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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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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 JANUARY 27, 1999
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)
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DELAWARE 33-0086628
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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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. [X]
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 April 7, 1999, as reported on the Nasdaq National Market, was
$15,874,826.
The number of shares of the registrant's common stock outstanding, as of
April 7, 1999, was 6,173,538.
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TABLE OF CONTENTS
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A Warning About Forward-Looking Statements.................. 1
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 10
Item 3. Legal Proceedings........................................... 10
Item 4. Submission of Matters to a Vote of Security Holders......... 10
PART II
Item 5. Market for Registrant's Common Equity and Related 11
Stockholder Matters.........................................
Item 6. Selected Financial Data..................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition 13
and Results of Operations...................................
Item 7A. Quantitative and Qualitative Disclosures About Market 19
Price.......................................................
Item 8. Financial Statements and Supplementary Data................. 19
Item 9. Changes in and Disagreements with Accountants on Accounting 19
and Financial Disclosure....................................
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 19
Item 11. Executive Compensation...................................... 22
Item 12. Security Ownership of Certain Beneficial Owners and 30
Management..................................................
Item 13. Certain Relationships and Related Transactions.............. 31
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 31
8-K.........................................................
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 document that are subject to
risks and uncertainties. These forward-looking statements include information
about possible or assumed future results of the company's financial condition,
operations, plans, objectives and performance. Additionally, when we use the
words "believes," "expects," "anticipates," "estimates" or similar expressions,
we are making forward-looking statements. Many possible events or factors could
affect the future financial results and performance of Diedrich Coffee. 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:
1. Our growth strategy may not be as successful as we expect if we are
unable to attract franchise area developers or single store
franchisees.
2. Inclement weather or adverse political changes may significantly
increase our coffee costs.
3. Competition within the retail specialty coffee market may intensify.
4. Adverse changes may occur in the securities or financial markets.
PART I
ITEM 1. BUSINESS.
GENERAL
Diedrich Coffee roasts and sells specialty coffee beans and brewed coffee
beverages primarily through its 40 company-operated retail locations and its two
franchised retail locations. In addition to brewed coffee, our retail locations
in Southern California, Colorado and Texas offer espresso-based beverages, such
as cappuccino, cafe latte, cafe mocha and espresso machiato, and various blended
drinks. To complement beverage sales, we sell light food items, whole bean
coffee and accessories through our coffeehouses. Diedrich Coffee also sells
whole bean coffees through its wholesale operations to over 300 businesses and
restaurant chains located primarily in Southern California.
The specialty coffee market consists of three distinct segments:
espresso/coffee bars, coffeehouses and mall-based coffee stores. Starbucks is
the leader in the espresso/coffee bar segment, Gloria Jean's is the leader in
the mall-based coffee store segment and the coffeehouse segment does not yet
have a leader. Our objective is to become the leading national chain of
neighborhood coffeehouses. Our strategy to accomplish this goal is to expand the
core Southern California market through the development of company-operated
stores, to enter into franchise area development agreements and selected
strategic acquisitions in other markets.
We believe that Diedrich Coffee offers customers a broad line of superior
tasting coffee products and a high level of customer service, which generates
strong sales and customer loyalty. As the coffeehouse business is marked by high
frequency of usage, often more than once a day, this produces high unit sales
levels and attractive profit margins.
The high quality, distinctive flavors that our roasting and drink recipes
produce enables us to differentiate ourself from competing specialty coffee
concepts. In addition to offering a superior product, our coffee is served in
attractive, comfortable neighborhood coffeehouses. Coffeehouses are ideally
suited for neighborhoods in the suburbs of metropolitan areas.
INDUSTRY OVERVIEW
According to the National Coffee Association's 1999 study, 48% of Americans
drink coffee and on average they drink 1.4 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
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coffees mass-marketed by the leading coffee companies). According to the
National Coffee Association's 1999 study, 4.9% of U.S. consumers stated that
they drank a specialty coffee "yesterday." This figure is up sharply from 3.3%
in 1998.
We believe 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 jumped from approximately
200 in 1989 to approximately 4,000 in 1995, and projects this number to increase
to over 10,000 by the end of 1999. We believe that, despite the increase in the
number of specialty coffee stores, retail distribution of specialty coffees
continues to be fragmented and the industry remains relatively unbranded.
BUSINESS STRATEGY
Our objective is to become the leading national chain of neighborhood
coffeehouses. Each element of Diedrich Coffee's business strategy is designed to
differentiate and reinforce our brand identity, to engender a high degree of
customer loyalty and to position us as the leading specialty coffeehouse
retailer. The key elements of this strategy include:
High Quality, Fresh Proprietary Roasted Coffee. To deliver and serve the
high quality coffee for which Diedrich Coffee is known, two essential elements
are required: (1) using the finest quality green coffee beans and (2) ensuring
that these are freshly roasted, using proprietary recipes.
Superior Customer Service. 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.
We place strong emphasis on identifying, hiring and retaining employees and
invest substantial resources in training them in customer service, sales skills,
coffee knowledge and beverage preparation. Our store employees receive ongoing
customer service training as part of our efforts to enable employees to take on
increasing levels of responsibility within stores. We are able to provide fast,
efficient morning service in coffeehouses and through conveniently located carts
and kiosks.
Brand Marketing. Our marketing strategy is to differentiate its concept and
create brand name recognition based upon the quality of its coffee products and
the image of its coffeehouses as neighborhood gathering places. We promote the
distinctive qualities of its products, educate customers about our offerings of
various coffees and roasts, promote our image of coffeehouses as neighborhood
gathering places and deliver enthusiastic customer service.
The Coffeehouse Concept. A Diedrich Coffee coffeehouse experience is
strongly influenced by three components: hospitality, ambiance and coffee
knowledge. Each component is made up of elements that are unique to Diedrich
Coffee:
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. Operations personnel acknowledge
patrons by name at the point of drink pick-up and greet regular customers
by name. While approximately 35% of coffeehouse business is quick morning
coffee pick-up, the coffeehouse focus on hospitality encourages
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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.
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 Coffee 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.
Coffee Knowledge. Diedrich Coffee is the only specialty retailer whose
founder, Martin Diedrich, has three generations of coffee growing, roasting
and global relationships. 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. Mr.
Diedrich is able to identify and secure exceptional, rare coffees, roast
them to perfection, and then offer them for sale to our customers.
GROWTH STRATEGY
In order to achieve our objective to become the leading national chain of
neighborhood coffeehouses, we have a growth strategy to increase our number of
retail locations and the sale of coffee products through other distribution
channels.
Franchising and Area Development. Our strategic plan stresses franchise
area development in markets outside of the core Southern California market. The
franchise area development program is focused on experienced and
well-capitalized franchise operators and area developers who are interested in
opening between 30 and 70 retail outlets within their area over a 5 to 7 year
period. Diedrich Coffee has registered, is exempt or is not required to register
to sell franchises in 38 states. In September 1998, Diedrich Coffee announced
its first franchise area development agreement which calls for the development
of at least 44 coffeehouses, as well as coffee carts and kiosks in the state of
North Carolina over the next five years. In November 1998, Diedrich Coffee
announced its second franchise area development agreement which provides for the
development of 50 coffeehouses, as well as coffee carts and kiosks in San Diego,
Palm Springs and Temecula, California over the next five years. This area
development agreement includes a one-year option to begin development of 45
coffeehouses in Arizona.
We are currently in various stages of discussion and negotiations with
several additional potential area developers. We have recently added two
franchise sales organizations to assist in the sales program. These sales
organizations are compensated through success-fees based on executed franchise
area development agreements. We intend to enter into franchise area development
agreements covering most major U.S. markets in order to complete the national
expansion of Diedrich Coffee coffeehouses, carts, kiosks and wholesale sales.
We have identified that area development franchising with experienced
multi-unit franchise operators as the preferred growth vehicle for Diedrich
Coffee for several reasons:
- familiarity with the trade areas and commitment to community
businesses;
- existing operating, financial, real estate, construction, training,
accounting, human resources and management functions that are ready to
expand;
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- better operators in their own markets than a national corporation; and
- commitment to being involved in the communities in which they operate.
The franchisee component of the Diedrich Coffee business plan is critical
to its success. We believe that the unit level economics of our area development
franchising strategy are compelling enough to attract experienced multi-unit
franchise operators who will play an integral role in completing our planned
expansion.
Selective Acquisitions. We evaluate potential acquisitions that may
accelerate our critical mass in existing or new markets. We believe our unique,
high-quality product and efficient operational system can add value to an
acquired location. We also 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. To this end, Diedrich Coffee entered into a merger agreement with
Coffee People, Inc. on March 16, 1999, which contemplates the acquisition of
Coffee People, Inc. The acquisition of Coffee People will add 40 new
coffeehouses to the Diedrich Coffee brand. Additionally, it will make Diedrich
Coffee the leader in the mall-based coffee store segment with the acquisition of
280 retail locations operating under the Gloria Jean's name.
Internal Growth. We will also continue to stress the development of
company-owned coffeehouses, kiosks and carts in its core Southern California
market and possibly other markets. Diedrich Coffee seeks to build additional
retail outlets in high visibility, high traffic locations ranging from 1,200 to
1,800 square feet plus an exterior patio. We are currently in lease negotiations
on four additional sites in Orange County. We will maintain Orange County and
some other markets for company-owned operations.
Wholesale. Diedrich Coffee has taken significant steps to build its
wholesale sales organization and to grow this business channel. The new director
of the wholesale division has substantial experience in the coffee business and
the sales staff also has been expanded. Wholesale sales accounted for
approximately 11% of sales in fiscal 1999. We have added regional divisions of a
number of well-known restaurant groups as wholesale customers, including Islands
Restaurants, Inc., Ruth's Chris Steakhouses, Culinary Adventures and Claim
Jumper, and recently announced a contract with El Torito to provide coffee to
its locations nationwide. These restaurant chains help solidify brand
recognition and demand for Diedrich Coffee. Additionally, we are actively
seeking new distribution channels for our products. For example, Diedrich Coffee
now offers its coffee on its website, www.diedrich.com, and is seeking to expand
this rapidly growing channel of distribution.
PRODUCT SUPPLY AND ROASTING
Sourcing. Coffee beans are an agricultural product grown commercially in
over fifty countries in tropical regions of the world. Coffee is the world's
second largest traded commodity. Its price and supply 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.
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 its 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 formulas and recipes that have been
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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.
We have several master roasters who are directly responsible for overseeing
the roasting process. These master roasters are trained by the company. They are
craftsmen who employ Diedrich Coffee's proprietary roasting formulas while
adjusting the formula to take into account the specific attributes of the coffee
being roasted. Each coffee bean contains aromatic oils and flavor
characteristics that develop from the soil, climate and environment where the
bean is gown. The skilled roastmaster analyzes the unroasted beans and carefully
controls the roasting process in an effort to maximize the flavor potential of
the 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. We are 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 acquired new vacuum pack and nitrogen flush packing
equipment that can extend roasted coffee shelf life from two weeks to
approximately 90 - 150 days.
COFFEEHOUSE OPERATIONS
The typical Diedrich Coffee coffeehouse is staffed with one or two
managers, and a staff of ten to fifteen part-time hourly employees from which
the operating shifts are filled. Additionally, informal local entertainment is
utilized on the weekends to enhance the neighborhood environment. The hours for
each coffeehouse are established based upon the locations and 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 Coffee 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. In fiscal 1999, our coffeehouse retail sales mix was
approximately 73% coffee beverages, 19% food items, 6% whole bean coffee and 2%
accessories and clothing.
MARKETING THE BUSINESS
Our marketing strategy is to differentiate Diedrich Coffee and build a
brand identity for our freshly roasted coffee and our coffeehouses. We implement
this strategy by promoting the distinctive qualities of Diedrich Coffee
products, educating consumers about our offering of various coffees, including
private estate coffees and roasts, and delivering enthusiastic customer service.
Our marketing efforts are based upon the belief that the fresh roasted flavor
achieved by Diedrich Coffee's commitment to quality and freshness delivers a
distinctive advantage in coffee flavor. A steady introduction of new coffee,
drink and food products is part of our marketing strategy to keep the concept
fresh and drive incremental sales volume.
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. 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. The
costs of these promotions do not have a material impact on our operating
results. In addition, we seek to develop our brand identity through
participation in local and regional community events.
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As Diedrich Coffee enters 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 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 use direct mail
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. There is no assurance that we will achieve such a level
of market penetration.
COMPETITION
We compete directly against all other premium coffee roasters, coffeehouses
and coffee bars, 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.
Diedrich Coffee's 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.
Although competition in the specialty coffee market is currently
fragmented, Diedrich Coffee competes with Starbucks Corporation, the market
leader, and other competitors who have significantly greater financial,
marketing and other resources than Diedrich Coffee. We believe that Starbucks
has increased the public awareness and experience of premium coffee nationwide,
helping to create consumer demand for Diedrich Coffee's coffee drinks and
roasted whole beans. The attractiveness of the gourmet specialty coffeehouse
market may draw additional competitors with substantially greater financial,
marketing and operating resources than Diedrich Coffee. In the wholesale and
office coffee service markets, we compete against well established providers,
including Starbucks. The suppliers of commercial-grade coffee in supermarkets,
restaurants and office coffee service are much larger than Diedrich Coffee. Some
of these companies have premium coffee product lines and may enter the specialty
coffee market.
We expect that competition for suitable sites for new coffeehouses will
remain intense. We compete against other specialty retailers and restaurants for
these sites, and there is no assurance that we will be able to continue to
secure adequate sites at acceptable rent levels.
TRADEMARKS
Diedrich Coffee owns several trademarks and service marks that have been
registered with the United States Patent and Trademark Office, including
Diedrich Coffee(R), Wiener Melange Blend(R), Harvest Peak(R), SCOOP-A-CCINO(R)
and Flor de Apanas(R). In addition, we have applications pending with the United
States Patent and Trademark Office for a number of additional marks. The
Diedrich Coffee trademark is material to our business. We also own registrations
and has applications pending in numerous foreign countries for trademark
protection of the Diedrich Coffee trademark and service mark. Trademark
registrations can generally be renewed so long as we continue to use the marks.
Diedrich Coffee owns copyrights on its 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 January 27, 1999, Diedrich Coffee employed a work force of 830 persons,
114 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 employees to be good. We are
improving employee benefits, training and other aspects of employment to attract
and retain valuable employees and managers.
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RISK FACTORS AND TRENDS AFFECTING DIEDRICH COFFEE AND ITS BUSINESS
Historical Losses May Continue.
Diedrich Coffee had a net loss of $2,562,000 in fiscal 1999; a net loss of
$9,113,000 in fiscal 1998; a net loss of $986,000 in fiscal 1997. A strategic
plan was put into place during fiscal 1999, that included growing the company
through area development agreements. We signed two area development agreements
during fiscal 1999; however, this did not enable us to become profitable. We
went through a restructuring in fiscal 1998 and significant changes in
executive, middle and coffeehouse management. The past successes of the new
executive team members will not necessarily lead to similar results at the
company. Although we believe the company is positioned for growth in fiscal 2000
there is no assurance that we will meet that objective. Please see "-- Recent
Developments" below.
Our growth strategy may be difficult to manage.
As of April 7, 1999, Diedrich Coffee owned 40 retail locations, which it
managed on a day-to-day basis, and operated two franchised retail locations. Our
growth strategy contemplates franchise area development for additional Diedrich
Coffee coffeehouses, as well as opening new company-operated coffeehouses and
increasing wholesale sales. 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;
- expand wholesale sales;
- 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
- impose and maintain strict quality control from green coffee
acquisition to the fresh cup of perfectly brewed coffee in a
customer's hand.
Should our franchisees encounter business or operational difficulties,
anticipated revenues from franchise fees and product sales to franchisees could
be adversely affected. These adverse results also could affect our ability to
sell additional franchises.
Franchise area development involves risks.
Franchise area development involves a number of risks. The company has no
prior experience in franchising, although some executives and managers have
substantial franchisor experience from other companies. Our training programs
and processes, although developed with franchisee needs in mind, will be tested
in fiscal year 2000. Over time, assuming that our franchise area development
plans are successful, our earnings will be increasingly dependent upon the
efforts of our franchisees. Area development may not proceed at the expected
rate nor with the projected profitability. There are additional risks associated
with administering a franchise system, such as support of franchisee
organizations. Franchise area development outside of Southern California
requires us to grow to manage and support operations at long distance.
If we are unable to obtain acceptable financing, it could have a material
adverse effect on our growth strategy.
In order to achieve our anticipated growth and the expansion of our
wholesale and retail business in fiscal 2000, including new coffeehouse
construction and franchising, Diedrich Coffee will need to incur debt or issue
additional equity securities in public or private financings. If additional
funds are raised through the issuance
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of equity securities, dilution to stockholders may result. If additional funds
are raised through the incurrence of debt, such 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 Diedrich Coffee or at all.
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 sought by Diedrich Coffee, 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 sought by Diedrich Coffee 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 and,
in such events, we may not be able to maintain our gross margins by raising
prices without affecting demand.
We are likely to continue experiencing fluctuations in quarterly results
because the sales of coffee products are seasonal.
Our business is subject to seasonal fluctuations as well as general trends
and fluctuations that affect retail restaurants and retailers in general. The
fall-winter holiday season generally experiences the highest sales. Hot weather
tends to depress sales of hot coffee and espresso drinks, especially
unseasonably warm weather in any season. Consequently, we will continue to
experience significant fluctuations in quarterly results.
Our industry is highly competitive and we may not compete effectively.
The highly competitive nature of the retail specialty coffee market could
adversely affect our business and financial condition. Our beverages compete
directly against restaurant and other retail locations that serve coffee. Our
whole bean coffees compete directly against specialty coffee sold at retail
through supermarkets and a growing number of specialty coffee stores. Barriers
to entry are low, and we expect competition to increase substantially. The
coffee industry is currently dominated by several large companies, such as Kraft
Foods, Inc., Proctor & Gamble Co. and Nestle S.A., many of which have begun
aggressively marketing gourmet coffee products. Although the retail specialty
coffee market remains fragmented, we compete directly with Starbucks, the
largest U.S. specialty coffee retailer, and numerous other regional coffee bar
and coffeehouse operators. Starbucks has substantially greater financial,
marketing and other sources than Diedrich Coffee and has operations in the
markets in which we currently operate or intend to expand.
The loss of key 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, particularly John E. Martin,
Chairman of the Board, Timothy J. Ryan, President and Chief Executive Officer,
and Martin Diedrich, Chief Coffee Officer. The loss of services of these
individuals could disrupt operations. Although Diedrich Coffee has employment
agreements with Messrs. Martin, Ryan and Diedrich, any of its executive officers
can terminate their employment if they choose to do so.
8
<PAGE> 11
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.
We may not be able to renew leases or control rents increases at our retail
locations.
As of April 7, 1999, all of Diedrich Coffee's thirty-three company-operated
coffeehouses are on leased premises. 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 Diedrich Coffee.
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.
Compliance with health and franchising government regulations applicable to
us could have a material adverse effect on our business, financial condition and
results of operations.
Each retail location and roasting facility is and will be subject to
licensing and reporting requirements by numerous governmental authorities. These
governmental authorities include health and safety agencies, such as OSHA and
state or county health departments. Difficulties in obtaining or failure to
obtain the necessary licenses or approvals could delay or prevent the
development or operation of a given retail location or roasting facility. Any
problems that we may encounter in renewing such licenses in one jurisdiction,
may adversely affect our licensing status on a federal, state or county level in
other relevant jurisdictions.
We are also subject to federal regulation and certain state laws that
govern the offer and sale of franchises. Many 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 states require companies to register certain
materials before franchises can be offered or sold in that state. The failure to
obtain or retain licenses or approvals to sell franchises could adversely affect
our business, financial condition and results of operations.
RECENT DEVELOPMENTS
On March 16, 1999, Diedrich Coffee signed a merger agreement with Coffee
People, Inc., which contemplates a merger in which Coffee People will become a
wholly-owned subsidiary of Diedrich Coffee. As a result of the merger, Coffee
People stockholders will receive from Diedrich Coffee in the aggregate:
- $17.75 million in cash;
- $1.5 million shares of Diedrich Coffee common stock; and
- $5.25 million in cash or shares of Diedrich Coffee common stock,
depending on the success of an equity offering or other type of financing
by Diedrich Coffee.
The merger's completion is subject to a number of conditions, including
securing financing and obtaining regulatory and stockholder approval. We expect
to complete the merger during the summer of 1999.
After the merger's completion, we anticipate the combined company will have
annual system-wide sales of more than $150 million through 363 retail outlets in
38 states and seven countries. The combined company's brands will include
Diedrich Coffee, Coffee People, Coffee Plantation and the Gloria Jean's mall-
based retail coffee locations.
After the merger, Coffee People and Coffee Plantation coffeehouses will
begin the process of evolving into Diedrich coffeehouses. By virtue of the
merger, we will acquire significant additional roasting capacity, packaging and
distribution capabilities and valuable infrastructure and management expertise.
We expect to
9
<PAGE> 12
realize some cost savings, after the merger through greater efficiencies;
although no assurance can be provided as to the extent, if any, of savings. The
combined company should facilitate further franchise area development.
ITEM 2. PROPERTIES.
FACILITIES AND RETAIL LOCATIONS
Diedrich Coffee leases approximately 25,000 square feet of office space for
administrative offices, warehousing, roasting and training facilities in Irvine,
California. The lease for this facility expires in October 2000, with an option
for one additional five-year term. As of January 27, 1999, we were also a party
to various leases for a total of forty-five retail locations, including
thirty-six operating coffeehouses, two subleased units and seven carts. We
converted and subleased two retail locations to a franchisee after the year
ended January 27, 1999. This was part of a signed area development agreement
that also includes the addition of 48 more locations throughout the San Diego
area. We closed two retail locations and the Denver warehouse in fiscal 1999 and
eleven retail locations in fiscal 1998 of which nine leases were terminated. All
of our operating coffeehouses are on leased premises and 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, some of these
leases expire in the near future, and there is no automatic renewal or option to
renew.
Set forth below is a list of each of our retail locations as of January 27,
1999, separated by the states in which they are located. As indicated in the
table, as of January 27, 1999, we were operating thirty-six coffeehouses and
seven carts.
<TABLE>
<CAPTION>
NUMBER
------
<S> <C>
COFFEEHOUSES
California................................................ 25
Colorado.................................................. 7
Texas..................................................... 4
COFFEE CARTS
California................................................ 7
--
Total Retail Locations............................ 43
==
</TABLE>
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of our business, Diedrich Coffee may become involved
in legal proceedings from time-to-time. As of January 27, 1999, 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
fourth quarter of the year ended January 27, 1999.
10
<PAGE> 13
PART II
ITEM 5. MARKET FOR DIEDRICH COFFEE'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Diedrich Coffee common stock is reported on the Nasdaq National Market
under the symbol "DDRX." The following table sets forth the high and low bid
information for the quarterly periods indicated for our common stock as reported
on the Nasdaq National Market since January 30, 1997.
<TABLE>
<CAPTION>
PRICE RANGE
----------------
PERIOD HIGH LOW
------ ------ ------
<S> <C> <C>
FISCAL YEAR ENDED JANUARY 28, 1998
First Quarter............................................. 8 3/4 2 3/8
Second Quarter............................................ 4 2 1/2
Third Quarter............................................. 4 1/16 2 7/16
Fourth Quarter............................................ 9 2 3/4
FISCAL YEAR ENDED JANUARY 27, 1999
First Quarter............................................. 8 5 11/16
Second Quarter............................................ 8 1/4 6 9/16
Third Quarter............................................. 7 1/4 3 3/8
Fourth Quarter............................................ 6 1/2 3 7/8
</TABLE>
At April 7, 1999, there were 6,173,538 shares outstanding and 147
stockholders of record of Diedrich Coffee common stock. Diedrich Coffee has not
paid dividends on its common stock and does not anticipate paying dividends in
the foreseeable future.
11
<PAGE> 14
ITEM 6. SELECTED FINANCIAL DATA.
The following five-year selected financial data may not be indicative of
Diedrich Coffee's future results of operations and should be read in conjunction
with "Item 7. Management's Discussion and Results of Operations" and our
consolidated financial statements and related notes.
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
JANUARY 27, JANUARY 28, JANUARY 29, JANUARY 31, JANUARY 31,
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales:
Retail............................... $21,248 $20,760 $18,118 $ 8,879 $6,673
Wholesale and other.................. 2,767 2,222 1,694 1,365 918
Franchise area development fees...... 200 -- -- -- --
------- ------- ------- ------- ------
Total........................... 24,215 22,982 19,812 10,244 7,591
------- ------- ------- ------- ------
Cost and expenses:
Cost of sales and related occupancy
costs.............................. 10,955 11,458 9,263 4,409 3,164
Store operating expenses............. 8,936 10,448 8,280 3,520 2,584
Other operating expenses............. 634 290 240 277 282
Depreciation and amortization........ 1,941 1,785 1,054 354 255
Provision for asset impairment and
restructuring costs................ -- 3,902 -- -- --
General and administrative
expenses........................... 4,014 4,006 2,003 1,335 851
------- ------- ------- ------- ------
Total........................... 26,480 31,889 20,840 9,895 7,136
------- ------- ------- ------- ------
Operating (loss) income................... (2,265) (8,907) (1,028) 349 455
Interest expense and other, net........... (293) (205) (86) (34) (78)
------- ------- ------- ------- ------
(Loss) income before income taxes......... (2,558) (9,112) (1,114) 315 377
Income tax provision (benefit)............ 4 1 (128) 129 53
------- ------- ------- ------- ------
Net (loss) income......................... $(2,562) $(9,113) $ (986) $ 186 $ 324
======= ======= ======= ======= ======
Basic (loss) income per common share(1)... $ (.43) $ (1.69) $ (.22)
======= ======= =======
Diluted (loss) income per share........... $ (.43) $ (1.69) $ (.22)
======= ======= =======
Pro forma net income per share(2)......... $ .06
=======
BALANCE SHEET DATA:
Working capital (deficiency)............ $ (655) $ (959) $ 1,949 $ (53) $ (418)
Total assets............................ 12,736 13,948 17,471 5,316 2,503
Long-term debt and long-term
obligations, less current portion.... 2,783 2,817 -- 829 471
Total stockholders' equity.............. 6,027 6,835 14,898 3,304 973
</TABLE>
- ---------------
(1) Net income (loss) per share for periods before the year ended January 31,
1996 is not presented due to the noncomparable capital structure. Net loss
per share for fiscal 1999, 1998 and 1997 is presented as basic earnings per
share under the provisions of SFAS 128.
(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.
12
<PAGE> 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Effective February 1, 1996, Diedrich Coffee changed its fiscal year end
from January 31 to a fiscal year ending on the Wednesday nearest January 31. In
connection with the change in fiscal year end, we began reporting quarterly
results in thirteen-week periods. Before the change in fiscal year end, our
quarterly periods included twelve weeks, except for the fourth quarter, which
had approximately sixteen weeks. References to fiscal 1999 refer to the fiscal
year ended January 27, 1999, references to fiscal 1998 refer to the fiscal year
ended January 28, 1998 and references to fiscal 1997 refer to the fiscal year
ended January 29, 1997.
The first retail store operating under the name of Diedrich Coffee
commenced operations in 1972. At the conclusion of fiscal 1999, we operated a
total of thirty-six coffeehouses and seven coffee carts located in California,
Colorado and Texas. 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 cappuccino, cafe latte, cafe mocha and espresso
machiato. To complement beverage sales, we sell light food items and whole bean
coffee through our coffeehouses. In addition, we have a strong wholesale
division that markets our products directly to independent and chain food
service establishments, as well as to businesses for office coffee systems
through brokers and sales representatives.
Diedrich Coffee grew rapidly in fiscal 1997 and experienced difficulties
associated with that growth in fiscal 1998. In March 1997, we 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
1997. 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
facilities of the Irvine Company in Orange County, California; seven carts were
operating under this agreement at fiscal year-end 1999.
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 are several: the increased one-time 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 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.
13
<PAGE> 16
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 and one in Denver, Colorado. Four coffee cart locations at premium
Irvine Office Company locations were opened in the first quarter of fiscal 1999.
Additional coffee cart and kiosk locations are under consideration and in
discussion with the Irvine Office Company and similar commercial property
managers, but no assurances can be given as to when or how many more coffee
carts may be installed. We recruited several senior level executives during
fiscal 1999 as part of our strategic growth plan in the areas of finance,
marketing and franchise development.
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 Coffee 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 Coffee 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 was introduced in November.
FRANCHISE AREA DEVELOPMENT AGREEMENTS
Management's franchise area development goal is to enter into franchise
area development agreements covering most major U.S. markets. On September 16,
1998, Diedrich Coffee announced its first franchise area development agreement,
which calls for the development of 44 coffeehouses and an undisclosed number of
carts and kiosks in the state of North Carolina over a five year period. In
connection with the signing of this agreement, we recorded and collected area
development fee income of $100,000. On November 16, 1998, we announced our
second franchise area development agreement, which provides for the development
of 50 coffeehouses and an undisclosed number of carts and kiosks in San Diego,
Palm Springs and Temecula, California over the next five years. This franchise
area development agreement includes a one-year option to begin development of 45
coffeehouses in Arizona. In connection with the signing of this agreement, we
recorded area development fee income of $100,000 and a note receivable for
$100,000.
Management is currently in various stages of discussion and negotiations
with several additional potential area developers. It has recently added two
franchise sales organizations to assist in the sales program. These sales
organizations are compensated through success-fees based on the execution of
area development agreements. There can be no assurances that positive sales will
result from these activities.
WHOLESALE
In fiscal 1998, we also took significant steps to build our 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 was expanded. These efforts proved successful in fiscal 1998, when
wholesale sales grew to $2,222,000, an increase of 31.1% from the prior year.
The new management team focused on continued sales growth in the wholesale sales
division in fiscal 1999 and delivered improved results: $2,767,000 in total
sales, an increase of 24.5% from fiscal 1998. In fiscal 1999, the wholesale
division placed its emphasis on upgrading coffee consumed at chain restaurants.
As a result, we added regional divisions of a number of well-known restaurant
groups as wholesale customers such as: Islands Restaurants, Inc., Ruth's Chris
Steakhouses, Culinary Adventures and Claim Jumper. In addition, we recently
announced an alliance with El Torito to provide coffee to their locations
nationwide.
14
<PAGE> 17
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to total sales,
unless otherwise indicated, of certain items included in Diedrich Coffee's
statements of income for the years indicated:
<TABLE>
<CAPTION>
YEAR YEAR YEAR
ENDED ENDED ENDED
JANUARY 27, JANUARY 28, JANUARY 29,
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net Sales:
Retail.................................................. 87.8% 90.3% 91.4%
Wholesale and Other..................................... 11.4 9.7 8.6
Franchise area development fees......................... 0.8 -- --
----- ----- -----
Total........................................... 100.0% 100.0% 100.0%
----- ----- -----
Cost and Expenses:
Cost of sales and related occupancy costs(1)............ 45.6% 49.9% 46.8%
Store operating expenses(2)............................. 42.1 50.3 45.7
Other operating expenses(3)............................. 22.9 13.0 14.2
Depreciation and amortization........................... 8.0 7.8 5.3
Asset impairment and restructuring costs................ -- 17.0 --
General and administrative expenses..................... 16.6 17.4 10.1
Operating (loss) income................................... (9.4) (38.8) (5.2)
Interest expense.......................................... (1.6) (0.8) (1.0)
Interest and other (expense) income....................... 0.4 (0.1) 0.5
----- ----- -----
Loss before income taxes.................................. (10.6) (39.6) (5.6)
----- ----- -----
Income tax provision (benefit)............................ -- -- (0.6)
----- ----- -----
Net (loss) income......................................... (10.6)% (39.7)% (5.0)%
===== ===== =====
</TABLE>
- ---------------
(1) As a percentage of sales from retail and wholesale operations
(2) As a percentage of sales from retail operations
(3) As a percentage of sales from wholesale operations
FISCAL YEAR ENDED JANUARY 27, 1999 COMPARED TO FISCAL YEAR ENDED JANUARY 28,
1998
Net sales. Net sales for fiscal 1999 increased 5.4% to $24,215,000 from
$22,982,000 for fiscal 1998. Net retail sales for fiscal 1999 increased 2.4% to
$21,248,000 from $20,760,000 for fiscal 1998, despite closing 2 stores in fiscal
1999. Wholesale and mail order sales 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.
The percentage increase in comparable coffeehouse sales comparing net sales
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 and closed during fiscal 1999.
Cost of sales and related occupancy costs. Cost of sales and related
occupancy costs for fiscal 1999 decreased to $10,955,000 from $11,458,000 for
fiscal 1998. As a percentage of net sales 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 decrease resulted from average unit volume efficiencies
associated with the closure of low volume locations, lower green coffee prices
and other efficiencies gained at the coffeehouse level. Interactive training
programs were developed during fiscal 1999 covering guest satisfaction and
product training. These programs assisted management in scrutinizing and
reducing the cost of sales. This reduction more than offset the impact of
increased occupancy costs, and an increase in the percentage of total revenues
contributed by wholesale sales.
15
<PAGE> 18
Store operating expenses. For fiscal 1999, coffeehouse-operating expenses,
as a percentage of retail net sales, decreased to 42.1% from 50.3% for fiscal
1998. In fiscal 1998, the company recorded a one-time charge of $1,700,000
associated with the closure of two coffeehouses and the Denver warehouse, which
accounted for 8.2% of retail net sales.
Other operating expenses. For fiscal 1999, other operating expenses, as a
percentage of wholesale and other net sales, increased to 22.9% from 13.0% for
fiscal 1998. This increase reflects the costs of additional management and sales
staff recruited to further develop the sales of the wholesale division. In
general, as chain accounts are based on negotiated pricing structures, the
margins may not be quite as favorable. As a percentage of net sales, these costs
should decrease as wholesale sales increase.
Depreciation and amortization. Depreciation and amortization increased to
$1,941,000 for fiscal 1999 from $1,785,000 for fiscal 1998, principally due to
the write-off of $55,000 associated with the remodel of one of the coffeehouses
to demonstrate the new Diedrich Coffee prototype.
General and administrative expenses. As a percentage of net sales, general
and administrative expenses decreased to 16.6% in fiscal 1999 from 17.4% for
fiscal 1998 due to the increase in sales and successful execution of the new
business plan. The current level of general and administrative expense is a
direct result of management's commitment to grow the company through franchise
area development and the development of new retail locations and wholesale
channels.
Interest expense. Interest expense increased to $385,000 for fiscal 1999
from $182,000 for fiscal 1998. The increase reflects a full year of interest on
the $2,500,000 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.
Net loss. The net loss for fiscal 1999 was $2,562,000 compared a net loss
of $9,113,000 for fiscal 1998. This change is primarily the result of the
restructuring charge taken in the first quarter of fiscal 1998 and an additional
$1,700,000 of operating expenses recorded in the fourth quarter of fiscal 1998.
In addition, store level margins improved during fiscal 1999 and comparable
sales increased 1.5%. The current year's net loss is principally related to an
increase in interest expense and general and administrative expenses.
FISCAL YEAR ENDED JANUARY 28, 1998 COMPARED TO FISCAL YEAR ENDED JANUARY 29,
1997
Net sales. Net sales for fiscal 1998 increased 16.0% to $22,982,000 from
$19,812,000 for fiscal 1997. Net retail sales for fiscal 1998 increased 14.6% to
$20,760,000 from $18,118,000 for fiscal 1997, despite the closure of 11 stores
in fiscal 1998. Wholesale and mail order sales for fiscal 1998 increased 31.1%
to $2,222,000 from $1,694,000 for fiscal 1997.
The percentage increase in comparable coffeehouse sales comparing net sales
for stores open during the full year in fiscal 1998 to net sales for the same
stores in fiscal 1997 was 0.1%. The number of coffeehouses involved in this
calculation ranged from 12 to 33 reflecting the number of stores added during
fiscal 1997.
Cost of sales and related occupancy costs. Cost of sales and related
occupancy costs for fiscal 1998 increased to $11,458,000 from $9,263,000 for
fiscal 1997. As a percentage of net sales, cost of sales and related occupancy
costs increased to 49.9% for fiscal 1998 from 46.8% for fiscal 1997. This
increase was primarily the result of increased costs related to higher green
coffee prices, increased retail discounting, an increased percentage of
wholesale sales as a percentage of total company sales as well as scheduled rent
increases.
Store operating expenses. For fiscal 1998, coffeehouse operating expenses,
as a percentage of retail net sales, increased to 50.3% from 45.7% for fiscal
1997. The year-end one-time charge of $1.7 million, described above, accounted
for 8.2% of retail net sales and more than offset decreases achieved during the
year primarily as a result of improved labor scheduling methods.
16
<PAGE> 19
Other operating expenses. For fiscal 1998, other operating expenses, as a
percentage of wholesale and other net sales, decreased to 13.0% from 14.2% for
fiscal 1997. This decrease reflects the fact that the cost of the additional
management and sales staff was more than offset by the growth in sales for the
wholesale division.
Depreciation and amortization. Depreciation and amortization increased to
$1,785,000 for fiscal 1998 from $1,054,000 for fiscal 1997, principally due to
the addition of depreciable assets related to new coffeehouses added during
fiscal 1997 and the conversion costs of the acquired locations being depreciated
for the full year.
Provision for store closings and restructuring costs. On March 12, 1997, we
announced that we were reviewing the performance of all coffeehouses to
determine which units were not meeting management's long-term operational
expectations. Subsequently, on April 29, 1997, we recorded an impairment
provision and a restructuring charge of approximately $4.6 million in connection
with the closure of 12 coffeehouses and other related expenses. Eleven of the
original 12 coffeehouses identified for closure were closed in fiscal 1998 with
leases terminated in most cases. In January 1998, the new management reviewed
the progress of all retail operations and determined that one coffeehouse
originally designated for closure would remain open. At year end, most of the
lease terminations provided for in the restructuring had been completed at a
lower cost than originally anticipated. As a result of these two factors,
management determined that the remaining restructuring reserve could be reduced
by $648,000.
General and administrative expenses. As a percentage of net sales, general
and administrative expenses increased to 17.4% in fiscal 1998 from 10.1% for
fiscal 1997, due to the addition of senior executive personnel and other
resources required to manage the business more effectively, turn Diedrich Coffee
around and position it for future growth.
Interest expense. Interest expense decreased to $182,000 for fiscal 1998
from $190,000 for fiscal 1997.
Income taxes. Net operating losses generated in 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 28, 1998, a net operating loss for federal income tax purposes of
$8,007,000 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.
Net loss. The net loss for fiscal 1998 was $9,113,000 compared to net loss
of $986,000 for fiscal 1997 due to the previously described factors.
LIQUIDITY AND CAPITAL RESOURCES
Diedrich Coffee had a working capital deficit, as of January 27, 1999, of
$655,000 compared to $959,000 at January 28, 1998. Cash used in operating
activities totaled $351,000 for fiscal 1999 as compared to $2,489,000 for fiscal
1998.
Net cash used in investing activities for fiscal 1999 totaled $1,523,000,
which consisted entirely of capital expenditures for property and equipment. Net
cash provided by financing activities for fiscal 1999 totaled $1,667,000. This
consists of the net proceeds from the issuance of common stock and stock options
exercised.
On March 30, 1998, we agreed to a private placement of 200,000 shares of
our common stock to Franchise Mortgage Acceptance Company, or the FMAC, at a
price of $6.375 (the stock's closing sale price for that day on the Nasdaq
National Market). In addition, the FMAC also received an option to purchase
100,000 additional shares of our common stock; this option may be exercised in
increments of 25,000 shares or more and expires 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.
We announced on April 14, 1998 that we were in the process of obtaining a
financing from FMAC to meet its expected capital requirements. After extensive
discussions, we determined that the structure required
17
<PAGE> 20
by FMAC was not in our best interest. In anticipation of this possible outcome,
we engaged an investment banker in November 1998 to seek alternative sources of
capital.
On April 6, 1999, Diedrich Coffee entered into a $1,000,000 loan agreement
and security agreement with Amre Youness, a former director of Diedrich Coffee.
All outstanding principal and interest is due and payable on April 6, 2000. The
loan is secured by our assets with interest accruing and paid monthly at the
prime rate plus 3%. In connection with the loan agreement, we issued warrants to
Mr. Youness to purchase 70,000 shares of our common stock at a price of $5.625
per share.
We believe that cash from operations and the additional loan described
above will be sufficient to satisfy our working capital needs at the anticipated
operating levels for the next twelve months. However, if the proposed merger
with Coffee People is completed, additional capital will be required to finance
the cash portion of the payment to the Coffee People stockholders and to pay
related fees and expenses. See "Item 1. Business -- Recent Developments."
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." or SOP 98-5. SOP 98-5 provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. It is effective for fiscal years beginning after December 15,
1998. We currently do not have any computer software developed internally.
In June 1998, FASB issues SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" was issued. This statement established
standards for derivative instruments and for hedging activities and requires
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. We have no
instruments or transactions subject to this statement.
In October 1998, the FASB issued SFAS No. 134, "Accounting for
Mortgage-backed Securities Retained after the Securitization of Mortgage Loans
Held for sale by a Mortgage Banking Enterprise." This statement requires that
after the securitization of a mortgage loan held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed security as a
trading security. This statement is not applicable to Diedrich Coffee.
YEAR 2000
We are currently working to resolve the potential impact of the year 2000
on the processing of data-sensitive information by our computerized information
systems. The year 2000 problem is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of our
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000, which could result in miscalculations
or system failures. We are investigating the impact of the year 2000 problem on
our business, including our operational, information and financial systems.
Based on the preliminary review of our existing businesses, we do not expect the
year 2000 problem, including the cost of making our computerized information
systems year 2000 compliant, to have a material adverse impact on our financial
position or results of operations in future periods. However, our inability to
resolve all potential year 2000 problems in a timely manner could have a
material adverse impact on Diedrich Coffee. We have also initiated
communications with significant suppliers and key business partners on which we
rely in an effort to determine the extent to which our business is vulnerable to
the failure by these third parties' to remediate their year 2000 problems.
Although we have not been informed of any material risks associated with the
year 2000 problem on these entities, there can be no assurance that the
computerized information systems of these third parties' will be year 2000
compliant on a timely basis. The inability of these third parties to remediate
their year 2000 problems could have a material adverse impact on Diedrich
Coffee.
We will have to modify certain applications and replace some of the
hardware used in the processing of financial information. In conjunction with
these upgrades, which are expected to be completed by the end of June 1999, we
believe we will have addressed any potential significant year 2000 issues. Total
expenditures related to the upgrade of the information systems are expected to
cost less than $20,000. As of January 27,
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<PAGE> 21
1999, we had incurred and expensed approximately $34,000 of expenditures
consisting of internal staff costs, outside consulting and other expenditures
related to this upgrade process. These costs are being funded through operating
cash flows. To the extent possible, we will be developing and executing
contingency plans designed to allow continued operation in the event of failure
of our or third parties' computer information systems.
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 fiscal 1999. 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 January 27, 1999, these
commitments totaled $1,135,000. These agreements are tied to specific market
prices, defined by both the origin of the coffee and the month of delivery, but
we have significant flexibility in selecting the date of the market price to be
used in each contract. We do not use commodity based financial instruments to
hedge coffee or any other commodity, as we believe 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 our products.
We do not and have not used derivative financial instruments for any
purpose, including hedging or mitigating interest rate risk.
MARKET RISK
Diedrich Coffee's market risk exposure with regard to financial instruments
is to changes in the "prime rate" in the United States. We borrowed $2,500,000
at the prime rate plus 3 1/2%. At January 27, 1999, a hypothetical 100 basis
point increase in the prime rate would result in additional interest expense of
$25,000 on an annualized basis.
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.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Diedrich Coffee's directors, executive officers and other key employees,
and their ages as of January 27, 1999, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION(S) HELD
---- --- ----------------
<S> <C> <C>
John E. Martin..... 53 Chairman of the Board and Director
Timothy J. Ryan.... 59 President, and Chief Executive Officer and Director
Martin R. 40 Vice Chairman of the Board, Secretary, Chief Coffee Officer
Diedrich......... and Director
Peter Churm........ 73 Director
Lawrence Goelman... 58 Director
Paul C. Heeschen... 42 Director
Ann Wride.......... 37 Vice President and Chief Financial Officer
Dolf Berle......... 36 Vice President of Franchise Development and Operations
Catherine Saar..... 39 Vice President of Marketing and Wholesale Sales
</TABLE>
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<PAGE> 22
The principal occupation for the last five years of each director and
executive officer of Diedrich Coffee, as well as some other information, is set
forth below.
JOHN E. MARTIN was appointed Chairman of the Board of Directors by the
board of directors as of November 17, 1997. From 1983 to 1996, Mr. Martin was
Chairman and Chief Executive Officer of Taco Bell Worldwide. From October 1996
to June 1997, Mr. Martin was Chairman of PepsiCo's Casual Dining Division. Mr.
Martin is also Chairman of publicly held Easyriders, Inc., a publishing company,
and Chairman of Culinary Adventures, a privately held company which owns and
operates several restaurants in Southern California. Mr. Martin serves on the
board of directors of: Williams Sonoma, Inc., Franchise Mortgage Acceptance
Company and The Good Guys! Inc.
MARTIN R. DIEDRICH has served as an officer and director of Diedrich Coffee
since 1985. In April 1997, he became Vice Chairman of the Board and Chief Coffee
Officer as well as continuing as Diedrich Coffee's Corporate Secretary. Prior to
that time, Mr. Diedrich served as Director of Coffee. In addition, he served as
Chairman of the Board from January 1996 to April 1997. Mr. Diedrich is an
internationally recognized specialty coffee expert who is a frequent speaker at
industry and trade association functions.
TIMOTHY J. RYAN was appointed as President and Chief Executive Officer by
the board of directors effective November 1997. From December 1995 until his
retirement in December 1996, Mr. Ryan was president of Sizzler U.S.A., a
division of Sizzler International, Inc. of which he was also Senior Vice
President. From November 1988 to December 1993, Mr. Ryan was Senior Vice
President of Marketing at Taco Bell Worldwide, and from December 1993 to
December 1995, he was Senior Vice President of Taco Bell's Casual Dining
Division.
PETER CHURM joined the board of directors in October 1996. He has been
Chairman Emeritus of Furon Company since 1992. He served as Chairman of the
Board of Furon Company from May 1980 through February 1992 and was President of
that company for more than sixteen years prior to that time. He is presently a
member of the boards of directors of Furon Company and CKE Restaurants, Inc.
LAWRENCE GOELMAN was the interim Chief Executive Officer of Diedrich Coffee
from March 1997 to November 1997 and has served as a member of the board of
directors since October 1996. He assumed the position of Chairman of the Board
in March 1997 until he was replaced by John E. Martin on November 17, 1997. Most
recently, Mr. Goelman served as President and Chief Executive Officer of
Pinnacle Micro, Inc. from May 1996 to December 1996. Mr. Goelman has also been a
managing partner of Tremont Partners, Inc. since June 1995. Prior to that, he
served as Chairman, President and Chief Executive Officer of CostCare, Inc. for
fourteen years. Mr. Goelman also currently serves as a director of Imagyn
Medical Technologies, Inc.
PAUL C. HEESCHEN became a director of Diedrich Coffee in January 1996. For
the past five years, Mr. Heeschen has been a principal of Heeschen & Associates,
a private investment firm. He is also the sole general partner of D.C.H., L.P.
and Redwood Enterprises VII, L.P., and a trustee of the Palm Trust, each of
which are stockholders of Diedrich Coffee.
ANN WRIDE joined Diedrich Coffee in April 1998 as Vice President and Chief
Financial Officer. Previously, Ms. Wride was Vice President and Chief Financial
Officer of Advantica Restaurant Group Inc.'s Coco's/Carrows Division from May
1996 to March 1998. Prior to joining Advantica, Ms. Wride served as Vice
President, Finance of Family Restaurants Inc. where she worked in various
capacities since 1989.
DOLF A. BERLE was appointed Vice President of Franchise Development in May
1998. In addition, Mr. Berle assumed the additional responsibility of Company
Operations in June 1998. Prior to joining Diedrich Coffee, Mr. Berle was Senior
Director of Operations for Pepsi Restaurants International from July 1997 to May
1998. From September 1996 to June 1997 Mr. Berle was Director of Operations for
Taco Bell International. Before joining the international division, Mr. Berle
served as Market Manager for Taco Bell in Nashville, Tennessee between June 1994
and August 1996.
CATHERINE A. SAAR was appointed Vice President of Marketing and Wholesale
Sales in July 1998. Ms. Saar was Vice President Marketing and Merchandising for
Frame-N-Lens from January 1998 to June
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<PAGE> 23
1998. From May 1993 to December 1997, Ms. Saar was Director of Corporate
Marketing for Smart and Final, Inc. Prior to this, Ms. Saar held various
marketing positions at Taco Bell Corporation.
BOARD COMMITTEES AND MEETINGS
Diedrich Coffee's board of directors has standing compensation and audit
committees. We do not have a standing nominating committee. Instead, the board
of directors acts as a committee of the whole with respect to nominations for
membership on the board. The members of each committee and the functions
performed thereby are described below:
Audit Committee. The audit committee of the board currently consists of Mr.
Churm, Mr. Heeschen and Mr. Goelman, each of whom have been a member of the
audit committee since its formation. The audit committee reviews the results and
scope of the audit and other services provided by our independent auditors,
reviews and evaluates our internal control functions and monitors transactions
between Diedrich Coffee and its employees, officers and directors.
Compensation Committee. The compensation committee of the board consists of
Messrs. Churm, Goelman and Heeschen. The compensation committee administers our
stock option plans and sets compensation levels for our executive officers.
During our fiscal year ended January 27, 1999, there were five meetings of
the board of directors, one meeting of the audit committee and one meeting of
the compensation committee. While a director, each of the current board members
attended 100% of the meetings of the board of directors and meetings of the
committees on which he served during such period.
DIRECTORS' COMPENSATION
Directors who are also employees of Diedrich Coffee receive no extra
compensation for their service on the board. Non-employee directors receive
reimbursement for out-of-pocket expenses incurred in attending board meetings
and receive stock option grants under our 1996 Non-Employee Directors Stock
Option Plan.
Under our non-employee directors plan, each non-employee director
automatically receives, upon becoming a director, a one-time grant of an option
to purchase up to 10,000 shares of Diedrich Coffee common stock. These initial
options will vest and become exercisable with respect to 50% of the underlying
shares upon the earlier of (1) the first anniversary of the grant date or (2)
immediately before the first annual meeting of stockholders following the grant
date, if the recipient has remained a non-employee director for the entire
period from the grant date to such earlier date, and with respect to the
remaining 50% of the underlying shares upon the earlier of (1) the second
anniversary of the grant date or (2) immediately before the second annual
meeting of stockholders following the grant date, if the recipient has remained
a non-employee director for the entire period from the grant date to such
earlier date. In addition to an initial grant, each non-employee director will
also receive, upon re-election to the board, an automatic grant of an option to
purchase up to 5,000 additional shares of our common stock. These additional
options will vest and become exercisable upon the earlier of (1) the first
anniversary of the grant date or (2) immediately before the annual meeting of
stockholders following the grant date, if the recipient has remained a
non-employee director for the entire period from the grant date to such earlier
date.
All non-employee director options have a term of ten years and an exercise
price equal to the fair market value of Diedrich Coffee common stock on the date
of grant. The non-employee directors plan provides that the exercise price may
be paid by company loan or withholding of underlying stock, or deferred until
completion of broker-assisted exercise and sale transactions. Vesting of
non-employee director options accelerates if the recipient of the option ceases
to be a director of Diedrich Coffee in connection with a change-in-control.
During the fiscal year ended January 27, 1999, options to purchase an aggregate
of 15,000 shares of our common stock were issued to non-employee directors
according to the terms of the non-employee directors plan.
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<PAGE> 24
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the securities laws of the United States, the directors and officers
of Diedrich Coffee and persons who own more than 10% of our equity securities
are required to report their initial ownership of our equity securities and any
subsequent changes in that ownership to the Commission and the Nasdaq National
Market. Specific due dates for these reports have been established, and we are
required to disclose in this document any late filings during the fiscal year
ended January 27, 1999. To our knowledge, based solely on our review of the
copies of such reports required to be furnished to the company during the fiscal
year ended January 27, 1999, all of these reports were timely filed.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth certain information with respect to
compensation paid by Diedrich Coffee during the last three fiscal years to our
Chief Executive Officer and our next most highly compensated persons who were
serving as executive officers of Diedrich Coffee on January 27, 1999 and whose
total annual salary and bonus for fiscal 1999 exceeded $100,000.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION
COMPENSATION AWARDS
FISCAL ------------ ------------
YEAR SECURITIES
ENDED UNDERLYING
NAME AND PRINCIPAL POSITION JANUARY SALARY($) OPTIONS(#)
--------------------------- ------- ------------ ------------
<S> <C> <C> <C>
John E. Martin(1)........................................... 1999 $100,000 --
Chairman of the Board 1998 20,385 850,000
1997 -- --
Timothy J. Ryan(2).......................................... 1999 $200,000 --
Chief Executive Officer and President 1998 33,035 600,000
1997 -- --
Martin R. Diedrich.......................................... 1999 $111,692 4,000
Vice Chairman of the Board, Secretary and Chief Coffee
Officer 1998 100,000 --
1997 100,000 --
Ann Wride(2)................................................ 1999 $122,808 54,000
Vice President and Chief Financial Officer 1998 -- --
1997 -- --
Dolf Berle(3)............................................... 1999 $105,519 54,000
Vice President of Franchise Development and Operations 1998 -- --
1997 -- --
</TABLE>
- ---------------
(1) Mr. Martin was appointed Chairman of the Board on November 17, 1997.
Accordingly, he did not earn or receive any compensation from Diedrich
Coffee before fiscal 1998.
(2) Mr. Ryan was appointed President and Chief Executive Officer on November 17,
1997. Accordingly, he did not earn or receive any compensation from Diedrich
Coffee before fiscal 1998.
(3) Ms. Wride joined Diedrich Coffee as Vice President and Chief Financial
Officer in April 1998. Accordingly, she did not earn or receive any
compensation from Diedrich Coffee until fiscal 1999.
(4) Mr. Berle joined Diedrich Coffee as Vice President of Franchise Development
in May 1998. Accordingly, he did not earn or receive any compensation from
Diedrich Coffee until fiscal 1999.
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<PAGE> 25
STOCK OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options granted
to the following executive officers during the fiscal year ended January 27,
1999.
<TABLE>
<CAPTION>
POTENTIAL
PERCENT OF REALIZABLE VALUE AT
TOTAL ASSUMED ANNUAL RATES
NUMBER OF OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES EXERCISE TERM(1)
OPTIONS IN FISCAL PRICE EXPIRATION -----------------------
NAME GRANTED(#) YEAR ($/SHARE) DATE 5%($) 10%($)
---- ---------- ---------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
John E. Martin..................... -- -- -- -- -- --
Timothy J. Ryan.................... -- -- -- -- -- --
Martin R. Diedrich(2).............. 4,000 2.1% $7.00 6/23/08 $ 16,209 $ 41,825
Ann Wride(3)....................... 50,000 25.9% 5.81 3/25/08 168,169 433,932
4,000 2.1% 7.00 6/23/08 16,209 41,825
Dolf Berle(4)...................... 50,000 25.9% 6.25 3/23/08 180,905 466,795
4,000 2.1% 7.00 6/23/08 16,209 41,825
</TABLE>
- ---------------
(1) The potential realizable values listed are based on an assumption that the
market price of Diedrich Coffee common stock appreciates at the stated rate,
compounded annually, from the date of grant to the expiration date. The 5%
and 10% assumed rates of appreciation are determined by the rules of the
Commission and do not represent our estimate of the future market price of
our common stock.
(2) All of Mr. Diedrich's options were granted pursuant to the 1996 Stock
Incentive Option Plan which was approved by our board of directors on June
23, 1998.
(3) 50,000 of Ms. Wride's options were granted pursuant to her employment letter
dated April 8, 1998, the terms of which are described under "-- Employment
Agreements and Compensatory Arrangements." 4,000 of Ms. Wride's options were
granted pursuant to the 1996 Stock Incentive Option Plan.
(4) 50,000 of Mr. Berle's options were granted pursuant to her employment letter
dated April 8, 1998, the terms of which are described under "-- Employment
Agreements and Compensatory Arrangements." 4,000 of Mr. Berle's options were
granted pursuant to the 1996 Stock Incentive Option Plan.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth the number of shares covered by exercisable
and unexercisable options held by the following executive officers on January
27, 1999, and the aggregate gains that would have been realized had these
options been exercised on January 27, 1999, even though these options were not
exercised, and the unexercisable options could not have been exercised, on that
date. The following executive officers did not exercise any stock options during
fiscal year 1999.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
FISCAL YEAR END(#) FISCAL YEAR END($)(1)
------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE(2) EXERCISABLE UNEXERCISABLE(2)
---- ----------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C>
John E. Martin........................ 550,000 300,000 $198,000 --
Timothy J. Ryan....................... 250,000 350,000 47,000 --
Martin Diedrich....................... -- 4,000 -- --
Ann Wride............................. -- 54,000 -- --
Dolf Berle............................ -- 54,000 -- --
</TABLE>
- ---------------
(1) These amounts represent the difference between the exercise price of the
in-the-money options and the market price of Diedrich Coffee common stock on
January 27, 1999. The closing price of our common stock on that day on the
Nasdaq National Market was $4.44. Options are in-the-money if the market
value of the shares covered thereby is greater than the option exercise
price.
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<PAGE> 26
(2) Future exercisability is subject to a number of factors, including, but not
limited to, the optionee remaining employed by Diedrich Coffee.
1996 STOCK INCENTIVE PLAN
In July 1996, we adopted the 1996 Stock Incentive Plan, which authorized
the granting of a variety of stock-based incentive awards, including incentive
and nonstatutory stock options. The purpose of the incentive plan is to promote
the interests of Diedrich Coffee and our stockholders by using investment
interests in Diedrich Coffee to attract, retain and motivate its management and
other persons, to encourage and reward their contributions to the performance of
Diedrich Coffee and to align their interests with the interests of our
stockholders. A total of 775,000 shares have been reserved for issuance under
the incentive plan. The incentive plan is administered by the compensation
committee of the board of directors, who determine the recipients and terms of
the awards granted. The compensation committee is comprised of disinterested
directors. The disinterested directors are eligible only to receive automatic
nondiscretionary awards under the 1996 Non-Employee Directors Stock Option Plan
described below. 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. No such below market options have been granted.
The board of directors or the compensation committee may amend, suspend or
terminate the incentive plan at any time. Only the compensation committee,
however, may take actions affecting the selection of award recipients or the
timing, pricing and amounts of any awards. In addition, the maximum number of
shares that may be sold or issued under the incentive plan may be increased and
the class of persons eligible to participate in the incentive plan may be
altered only with the approval of our stockholders. With respect to all other
amendments to the incentive plan, the board may, in its discretion, determine
that the amendment shall only become effective upon approval by our
stockholders. If the board determines that stockholder approval may be
advisable, such as for the purpose of obtaining or retaining any statutory or
regulatory benefits under federal or state securities laws, federal or state tax
laws, or for the purpose of satisfying applicable stock exchange listing
requirements.
1996 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN
In July 1996, we adopted the 1996 Non-Employee Directors Stock Option Plan,
which authorizes the granting of non-qualified stock options to disinterested
directors. The purpose of the directors plan is to promote the interests of
Diedrich Coffee and our stockholders by using investment interests in Diedrich
Coffee to attract and retain highly qualified 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 automatically
receives an initial, one-time grant of an option to purchase up to 10,000 shares
of Diedrich Coffee common stock. In addition to the initial grant, each
non-employee director will also receive, upon each re-election to our board, an
automatic grant of an option to purchase up to 5,000 additional shares of our
common stock. The initial grant vests over two years. The automatic re-election
grant vests immediately prior to the next annual meeting of stockholders. All
disinterested employee director options have a term of ten years and an exercise
price equal to the fair market value of our common stock on the date of grant.
1997 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN AND AGREEMENT
In April 1997, the disinterested directors on the board of directors
adopted and approved the 1997 Non-Employee Directors' Stock Option Plan and
Agreement to recognize and compensate the disinterested directors for their
service to Diedrich Coffee above and beyond normal requirements. Pursuant to
that plan, one-time grants of options to purchase up to 10,000 shares of our
common stock were granted to each of Mr. Churm and Mr. Heeschen. These options
vested on April 25, 1998, twelve months after they were granted. No additional
options are available for grant under the 1997 Non-Employee Directors Stock
Option Plan and Agreement.
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<PAGE> 27
EMPLOYMENT AGREEMENTS AND COMPENSATORY ARRANGEMENTS
John E. Martin
On November 17, 1997, John E. Martin entered into a letter agreement with
Diedrich Coffee appointing him as a director and as Chairman of the Board. The
agreement provides for a base salary of $100,000 per year for so long as Mr.
Martin continues as Chairman of the Board. Mr. Martin is not to receive employee
benefits nor any other compensation to which he would otherwise be entitled for
serving on the board and he may be terminated at the discretion of the board at
any time with or without reason. We have agreed to employ a full-time executive
assistant on his behalf with an annual salary not to exceed $72,000 per year. We
have also agreed (1) to reimburse Mr. Martin for all reasonable and necessary
travel and other business expenses incurred in connection with the performance
of services under the agreement; (2) to enter into an indemnification agreement
with Mr. Martin in the form provided to each of our other directors and
executive officers; and (3) to reimburse Mr. Martin for reasonable legal and
accounting fees incurred in connection with the negotiation and execution of the
agreement in an amount not to exceed $10,000. Finally, the agreement recognizes
that Mr. Martin's other business interests relate to restaurants and provides
that we waive any rights or claims to other business opportunities involving the
restaurant business which may become available to Mr. Martin, other than
opportunities involving the coffeehouse business or other businesses in which
the principal activity involves the sale of coffee and coffee beverages.
On November 17, 1997, Mr. Martin also entered into a stock option plan and
agreement with Diedrich Coffee. Mr. Martin's option agreement was approved by
our stockholders at a special meeting held on January 22, 1998. Mr. Martin was
granted options to purchase an aggregate of 850,000 shares of Diedrich Coffee
common stock for the purpose of encouraging and rewarding Mr. Martin's
contributions to the performance of the company and to align Mr. Martin's
interests with the interests of the stockholders. The options granted to Mr.
Martin are exercisable, at the following exercise prices:
(1) 450,000 shares of common stock at an exercise price of $4.00 per share;
(2) 100,000 shares of common stock at an exercise price of $5.00 per share;
(3) 150,000 shares of common stock at an exercise price of $8.00 per share;
and
(4) 150,000 shares of common stock at an exercise price of $10.00 per
share.
All of the options granted to Mr. Martin become exercisable on the earlier
of May 15, 2002 or as soon as the closing price of our common stock on the
Nasdaq National Market exceeds the respective exercise price for at least seven
trading days in any period of ten consecutive trading days. All options are to
terminate if unexercised on November 17, 2002 or, if Mr. Martin resigns from
Diedrich Coffee or we terminate Mr. Martin's employment for cause, the options
will become unexercisable within sixty days. Only Mr. Martin is eligible to
receive options under his option agreement and the options are not transferable
or assignable. Subject to the discretion of the compensation committee of the
board of directors, Mr. Martin may pay the exercise price for his options with
cash or by delivery of shares of Diedrich Coffee common stock with a value equal
to the exercise price or through a combination of cash and shares.
Timothy J. Ryan
On November 17, 1997, Timothy J. Ryan entered into a two-year employment
agreement with Diedrich Coffee as our President and Chief Executive Officer. The
agreement provides for an annual salary of $200,000 per year, a discretionary
performance bonus which may be awarded by the compensation committee after
twelve months of employment (not to initially exceed 25% of Mr. Ryan's base
salary), and employee benefits that include three weeks annual vacation leave,
reimbursement for all reasonable and necessary travel and other business
expenses incurred in connection with the performance of services under the
agreement, and the payment of a monthly car allowance of $600.00. The employment
agreement may be terminated before the completion of two years in the event of
Mr. Ryan's sustained incapacity as defined in the agreement or by us for cause
as defined in the agreement. Mr. Ryan may also be terminated for any other
reason, however, in such event, Mr. Ryan will be entitled to receive a severance
payment equal to fifty percent of his base salary.
25
<PAGE> 28
On November 17, 1997, Mr. Ryan also entered into a stock option plan and
agreement with Diedrich Coffee. Mr. Ryan's option agreement was approved by our
stockholders at a special meeting held on January 22, 1998. Mr. Ryan was granted
options to purchase an aggregate of 600,000 shares of Diedrich Coffee common
stock for the purpose of encouraging and rewarding Mr. Ryan's contributions to
the performance of the company and to align Mr. Ryan's interests with the
interests of the stockholders. The options granted to Mr. Ryan are exercisable,
at the following exercise prices:
(1) 50,000 shares of common stock at an exercise price of $3.50 per share;
(2) 75,000 shares of common stock at an exercise price of $4.50 per share;
(3) 125,000 shares of common stock at an exercise price of $5.00 per share;
(4) 175,000 shares of common stock at an exercise price of $8.00 per share;
and
(5) 175,000 shares of common stock at an exercise price of $10.00 per
share.
The options become exercisable on the earlier of May 15, 2002 or upon the
satisfaction of two conditions: (1) the options having vested pursuant to a
vesting schedule set forth in the agreement, and (2) after the date of the
agreement, the closing price of the common stock on the Nasdaq National Market
shall have exceeded the option price per share for at least seven trading days
in any period of ten consecutive trading days. All options are to terminate if
unexercised on November 17, 2002 or, if Mr. Ryan resigns from Diedrich Coffee
without good cause or we terminate Mr. Ryan's employment for cause, the options
will become unexercisable within sixty days. Only Mr. Ryan is eligible to
receive options under the his option agreement and the options are not
transferable or assignable. Subject to the discretion of the compensation
committee of the board of directors, Mr. Ryan may pay the exercise price for his
options with cash or by delivery of shares of Diedrich Coffee common stock with
a value equal to the exercise price or through a combination of cash and shares.
Martin R. Diedrich
Martin R. Diedrich entered into a new employment agreement with Diedrich
Coffee, which appointed Mr. Diedrich as Diedrich Coffee's Chief Coffee Officer
beginning as of June 29, 1998. The term of the agreement is three years. The
agreement provides for a base salary of $120,000 per annum, increasing to
$140,000 per annum beginning in the second year of the agreement, and to
$160,000 in the third year. Mr. Diedrich receives employee benefits consistent
with the company's policies for other senior executives.
Ann Wride
In April 1998, Ann Wride entered into an employment agreement with Diedrich
Coffee appointing her Vice President and Chief Financial Officer. The agreement
provides for a base salary of $155,000 per annum and an annual incentive bonus
of up to 25% of base salary based on the company's performance and Ms. Wride's
performance against objectives approved by the board. If terminated without
cause, Ms. Wride is entitled to six months salary as severance compensation. Ms.
Wride also received options to purchase up to 50,000 shares of Diedrich Coffee
common stock at an exercise price of $5.8125 vesting over two years. Ms. Wride
receives employee benefits consistent with the company's policies from other
senior executives.
Dolf Berle
In April 1998, Dolf Berle entered into an employment agreement with
Diedrich Coffee appointing him Vice President of Franchise Development. The
agreement provides for a base salary of $155,000 per annum and an annual
incentive bonus of up to 25% of base salary based on the company's performance
and Mr. Berle's performance against objectives approved by the board. If
terminated without cause, Mr. Berle is entitled to six months salary as
severance compensation. Mr. Berle also received options to purchase up to 50,000
shares of Diedrich Coffee common stock at an exercise price of $6.25 vesting
over two years. According to the terms of the employment agreement, Mr. Berle
was also granted 10,000 stock options annually for each of the five years
following the end of the two-year vesting period of the initial grant. The
exercise price of those
26
<PAGE> 29
options will be the date of the annual grant. Mr. Berle receives employee
benefits consistent with the company's policies from other senior executives.
Catherine Saar
On June 11, 1998, Catherine Saar entered into an employment agreement with
Diedrich Coffee appointing her Vice President, Marketing. The agreement provides
for a base salary of $120,000 per annum and an annual incentive bonus of up to
25% of base salary based on the company's performance and Ms. Saar's performance
against objectives approved by the board. If terminated without cause, Ms. Saar
is entitled to four months salary as severance compensation. Ms. Saar also
received options to purchase up to 20,000 shares of Diedrich Coffee common stock
at an exercise price of $7.75 vesting over two years. Ms. Saar is eligible for
subsequent option grants. Ms. Saar receives employee benefits consistent with
the company's policies for other senior executives.
REPORT OF THE COMPENSATION COMMITTEE
The compensation committee consists of Messrs. Churm, Goelman and Heeschen.
The compensation committee administers our stock option plans and sets
compensation levels for our executive officers. The company's executive
compensation policies and programs are designed to:
- provide competitive levels of overall compensation that will attract
and retain the best executive talent in the industry;
- motivate executive officers to perform at their highest level;
- align executive officer and stockholder interests to create
stockholder value; and
- reward executive officers for achievement of corporate and individual
objectives.
To achieve these goals, the compensation committee and the board of
directors have established an executive compensation program consisting
primarily of three integrated components: base salary, annual bonus and stock
options.
Base Salary. Base salaries for executive officers are set by the
compensation committee after considering factors such as competitive
environment, experience level, position, responsibility and overall contribution
of the executive. Base salaries for the executive officers were established in
their respective employment agreements.
Annual Bonus. All executive officers, including the Chief Executive
Officer, are eligible to receive an annual bonus. The employment agreements for
the executive officers provide for discretionary performance bonuses based upon
the company's performance and the respective executive officer's contribution
thereto. The board awarded annual bonuses to sixteen employees, including three
of the executive officers, for the fiscal year ended January 27, 1999, because
of outstanding performance by such persons during the year. These bonuses were
paid after the fiscal year ended January 27, 1999, but related to performance
during the fiscal year.
Stock Options. The third component of the compensation program for
executive officers is in the form of stock option awards. Diedrich Coffee's 1996
Stock Incentive Plan provides for long-term incentive compensation for Diedrich
Coffee employees, including executive officers. Stock option awards align the
interests of executive officers with those of stockholders by providing an
equity interest in the company, thereby providing incentive for the executive
officers to maximize stockholder value. Option awards directly tie executive
compensation to the value of Diedrich Coffee common stock. The compensation
committee is responsible for determining, subject to the terms of the 1996 Stock
Incentive Plan, the individuals to whom grants are made, the timing of grants
and the number of shares per grant. The number of shares are determined based
upon the individual's position in the company, competitive company practices and
the number of unvested shares already held by the individual. Stock options are
generally granted with an exercise price equal to the fair market value of
Diedrich Coffee common stock on the date of grant. During fiscal 1999, the
compensation committee granted stock options to approximately 76 employees. This
was a wider employee
27
<PAGE> 30
base than in past years. The goal of the compensation committee was to ensure
employees were focused on increasing stockholder value. The group included the
majority of corporate office employees as well as general managers and assistant
managers at the coffeehouse level.
Chief Executive Officer. In November 1997, Diedrich Coffee entered into an
employment agreement as well as a stock option plan and agreement with Mr. Ryan.
Our stockholders approved the stock option plan and agreement at a special
meeting called for that purpose on January 22, 1998. The terms of Mr. Ryan's
employment agreement and stock option plan and agreement were previously
described above. The process of establishing the Chief Executive Officer's
compensation parallels the process and criteria used in establishing
compensation levels for other executive officers. There were no changes made
during the fiscal year ended January 27, 1999 to Mr. Ryan's employment agreement
or his compensation package.
Policy with Respect to Internal Revenue Code Section 162(m). In 1993, the
Internal Revenue Code was amended to add Section 162(m). Section 162(m) and the
regulations thereunder place a limit of $1 million on the amount of compensation
that may be deducted by Diedrich Coffee in any year with respect to certain of
our most highly compensated officers. Section 162(m) does not, however, disallow
a deduction for qualified "performance-based compensation," the material terms
of which are disclosed to and approved by stockholders. At the present time, our
executive officer compensation levels, other than "perform once-based
compensation," do not exceed $1 million. The compensation committee and the
board of directors plan to take such actions in the future to minimize the loss
of tax deductions related to compensation as they deem necessary and appropriate
in light of specific compensation objectives.
Respectfully submitted,
Peter Churm
Paul C. Heeschen
Lawrence Goelman
COMPENSATION COMMITTEE INTERLOCKS
During the fiscal year ended January 27, 1999, the compensation committee
of Diedrich Coffee's board of directors consisted of Mr. Churm, Mr. Goelman and
Mr. Heeschen. No member of the compensation committee was, at any time during
the fiscal year ended January 27, 1999 or at any other time, an officer or
employee of Diedrich Coffee. There are no compensation committee interlocks
between Diedrich Coffee and other entities involving our executive officers and
board members who serve as executive officers or board members of such other
entities.
28
<PAGE> 31
STOCK PERFORMANCE GRAPH
The following graph shows a comparison of the cumulative total returns for
the period beginning on September 12, 1996, the date Diedrich Coffee common
stock was first publicly traded, and ending on January 27, 1999 for:
- Diedrich Coffee common stock;
- the Total Return Index for the Nasdaq National Market (U.S. companies);
and
- the Total Return Index for Nasdaq Retail Trade Stocks.
Each of the above assumes an initial value of $100 and reinvestment of
dividends. Although the graph would normally cover a five-year period, our
common stock has been publicly traded only since September 12, 1996, so the
graph begins on that date. The comparisons in the graph are required by the
Commission and are not intended to forecast or be indicative of possible future
performance of our common stock.
<TABLE>
<CAPTION>
RETAIL NASDAQ DDRX
------ ------ ----
<S> <C> <C> <C>
'9/12/96' 100.00 100.00 100.00
'10/30/96' 98.41 102.88 97.62
'1/29/97' 97.34 116.09 80.95
'4/30/97' 88.70 107.83 25.00
'7/30/97' 107.69 136.25 27.38
'10/29/97' 111.49 137.99 26.79
'1/28/98' 114.79 139.16 59.52
'4/29/98' 134.05 159.67 76.19
'7/29/98' 131.19 161.73 64.89
'10/28/98' 108.69 150.99 40.48
'1/27/99' 136.62 209.69 42.27
</TABLE>
29
<PAGE> 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table shows the number of shares of Diedrich Coffee common
stock beneficially owned as of April 7, 1999, by each person known by us to
beneficially own 5% or more of our common stock, by each of the directors, by
each of the executive officers named in the summary compensation table, and by
all directors and executive officers of Diedrich Coffee as a group. On April 7,
1999, there were 6,173,538 shares of common stock outstanding. Unless otherwise
stated, and except for voting and investment powers held jointly with a person's
spouse, the persons and entities named in the table have sole voting and
investment power with respect to all shares of common stock shown as
beneficially owned by them. All information with respect to beneficial ownership
is based on filings made by the respective beneficial owners with the Commission
or information provided to us by such beneficial owners.
<TABLE>
<CAPTION>
NAME AND ADDRESS AMOUNT AND NATURE PERCENT OF
OF BENEFICIAL OWNER(1) OF BENEFICIAL OWNERSHIP(2) CLASS
---------------------- -------------------------- ----------
<S> <C> <C>
D.C.H., L.P................................................. 1,473,197(3) 23.9%
450 Newport Center Drive
Suite 450
Newport Beach, CA 92660
Amre A. Youness............................................. 430,958(4) 6.6%
301 North Lake Avenue
Suite 910
Pasadena, CA 91101
Cosleno, Inc. .............................................. 340,000(5) 5.2%
3753 Howard Hughes Parkway
Suite 200
Las Vegas, NV 89109
Dolf A. Berle............................................... 25,000(6) *
Peter Churm................................................. 45,000(7) *
Martin Diedrich............................................. 655,107 10.6%
Lawrence Goelman............................................ 112,700(8) 1.8%
Paul C. Heeschen............................................ 1,786,480(9) 28.8%
Steven A. Lupinacci......................................... 309,061(10) 5.0%
John E. Martin.............................................. 1,258,533(11) 17.9%
Timothy J. Ryan............................................. 629,367(12) 9.3%
Ann Wride................................................... 25,000(13) *
All directors and executive officers as a group (8
persons).................................................. 4,537,187(14) 58.0%
</TABLE>
- ---------------
* Less than 1%
(1) Unless otherwise indicated, the address of each person in this table is c/o
Diedrich Coffee, 2144 Michelson Dr., Irvine, California 92612.
(2) Calculated pursuant to Rule 13d-3(d) under the Securities Exchange Act.
Shares not outstanding that are subject to options or warrants exercisable
by the holder thereof within 60 days of April 7, 1999 are deemed
outstanding for the purposes of calculating the number and percentage owned
by such stockholder, but not deemed outstanding for the purpose of
calculating the percentage owned by each other stockholder listed. Unless
otherwise noted, all shares listed as beneficially owned by a stockholder
are actually outstanding.
(3) Paul C. Heeschen, a director of Diedrich Coffee, is the sole general
partner of this limited partnership with voting and investment power as to
all shares beneficially owned by the limited partnership.
(4) Pursuant to Schedule 13D filed with the Commission and dated as of October
14, 1997, includes 340,000 shares that are subject to warrants exercisable
within 60 days of which he has shared voting and dispositive power with
Cosleno, Inc.
30
<PAGE> 33
(5) Pursuant to Schedule 13D as filed with the Commission and dated as of
October 14, 1997, Cosleno, Inc. and Amre A. Youness, who is the sole
stockholder of Cosleno, Inc., have shared voting and dispositive power of
the 340,000 shares that are subject to warrants exercisable within 60 days.
(6) Includes 25,000 shares subject to options that are exercisable within 60
days.
(7) Includes 25,000 shares subject to options that are exercisable within 60
days.
(8) Includes 100,000 shares subject to options that are exercisable within 60
days. This number does not include 85,000 shares held by the Virginia R.
Cirica Trust. Ms. Cirica is Mr. Goelman's wife. Mr. Goelman disclaims any
beneficial interest in the Virginia R. Cirica Trust, except to the extent
to which Mr. Goelman is a contingent beneficiary under the terms of that
trust.
(9) Includes 1,473,197 shares beneficially owned by D.C.H., L.P. and 255,914
shares beneficially owned by Redwood Enterprises VII, L.P. Mr. Heeschen is
the sole general partner of each of these partnerships with voting and
investment power as to all of such shares. Also includes 25,000 shares held
personally by Mr. Heeschen subject to options that are exercisable within
60 days and 25,000 shares purchased on the open market by the Palm Trust,
of which Mr. Heeschen is a trustee with shared voting and investment power
as to all of such shares.
(10) Mr. Lupinacci resigned as Chief Executive Officer, President and Chief
Financial Officer effective March 12, 1997.
(11) Includes 850,000 shares subject to options that are exercisable within 60
days.
(12) Includes 600,000 shares subject to options that are exercisable within 60
days.
(13) Includes 25,000 shares subject to options that are exercisable within 60
days.
(14) Includes 1,650,000 shares subject to options that are exercisable within 60
days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
On April 6, 1999, Diedrich Coffee entered into a $1,000,000 loan agreement
and security agreement with Amre Youness, a former director of Diedrich Coffee
and the beneficial owner of approximately 6.6% of the outstanding shares of
Diedrich Coffee common stock. Under the loan agreement, all outstanding
principal and interest is due and payable on April 6, 2000. The loan is secured
by the assets of Diedrich Coffee with interest accruing and paid monthly at the
prime rate plus 3%. In connection with the loan agreement, we issued warrants to
Mr. Youness to purchase 70,000 shares of Diedrich Coffee's common stock at a
price of $5.625 per share.
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 document beginning on page F-1.
31
<PAGE> 34
2. EXHIBITS.
<TABLE>
<S> <C>
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 Conversions Agreement in 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 Diedrich Coffee 1996 Stock Incentive Plan(1)
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.(4)
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(5)
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(5)
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(5)
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(5)
10.10 Stock Option Plan and Agreement by and between the Company
and Timothy J. Ryan granting Mr. Ryan the option to purchase
up to 600,000 shares of the Common Stock of the Company,
dated as of November 17, 1997(5)
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 (5)
10.12 Form of Promissory Note made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust (6)
</TABLE>
32
<PAGE> 35
<TABLE>
<S> <C>
10.13 Form of Term Loan Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust (6)
10.14 Form of Security Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust (6)
10.15 Form of Warrant Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust (6)
10.16 Form of Intercreditor Agreement made in favor of Nuvrty,
Inc., the Ocean Trust and the Grandview Trust (6)
10.17 Form of Common Stock and Option Purchase Agreement with
Franchise Mortgage Acceptance Company dated as of April 3,
1998 (7)
10.18 Separation and Release Agreement dated January 28, 1998 with
Kerry W. Coin (7)
10.19 Employment Agreement with Ann Wride dated April 8, 1998 (8)
10.20 Employment Agreement with Dolf Berle dated April 8, 1998 (9)
10.21 Employment Agreement with Catherine Saar dated June 11, 1998
(9)
10.22 Form of Franchise Agreement (10)
10.23 Form of Area Development Agreement (10)
10.24 Employment Agreement with Martin Diedrich dated June 29,
1998 (3)
11.1 Statement re: Computation of Per Share Earnings *
21.1 List of Subsidiaries (3)
24.1 Power of Attorney (contained on signature page of this
document)
27.1 Financial Data Schedule *
</TABLE>
- ---------------
* Filed herewith
(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 April 30, 1997, filed with the Securities
and Exchange Commission on June 13, 1997.
(5) 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.
(6) 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.
(7) Previously filed as an exhibit to Diedrich Coffee's annual report on Form
10-K for the fiscal year ended January 28, 1998.
(8) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended April 29, 1998, filed with the Securities
and Exchange Commission on June 11, 1998.
(9) 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.
(10) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended October 28, 1998, filed with the Securities
and Exchange Commission on December 11, 1998.
(b) REPORTS ON FORM 8-K.
None.
33
<PAGE> 36
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.
April 27, 1999 By: /s/ TIMOTHY J. RYAN
------------------------------------
Timothy J. Ryan
President and Chief Executive
Officer
POWER OF ATTORNEY
Each director and/or officer of Diedrich Coffee whose signature appears
below hereby constitutes and appoints TIMOTHY J. RYAN and ANN WRIDE as the true
and lawful attorneys-in-fact and agents for the undersigned, acting together or
alone, with full powers of substitution and resubstitution, for the undersigned
and in the undersigned's name, place and stead, in any and all capacities, to
sign and file any and all amendments and exhibits to this Report on Form 10-K,
and any and all applications and other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, acting together or alone, full powers and authority to do and perform
each and every act and thing requisite and necessary or desirable to be done,
hereby ratifying and confirming all that said attorneys-in-fact and agents,
acting together or alone, or their substitute or substitutes, may lawfully do or
cause to be done by virtue hereof.
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ JOHN E. MARTIN Chairman of the Board April 27, 1999
- ---------------------------------------------
John E. Martin
/s/ TIMOTHY J. RYAN President, Chief Executive Officer April 27, 1999
- --------------------------------------------- and Director (Principal Executive
Timothy J. Ryan Officer)
/s/ ANN WRIDE Vice President and Chief Financial April 27, 1999
- --------------------------------------------- Officer (Principal Financial and
Ann Wride Accounting Officer)
/s/ MARTIN R. DIEDRICH Chief Coffee Officer, Vice Chairman April 27, 1999
- --------------------------------------------- of the Board of Directors and
Martin R. Diedrich Secretary
/s/ LAWRENCE GOELMAN Director April 27, 1999
- ---------------------------------------------
Lawrence Goelman
/s/ PETER CHURM Director April 27, 1999
- ---------------------------------------------
Peter Churm
/s/ PAUL C. HEESCHEN Director April 27, 1999
- ---------------------------------------------
Paul C. Heeschen
</TABLE>
34
<PAGE> 37
DIEDRICH COFFEE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Balance Sheets.............................................. F-3
Statements of Operations.................................... F-4
Statements of Stockholders' Equity.......................... F-5
Statements of Cash Flows.................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 38
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders'
Diedrich Coffee, Inc.:
We have audited the accompanying balance sheets of Diedrich Coffee, Inc. as
of January 27, 1999 and January 28, 1998, and the related statements of
operations, stockholders' equity, and cash flows for the years ended January 27,
1999, January 28, 1998 and January 29, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Diedrich Coffee, Inc. as of
January 27, 1999 and January 28, 1998, and the results of its operations and its
cash flows for the years ended January 27, 1999, January 28, 1998 and January
29, 1997, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Orange County, California
March 26, 1999, except the
second paragraph of note 13
which is April 6, 1999
F-2
<PAGE> 39
DIEDRICH COFFEE, INC.
BALANCE SHEETS
ASSETS (NOTE 5)
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28,
1999 1998
------------ ------------
<S> <C> <C>
Current Assets:
Cash...................................................... $ 1,200,861 $ 1,408,161
Accounts receivable, less allowance for doubtful accounts
of $29,438 and $22,134................................. 263,651 181,628
Note receivable........................................... 100,000 --
Inventories (Note 2)...................................... 1,279,436 1,375,119
Prepaid expenses.......................................... 188,993 157,393
Income taxes receivable................................... 17,686 42,528
------------ ------------
Total current assets................................. 3,050,627 3,164,829
Property and equipment, net (Note 3)........................ 9,119,859 10,104,843
Costs in excess of net assets acquired, net (Note 4)........ 329,086 389,651
Other assets................................................ 236,880 289,103
------------ ------------
$ 12,736,452 $ 13,948,426
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current installments of obligations under capital leases
(Note 6)............................................... $ 169,488 $ 168,139
Accounts payable.......................................... 1,415,067 1,204,366
Accrued compensation...................................... 970,034 716,742
Accrued expenses (Note 7)................................. 1,039,097 1,796,869
Restructuring charge (Note 10)............................ 112,400 237,320
------------ ------------
Total current liabilities............................ 3,706,086 4,123,436
Obligations under capital lease -- long-term (Note 6)....... 283,106 317,292
Long term debt (Note 5)..................................... 2,500,000 2,500,000
Deferred rent............................................... 219,865 172,231
------------ ------------
Total liabilities.................................... 6,709,057 7,112,959
------------ ------------
Stockholders' Equity:
Common stock, $.01 par value; authorized 25,000,000
shares; issued and outstanding 6,167,313 shares at
January 27, 1999 and 5,741,650 at January 28, 1998..... 61,674 57,417
Additional paid-in capital................................ 18,708,032 16,928,546
Accumulated deficit....................................... (12,742,311) (10,150,496)
------------ ------------
Total stockholders' equity........................... 6,027,395 6,835,467
Commitments and contingencies (Note 6)
------------ ------------
$ 12,736,452 $ 13,948,426
============ ============
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 40
DIEDRICH COFFEE, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 27, JANUARY 28, JANUARY 29,
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net Sales:
Retail............................................ $21,248,462 $20,759,993 $18,117,720
Wholesale and other............................... 2,766,741 2,221,704 1,694,686
Franchise area development fees................... 200,000 -- --
----------- ----------- -----------
Total........................................ 24,215,203 22,981,697 19,812,406
----------- ----------- -----------
Cost and Expenses:
Cost of sales and related occupancy costs......... 10,955,197 11,457,612 9,263,286
Store operating expenses.......................... 8,935,644 10,447,349 8,279,621
Other operating expenses.......................... 634,124 289,867 240,227
Depreciation and amortization..................... 1,941,020 1,785,271 1,053,770
Provision for asset impairment and restructuring
costs.......................................... -- 3,902,332 --
General and administrative expenses............... 4,013,809 4,005,853 2,003,483
----------- ----------- -----------
Total........................................ 26,479,794 31,888,284 20,840,387
----------- ----------- -----------
Operating (loss) income............................. (2,264,591) (8,906,587) (1,027,981)
Interest expense.................................... (384,544) (182,135) (189,549)
Interest and other (expense) income................. 90,517 (23,239) 103,718
----------- ----------- -----------
Loss before income taxes............................ (2,558,618) (9,111,961) (1,113,812)
Income tax provision (benefit)...................... 3,690 800 (128,107)
----------- ----------- -----------
Net loss............................................ $(2,562,308) $(9,112,761) $ (985,705)
=========== =========== ===========
Net loss per share -- basic & diluted:.............. $ (0.43) $ (1.69) $ (0.22)
=========== =========== ===========
Weighted average shares outstanding............... 5,934,287 5,392,609 4,414,000
=========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 41
DIEDRICH COFFEE, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A PREFERRED SERIES B PREFERRED
STOCK STOCK COMMON STOCK
---------------------- ------------------------ ------------------- ADDITIONAL ACCUMULATED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT PAID IN CAPITAL DEFICIT
---------- --------- ---------- ----------- --------- ------- --------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 31,
1996................... 1,000,000 $ 800,000 1,608,568 $ 2,225,813 1,183,082 $11,831 $ 318,867 $ (52,030)
Initial public offering,
net.................... -- -- -- -- 1,600,000 16,000 12,563,452 --
Conversion of Series A
and B preferred
stock.................. (1,000,000) (800,000) (1,608,568) (2,225,813) 2,608,568 26,086 2,999,727 --
Net loss for the year.... -- -- -- -- -- -- -- (985,705)
---------- --------- ---------- ----------- --------- ------- ----------- ------------
Balance, January 29,
1997................... -- -- -- -- 5,391,650 53,917 15,882,046 (1,037,735)
Common stock issued...... -- -- -- -- 350,000 3,500 1,046,500 --
Net loss for the year.... -- -- -- -- -- -- -- (9,112,761)
---------- --------- ---------- ----------- --------- ------- ----------- ------------
Balance, January 28,
1998................... -- -- -- -- 5,741,650 57,417 16,928,546 (10,150,496)
Common stock issued...... -- -- -- -- 200,000 2,000 1,273,000 --
Exercise of options and
warrants............... -- -- -- -- 225,663 2,257 476,979 --
Amortization of
options................ -- -- -- -- -- -- 29,507 (29,507)
Net loss for the year.... -- -- -- -- -- -- -- (2,562,308)
---------- --------- ---------- ----------- --------- ------- ----------- ------------
Balance, January 27,
1999................... -- $ -- -- $ -- 6,167,313 $61,674 $18,708,032 $(12,742,311)
========== ========= ========== =========== ========= ======= =========== ============
<CAPTION>
TOTAL
-----------
<S> <C>
Balance, January 31,
1996................... $ 3,304,481
Initial public offering,
net.................... 12,579,452
Conversion of Series A
and B preferred
stock.................. --
Net loss for the year.... (985,705)
-----------
Balance, January 29,
1997................... 14,898,228
Common stock issued...... 1,050,000
Net loss for the year.... (9,112,761)
-----------
Balance, January 28,
1998................... 6,835,467
Common stock issued...... 1,275,000
Exercise of options and
warrants............... 479,236
Amortization of
options................ --
Net loss for the year.... (2,562,308)
-----------
Balance, January 27,
1999................... $ 6,027,395
===========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 42
DIEDRICH COFFEE, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 27, 1999 JANUARY 28, 1998 JANUARY 29, 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income...................................... $(2,562,308) $(9,112,761) $ (985,705)
Adjustments to reconcile net (loss) income to cash
(used in) provided by operating activities:
Depreciation and amortization........................ 1,941,020 1,785,271 1,053,770
Deferred income taxes................................ -- -- 48,192
Restructuring charge................................. -- 987,590
Impairment on long-lived assets...................... -- 2,203,217
Changes in operating assets and liabilities:
Accounts and notes receivable...................... (182,023) 28,735 (75,790)
Inventories........................................ 95,683 150,804 (969,652)
Prepaid expenses................................... (31,600) 27,670 (78,696)
Income taxes receivable............................ 24,842 242,544 (272,182)
Other assets....................................... 12,392 26,637 (121,881)
Accounts payable................................... 210,701 (595,926) 1,164,864
Accrued compensation............................... 165,614 186,971 232,137
Accrued expenses................................... (73,236) 1,562,055 136,250
Income taxes payable............................... -- -- (51,235)
Deferred rent...................................... 47,634 17,847 33,240
----------- ----------- -----------
Net cash (used in) provided by operating activities.... (351,281) (2,489,346) 113,312
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures for property and equipment...... (1,672,076) (1,724,397) (7,813,263)
Disposal of property and equipment................... 148,785
Acquisition of coffeehouses.......................... -- -- (1,916,000)
----------- ----------- -----------
Net cash (used in) investing activities.............. (1,523,291) (1,724,397) (9,729,263)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from notes payable.......................... -- -- 10,000
Payments on notes payable............................ -- -- (49,398)
Proceeds from line of credit......................... -- -- 4,100,000
Payments on line of credit........................... -- -- (4,100,000)
Proceeds from long-term debt......................... -- 4,500,000 1,622,520
Principal payments on long-term debt................. -- (2,000,000) (2,569,378)
Payments on capital lease obligations................ (86,964) -- --
Proceeds from issuance of common stock, net of fees
paid............................................... 1,275,000 1,050,000 12,579,452
Proceeds from stock options exercised................ 479,236 -- --
----------- ----------- -----------
Net cash provided by financing activities.............. 1,667,272 3,550,000 11,593,196
----------- ----------- -----------
Net (decrease) increase in cash........................ (207,300) (663,743) 1,977,245
Cash at beginning of year.............................. 1,408,161 2,071,904 94,659
----------- ----------- -----------
Cash at end of year.................................... $ 1,200,861 $ 1,408,161 $ 2,071,904
=========== =========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest........................................... $ 299,670 $ 154,999 $ 164,140
=========== =========== ===========
Income taxes....................................... $ 3,690 $ 800 $ 108,773
=========== =========== ===========
Non-cash Transactions
Equipment Purchased under Capital Leases........... $ 54,127 $ 498,513 --
=========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 43
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
Business
Diedrich Coffee, Inc. (the "Company") operates coffeehouses in Southern
California, Colorado and Texas, which sell coffee beverages made with its own
freshly roasted coffee. In addition, the Company sells light food items and
whole bean coffee through its coffeehouses. The Company also operates a
wholesale and mail order business in Southern California, which sells whole bean
coffee and related supplies and equipment.
Fiscal Year
The Company's fiscal year ends on the Wednesday closest to January 31.
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 straight-line 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.
Store Pre-opening Costs
Direct and incremental costs prior to the opening of a coffeehouse location
are expensed as incurred.
Fair Value of Financial Instruments
The carrying amounts of cash, accounts receivable, accounts payable 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.
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.
F-7
<PAGE> 44
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
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
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings per Share" in fiscal 1998. SFAS 128 requires the presentation
of "basic" earnings per share which represents net earnings divided by the
weighted average shares outstanding excluding all common stock equivalents. Dual
presentation of "diluted" earnings per-share reflecting the dilutive effect of
all common stock equivalents 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. The Company assesses the
recoverability of this intangible asset by determining whether the amortization
of the goodwill balance over its remaining life can be recovered through
undiscounted future operating cash flows of the acquired operations. The amount
of goodwill impairment, if any, is measured based on projected discounted future
operating cash flows using a discount rate reflecting the Company's average cost
of funds. The assessment of the recoverability of goodwill will be impacted if
estimated future operating cash flows are not achieved.
Stock Option Plans
Prior to February 1, 1996, the Company accounted for its stock option plans
in accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
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. On
February 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which permits entities to recognize as expense over the vesting
period the fair value of all stock-based awards on the date of the grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosures for employee stock option grants made in fiscal
1996 and future years as if the fair-value-based method defined in SFAS No. 123
had been applied. The Company has elected to continue to apply the provisions of
APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No.
123.
F-8
<PAGE> 45
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
Long-Lived Assets
It is the Company's policy to account for long-lived assets, including
intangibles, at the lower of amortized cost or fair value, less disposition
costs. 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 intangibles will not be recoverable, as determined by a non-discounted
cash flow generated by the asset, the carrying value of the Company's long-lived
assets will be reduced to its estimated fair market value based on the
discounted cash flows.
Advertising and Promotion Costs
Advertising costs are expensed as incurred. Promotion costs are charged to
income in the period of the promotional event. During fiscal 1999, the retail
stores were charged approximately $427,000, which was included in store
operating expenses and wholesale was charged $56,000, which was included in
other operating expenses, with the remaining amount to general and
administrative expenses. General and administrative expenses included
approximately $98,000 for the year ended January 27, 1999, $377,000 for the year
ended January 28, 1998 and $157,000 for the year ended January 29, 1997.
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.
Business Segment Reporting
The Company adopted SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information," effective in 1999. SFAS No. 131 establishes
new standards for reporting information about business segments and related
disclosures about products and services, geographic areas and major customers.
The business segments of the Company are wholesale and retail. Information
regarding these segments are in Note 11.
Revenue Recognition
Sales are recorded when payment is tendered at point of sale for retail and
upon shipment of product for wholesale.
F-9
<PAGE> 46
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28,
1999 1998
----------- -----------
<S> <C> <C>
Unroasted coffee.................................. $ 412,103 $ 535,885
Roasted coffee.................................... 115,979 67,965
Accessory and specialty items..................... 275,386 230,502
Other food, beverage and supplies................. 475,968 540,767
---------- ----------
$1,279,436 $1,375,119
========== ==========
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28,
1999 1998
----------- -----------
<S> <C> <C>
Leasehold improvements.......................... $ 6,475,369 $ 7,017,125
Equipment....................................... 4,555,017 4,047,109
Furniture and fixtures.......................... 1,948,423 2,022,252
Construction in progress........................ 504,279 250,716
Assets under capital lease...................... 552,640 498,513
----------- -----------
14,035,728 13,835,715
Accumulated depreciation and amortization....... (4,915,869) (3,730,872)
----------- -----------
$ 9,119,859 $10,104,843
=========== ===========
</TABLE>
4. ACQUISITIONS
During fiscal 1997, the Company purchased substantially all assets of
twelve coffeehouses previously owned by Brothers Gourmet Coffees, Inc., seven
bakery-espresso cafes from an unrelated third party and another coffeehouse from
an unrelated third party for total cash consideration of $1,916,000.
These acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the results of operations of the coffeehouses
acquired have been included with those of the Company as of their respective
acquisition date. The costs in excess of net assets acquired related to these
acquisitions was $874,000 and is being amortized over 15 years. The Company has
expensed or reserved these costs in connection with store closures. (See Note 7
and 10).
F-10
<PAGE> 47
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
5. DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28,
1999 1998
----------- -----------
<S> <C> <C>
NUVRTY, INC.
Note payable bearing interest at prime rate plus
3 1/2%, interest payable monthly. Note is
secured by the assets of the Company. Due
September 30, 2002.............................. $1,000,000 $1,000,000
GRANDVIEW TRUST
Note payable bearing interest at prime rate plus
3 1/2%, interest payable monthly. Note is
secured by the assets of the Company. Due
October 15, 2002................................ 750,000 750,000
OCEAN TRUST
Note payable bearing interest at prime rate plus
3 1/2%, interest payable monthly. Note is
secured by the assets of the Company. Due
October 16, 2002................................ 750,000 750,000
---------- ----------
$2,500,000 $2,500,000
========== ==========
</TABLE>
On September 30, 1997 the Company entered into a promissory note, term loan
agreement and security agreement with Nuvrty, Inc., a Colorado corporation and
predecessor-in-interest to Cosleno, Inc. controlled by Amre Youness, a former
director of the Company (the "Nuvrty Loan Documents"). All outstanding principal
and accrued interest is due and payable on September 30, 2002. The loan is
secured by the assets of the Company and provides 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 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 provide for
borrowing up to $750,000 from each Trust. Each loan is secured by the assets of
the Company. Interest on advances is accrued and payable monthly at the prime
rate plus 3 1/2%. The Company borrowed $750,000 under each facility. All
outstanding principal and accrued interest is due and payable to each of the
Ocean and Grandview Trusts on October 16, 2002.
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.
F-11
<PAGE> 48
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
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.
At January 27, 1999 the prime rate was 7.75%.
6. COMMITMENTS AND CONTINGENCIES
Lease Commitments
As of January 27, 1999, the Company leases warehouse and office space in
Irvine, California, warehouse space in Denver, Colorado, and thirty-six
coffeehouse locations in Southern California, Colorado and Texas expiring
through February 2009. 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 as of
January 27, 1999 are as follows:
<TABLE>
<CAPTION>
NON-CANCELABLE
YEAR ENDING JANUARY OPERATING LEASES CAPITAL LEASES
------------------- ---------------- --------------
<S> <C> <C>
2000.......................................... $1,842,000 $169,488
2001.......................................... 1,711,000 169,488
2002.......................................... 1,413,000 165,672
2003.......................................... 1,172,000 95,179
2004.......................................... 974,000 1,389
Thereafter.................................... 1,957,000 --
---------- --------
$9,069,000 $601,216
========== ========
Less amount representing interest............. 148,622
--------
Present value of minimum lease payments....... 452,594
Less current portion.......................... 169,488
--------
Long-term portion............................. $283,106
========
</TABLE>
Rent expense under operating leases approximated $2,070,000, $2,232,000,
and $1,772,000 for the years ended January 27, 1999, January 28, 1998 and
January 29, 1997, respectively.
Purchase Commitments
As of January 27, 1999 and January 28, 1998, the Company had entered into
fixed price purchase contracts for unroasted coffee aggregating approximately
$1,135,000 and $451,500, respectively. Such contracts are generally short-term
in nature and the Company believes that their cost approximates fair market
value.
F-12
<PAGE> 49
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
Contingencies
In the ordinary course of its business, the Company may become involved in
legal proceedings from time to time. As of March 26, 1999, the Company was not
aware of any pending legal proceedings which in the opinion of management would
adversely affect continuing operations..
7. ACCRUED EXPENSES
The following table sets forth details of accrued expenses:
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28,
1999 1998
----------- -----------
<S> <C> <C>
Accrued costs for store/warehouse closures........ $ 471,915 $ 986,000
Other accrued taxes............................... 113,664 331,224
Accrued worker's compensation insurance........... 159,872 147,532
Other accrued expenses............................ 293,646 332,113
---------- ----------
Total accrued expenses............................ $1,039,097 $1,796,869
========== ==========
</TABLE>
8. 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 were to become
exercisable on the eighth anniversary of the date of grant or earlier upon the
occurrence of certain events, including an IPO or a change in control (as
defined). If not exercised earlier, the options were to expire 10 years from the
date of grant. In May 1997, in connection with the termination of the
executive's employment agreement, the Company and the executive agreed to terms
under which 52,167 options were forfeited and the expiration date for the
remaining 79,183 options was changed to March 12, 1999. During Fiscal 1999, the
options to purchase 79,183 shares 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
475,000 shares were reserved for issuance under the Incentive Plan. The
stockholders approved at the 1997 annual meeting of stockholders, an increase of
300,000 shares for a total of 775,000 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.
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.
F-13
<PAGE> 50
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
In August 1996, one executive officer was granted options to purchase
120,000 shares of the Company's common stock, subject to a specified vesting
schedule, at an exercise price equal to the public offering price per share in
the Company's initial public offering. 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,
in connection with the termination of executive's employment agreement, the
Company and the executive agreed to terms under which the employee retained
options to purchase 80,000 shares. The remaining 40,000 options were canceled.
Options to purchase 62,500 shares were exercised in fiscal 1999 and options to
purchase 17,500 shares were exercised in fiscal 2000.
In September 1996, the holders of the Series A and Series B Preferred
Shares converted their shares into shares of common stock on a one-for-one
basis.
On September 11, 1996, the Company completed an initial public offering of
2,530,000 shares (including an over-allotment option). The offering consisted of
1,600,000 shares of common stock sold on behalf of the Company and 930,000
shares of common stock sold on behalf of certain selling stockholders. The net
proceeds of the offering to the Company, after deducting approximately
$2,621,000 in related expenses, were approximately $12,579,000.
In connection with the IPO, the managing underwriter received warrants
exercisable for 160,000 shares of the Company's common stock at $11.50 per
share. The warrants were exercisable commencing September 1997 and were to
expire in September 1999. The warrants were repriced to $5.25 and the exercise
period was shortened to provide for expiration in December 1998 pursuant to
written agreement on December 10, 1997. During fiscal 1999, 28,960 warrants were
exercised and the remaining 131,040 expired.
On April 25, 1997, the Company's Board of Directors approved the 1997
Non-Employee Director's Stock Option Plan which granted options to purchase
10,000 shares each 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 was granted the option to purchase 850,000 shares of the
common stock of the Company. Mr. Martin and the Company also agreed to terms
under which Mr. Martin purchased 333,333 shares of the Company's common stock at
$3.00 per share.
On November 18, 1997, Mr. Timothy J. Ryan joined the Company as Diedrich
Coffee's President and Chief Executive Officer. The Company entered into a
performance based Stock Option Plan and Agreement under which Mr. Ryan was
granted the option to purchase up to 600,000 shares of the common stock of the
Company. In addition, Mr. Ryan purchased 16,667 shares of common stock at $3.00
per share 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
F-14
<PAGE> 51
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
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 may be exercised in
increments of 25,000 shares or more and expires on April 3, 2000. 50,000 shares
are exercisable at $10.00 per share and 50,000 shares are exercisable at $12.50
per share. 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.
Information regarding the Company's stock options plans is summarized
below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS EXERCISE PRICE
--------- --------------
<S> <C> <C>
Shares authorized............................. 2,501,350
Shares under option
Outstanding at: January 31, 1996.............. 161,250 $3.04
Granted.................................. 140,000 $9.61
Exercised................................ -- --
Forfeited................................ -- --
Outstanding at: January 29, 1997.............. 301,350 $6.09
Granted.................................. 1,885,000 $5.60
Exercised................................ -- --
Forfeited................................ 202,167 $7.53
Outstanding at: January 28, 1998.............. 1,984,183 $5.48
Granted.................................. 308,100 $7.81
Exercised................................ 111,703 $2.26
Forfeited................................ 70,017 $3.20
Outstanding at: January 27, 1999.............. 2,057,267 $6.17
Weighted-average fair value of options granted
during the fiscal year:
1997..................................... $5.01
1998..................................... $2.56
1999..................................... $4.29
Options exercisable:
At January 29, 1997......................... 110,850
At January 28, 1998......................... 1,125,683
At January 27, 1999......................... 1,169,152
</TABLE>
In connection with debt (Note 5) the Company issued warrants to purchase
common stock at a price of $2.25 expiring at various times. As of January 27,
1999, January 28, 1998 and January 29, 1997, warrants of 850,000, 1,095,000 and
160,000, respectively, were outstanding and vested.
F-15
<PAGE> 52
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
The following table summarizes information about stock options outstanding
on January 27, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ ------------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
OUTSTANDING AVERAGE AVERAGE EXERCISABLE AVERAGE
AT REMAINING EXERCISE AT EXERCISE
JANUARY 27, 1999 LIFE (YEARS) PRICE JANUARY 27, 1999 PRICE
---------------- ------------ -------- ---------------- -----------
<S> <C> <C> <C> <C> <C>
$2.75 - $4.00............. 779,167 5.97 $ 3.54 749,152 $ 3.57
$4.01 - $6.00............. 376,500 7.02 $ 4.97 300,000 $ 4.88
$6.01 - $9.00............. 456,600 6.58 $ 7.66 -- --
$9.01 - $10.50............ 445,000 7.04 $10.22 120,000 $10.81
</TABLE>
Pro forma income and pro forma income per share, as if the fair value-based
method has been applied in measuring compensation cost for stock-based awards:
<TABLE>
<CAPTION>
1999 1998
----------- ------------
<S> <C> <C>
REPORTED
Net Loss................................... $(2,562,308) $ (9,112,761)
Basic loss per share....................... $ (0.43) $ (1.69)
PRO FORMA
Net Loss................................... $(3,082,569) $(13,588,746)
Basic loss per share....................... $ (0.52) $ (2.52)
</TABLE>
The pro forma net income (loss) and net income (loss) per share calculated
pursuant to the provisions of SFAS No. 123 for the year ended January 29, 1997
would not be significantly different from amounts reported and therefore are not
included herein.
The fair values of the options granted were estimated using the
Black-Scholes option-pricing model based on the following weighted average
assumptions:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Risk free interest rate................................. 4.5% 5.5%
Expected Life........................................... 6 years 6 years
Expected volatility..................................... 53% 128%
Expected dividend yield................................. 0% 0%
</TABLE>
F-16
<PAGE> 53
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
9. INCOME TAXES
The components of the income tax provision (benefit) are as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 27, JANUARY 28, JANUARY 29,
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal...................................... $ -- $ -- $(171,284)
State........................................ 3,690 800 (5,015)
------ ---- ---------
3,690 800 (176,299)
------ ---- ---------
Deferred:
Federal...................................... -- -- 40,542
State........................................ -- -- 7,650
------ ---- ---------
48,192
---------
$3,690 $800 $(128,107)
====== ==== =========
</TABLE>
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:
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28,
1999 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards...................... $ 3,900,495 $ 2,965,213
Accrued expenses...................................... 457,872 456,844
Restructure and Store closure Reserves................ 98,179 410,933
AMT credit............................................ 1,069 1,069
----------- -----------
Total deferred tax assets............................... 4,457,615 3,834,059
----------- -----------
Deferred tax liabilities:
Depreciation and amortization......................... 164,543 (199,432)
State income taxes.................................... -- --
----------- -----------
Total deferred tax liabilities.......................... 164,543 (199,432)
----------- -----------
Total deferred tax assets............................... 4,622,158 3,634,627
Less: Valuation allowance............................... (4,622,158) (3,634,627)
----------- -----------
Net deferred tax assets................................. $ -- $ --
=========== ===========
</TABLE>
F-17
<PAGE> 54
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
A reconciliation of the statutory Federal income tax rate with the
Company's effective income tax provision (benefit) rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 27, JANUARY 28, JANUARY 29,
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Federal statutory rate.......................... (34.0)% (34.0)% (34.0)%
State income taxes, net of Federal benefit...... (1.6) (3.3) 2.6
Other........................................... (2.8) (0.1) (1.0)
Valuation allowance............................. 38.6 37.4 20.9
----- ----- -----
0.2% --% (11.5)%
----- ----- -----
</TABLE>
As of January 27, 1999, the Company had net operating loss (NOL)
carryforwards of approximately $10,655,000 and $4,760,000 for Federal and state
purposes, respectively. The Federal NOL is available to offset future federal
taxable income through 2013, and the state NOL is available to offset future
state taxable income through 2003. The utilization of certain NOL carryforwards
could be limited due to restriction imposed under Federal and state laws upon a
change in ownership.
A valuation allowance against deferred tax assets of $4,622,158 was
recorded in fiscal 1999 to fully offset NOL carryforwards and other net deferred
tax assets at January 27, 1999.
10. RESTRUCTURING CHARGE
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, the new 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. The remaining balance of $112,000 at the end of
fiscal 1999 is designated for costs related to two closed locations currently
under sublease.
F-18
<PAGE> 55
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
11. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
JANUARY 27, JANUARY 28, JANUARY 29,
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
NUMERATOR:
Net (loss) income........................... (2,562,308) (9,112,761) (985,705)
DENOMINATOR:
Basic and diluted weighted average common
shares outstanding....................... 5,934,287 5,392,609 4,414,000
Basic and diluted loss per share............ (0.43) (1.69) (0.22)
</TABLE>
For the years ended January 27, 1999, January 28, 1998 and January 29,
1997, stock options of 2,057,267, 1,984,183 and 301,350 respectively, and
warrants of 850,000, 1,095,000 and 160,000 respectively, were not included in
the computation of diluted earnings per share as losses were incurred in those
years.
12. SEGMENT INFORMATION
In accordance with the requirements of SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information," the Company reportable
business segments and respective accounting policies, policies of the segments
are the same as those described in Note 1. Management evaluates segment
performance based primarily on revenue and earnings from operations. Interest
income and expenses is evaluated on a consolidated basis and not allocated to
the Company's business segments.
Segment information is summarized as follows for the years ended January
27, 1999, January 28, 1998 and January 29, 1997:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Net Revenues:
Retail operations....................... $21,248,462 $20,759,993 $18,117,720
Wholesale operations.................... 2,766,741 2,221,704 1,694,686
----------- ----------- -----------
24,015,203 22,981,697 19,812,406
----------- ----------- -----------
Earnings (loss) from operations:
Retail operations....................... 1,476,140 (5,160,947) 821,511
Wholesale operations.................... 392,467 512,313 291,689
----------- ----------- -----------
Total................................ $ 1,868,607 $(4,648,634) $ 1,113,200
=========== =========== ===========
</TABLE>
13. SUBSEQUENT EVENT
On March 16, 1999, the Company signed a definitive agreement to acquire
Coffee People, Inc. Under the terms of the agreement, Coffee People stockholders
will receive $17.75 million in cash, 1,500,000 shares of Diedrich Coffee common
stock, and $5.25 million in cash or stock depending on the success of Diedrich
Coffee's financing efforts. The transaction is expected to close during the
Summer 1999, subject to a number of conditions including the securing of
financing and stockholder and regulatory approval.
F-19
<PAGE> 56
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 27, 1999, JANUARY 28, 1998 AND JANUARY 29, 1997 -- (CONTINUED)
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 and interest is due and payable on April 6, 2000. The loan
is 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.
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The results of operations for fiscal 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Fiscal 1999:
Net sales....................................... $ 5,923 $6,030 $6,043 $ 6,219
Operating (loss)................................ (649) (677) (521) (418)
Net (loss)...................................... (746) (761) (609) (446)
Net (loss) per share............................ (.13) (.13) (.10) (.07)
Fiscal 1998:
Net sales....................................... $ 5,868 $5,811 $5,563 $ 5,740
Operating (loss)................................ (5,390) (661) (654) (2,202)
Net (loss)...................................... (5,383) (698) (739) (2,293)
Net (loss) per share............................ (1.00) (.13) (.14) (.42)
</TABLE>
F-20
<PAGE> 57
DIEDRICH COFFEE, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGES
- ------- ----------- ------------
<C> <S> <C>
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 Conversions Agreement in 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 Diedrich Coffee 1996 Stock Incentive Plan(1)
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.(4)
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(5)
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(5)
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(5)
</TABLE>
S-1
<PAGE> 58
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGES
- ------- ----------- ------------
<C> <S> <C>
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(5)
10.10 Stock Option Plan and Agreement by and between the Company
and Timothy J. Ryan granting Mr. Ryan the option to purchase
up to 600,000 shares of the Common Stock of the Company,
dated as of November 17, 1997(5)
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(5)
10.12 Form of Promissory Note made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(6)
10.13 Form of Term Loan Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust(6)
10.14 Form of Security Agreement made in favor of Nuvrty, Inc.,
the Ocean Trust and the Grandview Trust(6)
10.15 Form of Warrant Agreement made in favor of Nuvrty, Inc., the
Ocean Trust and the Grandview Trust(6)
10.16 Form of Intercreditor Agreement made in favor of Nuvrty,
Inc., the Ocean Trust and the Grandview Trust(6)
10.17 Form of Common Stock and Option Purchase Agreement with
Franchise Mortgage Acceptance Company dated as of April 3,
1998(7)
10.18 Separation and Release Agreement dated January 28, 1998 with
Kerry W. Coin(7)
10.19 Employment Agreement with Ann Wride dated April 8, 1998(8)
10.20 Employment Agreement with Dolf Berle dated April 8, 1998(9)
10.21 Employment Agreement with Catherine Saar dated June 11,
1998(9)
10.22 Form of Franchise Agreement(10)
10.23 Form of Area Development Agreement(10)
10.24 Employment Agreement with Martin Diedrich dated June 29,
1998(3)
11.1 Statement re: Computation of Per Share Earnings*
21.1 List of Subsidiaries(3)
24.1 Power of Attorney (contained on signature page of this
document)
27.1 Financial Data Schedule*
</TABLE>
- ---------------
* Filed herewith
(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.
S-2
<PAGE> 59
(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 April 30, 1997, filed with the Securities
and Exchange Commission on June 13, 1997.
(5) 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.
(6) 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.
(7) Previously filed as an exhibit to Diedrich Coffee's annual report on Form
10-K for the fiscal year ended January 28, 1998.
(8) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended April 29, 1998, filed with the Securities
and Exchange Commission on June 11, 1998.
(9) 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.
(10) Previously filed as an exhibit to Diedrich Coffee's Quarterly Report on
Form 10-Q, for the period ended October 28, 1998, filed with the Securities
and Exchange Commission on December 11, 1998.
S-3
<PAGE> 1
EXHIBIT 11.1
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
January 27, 1999 January 28, 1998 January 29, 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
NUMERATOR:
Net (loss) income (2,562,308) (9,112,761) (985,705)
DENOMINATOR:
Basic and diluted weighted
average common shares
outstanding 5,934,287 5,392,609 4,414,000
Basic and diluted loss earnings
per share (0.43) (1.69) (0.22)
</TABLE>
For the years ended January 27, 1999, January 28, 1998 and January 29,
1997, stock options of 2,057,267, 1,984,183 and 301,350 respectively, and
warrants of 850,000, 1,095,000 and 160,000 respectively, were not included in
the computation of diluted earnings per share as losses were incurred in those
years.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE DIEDRICH
COFFEE, INC. REPORT ON FORM 10-K FILED HEREWITH AND IS QUALIFIED IN IS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-27-1999
<PERIOD-START> JAN-29-1998
<PERIOD-END> JAN-27-1999
<CASH> 1,200,861
<SECURITIES> 0
<RECEIVABLES> 263,651
<ALLOWANCES> 0
<INVENTORY> 1,279,436
<CURRENT-ASSETS> 3,050,627
<PP&E> 14,035,728
<DEPRECIATION> 4,915,869
<TOTAL-ASSETS> 12,736,452
<CURRENT-LIABILITIES> 3,706,086
<BONDS> 0
0
0
<COMMON> 61,674
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 12,736,452
<SALES> 24,215,203
<TOTAL-REVENUES> 24,215,203
<CGS> 10,955,197
<TOTAL-COSTS> 10,955,197
<OTHER-EXPENSES> 15,524,597
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 384,544
<INCOME-PRETAX> (2,558,618)
<INCOME-TAX> 3,690
<INCOME-CONTINUING> (2,562,308)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,562,308)
<EPS-PRIMARY> (0.43)
<EPS-DILUTED> (0.43)
</TABLE>
