<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C., 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 27, 1998
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 number 0-23024
BROTHERS GOURMET COFFEES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1681708
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2255 GLADES ROAD
SUITE 100E
BOCA RATON, FL 33431
(Address of principal executive offices)
(Zip code)
(561) 995-2600
(Registrant's telephone number, including area code)
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 [ ]
As of May 11, 1998 the Registrant had issued and outstanding (1) 12,121,324
shares of Common Stock, par value $.0001 per share, and (2) 839,332 shares of
Class B Common Stock, par value $.0001 per share.
<PAGE>
BROTHERS GOURMET COFFEES, INC.
SPECIAL NOTE ABOUT FORWARD LOOKING STATEMENTS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED IN THIS QUARTERLY REPORT ON
FORM 10-Q FOR THE FISCAL QUARTER ENDING MARCH 27, 1998, CERTAIN MATTERS
DISCUSSED HEREIN INCLUDING, WITHOUT LIMITATION, PART I - FINANCIAL
INFORMATION, ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS AND ELSEWHERE IN THIS FORM 10-Q (AND ANY
DOCUMENTS INCORPORATED HEREIN BY REFERENCE) CONTAIN FORWARD LOOKING
STATEMENTS BASED ON MANAGEMENT'S EXPECTATIONS REGARDING, AND EVALUATIONS OF
CURRENT INFORMATION ABOUT, THE COMPANY'S BUSINESS THAT INVOLVE RISKS AND
UNCERTAINTIES THAT COULD CAUSE FUTURE RESULTS TO DIFFER, BOTH ADVERSELY AND
MATERIALLY, FROM CURRENTLY ANTICIPATED RESULTS. THESE STATEMENTS ARE
TYPICALLY IDENTIFIED BY THEIR INCLUSION OF PHRASES SUCH AS "THE COMPANY
ANTICIPATES," "MANAGEMENT BELIEVES" AND OTHER PHRASES OF SIMILAR MEANING.
SUCH FACTORS INCLUDE, AMONG OTHERS, THE EFFECT OF ECONOMIC AND MARKET
CONDITIONS; INDUSTRY AND INDUSTRY SEGMENT CONDITIONS AND DIRECTIONS; WEATHER;
COFFEE CROP AND GREEN COFFEE PRICE FLUCTUATIONS; FOREIGN LABOR PROBLEMS;
FOREIGN COFFEE DELIVERY DIFFICULTIES; PRODUCTION COSTS; COMPETITIVE
PRESSURES; THE COMPANY'S OWN FINANCING CONTINGENCIES AND RESTRICTIONS;
MANAGEMENT LIMITATIONS; THE ABILITY AND WILLINGNESS OF PURCHASERS TO COMPLETE
ACQUISITIONS OF THE COMPANY'S RETAIL COFFEE BARS AND THE GLORIA JEAN'S
STORES; THE COMPANY'S ABILITY TO RESOLVE POST-CLOSING DIFFERENCES WITH THE
PURCHASERS OF CERTAIN COMPONENTS OF THE COMPANY'S DISCONTINUED RETAIL
OPERATIONS; LEGISLATION AND REGULATIONS; RESOLUTION OF PENDING LITIGATION IN
WHICH THE COMPANY IS A DEFENDANT; THE ABILITY OF THE COMPANY TO CLOSE
CONTRACTS WITH NEW ACCOUNTS AND TO RENEW EXISTING ACCOUNTS AS SUCH ACCOUNTS
COME UP FOR RENEWAL; CHANGES IN CONSUMER TASTES AND PREFERENCES; THE SUCCESS
OR LACK THEREOF OF THE COMPANY'S NEW PRODUCTS, DISPLAY MODELS AND PACKAGING
LINES; AND OTHER FACTORS REFERENCED IN THIS FORM 10-Q. AS A RESULTS OF THE
FOREGOING AND OTHER FACTORS, NO ASSURANCE CAN BE GIVEN AS TO FUTURE RESULTS,
LEVELS OF ACTIVITY AND/OR ACHIEVEMENTS, AND NEITHER THE COMPANY NOR ANY OTHER
PERSON ASSUMES RESPONSIBILITY FOR THE ACCURACY OR COMPLETENESS OF THESE
STATEMENTS.
<PAGE>
BROTHERS GOURMET COFFEES, INC.
INDEX
PART I - FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets--March 27, 1998 and
December 26, 1997 . . . . . . . . . . . . . . . . . . . . . . . 1
Condensed Consolidated Statements of Operations--Three months
ended March 27, 1998 and March 28, 1997 . . . . . . . . . . . . 2
Condensed Consolidated Statements of Cash Flows--Three months
ended March 27, 1998 and March 28, 1997 . . . . . . . . . . . . 3
Notes to Condensed Consolidated Financial Statements--
March 27, 1998. . . . . . . . . . . . . . . . . . . . . . . . . 4
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations. . . . . . . . 8
PART II - OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 10
Item 2. Changes in Securities . . . . . . . . . . . . . . . . . . . . . 10
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . 10
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . 11
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . 11
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . 11
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
i
<PAGE>
BROTHERS GOURMET COFFEES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
March 27, December 26,
1998 1997
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Trade receivables, net $ 7,311 $ 11,118
Receivable from the sale of discontinued retail operations 1,640 1,818
Inventories 9,695 9,516
Prepaid expenses and other current assets 1,201 836
-------- --------
Total current assets 19,847 23,288
Plant and equipment, net 15,374 15,839
Other assets:
Excess of cost over net assets acquired, net 50,621 50,991
Prepaid promotional expenses, net 4,368 5,070
Debt acquisition costs, net 2,444 2,759
Other assets 1,051 1,066
-------- --------
$ 93,705 $ 99,013
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 1,742 $ 1,779
Accounts payable 3,629 4,419
Accrued expenses 6,253 5,477
Accrued losses and other costs of
discontinued retail operations 631 1,389
Accrued restructuring costs -- 29
-------- --------
Total current liabilities 12,255 13,093
Long-term debt, less current liabilities 27,557 27,777
Minority interest 65 83
Redeemable Warrants 300 300
Stockholders' equity:
Preferred Stock--10,000,000 shares authorized: $1.00 par value;
-0- shares issued and outstanding at March 27, 1998
and December 26, 1997 -- --
Common Stock -- 25,000,000 shares authorized:
$.0001 par value; 12,324,890 shares issued
at March 27, 1998 and December 26, 1997 1 1
Common Stock Class B -- 2,000,000 shares authorized:
$.0001 par value; 839,332 shares issued and outstanding
at March 27, 1998 and December 26, 1997 -- --
Additional paid-in capital 151,693 151,693
Accumulated deficit in earnings (97,716) (93,484)
Treasury stock (203,566 shares, at cost) (450) (450)
-------- --------
Total stockholders' equity 53,528 57,760
-------- --------
$ 93,705 $ 99,013
-------- --------
-------- --------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
<PAGE>
BROTHERS GOURMET COFFEES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three-months Three-months
Ended March 27, Ended March 28,
1998 1997
--------------- ---------------
<S> <C> <C>
Net sales $15,445 $16,808
Cost of goods sold 9,925 9,047
------- -------
Gross profit 5,520 7,761
Operating expenses:
Distribution, selling and marketing 6,580 7,069
Administrative 1,342 1,325
Amortization of intangibles 370 669
------- -------
Loss from operations (2,772) (1,302)
Other expenses (income):
Interest expense, net 1,461 943
Other (income) expense (1) 15
------- -------
Loss before discontinued retail operations (4,232) (2,260)
Loss on disposal of discontinued retail operations -- (2,700)
------- -------
Net loss $(4,232) $(4,960)
------- -------
------- -------
Loss per common share and loss per common share--
assuming dilution:
Loss from continuing operations $ (0.33) $ (0.20)
Loss from discontinued retail operations -- (0.24)
------- -------
Net loss $ (0.33) $ (0.44)
------- -------
------- -------
Weighted average common
shares outstanding 12,961 11,202
------- -------
------- -------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
BROTHERS GOURMET COFFEES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three-months Three-months
Ended March 27, Ended March 28,
1998 1997
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,232) $(4,960)
Adjustments to reconcile net loss to cash
provided by operating activities:
Discontinued retail operations -- 2,700
Depreciation and amortization 3,035 3,157
Provision for Doubtful Accounts 94 30
Changes in operating assets and liabilities:
Current assets 3,169 4,725
Current liabilities (43) (5,627)
Prepaid promotional expenses (285) (2,499)
Other noncurrent assets (3) (26)
------- -------
Net cash provided by (used in) operating activities:
Continuing operations 1,735 (2,500)
Discontinued retail operations (758) (406)
------- -------
977 (2,906)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of plant and equipment, net (704) (1,769)
Proceeds from sale of discontinued retail operations 178 100
------- -------
Net cash used in investing activities (526) (1,669)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under revolving line
of credit 55 5,010
Payment of term loan (413) (375)
Payments under capital lease (50) (37)
Debt issuance costs (43) (23)
------- -------
Net cash (used in) provided by financing activities (451) 4,575
------- -------
Change in cash -- --
Cash at the beginning of the period -- --
------- -------
Cash at the end of the period $ -- $ --
------- -------
------- -------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
BROTHERS GOURMET COFFEES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 27, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q pursuant to the
Securities Exchange Act of 1934, as amended (the "1934 Act"), and Article 10 of
Regulation S-X, as amended. Accordingly, they do not include all the financial
statements and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the three-month
period ended March 27, 1998 are not necessarily indicative of the results that
may be expected for the year ended December 25, 1998 ("Fiscal Year 1998"). For
further information, refer to the Brothers Gourmet Coffees, Inc.'s (the
"Company") consolidated financial statements and footnotes (collectively the
"1997 Financial Statements") included in its Annual Report on Form 10-K for the
(the "1997 Form 10-K") year ended December 26, 1997 ("Fiscal Year 1997").
NOTE 2--SALES
The Company is an integrated sourcer, roaster and wholesaler of high quality
gourmet coffee products. The Company distributes its product principally
through grocery stores, supermarkets, mass merchandisers, drug stores, military
commissaries, warehouse stores and specialty stores (the "wholesale distribution
channel"). The Company's business is seasonal, with increased sales during the
colder months. As a result, in a typical year, a substantial portion of the
Company's sales and its reported results from operations occur during the fourth
quarter of the year. The Company's results of operations for any particular
quarter may not necessarily be indicative of its results of operations for any
other particular quarter or for the whole year.
NOTE 3--EARNINGS PER SHARE
In 1997, the Financial Accounting Standard Board issued Statement No. 128,
"Earnings per share." Statement 128 replaced the calculation of primary and
fully diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options or warrants.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All earnings per share amounts for all periods have
been presented, and where appropriate, restated to conform to the Statement 128
requirements. Shares underlying options and warrants totaling 3,501,604 shares
and 3,369,120 shares are not included in the computation for the three-month
fiscal periods ended March 27, 1998 and March 28, 1997, respectively, because
the effect is antidilutive.
NOTE 4--INVENTORIES
The components of inventories consist of the following:
<TABLE>
<CAPTION>
March 27, December 26,
1998 1997
--------- ------------
<S> <C> <C>
Green coffee $3,910 $2,606
Finished goods 4,510 5,851
Packaging and other supplies 1,275 1,059
------ ------
$9,695 $9,516
------ ------
------ ------
</TABLE>
4
<PAGE>
BROTHERS GOURMET COFFEES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 27, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
NOTE 5--DEBT FACILITIES
A summary of indebtedness outstanding under various credit arrangements at
March 27, 1998 and December 26, 1997 is as follows:
<TABLE>
<CAPTION>
March 27, December 26,
1998 1997
--------- ------------
<S> <C> <C>
Revolving Credit Facility(a)(c) 11,233 $11,177
Term Loan Facility(b)(c) 6,088 6,500
Subordinated Note(d) 15,000 15,000
Capital lease obligations 100 150
------- -------
32,421 32,827
Less value ascribed to warrants (3,122) (3,271)
Less current maturities (1,742) (1,779)
------- -------
$27,557 $27,777
------- -------
------- -------
</TABLE>
(a) The Company's revolving credit facility (the "Revolving Credit
Facility"), in the aggregate principal amount of $21,500 (the "Revolving
Credit Facility"), bears interest at the prime rate plus 2.0% (10.50% at
March 27, 1998). Interest is payable monthly. The Revolving Credit Facility
matures on May 29, 1999. The Revolving Credit Facility carries an unused
commitment fee of .5% of the average daily unused balance. At March 27,
1998, the remaining availability under the Revolving Credit Facility was
$3,387. Eligible inventory, receivables and slotting fees collateralize
borrowings under the Revolving Credit Facility.
(b) The Company's term loan facility (the "Term Loan Facility") consists of
(1) a term loan in the amount of $2,138 ("Term Loan A") and (2) a second term
loan in the amount of $3,950 ("Term Loan B"). Term Loan A bears interest at
the prime rate plus 2.0% (10.5% at March 27, 1998) and is payable in fourteen
monthly installments of $37.5 each plus accrued interest and one installment
of $1,612.50 plus interest payable at maturity. Term Loan B bears interest
at a fixed rate of 11.75% and is payable in fourteen monthly installments of
$100 each plus accrued interest and one installment of $2,550 plus accrued
interest payable at maturity.
(c) The Revolving Credit Facility and the term Loan facility are components
of the Company's Amended and Restated Credit Agreement (the "Restated Credit
Agreement"), with Goldman Sachs Credit Partners, , L.P. ("GSCP").
(d) The Company's unsecured subordinated note facility (the "Subordinated
Note") with Dilmun Financial Services ("Dilmun"), in an aggregate principal
amount of $15,000, bears interest at the rate of 11.25% per annum. Interest
is payable quarterly and the Subordinated Note matures on December 26, 2002.
The Company's debt agreements with GSCP and Dilmun contain various financial
and non-financial covenants. These covenants require the Company (1)
beginning with the first quarter of 1998, to maintain total capital funds, as
defined in the Restated Credit Agreement, at various quarterly amounts, (2)
beginning with the second quarter of 1998, to maintain earnings before
interest expense, taxes paid, depreciation and amortization ("EBITDA"), as
defined in the Restated Credit Agreement, at various quarterly amounts, (3)
to maintain cash flow to debt service and consolidated tangible net worth,
both as defined in the Subordinated Note agreement, at specified levels, (4)
beginning in the first quarter of 1998, to limit annual capital expenditures
to $5,000 and (5) at all times during 1998, to restrict the payment of
dividends. At March 27, 1998, the Company continued not to be in compliance
with the cash flow coverage ratio
5
<PAGE>
BROTHERS GOURMET COFFEES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 27, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
covenant and consolidated tangible net worth covenant in the Subordinated
Note (the "Covenant Defaults"). Pursuant to the terms of the Subordinated
Note, management has determined that Dilmun does not have the right to
accelerate repayment of the Subordinated Note solely because of the Covenant
Defaults and, accordingly, the Company has continued to classify the
outstanding borrowings under the Subordinated Note as long-term. The Company
has asked Dilmun to amend the Subordinated Note to eliminate the Covenant
Defaults or, in the alternative, to waive the Covenant Defaults under the
Subordinated Note. The Company and Dilmun have not been able to reach
agreement on the terms of such amendment or waiver. See for more information
concerning the Company's debt facilities, see (1) Note 3 - Debt to the Notes
to the Company's 1997 Financial Statements and (2) PART I, ITEM 1. BUSINESS
- --Credit Facilities in the Company's 1997 Form 10-K
NOTE 6--DISCONTINUED RETAIL OPERATIONS
In June 1995, the Board of Directors (the "Board") adopted a plan (the
"Disposition Plan") to dispose of all of the Company's retail operations,
consisting of the Gloria Jean's specialty retail business ("Gloria Jean's")
and the Brothers Gourmet Coffee Bars (the "Coffee Bars"). Accordingly, the
operating results of discontinued retail operations, including provisions for
estimated losses during the phase-out period, have been segregated from
continuing operations and reported as a separate line item on the statement
of operations. Due to the subjective nature of estimating future operating
losses and incremental costs of disposal, it is reasonably possible that
these estimates may change in the future. Future changes in estimates will
be included in the statement of operations in the fiscal year determined.
See Note 8 -- Contingencies and Litigation below. For more information
concerning the Company's disposition of its Gloria Jean's business and the
Brothers Coffee Bars, see (1) Note 2 - Discontinued Retail Operations to
the Notes to the Company's 1997 Financial Statements and (2) PART I, ITEM 1.
BUSINESS -- Discontinued Retail Operations in the Company's 1997 Form 10-K
As of March 27, 1998, the Company's obligations under the non-cancelable
operating leases for its remaining five Coffee Bars were as follows: Fiscal
Year 1998 - $549; Fiscal Year 1999 - $753; Fiscal Year 2000 - $770; Fiscal
Year 2001 - $802; Fiscal Year 2002 - $831; and thereafter -$2,711. The
Company has sublease agreements on two (2) of the five (5) remaining
non-cancelable lease agreements. Future minimum sublease income under these
sublease agreements at March 27, 1998 is as follows: Fiscal Year 1998 - $253;
Fiscal Year 1999 - $341; Fiscal Year 2000 - $347; Fiscal Year 2001 - $375;
Fiscal Year 2002 - $384; and thereafter - $1,526. The Company is negotiating
to terminate its obligations under all of the remaining leases and estimates
that the total costs relating to the assignment and termination of these
leases will be approximately $111. This incremental cost has been included
in the estimated loss on disposal.
As of March 27, 1998, the Company remained as a guarantor on sixteen (16)
leases sold and assigned to third parties with future commitments under these
agreements at March 27, 1998 as follows: Fiscal Year 1998 - $673; Fiscal Year
1999 - $915; Fiscal Year 2000 - $845; Fiscal Year 2001 - $845; Fiscal Year
2002 - $422; and thereafter - $577.
NOTE 7--INCOME TAXES
The Company historically has experienced net operating losses and has
established valuation allowances to offset net deferred tax assets.
Accordingly, the Company has had no provision for income taxes and expects
this trend to continue for the remainder of Fiscal Year 1998.
6
<PAGE>
BROTHERS GOURMET COFFEES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 27, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
NOTE 8--CONTINGENCIES
In December 1996, in connection with the sale of its seven (7) Chicago coffee
bars, the Company permitted the purchaser to defer payment of a receivable
for the remaining $500 of sales proceeds at an annual interest rate of 9.5%.
The Company is currently negotiating with the purchaser for the collection of
these proceeds. In addition, the Company remains as guarantor on thirteen
(13) of the coffee bar leases sold and assigned to this purchaser. Future
commitments under these non-cancelable lease agreements at March 27, 1998 are
as follows: Fiscal Year 1998 -- $600; Fiscal Year 1999 -- $813; Fiscal Year
2000 -- $742; Fiscal Year 2001 -- $742; Fiscal Year 2002 - $373; and
thereafter $563. The Company could be required to honor its guarantee of
these leases which could have a material adverse affect on the Company's
results of operations and its financial condition.
NOTE 9--LITIGATION
For historical information concerning the Kona Coffee Class Action, Nassau &
Liberty Coffee Bar Litigation, Employee Litigation and Second Cup Warranty
Claims/Litigation, see (1) Note 9 - Contingencies to the Company's 1997
Financial Statements and (2) PART I, ITEM 3. LEGAL PROCEEDINGS in the
Company's 1997 Form 10-K. There have been no material developments with
respect to any of these litigation matters since April 5, 1998, except as set
forth below.
SECOND CUP WARRANTY CLAIMS/LITIGATION. In May 1998, the Company settled
two additional warranty claims, totaling $373, by agreeing to release an
additional $320 of the sales proceeds held in escrow to the purchaser, The
Second Cup ("Second Cup"). The Company and Second Cup are continuing to
discuss settlement of the remaining claims, which total approximately $965.
The Company disputes liability for certain of these remaining claims and, in
the case of several of the remaining claims for which it does not dispute
liability, it disputes the amount of its liability for such claims. The
current balance in the escrow fund, net of payments to be made with respect to
the two claims settled in May, is approximately $701.
KONA COFFEE CLASS ACTION. In April 1998, the parties attended a
settlement conference. While the Company believes that progress was made at
the conference toward settlement of this litigation, the parties were not
able to reach a definitive settlement. The defendants, including the
Company, continue to discus settlement of this litigation with the plaintiffs.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company is an integrated sourcer, roaster, and wholesaler of high
quality gourmet coffee products. The Company is one of the leading wholesale
suppliers of gourmet coffees in the United States. The Company distributes
its product principally through grocery stores, supermarkets, mass
merchandisers, drug stores, military commissaries, warehouse stores and
specialty stores (the "wholesale distribution channel").
FIRST QUARTER 1998 COMPARED WITH FIRST QUARTER 1997
NET SALES. Net sales decreased $1.4 million, or 8.1%, in the first
quarter of Fiscal Year 1998 as compared to the first quarter of Fiscal Year
1997. Sales decreased $2.6 million due to lower sales volume partially
offset by a $1.2 million increase in sales price realization ($0.41 per
pound). The decline in sales volume was attributable principally to (1)
timing of shipments to warehouses and distributors and (2) a loss of certain
customers. The Company's decision not to enter into unprofitable promotional
contracts, requiring the payment of substantial product placement costs
(slotting fees), was the primary reason for the loss of such customers.
GROSS PROFIT AND GROSS PROFIT MARGIN. Gross profit decreased $2.2
million, or 28.9%, in the first quarter of Fiscal Year 1998 as compared to
the first quarter of Fiscal Year 1997. The decrease resulted principally
from (1) a decrease in sales volume ($1.4 million) and (2) an increase in
green coffee costs ($1.8 million). The decrease in gross profit was
partially offset by an increase of $1.2 million from higher sales price
realization. The gross profit margin decreased as a percentage of sales from
46.2% in the first quarter of Fiscal Year 1997 to 35.7% in the first quarter
of Fiscal Year 1998 principally due to the higher cost of green coffee.
DISTRIBUTION, SELLING AND MARKETING EXPENSES. Distribution, selling and
marketing expenses decreased $.5 million, or 6.9%, in the first quarter of
Fiscal Year 1998 as compared to the first quarter of Fiscal Year 1997
principally due to lower distribution costs and customer related expenses.
Distribution costs decreased $.4 million as a result of a consolidation of the
Company's direct store distribution ("DSD") routes and lower freight-out
costs due to lower sales volume and lower shipping costs. Customer related
expenses decreased $.2 million due to lower slotting amortization ($.1) and
customer display equipment depreciation ($.1 million). Marketing costs
increased $.1 million due to the timing of advertising and coupon promotional
programs. Distribution, selling and marketing expenses as a percentage of
sales increased from 42.1% of sales in the first quarter of Fiscal Year 1997
to 42.6% of sales in the first quarter of Fiscal Year 1998 principally due to
lower sales.
AMORTIZATION OF INTANGIBLES. Amortization of intangibles expense
decreased $.3 million in the first quarter of 1998 as compared to the first
quarter of 1997 due to reductions in noncompete agreement amortization.
INTEREST EXPENSE. Interest expense increased $.5 million, or 55.0%, in
the first quarter of Fiscal Year 1998 as compared to the first quarter of
Fiscal Year 1997. The increase was principally due to (1) higher borrowing
amounts and (2) higher effective interest rates.
LOSS FROM CONTINUING OPERATIONS. Loss from continuing operations
increased $2.0 million in the first quarter of Fiscal Year 1998 as compared
to the first quarter of Fiscal Year 1997. The increase was principally due
to (1) a $2.2 million decrease in gross profit and (2) a $.5 million increase
in interest expense, partially offset by (3) a $.7 million decrease in
distribution, selling and marketing expenses and amortization of intangibles.
LOSS FROM DISCONTINUED RETAIL OPERATIONS. Loss from discontinued retail
operations decreased $2.7 million in the first quarter of Fiscal Year 1998 as
compared to the first quarter of Fiscal Year 1997. The first quarter Fiscal
Year 1997 loss was principally due to (1) the additional cost of settling
certain Gloria Jean's franchisee litigation ($1.3 million) and (2) increased
anticipated costs associated with post-closing claims with respect to the
sale of Gloria Jean's, the closing of the Coffee Bars and the
termination/buyout of certain remaining Coffee Bars leases ($1.4 million).
8
<PAGE>
NET LOSS. Net loss decreased $.7 million in the first quarter of Fiscal
Year 1998 as compared to the first quarter of Fiscal Year 1997 principally
due to the $2.7 reduction in loss from discontinued operations offsetting the
$2.0 increased loss from continuing operations.
YEAR 2000 COMPLIANCE
Until recently, many computer programs were written using two digits
rather than four digits to define the applicable year in the twentieth
century. Such software may recognize a date using "00" as the year 1900
rather than the year 2000. Utilizing both internal and external resources
the Company is in the process of defining, assessing and converting or
replacing various programs, hardware and instrumentation systems to make them
Year 2000 compatible. The Company's Year 2000 project is comprised of two
components - business applications and equipment. The business applications
component consists of the Company's business computer systems, as well as the
computer systems of third-party suppliers or customers, whose Year 2000
problems could potentially impact the Company. Equipment exposures consist
of personal computers, system servers, telephone equipment and roasting and
packaging equipment whose Year 2000 problems could also impact the Company.
The cost of the Year 2000 initiatives is not expected to be material to the
Company's results of operations or financial position.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities for the first quarter of
Fiscal Year 1998 was $1.0 million. The liquidation of $3.2 million of
current assets, principally accounts receivable, offset $2.2 of cash used by
cash operating losses, prepaid promotional expense payments and discontinued
retail operations. In the first quarter of Fiscal Year 1998, the Company made
$.7 million of capital expenditures, consisting of (1) $.4 million for
customer display equipment and (2) $.3 million for plant and computer
equipment. The Company reduced its outstanding borrowings by $.5 million.
Net cash (used in) provided by financing activities for the first
quarter of Fiscal Year 1998 was ($.5) million compared to $4.6 million for
the first quarter of Fiscal Year 1997. Net cash used in investing activities
for the first quarter of Fiscal Year 1998 was $.5 million compared to $1.7
million for the first quarter of Fiscal Year 1997.
Management expects capital expenditures in Fiscal Year 1998 (primarily
associated with the acquisition of customer display and plant equipment) not
to exceed $2.5 million. At March 27, 1998, the Company had approximately
$3.4 million of borrowing availability under its Revolving Credit Facility.
On March 2, 1998, the Company announced that the Board had retained the
investment bank, Schroder & Co., Inc. ("Schroders"), to help the Company
evaluate its brand, business and growth strategies and to identify methods and
opportunities to enhance shareholder value. In connection therewith, the
Company, with Schroders' assistance, is examining all aspects of its
business, including its short- and long-term liquidity needs. While the
Company believes that it has sufficient capital resources to operate its
business for the balance of Fiscal Year 1998, it could experience periods of
short-term tightness during the year, just as it has in past years.
In December 1996, the Company entered into the Subordinated Note
financing with Dilmun. The Subordinated Note is in the principal amount of
$15 million, matures on December 26, 2002 and bears interest at 11.25% fixed.
At December 26, 1997, the Company was not in compliance with the cash flow
coverage ratio covenant and the consolidated tangible net worth covenant in
the Subordinated Note (the "Covenant Defaults"). Pursuant to the terms of
the Subordinated Note, management has determined that the lender does not
have the right to accelerate repayment of the Subordinated Note solely
because of the Covenant Defaults and, accordingly, the Company has continued
to classify the outstanding borrowing under the Subordinated Note as
long-term. The Company and Dilmun have not been able to reach agreement on
the terms of such amendment or waiver.
SUPPLY OF COFFEE AND GENERAL RISK CONDITIONS
Coffee is the world's second largest traded commodity. Supply and price
can be, and have been, volatile. While most coffee trades in the commodities
market, coffee of the quality level sought by the Company has a tendency to
trade on a negotiated basis at a substantial premium above commodity coffee
pricing, depending upon the supply and demand at the time of purchase. The
supply and price can be affected by multiple factors, such as weather,
politics and economics in the coffee producing countries, many of which are
lesser developed nations.
The International Coffee Organization, through the imposition of export
quotas agreed upon by consumer and producer member nations, has in the past
attempted to maintain the commodity prices of green coffees. In August 1993,
21 coffee-producing countries formed a new cartel, the Association of
Coffee Producing Countries ("ACPC"), and announced plans to cut the supply
of coffee by 20% beginning October 1, 1993 in an attempt to raise world
coffee prices. In January 1997, the ACPC agreed to extend its current
limitations through 1998. The Company is unable to predict whether the ACPC
will be successful in achieving its goals; however, the supplies of green
coffees held by consumers (roasters and buyers) are currently at historical
low levels.
9
<PAGE>
During 1997, green coffee prices increased from $1.40 per pound at the
start of 1997 to a high of over $3.00 per pound in June 1997 and remained
relatively high, $1.70 per pound, at the end of 1997. These price levels in
1997 were principally due to a shortage of supply of many grades of coffee
caused by disruptive weather patterns throughout the world. Since the
beginning of 1998, coffee prices have been steadily moving lower due to
anticipated increases in future green coffee supplies. The current "C" price
for green coffee is $1.30 per pound. In response, to increased coffee prices
in 1997, the Company raised its selling prices, once in April and again in
July, to maintain its per pound gross profit margin. In response to
competitive prices and lower trends in green coffee, the Company reduced its
prices to the grocery stores and supermarkets in October 1997. The
reductions in the Company's selling prices have preceded the sell through of
the Company's higher cost green coffee inventories, thus reducing its fourth
quarter Fiscal Year 1997 and first quarter Fiscal Year 1998 gross profit
margins below historical levels. The Company expects its green coffee costs
to decrease steadily in the next six to nine months and the Company's gross
profit margins to return to historical levels.
A significant portion of the Company's green coffee supply is contracted
for future delivery, generally between three and twelve months forward (with
declining percentages of the supply being subject to futures contracts in the
latter portions of each year), to ensure both an adequate supply and reduced
risk of short-term price fluctuations. Green coffee is a large market with
well-established brokers, importers and warehousemen through which the
Company manages its requirements. In addition to forward purchases, the
Company keeps physical inventory in each of its production facility and
third-party warehouses representing from four to ten weeks of anticipated
supply. All coffee purchase transactions are in U.S. dollars, the industry's
standard currency. The Company believes that it is not dependent upon any
one importer or broker for its supply of green coffee beans from any
particular country.
SEASONALITY AND FLUCTUATIONS IN QUARTERLY RESULTS
The Company's business is seasonal, with increased sales during the
colder months. As a result, in a typical year, a substantial portion of the
Company's sales and its reported results from operations occur during the
fourth quarter of each fiscal year, while the Company's working capital
requirements fluctuate during the year with its greatest needs during the
third and fourth quarter of each year. The Company's results from operations
thus fluctuates somewhat from quarter to quarter. The timing of slotting fee
payments, other similar payments and product introduction costs in connection
with wholesale accounts and the amount of revenue contributed by such new
wholesale accounts may cause the Company's quarterly results of operations to
fluctuate in the future. The Company may experience quarterly losses and its
results of operations for any particular quarter may not necessarily be
indicative of net income or loss that may be expected for any other
particular quarter or for the whole year.
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See the discussion of the Kona Coffee Class Action, Nassau & Liberty
Coffee Bar Litigation, Employee Litigation and Second Cup Warranty
Claims/Litigation in (1) Note 9 - Contingencies to the Notes to the Company's
1997 Financial Statements"), (2) PART I, ITEM 3. LEGAL PROCEEDINGS in the
Company's 1997 Form 10-K and (3) Note 9 - Litigation to the Notes to the
Company's Condensed Consolidated Financial Statements for the first quarter
of Fiscal Year 1998, included herewith (the "First Quarter 1998 Financial
Statements") .
The Company is also involved in routine legal proceedings incidental to
the conduct of its business. Management believes that none of these routine
legal proceedings will have a material adverse effect on the financial
condition or operations of the Company.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
10
<PAGE>
See (1) PART I, ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Liquidity and Capital
Resources above, (2) Note 5 to Notes to the First Quarter 1998 Financial
Statements, (3) PART I, ITEM 1. BUSINESS - Debt Facilities in the Company's
1997 Form 10-K and (4) Note 3 - Debt to the Notes to the Company's 1997
Financial Statements for a detailed discussion of the continuing Covenant
Defaults under the Subordinated Note.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27 - Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
11
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BROTHERS GOURMET COFFEES, INC.
Dated: May 11, 1998 By: /s/ Barry Bilmes
----------------------------
Barry Bilmes
Vice President Finance
and Administration
Signing on behalf of the registrant
and as principal financial officer of
the registrant
12
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS (UNAUDITED) FOR THE THREE-MONTHS ENDED MARCH 27, 1998 CONTAINED IN
THE QUARTERLY REPORT ON FORM 10-Q FILED ON MAY 11, 1998, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-25-1998
<PERIOD-START> DEC-27-1997
<PERIOD-END> MAR-27-1998
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 7,311
<ALLOWANCES> 1,086
<INVENTORY> 9,695
<CURRENT-ASSETS> 19,847
<PP&E> 15,374
<DEPRECIATION> 0
<TOTAL-ASSETS> 93,705
<CURRENT-LIABILITIES> 12,255
<BONDS> 27,557
0
0
<COMMON> 1
<OTHER-SE> 53,528
<TOTAL-LIABILITY-AND-EQUITY> 93,705
<SALES> 15,445
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<CGS> 9,925
<TOTAL-COSTS> 8,292
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,461
<INCOME-PRETAX> (4,232)
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<EPS-PRIMARY> (0.33)
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