<PAGE> 1
Filed pursuant to
Rule 424(b)(4) under the
Securities Act of 1933
in connection with
[DIEDRICH COFFEE LOGO] Registration No. 333-78083
4,600,000 SHARES
COMMON STOCK
Diedrich Coffee, Inc. is offering 4,600,000 shares of common stock.
Concurrently with the closing of this offering, we will acquire Coffee People,
Inc. by way of a merger in which Coffee People will become a wholly-owned
subsidiary of Diedrich Coffee. We will use a portion of the net proceeds from
this offering to finance the cash payment to Coffee People stockholders in the
acquisition. We will use the remaining proceeds for general corporate purposes
for the combined company. This offering is contingent upon the completion of the
acquisition of Coffee People.
Diedrich Coffee common stock is traded on the Nasdaq National Market under
the symbol "DDRX." On June 30, 1999, the last reported sale price of Diedrich
Coffee common stock on the Nasdaq National Market was $7.00 per share.
----------------------------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 11.
----------------------------------
<TABLE>
<CAPTION>
PER
SHARE TOTAL
----- -----
<S> <C> <C>
Public Offering Price....................................... $6.00 $27,600,000
Underwriting Discounts and Commissions...................... $0.42 $ 1,932,000
Proceeds to Diedrich Coffee................................. $5.58 $25,668,000
</TABLE>
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE
NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS
IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
Diedrich Coffee has granted the underwriters the right to purchase up to an
additional 690,000 shares of common stock to cover over-allotments. BancBoston
Robertson Stephens Inc. expects to deliver the shares of common stock to
purchasers on July 7, 1999.
----------------------------------
BANCBOSTON ROBERTSON STEPHENS
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN
RAUSCHER INCORPORATED
FIRST SECURITY VAN KASPER
THE DATE OF THIS PROSPECTUS IS JUNE 30, 1999.
<PAGE> 2
[INSERT DESCRIPTION OF ARTWORK]
INSIDE FRONT COVER
Photograph of a cup of Diedrich drip coffee, a Diedrich cappuccino, a
Diedrich ice blended coffee drink, and a caffe latte from our beverage menu. A
selection of bakery goods and specialty coffee beans surround the coffee
beverages. The Diedrich Coffee logo ("Diedrich" in block red letters above a
crest, "coffee" in block letters below the crest) appears in the bottom right
corner.
FRONT GATEFOLD
[Photographs of the interior of a Diedrich coffeehouse and a barista
serving a customer]
Caption: Voted Best Coffeehouse in Orange County, 1989, 1992, 1994, 1997, and
1998. Voted Best Coffeehouse in Houston, 1998.
[Photograph of the exterior of a Gloria Jean's Mall Coffee Store]
Caption: Diedrich Coffee and Gloria Jean's Coffees: Two strong brands in the
Coffeehouse and Mall Coffee Store markets.
[Photograph of various Diedrich Coffee Papua New Guinea estate coffee
products]
Caption: Through special relationships with small plantations and growers,
Diedrich Coffee is able to acquire very rare estate coffees.
[Photograph of Martin Diedrich, Chief Coffee Officer of Diedrich Coffee]
Caption: Our Chief Coffee Officer Martin Diedrich, a recognized expert in
coffee, personally oversees the coffee selection and roasting. The Diedrich
family has been involved in the specialty coffee industry for three generations.
2
<PAGE> 3
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF OUR COMMON STOCK. IN THIS PROSPECTUS, "DIEDRICH
COFFEE," "WE," "US" AND "OUR" REFER TO DIEDRICH COFFEE, INC., AS IT EXISTS
BEFORE THE ACQUISITION AND THIS OFFERING OR, TOGETHER WITH COFFEE PEOPLE INC.,
AS THEY WILL EXIST AFTER THE ACQUISITION AND THIS OFFERING, AS THE CONTEXT
REQUIRES.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary..................................................... 4
Risk Factors................................................ 11
A Warning about Forward-Looking Statements.................. 18
The Coffee People Acquisition............................... 19
Use of Proceeds............................................. 20
Price Range of Diedrich Coffee Common Stock................. 20
Dividend Policy............................................. 20
Capitalization.............................................. 21
Dilution.................................................... 22
Unaudited Pro Forma Combined Condensed Financial
Information............................................... 23
Diedrich Coffee Selected Financial Data..................... 29
Diedrich Coffee Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 30
Coffee People Selected Financial Data....................... 38
Coffee People Management's Discussion and Analysis of
Financial Information and Results of Operations........... 39
Business.................................................... 48
Management.................................................. 64
Transactions Involving Officers, Directors and Principal
Stockholders.............................................. 72
Principal Stockholders...................................... 73
Description of Capital Stock................................ 75
Shares Eligible for Future Sale............................. 77
Underwriting................................................ 78
Legal Matters............................................... 80
Experts..................................................... 80
Where You Can Find Additional Information................... 80
Index to Financial Statements............................... F-1
</TABLE>
------------------------
"Diedrich Coffee," "Wiener Melange," "Harvest Peak," "SCOOP-A-CCINO" and
"Flor de Apanas" are registered trademarks and service marks of Diedrich Coffee.
"Coffee People," "Coffee Plantation," "Gloria Jean's," "Motor Moka" and "Aero
Moka" are registered trademarks and service marks of Coffee People. This
prospectus contains other trademarks, service marks and tradenames of Diedrich
Coffee, Coffee People and other companies.
3
<PAGE> 4
SUMMARY
Because this is only a summary, it does not contain all the information
that may be important to you. You should read the entire prospectus, including
"Risk Factors" and the financial statements and related notes, before deciding
to invest in our common stock. Except as otherwise noted, all information in
this prospectus assumes the underwriters will not exercise their over-allotment
option. Diedrich Coffee's fiscal year ends on the Wednesday closest to January
31. Coffee People's fiscal year ends on the last Saturday in June. Following
this offering, we intend to change our fiscal year to the 52 or 53 week period
ending on the Wednesday closest to June 30 of each year.
DIEDRICH COFFEE
Diedrich Coffee, following the acquisition of Coffee People, will be the
second largest specialty coffee retailer in the United States with annual
systemwide sales of more than $150 million through 361 retail locations in 38
states and 6 foreign countries. We sell specialty brewed coffee and
espresso-based beverages such as cappuccinos, lattes, mochas and espressos and
various blended drinks through these company-owned and franchised retail
locations. To complement beverage sales, we also sell light food items,
specialty whole bean coffee and accessories at our retail locations. In addition
to our network of retail locations, we will operate a large coffee roasting
facility located in Northern California that is presently operated by Coffee
People and will provide high-quality, freshly roasted coffee beans for our
retail locations and our wholesale accounts. We have over 300 wholesale accounts
with businesses and restaurant chains, such as Ruth's Chris Steakhouses
(California/Arizona locations), El Torito, Claim Jumper and Islands Restaurants.
We believe that as the specialty coffee market has matured, distinct
segments have emerged: espresso/coffee bars, coffeehouses and mall coffee
stores. Espresso/coffee bars offer limited seating to facilitate quick customer
turnover, are generally less than 1,200 square feet in size and are usually
located in densely populated urban areas. Coffeehouses are generally greater
than 1,200 square feet in size, located in suburban areas, and encourage
customers to linger and enjoy a more relaxed, comfortable atmosphere. Mall
coffee stores cater to mall consumers and place a heavier emphasis on the sale
of flavored whole bean coffee and coffee-related merchandise. Based on the
number of domestic retail coffee locations, Starbucks is the leader in the
espresso/coffee bar segment, Gloria Jean's is the leader in the mall coffee
store segment and there is presently no leader in the coffeehouse segment. Our
business objective is to be the leading specialty coffee company in both the
coffeehouse and mall coffee store segments.
We differentiate ourselves from other specialty coffee producers by
roasting our coffee beans in accordance with proprietary recipes developed over
three generations by the Diedrich family. Our roasting recipes take into account
the specific variety, origin and physical characteristics of each coffee bean to
maximize its unique flavor. In addition, we seek to differentiate our
coffeehouses by offering our customers a broad line of superior tasting coffee
products and a high level of personalized customer service, which generate
strong sales and customer loyalty. Diedrich coffeehouses offer a warm, friendly
environment specifically designed to encourage guests to linger with friends and
business associates or to relax alone in comfort. Ample seating is augmented by
cozy sofas and comfortable chairs to create intimate nooks for meeting and
relaxing. The critical components of our coffeehouse concept include high
quality, fresh roasted coffee and superior customer service by knowledgeable
employees.
The first retail store operating under the name of Diedrich Coffee
commenced operations in 1972. Our retail operations grew rapidly until 1997 when
we experienced difficulties managing such rapid growth. Diedrich Coffee
restructured its operations and, in November 1997, our board of directors
retained John Martin as Chairman of the Board and Tim Ryan as President and
Chief Executive Officer. Messrs. Martin and Ryan collectively bring more than 55
years of multi-unit food service experience to our company. They joined our
founder, Martin Diedrich, a recognized expert in sourcing, tasting and roasting
coffee, and began the process of building a team of experienced restaurant
industry executives to develop the Diedrich Coffee brand. To further our
objective to be the leading specialty coffee company in both the coffeehouse and
mall coffee store segments, our management team implemented a growth strategy to
increase our number of retail locations and the sale of coffee products through
other distribution channels.
4
<PAGE> 5
In order to implement our growth strategy, we intend to:
- focus on franchising through large, experienced area developers;
- develop additional company-operated retail locations;
- continue expanding our wholesale distribution channels;
- pursue the acquisition of selected coffee retailers; and
- explore international expansion.
While we believe that the mall coffee store segment has the capacity for
additional growth through owner-operator franchise agreements, we feel that the
coffeehouse segment has broader national and international potential.
Consequently, our objective is to expand our operations to 1,200 to 1,500
coffeehouses, as well as carts and kiosks, through large area franchise
development with experienced, well-capitalized, multi-unit franchise operators
interested in opening between 30 and 70 coffeehouses over a 5 to 7 year period.
During the second half of 1998, we announced two area development
agreements with franchisees located in North Carolina and Southern California.
During 1999 we have announced three additional area development agreements to
open coffeehouses in Kentucky, Tennessee, Northern Florida and Los Angeles,
California. In total, these agreements call for the development of up to 274
coffeehouses, as well as carts and kiosks, over the next 5 to 7 years. In
addition, these agreements contain options to develop an additional 148
coffeehouses in Arizona and the San Francisco Bay Area.
THE COFFEE PEOPLE ACQUISITION
In the third quarter of 1998, our management team recognized the value of
acquiring Coffee People as a strategic opportunity to:
- assume a market leadership position in an additional segment -- mall
coffee stores;
- achieve economies of scale in purchasing, roasting, packaging and
distribution;
- improve stability of financial and business operations through increased
cash flow and earnings; and
- accelerate the growth of our core coffeehouse concept.
In March 1999, we agreed to acquire Coffee People through a merger in which
Coffee People will become a wholly-owned subsidiary of Diedrich Coffee. The
common stock of Coffee People is currently traded on the Nasdaq SmallCap Market
under the symbol "MOKA." Coffee People operates 3 retail brands -- Gloria
Jean's, Coffee People and Coffee Plantation -- with 320 franchised and
company-owned retail locations throughout the United States and in 6 foreign
countries. We intend to convert Coffee People and Coffee Plantation coffeehouses
to the Diedrich Coffee brand. We do not intend to convert the Gloria Jean's
brand to the Diedrich Coffee brand in the near future. Rather, we intend to
implement new strategies to strengthen and reposition the Gloria Jean's brand to
maintain its leadership position within its market segment. Founded in 1979, the
Gloria Jean's concept offers a recognized brand name with growth potential.
Gloria Jean's outlets generally offer a full range of flavored and unflavored
coffee beans, coffee beverages and a variety of related gifts, supplies and
accessories.
As a result of the acquisition, Coffee People stockholders will receive in the
aggregate for their shares:
- $23.0 million in cash; and
- 1.5 million shares of Diedrich Coffee common stock.
The completion of this equity offering is contingent upon the acquisition's
completion. The acquisition's completion is subject to a number of conditions,
including the approval of the Diedrich Coffee and Coffee People stockholders and
completion of the acquisition of Coffee People by July 15, 1999. These
stockholder approvals will be obtained and the acquisition will be completed
immediately before the completion of this equity offering.
------------------------
We are a Delaware corporation. Our principal executive offices are located
at 2144 Michelson Drive, Irvine, California 92612, and our telephone number is
(949) 260-1600.
5
<PAGE> 6
THE OFFERING
Common stock offered by Diedrich
Coffee................................ 4,600,000 shares
Common stock outstanding after this
offering.............................. 12,273,538 shares(1)
Over-allotment option................. 690,000 shares
Use of proceeds....................... We intend to use the estimated net
proceeds of approximately $25.1
million as follows:
- $23.0 million to finance the cash
payment to Coffee People
stockholders in the acquisition;
and
- the remaining proceeds for general
corporate purposes. See "Use of
Proceeds."
Nasdaq National Market symbol......... DDRX
- -------------------------
(1) Based on 6,173,538 shares outstanding as of June 29, 1999 and 1,500,000
shares to be issued to Coffee People stockholders in connection with the
acquisition of Coffee People. Excludes 2,174,267 shares of common stock
reserved for issuance upon the exercise of options outstanding at a weighted
average exercise price of $6.17 per share, 850,000 shares of common stock
issuable upon the exercise of outstanding warrants at an exercise price of
$2.25 per share, 70,000 shares of common stock issuable upon the exercise of
outstanding warrants at an exercise price of $5.625 per share and 192,417
shares of common stock remain available for new grants under our stock
option plans.
6
<PAGE> 7
SUMMARY FINANCIAL DATA
We are providing the following financial information to aid you in your
analysis of your investment in Diedrich Coffee common stock. This information is
only a summary and you should read it in conjunction with the historical
financial statements and related notes contained in this document.
SUMMARY UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL INFORMATION
The acquisition of Coffee People will be accounted for as a purchase
transaction, which means that the purchase price will be allocated to assets
acquired and liabilities assumed based on their estimated fair values at the
time Diedrich Coffee and Coffee People are combined. We are providing the
following financial information to aid you in your analysis of the financial
aspects of the acquisition and this offering.
We have presented unaudited pro forma combined condensed statements of
operations and operating data for Diedrich Coffee's fiscal year ended January
27, 1999 and fiscal quarter ended April 28, 1999 that assumes the acquisition of
Coffee People was completed and the new debt was issued on January 29, 1998. For
the fiscal year ended January 27, 1999, we also assume that the merger between
Coffee People and Gloria Jean's occurred on December 13, 1997. We derived this
information from the audited financial statements for Diedrich Coffee for the
fiscal year ended January 27, 1999 and unaudited statements of operations and
operating data for Diedrich Coffee for the 13 weeks ended April 28, 1999, and
for Coffee People for the 52 weeks ended December 12, 1998 and the 12 weeks
ended March 6, 1999. Following this offering, we intend to change our fiscal
year to the 52 or 53 week period ending on the Wednesday closest to June 30 of
each year.
We have also presented unaudited pro forma combined condensed balance sheet
data as of April 28, 1999. This presentation assumes that the acquisition of
Coffee People has been completed, that the new debt has been issued and reflects
the sale of shares in this offering and the application of the net proceeds. We
derived this information from Diedrich Coffee's balance sheet data as of April
28, 1999 and Coffee People's balance sheet data as of March 6, 1999.
This information is only a summary of the unaudited pro forma combined
condensed financial information presented in pages 23 through 28 and should be
read in conjunction with our historical financial statements and related notes.
Although this pro forma financial information has been prepared based on
currently available information using assumptions we believe are appropriate,
you should note that this information may not be indicative of what actual
results would be in the future or would have been for the periods presented. You
should read the notes to the unaudited pro forma combined condensed financial
statements for further discussion of the assumptions we made to prepare this
information.
The unaudited pro forma combined financial data does not reflect certain
cost savings that management believes may be realized after the acquisition.
7
<PAGE> 8
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR FISCAL YEAR FOR FISCAL QUARTER
ENDED JANUARY 27, 1999 ENDED APRIL 28, 1999
ADJUSTED FOR THE ACQUISITION ADJUSTED FOR THE ACQUISITION
---------------------------- ----------------------------
<S> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Total revenues...................................... $ 77,311 $18,837
Acquisition and integration expenses................ 1,236 151
Depreciation and amortization....................... 4,203 857
Income (loss) from continuing operations............ (4,182) 82
Net loss............................................ $ (3,736) $ (240)
Weighted average shares outstanding -- basic and
diluted........................................... 12,034 12,273
Loss from continuing operations per common and
equivalent share.................................. $ (0.31) $ (0.02)
OPERATING DATA:
Retail locations open (at end of period):
Company-operated locations........................ 108 105
Franchised locations.............................. 258 257
-------- -------
Total retail locations..................... 366 362
======== =======
Systemwide sales(1):
Company-operated locations........................ $ 52,159 $12,555
Franchised locations.............................. 94,330 25,344
-------- -------
Total systemwide sales..................... $146,489 $37,899
======== =======
Wholesale revenues.................................. $ 18,797 $ 4,342
</TABLE>
<TABLE>
<CAPTION>
APRIL 28, 1999
--------------
AS ADJUSTED(3)
--------------
<S> <C>
BALANCE SHEET DATA:
Working capital(2).......................................... $ 7,723
Total assets................................................ 61,632
Long-term debt and capital lease obligations, less current
portion................................................... 10,643
Total stockholders' equity.................................. $39,560
</TABLE>
- -------------------------
(1) Consists of retail sales from company-operated retail locations and reported
sales from franchised locations.
(2) Working capital is defined as current assets less current liabilities
derived from the unaudited pro forma combined condensed balance sheet.
(3) Reflects the sale of 4,600,000 shares of common stock offered at the public
offering price of $6.00 per share after deducting the estimated underwriting
discounts and commissions and estimated offering expenses payable by us.
Please see "Use of Proceeds" for information regarding our anticipated use
of the proceeds of this offering and "Capitalization" for information
regarding our capitalization following this offering.
8
<PAGE> 9
DIEDRICH COFFEE FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR FISCAL YEARS ENDED FOR FISCAL QUARTERS ENDED
------------------------------------------------------ -------------------------------
JANUARY 29, 1997 JANUARY 28, 1998 JANUARY 27, 1999 APRIL 29, 1998 APRIL 28, 1999
---------------- ---------------- ---------------- -------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Total revenues...................... $19,812 $22,982 $24,215 $ 5,923 $ 6,098
Provision for asset impairment and
restructuring costs............... -- (3,902) -- -- --
Depreciation and amortization....... 1,054 1,785 1,941 482 507
Income (loss) from continuing
operations........................ (1,028) (8,907) (2,265) (649) (470)
Net income (loss)................... $ (986) $(9,113) $(2,562) $ (746) $ (568)
Weighted average shares
outstanding -- basic and
diluted........................... 4,414 5,393 5,934 5,801 6,173
Earnings (loss) per share -- basic
and diluted(1).................... $ (0.22) $ (1.69) $ (0.43) $ (0.13) $ (0.09)
OPERATING DATA (UNAUDITED):
Retail locations open (at end of
period):
Company-operated locations........ 47 41 43 43 40
Franchised locations.............. -- -- -- -- 2
------- ------- ------- ------- -------
Total retail locations.... 47 41 43 43 42
======= ======= ======= ======= =======
Systemwide sales(2):
Company-operated locations........ $18,118 $20,760 $21,248 $ 5,285 $ 5,190
Franchised locations.............. -- -- -- -- 200
------- ------- ------- ------- -------
Total systemwide sales.... $18,118 $20,760 $21,248 $ 5,285 $ 5,390
======= ======= ======= ======= =======
Wholesale revenues.................. $ 1,695 $ 2,222 $ 2,767 $ 638 $ 858
</TABLE>
<TABLE>
<CAPTION>
APRIL 28, 1999
--------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (UNAUDITED):
Total assets................................................................................................. $12,628
Long-term debt and capital leases.......................................................................... 2,759
Total stockholders' equity................................................................................. $ 5,460
</TABLE>
- -------------------------
(1) Net loss per share for fiscal 1997, 1998 and 1999 is presented as basic
earnings per share under the provisions of SFAS 128.
(2) For the fiscal quarter ended April 28, 1999, systemwide sales consist of
retail sales from company-operated retail locations and reported sales from
franchised coffeehouses. As the first Diedrich Coffee franchised coffeehouse
location opened after January 27, 1999, systemwide sales consist of retail
sales from company-operated retail locations for the other periods
presented.
9
<PAGE> 10
COFFEE PEOPLE FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE
-------------------------------------------------------------------------
PRO FORMA(1)
39 WEEKS 52 WEEKS 52 WEEKS 36 WEEKS 36 WEEKS 52 WEEKS
ENDED ENDED ENDED ENDED ENDED ENDED
JUNE 29, JUNE 28, JUNE 27, MARCH 7, MARCH 6, DECEMBER 12,
1996 1997 1998 1998 1999 1998
-------- -------- -------- ----------- ----------- ------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Total revenues................... $24,957 $ 30,579 $ 35,051 $25,495 $40,129 $ 53,096
Acquisition and integration
expense........................ -- -- 437 -- 950 1,236
Depreciation and amortization.... 978 1,152 1,811 1,109 1,152 --
Income (loss) from operations.... 1,986 (1,185) 1,197 3,310 986 (1,467)
Net income (loss)................ $ 1,224 $ (1,190) $ 738 $ 2,005 $ 400 $ (1,212)
Weighted average shares
outstanding -- basic and
diluted........................ 7,461 7,461 7,812 7,461 10,755 10,764
Earnings (loss) per share-basic
and diluted.................... $ 0.16 $ (0.16) $ 0.09 $ 0.27 $ 0.04 $ (0.11)
OPERATING DATA (UNAUDITED):
Retail locations open (at end of
period):
Company-operated locations..... 23 31 69 26 65 65
Franchised locations........... 224 236 246 254 255 258
------- -------- -------- ------- ------- --------
Total retail
locations............ 247 267 315 280 320 323
======= ======== ======== ======= ======= ========
Systemwide sales(2):
Company-operated locations..... $ 6,657 $ 7,631 $ 11,436 $ 6,891 $22,429 $ 30,911
Franchised locations........... 73,247 94,434 95,349 70,980 70,483 94,330
------- -------- -------- ------- ------- --------
Total systemwide
sales................ $79,904 $102,065 $106,785 $77,871 $92,912 $125,241
======= ======== ======== ======= ======= ========
Wholesale revenues............... 13,329 17,079 17,580 14,020 12,944 16,030
</TABLE>
<TABLE>
<CAPTION>
MARCH 6,
1999
------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (UNAUDITED):
Total assets.............................................................................. $ 54,288
Long-term debt............................................................................ 2,727
Total stockholders' equity................................................................ $ 43,919
</TABLE>
- -------------------------
(1) The pro forma information is presented as if the merger between Coffee
People and Gloria Jean's had been completed on December 13, 1997.
(2) Consists of retail sales from company-operated retail locations and reported
sales from franchised locations.
10
<PAGE> 11
RISK FACTORS
You should consider carefully the following risks before you decide to buy
our common stock. Our business, financial condition and results of operations
could be materially and adversely affected by any of the following risks.
IF WE ARE NOT ABLE TO SUCCESSFULLY MANAGE OUR GROWTH STRATEGY, OUR BUSINESS AND
RESULTS OF OPERATIONS MAY BE ADVERSELY IMPACTED
As of June 1, 1999, we operated 39 retail locations, which we managed on a
day-to-day basis, and had 2 franchised retail locations. We are acquiring 26
Coffee People brand retail locations, 14 Coffee Plantation retail locations and
280 Gloria Jean's retail locations. The Gloria Jean's retail locations are
predominantly franchised and located in malls. Our growth strategy contemplates
franchise area development for additional Diedrich coffeehouses as well as
opening new company-operated coffeehouses. In addition, we plan to continue
single store franchise development for Gloria Jean's and to increase wholesale
sales for both Diedrich Coffee and Gloria Jean's. Implementation of our growth
strategy may divert management's attention from other aspects of our business
and place a strain on management, operational and financial resources, and
accounting systems. Our continued growth will require us to:
- attract franchise area developers for Diedrich Coffee in the United
States and internationally;
- attract single store franchisees for Gloria Jean's in the United States
and internationally;
- continue to upgrade products and programs at Gloria Jean's;
- expand wholesale sales of Diedrich Coffee and Gloria Jean's;
- evaluate the potential acquisition of complementary coffee retailers;
- 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 brewed coffee in a customer's hand.
Should our franchisees encounter business or operational difficulties,
anticipated revenues from franchise fees, including royalties, and product sales
to franchisees could be adversely affected. These adverse results could also
affect our ability to sell additional franchises.
HISTORICAL LOSSES MAY CONTINUE AND, AS A RESULT, THE PRICE OF OUR COMMON STOCK
MAY BE NEGATIVELY AFFECTED
We had a net loss of $568,000 for the fiscal quarter ended April 28, 1999
and net losses of $2,562,000, $9,113,000, and $986,000 for the fiscal years
ended January, 1999, 1998 and 1997, respectively. Coffee People reported net
income of $400,000 for the 3 fiscal quarters ended March 6, 1999, net income of
$738,000 for the fiscal year ended June 27, 1998, and a net loss of $1,190,000
for the fiscal year ended June 28, 1997. We expect to sustain net losses for the
foreseeable future for the combined operations of Diedrich Coffee and Coffee
People. As a combined operation, we may never achieve profitability. Although
our revenues have grown in recent quarters, we may not be able to sustain these
growth rates. In addition, such growth rates are not necessarily indicative of
future growth. See "Diedrich Coffee Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Coffee People Management's
Discussion and Analysis of Financial Condition and Results of Operations."
11
<PAGE> 12
OUR GROWTH THROUGH FRANCHISE AREA DEVELOPMENT MAY NOT OCCUR AS RAPIDLY AS WE
CURRENTLY ANTICIPATE
We must continue to execute new franchise area development agreements with
franchisees in order to achieve the objective of our growth strategy to expand
our operations to 1,200 to 1,500 coffeehouses over the next 5 to 7 years. On
September 16, 1998, we announced our first franchise area development agreement
providing for the development of 44 coffeehouses and a number of carts and
kiosks over a 5 year period. Since that date, we have entered into 4 additional
franchise area development agreements providing for the development of 230
coffeehouses. To date, no coffeehouses have opened under the franchise area
development agreements. Our ability to attract, retain and contract with
qualified franchise operators will become increasingly important to our
operations as we expand. In addition, the coffeehouses contemplated in executed
franchise area development agreements may not open on the anticipated
development schedule. Our franchise area development strategy may not enhance
our results of operations. Failure to execute on our strategy to grow through
franchise area development will harm our business, financial condition and
results of operations.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, WHICH COULD HAVE A NEGATIVE
EFFECT ON THE PRICE OF OUR COMMON STOCK
Our operating results will fluctuate from quarter to quarter as the result
of a number of factors, including:
- fluctuations in prices of unroasted coffee;
- labor costs for our hourly and management personnel, including increases
in federal or state minimum wage requirements;
- the number, timing, mix and cost of coffeehouse and mall coffee store
openings, franchises, acquisitions or closings;
- comparable store sales results;
- the timing of realizing amortization and other expenses associated with
acquisitions;
- changes in consumer preferences; and
- the level of competition from existing or new competitors in the
specialty coffee industry.
We incur significant pre-opening expenses associated with our company-owned
coffeehouses and new coffeehouses experience an initial period of operating
losses. As a result, the opening of a significant number of company-owned
coffeehouses in a single period will have an adverse effect on our results of
operations. Due to the foregoing, we believe that period-to-period comparisons
of our operating results are not necessarily meaningful and such comparisons
should not be relied upon as indicators of future performance. From time to time
in the future, our operating results likely will fall below the expectations of
investors and public market securities analysts. Quarterly fluctuations, for any
reason, could cause our stock price to decline.
In addition, our business is subject to seasonal fluctuations. The December
holiday season generally experiences the highest sales. Hot weather tends to
depress sales of hot coffee and espresso drinks, especially unseasonably warm
weather. Consequently, we will continue to experience significant fluctuations
in quarterly results. See "Diedrich Coffee Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Seasonality and Quarterly
Results" and "Coffee People Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Seasonality."
WE MAY EXPERIENCE DIFFICULTIES INTEGRATING COFFEE PEOPLE AFTER THE ACQUISITION
We may experience difficulties integrating our operations with those of
Coffee People, and there can be no assurance that we will realize the operating
efficiencies and cost savings that we believe the acquisition will provide.
After the acquisition's completion, we intend to integrate, among other things,
roasting, packaging, purchasing, product development, information systems and
administrative functions
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<PAGE> 13
with those of Coffee People. The integration of the combined operations may
temporarily distract management from the day-to-day business of the combined
company after the acquisition. For example, Coffee People's integration will
require the experience and expertise of certain key managers of Coffee People
whom we expect to retain. There is no assurance that these Coffee People
managers will remain with us for the time period necessary to successfully
integrate Coffee People's operations. We expect to incur restructuring and
integration costs from combining Coffee People's operations with ours. These
costs may be substantial and may include costs for employee severance,
relocation and disposition of excess equipment and other acquisition-related
costs. We have not yet determined the total amount of these costs.
WE MAY BE REQUIRED TO SPEND MORE OF OUR CASH RESERVES BECAUSE OF THE ACQUISITION
THAN WE ANTICIPATED
Even if we are able to successfully integrate the operations of Coffee
People, there is no assurance that such integration will result in the
realization of the full benefits of the cost savings, efficiencies or revenue
enhancements that we currently expect or that such benefits will be achieved
within the time frame that we currently anticipate. The cost savings and other
benefits from the acquisition may be offset by costs incurred in integrating
Coffee People's operations, as well as by increases in other expenses, by
operating losses or by problems in the business unrelated to the acquisition.
WE MAY LOSE CUSTOMERS WHEN WE CONVERT COFFEE PEOPLE AND COFFEE PLANTATION BRAND
COFFEEHOUSES TO THE DIEDRICH COFFEE BRAND
Most Coffee People brand and Coffee Plantation retail locations are
neighborhood coffeehouses, which have loyal customers that are accustomed to and
expect Coffee People and Coffee Plantation brand products. We may lose these
customers when we convert the coffeehouses to the Diedrich Coffee brand.
THE LOSS OF KEY PERSONNEL OR OUR INABILITY TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL COULD SIGNIFICANTLY DISRUPT OUR BUSINESS
Our continued success largely will depend on the efforts and abilities of
our executive officers and other key employees, 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. See
"Management -- Executive Compensation -- Employment Agreements and Compensatory
Arrangements."
In addition, our success and the success of our franchisees will depend
upon our and their ability to attract and retain highly motivated,
well-qualified retail operators and other management personnel, as well as a
sufficient number of qualified employees. Qualified individuals needed to fill
these positions are in short supply in some geographic areas. Our inability to
recruit and retain such individuals may delay the planned openings of new retail
locations or result in higher employee turnover in existing retail locations,
which could have a material adverse effect on our business or results of
operations.
THE VALUE OF OUR STOCK AFTER THE ACQUISITION AND THIS OFFERING COULD CONTINUE TO
BE VOLATILE
The trading price of our common stock has fluctuated significantly in the
past. Often, these fluctuations have been greater than those experienced by the
stock market in general. The trading price of our common stock after the
acquisition and this offering is likely to continue experiencing wide price
fluctuations in response to factors such as:
- actual or anticipated variations in revenues or operating results;
- comments or recommendations issued by analysts who follow us and our
competitors;
- failure to meet analysts' expectations of performance; and
- our ability to execute our franchising strategy.
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<PAGE> 14
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, including new coffeehouse construction and
franchising, we will need to incur debt or issue additional stock in public or
private financings. If additional funds are raised through the issuance of
stock, dilution to stockholders may result. If additional funds are raised
through the incurrence of debt, these debt instruments will likely contain
restrictive financial, maintenance and security covenants, which could have a
material adverse effect on our business, financial condition and results of
operations. This additional financing may not be available at all or on terms
satisfactory to us.
OUR INDUSTRY IS HIGHLY COMPETITIVE AND WE MAY NOT HAVE THE RESOURCES TO COMPETE
EFFECTIVELY
The highly competitive nature of the retail specialty coffee market could
adversely affect our business and financial condition. With low barriers to
entry, competition in the industry is expected to increase from national and
regional chains, franchise operators and local specialty coffee stores. We
compete directly against all other premium coffee roasters, coffeehouses,
espresso/coffee bars and mall coffee stores, as well as against restaurant and
beverage outlets that serve coffee and a growing number of espresso stands,
carts and stores. In addition, we compete to draw consumers of standard or
commercial coffee to premium coffee. Our whole bean coffees compete directly
against specialty coffees sold at retail through supermarkets, specialty
retailers and a growing number of specialty coffee stores. We believe that our
customers choose among retailers primarily on the basis of product quality,
service, coffeehouse ambiance, convenience and, to a lesser extent, on price.
We compete with a growing number of specialty coffee retailers including
Starbucks, Seattle's Best Coffee, Barnie's, Coffee Beanery Ltd., Caribou, Peet's
Coffee and many others. The attractiveness of the gourmet specialty coffeehouse
market may draw additional competitors with substantially greater financial,
marketing and operating resources than us. A number of nationwide coffee
manufacturers, such as Kraft General Foods, Proctor & Gamble and Nestle,
distribute coffee products in supermarkets and convenience stores, which may
serve as substitutes for our coffees. Other specialty coffee companies including
Starbucks, Seattle's Best Coffee, Bucks County, Brothers Gourmet Coffees and
Green Mountain Coffee Roasters, sell whole bean coffees in supermarkets and
variety and discount stores.
The performance of individual coffeehouses or mall coffee stores may also
be affected by factors such as traffic patterns and the type, number and
proximity of competing coffeehouses or mall coffee stores. In addition, factors
such as inflation, increased coffee bean, food, labor and employee benefit costs
and the availability of experienced management and hourly employees may also
adversely affect the specialty coffee retail business in general and our
coffeehouses and mall coffee stores in particular.
OUR LACK OF DIVERSIFICATION MAY AFFECT BUSINESS IF DEMAND IS REDUCED
Our business is primarily centered on one product: fresh premium
custom-roasted coffee. To date, our operations have been limited to primarily
the purchase and roasting of green coffee beans and the sale of whole bean
coffee, coffee beverages and espresso drinks through our coffeehouses and our
wholesale coffee and mail order businesses. Any decrease in demand for coffee
would have a material adverse effect on our business, operating results and
financial condition.
SOME STOCKHOLDERS WILL CONTINUE TO INFLUENCE MATTERS AFFECTING US, WHICH MAY
CONFLICT WITH YOUR INTERESTS
Our current directors and officers beneficially own approximately 58% of
our outstanding shares of common stock before the acquisition and this offering.
After giving effect to the acquisition and this offering, these stockholders
will own approximately 33% of the voting power of our outstanding common stock,
depending on the number of shares sold in this offering and issued to Coffee
People stockholders in the acquisition. In addition, The Second Cup Ltd, which
is the majority stockholder of Coffee People, will receive approximately
1,039,500 shares of our common stock in connection with the acquisition of
Coffee People. After giving effect to the acquisition and this offering, this
will represent approximately 8% of our
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<PAGE> 15
outstanding shares of common stock. As a result of this stock ownership, these
stockholders may act in concert and continue to influence the vote on all
matters submitted to a vote of our stockholders, including the election of
directors, amendments to the certificate of incorporation and the by-laws and
approval of significant corporate transactions. See "Description of Capital
Stock." This consolidation of voting power could also delay, deter or prevent a
change-in-control of Diedrich Coffee that might be otherwise beneficial to
stockholders.
OUR COMPANY-OPERATED RETAIL LOCATIONS ARE CONCENTRATED IN THE WESTERN REGION OF
THE UNITED STATES, AND THEREFORE OUR BUSINESS IS SUBJECT TO FLUCTUATIONS IF
ADVERSE BUSINESS CONDITIONS OCCUR IN THAT REGION
After the acquisition, our company-operated retail locations will be
primarily located in the western region of the United States. Accordingly, we
are susceptible to fluctuations in our business caused by adverse economic or
other conditions in this region, including natural or other disasters. In
addition, some of our competitors have many more retail locations than we do.
Consequently, adverse economic or other conditions in a region, a decline in the
profitability of several existing retail locations or the introduction of
several unsuccessful new retail locations in a geographic area could have a more
significant effect on our results of operations than would be the case for a
company with a larger number of retail locations or with more geographically
dispersed retail locations.
OUR SUPPLY COSTS MAY BE HIGHER THAN WE EXPECT BECAUSE OF FLUCTUATIONS IN
AVAILABILITY AND COST OF UNROASTED COFFEE
Increases in the price of green coffee, or the unavailability of adequate
supplies of green coffee of the quality we seek, whether due to the failure of
our suppliers to perform, conditions in coffee-producing countries, or
otherwise, could have a material adverse effect on our results of operations. We
depend upon both outside brokers and our direct contacts with exporters and
growers in countries of origin for our supply of green coffee. Coffee supply and
price are subject to significant volatility beyond our control. Although most
coffee trades in the commodity market, coffee of the quality we seek tends to
trade on a negotiated basis at a substantial premium above commodity coffee
pricing, depending upon the origin, supply and demand at the time of purchase.
Supply and price can be affected by multiple factors in the producing countries,
including weather, political and economic conditions. In addition, green coffee
prices have been affected in the past, and may be affected in the future, by the
actions of certain organizations and associations, such as the International
Coffee Organization or the Association of Coffee Producing Countries. These
organizations have historically attempted to establish commodity price controls
of green coffee through agreements establishing export quotas or restricting
coffee supplies worldwide. These organizations, or others, may succeed in
raising green coffee prices. Should this happen, we may not be able to maintain
our gross margins by raising prices without affecting demand.
WE COULD BE SUBJECT TO ADVERSE PUBLICITY OR CLAIMS FROM OUR GUESTS
We may be the subject of complaints or litigation from guests alleging
beverage and food-related illness, injuries suffered on the premises or other
quality, health or operational concerns. Adverse publicity resulting from such
allegations may materially adversely affect us, regardless of whether such
allegations are true or whether we are ultimately held liable. We may also be
the subject of complaints or allegations from current, former or prospective
employees from time-to-time. A lawsuit or claim could result in an adverse
decision against us that could have a material adverse effect on our business,
financial condition and results of operations.
CHANGES IN CONSUMER PREFERENCES OR DISCRETIONARY SPENDING COULD NEGATIVELY
AFFECT OUR RESULTS
Our retail locations offer specialty coffee beans, brewed coffee beverages,
espresso-based beverages, blended drinks and light food items served in a casual
setting. Our continued success depends, in part, upon the popularity of these
types of coffee-based beverages and this style of casual dining. Shifts in
consumer preferences away from our coffee-based beverages or casual setting
could materially adversely affect our future profitability. Also, our success
depends to a significant extent on numerous factors
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<PAGE> 16
affecting discretionary consumer spending, including economic conditions,
disposable consumer income and consumer confidence. Adverse changes in these
factors could reduce guest traffic or impose practical limits on pricing, either
of which could adversely affect our business, financial condition, operating
results and cash flows.
WE MAY NOT BE ABLE TO RENEW LEASES OR CONTROL RENT INCREASES AT OUR RETAIL
LOCATIONS
Following the acquisition, all but 2 of our 78 company-operated
coffeehouses are on leased premises. Gloria Jean's stores are generally leased
by an indirect subsidiary of Coffee People and, in most cases, the franchisees
pay their rent directly to their landlord. Upon the expiration of some of these
leases, there is no automatic renewal or option to renew. Consequently, these
leases may not be renewed. If they are renewed, rents may increase
substantially. Either of these events could adversely affect us. Other leases
are subject to renewal at fair market value, which could involve substantial
rent increases, or are subject to renewal with scheduled rent increases, which
could result in rents being above fair market value.
SUBSTANTIAL SALES OF OUR COMMON STOCK COULD ADVERSELY AFFECT ITS MARKET PRICE
We cannot predict the effect, if any, that future sales of shares of our
common stock or the availability of such shares for future sale will have on its
market price from time-to-time. Sales of substantial amounts of our common
stock, or the perception that such sales could occur, could adversely affect
prevailing market prices for our stock.
OUR FAILURE OR INABILITY TO ENFORCE OUR TRADEMARKS AND TRADE NAMES COULD
ADVERSELY AFFECT OUR EFFORTS TO ESTABLISH BRAND EQUITY
Our ability to successfully expand our concept will depend in part on our
ability to maintain "brand equity" through the use of our trademarks, service
marks, trade dress and other proprietary intellectual property, including our
name and logos. We currently hold a number of trademarks and service marks
related to our brands. Some or all of our rights related to our intellectual
property may not be enforceable, even if registered, against any prior users of
similar intellectual property or our competitors who seek or intend to utilize
similar intellectual property in areas where we operate or intend to conduct
operations. If we fail to enforce our intellectual property rights, we may be
unable to capitalize on our efforts to maintain brand equity. It is possible
that we will encounter claims from prior users of similar intellectual property
in areas where we operate or intend to conduct operations, including foreign
countries. Claims from prior users could limit our operations and possibly cause
us to pay damages or licensing fees to a prior user or registrant of similar
intellectual property. See "Business -- Intellectual Property."
FUTURE CHANGES IN MINIMUM WAGE REQUIREMENTS COULD ADVERSELY AFFECT OUR BUSINESS,
FINANCIAL CONDITION, RESULTS OF OPERATIONS OR CASH FLOWS
A number of our employees are subject to various minimum wage requirements.
Many of our employees work in retail locations located in California and receive
salaries equal to the California minimum wage. The minimum wage in California
rose from $5.00 per hour effective March 1, 1997 to $5.75 per hour effective
March 1, 1998. Additionally, the minimum wage in Oregon recently rose to $6.50
per hour. There can be no assurance that similar increases will not be
implemented in these or other jurisdictions in which we operate or seek to
operate. In addition, the federal minimum wage increased to $5.15 per hour
effective September 1, 1997. There can be no assurance that we will be able to
pass additional increases in labor costs through to our guests in the form of
price adjustments and, accordingly, such minimum wage increases could have a
material adverse effect on our business, financial condition, results of
operations or cash flows.
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<PAGE> 17
COMPLIANCE WITH HEALTH, FRANCHISING AND OTHER GOVERNMENT REGULATIONS APPLICABLE
TO US COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Each retail location and roasting facility is and will be subject to
licensing and reporting requirements by numerous governmental authorities. These
governmental authorities include federal, state and local health, environmental,
labor relations, sanitation, building, zoning, fire, safety and other
departments relating to the development and operation of retail locations. Our
activities are also subject to the Americans with Disabilities Act and related
regulations, which prohibit discrimination on the basis of disability in public
accommodations and employment. Changes in any or all of these laws or
regulations could have a material adverse effect on our business, financial
condition and results of operations. Delays or failures in obtaining or
maintaining required construction and operating licenses, permits or approvals
could delay or prevent the opening of new retail locations or could materially
and adversely affect the operation of existing retail locations. In addition, we
may not be able to obtain necessary variances or amendments to required
licenses, permits or other approvals on a cost-effective and timely basis in
order to construct and develop retail locations in the future.
We are also subject to federal regulation and certain foreign and state
laws that govern the offer and sale of franchises and the franchisor-franchisee
relationship. Many foreign and state franchise laws impose substantive
requirements on franchise agreements, including limitations on noncompetition
provisions and on provisions concerning the termination or nonrenewal of a
franchise. Some foreign countries and states require companies to register
certain materials before franchises can be offered or sold in that country or
state. The failure to obtain or retain licenses or registration approvals to
sell franchises could delay or preclude franchise sales and otherwise adversely
affect our business, financial condition and results of operations.
Additionally, any franchise law violations may give existing and future
franchisees a basis to bring claims against the company. Franchise law violation
claims could include unfair business practices, negligent misrepresentation,
fraud, and statutory franchise investment and/or relationship violations.
Remedies may include damages and/or rescission of the franchise agreement by the
franchisee. Coffee People has not always been in technical compliance with a
number of state, federal and foreign franchise laws. Claims against us may
already exist and their assertion could adversely affect our business, financial
condition, and results of operations. See "Business -- Government Regulation."
GROWTH OF OUR INTERNATIONAL OPERATIONS MAY BE ADVERSELY AFFECTED BY FACTORS
OUTSIDE OF OUR CONTROL
As part of the Coffee People acquisition, we are acquiring 35 Gloria Jean's
franchised stores located outside of the United States and its territories. As
part of our growth strategy, we will be seeking franchise developers
internationally for Diedrich coffeehouses and Gloria Jean's stores. As a result,
our business and operations will be increasingly subject to the risk of changes
in economic conditions and, to a lesser extent, changes in social and political
conditions inherent in foreign operations, including changes in U.S. laws and
regulations relating to foreign trade and investment. In addition, consumer
tastes vary from region to region, and consumers located in the regions in which
we intend to expand our retail operations may not be as receptive to specialty
coffees as consumers in existing markets.
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<PAGE> 18
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 our and the combined company's
financial condition, operations, plans, objectives and performance.
Additionally, when we make statements about the acquisition, such as anticipated
cost savings or restructuring charges associated with the acquisition, we are
making forward-looking statements. When we use the words "believe," "expect,"
"anticipate," "estimate" or similar expressions, we are also making
forward-looking statements. Many possible events or factors could affect the
future financial results and performance of each of Diedrich Coffee and Coffee
People and the combined company after the acquisition. 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 make an
investment decision, along with the following possible events or factors:
- our growth strategy may not be as successful as we expect if we are
unable to attract franchise area developers or single store franchisees;
- our revenues after the acquisition could be lower than we expect, our
restructuring charges could be higher than we expect and our operating
costs could be greater than we expect;
- we may encounter difficulties and incur additional expenses integrating
Diedrich Coffee's and Coffee People's businesses, brands or operating
systems or retaining key personnel;
- competition within the retail specialty coffee market may intensify;
- inclement weather or adverse political changes may significantly increase
our coffee costs; and
- adverse changes may occur in the securities or financial markets.
In addition, this document contains forward-looking statements attributed
to third parties relating to their estimates regarding the specialty coffee
business. You should not place undue reliance on these forward-looking
statements.
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<PAGE> 19
THE COFFEE PEOPLE ACQUISITION
On March 16, 1999, we signed a merger agreement with Coffee People that
contemplates our acquisition of Coffee People. The common stock of Coffee People
is currently traded on the Nasdaq SmallCap Market under the symbol "MOKA." The
acquisition will be completed immediately before the completion of this equity
offering.
Coffee People operates 3 retail brands -- Gloria Jean's, Coffee People and
Coffee Plantation -- with 320 franchised and company-owned retail locations
throughout the United States and in 6 foreign countries. We intend to convert
Coffee People and Coffee Plantation coffeehouses to the Diedrich Coffee brand.
We do not intend to convert the Gloria Jean's brand to the Diedrich Coffee brand
in the near future. Rather, we intend to implement new strategies to strengthen
and reposition the Gloria Jean's brand within its market segment. Founded in
1979, the Gloria Jean's concept offers a recognized brand name with solid growth
potential. Gloria Jean's outlets generally offer a full range of flavored and
unflavored coffee beans, coffee beverages and a variety of related gifts,
supplies and accessories.
The acquisition will occur through a merger in which Coffee People will
become a wholly-owned subsidiary of Diedrich Coffee. As a result of the
acquisition, Coffee People stockholders will receive in the aggregate for their
shares:
- $23.0 million in cash; and
- 1.5 million shares of Diedrich Coffee common stock.
The completion of this equity offering is contingent upon the acquisition's
completion. The acquisition is subject to a number of conditions, including the
approval of the Diedrich Coffee and Coffee People stockholders and completion of
the acquisition of Coffee People by July 15, 1999. At the time of signing the
merger agreement, Second Cup Ltd. and some of Diedrich Coffee's directors,
officers and their affiliates agreed to vote the shares they own in favor of the
merger agreement and the transactions contemplated by it. Second Cup owns
approximately 69% of the outstanding Coffee People common stock through its
wholly-owned subsidiary. The Diedrich Coffee directors, officers and their
affiliates who signed the voting agreement own approximately 42% of the
outstanding Diedrich Coffee common stock.
Additionally, Second Cup has entered into a lock-up agreement with us that
restricts its ability to sell the shares of Diedrich Coffee common stock it will
receive in the acquisition for a period of time. Upon the expiration of that
period, we have agreed to grant Second Cup unlimited piggy-back registration
rights and two demand registration rights with respect to the shares it will
receive in the acquisition in order to mitigate the lock-up agreement's sale
restrictions and the impact of Second Cup's affiliate status.
Upon completion of the acquisition, we have agreed to create a vacancy on
the Diedrich Coffee board and appoint a director designated by Second Cup. Our
directors, officers and a significant stockholder have agreed to vote their
shares of Diedrich Coffee common stock in favor of Second Cup's designee at any
election of directors, for so long as Second Cup owns at least 50% of the shares
it will receive in the acquisition.
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USE OF PROCEEDS
We estimate the net proceeds from this offering, after deduction of
underwriting discounts and commissions and expenses of this offering, will be
approximately $25.1 million. We intend to use the net proceeds as follows:
- $23.0 million to finance the cash payment to Coffee People stockholders
in the acquisition; and
- the remaining proceeds for general corporate purposes.
Pending such uses, the net proceeds of this offering will be invested in
short-term interest-bearing securities.
PRICE RANGE OF DIEDRICH COFFEE COMMON STOCK
Diedrich Coffee common stock is reported on the Nasdaq National Market
under the symbol "DDRX." The following table sets forth the high and low sales
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 3/8
Third Quarter............................................. 4 1/16 2 7/16
Fourth Quarter............................................ 9 2 3/4
FISCAL YEAR ENDED JANUARY 27, 1999:
First Quarter............................................. $8 1/4 $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
FISCAL YEAR ENDING FEBRUARY 2, 2000:
First Quarter............................................. $6 7/8 $3 7/8
Second Quarter (through June 30, 1999).................... 7 1/8 4 3/4
</TABLE>
On June 30, 1999, there were 6,173,538 shares outstanding and 155
stockholders of record of our common stock. On June 30, 1999, the last reported
sale price of our common stock on the Nasdaq National Market was $7.00 per
share.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. We
do not expect to pay any cash dividends for the foreseeable future. We currently
intend to retain any future earnings to finance our growth. Any future
determination to pay cash dividends will be at the discretion of our board of
directors and will be dependent on earnings, financial condition, operating
results, capital requirements, any contractual restrictions and other factors
that our board deems relevant.
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CAPITALIZATION
The following table sets forth our capitalization as of April 28, 1999 on
an actual basis and as adjusted to give effect to the acquisition and the
receipt by us of the estimated net proceeds from the sale of 4,600,000 shares
offered at the public offering price of $6.00 per share. This information should
be read in conjunction with our consolidated financial statements and the notes
relating to such statements appearing elsewhere in this prospectus. This
information is based on the number of shares of common stock outstanding on
April 28, 1999. It excludes:
- 2,109,267 shares of common stock issuable upon the exercise of options
outstanding at a weighted average exercise price of $6.19 per share;
- 70,000 shares of common stock issuable upon the exercise of outstanding
warrants at an exercise price of $5.625 per share;
- 850,000 shares of common stock issuable upon the exercise of outstanding
warrants at an exercise price of $2.25 per share;
- 257,417 shares of common stock available for issuance under our stock
option plans; and
- 1,500,000 shares of common stock to be issued to Coffee People
stockholders in connection with the acquisition of Coffee People.
<TABLE>
<CAPTION>
APRIL 28, 1999
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents................................... $ 786 $ 6,194
======== ========
Long-term debt and capital lease obligations, less current
portion................................................... 2,759 10,643
======== ========
Stockholders' equity:
Common stock, $0.01 par value, 25,000,000 shares
authorized on an actual and adjusted basis; 6,173,538
shares issued and outstanding on an actual basis;
12,273,538 shares issued and outstanding on an as
adjusted basis......................................... 62 123
Additional paid-in capital.................................. 18,717 52,756
Accumulated deficit......................................... (13,319) (13,319)
-------- --------
Total stockholders' equity................................ 5,460 39,560
======== ========
Total capitalization................................. $ 8,219 $ 50,203
======== ========
</TABLE>
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DILUTION
Our net tangible book value as of April 28, 1999 was approximately $5.1
million, or $0.83 per share of common stock based on 6,173,538 shares of common
stock outstanding. Net tangible book value per share represents the amount of
our total tangible assets less total liabilities, divided by the number of
shares of common stock outstanding as of April 28, 1999. Assuming the sale by us
of the 4,600,000 shares offered at the offering price of $6.00 per share and
after deducting underwriting discounts and estimated offering expenses, and the
application of the estimated net proceeds and after giving effect to the
acquisition, our pro forma net tangible book value as of April 28, 1999 would
have been $21.6 million, or $1.76 per share of common stock. This represents an
immediate increase in net tangible book value of $0.93 per share to existing
stockholders and an immediate dilution in the pro forma net tangible book value
of $4.24 per share to new investors. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share............................. $6.00
Pro forma net tangible book value per share before this
offering............................................... $ 0.83
Increase attributable to the acquisition and offering..... 0.93
-------
Pro forma net tangible book value per share after the
acquisition and this offering............................. 1.76
-----
Pro forma dilution per share to new investors............... $4.24
=====
</TABLE>
The following table summarizes the differences as of April 28, 1999, on a
pro forma basis giving effect to the acquisition, between the total
consideration paid and the average price per share paid by the existing
stockholders and the new investors with respect to the number of shares of
common stock purchased from Diedrich Coffee based on the public offering price
of $6.00 per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
-------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders.................. 6,173,538 50.3% $18,778,687 33.9% $3.04
New investors.......................... 6,100,000 49.7 36,600,000 66.1 $6.00
---------- ----- ----------- -----
Total........................ 12,273,538 100.0% $55,378,687 100.0%
========== ===== =========== =====
</TABLE>
We expect there to be 12,273,538 shares of common stock outstanding after
the offering. The tables and calculations above assume no exercise of
outstanding options or warrants unless otherwise set forth in this prospectus.
On April 28, 1999, there were:
- 2,109,267 shares issuable upon the exercise of options outstanding at a
weighted average exercise price of $6.19 per share;
- 70,000 shares of common stock issuable upon the exercise of outstanding
warrants at an exercise price of $5.625 per share;
- 850,000 shares issuable upon the exercise of outstanding warrants at an
exercise price of $2.25 per share;
- 257,417 shares of common stock available for issuance under our stock
option plans; and
- 1,500,000 shares of common stock to be issued to Coffee People
stockholders in connection with the acquisition of Coffee People.
To the extent that these options or warrants are exercised, there will be
further dilution to new investors. Please see "Management -- Benefit Plans" and
"-- Employment Agreements and Compensatory Arrangements" for a discussion of our
stock option plans.
22
<PAGE> 23
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL INFORMATION
The following tables present summary historical information for Diedrich
Coffee and Coffee People derived from financial statements. The acquisition of
Coffee People will be accounted for using the purchase method of accounting and,
accordingly, the assets acquired and liabilities assumed will be recorded at
their fair values as of the date of the acquisition, which are not expected to
differ significantly from historical costs. The excess of the purchase price
over the fair value of the assets acquired and liabilities assumed will be
recorded as goodwill. Diedrich Coffee's fiscal year is the 52 or 53 week period
that ends on the Wednesday closest to January 31 of each year. Coffee People's
fiscal year is the 52 or 53 week period that ends on the last Saturday in June
of each year. Following this offering, we intend to change our fiscal year to
the 52 or 53 week period that ends on the Wednesday closest to June 30 of each
year.
The unaudited pro forma combined condensed balance sheet as of April 28,
1999 gives effect to the acquisition of Coffee People by Diedrich Coffee as of
that date and reflects the sale of the shares in this offering and the
application of the net proceeds. The unaudited pro forma combined condensed
statement of operations for the fiscal year ended January 27, 1999 presents the
results for Diedrich Coffee and Coffee People as if the merger between Coffee
People and Gloria Jean's had occurred on December 13, 1997 and the acquisition
of Coffee People by Diedrich Coffee had occurred on January 29, 1998. This
presentation also reflects the issuance of the new debt and the application of
the net proceeds.
The unaudited pro forma combined condensed statement of operations for the
fiscal quarter ended April 28, 1999 presents the results for Diedrich Coffee and
Coffee People as if the acquisition of Coffee People by Diedrich Coffee had
occurred on January 28, 1999 and reflects the issuance of the new debt and the
sale of the shares in this offering and the application of the net proceeds.
This unaudited pro forma financial information presented is based on the
assumptions and adjustments described in the accompanying notes. The unaudited
pro forma statement of operations does not purport to represent what our results
of operations actually would have been if the events described above had
occurred as of the dates indicated or what such results would be for any future
periods. The unaudited pro forma financial statements are based upon assumptions
and adjustments that we believe are reasonable. The unaudited pro forma
financial statements, and the accompanying notes, should be read in conjunction
with the historical financial statements and related notes, included elsewhere
in this document. In addition, the unaudited pro forma combined condensed
financial information does not reflect certain cost savings that management
believes may be realized following the acquisition of Coffee People by Diedrich
Coffee. These savings are expected to be realized primarily through combining
the operations of the companies and implementing Diedrich Coffee's management
practices.
23
<PAGE> 24
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
APRIL 28, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
-------------------------------
DIEDRICH COFFEE COFFEE PEOPLE
APRIL 28, MARCH 6, PRO FORMA PRO FORMA
1999 1999 ADJUSTMENTS COMBINED
--------------- ------------- --------------- ------------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............. $ 786 $ 2,773 $ 2,635(1) $ 6,194
Accounts and notes receivable......... 396 3,149 -- 3,545
Inventories........................... 1,417 3,722 -- 5,139
Other current assets.................. 547 3,353 -- 3,900
------- ------- ------- -------
Total current assets.................. 3,146 12,997 2,635 18,778
Property and equipment, net............. 8,872 12,262 -- 21,134
Costs in excess of net assets of
business acquired, net................ 322 25,530 (7,919)(2) 17,933
Other assets............................ 288 3,499 -- 3,787
------- ------- ------- -------
Total assets.......................... $12,628 $54,288 $(5,284) $61,632
======= ======= ======= =======
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt and
capital lease obligations.......... $ 1,169 $ 1,356 $ 162(3) $ 2,687
Accounts payable and accrued
compensation....................... 1,217 3,622 -- 4,839
Other current liabilities............. 1,795 1,734 -- 3,529
------- ------- ------- -------
Total current liabilities............. 4,181 6,712 162 11,055
Capital lease obligations, less current
portion............................... 259 784 1,043
Long-term debt.......................... 2,500 2,727 4,373(3) 9,600
Other liabilities....................... 228 146 -- 374
Total stockholders' equity............ 5,460 43,919 (9,819)(4) 39,560
------- ------- ------- -------
Total liabilities and stockholders'
equity............................. $12,628 $54,288 $(5,284) $61,632
======= ======= ======= =======
</TABLE>
- -------------------------
(1) Pro forma adjustments to cash as a result of the acquisition, a new credit
facility and the offering are as follows:
<TABLE>
<CAPTION>
APRIL 28, 1999
--------------
<S> <C>
Cash received from this offering*........................... $ 25,100
Cash paid for acquisition+.................................. (23,000)
Cash received for new debt issued........................... 12,000
Cash paid to retire debt.................................... (7,465)
Transaction costs of acquisition............................ (4,000)
--------
Pro forma cash adjustment................................... $ 2,635
========
</TABLE>
------------------------------
* Represents estimated cash proceeds from this offering, assuming that
4,600,000 shares are issued at a public offering price of $6.00 per
share, less underwriting discounts, commissions and expenses of $2,500.
+ Represents purchase price excluding 1,500,000 shares issued to Coffee
People stockholders in the acquisition.
24
<PAGE> 25
(2) Reflects adjustments to assets and liabilities assumed based on their
estimated fair values under the purchase method of accounting. The
allocation of the aggregate purchase cost below is preliminary. The final
allocation will be based on appraisals and other studies that will be
completed after the acquisition's completion and management's final
evaluation of such assets and liabilities. Some portion of the excess of
purchase cost over the historical cost of the net assets acquired will
ultimately be allocated to specific tangible and intangible assets and
liabilities, including inventory, land, property and equipment, and deferred
taxes and liabilities. The final allocation of purchase cost and the
resulting effect on net income may differ significantly from the pro forma
amounts included herein.
<TABLE>
<CAPTION>
APRIL 28, 1999
--------------
<S> <C>
Purchase price*............................................. $ 32,000
Direct acquisition costs.................................... 4,000
--------
Total consideration and direct acquisition
costs........................................... 36,000
Less: historical cost of net assets acquired................ (43,919)
--------
Net adjustment.............................................. $ (7,919)
========
</TABLE>
---------------------------------
* The purchase price assumes a $6.00 per share price for our common
stock at the time of the acquisition.
(3) These adjustments record (i) the proceeds of a new $12,000 credit facility
and (ii) the use of a portion of the proceeds to repay existing
indebtedness. The table below reflects the financing transactions.
<TABLE>
<CAPTION>
APRIL 28, 1999
--------------
<S> <C>
Current:
Current portion of new debt issued.......................... $ 2,400
Current portion of debt retired............................. (2,238)
-------
Net current adjustment............................ $ 162
=======
Long-term:
Long-term portion of new debt issued........................ $ 9,600
Long-term portion of debt retired........................... (5,227)
-------
Net long-term adjustment.......................... $ 4,373
=======
</TABLE>
(4) Adjustments to stockholders' equity based on the pro forma capitalization of
Diedrich Coffee are as follows:
<TABLE>
<CAPTION>
APRIL 28, 1999
--------------
<S> <C>
Coffee People stockholders' equity*......................... $(43,919)
Stock issued in offering and acquisition+................... 34,100
--------
Pro forma equity adjustment................................. $ (9,819)
========
</TABLE>
---------------------------------
* Represents the elimination of Coffee People's common stock of $44,659,
stock subscription note redeemable of $350 and accumulated deficit of
$390.
+ Represents 4,600,000 shares issued in this offering at $6.00 per
share, less underwriting discounts, commissions and expenses of
$2,500, plus an additional 1,500,000 shares issued to Coffee People
stockholders in the acquisition at $6.00 per share.
25
<PAGE> 26
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE FISCAL YEAR ENDED JANUARY 27, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
HISTORICAL
-------------------------- PRO FORMA(2)
DIEDRICH COFFEE ADJUSTMENTS COFFEE ADJUSTMENTS
COFFEE PEOPLE TO COFFEE PEOPLE FOR
----------- ------------ PEOPLE ------------ ACQUISITION PRO FORMA
FISCAL YEAR 52 WEEKS HISTORICAL 52 WEEKS OF COFFEE COMBINED
ENDED ENDED FOR MERGER ENDED PEOPLE BY ADJUSTED FOR
JANUARY 27, DECEMBER 12, WITH GLORIA DECEMBER 12, DIEDRICH THE
1999 1998 JEAN'S(1) 1998 COFFEE ACQUISITION
----------- ------------ ------------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Total revenues..................... $24,215 $44,341 $8,755 $53,096 $ -- $77,311
Cost of sales and related occupancy
costs............................ 10,955 26,415 4,408 30,823 -- 41,778
Store operating expenses........... 8,936 11,275 2,972 14,247 -- 23,183
Other operating expenses........... 634 -- -- -- -- 634
Depreciation....................... 1,885 1,300 499 1,799 -- 3,684
Amortization....................... 56 587 156 743 (280)(3) 519
General and administrative
expenses......................... 4,014 4,760 955 5,715 -- 9,729
Acquisition and integration
expenses......................... -- 1,236 -- 1,236 -- 1,236
------- ------- ------ ------- ------ -------
Total costs and expenses....... 26,480 45,573 8,990 54,563 (280) 80,763
------- ------- ------ ------- ------ -------
Operating income (loss)............ (2,265) (1,232) (235) (1,467) 280 (3,452)
Interest (expense) and other
income........................... (293) (39) (156) (195) (242)(4) (730)
------- ------- ------ ------- ------ -------
Income (loss) from continuing
operations....................... (2,558) (1,271) (391) (1,662) 38 (4,182)
Income tax provision (benefit)..... 4 (450) -- (450) -- (446)
------- ------- ------ ------- ------ -------
Net income (loss).................. $(2,562) $ (821) $ (391) $(1,212) $ 38 $(3,736)
======= ======= ====== ======= ====== =======
Basic and diluted loss per common
share............................ $ (0.43) $ (0.31)
Weighted average number of common
shares outstanding............... 5,934 12,034
</TABLE>
- -------------------------
(1) These pro forma adjustments represent the results of operations from
December 13, 1997 through May 19, 1998 for Coffee People (Oregon) and Coffee
Plantation which were merged with Gloria Jean's on May 19, 1998.
(2) The pro forma information is as if the merger between Coffee People and
Gloria Jean's had been completed on December 13, 1997.
(3) Represents the reduction in amortization of goodwill based on preliminary
estimated fair values of the assets acquired and liabilities assumed. The
final allocation will be based upon appraisals and other studies that will
be completed subsequent to the acquisition and management's final evaluation
of such assets and liabilities. The final allocation of the purchase cost
and the resulting effect on net income may differ significantly from the pro
forma amounts indicated herein.
Amortization expense is summarized below:
<TABLE>
<S> <C>
Costs in excess of net assets of business acquired, net.... $18,525
Amortization period in years............................... 40
-------
463
Less amortization recorded by Coffee People................ (743)
-------
$ (280)
=======
</TABLE>
26
<PAGE> 27
(4) Interest expense based on the pro forma capitalization of Diedrich Coffee is
summarized in the table below:
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 27, 1999
----------------
<S> <C>
New term loan *............................................. $ 960
Existing debt +............................................. (718)
-----
Pro Forma interest expense adjustment..................... $ 242
=====
</TABLE>
- -------------------------
* Represents interest on new debt of $12,000 to be entered into concurrently
with the completion of this offering. Assumes an interest rate of 8.00%.
+ Represents interest paid on existing debt that will be retired as result of
the acquisition. Based on a blended interest rate of 9.2%.
27
<PAGE> 28
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE FISCAL QUARTER ENDED APRIL 28, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
--------------------- PRO FORMA
DIEDRICH COFFEE ADJUSTMENTS
COFFEE PEOPLE FOR
--------- --------- ACQUISITION PRO FORMA
QUARTER 12 WEEKS OF COFFEE COMBINED
ENDED ENDED PEOPLE BY ADJUSTED FOR
APRIL 28, MARCH 6, DIEDRICH THE
1999 1999 COFFEE ACQUISITION
--------- --------- ----------- -------------
<S> <C> <C> <C> <C>
Total revenues...................................... $6,098 $12,739 $ -- $18,837
Cost of sales and related occupancy costs........... 2,758 5,560 -- 8,318
Store operating expenses............................ 2,288 5,007 -- 7,295
Other operating expenses............................ 158 -- -- 158
Depreciation........................................ 507 238 -- 745
Amortization........................................ -- 107 5(1) 112
General and administrative expenses................. 857 842 -- 1,699
Acquisition and integration expenses................ -- 151 -- 151
------ ------- ------ -------
Total costs and expenses....................... 6,568 11,905 5 18,478
------ ------- ------ -------
Operating income (loss)............................. (470) 834 (5) 359
Interest (expense) and other income................. (95) (107) (75)(2) (277)
------ ------- ------ -------
Income (loss) from continuing operations............ (565) 727 (80) 82
Income tax provision (benefit)...................... 3 319 -- 322
------ ------- ------ -------
Net income (loss)................................... $ (568) $ 408 $ (80) $ (240)
====== ======= ====== =======
Basic and diluted loss per common share............. $(0.09) $ (0.02)
Weighted average number of common shares
outstanding....................................... 6,173 12,273
</TABLE>
- -------------------------
(1) Represents the reduction in amortization of goodwill based on preliminary
estimated fair values of the assets acquired and liabilities assumed. The
final allocation will be based upon appraisals and other studies that will
be completed subsequent to the acquisition and management's final evaluation
of such assets and liabilities. The final allocation of the purchase cost
and the resulting effect on net income may differ significantly from the pro
forma amounts indicated herein.
Amortization expense is summarized below:
<TABLE>
<S> <C>
Costs in excess of net assets of business acquired, net.... $17,933
Amortization period in years............................... 40
-------
112
Less amortization recorded by Coffee People................ (107)
-------
$ 5
=======
</TABLE>
(2) Interest expense based on the pro forma capitalization of Diedrich Coffee is
summarized in the table below:
<TABLE>
<CAPTION>
QUARTER ENDED
APRIL 28, 1999
--------------
<S> <C>
Term loan *................................................. $ 240
Existing debt +............................................. (165)
-----
Pro Forma interest expense adjustment..................... $ 75
=====
</TABLE>
---------------------------------
* Represents interest on new debt of $12,000 to be entered into
concurrently with the completion of this offering. Assumes an
interest rate of 8.00%.
+ Represents interest paid on existing debt that will be retired as
result of the acquisition. Based on a blended interest rate of 9.2%.
28
<PAGE> 29
DIEDRICH COFFEE SELECTED FINANCIAL DATA
The following historical financial information may not be indicative of our
future financial results of operations and should be read in conjunction with
"Diedrich Coffee Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the consolidated financial statements and related
notes.
<TABLE>
<CAPTION>
QUARTER QUARTER
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED ENDED ENDED
JANUARY 31, JANUARY 31, JANUARY 29, JANUARY 28, JANUARY 27, APRIL 29, APRIL 28,
1995 1996 1997 1998 1999 1998 1999
----------- ----------- ----------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Revenues:
Retail..................... $6,673 $8,879 $18,118 $20,760 $21,248 $ 5,285 $ 5,190
Wholesale and other........ 918 1,365 1,694 2,222 2,767 638 858
Franchise revenue.......... -- -- -- -- 200 -- 50
------ ------ ------- ------- ------- ------- -------
Total revenues...... 7,591 10,244 19,812 22,982 24,215 5,923 6,098
====== ====== ======= ======= ======= ======= =======
Cost and expenses:
Cost of sales and related
occupancy costs.......... 3,164 4,409 9,263 11,458 10,955 2,682 2,758
Store operating expenses... 2,584 3,520 8,280 10,448 8,936 2,284 2,288
Other operating expenses... 282 277 240 290 634 149 158
Depreciation and
amortization............. 255 354 1,054 1,785 1,941 482 507
Provision for asset
impairment and
restructuring costs...... -- -- -- 3,902 -- -- --
General and administrative
expenses................. 851 1,335 2,003 4,006 4,014 975 857
------ ------ ------- ------- ------- ------- -------
Total............... 7,136 9,895 20,840 31,889 26,480 6,572 6,568
------ ------ ------- ------- ------- ------- -------
Operating income (loss)...... 455 349 (1,028) (8,907) (2,265) (649) (470)
Interest expense............. (78) (34) (190) (182) (385) (97) (96)
Interest and other income
(expense).................. 104 (23) 92 1 1
------ ------ ------- ------- ------- ------- -------
Income (loss) before income
taxes...................... 377 315 (1,114) (9,112) (2,558) (745) (565)
Income tax provision
(benefit).................. 53 129 (128) 1 4 1 3
------ ------ ------- ------- ------- ------- -------
Net income (loss)............ $ 324 $ 186 $ (986) $(9,113) $(2,562) $ (746) $ (568)
====== ====== ======= ======= ======= ======= =======
Net income (loss) per share--
basic and diluted(1)....... -- -- $ (0.22) $ (1.69) $ (0.43) $ (0.13) $ (0.09)
Pro forma net income per
share(2)................... $ 0.06
BALANCE SHEET DATA:
Working capital
(deficiency)............... $ (418) $ (53) $ 1,949 $ (959) $ (655) $ 192 $(1,036)
Total assets................. 2,503 5,316 17,471 13,948 12,736 13,721 12,628
Long-term debt and long-term
obligations under capital
leases..................... 471 829 -- 2,817 2,783 2,849 2,759
Total stockholders' equity... 973 3,304 14,898 6,835 6,027 7,365 5,460
</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.
29
<PAGE> 30
DIEDRICH COFFEE 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. Following this offering, we intend to change our fiscal
year to the 52 or 53 week period ending on the Wednesday closest to June 30 of
each year.
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 36 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.
We grew rapidly in fiscal 1997 and experienced difficulties managing 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 locations 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 were 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
30
<PAGE> 31
closures as well as provisions for other contingencies resulted in additional
operating expenses of approximately $1.7 million in the fourth quarter of fiscal
1998.
According to our strategic plan, the roasting facility in Denver, Colorado
was closed in the first quarter of fiscal 1999 and roasting was consolidated in
Southern California. We also closed an under-performing store in San Diego,
California and one in Denver, Colorado. We opened four coffee carts at premium
office locations in fiscal 1999 for a total of seven. We are in discussions with
commercial property managers regarding additional coffee cart and kiosk
locations. However, no assurances can be given as to when or how many more
coffee carts may be installed. We also 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 coffeehouse employee. This program was completed during fiscal
1999. The team also developed, tested and introduced several new product
programs, including:
- Martin Diedrich Signature Coffee Selections featuring coffee beans that
were only available in the United States at Diedrich coffeehouses;
- a line of five new Icy Blended drinks to address seasonal softness in the
warmer months;
- Chai Tea and new mocha products, including white chocolate mocha, were
added to the menu; and
- a new line of holiday merchandise was introduced in November 1998.
On March 16, 1999, we signed a merger agreement with Coffee People that
contemplates a merger in which Coffee People will become a wholly-owned
subsidiary of our company. The acquisition is subject to a number of conditions,
including securing financing, obtaining the approval of the Diedrich Coffee and
Coffee People stockholders and completion of the acquisition of Coffee People by
July 15, 1999.
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, we announced our first franchise area development agreement which calls
for the development of 44 coffeehouses 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 in San Diego, Palm Springs and Temecula,
California over the next five years. This franchise area development agreement
also 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 as well as a note receivable for $100,000. On
May 17, 1999, we announced our third franchise area development agreement which
provides for the development of 50 coffeehouses in the northern portion of
Florida. On May 26, 1999, we announced our fourth franchise area development
agreement which calls for the development of 80 coffeehouses in the Los Angeles,
California market. This agreement also gives the franchisee an option to develop
up to 103 additional stores in the San Francisco Bay Area. In connection with
the signing of this agreement, we will record an area development fee of $32,000
in fiscal 2000. On June 1, 1999, we announced our fifth franchise area
development agreement which provides for the development of 50 coffeehouses in
the states of Kentucky and Tennessee. In connection with the signing of this
agreement, we will record an area development fee of $20,000 in fiscal 2000.
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. Positive sales may not result from these
activities.
WHOLESALE
In fiscal 1998, we 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
31
<PAGE> 32
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 a number of well-known restaurant groups as wholesale
customers such as Ruth's Chris Steakhouses (California/Arizona locations), El
Torito, Claim Jumper and Islands Restaurants.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to total
revenues, unless otherwise indicated, of certain items included in Diedrich
Coffee's statements of income for the years indicated:
<TABLE>
<CAPTION>
YEAR YEAR YEAR QUARTER QUARTER
ENDED ENDED ENDED ENDED ENDED
JANUARY 29, JANUARY 28, JANUARY 27, APRIL 29 APRIL 28,
1997 1998 1999 1998 1999
----------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Retail...................................... 91.4% 90.3% 87.8% 89.2% 85.1%
Wholesale and other......................... 8.6 9.7 11.4 10.8 14.1
Franchise revenues.......................... -- -- 0.8 -- 0.8
----- ----- ----- ----- -----
Total revenues...................... 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
Cost and Expenses:
Cost of sales and related occupancy costs... 46.8% 49.9% 45.2% 45.3% 45.2%
Store operating expenses(1)................. 45.7 50.3 41.7 43.2 43.7
Other operating expenses(2)................. 14.2 13.0 22.9 23.3 18.4
Depreciation and amortization............... 5.3 7.8 8.0 8.1 8.3
Asset impairment and restructuring costs.... -- 17.0 -- -- --
General and administrative expenses......... 10.1 17.4 16.6 16.5 14.1
Operating income (loss)....................... (5.2) (38.8) (9.4) (11.0) (7.7)
Interest expense.............................. (1.0) (0.8) (1.6) (1.6) (1.6)
Interest and other income (expense)........... 0.5 (0.1) 0.4 -- --
----- ----- ----- ----- -----
Loss before income taxes...................... (5.6) (39.6) (10.6) (12.6) (9.3)
Income tax provision (benefit)................ (0.6) -- -- -- --
----- ----- ----- ----- -----
Net income (loss)............................. (5.0)% (39.7)% (10.6)% (12.6)% (9.3)%
===== ===== ===== ===== =====
</TABLE>
- -------------------------
(1) As a percentage of revenues from retail and franchise operations.
(2) As a percentage of revenues from wholesale operations.
Thirteen Weeks Ended April 28, 1999 Compared with the Thirteen Weeks Ended
April 29, 1998
Total Revenues. Total revenues for the thirteen weeks ended April 28, 1999
increased 3.0% to $6,098,000 from $5,923,000 for the thirteen weeks ended April
29, 1998 principally due to an increase in comparable store sales. During this
most recent quarter, we derived 85.1% of total revenues from our retail
coffeehouse operations. Wholesale and other revenue accounted for 14.1% of total
revenues and franchise revenues accounted for 0.8% of total revenues. Retail
revenues for the thirteen weeks ended April 28, 1999 decreased 1.8% to
$5,190,000 from $5,285,000 in the thirteen weeks April 29, 1998. This decrease
was a result of three fewer company-operated coffeehouses during the most recent
quarter. Two of these retail locations were franchised during the quarter ended
April 28, 1999 and one was closed. As of April 28, 1999, we operated 33
coffeehouses and 7 carts; whereas on April 29, 1998, we operated 36 coffeehouses
and 7 carts. The percentage increase in comparable store sales was 3.2% during
the first quarter of fiscal 2000. This increase was principally a result of
improved targeted marketing programs.
Wholesale and other revenues increased 34.5% to $858,000 for the thirteen
weeks ended April 28, 1999 from $638,000 for the thirteen weeks ended April 29,
1998. The increase reflects increasing demand for our wholesale coffee products
and increased sales efforts. Although we anticipate continued improvement in
wholesale sales, this will depend upon successful marketing of products produced
using the
32
<PAGE> 33
new packaging equipment that we acquired and installed during the latter part of
fiscal 1999. Strong increases in wholesale revenues may not continue.
Franchise revenue was $50,000 for the thirteen weeks ended April 28, 1999.
Franchise revenue consists of initial franchise fees and royalties received on
sales made at each franchise location. Since we first recorded franchise revenue
in the third quarter of fiscal 1999, there was no franchise revenue for the
thirteen weeks ended April 29, 1998. As of April 28, 1999, we had two franchised
coffeehouses.
Cost of Sales and Related Occupancy Costs. Cost of roasted coffee, dairy,
food, paper and bar supplies, accessories and clothing (cost of sales) and rent
(related occupancy costs) for the thirteen weeks ended April 28, 1999 increased
to $2,758,000 from $2,683,000 for the thirteen weeks ended April 29, 1998. As a
percentage of total revenue, cost of sales and related occupancy costs decreased
slightly to 45.2% in the first quarter of fiscal 2000 from 45.3% for the first
quarter of fiscal 1999. Better average unit volume efficiencies resulting from
lower green coffee prices and the addition of franchise revenues offset an
increase in labor costs resulting from new training programs implemented at the
store level.
Store Operating Expenses. Store operating expenses increased to $2,288,000
for the thirteen weeks ended April 28, 1999 from $2,284,000 for the thirteen
weeks ended April 29, 1998. As a percentage of retail and franchise revenues,
store operating expenses increased to 43.7% in the first quarter of fiscal 2000
from 43.2% in the first quarter of fiscal 1999. These increases were due to
additional personnel and expenses related to our increased franchising
activities.
Other Operating Expenses. Other operating expenses, those associated with
wholesale and other revenues, increased to $158,000 for the first quarter of
fiscal 2000 from $149,000 in the first quarter of fiscal 1999. These expenses,
as a percentage of revenues from the wholesale division, decreased to 18.4% from
23.3%. The decrease as a percentage of revenues from the wholesale division
reflects the increase in wholesale revenues, as a result of the emphasis placed
on adding new chain restaurant accounts.
Depreciation and Amortization. Depreciation and amortization increased to
$507,000 for the thirteen weeks ended April 28, 1999 from $482,000 for the
thirteen weeks ended April 29, 1998. As a percentage of total revenue,
depreciation and amortization increased to 8.3% in comparison to 8.1% for the
prior quarter.
General and Administrative Expenses. General and administrative expenses
decreased to $857,000 for the first quarter of fiscal 2000 from $975,000 for the
first quarter of fiscal 1999. As a percentage of total revenue, general and
administrative expenses decreased to 14.1% from 16.5%. This decrease was
primarily a result of the elimination of management personnel that were not
essential to our current growth strategy.
Interest Expense. Interest expense decreased to $96,000 for the thirteen
weeks ended April 28, 1999 from $97,000 for the thirteen weeks ended April 29,
1998. This slight decrease is a result of a lower prime rate in 1999 from 1998.
Fiscal Year Ended January 27, 1999 Compared to Fiscal Year Ended January
28, 1998
Total Revenues. Total revenues for fiscal 1999 increased 5.4% to
$24,215,000 from $22,982,000 for fiscal 1998. Of the total revenues for fiscal
1999, 87.8% were derived from retail sales, 11.4% from wholesale and other
revenues and 0.8% from franchise revenues. Retail sales for fiscal 1999
increased 2.4% to $21,248,000 from $20,760,000 for fiscal 1998 as a result of
increased customer traffic in our stores, despite closing 2 stores in fiscal
1999. The percentage increase in comparable store sales for stores open during
the full year in fiscal 1999 was 1.5%. Wholesale and other revenues for the year
ended January 27, 1999 increased 24.5% to $2,767,000 from $2,222,000 for the
year ended January 28, 1998 primarily as a result of increased sales to chain
restaurant accounts. In addition, we recognized franchise revenues of $200,000
in fiscal 1999 as a result of signing our first two area development agreements.
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 total revenues, cost of sales and related
occupancy costs decreased to 45.2% 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
33
<PAGE> 34
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.
Store Operating Expenses. For fiscal 1999, store operating expenses, as a
percentage of retail and franchise revenues, decreased to 41.7% 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 and franchise revenues.
Other Operating Expenses. For fiscal 1999, other operating expenses, as a
percentage of wholesale and other revenues, 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 through
an emphasis on upgrading the coffee consumed at chain restaurants. In general,
as chain accounts are based on negotiated pricing structures, future margins for
wholesale sales may not be quite as favorable as they have been in the past.
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. As a percentage of total
revenue, depreciation and amortization increased to 8.0% from 7.8% during the
prior year.
General and Administrative Expenses. General and administrative expenses
increased slightly to $4,014,000 in fiscal 1999 from $4,006,000 in fiscal 1998.
As a percentage of total revenues, this represents a slight decrease to 16.6% in
fiscal 1999 from 17.4% for fiscal 1998. This slight decrease is due to the
increase in total revenues. General and administrative expenses have remained at
a relatively high percentage of total revenues due to management's commitment to
establish the infrastructure necessary to grow the company.
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 borrowed in September and October of 1997 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 was 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.
Fiscal Year Ended January 28, 1998 Compared to Fiscal Year Ended January
29, 1997
Total Revenues. Total revenues for fiscal 1998 increased 16.0% to
$22,982,000 from $19,812,000 for fiscal 1997 primarily due to the increase in
retail revenues. Of total revenues for fiscal 1998, 90.3% were derived from
retail sales and 9.7% from wholesale and other sales. Retail revenues for fiscal
1998 increased 14.6% to $20,760,000 from $18,118,000 for fiscal 1997 due to a
price increase in the second quarter and a nominal increase in comparable store
sales. The percentage increase in comparable store 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%. Wholesale and other revenues for fiscal 1998 increased
31.1% to $2,222,000 from $1,694,000 for fiscal 1997. This increase was
principally due to increased focus on wholesale sales by management.
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 total revenues, 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 revenues, as well as scheduled rent
increases.
34
<PAGE> 35
Store Operating Expenses. For fiscal 1998, store operating expenses, as a
percentage of retail revenues, increased to 50.3% from 45.7% for fiscal 1997.
The year-end one-time charge of $1,700,000, associated with the closure of two
coffeehouses and the Denver warehouse, accounted for 8.2% of retail revenues and
more than offset decreases achieved during the year primarily as a result of
improved labor scheduling methods.
Other Operating Expenses. For fiscal 1998, other operating expenses
increased to $290,000 from $240,000 in fiscal 1997. This increase is the result
of adding management and sales staff to further the growth in wholesale sales.
However, other operating expenses, as a percentage of wholesale and other sales,
decreased to 13.0% from 14.2% for fiscal 1997 due to the increase 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. As a percentage of total revenue, depreciation and
amortization increased to 7.8% from 5.3% during the prior 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. General and administrative expenses
increased to $4,006,000 in fiscal 1998 from $2,003,000 in fiscal 1997. As a
percentage of total revenues, this represented an increase 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,
restructure the company 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 was available to be utilized against future taxable income for years
through fiscal 2013, subject to a possible annual limitation due to the change
in ownership rules under the Internal Revenue Code.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our capital requirements in recent years principally through
private placements of our common stock and long-term debt. We had a working
capital deficit, as of April 28, 1999, of $1,036,000 compared to a working
capital deficit of $655,000 as of January 27, 1999. Cash used in operating
activities totaled $1,134,000 for the thirteen weeks ended April 28, 1999 as
compared to $375,000 for the thirteen weeks ended April 29, 1998 and $351,000
for fiscal 1999 as compared to $2,489,000 for fiscal 1998.
Net cash used in investing activities for the thirteen weeks ended April
28, 1999 and fiscal 1999 totaled $257,000 and $1,523,000, respectively, which
consisted principally of capital expenditures for property and equipment. Net
cash provided by financing activities for the thirteen weeks ended April 28,
1999 totaled $976,000, which consisted of proceeds from long-term debt. Net cash
provided by financing activities for fiscal 1999 totaled $1,667,000. This
consisted 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 FMAC, at a price
of $6.375 (the stock's closing sale price for that day on the Nasdaq National
Market). In addition, FMAC also received an option to purchase
35
<PAGE> 36
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 50,000 shares are exercisable at $12.50 per share. We completed
this transaction on April 3, 1998.
We announced on April 14, 1998 that we were in the process of obtaining a
financing from FMAC to meet expected capital requirements. After extensive
discussions, we determined that the structure required 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.
As of April 28, 1999, we had $2,500,000 of long-term debt that consisted of
three term loans with three separate investors on substantially similar terms.
Each of the loans bears interest at the prime rate plus 3 1/2% with interest
only payable monthly. The principal is due in one lump sum at maturity. The
loans mature at different times in September and October of 2002 and are secured
by all of our assets.
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.
On April 9, 1999, we received a statement of proposed terms and conditions
from BankBoston, N.A. to establish new credit facilities for Diedrich Coffee
after the completion of the acquisition of Coffee People. The new credit
facilities are conditioned upon the completion of the acquisition of Coffee
People, the completion of a public equity offering with gross proceeds of at
least $18.0 million and other usual and customary conditions for credit
facilities. The credit facilities will be secured by all of our assets. These
credit facilities would be established concurrently with the completion of this
offering and would consist of a term loan and a revolving credit facility. The
term loan would be in the principal amount of $12 million fully amortized over
five years. The term loan would bear interest at the rate of approximately 8%
per annum. The revolving credit facility would provide for a maximum borrowing
of $3 million. The revolving credit facility would bear interest at the rate of
BankBoston's base rate plus 1.25% or Libor plus 3.00% and would terminate in
five years unless extended by the mutual agreement of us and BankBoston. If
advances under the revolving credit facility are to be used to finance
additional company-owned retail locations, at least 90% of existing
company-owned retail locations must then have positive cash flow. We intend to
use the proceeds from these new credit facilities to repay our existing
indebtedness, pay fees and expenses related to the acquisition of Coffee People,
finance additional company-owned retail locations and for general corporate
purposes.
We believe that cash from operations, the credit facilities described above
and the net proceeds from this offering will be sufficient to finance the cash
payment to Coffee People stockholders, to pay related fees and expenses and to
satisfy our working capital needs at the anticipated operating levels for the
next twelve months.
SEASONALITY AND QUARTERLY RESULTS
Our business is subject to seasonal fluctuations as well as economic trends
that affect retailers in general. Historically, our net sales have not been
realized proportionately in each quarter, with net sales being the highest
during the last fiscal quarter which includes the December holiday season. Hot
weather tends to reduce sales. Quarterly results are affected by the timing of
the opening of new stores, which may not occur as anticipated due to events
outside our control. As a result of these factors, and of the other
contingencies and risk factors described elsewhere in this report, the financial
results for any individual quarter may not be indicative of the results that may
be achieved in a full fiscal year.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." 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.
36
<PAGE> 37
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 September 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 April 28, 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.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivative Instruments
We did not invest in market risk sensitive instruments in fiscal 1999 or
the first quarter of fiscal 2000. From time to time, we enter into agreements to
purchase green coffee in the future at prices to be determined within two to
twelve months of the time of actual purchase. At April 28, 1999, these
commitments totaled $1,602,000. 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 correlation between increases in green coffee
prices and the final selling prices of our products.
We 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% and $1,000,000 at the prime rate plus 3%. At April
28, 1999, a hypothetical 100 basis point increase in the prime rate would result
in additional interest expense of $35,000 on an annualized basis. At April 28,
1999, the prime rate was 7.75%.
37
<PAGE> 38
COFFEE PEOPLE SELECTED FINANCIAL DATA
The selected financial data should be read in conjunction with "Coffee
People Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the consolidated financial statements and related notes.
<TABLE>
<CAPTION>
39-WEEK FISCAL FISCAL
PERIOD YEAR YEAR 36 WEEKS 36 WEEKS
ENDED ENDED ENDED ENDED ENDED
JUN. 29, JUN. 28, JUN. 27, MARCH 7, MARCH 6,
1996 1997 1998 1998 1999
------------ ---------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Franchise revenues.................... $ 4,971 $ 5,869 $ 6,035 $ 4,584 $ 4,756
Retail sales.......................... 6,657 7,631 11,436 6,891 22,429
Wholesale sales....................... 13,329 17,079 17,580 14,020 12,944
------- ------- ------- ------- -------
Total revenues................ 24,957 30,579 35,051 25,495 40,129
Expenses:
Cost of goods sold.................... 14,389 18,494 19,296 13,210 18,384
Store and other operating expenses.... 4,779 6,080 8,231 5,735 15,605
Depreciation and amortization......... 978 1,152 1,811 1,109 1,152
General and administrative expenses... 2,825 5,458 4,079 2,131 3,052
Provision for store closures.......... -- 580 -- -- --
Acquisition and integration
expenses........................... -- -- 437 -- 950
------- ------- ------- ------- -------
Total expenses................ 22,971 31,764 33,854 22,185 39,143
------- ------- ------- ------- -------
Income (loss) from operations........... 1,986 (1,185) 1,197 3,310 986
Interest and other income............... 203 426 315 207 92
Interest expense........................ -- -- 46 -- 368
------- ------- ------- ------- -------
Income (loss) before income taxes....... 2,189 (759) 1,466 3,517 710
Provision for income taxes.............. 965 4 728 1,512 310
Income (loss) before cumulative effect
of change in accounting principle..... -- (763) -- -- --
Cumulative effect of change in
accounting principle.................. -- (427) -- -- --
------- ------- ------- ------- -------
Net income (loss)....................... $ 1,224 $(1,190) $ 738 $ 2,005 $ 400
======= ======= ======= ======= =======
Net income (loss) per share -- basic and
diluted:
Income (loss) before cumulative effect
of change in accounting
principle.......................... $ 0.16 $ (0.10) $ 0.09 $ 0.27 $ 0.04
Cumulative effect of change in
accounting principle, net of tax
benefit............................ -- (0.06) -- -- --
------- ------- ------- ------- -------
Net income (loss)..................... $ 0.16 $ (0.16) $ 0.09 $ 0.27 $ 0.04
======= ======= ======= ======= =======
BALANCE SHEET DATA:
Working capital (deficit)............... $ 7,777 $10,802 $ 5,277 $15,074 $ 6,285
Total assets............................ 40,219 38,923 55,695 40,746 54,288
Long-term debt obligations, less current
portion............................... -- -- 3,798 -- 2,727
Total stockholders' equity.............. 35,487 34,297 43,502 37,840 43,919
</TABLE>
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<PAGE> 39
COFFEE PEOPLE MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
As of March 6, 1999, Coffee People had 254 franchised and 26
company-operated stores operating under the Gloria Jean's brand in 38 states,
one U.S. territory, and six foreign countries, 26 company-operated stores
operating in Oregon under the Coffee People brand and one franchised and 13
company-operated stores operating in Arizona under the Coffee Plantation brand.
Coffee People also operates a coffee roasting facility in Castroville,
California.
Gloria Jean's retail outlets generally offer a full range of gourmet
coffees, hot and cold beverages, teas, and food, as well as a variety of related
gifts, supplies, equipment and accessories. Coffee People (Oregon) and Coffee
Plantation stores sell coffee beverages, coffee beans, cookies, pastries and
coffee related merchandise.
The merger between Coffee People and Gloria Jean's on May 19, 1998 was
accounted for as a reverse merger in which Gloria Jean's was treated as the
acquiror for financial reporting purposes. As a result of this accounting
treatment, the historical financial statements of Gloria Jean's became the
historical financial statements of the combined company. Also consistent with
this accounting treatment, the fiscal year end for Coffee People was changed
from December 31 to the last Saturday in June, to conform to the year-end used
by Gloria Jean's.
Because of the reverse merger accounting treatment, the financial results
for the twenty-six week periods ended March 6, 1999 reflect the operations of
the combined companies while the financial results for the twenty-six week
periods ended March 7, 1998 reflect the operations of Gloria Jean's only.
Because the merger closed on May 19, 1998, approximately six weeks before the
1998 fiscal year-end, the operating results attributable to the acquired Coffee
People (Oregon) and Coffee Plantation operations have had only a limited impact
on the overall operating results of the combined company for the fiscal year
ended June 27, 1998. Certain costs associated with the acquisition and
integration of Coffee People operations have been accounted for as acquisition
and integration expenses.
On March 16, 1999, Coffee People signed a merger agreement with Diedrich
Coffee that contemplates the acquisition of Coffee People by Diedrich Coffee.
The acquisition will occur through a merger in which Coffee People will become a
wholly-owned subsidiary of Diedrich Coffee. The acquisition is subject to a
number of conditions, including obtaining the approval of the Coffee People and
Diedrich Coffee stockholders and completing the acquisition of Coffee People by
July 15, 1999.
If these conditions are met, the merger is expected to close immediately
prior to the completion of this equity offering.
RESULTS OF OPERATIONS
Thirty-Six Weeks Ended March 6, 1999 Compared to Thirty-Six Weeks Ended
March 7, 1998
Total Revenues. Total revenues increased 57.4% to $40,129,000 for the
thirty-six week period ended March 6, 1999, from $25,495,000 for the same period
in fiscal 1998. The increase in total revenues was due primarily to an increase
in retail sales from company-operated stores, offset by a decrease in wholesale
revenue.
Retail sales at company-operated stores increased 225.5% to $22,429,000 for
the fiscal 1999 thirty-six week period from $6,891,000 in the fiscal 1998
thirty-six week period. The increase in retail sales was due primarily to sales
of $16,563,000 at the Coffee People (Oregon) and Coffee Plantation stores
acquired on May 19, 1998.
Wholesale revenue consists primarily of sales of roasted coffee and other
products and supplies to franchisees. Wholesale revenue decreased 7.7% to
$12,944,000 for the thirty-six weeks ended March 6, 1999 from $14,020,000 for
the same thirty-six week period in fiscal 1998. The decrease was primarily due
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to decreased sales to franchise stores because of lower sales volume and a shift
from the sale of whole beans to drink sales.
Franchise revenue consists primarily of initial franchise fees and
royalties received by Coffee People on sales made at each franchise location.
Franchise revenue increased 3.8% to $4,756,000 for the thirty-six week period
ended March 6, 1999 from $4,584,000 for the same thirty-six week period in
fiscal 1998. The components of this increase were an increase in franchise and
other fees in the amount of $202,000, offset by a reduction of $30,000 in
royalty revenue. The increase in franchise fees was primarily from a territory
fee in the amount of $150,000 and a Coffee Plantation initial franchise fee in
the amount of $50,000. Royalty revenues remained relatively constant at
$4,050,000 in 1999 compared to $4,080,000 for the same period in 1998, due
primarily to the addition of one Coffee Plantation store and eight international
stores, offset by a decrease of five domestic stores.
Costs and Expenses. Cost of goods sold increased 39.2% to $18,384,000 for
the thirty-six weeks ended March 6, 1999, from $13,210,000 in the same period of
fiscal 1998, due to increases associated with the increase in retail sales
attributed to the Coffee People (Oregon) and Coffee Plantation stores acquired
on May 19, 1998. Cost of goods sold as a percentage of corporate store sales and
wholesale revenue decreased to 52.0% in the thirty-six week period ended March
6, 1999, from 63.2% in the thirty-six week period ended March 7, 1998. The
decrease was due primarily to a more favorable cost relationship associated with
retail sales generated at the Coffee People (Oregon) and Coffee Plantation
stores acquired on May 19, 1998.
Store and other operating expenses increased 172.1% to $15,605,000 in the
thirty-six week period ended March 6, 1999, from $5,735,000 in the same period
of fiscal 1998. The increase was due primarily to store operating expenses
attributable to the Coffee People (Oregon) and Coffee Plantation stores acquired
on May 19, 1998, increased store operating expenses at Gloria Jean's
company-operated stores, and increased franchise administration expenses
necessary to support the planned growth in the franchise business. As a
percentage of total revenues, store and other operating expenses increased to
38.9% in the fiscal 1999 thirty-six week period from 22.5% in the fiscal 1998
thirty-six week period.
Depreciation and amortization increased 3.9% to $1,152,000 in the
thirty-six week period ended March 6, 1999 from $1,109,000 in the thirty-six
week period ended March 7, 1998. Depreciation and amortization increased
primarily due to an increase in goodwill amortization resulting from the reverse
merger with Gloria Jean's. As a percentage of total revenues, depreciation and
amortization expense decreased to 2.9% for the thirty-six week period ended
March 6, 1999 from 4.3% in the same thirty-six week period of fiscal 1998. The
decrease in depreciation was due primarily to the suspension of depreciation at
the Gloria Jean's company-operated stores, which are being held for sale to
franchisees.
General and administrative expenses increased 43.2% to $3,052,000 in the
thirty-six week period ended March 6, 1999 from $2,131,000 in the same period of
fiscal 1998 primarily because of general and administrative infrastructure
acquired as part of the Coffee People acquisition completed in May 1998.
Additionally, general and administrative expenses were favorably impacted in
1998 due to a reimbursement of pre-merger related expenses from Brothers Gourmet
Coffee in the amount of $276,000. As a percentage of total revenues, general and
administrative expenses decreased to 7.6% in the fiscal 1999 thirty-six week
period compared to 8.4% for the same period in fiscal 1998.
Acquisition and integration expenses amounted to $950,000 in the fiscal
1999 thirty-six week period. This consists of $799,000 in one-time costs
associated with integrating Coffee People operations and a portion of costs
associated with exiting certain Coffee People activities, including relocating
the administrative function from Beaverton, Oregon to Castroville, California
and franchising Coffee People (Oregon) and Coffee Plantation retail stores, and
$151,000 in expenses relating to the anticipated merger with Diedrich Coffee.
Interest and Other Income. Interest income as a percentage of total
revenues decreased to 0.2% for the thirty-six week period ended March 6, 1999
from 0.8% for the same period in fiscal 1998, due to the
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overall increase in revenues and a reduction in cash balances available for
short-term investment in interest-bearing instruments.
Interest Expense. Interest expense as a percentage of total revenues
increased to 0.9% for the thirty-six week period ended March 6, 1999 from 0.0%
for the same period in fiscal 1998, as a result of interest incurred on
long-term debt obligations acquired as part of the Coffee People acquisition on
May 19, 1998 and the November 1998 sale-leaseback transaction.
Income Taxes. The provision for income taxes was $310,000 for the
thirty-six week period ended March 6, 1999, compared to $1,512,000 for the same
period in fiscal 1998. The effective tax rates of 43.7% for the thirty six week
period ended March 6, 1999 and 43.0% for the thirty six week period ended March
7, 1998, result from federal and state income taxes and nondeductible goodwill
amortization.
Fiscal Year Ended June 27, 1998 Compared to Fiscal Year Ended June 28, 1997
Total Revenues. Total revenues increased 14.6% to $35,051,000 for the
fiscal year ended June 27, 1998, from $30,579,000 for the fiscal year ended June
28, 1997. The increase in total revenues was due primarily to an increase in
retail sales from company-operated stores.
Retail sales at company-operated stores increased 49.9% to $11,436,000 for
the 1998 fiscal year from $7,631,000 in the 1997 fiscal year. The increase in
retail sales was due primarily to sales of $2,406,000 at Coffee People (Oregon)
and Coffee Plantation stores acquired on May 19, 1998, and to an increase in the
weighted average number of company-operated Gloria Jean's stores -- 31 during
the fiscal year ended June 27, 1998 as compared to 25 during the fiscal year
ended June 28, 1997.
Wholesale sales consist primarily of sales of roasted coffee and other
products and supplies to franchisees. Wholesale sales for the fiscal year ended
June 27, 1998 increased 2.9% to $17,580,000 for the fiscal year ended June 27,
1998 from $17,079,000 for the fiscal year ended June 28, 1997. This increase was
due to increased sales of coffee beans as a result of new franchisees as well as
a general price increase for products sold to franchised stores.
Franchise revenues consist primarily of initial franchise fees and
royalties received by Gloria Jean's on sales made at each franchise location.
Franchise revenue increased 2.8% to $6,035,000 for the fiscal year ended June
27, 1998 from $5,869,000 for the fiscal year ended June 28, 1997. The components
of this increase were a 27.7% increase in franchise fees to $640,000 in the 1998
fiscal year from $501,000 in the 1997 fiscal year and a 0.5% increase in
royalties to $5,395,000 in the 1998 fiscal year from $5,368,000 in the 1997
fiscal year. The increase in franchise fees was due to an increase in the number
of new stores franchised during the 1998 fiscal year over the number franchised
in the 1997 fiscal year. The increase in royalties was due to an increase in the
number of franchised stores, which was offset by a decline of approximately one
percent in comparable store sales at franchised stores.
Costs and Expenses. Cost of goods sold increased 4.3% to $19,296,000 for
the fiscal year ended June 27, 1998, from $18,494,000 in the fiscal year ended
June 28, 1997, due to increases associated with the increases in retail sales.
These increases were partially offset by a reduction in cost of goods sold
associated with wholesale sales. Cost of goods sold as a percentage of retail
and wholesale sales decreased to 66.5% in the fiscal year ended June 27, 1998,
from 74.8% in the fiscal year ended June 28, 1997, due primarily to improvements
in production controls, plant efficiencies and a general increase in prices on
sales of products to franchised stores and also due to a more favorable cost
relationship associated with retail sales generated at the Coffee People
(Oregon) and Coffee Plantation stores acquired on May 19, 1998. Product costs as
a percentage of retail sales are lower at Coffee People (Oregon) and Coffee
Plantation stores than at Gloria Jean's company-operated stores.
Store and other operating expenses increased 35.4% to $8,231,000 in the
fiscal year ended June 27, 1998, from $6,080,000 in the fiscal year ended June
28, 1997, primarily as a result of increased store operating expenses at Gloria
Jean's company-operated stores and store operating expenses attributable to the
Coffee People (Oregon) and Coffee Plantation stores acquired on May 19, 1998,
and also to an increase in operating expenses associated with franchise
administration. These increases were partially
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offset by a decline in franchise bad debt expense due to improved credit and
collection efforts. As a percentage of total revenues, store and other operating
expenses increased to 23.5% in the 1998 fiscal year from 19.9% in the 1997
fiscal year.
Depreciation and amortization increased 57.2% to $1,811,000 in the fiscal
year ended June 27, 1998 from $1,152,000 in the fiscal year ended June 28, 1997,
due to depreciation and amortization expense associated with the Coffee People
(Oregon) and Coffee Plantation stores acquired in May 1998 and an increase in
depreciation associated with new company-operated Gloria Jean's stores opened
during the year. These Gloria Jean's company-operated store assets were
depreciated until Coffee People decided at the end of fiscal year 1998 to
actively market all company-operated stores to franchisees. As a percentage of
total revenues, depreciation and amortization expense increased to 5.2% for the
fiscal year ended June 27, 1998 from 3.8% in the fiscal year ended June 28,
1997, primarily due to depreciation and amortization associated with the
increased number of company-operated stores opened or acquired during the year,
which generally have higher depreciation expense as a percentage of retail
sales.
General and administrative expenses decreased to $4,079,000 in the 1998
fiscal year from $5,458,000 in the 1997 fiscal year primarily as a result of
expenses charged to general and administrative expense during the 1997 fiscal
period which were not incurred in the 1998 fiscal period, and as a result of a
$643,000 reimbursement received from Brothers in fiscal year 1998 in connection
with indemnification agreements associated with the 1995 acquisition of the
Gloria Jean's business from Brothers. The Brothers reimbursement in fiscal year
1998 represents a recovery of costs previously charged to general and
administrative expenses. Charges incurred in fiscal year 1997 that were not
incurred in fiscal year 1998 consisted of $420,000 associated with the
reacquisition and closure of a Gloria Jean's store pursuant to a repurchase
agreement and expenses associated with building a new management team and
implementing systems, standards and controls throughout the organization.
General and administrative expense reductions in fiscal year 1998 were offset
somewhat by general and administrative expense increases arising as a result of
the Coffee People acquisition completed in May 1998. In addition, during fiscal
years 1998 and 1997, Coffee People recorded charges to general and
administrative expense of $223,000 and $198,000, respectively, for costs
associated with the write down of certain Gloria Jean's company-operated store
assets. General and administrative expenses as a percentage of total revenues
decreased because of the foregoing factors to 11.6% in the 1998 fiscal year from
17.8% in the 1997 fiscal year.
Provision for Store Closures. Coffee People took a charge of $580,000 in
fiscal year 1997 to provide for the closure of eight company-operated Gloria
Jean's stores. Costs relating to these stores incurred during the fiscal year
ended June 27, 1998 were $530,000. These costs were charged against the accrual
established at the end of the 1997 fiscal year. As of June 27, 1998, five of the
eight stores had been disposed of pursuant to lease termination agreements.
As of June 27, 1998, all of the Gloria Jean's company-operated stores are
held for sale to franchisees. For the 1998 fiscal year, revenues and operating
losses for these stores were $9,030,000 and $(1,204,000), respectively. While
management intends to sell these stores during fiscal year 1999, there can be no
assurance that all of these actions can be taken by Coffee People or that, if
taken, such actions will improve Coffee People's financial position, results of
operations or cash flows.
Acquisition and Integration Expenses. Acquisition and integration expenses
of $437,000 consist of costs associated with integrating Coffee People
operations and a portion of costs associated with exiting Coffee People
activities, including relocating the administrative functions from Beaverton,
Oregon to Castroville, California and franchising Coffee People (Oregon) and
Coffee Plantation retail stores. The exit costs have been capitalized and
recorded as an increase to goodwill to the extent of Second Cup's 69.4%
ownership interest. The remaining exit costs have been expensed and are included
in acquisition and integration expenses.
Interest and Other Income. Interest and other income as a percentage of
total revenues decreased to 0.9% for the fiscal year ended June 27, 1998 from
1.4% for the fiscal year ended June 28, 1997, due to a reduction in
interest-bearing loans receivable from an affiliated company resulting from the
repayment of such loans in fiscal year 1997.
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Interest Expense. Interest expense as a percentage of total revenues was
0.1% for the fiscal year ended June 27, 1998, as a result of interest incurred
on long-term debt obligations acquired as part of the Coffee People acquisition
on May 19, 1998, and there was no interest expense in the fiscal year ended June
28, 1997.
Income Taxes. The provision for income taxes increased to $728,000 for the
fiscal year ended June 27, 1998, from $4,000 for the fiscal year ended June 28,
1997, due to Coffee People generating taxable income during the 1998 period. The
effective tax rate of 49.7% for fiscal year 1998 primarily results from federal
and state income taxes and nondeductible goodwill amortization.
Fifty-Two Week Period Ended June 28, 1997 Compared to the Thirty-Nine Week
Period Ended June 29, 1996.
The data presented for fiscal year 1996 consists of the thirty-nine week
period ended June 29, 1996, due to the acquisition of Gloria Jean's by Second
Cup effective September 30, 1995. Fiscal year 1997 consists of a full fifty-two
weeks. Approximately 30% to 35% of annual sales typically occur in the eight
week period preceding the year-end holidays. This seasonal trend together with
the substantial differences arising from the comparison of two periods of
differing lengths should be considered when reviewing the following discussion.
Total Revenues. Total revenues increased 22.5% to $30,579,000 for the
fiscal year ended June 28, 1997 from $24,957,000 for the 39 week period ended
June 29, 1996, due primarily to the impact of a full year of reported results in
1997 versus thirty-nine weeks in 1996. An additional 14 new franchises opened
during fiscal year 1997 also contributed to the increases in wholesale and other
revenue and franchise revenues. Retail sales increased to $7,631,000 for the
fiscal year ended June 29, 1997 from $6,657,000 for the thirty-nine week period
ended June 29, 1996. Wholesale and other revenues increased to $17,079,000 for
the fifty-two week period ended June 28, 1997 from $13,329,000 for the period
ended June 29, 1996. Franchise revenues increased to $5,869,000 for the 1997
period from $4,971,000 for the thirty-nine week period ended June 29, 1996.
Costs and Expenses. Cost of goods sold increased to $18,494,000 for the
fifty-two week period ended June 28, 1997 from $14,389,000 for the thirty-nine
week period ended June 29, 1996. Cost of goods sold increased to 74.8% as a
percentage of retail and wholesale sales for the 1997 period from 72.0% for the
1996 period due primarily to a write down of approximately $600,000 for holiday
gift pack inventory, which did not meet Gloria Jean's quality standards, and due
to a larger number of underperforming company-operated stores that had poor
operating efficiencies and higher coffee costs.
Store and other operating expenses increased to $6,080,000 for the 1997
period from $4,779,000 for the 1996 period. Store and other operating expenses
as a percentage of total revenues increased to 19.9% in 1997 from 19.2% in 1996
primarily due to a larger number of underperforming company-operated stores
incurring higher operating expenses.
General and administrative expenses increased to $5,458,000 for the period
ended June 28, 1997 from $2,825,000 for the period ended June 29, 1996. General
and administrative expenses as a percentage of total revenues increased to 17.8%
in 1997 from 11.3% in 1996, due primarily to the investment undertaken in
building a new management team and implementing improved systems, standards and
controls throughout the organization. The increase also related to a $198,000
write-down to market value of assets at company-operated stores which were held
for sale and a provision of $420,000 related to reacquisition and store closure
costs associated with a repurchase agreement.
Provision for Store Closures. The provision for store closures of $580,000
consisted primarily of lease termination costs for eight of the company-operated
stores held for disposal. As of June 28, 1997, management determined it was not
feasible to sell these stores and implemented a plan to close them during fiscal
year 1998.
Revenues and operating income (losses) for the 24 company-operated stores
held for disposal, including the eight company-operated stores slated for
closure at June 28, 1997, were $7,051,000 and
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$(368,000) respectively, for the fiscal year ended June 28, 1997 and $5,592,000
and $176,000, respectively, for the thirty-nine week period ended June 29, 1996.
Cumulative Effect of Change in Accounting Principle. Effective as of the
beginning of fiscal year 1997, Gloria Jean's adopted the provisions of Statement
of Financial Accounting Standards No. 121, "Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). The
initial application of SFAS 121 to long-lived assets held for disposal at June
29, 1996 resulted in a non-cash charge of $427,000 (net of tax benefit of
$262,000), which represents the adjustment required to remeasure such assets at
the lower of carrying amount or fair value less costs to sell. Long-lived assets
held for disposal consist of leasehold improvements and furniture and other
property at company-operated stores, which were held for sale. Assets held for
disposal at June 28, 1997 had an adjusted carrying value of $1,560,000.
Income Taxes. The provision for income taxes decreased to $4,000 for the
fiscal year ended June 28, 1997 from $965,000 for the thirty-nine week period
ended June 29, 1996. The decrease is due to Gloria Jean's reporting a net loss
before income taxes during fiscal 1997 as compared to income before income taxes
during the thirty-nine week period ended June 29, 1996. The effective income tax
rate decreased to 0% during fiscal year 1997 from 44.1% during the thirty-nine
week period ended June 29, 1996. During fiscal 1997, the federal and state
income tax benefit from the loss before income taxes was offset by amortization
of nondeductible goodwill and the write-off of an uncollectible income tax
receivable. During the thirty-nine week period ended June 29, 1996, the
effective income tax rate was comprised of federal and state income taxes and
amortization of nondeductible goodwill.
During fiscal 1997, management determined that no valuation allowance was
required for Gloria Jean's deferred tax assets of $2,592,000 since, based on
internal forecasts, management believes it is more likely than not the deferred
tax assets will be realized through future taxable income. The adjustment to the
valuation allowance during fiscal 1997 of $1,619,000 was recorded as a reduction
in goodwill since the prior year's valuation allowance related to net operating
loss carry forwards acquired from Brothers.
LIQUIDITY AND CAPITAL RESOURCES
As of March 6, 1999, all seven of the Coffee People (Oregon) stores located
outside of Oregon that Coffee People had identified for closure or disposition
in its quarter ended June 30, 1997 had been closed. Of these stores, three had
been sold and their store leases assigned and one store lease had been
terminated by agreement. Eight Gloria Jean's stores were identified for disposal
during fiscal year 1997. Five were disposed of during fiscal year 1998 pursuant
to lease termination agreements. Of the three remaining Gloria Jean's stores,
one was disposed of after June 27, 1998 pursuant to a lease termination
agreement and two remain open. Coffee People continues to make payments on the
lease obligations for the three remaining Coffee People stores and for the two
remaining Gloria Jean's stores. Coffee People will continue to make cash outlays
for these stores for such items as rent, utilities and insurance until such time
as it is able to sell the stores or until it can negotiate satisfactory
arrangements with landlords for re-leasing the store premises or for otherwise
terminating the leases. Such costs are charged against the accrual for store
closures. There can be no assurance that Coffee People will be successful at
selling these stores or in negotiating with landlords for the re-leasing of the
store premises or for terminating the leases. If Coffee People is not successful
in these efforts, such cash outlays could continue for an indeterminate period
during the term of the store leases. Coffee People is working with local real
estate brokers to market, re-lease or sublease these stores. The lease terms for
these stores range from two and one-half to nine years with expiration dates
ranging from January 2001 through May 2007. Minimum future rental payments as of
March 6, 1999 under the five leases total $1,272,000.
As of March 6, 1999, Coffee People had $2,773,000 in cash and equivalents.
Coffee People had working capital of $6,285,000 as of March 6, 1999, as
compared to working capital of $5,277,000 at June 27, 1998.
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For the thirty-six week period ended March 6, 1999, cash provided by
operating activities was $398,000, as compared to cash provided by operating
activities of $2,875,000 for the same period in fiscal 1998. Cash provided by
operating activities for the thirty-six week period ended March 6, 1999,
consisted primarily of net income and depreciation, offset by accrued
liabilities, prepaid expenses and a decrease in payable to a related party.
For the thirty-six week periods ended March 6, 1999 and March 7, 1998, net
cash used in investing activities was $266,000 and $1,302,000, respectively,
primarily as a result of the purchase of property, plant and equipment offset by
proceeds from disposal of equipment.
For the thirty-six week period ended March 6, 1999, Coffee People had cash
used in financing activities of $181,000, primarily as a result of borrowings
under long-term debt and a capital lease obligation in the amount of $2,334,000,
offset by principal payments on long-term debt in the amount of $2,525,000. For
the thirty-six week period ended by March 7, 1998, Coffee People had neither
cash used nor generated by financing activities.
Coffee People has a line of credit with one of its primary banks providing
for borrowings through August 1, 1999 of up to $500,000. Borrowings bear
interest at the rate of 0.5% over the bank's reference rate, which was 7.75% as
of March 6, 1999, and are secured by substantially all of Coffee People's
assets, including accounts receivable, inventory trade fixtures and equipment.
As of March 6, 1999, there were no borrowings outstanding under the line of
credit; however, $73,000 of the line was reserved for a letter of credit dated
September 1998.
At the time of the merger with Gloria Jean's, Coffee People entered into a
loan agreement with The Second Cup Ltd., which provides for a credit facility of
up to $4,000,000 over a five year term. The facility expires May 19, 2003. The
interest rate for amounts drawn under the line is 11.5%. As of March 6, 1999,
Coffee People had no borrowings under this agreement.
On November 24, 1998, Coffee People entered into a sale-leaseback
transaction involving equipment at twelve company-operated Gloria Jean's retail
stores. The $922,000 proceeds received by Coffee People from the lease
transaction were used for working capital and general corporate purposes. The
interest rate on the capital lease obligation is 10.5%. The capital lease assets
are recorded in property, plant and equipment. At the end of the lease term,
Coffee People has an option to purchase the equipment for the greater of fair
market value or 10% of the lessor's original cost, or renew the lease for a
minimum of an additional eight months.
Coffee People believes that anticipated cash flow from operations, existing
cash and bank debt and the credit facility will be sufficient to meet its cash
requirements through the end of the next twelve months.
SEASONALITY
Coffee People's business is subject to seasonal fluctuations, due to
seasonal changes and general economic conditions, among other factors.
Historically, net sales from Coffee People (Oregon) stores have been highest
during the first and fourth fiscal quarters, which include the spring and summer
months. Gloria Jean's highest sales and earnings have historically occurred in
the second and third fiscal quarters, which include the peak holiday shopping
months. Coffee Plantation sales are also seasonal with higher sales and earnings
occurring in the second and third fiscal quarters when the weather is cooler and
more favorable to drinking hot beverages.
In addition, quarterly results have been substantially affected by the
timing of new store openings. This trend is likely to continue. Because of the
seasonality of Gloria Jean's business and the impact of new store openings,
results for any quarter do not necessarily indicate the results that may be
achieved for a full fiscal year, and cannot be used to indicate financial
performance for an entire year.
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YEAR 2000
The "year 2000 problem" refers to the possible failure of many computer
systems that may arise as a result of many existing computer programs using only
the last two digits to refer to a year. Coffee People has undertaken an initial
review of the potential effects on it of the year 2000 problem. These potential
problems are being addressed on a system-by-system basis.
Coffee People has determined that its general accounting system, which
includes invoicing, accounts receivable and inventory control, must be upgraded
to make the system year 2000 compliant. Coffee People has expended approximately
$5,000 to remedy this problem. Coffee People does not expect to incur any
additional material costs to upgrade the accounting system.
Coffee People is continuing to review its information technology hardware
and software, including personal computers, application and network software for
year 2000 compliance readiness. The review process entails evaluation of
hardware/software and testing. Coffee People believes its information technology
review will be completed by the end of the current fiscal year. While the review
process is ongoing, Coffee People believes that the cost to bring its
information technology systems into year 2000 compliance will be under $50,000
and it does not foresee any material difficulties with completing the necessary
changes before January 1, 2000.
Coffee People expects that its review of non-information technology systems
(including voice communications and security) will be completed before the end
of the current fiscal year. The estimated cost to remedy non-information
technology systems is not expected to be material.
Coffee People expects that the source of funds for evaluation and
remediation of year 2000 compliance issues will be cash flows from operations.
Coffee People believes that its most significant internal risk posed by the
year 2000 Problem is the possibility of a failure of its accounting system. If
the accounting system were to fail, Coffee People would have to implement manual
processes, which may slow the timeliness of information needed to manage the
business. As discussed above, Coffee People plans to avoid this risk by
upgrading its accounting systems; however, there can be no assurance that such
actions will avoid problems that may arise.
The third parties whose year 2000 problems could have the greatest effect
on Coffee People are believed by Coffee People to be banks that maintain Coffee
People's depository accounts and credit card processing systems, the company
that processes Coffee People's payroll and which maintains Coffee People's human
resource databases, and companies that supply or distribute coffee beans and
other goods. Coffee People is in the process of confirming the state of year
2000 readiness of these parties. It is anticipated Coffee People will complete
this process prior to the end of the fiscal year.
Coffee People is in the process of developing a contingency plan to address
potential year 2000 problems. The contingency plan is anticipated to be
completed prior to the end of the fiscal year.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivative Instruments
The supply and price of green coffee beans is subject to significant
volatility, generally caused by multiple factors beyond Coffee People's control,
including weather, political and economic conditions in coffee producing
countries, and other supply-related matters. Because Coffee People's coffee
roasting operation supplies products to franchisees on a cost-plus basis, Coffee
People believes that its gross profit on wholesale sales is generally insulated
from the risk of volatility in prices of green coffee beans, except to the
extent that such fluctuation affects the demand for specialty coffee.
Company-operated stores are not so similarly insulated. In addition, other
factors may affect gross profit, such as production efficiencies or
inefficiencies, including roasting shrinkage, and write-offs of excess coffee
inventories. During fiscal year 1997, worldwide coffee prices increased
significantly.
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In order to avoid speculation on spot coffee prices, Coffee People
typically undertakes to lock in the cost of a portion of its future coffee
purchases by entering into contracts to purchase green coffee over future
periods at fixed prices, or at future prices to be determined within one to 12
months from the time of the actual purchase. At March 6, 1999, these purchase
commitments totaled approximately $2,920,000 for approximately 2,420,000 pounds
of green coffee, at an average contract cost per pound of $1.21. These
commitments together with existing inventory represent approximately 80% of
Coffee People's estimated coffee requirements through March 3, 2000. These
commitments are not currently favorable to market at March 6, 1999, as the
current market price for a pound of green coffee is approximately $1.03 per
pound.
Coffee People does not use commodity based financial instruments to hedge
coffee purchases.
Financial Market Risk
Coffee People does not maintain a substantial investment portfolio.
However, it does have arrangements with its primary bank to invest monies on
deposit in overnight repurchase agreements and in other marketable short-term
securities with maturities of generally less than 90 days. Based upon the
current portfolio, a 100 basis point move in short-term interest rates would not
have a material effect on Coffee People's financial condition or results of
operations.
Coffee People's principal market risk with respect to its financial debt
instruments is to changes in the prime rate charged by major banks in the United
States and to other benchmark rates to which interest rates under Coffee
People's loan agreements may be tied. In June 1998, Coffee People elected to
have a portion of its term loan with Bank of America bear interest at 2.25% over
IBOR, an offshore rate used by the bank that is similar to LIBOR. Under the
current arrangement, this rate will be adjusted periodically.
On April 9, 1999, Coffee People elected to have the interest rate on
$3,000,000 of its term loan continue to be referenced to the IBOR. The rate has
been fixed at 7.18% through May 10, 1999. The rate on the remaining balance of
$674,500 is 8.25%, 0.5% over the bank's prime rate of 7.75% as of March 6, 1999.
At March 6, 1999, a 100 basis point increase in the IBOR would result in
additional interest expense of $30,000 on an annualized basis. A return to the
8.25% floating rate tied to the prime rate, which was 7.75% at March 6, 1999,
would have a similar impact on Coffee People's results of operations.
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BUSINESS
OVERVIEW
Diedrich Coffee, following the acquisition of Coffee People, will be the
second largest specialty coffee retailer in the United States with annual
systemwide sales of more than $150 million through 361 retail locations in 38
states and 6 foreign countries. We sell specialty brewed coffee and
espresso-based beverages such as cappuccinos, lattes, mochas and espressos and
various blended drinks through these company-owned and franchised retail
locations. To complement beverage sales, we also sell light food items,
specialty whole bean coffee and accessories at our retail locations. In addition
to our network of retail locations, we will operate a large coffee roasting
facility located in Northern California that is presently operated by Coffee
People and will provide high-quality, freshly roasted coffee beans for our
retail locations and our wholesale accounts. We have over 300 wholesale accounts
with businesses and restaurant chains, such as Ruth's Chris Steakhouses
(California/Arizona locations), El Torito, Claim Jumper and Islands Restaurants.
We believe that as the specialty coffee market has matured, distinct
segments have emerged: espresso/coffee bars, coffeehouses and mall coffee
stores. Espresso/coffee bars offer limited seating to facilitate quick customer
turnover, are generally less than 1,200 square feet in size and are usually
located in densely populated urban areas. Coffeehouses are generally greater
than 1,200 square feet in size, located in suburban areas, and encourage
customers to linger and enjoy a more relaxed, comfortable atmosphere. Mall
coffee stores cater to mall consumers and place a heavier emphasis on the sale
of flavored whole bean coffee and coffee-related merchandise. Based on the
number of domestic retail coffee locations, Starbucks is the leader in the
espresso/coffee bar segment, Gloria Jean's is the leader in the mall coffee
store segment and there is presently no leader in the coffeehouse segment. Our
business objective is to be the leading specialty coffee company in both the
coffeehouse and mall coffee store segments.
We differentiate ourselves from other specialty coffee producers by
roasting our coffee beans in accordance with proprietary recipes developed over
three generations by the Diedrich family. Our roasting recipes take into account
the specific variety, origin and physical characteristics of each coffee bean to
maximize its unique flavor. In addition, we seek to differentiate our
coffeehouses by offering our customers a broad line of superior tasting coffee
products and a high level of personalized customer service, which generate
strong sales and customer loyalty. Diedrich coffeehouses offer a warm, friendly
environment specifically designed to encourage guests to linger with friends and
business associates or to relax alone in comfort. Ample seating is augmented by
cozy sofas and comfortable chairs to create intimate nooks for meeting and
relaxing. The critical components of our coffeehouse concept include high
quality, fresh roasted coffee and superior customer service by knowledgeable
employees.
COMPANY BACKGROUND
The first retail store operating under the name of Diedrich Coffee
commenced operations in 1972. Our retail operations grew rapidly until 1997 when
we experienced difficulties managing such rapid growth. Diedrich Coffee
restructured its operations and, in November 1997, our board of directors
retained John Martin as Chairman of the Board and Tim Ryan as President and
Chief Executive Officer. Messrs. Martin and Ryan collectively bring more than
fifty-five years of multi-unit food service experience to our company. They
joined our founder, Martin Diedrich, a recognized expert in sourcing, tasting
and roasting coffee, and began the process of building a team of experienced
restaurant industry executives to develop the Diedrich Coffee brand. To further
our objective to be the leading specialty coffee company in both the coffeehouse
and mall coffee store segments, our management team implemented a growth
strategy to increase our number of retail locations and the sale of coffee
products through other distribution channels. The principal focus of this growth
strategy is franchise area development.
In March 1999, we agreed to acquire Coffee People through a merger in which
Coffee People will become a wholly-owned subsidiary of Diedrich Coffee. Coffee
People operates three retail brands -- Gloria Jean's, Coffee People and Coffee
Plantation -- with 320 franchised and company-owned retail locations throughout
the United States and in 6 foreign countries. The completion of this equity
offering is
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contingent upon the acquisition's completion. The acquisition is subject to a
number of conditions, including the approval of the Diedrich Coffee and Coffee
People stockholders and completion of the acquisition of Coffee People by July
15, 1999. These stockholder approvals will be obtained and the acquisition will
be completed immediately before completion of this equity offering.
INDUSTRY OVERVIEW
Specialty coffee sales as a percentage of total coffee sales in the United
States have been increasing steadily. According to the National Coffee
Association, sales of specialty coffee grew from approximately 17% to almost 30%
of total coffee sales in the United States from 1989 through 1997. According to
the National Coffee Association's 1998 study, 47% of Americans drink coffee. 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
coffees mass-marketed by the leading coffee companies).
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 projects the number of
specialty coffee beverage outlets in the United States to increase to over
10,000 by the end of 1999. We believe that, despite the increase in the number
of specialty coffee stores, the market is highly fragmented and, with the
exception of Starbucks with less than 20% of the total retail locations, remains
relatively unbranded.
THE DIEDRICH COFFEE CONCEPTS
Our business objective is to be the leading specialty coffee retailer in
both the coffeehouse and mall coffee store segments. To achieve this goal, we
must continue to deliver and serve the high quality coffee for which Diedrich
Coffee is known by using only the finest quality green coffee beans and ensuring
that these beans are freshly roasted using our proprietary recipes. In addition,
the friendliness, speed and consistency of the service and the coffee knowledge
of our employees are critical to developing Diedrich Coffee's quality brand
identity and to building a loyal customer base. Our marketing strategy is to
continue developing brand name recognition based upon the quality of our coffee
products, education of our customers about our offerings of various coffees and
roasts, and the image of our coffeehouses as neighborhood gathering places.
Coffeehouses
A Diedrich coffeehouse experience is strongly influenced by three
components: ambiance, hospitality and coffee knowledge. Each component is made
up of the following elements that are unique to Diedrich Coffee:
Ambiance. Diedrich Coffee guest comments indicate taste superiority of
our products versus the competition. Moreover, surveys also indicate that
customers are not only loyal to a better, specialty cup of coffee, but also
to the ambiance provided by the comfortable surroundings designed into
every Diedrich coffeehouse. Our coffeehouses are specifically designed to
encourage guests to linger with
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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.
Hospitality. Our coffeehouses deliver specific consumer benefits that
address a wide range of otherwise unmet needs in the suburban neighborhoods
of America. As a neighborhood coffeehouse chain, Diedrich Coffee is the
non-alcoholic answer to the corner pub. Coffeehouse employees greet regular
customers by name and acknowledge all patrons by name at the point of drink
pick-up. While a large percentage of coffeehouse business is quick morning
coffee pick-up, the coffeehouse focus on hospitality encourages development
of strong afternoon and evening business, complemented by the availability
of desserts, pastries and quality, non-caffeinated beverages. Surveys and
customer comments indicate that patrons are treated as part of the Diedrich
Coffee community and frequently revisit the coffeehouse.
Coffee Knowledge. Diedrich Coffee is the only specialty retailer whose
founder, Martin Diedrich, comes from three generations of experience in the
specialty coffee industry. Mr. Diedrich, currently Chief Coffee Officer, is
intimately involved in the daily business of sourcing, tasting and roasting
coffees. He is also directly involved in the training of coffeehouse team
members. The coffee knowledge and expertise that is transferred from
coffeehouse to customer is a competitive advantage, as the interest in
specialty coffee continues to develop. Like the wine industry, as customer
sophistication grows, so does the customer's desire for more and better
information, and for a wider selection of quality coffee varieties. We are
able to identify and secure exceptional, rare coffees, roast them to
perfection, and then offer these freshly roasted coffees for sale to our
customers.
Mall Coffee Stores
Gloria Jean's is the current leader in the mall coffee store segment with
280 coffee stores in 38 states and 6 foreign countries. Gloria Jean's specialty
coffee stores are located across the country in high-traffic malls that are
anchored by high profile retailers, such as Nordstrom, Macy's and
Williams-Sonoma. Mall coffee stores can be differentiated from a traditional
coffeehouse based upon the following:
Captive Consumer Base. A major benefit of mall retailing is its
captive consumer base. The primary function of Gloria Jean's marketing is
to entice consumers inside with eye-catching signage and window displays.
Everyday new customers walk by the front entrances of Gloria Jean's stores
affording us the opportunity to introduce them to Gloria Jean's coffee.
Once inside a mall, consumers are unlikely to leave to purchase coffee,
refreshments or gifts similar to those offered by Gloria Jean's. Mall
employees are also captive consumers and represent an important component
of our customer base.
Constant Customer Flow. Unlike a coffeehouse, which serves a
significant amount of its coffee before ten o'clock in the morning, Gloria
Jean's experiences customer flow throughout the day. As a mall coffee
store, Gloria Jean's consumer traffic pattern is driven by mall hours and
the mall dynamic. Gloria Jean's is busiest on weekends and holidays. In
addition, the mall plays a key role in marketing to consumers living in
neighboring communities.
Flavored Coffees. Gloria Jean's was a pioneer in developing high
quality flavored coffees and continues to be a leader in the sale of
flavored coffees today. Unlike many coffee roasters and retailers who use
second-tier whole beans and attempt to disguise the taste with their
various flavors, Gloria Jean's flavored coffees begin with a top quality
single-origin coffee that is roasted and then coated with exclusive
flavorings. Gloria Jean's offers more than 40 flavored whole bean coffees,
both regular and decaffeinated.
Higher Percentage of Whole Bean and Merchandise Sales. The shopping
experience is integral to mall coffee stores, and sales of whole bean
coffee and coffee-related merchandise tend to represent a
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higher percentage of the sales mix than at a coffeehouse. In addition to an
extensive menu of hot and cold beverages, Gloria Jean's offers consumers a
wide array of whole bean coffees, coffee and tea related merchandise, and
all of the accoutrements necessary for a complete in-home coffee
experience. Gloria Jean's also sells gift merchandise, including holiday
gift packs and custom-made gift baskets.
GROWTH STRATEGY
In order to achieve our objective to be the leading specialty coffee
company in both the coffeehouse and mall coffee store segments, our management
team implemented a growth strategy to increase our number of retail locations
and the sale of our coffee products through other distribution channels. The
growth strategy developed by our management team includes:
Franchising through Area Development for Coffeehouses
Our strategic plan emphasizes franchise area development in markets outside
of the core Orange County, California market. Our objective is to expand our
operations to 1,200 to 1,500 coffeehouses, as well as additional carts and
kiosks, through large area development agreements with experienced multi-unit
franchise operators over the next 5 to 7 years. 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 34 states. Since
September 1998, we have announced 5 franchise area development agreements that
provide for the development of 274 coffeehouses with options to develop an
additional 148 coffeehouses. In September 1998, we announced our first franchise
area development agreement which calls for the development of at least 44
coffeehouses in the state of North Carolina over the next five years. In
November 1998, we announced our second franchise area development agreement
which provides for the development of 50 coffeehouses in San Diego, Palm Springs
and Temecula, California over the next 5 years. This area development agreement
includes a one-year option to begin development of 45 coffeehouses in Arizona.
Two more franchise area development agreements were announced in May 1999. One
agreement provides for the development of 50 coffeehouses in Northern Florida
over the next 6 years. The other agreement provides for the development of 80
coffeehouses in Los Angeles, California over the next 7 years and the option to
develop up to 103 coffeehouses in Northern California. In June 1999, we
announced a fifth franchise area development agreement which provides for the
development of 50 coffeehouses in the states of Kentucky and Tennessee over the
next 5 years.
We are currently in various stages of discussion and negotiation with
several additional potential area developers. We have recently added two
franchise sales organizations to assist in the sales program. These sales
organizations receive performance-based compensation for 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 coffeehouses, carts, and kiosks.
We have identified area development franchising with experienced multi-unit
franchise operators as our preferred growth vehicle because we believe these
operators have:
- familiarity with the trade areas and commitment to community businesses;
- existing operational, financial, real estate, construction, training,
accounting, human resources and management functions that are ready to
expand; and
- the ability to be better operators in their own markets than a national
corporation.
The franchisee component of our growth strategy is critical to our success.
We believe that our compelling unit level economics are attractive to
experienced multi-unit franchise operators who will play an integral role in
completing our planned expansion.
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Developing Company-Operated Retail Locations
We will continue to develop company-operated coffeehouses, kiosks and carts
in our core Southern California market and other strategic markets. We are
developing additional coffeehouses in the Phoenix area where 14 retail locations
currently operate under the Coffee Plantation brand name. Both the Orange County
and Phoenix markets have significant capacity for the addition of more
coffeehouses. The transition of the Phoenix Coffee Plantation stores to Diedrich
coffeehouses will occur gradually over the next couple of years.
We intend to develop additional retail locations in high visibility,
high-traffic locations ranging from 1,200 to 1,800 square feet with an exterior
patio area for additional seating. Historically, our most successful
coffeehouses are located between our target demographic customer's home and
office. The prime locations are generally in a strip mall or center in a
neighborhood setting. We are currently in lease negotiations on approximately
eight sites in Orange County and Phoenix and recently executed leases for an
additional three coffeehouses.
Expanding Wholesale Distribution Channel
We have taken significant steps to build our wholesale sales organization
and to grow this business channel. Wholesale sales accounted for approximately
11% of sales in fiscal 1999 and 16% of sales in the first quarter of fiscal
2000. We have added a number of well-known restaurant groups as wholesale
customers, including Ruth's Chris Steakhouses (California/Arizona locations),
Islands Restaurants, El Torito and Claim Jumper. The sale of Diedrich Coffee
products at these restaurant chains helps solidify brand recognition and demand
for our coffee. Additionally, we are actively seeking new distribution channels
for our products. For example, we now offer our coffee on our website and are
seeking to expand this rapidly growing channel of distribution.
Pursuing Selected Acquisitions
We evaluate potential acquisitions that may accelerate our critical mass in
existing or new markets. In particular, we look for acquisition targets that may
provide:
- improved stability of financial and business operations due to increased
cash flow and earnings;
- greater access to capital, distribution channels and coffee roasting
infrastructures; and
- decreased supply and distribution costs.
To this end, we entered into the merger agreement with Coffee People. The
acquisition of Coffee People will add 40 new retail locations to the Diedrich
Coffee brand. Additionally, it will make Diedrich Coffee the leader in the mall
coffee store segment with the acquisition of 280 Gloria Jean's mall coffee
stores. We believe that acquisitions will continue to be available at a discount
to the cost of constructing new stores, especially where targets may be
currently underperforming despite attractive real estate attributes. We believe
our unique, high-quality product and efficient operating system can add value to
an acquired location.
Exploring International Expansion
Gloria Jean's stores located outside of the United States are operated by
individual franchisees. We intend to continue exploring the expansion of our
international presence through franchising or licensing in various markets for
both coffeehouses and mall coffee stores.
UNIT-LEVEL ECONOMICS
Franchised Stores
The franchisee of Diedrich coffeehouses is responsible for all of the
capital expenditures associated with the store, although we do assist in site
selection and help coordinate construction and development to
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ensure consistency. Our typical franchise development agreement calls for a
fixed number of coffeehouses to be built over a five to seven year period. The
area development fee is based on $2,000 per coffeehouse and is paid in 5 annual
installments. For example, if the area development agreement calls for 50
coffeehouses, the franchisee would pay us a total of $100,000 spread evenly over
a 5 year period. In addition, the franchisee pays a fee of $28,000 upon the
opening of each coffeehouse. Ongoing charges to franchisees include a royalty
fee of 5% of gross sales and an advertising cooperative contribution of 2% of
gross sales. The franchisee purchases the whole beans from us at full cost. The
franchisee pays the same price for its beans as do our company-operated
coffeehouses.
In the Gloria Jean's mall coffee store franchises, the franchisee is
responsible for all of the capital expenditures associated with the store,
although we usually coordinate construction and development of new stores to
ensure consistency. For drive-thru units, we plan to use both a single store and
an area development approach, under which the area developer agrees to develop a
specified number of units in a geographical territory and obtains certain rights
to that territory. Typical franchise agreements provide for the payment of
$25,000 upon the opening of each store. This fee is reduced to $20,000 if it is
the franchisee's second store. Ongoing charges to franchisees include a royalty
fee of 6% of gross sales and an advertising fund contribution of 2% of gross
sales, as well as a $1.00 per pound margin on beans sold to franchisees.
Company-Operated Stores
In fiscal 1999, our Diedrich coffeehouses located in Orange County
generated average store sales of approximately $740,000. During the same fiscal
year, these locations generated average cash flow of approximately $190,000 or
26% of total sales. Comparable unit level sales for these coffeehouses increased
4.4% for fiscal 1999. We currently lease most of our locations and plan to lease
all of our future locations. We intend to develop coffeehouses that require an
initial investment of between $300,000 and $325,000, excluding lease costs.
However, individual store investment costs could vary due to a variety of
factors, including competition for sites, location, construction costs and unit
size.
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RETAIL LOCATIONS
Set forth below is a list of each of the retail locations of Diedrich
Coffee and Coffee People as of June 1, 1999, separated by the states and foreign
countries in which they are located.
COFFEEHOUSES AND CARTS
<TABLE>
<CAPTION>
COMPANY-
LOCATION FRANCHISED OPERATED
-------- ---------- --------
<S> <C> <C>
Arizona............... 1 13
California............ 2 28
Colorado.............. -- 7
</TABLE>
<TABLE>
<CAPTION>
COMPANY-
LOCATION FRANCHISED OPERATED
-------- ---------- --------
<S> <C> <C>
Oregon................ -- 26
Texas................. -- 4
-- --
Total.............. 3 78
== ==
</TABLE>
MALL COFFEE STORES
<TABLE>
<CAPTION>
COMPANY-
LOCATION FRANCHISED OPERATED
-------- ---------- --------
<S> <C> <C>
DOMESTIC
Arizona............... 5 --
Arkansas.............. 1 --
California............ 33 7
Colorado.............. 3 1
Connecticut........... 5 1
Florida............... 10 2
Georgia............... 1 --
Hawaii................ 3 --
Illinois.............. 30 1
Indiana............... 4 --
Kansas................ 1 1
Kentucky.............. 2 --
Louisiana............. -- 2
Maine................. 2 --
Maryland.............. 4 --
Massachusetts......... 5 --
Michigan.............. 6 --
Minnesota............. 8 1
Missouri.............. 7 1
Nebraska.............. 3 --
Nevada................ 2 1
New Hampshire......... 3 --
New Jersey............ 3 --
New Mexico............ 1 --
New York.............. 9 1
North Carolina........ 9 --
</TABLE>
<TABLE>
<CAPTION>
COMPANY-
LOCATION FRANCHISED OPERATED
-------- ---------- --------
<S> <C> <C>
North Dakota.......... 1 --
Ohio.................. 8 2
Oklahoma.............. 2 --
Pennsylvania.......... 10 1
South Carolina........ 2 --
Tennessee............. 3 2
Texas................. 8 2
Vermont............... -- 1
Virginia.............. 7 1
Washington............ 2 1
West Virginia......... -- 1
Wisconsin............. 11 --
Guam.................. 1 --
--- --
Total Domestic..... 215 30
=== ==
INTERNATIONAL
Australia............. 8 --
Ireland............... 3 --
Japan................. 10 --
Korea................. 4 --
Mexico................ 6 --
United Arab
Emirates........... 4 --
--- --
Total
International.... 35 0
=== ==
Total Domestic and
International.... 250 30
=== ==
</TABLE>
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After the acquisition of Coffee People, we will operate through four retail
operating systems:
Neighborhood Coffeehouses
Neighborhood coffeehouses, located in both urban and suburban neighborhoods
and business districts, offer a complete line of coffee products, including
beverages, beans and merchandise. As of June 1, 1999, we had 51 neighborhood
coffeehouses.
Mall Coffee Stores
Our mall coffee stores consist primarily of Gloria Jean's outlets. Mall
coffee stores generally are full-service stores with limited seating, selling
coffee-related merchandise and whole beans along with prepared espresso-based
drinks and other hot and cold beverages. As of June 1, 1999, there were 280 mall
coffee stores.
Drive-Thru Espresso Bars
The drive-thru espresso bars operate under the Motor Moka(R) sub-brand. As
of June 1, 1999, Coffee People operated nine of these stores in Portland,
Oregon, two of which have indoor seating. Drive-thru stores without indoor
seating generally have a walk-up window. These stores are designed to maximize
customer convenience by eliminating the need to park a car and walk into a
store.
Specialty Carts or Kiosks
Our specialty cart or kiosk format is designed for placement in
high-traffic locations such as supermarkets, university campuses, airports and
office building lobbies. Kiosks primarily sell coffee beverages and pastries. As
of June 1, 1999, we operated 21 carts or kiosks. We intend to expand in this
area as opportunities arise.
RETAIL OPERATIONS
Coffeehouses
The typical Diedrich coffeehouse is staffed with 1 or 2 managers and a
staff of 10 to 15 part-time hourly employees from which the operating shifts are
filled. Additionally, local entertainment is used on the weekends to enhance the
neighborhood atmosphere. The hours for each coffeehouse are established based
upon location and customer demand, but typically are from 6:00 a.m. to 11:00
p.m., Monday through Saturday, in residential locations and from 6:00 a.m. to
5:00 p.m., Monday through Friday, in commercial locations.
In addition to coffee beverages, all Diedrich coffeehouses offer a limited
selection of light food items, such as bagels, croissants and pastries and
dessert items, such as cookies and cakes, to complement beverage sales. Our
coffeehouses also sell more than twenty different selections of regular and
decaffeinated roasted whole bean coffees, and they carry select coffee-related
merchandise items. The following table sets forth, as percentages, the
approximate sales mix by categories of products in fiscal 1999 for the
company-operated coffeehouses operated by Diedrich Coffee and Coffee People:
<TABLE>
<S> <C>
Beverages................................................... 71%
Coffee beans................................................ 6%
Food items.................................................. 21%
Accessories and clothing.................................... 2%
---
Total............................................. 100%
===
</TABLE>
Mall Coffee Stores
Gloria Jean's retail outlets generally offer a full range of coffee beans,
coffee beverages, teas and food as well as a variety of related gifts, supplies,
equipment and accessories. The hours for each mall coffee store are established
based on the operating hours for the mall in which the store is located. The
following
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table sets forth, as percentages, the approximate sales mix by category of
products sold in company-operated mall coffee stores for the 36 weeks ended
March 6, 1999:
<TABLE>
<S> <C>
Beverages................................................... 63%
Coffee beans................................................ 17%
Food items.................................................. 6%
Gifts and other merchandise................................. 14%
---
Total............................................. 100%
===
</TABLE>
Franchise Operations
Our current franchise agreements require franchisees to purchase all of
their coffee from Diedrich Coffee or Coffee People. In addition, we supply
franchisees with other non-coffee products, such as cups, bags and napkins.
Suppliers of products sold in franchised stores are subject to our approval to
ensure that quality standards and product consistency are maintained at all
times.
We have the first right to purchase any existing franchise store that a
franchisee wishes to sell. If we do not choose to purchase the franchise, we
have the right to approve the new franchisee before the franchise transfer.
Management believes that store profitability and the quality of customer
service are maximized when stores are operated by talented and committed
management. We have implemented a rigorous screening process for the selection
of qualified franchisees and management.
Franchise Support Programs
We provide a variety of support services to our franchisees. These services
include:
- training;
- business consultation;
- marketing;
- product sourcing; and
- volume purchasing savings.
We have established an intensive four week training program for our franchisees,
which includes training on in-store operations, coffee knowledge, merchandising,
buying, controls and accounting. Management works closely with franchisee
representatives on issues that affect the operations of stores. Franchisees are
surveyed regularly to provide feedback on subjects that affect the operations of
their stores.
WHOLESALE OPERATIONS
Currently, Diedrich Coffee has over 300 wholesale accounts. We previously
concentrated on smaller, single store restaurant operators as wholesale clients.
With our current management team came a shift in focus to larger, chain
customers. As specialty coffee has grown in overall popularity, the restaurant
customer has demanded a high quality cup of coffee as a supplement to a fine
meal. The shift to chain accounts resulted in several new customers, including
Ruth's Chris Steakhouse (California/Arizona locations), Claim Jumper, Islands
Restaurants and El Torito Restaurants. Diedrich Coffee not only supplies coffee
to these customers, but also approves the equipment and trains the employees of
these customers to ensure that the quality of coffee served meets our rigorous
standards. These customers specify that Diedrich Coffee products are served in
their menus providing Diedrich Coffee with exposure to the restaurants' patrons.
MARKETING
Coffeehouse Strategy
Our marketing strategy is to differentiate Diedrich Coffee and to build a
strong brand identity primarily utilizing the coffeehouse model. The wholesale
division and the office coffee service help ensure the visibility of the brand,
but the core of this business is the coffeehouse. We implement this strategy at
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the coffeehouse level by promoting the distinctive qualities of the various
Diedrich Coffee products, educating customers about the origins of coffee,
including the private estate coffees and roasts and delivering excellent
customer service in a cozy, comfortable atmosphere. Our marketing efforts are
based upon the belief that the proprietary roast recipes and our commitment to
quality and freshness deliver a distinctive advantage in the coffee product. A
steady introduction of new coffee and coffee-related drinks is an intrinsic
aspect of our marketing strategy. The Coffee People and Coffee Plantation
coffeehouses being acquired in connection with the Coffee People acquisition
will be converted to the Diedrich Coffee brand.
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.
As we enter new markets, we plan to tailor our marketing strategy to the
overall level of awareness and availability of specialty coffee in that market.
Our promotions will focus on the superior proprietary roast recipes and taste of
Diedrich Coffee. In markets that are more knowledgeable about specialty coffees,
our advertising will focus on the superiority of our guaranteed freshly roasted
products versus competitive specialty brands. We plan to utilize print and other
mass media advertising to expand brand awareness when Diedrich Coffee has
achieved sufficient market penetration, in our judgment, to make such efforts
cost-effective.
Mall Coffee Store Strategy
We do not intend to convert the Gloria Jean's stores that we are acquiring
in the acquisition to the Diedrich Coffee brand in the near future. Rather, we
intend to implement new strategies to strengthen and reposition this brand
within its market segment.
Gloria Jean's marketing strategy is based on its coffee expertise, customer
service, and innovative coffee and tea merchandise. We have a highly trained
staff of certified coffee agents in stores who can impart coffee knowledge to
increasingly sophisticated consumers. Our customer service spans from brewing
and serving the best tasting cup of coffee to answering questions about the wide
variety of coffees available. Finally, through our marketing efforts, consumers
expect to find high quality, unique accessories and equipment to facilitate an
in-home occasion or for gifting to others at Gloria Jean's stores.
Gloria Jean's marketing strategy is to drive store sales and to increase
brand awareness through high impact and low cost marketing programs.
Specifically, we try to increase store sales through high margin new product
introductions and in-store promotions. In addition, we strive to increase brand
awareness through opportunistic communication vehicles, such as direct mailings
and website development.
PRODUCT SUPPLY AND ROASTING
Sourcing
Coffee beans are an agricultural product grown commercially in over fifty
countries in tropical regions of the world. The price and supply of coffee are
subject to significant volatility. There are many varieties of coffee and a
range of quality grades within each variety. Although the broader coffee market
generally treats coffee as a fungible commodity, the specialty coffee industry
focuses on the highest grades of coffee. Diedrich Coffee purchases only premium
grade arabica coffee beans and believes these beans are the best available from
each producing region. The premium grade arabica bean is a higher quality
variety than the average grade arabica or robusta variety coffee bean, which are
typically found in non-specialty or mass-merchandised commercial coffees. We
seek to purchase the finest qualities and varieties of coffee by identifying the
unique characteristics and flavor of the varieties available from each region of
the world. The background and experience of our personnel allows Diedrich Coffee
to maintain its commitment to serve and sell only the highest quality coffee.
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During the buying season, we may enter into forward commitments for the
purchase of more than a dozen different types of coffee, plus specially featured
coffees, that may only be available in small quantities. Rotating our coffee
selection enables us to provide our customers with a wider variety of coffees,
as well as certain coffees that are available only on a seasonal basis. We
contract for future delivery of green coffee to help ensure adequacy of supply
and typically maintain a minimum six-week supply of each variety of whole beans
then available.
Roasting
Diedrich Coffee employs a roasting process that varies based upon the
variety, quality, origin and physical characteristics of the coffee beans being
roasted. We utilize recipes and techniques that have been developed over three
generations to bring out the best characteristics of the coffee during the
roasting process and to develop the optimal flavor conditions that a coffee has
to offer. This approach differentiates Diedrich Coffee from commercial coffee
producers and other specialty producers employing uniform roasting processes
that do not differentiate between the types of coffee being roasted.
Our master roasters, trained by the company, are responsible for overseeing
the roasting process. They are craftsmen who employ our proprietary roasting
formulas while adjusting the formula to take into account the specific
attributes of each coffee bean being roasted. Each coffee bean contains aromatic
oils and flavor characteristics that develop from the soil, climate and
environment where the bean is grown. The skilled roastmaster determines and
carefully controls the roasting conditions in an effort to maximize the flavor
potential of each batch of coffee. The roastmaster hears how the roast pops,
smells the developing aroma and identifies the right shades of color. He draws
upon experience and knowledge to properly adjust airflow, time and temperature
while the roast is in progress in order to optimize each roast.
Coffee People has operated its own coffee roasting facility in Northern
California, from which it supplied all of its franchised and company-operated
stores. This roasting facility is ideally located to receive coffee shipments
through the port of San Francisco and receives favorable freight rates from
California to distribute its roasted coffee nationwide. In addition, prior to
the completion of the acquisition, Coffee People began roasting some of the
green coffee sourced by Diedrich Coffee for use in Diedrich Coffee retail
locations in this facility. This roasting facility has the capacity to roast up
to ten million pounds annually. Currently, less than four million pounds are
being roasted at this facility annually. After the completion of the
acquisition, Diedrich Coffee will close its roasting facility in Southern
California and all roasting will be done at the Northern California facility.
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
significantly extend the shelf life of roasted coffee.
MANAGEMENT INFORMATION SYSTEMS
All of the Diedrich coffeehouses use point-of-sale systems which ensure
efficient service to the customers, assist store management in minimizing
operating costs and maintain the necessary information to provide management
with timely financial and marketing data. The system includes functions to
record all customer sales, authorize credit card transactions, forecast labor
requirements based on estimated sales activity, manage store inventory and
analyze actual versus theoretical food costs. Currently, Coffee People is
testing point-of-sale with equivalent capabilities in its corporate and
franchised stores. In addition to providing point-of-sale functionality and
analysis in the stores, the system will also forward detailed sales information
from the franchise locations to the corporate office facilitating system-wide
analysis and providing the necessary information to develop and measure
corporate marketing programs. It is expected
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that the system will be installed in a significant number of the franchised mall
coffee stores by the end of 1999.
The systems used in our corporate offices provide financial reporting that
includes performance comparisons of actual, budget and prior year results by
period and year-to-date, statistical recaps and rolling 13 period reports. This
information allows management to measure store performance based on sales, cost
of sales, labor and store expenses on a timely basis. After the acquisition, we
intend to consolidate our corporate information systems.
We use a computer-based manufacturing system to monitor the roasting
activities at the Northern California facility. This application compares
recipes with production activity to measure production efficiency, production
requirements and raw material utilization. Systems have also been implemented
which gather information on the roasting process to ensure company standards for
coffee production are achieved.
COMPETITION
The specialty coffee market is intensely competitive and highly fragmented.
With low barriers to entry, competition in the industry is expected to increase
from national and regional chains, franchise operators and local specialty
coffee stores. We compete directly against all other premium coffee roasters,
coffeehouses, espresso/coffee bars and mall coffee stores, as well as against
restaurant and beverage outlets that serve coffee and a growing number of
espresso stands, carts and stores. In addition, we compete to draw consumers of
standard or commercial coffee to premium coffee. Our whole bean coffees compete
directly against specialty coffees sold at retail through supermarkets,
specialty retailers and a growing number of specialty coffee stores. We believe
that our customers choose among retailers primarily on the basis of product
quality, service, coffeehouse ambiance, convenience and, to a lesser extent, on
price.
We compete with a growing number of specialty coffee retailers including
Starbucks, Coffee Beanery, Caribou, Barnie's, Tully's, New World Coffee &
Bagels, Peet's Coffee and many others. The attractiveness of the gourmet
specialty coffeehouse market may draw additional competitors with substantially
greater financial, marketing and operating resources than us. A number of
nationwide coffee manufacturers, such as Kraft General Foods, Proctor & Gamble,
and Nestle, distribute coffee products in supermarkets and convenience stores,
which may serve as substitutes for our coffees. Other specialty coffee companies
including Starbucks, Seattle's Best Coffee, Bucks County, Brothers Gourmet
Coffees and Green Mountain Coffee Roasters, sell whole bean coffees in
supermarkets and variety and discount stores.
The performance of individual coffeehouses or mall coffee stores may also
be affected by factors such as traffic patterns and the type, number and
proximity of competing coffeehouses or mall coffee stores. In addition, factors
such as inflation, increased coffee bean, food, labor and employee benefit costs
and the availability of experienced management and hourly employees may also
adversely affect the specialty coffee retail business in general and our
coffeehouses and mall coffee stores in particular.
INTELLECTUAL PROPERTY
We own several trademarks and service marks that are registered with the
United States Patent and Trademark Office, including Diedrich Coffee,(R) Wiener
Melange,(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 have 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. We own copyrights on our
promotional materials, coffeehouse graphics and operational and training
materials. We do not believe that any of these copyrights, valuable as they are,
are material to our business.
Coffee People owns federal trademark or service mark registrations for
Coffee People,(R) Coffee Plantation,(R) Gloria Jean's,(R) Motor Moka(R) and Aero
Moka(R) as well as several other slogans, product names, design marks and logos.
Coffee People also owns a number of common law service marks and trademarks in
the United States including "Gloria Jean's Coffee Bean." Several federal
trademark applications are pending, including one for "Gloria Jean's Coffees."
Coffee People has also received
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trademark and service mark protection for the name Coffee People and related
marks in Canada and Japan.
PROPERTIES
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 June 1, 1999, we were also a party to
various leases for a total of 45 retail locations, including 32 operating
coffeehouses, 6 subleased units and 7 carts. Included in these subleased units
are two retail locations to a franchisee subleased in the first quarter of
fiscal 2000. This was part of an executed 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.
All of the Gloria Jean's locations are operated in leased premises, most
situated in regional malls. Virtually all of the leased premises occupied by
franchised outlets are leased by Gloria Jean's which then enters into sublease
agreements with the franchisee on a cost pass-through basis. Gloria Jean's,
however, remains obligated under the lease. Gloria Jean's stores are designed to
accommodate locations in various sizes, ranging from 170 square foot kiosk
outlets, which sell principally coffee drinks and other beverages, to 2,000
square foot coffeehouses which also provide limited food offerings.
Coffee People owns the land and buildings on which two of its
company-operated Coffee People brand drive-thru Motor Moka(R) espresso bars are
operated. In addition, it owns the building and leases the underlying land for
five additional company-operated facilities. Existing company-operated retail
stores range from 150 to 2,850 square feet. The monthly lease rate for certain
stores is based on that store's monthly sales revenue. Some of Coffee People's
leases expire in the near future.
One of the Coffee People brand company-operated stores is operated in a
shopping mall undergoing redevelopment for which rent is paid month-to-month.
The lessor, at any time, could demand that Coffee People vacate the premises on
30 days prior written notice. Coffee People has periodic discussions with the
lessor relative to entering into a long-term lease.
Under its lease with the Port of Portland for the seven Aero Moka stores at
Portland International Airport, Coffee People is required to enter into a joint
venture with a certified disadvantaged business enterprise for one of its
airport stores. Upon entry into the joint venture, Coffee People will have a 49%
ownership in that store.
Coffee People's corporate offices and roasting facilities in Castroville,
California consist of approximately 60,000 square feet and are leased through
December 31, 2005. Coffee People currently leases approximately 9,400 square
feet of office space in Beaverton, Oregon and approximately 1,900 square feet of
office space in Tempe, Arizona for its regional offices. Coffee People is
seeking to sublet or assign the lease, which expires in February 2004, for
portions of its Beaverton office. Approximately 2,660 square feet is currently
subleased to a third party.
EMPLOYEES
As of June 1, 1999, Diedrich Coffee and Coffee People collectively employed
a work force of 1,734 persons, 488 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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GOVERNMENT REGULATION
In addition to the laws and regulations relating to the food service
industry, we are subject to Federal Trade Commission, or FTC, regulation and
foreign and state laws that regulate the offer and sale of franchises as well as
the franchise relationship.
The FTC's Trade Regulation Rule relating to Disclosure Requirements and
Prohibitions Concerning Franchising and Business Opportunity Ventures generally
requires us to give prospective franchisees a franchise offering circular
containing information prescribed by the rule.
Foreign and state laws that regulate the offer and sale of franchises and
the franchisor-franchisee relationship exist in a substantial number of states
and foreign countries. These laws generally require registration of the
franchise offering with state authorities before making offers or sales and
regulate the franchise relationship by, for example:
- prohibiting interference with the right of free association among
franchisees;
- prohibiting discrimination in fees and charges;
- regulating the termination of the relationship by requiring "good cause"
to exist as a basis for the termination, advance notice to the franchisee
of the termination, and an opportunity to cure a default;
- requiring repurchase of inventories in some circumstances;
- restricting nonrenewal by the franchisor;
- limiting restrictions on transfers or inheritance of the franchisee's
interests; and
- regulating placement of competing units that might adversely affect the
franchisee's results.
Coffee People has not always been in technical compliance with a number of
state, federal and foreign franchise laws. Failure to comply with these laws may
adversely affect us.
Any changes to the FTC rule or state or foreign franchise laws, or future
court or administrative decisions, however, could affect our franchise business.
There are also extensive federal, state and local government regulations
relating to the development and operation of food service outlets, including
laws and regulations relating to:
- building and seating requirements;
- the preparation and sale of food;
- cleanliness;
- safety in the workplace; and
- accommodations for the disabled.
Our relationship with our employees is also subject to regulation, such as:
- minimum wage requirements;
- anti-discrimination laws;
- overtime and working conditions; and
- citizenship requirements.
LEGAL PROCEEDINGS
In the ordinary course of our business, we may become involved in legal
proceedings from time-to-time. As of June 1, 1999, Diedrich Coffee was not a
party to any material pending legal proceedings.
Coffee People is and may continue to be a defendant and a plaintiff in
various lawsuits and arbitrations from time to time. No legal proceedings are in
progress or pending against Coffee People, other than proceedings set forth
below or proceedings incidental to carrying on its business and operations in
the ordinary course which, individually or in the aggregate, are not material to
Coffee People.
Security Trust Company v. Gloria Jean's Gourmet Coffees Corporation. The
claimant filed a claim in the Superior Court of the State of California, County
of Contra Costa, asking for unpaid rent and late charges for a Gloria Jean's
store in Richmond, California vacated by Coffee People. Gloria Jean's has
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requested that the landlord mitigate damages caused by early termination of the
lease by seeking to relet the premises. Unpaid rent plus rent through the
remainder of the original lease term would be approximately $175,000. Management
does not believe the outcome of this litigation will have a material adverse
effect on Coffee People.
KKW Enterprises, Inc. v. Gloria Jean's Gourmet Coffee Franchising Corp. On
or about May 7, 1998, plaintiff filed a complaint against Franchising Corp. in
the Superior Court of the State of Rhode Island for Providence County alleging
that Franchising Corp., by making certain misrepresentations, fraudulently
induced plaintiff to enter into franchise agreements for Gloria Jean's stores.
Plaintiff seeks damages for the losses it purportedly sustained in obtaining and
operating its Gloria Jean's stores, punitive damages and attorneys' fees, among
others, and rescission of its two remaining franchise agreements. On Franchising
Corp.'s motion, the case was removed to the United States District Court for the
District of Rhode Island. Franchising Corp. has filed a Demand for Arbitration
with the Chicago office of the American Arbitration Association, seeking a
declaration that Franchising Corp. has no liability for the claims asserted, and
has demanded that plaintiff submit the claims pending in the District Court to
arbitration in accordance with the franchising agreements. This case is still in
the early stages of litigation and there can be no assurance that a favorable
outcome will be obtained or that, if the matter were resolved in favor of the
plaintiff, there would not be a material adverse effect on Coffee People.
Sugai Products, Inc., et. al. v. Kona Kai Farms, Inc., Regton Companies,
Inc., Starbucks Corp., Peet's Coffee and Tea, Inc., Gloria Jean's Gourmet
Coffees Corp., et. al. On January 9, 1997, the plaintiffs filed a putative class
action against the defendants alleging violation of the Lanham Act, the Hawaii
Uniform Deceptive Trade Practices Act and the Hawaii Unfair Trade Practices Act.
The plaintiffs, who purport to represent a class of Kona coffee growers,
wholesalers and retailers, allege that the defendants sold coffee beans grown in
Central America under the false label "Kona coffee," and seek an injunction,
unspecified damages, attorneys' fees and costs. In March, Gourmet Coffees Corp.
and certain other defendants moved to dismiss the complaint or, in the
alternative, for a more definitive statement of the claim. The plaintiffs filed
a motion for class certification in July 1997. In January 1998, the United
States District Court for the District of Hawaii denied class certification.
Yumane Enterprises, et al. v. Kona Kai Farms, Inc., et al. Plaintiffs, a
purported class of Kona Coffee farmers, filed a class action on October 23, 1998
in United States District Court for the District of Hawaii. Plaintiffs allege
identical allegations as described above in the Sugai Products, Inc. case. Upon
motion of the defendants, including Gloria Jean's, this action was consolidated
with the Sugai Products, Inc. case.
Patrick, et al. v. Kona Kai Farms, Inc., et al. On October 23, 1998, four
named plaintiffs, on behalf of themselves and the general public, filed a
complaint in California state court against Gloria Jean's and other defendants.
Plaintiffs allege violations of California Business and Professions Code sec.
17200 and common law unfair competition and business practices, arising from the
alleged sale of Panamanian coffee as Kona coffee.
Although Gloria Jean's has denied the claims asserted by the plaintiffs in
the three Kona coffee-related cases described above, and intends to vigorously
defend its position, there can be no assurance that a favorable outcome will be
obtained or that, if the matter were resolved in favor of the plaintiffs, there
would not be a material adverse affect on Coffee People.
Charles Walker, Phyllis Jean, Buckeye's Best Bean Corp. d/b/a Gloria Jean's
Gourmet Coffee v. Gloria Jean's Gourmet Coffee Franchising Corp., et al.
Plaintiffs filed a demand for arbitration on December 9, 1998, alleging common
law fraud, negligent misrepresentation, violations of the Ohio Business
Opportunity Purchasers Protection Act, violations of the Illinois Franchise Act
and breach of contract. Plaintiffs have asserted a claim for unjust enrichment
and punitive damages and are seeking damages in excess of $500,000. Although
Gloria Jean's has denied the claims, and intends to vigorously defend its
position, there can be no assurance that a favorable outcome will be obtained or
that, if the matter were resolved in favor of the plaintiff, there would not be
a material adverse effect on Coffee People.
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In June of last year, Gloria Jean's, Brothers Gourmet Coffees, and Brothers
Retail Corp. agreed on present and future indemnification in connection with the
settlement of the escrow account established pursuant to The Second Cup's
purchase of Gloria Jean's stock from Brothers. As consideration for the
settlement, Gloria Jean's has released Brothers from further liability for all
pending and future legal proceedings. Brothers has agreed to continued
indemnification of Gloria Jean's in connection with the Kona litigation as it
relates to the period ended November 9, 1995 and for amounts owed on California
and Illinois sales tax audits, currently under way, in excess of $130,000. On
August 27, 1998, Brothers filed a voluntary petition for relief under Chapter 11
of Title 11 of the United States Code with the United States Bankruptcy Court
for the District of Delaware. However, Coffee People intends to take such legal
measures management believes appropriate to protect any claims it may have
against Brothers.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Upon completion of this offering, our directors, executive officers and
other key employees will be 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. Diedrich...... 40 Vice Chairman of the Board, Secretary, Chief Coffee
Officer and Director
Peter Churm(1)(2)....... 73 Director
Lawrence 58 Director
Goelman(1)(2).........
Paul C. 42 Director
Heeschen(1)(2)........
Randy Powell............ 38 Director nominee
Ann Wride............... 37 Vice President and Chief Financial Officer
Dolf Berle.............. 36 Vice President of Franchise Development and Operations
Catherine Saar.......... 40 Vice President of Marketing and Wholesale Sales
Robert Rodriguez........ 45 President, Gloria Jean's division
Thomas M. Twitchel...... 41 Senior Vice President, Coffee Plantation division
James A. McDermet....... 46 Senior Vice President, Coffee People (Oregon) division
</TABLE>
- -------------------------
(1) Audit committee member.
(2) Compensation committee member.
The principal occupation for the last five years of each director and
executive officer, as well as some other information, is set forth below.
John E. Martin was appointed Chairman of the Board of Directors by the
board 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 that owns and operates several
restaurants in Southern California. In addition, Mr. Martin serves on the boards
of directors of: Williams-Sonoma, Inc., Franchise Mortgage Acceptance Company
and The Good Guys! Inc.
Timothy J. Ryan was appointed as President and Chief Executive Officer by
the board 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. Sizzler
International, Inc. filed for bankruptcy protection in June 1996. 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. In addition, Mr. Ryan serves on
the board of directors of Rubio's Restaurants, 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. Before
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.
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 16 years before that time. He also serves on 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 since
October 1996. He assumed the position of
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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. Before that, he served as Chairman, President and Chief Executive Officer
of CostCare, Inc. for 14 years. Mr. Goelman also serves on the board of Imagyn
Medical Technologies, Inc.
Paul C. Heeschen became a director of Diedrich Coffee in January 1996. For
the past eight 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.
Randy Powell will be appointed a director of Diedrich Coffee upon the
completion of the acquisition of Coffee People, as Second Cup's director
nominee. Mr. Powell is the President and Chief Executive Officer of The Second
Cup Ltd. Mr. Powell joined Second Cup as President and Chief Operating Officer,
Canadian Operations effective August 11, 1997. From June 1994 to August 1997,
Mr. Powell was President and General Manager, S.C. Johnson & Son, Limited and
prior to June 1994, he was Vice-President Sales, Campbell Soup Company Limited.
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. Before 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. Additionally, Mr. Berle assumed responsibility for Company Operations in
June 1998. Before 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 1998. From May 1993 to December 1997, Ms.
Saar was Director of Corporate Marketing for Smart and Final, Inc. Before this,
Ms. Saar held various marketing positions at Taco Bell Corporation.
Robert Rodriguez has been President of Coffee People's Gloria Jean's unit
since September 1998. Previously, he was with McDonald's Corporation from 1992
to September 1998, serving as Region Vice President of Operations and Division
Vice President of Strategic Planning. He worked for Taco Bell from 1981 to 1992,
serving as Zone Vice President from 1989 to December 1991.
Thomas M. Twitchel became Senior Vice President of Coffee People's Coffee
Plantation division in May 1998. He was a management and real estate consultant
with TMT Partners from August 1997 to May 1998. From November 1996 to August
1997, he was Senior Vice President of Coffee Plantation, Inc., a wholly-owned
subsidiary of Second Cup, Ltd. Mr. Twitchel was Vice President of Operations
with Red Robin International, Inc. in Irvine, California from 1993 until 1996.
James A. McDermet joined Coffee People in November 1998 as Senior Vice
President of the Coffee People (Oregon) division. From July 1996 to June 1998,
he was President and Chief Operating Officer of Briazz, Inc. From November 1994
to July 1996, he was President and Chief Operating Officer of Java Southeast,
Inc. From 1975 to 1994, he served in various capacities at Burger King
Corporation, including Retail Division Sector Vice President and Regional Vice
President and General Manager where he oversaw over 300 company and franchise
locations.
BOARD COMMITTEES
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
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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.
DIRECTOR 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> 67
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth compensation earned during the last three
fiscal years by 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(3)................................................ 1999 $122,808 54,000
Vice President and Chief Financial Officer 1998 -- --
1997 -- --
Dolf Berle(4)............................................... 1999 $105,519 54,000
Vice President of Franchise Development and Operations 1998 -- --
1997 -- --
</TABLE>
- -------------------------
(1) Mr. Martin was appointed Chairman of the Board on November 17, 1997.
Accordingly, he did not earn or receive any compensation from Diedrich
Coffee before fiscal 1998.
(2) Mr. Ryan was appointed President and Chief Executive Officer on November 17,
1997. Accordingly, he did not earn or receive any compensation from Diedrich
Coffee before fiscal 1998.
(3) Ms. Wride joined Diedrich Coffee as Vice President and Chief Financial
Officer in April 1998. Accordingly, she did not earn or receive any
compensation from Diedrich Coffee until fiscal 1999.
(4) Mr. Berle joined Diedrich Coffee as Vice President of Franchise Development
in May 1998. Accordingly, he did not earn or receive any compensation from
Diedrich Coffee until fiscal 1999.
Stock Option Grants In Last Fiscal Year
The following table sets forth information regarding stock options granted
to the following executive officers during the fiscal year ended January 27,
1999.
<TABLE>
<CAPTION>
POTENTIAL
PERCENT OF REALIZABLE VALUE AT
TOTAL ASSUMED ANNUAL RATES
NUMBER OF OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES EXERCISE TERM(1)
OPTIONS IN FISCAL PRICE EXPIRATION -----------------------
NAME GRANTED(#) YEAR ($/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
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<PAGE> 68
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 his 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 information concerning the number and value
of unexercised options held by the following executive officers on January 27,
1999. None of these executive officers exercised options to purchase common
stock 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 by the option is greater than the option
exercise price.
(2) Future exercisability is subject to a number of factors, including, but not
limited to, the optionee remaining employed by Diedrich Coffee.
BENEFIT PLANS
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. Our stockholders approved the plan in September
1996. 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 475,000
shares were initially authorized under the plan. On June 26, 1997, the
stockholders increased the number of shares authorized by 300,000, to a total of
775,000 authorized shares. The incentive plan is administered by the
compensation committee of the board, 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 or the compensation committee may amend, suspend or terminate the
incentive plan at any time. 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
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<PAGE> 69
our stockholders. The board or compensation committee may allow award recipients
to pay for the exercise of options with a promissory note issued by the company
or in a broker-assisted type transaction with the company. In the event of a
change in control of Diedrich Coffee, awards outstanding under this plan
terminate without contrary agreement or action by the board of directors. In
such a case, the board has the ability to accelerate the vesting of the
outstanding awards or provide for the creation of new awards to replace those
awards that would terminate.
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. Our stockholders approved the plan in September 1996. 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 before
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. We may allow award recipients to
pay for the exercise of options in a broker-assisted type transaction with the
company. In the event of a change in control of Diedrich Coffee and the
subsequent termination of a director, the vesting of all options accelerates.
Upon such an acceleration, the initial option grants are exercisable for a
period of one year following the director's termination, while additional option
grants are exercisable for 90 days following the termination.
1997 Non-Employee Directors Stock Option Plan and Agreement
In April 1997, the disinterested directors on the board 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 and will expire on the
earlier of April 25, 2007, or 180 days after the termination of the director. We
may allow Messrs. Churm and Heeschen to pay for the exercise of the options in a
broker-assisted type transaction with the company. In the event of a change in
control of Diedrich Coffee and the subsequent termination of either director,
the terminated director has 180 days to exercise his options. No additional
options are available for grant under the 1997 Non-Employee Directors Stock
Option Plan and Agreement.
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 the board may terminate him in its discretion 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
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<PAGE> 70
$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 that 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. Our stockholders approved Mr. Martin's option
agreement at a special meeting held on January 22, 1998. We granted Mr. Martin
options to purchase an aggregate of 850,000 shares of our 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 our stockholders. The options granted to Mr. Martin are
exercisable, at the following exercise prices:
- 450,000 shares of common stock at an exercise price of $4.00 per share;
- 100,000 shares of common stock at an exercise price of $5.00 per share;
- 150,000 shares of common stock at an exercise price of $8.00 per share;
and
- 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, Mr. Martin may pay the exercise price for his options with cash or by
delivery of shares of our 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. We may also terminate Mr. Ryan 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.
On November 17, 1997, Mr. Ryan also entered into a stock option plan and
agreement with Diedrich Coffee. Our stockholders approved Mr. Ryan's option
agreement at a special meeting held on January 22, 1998. We granted Mr. Ryan
options to purchase an aggregate of 600,000 shares of our 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 our
stockholders. The options granted to Mr. Ryan are exercisable, at the following
exercise prices:
- 50,000 shares of common stock at an exercise price of $3.50 per share;
- 75,000 shares of common stock at an exercise price of $4.50 per share;
- 125,000 shares of common stock at an exercise price of $5.00 per share;
- 175,000 shares of common stock at an exercise price of $8.00 per share;
and
- 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
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<PAGE> 71
(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, Mr. Ryan may pay the exercise price for his
options with cash or by delivery of shares of our 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 him 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 term of
the agreement is two years. 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 our common stock at an exercise price of $5.8125, vesting
over two years. Ms. Wride receives employee benefits consistent with the
company's policies for 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 our 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 options will be the date of the annual grant. Mr. Berle receives employee
benefits consistent with the company's policies for 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 our common stock at an
exercise price of $7.75, vesting over two years. Ms. Saar receives employee
benefits consistent with the company's policies for other senior executives.
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<PAGE> 72
TRANSACTIONS INVOLVING OFFICERS,
DIRECTORS AND PRINCIPAL STOCKHOLDERS
On April 6, 1999, we 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 our 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 common stock at a price of $5.625 per
share.
On August 19, 1997, the company entered into a promissory note, term loan
agreement and security agreement with the Virginia R. Cirica Trust. The trust is
controlled by Ms. Cirica, who is the spouse of Lawrence Goelman, then Chairman
and Interim Chief Executive Officer and currently a director of Diedrich Coffee.
Shortly before the trust entered into the loan documents, Mr. Goelman
loaned Ms. Cirica approximately $250,000. Some of those funds were transferred
by Ms. Cirica to the trust and advanced to Diedrich Coffee pursuant to the loan
documents. The loan was secured by the assets of Diedrich Coffee and provided
for borrowings up to $500,000 with interest accruing at the prime rate plus
3 1/2%. This note was fully paid and discharged on December 17, 1997.
In connection with the loan documents with the Cirica Trust, Diedrich
Coffee issued a warrant to the trust to purchase up to 85,000 shares of Diedrich
Coffee's common stock if the loan were repaid in full within 120 days of
closing, or up to 170,000 shares of Diedrich Coffee's common stock if the loan
was not repaid within 120 days, all at a price of $2.25 a share. The warrants
were reduced to 85,000 shares of Diedrich Coffee's common stock by virtue of the
December repayment of the note in full. The warrants were exercised in December
1998. Mr. Goelman disclaims any pecuniary interest in the loan to Diedrich
Coffee and any beneficial interest in the trust, except to the extent to which
Mr. Goelman is a contingent beneficiary under the terms of the trust.
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<PAGE> 73
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of June 1, 1999, and as adjusted to reflect the
sale of the shares of common stock offered in this offering, by:
- each person or group of affiliated persons who we know owns beneficially
5% or more of our common stock;
- each of our directors;
- each of our executive officers listed in the summary compensation table;
and
- all of our directors and executive officers as a group.
Percentage of ownership is calculated as required by Commission Rule
13d-3(d)(1). Except as indicated in the footnotes to this table, the persons
named in the table have sole voting and investment power with respect to all
shares of common stock shown as beneficially owned by them, subject to community
property laws. The table below includes the number of shares underlying options
that are exercisable within 60 days from June 1, 1999.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
BEFORE THIS OFFERING AFTER THIS OFFERING
---------------------------------------- -------------------------------------
NAME AND ADDRESS AMOUNT AND NATURE PERCENT OF AMOUNT AND NATURE PERCENT OF
OF BENEFICIAL OWNER(1) OF BENEFICIAL OWNERSHIP(2) CLASS OF BENEFICIAL OWNERSHIP CLASS
---------------------- -------------------------- ---------- ----------------------- ----------
<S> <C> <C> <C> <C>
The Second Cup Ltd. .......... -- * 1,039,500(3) 8.5%
175 Bloor Street East, Suite
801,
South Tower
Toronto, Ontario M4W 3R8
Canada
D.C.H., L.P................... 1,473,197(4) 23.9% 1,473,197 12.0
450 Newport Center Drive
Suite 450
Newport Beach, CA 92660
Amre A. Youness............... 500,958(5) 7.6 500,958 4.0
301 North Lake Avenue
Suite 910
Pasadena, CA 91101
Cosleno, Inc. ................ 340,000(6) 5.2 340,000 2.7
3753 Howard Hughes Parkway
Suite 200
Las Vegas, NV 89109
Steven A. Lupinacci........... 309,061(7) 5.0 309,061 2.5
Dolf A. Berle................. 26,000(8) * 26,000 *
Peter Churm................... 50,000(9) * 50,000 *
Martin Diedrich............... 656,107(10) 10.6 656,107 5.3
Lawrence Goelman.............. 117,700(11) 1.9 117,700 *
Paul C. Heeschen.............. 1,796,480(12) 29.0 1,796,480 14.6
John E. Martin................ 1,258,533(13) 17.9 1,258,533 9.6
Timothy J. Ryan............... 629,367(14) 9.3 629,367 4.9
Catherine Saar................ 11,000(15) * 11,000 *
Ann Wride..................... 26,000(16) * 26,000 *
All directors and executive
officers as a group (9
persons).................... 4,571,187(17) 58.1% 4,571,187 32.7%
</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 June 1, 1999 are deemed outstanding
for the purposes of calculating the number and percentage owned by
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<PAGE> 74
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) The Second Cup Ltd. is the majority stockholder of Coffee People and will
receive approximately 1,039,500 shares in connection with Diedrich Coffee's
acquisition of Coffee People.
(4) 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.
(5) Pursuant to Schedule 13D filed with the Commission and dated as of October
14, 1997, includes 70,000 shares that are subject to warrants exercisable
within 60 days and 340,000 shares that are subject to warrants exercisable
within 60 days of which he has shared voting and dispositive power with
Cosleno, Inc.
(6) 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.
(7) Mr. Lupinacci resigned as Chief Executive Officer, President and Chief
Financial Officer effective March 12, 1997.
(8) Includes 26,000 shares subject to options that are exercisable within 60
days.
(9) Includes 30,000 shares subject to options that are exercisable within 60
days.
(10) Includes 1,000 shares subject to options that are exercisable within 60
days.
(11) Includes 105,000 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.
(12) 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 7,369 shares owned
personally by Mr. Heeschen, 30,000 shares held personally by Mr. Heeschen
subject to options that are exercisable within 60 days and 30,000 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.
(13) Includes 850,000 shares subject to options that are exercisable within 60
days.
(14) Includes 600,000 shares subject to options that are exercisable within 60
days.
(15) Includes 11,000 shares subject to options that are exercisable within 60
days.
(16) Includes 26,000 shares subject to options that are exercisable within 60
days.
(17) Includes 1,679,000 shares subject to options that are exercisable within 60
days.
74
<PAGE> 75
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 25 million shares of common stock,
$0.01 par value per share, and 3 million shares of preferred stock, $0.01 par
value per share.
DIEDRICH COFFEE COMMON STOCK
At June 4, 1999, there were approximately 6.2 million shares of our common
stock outstanding held of record by 153 persons. Exercisable stock options and
stock warrants to purchase an aggregate of approximately 3.1 million shares of
common stock were also outstanding.
Diedrich Coffee common stockholders are entitled to one vote per share on
all matters to be voted upon by our stockholders. Our common stockholders may
not cumulate votes for the election of directors.
Our common stockholders are entitled to receive ratably any dividends as
may be declared from time to time by our board out of funds legally available
for dividend payments, subject to any dividend preferences of any holders of
preferred stock. In the event of liquidation or dissolution of Diedrich Coffee,
our common stockholders are entitled to share ratably in all assets remaining
after payment of liabilities and liquidation preferences of any preferred stock.
Our common stockholders do not have any preemptive or conversion rights or other
subscription rights. Neither redemption nor sinking fund provisions apply to our
common stock.
All outstanding shares of our common stock are fully paid and
non-assessable, and the shares of Diedrich Coffee common stock that will be
outstanding after the acquisition will be fully paid and non-assessable.
DIEDRICH COFFEE PREFERRED STOCK
At June 4, 1999, no shares of our preferred stock were outstanding. Our
board may issue up to 3 million shares of preferred stock in one or more series
and, subject to the Delaware General Corporation Law, may:
- fix the number of shares and designation of any series;
- fix its preferences, limitations, rights, qualifications and
restrictions; and
- determine the voting powers of any such series.
Although we presently do not intend to do so, the board may issue preferred
stock with voting and conversion rights, which could negatively affect the
voting power or other rights of our common stockholders without stockholder
approval. For example, the issuance of preferred stock could decrease the amount
of earnings and assets available for distribution to our common stockholders. In
addition, any such issuance could have the effect of making removal of the
present management more difficult, or resulting in restrictions upon the payment
of dividends and other distributions to our common stockholders. The issuance of
preferred stock may delay or prevent a change-in-control of Diedrich Coffee.
CERTAIN PROVISIONS OF DELAWARE LAW
The company is a Delaware corporation and is subject to the provisions of
Section 203 of the Delaware General Corporation Law, an anti-takeover law. In
general, the statute prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction by which that person
became an interested stockholder, unless the business combination is approved in
a prescribed manner. For purposes of Section 203, a "business combination"
includes a merger, asset sale or other transaction resulting in a financial
benefit to the interested stockholder, and an "interested stockholder" is a
person who, together with affiliates and associates, owns, or within three years
prior did own, 15% or more of the company's voting stock.
CERTAIN CHARTER AND BYLAW PROVISIONS
Special Meetings. Our bylaws provide that special meetings of the
stockholders may be called only by the board of directors or the president of
the company. This provision may make it more difficult for stockholders to take
action opposed by the board.
75
<PAGE> 76
Indemnification of Directors and Officers. Our bylaws provide a right to
indemnification to the full extent permitted by law for expenses, attorney's
fees, damages, punitive damages, judgments, penalties, fines and amounts paid in
settlement actually and reasonably incurred by any director or officer whether
or not the indemnified liability arises or arose from any threatened, pending or
completed proceeding by or in the company's right by reason of the fact that
such director or officer is or was serving as a director or officer at the
company's request, as a director, officer, partner, venturer, proprietor,
employee, agent, or trustee of another corporation, partnership, joint venture,
trust, employee benefit plan or other enterprise. Our bylaws also provide for
the advancement of expenses to an indemnified party upon receipt of an
undertaking by the party to repay those amounts if it is finally determined that
the indemnified party is not entitled to indemnification.
Our bylaws authorize us to take steps to ensure that all persons entitled
to the indemnification are properly indemnified, including, if the board of
directors so determines, purchasing and maintaining insurance.
LIMITATION OF LIABILITY
Our articles of incorporation provide that no director shall be personally
liable to the company or its stockholders for monetary damages for a breach of
fiduciary duty as a director, except for liability:
- for any breach by such person of a duty of loyalty;
- for acts or omissions not in good faith or involving intentional
misconduct or a knowing violation of law;
- for the payment of unlawful dividends and certain other actions
prohibited by Delaware corporate law; and
- for any transaction resulting in receipt by such person of an improper
personal benefit.
TRANSFER AGENT
The transfer agent and registrar for the common stock is U.S. Stock
Transfer Corporation.
76
<PAGE> 77
SHARES ELIGIBLE FOR FUTURE SALE
SHARES OUTSTANDING AND FREELY TRADEABLE AFTER OFFERING
Upon completion of this offering, we will have approximately 12.3 million
shares of common stock outstanding. The 4.6 million shares of common stock to be
sold by the company in this offering will be freely tradeable without
restriction or limitation under the Securities Act, except for any such shares
held by "affiliates" of the company, as such term is defined under Rule 144 of
the Securities Act. The shares held by affiliates will be subject to the resale
limitations under Rule 144. Diedrich Coffee's directors, executive officers and
its existing stockholders have agreed not to sell, directly or indirectly, any
shares owned by them for a period of 180 days after the date of this prospectus
without the prior written consent of BancBoston Robertson Stephens Inc. See
"Underwriting." Upon the expiration of this 180 days lock-up period, or earlier
upon the consent of the representative, all of these shares will become eligible
for sale subject to the restrictions of Rule 144.
RULE 144
In general, under Rule 144, as currently in effect, a person, or persons
whose shares are aggregated, who has beneficially owned shares for at least one
year, including an affiliate of the company, would be entitled to sell, within
any three-month period, that number of shares that does not exceed the greater
of 1% of the then-outstanding shares of common stock (approximately 123,000
shares of common stock after this offering) and the average weekly trading
volume in the common stock during the four calendar weeks immediately preceding
the date on which the notice of sale is filed with the Commission, provided
certain manner of sale and notice requirements and requirements as to the
availability of current public information about the company are satisfied. In
addition, affiliates of the company must comply with the restrictions and
requirements of Rule 144, other than the one-year holding period requirement, in
order to sell shares of common stock. As defined in Rule 144, an "affiliate" of
an issuer is a person who, directly or indirectly, through the use of one or
more intermediaries controls, or is controlled by, or is under common control
with, such issuer. Under Rule 144(k), a holder of "restricted securities" who is
not deemed an affiliate of the issuer and who has beneficially owned shares for
a least two years would be entitled to sell shares under Rule 144(k) without
regard to the limitations described in this paragraph.
EFFECT OF SUBSTANTIAL SALES ON MARKET PRICE OF COMMON STOCK
The company is unable to estimate the number of shares that may be sold in
the future by its existing stockholders or the effect, if any, that such sales
will have on the market price of the common stock prevailing from time-to-time.
Sales of substantial amounts of common stock, or the prospect of such sales,
could adversely affect the market price of our common stock.
77
<PAGE> 78
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Dain Rauscher Wessels, a division of Dain
Rauscher Incorporated, and First Security Van Kasper, have severally agreed with
us, subject to the terms and conditions of the underwriting agreement, to
purchase from us the number of shares of common stock set forth opposite their
names below. The underwriters are committed to purchase and pay for all these
shares if any are purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- ----------- ---------
<S> <C>
BancBoston Robertson Stephens Inc........................... 2,300,000
Dain Rauscher Wessels....................................... 1,610,000
First Security Van Kasper................................... 690,000
---------
Total............................................. 4,600,000
=========
</TABLE>
The representatives have advised us that the underwriters propose to offer
the shares of common stock to the public at the public offering price on the
cover page of this prospectus and to some dealers at such price less a
concession of not in excess of $0.25 per share, of which $0.10 may be reallowed
to other dealers. After this offering, the public offering price, concession,
and reallowance to dealers may be reduced by the representatives. This reduction
will not change the amount of proceeds we will receive as stated on the cover
page of this prospectus. The common stock is offered by the underwriters as
stated in this prospectus, subject to receipt and acceptance by them and subject
to their right to reject any order in whole or in part.
Over-Allotment Option. We have granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to 690,000 additional shares of common stock at the same price per
share as we will receive for the 4,600,000 shares that the underwriters have
agreed to purchase. To the extent that the underwriters exercise this option,
each of the underwriters will have a firm commitment to purchase approximately
the same percentage of the additional shares that the number of shares of common
stock to be purchased by it shown in the above table represents as a percentage
of the 4,600,000 shares offered hereby. If purchased, those additional shares
will be sold by the underwriters on the same terms as those on which the
4,600,000 shares are being sold. We will be obligated, pursuant to the option,
to sell shares to the extent the option is exercised. The underwriters may
exercise this option only to cover over-allotments made in connection with the
sale of the shares of common stock offered in this prospectus. If this option is
exercised in full, the total price to public, underwriting discounts and
commissions and proceeds to company will be $31,740,000, $2,221,800 and
$29,518,200, respectively.
Directed Share Program. At our request, the underwriters have reserved up
to 200,000 shares of common stock to be issued by us and offered for sale in
this prospectus, at the initial public offering price, to our directors,
officers, employees, business associates and persons otherwise related to
Diedrich Coffee. The number of shares of common stock available for sale to the
general public will be reduced to the extent these individuals purchase these
reserved shares. The underwriters will offer any reserved shares that are not so
purchased to the general public on the same basis as the other shares offered in
this prospectus.
Indemnity. The underwriting agreement contains covenants of indemnity among
the underwriters and us against various civil liabilities, including liabilities
under the Securities Act and liabilities arising from breaches of
representations and warranties contained in the underwriting agreement.
Lock-Up Agreements. Each executive officer and director of Diedrich Coffee
has agreed, during the period ending 180 days after the date of this prospectus
subject to various exceptions, not to offer to sell, contract to sell, or
otherwise sell, dispose of, loan, pledge or grant any rights with respect to any
shares of common stock or any options or warrants to purchase any shares of
common stock, or any securities convertible into or exchange for shares of
common stock owned as of the date of this prospectus or
78
<PAGE> 79
thereafter acquired directly by these holders or with respect to which they have
the power of disposition, without the prior written consent of BancBoston
Robertson Stephens Inc. However, BancBoston Robertson Stephens Inc. may, in its
sole discretion and at any time or from time-to-time without notice, release all
or any portion of the securities subject to the lock-up agreements. There are no
existing agreements between the representatives and any of our stockholders who
have executed a lock-up agreement providing consent to the sale of shares before
the expiration of the lock-up period.
In addition, we have agreed that during the lock-up period we will not,
without the prior written consent of BancBoston Robertson Stephens Inc., subject
to various exceptions,
- consent to the disposition of any shares held by stockholders subject to
lock-up agreements before the expiration of the lock-up period; or
- issue, sell, contract to sell, or otherwise dispose of, any shares of
common stock, any options to purchase any shares of common stock or any
securities convertible into, exercisable for or exchangeable for shares
of common stock other than our sale of shares in this offering, the
issuance of common stock upon the exercise of outstanding options, and
the issuance of options under existing stock option and incentive plans
provided the options do not vest before the expiration of the lock-up
period. See "Shares Eligible for Future Sale."
The underwriters have advised us that they do not intend to confirm sales
of more than 5% of the common stock offered in this offering to accounts over
which they exercise discretionary authority.
Stabilization. The representatives have advised us that, pursuant to
Regulation M under the Securities Act, some persons participating in this
offering may engage in transactions, including stabilizing bids, syndicate
covering transactions or the imposition of penalty bids that may have the effect
of stabilizing or maintaining the market price of the common stock at a level
above that which might otherwise prevail in the open market. A "stabilizing bid"
is a bid for or the purchase of shares of common stock on behalf of the
underwriters for the purpose of fixing or maintaining the price of the common
stock. A "syndicate covering transaction" is the bid for or the purchase of
common stock on behalf of the underwriters to reduce a short position incurred
by the underwriters in connection with this offering. A "penalty bid" is an
arrangement permitting the representatives to reclaim the selling concession
otherwise accruing to an underwriter or syndicate member in connection with this
offering if the common stock originally sold by such underwriter or syndicate
member is purchased by the representatives in a syndicate covering transaction
and has therefore not been effectively placed by such underwriter or syndicate
member. The representatives have advised us that these transactions may be
effected on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
Passive Market Making. In connection with this offering, certain
underwriter and selling group members (if any) who are qualified market makers
on the Nasdaq National Market may engage in passive market making transactions
in the common stock on the Nasdaq National Market in accordance with Rule 103 of
Regulation M under the Exchange Act, during the business day prior to the
pricing of the offering, before the commencement of offers or sales of the
common stock. Passive market makers must comply with applicable volume and price
limitations and must be identified as such. In general, a passive market maker
must display its bid at a price not in excess of the highest independent bid for
such security; if all independent bids are lowered below the passive market
maker's bid, however, such bid must then be lowered when certain purchase limits
are exceeded.
Expenses of the Offering. We estimate the total expense of the offering to
be $600,000.
Certain Relationships. BancBoston Robertson Stephens Inc. has acted as a
financial advisor for Coffee People and has received customary fees for its
services. First Security Van Kasper has acted our financial advisor and
delivered a fairness opinion on our behalf regarding the acquisition of Coffee
People. First Security Van Kasper has received customary fees for these
services.
79
<PAGE> 80
LEGAL MATTERS
The validity of our common stock offered hereby will be passed upon for us
by Gibson, Dunn & Crutcher LLP, Orange County, California. Brobeck, Phleger &
Harrison LLP, San Francisco has acted as counsel to the underwriters in
connection with certain legal matters related to this offering.
EXPERTS
The financial statements of Diedrich Coffee, Inc. as of January 27, 1999
and January 28, 1998, and for each of the years ended January 27, 1999, January
28, 1998 and January 27, 1997, have been included herein and in the registration
statement in reliance upon the report of KPMG LLP, independent certified public
accountants, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
The consolidated financial statements of Coffee People, Inc. as of June 27,
1998 and June 28, 1997 and for each of the two years in the period ended June
27, 1998 included in this prospectus have been so included in reliance on the
report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
The consolidated financial statements of Coffee People, Inc. (formerly
Gloria Jean's, Inc.) for the 39-week period ended June 29, 1996 included in this
prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Commission a registration statement on Form S-1
under the Securities Act that registers the shares of our common stock to be
sold in this offering. The registration statement, including the attached
exhibits and schedules, contain additional relevant information about us and our
capital stock. The rules and regulations of the Commission allow us to omit
certain information included in the registration statement from this document.
In addition, we file reports, proxy statements and other information with
the Commission under the Securities Exchange Act. You may read and copy this
information at the following public reference rooms of the Commission:
<TABLE>
<S> <C> <C>
Washington, D.C. New York, New York Chicago, Illinois
450 Fifth Street, N. W. 7 World Trade Center 500 West Madison Street
Room 1024 Suite 1300 Suite 1400
Washington, D.C. 20549 New York, NY 10048 Chicago, IL 60661-2511
</TABLE>
You may also obtain copies of this information by mail from the Public
Reference Section of the Commission, 450 Fifth Street, N.W. Room 1024,
Washington, D.C. 20549, at prescribed rates. You may obtain information on the
operation of the public reference rooms by calling the Commission at
1-800-SEC-0330.
The Commission also maintains an internet website that contains reports,
proxy statements and other information about issuers, like Diedrich Coffee, who
file electronically with the Commission. The address of that site is
http://www.sec.gov.
We intend to furnish our stockholders with annual reports containing
audited financial statements, and make available to our stockholders quarterly
reports for the first three quarters of each year containing unaudited interim
financial information.
80
<PAGE> 81
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
DIEDRICH COFFEE, INC.
Independent Auditors' Report................................ F-2
Balance Sheets as of January 28, 1998 and January 27,
1999...................................................... F-3
Statements of Operations for the Years Ended January 29,
1997, January 28, 1998 and January 27, 1999............... F-4
Statements of Stockholders' Equity for the Years Ended
January 29, 1997, January 28, 1998 and January 27, 1999... F-5
Statements of Cash Flows for the Years Ended January 29,
1997, January 28, 1998 and January 27, 1999............... F-6
Notes to Financial Statements............................... F-7
Unaudited Condensed Balance Sheets as of January 27, 1999
and April 28, 1999........................................ F-19
Unaudited Condensed Statement of Operations for the Thirteen
Weeks Ended April 29, 1998 and April 28, 1999............. F-20
Unaudited Condensed Statements of Cash Flows for the
Thirteen Weeks Ended April 29, 1998 and April 28, 1999.... F-21
Notes to Unaudited Condensed Financial Statements........... F-22
COFFEE PEOPLE, INC.
Consolidated Reports of Independent Accountants............. F-25
Consolidated Balance Sheets as of June 28, 1997 and June 27,
1998...................................................... F-27
Consolidated Statements of Operations for the 39-Week Period
June 29, 1996 and for the Years Ended June 28, 1997 and
June 27, 1998............................................. F-28
Consolidated Statements of Stockholders' Equity for the
39-Week Period June 29, 1996 and for the Years Ended June
28, 1997 and June 27, 1998................................ F-29
Consolidated Statements of Cash Flows for the 39-Week Period
June 29, 1996 and for Years Ended June 28, 1997 and June
27, 1998.................................................. F-30
Notes to Consolidated Financial Statements.................. F-31
Unaudited Consolidated Balance Sheets as of June 27, 1998
and March 6, 1999......................................... F-45
Unaudited Consolidated Statements of Operations for the
Thirty-Six Weeks Ended March 7, 1998 and March 6, 1999.... F-46
Unaudited Consolidated Statements of Cash Flows for the
Thirty-Six Weeks Ended March 7, 1998 and March 6, 1999.... F-47
Notes to Unaudited Consolidated Financial Statements As of
June 27, 1998 and March 6, 1999........................... F-48
</TABLE>
F-1
<PAGE> 82
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> 83
DIEDRICH COFFEE, INC.
BALANCE SHEETS
JANUARY 28, 1998 AND JANUARY 27, 1999
<TABLE>
<CAPTION>
1998 1999
------------ ------------
<S> <C> <C>
ASSETS (NOTE 5)
Current Assets:
Cash...................................................... $ 1,408,161 $ 1,200,861
Accounts receivable, less allowance for doubtful accounts
of $29,438 and $22,134................................. 181,628 263,651
Note receivable........................................... -- 100,000
Inventories (Note 2)...................................... 1,375,119 1,279,436
Prepaid expenses.......................................... 157,393 188,993
Income taxes receivable................................... 42,528 17,686
------------ ------------
Total current assets................................. 3,164,829 3,050,627
Property and equipment, net (Note 3)........................ 10,104,843 9,119,859
Costs in excess of net assets acquired, net (Note 4)........ 389,651 329,086
Other assets................................................ 289,103 236,880
------------ ------------
Total assets......................................... $ 13,948,426 $ 12,736,452
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current installments of obligations under capital leases
(Note 6)............................................... $ 168,139 $ 169,488
Accounts payable.......................................... 1,204,366 1,415,067
Accrued compensation...................................... 716,742 970,034
Accrued expenses (Note 7)................................. 1,796,869 1,039,097
Restructuring charge (Note 10)............................ 237,320 112,400
------------ ------------
Total current liabilities............................ 4,123,436 3,706,086
Obligations under capital lease -- long-term (Note 6)....... 317,292 283,106
Long term debt (Note 5)..................................... 2,500,000 2,500,000
Deferred rent............................................... 172,231 219,865
------------ ------------
Total liabilities.................................... 7,112,959 6,709,057
------------ ------------
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..... 57,417 61,674
Additional paid-in capital................................ 16,928,546 18,708,032
Accumulated deficit....................................... (10,150,496) (12,742,311)
------------ ------------
Total stockholders' equity........................... 6,835,467 6,027,395
Commitments and contingencies (Note 6)
------------ ------------
Total liabilities and stockholders' equity........... $ 13,948,426 $ 12,736,452
============ ============
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 84
DIEDRICH COFFEE, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Retail............................................ $18,117,720 $20,759,993 $21,248,462
Wholesale and other............................... 1,694,686 2,221,704 2,766,741
Franchise revenue................................. -- -- 200,000
----------- ----------- -----------
Total revenues............................... 19,812,406 22,981,697 24,215,203
----------- ----------- -----------
Cost and Expenses:
Cost of sales and related occupancy costs......... 9,263,286 11,457,612 10,955,197
Store operating expenses.......................... 8,279,621 10,447,349 8,935,644
Other operating expenses.......................... 240,227 289,867 634,124
Depreciation and amortization..................... 1,053,770 1,785,271 1,941,020
Provision for asset impairment and restructuring
costs.......................................... -- 3,902,332 --
General and administrative expenses............... 2,003,483 4,005,853 4,013,809
----------- ----------- -----------
Total........................................ 20,840,387 31,888,284 26,479,794
----------- ----------- -----------
Operating (loss) income............................. (1,027,981) (8,906,587) (2,264,591)
Interest expense.................................... (189,549) (182,135) (384,544)
Interest and other (expense) income................. 103,718 (23,239) 90,517
----------- ----------- -----------
Loss before income taxes............................ (1,113,812) (9,111,961) (2,558,618)
Income tax provision (benefit)...................... (128,107) 800 3,690
----------- ----------- -----------
Net loss............................................ $ (985,705) $(9,112,761) $(2,562,308)
=========== =========== ===========
Net loss per share -- basic & diluted:.............. $ (0.22) $ (1.69) $ (0.43)
=========== =========== ===========
Weighted average shares outstanding............... 4,414,000 5,392,609 5,934,287
=========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 85
DIEDRICH COFFEE, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
<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> 86
DIEDRICH COFFEE, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income......................................... $ (985,705) $(9,112,761) $(2,562,308)
Adjustments to reconcile net (loss) income to cash (used
in) provided by operating activities:
Depreciation and amortization........................... 1,053,770 1,785,271 1,941,020
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......................... (75,790) 28,735 (182,023)
Inventories........................................... (969,652) 150,804 95,683
Prepaid expenses...................................... (78,696) 27,670 (31,600)
Income taxes receivable............................... (272,182) 242,544 24,842
Other assets.......................................... (121,881) 26,637 12,392
Accounts payable...................................... 1,164,864 (595,926) 210,701
Accrued compensation.................................. 232,137 186,971 165,614
Accrued expenses...................................... 136,250 1,562,055 (73,236)
Income taxes payable.................................. (51,235) -- --
Deferred rent......................................... 33,240 17,847 47,634
----------- ----------- -----------
Net cash (used in) provided by operating activities....... 113,312 (2,489,346) (351,281)
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures for property and equipment......... (7,813,263) (1,724,397) (1,672,076)
Disposal of property and equipment...................... 148,785
Acquisition of coffeehouses............................. (1,916,000) -- --
----------- ----------- -----------
Net cash (used in) investing activities................. (9,729,263) (1,724,397) (1,523,291)
----------- ----------- -----------
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............................ 1,622,520 4,500,000 --
Principal payments on long-term debt.................... (2,569,378) (2,000,000) --
Payments on capital lease obligations................... -- -- (86,964)
Proceeds from issuance of common stock, net of fees
paid.................................................. 12,579,452 1,050,000 1,275,000
Proceeds from stock options exercised................... -- -- 479,236
----------- ----------- -----------
Net cash provided by financing activities................. 11,593,196 3,550,000 1,667,272
----------- ----------- -----------
Net (decrease) increase in cash........................... 1,977,245 (663,743) (207,300)
Cash at beginning of year................................. 94,659 2,071,904 1,408,161
----------- ----------- -----------
Cash at end of year....................................... $ 2,071,904 $ 1,408,161 $ 1,200,861
=========== =========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest.............................................. $ 164,140 $ 154,999 $ 299,670
=========== =========== ===========
Income taxes.......................................... $ 108,773 $ 800 $ 3,690
=========== =========== ===========
Non-cash Transactions
Equipment Purchased under Capital Leases.............. -- $ 498,513 $ 54,127
=========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 87
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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.
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.
F-7
<PAGE> 88
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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.
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
F-8
<PAGE> 89
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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.
2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JANUARY 28, JANUARY 27,
1998 1999
----------- -----------
<S> <C> <C>
Unroasted coffee............................................ $ 535,885 $ 412,103
Roasted coffee.............................................. 67,965 115,979
Accessory and specialty items............................... 230,502 275,386
Other food, beverage and supplies........................... 540,767 475,968
---------- ----------
$1,375,119 $1,279,436
========== ==========
</TABLE>
3. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
<TABLE>
<CAPTION>
JANUARY 28, JANUARY 27,
1998 1999
----------- -----------
<S> <C> <C>
Leasehold improvements.................................... $ 7,017,125 $ 6,475,369
Equipment................................................. 4,047,109 4,555,017
Furniture and fixtures.................................... 2,022,252 1,948,423
Construction in progress.................................. 250,716 504,279
Assets under capital lease................................ 498,513 552,640
----------- -----------
13,835,715 14,035,728
Accumulated depreciation and amortization................. (3,730,872) (4,915,869)
----------- -----------
$10,104,843 $ 9,119,859
=========== ===========
</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-9
<PAGE> 90
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
5. DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JANUARY 28, JANUARY 27,
1998 1999
----------- -----------
<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.
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%.
F-10
<PAGE> 91
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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.
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.
F-11
<PAGE> 92
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
7. ACCRUED EXPENSES
The following table sets forth details of accrued expenses:
<TABLE>
<CAPTION>
JANUARY 28, JANUARY 27,
1998 1999
----------- -----------
<S> <C> <C>
Accrued costs for store/warehouse closures.................. $ 986,000 $ 471,915
Other accrued taxes......................................... 331,224 113,664
Accrued worker's compensation insurance..................... 147,532 159,872
Other accrued expenses...................................... 332,113 293,646
---------- ----------
Total accrued expenses...................................... $1,796,869 $1,039,097
========== ==========
</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.
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.
F-12
<PAGE> 93
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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 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.
F-13
<PAGE> 94
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
Information regarding the Company's stock options plans is summarized
below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS EXERCISE PRICE
--------- --------------
<S> <C> <C>
Shares authorized...................................... 2,601,350
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......................................... 164,999 $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 are outstanding and vested.
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>
F-14
<PAGE> 95
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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>
1998 1999
------------ -----------
<S> <C> <C>
REPORTED
Net Loss............................................. $ (9,112,761) $(2,562,308)
Basic loss per share................................. $ (1.69) $ (0.43)
PRO FORMA
Net Loss............................................. $(13,588,746) $(3,082,569)
Basic loss per share................................. $ (2.52) $ (0.52)
</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>
1998 1999
------- -------
<S> <C> <C>
Risk free interest rate..................................... 5.5% 4.5%
Expected Life............................................... 6 years 6 years
Expected volatility......................................... 128% 53%
Expected dividend yield..................................... 0% 0%
</TABLE>
9. INCOME TAXES
The components of the income tax provision (benefit) are as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
JANUARY 29, JANUARY 28, JANUARY 27,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Current:
Federal........................................ $(171,284) $ -- $ --
State.......................................... (5,015) 800 3,690
--------- ---- ------
(176,299) 800 3,690
--------- ---- ------
Deferred:
Federal........................................ 40,542 -- --
State.......................................... 7,650 -- --
--------- ---- ------
48,192
------
$(128,107) $800 $3,690
========= ==== ======
</TABLE>
F-15
<PAGE> 96
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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 28, JANUARY 27,
1998 1999
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................... $ 2,965,213 $ 3,900,495
Accrued expenses.......................................... 456,844 457,872
Restructure and Store closure Reserves.................... 410,933 98,179
AMT credit................................................ 1,069 1,069
----------- -----------
Total deferred tax assets................................... 3,834,059 4,457,615
----------- -----------
Deferred tax liabilities:
Depreciation and amortization............................. (199,432) 164,543
State income taxes........................................ -- --
----------- -----------
Total deferred tax liabilities.............................. (199,432) 164,543
----------- -----------
Total deferred tax assets................................... 3,634,627 4,622,158
Less: Valuation allowance................................... (3,634,627) (4,622,158)
----------- -----------
Net deferred tax assets..................................... $ -- $ --
=========== ===========
</TABLE>
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 29, JANUARY 28, JANUARY 27,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Federal statutory rate................................... (34.0)% (34.0)% (34.0)%
State income taxes, net of Federal benefit............... 2.6 (3.3) (1.6)
Other.................................................... (1.0) (0.1) (2.8)
Valuation allowance...................................... 20.9 37.4 38.6
----- ----- -----
(11.5)% -- 0.2%
----- ----- -----
</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
F-16
<PAGE> 97
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
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.
11. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
JANUARY 29, JANUARY 28, JANUARY 27,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
NUMERATOR:
Net (loss) income..................................... (985,705) (9,112,761) (2,562,308)
DENOMINATOR:
Basic and diluted weighted average common shares
outstanding........................................ 4,414,000 5,392,609 5,934,287
Basic and diluted loss per share...................... (0.22) (1.69) (0.43)
</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>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Net Revenues:
Retail operations................................. $18,117,720 $20,759,993 $21,248,462
Wholesale operations.............................. 1,694,686 2,221,704 2,766,741
----------- ----------- -----------
19,812,406 22,981,697 24,015,203
----------- ----------- -----------
Earnings (loss) from operations:
Retail operations................................. 821,511 (5,160,947) 1,476,140
Wholesale operations.............................. 291,689 512,313 392,467
----------- ----------- -----------
Total.......................................... $ 1,113,200 $(4,648,634) $ 1,868,607
=========== =========== ===========
</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.
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
F-17
<PAGE> 98
DIEDRICH COFFEE, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JANUARY 29, 1997, JANUARY 28, 1998 AND JANUARY 27, 1999
warrants to Mr. Youness to purchase 70,000 shares of the Company's common stock
at a price of $5.625 per share. The fair value of the warrants is estimated to
be $100,000. This estimated fair value will be charged to interest expense and
amortized ratably over the life of the loan.
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-18
<PAGE> 99
DIEDRICH COFFEE, INC.
UNAUDITED CONDENSED BALANCE SHEETS
JANUARY 27, 1999 AND APRIL 28, 1999
<TABLE>
<CAPTION>
JANUARY 27, APRIL 28,
1999 1999
----------- -----------
(AUDITED)
<S> <C> <C>
ASSETS (NOTE 3)
Current Assets:
Cash...................................................... $ 1,200,861 $ 786,356
Accounts receivable....................................... 263,651 295,910
Note receivable........................................... 100,000 100,000
Inventories (Note 2)...................................... 1,279,436 1,417,429
Prepaid expenses.......................................... 188,993 527,696
Income taxes receivable................................... 17,686 17,686
----------- -----------
Total current assets.............................. 3,050,627 3,145,077
Property and equipment, net................................. 9,119,859 8,872,401
Costs in excess of net assets acquired, net................. 329,086 322,280
Note receivable -- long-term................................ -- 40,000
Other assets................................................ 236,880 248,253
----------- -----------
Total assets...................................... $12,736,452 $12,628,011
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current installments of obligations under capital lease... $ 169,488 $ 169,488
Note payable (Note 3)..................................... -- 1,000,000
Accounts payable.......................................... 1,415,067 1,217,387
Accrued compensation...................................... 970,034 672,668
Accrued expenses.......................................... 1,039,097 1,018,541
Provision for store closings and restructuring costs...... 112,400 103,143
----------- -----------
Total current liabilities......................... 3,706,086 4,181,227
Obligation under capital lease -- long term................. 283,106 259,049
Long term debt (Note 4)..................................... 2,500,000 2,500,000
Deferred rent............................................... 219,865 228,179
----------- -----------
Total liabilities................................. 6,709,057 7,168,455
----------- -----------
Stockholders' Equity: (Note 5)
Common stock................................................ 61,674 61,736
Additional paid-in capital.................................. 18,708,032 18,716,951
Accumulated deficit......................................... (12,742,311) (13,319,131)
----------- -----------
Total stockholders' equity........................ 6,027,395 5,459,556
----------- -----------
Commitments and contingencies
Total liabilities and stockholders' equity........ $12,736,452 $12,628,011
=========== ===========
</TABLE>
See accompanying notes to financial statements.
F-19
<PAGE> 100
DIEDRICH COFFEE, INC.
UNAUDITED CONDENSED STATEMENT OF OPERATIONS
THIRTEEN WEEKS ENDED APRIL 29, 1998 AND APRIL 28, 1999
<TABLE>
<CAPTION>
THIRTEEN WEEKS THIRTEEN WEEKS
ENDED APRIL 29, ENDED APRIL 28,
1998 1999
--------------- ---------------
<S> <C> <C>
Revenues:
Retail.................................................... $5,285,060 $5,189,865
Wholesale and other....................................... 638,301 858,408
Franchise revenue......................................... -- 50,030
---------- ----------
Total revenues.................................... 5,923,361 6,098,303
---------- ----------
Cost and Expenses:
Cost of sales and related occupancy costs................. 2,682,665 2,758,104
Store operating expenses.................................. 2,283,903 2,288,028
Other operating expenses.................................. 148,785 157,508
Depreciation and amortization............................. 482,222 506,935
General and administrative expenses....................... 974,848 857,267
---------- ----------
Total............................................. 6,572,423 6,567,842
---------- ----------
Operating loss.............................................. (649,062) (469,539)
Interest expense............................................ (97,273) (96,097)
Interest and other income................................... 1,510 597
---------- ----------
Loss before income taxes.................................... (744,825) (565,039)
Income tax provision........................................ 800 2,800
---------- ----------
Net loss.................................................... $ (745,625) (567,839)
========== ==========
Basic net loss per share:................................. $ (0.13) $ (0.09)
========== ==========
Diluted net loss per share:............................... $ (0.13) $ (0.09)
========== ==========
Weighted average shares outstanding......................... 5,800,991 6,172,512
========== ==========
</TABLE>
See accompanying notes to financial statements.
F-20
<PAGE> 101
DIEDRICH COFFEE, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
THIRTEEN WEEKS ENDED APRIL 29, 1998 AND APRIL 28, 1999
<TABLE>
<CAPTION>
THIRTEEN WEEKS THIRTEEN WEEKS
ENDED APRIL 29, ENDED APRIL 28,
1998 1999
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (745,625) $ (567,839)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization.......................... 482,222 506,935
Changes in assets and liabilities:
Accounts receivable.................................. (16,030) (32,259)
Inventories.......................................... 173,647 (137,993)
Prepaid expenses..................................... (27,010) (338,703)
Income taxes receivable.............................. 23,165 --
Note receivable -- long-term......................... -- (40,000)
Other assets......................................... 430 (13,922)
Accounts payable..................................... (53,670) (197,680)
Accrued compensation................................. (189,616) (297,366)
Accrued expenses..................................... (32,385) (23,007)
Deferred rent........................................ 9,508 8,314
----------- ----------
Net cash used in operating activities....................... (375,364) (1,133,520)
----------- ----------
Cash flows from investing activities:
Capital expenditures for property and equipment........ (373,575) (256,928)
Property disposition................................... -- --
----------- ----------
Net cash used in investing activities....................... $ (373,575) $ (256,928)
=========== ==========
Cash flows from financing activities:
Proceeds from issuance of common stock, net fees
paid................................................. 1,275,000 --
Proceeds from note payable............................. -- 1,000,000
Payment on capital lease obligation.................... (20,613) (24,057)
----------- ----------
Net cash provided by financing activities................... $ 1,254,387 $ 975,943
----------- ----------
Net increase (decrease) in cash............................. 505,448 (414,505)
----------- ----------
Cash at beginning of period................................. 1,408,161 1,200,861
----------- ----------
Cash at end of period....................................... $ 1,913,609 786,356
=========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest............................................... $ 75,000 $ 71,641
=========== ==========
Income taxes........................................... $ 800 $ 2,800
=========== ==========
Non-cash transactions Equipment purchased under capital
lease..................................................... $ 54,127 $ --
=========== ==========
</TABLE>
See accompanying notes to financial statements
F-21
<PAGE> 102
DIEDRICH COFFEE, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
THIRTEEN WEEKS ENDED APRIL 28, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The unaudited condensed financial statements of Diedrich Coffee, Inc. (the
"Company") have been prepared in accordance with generally accepted accounting
principles for interim financial information. In the opinion of management, all
adjustments (consisting of normal, recurring adjustments and accruals)
considered necessary for a fair presentation of the Company's financial position
at April 28,1999 and the results of operations and cash flows for the thirteen
weeks ended April 28,1999 and April 29,1998 have been included. Results for the
interim periods are not necessarily indicative of the results for an entire
year. This information should be read in conjunction with the financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K for the year ended January 27,1999.
NET LOSS PER COMMON SHARE
The computation of basic earnings per share in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 128, "Earnings Per Share" is based on
the weighted average number of common shares outstanding during the periods
presented. All periods presented have been calculated in accordance with SFAS
No. 128.
2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JANUARY 27, APRIL 28,
1999 1999
----------- ----------
<S> <C> <C>
Green coffee (raw materials)................................ $ 412,103 $ 532,132
Roasted coffee (finished goods)............................. 115,979 181,799
Accessory and specialty items............................... 275,386 220,168
Other food, beverage and supplies........................... 475,968 483,330
---------- ----------
$1,279,436 $1,417,429
========== ==========
</TABLE>
3. NOTE PAYABLE
On April 6, 1999, the Company entered into a $1,000,000 loan agreement and
security agreement with Amre Youness, a former director of the Company. All
outstanding principal and interest 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. The fair value of the warrants is
estimated to be $100,000. This estimated fair value will be charged to interest
expense and amortized ratably over the life of the loan.
F-22
<PAGE> 103
DIEDRICH COFFEE, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
THIRTEEN WEEKS ENDED APRIL 28, 1999
4. DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JANUARY 27, APRIL 28,
1999 1999
----------- ----------
<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
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 up to 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 up to 255,000 shares of the Company's common stock at a price of $2.25
per share. The warrants are exercisable immediately and expire on the later of
October 16, 2003 or one year following payment in full of the respective loans.
The Company used the proceeds from the Ocean Trust and Grandview Trust loans to
pay off and discharge outstanding indebtedness.
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." Due to the relative immateriality of the
fair value of the warrants, none of the proceeds from issuance of the debt were
allocated to the warrants. The determination of fair value was calculated using
both a Cost of Replacement Model and the Monte Carlo simulation of possible
warrant exercise.
F-23
<PAGE> 104
DIEDRICH COFFEE, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
THIRTEEN WEEKS ENDED APRIL 28, 1999
5. STOCKHOLDERS' EQUITY
On March 30, 1998 the Company agreed to a private placement of 200,000
shares of the Company's common stock to Franchise Mortgage Acceptance Company
("FMAC") at a price of $6.375 (the stock's closing sale price for that day on
the Nasdaq National Stock 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. 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. The fair
value of this option is estimated to be $72,042. The estimated fair value of the
option has been charged to equity and will be amortized ratably over the two
year life of the option. This transaction was completed on April 3, 1998.
On September 22, 1998, 6,140 shares of common stock were issued pursuant to
the exercise of certain Boston Group warrants. On October 28, 1998, 18,382
shares of common stock were issued pursuant to the exercise of certain options
granted under the Company's 1996 Stock Incentive Plan.
During the last quarter of fiscal 1999, an additional 15,120 shares of
common stock were issued pursuant to the exercise of certain Boston Group
warrants and 7,472 shares of common stock were issued pursuant to the exercise
of options granted under the Company's 1996 Stock Incentive Plan.
On February 12, 1999, 6,225 shares of common stock were issued pursuant to
the exercise of options granted under the Company's 1996 Stock Incentive Plan.
F-24
<PAGE> 105
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders of
Coffee People, Inc.
We have audited the accompanying consolidated statements of operations, of
stockholders' equity and of cash flows of Coffee People, Inc. (formerly Gloria
Jean's Inc.) and its subsidiaries for the 39-week period ended June 29, 1996.
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 audit.
We conducted our audit in accordance with generally accepted auditing
standards of the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.
In our opinion, the consolidated financial statements audited by us present
fairly, in all material respects, the results of operations and cash flows of
Coffee People, Inc. and its subsidiaries for the 39-week period ended June 29,
1996 in conformity with generally accepted accounting principles in the United
States.
/s/ PricewaterhouseCoopers
Toronto, Ontario
August 16, 1996
F-25
<PAGE> 106
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Coffee People, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Coffee People, Inc. and its subsidiaries at June 27, 1998 and June 28, 1997, and
the results of their operations and their cash flows for the years then ended,
in conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audits 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 5 to the consolidated financial statements, the
Company changed its method of accounting for long-lived assets to be disposed
of, effective as of the beginning of fiscal 1997.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
August 26, 1998
F-26
<PAGE> 107
COFFEE PEOPLE, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 28, 1997 AND JUNE 27, 1998
<TABLE>
<CAPTION>
JUNE 28, JUNE 27,
1997 1998
-------- --------
(IN THOUSANDS EXCEPT
SHARE AMOUNTS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 7,281 $ 2,822
Accounts receivable, net of allowance for doubtful
accounts of $1,156 and $1,660.......................... 2,233 3,262
Receivable from affiliate................................. 285 --
Inventories............................................... 3,563 4,052
Prepaid expenses and other assets......................... 424 713
------- -------
Deferred income taxes..................................... 1,342 2,621
Total current assets................................. 15,128 13,470
Property, plant and equipment, net.......................... 6,415 12,711
Goodwill, net............................................... 16,187 25,967
Other assets................................................ 60 113
Deferred income taxes....................................... 1,133 3,434
------- -------
Total assets......................................... $38,923 $55,695
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......................... $ -- $ 1,279
Accounts payable.......................................... 1,550 1,421
Payable to related party.................................. -- 984
Accrued liabilities....................................... 1,038 1,010
Accrued payroll and employee benefits..................... 541 931
Accrued acquisition expenses.............................. -- 631
Accrual for store closures................................ 580 1,291
Franchisee deposits....................................... 486 459
Deferred franchise fee income............................. 131 187
------- -------
Total current liabilities............................ 4,326 8,193
Long-term debt, less current portion........................ -- 3,798
Deferred rent expense....................................... 300 202
------- -------
Total liabilities.................................... 4,626 12,193
------- -------
Commitments and contingencies (Note 9)
Stockholders' equity:
Preferred stock, no par value; authorized, 10,000,000
shares; none issued or outstanding..................... -- --
Common stock, no par value; authorized, 5,000,000 shares;
issued and outstanding, 10,746,040 and 7,460,679
shares................................................. 35,825 44,630
Stock subscription notes receivable....................... -- (338)
Accumulated deficit....................................... (1,528) (790)
------- -------
Total stockholders' equity........................... 34,297 43,502
------- -------
Total liabilities and stockholders' equity........... $38,923 $55,695
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE> 108
COFFEE PEOPLE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
THIRTY-NINE WEEKS ENDED JUNE 29, 1996 AND
YEARS ENDED JUNE 28, 1997 AND JUNE 27, 1998
<TABLE>
<CAPTION>
FOR THE
39-WEEK FOR THE FISCAL
PERIOD YEAR ENDED
ENDED --------------------
JUNE 29, JUNE 28, JUNE 27,
1996 1997 1998
-------- -------- --------
(IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Revenues:
Franchise revenue......................................... $ 4,971 $ 5,869 $ 6,035
Corporate store sales..................................... 6,657 7,631 11,436
Wholesale sales........................................... 13,329 17,079 17,580
------- ------- -------
Total revenues....................................... 24,957 30,579 35,051
------- ------- -------
Expenses:
Cost of goods sold........................................ 14,389 18,494 19,296
Store and other operating expenses........................ 4,779 6,080 8,231
Depreciation and amortization............................. 978 1,152 1,811
General and administrative expenses....................... 2,825 5,458 4,079
Provision for store closures.............................. -- 580 --
Acquisition and integration expenses -- -- 437
------- ------- -------
Total expenses....................................... 22,971 31,764 33,854
------- ------- -------
Income (loss) from operations............................... 1,986 (1,185) 1,197
Interest income............................................. 203 426 315
Interest expense............................................ -- -- (46)
------- ------- -------
Income (loss) before income taxes........................... 2,189 (759) 1,466
Provision for income taxes.................................. 965 4 728
------- ------- -------
Income (loss) before cumulative effect of change in
accounting principle...................................... 1,224 (763) 738
Cumulative effect of change in accounting principle, net of
income tax benefit of $262................................ -- (427) --
------- ------- -------
Net income (loss)........................................... $ 1,224 $(1,190) $ 738
======= ======= =======
Net income (loss) per share -- basic and diluted:
Income (loss) before cumulative effect of change in
accounting principle................................... $ .16 $ (.10) $ .09
Cumulative effect of change in accounting principle....... -- (.06) --
------- ------- -------
Net income (loss)...................................... $ .16 $ (.16) $ .09
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE> 109
COFFEE PEOPLE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THIRTY-NINE WEEKS ENDED JUNE 29, 1996 AND
YEARS ENDED JUNE 28, 1997 AND JUNE 27, 1998
<TABLE>
<CAPTION>
COMMON STOCK STOCK
--------------------- SUBSCRIPTION
EQUIVALENT NOTES ACCUMULATED
SHARES AMOUNT RECEIVABLE DEFICIT TOTAL
---------- ------- ------------ ----------- -------
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Issuance of common stock......................... 7,460,679 $35,825 $ -- $ -- $35,825
Net income....................................... -- -- -- 1,224 1,224
Dividends........................................ -- -- -- (1,562) (1,562)
---------- ------- ----- ------- -------
Balance, June 29, 1996........................... 7,460,679 35,825 -- (338) 35,487
Net loss......................................... -- -- -- (1,190) (1,190)
---------- ------- ----- ------- -------
Balance, June 28, 1997........................... 7,460,679 35,825 -- (1,528) 34,297
Gloria Jean's, Inc. reverse merger, net of stock
issuance costs................................. 3,274,111 11,398 (313) -- 11,085
CP Old, Inc. merger.............................. -- 2,498 -- -- 2,498
Stock redemption from Second Cup, Inc............ -- (5,116) -- -- (5,116)
Exercise of stock options........................ 11,250 25 (25) -- --
Net income....................................... -- -- -- 738 738
---------- ------- ----- ------- -------
Balance, June 27, 1998........................... 10,746,040 $44,630 $(338) $ (790) $43,502
========== ======= ===== ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-29
<PAGE> 110
COFFEE PEOPLE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
THIRTY-NINE WEEKS ENDED JUNE 29, 1996 AND
YEARS ENDED JUNE 28, 1997 AND JUNE 27, 1998
<TABLE>
<CAPTION>
FOR THE FOR THE FISCAL
39-WEEK YEAR ENDED
PERIOD ENDED --------------------
JUNE 29, JUNE 28, JUNE 27,
1996 1997 1998
------------ -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $ 1,224 $(1,190) $ 738
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization......................... 978 1,152 1,811
Provision for store closures -- 580 --
Deferred income taxes................................. 965 (414) 702
Write down of assets held for disposal................ -- 887 223
Loss (gain) on disposal of assets..................... (8) (65) 147
Write off of uncollectible income taxes receivable.... -- 127 --
Changes in assets and liabilities, net of amounts
acquired:
Accounts receivable................................ 1,588 423 (861)
Receivable from/due to affiliate................... -- (285) 1,269
Inventories........................................ 236 438 48
Prepaid expenses and other assets.................. 273 (14) 126
Income taxes receivable............................ (23) 190 --
Accounts payable................................... (999) 493 (1,077)
Accrued liabilities................................ (482) 615 (1,617)
Accrual for store closures......................... -- -- (584)
Income taxes payable............................... -- -- 26
Franchisee deposits................................ (208) (138) (27)
Deferred franchise fee income...................... -- (129) 56
Deferred rent expense.............................. (50) 35 (98)
-------- ------- -------
3,494 2,705 882
-------- ------- -------
Cash flows from investing activities:
Purchase of property, plant and equipment................. (1,179) (2,919) (2,260)
Proceeds from disposal of property, plant and equipment 145 369 221
Acquisition of business................................... (29,597) -- --
Loans to an affiliated company............................ (3,800) 3,800 --
Cash acquired in Gloria Jean's, Inc. reverse merger, net
of transaction expenses................................. -- -- 1,258
Cash received in CP Old, Inc. merger...................... -- -- 226
-------- ------- -------
(34,431) 1,250 (555)
-------- ------- -------
Cash flows from financing activities:
Proceeds on issuance of shares............................ $ 35,825 $ -- $ --
Dividends paid............................................ -- (1,562) --
Stock redemption from Second Cup, Inc..................... -- -- (4,675)
Payments on long-term debt................................ -- -- (111)
-------- ------- -------
35,825 (1,562) (4,786)
-------- ------- -------
Increase (decrease) in cash and cash equivalents............ 4,888 2,393 (4,459)
Cash and cash equivalents, beginning of period.............. -- 4,888 7,281
-------- ------- -------
Cash and cash equivalents, end of period.................... $ 4,888 $ 7,281 $ 2,822
======== ======= =======
Supplemental cash flow information:
Cash paid for income taxes................................ $ 23 $ -- $ --
Noncash transactions:.....................................
Dividend declared....................................... $ 1,562 $ -- $ --
Accrual for stock redemption from Second Cup, Inc....... $ -- $ -- $ 441
Disposal of property, plant and equipment in exchange
for note receivable................................... $ -- $ -- $ 109
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-30
<PAGE> 111
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
1. ORGANIZATION, OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND OPERATIONS
Coffee People, Inc. (Coffee People), formerly Gloria Jean's Inc. (Gloria
Jean's), an Oregon Corporation, is a retailer of gourmet coffee, with 246
franchised and 69 company-owned retail stores operating in 36 states and 6
foreign countries under the names of Gloria Jean's, Coffee People and Coffee
Plantation. The retail stores offer a full range of coffee beverages, coffee
beans, teas and food, as well as a variety of related gifts, supplies, equipment
and accessories.
On May 19, 1998, the Company issued 7,460,679 shares of its common stock to
Second Cup, Inc. (Second Cup), in exchange for 100% of the outstanding common
stock of Gloria Jean's, a wholly-owned subsidiary of Second Cup. After the
merger, Second Cup owned 69.5% of the outstanding common stock of the combined
company. The merger has been accounted for as a reverse merger in which Gloria
Jean's is the accounting acquirer.
Prior to the Gloria Jean's reverse merger, Gloria Jean's was merged with CP
Old, Inc., a wholly-owned subsidiary of Second Cup, and the combined company
continued as Gloria Jean's. At the time of the CP Old, Inc. merger, CP Old, Inc.
had no operations.
On October 16, 1995, the Company acquired all of the issued and outstanding
shares of stock of Edglo Enterprises (Edglo) and its wholly-owned subsidiary
companies, and certain other assets.
The consolidated financial statements include the accounts of Coffee People
and its wholly-owned subsidiaries (the Company). All significant intercompany
accounts and transactions have been eliminated in consolidation.
Under its franchise agreements, the Company develops and constructs a new
store, provides training, and assists in the grand opening and merchandising for
which it receives an initial franchise fee. Ongoing charges to franchisees
include a royalty fee of 6% of gross sales and an advertising fund contribution
of up to 3% of gross sales. Franchisees are required to purchase all of their
coffee from the Company, which is roasted in the Company's facility in
California, except for those franchisees who commenced operations prior to July
1993. These latter franchisees are required to purchase approximately 85% of
their coffee requirements from the Company.
FISCAL YEAR END
The Company's fiscal year is a fifty-two or fifty-three week period ending
on the last Saturday in June. Fiscal 1998 and 1997 each consisted of fifty-two
weeks.
FINANCIAL STATEMENT PRESENTATION
Certain reclassifications of prior period amounts have been made to conform
with the June 27, 1998 presentation.
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.
F-31
<PAGE> 112
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash and cash equivalents,
accounts receivable, accounts payable and debt instruments. At June 27, 1998 and
June 28, 1997, the fair value of the Company's receivables, accounts payable,
and debt under loans approximated the carrying value.
CONCENTRATION OF CREDIT
Accounts receivable primarily consist of amounts related to royalties and
sales of whole beans and related products to franchisees. The Company extends
credit to the majority of its franchisees. Credit losses are provided for in the
financial statements based upon the Company's previous experience and
management's expectations.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid instruments with a maturity of
three months or less at the time of purchase to be cash equivalents. The
concentration of credit risk associated with cash and cash equivalents is low
due to the credit quality of the financial institutions and the liquidity of
these financial instruments.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or
market. Certain of the Company's inventories are subject to price fluctuations.
Cost includes materials, labor and manufacturing overhead.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation of property,
plant and equipment is provided using the straight-line method over the
estimated useful lives of the assets ranging from three to seven years for
equipment, furniture and fixtures, and twenty-five years for buildings.
Leasehold improvements are capitalized and amortized on a straight-line basis
over the shorter of the initial lease term or the estimated useful lives of the
assets, generally ten years. Maintenance and repairs are charged to expense as
incurred.
GOODWILL
Amortization of goodwill is provided using the straight-line method over 40
years. Accumulated amortization as of June 27, 1998 and June 28, 1997 was $1,276
and $801, respectively. Amortization expense for the fiscal years ended June 27,
1998 and June 28, 1997, and the 39-week period ended June 29, 1996 was $475,
$455 and $348, respectively.
The Second Cup Ltd., the largest specialty coffee retailer in Canada, has
been in operation since 1975. At the time of the acquisition of Gloria Jean's in
September 1995, the transaction was considered as a platform for the Second Cup
Ltd. to expand their well established operations into the United States. Since
specialty coffee's place in the North American marketplace has been established
over an extensive period and is not considered to be restricted by any existing
regulatory, contractual or market factors, management determined 40 years to be
an appropriate useful life over which to amortize the goodwill.
IMPAIRMENT OF LONG-LIVED ASSETS
Effective as of the beginning of fiscal 1997, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" (SFAS 121), on a prospective basis. SFAS 121 requires the Company to review
long-lived assets and certain identifiable intangibles, including goodwill, for
impairment
F-32
<PAGE> 113
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. The assessment of impairment is based on the
estimated undiscounted future cash flows from operating activities compared with
the carrying value of the assets. If the undiscounted future cash flows of an
asset are less than the carrying value, a write-down would be recorded, measured
by the amount of the difference between the carrying value of the asset and the
fair value of the asset. Management believes there has been no decline in the
carrying value of long-lived assets, including goodwill.
Assets to be disposed of are recorded at the lower of carrying amount or
fair value less cost to sell (Note 5). Such assets are not depreciated while
held for sale.
FRANCHISE OPERATIONS
Initial franchise fees for stores are deferred and recognized as income
when the store has opened. Franchise revenue consists of royalties and franchise
fees. Such amounts totaled $5,395 and $640, respectively, for the fiscal year
ended June 27, 1998, $5,368 and $501, respectively, for the fiscal year ended
June 28, 1997, and $4,242 and $729, respectively, for the 39-week period ended
June 29, 1996. Costs directly associated with franchise operations, excluding
cost of sales, were $1,745, $1,930 and $1,048, respectively, for the fiscal
years ended June 27, 1998 and June 28, 1997, and the 39-week period ended June
29, 1996. Cost of sales related to franchise operations was $14,020, $13,516 and
$11,551, respectively, for the fiscal years ended June 27, 1998 and June 28,
1997, and the 39-week period ended June 29, 1996.
DEFERRED RENT EXPENSE
Certain of the Company's lease agreements provide for scheduled rent
increases during the term of the lease. Rent is expensed on a straight-line
basis over the initial lease term.
STORE OPENING COSTS
Costs incurred in connection with start-up and promotion of new stores are
expensed as incurred.
ADVERTISING
Advertising costs are expensed as incurred. For the fiscal years ended June
27, 1998 and June 28, 1997, and the 39-week period ended June 29, 1996,
advertising costs were $325, $341 and $156, respectively.
INCOME TAXES
The Company accounts for income taxes using the liability method. Under
this method, deferred income taxes are provided for the temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities. A valuation allowance is provided against deferred tax assets
to the extent that it is more likely than not that the asset will not be
realized.
The Company's results of operations were included in Second Cup's
consolidated federal and state income tax returns until the Gloria Jean's
reverse merger on May 19, 1998 (Note 2). For financial reporting purposes,
Second Cup allocated income taxes to the Company as though it were a separate
taxpayer.
Accounting for stock-based compensationThe Company measures compensation cost
for employee stock options and similar equity instruments using the intrinsic
value-based method of accounting.
EARNINGS PER SHARE
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (SFAS 128) as of the beginning of the
second quarter of fiscal 1998. SFAS 128
F-33
<PAGE> 114
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
required the Company to replace its traditional earnings per share (EPS)
disclosures with a dual presentation of basic and diluted EPS and to restate all
prior EPS data presented. During the fiscal years ended June 27, 1998 and June
28, 1997, and the 39-week period ended June 29, 1996, basic and diluted EPS are
the same. The number of shares used in the EPS calculation were 7,812,491,
7,460,679 and 7,460,679, respectively, for the fiscal years ended June 27, 1998
and June 28, 1997, and the 39-week period ended June 29, 1996. Historical EPS
prior to the Gloria Jean's merger has been retroactively restated to reflect the
equivalent number of shares received in the reverse merger (Note 2).
2. MERGERS AND ACQUISITIONS
GLORIA JEAN'S REVERSE MERGER
On May 19, 1998, Coffee People, Inc. (Old Coffee People) issued 7,460,679
shares of common stock having a value of $11,398, net of stock issuance costs of
$1,330, to Second Cup in exchange for 100% of the outstanding common stock of
Gloria Jean's. The merger has been accounted for as a reverse merger in which
Gloria Jean's is the accounting acquirer. The historical records of Gloria
Jean's became the historical records of the company, and the purchase method of
accounting was applied to the Old Coffee People assets acquired and liabilities
assumed to the extent of Second Cup's 69.5% ownership interest. The results of
operations of Old Coffee People have been included with those of Gloria Jean's
beginning May 19, 1998. Historical stockholders' equity and EPS prior to the
merger have been retroactively restated for the equivalent number of shares
received in the merger after giving effect to the difference in par value of
Gloria Jean's common stock ($1 par value) and Old Coffee People's common stock
(no par value). Pursuant to the merger agreement, Gloria Jean's redeemed a
portion of its current outstanding common stock from Second Cup prior to the
merger. The stock was redeemed for an amount which left not less than $2,500 in
cash and cash equivalents in the accounts of Gloria Jean's after payment of
expenses incurred related to the merger. The stock redemption totaled $5,116.
Old Coffee People sells coffee beverages, coffee beans, cookies, pastries,
ice cream, shakes and coffee-related merchandise at company-owned retail stores
located principally in Oregon and Arizona. The following is the allocation of
the purchase price to the net assets acquired at fair value:
<TABLE>
<S> <C>
Issuance of common stock, net of stock issuance costs....... $11,398
Transaction costs........................................... 838
-------
Total purchase price...................................... 12,236
-------
Net assets acquired....................................... 2,003
-------
Cost in excess of net assets acquired....................... $10,233
=======
</TABLE>
The following unaudited pro forma information is presented to show the
results of operations had the acquisition occurred June 29, 1996:
<TABLE>
<CAPTION>
FOR THE FISCAL YEAR
ENDED
--------------------
JUNE 28, JUNE 27,
1997 1998
-------- --------
<S> <C> <C>
Total revenues.............................................. $52,190 $56,147
Income before cumulative effect of change in accounting
principle................................................. (7,747) 520
Net income (loss)........................................... (8,174) 520
Earnings (loss) per share -- basic and diluted.............. $ (.76) $ .05
</TABLE>
The above results of operations are not intended to be indicative of the
results of operations which actually would have been realized had the
acquisition occurred as of June 29, 1996, nor of the future results of
operations of the combined company.
F-34
<PAGE> 115
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
The Company has developed a plan to consolidate certain corporate functions
and to restructure Old Coffee People's operations. Such plan includes relocating
certain Old Coffee People corporate employees to the Company's Castroville,
California headquarters, terminating corporate employees with duplicative
functions, consolidating the roasting of coffee in the Company's Castroville
roasting facility and franchising Old Coffee People's retail stores. Management
anticipates that the relocation and termination of employees will be completed
by November 1998 and a majority of the retail stores will be franchised by the
end of 1999. As of June 27, 1998, the Company accrued $548 related to these
activities. These costs have been capitalized and recorded as an increase in
goodwill to the extent of Second Cup's 69.5% ownership interest. The remaining
costs were charged to expense and are included in acquisition and integration
expenses.
CP OLD, INC. MERGER
In May 1998, Gloria Jean's was merged with CP Old, Inc., a wholly-owned
subsidiary of Second Cup, and the combined company continued as Gloria Jean's.
At the time of the merger, CP Old, Inc. had no operations. Upon closing of the
merger, the assets and liabilities of CP Old, Inc. were transferred at their
historical carrying values with a corresponding increase in stockholders'
equity. Such assets and liabilities consisted of the following:
<TABLE>
<S> <C>
Cash........................................................ $ 226
Deferred tax assets......................................... 2,272
------
Net assets................................................ $2,498
======
</TABLE>
EDGLO ACQUISITION
On October 16, 1995, the Company acquired Edglo. The effective date of the
acquisition was designated as September 30, 1995 for convenience purposes. The
acquisition has been accounted for using the purchase method of accounting. The
following is the allocation to the net assets acquired at fair value of the
purchase price paid of $29,597 (including acquisition costs of $350):
<TABLE>
<S> <C>
Current assets.............................................. $10,723
Capital assets.............................................. 4,972
Other assets................................................ 68
Goodwill.................................................... 18,609
-------
34,372
-------
Current liabilities......................................... 4,460
Other liabilities........................................... 315
-------
4,775
-------
Net assets acquired......................................... $29,597
=======
</TABLE>
During the fiscal year ended June 27, 1998, the Company received $642
(included as a reduction in general and administrative expenses) from the former
owners of Edglo pursuant to an escrow agreement. This amount represents a
reimbursement for certain expenses incurred by Gloria Jean's as a result of the
Edglo acquisition. Such expenses were included in general and administrative
expenses in years prior to fiscal 1998.
F-35
<PAGE> 116
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
3. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 28, JUNE 27,
1997 1998
-------- --------
<S> <C> <C>
Coffee
Unroasted............................................... $1,175 $2,169
Roasted................................................. 840 368
Other merchandise held for sale........................... 490 898
Supplies.................................................. 1,058 617
------ ------
$3,563 $4,052
====== ======
</TABLE>
During the fiscal year ended June 28, 1997, inventory writedowns resulting
from excess inventory totaled approximately $600.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 28, JUNE 27,
1997 1998
-------- --------
<S> <C> <C>
Land..................................................... $ -- $ 786
Building................................................. -- 745
Manufacturing equipment.................................. 2,460 2,580
Leasehold improvements................................... 3,893 6,954
Furniture, fixtures and other............................ 2,044 4,572
------- -------
8,397 15,637
Less: Accumulated depreciation........................... (1,095) (2,071)
Less: Write down of assets held for disposal............. (887) (855)
------- -------
$ 6,415 $12,711
======= =======
</TABLE>
Included above in manufacturing equipment and leasehold improvements are
assets under construction of $89 at June 27, 1998 and $539 at June 28, 1997.
5. ASSETS HELD FOR SALE AND PROVISION FOR STORE CLOSURE COSTS
Effective as of the beginning of fiscal 1997, the Company adopted the
provisions of SFAS 121. The initial application of SFAS 121 to long-lived assets
held for disposal at June 30, 1996 resulted in a non-cash charge of $427 (net of
tax benefit of $262) which represents the adjustment required to remeasure such
assets at the lower of carrying amount or fair value less cost to sell.
Long-lived assets held for disposal consist of leasehold improvements and
furniture, fixtures and other property at the Company's corporate-owned stores
which management plans to sell to franchisees.
During fiscal 1998 and 1997, the Company recorded additional charges of
$223 and $198 (included in general and administrative expenses), respectively,
to remeasure long-lived assets at corporate-owned stores which management plans
to sell to franchisees or close, at the lower of carrying amount or fair value
less cost to sell. As of June 27, 1998, all of the Gloria Jean's corporate-owned
stores are held for sale to franchises. Assets held for sale at June 27, 1998
and June 28, 1997 had adjusted carrying values of $2,895 and $1,560,
respectively. Revenues and operating income (losses) for these stores totaled
$9,030 and $(1,204), respectively, for the fiscal year ended June 27, 1998,
$7,051 and $(368), respectively, for the fiscal year ended June 28, 1997, and
$5,592 and $176, respectively, for the 39-week period ended June 29,
F-36
<PAGE> 117
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
1996. During the fiscal year ended June 27, 1998, the Company sold eight
corporate-owned stores. The Company is negotiating with a third-party equipment
leasing company for a sale-leaseback of substantially all of the Gloria Jean's
corporate-owned store assets. Management believes the selling price for these
store assets will approximate their carrying value at June 27, 1998. While the
corporate-owned stores are being actively marketed for sale, the Company expects
the period of sale may exceed one year for some of the stores.
As of June 28, 1997, the Company determined that it was not feasible to
sell eight of the corporate-owned stores held for disposal and recorded a
provision of $580 for store closure costs consisting primarily of lease
termination costs. The Company incurred costs of $530 for store closures during
fiscal 1998 and charged this amount against the accrual for store closures.
As of June 27, 1998, the accrual for store closures consists of closure
costs at the Old Coffee People corporate-owned stores which were closed as of
the Gloria Jean's reverse merger date. The accrual of $1,291 consists primarily
of lease termination costs. The Company is working with local real estate
brokers to market, re-lease or sublease all of these stores.
6. DEBT
The Company assumed debt in connection with the Gloria Jean's reverse
merger. Such debt consists of the following at June 27, 1998:
<TABLE>
<S> <C>
Note payable to bank, payable in monthly installments of $6
each, plus interest at 9.0%, commencing September 1, 1995,
due August 1, 1998........................................ $ 12
Note payable to bank, payable in monthly installments of
$100 each, plus interest at two different interest rates
(8.0% at June 27, 1998), commencing June 1, 1997, due May
1, 2002................................................... 4,700
Note payable to stockholder (also a director), payable in
monthly installments of $3, including interest at 2.0%
over the prime rate (10.50% at June 27, 1998), due
December 1, 2002.......................................... 149
Note payable to the Port of Portland, payable in monthly
installments of $5, commencing April 8, 1995, including
interest at 12.0%, due March 8, 2003...................... 216
-------
5,077
Less-current portion........................................ (1,279)
-------
$ 3,798
=======
</TABLE>
The Company has a line of credit agreement with a bank in the amount of
$500 expiring August 1999. The interest rate for amounts drawn under the line is
0.5% over the prime rate. There is no amount outstanding under the line of
credit at June 27, 1998. Of the $500 line, a total of $73 is reserved for use
under a letter of credit dated September 1998.
The Company has a revolving line of credit agreement with Second Cup
Limited in the amount of $4,000 expiring May 2003. The interest rate for amounts
drawn under the line is 11.5%. There is no amount outstanding under the line of
credit at June 27, 1998.
The bank notes and line of credit are secured by substantially all of Old
Coffee People's assets, including accounts receivable, inventories, trade
fixtures and equipment. These debt agreements contain restrictions relating to
specified financial ratios as well as the lender's standard covenants and
restrictions. As of June 27, 1998, the Company was in compliance with all debt
covenants.
The stockholder note is secured by substantially all of the Company's
assets and is subordinated to the bank notes.
F-37
<PAGE> 118
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
The principal payments on long-term debt are as follows at June 27, 1998:
<TABLE>
<S> <C>
1999........................................................ $1,279
2000........................................................ 1,268
2001........................................................ 1,271
2002........................................................ 1,179
2003........................................................ 80
------
$5,077
======
</TABLE>
7. INCOME TAXES
The Company's provision (benefit) for income taxes consists of the
following:
<TABLE>
<CAPTION>
FOR THE FISCAL
FOR THE YEAR ENDED
39-WEEK --------------------
PERIOD ENDED JUNE 28, JUNE 27,
JUNE 29, 1996 1997 1998
------------- -------- --------
<S> <C> <C> <C>
Current provision
Federal............................................ $ -- $ 135 $ 26
State.............................................. -- 21 --
---- ----- ----
-- 156 26
---- ----- ----
Deferred provision (benefit)
Federal............................................ 863 (371) 628
State.............................................. 102 (43) 74
---- ----- ----
965 (414) 702
---- ----- ----
$965 $(258) $728
==== ===== ====
</TABLE>
The Company's provision (benefit) for income taxes is included in the
financial statements as follows:
<TABLE>
<CAPTION>
FOR THE FISCAL
FOR THE YEAR ENDED
39-WEEK --------------------
PERIOD ENDED JUNE 28, JUNE 27,
JUNE 29, 1996 1997 1998
------------- -------- --------
<S> <C> <C> <C>
Continuing operations................................ $965 $ 4 $728
Cumulative effect of change in accounting
principle.......................................... -- (262) --
---- ----- ----
$965 $(258) $728
==== ===== ====
</TABLE>
The cumulative effect of change in accounting principle of $427 is net of
an income tax benefit of $262, comprised of federal and state income taxes.
The reconciliation of the statutory federal income tax rate to the
Company's effective income tax rate is as follows:
<TABLE>
<CAPTION>
FOR THE FOR THE FISCAL
39-WEEK PERIOD YEAR ENDED
ENDED --------------------
JUNE 29, JUNE 28, JUNE 27,
1996 1997 1998
-------------- -------- --------
<S> <C> <C> <C>
Federal statutory rate.............................. 34.0% (34.0)% 34.0%
State income taxes, net of federal benefit.......... 4.0 (4.0) 4.0
Amortization of nondeductible goodwill.............. 6.0 22.8 12.0
Write-off of uncollectible income taxes
receivable........................................ -- 16.7 --
Other............................................... 0.1 (1.5) (0.3)
---- ----- ----
44.1% 0.0% 49.7%
==== ===== ====
</TABLE>
F-38
<PAGE> 119
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
The components of the Company's net deferred tax assets and liabilities
consist of the following:
<TABLE>
<CAPTION>
JUNE 28, JUNE 27,
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets
Allowance for doubtful accounts........................... $ 628 $ 588
Net operating loss carryforwards (NOLs)................... 1,281 3,913
Asset write downs, store closures and relocation
provisions............................................. 635 1,748
Basis difference in property, plant and equipment......... -- 155
Employee benefits......................................... -- 151
Other..................................................... 48 199
------ ------
2,592 6,754
Valuation allowance......................................... -- (699)
------ ------
Net deferred tax assets..................................... 2,592 6,055
Deferred tax liability
Basis difference in property, plant and equipment......... (117) --
------ ------
Net deferred tax assets..................................... $2,475 $6,055
====== ======
</TABLE>
During the fiscal year ended June 28, 1997, the Company reversed a $1,619
valuation allowance related to NOLs acquired from Edglo. The non-cash adjustment
to the valuation allowance was recorded as a reduction in goodwill.
In connection with the Gloria Jean's reverse merger (Note 2), the Company
recorded a deferred tax asset of $2,010, net of a valuation allowance of $699.
This amount was recorded as a reduction to goodwill arising from the Gloria
Jean's reverse merger. The valuation allowance of $699 relates to NOLs of Old
Coffee People which, due to limitations on utilization of the NOLs, management
believes are not more likely than not realizable. To the extent these NOLs are
utilized, goodwill will be reduced.
In connection with the CP Old, Inc. merger, the Company recorded a deferred
tax asset of $2,272 related to CP Old, Inc. NOLs which management believes will
more likely than not be realized. The effect of recording this deferred tax
asset was an increase in stockholders' equity (common stock).
Based on internal forecasts and industry trends, management believes it is
more likely than not the deferred tax assets of $6,055 at June 27, 1998 will be
realized through future taxable income.
The Company has federal NOLs of approximately $10,298 which expire as
follows:
<TABLE>
<S> <C>
2010....................................................... $ 3,938
2011....................................................... 3,056
2012....................................................... 2,986
2013....................................................... 318
-------
$10,298
=======
</TABLE>
Approximately $1,840 of these NOLs are available to offset Old Coffee
People's future taxable income. Pursuant to Internal Revenue Code Section 382
(Section 382), utilization of these NOLs is limited to $700 per year.
Approximately $6,620 of these NOLs are available to offset Gloria Jean's future
taxable income. Pursuant to Section 382, utilization of these NOLs is limited to
$568 per year. Utilization of all of the Company's NOLs may be further limited
in the event of a change in ownership of the Company.
F-39
<PAGE> 120
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
8. FRANCHISED AND COMPANY-OWNED STORES
The number of retail stores is as follows:
<TABLE>
<CAPTION>
COMPANY-
FRANCHISED OWNED
STORES STORES
---------- --------
<S> <C> <C>
Beginning of period, June 28, 1997.......................... 236 31
Opened/acquired............................................. 14 51
Franchised.................................................. 8 (8)
Closed...................................................... (12) (5)
--- --
End of period, June 27, 1998................................ 246 69
=== ==
</TABLE>
9. MINIMUM LEASE COMMITMENTS AND CONTINGENT LIABILITIES
The Company leases certain retail store, office and warehouse facilities
under operating leases expiring through 2008. The Company is the lessee in most
of the franchisees' lease agreements. The Company has sublease agreements with
individual franchisees, whereby the franchisee assumes responsibility for and
makes lease payments directly to the landlord. The Company also has sublease
agreements for certain company-owned stores and office facilities whereby the
sublease tenants are responsible for the lease payments. Rental expense is
reported net of sublease income in accordance with retail industry practice.
Most lease agreements contain renewal options at varying terms and rent
escalation clauses. Certain leases provide for contingent rentals based upon
gross sales.
Rental expense under lease agreements for the fiscal year ended June 27,
1998 and June 28, 1997, and the 39-week period ended June 29, 1996 was $2,159,
$1,700 and $1,540, respectively, net of sublease income.
Minimum future lease commitments as of June 27, 1998 are as follows:
<TABLE>
<CAPTION>
GROSS NET
MINIMUM LESS MINIMUM
LEASE SUBLEASE LEASE
COMMITMENTS RENTALS COMMITMENTS
----------- -------- -----------
<S> <C> <C> <C>
1999............................................. $11,853 $ 8,000 $ 3,853
2000............................................. 11,281 7,589 3,692
2001............................................. 10,033 6,708 3,325
2002............................................. 8,470 5,596 2,874
2003............................................. 7,158 4,490 2,668
Thereafter....................................... 15,720 8,438 7,282
------- ------- -------
$64,515 $40,821 $23,694
======= ======= =======
</TABLE>
As of June 28, 1997, the Company accrued $420 (included in accrued
liabilities) related to its obligation to repurchase a franchised store if the
franchised store did not meet certain financial targets. When this franchised
store was repurchased, the Company intended to close it. The amount accrued
consisted primarily of the estimated repurchase price and lease termination
costs. Costs incurred to repurchase and close the franchised store were $373 as
of June 27, 1998. During the fiscal year ended June 27, 1998, the Company was
reimbursed for such costs pursuant to an escrow agreement with the former owners
of Gloria Jean's (Note 2).
As of June 27, 1998, the Company has approximately $4,200 of outstanding
purchase commitments related to green coffee.
F-40
<PAGE> 121
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
The Company has an agreement with a supplier to purchase substantially all
of the coffee requirements for its Oregon stores through January 1999.
As a requirement under a lease with the Port of Portland, the Company is
committed to enter into a joint venture with a third party for one of the
Company's stores at Portland International Airport. Once the agreement is
finalized, the Company will have a 49% ownership interest in that store.
The Company is subject to litigation in the ordinary course of business. In
the opinion of management, the ultimate outcome of existing litigation would not
have a material adverse effect on the Company's financial condition, results of
operations or cash flows.
10. STOCK SUBSCRIPTION NOTES RECEIVABLE
The Company has stock subscription notes receivable which were issued
primarily by Old Coffee People to certain officers and employees upon the
exercise of incentive stock options. The notes bear interest at the rate of 8.5%
per annum from the date of exercise and are due from December 1998 through May
2003. The notes provide that in the event any of the common stock is sold before
the notes mature, all accrued interest and a pro rata portion of the principal
balance must be paid.
11. INCENTIVE PLANS
STOCK OPTION PLANS
At the time of the Gloria Jean's reverse merger, Old Coffee People had four
stock option plans -- the 1993 Stock Option Plan, the 1994 Stock Option Plan,
the 1995 Stock Option Plan and the 1996 Stock Option Plan. These stock option
plans continued in effect subsequent to the Gloria Jean's reverse merger.
Optionholders as of the merger date were given the opportunity to reprice their
existing stock options at a price equal to the fair market value of the stock on
the date the repricing was approved by the Board of Directors. Optionholders
choosing to reprice their stock options cancelled their option shares and
received a reduced number of new option shares on the repricing date. No options
were repriced as of June 27, 1998. On August 1, 1998, seven optionholders
elected to reprice their stock options. As a result, 302,000 old option shares
with a weighted average price per share of $9.21 were surrendered and 77,850 new
option shares were issued at an exercise price of $3.20 per share. The exercise
price exceeded the fair market value on the grant date.
Effective May 19, 1998, the Company adopted the 1998 Stock Option Plan.
Under all five stock option plans, key employees and consultants may be granted
either incentive or nonqualified stock options. Incentive stock options must
comply with the requirements of the Internal Revenue Code, may be granted only
to employees and may be granted at not less than the fair market value of the
stock at the date of grant. Nonqualified options may be granted to employees and
consultants at not less than 85% of the fair market value of the stock at the
date of grant. Cancelled options are available for future grant. The number of
options granted, the option price, the term of the option and the vesting period
are determined by the Board of Directors.
F-41
<PAGE> 122
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
Stock option activity under the aforementioned stock options plans was as
follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF PRICE PER
SHARES SHARE
--------- ---------
<S> <C> <C>
Outstanding at Gloria Jean's reverse merger date............ 342,439 $8.57
Granted..................................................... 248,000 3.20
Exercised................................................... (11,250) 2.22
------- -----
Outstanding at June 27, 1998.............................. 579,189 $6.39
======= =====
</TABLE>
For all five plans, there were 1,005,953 shares of unissued common stock
reserved for issuance at June 27, 1998. Options to purchase 188,565 shares with
a weighted average exercise price of $8.84 were exercisable at June 27, 1998.
Options outstanding and exercisable, and related weighted average life
information by grant price as of June 27, 1998 were as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
OPTION OPTIONS OPTIONS REMAINING LIFE
PRICE OUTSTANDING EXERCISABLE (YEARS)
- ------ ----------- ----------- ----------------
<S> <C> <C> <C>
$ 2.22 13,689 13,689 5
3.20 248,000 -- 10
4.75 5,000 1,000 9
5.56 2,000 400 9
6.50 30,000 6,000 9
6.94 16,500 3,300 9
8.00 21,000 18,376 6
9.00 63,000 37,800 8
10.00 150,000 90,000 7
10.00 30,000 18,000 8
------- -------
579,189 188,565
======= =======
</TABLE>
No compensation cost has been recognized for the 1998 Stock Option Plan. If
compensation cost for this plan had been determined based on the fair value at
the grant date, the Company's net income and net income per share for the fiscal
year ended June 27, 1998 would be as follows:
<TABLE>
<S> <C>
Net income.................................................. $696
Net income per share -- basic and diluted................... $.09
</TABLE>
The Company used the Black-Scholes option pricing model to estimate the
fair value of options granted during the fiscal year ended June 27, 1998 (no
options were granted during the fiscal year ended June 28, 1997 or the 39-week
period ended June 29, 1996). The weighted average assumptions used to compute
compensation cost in the above pro forma and to estimate the weighted average
fair market value of options granted are as follows:
<TABLE>
<S> <C>
Risk-free interest rate..................................... 5.5%
Dividend yield.............................................. 0%
Volatility.................................................. 70%
Expected term (years)....................................... 5
Weighted average fair market value.......................... $1.94
</TABLE>
F-42
<PAGE> 123
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
EMPLOYEE STOCK PURCHASE PLAN
At the time of the Gloria Jean's reverse merger, Old Coffee People had an
Employee Stock Purchase Plan (the ESPP) under which 150,000 shares of common
stock have been reserved for issuance to and purchase by employees of Old Coffee
People. The ESPP continued after the reverse merger. All Old Coffee People
employees with over four months of service who work more than 20 hours per week
and who do not own stock and stock options for more than 5% of the Company's
stock are eligible to participate in the ESPP. The ESPP is intended to qualify
as an "employee stock purchase plan" under Section 423 of the Internal Revenue
Code. No shares were purchased under the ESPP during the fiscal year ended June
27, 1998.
12. RETIREMENT PLANS
Effective March 1, 1997, the Company adopted a tax deferred savings plan
(the 401(k) Plan). Substantially all employees with over one year of service are
eligible to participate in the 401(k) Plan. Participants who choose to
participate may contribute up to 15% of their pretax compensation to the 401(k)
Plan subject to the statutorily prescribed annual limits. All contributions to
the 401(k) Plan are fully vested and nonforfeitable at all times. The Company
does not match employee contributions.
Old Coffee People has a tax deferred savings plan (Old Coffee People 401(k)
Plan) which covers all employees of Old Coffee People with over six months of
service and who work an average of at least 30 hours per week. Participants may
contribute up to 20% of their pretax compensation to the Old Coffee People
401(k) Plan subject to the statutorily prescribed annual limits. All
contributions to the Old Coffee People 401(k) Plan, including company
contributions, are fully vested and nonforfeitable at all times. Company
contributions were immaterial during the fiscal year ended June 27, 1998.
13. RELATED PARTY TRANSACTIONS
During the period ended June 29, 1996, the Company issued 1,200 shares of
its common stock to Second Cup for cash of $35,825.
In February 1996, the Company commenced roasting coffee for CP Old, Inc.
The Company initially charged CP Old, Inc. a roasting fee and subsequently
sold roasted coffee to CP Old, Inc. For the fiscal year ended June 28, 1997 and
the 39-week period ended June 29, 1996, total sales to the affiliated company
were $823 and $56, respectively (none in fiscal 1998).
The Company had demand loans to an affiliated company which bore interest
at 8.25% per annum. The loans were repaid during fiscal 1997. Interest received
was $280 for the fiscal year ended June 28, 1997 and $66 for the 39-week period
ended June 29, 1996.
During the fiscal year ended June 27, 1998, The Second Cup Ltd. incurred
costs on the Company's behalf. Such amounts are included in payable to related
party.
As of June 27, 1998, the Company had a lease with a stockholder who is a
director of the Company. Rental expense associated with this lease was
approximately $10,000 during the fiscal year ended June 27, 1998.
14. CASH HELD IN TRUST
The Company holds cash in trust on behalf of franchisees, which includes
the advertising fund and the construction trust account. The cash held in trust
amounted to $795 at June 27, 1998. These funds have not been included in the
Company's balance sheet.
F-43
<PAGE> 124
COFFEE PEOPLE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 29, 1996, JUNE 28, 1997 AND JUNE 27, 1998
(IN THOUSANDS)
15. UNAUDITED QUARTERLY DATA
<TABLE>
<CAPTION>
PER SHARE -- BASIC
AND DILUTED
-----------------------------
INCOME (LOSS) INCOME (LOSS)
BEFORE BEFORE
CUMULATIVE CUMULATIVE
INCOME (LOSS) EFFECT OF CHANGE EFFECT OF CHANGE
FROM IN ACCOUNTING NET INCOME IN ACCOUNTING NET INCOME
REVENUES OPERATIONS PRINCIPLE (LOSS) PRINCIPLE (LOSS)
-------- ------------- ---------------- ---------- ---------------- ----------
<S> <C> <C> <C> <C> <C> <C>
FISCAL 1998:
1st Quarter.................. $ 7,940 $ 784 $ 492 $ 492 $ .07 $ .07
2nd Quarter.................. 10,115 1,796 1,057 1,057 .14 .14
3rd Quarter.................. 7,394 730 456 456 .06 .06
4th Quarter.................. 9,602 (2,113) (1,267) (1,267) (.15) (.15)
------- ------- ------- -------
$35,051 $ 1,197 $ 738 $ 738 $ .09 $ .09
======= ======= ======= =======
FISCAL 1997:
1st Quarter.................. $ 5,493 $ (740) $ (629) $(1,056) $(.08) $(.14)
2nd Quarter.................. 11,230 1,947 2,041 2,041 .27 .27
3rd Quarter.................. 6,607 (438) (308) (308) (.04) (.04)
4th Quarter.................. 7,249 (1,954) (1,867) (1,867) (.25) (.25)
------- ------- ------- -------
$30,579 $(1,185) $ (763) $(1,190) $(.10) $(.16)
======= ======= ======= =======
</TABLE>
F-44
<PAGE> 125
COFFEE PEOPLE, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
JUNE 27, 1998 AND MARCH 6, 1999
<TABLE>
<CAPTION>
JUNE 27, MARCH 6,
1998 1999
--------- -----------
(AUDITED)
(IN THOUSANDS
EXCEPT SHARE AMOUNTS)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 2,822 $ 2,773
Accounts receivable, net.................................. 3,262 3,149
Inventories............................................... 4,052 3,722
Prepaid expenses and other assets......................... 713 926
Deferred income taxes..................................... 2,621 2,427
------- -------
Total current assets.............................. 13,470 12,997
Property, plant and equipment, net.......................... 12,711 12,262
Goodwill, net............................................... 25,967 25,530
Other assets................................................ 113 114
Deferred income taxes....................................... 3,434 3,385
------- -------
Total assets...................................... $55,695 $54,288
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......................... $ 1,279 $ 1,237
Current portion of capital lease obligations.............. -- 119
Accounts payable.......................................... 1,421 1,795
Payable to related party.................................. 984 --
Accrued liabilities....................................... 2,572 1,827
Provision for store closures.............................. 1,291 1,102
Franchisee deposits....................................... 459 538
Deferred franchise fee income............................. 187 94
------- -------
Total current liabilities......................... 8,193 6,712
Long-term debt.............................................. 3,798 2,727
Capital lease obligations................................... -- 784
Deferred rent expense....................................... 202 146
Stockholders' equity
Preferred stock, no par value; authorized 10,000,000 shares
none issued or outstanding................................ -- --
Common stock, no par value; authorized 50,000,000 shares
issued and outstanding, 10,762,757 and 10,746,040......... 44,630 44,659
Stock subscription notes receivable......................... (338) (350)
Accumulated deficit......................................... (790) (390)
------- -------
Total stockholders' equity........................ 43,502 43,919
------- -------
Total liabilities and stockholders' equity........ $55,695 $54,288
======= =======
</TABLE>
F-45
<PAGE> 126
COFFEE PEOPLE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
PERIODS ENDED MARCH 7, 1998 AND MARCH 6, 1999
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED THIRTY-SIX WEEKS ENDED
------------------------- -------------------------
MARCH 7, MARCH 6, MARCH 7, MARCH 6,
1998 1999 1998 1999
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues:
Franchise revenue................................ $ 1,589 $ 1,689 $ 4,584 $ 4,756
Corporate store sales............................ 2,759 7,566 6,891 22,429
Wholesale revenue................................ 3,047 3,484 14,020 12,944
------- ------- ------- -------
Total revenues........................... 7,395 12,739 25,495 40,129
Expenses:
Cost of goods sold............................... 3,704 5,560 13,210 18,384
Store and other operating expenses............... 1,982 5,007 5,735 15,605
Depreciation and amortization.................... 377 345 1,109 1,152
General and administrative expenses.............. 602 842 2,131 3,052
Acquisition and integration expenses............. -- 151 -- 950
------- ------- ------- -------
Total expenses........................... 6,665 11,905 22,185 39,143
Operating income................................... 730 834 3,310 986
------- ------- ------- -------
Interest and other income.......................... 69 36 207 92
Interest expense................................... -- 143 -- 368
------- ------- ------- -------
Income before income taxes......................... 799 727 3,517 710
Provision for income taxes......................... 343 319 1,512 310
------- ------- ------- -------
Net income......................................... $ 456 $ 408 $ 2,005 $ 400
======= ======= ======= =======
Net income per share -- basic and diluted.......... $ 0.06 $ 0.04 $ 0.27 $ 0.04
======= ======= ======= =======
Weighted average common shares -- basic............ 7,461 10,761 7,461 10,775
Weighted average common and common equivalent
shares outstanding -- diluted.................... 7,461 10,776 7,461 10,771
</TABLE>
F-46
<PAGE> 127
COFFEE PEOPLE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIODS ENDED MARCH 7, 1998 AND MARCH 6, 1999
<TABLE>
<CAPTION>
THIRTY-SIX WEEKS ENDED
-------------------------
MARCH 7, MARCH 6,
1998 1999
----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 2,005 $ 400
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 1,109 1,152
Provision for uncollectible accounts................... -- 190
Deferred income taxes.................................. 880 243
Interest income on stock subscription notes
receivable............................................ -- (12)
Change in assets and liabilities, net of amounts
acquired:
Accounts receivable.................................. (88) (77)
Receivable from/due to related party................. 312 (984)
Inventories.......................................... (503) 330
Prepaid expenses and other assets.................... 221 (214)
Accounts payable..................................... (247) 374
Accrued liabilities.................................. (603) (745)
Accrual for store closures........................... (264) (189)
Franchisee deposits.................................. 76 79
Deferred franchise fee income........................ (28) (93)
Deferred rent expense................................ 5 (56)
------- -------
2,875 398
------- -------
Cash flows from investing activities:
Purchase of property, plant and equipment................. (1,400) (752)
Proceeds from disposal of property, plant and equipment... 98 511
Additions to goodwill..................................... -- (25)
------- -------
(1,302) (266)
------- -------
Cash flows from financing activities:
Proceeds on issuance of shares............................ -- 29
Borrowings under capital lease obligation................. -- 922
Borrowings under long-term debt........................... -- 1,412
Payment on capital lease obligation....................... -- (19)
Payment on long-term debt................................. -- (2,525)
------- -------
-- (181)
------- -------
Decrease in cash and cash equivalents....................... 1,573 (49)
Cash and cash equivalents, beginning of period.............. 7,281 2,822
------- -------
Cash and cash equivalents, end of period.................... 8,854 2,773
======= =======
Supplemental cash flow information
Interest.................................................. -- 297
Cash paid for income taxes................................ -- 26
</TABLE>
F-47
<PAGE> 128
COFFEE PEOPLE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 6, 1999
(IN THOUSANDS)
NOTE 1. FINANCIAL STATEMENT PRESENTATION
The interim financial data is unaudited; however, in the opinion of
management, the interim data includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of the results for the
interim periods. The financial statements included herein have been prepared by
the Company pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures included herein
are adequate to make the information presented not misleading. The operating
results for interim periods are not necessarily indicative of results to be
expected for an entire year. The aforementioned statements should be read in
conjunction with the consolidated financial statements for the fiscal year ended
June 27, 1998, appearing in the Company's Annual Report on Form 10-K.
Certain reclassifications of prior period amounts have been made to conform
with the March 6, 1999 presentation.
NOTE 2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 27, MARCH 6,
1998 1999
-------- -----------
(UNAUDITED)
<S> <C> <C>
Coffee:
Unroasted............................................. $2,169 $1,429
Roasted............................................... 368 289
Other merchandise held for sale......................... 898 703
Supplies................................................ 617 1,301
------ ------
$4,052 $3,722
====== ======
</TABLE>
NOTE 3. FRANCHISING STRATEGY
On September 1, 1998, the Company announced that it was adopting a
franchising strategy in which it would offer existing Coffee People (Oregon) and
Coffee Plantation stores for sale to franchisees as well as offering new
franchise opportunities for these brands. As a result of the proposed and
pending merger with Diedrich Coffee, Inc., the Company has deferred execution of
this strategy. (See Note 5)
As a result of the decision to hold all existing Coffee People (Oregon) and
Coffee Plantation stores for sale, depreciation on these stores was suspended
effective September 1, 1998. In addition, as of March 6, 1999, the Coffee People
(Oregon) and Coffee Plantation store assets are stated at the lower of carrying
value or fair market value less cost to sell.
NOTE 4. SALE-LEASEBACK TRANSACTION
On November 24, 1998, the Company entered into a sale-leaseback transaction
involving equipment at twelve company-operated Gloria Jean's retail stores. The
$922,000 proceeds received by the Company from the lease transaction were used
for general corporate purposes and working capital. The interest rate on the
capital lease obligation is 10.5%. The capital lease assets are recorded in
property, plant and equipment. At the end of the lease term, the Company has an
option to purchase the equipment for the greater of fair market value or 10% of
the lessor's original cost, or renew the lease for an additional eight months.
F-48
<PAGE> 129
COFFEE PEOPLE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 6, 1999
(IN THOUSANDS)
NOTE 5. DIEDRICH COFFEE, INC. MERGER
On March 16, 1999, Coffee People, Inc. entered into an Agreement and Plan
of Merger with Diedrich Coffee, Inc. (NASDAQ:DDRX). Pursuant to the merger
agreement, Coffee People has agreed to merge with a subsidiary of Diedrich
Coffee. After the merger is effective Coffee People will be a wholly owned
subsidiary of Diedrich Coffee. Under the terms of the merger agreement, Coffee
People shareholders will receive $17.75 million in cash, 1,500,000 shares of
Diedrich Coffee common stock, and an additional $5.25 million in cash or a
combination of cash and stock based on the net proceeds of a public equity
offering planned by Diedrich Coffee prior to the completion of the merger.
Closing of the merger is subject to a number of conditions, including completion
of the public equity offering by Diedrich Coffee upon certain specified terms,
receipt of regulatory approvals and approval by the shareholders of Coffee
People and Diedrich Coffee. If these conditions are met, the transaction is
expected to close during the summer of 1999.
F-49
<PAGE> 130
PAGE ONE OF INSERT
[Photographs of various Diedrich Coffee estate coffee labels]
PAGE TWO AND THREE OF INSERT
<TABLE>
<CAPTION>
CHARACTERISTICS:
-----------------------------------------------------------
ORIGIN/BLEND: REGION: ROAST: AROMA BODY ACIDITY TASTE FINISH
------------- --------- ------ ------- --------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Mexico............... Americas Light floral medium delicate nutty sweet
Costa Rica........... Americas Light citrusy medium crisp butterscotch clean
Java*................ Indonesia Light berry mellow perky winy smooth
Guatemala,
Antigua*........... Americas Light spicy medium bright smokey resonant
Columbia*............ Americas Medium sweet light clean caramel soft
Huehuetenango........ Americas Medium herbal full snappy chocolate clean
Zimbabwe............. Africa Medium nutty dense crisp spicy sweet
Yemen Mocca Java..... Blend Medium spicy syrupy light fruity creamy
Sulawesi............. Indonesia Medium winy full soft rich mellow
Ethiopia............. Africa Full jasmine medium bright tea-like smooth
Yemen Mocca.......... Africa Full pungent syrupy snappy wild-nutty lingering
Sumatra*............. Indonesia Full musty thick lively pleasantly buttery
earthy
Kenya................ Africa Full berry rich crisp black currant bold
Nepenthe............. Blend Full fruity saturated lively vanilla round
sweetness
Apanas............... Blend Full perfumy full brisk chocolate resonant
Morning Blend........ Blend Full floral hearty vivacious vanilla creamy
Bantu Blend.......... Blend Full spicy velvety winy chocolate sweet
nutty
Expresso*............ Blend Dark pungent heavy snappy nutty sharp
Wiener Melange*...... Blend Dark floral deep crisp vanilla-nutty well
balanced
French Roast*........ Blend Dark toasty syrupy crisp molasses pleasant
</TABLE>
- ---------------
* Also Available in Decaf.
<PAGE> 131
INSIDE BACK COVER
[Photograph of Diedrich Coffee Internet web page]
[Photograph of various Diedrich Coffee Guatemalan estate coffee products]
[Photograph of Diedrich Coffee coffeehouse interior]
[Photograph of Gloria Jean's coffee beverage]
[Photograph of Diedrich Coffee coffeehouse interior]
[Photograph of Gloria Jean's mall coffee store interior]
BACK COVER
Diedrich Coffee logo centered over a map of Southeast Asia and Australia.
<PAGE> 132
LOGO
