitperson assists guests in selecting a meal that balances the principles of fan and t'sai foods to attain a harmony of taste, texture, color and aroma. Provide Excellent Dining Value. The Company believes it provides its guests with an exceptional value by serving high quality Chinese cuisine in a memorable atmosphere with superior customer service, all for an average check of approximately $17.00. This price-value relationship helps create the long-term bond between P.F. Chang's and its guests. Because of the superior level of customer satisfaction it delivers, the Company believes it enjoys a high level of repeat business, which serves as a solid foundation from which to grow incremental sales. For the fiscal year ended December 28, 1997 and the six months ended June 28, 1998, the Company generated comparable restaurant sales growth of approximately 13.8% and 11.7%, respectively. Achieve Exceptional Restaurant Economics. In the first six months of 1998, the Company's restaurants produced average weekly sales of $93,839 and restaurant operating income of 20.2% of sales. In addition, for the 12 month period ended June 28, 1998, the Company's restaurants have achieved restaurant pre-tax return on investment of 38.2%. The Company believes that it has been able to achieve these results due to the broad appeal of the P.F. Chang's concept, careful site selection and consistent application of its management and training concepts. Pursue Accelerated, Disciplined Restaurant Expansion. The Company plans to develop restaurants in both existing and new markets nationwide where the Company believes it can generate attractive unit-level economics. The Company targets high traffic, high visibility locations in affluent urban and suburban markets. The flexibility of the P.F. Chang's concept enables the Company to open successful restaurants in a wide variety of locations, including residential neighborhoods, shopping centers, office buildings and hotels. The Company expects to open ten new restaurants in 1998 (four of which are open) and 13 in 1999. 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 $1.5 million to $2.0 million and a total capitalized investment of between $2.5 million and $3.0 million per restaurant. This total investment includes the capitalized lease value of the property, which can vary greatly depending on the specific trade area. Leverage P.F. Chang's Partnership Management Philosophy. The Company believes that economic participation by management at the operating level is a key to the long-term success of its restaurants. The Company has developed a partnership management philosophy based on a three person team at each restaurant: the Market Partner (regional manager), Operating Partner (restaurant manager) and Culinary Partner (chef). Each of these partners is provided an opportunity to invest in and to participate in the cash flows of the restaurants for which they are responsible. As a result of this structure, the Company believes it is able to (i) attract and retain highly experienced and motivated managers with powerful incentives to execute the Company's strategy and maximize stockholder value, (ii) provide stable restaurant management which reduces staff turnover and increases customer satisfaction and (iii) leverage the specific market knowledge of its partners to facilitate the rapid expansion of the concept. 27 29 UNIT ECONOMICS The following table depicts the pre-tax return on investment for the fiscal years 1995, 1996 and 1997, as well as the 12 months ended June 28, 1998. Return on investment is calculated as the quotient of restaurant income (loss) before interest, taxes and rent divided by the total restaurant investment. The computation of return on investment excludes rents, interest and taxes 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). RETURN ON INVESTMENT (DOLLARS IN THOUSANDS, EXCEPT AVERAGE WEEKLY SALES)
FISCAL FISCAL FISCAL 12 MONTHS ENDED 1995 1996 1997 JUNE 28, 1998 TOTAL RESTAURANTS Sales weeks................................... 129 225 440 597 Average weekly sales.......................... $81,122 $81,976 $90,383 $ 92,133 Sales......................................... 10,465 18,445 39,768 55,003 Restaurant income (loss) before income taxes(1).................................... $ 585 $ 1,502 $ 4,482 $ 7,175 Interest expense.............................. 13 67 214 230 Rent expense(2)............................... 656 1,297 2,124 2,944 ------- ------- ------- ---------- Restaurant EBIT + rent(a)..................... $ 1,254 $ 2,866 $ 6,820 $ 10,349 ======= ======= ======= ========== Average restaurant assets employed (net)(3)... $ 1,522 $ 2,448 $ 8,243 $ 11,794 Present value of remaining lease obligations(4).............................. 3,461 5,891 11,272 15,283 ------- ------- ------- ---------- Total restaurant investment(b)................ $ 4,983 $ 8,339 $19,515 $ 27,077 ======= ======= ======= ========== Return on investment(a)/(b)................... 25.2% 34.4% 34.9% 38.2% RESTAURANTS OPENED IN 1998 Sales weeks.................................................................. 13 Average weekly sales......................................................... $ 108,392 Sales........................................................................ 1,409 Restaurant income (loss) before income taxes(1).............................. $ (231) Interest expense............................................................. -- Rent expense(2).............................................................. 96 ---------- Restaurant EBIT + rent(a).................................................... $ (135) ========== Average restaurant assets employed (net)(3).................................. $ 307 Present value of remaining lease obligations(4).............................. 476 ---------- Total restaurant investment(b)............................................... $ 783 ========== Return on investment(a)/(b).................................................. (17.2)%
28 30
FISCAL FISCAL FISCAL 12 MONTHS ENDED 1995 1996 1997 JUNE 28, 1998 RESTAURANTS OPENED IN 1997 Sales weeks....................................................... 76 220 Average weekly sales.............................................. $73,675 $ 77,381 Sales............................................................. 5,599 17,024 Restaurant income (loss) before income taxes(1)................... $(1,727) $ 54 Interest expense.................................................. -- -- Rent expense(2)................................................... 282 881 ------- ---------- Restaurant EBIT + rent(a)......................................... $(1,445) $ 935 ======= ========== Average restaurant assets employed (net)(3)....................... $ 2,230 $ 5,787 Present value of remaining lease obligations(4)................... 2,068 5,795 ------- ---------- Total restaurant investment(b).................................... $ 4,298 $ 11,582 ======= ========== Return on investment(a)/(b)....................................... (33.6)% 8.1% RESTAURANTS OPENED IN 1996 Sales weeks............................................ 17 156 156 Average weekly sales................................... $63,527 $92,930 $ 101,974 Sales.................................................. 1,080 14,497 15,908 Restaurant income (loss) before income taxes(1)........ $ (850) $ 1,866 $ 2,744 Interest expense....................................... 10 193 213 Rent expense(2)........................................ 65 717 787 ------- ------- ---------- Restaurant EBIT + rent(a).............................. $ (775) $ 2,776 $ 3,744 ======= ======= ========== Average restaurant assets employed (net)(3)............ $ 402 $ 4,060 $ 3,849 Present value of remaining lease obligations(4)........ 704 4,294 4,267 ------- ------- ---------- Total restaurant investment (b)........................ $ 1,106 $ 8,354 $ 8,116 ======= ======= ========== Return on investment (a)/(b)........................... (70.1)% 33.2% 46.1% RESTAURANTS OPENED PRIOR TO 1996 Sales weeks................................... 129 208 208 208 Average weekly sales.......................... $81,122 $83,484 $94,578 $ 99,339 Sales......................................... 10,465 17,365 19,672 20,663 Restaurant income (loss) before income taxes(1).................................... $ 585 $ 2,352 $ 4,343 $ 4,608 Interest expense.............................. 13 57 21 17 Rent expense(2)............................... 656 1,232 1,125 1,180 ------- ------- ------- ---------- Restaurant EBIT + rent(a)..................... $ 1,254 $ 3,641 $ 5,489 $ 5,805 ======= ======= ======= ========== Average restaurant assets employed (net)(3)... $ 1,522 $ 2,046 $ 1,953 $ 1,851 Present value of remaining lease obligations(4).............................. 3,461 5,187 4,910 4,745 ------- ------- ------- ---------- Total restaurant investment(b)................ $ 4,983 $ 7,233 $ 6,863 $ 6,596 ======= ======= ======= ========== Return on investment(a)/(b)................... 25.2% 50.3% 80.0% 88.0%
- --------------- (1) Restaurant income (loss) before income taxes represents restaurant revenues less all restaurant-specific operating costs, depreciation, preopening costs, and interest expense. Preopening costs are aggregated in the month in which a restaurant opens. General and administrative expenses, interest expense on general corporate debt, depreciation on general corporate assets, and amortization of goodwill are excluded from the calculation. (2) Rent expense consists of minimum contractual rents plus contingent rents. (3) Average restaurant assets employed (net) represents the 12 month average of all restaurant-specific long-term assets, net of any accumulated depreciation, determined on a prorated basis for restaurants opened within the period. (4) 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% discount rate, determined on a prorated basis for restaurants opened within the period. 29 31 LOCATIONS The following table depicts existing restaurants and restaurants expected to open in 1998:
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) August 1998 7,000 196 Dallas, TX (NorthPark) August 1998 6,100 178 PLANNED LOCATIONS ANTICIPATED OPENING DATE - --------------------------------------------- ------------------------------------------- Atlanta, GA (Ashwood & Perimeter) Fourth Quarter 1998 Birmingham, AL (The Summit) Fourth Quarter 1998 Denver, CO (LoDo) Fourth Quarter 1998 Northbrook, IL (Northbrook Court) Fourth Quarter 1998 Troy, MI (Somerset) Fourth Quarter 1998 West Hollywood, CA (Beverly Center) Fourth Quarter 1998
- ------------------------------ * Many of the Company's restaurants have outdoor seating in addition to interior seating. ** Opened on June 29, 1998 following the end of the fiscal quarter ended June 28, 1998. In 1999, the Company intends to open 13 new restaurants in approximately seven new markets, including New York, Boston, Orlando, San Francisco, Salt Lake City, Raleigh and Cincinnati. 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 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 $2.5 million and $3.0 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, 30 32 of approximately $1.5 million to $2.0 million. Preopening expenses are expected to average approximately $250,000 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. 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 added or 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 $4.00 to $7.00. The Company's average check per guest, including alcoholic beverages, is approximately $17.00. 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. DECOR AND ATMOSPHERE The Company believes that ambiance plays a critical role in the dining experience. By combining the influences of Chinese and American cultures, each restaurant is designed to create a warm, sophisticated environment that is intended to be suitable for a variety of occasions. Each restaurant incorporates certain elements of local styles and common design elements, including hand-painted murals depicting 12th century China, sculptures of Xi'an warriors, hardwood and slate flooring, decorative lighting and custom millwork, all of which provide continuity of the brand. Seating is a comfortable combination of tables, booths and banquettes. Bistro-style counter seating is also available, frequently with a view of the exhibition-style kitchen in order to accommodate peak-period demand and the preferences of single or time-pressed diners. 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") and 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. 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 partner's 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 31 33 reference to trailing cash flows. 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 eight 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 anticipates adding six to eight Market Partners over the next five years for its domestic development. 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 operation 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 personal are required to successfully complete all sections of this program. The training program is comprised of a series of projects and skill assessments. Each trainee is formally evaluated at the end of each week in writing by the Operating Partner and Culinary Partner. This feedback is forwarded to the program's administrators, the Director of Training and the Director of Culinary Development. 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. A trainee cannot advance or complete the program without being certified. The Operating Partners and Culinary Partners are responsible for selecting employees for their restaurants. The Partners are accountable 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. In most cases, the commercials are endorsed, live reads that are typically longer than a normal 60 second commercial. 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 32 34 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 of Southwest Airlines and America West Airlines, 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. 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 the 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. 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. PROPERTIES All of the Company's restaurants are located in leased facilities. Current restaurant leases have expiration dates ranging from 2002 to 2019, with the majority of the leases providing for five-year options to renew for at least 33 35 one additional term. All of 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 located in approximately 4,400 square feet of leased space in Phoenix, Arizona. EMPLOYEES At June 28, 1998, the Company employed approximately 1,900 persons, 30 of whom were executive office personnel, 144 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. 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. 34 36 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information concerning each of the Company's directors and executive officers:
NAME AGE POSITION Chief Executive Officer, President and Richard L. Federico....................... 44 Director Robert T. Vivian.......................... 40 Chief Financial Officer and Secretary Frank Ziska............................... 51 Chief Development Officer Gregory C. Carey.......................... 46 Chief Operating Officer Paul M. Fleming........................... 44 Director and Founder J. Michael Chu(2)......................... 40 Director Gerald R. Gallagher(1).................... 57 Director R. Michael Welborn(1)(2).................. 47 Director James G. Shennan.......................... 57 Director Yves Sisteron............................. 43 Director
- ------------------------------ (1) Compensation Committee Member. (2) Audit Committee Member. Richard L. Federico joined the Company as President and a director in February 1996 and in September 1997 succeeded Paul M. Fleming as Chief Executive Officer. From February 1989 to January 1996 Mr. Federico served as President of the Italian Concepts division of Brinker International, Inc. where he was responsible for concept development and operations. Under his direction, this division grew from one unit in 1989 to more than 70 units by 1996. Robert T. Vivian has served as Chief Financial Officer and Secretary since April 1996. From January 1991 to April 1996 Mr. Vivian served in a variety of positions at Brinker International, Inc., the most recent of which was Vice President of Investor Relations. In this capacity, Mr. Vivian was responsible for dissemination of financial information and corporate communications to Brinker's stockholders. Frank Ziska has served as Chief Development Officer since June 1998. Prior to joining the Company, from 1994 to June 1998, Mr. Ziska served as Managing Director of United States and Canadian Operations for Cushman & Wakefield Worldwide, a real estate brokerage firm. Prior to that time, beginning in 1989, Mr. Ziska served as Managing Director and Branch Manager of Arizona Operations for Cushman & Wakefield of Arizona, Inc. Gregory C. Carey has served as Chief Operating Officer of the Company since August 1998. From June 1994 to August 1998 Mr. Carey served as Chief Operating Officer for Rainforest Cafe Inc. where he was responsible for operations as well as site selection, design and implementation. From July 1989 to June 1994 Mr. Carey was Senior General Manager for Restaurants Unlimited, Inc. Paul M. Fleming founded the Company in January 1996 and has served as a director of the Company since that time. Mr. Fleming also served as Chief Executive Officer of the Company from January 1996 to September 1997. From November 1992 to February 1996, Mr. Fleming served as President of Fleming Chinese Restaurants, Inc., the entity which opened, developed and managed the first four P.F. Chang's restaurants, each of which were owned by separate entities and were located in Scottsdale, Arizona and Irvine, Newport Beach and La Jolla, California. In addition, from 1983 to 1997, Mr. Fleming was also a franchisee of Ruth's Chris Steakhouse, Inc. J. Michael Chu has served as a director of the Company since February 1996. Mr. Chu has been a Managing Director of Catterton-Simon Partners, a venture capital firm, since 1990. Mr. Chu also serves on the boards of directors of Fine Host Corp and several private companies. 35 37 Gerald R. Gallagher has served as a director of the Company since February 1996. He has been a General Partner of Oak Investment Partners, a venture capital firm, since May 1987. Mr. Gallagher also serves on the boards of directors of several private companies. R. Michael Welborn has served as a director of the Company since August 1996. Mr. Welborn has served as the Chairman of Bank One, Arizona, N.A., a commercial bank, since January 1996. From September 1993 to December 1995 he served as Managing Director of The Venture West Group, a merchant bank. From May 1988 to September 1993 Mr. Welborn served as Chairman of Citibank of Arizona. Mr. Welborn also serves on the boards of directors of Bank One, Arizona, N.A. and a private company. James G. Shennan, Jr. has served as a director of the Company since May 1997. He has been a principal of Trinity Ventures, a venture capital firm, since June 1989. Mr. Shennan also serves on the boards of directors of Starbuck's Corporation and a number of privately-held, consumer-oriented companies in which Trinity Ventures is an investor. Yves Sisteron has served as a director of the Company since May 1997. Mr. Sisteron has been a Principal of Global Retail Partners, L.P. since January 1996 and a Manager, U.S. Investments of Carrefour S.A. since March 1993. Mr. Sisteron has a J.D. and an L.L.M. from Lyon Law School and an L.L.M. in Comparative Law from New York University School of Law. Mr. Sisteron also serves on the boards of directors of InterWorld Technology Ventures, Inc. and several private companies. Currently, all directors hold office until the next annual meeting of stockholders and until their successors have been duly elected and qualified. Officers are elected by and serve at the discretion of the Company's Board of Directors. There are no family relationships among the directors or officers of the Company. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISIONS The Compensation Committee of the Company's Board of Directors is comprised of Michael Welborn and Gerald Gallagher. Neither of these individuals was at any time during the 1997 fiscal year or at any other time an officer or employee of the Company. No executive officer of the Company serves as a member of the board of directors or compensation committee of any entity which has one or more executive officers serving as a member of the Company's Board of Directors or Compensation Committee. DIRECTOR COMPENSATION The Company does not compensate directors for service on the Board of Directors or its committees but does reimburse reasonable costs and expenses associated with attendance at meetings. Mr. Welborn, the only director who is not a member of management and who is not affiliated with any of the Company's venture capital investors, received a nonqualified stock option to purchase 25,000 shares of Common Stock, at an exercise price of $2.40 per share in August 1996, subject to vesting over a five year period. In addition, following the consummation of this offering, future directors and certain of the Company's existing directors will be eligible for automatic stock option grants under the Company's 1998 Stock Option Plan. See "Management -- Benefit Plans." LIMITATION OF LIABILITY AND INDEMNIFICATION Pursuant to provisions of the Delaware General Corporation Law ("DGCL"), the Company has adopted provisions in its Charter, which provide that directors of the Company shall not be personally liable for monetary damages to the Company or its stockholders for a breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Company or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under Section 174 of the DGCL relating to improper dividends or distributions; or (iv) for any transaction from which the director derived an improper personal benefit. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. The Certificate also authorizes the Company to indemnify its current and former officers, directors, employees or agents against certain liabilities that may arise by reason of their status or service as directors, 36 38 officers, employees or agents of the Company (other than liabilities arising from acts or omissions not in good faith or willful misconduct). The Company's By-laws authorize the Company to indemnify its officers, directors, employees and agents to the extent permitted by the DGCL. Pursuant to Section 145 of the DGCL, which empowers the Company to enter into indemnification agreements with its officers, directors, employees and agents, the Company has entered into separate indemnification agreements with its directors and executive officers which may, in some cases, be broader than the specific indemnification provisions contained in the DGCL. The indemnification agreements may require the Company, among other things, to indemnify such executive officers and directors against certain liabilities that may arise by reason of their status or service as directors or officers (other than liabilities arising from acts or omissions not in good faith or willful misconduct) and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. At present, there is no pending litigation or proceeding involving a director, officer, employee or agent of the Company where indemnification will be required or permitted and the Company is not aware of any threatened litigation or proceeding that may result in a claim for such indemnification. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth information concerning the compensation paid to each person who served as the Company's Chief Executive Officer during the fiscal year ended December 28, 1997 and each other executive officer whose combined salary and bonus for the fiscal year ended December 28, 1997 exceeded $100,000 for services rendered in all capacities to the Company and its subsidiaries for that fiscal year. The executive officers named below are referred to herein as the "Named Executive Officers." SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION/ AWARDS ------------------ ANNUAL COMPENSATION SHARES OF -------------------- COMMON STOCK NAME AND PRINCIPAL POSITION(S) SALARY BONUS UNDERLYING OPTIONS - ------------------------------ -------- -------- ------------------ Richard L. Federico.................................. $270,000 $115,000 50,000 Chief Executive Officer and President Robert T. Vivian..................................... 106,000 23,000 7,500 Chief Financial Officer and Secretary Paul M. Fleming...................................... 167,000 50,000 -- Founder and former Chief Executive Officer
37 39 OPTION GRANTS The following table sets forth certain information concerning the grant of options to purchase the Company's Common Stock made during the fiscal year ended December 28, 1997 to each of the Named Executive Officers: OPTION GRANTS IN FISCAL YEAR 1997
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF NUMBER OF SHARES PERCENT OF TOTAL STOCK PRICE OF COMMON STOCK OPTIONS GRANTED EXERCISE APPRECIATION FOR UNDERLYING TO EMPLOYEES OR BASE OPTION TERM(3) OPTIONS IN FISCAL PRICE EXPIRATION -------------------- NAME AND PRINCIPAL POSITION(S) GRANTED(1) YEAR 1997(2) ($/SH) DATE 5% 10% - ------------------------------ ---------------- ---------------- -------- ---------- -------- -------- Richard L. Federico........ 50,000 29.4% $ 6.00 08/14/07 $188,688 $478,123 Chief Executive Officer and President Robert T. Vivian........... 7,500 4.4 10.00 11/25/07 47,167 119,531 Chief Financial Officer and Secretary Paul M. Fleming............ -- -- -- -- -- -- Founder and former Chief Executive Officer
- ------------------------------ (1) Options generally vest over a period of five years with 20% of the options vesting one year after the date of grant and the balance vesting in equal monthly installments. (2) In 1997, the Company granted options to purchase an aggregate of 170,000 shares. (3) Potential Realizable Value is based on certain assumed rates of appreciation pursuant to rules prescribed by the Securities and Exchange Commission ("SEC"). Actual gains, if any, on stock option exercises are dependent upon future performance of the Company and related Common Stock price levels during the terms of the options. There can be no assurance that the amounts reflected in this table will be achieved. FISCAL YEAR-END VALUES OF STOCK OPTIONS The following table sets forth certain information concerning the 1997 fiscal year-end value of unexercised options held by the Named Executive Officers. None of the Named Executive Officers exercised any options during fiscal 1997. AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT 12/28/97 12/28/97(2) ------------------------------- ------------------------------- NAME EXERCISABLE(1) UNEXERCISABLE EXERCISABLE(1) UNEXERCISABLE ---- -------------- ------------- -------------- ------------- Richard L. Federico................... 393,965 0 $2,814,134 -- Robert T. Vivian...................... 93,490 0 653,524 -- Paul M. Fleming....................... 286,640 0 1,719,840 --
- ------------------------------ (1) All options issued to the Named Executive Officers are immediately exercisable. However, unvested shares are subject to a right of repurchase on behalf of the Company in the event of the Named Executive Officer's termination of service with the Company. (2) Calculated by determining the difference between the fair market value of the securities underlying the option at December 28, 1997 ($10.00 as determined by the Company's Board of Directors) and the exercise price of the Named Executive Officer's options. 38 40 BENEFIT PLANS 1998 Stock Option Plan. A total of 280,000 shares of the Company's Common Stock (the "Share Reserve") have been reserved for issuance under the Company's 1998 Stock Option Plan (the "1998 Option Plan"). In addition, the Share Reserve will be increased if any outstanding options issued under the 1997 Restaurant Management Plan and the 1996 Employee Stock Option Plan (collectively, the "Prior Plans") expire or are canceled, or if the Company exercises its right to repurchase unvested shares of stock which were acquired upon exercise of options granted under the Prior Plans. As of June 28, 1998, no shares of Common Stock have been issued upon exercise of options and an aggregate of 1,009,635 shares were subject to outstanding options under the Prior Plans. The 1998 Option Plan provides for discretionary grants of incentive stock options and nonqualified stock options to the Company's employees, officers, directors, consultants, advisors, and/or other independent contractors. The option price per share for an incentive stock option may not be less than 100% 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% of the fair market value of a share of Common Stock on the grant date. The option price per share for an incentive stock option granted to a person owning stock possessing more than 10% of the total combined voting power of all classes of stock of the Company (or a parent or subsidiary) may not be less than 110% 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 ten years. The 1998 Option 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, Michael Welborn and each outside director elected after the consummation of this offering remaining in office on the day following each annual meeting of stockholders will be granted an option to purchase 2,500 shares. With respect to the other outside directors in office prior to consummation of this offering (Messrs. Chu, Gallagher and Sisteron), each such director remaining in office 18 months after the consummation of this offering shall be granted an option to purchase 2,500 shares on the day following each annual meeting of stockholders thereafter. 1997 Restaurant Management Stock Option Plan. As of June 28, 1998, 56,875 shares were subject to options outstanding under the Company's 1997 Restaurant Management Plan (the "Restaurant Management Plan"). All of such outstanding options were exercisable as of such date subject, in certain cases, to the Company's right to repurchase the shares acquired upon exercise. The Company will not issue additional options under the Restaurant Management Plan. The Restaurant Management Plan provides for grants of incentive stock options and nonqualified stock options to employees of the Company who hold the position of general manager or assistant manager or a position of similar importance to the Company. The option price per share for an incentive stock option may not be less than 100% of the fair market value of a share of Common Stock on the grant date. The option price per share for nonqualified stock option may not be less than 85% of the fair market value of a share of Common Stock on the grant date. The option price per share for an option granted to a person owning stock possessing more than 10% of the total combined voting power of all classes of stock of the Company (or a parent or subsidiary) or 10% of the total combined value of all such classes of stock may not be less than 110% of the fair market value of a share of Common Stock on the grant date. Generally, options vest over five years with 20% of the options vesting one year after the grant date and the balance vesting in equal monthly installments over the remaining term of the options. Options expire within ten years. 1996 Employee Stock Option Plan. As of June 28, 1998, 952,760 shares were subject to options under the Company's 1996 Employee Stock Option Plan (the "Employee Plan"). All of such outstanding options were exercisable as of such date subject, in certain cases, to the Company's right to repurchase the shares acquired upon exercise. The Company will not issue any additional options under the Employee Plan. The Employee Plan provides for grants of incentive stock options and nonqualified stock options to the Company's employees (including officers), directors, consultants, advisors, and/or other independent contractors. The option price per share for an incentive stock option may not be less than 100% of the fair market value of a share of Common Stock on the grant date. The option price per share for a nonqualified stock option may not be less than 85% of the fair market value of a share of Common Stock on the grant date. The option price per 39 41 share for an option granted to a person owning stock possessing more than 10% of the total combined voting power of all classes of stock of the Company (or a parent or subsidiary) or 10% of the total combined value of all such classes of stock may not be less than 110% of the fair market value of a share of Common Stock on the grant date. Generally, options vest over five years with 20% of the options vesting one year after the grant date and the balance vesting in equal monthly installments over the remaining term of the options. Options expire within ten years. 1998 Employee Stock Purchase Plan. A total of 400,000 shares of the Company's Common Stock have been reserved for issuance under the Company's 1998 Employee Stock Purchase Plan (the "Purchase Plan"), none of which have been issued. 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 six month purchase periods. The price at which stock is purchased under the Purchase Plan is equal to 85% 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. The initial offering period will commence on the effective date of this offering. EMPLOYMENT AGREEMENT The Company entered into an employment agreement with Paul M. Fleming on January 31, 1996. Pursuant to the terms of the agreement, Mr. Fleming served as Chief Executive Officer of the Company from January 1996 until September 1997 and is currently serving as a director and an employee of the Company for a term which expires January 31, 1999. The term of Mr. Fleming's employment will be automatically renewed for successive one year terms unless either Mr. Fleming or the Company provides notice of an intention not to renew the agreement. In the event that Mr. Fleming's employment is terminated by the Company without cause or by Mr. Fleming for good reason (as defined in the agreement), Mr. Fleming is entitled to receive as severance compensation (i) his base salary until the earlier of (a) one year from the date of termination or (b) the expiration of the initial term of the agreement, (ii) a lump sum payment of the average annual bonuses paid over the term of the agreement and (iii) the right to exercise in full all unvested stock options granted to him in accordance with the terms of the Employee Plan under the agreement. In addition to his base salary, Mr. Fleming is eligible to receive discretionary bonuses, when and if declared by the Board of Directors. The agreement prohibits Mr. Fleming from competing with the Company during the term of the agreement and for two years after the termination thereof. 40 42 CERTAIN TRANSACTIONS Since December 31, 1995, there has not been, nor is there currently proposed, any transaction or series of similar transactions to which the Company or its Predecessors was or is to be a party in which the amount involved exceeds $60,000 and in which any director, executive officer or beneficial holder of more than 5% of any class of voting securities of the Company or members of such person's immediate family had or will have a direct or indirect material interest other than the transactions described below. Formation and Series A Preferred Financing. The Company was formed on January 31, 1996, through the issuance of 500 shares of Common Stock to Paul Fleming for a purchase price of $100. In February 1996, the Company sold shares of Series A Preferred Stock convertible into 2,487,500 shares of Common Stock at a price of $4.00 per common share and related warrants for an aggregate purchase price of $9,950,000. Contemporaneously, the Company acquired Paul and Kelly Fleming's 52% interest in Fleming Chinese Restaurants, Inc., which operated the first P.F. Chang's restaurant in Scottsdale, Arizona, for $1,037,000 in cash and $954,000 in notes payable. The Company also acquired from the Flemings (i) a 43% interest in P.F. Chang's II, Inc., which operated a P.F. Chang's restaurant in Newport Beach, California, (ii) a 50% ownership in P.F. Chang's III, L.L.C., which operated a P.F. Chang's restaurant in La Jolla, California and (iii) a 54% ownership interest in P.F. Chang's IV, L.L.C., which operated a P.F. Chang's restaurant in Irvine, California, all for an aggregate purchase price of $2,006,000 in cash and 2,499,500 shares of Common Stock of the Company. In September 1996, the Company issued shares of Series A Preferred Stock convertible into 189,635 shares of Common Stock at a price of $4.00 per common share for an aggregate purchase price of $758,540. Pursuant to the terms of the Company's Charter, on March 31, 1998 and June 30, 1998 the Company issued, and upon the consummation of this offering will issue, paid-in-kind dividends ("PIK Dividends") to the stockholders of the Company who hold Series A Preferred Stock. PIK Dividends are cumulative and are equal to 6% of the number of shares of Series A Preferred Stock owned by each stockholder payable in quarterly installments. Upon completion of this offering, all shares of the Series A Preferred Stock will convert into shares of Common Stock. The following executive officers, directors and beneficial holders of more than 5% of a class of the Company's capital stock purchased shares of the Series A Preferred Stock having an aggregate purchase price of at least $60,000.
SHARES EXECUTIVE OFFICERS, DIRECTORS AND 5% STOCKHOLDERS(1) PURCHASED(4) - ---------------------------------------------------- ------------ Oak Investment Partners VI, Limited Partnership(2).......... 906,085 Catterton-Simon Partners, L.P.(2)........................... 625,000 Trinity Ventures V, L.P.(2)................................. 475,000 Silver Creek Investments Limited(2)......................... 437,500 Yves Sisteron(2)............................................ 40,450 Richard L. Federico(3)...................................... 50,000
- ------------------------------ (1) See notes to "Principal and Selling Stockholders" for information relating to the beneficial ownership of shares and identification of affiliated stockholders. (2) A beneficial owner (together with its affiliates) of more than 5% of a class of the Company's capital stock. Gerald R. Gallagher, J. Michael Chu, James G. Shennan and Yves Sisteron, each a director of the Company, are affiliated with Oak Investment Partners VI, Limited Partnership, Catterton-Simon Partners, L.P., Trinity Ventures V, L.P. and Global Retail Partners, L.P., respectively. (3) An officer and director of the Company. (4) Represents number of shares of Common Stock issuable upon conversion of purchased shares of Series A Preferred Stock. Excludes an aggregate of 115,749 shares of Common Stock issuable upon conversion of PIK Dividends paid to holders of Series A Preferred Stock on March 31, 1998, June 30, 1998 and September 30, 1998. 41 43 Series B Preferred Financing. In May 1997, the Company sold shares of Series B Preferred Stock convertible into 758,565 shares of Common Stock at a price of $8.70 per common share, for an aggregate purchase price of $6,599,519. The following executive officers, directors and beneficial holders of more than 5% of a class of the Company's capital stock purchased shares of Series B Preferred Stock having an aggregate purchase price of at least $60,000.
SHARES EXECUTIVE OFFICERS, DIRECTORS AND 5% STOCKHOLDERS(1) PURCHASED(3) - ---------------------------------------------------- ------------ Global Retail Partners, L.P.(2)............................. 322,018 Oak Investment Partners VI, Limited Partnerships(2)......... 114,942 Catterton-Simon Partners, L.P.(2)........................... 114,942 Trinity Ventures V, L.P.(2)................................. 114,942 Silver Creek Investments Limited(2)......................... 54,959
- ------------------------------ (1) See notes to table of beneficial ownership in "Principal and Selling Stockholders" for information relating to the beneficial ownership of shares and identification of affiliated stockholders. (2) A beneficial owner (together with its affiliates) of more than 5% of a class of the Company's Capital Stock. Gerald R. Gallagher, J. Michael Chu, James G. Shennan and Yves Sisteron, each a director of the Company, are affiliated with Oak Investment Partners VI, Limited Partnership, Catterton-Simon Partners, L.P., Trinity Ventures V, L.P. and Global Retail Partners, L.P., respectively. (3) Represents number of shares of Common Stock issuable upon conversion of purchased shares of Series B Preferred Stock. Purchase of Remaining Minority Interests. During 1997, the Company purchased substantially all the remaining outstanding minority interests in the Scottsdale, La Jolla and Newport Beach restaurants for approximately $2,520,000 in cash and $2,426,000 in Common Stock of the Company to be issued upon consummation of this offering upon conversion of the Deferred Purchase Price Liability. The number of shares of Common Stock to be issued will be determined by dividing $2,426,000 by the initial offering per share price. In the event the offering is not completed by October 23, 1998, the Company will be obligated (upon demand of the individual holders) to pay the minority interest holders an aggregate amount of $2,426,000 in cash. Promissory Notes. Prior to the formation of the Company, Paul Fleming, the founder and a director of the Company, personally guaranteed several promissory notes entered into by the Predecessors to pay for improvements to the Scottsdale, La Jolla and Newport Beach restaurants. The aggregate original principal amount of the notes was $472,000. In connection with the Company's acquisition of the interests in the Predecessors, the Company assumed the promissory notes. Mr. Fleming remains a guarantor of the notes. As of June 28, 1998, the aggregate outstanding principal amount of the notes was approximately $120,000. 42 44 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information concerning the beneficial ownership of the Company's Common Stock as of June 28, 1998, and as adjusted to reflect the sale of the shares offered hereby, assuming no exercise of the Underwriters' over-allotment option, by (i) each person (together with its affiliates) who is known by the Company to be the beneficial owner of more than 5% of the Company's Common Stock; (ii) each of the Named Executive Officers; (iii) each director of the Company (who, where applicable, is listed under the name of the principal stockholder with which he is affiliated); (iv) all executive officers and directors of the Company as a group; and (v) each of the Selling Stockholders. Except pursuant to applicable community property laws or as indicated in the footnotes to this table, the Company believes that each stockholder identified in the table possesses sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by such stockholder. The address of the individuals listed below is the address of the Company appearing on the cover of this registration statement.
SHARES SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO THE OFFERING(1) SHARES AFTER THE OFFERING(1) ------------------------- BEING ----------------------- NUMBER PERCENT(2) OFFERED NUMBER PERCENT(2) Oak Investment Partners VI, Limited Partnership(3)...................... 1,062,415 Gerald R. Gallagher 4550 Norwest Center Minneapolis, MN 55402 Catterton-Simon Partners, L.P.(4)..... 768,491 J. Michael Chu 9 Greenwich Office Park Greenwich, CT 06830 Trinity Ventures V, L.P.(5)........... 611,639 James G. Shennan, Jr. 3000 Sand Hill Road Building 1, Suite 240 Menlo Park, CA 94025 Global Retail Partners, L.P.(6)....... 364,316 Yves Sisteron 2121 Avenue of the Stars, Suite 1600 Los Angeles, CA 90067 Silver Creek Investments Limited(7)... 512,443 61 Purchase Street, Suite #2R Rye, NY 10580 Paul M. Fleming(8).................... 2,774,170 R. Michael Welborn(9)................. 30,172 Richard L. Federico(10)............... 446,249 Robert T. Vivian(11).................. 93,490 All officers and directors as a group (10 persons)(12).................... 6,150,912
- ------------------------------ * Less than one percent. (1) Pursuant to Rule 13d-3 under the Securities Exchange Act of 1934, as amended, a person has beneficial ownership of any securities over which such person directly or indirectly, through any contract, arrangement, undertaking, relationship or otherwise has or shares voting power and/or investment power, or as to which such person has the right to acquire such voting and/or investment power within 60 days. (2) Percentage ownership is based on: (i) before the offering, shares of Common Stock (which includes (a) shares outstanding on June 28, 1998, (b) 82,130 shares of Common Stock issuable upon conversion of PIK Dividends paid to holders of Series A Preferred Stock prior to consummation of the offering, and (c) shares issuable upon completion of this offering upon conversion of the Deferred Purchase Price Liability (assuming 43 45 an initial public offering price of $ per share)); and (ii) after the offering, shares of Common Stock outstanding (assuming no exercise of the Underwriter's over-allotment option). Percentage of beneficial ownership as to any person as of a particular date is calculated by dividing the number of shares beneficially owned by such person by the sum of the number of shares outstanding as of such date and the number of shares as to which such person has the right to acquire voting and/or investment power within 60 days of such date. (3) Includes 27,797 shares of Common Stock issuable upon conversion of PIK Dividends paid to the named stockholder and its affiliates who hold Series A Preferred Stock prior to consummation of the offering. Includes 1,038,191 shares held by Oak Investment Partners VI, Limited Partnership and 24,224 shares held by Oak VI Affiliates Fund, Limited Partnership. Gerald Gallagher, a director of the Company, is a partner of Oak Investment Partners with certain voting and investment power over such shares. Although Mr. Gallagher may be deemed to be a beneficial owner of such shares, he disclaims all such beneficial ownership except to the extent of any pecuniary interest therein which he may have. (4) Includes 19,174 shares of Common Stock issuable upon conversion of PIK Dividends paid to the named stockholder and its affiliates who hold Series A Preferred Stock prior to consummation of the offering. Includes 457,484 shares held by Catterton-Simon Partners, L.P., 224,800 shares held by Catterton-PFC, L.L.C. and 86,207 shares held by Catterton-PFC Partners II, L.L.C. Michael Chu, a director of the Company, is President and Managing Director of Catterton-Simon Partners with certain voting and investment power over such shares. Although Mr. Chu may be deemed to be a beneficial owner of such shares, he disclaims all such beneficial ownership except to the extent of any pecuniary interest therein which he may have. (5) Includes 14,572 shares of Common Stock issuable upon conversion of PIK Dividends paid to the named stockholder and its affiliates who hold Series A Preferred Stock prior to consummation of the offering. Includes 575,993 shares held by Trinity Ventures V, L.P. and 35,645 shares held by Trinity Ventures V Side-by-Side Fund, L.P. James G. Shennan, Jr., a director of the Company, is a partner of Trinity Ventures with certain voting and investment power over such shares. Although Mr. Shennan may be deemed to be a beneficial owner of such shares, he disclaims all such beneficial ownership except to the extent of any pecuniary interest therein which he may have. (6) Includes 1,242 shares of Common Stock issuable upon conversion of PIK Dividends paid to Yves Sisteron and certain other individuals affiliated with DLJ who hold Series A Preferred Stock prior to consummation of the offering. Includes 8,047 shares held by Mr. Sisteron, 202,662 shares held by Global Retail Partners, L.P., 13,952 shares held by Global Retail Partners Funding, Inc., 13,174 shares held by GRP Partners, L.P., 60,389 shares held by DLJ Diversified Partners, L.P., 3,488 shares held by DLJ First ESC, L.P., 22,426 shares held by DLJ Diversified Partners -- A, L.P. and 40,177 shares held by certain other individuals affiliated with DLJ. Each of such persons is affiliated with Global Retail Partners, L.P. and Global Retail Partners, L.P. and such affiliates are each affiliates of DLJ. Yves Sisteron, a director of the Company, is a Principal of Global Retail Partners L.P. Mr. Sisteron disclaims beneficial ownership of all shares owned by Global Retail Partners, L.P. and its affiliates except to the extent of his pecuniary interest, if any, therein. (7) Includes 13,422 shares of Common Stock issuable upon conversion of PIK Dividends paid to the named stockholder who holds Series A Preferred Stock prior to consummation of the offering. (8) Includes 286,640 shares subject to options which are exercisable within 60 days of September 30, 1998. (9) Includes 25,000 shares subject to options which are exercisable within 60 days of September 30, 1998. (10) Includes 1,534 shares of Common Stock issuable upon conversion of PIK Dividends paid to the named stockholder who holds Series A Preferred Stock prior to consummation of the offering. Includes 393,965 shares subject to options which are exercisable within 60 days of September 30, 1998. (11) Includes 93,490 shares subject to options which are exercisable within 60 days of September 30, 1998. (12) Includes 799,095 shares subject to options which are exercisable within 60 days of September 30, 1998 and 64,319 shares of Common Stock issuable upon conversion of PIK Dividends. 44 46 DESCRIPTION OF CAPITAL STOCK The following description of the capital stock of the Company and certain provisions of the Company's Charter and By-laws is a summary and is qualified in its entirety by the provisions of the Charter and By-laws, which have been filed as exhibits to the Company's Registration Statement, of which this Prospectus is a part. Upon the closing of the offering, the authorized capital stock of the Company will consist of 20,000,000 shares of Common Stock, $0.001 par value, and 10,000,000 shares of Preferred Stock, $0.001 par value. COMMON STOCK As of June 28, 1998, there were shares of Common Stock (after giving effect to the conversion into Common Stock of the Preferred Stock and the Deferred Purchase Price Liability upon the closing of this offering) outstanding held of record by fifty-nine (59) stockholders. Holders of Common Stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, the holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by the Board of Directors out of funds legally available thereof. In the event of a liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior liquidation rights of preferred stock, if any, then outstanding. The Common Stock has no preemptive or conversion rights or other subscriptive rights. There are no redemption or sinking fund provisions applicable to the Common Stock. All outstanding shares of Common Stock are fully paid and non-assessable, and the shares of Common Stock to be outstanding upon completion of the offering contemplated by this Prospectus will be fully paid and non-assessable. The Charter does not provide for cumulative voting, and accordingly, the holders of a majority of the shares of Common Stock entitled to vote in any election of directors may elect all of the directors standing for election. PREFERRED STOCK Upon consummation of the offering there will be no outstanding shares of preferred stock of the Company. The Board of Directors has the authority, without action by the stockholders, to designate and issue preferred stock in one or more series and to designate the dividend rate, voting rights and other rights, preferences and restrictions of each series, any or all of which may be greater than the rights of the Common Stock. It is not possible to state the actual effect of the issuance of any shares of preferred stock upon the rights of holders of the Common Stock until the Board of Directors determines the specific rights of the holders of such preferred stock. However, the effects might include, among other things, restricting dividends on the Common Stock, diluting the voting power of the Common Stock, impairing the liquidation rights of the Common Stock and delaying or preventing a change in control of the Company without further action by the stockholders. The Company has no present plans to issue any shares of preferred stock. REGISTRATION RIGHTS Pursuant to the Amended and Restated Registration Rights Agreement dated May 1, 1997, between the Company and certain stockholders, certain investors holding an aggregate of shares (the "Registrable Securities") will have certain "demand" rights to register those shares under the Securities Act. Beginning 180 days after the date of this Prospectus, if requested by holders of more than 50% of the Registrable Securities then outstanding and assuming a reasonably anticipated aggregate price to the public of at least $5 million, then, subject to certain limitations, the Company must file a registration statement under the Securities Act covering all Registrable Securities requested to be included by holders of Registrable Securities. The Company is required to effect up to three such "demand" registrations. The Company has the right to delay any such registration for up to 90 days under certain circumstances. All fees, costs and expenses of such registrations other than underwriting discounts and commissions, will be borne by the Company. In addition, holders of Registrable Securities have certain "piggyback" registration rights. If the Company proposes to register any of its securities under the Securities Act other than in connection with the Company's employee benefit plans or a corporate reorganization, then, subject to certain limitations, the 45 47 holders of Registrable Securities may require the Company to include all or a portion of their shares in such registration, although the managing underwriter of any such offering has certain rights to limit the number of shares in such registration. Subject to certain limitations, expenses incurred in connection with the above registrations (other than underwriters' and brokers' discounts and commissions) will be borne by the Company. DEFERRED PURCHASE PRICE LIABILITY In connection with the repurchase by the Company of minority interests in the Scottsdale, La Jolla and Newport Beach restaurants, certain of the former minority interest holders have the right to receive a number of shares of restricted Common Stock of the Company upon completion of the offering determined by dividing $2,426,000 by the initial public offering price per share. In the event the offering is not completed by October 23, 1998, the Company will be obligated (upon demand of the individual holders) to pay the holders of such rights the aggregate amount of $2,426,000 in cash. LIMITATION OF LIABILITY AND INDEMNIFICATION Section 102(b)(7) of the DGCL authorizes corporations to limit or eliminate the personal liability of directors to corporations and their stockholders for monetary damages for a breach of a director's fiduciary duty of care. Although Section 102(b)(7) does not change a director's duty of care, it enables corporations to limit available relief to equitable remedies such as injunction or rescission. The Company's Charter limits the liability of directors to the Company and its stockholders. Specifically, directors of the Company are not personally liable for monetary damages to the Company or its stockholders for a breach of fiduciary duty as a director, except for liability: (i) for any breach of the director's duty of loyalty to the Company or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under Section 174 of the DGCL; or (iv) for any transaction from which the director derived an improper personal benefit. ANTI-TAKEOVER PROVISIONS General. Certain provisions of the DGCL and the Company's Charter and By-laws may discourage or make it more difficult for a third-party to acquire control of the Company. Such provisions may limit the price that certain investors are willing to pay in the future for shares of the Company's Common Stock. These certain provisions may also have the effect of discouraging or preventing certain types of transactions involving an actual or threatened change of control of the Company (including unsolicited takeover attempts), even though such a transaction may offer the Company's stockholders the opportunity to sell their stock at a price above the prevailing market price. The Charter allows the Company to issue preferred stock with rights senior to those of the Common Stock and other rights that could adversely affect the interests of holders of shares of Common Stock without any further vote or action by the stockholders. The issuance of preferred stock, for example, could decrease the amount of earnings or assets available for distribution to the holders of shares of Common Stock or could adversely affect the rights and powers, including voting rights, of the holders of shares of Common Stock. In certain circumstances, such issuance could have the effect of decreasing the market price of the Common Stock, as well as having the anti-takeover effects discussed above. Delaware Takeover Statute. The Company is subject to Section 203 of the DGCL, which prohibits a Delaware corporation from engaging in a "business combination" with certain persons ("Interested Stockholders") for three years following the time any such person becomes an Interested Stockholder. Interested Stockholders generally include (i) persons who are the beneficial owners of 15% or more of the outstanding voting stock of the corporation, and (ii) persons who are affiliates or associates of the corporation and who hold 15% or more of the corporation's outstanding voting stock at any time within three years before the date on which such person's status as an Interested Stockholder is determined. Subject to certain exceptions, a business combination includes, among other things, (i) mergers or consolidations, (ii) the sale, lease, exchange, mortgage, pledge, transfer or other disposition of assets having an aggregate market value equal to 10% or more of either the aggregate market value of all assets of the corporation determined on a consolidated 46 48 basis or the aggregate market value of all the outstanding stock of the corporation, (iii) transactions that result in, among other things, the issuance or transfer by the corporation of any stock of the corporation to the Interested Stockholder, except pursuant to a transaction that effects a pro rata distribution to all stockholders of the corporation, (iv) any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series, or securities convertible into the stock of any class or series, of the corporation that is owned directly or indirectly by the Interested Stockholder, or (v) any receipt by the Interested Stockholder of the benefit (except proportionately as a stockholder) of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation. Section 203 does not apply to a business combination if (i) before a person becomes an Interested Stockholder, the board of directors of the corporation approved either the business combination or the transaction which resulted in the Interested Stockholder becoming an Interested Stockholder, (ii) upon consummation of the transaction which resulted in the stockholder becoming an Interested Stockholder, the Interested Stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, other than certain excluded shares, or (iii) at or subsequent to such time the business combination is (a) approved by the board of directors of the corporation and (b) authorized at a regular or special meeting of stockholders, and not by written consent, by the affirmative vote of the holders of at least two-thirds of the outstanding voting stock of the corporation not owned by the Interested Stockholder. CHARTER AND BY-LAWS The Company's By-laws provide that special meetings of the stockholders of the Company may be called only by the President of the Company, and shall be called by the President or Secretary of the Company upon the written request of a majority of the Board of Directors or by any person or persons holding shares representing a majority of the outstanding capital stock entitled to vote. The Company's Bylaws also require advance written notice of a special meeting to each stockholder of the Company entitled to vote at such meeting not less than 10, nor more than 60, days prior to the meeting. The Company's Charter does not include a provision for cumulative voting in the election of directors. Under cumulative voting, a minority stockholder holding a sufficient number of shares may be able to ensure the election of one or more directors. The absence of cumulative voting may have the effect of limiting the ability of minority stockholders to effect changes in the Board of Directors and, as a result, may have the effect of deterring a hostile takeover or delaying or preventing changes in control or management of the Company. The Company's By-laws provide that the authorized number of directors may be changed by an amendment to the By-laws adopted by the Board of Directors or by the stockholders. Vacancies in the Board of Directors may be filled either by holders of a majority of the Company's directors then in office, though less than a quorum, or by a sole remaining director, or if there are no directors in office, in the manner provided by statute. If the directors then in office constitute less than a majority of the whole board, any stockholder or stockholders holding at least ten percent (10%) of the outstanding capital stock entitled to vote may apply to the Court of Chancery to order an election. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is First Chicago Trust Company, P.O. Box 20533, Jersey City, New Jersey 07303, attention: John Gagnon (201) 222-4114. 47 49 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for the Common Stock. Future sales of substantial amounts of Common Stock in the public market could adversely affect market prices prevailing from time to time. Furthermore, since only a limited number of shares will be available for sale shortly after the offering because of certain contractual and legal restrictions on resale (as described below), sales of substantial amounts of Common Stock in the public market after such restrictions lapse could adversely affect the prevailing market price at such time and the ability of the Company to raise equity capital in the future. Upon completion of this offering, the Company will have outstanding an aggregate of shares of Common Stock, assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options or warrants to purchase Common Stock. Of these shares, the shares of Common Stock to be sold in this Offering will be freely tradable without restriction or further registration under the Securities Act, unless such shares are held by "affiliates" of the Company, as that term is defined in Rule 144 under the Securities Act (the "Affiliates"). The remaining shares held by existing stockholders of the Company were sold by the Company in reliance on exemptions from the registration requirements of the Securities Act and are "restricted" securities within the meaning of Rule 144 under the Securities Act (the "Restricted Shares"). Restricted Shares may be sold in the public market only if registered or if they qualify for an exemption from registration under Rule 144 or Rule 701 promulgated under the Securities Act, which rules are summarized below. As a result of the contractual restrictions described below and the provisions of Rule 144 Rule and 701, the Restricted Shares will be available for sale in the public market as follows (based on the number of shares outstanding as of June 28, 1998): (i) Restricted Shares will be eligible for sale 90 days after the date of this Prospectus; and (ii) all Restricted Shares will be eligible for sale upon expiration of the lock-up agreements 180 days after the date of this Prospectus. All officers and directors, and certain stockholders and option holders of the Company have agreed not to sell, make any short sale of, grant any option for the purchase of, or otherwise transfer or dispose of, any shares of Common Stock or any securities convertible into or exercisable for Common Stock held by such persons for a period of 180 days after the date of this Prospectus, without the prior written consent of DLJ. When determining whether or not to release shares from the lock-up agreements, DLJ will consider, among other factors, the stockholder's reasons for requesting the release, the number of shares for which the release is being requested and market conditions at the time. In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated), including an Affiliate, who has beneficially owned shares for at least one year is entitled to sell, within any three-month period commencing 90 days after the date of this Prospectus, a number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock (approximately shares immediately after the offering) or (ii) the average weekly trading volume of the Common Stock on the Nasdaq National Market during the four calendar weeks preceding such sale, subject to the filing of a Form 144 with respect to such sale. Sales under rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about the Company. In addition, a person who is not deemed to have been an Affiliate of the Company at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, would be entitled to sell such shares under Rule 144(k) without regard to the requirements described above. Therefore, unless otherwise restricted, "144(k) shares" may be sold immediately following completion of the offering. In general, under Rule 701 of the Securities Act as currently in effect, any employee, consultant or advisor of the Company who purchased shares from the Company in connection with a compensatory stock or option plan or written employment agreement is eligible to resell such shares 90 days after the effective date of the offering in reliance on Rule 144, but without compliance with certain restrictions, including the holding period conditions, contained in Rule 144. Within 90 days of the date of this Prospectus, the Company intends to file a registration statement under the Securities Act to register shares of Common Stock reserved for issuance under its equity incentive plans, thus permitting the resale of such shares by non-affiliates in the public market without restriction under the Securities Act. Such registration statements will become effective immediately upon filing. As of June 28, 1998, 1,009,635 options to purchase shares of Common Stock were outstanding under the Company's stock option plans and agreements, all of which are subject to the lock-up agreements described above. 48 50 UNDERWRITING Subject to the terms and conditions of an Underwriting Agreement dated , 1998 (the "Underwriting Agreement"), the Underwriters named below, who are represented by Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"), NationsBanc Montgomery Securities LLC ("NationsBanc Montgomery") and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated ("Dain Rauscher Wessels") (the "Representatives"), have severally agreed to purchase from the Company and the Selling Stockholders the respective number of shares of Common Stock set forth opposite their names below.
NUMBER OF UNDERWRITERS SHARES - ------------ ----------- Donaldson, Lufkin & Jenrette Securities Corporation......... NationsBanc Montgomery Securities LLC....................... Dain Rauscher Wessels....................................... ----------- Total............................................. ===========
The Underwriting Agreement provides that the obligations of the several Underwriters to purchase and accept delivery of the shares of Common Stock offered hereby are subject to approval by their counsel of certain legal matters and to certain other conditions. The Underwriters are obligated to purchase and accept delivery of all the shares of Common Stock offered hereby (other than those shares covered by the over-allotment option described below) if any are purchased. The Underwriters initially propose to offer the shares of Common Stock in part directly to the public at the initial public offering price set forth on the cover page of this Prospectus and in part to certain dealers (including the Underwriters) at such price less a concession not in excess of $ per share. The Underwriters may allow, and such dealers may re-allow, to certain other dealers a concession not in excess of $ per share. After the initial offering of the Common Stock, the public offering price and other selling terms may be changed by the Representatives at any time without notice. The Underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. The Company and the Selling Stockholders have granted to the Underwriters an option, exercisable within 30 days after the date of this Prospectus, to purchase, from time to time, in whole or in part, up to an aggregate of additional shares of Common Stock at the initial public offering price less underwriting discounts and commissions. The Underwriters may exercise such option solely to cover over-allotments, if any, made in connection with the offering. To the extent that the Underwriters exercise such option, each Underwriter will become obligated, subject to certain conditions, to purchase its pro rata portion of such additional shares based on such Underwriter's percentage underwriting commitment as indicated in the preceding table. The Company and the Selling Stockholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments that the Underwriters may be required to make in respect thereof. Each of the Company, its executive officers and directors and certain stockholders of the Company (including the Selling Stockholders) has agreed, subject to certain exceptions, not to (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers all or a portion of the economic consequences associated with the ownership of any Common Stock (regardless of whether any of the transactions described in clause (i) or (ii) is to be settled by the delivery of Common Stock, or such other securities, in cash or otherwise) for a period of 180 days after the date of this Prospectus without the prior written consent of DLJ. In addition, during such period, the Company has also agreed not to file any registration statement with respect to, and each of its executive officers, directors and certain stockholders of the Company (including the Selling Stockholders) has agreed not to make any demand for, or exercise any right with respect to, the 49 51 registration of any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock other than registrations relating to equity compensation plans without DLJ's prior written consent. Prior to the offering, there has been no established trading market for the Common Stock. The initial public offering price for the shares of Common Stock offered hereby will be determined by negotiation among the Company, representatives of the Selling Stockholders and the Representatives. The factors to be considered in determining the initial public offering price include the history of and the prospects for the industry in which the Company competes, the past and present operations of the Company, the historical results of operations of the Company, the prospects for future earnings of the Company, the recent market prices of securities of generally comparable companies and the general condition of the securities markets at the time of the offering. Global Retail Partners, L.P. ("GRP") and certain of its affiliates, each an affiliate of DLJ, are stockholders of the Company. Yves Sisteron, a Principal of GRP and a director of the Company, has been elected to the Board of Directors pursuant to the provisions of a stockholder agreement which entitles Global Retail Partners, L.P., as a holder of Series B Preferred Stock and so long as it continues to hold at least a specified percentage of the Series B Preferred Stock, to elect one of the seven directors of the Company. Such stockholder agreement will terminate upon consummation of this offering. In May 1997, Global Retail Partners, L.P. and its affiliates, including Mr. Sisteron, acquired shares of the Company's Series B Preferred Stock convertible into an aggregate of 322,018 shares of Common Stock. Previously, in February 1996, Mr. Sisteron and two other individual affiliates of DLJ, acquired shares of the Company's Series A Preferred Stock convertible into an aggregate of 40,450 shares of Common Stock and have since received and will receive scheduled PIK Dividends thereon. In addition, certain individuals who are associated with NationsBanc Montgomery acquired shares of Series A Preferred Stock convertible into an aggregate of 90,762 shares of Common Stock in February 1996, and such individuals and one other individual associated with NationsBanc Montgomery acquired shares of Series B Preferred Stock convertible into an aggregate of 24,404 shares of Common Stock in May 1997. In February 1996, NationsBanc Montgomery also received a five-year warrant to purchase shares of Series A Preferred Stock convertible into 62,190 shares of Common Stock at an exercise price of $4.00 per common share in connection with placement agent and other services it performed for the Company. See "Management," "Certain Transactions" and "Principal and Selling Stockholders." Other than in the United States, no action has been taken by the Company, the Selling Stockholders or the Underwriters that would permit a public offering of the shares of Common Stock offered hereby in any jurisdiction where action for that purpose is required. The shares of Common Stock offered hereby may not be offered or sold, directly or indirectly, nor may this Prospectus or any other offering material or advertisements in connection with the offer and sale of any such shares of Common Stock be distributed or published in any jurisdiction, except under circumstances that will result in compliance with the applicable rules and regulations of such jurisdiction. Persons into whose possession this Prospectus comes are advised to inform themselves about and to observe any restrictions relating to the offering of the Common Stock and the distribution of this Prospectus. This Prospectus does not constitute an offer to sell or a solicitation of an offer to buy any shares of Common Stock offered hereby in any jurisdiction in which such an offer or a solicitation is unlawful. In connection with the offering, the Underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the Common Stock. Specifically, the Underwriters may over-allot the offering, creating a syndicate short position. The Underwriters may bid for and purchase shares of Common Stock in the open market to cover such syndicate short position or to stabilize the price of the Common Stock. In addition, the underwriting syndicate may reclaim selling concessions from syndicate members and selected dealers if they repurchase previously distributed Common Stock in syndicate covering transactions, in stabilizing transactions or otherwise. These activities may stabilize or maintain the market price of the Common Stock above independent market levels. The Underwriters are not required to engage in these activities, and may end any of these activities at any time. 50 52 LEGAL MATTERS The validity of the securities offered hereby has been and general corporate legal matters will be passed upon for the Company by Gray Cary Ware & Freidenrich LLP, San Diego, California. Certain legal matters will be passed upon for the Underwriters by Akin, Gump, Strauss, Hauer & Feld, L.L.P., San Antonio, Texas. EXPERTS The consolidated financial statements of P.F. Chang's China Bistro, Inc. at December 28, 1997 and December 29, 1996 and for the year ended December 28, 1997, and the period from February 29, 1996 to December 29, 1996, and the combined results of operations of its Predecessors for the period from January 1, 1996 to February 28, 1996 and the year ended December 31, 1995 appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission a Registration Statement (which term shall include any amendments thereto) on Form S-1 under the Securities Act with respect to the Common Stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement. As used herein, the term "Registration Statement" means the initial Registration Statement (including the exhibits, schedules, financial statements and notes filed as part thereof) and any and all amendments thereto. This Prospectus omits certain information contained in the Registration Statement as permitted by the rules and regulations of the Commission. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement. Statements herein concerning the contents of any contract or other document are not necessarily complete and in each instance reference is made to the copy of such contract or other document filed with the Commission as an exhibit to the Registration Statement, each such statement being qualified by and subject to such reference in all respects. With respect to each such document filed with the Commission as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved. As a result of this offering, the Company will become subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and in accordance therewith, will file reports and other information with the Commission. Reports, registration statements, proxy statements, and other information filed by the Company with the Commission can be inspected and copied at the public reference facilities maintained by the Commission at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549 and at the Commission's Regional Offices: 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, New York, New York 10048. Copies of such material can be obtained at prescribed rates from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. The Commission maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. The Company intends to furnish holders of the Common Stock with annual reports containing, among other information, audited financial statements certified by an independent audited accounting firm and quarterly reports containing unaudited condensed financial information for the first three quarters of each fiscal year. The Company intends to furnish such other reports as it may determine or as may be required by law. 51 53 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 29, 1996, December 28, 1997, and June 28, 1998 (unaudited)................ F-3 Consolidated Statements of Operations for the Year Ended December 31, 1995, the Period from January 1, 1996 to February 28, 1996, the Period from February 29, 1996 to December 29, 1996, the Year Ended December 28, 1997, and the Six Months Ended June 29, 1997 and June 28, 1998 (unaudited)....................................... F-4 Consolidated Statements of Convertible Redeemable Preferred Stock and Common Stockholders' and Members' Equity (Deficit) for the Year Ended December 31, 1995, the Period from January 1, 1996 to February 28, 1996, the Period from February 29, 1996 to December 29, 1996, the Year Ended December 28, 1997, and the Six Months Ended June 28, 1998 (unaudited)........................ F-5 Consolidated Statements of Cash Flows for the Year Ended December 31, 1995, the Period from January 1, 1996 to February 28, 1996, the Period from February 29, 1996 to December 29, 1996, the Year Ended December 28, 1997, and the Six Months Ended June 29, 1997 and June 28, 1998 (unaudited)....................................... F-6 Notes to Consolidated Financial Statements................ F-7
F-1 54 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. (Company) as of December 29, 1996 and December 28, 1997, and the related consolidated statements of operations, convertible redeemable preferred stock and common stockholders' and members' equity (deficit), and cash flows for the period from February 29, 1996 to December 29, 1996 and for the year ended December 28, 1997. We have also audited the combined statements of operations, stockholders' and members' equity (deficit), and cash flows of the corporations and limited liability companies listed in Note 2 for the year ended December 31, 1995 and for the period from January 1, 1996 to February 28, 1996. 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 generally accepted auditing standards. 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 29, 1996 and December 28, 1997 and the results of its operations and its cash flows for the period from February 29, 1996 to December 29, 1996 and for the year ended December 28, 1997, and the combined results of operations and cash flows of the corporations and limited liability companies listed in Note 2 for the year ended December 31, 1995 and for the period from January 1, 1996 to February 28, 1996, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Phoenix, Arizona January 26, 1998, except for Note 11 as to which the date is August 27, 1998 F-2 55 P.F. CHANG'S CHINA BISTRO, INC. CONSOLIDATED BALANCE SHEETS
PRO FORMA DECEMBER 29, DECEMBER 28, JUNE 28, JUNE 28, 1996 1997 1998 1998 ------------ ------------ -------- --------- (UNAUDITED) (IN THOUSANDS) ASSETS Current assets: Cash and cash equivalents............................ $ 1,877 $ 2,739 $ 1,802 $ 1,802 Receivables.......................................... 659 2,062 825 825 Inventories.......................................... 194 363 362 362 Current portion of notes receivable from related parties............................................ -- 130 69 69 Prepaids and other current assets.................... 79 417 766 766 ------- ------- ------- ------- Total current assets................................... 2,809 5,711 3,824 3,824 Construction-in-progress............................... 3,202 3,787 7,522 7,522 Property and equipment, net............................ 2,954 10,207 14,234 14,234 Goodwill, net of accumulated amortization of $154,000, $398,000 and $616,000 in 1996, 1997 and 1998, respectively......................................... 3,971 8,307 8,089 8,089 Notes receivable from related parties, less current portion.............................................. -- 162 187 187 Other assets........................................... 108 315 409 409 ------- ------- ------- ------- Total assets........................................... $13,044 $28,489 $34,265 $34,265 ======= ======= ======= ======= LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Revolving line of credit............................. $ -- $ 5,500 $ 9,000 $ 9,000 Accounts payable..................................... 1,049 1,658 2,789 2,789 Accrued payroll...................................... 624 1,214 1,266 1,266 Other accrued expenses............................... 536 988 1,470 1,470 Unearned revenue..................................... 133 305 269 269 Current portion of long-term debt, including $290,000, $316,000, and $333,000 due to related parties in 1996, 1997 and 1998, respectively....... 432 481 441 441 Deferred purchase price.............................. -- 2,426 2,426 -- Accrued minority members' distributions.............. 281 -- -- -- ------- ------- ------- ------- Total current liabilities.............................. 3,055 12,572 17,661 15,235 Long-term debt, including $775,000, $446,000 and $273,000 due to related parties in 1996, 1997 and 1998, respectively................................... 1,331 2,391 2,159 2,159 Interests of minority members and partners in consolidated limited liability companies and partnerships......................................... 15 164 236 236 Commitments and contingencies.......................... Convertible redeemable preferred stock, $0.001 par value, 10,000,000 shares authorized: Series A--5,354,270 shares issued and outstanding at December 29, 1996 and December 28, 1997 and 5,434,578 shares issued and outstanding at June 28, 1998, liquidation preference of $10,709,000 at December 29, 1996 and December 28, 1997 and $10,869,000 at June 28, 1998....................... 10,517 11,175 11,432 -- Series B--1,517,131 shares issued and outstanding, liquidation preference of $6,600,000 at December 28, 1997 and June 28, 1998......................... -- 6,633 6,853 -- Common stockholders' equity (deficit): Common stock, $0.001 par value, 20,000,000 shares authorized: 2,500,000 shares issued and outstanding ( shares pro forma)........................ 3 3 3 6 Additional paid-in capital........................... 2 2 2 20,710 Accumulated deficit.................................. (1,879) (4,451) (4,081) (4,081) ------- ------- ------- ------- Total common stockholders' equity (deficit)............ (1,874) (4,446) (4,076) 16,635 ------- ------- ------- ------- Total liabilities, convertible redeemable preferred stock and common stockholders' equity (deficit)...... $13,044 $28,489 $34,265 $34,265 ======= ======= ======= =======
See accompanying notes. F-3 56 P.F. CHANG'S CHINA BISTRO, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
PREDECESSORS COMPANY ------------------------------ ------------------------------------------------- PERIOD FROM PERIOD FROM JANUARY 1, 1996 FEBRUARY 29, SIX MONTHS ENDED YEAR ENDED TO 1996 TO YEAR ENDED ------------------- DECEMBER 31, FEBRUARY 28, DECEMBER 29, DECEMBER 28, JUNE 29, JUNE 28, 1995 1996 1996 1997 1997 1998 ------------ --------------- ------------ ------------ -------- -------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenues.......................... $10,465 $2,815 $15,630 $39,768 $17,703 $32,937 Costs and expenses: Restaurant operating costs: Cost of sales................. 2,957 772 4,454 11,317 5,029 9,099 Labor......................... 3,347 918 4,736 11,683 5,228 9,400 Operating..................... 1,528 527 2,944 6,727 2,871 5,440 Occupancy..................... 1,059 205 1,279 2,743 1,206 2,357 ------- ------ ------- ------- ------- ------- Total restaurant operating costs........ 8,891 2,422 13,413 32,470 14,334 26,296 General and administrative...... 192 17 1,368 4,276 1,823 2,753 Depreciation and amortization... 322 82 352 1,102 451 1,013 Preopening...................... 400 17 765 1,922 399 1,217 ------- ------ ------- ------- ------- ------- Income (loss) from operations..... 660 277 (268) (2) 696 1,658 Interest income (expense): Interest expense................ (13) (4) (163) (380) (150) (520) Interest income................. - - 36 63 23 65 ------- ------ ------- ------- ------- ------- Income (loss) before elimination of minority members' and partners' interests and provision for income taxes...... 647 273 (395) (319) 569 1,203 Elimination of minority members' and partners' interests......... - - (720) (1,308) (758) (345) ------- ------ ------- ------- ------- ------- Income (loss) before provision for income taxes.................... 647 273 (1,115) (1,627) (189) 858 Provision for income taxes........ - - (30) (69) (52) (11) ------- ------ ------- ------- ------- ------- Net income (loss)................. $ 647 $ 273 (1,145) (1,696) (241) 847 ======= ====== Redeemable preferred stock accretion....................... (504) (876) (396) (477) ------- ------- ------- ------- Net income (loss) available to common stockholders............. $(1,649) $(2,572) $ (637) $ 370 ======= ======= ======= ======= Net income (loss) per share: Basic........................... $ (0.66) $ (1.03) $ (0.25) $ 0.15 ======= ======= ======= ======= Diluted......................... $ (0.66) $ (1.03) $ (0.25) $ 0.13 ======= ======= ======= ======= Weighted average shares used in computation: Basic........................... 2,500 2,500 2,500 2,500 ======= ======= ======= ======= Diluted......................... 2,500 2,500 2,500 6,655 ======= ======= ======= ======= Pro forma data (unaudited): Net income (loss) per share: Basic......................... $ (0.30) $ 0.14 ======= ======= Diluted....................... $ (0.30) $ 0.13 ======= ======= Weighted average shares used in computation: Basic......................... 5,706 6,099 ======= ======= Diluted....................... 5,706 6,798 ======= =======
See accompanying notes. F-4 57 P.F. CHANG'S CHINA BISTRO, INC. CONSOLIDATED STATEMENTS OF CONVERTIBLE REDEEMABLE PREFERRED STOCK AND COMMON STOCKHOLDERS' AND MEMBERS' EQUITY (DEFICIT)
CONVERTIBLE REDEEMABLE PREFERRED STOCK ----------------------------------------- SERIES A SERIES B ------------------- ------------------ SHARES AMOUNT SHARES AMOUNT ------- -------- ------- ------- (IN THOUSANDS) PREDECESSORS Balances, January 1, 1995......................... -- $ -- -- $ -- Members' contributions............................ -- -- -- -- Distributions..................................... -- -- -- -- Net income (loss)................................. -- -- -- -- ----- ------- ----- ------ Balances, December 31, 1995....................... -- -- -- -- Distributions..................................... -- -- -- -- Net income (loss)................................. -- -- -- -- ----- ------- ----- ------ Balances, February 28, 1996....................... -- -- -- -- COMPANY Conversion of S corporations to limited liability companies....................................... -- -- -- -- Purchase of members' interests.................... -- -- -- -- Reclassification to minority interest upon consolidation in connection with acquisition of interests....................................... -- -- -- -- Issuance of common stock.......................... -- -- -- -- Issuance of Series A preferred stock, net of issuance costs of $695,000...................... 5,354 10,013 -- -- Redeemable preferred stock accretion.............. -- 504 -- -- Net loss.......................................... -- -- -- -- ----- ------- ----- ------ 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 (unaudited)..................................... 80 -- -- -- Redeemable preferred stock accretion (unaudited)..................................... -- 257 -- 220 Net income (unaudited)............................ -- -- -- -- ----- ------- ----- ------ Balances, June 28, 1998 (unaudited)............... 5,434 $11,432 1,517 $6,853 ===== ======= ===== ====== COMMON STOCKHOLDERS' AND MEMBERS' EQUITY (DEFICIT) -------------------------------------------------------------------- COMMON STOCK ADDITIONAL ---------------- PAID-IN MEMBERS' ACCUMULATED SHARES AMOUNT CAPITAL CAPITAL DEFICIT TOTAL ------ ------ ---------- -------- ----------- ------- (IN THOUSANDS) PREDECESSORS Balances, January 1, 1995......................... 20 $-- $1,419 $ -- $ (202) $ 1,217 Members' contributions............................ -- -- -- 710 -- 710 Distributions..................................... -- -- (706) (50) (523) (1,279) Net income (loss)................................. -- -- -- (18) 665 647 ----- -- ------ ------- ------- ------- Balances, December 31, 1995....................... 20 -- 713 642 (60) 1,295 Distributions..................................... -- -- (112) -- (228) (340) Net income (loss)................................. -- -- -- (12) 285 273 ----- -- ------ ------- ------- ------- Balances, February 28, 1996....................... 20 -- 601 630 (3) 1,228 COMPANY Conversion of S corporations to limited liability companies....................................... (20) -- (601) 601 -- -- Purchase of members' interests.................... -- -- -- (1,231) -- (1,231) Reclassification to minority interest upon consolidation in connection with acquisition of interests....................................... -- -- -- -- (227) (227) Issuance of common stock.......................... 2,500 3 2 -- -- 5 Issuance of Series A preferred stock, net of issuance costs of $695,000...................... -- -- -- -- -- -- Redeemable preferred stock accretion.............. -- -- -- -- (504) (504) Net loss.......................................... -- -- -- -- (1,145) (1,145) ----- -- ------ ------- ------- ------- 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 (unaudited)..................................... -- -- -- -- -- -- Redeemable preferred stock accretion (unaudited)..................................... -- -- -- -- (477) (477) Net income (unaudited)............................ -- -- -- -- 847 847 ----- -- ------ ------- ------- ------- Balances, June 28, 1998 (unaudited)............... 2,500 $3 $ 2 $ -- $(4,081) $(4,076) ===== == ====== ======= ======= =======
See accompanying notes. F-5 58 P.F. CHANG'S CHINA BISTRO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
PREDECESSORS COMPANY ------------------------------ ------------------------------------------------------ PERIOD FROM PERIOD FROM SIX MONTHS ENDED YEAR ENDED JANUARY 1, 1996 FEBRUARY 29, 1996 YEAR ENDED ------------------- DECEMBER 31, TO FEBRUARY 28, TO DECEMBER 29, DECEMBER 28, JUNE 29, JUNE 28, 1995 1996 1996 1997 1997 1998 ------------ --------------- ----------------- ------------ -------- -------- (UNAUDITED) (IN THOUSANDS) OPERATING ACTIVITIES: Net income (loss)....................... $ 647 $ 273 $(1,145) $(1,696) $ (241) $ 847 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation.......................... 322 82 198 858 348 795 Amortization.......................... -- -- 154 244 103 218 Minority members' and partners' interests........................... -- -- 720 1,308 758 345 Change in operating assets and liabilities: Receivables......................... (127) 134 (658) (1,403) 659 1,237 Inventories......................... (54) (5) (75) (169) (10) 1 Prepaids and other current assets... (56) (6) 17 (338) (310) (349) Other assets........................ (40) 8 (63) (207) 3 (94) Accounts payable.................... 489 (65) 395 609 (331) 1,131 Accrued payroll..................... 50 80 385 590 (433) 52 Other accrued expenses.............. 299 (143) 289 452 214 482 Unearned revenue.................... 67 (13) 63 172 (3) (36) Accrued minority members' distributions..................... -- -- -- (281) (281) -- ------- ----- ------- ------- ------- ------- Net cash provided by operating activities............................ 1,597 345 280 139 476 4,629 INVESTING ACTIVITIES: Capital expenditures.................... (824) -- (4,008) (8,696) (2,769) (8,557) Decrease (increase) in notes receivable from related parties.................. -- -- -- (292) (119) 36 Payment for members' interests.......... -- -- (4,175) (2,520) -- -- ------- ----- ------- ------- ------- ------- Net cash used in investing activities... (824) -- (8,183) (11,508) (2,888) (8,521) FINANCING ACTIVITIES: Net proceeds from revolving line of credit................................ -- -- -- 5,500 -- 3,500 Proceeds from issuance of long-term debt.................................. -- -- -- 1,600 1,600 -- Repayments of long-term debt............ (71) (7) (267) (491) (246) (272) Proceeds from issuance of common stock................................. -- -- 5 -- -- -- Proceeds from issuance of redeemable preferred stock, net of issuance costs................................. -- -- 10,013 6,415 6,415 -- Proceeds from minority partners' contributions......................... -- -- -- 441 183 92 Proceeds from members' contributions.... 710 -- -- -- -- -- Distributions to members and stockholders.......................... (1,279) (340) -- -- -- -- Distributions to minority members and partners.............................. -- -- (449) (1,234) (321) (365) ------- ----- ------- ------- ------- ------- Net cash provided by (used in) financing activities............................ (640) (347) 9,302 12,231 7,631 2,955 ------- ----- ------- ------- ------- ------- Net increase (decrease) in cash and cash equivalents........................... 133 (2) 1,399 862 5,219 (937) Cash and cash equivalents at the beginning of the period............... 347 480 478 1,877 1,877 2,739 ------- ----- ------- ------- ------- ------- Cash and cash equivalents at the end of the period............................ $ 480 $ 478 $ 1,877 $ 2,739 $ 7,096 $ 1,802 ======= ===== ======= ======= ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest.................. $ 13 $ 4 $ 108 $ 319 $ 112 $ 494 Cash paid for income taxes.............. -- -- 30 69 52 11 Purchase of members' interests through issuance of long-term debt............ -- -- 1,266 -- -- -- Purchase of property and equipment through issuance of long-term debt.... 200 -- 421 -- -- -- Purchase of members' and partners' interest through deferred purchase price................................. -- -- -- 2,426 -- --
See accompanying notes. F-6 59 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 28, 1997 AND JUNE 28, 1998 (THE INFORMATION AS OF JUNE 28, 1998 AND FOR THE SIX MONTHS ENDED JUNE 29, 1997 AND JUNE 28, 1998 IS UNAUDITED) 1. BASIS OF PRESENTATION P.F. Chang's China Bistro, Inc. (Company) operates restaurants in Arizona, California, Colorado, Texas, Nevada, Florida, North Carolina, Louisiana, and Virginia under the name of "P.F. Chang's China Bistro." The Company was formed in January, 1996 through the issuance of 500 shares of common stock to Mr. Paul Fleming for $100 in cash. In February 1996, the Company sold 4,975,000 shares of Series A convertible preferred stock convertible into 2,487,500 shares of common stock and warrants for $9,950,000 in cash. Contemporaneously, the Company acquired Mr. Fleming's 52 percent interest in Fleming Chinese Restaurants, Inc., which operates a restaurant in Scottsdale, Arizona (Scottsdale), for $1,037,000 in cash and $954,000 in notes payable. The Company also acquired Mr. Fleming's 43 percent interest in P.F. Chang's II, Inc., which operates a restaurant in Newport Beach, California (Newport Beach); 49.85 percent ownership in P.F. Chang's III, L.L.C., which operates a restaurant in La Jolla, California (La Jolla); and 54.2 percent ownership interest in P.F. Chang's IV, L.L.C., which operates a restaurant in Irvine, California (Irvine), for $2,006,000 in cash and 2,499,500 shares of common stock of the Company. In addition, in 1996 the Company acquired an additional 18 percent ownership in Scottsdale and the remaining 45.8 percent ownership of Irvine in various transactions for an aggregate of $1,132,000 in cash and $312,000 in notes payable. The acquisition of the ownership interests in the various entities during 1996 have been accounted for under the purchase method of accounting for business combinations. Accordingly, the purchase price was allocated to the proportional assets acquired and liabilities assumed based on their relative fair values, with $4,125,000 allocated to goodwill. As a result of the start-up nature of the operations of the Company, the significant prior claims of the preferred stockholders of the Company, and the minority interests in Scottsdale, Newport Beach and La Jolla, no significant value was assigned to the common stock issued in the acquisitions. During 1997, the Company purchased substantially all the remaining outstanding minority interests in the Scottsdale, La Jolla and Newport Beach restaurants for approximately $2,520,000 in cash and $2,426,000 in common stock of the Company to be issued in connection with a contemplated initial public offering (IPO). Upon consummation of an IPO, the number of common shares to be issued will be the fixed purchase price of $2,426,000 divided by the price per share of the common stock sold in the IPO. Should the IPO not be completed by a stipulated date as defined, the Company will be obligated (upon demand of the individual holders) to pay the minority interest holders the $2,426,000 in cash. The acquisition of the ownership interests in the various entities during 1997 has been accounted for under the purchase method of accounting for business combinations. Accordingly, the purchase price was allocated to the proportional assets acquired and liabilities assumed based on their relative fair values, with $4,581,000 allocated to goodwill. Two of the predecessor entities, Fleming Chinese Restaurants, Inc. and P.F. Chang's II, Inc. were dissolved and their operations transferred to two new entities, PFCCB Scottsdale, L.L.C. and PFCCB Newport Beach, L.L.C. Accordingly, at December 29, 1996, each of the existing restaurants was structured as a limited liability corporation, and the Company's ownership of these restaurants is through its membership in each limited liability corporation. The Company's new restaurants are generally organized as partnerships with the Company as general partner. The operations of the predecessor entities which operated the restaurants have been presented in the accompanying combined financial statements for 1995 and through the date of acquisition at historical cost due to the common ownership. The allocation of the purchase price resulted in no material adjustment to the historical recorded basis in the assets and liabilities except for goodwill. Therefore, the effect to the statement of operations is primarily amortization subsequent to the date of acquisition. F-7 60 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has incurred successive losses and has negative working capital at December 28, 1997, and its capital requirements, including start-up costs, related to the opening of additional restaurants have been, and will continue to be significant. The Company has experienced positive operating cash flows since its inception. To date, the Company has been substantially dependent upon loans from lending institutions and private equity funding to develop its restaurants. The Company will be required to seek significant amounts of additional debt and/or equity capital in order to fund its planned development activities. Although there is no assurance that the Company will be able to obtain adequate financing for its future development, management believes that such capital will be available to the Company. In the event the Company is unsuccessful in obtaining additional funds for development, management may need to take steps to continue to operate within the available cash flow. Such steps may include, among others, the postponement of planned future development. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The 1996 and 1997 consolidated financial statements include the accounts and operations of the Company and its subsidiaries or partnerships in which it owns more than a 50 percent interest. All material balances and transactions between the consolidated entities have been eliminated. The 1995 combined statements of operations and cash flows includes the accounts of Fleming Chinese Restaurants, Inc., P.F. Chang's II, Inc., P.F. Chang's III, L.L.C., and P.F. Chang's IV, L.L.C. All material balances and transactions between the combined entities have been eliminated. INTERIM FINANCIAL INFORMATION The consolidated financial statements for the six months ended June 29, 1997 and June 28, 1998 are unaudited and have been prepared on the same basis as the audited consolidated financial statements included herein. In the opinion of management, such unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of financial position and results of operations. The results of operation for such interim periods are not necessarily indicative of the results that may be expected for any future periods. 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. 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 affiliated partnerships. Payments of principal and interest of 11.0 percent amortized over a five year period are due monthly with a balloon payment for the outstanding principal and interest due at the end of two years. F-8 61 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) CONSTRUCTION-IN-PROGRESS The Company capitalizes all direct costs in the construction of new restaurants. Upon opening, these costs are depreciated over their useful lives based upon the property classifications. 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 approximate 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, after which 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 (see Note 1) 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 during the year ended December 31, 1995, the period from January 1, 1996 to February 28, 1996, the period from February 29, 1996 to December 29, 1996, and for the year ended December 28, 1997 was approximately $328,000, $10,000, $232,000, and $901,000, respectively. During the six months ended June 29, 1997 and June 28, 1998, advertising expense was approximately $432,000 and $550,000, respectively. PREOPENING Preopening expenses, consisting primarily of manager salaries and relocation, advertising, and 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 No. 109, "Accounting for Income Taxes." Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax bases 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. Minority members' and partners' interests in income or loss of limited liability corporations and partnerships includes no provision for income taxes as any tax liability related thereto is the responsibility of the individual minority members. The predecessor entities are S corporations and limited liability corporations under the Internal Revenue Code. Accordingly, the taxable income and losses are allocated and taxed directly to the stockholders and F-9 62 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) members resulting in no tax provision for the year ended December 31, 1995 or the period from January 1, 1996 to February 28, 1996. 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 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 Statement of Financial Accounting Standards No. 128, "Earnings per Share." Pro forma basic and diluted net income per share has been computed giving effect to the conversion of all the outstanding shares of convertible redeemable preferred stock and deferred purchase price liability into common stock upon closing of the Company's IPO (determined using the if-converted method). PRO FORMA BALANCE SHEET (UNAUDITED) As discussed in Notes 1 and 6, the convertible redeemable preferred stock and deferred purchase price liability will be automatically converted upon the closing of the public offering contemplated herein. The accompanying pro forma balance sheet gives effect to this conversion as if such event occurred on June 28, 1998. FISCAL YEAR The Company's fiscal year ends on the Sunday closest to the end of December and includes 52 weeks in 1995, 1996 and 1997. 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. 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. F-10 63 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) RECLASSIFICATIONS Certain amounts shown in the prior period combined and consolidated financial statements have been reclassified to conform with the current year consolidated financial statements presentation. 3. PROPERTY AND EQUIPMENT Property and equipment consists of the following:
DECEMBER 29, DECEMBER 28, JUNE 28, 1996 1997 1998 ------------ ------------ ----------- (IN THOUSANDS) (UNAUDITED) Leasehold improvements........................ $1,551 $ 6,904 $10,380 Furniture, fixtures and equipment............. 1,946 4,386 5,576 China and smallwares.......................... 142 423 575 ------ ------- ------- 3,639 11,713 16,531 Less accumulated depreciation................. 685 1,506 2,297 ------ ------- ------- $2,954 $10,207 $14,234 ====== ======= =======
4. REVOLVING LINE OF CREDIT On October 24, 1997, the Company entered into a $10,000,000 revolving line of credit agreement with a finance corporation. The line of credit bears interest at LIBOR plus 4.0 percent, payable monthly, and expires on November 1, 1998. At December 28, 1997, amounts available under the line of credit were approximately $4,500,000. In June 1998, the Company amended its revolving line of credit to provide for a $20,000,000 line with interest at LIBOR plus 3.5 percent and expires on July 1, 1999. At June 28, 1998, amounts available under the line of credit were $11,000,000. The weighted average interest rate under the line of credit was 9.5 percent in 1997 and 1998, respectively. The line of credit requires the Company to maintain a net worth of at least $10,000,000 including convertible redeemable preferred stock. The line of credit agreement also contains covenants which place various restrictions on sales of properties, transactions with affiliates, creation of additional debt, and other nonfinancial covenants, as defined. The line of credit agreement is collateralized by the Company's interests in certain affiliated partnerships. F-11 64 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5. LONG-TERM DEBT Long-term debt consists of the following:
DECEMBER 29, DECEMBER 28, JUNE 28, 1996 1997 1998 ------------ ------------ ------------ (IN THOUSANDS) (UNAUDITED) $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. ............... $ -- $1,088 $1,080 $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. ................................... -- 463 436 $1,266,000 unsecured promissory notes to related parties, payable 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. ............................... 1,065 762 606 $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. ............... 421 382 358 $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. ................ 173 133 114 Other......................................... 104 44 6 ------ ------ ------ 1,763 2,872 2,600 Less current portion.......................... 432 481 441 ------ ------ ------ $1,331 $2,391 $2,159 ====== ====== ======
The aggregate annual payments of long-term debt outstanding at December 28, 1997, for the next five years and thereafter, are summarized as follows: 1998--$481,000; 1999--$523,000; 2000--$281,000; 2001--$178,000; 2002--$184,000; and thereafter--$1,225,000. F-12 65 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 6. PREFERRED STOCK AND COMMON STOCKHOLDERS' EQUITY PREFERRED STOCK In February 1996, the Company issued 4,975,000 shares of Series A convertible redeemable preferred stock (Series A preferred stock) convertible into 2,487,500 shares of common stock, and warrants exercisable for 1,243,750 shares of Series A preferred stock convertible into 621,875 Shares of common stock, for an aggregate purchase price of approximately $9,950,000, less issuance costs of $695,000. In September 1996, the Company issued an additional 379,270 shares of Series A preferred stock convertible into 189,635 shares of common stock for $758,000 in order to purchase the remaining minority interests in the Irvine restaurant. The Series A preferred stock has a $0.001 par value and an annual six percent dividend payable quarterly on March 31, June 30, September 30, and December 31 in shares of such Series A preferred stock on a cumulative basis beginning January 1, 1998. The Company may also declare, upon unanimous consent of the Non-Investor Directors as defined, a cash dividend equal to ten percent of the liquidation price of the Series A preferred stock in lieu of the Series A preferred stock dividend. In May 1997, the Company issued 1,517,131 shares of Series B convertible redeemable preferred stock (Series B preferred stock) convertible into 758,565 shares of common stock for an aggregate purchase price of $6,599,000, less issuance costs of approximately $184,000. The Series B preferred stock has a $0.001 par value and an annual six percent dividend payable quarterly on March 31, June 30, September 30, and December 31 in shares of such Series B preferred stock on a cumulative basis beginning April 1, 1999. The Company may also declare, upon unanimous consent of the Non-Investor Directors as defined, a cash dividend equal to ten percent of the liquidation price of the Series B preferred stock in lieu of the Series B preferred stock dividend. Each two shares of Series A and Series B preferred stock are convertible at any time into one share of common stock, subject to dilution adjustments as defined, at the option of the holder and is automatically converted into common stock at the date of a qualified IPO. The Series A preferred stock is mandatorily redeemable at a minimum of 50 percent of the shares outstanding in May 2003 with the remaining outstanding shares becoming mandatorily redeemable in May 2004 at $2.00 per share plus accrued and unpaid dividends. The Series A preferred stock has a liquidation preference equal to the greater of $2.00 per share or such amount per share as would have been payable had each share of Series A preferred stock been converted into common stock. The Series B preferred stock is mandatorily redeemable at a minimum of 50 percent of the shares outstanding in May 2003 with the remaining in May 2004 at $4.35 per share plus accrued and unpaid dividends. The Series B preferred stock has a liquidation preference equal to the greater of $4.35 per share or such amount per share as would have been payable had each share of Series B preferred stock been converted into common stock. Upon voluntary or involuntary liquidation, the holders of the Series A and Series B preferred stock shall be entitled to be paid out of the assets of the Company with the common stockholders being entitled to all remaining assets of the Company to be distributed. The holders of the Series A and Series B preferred stock have the right to vote based on the number of shares of common stock into which each share of Series A and Series B preferred stock would thus be converted. The difference between the redemption amount and the carrying amount of the Series A and Series B preferred stock and dividends thereon calculated on a straight-line basis beginning with the date of issuance is being recorded through periodic accretions charged to accumulated deficit. Effective April 30, 1997, 2,233,980 and 417,156 shares of Series A and Series B preferred stock, respectively, have been reserved for issuance upon the exercise of warrants previously issued and upon issuance of "payment-in-kind" dividends of Series A and Series B preferred stock. The warrant to purchase Series A preferred stock issued during 1996 was cancelable by the Company should the Irvine restaurant achieve certain operating goals. During 1997, the Irvine restaurant achieved such goals, and the warrant was consequently canceled. F-13 66 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In connection with the original capitalization of the Company, an additional warrant to purchase 124,380 shares of Series A 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. SHAREHOLDERS' AGREEMENT The Company's common and preferred stock is subject to a shareholders' agreement which provides to the stockholders a right of first refusal to purchase the other stockholders' interests. Before any such shares of common and preferred stock may be sold, assigned, transferred, pledged, encumbered, or disposed in any way, such shares shall first be offered to the Company and other stockholders party to the shareholders' agreement. In addition, such stockholders have certain bring-along and tag-along rights with respect to sales of common stock by certain other stockholders. Upon a qualified IPO, all rights and obligations under the shareholders' agreement terminate. 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 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. 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. COMMON STOCK The Company has reserved 5,912,920 shares of common stock for issuance upon the exercise of options and warrants to purchase such shares, and upon the conversion of Series A and Series B preferred stock into such shares. STOCK OPTION PLAN The Company has elected to follow APB 25 and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," (Statement 123) requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 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 F-14 67 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 December 28, 1997 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. Incentive options granted to individuals who own more than ten percent of the total combined voting power of all classes of stock shall not be exercisable after five years and options granted to prospective employees, consultants or directors may not become exercisable prior to the date on which such person commences services with the Company. Upon certain changes in control of the Company, the Plan provides 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. Pro forma information regarding net income (loss) is required by Statement 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 1996 and 1997: 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 .01 and .122, 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 the Company's employee stock options have characteristics significantly different from those of traded options, and 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 Statement 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:
PERIOD FROM FEBRUARY 29, 1996 TO YEAR ENDED DECEMBER 29, DECEMBER 28, 1996 1997 ------------ ------------ (IN THOUSANDS) Net loss, as reported.............................. $1,145 $1,696 Pro forma compensation expense for stock options... 48 82 ------ ------ Pro forma net loss................................. $1,193 $1,778 ====== ======
F-15 68 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Information regarding activity for stock options outstanding under the Plans are as follows:
OUTSTANDING OPTIONS ---------------------- SHARES WEIGHTED- AVAILABLE AVERAGE FOR EXERCISE OPTIONS SHARES PRICE --------- --------- --------- Outstanding at December 31, 1995................... -- -- $ -- Authorized....................................... 890,000 -- -- Granted.......................................... (791,510) 791,510 2.98 Exercised........................................ -- -- -- Forfeited (canceled)............................. -- -- -- -------- --------- ----- 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 (unaudited)........................... -- -- -- Granted (unaudited).............................. (48,125) 48,125 13.09 Exercised (unaudited)............................ -- -- -- Forfeited (canceled) (unaudited)................. -- -- -- -------- --------- ----- Outstanding at June 28, 1998 (unaudited)........... 76,865 1,009,635 $3.87 ======== ========= =====
Information regarding options outstanding and exercisable at December 28, 1997 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------ ---------------------------- WEIGHTED- AVERAGE REMAINING WEIGHTED- WEIGHTED- RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ------------------------------------------------------------------------------------------- $2.40 504,872 8.16 years $ 2.40 176,672 $2.40 $4.00-$6.00 445,388 5.38 years 4.38 105,510 4.00 $10.00 11,250 9.90 years 10.00 -- --
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 during the period from February 29, 1996 to December 29, 1996 and for the year ended December 28, 1997 was $0.56 and $1.38, respectively. F-16 69 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. INCOME TAXES Income tax expense consisted of the following:
PERIOD FROM FEBRUARY 29, 1996 TO YEAR ENDED DECEMBER 29, DECEMBER 28, 1996 1997 ------------ ------------ (IN THOUSANDS) Federal: Current.......................................... $-- $-- Deferred......................................... -- -- --- --- -- -- State: Current.......................................... 30 69 Deferred......................................... -- -- --- --- 30 69 --- --- $30 $69 === ===
The Company's effective tax rate differs from the federal statutory rate for the following reasons:
PERIOD FROM FEBRUARY 29, 1996 TO YEAR ENDED DECEMBER 29, DECEMBER 28, 1996 1997 ------------ ------------ (IN THOUSANDS) Income tax benefit at federal statutory rate....... $(379) $(553) State taxes, net of federal benefit................ 30 69 Increase in valuation allowance.................... 398 426 Other, net......................................... (19) 127 ----- ----- $ 30 $ 69 ===== =====
The Company's net income for the year ended December 31, 1995 and for the period from January 1, 1996 to February 28, 1996 included earnings attributable to the Scottsdale, Newport Beach, La Jolla and Irvine restaurants. These restaurants were organized as limited liability companies or had elected under Subchapter S of the Internal Revenue Code to have their stockholders pay any federal and state income tax due on their earnings. Although income prior to the consolidation attributable to the acquired restaurants is included in the Company's consolidated financial statements, the Company is not required to pay income taxes on the income since they are the responsibility of the members and stockholders of the acquired companies. F-17 70 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The income tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:
DECEMBER 29, DECEMBER 28, 1996 1997 ------------ ------------ (IN THOUSANDS) Deferred tax assets: Bonus accrual.................................... $ 47 $ -- Depreciation on property and equipment........... 44 2 Preopening expenses.............................. 80 267 Goodwill amortization............................ 7 -- Net operating loss carryforwards................. 290 760 ----- ------ 468 1,029 Deferred tax liabilities: Goodwill amortization............................ -- 136 ----- ------ 468 893 Valuation allowance................................ (468) (893) ----- ------ Net deferred tax assets............................ $ -- $ -- ===== ======
During the period from January 1, 1996 to December 29, 1996 and for the year ended December 28, 1997, the valuation allowance increased $468,000 and $425,000, respectively. At December 28, 1997, the Company has a net operating loss carryforward of approximately $1,900,000 which begins to expire for federal purposes in 2011 and for state purposes in 2001. F-18 71 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 8. NET INCOME (LOSS) PER SHARE AND PRO FORMA NET INCOME (LOSS) PER SHARE The following table sets forth the computation of basic and diluted net income (loss) per share:
PERIOD FROM FEBRUARY 29, SIX MONTHS ENDED 1996 TO YEAR ENDED -------------------- DECEMBER 29, DECEMBER 28, JUNE 29, JUNE 28, 1996 1997 1997 1998 ------------ ------------ -------- -------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Numerator: Net income (loss).................... $(1,145) $(1,696) $ (241) $ 847 Convertible redeemable preferred stock accretion................... (504) (876) (396) (477) ------- ------- ------ ------ Numerator for basic net income (loss) per share--income available to common stockholders............... (1,649) (2,572) (637) 370 Effect of dilutive securities: Convertible redeemable preferred stock accretion................. -- -- -- 477 ------- ------- ------ ------ Numerator for diluted net income (loss) per share--income available to common stockholders after assumed conversions............... $(1,649) $(2,572) $ (637) $ 847 ======= ======= ====== ====== Denominator: Denominator for basic net income (loss) per share--weighted-average shares............................ 2,500 2,500 2,500 2,500 Effect of dilutive securities: Employee and director stock options........................... -- -- -- 660 Warrants............................. -- -- -- 39 Convertible redeemable preferred stock............................. -- -- -- 3,456 ------- ------- ------ ------ Denominator for diluted net income (loss) per share--adjusted weighted average shares and assumed conversions.......................... 2,500 2,500 2,500 6,655 ======= ======= ====== ====== Net income (loss) per share: Basic................................ $ (0.66) $ (1.03) $(0.25) $ 0.15 ======= ======= ====== ====== Diluted.............................. $ (0.66) $ (1.03) $(0.25) $ 0.13 ======= ======= ====== ======
Warrants to purchase Series A Preferred Stock convertible into 62,190 shares of common stock and options to purchase 961,510 shares of common stock ranging from $2.40 to $10.00 per share were outstanding during the year ended December 28, 1997, but were not included in the computation of diluted net income (loss) per share because the effect would be antidilutive. The Series A and B preferred stock convertible to common stock is not included in the computation of diluted net income (loss) per share during the year ended December 28, 1997, because the assumed conversions would be antidilutive. As discussed in Note 1 and should the Company complete an IPO, contingently issuable shares based on the IPO common stock price will be issued. As the conditions for the shares to be issued have not been satisfied, the contingent shares are not included in diluted net income (loss) per share. F-19 72 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table sets forth the computation of basic and diluted pro forma net income (loss) per share giving effect to the conversion of the preferred stock and the deferred purchase price to common stock as of the beginning of each period presented:
YEAR ENDED SIX MONTHS DECEMBER 28, ENDED JUNE 28, 1997 1998 ------------ -------------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Numerator for basic pro forma net income (loss) per share: Net income (loss)....................................... $(1,696) $ 847 ======= ====== Denominator: Weighted-average shares................................. 2,500 2,500 Conversion of convertible preferred stock and deferred purchase price liability............................. 3,206 3,599 ------- ------ Denominator for basic pro forma net income (loss) per share................................................ 5,706 6,099 Effect of dilutive securities: Employee and director stock options.................. -- 660 Warrants............................................. -- 39 ------- ------ Denominator for dilutive pro forma net income (loss) per share -- adjusted weighted average shares and assumed conversions.......................................... 5,706 6,798 ======= ====== Pro forma net income (loss) per share: Basic................................................... $ (0.30) $ 0.14 ======= ====== Diluted................................................. $ (0.30) $ 0.13 ======= ======
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 2019. The restaurant facility and real property leases primarily have renewal clauses of five to 15 years exercisable at the option of the Company and 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 during the year ended December 31, 1995, the period from January 1, 1996 to February 28, 1996, the period from February 29, 1996 to December 29, 1996 and for the year ended December 28, 1997 was approximately $656,000, $121,000, $1,176,000 and $2,203,000, respectively. During the six months ended June 29, 1997 and June 28, 1998, rent expense was approximately $698,000 and $1,311,000, respectively. Contingent rent included in rent expense during the year ended December 31, 1995, the period from January 1, 1996 to February 28, 1996, the period from February 29, 1996 to December 29, 1996 and for the year ended December 28, 1997 was approximately $152,000, $76,000, $225,000 and $605,000, respectively. During the six months ended June 29, 1997 and June 28, 1998, contingent rent included in rent expense was approximately $270,000 and $493,000, respectively. At December 28, 1997, 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 F-20 73 P.F. CHANG'S CHINA BISTRO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) additional contingent rent based upon gross sales, as defined in the leases. Future minimum lease payments under operating leases (including restaurants to be opened in 1998) are as follows (in thousands): 1998............................................... $ 3,158 1999............................................... 4,161 2000............................................... 4,220 2001............................................... 4,172 2002............................................... 4,145 Thereafter......................................... 38,537 ------- Total minimum lease payments....................... $58,393 =======
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 are included in the above disclosed amounts. 10. BENEFIT PLAN Effective July 1, 1997, the Company adopted the 401(k) Defined Contribution Benefit 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 year ended December 28, 1997 and for the six months ended June 28, 1998, the Company did not make any contributions to the Plan. 11. SUBSEQUENT EVENTS On June 2, 1998, the Company's Board of Directors approved, subject to stockholder approval, a one-for-two reverse stock split of the common stock and made conforming adjustments on the terms of all outstanding common stock equivalents, including the preferred stock, except for the par value and authorized shares. All shares and per share information in the accompanying consolidated financial statements has been retroactively adjusted to reflect the reverse split. During 1998, the Company's Board of Directors approved, subject to stockholder approval, 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 280,000 shares 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% 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 option price per share for an incentive stock option granted to a person owning stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Company (or a parent or subsidiary) may not be less than 110 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 1998, the Company's Board of Directors approved, subject to stockholder approval, 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-21 74 APPETIZERS - -------------------------------------------------------------------------------- PEKING RAVIOLIS Crescent-shaped dumplings filled with ground pork and vegetables. (Pan Fried or Steamed) $4.95 TRADITIONAL SPARE RIBS BBQed using our age-old technique. $5.95 SALT & PEPPER SHRIMP Shell on shrimp, tossed with scallions, Kosher salt and course black pepper. $6.95 CHANG'S CHICKEN IN SOOTHING LETTUCE WRAP Quickly-cooked spiced chicken served in a cool lettuce cup. $5.95 NORTHERN STYLE SHORT RIBS Marinated and lightly fried. Served with a salt and pepper dip. $5.95 CHANG'S VEGETABLES IN SOOTHING LETTUCE WRAP Wok seared vegetables Southeast Asian style with mint and lime. Served in a cool lettuce cup. $5.95 HARVEST SPRING ROLLS Shredded vegetables wrapped in a delicate pancake then fried. $3.50 VEGETARIAN DUMPLINGS Crescent-shaped dumplings filled with shredded vegetables. (Pan Fried or Steamed) $4.95 CANTONESE PORK MEDALLIONS BBQed, then sliced. $4.95 SHRIMP DUMPLINGS Steamed, served with a ginger chili soy sauce. $6.95 RED SAUCED WONTONS Shrimp and pork filled wontons served with chili soy sauce. $5.75 SOUPS - -------------------------------------------------------------------------------- HOT AND SOUR SOUP A seductive blend of chicken and bean curd. Sparked with hot white pepper, and vinegar which creates an appetite for more. Cup $2.95 Bowl $4.95 WONTON SOUP Mushrooms, chicken, shrimp, and pork wontons in a chicken broth. Bowl $4.95 SALADS - -------------------------------------------------------------------------------- WONTON CHICKEN SALAD Fried wonton strips, chicken and garden vegetables with a refreshing vinaigrette on shredded lettuce. $6.95 WARM DUCK SALAD Strips of crisp duck tossed with soy vinaigrette and red cabbage. $8.95 AHI TUNA SALAD Rolled in Chinese spices, wok seared, served on mixed greens with a spicy mustard dressing. $9.95 COLD CUCUMBER SALAD Cucumbers sprinkled with soy and sesame. $4.95 CHANG'S CHICKEN SALAD Tossed with a ginger vinaigrette and peanut sauce on a bed of greens. $7.95 BARBECUE CHICKEN SALAD Slow roasted Cantonese style chicken breast served warm over mixed greens. $7.95 75 CHANG'S RECOMMENDS ---------------------------------- (Served with steamed rice) LEMON PEPPER SHRIMP Served on sauteed chives and bean sprouts. $12.95 CANTONESE DUCK Slow-roasted with Chang's secret ingredients. $12.95 PHILIP'S BETTER LEMON CHICKEN Quick-fired with a tart citrus sauce that has a hint of sweetness. $10.75 MALAYSIAN CHICKEN In a curry sauce with coconut milk and onions. Served with peanuts, raisins, coconut and plum sauce on the side. $9.95 [CHINESE CHARACTER]BEEF A LA SZECHWAN Twice-cooked with celery and carrots resulting in a crispy texture unlike anything you are used to. $11.95 [CHINESE CHARACTER]SZECHWAN CHICKEN CHOW FUN Wok seared with chilis, green onions and Szechwan preserved vegetables. $8.95 [CHINESE CHARACTER]SZECHWAN FROM THE SEA Tender scallops, shrimp or calamari prepared in a red chili garlic sauce. $11.95 CHEF ROY'S FAVORITE CHICKEN With oyster sauce and scallions. Served on a bed of fresh steamed broccoli. $10.25 CHICKEN WITH BLACK BEAN SAUCE Chunks of chicken, stir-fried in Oriental black bean sauce. $10.50 [CHINESE CHARACTER]CHANG'S SPICY CHICKEN Lightly-breaded chunks stir-fried in a sweet Szechwan sauce. (Our version of General Chu's) $10.75 CANTONESE CHICKEN Slow-roasted with Chang's secret ingredients. $9.95 CRISPY HONEY SHRIMP Lightly battered shrimp, quick fried and coated with a flavorful sauce. $12.95 MEATS ---------------------------------- (Served with steamed rice) [CHINESE CHARACTER]ORANGE PEEL BEEF Szechwan-style beef tossed with red chilis and fresh orange peel for a rewarding taste sensation. $10.25 MONGOLIAN BEEF Quickly-cooked steak with scallions and garlic. $10.95 SWEET AND SOUR PORK Stir-fried with pineapples, peppers and onions in a pungent sweet flavored sour sauce. $8.95 MU SHU PORK An American favorite served with hoisin sauce and thin pancakes. $7.95 CHICKEN ---------------------------------- (Served with steamed rice) [CHINESE CHARACTER]KUNG PAO CHICKEN Diced chicken quick-fired with peanuts, chili peppers and scallions. Our hot favorite. $9.95 [CHINESE CHARACTER]ORANGE PEEL CHICKEN Tossed with orange peel and chili peppers for a spicy/citrus combination. $9.95 MU SHU CHICKEN A Chinese classic served with hoisin sauce and thin pancakes. $8.95 [CHINESE CHARACTER]SPICY GROUND CHICKEN AND EGGPLANT Eggplant sauteed with fiery spices, ground chicken and scallions. $8.95 SWEET AND SOUR CHICKEN Stir-fried with pineapples, peppers and onions in a pungent sweet flavored sour sauce. $8.95 76 SEAFOOD (Served with steamed rice) TREASURES OF THE SEA [CHINESE CHARACTER]ORANGE PEEL SHRIMP Choice of scallops or shrimp Tossed with hot chilis and sauteed with chives, snow fresh orange peel. peas and wine. $12.95 $11.95 CHANG'S LEMON SCALLOPS PAUL'S CATFISH A light lemon sauce over Farm raised catfish fillets quick-cooked scallops. sauteed and served with $11.95 black bean sauce. $12.95 [CHINESE CHARACTER]KUNG PAO SCALLOPS OR SHRIMP Cooked traditionally with peanuts and fresh chili peppers. $1l.95 NOODLES, MEINS AND RICE DOUBLE PAN FRIED NOODLES [CHINESE CHARACTER]GARLIC NOODLES Semi-crisp egg noodles stir-fried Egg noodles tossed with with vegetables and served with a garlic and chilis. choice of beef, pork, A Mainland tradition. chicken, or shrimp. $7.95 $8.95 CHOW MEIN P.F. CHANG'S FRIED RICE Egg noodles stir fried with a Mixed with egg and soy, garnished choice of beef, pork, with sliced scallions. Choice of chicken or shrimp. beef, chicken, pork, or shrimp. $8.95 $5.95 [CHINESE CHARACTER]DAN DAN NOODLES SINGAPORE NOODLES Scallions, garlic and chilis sauteed Thin rice noodles stir-fried with ground chicken nesting on hot with vegetables. Served egg noodles. Garnished with shredded with or without curry. cucumber and bean sprouts. (Chinese angel hair) $8.95 $7.95 CANTONESE CHOW FUN Wide rice noodles with choice of chicken or beef with onions and garlic. $9.95 VEGETARIAN PLATES AND SIDES SZECHWAN-STYLE LONG BEANS GARLIC SNAP PEAS Quickly cooked with Stir-fried with garlic. preserved vegetables. $4.95 $5.95 SPINACH SAUTEED WITH GARLIC BUDDHA'S FEAST The name says it all. Mixed vegetables. $4.95 (Steamed or Stir-Fried) $5.95 SHANGHAI SNOW PEAS POACHED BABY BOK CHOY Sauteed with black mushrooms Served with lightly and water chestnuts. sauteed black mushrooms. $4.95 $5.95 [CHINESE CHARACTER]SAUTEED SPICY EGGPLANT Tossed with scallions and a fiery sauce. $6.95 Please no cigar or pipe smoking. [CHINESE CHARACTER]Spicy dish Sorry, no checks accepted. 77 WELCOME -------------------------------------------- P.F. Chang's believes that variety is the keystone of a great meal. Our menu offers culinary creations from the major regions of China: Canton, Shanghai, Szechwan, Hunan, Mongolia, as well as our unique specialties, which draw on a multitude of traditions to create a unique dining adventure. FAN AND T'SAI -------------------------------------------- The essential goal of a Chinese meal is to attain the 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. Only the very best of fresh ingredients find their way to our kitchens. You can't help but notice a unique clarity and distinctness of flavor. And no MSG is allowed by our chef in food preparation. WINE AND CHINESE? -------------------------------------------- Absolutely. It's a perfect way to excite all the flavors of each of China's principal food regions. Your server can offer sophisticated recommendations from our extensive wine list for the ideal selection. And make sure to sample our specially blended teas. They are the perfect complement to our one-of-a-kind dessert creations. PREPARATIONS FOR YOU -------------------------------------------- We are proud of our food preparation techniques. Each dish is prepared to order using only the freshest of ingredients. Ask questions. Then experience a memorable blend of Chinese cuisine and American hospitality: the delicious harmony of P.F. Chang's China Bistro. 78 YOU ARE SURROUNDED --------------------------------- ...by a unique environment combining the best influences of Chinese and American cultures. As you dine in comfort, enjoying the finest traditions of American hospitality, you are also aware of the mystery and legend of a people thousands of years old. You'll notice... FROM THE MOMENT --------------------------------- ...you enter P.F. Chang's China Bistro, everything you see from the Mural to the Menu tells ancient stories of Emperors, Gods, Guardians and more. In fact... THE SCULPTURES --------------------------------- ...are interpretations of those unearthed in the ancient city of Xi'an, dating back to the 11th Century B.C. They depict a time when lions proudly guarded the Qian Ling Mausoleum during the T'ang Dynasty; when loyal handmaidens willingly attended to the needs of royalty and when stern figures of warriors were buried with Emperors in place of entombing the ruler's actual servants. Now, if you... LOOK TO THE MURAL --------------------------------- ... intimidation gives way to meditation in this dramatic recreation of a typical mid-12th Century narrative screen painting. The challenge for our artist was to achieve a mural of this magnitude from a very small original scene. And finally... THE MENU SPEAKS --------------------------------- ...to us in Chinese symbols, each with a variety of meanings when read alone, but presenting a specific meaning when combined. Look at the front of the menu. The topmost character symbolizes all things rich, and often represents China, herself. The lower figure usually means an intimate, casual place to enjoy fine dining. Combined on the front of our menu, these characters can be read to mean...A China Bistro. [P. F. CHANG'S CHINA BISTRO LOGO] 79 The inside back cover of the prospectus contains photographs of menu items offered at the Company's restaurants set over the background of a mural depicting 12th century China. 80 - ------------------------------------------------------ - ------------------------------------------------------ NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING STOCKHOLDER OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM IT IS UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. ------------------ TABLE OF CONTENTS
PAGE Prospectus Summary......................... 3 Risk Factors............................... 6 Use of Proceeds............................ 11 Dividend Policy............................ 11 Capitalization............................. 12 Dilution................................... 13 Selected Consolidated Financial and Operating Data........................... 14 Management's Discussion and Analysis of Financial Condition and Results of Operations............................... 16 Business................................... 26 Management................................. 35 Certain Transactions....................... 41 Principal and Selling Stockholders......... 43 Description of Capital Stock............... 45 Shares Eligible for Future Sale............ 48 Underwriting............................... 49 Legal Matters.............................. 51 Experts.................................... 51 Additional Information..................... 51 Index to Consolidated Financial Statements............................... F-1
------------------ UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ - ------------------------------------------------------ SHARES [P.F. CHANG'S LOGO] COMMON STOCK ------------------------- PROSPECTUS ------------------------- DONALDSON, LUFKIN & JENRETTE NATIONSBANC MONTGOMERY SECURITIES LLC DAIN RAUSCHER WESSELS a division of Dain Rauscher Incorporated , 1998 - ------------------------------------------------------ - ------------------------------------------------------ 81 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth all expenses, other than the underwriting discounts and commissions, payable by the Registrant in connection with the sale of the Common Stock being registered. The Company is paying all of the expenses incurred on behalf of the Selling Stockholders (other than underwriting discounts and commissions). All amounts shown are estimates except for the registration fee and the NASD filing fee. Registration fee............................................ $ 16,963 NASD filing fee............................................. 6,250 Nasdaq National Market fee.................................. 41,250 Blue sky qualification fees and expenses.................... 5,000 Printing and engraving expenses............................. 100,000 Legal fees and expenses..................................... 300,000 Accounting fees and expenses................................ 100,000 Transfer agent and registrar fees........................... 10,000 Fee for Custodian for Selling Stockholders.................. 10,000 Miscellaneous............................................... 65,537 -------- Total............................................. $650,000 ========
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS. Section 145 of the DGCL permits indemnification of officers, directors, and other corporate agents under certain circumstances and subject to certain limitations. The Registrant's Amended and Restated Certificate of Incorporation and By-laws provide that the Registrant shall indemnify its directors, officers, employees and agents to the full extent permitted by the DGCL, including circumstances in which indemnification is otherwise discretionary under Delaware law. In addition, the Registrant has entered into separate indemnification agreements with its directors and executive officers which require the Registrant, among other things, to indemnify them against certain liabilities which may arise by reason of their status or service (other than liabilities arising from acts or omissions not in good faith or willful misconduct). These indemnification provisions and the indemnification agreements entered into between the Registrant and its executive officers and directors may be sufficiently broad to permit indemnification of the Registrant's executive officers and directors for liabilities (including reimbursement of expenses incurred) arising under the Securities Act of 1933, as amended (the "Securities Act"). The Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement provides for indemnification by the Underwriters of the Registrant and its officers and directors for certain liabilities arising under the Securities Act, or otherwise. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. Since July 31, 1995, the Registrant and its Predecessors have sold and issued the following unregistered securities: (a) Issuances of Shares of Common Stock. On January 31, 1996, the Registrant issued a total of 500 shares of Common Stock to Paul Fleming in exchange for an aggregate purchase price of $100.00, or $0.20 per share. On February 28, 1996, the Registrant issued a total of 2,499,500 shares of Common Stock to Paul and Kelly Fleming in exchange for their interests in the Predecessors. (b) Issuances of Shares of Preferred Stock. On February 1, 1996, the Registrant sold shares of Series A Convertible Redeemable Preferred Stock ("Series A Preferred Stock") convertible into 2,487,500 shares of Common Stock and Warrants exercisable for shares of Series A Preferred Stock convertible into 621,875 shares of Common Stock to accredited II-1 82 investors for an aggregate purchase price of $9,950,000. In September 1996, the Company issued additional shares of Series A Preferred Stock convertible into 189,635 shares of Common Stock to accredited investors for an aggregate purchase price of $758,540. On March 31, 1998 and June 30, 1998, the Company issued shares of Series A Preferred Stock as paid-in-kind dividends to holders of Series A Preferred Stock convertible into an aggregate of 80,913 shares of Common Stock. On May 1, 1997, the Registrant sold shares of Series B Convertible Redeemable Preferred Stock convertible into 758,565 shares of Common Stock to accredited investors for an aggregate offering price of $6,599,519. (c) Option Issuances to, and Exercises by, Employees and Directors. From June 28, 1996 to June 28, 1998, the Registrant issued options to purchase a total of 1,009,635 shares of Common Stock at a weighted-average exercise price of $3.87 per share to 45 employees. No consideration was paid to the Registrant by any recipient of any of the foregoing options for the grant of any such options. As of June 28, 1998, no employees had exercised their options. (d) Warrants In connection with the original capitalization of the Company, warrants to purchase shares of Series A Preferred Stock convertible into 62,190 shares of Common Stock at $4.00 per common share were issued to an investment bank. The warrants expire February 28, 2001. There were no underwriters employed in connection with any of the transactions set forth in Item 15. The issuances described in Items 15(a) and 15(b) were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering. In addition, the issuances described in Item 15(c) were deemed exempt from registration under the Securities Act in reliance on Rule 701 promulgated thereunder as transactions pursuant to compensatory benefit plans and contracts relating to compensation. The recipients of securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and other instruments issued in such transactions. All recipients either received adequate information about the Registrant or had access, through employment or other relationships, to such information. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits.
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT 1.1 Form of Underwriting Agreement. 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. 5.1** Opinion of Gray Cary Ware & Freidenrich LLP. 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 31, 1996. 10.7* Series A Preferred Stock Purchase Agreement dated February 1, 1996. 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 June 20, 1998. 10.10* Office Lease between the Company and U.S. West Business Resources, Inc. dated February 15, 1997. 21.1* List of Subsidiaries. 23.1 Consent of Independent Auditors (see page II-5).
II-2 83
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT 23.2** Consent of Counsel (included in Exhibit 5.1). 24.1* Power of Attorney (see page II-4). 27.1* Financial Data Schedule.
- ------------------------------ * Filed with the Registrant's Registration Statement on Form S-1 (File No. 333-59749) on July 24, 1998. ** To be filed by amendment. (b) Financial Statement Schedules. None. ITEM 17. UNDERTAKINGS. The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification by the Registrant for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions referenced in Item 14 of this Registration Statement or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, employee or agent of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer, employee or agent in connection with the securities being registered hereunder, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of Prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective; and (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at the time shall be deemed to be the initial bona fide offering thereof. II-3 84 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Scottsdale, County of Maricopa, State of Arizona, on the 3rd day of September 1998. P.F. Chang's China Bistro, Inc. By: RICHARD L. FEDERICO* ------------------------------------ Richard L. Federico Chief Executive Officer and President (Principal Executive Officer) Pursuant to the requirements of the Securities Act, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE RICHARD L. FEDERICO* Chief Executive Officer, September 3, 1998 - --------------------------------------------------- President and Director Richard L. Federico (Principal Executive Officer) /s/ ROBERT T. VIVIAN Chief Financial Officer and September 3, 1998 - --------------------------------------------------- Secretary (Principal Robert T. Vivian Financial and Accounting Officer) PAUL M. FLEMING* Director September 3, 1998 - --------------------------------------------------- Paul M. Fleming J. MICHAEL CHU* Director September 3, 1998 - --------------------------------------------------- J. Michael Chu GERALD R. GALLAGHER* Director September 3, 1998 - --------------------------------------------------- Gerald R. Gallagher R. MICHAEL WELBORN* Director September 3, 1998 - --------------------------------------------------- R. Michael Welborn JAMES G. SHENNAN, JR.* Director September 3, 1998 - --------------------------------------------------- James G. Shennan, Jr. YVES SISTERON* Director September 3, 1998 - --------------------------------------------------- Yves Sisteron *By: /s/ ROBERT T. VIVIAN September 3, 1998 --------------------------------------------- Robert T. Vivian, Attorney-in-Fact
II-4 85 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS CONSENT OF ERNST & YOUNG LLP We consent to the reference to our firm under the captions "Selected Consolidated Financial and Operating Data" and "Experts" and to the use of our report dated January 26, 1998, except Note 11 as to which the date is August 27, 1998, in Amendment No. 1 to the Registration Statement (Form S-1 No. 333-59749) and related Prospectus of P.F. Chang's China Bistro, Inc. for the registration of shares of its common stock. /s/ ERNST & YOUNG LLP Phoenix, Arizona September 2, 1998 II-5 86 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------- ----------------------- 1.1 Form of Underwriting Agreement 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 5.1** Opinion of Gray Cary Ware & Freidenrich LLP 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 31, 1996 10.7* Series A Preferred Stock Purchase Agreement dated February 1, 1996 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 June 20, 1998 10.10* Office Lease between the Company and U.S. West Business Resources, Inc. dated February 15, 1997 21.1* List of Subsidiaries 23.1 Consent of Independent Auditors (see page II-5) 23.2** Consent of Counsel (included in Exhibit 5.1) 24.1* Power of Attorney (see page II-4) 27.1* Financial Data Schedule
- ------------------------------ * Filed with the Registrant's Registration Statement on Form S-1 (File No. 333-59749) on July 24, 1998. ** To be filed by amendment. EX-1.1 2 EX-1.1 1 EXHIBIT 1.1 __________ Shares P.F. CHANG'S CHINA BISTRO, INC. Common Stock UNDERWRITING AGREEMENT __________, 1998 DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION NATIONSBANC MONTGOMERY SECURITIES LLC DAIN RAUSCHEL WESSELS, a division of Dain Rauscher Incorporated As representatives of the several Underwriters named in Schedule I hereto c/o Donaldson, Lufkin & Jenrette Securities Corporation 277 Park Avenue New York, New York 10172 Dear Sirs: P.F. CHANG'S CHINA BISTRO, INC., a Delaware corporation (the "COMPANY"), proposes to issue and sell to the several underwriters named in Schedule I hereto (the "UNDERWRITERS"), and certain stockholders of the Company named in Schedule II hereto (the "SELLING STOCKHOLDERS") severally propose to sell to the several Underwriters, an aggregate of _______________ shares of the Common Stock, $0.001 par value of the Company (the "FIRM SHARES"), of which _____________ shares are to be issued and sold by the Company and _____________ shares are to be sold by the Selling Stockholders, each Selling Stockholder selling the amount set forth opposite such Selling Stockholder's name in Schedule II hereto. The Company also proposes to issue and sell to the several Underwriters not more than an additional _______ shares of its Common Stock, $0.001 par value, (the "ADDITIONAL SHARES") if requested by the Underwriters as provided in Section 2 hereof. The Firm Shares and the Additional Shares are hereinafter referred to collectively as the "SHARES". The shares of common stock of the Company to be outstanding after giving effect to the sales contemplated hereby are hereinafter referred to as the "COMMON STOCK". The Company and the Selling Stockholders are hereinafter sometimes referred to collectively as the "SELLERS." SECTION 1. Registration Statement and Prospectus. The Company has prepared and filed with the Securities and Exchange Commission (the "COMMISSION") in accordance with the provisions of the Securities Act of 1933, as amended, and the rules and regulations of the Commission thereunder (collectively, the "ACT"), a registration statement on Form S-1, including a prospectus, relating to the Shares. The registration statement, as amended at the time it became 1 2 effective, including the information (if any) deemed to be part of the registration statement at the time of effectiveness pursuant to Rule 430A under the Act, is hereinafter referred to as the "REGISTRATION STATEMENT"; and the prospectus in the form first used to confirm sales of Shares is hereinafter referred to as the "PROSPECTUS". If the Company has filed or is required pursuant to the terms hereof to file a registration statement pursuant to Rule 462(b) under the Act registering additional shares of Common Stock (a "RULE 462(B) REGISTRATION STATEMENT"), then, unless otherwise specified, any reference herein to the term "Registration Statement" shall be deemed to include such Rule 462(b) Registration Statement. SECTION 2. Agreements to Sell and Purchase and Lock-Up Agreements . On the basis of the representations and warranties contained in this Agreement, and subject to its terms and conditions, (i) the Company agrees to issue and sell ______________ Firm Shares, (ii) each Selling Stockholder agrees, severally and not jointly, to sell the number of Firm Shares set forth opposite such Selling Stockholder's name in Schedule II hereto and (iii) each Underwriter agrees, severally and not jointly, to purchase from each Seller at a price per Share of $______ (the "PURCHASE PRICE") the number of Firm Shares (subject to such adjustments to eliminate fractional shares as you may determine) that bears the same proportion to the total number of Firm Shares to be sold by such Seller as the number of Firm Shares set forth opposite the name of such Underwriter in Schedule I hereto bears to the total number of Firm Shares. On the basis of the representations and warranties contained in this Agreement, and subject to its terms and conditions, the Company agrees to issue and sell the Additional Shares and the Underwriters shall have the right to purchase, severally and not jointly, up to _______ Additional Shares from the Company at the Purchase Price. Additional Shares may be purchased solely for the purpose of covering over-allotments made in connection with the offering of the Firm Shares. The Underwriters may exercise their right to purchase Additional Shares in whole or in part from time to time by giving written notice thereof to the Company within 30 days after the date of this Agreement. You shall give any such notice on behalf of the Underwriters and such notice shall specify the aggregate number of Additional Shares to be purchased pursuant to such exercise and the date for payment and delivery thereof, which date shall be a business day (i) no earlier than two business days after such notice has been given (and, in any event, no earlier than the Closing Date (as hereinafter defined)) and (ii) no later than ten business days after such notice has been given. If any Additional Shares are to be purchased, each Underwriter, severally and not jointly, agrees to purchase from the Company the number of Additional Shares (subject to such adjustments to eliminate fractional shares as you may determine) which bears the same proportion to the total number of Additional Shares to be purchased from the Company as the number of Firm Shares set forth opposite the name of such Underwriter in Schedule I bears to the total number of Firm Shares. Each Seller hereby agrees not to (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers all or a portion of the economic consequences associated with the ownership of any Common Stock (regardless of whether any of the 2 3 transactions described in clause (i) or (ii) is to be settled by the delivery of Common Stock, or such other securities, in cash or otherwise), except to the Underwriters pursuant to this Agreement, for a period of 180 days after the date of the Prospectus without the prior written consent of Donaldson, Lufkin & Jenrette Securities Corporation. Notwithstanding the foregoing, during such period (i) the Company may grant stock options pursuant to the Company's existing stock option plan and (ii) the Company may issue shares of Common Stock upon the exercise of an option or warrant or the conversion of a security outstanding on the date hereof. The Company also agrees not to file any registration statement with respect to any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock for a period of 180 days after the date of the Prospectus without the prior written consent of Donaldson, Lufkin & Jenrette Securities Corporation. In addition, each Selling Stockholder agrees that, for a period of 180 days after the date of the Prospectus without the prior written consent of Donaldson, Lufkin & Jenrette Securities Corporation, it will not make any demand for, or exercise any right with respect to, the registration of any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock. The Company shall, prior to or concurrently with the execution of this Agreement, deliver an agreement executed by (i) each Selling Stockholder, (ii) each of the directors and officers of the Company who is not a Selling Stockholder and (iii) each stockholder listed on Annex I hereto to the effect that such person will not, during the period commencing on the date such person signs such agreement and ending 180 days after the date of the Prospectus, without the prior written consent of Donaldson, Lufkin & Jenrette Securities Corporation, (A) engage in any of the transactions described in the first sentence of this paragraph or (B) make any demand for, or exercise any right with respect to, the registration of any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock. SECTION 3. Terms of Public Offering. The Sellers are advised by you that the Underwriters propose (i) to make a public offering of their respective portions of the Shares as soon after the execution and delivery of this Agreement as in your judgment is advisable and (ii) initially to offer the Shares upon the terms set forth in the Prospectus. SECTION 4. Delivery and Payment. The Shares shall be represented by definitive certificates and shall be issued in such authorized denominations and registered in such names as Donaldson, Lufkin & Jenrette Securities Corporation shall request no later than two business days prior to the Closing Date or the applicable Option Closing Date (as defined below), as the case may be. The Shares shall be delivered by or on behalf of the Sellers, with any transfer taxes thereon duly paid by the respective Sellers, to Donaldson, Lufkin & Jenrette Securities Corporation through the facilities of The Depository Trust Company ("DTC"), for the respective accounts of the several Underwriters, against payment to the Sellers of the Purchase Price therefor by wire transfer of Federal or other funds immediately available in New York City. The certificates representing the Shares shall be made available for inspection not later than 9:30 A.M., New York City time, on the business day prior to the Closing Date or the applicable Option Closing Date, as the case may be, at the office of DTC or its designated custodian (the "DESIGNATED OFFICE"). The time and date of delivery and payment for the Firm Shares shall be 9:00 A.M., New York City time, on ________, 1998 or such other time on the same or such 3 4 other date as Donaldson, Lufkin & Jenrette Securities Corporation and the Company shall agree in writing. The time and date of delivery and payment for the Firm Shares are hereinafter referred to as the "CLOSING DATE". The time and date of delivery and payment for any Additional Shares to be purchased by the Underwriters shall be 9:00 A.M., New York City time, on the date specified in the applicable exercise notice given by you pursuant to Section 2 or such other time on the same or such other date as Donaldson, Lufkin & Jenrette Securities Corporation and the Company shall agree in writing. The time and date of delivery and payment for any Additional Shares are hereinafter referred to as the "OPTION CLOSING DATE". The documents to be delivered on the Closing Date or any Option Closing Date on behalf of the parties hereto pursuant to Section 9 of this Agreement shall be delivered at the offices of Akin, Gump, Strauss, Hauer & Feld, L.L.P., [590 Madison Avenue, New York, New York 10022] and the Shares shall be delivered at the Designated Office, all on the Closing Date or such Option Closing Date, as the case may be. SECTION 5. Agreements of the Company. The Company agrees with you: (a) To advise you promptly and, if requested by you, to confirm such advice in writing, (i) of any request by the Commission for amendments to the Registration Statement or amendments or supplements to the Prospectus or for additional information, (ii) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or of the suspension of qualification of the Shares for offering or sale in any jurisdiction, or the initiation of any proceeding for such purposes, (iii) when any amendment to the Registration Statement becomes effective, (iv) if the Company is required to file a Rule 462(b) Registration Statement after the effectiveness of this Agreement, when the Rule 462(b) Registration Statement has become effective and (v) of the happening of any event during the period referred to in Section 5(d) below which makes any statement of a material fact made in the Registration Statement or the Prospectus untrue or which requires any additions to or changes in the Registration Statement or the Prospectus in order to make the statements therein not misleading. If at any time the Commission shall issue any stop order suspending the effectiveness of the Registration Statement, the Company will use its best efforts to obtain the withdrawal or lifting of such order at the earliest possible time. (b) To furnish to you four signed copies of the Registration Statement as first filed with the Commission and of each amendment to it, including all exhibits, and to furnish to you and each Underwriter designated by you such number of conformed copies of the Registration Statement as so filed and of each amendment to it, without exhibits, as you may reasonably request. (c) To prepare the Prospectus, the form and substance of which shall be satisfactory to you, and to file the Prospectus in such form with the Commission within the applicable period specified in Rule 424(b) under the Act; during the period specified in Section 5(d) below, not to file any further amendment to the Registration Statement and not to make any amendment or supplement to the Prospectus of which you shall not previously have been advised or to which 4 5 you shall reasonably object after being so advised; and, during such period, to prepare and file with the Commission, promptly upon your reasonable request, any amendment to the Registration Statement or amendment or supplement to the Prospectus which may be necessary or advisable in connection with the distribution of the Shares by you, and to use its best efforts to cause any such amendment to the Registration Statement to become promptly effective. (d) Prior to 10:00 A.M., New York City time, on the first business day after the date of this Agreement and from time to time thereafter for such period as in the opinion of counsel for the Underwriters a prospectus is required by law to be delivered in connection with sales by an Underwriter or a dealer, to furnish in New York City to each Underwriter and any dealer as many copies of the Prospectus (and of any amendment or supplement to the Prospectus) as such Underwriter or dealer may reasonably request. (e) If during the period specified in Section 5(d), any event shall occur or condition shall exist as a result of which, in the opinion of counsel for the Underwriters, it becomes necessary to amend or supplement the Prospectus in order to make the statements therein, in the light of the circumstances when the Prospectus is delivered to a purchaser, not misleading, or if, in the opinion of counsel for the Underwriters, it is necessary to amend or supplement the Prospectus to comply with applicable law, forthwith to prepare and file with the Commission an appropriate amendment or supplement to the Prospectus so that the statements in the Prospectus, as so amended or supplemented, will not in the light of the circumstances when it is so delivered, be misleading, or so that the Prospectus will comply with applicable law, and to furnish to each Underwriter and to any dealer as many copies thereof as such Underwriter or dealer may reasonably request. (f) Prior to any public offering of the Shares, to cooperate with you and counsel for the Underwriters in connection with the registration or qualification of the Shares for offer and sale by the several Underwriters and by dealers under the state securities or Blue Sky laws of such jurisdictions as you may request, to continue such registration or qualification in effect so long as required for distribution of the Shares and to file such consents to service of process or other documents as may be necessary in order to effect such registration or qualification; provided, however, that the Company shall not be required in connection therewith to qualify as a foreign corporation in any jurisdiction in which it is not now so qualified or to take any action that would subject it to general consent to service of process or taxation other than as to matters and transactions relating to the Prospectus, the Registration Statement, any preliminary prospectus or the offering or sale of the Shares, in any jurisdiction in which it is not now so subject. (g) To mail and make generally available to its stockholders as soon as practicable an earnings statement covering the twelve-month period ending __________, 199_ that shall satisfy the provisions of Section 11(a) of the Act, and to advise you in writing when such statement has been so made available. (h) During the period of three years after the date of this Agreement, to furnish to you as soon as available copies of all reports or other communications furnished to the record holders 5 6 of Common Stock or furnished to or filed with the Commission or any national securities exchange on which any class of securities of the Company is listed and such other publicly available information concerning the Company and its subsidiaries as you may reasonably request. (i) Whether or not the transactions contemplated in this Agreement are consummated or this Agreement is terminated, to pay or cause to be paid all expenses incident to the performance of the Sellers' obligations under this Agreement, including: (i) the fees, disbursements and expenses of the Company's counsel, the Company's accountants and any Selling Stockholder's counsel (in addition to the Company's counsel) in connection with the registration and delivery of the Shares under the Act and all other fees and expenses in connection with the preparation, printing, filing and distribution of the Registration Statement (including financial statements and exhibits), any preliminary prospectus, the Prospectus and all amendments and supplements to any of the foregoing, including the mailing and delivering of copies thereof to the Underwriters and dealers in the quantities specified herein, (ii) all costs and expenses related to the transfer and delivery of the Shares to the Underwriters, including any transfer or other taxes payable thereon, (iii) all costs of printing or producing this Agreement and any other agreements or documents in connection with the offering, purchase, sale or delivery of the Shares, (iv) all expenses in connection with the registration or qualification of the Shares for offer and sale under the securities or Blue Sky laws of the several states and all costs of printing or producing any Preliminary and Supplemental Blue Sky Memoranda in connection therewith (including the filing fees and fees and disbursements of counsel for the Underwriters in connection with such registration or qualification and memoranda relating thereto), (v) the filing fees and disbursements of counsel for the Underwriters in connection with the review and clearance of the offering of the Shares by the National Association of Securities Dealers, Inc., (vi) all fees and expenses in connection with the preparation and filing of the registration statement on Form 8-A relating to the Common Stock and all costs and expenses incident to the listing of the Shares on the Nasdaq National Market, (vii) the cost of printing certificates representing the Shares, (viii) the costs and charges of any transfer agent, registrar and/or depositary, and (ix) all other costs and expenses incident to the performance of the obligations of the Company and the Selling Stockholders hereunder for which provision is not otherwise made in this Section. The provisions of this Section shall not supersede or otherwise affect any agreement that the Company and the Selling Stockholders may otherwise have for allocation of such expenses among themselves. (j) To use its best efforts to list for quotation the Shares on the Nasdaq National Market and to maintain the listing of the Shares on the Nasdaq National Market for a period of three years after the date of this Agreement. (k) To use its best efforts to do and perform all things required or necessary to be done and performed under this Agreement by the Company prior to the Closing Date or any Option Closing Date, as the case may be, and to satisfy all conditions precedent to the delivery of the Shares. 6 7 (l) If the Registration Statement at the time of the effectiveness of this Agreement does not cover all of the Shares, to file a Rule 462(b) Registration Statement with the Commission registering the Shares not so covered in compliance with Rule 462(b) by 10:00 P.M., New York City time, on the date of this Agreement and to pay to the Commission the filing fee for such Rule 462(b) Registration Statement at the time of the filing thereof or to give irrevocable instructions for the payment of such fee pursuant to Rule 111(b) under the Act. SECTION 6. Representations and Warranties of the Company. The Company represents and warrants to each Underwriter that: (a) The Registration Statement has become effective (other than any Rule 462(b) Registration Statement to be filed by the Company after the effectiveness of this Agreement); any Rule 462(b) Registration Statement filed after the effectiveness of this Agreement will become effective no later than 10:00 P.M., New York City time, on the date of this Agreement; and no stop order suspending the effectiveness of the Registration Statement is in effect, and no proceedings for such purpose are pending before or threatened by the Commission. (b) (i) The Registration Statement (other than any Rule 462(b) Registration Statement to be filed by the Company after the effectiveness of this Agreement), when it became effective, did not contain and, as amended, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) the Registration Statement (other than any Rule 462(b) Registration Statement to be filed by the Company after the effectiveness of this Agreement) and the Prospectus comply and, as amended or supplemented, if applicable, will comply in all material respects with the Act, (iii) if the Company is required to file a Rule 462(b) Registration Statement after the effectiveness of this Agreement, such Rule 462(b) Registration Statement and any amendments thereto, when they become effective (A) will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (B) will comply in all material respects with the Act and (iv) the Prospectus does not contain and, as amended or supplemented, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, except that the representations and warranties set forth in this paragraph do not apply to statements or omissions in the Registration Statement or the Prospectus based upon information relating to any Underwriter furnished to the Company in writing by such Underwriter through you expressly for use therein. (c) Each preliminary prospectus filed as part of the registration statement as originally filed or as part of any amendment thereto, or filed pursuant to Rule 424 under the Act, complied when so filed in all material respects with the Act, and did not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, except that the representations and warranties set forth in this paragraph do not apply to statements or omissions in any preliminary prospectus based upon information relating to any 7 8 Underwriter furnished to the Company in writing by such Underwriter through you expressly for use therein. (d) Each of the Company and its subsidiaries has been duly incorporated or organized, is validly existing as a corporation, limited partnership or limited liability company, as the case may be, in good standing under the laws of its jurisdiction of incorporation or organization and has the power and authority to carry on its business as described in the Prospectus and to own, lease and operate its properties, and each is duly qualified and is in good standing as a foreign corporation, limited partnership or limited liability company, as the case may be, authorized to do business in each jurisdiction in which the nature of its business or its ownership or leasing of property requires such qualification, except where the failure to be so qualified would not have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole. (e) There are no outstanding subscriptions, rights, warrants, options, calls, convertible securities, commitments of sale or liens granted or issued by the Company or any of its subsidiaries relating to or entitling any person to purchase or otherwise to acquire any shares of the capital stock of the Company or any of its subsidiaries, except as otherwise disclosed in the Registration Statement. (f) All the outstanding shares of capital stock of the Company (including the Shares to be sold by the Selling Stockholders) have been duly authorized and validly issued and are fully paid, non-assessable and not subject to any preemptive or similar rights; all the shares of Common Stock of the Company to be issued by the Company on or prior to the Closing Date upon conversion of the Company's outstanding shares of Convertible Redeemable Preferred Stock and Deferred Purchase Price Liability (as such terms are defined in the Prospectus) have been duly authorized and, upon the issuance thereof in the manner described in the Prospectus, will be validly issued, fully paid, non-assessable, and not subject to any preemptive or similar rights; and the Shares to be issued and sold by the Company have been duly authorized and, when issued and delivered to the Underwriters against payment therefor as provided by this Agreement, will be validly issued, fully paid and non-assessable, and the issuance of such Shares will not be subject to any preemptive or similar rights. (g) All of the outstanding shares of capital stock (or equivalent partnership or membership interests, as the case may be, for noncorporate subsidiaries) of each of the Company's subsidiaries have been duly authorized and validly issued and are fully paid and non-assessable, and are owned by the Company, directly or indirectly through one or more subsidiaries, free and clear of any security interest, claim, lien, encumbrance or adverse interest of any nature. (h) The authorized capital stock of the Company conforms as to legal matters to the description thereof contained in the Prospectus. 8 9 (i) Neither the Company nor any of its subsidiaries is in violation of its respective charter or by-laws (or equivalent organizational documents for non-corporate subsidiaries) or in default in the performance of any obligation, agreement, covenant or condition contained in any indenture, loan agreement, mortgage, lease or other agreement or instrument that is material to the Company and its subsidiaries, taken as a whole, to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or their respective property is bound. (j) The execution, delivery and performance of this Agreement by the Company, the compliance by the Company with all the provisions hereof and the consummation of the transactions contemplated hereby will not (i) require any consent, approval, authorization or other order of, or qualification with, any court or governmental body or agency (except such as may be required under the securities or Blue Sky laws of the various states), (ii) conflict with or constitute a breach of any of the terms or provisions of, or a default under, the charter or by-laws of the Company or any of its subsidiaries (or equivalent organizational documents for non-corporate subsidiaries) or any indenture, loan agreement, mortgage, lease or other agreement or instrument that is material to the Company and its subsidiaries, taken as a whole, to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or their respective property is bound, (iii) violate or conflict with any applicable law or any rule, regulation, judgment, order or decree of any court or any governmental body or agency having jurisdiction over the Company, any of its subsidiaries or their respective property or (iv) result in the suspension, termination or revocation of any Authorization (as defined below) of the Company or any of its subsidiaries or any other impairment of the rights of the holder of any such Authorization. (k) There are no legal or governmental proceedings pending or threatened to which the Company or any of its subsidiaries is or could be a party or to which any of their respective property is or could be subject that are required to be described in the Registration Statement or the Prospectus and are not so described; nor are there any statutes, regulations, contracts or other documents that are required to be described in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement that are not so described or filed as required. (l) Neither the Company nor any of its subsidiaries has violated any foreign, federal, state or local law or regulation relating to the protection of human health and safety, the environment or hazardous or toxic substances or wastes, pollutants or contaminants ("ENVIRONMENTAL LAWS"), any provisions of the Employee Retirement Income Security Act of 1974, as amended, or any provisions of the Foreign Corrupt Practices Act or the rules and regulations promulgated thereunder, except for such violations which, singly or in the aggregate, would not have a material adverse effect on the business, prospects, financial condition or results of operation of the Company and its subsidiaries, taken as a whole. (m) Each of the Company and its subsidiaries has such permits, licenses, consents, exemptions, franchises, authorizations and other approvals (each, an "AUTHORIZATION") of, and has made all filings with and notices to, all governmental or regulatory authorities and self- 9 10 regulatory organizations and all courts and other tribunals, including, without limitation, under any applicable Environmental Laws, as are necessary to own, lease, license and operate its respective properties and to conduct its business, except where the failure to have any such Authorization or to make any such filing or notice would not, singly or in the aggregate, have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole. Each such Authorization is valid and in full force and effect and each of the Company and its subsidiaries is in compliance with all the terms and conditions thereof and with the rules and regulations of the authorities and governing bodies having jurisdiction with respect thereto; and no event has occurred (including, without limitation, the receipt of any notice from any authority or governing body) which allows or, after notice or lapse of time or both, would allow, revocation, suspension or termination of any such Authorization or results or, after notice or lapse of time or both, would result in any other impairment of the rights of the holder of any such Authorization; and such Authorizations contain no restrictions that are burdensome to the Company or any of its subsidiaries; except where such failure to be valid and in full force and effect or to be in compliance, the occurrence of any such event or the presence of any such restriction would not, singly or in the aggregate, have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole. (n) There are no costs or liabilities associated with Environmental Laws (including, without limitation, any capital or operating expenditures required for clean-up, closure of properties or compliance with Environmental Laws or any Authorization, any related constraints on operating activities and any potential liabilities to third parties) which would, singly or in the aggregate, have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole. (o) The Company and its subsidiaries own or possess, or can acquire on reasonable terms, all patents, patent rights, licenses, inventions, copyrights, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information, systems or procedures), trademarks, service marks and trade names ("INTELLECTUAL PROPERTY") currently employed by them in connection with the business now operated by them except where the failure to own or possess or otherwise be able to acquire such intellectual property would not, singly or in the aggregate, have a material adverse effect on the business, prospects, financial condition or results of operation of the Company and its subsidiaries, taken as a whole; and neither the Company nor any of its subsidiaries has received any notice of infringement of or conflict with asserted rights of others with respect to any of such intellectual property which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole. (p) The Company and each of its subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which they are engaged; and neither the Company nor any of its subsidiaries (i) has received notice from any insurer or agent of such insurer that substantial 10 11 capital improvements or other material expenditures will have to be made in order to continue such insurance or (ii) has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers at a cost that would not have a material adverse effect on the business, prospects, financial conditions or results of operations of the Company and its subsidiaries, taken as a whole. (q) No relationship, direct or indirect, exists between or among the Company or any of its subsidiaries on the one hand, and the directors, officers, stockholders, customers or suppliers of the Company or any of its subsidiaries on the other hand, which is required by the Act to be described in the Registration Statement or the Prospectus which is not so described. (r) This Agreement has been duly authorized, executed and delivered by the Company. (s) Ernst & Young LLP are independent public accountants with respect to the Company and its subsidiaries as required by the Act. (t) The consolidated financial statements included in the Registration Statement and the Prospectus (and any amendment or supplement thereto), together with related schedules and notes, present fairly the consolidated financial position, results of operations and changes in financial position of the Company and its subsidiaries and the combined financial position, results of operations and changes in financial position of the Predecessors (as such term is defined in the Registration Statement and Prospectus), in each case on the basis stated therein at the respective dates or for the respective periods to which they apply; such statements and related schedules and notes have been prepared in accordance with generally accepted accounting principles consistently applied throughout the periods involved, except as disclosed therein; the supporting schedules, if any, included in the Registration Statement present fairly in accordance with generally accepted accounting principles the information required to be stated therein; and the other financial and statistical information and data set forth in the Registration Statement and the Prospectus (and any amendment or supplement thereto) are, in all material respects, accurately presented and prepared on a basis consistent with such financial statements and the books and records of the Company and the Predecessors, as the case may be. (u) The pro forma financial data of the Company and its subsidiaries and the Predecessors, as the case may be, and the related notes thereto set forth in the Registration Statement and the Prospectus (and any supplement or amendment thereto) have been prepared on a basis consistent with the historical financial statements of the Company and its subsidiaries and the Predecessors, as the case may be, give effect to the assumptions used in the preparation thereof on a reasonable basis and in good faith and present fairly the historical and proposed transactions contemplated by the Registration Statement and the Prospectus. Such pro forma financial data have been prepared in accordance with the applicable requirements of Rule 11-02 of Regulation S-X promulgated by the Commission. 11 12 (v) The Company and each of its subsidiaries maintains a system of internal accounting controls sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management's general or specific authorizations; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain asset accountability; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (w) All material tax returns required to be filed by the Company and each of its subsidiaries in any jurisdiction have been filed, other than those filings being contested in good faith, and all material taxes, including withholding taxes, penalties and interest, assessments, fees and other charges due pursuant to such returns or pursuant to any assessment received by the Company or any of its subsidiaries have been paid, other than those being contested in good faith and for which adequate reserves have been provided. (x) The Company is not and, after giving effect to the offering and sale of the Shares and the application of the proceeds thereof as described in the Prospectus, will not be, an "investment company" as such term is defined in the Investment Company Act of 1940, as amended. (y) Except as otherwise disclosed in the Registration Statement with respect to registration rights held by certain stockholders of the Company (which registration rights have been waived with respect to any obligation of the Company to include such securities with the Shares registered pursuant to the Registration Statement), there are no contracts, agreements or understandings between the Company and any person granting such person the right to require the Company to file a registration statement under the Act with respect to any securities of the Company or to require the Company to include such securities with the Shares registered pursuant to the Registration Statement. (z) Since the respective dates as of which information is given in the Prospectus other than as set forth in the Prospectus (exclusive of any amendments or supplements thereto subsequent to the date of this Agreement), (i) there has not occurred any material adverse change or any development involving a prospective material adverse change in the condition, financial or otherwise, or the earnings, business, management or operations of the Company and its subsidiaries, taken as a whole, (ii) there has not been any material adverse change or any development involving a prospective material adverse change in the capital stock or in the long-term debt of the Company or any of its subsidiaries and (iii) neither the Company nor any of its subsidiaries has incurred any material liability or obligation, direct or contingent. (aa) Each certificate signed by any officer of the Company and delivered to the Underwriters or counsel for the Underwriters shall be deemed to be a representation and warranty by the Company to the Underwriters as to the matters covered thereby. 12 13 SECTION 7. Representations and Warranties of the Selling Stockholders. Each Selling Stockholder represents and warrants to each Underwriter that: (a) Such Selling Stockholder is the lawful owner of the Shares to be sold by such Selling Stockholder pursuant to this Agreement and has, and on the Closing Date will have, good and clear title to such Shares, free of all restrictions on transfer, liens, encumbrances, security interests, equities and claims whatsoever. (b) The Shares to be sold by such Selling Stockholder have been duly authorized and are validly issued, fully paid and non-assessable. (c) Such Selling Stockholder has, and on the Closing Date will have, full legal right, power and authority, and all authorization and approval required by law, to enter into this Agreement, the Custody Agreement signed by such Selling Stockholder and , as Custodian, relating to the deposit of the Shares to be sold by such Selling Stockholder (the "CUSTODY AGREEMENT") and the Power of Attorney of such Selling Stockholder appointing certain individuals as such Selling Stockholder's attorneys-in-fact (the "ATTORNEYS") to the extent set forth therein, relating to the transactions contemplated hereby and by the Registration Statement and the Custody Agreement (the "POWER OF ATTORNEY") and to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder in the manner provided herein and therein. (d) This Agreement has been duly authorized, executed and delivered by or on behalf of such Selling Stockholder. (e) The Custody Agreement of such Selling Stockholder has been duly authorized, executed and delivered by such Selling Stockholder and is a valid and binding agreement of such Selling Stockholder, enforceable in accordance with its terms. (f) The Power of Attorney of such Selling Stockholder has been duly authorized, executed and delivered by such Selling Stockholder and is a valid and binding instrument of such Selling Stockholder, enforceable in accordance with its terms, and, pursuant to such Power of Attorney, such Selling Stockholder has, among other things, authorized the Attorneys, or any one of them, to execute and deliver on such Selling Stockholder's behalf this Agreement and any other document that they, or any one of them, may deem necessary or desirable in connection with the transactions contemplated hereby and thereby and to deliver the Shares to be sold by such Selling Stockholder pursuant to this Agreement. (g) Upon delivery of and payment for the Shares to be sold by such Selling Stockholder pursuant to this Agreement, good and clear title to such Shares will pass to the Underwriters, free of all restrictions on transfer, liens, encumbrances, security interests, equities and claims whatsoever. 13 14 (h) The execution, delivery and performance of this Agreement and the Custody Agreement and Power of Attorney of such Selling Stockholder by or on behalf of such Selling Stockholder, the compliance by such Selling Stockholder with all the provisions hereof and thereof and the consummation of the transactions contemplated hereby and thereby will not (i) require any consent, approval, authorization or other order of, or qualification with, any court or governmental body or agency (except such as may be required under the securities or Blue Sky laws of the various states), (ii) conflict with or constitute a breach of any of the terms or provisions of, or a default under, the organizational documents of such Selling Stockholder, if such Selling Stockholder is not an individual, or any indenture, loan agreement, mortgage, lease or other agreement or instrument to which such Selling Stockholder is a party or by which such Selling Stockholder or any property of such Selling Stockholder is bound or (iii) violate or conflict with any applicable law or any rule, regulation, judgment, order or decree of any court or any governmental body or agency having jurisdiction over such Selling Stockholder or any property of such Selling Stockholder. (i) The information in the Registration Statement under the caption "Principal and Selling Stockholders" which specifically relates to such Selling Stockholder does not, and will not on the Closing Date, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. (j) At any time during the period described in Section 5(d), if there is any change in the information referred to in Section 7(i), such Selling Stockholder will immediately notify you of such change. (k) Each certificate signed by or on behalf of such Selling Stockholder and delivered to the Underwriters or counsel for the Underwriters shall be deemed to be a representation and warranty by such Selling Stockholder to the Underwriters as to the matters covered thereby. (l) To the best of such Selling Stockholder's knowledge, (i) the Registration Statement (other than any Rule 462(b) Registration Statement to be filed by the Company after the effectiveness of this Agreement), when it became effective, did not contain and, as amended, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) if the Company is required to file a Rule 462(b) Registration Statement after the effectiveness of this Agreement, such Rule 462(b) Registration Statement and any amendments thereto, when they become effective, will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading, and (iii) the Prospectus does not contain and, as amended or supplemented, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, except that the representations and warranties set forth in this paragraph do not apply to statements or omissions in the Registration Statement or the Prospectus based upon information relating to any Underwriter furnished to the Company in writing by such Underwriter through you expressly for use therein. 14 15 SECTION 8. Indemnification. (a) The Sellers, jointly and severally, agree to indemnify and hold harmless each Underwriter, its directors, its officers and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Act or Section 20 of the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), from and against any and all losses, claims, damages, liabilities and judgments (including, without limitation, any legal or other expenses incurred in connection with investigating or defending any matter, including any action, that could give rise to any such losses, claims, damages, liabilities or judgments) caused by any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (or any amendment thereto), the Prospectus (or any amendment or supplement thereto) or any preliminary prospectus, or caused by any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such losses, claims, damages, liabilities or judgments are caused by any such untrue statement or omission or alleged untrue statement or omission based upon information relating to any Underwriter furnished in writing to the Company by such Underwriter through you expressly for use therein provided, however, that the foregoing indemnity agreement with respect to any preliminary prospectus shall not inure to the benefit of any Underwriter who failed to deliver a Prospectus, as then amended or supplemented, (so long as the Prospectus and any amendment or supplement thereto was provided by the Company to the several Underwriters in the requisite quantity and on a timely basis to permit proper delivery on or prior to the Closing Date) to the person asserting any losses, claims, damages, liabilities or judgments caused by any untrue statement or alleged untrue statement of a material fact contained in such preliminary prospectus, or caused by any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, if such material misstatement or omission or alleged material misstatement or omission was cured in the Prospectus, as so amended or supplemented, and such Prospectus was required by law to be delivered at or prior to the written confirmation of sale to such person. Notwithstanding the foregoing, the aggregate liability of any Selling Stockholder pursuant to this Section 8(a) shall be limited to an amount equal to the total proceeds (before deducting underwriting discounts and commissions and expenses) received by such Selling Stockholder from the Underwriters for the sale of the Shares sold by such Selling Stockholder hereunder. 15 16 Notwithstanding the foregoing, and without limiting in any way the ability of the Underwriters to commence an action or proceeding against any of the Selling Stockholders, no Selling Stockholder shall be required to make payment of any amount pursuant to this Section 8 to any Underwriter with respect to any losses, claims, damages, liabilities or judgments which fall within the scope of this Section 8 unless and until (i) the Underwriters make a written demand for indemnification from the Company and (ii) the Company or any subsidiary has failed to pay any amount owed to any Underwriter pursuant to this Section 8(a) with respect to any such losses, claims, damages, liabilities and judgments, within twenty business days. In the event that any Selling Stockholder fails to comply with its obligations with respect to any losses, claims, damages, liabilities or judgments, the Underwriters further agree that (x) they will not commence any legal proceeding against any such Selling Stockholder to recover such losses, claims, damages, liabilities or judgments unless, prior to or concurrently therewith they shall have commenced a legal proceeding against the Company or any of its subsidiaries to recover the same, (y) the Underwriters will diligently and in good faith prosecute any such legal proceeding against the Company and its subsidiaries for as long as the Selling Stockholders are a party thereto, and (z) in the event that judgments are entered in favor of the Underwriters against both the Company or its subsidiaries and the Selling Stockholders in any such legal proceeding, (1) during the period of 45 days following the date on which the judgment against the Company or its subsidiaries becomes final and is not subject to appeal, the Underwriters will take commercially reasonable steps to enforce the judgment entered against the Company or its subsidiaries and will not seek to enforce the judgment entered against any Selling Stockholder and (2) after the expiration of such period, the Underwriters may seek to enforce the judgment entered against any such Selling Stockholder, but will continue to take commercially reasonable steps to enforce the judgment entered against the Company or its subsidiaries for so long as they are seeking to enforce the judgment entered against the Selling Stockholders. Notwithstanding the foregoing, the Selling Stockholders shall be liable in accordance with Section 8(a) without regard to the provisions set forth in this paragraph immediately after any Insolvency Event (as hereinafter defined). For the purposes of the foregoing paragraph, an "Insolvency Event" shall have occurred when the Company or any of its subsidiaries has (i) commenced a voluntary proceeding under any Federal or state bankruptcy, insolvency, reorganization or similar law, or other proceeding to be adjudicated a bankrupt or insolvent, (ii) consented to the entry of a decree or order for relief in any involuntary proceeding or to the commencement of any similar proceeding against it, (iii) had entered against it any decree or order for relief in any involuntary proceeding or adjudging the Company or any subsidiary a bankrupt or insolvent or appointing a custodian, receiver or similar official of the Company or any subsidiary or any substantial part of its property, or had any such party appointed or take possession thereof, (iv) made any assignment for the benefit or creditors, or (v) taken any corporate action to authorize any of the foregoing actions. (b) Each Underwriter agrees, severally and not jointly, to indemnify and hold harmless the Company, its directors, its officers who sign the Registration Statement, each person, if any, who controls the Company within the meaning of Section 15 of the Act or Section 20 of the Exchange Act, each Selling Stockholder and each person, if any, who controls such Selling Stockholder within the meaning of Section 15 of the Act or Section 20 of the Exchange Act to 16 17 the same extent as the foregoing indemnity from the Sellers to such Underwriter but only with reference to information relating to such Underwriter furnished in writing to the Company by such Underwriter through you expressly for use in the Registration Statement (or any amendment thereto), the Prospectus (or any amendment or supplement thereto) or any preliminary prospectus. (c) In case any action shall be commenced involving any person in respect of which indemnity may be sought pursuant to Section 8(a) or 8(b) (the "INDEMNIFIED PARTY"), the indemnified party shall promptly notify the person against whom such indemnity may be sought (the "INDEMNIFYING PARTY") in writing and the indemnifying party shall assume the defense of such action, including the employment of counsel reasonably satisfactory to the indemnified party and the payment of all fees and expenses of such counsel, as incurred (except that in the case of any action in respect of which indemnity may be sought pursuant to both Sections 8(a) and 8(b), the Underwriter shall not be required to assume the defense of such action pursuant to this Section 8(c), but may employ separate counsel and participate in the defense thereof, but the fees and expenses of such counsel, except as provided below, shall be at the expense of such Underwriter). Any indemnified party shall have the right to employ separate counsel in any such action and participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of the indemnified party unless (i) the employment of such counsel shall have been specifically authorized in writing by the indemnifying party, (ii) the indemnifying party shall have failed to assume the defense of such action or employ counsel reasonably satisfactory to the indemnified party or (iii) the named parties to any such action (including any impleaded parties) include both the indemnified party and the indemnifying party, and the indemnified party shall have been advised by such counsel that there may be one or more legal defenses available to it which are different from or additional to those available to the indemnifying party (in which case the indemnifying party shall not have the right to assume the defense of such action on behalf of the indemnified party). In any such case, the indemnifying party shall not, in connection with any one action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable for (i) the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) for all Underwriters, their officers and directors and all persons, if any, who control any Underwriter within the meaning of either Section 15 of the Act or Section 20 of the Exchange Act, (ii) the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) for the Company, its directors, its officers who sign the Registration Statement and all persons, if any, who control the Company within the meaning of either such Section and (iii) the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) for all Selling Stockholders and all persons, if any, who control any Selling Stockholder within the meaning of either such Section, and all such fees and expenses shall be reimbursed as they are incurred. In the case of any such separate firm for the Underwriters, their officers and directors and such control persons of any Underwriters, such firm shall be designated in writing by Donaldson, Lufkin & Jenrette Securities Corporation. In the case of any such separate firm for the Company and such directors, officers and control persons of the Company, such firm shall be designated in writing by the Company. In the case of any such separate firm for the Selling Stockholders and such control persons of any Selling Stockholders, such firm shall be designated in writing by the Attorneys. The indemnifying party shall indemnify and hold harmless the 17 18 indemnified party from and against any and all losses, claims, damages, liabilities and judgments by reason of any settlement of any action (i) effected with its written consent or (ii) effected without its written consent if the settlement is entered into more than twenty business days after the indemnifying party shall have received a request from the indemnified party for reimbursement for the fees and expenses of counsel (in any case where such fees and expenses are at the expense of the indemnifying party) and, prior to the date of such settlement, the indemnifying party shall have failed to comply with such reimbursement request. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement or compromise of, or consent to the entry of judgment with respect to, any pending or threatened action in respect of which the indemnified party is or could have been a party and indemnity or contribution may be or could have been sought hereunder by the indemnified party, unless such settlement, compromise or judgment (i) includes an unconditional release of the indemnified party from all liability on claims that are or could have been the subject matter of such action and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act, by or on behalf of the indemnified party. (d) To the extent the indemnification provided for in this Section 8 is unavailable to an indemnified party or insufficient in respect of any losses, claims, damages, liabilities or judgments referred to therein, then each indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, liabilities and judgments (i) in such proportion as is appropriate to reflect the relative benefits received by the Sellers on the one hand and the Underwriters on the other hand from the offering of the Shares or (ii) if the allocation provided by clause 8(d)(i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause 8(d)(i) above but also the relative fault of the Sellers on the one hand and the Underwriters on the other hand in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or judgments, as well as any other relevant equitable considerations. The relative benefits received by the Sellers on the one hand and the Underwriters on the other hand shall be deemed to be in the same proportion as the total net proceeds from the offering (after deducting underwriting discounts and commissions, but before deducting expenses) received by the Sellers, and the total underwriting discounts and commissions received by the Underwriters, bear to the total price to the public of the Shares, in each case as set forth in the table on the cover page of the Prospectus. The relative fault of the Sellers on the one hand and the Underwriters on the other hand shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Selling Stockholders on the one hand or the Underwriters on the other hand and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Sellers and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 8(d) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. The amount paid or payable by an indemnified party as a result of the 18 19 losses, claims, damages, liabilities or judgments referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any legal or other expenses incurred by such indemnified party in connection with investigating or defending any matter, including any action, that could have given rise to such losses, claims, damages, liabilities or judgments. Notwithstanding the provisions of this Section 8, no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute pursuant to this Section 8(d) are several in proportion to the respective number of Shares purchased by each of the Underwriters hereunder and not joint. (e) The remedies provided for in this Section 8 are not exclusive and shall not limit any rights or remedies which may otherwise be available to any indemnified party at law or in equity. (f) Each Selling Stockholder hereby designates P.F. Chang's China Bistro, Inc., 5090 North 40th Street, Suite 160, Phoenix, Arizona 85018, as its authorized agent, upon which process may be served in any action which may be instituted in any state or federal court in the State of New York by any Underwriter, any director or officer of any Underwriter or any person controlling any Underwriter asserting a claim for indemnification or contribution under or pursuant to this Section 8, and each Selling Stockholder will accept the jurisdiction of such court in such action, and waives, to the fullest extent permitted by applicable law, any defense based upon lack of personal jurisdiction or venue. A copy of any such process shall be sent or given to such Selling Stockholder, at the address for notices specified in Section 12 hereof. SECTION 9. Conditions of Underwriters' Obligations. The several obligations of the Underwriters to purchase the Firm Shares under this Agreement are subject to the satisfaction of each of the following conditions: (a) All the representations and warranties of the Company contained in this Agreement shall be true and correct on the Closing Date with the same force and effect as if made on and as of the Closing Date. (b) If the Company is required to file a Rule 462(b) Registration Statement after the effectiveness of this Agreement, such Rule 462(b) Registration Statement shall have become effective by 10:00 P.M., New York City time, on the date of this Agreement; and no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been commenced or shall be pending before or contemplated by the Commission. (c) You shall have received on the Closing Date a certificate dated the Closing Date, signed by Richard L. Federico and Robert Vivian, in their capacities as the Chief Executive Officer and Chief Financial Officer of the Company, confirming the matters set forth in Sections 19 20 6(z), 9(a) and 9(b) and that the Company has complied with all of the agreements and satisfied all of the conditions herein contained and required to be complied with or satisfied by the Company on or prior to the Closing Date. (d) Since the respective dates as of which information is given in the Prospectus other than as set forth in the Prospectus (exclusive of any amendments or supplements thereto subsequent to the date of this Agreement), (i) there shall not have occurred any change or any development involving a prospective change in the condition, financial or otherwise, or the earnings, business, management or operations of the Company and its subsidiaries, taken as a whole, (ii) there shall not have been any change or any development involving a prospective change in the capital stock or in the long-term debt of the Company or any of its subsidiaries and (iii) neither the Company nor any of its subsidiaries shall have incurred any liability or obligation, direct or contingent, the effect of which, in any such case described in clause 9(d)(i), 9(d)(ii) or 9(d)(iii), in your judgment, is material and adverse and, in your judgment, makes it impracticable to market the Shares on the terms and in the manner contemplated in the Prospectus. (e) All the representations and warranties of each Selling Stockholder contained in this Agreement shall be true and correct on the Closing Date with the same force and effect as if made on and as of the Closing Date and you shall have received on the Closing Date a certificate dated the Closing Date from each Selling Stockholder to such effect and to the effect that such Selling Stockholder has complied with all of the agreements and satisfied all of the conditions herein contained and required to be complied with or satisfied by such Selling Stockholder on or prior to the Closing Date. (f) You shall have received on the Closing Date an opinion (satisfactory to you and counsel for the Underwriters), dated the Closing Date, of Gray Cary Ware & Freidenrich, LLP, counsel for the Company and the Selling Stockholders, to the effect that: (i) each of the Company and its subsidiaries has been duly incorporated or organized, is validly existing as a corporation, limited partnership or limited liability company, as the case may be, in good standing under the laws of its jurisdiction of incorporation or organization and has the power and authority to carry on its business as described in the Prospectus and to own, lease and operate its properties; (ii) each of the Company and its subsidiaries is duly qualified and is in good standing as a foreign corporation, limited partnership or limited liability company, as the case may be, authorized to do business in each jurisdiction in which the nature of its business or its ownership or leasing of property requires such qualification, except where the failure to be so qualified would not have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole; (iii) all the outstanding shares of capital stock of the Company (including the Shares to be sold by the Selling Stockholders) have been duly authorized and validly 20 21 issued and are fully paid, non-assessable and not subject to any preemptive or similar rights; and all the shares of Common Stock of the Company to be issued by the Company on or prior to the Closing Date upon conversion of the Company's outstanding shares of Convertible Redeemable Preferred Stock and Deferred Purchase Price Liability (as such terms are defined in the Prospectus) have been duly authorized and, upon the issuance thereof in the manner described in the Prospectus, will be validly issued, fully paid, non-assessable, and not subject to any preemptive or similar rights; (iv) the Shares to be issued and sold by the Company hereunder have been duly authorized and, when issued and delivered to the Underwriters against payment therefor as provided by this Agreement, will be validly issued, fully paid and non-assessable, and the issuance of such Shares will not be subject to any preemptive or similar rights; (v) all of the outstanding shares of capital stock (or equivalent partnership or membership interests, as the case may be, for non-corporate subsidiaries) of each of the Company's subsidiaries have been duly authorized and validly issued and are fully paid and non-assessable, and are owned by the Company, directly or indirectly through one or more subsidiaries, free and clear of any security interest, claim, lien, encumbrance or adverse interest of any nature; (vi) this Agreement has been duly authorized, executed and delivered by the Company and by or on behalf of each Selling Stockholder; (vii) the authorized capital stock of the Company conforms as to legal matters to the description thereof contained in the Prospectus; (viii) the Registration Statement has become effective under the Act, no stop order suspending its effectiveness has been issued and no proceedings for that purpose are, to the best of such counsel's knowledge after due inquiry, pending before or contemplated by the Commission; (ix) the statements under the captions "Business-Government Regulation," "Management-Limitation of Liability and Indemnification," "Management-Benefit Plans-Certain Transactions," "Description of Capital Stock," "Shares Eligible for Future Sale" and "Underwriting" in the Prospectus and Items 14 and 15 of Part II of the Registration Statement, insofar as such statements constitute a summary of the legal matters, documents or proceedings referred to therein, fairly present the information called for with respect to such legal matters, documents and proceedings; (x) neither the Company nor any of its subsidiaries is in violation of its respective charter or by-laws (or equivalent organizational documents for non-corporate subsidiaries), and, to the best of such counsel's knowledge after due inquiry, neither the Company nor any of its subsidiaries is in default in the performance of any obligation, agreement, covenant or condition contained in any indenture, loan agreement, mortgage, lease or other agreement or instrument that is material to the Company and its 21 22 subsidiaries, taken as a whole, to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or their respective property is bound; (xi) the execution, delivery and performance of this Agreement by the Company, the compliance by the Company with all the provisions hereof and the consummation of the transactions contemplated hereby will not (A) require any consent, approval, authorization or other order of, or qualification with, any court or governmental body or agency (except such as may be required under the securities or Blue Sky laws of the various states), (B) conflict with or constitute a breach of any of the terms or provisions of, or a default under, the charter or by-laws of the Company or any of its subsidiaries (or equivalent organizational documents for non-corporate subsidiaries) or any indenture, loan agreement, mortgage, lease or other agreement or instrument that is material to the Company and its subsidiaries, taken as a whole, to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or their respective property is bound, (C) violate or conflict with any applicable law or any rule, regulation, judgment, order or decree of any court or any governmental body or agency having jurisdiction over the Company, any of its subsidiaries or their respective property or (D) result in the suspension, termination or revocation of any Authorization of the Company or any of its subsidiaries or any other impairment of the rights of the holder of any such Authorization; (xii) after due inquiry, such counsel does not know of any legal or governmental proceedings pending or threatened to which the Company or any of its subsidiaries is or could be a party or to which any of their respective property is or could be subject that are required to be described in the Registration Statement or the Prospectus and are not so described, or of any statutes, regulations, contracts or other documents that are required to be described in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement that are not so described or filed as required; (xiii) neither the Company nor any of its subsidiaries has violated any Environmental Law, any provisions of the Employee Retirement Income Security Act of 1974, as amended, or any provisions of the Foreign Corrupt Practices Act or the rules and regulations promulgated thereunder, except for such violations which, singly or in the aggregate, would not have a material adverse effect on the business, prospects, financial condition or results of operation of the Company and its subsidiaries, taken as a whole; (xiv) each of the Company and its subsidiaries has such Authorizations of, and has made all filings with and notices to, all governmental or regulatory authorities and self-regulatory organizations and all courts and other tribunals, including, without limitation, under any applicable Environmental Laws, as are necessary to own, lease, license and operate its respective properties and to conduct its business, except where the failure to have any such Authorization or to make any such filing or notice would not, singly or in the aggregate, have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole; each such Authorization is valid and in full force and effect and each of the 22 23 Company and its subsidiaries is in compliance with all the terms and conditions thereof and with the rules and regulations of the authorities and governing bodies having jurisdiction with respect thereto; and no event has occurred (including, without limitation, the receipt of any notice from any authority or governing body) which allows or, after notice or lapse of time or both, would allow, revocation, suspension or termination of any such Authorization or results or, after notice or lapse of time or both, would result in any other impairment of the rights of the holder of any such Authorization; and such Authorizations contain no restrictions that are burdensome to the Company or any of its subsidiaries; except where such failure to be valid and in full force and effect or to be in compliance, the occurrence of any such event or the presence of any such restriction would not, singly or in the aggregate, have a material adverse effect on the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole; (xv) the Company is not and, after giving effect to the offering and sale of the Shares and the application of the proceeds thereof as described in the Prospectus, will not be, an "investment company" as such term is defined in the Investment Company Act of 1940, as amended; (xvi) except as otherwise disclosed in the Registration Statement with respect to registration rights held by certain stockholders of the Company (which registration rights have been waived with respect to any obligation of the Company to include such securities with the Shares registered pursuant to the Registration Statement), to the best of such counsel's knowledge after due inquiry, there are no contracts, agreements or understandings between the Company and any person granting such person the right to require the Company to file a registration statement under the Act with respect to any securities of the Company or to require the Company to include such securities with the Shares registered pursuant to the Registration Statement; (xvii) (A) the Registration Statement and the Prospectus and any supplement or amendment thereto (except for the financial statements and other financial data included therein as to which no opinion need be expressed) comply as to form with the Act, (B) such counsel has no reason to believe that at the time the Registration Statement became effective or on the date of this Agreement, the Registration Statement and the prospectus included therein (except for the financial statements and other financial data as to which such counsel need not express any belief) contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (C) such counsel has no reason to believe that the Prospectus, as amended or supplemented, if applicable (except for the financial statements and other financial data, as aforesaid) contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; (xviii) each Selling Stockholder is the lawful owner of the Shares to be sold by such Selling Stockholder pursuant to this Agreement and has good and clear title to such 23 24 Shares, free of all restrictions on transfer, liens, encumbrances, security interests, equities and claims whatsoever; (xix) each Selling Stockholder has full legal right, power and authority, and all authorization and approval required by law, to enter into this Agreement and the Custody Agreement and the Power of Attorney of such Selling Stockholder and to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder in the manner provided herein and therein; (xx) the Custody Agreement of each Selling Stockholder has been duly authorized, executed and delivered by such Selling Stockholder and is a valid and binding agreement of such Selling Stockholder, enforceable in accordance with its terms; (xxi) the Power of Attorney of each Selling Stockholder has been duly authorized, executed and delivered by such Selling Stockholder and is a valid and binding instrument of such Selling Stockholder, enforceable in accordance with its terms, and, pursuant to such Power of Attorney, such Selling Stockholder has, among other things, authorized the Attorneys, or any one of them, to execute and deliver on such Selling Stockholder's behalf this Agreement and any other document they, or any one of them, may deem necessary or desirable in connection with the transactions contemplated hereby and thereby and to deliver the Shares to be sold by such Selling Stockholder pursuant to this Agreement; (xxii) upon delivery of and payment for the Shares to be sold by each Selling Stockholder pursuant to this Agreement, good and clear title to such Shares will pass to the Underwriters, free of all restrictions on transfer, liens, encumbrances, security interests, equities and claims whatsoever; and (xxiii) the execution, delivery and performance of this Agreement and the Custody Agreement and Power of Attorney of each Selling Stockholder by such Selling Stockholder, the compliance by such Selling Stockholder with all the provisions hereof and thereof and the consummation of the transactions contemplated hereby and thereby will not (A) require any consent, approval, authorization or other order of, or qualification with, any court or governmental body or agency (except such as may be required under the securities or Blue Sky laws of the various states), (B) conflict with or constitute a breach of any of the terms or provisions of, or a default under, the organizational documents of such Selling Stockholder, if such Selling Stockholder is not an individual, or any indenture, loan agreement, mortgage, lease or other agreement or instrument to which such Selling Stockholder is a party or by which any property of such Selling Stockholder is bound or (C) violate or conflict with any applicable law or any rule, regulation, judgment, order or decree of any court or any governmental body or agency having jurisdiction over such Selling Stockholder or any property of such Selling Stockholder. 24 25 The opinion of Gray Cary Ware & Freidenrich, LLP described in Section 9(f) above shall be rendered to you at the request of the Company and the Selling Stockholders and shall so state therein. (g) You shall have received on the Closing Date an opinion, dated the Closing Date, of Akin, Gump, Strauss, Hauer & Feld, L.L.P., counsel for the Underwriters, as to the matters referred to in Sections 9(f)(iv), 9(f)(vi) (but only with respect to the Company), 9(f)(ix) (but only with respect to the statements under the caption "Description of Capital Stock" and "Underwriting") and 9(f)(xvii). In giving such opinions with respect to the matters covered by Section 9(f)(xvii), counsel for the Company and the Selling Stockholders and counsel for the Underwriters may state that their opinion and belief are based upon their participation in the preparation of the Registration Statement and Prospectus and any amendments or supplements thereto and review and discussion of the contents thereof, but are without independent check or verification except as specified. (h) You shall have received, on each of the date hereof and the Closing Date, a letter dated the date hereof or the Closing Date, as the case may be, in form and substance satisfactory to you, from Ernst & Young, L.L.P., independent public accountants, containing the information and statements of the type ordinarily included in accountants' "comfort letters" to Underwriters with respect to the financial statements and certain financial information contained in the Registration Statement and the Prospectus. (i) The Company shall have delivered to you the agreements specified in Section 2 hereof which agreements shall be in full force and effect on the Closing Date. (j) The Shares shall have been duly listed for quotation on the Nasdaq National Market. (k) The Company and the Selling Stockholders shall not have failed on or prior to the Closing Date to perform or comply with any of the agreements herein contained and required to be performed or complied with by the Company or the Selling Stockholders, as the case may be, on or prior to the Closing Date. (l) You shall have received on the Closing Date, a certificate of each Selling Stockholder who is not a U.S. Person (as defined under applicable U.S. federal tax legislation) to the effect that such Selling Stockholder is not a U.S. Person, which certificate may be in the form of a properly completed and executed United States Treasury Department Form W-8 (or other applicable form or statement specified by Treasury Department regulations in lieu thereof). The several obligations of the Underwriters to purchase any Additional Shares hereunder are subject to the delivery to you on the applicable Option Closing Date of such documents as you may reasonably request with respect to the good standing of the Company, the due 25 26 authorization and issuance of such Additional Shares and other matters related to the issuance of such Additional Shares. SECTION 10. Effectiveness of Agreement and Termination. This Agreement shall become effective upon the execution and delivery of this Agreement by the parties hereto. This Agreement may be terminated at any time on or prior to the Closing Date by you by written notice to the Sellers if any of the following has occurred: (i) any outbreak or escalation of hostilities or other national or international calamity or crisis or change in economic conditions or in the financial markets of the United States or elsewhere that, in your judgment, is material and adverse and, in your judgment, makes it impracticable to market the Shares on the terms and in the manner contemplated in the Prospectus, (ii) the suspension or material limitation of trading in securities or other instruments on the New York Stock Exchange, the American Stock Exchange, the Chicago Board of Options Exchange, the Chicago Mercantile Exchange, the Chicago Board of Trade or the Nasdaq National Market or limitation on prices for securities or other instruments on any such exchange or the Nasdaq National Market, (iii) the suspension of trading of any securities of the Company on any exchange or in the over-the-counter market, (iv) the enactment, publication, decree or other promulgation of any federal or state statute, regulation, rule or order of any court or other governmental authority which in your opinion materially and adversely affects, or will materially and adversely affect, the business, prospects, financial condition or results of operations of the Company and its subsidiaries, taken as a whole, (v) the declaration of a banking moratorium by either federal or New York State authorities or (vi) the taking of any action by any federal, state or local government or agency in respect of its monetary or fiscal affairs which in your opinion has a material adverse effect on the financial markets in the United States. If on the Closing Date or on an Option Closing Date, as the case may be, any one or more of the Underwriters shall fail or refuse to purchase the Firm Shares or Additional Shares, as the case may be, which it has or they have agreed to purchase hereunder on such date and the aggregate number of Firm Shares or Additional Shares, as the case may be, which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase is not more than one-tenth of the total number of Firm Shares or Additional Shares, as the case may be, to be purchased on such date by all Underwriters, each non-defaulting Underwriter shall be obligated severally, in the proportion which the number of Firm Shares set forth opposite its name in Schedule I bears to the total number of Firm Shares which all the non-defaulting Underwriters have agreed to purchase, or in such other proportion as you may specify, to purchase the Firm Shares or Additional Shares, as the case may be, which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date; provided that in no event shall the number of Firm Shares or Additional Shares, as the case may be, which any Underwriter has agreed to purchase pursuant to Section 2 hereof be increased pursuant to this Section 10 by an amount in excess of one-ninth of such number of Firm Shares or Additional Shares, as the case may be, without the written consent of such Underwriter. If on the Closing Date any Underwriter or Underwriters shall fail or refuse to purchase Firm Shares and the aggregate number of Firm Shares with respect to which such default occurs is more than one-tenth of the aggregate number of Firm Shares to be purchased by all Underwriters and 26 27 arrangements satisfactory to you, the Company and the Selling Stockholders for purchase of such Firm Shares are not made within 48 hours after such default, this Agreement will terminate without liability on the part of any non-defaulting Underwriter, the Company or the Selling Stockholders. In any such case which does not result in termination of this Agreement, either you or the Sellers shall have the right to postpone the Closing Date, but in no event for longer than seven days, in order that the required changes, if any, in the Registration Statement and the Prospectus or any other documents or arrangements may be effected. If, on an Option Closing Date, any Underwriter or Underwriters shall fail or refuse to purchase Additional Shares and the aggregate number of Additional Shares with respect to which such default occurs is more than one-tenth of the aggregate number of Additional Shares to be purchased on such date, the non-defaulting Underwriters shall have the option to (i) terminate their obligation hereunder to purchase such Additional Shares or (ii) purchase not less than the number of Additional Shares that such non-defaulting Underwriters would have been obligated to purchase on such date in the absence of such default. Any action taken under this paragraph shall not relieve any defaulting Underwriter from liability in respect of any default of any such Underwriter under this Agreement. SECTION 11. Agreements of the Selling Stockholders. Each Selling Stockholder agrees with you and the Company: (a) To pay or to cause to be paid all transfer taxes payable in connection with the transfer of the Shares to be sold by such Selling Stockholder to the Underwriters. (b) To do and perform all things to be done and performed by such Selling Stockholder under this Agreement prior to the Closing Date and to satisfy all conditions precedent to the delivery of the Shares to be sold by such Selling Stockholder pursuant to this Agreement. SECTION 12. Miscellaneous. Notices given pursuant to any provision of this Agreement shall be addressed as follows: (i) if to the Company, to P.F. Chang's China Bistro, Inc., 5090 North 40th Street, Suite 160, Phoenix, Arizona 85018, (ii) if to the Selling Stockholders, to __________________________________________________ c/o _________________________________________ and (iii) if to any Underwriter or to you, to you c/o Donaldson, Lufkin & Jenrette Securities Corporation, 277 Park Avenue, New York, New York 10172, Attention: Syndicate Department, or in any case to such other address as the person to be notified may have requested in writing. The respective indemnities, contribution agreements, representations, warranties and other statements of the Company, the Selling Stockholders and the several Underwriters set forth in or made pursuant to this Agreement shall remain operative and in full force and effect, and will survive delivery of and payment for the Shares, regardless of (i) any investigation, or statement as to the results thereof, made by or on behalf of any Underwriter, the officers or directors of any Underwriter, any person controlling any Underwriter, the Company, the officers or directors of the Company, any person controlling the Company, any Selling Stockholder or any person controlling such Selling Stockholder, (ii) acceptance of the Shares and payment for them hereunder and (iii) termination of this Agreement. 27 28 If for any reason the Shares are not delivered by or on behalf of any Seller as provided herein (other than as a result of any termination of this Agreement pursuant to Section 10), the Sellers agree, jointly and severally, to reimburse the several Underwriters for all out-of-pocket expenses (including the fees and disbursements of counsel) incurred by them. Notwithstanding any termination of this Agreement, the Company shall be liable for all expenses which it has agreed to pay pursuant to Section 5(i) hereof. The Sellers also agree, jointly and severally, to reimburse the several Underwriters, their directors and officers and any persons controlling any of the Underwriters for any and all fees and expenses (including, without limitation, the fees disbursements of counsel) incurred by them in connection with enforcing their rights hereunder (including, without limitation, pursuant to Section 8 hereof). Except as otherwise provided, this Agreement has been and is made solely for the benefit of and shall be binding upon the Company, the Selling Stockholders, the Underwriters, the Underwriters' directors and officers, any controlling persons referred to herein, the Company's directors and the Company's officers who sign the Registration Statement and their respective successors and assigns, all as and to the extent provided in this Agreement, and no other person shall acquire or have any right under or by virtue of this Agreement. The term "successors and assigns" shall not include a purchaser of any of the Shares from any of the several Underwriters merely because of such purchase. This Agreement shall be governed and construed in accordance with the laws of the State of New York. This Agreement may be signed in various counterparts which together shall constitute one and the same instrument. 28 29 Please confirm that the foregoing correctly sets forth the agreement among the Company, the Selling Stockholders and the several Underwriters. Very truly yours, P.F. CHANG'S CHINA BISTRO, INC. By: ______________________________ Title: THE SELLING STOCKHOLDERS NAMED IN SCHEDULE II HERETO, ACTING SEVERALLY By ______________________________ Attorney-in-fact DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION NATIONSBANC MONTGOMERY SECURITIES LLC DAIN RAUSCHER WESSELS, a division of Dain Rauscher Incorporated Acting severally on behalf of themselves and the several Underwriters named in Schedule I hereto By DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION By ___________________________ 29 30 SCHEDULE I Underwriters Number of Firm Shares to be Purchased Donaldson, Lufkin & Jenrette Securities Corporation Nationsbanc Montgomery Securities LLC Dain Rauscher Wessels, a division of Dain Rauscher Incorporated [Names of other underwriters] Total 1 31 SCHEDULE II Selling Stockholders Number of Firm Name Shares Being Sold Total 2 32 Annex I [Insert names of stockholders of the Company who will be required to sign lock ups] 3 33 COMMENTARY TO UNDERWRITING AGREEMENTS WITH SECONDARY COMPONENTS 1. TRANSFER TAXES. The state of New York imposes a transfer tax on secondary sales of stock which tax is subsequently reimbursed to the payor. Such tax is generally payable if the underwriting agreement is signed in New York or the offering is closed in New York. As a result of the relationship between Donaldson, Lufkin & Jenrette Securities Corporation and Pershing, a clearing house, Selling Stockholders participating in the offering need not pay such transfer tax prior to delivering their Shares. Instead, at the end of each quarter, Pershing will remit to the state of New York the total amount of the transfer tax due on all secondary offerings underwritten by Donaldson, Lufkin & Jenrette Securities Corporation and will simultaneously be reimbursed for the full amount of the transfer tax. Steve Tyrell at Pershing (201-413-2130 (phone) and 201-413-5265 (fax)) is in charge of this reimbursement procedure and should be contacted early in the transaction with an estimate of the taxes. The tax rate is:
Sale Price Per Share Tax Rate Per Share -------------------- ------------------ $20.00 and over $0.05 $10.00 - $19.99 $0.0375 $5.00 - $9.99 $0.025 Under $5.00 $0.0125
Although there is a $350 maximum tax on a single taxable sale, a sale by a selling stockholder to a group of underwriters each of whom is severally liable for its purchase is treated as a number of separate sales. (For example, the sale of shares by a single stockholder to a syndicate consisting of 20 underwriters would have a maximum tax of $350 x 20 = $7,000.) If there is more than one selling stockholder, the sale of shares by each selling stockholder to each underwriter is treated as a separate transaction. (For example, the sale of shares by 20 stockholders to a syndicate consisting of 20 underwriters would have a maximum tax of $350 x 20 x 20 = $140,000.) 2. SELLING STOCKHOLDERS. This form assumes that the Selling Stockholders (i) are not officers or directors of the Company and (ii) do not control or otherwise exert significant influence over the Company, whether by ownership of securities of the Company, by contract or otherwise. If the Selling Stockholders are officers or directors of the Company or control or otherwise exert significant influence over the Company, then the following changes to this form should be considered and discussed with Maureen Block in the legal department of Donaldson, Lufkin & Jenrette Securities Corporation (415-249-2188). ii 34 (a) REPRESENTATIONS AND WARRANTIES AND COVENANTS OF THE COMPANY. If any Selling Stockholder controls the Company, it may be appropriate for such Selling Stockholder to make all of the representations and warranties that the Company makes, jointly and severally, with the Company, and to agree to pay all costs and expenses in connection with the offering that the Company agrees to pay, jointly and severally, with the Company. (b) REPRESENTATIONS AND WARRANTIES OF SELLING STOCKHOLDERS - DISCLOSURE REPRESENTATION. Each Selling Stockholder's representation regarding the adequacy and completeness of the offering document is limited to the information provided by such Stockholder on the theory that such information is the only information with which such Stockholder is intimately familiar. If the Selling Stockholders are officers, directors or control persons of the Company or otherwise exert significant influence over the Company then, in light of their familiarity with the Company, it may be appropriate for their disclosure representation to track that of the Company-- that is, to cover the entire offering document. (c) INDEMNIFICATION AND CONTRIBUTION. Even though the Selling Stockholders' disclosure representation is limited to information provided by the Selling Stockholders, this form requires the Selling Stockholders to indemnify the Underwriters against misstatements or omissions in the entire offering document with the Selling Stockholders liability limited to the benefits it receives from the offering--that is the net proceeds received by such Stockholders for the sale of their Shares. The theory for this position is that each Selling Stockholder (vis-a-vis the Underwriters) should bear the risk that the entire offering document is correct but that such Stockholder (unlike the Company) should not have unlimited liability for information that such Stockholder has not provided. In certain situations (i.e., where the Selling Stockholders are individual investors who are not venture capitalists) it may be appropriate to limit the scope of the Selling Stockholders' indemnity to information that they provide. If the Selling Stockholders are officers, directors or control persons of the Company or otherwise exert significant influence over the Company then, in light of their ability to verify the information in the disclosure document, it may be appropriate to remove the monetary limitation on their indemnity. In contrast to the Selling Stockholders' indemnity, the Company's indemnity is not limited, monetarily or otherwise. The Company's ability to indemnify the Underwriters with respect to information provided by the Selling Stockholders, however, depends on the laws of its state of incorporation. If the Company is contractually obligated to register the Selling Stockholders' shares or in some other way benefits from the secondary portion of the offering, then the Company should generally be permitted by law to provide a complete indemnity. 3. OPINIONS. This form assumes that the opinion of the Company's counsel will address all matters relating to the Selling Stockholders and, if such counsel deems it necessary, it will require one or more Selling Stockholders to provide opinions from their counsel upon which it will rely. (In the event of such reliance, the opinions upon which the Company's counsel will rely should be in form and substance satisfactory to Underwriters' counsel and the opinion of Company's counsel should state that they are justified in relying on each such opinion and both these conditions should be included in the Underwriting Agreement.) Requiring the Company's counsel to give all such opinions alleviates the need for Underwriters' counsel to deal directly with iii 35 counsel for each Selling Stockholder which can be both time consuming and costly. Whether or not the Company's counsel is prepared to render all Selling Stockholder-related opinions, any opinions that will be required from any Selling Stockholder's counsel should be identified early in the transaction to ensure timely delivery of such an opinion. 4. POWERS OF ATTORNEY AND CUSTODY AGREEMENT. A Power of Attorney and a Custody Agreement should be secured from each Selling Stockholder early in the transaction and, in any event, no later than the commencement of the roadshow. The purpose of the Power of Attorney and the Custody Agreement is to facilitate the pricing of the offering and the delivery of the Shares to be sold by the Selling Stockholders and to streamline the mechanics of the offering process when there are a large number of Selling Stockholders. Failure to secure a Power of Attorney from each Selling Stockholder could delay the pricing of the offering and the signing of the Underwriting Agreement. Similarly, failure to secure a Custody Agreement from each Selling Stockholder could delay the closing of the transaction if a Selling Stockholder were to refuse to deliver the Shares it was selling and would complicate payment for the Shares by the Underwriters. In the event that any Selling Stockholder objects to signing either of such documents Maureen Block in the legal department of Donaldson, Lufkin & Jenrette Securities Corporation should be contacted. iv -----END PRIVACY-ENHANCED MESSAGE-----