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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 28, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NO. 0-21203
DIEDRICH COFFEE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0086628
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
2144 MICHELSON DRIVE
IRVINE, CALIFORNIA 92612
(949) 260-1600
(Address of principal executive offices, including zip code
and telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's common stock held by
non-affiliates, based upon the closing sale price of the registrant's common
stock on September 15, 2000, as reported on the Nasdaq National Market, was
$16,028,106.00.
The number of shares of the registrant's common stock outstanding, as of
September 15, 2000, was 12,616,871.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference from registrant's
definitive proxy statement pursuant to Schedule 14A for its annual meeting of
stockholders to be held on November 29, 2000, which proxy statement will be
filed not later than 120 days after the close of the registrant's fiscal year
ended June 28, 2000.
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TABLE OF CONTENTS
PAGE
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A Warning About Forward-Looking Statements 1
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 18
Item 3. Legal Proceedings........................................... 18
Item 4. Submission of Matters to a Vote of Security Holders......... 18
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 19
Item 6. Selected Financial Data..................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 21
Item 7A Quantitative and Qualitative Disclosures About Market Risk.. 29
Item 8. Financial Statements and Supplementary Data................. 29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 30
Item 11. Executive Compensation...................................... 30
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 30
Item 13. Certain Relationships and Related Transactions.............. 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K................................................. 31
Signatures.................................................. 34
Financial Statements........................................ F-1
Index to Exhibits........................................... S-1
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A WARNING ABOUT FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this annual report that are subject to
risks and uncertainties. These forward-looking statements include information
about possible or assumed future results of Diedrich Coffee's financial
condition, operations, plans, objectives and performance. Additionally, when we
use the words "believe," "expect," "anticipate," "estimate" or similar
expressions, we are making forward-looking statements. Many possible events or
factors could affect our future financial results and performance. This could
cause our results or performance to differ materially from those expressed in
our forward-looking statements. You should consider these risks when you review
this document, along with the following possible events or factors:
- the financial and operating performance of the Gloria Jean's division;
- our ability to regain profitability;
- our ability to perform within the terms of our amended credit agreement;
- the ability of our repositioning program in the Gloria Jean's division;
- the success of the higher margin Gloria Jean's products;
- the successful execution of our growth strategy;
- the impact of competition; and
- the availability of working capital.
Foreseeable risks and uncertainties are described elsewhere in this report
and in detail under "Item 1. Business -- Risk Factors and Trends Affecting
Diedrich Coffee and Its Business." You are cautioned not to place undue reliance
on these forward-looking statements, which reflect management's analysis only as
of the date of this annual report. We undertake no obligation to publicly
release the results of any revision of the forward-looking statements.
PART I
ITEM 1: BUSINESS.
OVERVIEW
Diedrich Coffee is a specialty coffee retailer that sells specialty
brewed coffee and espresso-based beverages such as cappuccinos, lattes, mochas
and espressos and various blended drinks through its retail locations. To
complement beverage sales, we also sell light food items, specialty whole bean
coffee and accessories at our retail locations. Our brands include Diedrich
Coffee, Gloria Jean's, Coffee People and Coffee Plantation. As of June 28, 2000,
we owned and operated 102 retail locations and had 259 franchised retail
locations. We are the nation's second largest specialty coffee retailer with
annual system-wide revenues in excess of $150 million. Our retail units are
located in 37 states and 9 foreign countries. We also have over 300 wholesale
accounts with businesses and restaurant chains. In addition, we operate a large
coffee roasting facility in Northern California that supplies freshly roasted
coffee beans to our retail locations and wholesale accounts.
Diedrich Coffee believes that as the specialty coffee market has
matured, distinct segments have emerged: espresso/coffee bars, coffeehouses and
mall coffee stores. Espresso/coffee bars offer limited seating to facilitate
quick customer turnover, are generally less than 1,200 square feet in size and
are usually located in densely populated urban areas. Coffeehouses are generally
greater than 1,200 square feet in size, located in suburban areas, and encourage
customers to linger and enjoy a more relaxed, comfortable atmosphere. Mall
coffee stores cater to mall consumers and place a heavier emphasis on the sale
of flavored whole bean coffee and coffee-related merchandise. Based on the
number of domestic retail coffee locations, Starbucks is the leader in the
espresso/coffee bar segment, Gloria Jean's is the leader in the mall coffee
store segment and there is presently no leader in the coffeehouse segment. Our
business objective is to become the leading specialty coffee company in the
coffeehouse segment in addition to maintaining our position as the leader in the
mall coffee store segment.
We differentiate ourselves from other specialty coffee producers by
roasting our coffee beans in accordance with proprietary recipes developed over
three generations by the Diedrich family. Our roasting recipes take into account
the specific variety, origin and physical characteristics of each coffee bean to
maximize its unique flavor. In addition, we seek to differentiate our
coffeehouses and mall stores by offering our customers a broad line of superior
tasting coffee products and a high level of personalized customer service, which
generate strong sales and
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customer loyalty. Diedrich coffeehouses offer a warm, friendly environment
specifically designed to encourage guests to linger with friends and business
associates or to relax alone in comfort. Ample seating is augmented by cozy
sofas and comfortable chairs to create intimate nooks for meeting and relaxing.
The critical components of our Diedrich Coffee concepts include high quality,
fresh roasted coffee and superior customer service by knowledgeable employees.
COMPANY BACKGROUND
The first retail store operating under the name of Diedrich Coffee commenced
operations in 1972. Our retail operations grew rapidly until 1997 when we
experienced difficulties managing such rapid growth. We restructured our
operations in November 1997. In 1998 we decided to grow our business through
franchising arrangements and have executed nine franchise development agreements
that provide for the development of 331 Diedrich coffeehouses. In July 1999 we
acquired Coffee People, including its Gloria Jean's division, which makes us the
current leader in the mall coffee store segment with 278 coffee stores.
INDUSTRY OVERVIEW
Specialty coffee sales as a percentage of total coffee sales in the United
States have been increasing steadily. According to the National Coffee
Association , sales of specialty coffee grew from approximately 17% to almost
30% of total coffee sales in the United States from 1989 through 1997. According
to the National Coffee Association's 2000 study, 54% of Americans drink coffee
every day, representing 110 million daily drinkers. On average they drink 3.1
cups per day. The U.S. coffee market consists of two distinct product
categories: (1) commercial ground roast, mass-merchandised coffee and (2)
specialty coffees, which include gourmet coffees (premium grade arabica coffees
sold in whole bean and ground form) and premium coffees (upscale coffees
mass-marketed by the leading coffee companies). According to the National Coffee
Association, 20 million American adults drink gourmet coffee beverages every
day.
Diedrich Coffee believes that several factors have contributed to the
increase in demand for gourmet coffee including:
- greater consumer awareness of gourmet coffee as a result of its increasing
availability;
- increased quality differentiation over commercial grade coffees by
consumers;
- increased demand for all premium food products, including gourmet coffee,
where the differential in price from the commercial brands is small
compared to the perceived improvement in product quality and taste;
- ease of preparation of gourmet coffees resulting from the increased use of
automatic drip coffee makers and home espresso machines; and
- the decline in alcoholic beverage consumption.
The Specialty Coffee Association of America estimates that the number of
specialty coffee beverage outlets in the United States had increased to over
10,000 by the end of 1999. Diedrich Coffee believes that, despite the increase
in the number of specialty coffee stores, the market is highly fragmented and,
with the exception of Starbucks with less than 30% of the total retail
locations, remains relatively unbranded.
THE DIEDRICH COFFEE CONCEPTS
Our business objective is to be the leading specialty coffee retailer in
both the coffeehouse and mall coffee store segments. To achieve this goal, we
must continue to deliver and serve the high quality coffee for which Diedrich
Coffee is known by using only the finest quality green coffee beans and ensuring
that these beans are freshly roasted using our proprietary recipes. In addition,
the friendliness, speed and consistency of the service and the coffee knowledge
of our employees are critical to developing Diedrich Coffee's quality brand
identity and to building a loyal customer base. Our marketing strategy is to
continue developing brand name recognition based
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upon the quality of our coffee products, education of our customers about our
offerings of various coffees and roasts, and the image of our coffeehouses as
neighborhood gathering places.
Coffeehouses
A Diedrich coffeehouse experience is strongly influenced by three
components: ambiance, hospitality and coffee knowledge. Each component is made
up of the following elements that are unique to Diedrich Coffee:
Ambiance. Diedrich Coffee guest comments indicate taste superiority of
our products versus the competition. Moreover, surveys also indicate that
customers are not only loyal to a better, specialty cup of coffee, but also to
the ambiance provided by the comfortable surroundings designed into every
Diedrich coffeehouse. Our coffeehouses are specifically designed to encourage
guests to linger with friends and business associates, or to relax alone in
comfort. The architectural design of the Diedrich Coffee prototype is a
contemporary American interpretation of the European colonial plantation style
of the 1800's. Ample seating is augmented with cozy sofas and comfortable chairs
to create intimate nooks for meeting and relaxing. A weekly entertainment
schedule is provided to encourage patrons to revisit on weekend evenings. We are
in the process of converting the Coffee People and Coffee Plantation
coffeehouses acquired in our acquisition of Coffee People in July 1999 into
Diedrich Coffee coffeehouses. See "Recent Developments".
Hospitality. Our coffeehouses deliver specific consumer benefits that
address a wide range of otherwise unmet needs in the suburban neighborhoods of
America. As a neighborhood coffeehouse chain, Diedrich Coffee is the
non-alcoholic answer to the corner pub. Coffeehouse employees greet regular
customers by name and acknowledge all patrons by name at the point of drink
pick-up. While a large percentage of coffeehouse business is quick morning
coffee pick-up, the coffeehouse focus on hospitality encourages development of
strong afternoon and evening business, complemented by the availability of
desserts, pastries and quality, non-caffeinated beverages. Surveys and customer
comments indicate that patrons are treated as part of the Diedrich Coffee
community and frequently revisit the coffeehouse.
Coffee Knowledge. Diedrich Coffee is the only specialty retailer whose
founder, Martin Diedrich comes from three generations of experience in the
specialty coffee industry. Mr. Diedrich, currently Chief Coffee Officer, is
intimately involved in the daily business of sourcing, tasting and roasting
coffees. He is also directly involved in the training of coffeehouse team
members. The coffee knowledge and expertise that is transferred from coffeehouse
to customer is a competitive advantage, as the interest in specialty coffee
continues to develop. Like the wine, industry, as customer sophistication grows,
so does the customer's desire for more and better information, and for a wider
selection of quality coffee varieties. We are able to identify and secure
exceptional, rare coffees, roast them to perfection, and then offer these
freshly roasted coffees for sale to our customers.
Mall Coffee Stores
Gloria Jean's is the current leader in the mall coffee store segment
with 278 coffee stores in 37 states and 9 foreign countries. Gloria Jean's
specialty coffee stores are located across the country in high traffic malls
that are anchored by high profile retailers, such as Nordstrom, Macy's and
Williams-Sonoma. Mall coffee stores can be differentiated from a traditional
coffeehouse based upon the following:
Captive Consumer Base. A major benefit of mall retailing is its captive
consumer base. The primary function of Gloria Jean's marketing is to entice
consumers inside with eye-catching signage and window displays. Every day new
customers walk by the front entrances of Gloria Jean' stores affording us the
opportunity to introduce them to Gloria Jean's coffee. Once inside a mall,
consumers are unlikely to leave to purchase coffee, refreshments or gifts
similar to those offered by Gloria Jean's. Mall employees are also captive
consumers and represent an important component of our customer base.
Constant Customer Flow. Unlike a coffeehouse, which serves a significant
amount of its coffee before ten o'clock in the morning, Gloria Jean's
experiences customer flow throughout the day. As a mall coffee store, Gloria
Jean's consumer traffic pattern is driven by mall hours and the mall dynamic;
Gloria Jean's is busiest on weekends and holidays. In addition, the mall plays a
key role in marketing to consumers living in neighboring communities.
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Flavored Coffees. Gloria Jean's was a pioneer in developing high quality
flavored coffees and continues to be a leader in the sale of flavored coffees
today. Unlike many coffee roasters and retailers who use second-tier whole beans
and attempt to disguise the taste with their various flavors, Gloria Jean's
flavored coffees begin with a top quality single-origin coffee that is roasted
and then coated with exclusive flavorings. Gloria Jean's offers more than 40
flavored whole bean coffees, both regular and decaffeinated.
Higher Percentage of Whole Beans and Merchandise Sales. The shopping
experience is integral to mall coffee stores, and sales of whole bean coffee and
coffee-related merchandise tend to represent a higher percentage of the sales
mix than at a coffeehouse. In addition to an extensive menu of hot and cold
beverages, Gloria Jean's offers consumers a wide array of whole bean coffees,
coffee and tea related merchandise, and all of the accoutrements necessary for a
complete in-home coffee experience. Gloria Jean's also sells gift merchandise,
including holiday gift packs and custom-made gift baskets.
GROWTH STRATEGY
The Diedrich Coffee Brand
In order to achieve Diedrich Coffee's objective to be a successful national
chain of neighborhood coffeehouses, we implemented a growth strategy to increase
our number of retail locations and the sale of our coffee products through other
distribution channels. This growth strategy includes:
Franchising through Area Development for Diedrich Coffee Coffeehouses
Diedrich Coffee's strategic plan emphasizes franchise area development in
markets outside of the core Orange County, California market. Our objective is
to expand our operations through large area development agreements with
experienced multi-unit franchise operators. Diedrich Coffee has registered, is
exempt or is not required to register to sell franchises in 41 states. Since
September 1998, we have announced the execution of nine franchise area
development agreements that provided for the development of 441 coffeehouses. We
subsequently terminated two of these area development agreements; one for 50
coffeehouses in the states of Kentucky and Tennessee, and another agreement for
50 coffeehouses primarily in San Diego county, California. We anticipate the
termination of one additional franchise area development agreement in the coming
year, which will reduce the number of franchise coffeehouse commitments to 331.
We are currently in various stages of discussion and negotiation with a
number of potential area developers and are in the process of refining our
overall franchise recruitment techniques and strategies. We intend to enter into
franchise area development agreements covering most major U.S. markets in order
to continue the national expansion of Diedrich coffeehouses, carts, and kiosks.
We have identified area development franchising with experienced multi-unit
franchise operators as our preferred growth vehicle because we believe these
operators have:
- familiarity with the trade areas and commitment to community businesses;
- existing operational, financial, real estate, construction, training,
accounting, human resources and management functions that are ready to
expand; and
- the ability to be better operators in their own local markets than a
national operator with operations extended from coast to coast.
The franchisee component of our growth strategy is critical to our success.
We believe that our unit level economics are attractive to experienced
multi-unit franchise operators who will play an integral role in completing our
planned expansion.
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Developing Company-Operated Diedrich Coffee Retail Locations
Diedrich Coffee expects to continue to develop company-operated coffeehouses,
kiosks and carts in our core Southern California market and other strategic
markets. We intend to develop additional retail locations in high visibility,
high-traffic locations ranging from 1,200 to 1,800 square feet with an exterior
patio area for additional seating. Historically, our most successful
coffeehouses are located between our target demographic customer's home and
office. The prime locations are generally in a strip mall or center in a
neighborhood setting. In fiscal 2001, we plan to build three new Diedrich stores
in Orange County and two in the Portland, Oregon airport.
Expanding Wholesale Distribution Channel
Diedrich Coffee has taken significant steps to build our wholesale sales
organization and to grow this business channel. We have also added a number of
well-known restaurant groups as wholesale customers, including Ruth's Chris
Steakhouses (California/Arizona locations), Islands Restaurants, Ruby's
Restaurants and Claim Jumper. The sale of Diedrich Coffee products at these
restaurant chains helps solidify brand recognition and demand for our coffee.
Additionally, we are actively seeking new distribution channels for our
products. For example, we have recently begun shipments of our Keurig line of
individual coffee "K-cups" through Keurig distributors serving the office coffee
market. We also offer our coffee on our website and are seeking to expand this
rapidly growing channel of distribution.
Pursuing Selected Acquisitions
Diedrich Coffee evaluates potential acquisitions that may accelerate our
critical mass in existing or new markets. In particular, we look for acquisition
targets that may provide:
- improved stability of financial and business operations due to increased
cash flow and earnings;
- greater access to capital, distribution channels and coffee roasting
infrastructures; and
- decreased supply and distribution costs.
To this end, we acquired Coffee People in July 1999. The acquisition of
Coffee People added 41 new retail locations to the Diedrich Coffee brand.
Additionally, it made Diedrich Coffee the leader in the mall coffee store
segment with the acquisition of 278 Gloria Jean's mall coffee stores. We believe
that acquisitions will continue to be available at a discount to the cost of
constructing new stores, especially where targets may be currently
underperforming despite attractive real estate attributes. We believe our
unique, high-quality product and efficient operating system can add value to an
acquired location.
The Gloria Jean's Brand
Since the end of the 1999 holiday season, Diedrich Coffee has witnessed a
significant increase in the number of premature closures of franchised Gloria
Jean's retail locations (i.e. prior to the expiration of the franchise agreement
and sublease). As a result, Diedrich Coffee determined that it was appropriate
to reevaluate Gloria Jean's previous growth strategy and projections, business
model and unit level economics, and to deemphasize attempting to grow Gloria
Jean's aggressively with new franchises until this review is complete. While
significant progress has been made developing a new growth strategy, the process
has not yet been completed. Therefore, until a new growth strategy has been
finalized, Gloria Jean's will continue to franchise new domestic sites only on a
limited basis, primarily to existing franchisees seeking to expand. We have
already made several modifications to our Gloria Jean's franchising business
model, as a result of its recent reevaluations. Franchisees are now required to
obtain their own master leases directly from mall owners, rather than subleasing
their locations from Gloria Jean's. Previously, Gloria Jean's would remain
responsible for the master lease obligations if a franchisee were to default
under the sublease. Also, franchisees will now be required to hire their own
architects and contractors to develop new Gloria Jean's locations to meet
approved specifications, rather than the past practice where Gloria Jean's
construction and development personnel supervised and coordinated this process.
While we feel that these and other potential future changes to Gloria Jean's
franchising model will ultimately result in a stronger Gloria Jean's franchise
system, they will probably result in slower growth in the near term.
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We have also been developing a new Gloria Jean's concept called Glories
Fountain Cafe, which focuses on beverage sales, both coffee and non-coffee. The
concept is intended to attract a younger customer than the current Gloria Jean's
concept. The first prototype is scheduled to open at the end of September 2000
in Thousand Oaks, California. If the results are favorable, the new concept will
be offered to Gloria Jean's franchisees for new unit development as well as for
the potential remodeling/conversion of certain existing Gloria Jean's locations
based upon a variety of factors.
Gloria Jean's has been successful establishing coffeehouses
internationally through Area Development Agreements, and international
franchisees presently operate retail locations in 9 countries. We will continue
to grow the Gloria Jean's brand internationally through such Area Development
Agreements.
UNIT-LEVEL ECONOMICS
Franchised Stores -- Coffeehouses
The franchisee of Diedrich coffeehouses is responsible for all of the capital
expenditures associated with the store, although we do assist in site selection
and help coordinate construction and development to ensure consistency. Our
typical franchise development agreement calls for a fixed number of coffeehouses
to be built over a five to seven year period. The area development fee is based
on $2,000 per coffeehouse and is paid upon execution of the franchise area
development agreement. (Our previous form of franchise area development
agreement allowed the area development fee to be paid in five annual
installments. For example, if the area development agreement called for 50
coffeehouses, the franchisee would pay us a total of $100,000 spread evenly over
a five-year period.) In addition, the franchisee pays a fee of $28,000 upon
execution of the franchise agreement for each coffeehouse. Ongoing charges to
franchisees include a royalty fee of 5% of gross sales and an advertising
cooperative contribution of 2% of gross sales. The franchisee purchases the
whole beans from us at full cost. The franchisee pays the same price for its
beans as do our company-operated coffeehouses.
Franchised Stores -- Mall Stores
In the Gloria Jean's mall coffee store franchises, the franchisee is
responsible for all of the capital expenditures associated with the store,
although we do assist in site selection and help coordinate construction and
development to ensure consistency. Typical franchise agreements provide
for the payment of $25,000 upon the opening of each store. This fee is reduced
to $20,000 if it is the franchisee's second store. Ongoing charges to
franchisees include a royalty fee of 6% of gross sales and an advertising fund
contribution of 2% of gross sales, as well as a $1.00 per pound margin on beans
sold to franchisees.
Company-Operated Stores
In fiscal 2000, our Diedrich coffeehouses located in Orange County generated
average store sales of approximately $808,000. During the same fiscal year,
these locations generated average cash flow of approximately $211,000 or 26.1%
of total sales. Comparable unit level sales for these coffeehouses increased
3.0% for fiscal 2000. We currently lease most of our locations and plan to lease
all of our future locations. We intend to develop coffeehouses that require an
initial investment of between $300,000 and $375,000, excluding lease costs.
However, individual store investment costs vary significantly due to a variety
of factors, including competition for sites, location, construction costs and
unit size.
RETAIL OPERATIONS
Coffeehouses
The typical Diedrich coffeehouse is staffed with 1 or 2 managers and a staff
of 10 to 15 part-time hourly employees from which the operating shifts are
filled. Additionally, local entertainment is used on the weekends to enhance the
neighborhood atmosphere. The hours for each coffeehouse are established based
upon location and
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customer demand, but typically are from 6:00 a.m. to 11:00 p.m., Monday through
Saturday, in residential locations and from 6:00 a.m. to 5:00 p.m., Monday
through Friday, in commercial locations.
In addition to coffee beverages, all Diedrich coffeehouses offer a limited
selection of light food items, such as bagels, croissants and pastries and
dessert items, such as cookies and cakes, to complement beverage sales. Our
coffeehouses also sell more than twenty different selections of regular and
decaffeinated roasted whole bean coffees, and they carry select coffee-related
merchandise items. The following table sets forth, as percentages, the
approximate sales mix by categories of products in fiscal 2000 for Diedrich
Coffee company-operated coffeehouses:
Beverages............................... 73%
Coffee beans............................ 6%
Food items.............................. 19%
Accessories and clothing................ 2%
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Total......................... 100%
===
Franchise Operations
Diedrich Coffee's current franchise agreements require both Diedrich and
Gloria Jean's franchisees to purchase all of their coffee from us. (However
certain Gloria Jean's franchisees with Franchise Agreements dating prior to 1993
are permitted to purchase up to 15% of their beans from approved alternate
suppliers, subject to a number of restrictions). In addition, we supply
franchisees with other non-coffee products, such as cups, bags and napkins.
Suppliers of products sold in franchised stores are subject to our approval to
ensure that quality standards and product consistency are maintained at all
times.
We have the first right to purchase any existing franchise store that a
franchisee wishes to sell. If we do not choose to purchase the franchise, we
have the right to approve the new franchisee before the franchise transfer.
Management believes that store profitability and the quality of customer
service are maximized when stores are operated by talented and committed
management. We have implemented a rigorous screening process for the selection
of qualified franchisees and management.
Franchise Support Programs
For both Diedrich Coffee and Gloria Jean's Franchisee, we provide a variety
of support services to our franchisees. These services include:
- training;
- business consultation;
- marketing;
- product sourcing; and
- volume purchasing savings.
We have established an intensive training program for our franchisees, which
includes training on in-store operations, coffee knowledge, merchandising,
buying, controls and accounting. Management works closely with franchisee
representatives on issues that affect the operations of stores. Franchisees are
surveyed regularly to provide feedback on subjects that affect the operations of
their stores.
WHOLESALE OPERATIONS
Currently, Diedrich Coffee has over 300 wholesale accounts, which purchase
coffee from us under the Diedrich brand. As specialty coffee has grown in
overall popularity, the restaurant customer has demanded a high quality cup of
coffee as a supplement to a fine meal. Our chain accounts include Ruth's Chris
Steakhouse (California/Arizona
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locations), Claim Jumper, Islands Restaurants and Ruby's Restaurants. Diedrich
Coffee not only supplies coffee to these customers, but also approves the
equipment and trains the employees of these customers to ensure that the quality
of coffee served meets our rigorous standards. These customers specify that
Diedrich Coffee products are served in their menus providing Diedrich Coffee
with exposure to the restaurants' patrons.
We are actively seeking new distribution channels for our products. For
example, we have recently entered into a Licensing Agreement with Keurig, Inc.
whereby we utilize Keurig's patented single-serve coffee brewing technology and
its existing extensive distribution channels within the office coffee service
market. In June 2000, we began shipments of individual serving "K-cups" of both
Diedrich and Gloria Jean's coffee through Keurig distributors serving the office
coffee service market. We also offer our coffee on our website and are seeking
to expand this rapidly growing channel of distribution.
As a result of the Coffee People acquisition, we supply our Gloria Jean's
franchisees with roasted coffee from our roasting facility in northern
California. These sales now represent a significant portion of our wholesale
business, since unlike the sale of coffee beans to Diedrich Coffee coffeehouses,
sales of beans to Gloria Jean's outlets reflect a normal wholesale profit
margin.
MARKETING
Our marketing strategy is to differentiate Diedrich Coffee and to build a
strong brand identity primarily utilizing the coffeehouse model. The wholesale
division and the office coffee service help ensure the visibility of the brand,
but the core of this business is the coffeehouse. We implement this strategy at
the coffeehouse level by promoting the distinctive qualities of the various
Diedrich Coffee products, educating customers about the origins of coffee,
including the private estate coffees and roasts and delivering excellent
customer service in a cozy, comfortable atmosphere. Our marketing efforts are
based upon the belief that the proprietary roast recipes and our commitment to
quality and freshness deliver a distinctive advantage in the coffee product. A
steady introduction of new coffee and coffee-related drinks is an intrinsic
aspect of our marketing strategy.
To date, we have relied primarily upon the high visibility of our real estate
locations, word-of-mouth, public relations, local store marketing and the
inviting atmosphere of our coffeehouses to drive growth. However, we have begun
advertising new products and promotions through various media including radio.
We also conduct in-store coffee tastings, provide brewed coffee at local
neighborhood events, donate coffee to local charities and mail periodic
announcements to neighborhood residents to announce a store opening or the
introduction of a new product.
As we enter new markets, we plan to tailor our marketing strategy to the
overall level of awareness and availability of specialty coffee in that market.
Our promotions will focus on the superior proprietary roast recipes and taste of
Diedrich Coffee. In markets that are more knowledgeable about specialty coffees,
our advertising will focus on the superiority of our guaranteed freshly roasted
products versus competitive specialty brands. We plan to utilize print and other
mass media advertising to expand brand awareness when Diedrich Coffee has
achieved sufficient market penetration, in our judgment, to make such efforts
cost-effective.
PRODUCT SUPPLY AND ROASTING
Sourcing
Coffee beans are an agricultural product grown commercially in over fifty
countries in tropical regions of the world. The price and supply of coffee are
subject to significant volatility. There are many varieties of coffee and a
range of quality grades within each variety. Although the broader coffee market
generally treats coffee as a fungible commodity, the specialty coffee industry
focuses on the highest grades of coffee. Diedrich Coffee purchases only premium
grade arabica coffee beans and believes these beans are the best available from
each producing region. The premium grade arabica bean is a higher quality
variety than the average grade arabica or robusta variety coffee bean, which are
typically found in non-specialty or mass-merchandised commercial coffees. We
seek to purchase the finest qualities and varieties of coffee by identifying the
unique characteristics and flavor of the varieties available from each region of
the world. The background and experience of our personnel allows Diedrich Coffee
to maintain its commitment to serve and sell only the highest quality coffee.
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During the buying season, we may enter into forward commitments for the
purchase of more than a dozen different types of coffee, plus specially featured
coffees, that may only be available in small quantities. Rotating our coffee
selection enables us to provide our customers with a wider variety of coffees,
as well as certain coffees that are available only on a seasonal basis. We
contract for future delivery of green coffee to help ensure adequacy of supply
and typically maintain a minimum six-week supply of each variety of whole beans
then available.
Roasting
Diedrich Coffee employs a roasting process that varies based upon the
variety, quality, origin and physical characteristics of the coffee beans being
roasted. We utilize recipes and techniques that have been developed over three
generations to bring out the best characteristics of the coffee during the
roasting process and to develop the optimal flavor conditions that a coffee has
to offer. This approach differentiates Diedrich Coffee from commercial coffee
producers and other specialty producers employing uniform roasting processes
that do not differentiate between the types of coffee being roasted.
Diedrich Coffee's master roasters are responsible for overseeing the roasting
process. They are craftsmen who employ our proprietary roasting formulas while
adjusting the formula to take into account the specific attributes of each
coffee bean being roasted. Each coffee bean contains aromatic oils and flavor
characteristics that develop from the soil, climate and environment where the
bean is grown. The skilled roastmaster determines and carefully controls the
roasting conditions in an effort to maximize the flavor potential of each batch
of coffee. The roastmaster hears how the roast pops, smells the developing aroma
and identifies the right shades of color. He draws upon experience and knowledge
to properly adjust airflow, time and temperature while the roast is in progress
in order to optimize each roast.
Freshness
Diedrich Coffee is committed to serving our customers beverages and whole
bean products from freshly roasted coffee beans. Our coffee is delivered to our
coffeehouses promptly after roasting to guarantee the freshness of each cup of
coffee or package of whole coffee beans sold in our coffeehouses. Serving only
freshly roasted coffee is imperative because roasted coffee is a highly
perishable product, which steadily loses quality after being roasted at a rate
that varies in relation to its exposure to oxygen in storing, packaging and
handling. We recently began utilizing new vacuum pack and nitrogen flush packing
equipment that can significantly extend the shelf life of roasted coffee.
MANAGEMENT INFORMATION SYSTEMS
All of the Diedrich coffeehouses use point-of-sale systems which ensure
efficient service to the customers, assist store management in minimizing
operating costs and maintain the necessary information to provide management
with timely financial and marketing data. The system includes functions to
record all customer sales, authorize credit card transactions, forecast labor
requirements based on estimated sales activity, manage store inventory and
analyze actual versus theoretical food costs.
The systems used in Diedrich Coffee's corporate offices provide financial
reporting that includes performance comparisons of actual, budget and prior year
results by period and year-to-date, statistical recaps and 12 month reports.
This information allows management to measure store performance based on sales,
cost of sales, labor and store expenses on a timely basis.
COMPETITION
The specialty coffee market is intensely competitive and highly fragmented.
With low barriers to entry, competition in the industry is expected to increase
from national and regional chains, franchise operators and local specialty
coffee stores. We compete directly against all other premium coffee roasters,
coffeehouses, espresso/coffee bars and mall coffee stores, as well as against
restaurant and beverage outlets that serve coffee and a growing number of
espresso stands, carts and stores. In addition, we compete to draw consumers of
standard or commercial coffee to premium coffee. Our whole bean coffee competes
directly against specialty coffees sold at retail through supermarket, specialty
retailers and a growing number of specialty coffee stores. We believe that our
customers
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choose among retailers primarily on the basis of product quality, service,
coffeehouse ambiance, convenience and, to a lesser extent, on price.
We compete with a growing number of specialty coffee retailers including
Starbucks, Coffee Beanery, Caribou, Barnie's, Tully's, New World Coffee &
Bagels, Peet's Coffee and many others. The attractiveness of the gourmet
specialty coffeehouse market may draw additional competitors with substantially
greater financial, marketing and operating resources than us. A number of
nationwide coffee manufacturers, such as Kraft General Foods, Proctor & Gamble,
and Nestle, distribute coffee products in supermarkets and convenience stores,
which may serve as substitutes for our coffees. Other specialty coffee companies
including Starbucks, Seattle's Best Coffee, Bucks County, Brothers Gourmet
Coffees and Green Mountain Coffee Roasters, sell whole bean coffees in
supermarkets and variety and discount stores.
The performance of individual coffeehouse or mall coffee stores may also be
affected by factors such as traffic patterns and the type, number and proximity
of competing coffeehouses or mall coffee stores. In addition, factors such as
inflation, increased coffee bean, food, labor and employee benefit costs and the
availability of experienced management and hourly employees may also adversely
affect the specialty coffee retail business in general and our coffeehouses and
mall coffee stores in particular.
INTELLECTUAL PROPERTY
Diedrich Coffee owns several trademarks and service marks that have been
registered with the United States Patent and Trademark Office, including
Diedrich Coffee(R), Gloria Jean's(R), Coffee People(R), Coffee Plantation(R),
Motor Moka(R), Aero Moka(R), Wiener Melange Blend(R), Harvest Peak(R),
SCOOP-A-CCINO(R) and Flor de Apanas(R), as well as other slogans, product names,
design marks and logos. In addition, we have applications pending with the
United States Patent and Trademark Office for a number of additional marks. We
also own registrations and have applications pending in numerous foreign
countries for the protection of the Diedrich Coffee and Coffee People trademark
and service mark. These trademark registrations can generally be renewed as long
as we continue to use the marks protected by the registrations. The Diedrich
Coffee trademark is material to our business. We also own a number of common law
service marks and trademarks in the United States including "Gloria Jean's
Coffee Bean." We have also received trademark and service mark protection for
the name Coffee People and related marks in Canada and Japan. We own copyrights
on our promotional materials, coffeehouse graphics and operational and training
materials. We do not believe that any of these copyrights, valuable as they are,
are material to our business.
EMPLOYEES
At June 28, 2000, Diedrich Coffee employed a work force of 1,336 persons, 562
of whom were employed full-time. None of our employees is represented by a labor
union, no employees are currently covered by collective bargaining agreements,
and we consider our relations with our employees to be good. We are improving
employee benefits, training and other aspects of employment to attract and
retain valuable employees and managers.
GOVERNMENT REGULATION
In addition to the laws and regulations relating to the food service
industry, Diedrich Coffee is subject to Federal Trade Commission, or FTC,
regulation and state laws that regulate the offer and sale of franchises as well
as the franchise relationship.
The FTC's Trade Regulation Rule relating to Disclosure Requirements and
Prohibitions Concerning Franchising and Business Opportunity Ventures generally
requires us to give prospective franchisees a franchise offering circular
containing information prescribed by the rule.
A number of states have laws that regulate the offer and sale of franchises
and the franchisor-franchisee relationship. These laws generally require
registration of the franchise offering with state authorities before making
offers or sales and regulate the franchise relationship by, for example:
- prohibiting interference with the right of free association among
franchisees;
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- prohibiting discrimination in fees and charges;
- regulating the termination of the relationship by requiring "good cause"
to exist as a basis for the termination, advance notice to the franchisee
of the termination, and an opportunity to cure a default;
- requiring repurchase of inventories in some circumstances;
- restricting nonrenewal by the franchisor;
- limiting restrictions on transfers or inheritance of the franchisee's
interests; and
- regulating placement of competing units that might adversely affect the
franchisee's results.
Failure to comply with these laws may adversely affect us.
Any changes to the FTC rule or state franchise laws, or future court or
administrative decisions, however, could affect our franchise business.
There are also extensive federal, state and local government regulations
relating to the development and operation of food service outlets, including
laws and regulations relating to:
- building and seating requirements;
- the preparation and sale of food;
- cleanliness;
- safety in the workplace; and
- accommodations for the disabled.
Our relationship with our employees is also subject to regulation, such as:
- minimum wage requirements;
- anti-discrimination laws;
- overtime and working conditions; and
- citizenship requirements.
RISK FACTORS AND TRENDS AFFECTING DIEDRICH COFFEE AND ITS BUSINESS
WE HAVE SUCCESSFULLY COMPLETED NEGOTIATIONS TO MODIFY OUR BANK CREDIT
AGREEMENT SO THAT WE ARE NO LONGER IN DEFAULT. HOWEVER, IF WE ARE NOT ABLE TO
SUCCESSFULLY MANAGE OUR REPAYMENT STRATEGY, OR IF WE ARE UNABLE TO MAINTAIN
COMPLIANCE WITH OUR REVISED FINANCIAL COVENANTS, OUR LENDER MAY DECLARE US TO BE
IN DEFAULT AND EXERCISE ITS CONTRACTUAL REMEDIES.
We announced in June 2000 that we were in default under our Credit Agreement
for our term loan and revolving credit facility because of our failure to meet
certain financial covenants. We negotiated an extension of the due date for the
$666,667 term loan principal installment due June 30, 2000 and subsequently paid
that installment on the extended due date of July 31, 2000. On September 26,
2000, we entered into a First Amendment to Credit Agreement with our lender to
amend the terms of our Credit Agreement. The amended Credit Agreement
significantly reduces the required principal payments due in fiscal 2001, but
certain assets will likely need to be sold in order to meet the terms of the
amended Agreement. There is no assurance that we will be able to sell such
assets on the timetables or for the values anticipated. The First Amendment to
Credit Agreement also now requires that the debt be paid in full by September
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2002. To pay off the loan in 2002, we may need to obtain new financing which may
not be readily available to us at that time. In addition to the required payment
changes, the First Amendment to Credit Agreement amends the financial covenants
contained in the Loan Agreement. If we are unable to comply with the terms of
our revised financial covenants, our lender may declare a default and
immediately accelerate the due date of our outstanding loans. If we are unable
to repay our outstanding loans when asked to do so by the lender, the lender may
exercise any one or more of the remedies available to it, including foreclosing
on the assets pledged to support the facility, which includes virtually all of
our assets. The lender may also require our subsidiaries to repay amounts
outstanding because each of our subsidiaries is a co-borrower under the First
Amendment to Credit Agreement.
WE HAVE INCURRED SUBSTANTIAL COSTS AS A RESULT OF THE ACQUISITION OF COFFEE
PEOPLE.
Since our acquisition of Coffee People in July 1999, we have incurred various
integration costs from combining Coffee People's operations with those of
Diedrich Coffee. More significant, however, have been unanticipated costs and
expenses associated with an increase in the number of Gloria Jean's franchise
unit closures over historical closure rates. These include lost royalty
contributions and profit on the sale of coffee beans to such franchisees,
increased bad debt expense, the costs of rents on the master leases for closed
franchised stores with remaining master lease term, but with no sublease
contribution to offset these costs, or alternatively, the cost of negotiating an
early termination of these lease with the landlord, including in certain
instances legal representation and litigation costs, and brokerage commissions.
These costs have been substantial. We recorded a non-cash asset impairment
charge of $16,370,000 in the fiscal quarter ended June 28, 2000, primarily
related to intangible assets acquired in the acquisition, and also recorded
operating charges of approximately $1.2 million during fiscal 2000, in
connection with the costs described above.
HISTORICAL LOSSES MAY CONTINUE AND, AS A RESULT, THE PRICE OF OUR COMMON STOCK
MAY BE NEGATIVELY AFFECTED.
Diedrich Coffee had a net loss of $22,424,000 for the fiscal year ended June
2000, a net loss of $2,349,000 for the twenty-two weeks ended June 30, 1999 and
net losses of $2,562,000 and $9,113,000, and $986,000 for the fiscal years ended
January, 1999, 1998 and 1997. Despite the acquisition of Coffee People and the
implementation of a strategic plan during fiscal 1999 that included growing
Diedrich Coffee through franchise area development agreements, we have not
become profitable. We expect to sustain net losses for the foreseeable future.
We may never achieve profitability.
IF WE ARE NOT ABLE TO SUCCESSFULLY MANAGE OUR GROWTH STRATEGY, OUR BUSINESS AND
RESULTS OF OPERATIONS MAY BE ADVERSELY IMPACTED.
As of June 28, 2000, Diedrich Coffee operated 80 Diedrich Coffee, Coffee
People or Coffee Plantation retail locations, which it managed on a day-to-day
basis, and had 3 franchised coffeehouse locations. Diedrich Coffee also has 278
Gloria Jean's retail locations, of which 256 are franchised. The Gloria Jean's
retail locations are located in malls. Our growth strategy contemplates
franchise area development for additional Diedrich coffeehouses as well as
opening new company-operated coffeehouses. In addition, we plan to continue
single store franchise development for Gloria Jean's and to increase wholesale
sales for both Diedrich Coffee and Gloria Jean's. Implementation of our growth
strategy may divert management's attention from other aspects of our business
and place a strain on management, operational and financial resources, and
accounting systems. Our continued growth will require us to:
- attract franchise area developers for Diedrich Coffee in the United States
and internationally;
- attract single store franchisees for Gloria Jean's in the United States,
and franchised area developers internationally;
- continue to upgrade products and programs at Gloria Jean's;
- expand wholesale sales of Diedrich Coffee and Gloria Jean's;
- obtain (or have our franchise area developers obtain) suitable sites at
acceptable costs in highly competitive real estate markets;
- hire, train and retain qualified personnel;
- integrate newly franchised or corporate locations into existing product
distribution;
- improve inventory control, marketing and information systems; and
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- impose and maintain strict quality control from green coffee acquisition
to the fresh cup of brewed coffee in a customer's hand.
Should our franchisees encounter business or operational difficulties,
anticipated revenues from franchise fees, including royalties and product sales
to franchisees could be adversely affected. These adverse results could also
affect our ability to sell additional franchises. Diedrich Coffee previously
pursued an aggressive growth strategy in fiscal years 1997 and 1998 that was not
successful for a number of reasons. Some locations acquired were not suitable
for Diedrich Coffee coffeehouses. Company management and infrastructure did not
keep pace with the growth, leading to inefficiencies and losses. Diedrich Coffee
also took a substantial charge in the fourth quarter of fiscal 2000 in
connection with the closure of 39 Gloria Jean's locations it acquired in its
acquisition of Coffee People in July 1999. If we are unable to properly manage
our growth strategy, our business and results of operations may be adversely
impacted.
IF WE ARE UNABLE TO OBTAIN ACCEPTABLE FINANCING, IT COULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR GROWTH STRATEGY AND OUR ABILITY TO CONTINUE OPERATIONS.
In order to achieve our anticipated growth and the expansion of our wholesale
and retail business, including new coffeehouse construction and franchising, we
will need to incur debt or issue additional stock in public or private
financings. If additional funds are raised through the issuance of stock,
dilution to stockholders may result. If additional funds are raised through the
incurrence of debt, these debt instruments will likely contain restrictive
financial, maintenance and security covenants, which could have a material
adverse effect on our business, financial condition and results of operations.
This additional financing may not be available on terms satisfactory to us.
OUR GROWTH THROUGH FRANCHISE AREA DEVELOPMENT MAY NOT OCCUR AS RAPIDLY AS WE
CURRENTLY ANTICIPATE.
Our ability to recruit, retain and contract with qualified franchise area
developers has become, and will continue to be, increasingly important to our
operations as we expand. In addition, the coffeehouses contemplated in existing
franchise area development agreements may not open on the anticipated
development schedule. Our franchisees are dependent upon the availability of
adequate sources of financing on acceptable terms in order to meet their
development obligations, and the credit markets for such franchise financing
have historically been somewhat volatile. Prospective franchise lenders have
historically been cautious in their approach to financing smaller or newer, less
established retail brands vis-a-vis larger and more established franchised
systems. Such financing may not be available to our franchised area developers,
or only available upon disadvantageous terms. Our franchise development strategy
may not enhance our results of operations. Failure to execute on our strategy to
grow through franchise area development would harm our business, financial
condition and results of operations.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, WHICH COULD HAVE A NEGATIVE
EFFECT ON THE PRICE OF OUR COMMON STOCK.
Our operating results will fluctuate from quarter to quarter as the result of
a number of factors, including:
- fluctuations in prices of unroasted coffee;
- labor costs for our hourly and management personnel, including increases
in federal or state minimum wage requirements;
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- the number, timing, mix and cost of coffeehouse and mall coffee store
openings, franchises, acquisitions or closings;
- comparable store sales results;
- changes in consumer preferences; and
- the level of competition from existing or new competitors in the specialty
coffee industry.
We incur significant pre-opening expenses associated with our company-owned
coffeehouses, and new coffeehouses experience an initial period of operating
losses. As a result, the opening of a significant number of company-owned
coffeehouses in a single period will have an adverse effect on our results of
operations. Due to the foregoing, we believe that period-to-period comparisons
of our operating results are not necessarily meaningful and such comparisons
should not be relied upon as indicators of future performance. From time to time
in the future, our operating results likely will fall below the expectations of
investors and public market securities analysts. Quarterly fluctuations, for any
reason, could cause our stock price to decline.
In addition, our business is subject to seasonal fluctuations. The December
holiday season generally experiences the highest sales. Hot weather tends to
depress sales of hot coffee and espresso drinks, especially unseasonably warm
weather. Consequently, we will continue to experience significant fluctuations
in quarterly results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Seasonality and Quarterly Results."
THE LOSS OF KEY PERSONNEL OR OUR INABILITY TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL COULD SIGNIFICANTLY DISRUPT OUR BUSINESS.
Our continued success largely will depend on the efforts and abilities of our
executive officers and other key employees. The loss of services of these
individuals could disrupt operations. Although Diedrich Coffee has employment
agreements with each of its executive officers, any of its executive officers
can terminate their employment if they choose to do so.
In addition, our success and the success of our franchisees will depend upon
our and their ability to attract and retain highly motivated, well-qualified
retail operators and other management personnel, as well as a sufficient number
of qualified employees. Qualified individuals needed to fill these positions are
in short supply in some geographic areas. Our inability to recruit and retain
such individuals may delay the planned openings of new retail locations or
result in higher employee turnover in existing retail locations, which could
have a material adverse effect on our business or results of operations.
OUR INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT HAVE THE RESOURCES TO COMPETE
EFFECTIVELY.
The highly competitive nature of the retail specialty coffee market could
adversely affect our business and financial condition. With low barriers to
entry, competition in the industry is expected to increase from national and
regional chains, franchise operators and local specialty coffee stores. We
compete directly against all other premium coffee roasters, coffeehouses,
espresso/coffee bars and mall coffee stores, as well as against restaurant and
beverage outlets that serve coffee and a growing number of espresso stands,
carts and stores. In addition, we compete to draw consumers of standard or
commercial coffee to premium coffee. Our whole bean coffees compete directly
against specialty coffees sold at retail through supermarkets, specialty
retailers and a growing number of specialty coffee stores. We believe that our
customers choose among retailers primarily on the basis of product quality,
service, coffeehouse ambiance, convenience and, to a lesser extent, on price.
We compete with a growing number of specialty coffee retailers including
Starbucks, Seattle's Best Coffee, Barnie's, Coffee Beanery Ltd., Caribou, Peet's
Coffee and many others. The attractiveness of the gourmet specialty coffeehouse
market may draw additional competitors with substantially greater financial,
marketing and operating
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resources than us. A number of nationwide coffee manufacturers, such as Kraft
General Foods, Proctor & Gamble and Nestle, distribute coffee products in
supermarkets and convenience stores, which may serve as substitutes for our
coffees. Other specialty coffee companies including Starbucks, Seattle's Best
Coffee, Bucks County, Brothers Gourmet Coffees and Green Mountain Coffee
Roasters, sell whole bean coffees in supermarkets and variety and discount
stores.
The performance of individual coffeehouses or mall coffee stores may also be
affected by factors such as traffic patterns and the type, number and proximity
of competing coffeehouses or mall coffee stores. In addition, factors such as
inflation, increased coffee bean, food, labor and employee benefit costs and the
availability of experienced management and hourly employees may also adversely
affect the specialty coffee retail business in general and our coffeehouses and
mall coffee stores in particular.
OUR LACK OF DIVERSIFICATION MAY AFFECT BUSINESS IF DEMAND IS REDUCED.
Our business is primarily centered on one product: fresh premium
custom-roasted coffee. To date, our operations have been limited to primarily
the purchase and roasting of green coffee beans and the sale of whole bean
coffee, coffee beverages and espresso drinks through our coffeehouses and our
wholesale coffee and mail order businesses. Any decrease in demand for coffee
would have a material adverse effect on our business, operating results and
financial condition.
OUR COMPANY-OPERATED RETAIL LOCATIONS ARE CONCENTRATED IN THE WESTERN REGION OF
THE UNITED STATES, AND THEREFORE OUR BUSINESS IS SUBJECT TO FLUCTUATIONS IF
ADVERSE BUSINESS CONDITIONS OCCUR IN THAT REGION.
Our company-operated retail locations are primarily located in the western
region of the United States. Accordingly, we are susceptible to fluctuations in
our business caused by adverse economic or other conditions in this region,
including natural or other disasters. In addition, some of our competitors have
many more retail locations than we do. Consequently, adverse economic or other
conditions in a region, a decline in the profitability of several existing
retail locations or the introduction of several unsuccessful new retail
locations in a geographic area could have a more significant effect on our
results of operations than would be the case for a company with a larger number
of retail locations or with more geographically dispersed retail locations.
OUR SUPPLY COSTS MAY BE HIGHER THAN WE EXPECT BECAUSE OF FLUCTUATIONS IN
AVAILABILITY AND COST OF UNROASTED COFFEE.
Increases in the price of green coffee, or the unavailability of adequate
supplies of green coffee of the quality we seek, whether due to the failure of
its suppliers to perform, conditions in coffee-producing countries, or
otherwise, could have a material adverse effect on our results of operations. We
depend upon both outside brokers and our direct contacts with exporters and
growers in countries of origin for our supply of green coffee. Coffee supply and
price are subject to significant volatility beyond our control. Although most
coffee trades in the commodity market, coffee of the quality we seek tends to
trade on a negotiated basis at a substantial premium above commodity coffee
pricing, depending upon the origin, supply and demand at the time of purchase.
Supply and price can be affected by multiple factors in the producing countries,
including weather, political and economic conditions. In addition, green coffee
prices have been affected in the past, and may be affected in the future, by the
actions of certain organizations and associations, such as the International
Coffee Organization or the Association of Coffee Producing Countries. These
organizations have historically attempted to establish commodity price controls
of green coffee through agreements establishing export quotas or restricting
coffee supplies worldwide. These organizations, or others, may succeed in
raising green coffee prices. Should this happen, we may not be able to maintain
our gross margins by raising prices without affecting demand.
WE COULD BE SUBJECT TO ADVERSE PUBLICITY OR CLAIMS FROM OUR GUESTS.
We may be the subject of complaints or litigation from guests alleging
beverage and food-related illness, injuries suffered on the premises or other
quality, health or operational concerns. Adverse publicity resulting from such
allegations may materially adversely affect us, regardless of whether such
allegations are true or whether we are ultimately held liable. We may also be
the subject of complaints or allegations from current, former or prospective
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employees from time-to-time. A lawsuit or claim could result in an adverse
decision against us that could have a material adverse effect on our business,
financial condition and results of operations.
CHANGES IN CONSUMER PREFERENCES OR DISCRETIONARY SPENDING COULD NEGATIVELY
AFFECT OUR RESULTS.
Our retail locations offer specialty coffee beans, brewed coffee beverages,
espresso-based beverages, blended drinks and light food items served in a casual
setting. Our continued success depends, in part, upon the popularity of these
types of coffee-based beverages and this style of casual dining. Shifts in
consumer preferences away from our coffee-based beverages or casual setting
could materially adversely affect our future profitability. Also, our success
depends to a significant extent on numerous factors affecting discretionary
consumer spending, including economic conditions, disposable consumer income and
consumer confidence. Adverse changes in these factors could reduce guest traffic
or impose practical limits on pricing, either of which could adversely affect
our business, financial condition, operating results and cash flows.
WE MAY NOT BE ABLE TO RENEW LEASES OR CONTROL RENT INCREASES AT OUR RETAIL
LOCATIONS.
All but 2 of our 102 company-operated coffeehouses are presently on leased
premises. Gloria Jean's stores are generally leased by an indirect subsidiary of
Coffee People, although in most cases, the franchisees pay their rent directly
to their landlord. Upon the expiration of some of these leases, there is no
automatic renewal or option to renew. Consequently, these leases may not be
renewed. If they are renewed, rents may increase substantially. Either of these
events could adversely affect us. Other leases are subject to renewal at fair
market value, which could involve substantial rent increases, or are subject to
renewal with scheduled rent increases, which could result in rents being above
fair market value.
OUR FAILURE OR INABILITY TO ENFORCE OUR TRADEMARKS AND TRADE NAMES COULD
ADVERSELY AFFECT OUR EFFORTS TO ESTABLISH BRAND EQUITY.
Our ability to successfully expand our concept will depend in part on our
ability to maintain "brand equity" through the use of our trademarks, service
marks, trade dress and other proprietary intellectual property, including our
name and logos. We currently hold a number of trademarks and service marks
related to our brands. Some or all of our rights related to our intellectual
property may not be enforceable, even if registered, against any prior users of
similar intellectual property or our competitors who seek or intend to utilize
similar intellectual property in areas where we operate or intend to conduct
operations. If we fail to enforce our intellectual property rights, we may be
unable to capitalize on our efforts to maintain brand equity. It is possible
that we will encounter claims from prior users of similar intellectual property
in areas where we operate or intend to conduct operations, including foreign
countries. Claims from prior users could limit our operations and possibly cause
us to pay damages or licensing fees to a prior user or registrant of similar
intellectual property. See "Business -- Intellectual Property."
FUTURE CHANGES IN MINIMUM WAGE REQUIREMENTS COULD ADVERSELY AFFECT OUR BUSINESS,
FINANCIAL CONDITION, RESULTS OF OPERATIONS OR CASH FLOWS.
A number of our employees are subject to various minimum wage requirements.
Many of our employees work in retail locations 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. Additionally, the minimum wage in Oregon recently rose to $6.50
per hour. There can be no assurance that similar increases will not be
implemented in these or other jurisdictions in which we operate or seek to
operate. In addition, the federal minimum wage increased to $5.15 per hour
effective September 1, 1997. There can be no assurance that we will be able to
pass additional increases in labor costs through to our guests in the form of
price adjustments and, accordingly, such minimum wage increases could have a
material adverse effect on our business, financial condition, results of
operations or cash flows.
COMPLIANCE WITH HEALTH, FRANCHISING AND OTHER GOVERNMENT REGULATIONS APPLICABLE
TO US COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
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Each retail location and roasting facility is and will be subject to
licensing and reporting requirements by numerous governmental authorities. These
governmental authorities include federal, state and local health, environmental,
labor relations, sanitation, building, zoning, fire, safety and other
departments relating to the development and operation of retail locations. Our
activities are also subject to the Americans with Disabilities Act and related
regulations, which prohibit discrimination on the basis of disability in public
accommodations and employment. Changes in any or all of these laws or
regulations could have a material adverse effect on our 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 retail locations or could materially
and adversely affect the operation of existing retail locations. In addition, we
may not 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 retail locations in the future.
We are also subject to federal regulation and certain foreign and state laws
that govern the offer and sale of franchises and the franchisor-franchisee
relationship. Many foreign and state franchise laws impose substantive
requirements on franchise agreements, including limitations on noncompetition
provisions and on provisions concerning the termination or nonrenewal of a
franchise. Some foreign countries and states require companies to register
certain materials before franchises can be offered or sold in that country or
state. The failure to obtain or retain licenses or registration approvals to
sell franchises could delay or preclude franchise sales and otherwise adversely
affect our business, financial condition and results of operations.
Additionally, any franchise law violations may give existing and future
franchisees a basis to bring claims against Diedrich Coffee. Franchise law
violation claims could include unfair business practices, negligent
misrepresentation, fraud, and statutory franchise investment and/or relationship
violations. Remedies may include damages and/or recission of the franchise
agreement by the franchisee. These claims may already exist and their assertion
against us could adversely affect our business, financial condition, and results
of operations. See "Business -- Government Regulation."
GROWTH OF OUR INTERNATIONAL OPERATIONS MAY BE ADVERSELY AFFECTED BY FACTORS
OUTSIDE OF OUR CONTROL.
We have 62 Gloria Jean's franchised stores located outside of the United
States and its territories. As part of our growth strategy, we will be seeking
franchise developers internationally for Gloria Jean's stores. As a result, our
business and operations will be increasingly subject to the risk of changes in
economic conditions and, to a lesser extent, changes in social and political
conditions inherent in foreign operations, including changes in U.S. laws and
regulations relating to foreign trade and investment. In addition, consumer
tastes vary from region to region, and consumers located in the regions in which
we intend to expand our retail operations may not be as receptive to specialty
coffees as consumers in existing markets.
WE MAY LOSE CUSTOMERS WHEN WE CONVERT COFFEE PEOPLE AND COFFEE PLANTATION BRAND
COFFEEHOUSES TO THE DIEDRICH COFFEE BRAND.
Most Coffee People brand and Coffee Plantation retail locations are
neighborhood coffeehouses which have loyal customers that are accustomed to and
expect Coffee People and Coffee Plantation brand products. We may lose these
customers when we convert the coffeehouses to the Diedrich Coffee brand which is
planned to occur over the next 12 to 18 months.
Recent Developments
On July 7, 1999, we completed the acquisition of Coffee People, Inc. Under
the terms of the merger agreement, Coffee People stockholders received $23.0
million in cash and 1.5 million shares of the Company's common stock. The
acquisition was funded from the proceeds of an offering of 4.6 million shares of
the Company's stock. The Coffee People brands acquired as a result of the merger
include Coffee People, Coffee Plantation, and Gloria Jean's. We intend to
eventually convert the Coffee People and Coffee Plantation coffeehouses to the
Diedrich brand.
Since the acquisition of the Coffee People brands, 39 underperforming Gloria
Jean's locations, six of which were company operated, have closed. The closure
of these units and other operational shortfalls led to our inability to meet
certain financial covenants contained in our Credit Agreement and on June 29,
2000 we announced that we expected to be in default under the Credit Agreement.
Our lender, Fleet National Bank, agreed to extend the due date of our June 30,
2000 quarterly principal payment until July 31, 2000 and to forbear until
September 30, 2000 from exercising any of its rights and remedies arising from
financial covenant defaults. On September 26, 2000, we entered into a First
Amendment to Credit Agreement with Fleet National Bank to amend certain terms of
the original Credit Agreement. The First Amendment to Credit Agreement provides,
among other things, for a significant reduction in required minimum principal
amortization payments in fiscal 2001, an acceleration in the maturity date of
all amounts owed under the Credit Agreement, an agreement between the parties as
to certain assets intended to be sold as well as the allocation of future net
asset sale proceeds between the Company and the bank, a reduction in the overall
amount of the revolving credit facility and certain new restrictions governing
use of the facility, and a modification of the financial covenants and our
ability to obtain new third party debt going forward.
On September 25, 2000, after 3 years as our President and CEO, Timothy J.
Ryan announced his retirement from Diedrich Coffee. Effective September 27,
2000, Mr. Ryan will be replaced by J. Michael Jenkins. Mr. Jenkins has over 30
years of experience in the restaurant industry, having served as CEO & Chairman
of the Steak & Ale restaurant chain, Executive Vice President of Marriott
Corporations Bob's Big Boy Chain, President & CEO of the T.G.I. Friday's chain,
President & CEO of Metromedia Steakhouses, CEO of El Chico Restaurants, CEO of
Vicorp Restaurants, and CEO of Boston Chicken.
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ITEM 2. PROPERTIES.
Office Space
We lease approximately 25,000 square feet of office space for
administrative offices, warehousing, and training facilities in Irvine,
California. The lease for this facility expires in October 2000 and we are
presently in the process of negotiating a three year extension. We currently
lease approximately 9,400 square feet of office space in Beaverton, Oregon and
1,888 square feet of office space in Tempe, Arizona for our regional offices. We
are seeking to sublet or assign the Beaverton lease, which expires in February
2004. Approximately, 6,750 square feet is currently subleased to a third party.
The Tempe lease is on a month-to-month basis. We also have a 60,000 square foot
roasting facility located in Castroville, California that is leased through
December 31, 2005.
Company-Owned Locations
In addition, as of June 28, 2000, we were a party to various leases for
a total of 100 company operated retail locations. We closed eleven retail
locations in fiscal 2000 (six of which were company-operated Gloria Jean's
locations, three were Coffee People or Coffee Plantation locations, and two of
which were Diedrich Coffee locations), two retail locations and a Denver
warehouse in fiscal 1999 and eleven retail locations in fiscal 1998. The
majority of these closures are associated with leases which have been
terminated, however Diedrich Coffee remains obligated on five others which have
been subleased. Our company-operated retail locations on leased premises are
subject to varying arrangements specified in property specific leases. For
example, some of the leases require a flat rent, subject to regional
cost-of-living increases, while others are based upon a percentage of gross
sales. In addition, certain of these leases expire in the near future, and there
is no automatic renewal or option to renew. No assurance can be given that
leases can be renewed, or if renewed, that rents will not increase
substantially, both of which would adversely affect us. Other leases are subject
to renewal at fair market value, which could involve substantial increases or
are subject to renewal with a scheduled rent increase, which could result in
rents being above fair market value.
We currently owns the land and buildings in Portland, Oregon at which
two of its company-operated Coffee People Oregon drive through espresso bars
(Motor Moka(R)) are operated, and an additional vacant parcel of land behind one
of the two.
Under its lease with the Port of Portland for the seven Aero Moka stores
at Portland International Airport, we are required to enter into a joint venture
with a certified disadvantaged business enterprise for one of its airport
stores. Upon entry into the joint venture, we will have a 49 percent ownership
in that store.
Franchised Stores
All of the our Gloria Jean's locations are operated on leased premises,
most situated in regional malls, 216 of which are located in the United States
and 62 of which are located in foreign countries. Virtually all of the leased
premises occupied by franchised outlets are leased by Gloria Jean's which then
enters into sublease agreements with the franchisee on a cost pass-through
basis. Gloria Jean's, however, remains obligated under the lease. Gloria Jean's
stores are designed to accommodate locations in various sizes, ranging from 170
square foot kiosk outlets (which sell principally coffee drinks and other
beverages) to 2,000 square foot full service stores.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of our business, we may become involved in legal
proceedings from time to time. As of September 15, 2000, we were not a party to
any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders during the
sixteen weeks ended June 28, 2000.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Diedrich Coffee's common stock is reported on the NASDAQ National Market
System under the symbol "DDRX." The following table sets forth, for the periods
indicated, the range of high and low trading prices for the common stock as
reported on the NASDAQ National Market System. Diedrich Coffee changed its
fiscal year end in July 1999 from the Wednesday nearest January 31 to the
Wednesday nearest June 30. This table restates the quarters as if the change in
fiscal year occurred in July 1998.
PRICE RANGE
--------------------------
PERIOD HIGH LOW
------ ---- ---
RESTATED FISCAL YEAR ENDED JUNE 30, 1999
Twelve Weeks Ended September 23, 1998 7 7/8 4
Twelve Weeks Ended December 16, 1998 6 1/2 3 3/8
Twelve Weeks Ended March 10, 1999 6 7/8 3 7/8
Sixteen Weeks Ended June 30, 1999 7 1/8 4 3/8
FISCAL YEAR ENDED JUNE 28, 2000
Twelve Weeks Ended September 22, 1999 6 5/8 4 3/16
Twelve Weeks Ended December 15, 1999 5 11/16 4
Twelve Weeks Ended March 8, 2000 4 9/16 3 1/4
Sixteen Weeks Ended June 28, 2000 3 7/8 2 3/16
FISCAL YEAR ENDED JUNE 27, 2001
Twelve Weeks Ended September 20, 2000 2 7/8 1 5/16
At September 15, 2000, there were 12,616,871 shares outstanding and 643
stockholders of record of Diedrich Coffee's common stock. Diedrich Coffee has
not paid dividends on its common stock and does not anticipate paying dividends
in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA.
In an effort to align our fiscal year with that of Coffee People, which we
acquired on July 7, 1999, we changed our year end from a fiscal year ending the
Wednesday nearest January 31 to a fiscal year ending on the Wednesday nearest
June 30. Accordingly, the selected financial data, includes information as of
and for the twenty-two weeks ended June 30, 1999 in addition to the last five
fiscal years. The following selected financial data may not be indicative of our
future results of operations and should be read in conjunction with "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and should be read in conjunction with our consolidated financial
statements and related notes.
TWENTY-TWO
WEEKS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
JUNE 28, JUNE 30, JANUARY 27, JANUARY 28, JANUARY 29, JANUARY 31,
2000 1999 1999 1998 1997 1996
---------- ------------ ------------ ------------ ------------ ------------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Net Revenue:
Retail ........................ $ 48,857 $ 8,838 $ 21,248 $ 20,760 $ 18,118 $ 8,879
Wholesale and other ........... 18,788 1,415 2,767 2,222 1,694 1,365
Franchise revenue ............. 6,813 109 200 -- -- --
--------- ------------ ------------ ------------ ------------ ------------
Total ..................... 74,458 10,362 24,215 22,982 19,812 10,244
--------- ------------ ------------ ------------ ------------ ------------
Cost and expenses:
Cost of sales and related
occupancy costs ............. 38,113 4,614 10,955 11,458 9,263 4,409
Store operating expenses ...... 24,708 3,861 8,936 10,447 8,280 3,520
Other operating expenses ...... 1,837 284 634 290 240 277
Depreciation and
amortization................. 4,331 1,212 1,941 1,785 1,054 354
Provision for asset
impairment and restructuring
costs........................ 16,370 799 -- 3,902 -- --
General and administrative
expenses .................... 10,439 1,646 4,014 4,006 2,003 1,335
--------- ------------ ------------ ------------ ------------ ------------
Total ..................... 95,798 12,416 26,480 31,888 20,840 9,895
--------- ------------ ------------ ------------ ------------ ------------
Operating income (loss) ........... (21,340) (2,054) (2,265) (8,906) (1,028) 349
Interest expense and other, net ... (1,065) (292) (293) (205) (86) (34)
--------- ------------ ------------ ------------ ------------ ------------
Income (loss) before income
taxes ........................... (22,405) (2,346) (2,558) (9,111) (1,114) 315
Income tax expense (benefit) ..... 19 3 4 1 (128) 129
--------- ------------ ------------ ------------ ------------ ------------
Net income(loss) .................. $ (22,424) $ (2,349) $ (2,562) $ (9,112) $ (986) $ 186
========= ============ ============ ============ ============ ============
Basic income (loss) per common
share(1)......................... (1.80) (0.38) (0.43) (1.69) (0.22) --
========= ============ ============ ============ ============ ============
Diluted income (loss) per share ... (1.80) (0.38) (0.43) (1.69) (0.22) --
========= ============ ============ ============ ============ ============
Pro forma net income per
share(2)......................... 0.06
============
BALANCE SHEET DATA:
Working capital (deficiency) .... $ (4,216) $ (2,122) $ (655) $ (959) $ 1,949 $ (53)
Total assets .................... 40,330 11,465 12,736 13,948 17,471 5,316
Long-term debt and long-term
obligations, less current
portion ....................... 10,256 2,739 2,783 2,817 -- 829
Total stockholders' equity ...... 15,122 3,779 6,027 6,835 14,898 3,304
(1) Net income (loss) per share for the year ended January 31, 1996 is not
presented due to the noncomparable capital structure
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(2) Pro forma net income per share is computed by dividing net income by the
weighted average number of common and common equivalent shares
outstanding during the respective period, assuming the conversion of the
Series A and Series B Preferred Stock into Common Stock as of the date
of issuance. Dividends on the Series A and Series B Preferred Stock have
been excluded from the computation since the preferred stock has been
assumed to have been converted to Common Stock.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
In an effort to align our fiscal year with that of Coffee People, which we
acquired July 7, 1999, we changed our year end from a fiscal year ending on the
Wednesday nearest January 31 to a fiscal year ending on the Wednesday nearest
June 30. References to fiscal 2000 refer to the fiscal year ended June 28, 2000.
References to the twenty-two weeks ended June 30, 1999 refers to the
transitional period beginning on January 28, 2000 (the first day after the close
of fiscal 1999) and ending on June 30, 1999 (the day prior to the start of
fiscal 2000). References to fiscal 1999, 1998 and 1997 refer to the fiscal year
ended January 27, 1999, January 28, 1998 and January 29, 1997, respectively.
The first retail store operating under the name of Diedrich Coffee commenced
operations in 1972. At the conclusion of fiscal 2000, Diedrich Coffee owned and
operated 102 retail locations and had 259 franchised retail locations. We sell
high quality coffee beverages made with our own freshly roasted coffee. In
addition to brewed coffee, we offer a broad range of espresso based beverages
such as espresso, cappuccino, cafe latte, cafe mocha and espresso machiato. To
complement beverage sales, we sell light food items and whole bean coffee
through our retail locations. In addition, we have a wholesale division that
markets our products directly to independent and chain food service
establishments as well as to office coffee systems through brokers and sales
representatives.
We grew rapidly in fiscal 1997 and experienced difficulties associated with
that growth in fiscal 1998. In March 1997, the Company announced the resignation
of Steven Lupinacci, President and Chief Executive Officer. We took a
restructuring charge of $3.9 million for closing 12 coffeehouses in fiscal 1998.
In addition to closing 11 of these 12 coffeehouses, we opened new coffeehouses
in Houston, Texas as well as Irvine and Santa Monica, California. We also
entered into an agreement to place coffee carts at premium office locations in
Orange County, California; six carts were operating under this agreement at
fiscal year end 2000.
Mr. Lawrence Goelman became Chairman of the Board and Interim Chief Executive
Officer on March 12, 1997. Kerry Coin was appointed President and Chief
Operating Officer on April 25, 1997. Under the board's direction, management
developed and executed a turnaround plan intended to return Diedrich Coffee to
operating profitability. Underperforming stores were closed, leases assigned,
terminated or sublet and new channels of distribution were developed.
Experienced professional managers were recruited. The wholesale division was
given aggressive growth targets and the resources needed to meet them. New
management and training systems were developed and implemented. In the third
quarter of fiscal 1998, we raised $3 million of working capital through the
private placement of secured debt. On November 17, 1997, the board appointed Mr.
John E. Martin as Chairman of the Board and Mr. Timothy J. Ryan as President and
Chief Executive Officer.
Despite the efforts of the interim management team led by Messrs. Goelman and
Coin, Diedrich Coffee did not meet its stated goal of cash-flow positive
operating results by the end of the last quarter of fiscal 1998. The reasons for
the shortfall were several: the increased general and administrative costs
associated with the addition of the new executive management team headed by John
Martin and Tim Ryan, inadequate and unsuccessful marketing programs, delays in
the installation of coffee carts in Orange County and inadequate management of
certain labor costs.
Messrs. Martin and Ryan determined that, while the turnaround plan
implemented by the interim management team had stabilized Diedrich Coffee
operationally, it was not likely to result in profitable growth in the near
future. Accordingly, they initiated a business planning process that resulted in
a strategic five-year plan directed toward growth through franchise area
development agreements combined with focused company unit growth and
centralization of production facilities. This plan also built on the interim
management strategy of developing new wholesale business channels. New
management also reviewed the existing asset base and determined that one
coffeehouse designated for closure would remain open and two additional
coffeehouses and the Denver warehouse
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would be closed. Charges for these closures as well as provisions for other
contingencies resulted in additional operating expenses of approximately $1.7
million in the fourth quarter of fiscal 1998.
According to Diedrich Coffee's strategic plan, the roasting facility in
Denver, Colorado was closed in the first quarter of fiscal 1999 and roasting was
consolidated in Southern California. We also closed an under-performing store in
San Diego, California and one in Denver, Colorado. Four coffee cart locations at
premium office buildings owned by the Irvine Company were opened in the first
quarter of fiscal 1999.
Management undertook several steps to ensure that the base business was
operating well before initiating the franchising sales program. It upgraded the
quality of the store management teams and then undertook a program to retrain
every Diedrich coffeehouse employee. This program was completed during fiscal
1999. The team also developed, tested and introduced several new product
programs, including:
- Martin Diedrich Signature Coffee Selections featuring coffee beans that
were only available in the United States at Diedrich coffeehouses;
- a line of five new Icy Blended drinks to address seasonal softness in the
warmer months;
- Chai Tea and new mocha products, including white chocolate mocha, were
added to the menu; and
- a new line of holiday merchandise.
On July 7, 1999, we completed the acquisition of Coffee People, Inc. Under
the terms of the merger agreement, Coffee People stockholders received $23.0
million in cash and 1.5 million shares of the Company's common stock. The
acquisition was funded from the proceeds of an offering of 4.6 million shares of
the Company's stock. The Coffee People brands acquired as a result of the merger
include Coffee People, Coffee Plantation, and Gloria Jean's. We intend to
eventually convert the Coffee People and Coffee Plantation coffeehouses to the
Diedrich brand.
On September 25, 2000, after 3 years as our President and CEO, Timothy J.
Ryan announced his retirement from Diedrich Coffee. Effective September 27,
2000, Mr. Ryan will be replaced by J. Michael Jenkins. Mr. Jenkins has over 30
years of experience in the restaurant industry, having served as CEO & Chairman
of the Steak & Ale restaurant chain, Executive Vice President of Mariott
Corporations Bob's Big Boy chain, President & CEO of the T.G.I. Friday's chain,
President & CEO of Metromedia Steakhouses, CEO of El Chico Restaurants, CEO of
Vicorp Restaurants, and CEO of Boston Chicken.
FRANCHISE AREA DEVELOPMENT AGREEMENTS
Management's franchise development goals are to enter into franchise area
development agreements covering major U.S. markets. As of June 28, 2000,
Diedrich Coffee had a total of eight area development agreements with
commitments for 391 coffeehouses, although one agreement has been terminated
since June 28, 2000, and we anticipate the termination of one additional
franchise area development agreement in the coming year, which will reduce the
number of coffeehouse commitments to 331. To date, three coffeehouses have
opened under existing franchise area development agreements and 20 franchised
Diedrich Coffee coffeehouses are anticipated to open in fiscal year 2001.
Management is currently in various stages of discussion and/or negotiations
with additional potential area developers. To augment our franchising efforts,
Diedrich Coffee added a full-time Vice President of Franchising, Joseph E.
Caruso, and additional experienced franchising resources that we have devoted to
improving our franchise recruitment capabilities and capture rate. There can be
no assurances of positive sales results from these activities.
WHOLESALE
In fiscal 1998 Diedrich Coffee took significant steps to build its wholesale
sales organization and grow this business channel. A new director of the
wholesale division, with substantial experience in the coffee business, was
hired and the sales staff expanded. These efforts were successful in fiscal
1998, when wholesale sales grew to $2,221,000 of total sales, an increase of
31.1% from the prior year. In fiscal 1999, the wholesale division focused its
efforts on upgrading coffee consumed at chain restaurants. As a result, Diedrich
Coffee added regional divisions of a number of well-known restaurant groups as
wholesale customers such as: Islands Restaurants, Inc., Ruth's Chris Steakhouses
(California/ Arizona locations), Culinary Adventures and Claim Jumper. In fiscal
1999, $2,767,000 in wholesale revenue represented an increase of 24.5% from
fiscal 1998. In fiscal 2000, Diedrich Coffee expanded its wholesale office
coffee service business through a strategic partnership with Keurig.
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RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to total sales,
unless otherwise indicated, of certain items included in the Company's
statements of income for the years and periods indicated:
YEAR ENDED TWENTY-TWO YEAR ENDED YEAR ENDED
JUNE 28, WEEKS ENDED JANUARY 27, JANUARY 28,
2000 JUNE 30, 1999 1999 1998
--------------------------------------------------------------------
Net Revenue:
Retail ....................................... 65.6% 85.3% 87.8% 90.3%
Wholesale and Other .......................... 25.2 13.7 11.4 9.7
Franchise revenue ............................ 9.2 1.0 0.8 --
----------- ----------- ----------- -----------
Total ..................................... 100.0% 100.0% 100.0% 100.0%
----------- ----------- ----------- -----------
Cost and Expenses:
Cost of sales and related occupancy costs(1).. 56.3 45.0% 45.6% 49.9%
Store operating expenses(2) .................. 44.4 43.2 41.7 50.3
Other operating expenses(3) .................. 9.8 20.1 22.9 13.0
Depreciation and amortization ................ 5.8 11.7 8.0 7.8
Asset impairment and restructuring costs ..... 22.0 7.7 -- 17.0
General and administrative expenses .......... 14.0 15.9 16.6 17.4
----------- ----------- ----------- -----------
Total ..................................... 128.6 119.8% 109.4% 138.8%
----------- ----------- ----------- -----------
Operating loss .................................... (28.6)% (19.8)% (9.4)% (38.8)%
Interest expense .................................. (1.8) (2.7) (1.6) (0.8)
Interest and other income (expense), net .......... 0.1 (0.1) 0.4 (0.1)
----------- ----------- -----------
Loss before income taxes .......................... (30.1) (22.6) (10.6) (39.7)
Income tax expense ................................ -- 0.1 -- --
----------- ----------- ----------- -----------
Net loss .......................................... (30.1)% (22.7)% (10.6)% (39.7)%
=========== =========== =========== ===========
(1) As a percentage of sales from retail and wholesale operations
(2) As a percentage of sales from retail operations and franchise fees
(3) As a percentage of sales from wholesale operations
Coffee People Acquisition. On July 7, 1999, Diedrich Coffee acquired Coffee
People in a transaction that was accounted for using the purchase method of
accounting; and accordingly, the assets acquired and liabilities assumed were
recorded as of their fair values on that date. The results of operations for the
year ended June 28, 2000 differ significantly from all prior periods presented
because of this acquisition.
Change in Fiscal Year. In an effort to align our fiscal year with that of
Coffee People which Diedrich Coffee acquired on July 7, 1999, we changed our
year end from a fiscal year ending the Wednesday nearest January 31 to a fiscal
year ending on the Wednesday nearest June 30. Accordingly, the following results
of operations include a discussion for the year ended June 28, 2000 compared to
the year ended January 27, 1999 and a discussion of the year ended January 27,
1999 compared to the year ended January 28, 1998. In addition, the following
results of operations includes a discussion of the 22-week transition period
ended June 30, 1999 compared to the 26 weeks ended June 29, 1998, as the
seasonal nature of the Company's business does now allow for a meaningful
comparison of annualized results for the twenty-two week period ended June 30,
1999, to the fiscal year ended June 28, 2000.
YEAR ENDED JUNE 28, 2000 COMPARED TO YEAR ENDED JANUARY 27, 1999
Total Revenues. Total revenues for the year ended June 28, 2000 increased
207.5% to $74,458,000 from $24,215,000 for the year ended January 27, 1999. This
increase was primarily attributable to the acquisition of Coffee People. Retail
revenues for the year ended June 28, 2000 increased 129.9% to $48,857,000 from
$21,248,000 for the year ended January 27, 1999. The increase was primarily
attributable to the acquisition of company-operated retail coffeehouses in
Oregon and Arizona from Coffee People, and to a lesser degree acquired
company-operated
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Gloria Jean's mall stores. Wholesale and mail order revenues for the year ended
June 28, 2000 increased 579.1% to $18,788,000 from $2,767,000 for the year ended
January 27, 1999. The increase was primarily attributable to the addition of the
Gloria Jean's franchisee operations, which purchases roasted coffee from
Diedrich Coffee. Since Diedrich coffee realizes a normal wholesale profit margin
on its sale of roasted coffee beans to its Gloria Jean's franchisees, these
revenues and related contribution are recorded in the wholesale division's
operating results. Franchise revenue increased to $6,813,000 for the year ended
June 28, 2000 from $200,000 for the year ended January 27, 1999. Franchise
revenue consists of initial franchise fees, franchisee renewal fees, area
development fees and royalties received on revenue made at franchised location.
As of June 28, 2000, we had 3 franchised Diedrich Coffee coffeehouses, 193
franchised Gloria Jean's mall coffee stores, and 62 international Gloria Jean's
franchised locations. The increase in franchise revenue is principally due to
the franchised Gloria Jean's coffee stores obtained in our acquisition of Coffee
People.
The percentage increase (decrease) in comparable coffeehouse sales comparing
net sales for stores open during the full year in fiscal 2000 to net sales for
the same stores in fiscal 1999 was 4.2% for Diedrich stores and (5.9%) combined
for Coffee People Oregon and Coffee Plantation Arizona stores which were not
owned by the Company during fiscal 1999. There were 39 Diedrich locations and
13 Coffee People Oregon and Coffee Plantation Arizona stores locations involved
in this calculation.
Cost of Sales and Related Occupancy Costs. Cost of sales and related
occupancy costs for the year ended June 28, 2000 increased 247.9% to $38,113,000
from $10,955,000 for the year ended January 27, 1999. As a percentage of total
revenue from retail and wholesale, cost of sales and related occupancy costs
increased to 56.3% for the year ended June 28, 2000 from 45.6% for the year
ended January 27, 1999. This increase is primarily related to the lower margin
received on coffee and products sold to Gloria Jean's franchisees in the later
period versus sales to retail customers and unrelated wholesale accounts in the
earlier period, and the impact of increased occupancy costs.
Store Operating Expenses. For the year ended June 28, 2000, store operating
expenses, as a percentage of total revenue from retail and franchise, increased
to 44.4% from 41.7% for the year ended January 27, 1999. This increase can be
attributed to an increase in labor expense due to additional staff training at
the store level, as well as the addition of the Coffee People Oregon stores.
Oregon has a higher minimum wage compared to states in which Diedrich Coffee
operated during the prior year.
Other Operating Expenses. For the year ended June 28, 2000, other operating
expenses, as a percentage of wholesale and other revenue, decreased to 9.8% from
22.9% for the year ended January 27, 1999. This decrease can be attributed to
the larger revenue base caused by the addition of the Gloria Jean's franchisees.
Depreciation and Amortization. Depreciation and amortization increased to
$4,331,000 for the year ended June 28, 2000 from $1,941,000 for the year ended
January 27, 1999. The increase was primarily due to the addition of Coffee
People depreciable assets and the amortization of goodwill associated with the
acquisition of Coffee People. As a percentage of total revenue, depreciation and
amortization decreased to 5.8% for the year ended June 28, 1000 in comparison to
8.0% for the year ended January 27, 1999.
Asset Impairment and Restructuring Costs. Asset impairment and restructuring
costs was $16,370,000 for the year ended June 28, 2000. The charge was primarily
attributable to the write-down of goodwill associated with the Coffee People
(Gloria Jean's) acquisition.
General and Administrative Expenses. As a percentage of total revenue,
general and administrative expenses decreased to 14.0% in the year ended June
28, 2000 from 16.6% for the year ended January 27, 1999 due to a reduction of
general and administrative expenses relative to sales as revenue flows increased
and successful execution of the new business plan. The overall level of general
and administrative expense is directly related to management's commitment to
grow Diedrich Coffee through the continued development of company-owned and
franchise locations plus new wholesale channels.
Interest Expense. Interest expense increased to $1,316,000 for the year ended
June 28, 2000 from $385,000 for the year ended January 27, 1999. The increase is
primarily due to bank debt incurred in connection with the acquisition of Coffee
People.
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Income Taxes. Net operating losses generated in the year ended June 28, 2000,
the twenty-two weeks ended June 30, 1999, the years ended January 27, 1999 and
January 28, 1998 and prior were carried back or forward as the case may be, and
utilized to offset the allowable portion of income tax in fiscal 1996. As of
June 28, 2000, a net operating loss for federal income tax purposes of
$24,555,000 is available to be utilized against future taxable income for years
through fiscal 2014 subject to a possible annual limitation due to the change in
ownership rules under the Internal Revenue Code.
TWENTY-TWO WEEKS ENDED JUNE 30, 1999 COMPARED WITH THE TWENTY-SIX WEEKS ENDED
JULY 29, 1998
Total Revenues. Total revenues of $10,362,000 for the twenty-two weeks ended
June 30, 1999 were 13.3% lower than the total revenues of $11,953,000 for the
twenty-six weeks ended July 29, 1998. Retail revenues of $8,838,000 for the
twenty-two weeks ended June 30, 1999 were 16.9% lower than the retail revenues
of $10,629,000 for the twenty-six weeks ended July 29, 1998. Wholesale and other
revenues for the twenty-two weeks ended June 30, 1999 increased 6.9% to
$1,416,000 from $1,324,000 for the twenty-six weeks ended July 29, 1998.
Franchise revenues were $109,000 for the twenty-two weeks ended June 30, 1999.
The percentage increase in comparable store sales was 3.4% for the twenty-two
weeks ended June 30, 1999. This increase was principally a result of improved
targeted marketing programs as no price increases were taken. As of June 30,
1999, the Company operated 39 retail locations, whereas as of July 29, 1998, we
operated 43 retail locations.
Cost of Sales and Related Occupancy Costs. Costs of sales and related
occupancy costs for the twenty-two weeks ended June 30, 1999 decreased to
$4,614,000, compared to $5,395,000 for the twenty-six weeks ended July 29, 1998.
As a percentage of total revenue from retail and wholesale, costs of sales and
related occupancy costs decreased slightly to 45.0% for the twenty-two weeks
ended June 30, 1999 from 45.1% for the twenty-six weeks ended July 29, 1998.
Store Operating Expenses. For the twenty-two weeks ended June 30, 1999, store
operating expenses, as a percentage of retail and franchise, increased to 43.2%
from 42.9% for the twenty-six weeks ended July 29, 1998. This increase is
primarily the result of increases in labor costs resulting from new training
programs implemented at the store level and a provision for inventory reserves
for excess accessories of $30,000.
Other Operating Expenses. For the twenty-two weeks ended June 30, 1999, other
operating expenses, as a percentage of wholesale revenue, decreased to 20.1%
from 22.3% for the twenty-six weeks ended July 29, 1998. The decrease as a
percentage of revenues from the wholesale division reflects the increase in
wholesale revenues, as a result of the emphasis placed on adding new chain
restaurant accounts.
Depreciation and Amortization. Depreciation and amortization increased to
$1,212,000 for the twenty-two weeks ended June 30, 1999 from $944,000 for the
twenty-six weeks ended July 29, 1998. The increase is primarily due to the
accelerated depreciation taken on a closed coffeehouse.
General and Administrative Expenses. For the twenty-two weeks ended June 30,
1999, general and administrative expenses, as a percentage of total revenue,
decreased to 15.9% from 17.5% for the twenty-six weeks ended July 29, 1998. This
decrease was primarily a result of the elimination of management personnel that
were not essential to our current growth strategy.
Interest Expense. Interest expense increased to $283,000 for the twenty-two
weeks ended June 30, 1999 from $197,000 for the twenty-six weeks ended July 29,
1998. The increase is related to a acceleration of non-cash interest related to
the fair market value of the warrants, relating to the note payable with Amre
Youness, a former director of Diedrich Coffee.
YEAR ENDED JANUARY 27, 1999 COMPARED TO YEAR ENDED JANUARY 28, 1998
Total Revenues. Total revenues for the year ended January 27, 1999 increased
5.4% to $24,215,000 from $22,982,000 for the year ended January 28, 1998. Retail
revenues for the year ended January 27, 1999 increased 2.4% to $21,248,000 from
$20,760,000 for the year ended January 28, 1998, despite closing 2 stores in
fiscal 1999. Wholesale and mail order revenues for the year ended January 27,
1999 increased 24.5% to $2,767,000 from $2,222,000 for the year ended January
28, 1998.
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The percentage increase in comparable coffeehouse sales comparing total
revenues for stores open during the full year in fiscal 1999 to net sales for
the same stores in fiscal 1998 was 1.5%. The number of coffeehouses involved in
this calculation ranged from 33 to 37 reflecting the number of stores added
during fiscal 1998.
Cost of Sales and Related Occupancy Costs. Cost of sales and related
occupancy costs for the year ended January 27, 1999 decreased to $10,955,000
from $11,458,000 for the year ended January 28, 1998. As a percentage of total
revenues from retail and wholesale, cost of sales and related occupancy costs
decreased to 45.6% for fiscal 1999 from 49.9% for fiscal 1998. This decreased
percentage was the result of average unit volume efficiencies resulting from the
closure of low volume locations, lower green coffee prices as well as purchasing
efficiencies and the additional efficiencies gained at the coffeehouse level.
These more than offset the impact of increased occupancy costs, and an increase
in the percentage of total revenues contributed by wholesale revenue.
Store Operating Expenses. For the year ended January 27, 1999,
coffeehouse-operating expenses, as a percentage of total retail revenues,
decreased to 42.1% from 50.3% for the year ended January 28, 1998. In fiscal
1998 a one time charge of $1.7 million accounted for 8.2% of retail net
revenues.
Other Operating Expenses. For the year ended January 27, 1999, other
operating expenses, as a percentage of wholesale and other net revenues,
increased to 22.9% from 13.0% for the year ended January 29, 1997. This increase
reflects the costs of additional management and sales staff recruited to further
develop the sales of the wholesale division. As a percentage of total revenue,
these costs should decrease as wholesale revenues increase.
Depreciation and Amortization. Depreciation and amortization increased to
$1,941,000 for the year ended January 27, 1999 from $1,785,000 for the year
ended January 28, 1998, principally due to the asset write-off resulting from
the remodel of a coffeehouse, to demonstrate the new Diedrich Coffee prototype.
General and Administrative Expenses. As a percentage of total revenue,
general and administrative expenses decreased to 16.6% in the year ended January
27, 1999 from 17.4% for the year ended January 28, 1998 due to a reduction of
general and administrative expenses relative to sales as revenue flows increased
and successful execution of the new business plan. The level of general and
administrative expense is directly relate to management's commitment to grow the
Company through retail locations development, new wholesale channels and
franchise area development.
Interest Expense. Interest expense increased to $385,000 for the year ended
January 27, 1999 from $182,000 for the year ended January 28, 1998. The increase
is a result of a full year of interest on the $2.5 million in long-term debt and
$553,000 in assets under capital leases.
Income Taxes. Net operating losses generated in fiscal 1999, fiscal 1998,
fiscal 1997, fiscal 1994 and prior were carried back or forward, as the case may
be, and utilized to offset the allowable portion of income tax in fiscal 1996.
As of January 27, 1999, a net operating loss for Federal income tax purposes of
$10,655,000 is available to be utilized against future taxable income for years
through fiscal 2013, subject to a possible annual limitation due to the change
in ownership rules under the Internal Revenue Code.
LIQUIDITY AND CAPITAL RESOURCES
Diedrich Coffee had working capital deficit, as of June 28, 2000, of
$4,216,000 compared to $2,125,000 at June 30, 1999. Cash used in operating
activities totaled $649,000 for the year ended June 28, 2000 as compared to cash
used in operating activities of $351,000 for the year ended January 27, 1999.
Net cash used in investing activities for the year ended June 28, 2000
totaled $24,554,000 which consisted primarily of the acquisition of Coffee
People and capital expenditures for property and equipment. Net cash provided by
financing activities for the year ended June 28, 2000 totaled $27,594,000. This
consists of the net proceeds from the issuance of common stock and proceeds from
the term loan, net of proceeds on long-term debt and capital lease obligations.
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On July 7, 1999, Diedrich Coffee completed a secondary offering of 4,930,000
shares (including an over-allotment option). All of the shares of common stock
were sold on behalf of Diedrich Coffee, of which 330,000 shares of common stock
were sold pursuant to the exercise of the underwriters' over-allotment option.
The net proceeds of the offering to Diedrich Coffee, after deducting
approximately $4.1 million in underwriters' commissions and related expenses,
were approximately $25.4 million.
On July 7, 1999, we entered into a Credit Agreement with BankBoston, N.A.
(subsequently merged into Fleet National Bank) secured by pledges of all of
Diedrich Coffee's assets and its subsidiaries' stock and which provided for a
$12 million term loan and a $3 million revolving credit facility. Diedrich
Coffee used the proceeds of the term loan to repay existing indebtedness and to
pay expenses related to the acquisition of Coffee People. The term loan provided
for principal repayment based upon a five year amortization, with quarterly
principal payments of $666,667 and quarterly interest payments based upon a
formula described below. Diedrich Coffee established the revolving credit
facility for future flexibility to remodel existing company-owned coffeehouses,
develop new company coffeehouses, and for general corporate purposes. Diedrich
Coffee has not drawn down any borrowings under the revolving credit facility
since it was established, although it presently has $293,000 of outstanding
Letters of Credit backed by the revolving credit facility. Amounts outstanding
under the Credit Agreement bear interest, at the Company's option, at Fleet's
base rate plus 1.25% or an adjusted Eurodollar rate plus 3.0%.
Due to problems with the Gloria Jean's unit acquired from Coffee People,
including the closure of 39 Gloria Jean's locations, 6 of which were company
owned, in the year subsequent to the acquisition, we announced on June 29, 2000
that we expected to be in default under our Credit Agreement because of our
inability to meet certain financial covenants. We simultaneously announced that
on June 27, 2000, we entered into a Letter Agreement with Fleet National Bank
under which the bank agreed to extend the due date of the June 30, 2000
quarterly principal payment until July 31, 2000, and to forbear until July 31,
2000 from exercising any of its rights and remedies arising from financial
covenant defaults. We subsequently made the July 31, 2000 principal payment as
required on the extended due date, and on August 17, 2000 we entered into an
extension of the June 27, 2000 Letter Agreement which extended through September
30, 2000 the bank's forbearance from exercising any of its default remedies.
On September 26, 2000, we entered into a First Amendment to Credit Agreement
with Fleet National Bank to amend certain terms of the original Credit
Agreement. The First Amendment to Credit Agreement provides, among other things,
for a significant reduction in required minimum principal amortization payments
going forward, an acceleration in the maturity date of all amounts owed under
the Credit Agreement, an agreement between the parties as to certain assets
intended to be sold as well as the allocation of future net asset sale proceeds
between the Company and the bank, the introduction of an additional event of
default under the Agreement, a reduction in the overall amount of the revolving
credit facility and certain new restrictions governing use of the facility, and
a modification of the financial covenants and the Company's ability to obtain
new third party debt going forward.
Specifically, under the terms of the First Amendment to Credit Agreement, no
further principal payments on the term loan are required from August 1, 2000
until January 31, 2001. The Company must then pay minimum principal payments of
$25,000 per month beginning February 1, 2001, which increase to $100,000 per
month beginning July 1, 2001 until all amounts owed under the Credit Agreement
are repaid. The First Amendment to Credit Agreement accelerates the final
maturity date of all remaining amounts owed under the credit Agreement to
September 1, 2002. In addition, the Company and the bank identified certain
assets that could be sold without interfering with the Company's growth
strategy, including two pieces of owned real property under existing company
retail locations, which will be leased back from the buyer, a third parcel of
owned real property, presently undeveloped, and certain company operated
coffeehouses outside of its core southern California market that could be
refranchised (with Area Development Agreements). Under the terms of the First
Amendment to Credit Agreement, the bank will receive 50% of the net proceeds
from any such asset sales. We intend to commence these sales as soon as
possible. The interest rate and the timing of (quarterly) interest payments
under the original Credit Agreement remain unchanged under the First Amendment
to Credit Agreement.
The amendment also introduces an additional event of default under the
Agreement. The amendment specifies that a materially adverse change in the
financial condition of Diedrich Coffee (or any of our subsidiaries), as
determined by the bank in its sole and exclusive discretion, is defined as an
event of default. Under any event of default, the bank may declare all amounts
owed immediately due and payable. Additional changes to the Credit Agreement
under the terms of the First Amendment to Credit Agreement include a reduction
in the revolving credit facility, which the Company had previously been unable
to access because of the covenant defaults, from a $3,000,000 limit to
$1,293,000 and a restriction that the reduced facility be used only to back up
existing and future standby Letters of Credit. The First Amendment to Credit
Agreement preserves the Company's ability to obtain third party financing for
capital projects and maintenance capital, and increases its flexibility to
obtain
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subordinated debt as a source of additional working capital. Under the
First Amendment to Credit Agreement the bank waived the previous financial
covenant defaults, and agreed to new financial covenant ratios going forward
based upon updated financial information and projections prepared by the
Company. In addition to resetting such ratios in the financial covenants as
contained in the original Credit Agreement, the parties agreed to a new covenant
under the First Amendment to Credit Agreement which commits the Company to
achieving certain minimum levels of cumulative principal repayments in addition
to amounts already paid to date in fiscal 2001 or reflected in the new go
forward minimum monthly principal payment obligations discussed above: $283,333
by March 2001; $708,333 by June 30, 2001; and $1,619,900 by September 30, 2001.
Such incremental principal repayments (above the scheduled minimum monthly
amounts described above) are anticipated to be generated primarily from the 50%
of net proceeds to be paid to the bank from future asset sales, the issuance of
new debt or equity, or a combination of these sources.
Diedrich Coffee believes that cash from operations and asset sales will be
sufficient to satisfy our working capital needs at the anticipated operating
levels, including its obligations under its Credit Agreement modified as
described above, for the next twelve months.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes
accounting and reporting standards for derivative instruments, including
derivative instruments embedded in other contracts, and hedging activities. SFAS
133, as amended by SFAS 137 and SFAS 138, is effective for all fiscal quarters
of fiscal years beginning after December 15, 2000. Diedrich Coffee has not
determined whether the application of this accounting standard will have a
material impact on its financial position, results of operations or liquidity.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101 ("SAB101") "Revenue Recognition in Financial
Statements." This Staff Accounting Bulletin summarizes certain of the staff
views in applying generally accepted accounting principles to revenue
recognition in financial statements. SAB101, as amended, is effective for the
fourth fiscal quarter of the fiscal years beginning after December 15, 1999. We
do not expect the adoption of SAB101 to have a material impact on our
consolidated results of operations.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation - an Interpretation of APB Opinion No.
25" ("FIN 44"). This Interpretation clarifies the definition of employee for
purpose of applying Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," the criteria for determining whether a plan
qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occur after either
December 15, 1998, or January 12, 2000. Diedrich Coffee does not believe that
the impact of FIN 44 will have a material effect on its financial position or
results of operation.
OTHER MATTERS
SEASONALITY AND QUARTERLY RESULTS
Our business is subject to seasonal fluctuations as well as economic trends
that affect retailers in general. Historically, our net sales have not been
realized proportionately in each quarter, with net sales being the highest
during the last fiscal quarter which includes the December holiday season. Hot
weather tends to reduce sales. Quarterly results are affected by the timing of
the opening of new stores, which may not occur as anticipated due to events
outside our control. As a result of these factors, and of the other
contingencies and risk factors described elsewhere in this report, the financial
results for any individual quarter may not be indicative of the results that
may be achieved in a full fiscal year.
YEAR 2000
We have addressed the potential business and operational risks associated
with the Year 2000. The Year 2000 issue involved the use of a two-digit year
field instead of a four-digit year field in the computer systems. If computer
systems cannot distinguish between the year 1900 and the year 2000, system
failures or other computer errors could result. To date, Diedrich Coffee is not
aware of the occurrence of any significant Year 2000 problems being reported.
Some business risks associated with the Year 2000 issue may remain throughout
2000. However, it is not anticipated that future Year 2000 issues, if any, will
have a material adverse effect on Diedrich Coffee.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
DERIVATIVE INSTRUMENTS. Diedrich Coffee does not and did not invest in market
risk sensitive instruments in the fiscal 2000. From time to time, we enter into
agreements to purchase green coffee in the future at prices to be determined
within two to twelve months of the time of actual purchase. At June 28, 2000
these commitments totaled $3,421,000. These agreements are tied to specific
market prices (defined by both the origin of the coffee and the month of
delivery) but Diedrich Coffee has significant flexibility in selecting the date
of the market price to be used in each contract. Diedrich Coffee does not use
commodity based financial instruments to hedge coffee or any other commodity
Diedrich Coffee as believes there will continue to be a high probability of
maintaining a strong correlation between increases in green coffee prices and
the final selling prices of Diedrich Coffee's products.
MARKET RISK. Diedrich Coffee's market risk exposure with regard to financial
instruments is to changes in the "adjusted Eurodollar rate". We borrowed
$10,666,667 at the adjusted Eurodollar rate plus 3%. At June 28, 2000, a
hypothetical 100 basis point increase in the adjusted Eurodollar rate would
result in additional interest expense of $107,000 on an annualized basis.
Diedrich Coffee does not and has not used derivative financial instruments
for any purpose, including hedging or mitigating interest rate risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required by this item are set
forth at the end of this Annual Report on Form 10-K beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is incorporated herein by reference
from the portions of the definitive Proxy Statement captioned "Election of
Directors," "Compensation of Executive Officers," and "Section 16(a) Beneficial
Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated herein by reference
from the portions of the Definitive Proxy Statement captioned "Compensation of
Executive Officers" and "Director Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated herein by reference
from the portion of the Definitive Proxy Statement captioned "Security Ownership
of Certain Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated herein by reference
from the portion of the Definitive Proxy Statement captioned "Certain
Transactions Regarding Diedrich Coffee."
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements.
The financial statements required to be filed hereunder are set forth at
the end of this Report beginning on page F-1
2. Exhibits
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 Form of Agreement and Plan of merger by and between Diedrich Coffee, a
California corporation, and Diedrich Coffee, Inc., a Delaware
corporation(1)
2.2 Agreement and Plan of Merger dated as of March 16, 1999, by and
among Diedrich Coffee, CP Acquisition Corp., a wholly owned
subsidiary of Diedrich Coffee, and Coffee People(2)
3.1 Certificate of Incorporation of the Company(1)
3.2 Bylaws of the Company(1)
4.1 Purchase Agreement for Series A Preferred Stock dated as of
December 11, 1992 by and among Diedrich Coffee, Martin R.
Diedrich, Donald M. Holly, SNV Enterprises and D.C.H., L.P.(1)
4.2 Purchase Agreement for Series B Preferred Stock dated as of June
29, 1995 by and among Diedrich Coffee, Martin R. Diedrich, Steven
A. Lupinacci, Redwood Enterprises VII, L.P. and Diedrich Partners
I, L.P.(1)
4.3 Specimen Stock Certificate(1)
4.4 Form of conversion Agreement in the connection with the
conversion of Series A and Series B Preferred Stock into Common
Stock(1)
4.5 Form of Lock-up Letter Agreement among The Second Cup, Ltd. and
Diedrich Coffee, Inc.(3)
4.6 Voting Agreement and Irrevocable Proxy dated as of March 16, 1999
by and among Diedrich Coffee, Inc., D.C.H., L.P., Peter Churm,
Martin R. Diedrich, Lawrence Goelman, Paul C. Heeschen, John E.
Martin, Timothy J. Ryan, and Second Cup USA Holdings Ltd.(3)
10.1 Form of Indemnification Agreement(1)
10.2 Amended and Restated Diedrich Coffee 1996 Stock Incentive Plan(4)
10.3 Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan(1)
10.4 Agreement of Sale dated as of February 23, 1996 by and among
Diedrich Coffee (as purchaser) and Brothers Coffee Bars, Inc. and
Brothers Gourmet Coffees, Inc. (as sellers)(1)
10.5 Separation agreement dated May 13, 1997 between Steven A.
Lupinacci and Diedrich Coffee, Inc.(5)
10.6 Letter agreement by and between the Company and John E. Martin
appointing Mr. Martin Chairman of the Board, dated as of November
17, 1997(6)
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10.7 Stock Option Plan and Agreement by and between the company and
John E. Martin granting Mr. Martin the option to purchase up to
850,000 shares of the Common Stock of the Company, dated as of
November 17, 1997(6)
10.8 Common Stock Purchase Agreement by and between the company and
John E. Martin under which Mr. Martin agrees to purchase 333,333
shares of the Common Stock of the Company, dated as of November
17, 1997(6)
10.9 Employment Agreement by and between the Company and Timothy J.
Ryan retaining Mr. Ryan as Chief Executive Officer, dated as of
November 17, 1997(6)
10.10 Stock Option Plan and Agreement by and between the company and
Timothy J. Ryan granting Mr. Ryan up to 600,000 shares of the
Common Stock of the Company, dated as of November 17, 1997(6)
10.11 Common Stock Purchase Agreement by and between the Company and
Timothy J. Ryan under which Mr. Ryan agrees to purchase 16,667
shares of the Common Stock of the Company, dated as of November
17, 1997(6)
10.12 Form of Promissory Note made in favor of Nuvrty, Inc., the Ocean
Trust and the Grandview Trust(7)
10.13 Form of Term Loan Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(7)
10.14 Form of Security Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(7)
10.15 Form of Warrant Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(7)
10.16 Form of Intercreditor Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust(7)
10.17 Form of Common Stock and Option Purchase Agreement with Franchise
Mortgage Acceptance Company dated as of April 3, 1998(8)
10.18 Separation and Release Agreement dated January 28, 1998 with
Kerry W. Coin(8)
10.19 Employment Agreement with Ann Wride dated April 8, 1998(9)
10.20 Employment Agreement with Catherine Saar dated June 11, 1998(10)
10.21 Form of Franchise Agreement(11)
10.22 Form of Area Development Agreement(11)
10.23 Employment Agreement with Martin R. Diedrich dated June 29, 1998(3)
10.24 Credit Agreement, dated, as of July 7, 1999, by and among
BankBoston, N.A., Diedrich Coffee and its subsidiaries(12)
10.25 Security Agreement, dated, as of July 7, 1999, by and among
BankBoston, N.A., Diedrich Coffee and its subsidiaries(12)
10.26 Securities Pledge Agreement, dated, as of July 7, 1999, by and
among BankBoston, N.A., Diedrich Coffee and its subsidiaries(12)
10.27 Trademark Security Agreement, dated, as of July 7, 1999, by and
among BankBoston, N.A., Diedrich Coffee and its subsidiaries(12)
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10.28 Form of Term Note made in favor of BankBoston, N.A.(12)
10.29 Form of Revolving Note made in favor of BankBoston, N.A.(12)
10.30 Employment Agreement with Matt McGuinness dated effective March
13, 2000*
10.31 Letter Agreement re: employment with Greg MacIsaac dated February
25, 2000*
10.32 First Amendment to Credit Agreement*
10.33 Letter Agreement re: employment with J. Michael Jenkins dated
September 2000*
21.1 List of Subsidiaries*
23.1 The Report on Schedule and Consent of Independent Auditors*
27.1 Financial Data Schedule*
- ---------------------
* Filed with this Form 10-K
(1) Previously filed as an exhibit to Diedrich Coffee's Registration
Statement on Form S-1 (No. 333-08633), as amended, as declared
effective by the Securities and Exchange Commission on September
11, 1996.
(2) Previously filed as Appendix A to Diedrich Coffee's Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on April 23, 1999.
(3) Previously filed as an exhibit to Diedrich Coffee's Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on April 23, 1999.
(4) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended September 22, 1999,
filed with the Securities and Exchange Commission on November 5,
1999.
(5) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended April 30, 1997, filed
with the Securities and Exchange Commission on June 13, 1997.
(6) Previously filed as an exhibit to Diedrich Coffee's Current
Report on Form 8-K, filed with the Securities and Exchange
Commission on November 25, 1997.
(7) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended October 29, 1997, filed
with the Securities and Exchange Commission on December 11, 1997.
(8) Previously filed as an exhibit to Diedrich Coffee's annual report
on Form 10-K for the fiscal year ended January 28, 1998.
(9) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended April 28, 1999, filed
with the Securities and Exchange Commission on June 11, 1998.
(10) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended July 29, 1998, filed
with the Securities and Exchange Commission on September 10,
1998.
(11) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended April 28, 1999, filed
with the Securities and Exchange Commission on December 11, 1998.
(12) Incorporated by reference to Diedrich Coffee's Transition Report
on Form 10-Q for the period from January 28, 1999 to June 30,
1999, filed with the Securities and Exchange Commission on August
16, 1999.
(b) Reports on Form 8-K.
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DIEDRICH COFFEE, INC.
September 26, 2000 By: /s/ Timothy J. Ryan
---------------------------------
Timothy J. Ryan
President, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ John E. Martin Chairman of the Board September 26, 2000
- ----------------------------------------------
John E. Martin
/s/ Timothy J. Ryan President, Chief Executive Officer and September 26, 2000
- ---------------------------------------------- Director (Principal Executive Officer)
Timothy J. Ryan
/s/ Matthew McGuinness Senior Vice President and Chief September 26, 2000
- ---------------------------------------------- Financial Officer (Principal Financial
Matthew McGuinness and Accounting Officer)
/s/ Martin R. Diedrich Chief Coffee Officer, Vice Chairman of September 26, 2000
- ---------------------------------------------- the Board of Directors and Secretary
Martin R. Diedrich
/s/ Lawrence Goelman Director September 26, 2000
- ----------------------------------------------
Lawrence Goelman
/s/ Peter Churm Director September 26, 2000
- ----------------------------------------------
Peter Churm
/s/ Paul Heeschen Director September 26, 2000
- ----------------------------------------------
Paul C. Heeschen
Director September 26, 2000
- ----------------------------------------------
Randy Powell
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DIEDRICH COFFEE, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
38
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Diedrich Coffee, Inc.:
We have audited the accompanying consolidated balance sheets of Diedrich Coffee,
Inc. and subsidiaries as of June 28, 2000 and June 30, 1999, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year ended June 28, 2000, the twenty-two weeks ended June 30, 1999, and the
years ended January 27, 1999 and January 28, 1998. These consolidated financial
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Diedrich Coffee,
Inc. and subsidiaries as of June 28, 2000 and June 30, 1999, and the results of
its operations and its cash flows for the year ended June 28, 2000, the
twenty-two weeks ended June 30, 1999, and the years ended January 27, 1999 and
January 28, 1998, in conformity with accounting principles generally accepted in
the United States of America.
KPMG LLP
Orange County, California
September 22, 2000, except
as to paragraphs 3 through 5 of note 6,
which are as of September 26, 2000
F-2
39
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS (NOTE 6) JUNE 28, 2000 JUNE 30, 1999
------------- -------------
Current Assets:
Cash $ 2,943,554 $ 552,124
Accounts receivable, less allowance for doubtful accounts of $1,137,971 at
June 28, 2000 and $31,442 at June 30, 1999 2,359,015 335,903
Note receivable -- 100,000
Inventories (Note 2) 4,327,011 1,432,249
Prepaid expenses 382,193 153,113
Income taxes receivable 16,232 17,686
------------- -------------
Total current assets 10,028,005 2,591,075
Property and equipment, net (Notes 3 and 11) 15,455,807 7,504,439
Costs in excess of net assets acquired, net of amortization of $745,309
(Notes 4 and 11) 14,184,306 --
Note receivable -- 40,000
Other assets 661,736 1,329,185
------------- -------------
Total assets $ 40,329,854 $ 11,464,699
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current installments of obligations under capital leases (Note 8) $ 390,699 $ 169,488
Current installments of long-term debt (Note 6) 1,075,000 --
Current note payable (Note 5) -- 1,000,000
Accounts payable 6,393,029 1,978,325
Accrued compensation 1,612,572 900,565
Accrued expenses (Note 7) 2,065,078 569,162
Franchisee deposits 662,974 --
Deferred franchise fee income 796,500 --
Provision for store closure 1,246,920 --
Restructuring charge (Note 11) 936 95,195
------------- -------------
Total current liabilities 14,243,708 4,712,735
Obligations under capital leases, excluding current installments (Note 8) 659,865 239,049
Long term debt, excluding current installments (Note 6) 9,591,667 2,500,000
Deferred rent 713,025 233,548
------------- -------------
Total liabilities 25,208,265 7,685,332
------------- -------------
Stockholders' Equity:
Common stock, $.01 par value; authorized 25,000,000 shares; issued and 126,169 61,736
outstanding 12,616,871 shares at June 28, 2000 and 6,173,538 at
June 30, 1999
Additional paid-in capital 52,552,412 18,826,473
Accumulated deficit (37,556,992) (15,108,842)
------------- -------------
Total stockholders' equity 15,121,589 3,779,367
Commitments and contingencies (Note 8)
------------- -------------
Total liabilities and stockholders' equity $ 40,329,854 $ 11,464,699
============= =============
See accompanying notes to consolidated financial statements.
F-3
40
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
TWENTY-TWO WEEKS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED
JUNE 28, JUNE 30, JANUARY 27, JANUARY 28,
2000 1999 1999 1998
------------ ------------ ------------ ------------
Net Revenue:
Retail $ 48,857,304 $ 8,837,640 $ 21,248,462 $ 20,759,993
Wholesale and other 18,788,369 1,415,604 2,766,741 2,221,704
Franchise revenue 6,812,690 108,913 200,000 --
------------ ------------ ------------ ------------
Total 74,458,363 10,362,157 24,215,203 22,981,697
------------ ------------ ------------ ------------
Cost and Expenses:
Cost of sales and related occupancy costs 38,112,813 4,614,028 10,955,197 11,457,612
Store operating expenses 24,708,039 3,861,190 8,935,644 10,447,349
Other operating expenses 1,836,798 284,291 634,124 289,867
Depreciation and amortization 4,330,671 1,211,971 1,941,020 1,785,271
Provision for asset impairment and restructuring costs 16,370,201 798,551 -- 3,902,332
General and administrative expenses 10,439,759 1,645,999 4,013,809 4,005,853
------------ ------------ ------------ ------------
Total 95,798,281 12,416,030 26,479,794 31,888,284
------------ ------------ ------------ ------------
Operating loss (21,339,918) (2,053,873) (2,264,591) (8,906,587)
Interest expense (1,316,091) (282,937) (384,544) (182,135)
Interest and other income (expense), net 251,001 (8,960) 90,517 (23,239)
------------ ------------ ------------ ------------
Loss before income tax provision (22,405,008) (2,345,770) (2,558,618) (9,111,961)
Income tax expense 18,569 2,800 3,690 800
------------ ------------ ------------ ------------
Net loss $(22,423,577) $ (2,348,570) $ (2,562,308) $ (9,112,761)
============ ============ ============ ============
Net loss per share - basic and diluted: $ (1.80) $ (0.38) $ (0.43) $ (1.69)
============ ============ ============ ============
Weighted average shares outstanding - basic and diluted 12,479,408 6,172,932 5,934,287 5,392,609
============ ============ ============ ============
See accompanying notes to consolidated financial statements
F-4
41
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock
Additional Paid-In Accumulated
Shares Amount Capital Deficit Total
------------ ------------ ------------ ------------ ------------
Balance, January 29, 1997 5,391,650 $ 53,917 $ 15,882,046 $ (1,037,735) $ 14,898,228
Common stock issued 350,000 3,500 1,046,500 -- 1,050,000
Net loss -- -- -- (9,112,761) (9,112,761)
------------ ------------ ------------ ------------ ------------
Balance, January 29, 1998 5,741,650 57,417 16,928,546 (10,150,496) 6,835,467
Common stock issued 200,000 2,000 1,273,000 -- 1,275,000
Exercise of options and warrants 225,663 2,257 476,979 -- 479,236
Amortization of options -- -- 29,507 (29,507) --
Net loss -- -- -- (2,562,308) (2,562,308)
------------ ------------ ------------ ------------ ------------
Balance, January 27, 1999 6,167,313 61,674 18,708,032 (12,742,311) 6,027,395
Exercise of options and warrants 6,225 62 (62) -- --
Amortization of options -- -- 17,961 (17,961) --
Warrants issued in connection with
debt (note 6) -- -- 100,542 -- 100,542
Net loss -- -- -- (2,348,570) (2,348,570)
------------ ------------ ------------ ------------ ------------
Balance, June 30, 1999 6,173,538 61,736 18,826,473 (15,108,842) 3,779,367
Exercise of options and warrants 13,333 133 38,199 -- 38,332
Acquisition of Coffee People and
proceeds from secondary offering, net
(note 4) 6,430,000 64,300 33,663,167 -- 33,727,467
Amortization of options -- -- 24,573 (24,573) --
Net loss -- -- -- (22,423,577) (22,423,577)
------------ ------------ ------------ ------------ ------------
Balance, June 28, 2000 12,616,871 $ 126,169 $ 52,552,412 $(37,556,992) $ 15,121,589
============ ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
F-5
42
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
TWENTY-TWO
YEAR ENDED WEEKS ENDED YEAR ENDED YEAR ENDED
JUNE 28, 2000 JUNE 30, 1999 JANUARY 27, 1999 JANUARY 28, 1998
------------- ------------- ---------------- ----------------
Cash flows from operating activities:
Net loss $(22,423,577) $(2,348,570) $(2,562,308) $(9,112,761)
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Depreciation and amortization 4,330,671 1,211,971 1,941,020 1,785,271
Amortization of loan fees 79,364 -- -- --
Restructuring charge -- -- -- 987,590
Provision for asset impairment (note 11) 16,370,201 798,551 -- 2,203,217
Early retirement of note payable (note 5) -- 100,542 -- --
Changes in operating assets and liabilities:
Accounts receivable 155,401 (72,252) (182,023) 28,735
Inventories 485,692 (152,813) 95,683 150,804
Prepaid expenses 339,715 35,880 (31,600)
27,670
Income taxes receivable 1,454 -- 24,842 242,544
Other assets 89,902 (44,965) 12,392 26,637
Accounts payable 1,668,881 563,258 210,701 (595,926)
Accrued compensation (173,476) (69,469) 165,614 186,971
Accrued expenses (1,955,796) (158,054) (73,236) 1,562,055
Provision for store closure (334,872) -- -- --
Deferred franchise fees income and
franchisee deposits 638,323 -- -- --
Deferred rent 79,292 13,683 47,634 17,847
------------ ----------- ----------- -----------
Net cash used in operating activities (648,825) (122,238) (351,281) (2,489,346)
------------ ----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures for property and equipment (3,446,310) (402,676) (1,672,076) (1,724,397)
Proceeds from disposal of property and equipment 107,479 -- 148,785 --
Insurance of note receivable -- (40,000) -- --
Acquisitions, net of cash acquired (21,215,377) (1,039,766) -- --
------------ ----------- ----------- -----------
Net cash used in investing activities (24,554,208) (1,482,442) (1,523,291) (1,724,397)
------------ ----------- ----------- -----------
Cash flows from financing activities:
Proceeds from notes payable -- 1,000,000 -- --
Payments on notes payable -- (44,057) -- --
Payments on long-term debt (8,475,024) -- -- (2,000,000)
Payments on capital lease obligations (884,493) -- (86,964) --
Proceeds from issuance of common stock, net of fees paid 25,350,799 -- 1,275,000 1,050,000
Proceeds from issuance of debt, net of issuance costs 11,603,181 -- -- 4,500,000
Proceeds from stock options exercised -- -- 479,236 --
------------ ----------- ----------- -----------
Net cash provided by financing activities 27,594,463 955,943 1,667,272 3,550,000
------------ ----------- ----------- -----------
Net increase (decrease) in cash 2,391,430 (648,737) (207,300) (663,743)
Cash at beginning of year 552,124 1,200,861 1,408,161 2,071,904
------------ ----------- ----------- -----------
Cash at end of year $ 2,943,554 $ 552,124 $ 1,200,861 $ 1,408,161
============ =========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,038,810 $ 133,313 $ 299,670 $ 154,999
============ =========== =========== ===========
Income taxes $ 18,569 $ 2,800 $ 3,690 $ 800
============ =========== =========== ===========
Non-cash transactions
Issuance of common stock to acquire Coffee People $ 8,415,000 $ -- $ -- $ --
============ =========== =========== ===========
Equipment purchased under capital leases $ -- $ -- $ 54,127 $ 498,513
============ =========== =========== ===========
See accompanying notes to financial statements
F-6
43
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 28, 2000, JUNE 30, 1999, JANUARY 27, 1999, AND JANUARY 28, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
Business
Diedrich Coffee, Inc. is a specialty coffee roaster, wholesaler,
retailer and franchiser whose brands include Diedrich Coffee, Coffee People,
Coffee Plantation and Gloria Jean's. The Company, as of June 28, 2000, owns and
operates 102 retail locations and is the franchiser of 259 retail locations. The
retail units are located in 37 states and 9 foreign countries. The Company also
has over 300 wholesale accounts with businesses and restaurant chains. In
addition, the Company operates a large coffee roasting facility in Northern
California that supplies freshly roasted coffee beans to its retail locations
and wholesale accounts.
Basis of Presentation and Change in Fiscal Year
The consolidated financial statements include the accounts of
Diedrich Coffee, Inc. and its wholly owned subsidiaries (the "Company"). All
significant intercompany transactions are eliminated. In order to align its
fiscal year with that of Coffee People, Inc. ("Coffee People"), which the
Company acquired on July 7, 1999 (Note 4), the Company changed its fiscal year
end from a fiscal year ending the Wednesday nearest January 31 to a fiscal year
ending Wednesday nearest June 30. Accordingly, the transition period statements
of operations, stockholders' equity and cash flows for the twenty-two weeks
ended June 30, 1999 are not necessarily comparable to the accompanying years
ended June 28, 2000, January 27, 1999 and January 28, 1998 nor are they
indicative of a full year's results of operations.
Inventories
Inventories are stated at the lower of cost or market. The cost
for inventories is determined using the first-in, first-out method.
Property and Depreciation
Property and equipment, including assets under capital leases are
recorded at cost. Depreciation is calculated using the straight-line method over
estimated useful lives of five to seven years. Property and equipment held under
capital leases and leasehold improvements are amortized using the straight-line
method over the shorter of their estimated useful lives or the term of the
related leases.
Major renewals and improvements are capitalized. Maintenance and
repairs that do not improve or extend the life of the respective assets are
charged to expense as incurred.
Deferred Financing Costs
Costs related to the issuance of debt are deferred and amortized
using a method which approximates the effective interest method as a component
of interest expense over the terms of the respective debt issues.
Store Pre-opening Costs
Direct and incremental costs prior to the opening of a
coffeehouse location are expensed as incurred.
F-7
44
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, notes
receivable, income tax receivable, accounts payable, accrued compensation and
accrued expenses approximate fair value because of the short-term maturity of
these financial instruments. The Company believes the carrying amounts of the
Company's notes payable and long-term debt approximate fair value because the
interest rates on these instruments are subject to change with, or approximate,
market interest rates and other terms and conditions are consistent with the
currently available to the Company.
Rent Expense
Certain lease agreements provide for scheduled rent increases
during the lease terms or for rental payments commencing on a date other than
the date of initial occupancy. Rent expense is recorded on a straight-line basis
over the respective terms of the leases.
Income Taxes
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Net Income (Loss) per Common Share
Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share" requires the presentation of "basic" earnings per share
which represents net earnings divided by the weighted average shares outstanding
excluding all potentially dilutive common shares. Dual presentation of "diluted"
earnings per-share reflecting the dilutive effect of all potentially dilutive
common shares is also required.
Costs in Excess of Net Assets Acquired
Costs in excess of net assets acquired is amortized on a
straight-line basis over the expected periods to be benefited, generally 40
years.
Stock Option Plans
The Company applies the intrinsic value-method of accounting
prescribed by Accounting Principals Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations, in accounting for
its fixed plan stock options. As such, compensation expense would be recorded on
the date of grant only if the current market price of the underlying stock
exceeded the exercise price. SFAS No. 123, "Accounting for Stock-Based
Compensation," established accounting and disclosure requirements using a fair
value-based method of accounting for stock-based employee compensation plans. As
allowed by SFAS No. 123, the Company has elected to continue to apply the
intrinsic value-based method of accounting described above, and has adopted the
disclosure requirements of SFAS No. 123.
F-8
45
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Long-Lived Assets and Certain Identifiable Intangibles
It is the Company's policy to account for long-lived assets,
including intangibles, at the lower of amortized cost or fair value. Long-lived
assets and certain identifiable intangibles are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. If this assessment indicates that the carrying amount
will not be recoverable, as determined by a non-discounted cash flow generated
by the asset, the carrying value will be reduced to its estimated fair value
based on the discounted cash flows.
Revenue Recognition
Retail and wholesale sales are recorded when payment is tendered at
point of sale for retail and upon shipment of product for wholesale. Franchise
fees are recognized when a franchised coffeehouse begins operations, at which
time the Company has performed its obligations related to such fees. Fees
received pursuant to development agreements which grant the right to develop
franchised restaurants in future periods in specific geographic areas are
deferred and recognized on a pro rata basis as the franchised coffeehouses
subject to the development agreements begin operations. Both franchise and
development fees are nonrefundable. Franchise royalties, which are based upon a
percentage of franchised coffeehouses' sales, are recognized as earned.
Advertising and Promotion Costs
Advertising costs are expensed as incurred. Promotion costs are
charged to expense in the period of the promotional event. During the year ended
June 28, 2000, the twenty-two weeks ended June 30, 1999, and the year ended
January 27, 1999, the retail stores were charged approximately $926,000,
$185,000 and $427,000, respectively, which is included in store operating
expenses and wholesale was charged approximately $149,000, $22,000 and $56,000,
respectively, which is included in other operating expenses, with the remaining
amount of $281,000, $233,000 and $377,000, respectively, charged to general and
administrative expenses. Additionally, general and administrative expenses
included approximately $377,000 for the year ended January 28, 1998.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the 1999 and 1998
consolidated financial statements to conform to the 2000 presentation.
2. INVENTORIES
Inventories consist of the following:
JUNE 28, 2000 JUNE 30, 1999
-------------- -------------
Unroasted coffee $ 1,371,009 $ 574,745
Roasted coffee 789,816 157,115
Accessory and specialty items 750,667 258,889
Other food, beverage and supplies 1,415,519 441,500
-------------- --------------
$ 4,327,011 $ 1,432,249
============== ==============
F-9
46
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
3. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
JUNE 28, 2000 JUNE 30, 1999
-------------- --------------
Land $ 786,000 $ --
Buildings 745,000 --
Leasehold improvements 8,386,504 5,896,832
Equipment 12,116,252 4,949,376
Furniture and fixtures 1,197,133 1,695,309
Construction in progress 307,089 194,659
-------------- --------------
23,537,978 12,736,176
Accumulated depreciation and amortization (8,082,171) (5,231,737)
-------------- --------------
$ 15,455,807 $ 7,504,439
============== ==============
Property under capitalized leases in the amount of $552,641 at June 28,
2000 and June 30, 1999 is included in equipment. Accumulated amortization of
this equipment under capitalized leases amounted to $318,715 and $191,625 at
June 28, 2000 and June 30, 1999, respectively.
4. ACQUISITION OF COFFEE PEOPLE, INC.
On July 7, 1999, the Company acquired Coffee People pursuant to
an Agreement and Plan of Merger. The acquisition was affected through the merger
of CP Acquisition Corp., an indirect wholly owned subsidiary of the Company,
with and into Coffee People. As a result of the acquisition, each share of
Coffee People common stock was converted into the right to receive $2.11 in cash
and 0.14 shares of the Company's common stock. At the time of the acquisition,
Coffee People owned 67 retail stores and franchised 253 retail stores in 36
states and 7 foreign countries under the names Gloria Jean's, Coffee People and
Coffee Plantation.
The Company, in recording the fair value of assets acquired and
liabilities assumed, has made certain estimates. These estimates consist
primarily of recording property and equipment at estimated fair value. The
acquisition has been accounted for as a purchase and the resulting costs in
excess of net assets acquired are being amortized using the straight-line method
over a 40 year period.
The assets acquired, including the costs in excess of net assets
acquired, and liabilities assumed in the acquisition of Coffee People are
summarized in the following table.
Fair value of tangible assets acquired $ 14,883,493
Costs in excess of net assets acquired 29,743,746
Liabilities assumed at fair value (13,957,096)
Common stock issued (8,415,000)
------------
Net cash paid for acquisition 22,255,143
Cash acquired in acquisition 1,761,333
------------
Cash paid for acquisition $ 24,016,476
============
F-10
47
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Details of total purchase and assumed liabilities recorded, and activity
in these accounts through June 28, 2000 are summarized in the following table.
Balance at July 7, 2000 acquisition date $1,824,367
----------
Personnel 1,254,947
Leases 249,420
Other 10,000
----------
Total year ended June 28, 2000 activity 1,514,367
----------
Personnel 10,000
Leases 300,000
Other --
----------
Balance at June 28, 2000 $ 310,000
==========
In conjunction with the transaction, the Company acquired 31 corporate
owned Gloria Jean's stores, of which 14 we expect to continue to operate as
corporate owned Gloria Jean's stores, 12 have been sold to Gloria Jean's
franchisees, 5 have been closed as of June 28, 2000. Under the provisions of
Emerging Issues Task Force 87-11 Allocation of Purchase Price to Assets to Be
Sold, the Company has excluded the operating results of the 17 stores from the
condensed consolidated statement of operations for the year ended June 28, 2000.
The total revenues excluded from the Company's condensed consolidated statement
of operations for the year ended June 28, 2000 totaled $1,654,117, and the
related net losses totaled $393,691. Such net losses have been charged against
the reserve for disposal of stores. During the fourth quarter of the year ended
June 28, 2000, the Company decided to keep seven more of the stores that were
originally designated to be closed or disposed of. In accordance with Emerging
Issues Task Force 90-6 Accounting for Certain Events Not Addressed in Issue No.
87-11 Relating to Acquired Operating Unit to Be Sold, the Company reversed the
results of operations out of the reserve and included the results of operations
for the first, second and third quarter of these seven stores in the condensed
consolidated statement of operation for the year ended June 28, 2000. The impact
of the reversal on total revenues in the fourth quarter for the year ended June
28, 2000 was $1,155,101 and the impact on the statement of operations was an
additional net loss of $115,632.
The following table presents selected unaudited pro forma results of
operations for the Company, assuming the Coffee People acquisition had occurred
on July 1, 1998. The unaudited pro forma results of operations do not include
the operating results of the 17 Gloria Jean's Company-owned stores to be closed
or disposed of. The pro forma results of operations are not indicative of the
results of operations of the combined companies that would have occurred had the
acquisition occurred on July 1, 1998, nor are they indicative of future
operating results.
Forty-Eight
Weeks Ended
June 30, 1999
----------------
Total revenues $ 77,806,061
Net loss $ (17,317,405)
Net loss per share - basic & diluted $ (1.37)
Weighted average shares outstanding
- basic & diluted 12,602,932
The above pro forma results include the forty-eight weeks ended June 30,
1999 for Diedrich Coffee and fifty-two weeks ended June 26, 1999 for Coffee
People.
F-11
48
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
5. NOTE PAYABLE
On April 6, 1999, the Company entered into a $1,000,000 loan agreement and
security agreement with Amre Youness, a former director of the Company. All
outstanding principal was due and payable on April 6, 2000. The loan was secured
by the assets of the Company with interest accruing and paid monthly at the
prime rate plus 3%. In connection with the loan agreement, the Company issued
warrants to Mr. Youness to purchase 70,000 shares of the Company's common stock
at a price of $5.625 per share. The fair value of the warrants is estimated to
be $100,000. In connection with the acquisition of Coffee People (note 4), the
loan was repaid on July 8, 1999. As a result of the early repayment, the Company
accelerated amortization of the discount attributable to the warrant fair values
resulting in an approximate $100,000 non-cash charge to interest expense during
the twenty-two weeks ended June 30, 1999.
6. DEBT
Long-term debt consists of the following:
JUNE 28, 2000 JUNE 30, 1999
------------- -------------
BANCBOSTON, N.A. (FLEET NATIONAL BANK)
Note payable bearing interest at a rate of 9.63% as of June 28, 2000 and
payable in monthly installments of $25,000 beginning February 1, 2001
and increasing to $100,000 beginning July 1, 2001. Due September 1, 2002
Note is secured by the assets of the Company and its
subsidiaries' stock $10,666,667 $ --
NUVRTY, INC
Note payable bearing interest at prime rate plus 3-1/2%, interest payable
monthly. Note was secured by the assets of the Company
Paid in full July 8, 1999 -- 1,000,000
GRANDVIEW TRUST
Note payable bearing interest at prime rate plus 3-1/2%, interest payable
monthly. Note was secured by the assets of the Company
Paid in full July 8, 1999 -- 750,000
OCEAN TRUST
Note payable bearing interest at prime rate plus 3-1/2%, interest payable
monthly. Note was secured by the assets of the Company
Paid in full July 8, 1999 -- 750,000
----------- ----------
Less current installments 1,075,000 --
----------- ----------
Long-term debt, excluding current installments $ 9,591,667 $2,500,000
=========== ==========
On July 7, 1999, the Company entered into a Credit Agreement with BankBoston,
N.A. (subsequently merged into Fleet National Bank) secured by pledges of all of
the Company's assets and its subsidiaries' stock and which provided for a $12
million term loan and a $3 million revolving credit facility. The Company used
the proceeds of the term loan to repay existing indebtedness and to pay expenses
related to the acquisition of Coffee People. The term loan provided for
principal repayment based upon a five year amortization, with quarterly
principal payments of $666,667 and quarterly interest payments based upon a
formula described below. The Company established the revolving credit facility
for future flexibility to remodel existing company-owned coffeehouses, develop
new company coffeehouses, and for general corporate purposes. The Company has
not drawn
F-12
49
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
down any borrowings under the revolving credit facility since it was
established, although it presently has $293,000 of outstanding Letters of Credit
backed by the revolving credit facility. Amounts outstanding under the Credit
Agreement bear interest, at the Company's option, at Fleet's base rate plus
1.25% or an adjusted Eurodollar rate plus 3.0%. At June 28, 2000, the adjusted
Eurodollar rate was 9.88%.
Due to problems with the Gloria Jean's units acquired from Coffee
People, including the closure of 39 Gloria Jean's locations, six of which were
company operated, in the year subsequent to the acquisition, we announced on
June 29, 2000 that we expected to be in default under our Credit Agreement
because of our inability to meet certain financial covenants. We simultaneously
announced that on June 27, 2000, we had entered into a Letter Agreement with
Fleet National Bank under which the bank agreed to extend the due date of the
June 30, 2000 quarterly principal payment until July 31, 2000, and to forbear
until July 31, 2000 from exercising any of its rights and remedies arising from
financial covenant defaults. We subsequently made the July 31, 2000 principal
payment as required on the extended due date, and on August 17, 2000 we entered
into an extension of the June 27, 2000 Letter Agreement which extended through
September 30, 2000 the bank's forbearance from exercising any of its default
remedies.
On September 26, 2000, we entered into a First Amendment to Credit
Agreement with Fleet National Bank to amend certain terms of the original Credit
Agreement. The First Amendment to Credit Agreement provides, among other things,
for a significant reduction in required minimum principal amortization payments
going forward, an acceleration in the maturity date of all amounts owed under
the Credit Agreement, an agreement between the parties as to certain assets
intended to be sold as well as the allocation of future net asset sale proceeds
between the Company and the bank, the introduction of an additional event of
default under the Agreement, a reduction in the overall amount of the revolving
credit facility and certain new restrictions governing use of the facility, and
a modification of the financial covenants going forward.
Specifically, under the terms of the First Amendment to Credit
Agreement, no further principal payments on the term loan are required from
August 1, 2000 until January 31, 2001. The Company must then pay minimum
principal payments of $25,000 per month beginning February 1, 2001, which
increase to $100,000 per month beginning July 1, 2001 until all amounts owed
under the Credit Agreement are repaid. The First Amendment to Credit Agreement
accelerates the maturity date of all remaining amounts owed under the credit
Agreement to September 1, 2002. In addition, the Company and the bank identified
certain assets that could be sold without interfering with the Company's growth
strategy, including two pieces of owned real property under existing company
retail locations, which are expected to be leased back from the buyer, a third
parcel of owned real property, presently undeveloped, and certain company
operated coffeehouses outside of its core southern California market that could
be refranchised (with Area Development Agreements). Under the terms of the First
Amendment to Credit Agreement, the bank is to receive 50% of the net proceeds
from any such asset sales, which are expected to begin in November 2000 and to
be completed by the end of June 2002. The interest rate and the timing of
quarterly interest payments under the original Credit Agreement remain unchanged
under the First Amendment to Credit Agreement.
The amendment also introduces an additional event of default under the
Agreement. The amendment specifies that a materially adverse change in the
financial condition of the Company (or any of its subsidiaries), as determined
by the bank in its sole and exclusive discretion, is defined as an event of
default. Under any event of default, the bank may declare all amounts owed
immediately due and payable. Additional changes under the terms of the First
Amendment to Credit Agreement include a reduction in the revolving credit
facility, which the Company had previously been unable to access because of the
covenant defaults, from a $3,000,000 limit to $1,293,000, and a restriction that
the reduced facility be used only to back up existing and future standby Letters
of Credit. The First Amendment to Credit Agreement preserves the Company's
ability to obtain third party financing for capital projects and maintenance
capital, and increases its flexibility to obtain subordinated debt as a source
of additional working capital. Under the First Amendment to Credit Agreement the
bank waived the previous financial covenant defaults, and agreed to new
financial covenant ratios going forward based upon updated financial information
and projections prepared by the Company. In addition to resetting such ratios in
the financial covenants as contained in the original Credit Agreement, the
parties agreed to a new covenant under the First Amendment to Credit Agreement
which commits the Company to achieving certain predetermined minimum levels of
cumulative principal repayments in addition to amounts already paid to date in
fiscal 2001 or reflected in the new go forward minimum monthly principal payment
obligations discussed above: $283,333 by March 2001; $708,333 by June 30, 2001;
and $1,619,900 by September 30, 2001. Such incremental principal repayments
(above the scheduled minimum monthly amounts described above) are anticipated to
be generated primarily from the 50% of net proceeds to be paid to the bank from
future asset sales, the issuance of new debt or equity, or a combination of
these sources. Total minimum required principal repayments for the Fleet
National Bank debt (including both minimum principal payments and the
incremental principal repayments committed to in the modified covenants, as well
as the $666,667
F-13
50
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
principal payments made on July 31, 2000) are as follows: $1,075,000 in fiscal
2001; $2,536,900 in fiscal 2002; and $7,054,767 in fiscal 2003.
On September 30, 1997 the Company entered into a promissory note, term
loan agreement and security agreement with Nuvrty, Inc., a Colorado corporation
controlled by Amre Youness, a former director of the Company (the "Nuvrty Loan
Documents"). All outstanding principal and accrued interest was due and payable
on September 30, 2002. The loan was secured by the assets of the Company and
provided for borrowings up to $1,000,000 with interest accruing and paid monthly
at the prime rate plus 3-1/2%. The Company borrowed the full amount under the
loan. In connection with the acquisition of Coffee People (note 4), the Company
repaid the loan on July 8, 1999.
In connection with the Nuvrty Loan Documents, the Company issued a
warrant to Nuvrty to purchase 340,000 shares of the Company's common stock at a
price of $2.25 per share. The warrants are exercisable immediately and expire on
the later of September 30, 2003 or one year following payment in full of the
loan.
On October 16, 1997 the Company entered into parallel promissory notes,
term loan agreements and security agreements with the Ocean and Grandview Trusts
on terms identical to those entered into with Nuvrty, Inc. (the "Ocean Trust
Loan Documents" and the "Grandview Trust Loan Documents", respectively). The
Ocean Trust Loan Documents and the Grandview Trust Loan Documents provided for
borrowing up to $750,000 from each Trust. Each loan was secured by the assets of
the Company. Interest on advances was payable monthly at the prime rate plus 3
_%. The Company borrowed $750,000 under each facility. All outstanding principal
and accrued interest was due and payable to each of the Ocean and Grandview
Trusts on October 16, 2002. In connection with the acquisition of Coffee People
(note 4), the Company repaid the long-term debt on July 8, 1999.
In connection with the Ocean Trust Loan Documents and the Grandview
Trust Loan Documents the Company issued warrants to each Trust respectively to
purchase 255,000 shares of the Company's common stock at a price of $2.25 per
share. The warrants are exercisable immediately and expire on the later of
October 16, 2003 or one year following payment in full of the respective loans.
The warrants associated with all the above debt were accounted for in
accordance with the provisions of APB 14, "Accounting for Convertible Debt and
Debt Issued Stock Purchase Warrants." In accordance with APB 14, none of the
proceeds from issuance of the debt was allocated to the warrants based on their
relative fair value, which is insignificant, calculated using both a Cost of
Replacement Model and the Monte Carlo simulation of possible warrant exercise
and no expense was recognized.
7. ACCRUED EXPENSES
The following table sets forth details of accrued expenses:
JUNE 28, 2000 JUNE 30, 1999
------------- -------------
Accrued severance and relocation costs $ 548,346 $ --
Due to franchisee trust accounts 377,605 --
Accrued Interest 239,252 41,335
Accrued professional fees 180,000 --
Accrued legal settlements 139,852 --
Other accrued expenses 580,023 527,827
------------- -------------
Total accrued expenses $ 2,065,078 $ 569,162
============= =============
F-14
51
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
8. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
As of June 28, 2000, the Company leases warehouse and office space in
Irvine, California, Castroville, California, Tempe, Arizona, and Beaverton,
Oregon and 106 retail locations expiring at various dates through October 2013.
The leases for five of the coffeehouse locations are guaranteed by an
officer/director of the Company. Certain of the coffeehouse leases require the
payment of property taxes, normal maintenance and insurance on the properties
and additional rents based on percentages of sales in excess of various
specified retail sales levels. Contingent rent expense was insignificant for all
periods presented.
Future minimum lease payments under non-cancelable operating leases and capital
leases as of June 28, 2000 are as follows:
Non-cancelable
Year Ending June Operating Leases Capital Leases
- ---------------- ---------------- ----------------
2001 ................................. $ 5,340,385 $ 390,699
2002 ................................. 4,946,555 364,229
2003 ................................. 4,604,752 241,876
2004 ................................. 4,248,852 201,884
2005 ................................. 3,666,502 158,384
Thereafter ........................... 7,871,242 73,152
---------------- ----------------
$ 30,678,288 1,430,224
================
Less amount representing interest .... 379,660
----------------
Present value of minimum lease
payments (8% to 15%) ............... 1,050,564
Less current installments ............ 390,699
----------------
Obligations under capital leases,
excluding current installments ..... $ 659,865
================
Rent expense under operating leases approximated $7,885,763, $811,000,
$2,070,000 and $2,232,000 for the year ended June 28, 2000, for the twenty-two
weeks ended June 30, 1999 and for the years ended January 27, 1999 and January
28, 1998, respectively.
PURCHASE COMMITMENTS
As of June 28, 2000, the Company had entered into fixed price purchase
contracts for unroasted coffee aggregating approximately $3,421,000. Such
contracts are generally short-term in nature, and the Company believes that
their cost approximates fair market value.
CONTINGENCIES
In the ordinary course of its business, the Company may become involved
in legal proceedings from time to time. As of September 22, 2000, the Company
was not aware of any pending legal proceedings which in the opinion of
management, based in part on advice from legal counsel, would adversely affect
the Company's financial position or results of operations.
9. STOCKHOLDERS' EQUITY
In June 1995, one executive officer was granted options to purchase
131,350 shares of the Company's common stock at $1.45 per share, the estimated
fair value of the common stock on the grant date. The options become exercisable
upon the occurrence of certain events, including the initial public offering and
a change in control (as defined). If not exercisable earlier, the options become
exercisable in June 2003 and expire 10 years from the date of grant. In May
1997, the Company and the executive agreed to terms under which 52,167 options
were forfeited and the expiration date for the remaining 79,183 was changed to
March 12, 1999. During the year ended January 27, 1999, the remaining 79,183
options were exercised.
In July 1996, the Company adopted the 1996 Stock Incentive Plan (the
"Incentive Plan"), which authorized the granting of a variety of stock-based
incentive awards, including incentive and nonstatutory stock options. A total of
775,000 shares have been reserved for issuance under the Incentive Plan. The
stockholders approved at the 1997 annual meeting of stockholders, an increase of
300,000 shares reserved for issuance pursuant to the Incentive Plan. The
Incentive Plan is administered by a committee of the Board of Directors, who
determine the recipients and terms of the awards granted. Under the Incentive
Plan, options to purchase common stock may be granted with an exercise price
below market value of such stock on the grant date.
F-15
52
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
In July 1996, the Company adopted the 1996 Non-Employee Directors Stock
Option Plan (the "Directors Plan"), which authorizes the granting of
non-qualified stock options to independent directors. A total of 125,000 shares
have been reserved for issuance under the Directors Plan. Pursuant to the
Directors Plan, each non-employee director receives certain automatic grants of
options, which generally vest over two years. All non-employee director options
have a term of ten years and an exercise price equal to the fair market value of
the Company's common stock on the date of grant.
In August 1996, one executive officer was granted options to purchase
120,000 shares of the Company's common stock at an exercise price equal to the
initial public offering price per share. The options become exercisable as
follows: (a) 100,000 share options vest monthly over three years at the rate of
30% in the first year, 30% in the second year and 40% in the third year, (b)
10,000 share options of which 5,000 options vest immediately upon the
commencement of employment and the remaining 5,000 options vest monthly over the
first six months of employment and (c) 10,000 share options which fully vest 65
days after the commencement of employment. On September 24, 1997 the Company and
the executive agreed to revise the exercise price of these options to $3.00 per
share (the closing price of the Company's stock on that date). In January 1998,
the Company and the executive agreed to terms under which the employee retained
the 62,500 options vested under the foregoing schedule and to grant the right to
an additional 17,500 shares vesting on August 31, 1998. The expiration date of
these options was changed to November 1, 1998. The remaining 40,000 options
listed on the foregoing schedule were canceled.
On April 25, 1997, the Company's Board of Directors approved the 1997
Non-Employee Director's Stock Option Plan for options for 10,000 shares each
were granted to two non-employee directors. These options have an exercise price
of $2.75, became vested on April 25, 1998 and expire on April 25, 2007.
On November 18, 1997, Mr. John E. Martin joined the Company's Board of
Directors as Chairman. The Company and Mr. Martin entered into an agreement
under which Mr. Martin would be granted the option to purchase 850,000 shares of
the common stock of the Company subject to stockholder approval. Mr. Martin and
the Company also agreed to terms under which Mr. Martin would purchase 333,333
shares at $3.00 per share in the Company pursuant to a private sales of
restricted stock.
On November 18, 1997, Mr. Timothy J. Ryan joined the Company as Diedrich
Coffee's President and Chief Executive Officer. Subject to stockholder approval,
the Company entered into a performance based Stock Option Plan and Agreement
under which Mr. Ryan would be granted the option to purchase up to 600,000
shares of the common stock of the Company and Mr. Ryan would purchase 16,667
shares at $3.00 per share in the Company pursuant to a private sale of
restricted stock.
On January 22, 1998 the stockholders of the Company approved the stock
option plans and agreements with John Martin and Timothy Ryan. On January 28,
1998 Messrs. Martin and Ryan completed their respective private purchases of
Company stock of $1,000,000 and $50,000, respectively.
On March 30, 1998 the Company agreed to a private placement of 200,000
shares of the Company's common stock to Franchise Mortgage Acceptance Company
("FMAC") at a price of $6.375 (the stock's closing sale price for that day on
the Nasdaq National Market). In addition, FMAC also received an option to
purchase 100,000 additional shares of the Company's common stock; this option
could have been exercised in increments of 25,000 shares or more and expired on
April 3, 2000. The exercise prices of this option are as follows: 50,000 shares
are exercisable at $10.00 per share and $12.50 per share respectively. This
transaction was completed on April 3, 1998. Mr. John E. Martin, Chairman of
Diedrich Coffee, Inc., serves on the Board of Directors of FMAC.
On July 7, 1999, the Company completed a secondary offering of 4,930,000
shares (including an over-allotment option). All of the shares of common stock
were sold on behalf of the Company, of which 330,000 shares of common stock were
sold pursuant to the exercise of the underwriters' over-allotment option. The
net proceeds of the offering to the Company, after deducting approximately $4.1
million in underwriters' commissions and related expenses, were approximately
$25.4 million.
Information regarding the Company's stock option plans is summarized
below:
F-16
53
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Weighted Average
Options Exercise Price
------- --------------
Shares authorized 2,501,350
==========
Outstanding at January 29, 1997 301,350 $ 6.09
5 Granted 1,885,000 $ 5.60
Forfeited (202,167) $ 7.53
----------
Outstanding at January 28, 1998 1,984,183 $ 5.48
Granted 308,100 $ 7.81
Exercised (164,999) $ 2.26
Forfeited (70,017) $ 3.20
----------
Outstanding at January 27, 1999 2,057,267 $ 6.17
Granted 150,000 $ 5.89
Exercised (17,500) $ 3.00
Forfeited (4,200) $ 6.82
----------
Outstanding at June 30, 1999 2,185,567 $ 6.17
Granted 632,755 $ 4.84
Exercised (13,333) $ 2.87
Forfeited (462,567) $ 6.77
----------
Outstanding at June 28, 2000 2,342,422 $ 5.72
==========
Weighted-average fair value of options granted:
Year ended January 28, 1998 $ 2.56
Year ended January 27, 1999 $ 4.29
Twenty-Two weeks ended June 30, 1999
$ 3.35
Year ended June 28, 2000 $ 4.15
Options exercisable:
At January 28, 1998 1,125,683
At January 27, 1999 1,169,152
At June 30, 1999 1,259,645
At June 28, 2000 1,134,979
In connection with note payable (Note 4) and debt (Note 5) the Company
issued warrants to purchase common stock at a price of $5.625 and $2.25,
respectively expiring at various times. As of June 28, 2000, June 30, 1999,
January 27, 1999 and January 28, 1998, warrants of 920,000, 920,000, 850,000 and
1,095,000 are outstanding and vested.
The following table summarizes information about stock options outstanding on
June 28, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ----------------------------
WEIGHTED NUMBER WEIGHTED
NUMBER OUTSTANDING WEIGHTED AVERAGE EXERCISABLE AVERAGE
AT AVERAGE REMAINING EXERCISE AT EXERCISE
JUNE 28, 2000 LIFE (YEARS) PRICE JUNE 28, 2000 PRICE
------------- ------------ ----- -------------- ---------
$ 2.75 - $ 4.00 938,667 7.11 $ 3.58 741,667 $ 3.59
$ 4.01 - $ 6.00 616,355 8.39 $ 5.19 300,700 $ 4.87
$ 6.01 - $ 9.00 442,400 7.65 $ 7.69 72,612 $ 6.88
$ 9.01 - $ 10.50 345,000 7.32 $ 9.88 20,000 $ 9.99
--------- ---------
2,342,422 1,134,979
========= =========
F-17
54
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Pro forma net loss and pro forma net loss per share, as if the fair value-based
method has been applied in measuring compensation cost for stock-based awards:
Year Ended Twenty-Two Weeks Year Ended Year Ended
June 28, 2000 Ended June 30, 1999 January 27, 1999 January 28, 1998
------------- ------------------- ---------------- ----------------
PRO FORMA
Net Loss $ (23,481,650) $ (2,778,604) $ (3,082,569) $ (13,588,746)
Basic and
diluted loss $ (1.88) $ (0.45) $ (0.52) $ (2.52)
per share
The fair values of the options granted were estimated using the Black-Scholes
option-pricing model based on the following weighted average assumptions:
Year Ended Twenty-Two Year Ended Year Ended
June 28, Weeks Ended January 27, January 28,
2000 June 30, 1999 1999 1998
----------- ------------- ----------- -----------
Risk free interest rate 6.28% 5.67% 4.5% 5.5%
Expected Life 6 years 6 years 6 years 6 years
Expected volatility 72% 48% 53% 128%
Expected dividend yield 0% 0% 0% 0%
10. INCOME TAXES
The components of the income tax expense are as follows:
YEAR ENDED TWENTY-TWO YEAR ENDED YEAR ENDED
JUNE 28, WEEKS ENDED JANUARY 27, JANUARY 28,
2000 JUNE 30, 1999 1999 1998
---------- ------------- ----------- -----------
Current:
Federal............... $ -- $ -- $ -- $ --
State................. 18,569 2,800 3,690 800
------- ------ ------ ----
18,569 2,800 3,690 800
------- ------ ------ ----
Deferred:
Federal............... -- -- -- --
State................. -- -- -- --
------- ------ ------ ----
$18,569 $2,800 $3,690 $800
======= ====== ====== ====
F-18
55
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting and income tax purposes. The significant components of deferred tax
assets and liabilities are as follows:
JUNE 28, JUNE 30,
2000 1999
------------ -----------
Deferred tax assets:
Net operating loss carryforwards ......... $ 9,113,494 $ 4,510,807
Intangible assets ........................ 520,245 511,235
Depreciation ............................. 441,563 --
Property and equipment impairment ........ 2,131,425 --
Accrued expenses ......................... 642,034 415,099
Restructure and store closure accurals.... 486,664 90,953
AMT credit ............................... 27,244 1,069
Other .................................... 100,922 --
------------ -----------
Total gross deferred tax assets ............ 13,463,591 5,529,163
Less valuation allowance ................... (13,463,591) (5,515,251)
------------ -----------
Deferred tax liabilities - depreciation..... -- 13,912
------------ -----------
Net deferred tax assets .................... $ -- $ --
============ ===========
A reconciliation of the statutory Federal income tax rate with the
Company's effective income tax expense (benefit) rate is as follows:
YEAR ENDED TWENTY-TWO WEEKS YEAR ENDED YEAR ENDED
JUNE 28, 2000 ENDED JUNE 30, 1999 JANUARY 27, 1999 JANUARY 28, 1998
------------- ------------------- ---------------- ----------------
Federal statutory rate ........ (34.0)% (34.0)% (34.0)% (34.0)%
State income taxes, net of .... (3.34) (3.74) (1.6) (3.3)
Federal benefit
Other ......................... 2.66 (0.21) (2.8) (0.1)
Valuation allowance ........... 34.6 38.07 38.6 37.4
0.08% 0.12% 0.2% --%
As of June 28, 2000, the Company had net operating loss (NOL)
carryforwards of approximately $24,555,000 and $17,697,000 for Federal and state
purposes, respectively. The Federal NOL is available to offset future federal
taxable income through 2014, and the state NOL is available to offset future
state taxable income through 2004. The utilization of certain NOL carryforwards
could be limited due to restriction imposed under Federal and state laws upon a
change in ownership.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon the level of historical taxable income and projections for future taxable
income over the periods which the deferred tax assets are deductible, management
believes it is more likely than not the Company will realize the benefits of
these deductible differences, net of the existing valuation allowances at June
28, 2000 and June 30, 1999.
11. IMPAIRMENT AND RESTRUCTURING CHARGES
On July 7, 1999, the Company purchased Coffee People (see note 4). Since
the acquisition and as announced by the Company on June 29, 2000, the Gloria
Jean's division has seen the premature closure of 39 locations, six of which
were Company operated, and other significant operating shortfalls. A revised
operating plan was developed to restructure and stabilize the division.
Consequently, in the fourth quarter of the year ended June 28, 2000, pursuant to
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived
F-19
56
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Assets to Be Disposed of," the Company evaluated the recoverability of the
carrying value of its long-lived assets, including intangibles of all its
divisions. Considerable management judgement is necessary to estimate future
cash flow. As a result of this evaluation, the Company determined that Gloria
Jean's estimated future cash flows were insufficient to recover the carrying
value of certain of Gloria Jean's long-lived assets. Accordingly, the Company
adjusted the carrying value of Gloria Jean's long-lived assets, primarily costs
in excess of net assets acquired, resulting in a noncash impairment charge of
approximately $14,818,000 against costs in excess of net assets acquired and an
additional $343,000 against property and equipment. The Company also recorded an
impairment charge for its Diedrich Coffee division in the amount of $423,000 and
for its Coffee People and Coffee Plantation divisions in the amount of $786,000.
Total asset impairment charges recorded in the fourth quarter of the year ended
June 28, 2000 were $16,370,000.
On March 12, 1997, the Company announced that it was reviewing the
performance of all of the Company's coffeehouses to determine which units were
not meeting management's long-term operational expectations. As a result of this
review, twelve stores were identified to be closed. In connection with the store
closures and other related expenses, the Company recorded an impairment
provision and restructuring charge totaling approximately $4.6 million in the
first quarter of fiscal 1998. Eleven of the twelve stores were closed with eight
leases terminated and three locations subleased. In January 1998, management
reviewed the progress of all retail operations and determined that one
coffeehouse originally designated for closure would remain open. During fiscal
1998, most of the lease terminations provided for in the restructuring had been
completed at less cost than originally anticipated. As a result of these two
factors, management determined that the remaining restructuring reserve could be
reduced by $648,000 to $237,000.
12. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
TWENTY-TWO
YEAR ENDED JUNE WEEKS ENDED JUNE YEAR ENDED YEAR ENDED
28, 2000 30, 1999 JANUARY 27, 1999 JANUARY 28,
--------------- ---------------- ---------------- -------------
NUMERATOR:
Net loss .............................. $(22,423,577) $(2,348,570) $(2,562,308) $(9,112,761)
============ =========== =========== ===========
DENOMINATOR:
Basic weighted average
common shares outstanding ............. 12,479,408 6,172,932 5,934,287 5,392,609
Effect of dilutive securities ......... -- -- -- --
------------ ----------- ----------- -----------
Diluted weighted average
common shares outstanding ............. 12,479,408 6,172,932 5,934,287 5,392,609
============ =========== =========== ===========
Basic and diluted loss per share ............ $ (1.80) $ (0.38) $ (0.43) $ (1.69)
For the year ended June 28, 2000, the twenty-two weeks ended June 30,
1999, and the years ended January 27, 1999 and January 28, 1998,
employee stock options of 2,342,422, 2,185,567, 2,057,267 and 1,984,183,
respectively, and warrants of 920,000, 920,000, 850,000 and 1,095,000
(as described in note 5 and 6), were not included in the computation of
diluted earnings per share as their impact would have been
anti-dilutive.
13. SEGMENT INFORMATION
The Company has three reportable segments which include retail
operations, wholesale operations and franchise operations. The Company evaluates
performance of its operating segments based on income before provision for asset
impairment and restructuring costs, income taxes, interest expense, depreciation
and amortization, and general and administrative expenses.
F-20
57
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Summarized financial information concerning the Company's reportable
segments is shown in the following table. The other total assets consist of
corporate cash, costs in excess of net assets acquired and corporate property,
plant and equipment. The other component of segment profit before tax includes
corporate general and administrative expenses, provision for asset impairment
and restructuring costs, depreciation and amortization expense and interest
expense.
RETAIL WHOLESALE FRANCHISE
OPERATIONS OPERATIONS OPERATIONS OTHER TOTAL
------------ ----------- ---------- ------------ ------------
Year ended June 28, 2000
Total revenues $ 48,857,304 $18,788,369 $6,812,690 $ -- $ 74,458,363
Interest expense -- -- -- 1,316,091 1,316,091
Depreciation and amortization 2,075,267 668,691 -- 1,586,713 4,330,671
Segment profit (loss) before tax (135,276) 2,340,734 3,185,220 (27,795,686) (22,405,008)
Total assets as of June 28, 2000 $ 13,679,086 $ 2,139,241 $ 549,713 $ 23,961,814 $ 40,329,854
RETAIL WHOLESALE FRANCHISE
OPERATIONS OPERATIONS OPERATIONS OTHER TOTAL
------------ ----------- ---------- ------------ ------------
Twenty-Two weeks ended June 30, 1999
Total revenues $ 8,837,640 $ 1,415,604 $ 108,913 $ -- $ 10,362,157
Interest expense -- -- -- 282,937 282,937
Depreciation & amortization 880,897 59,907 -- 271,167 1,211,971
Segment profit (loss) before tax 407,898 (291,363) (46,883) (2,415,422) (2,345,770)
Total assets as of June 30, 1999 $ 6,224,572 $ 1,735,354 $ 150,016 $ 3,354,757 $ 11,464,699
RETAIL WHOLESALE FRANCHISE
OPERATIONS OPERATIONS OPERATIONS OTHER TOTAL
------------ ----------- ---------- ------------ ------------
Year ended January 27, 1999
Total revenues $ 21,248,462 $ 2,766,741 $ 200,000 $ -- $ 24,215,203
Interest expense -- -- -- 384,544 384,544
Depreciation and amortization 1,478,070 115,747 -- 347,203 1,941,020
Segment profit (loss) before tax 1,476,140 392,467 200,000 (4,627,225) (2,558,618)
RETAIL WHOLESALE FRANCHISE
OPERATIONS OPERATIONS OPERATIONS OTHER TOTAL
------------ ----------- ---------- ------------ ------------
Year ended January 28, 1998
Total revenues $ 20,759,993 $ 2,221,704 $ -- $ -- $ 22,981,697
Interest expense -- -- -- 182,135 182,135
Depreciation & amortization 1,374,932 76,377 -- 333,962 1,785,271
Segment profit (loss) before tax (5,160,947) 512,313 -- (4,463,327) (9,111,961)
F-21
58
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations for the year ended June 28, 2000, the
twenty-two weeks ended June 30, 1999 and the year ended January 27,
1999 were as follows:
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
(in thousands, except per share data)
Year Ended June 28, 2000:
Total revenues $16,273 $19,133 $16,745 $22,307
Operating income (loss) (162) 886 311 (22,375)
Net income (loss) (389) 599 79 (22,713)
Net income (loss) per share (0.03) 0.05 0.01 (1.83)
Twenty-Two Weeks Ended June 30, 1999:
Total revenues $6,098 $4,264
Operating loss (470) (1,584)
Net loss (568) (1,781)
Net loss per share (0.09) (0.29)
Year Ended January 27, 1999:
Total revenues $5,923 $6,030 $6,043 $6,219
Operating loss (649) (677) (521) (418)
Net loss (746) (761) (609) (446)
Net loss per share (0.13) (0.13) (0.10) (0.07)
Quarterly operating results are not necessarily representative of
operations for a full year for various reasons, including seasonal nature of our
business, which may affect sales volume and food costs. For the year ended June
28, 2000, all quarters have 12 week accounting periods, except the fourth
quarter, which has a 16 week accounting period. For the twenty-two weeks ended
June 30, 1999, the first quarter had a 13 week accounting period and the second
quarter had a 9 week accounting period. For the year ended January 27, 1999, all
quarters have 13 week accounting periods.
In the fourth quarter for the year ended June 28, 2000, the Company
recorded an asset impairment charge of $16,370,000 (see note 11).
F-22
59
DIEDRICH COFFEE, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Allowance for
-----------------
Doubtful Accounts
Balance at January 29, 1997 $ 4,000
Charges to operations 18,134
Amounts written off --
Adjustments --
-----------
Balance at January 28, 1998 22,134
Charges to operations 7,304
Amounts written off --
Adjustments --
-----------
Balance at January 27, 1999 29,438
Charges to operations 2,004
Amounts written off --
Adjustments --
-----------
Balance at June 30, 1999 31,442
Charges to operations 566,299
Amounts written off (773,431)
Adjustments --
Acquired through acquisitions 1,313,661
-----------
Balance at June 28, 2000 $ 1,137,971
===========
see accompanying independent auditors' report
F-23
60
DIEDRICH COFFEE, INC.
INDEX TO EXHIBITS
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGES
------ ----------- -----
2.1 Form of Agreement and Plan of merger by and between Diedrich
Coffee, a California corporation, and Diedrich Coffee, Inc., a
Delaware corporation (1)
2.2 Agreement and Plan of Merger dated as of March 16, 1999, by and
among Diedrich Coffee, CP Acquisition Corp., a wholly owned
subsidiary of Diedrich Coffee, and Coffee People (2)
3.1 Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
4.1 Purchase Agreement for Series A Preferred Stock dated as of
December 11, 1992 by and among Diedrich Coffee, Martin R. Diedrich,
Donald M. Holly, SNV Enterprises and D.C.H., L.P. (1)
4.2 Purchase Agreement for Series B Preferred Stock dated as of June
29, 1995 by and among Diedrich Coffee, Martin R. Diedrich, Steven
A. Lupinacci, Redwood Enterprises VII, L.P. and Diedrich Partners
I, L.P. (1)
4.3 Specimen Stock Certificate (1)
4.4 Form of conversion Agreement in the connection with the
conversion of Series A and Series B Preferred Stock into Common
Stock (1)
4.5 Form of Lock-up Letter Agreement among The Second Cup, Ltd. and
Diedrich Coffee, Inc. (3)
4.6 Voting Agreement and Irrevocable Proxy dated as of March 16, 1999
by and among Diedrich Coffee, Inc., D.C.H., L.P., Peter Churm,
Martin R. Diedrich, Lawrence Goelman, Paul C. Heeschen, John E.
Martin, Timothy J. Ryan, and Second Cup USA Holdings Ltd. (3)
10.1 Form of Indemnification Agreement (1)
10.2 Amended and Restated Diedrich Coffee 1996 Stock Incentive Plan (4)
10.3 Diedrich Coffee 1996 Non-Employee Directors Stock Option Plan (1)
10.4 Agreement of Sale dated as of February 23, 1996 by and among
Diedrich Coffee (as purchaser) and Brothers Coffee Bars, Inc. and
Brothers Gourmet Coffees, Inc. (as sellers) (1)
10.5 Separation agreement dated May 13, 1997 between Steven A. Lupinacci
and Diedrich Coffee, Inc. (5)
10.6 Letter agreement by and between the Company and John E. Martin
appointing Mr. Martin Chairman of the Board, dated as of November
17, 1997 (6)
S-1
61
10.7 Stock Option Plan and Agreement by and between the company and
John E. Martin granting Mr. Martin the option to purchase up to
850,000 shares of the Common Stock of the Company, dated as of
November 17, 1997 (6)
10.8 Common Stock Purchase Agreement by and between the company and
John E. Martin under which Mr. Martin agrees to purchase 333,333
shares of the Common Stock of the Company, dated as of November
17, 1997 (6)
10.9 Employment Agreement by and between the Company and Timothy J.
Ryan retaining Mr. Ryan as Chief Executive Officer, dated as of
November 17, 1997 (6)
10.10 Stock Option Plan and Agreement by and between the company and
Timothy J. Ryan granting Mr. Ryan up to 600,000 shares of the
Common Stock of the Company, dated as of November 17, 1997 (6)
10.11 Common Stock Purchase Agreement by and between the Company and
Timothy J. Ryan under which Mr. Ryan agrees to purchase 16,667
shares of the Common Stock of the Company, dated as of November
17, 1997 (6)
10.12 Form of Promissory Note made in favor of Nuvrty, Inc., the Ocean
Trust and the Grandview Trust (7)
10.13 Form of Term Loan Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust (7)
10.14 Form of Security Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust (7)
10.15 Form of Warrant Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust (7)
10.16 Form of Intercreditor Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust (7)
10.17 Form of Common Stock and Option Purchase Agreement with Franchise
Mortgage Acceptance Company dated as of April 3, 1998 (8)
10.18 Separation and Release Agreement dated January 28, 1998 with Kerry W. Coin (8)
10.19 Employment Agreement with Ann Wride dated April 8, 1998 (9)
10.20 Employment Agreement with Catherine Saar dated June 11, 1998 (10)
10.21 Form of Franchise Agreement (11)
10.22 Form of Area Development Agreement (11)
10.23 Employment Agreement with Martin R. Diedrich dated June 29, 1998 (3)
10.24 Credit Agreement, dated, as of July 7, 1999, by and among
BankBoston, N.A., Diedrich Coffee and its subsidiaries (12)
10.25 Security Agreement, dated, as of July 7, 1999, by and among
BankBoston, N.A., Diedrich Coffee and its subsidiaries (12)
S-2
62
10.26 Securities Pledge Agreement, dated, as of July 7, 1999, by and
among BankBoston, N.A., Diedrich Coffee and its subsidiaries
(12)
10.27 Trademark Security Agreement, dated, as of July 7, 1999, by and
among BankBoston, N.A., Diedrich Coffee and its subsidiaries
(12)
10.28 Form of Term Note made in favor of BankBoston, N.A. (12)
10.29 Form of Revolving Note made in favor of BankBoston, N.A. (12)
10.30 Employment Agreement with Matt McGuinness dated effective March 13, 2000*
10.31 Letter Agreement re: employment with Greg MacIsaac dated February 25, 2000*
10.32 First Amendment to Credit Agreement*
10.33 Letter Agreement re: employment with J. Michael Jenkins dated
September 2000*
23.1 The Report on Schedule and Consent of Independent Auditors*
27.1 Financial Data Schedule*
- ---------------------
* Filed with this Form 10-K
(1) Previously filed as an exhibit to Diedrich Coffee's Registration
Statement on Form S-1 (No. 333-08633), as amended, as declared
effective by the Securities and Exchange Commission on September
11, 1996.
(2) Previously filed as Appendix A to Diedrich Coffee's Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on April 23, 1999.
(3) Previously filed as an exhibit to Diedrich Coffee's Registration
Statement on Form S-4, filed with the Securities and Exchange
Commission on April 23, 1999.
(4) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended September 22, 1999,
filed with the Securities and Exchange Commission on November 5,
1999.
(5) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended April 30, 1997, filed
with the Securities and Exchange Commission on June 13, 1997.
(6) Previously filed as an exhibit to Diedrich Coffee's Current
Report on Form 8-K, filed with the Securities and Exchange
Commission on November 25, 1997.
(7) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended October 29, 1997, filed
with the Securities and Exchange Commission on December 11, 1997.
(8) Previously filed as an exhibit to Diedrich Coffee's annual report
on Form 10-K for the fiscal year ended January 28, 1998.
(9) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended April 28, 1999, filed
with the Securities and Exchange Commission on June 11, 1998.
(10) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended July 29, 1998, filed
with the Securities and Exchange Commission on September 10,
1998.
(11) Previously filed as an exhibit to Diedrich Coffee's Quarterly
Report on Form 10-Q for the period ended April 28, 1999, filed
with the Securities and Exchange Commission on December 11, 1998.
(12) Incorporated by reference to Diedrich Coffee's Transition Report
on Form 10-Q for the period from January 28, 1999 to June 30,
1999, filed with the Securities and Exchange Commission on August
16, 1999.
S-3